Smithfield Foods Inc (SFD) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Smithfield Foods' second-quarter conference call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for questions; instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded and a replay will be available after 1230 PM today through midnight, Wednesday, December 7. You may access the AT&T Executive Playback service at any time by dialing 1-800-475-6701 and entering the access code 804620.

I would now like to turn the conference over to our host, Jerry Hostetter. Please go ahead, sir.

Good morning. Welcome to a conference call to discuss Smithfield Foods' fiscal year 2006 second-quarter results. We'd 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 2005.

With us today are Dan Stevens, Chief Financial Officer, Richard Poulson, Executive Vice President and Senior Advisor 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?

Thank you, Jerry.

I am pleased this morning to report a good second fiscal quarter for Smithfield Foods. If you read our press release this morning, we are reporting net income of $51.6 million or $0.46 per share, compared with 58.4 million in the second quarter of last year or $0.52 a share. On a year-to-date basis for the first six months, it's 100.6 million or $0.90 a share, compared with 113.3, $1.01 per share.

Both second quarters this year and last year include special charges which you need to be aware of. In this year's second quarter, we have $0.09 related to restructuring charges, compared with $0.05 in last year's second quarter, so on a comparative basis, you should be comparing $0.55 versus $0.57 and the same additions (ph) apply to the first six months' numbers.

If you remember, in our first-quarter call, we made reference to the fact that we were anticipating a restructuring charge during our second quarter. I think we indicated that would be in the 8 to $10 million on a pre-tax basis. The actual restructuring charge that we've recorded for the quarter is $16.3 million. That represents the costs associated with closing one of our slaughter operations in Smithfield, Virginia. I will talk about that when I get little further into the operations. That came in at $8 million, right in the range of where we had indicated.

In addition to that, as we've gone into the quarter, we are continuing to look at our operations and we made a decision that we just announced yesterday to close a plant that we've got, our Valleydale plant in Salem, Virginia. We made the decision to cease production operations over a period of time in that operation and relocate those operations into our other plants. We recorded an additional charge and so the total for the quarter is at 16.3 million.

On an overall basis, we are satisfied with this quarter. In fact, we're pleased with this quarter. We did have very strong earnings last year for the first, second, third and fourth quarters, so we are up against very strong comparables from the record year last year, and we're tracking very close to last year's numbers.

Hog production continues to be an important part of the earnings (indiscernible) the second quarter. As well, we had good contributions in the fresh meat side of the business, and our processed meats business is solid on both of those fronts. I would not tell you that we are satisfied with the level on the fresh pork or the processed meats and they're not where they should be but they are satisfactory at this point.

Going to the other business, the business segments, beef is not performing -- not profitable at this point. You know the industry conditions. I am satisfied that we're managing this both from a cattle-production standpoint and from a beef-processing operating standpoint as well as possible. Our losses there are very, very modest, given the adverse conditions in the industry. I think if those conditions change and there's rumors everywhere about the Japanese market, but I have no more information to give you than anyone also does. But when that happens, I think, to the extent it shows up on the cattle side, we've got cattle exposure that we will see the benefit there and as it impacts the processing operations favorably, we will be prepared to take advantage of that benefit of that almost immediately.

In the fresh meat side, I want to talk about that for a minute in terms of the restructuring. We've been looking at our fresh meat operations in the East for some time and evaluating the fact that we have not been able to get to full capacity, given that we had three slaughter plants, two in Virginia and our large plant in North Carolina. Given the moratorium that existed -- that exists in North Carolina and what we call the de facto moratorium in the state of Virginia, we simply have not been able to get up to capacity levels that make these plants run like they should. We've been running short hours, particularly in Virginia. We made the decision this quarter to cease operations in one of the Virginia plants, our Smithfield Packing Company plant, and to move a substantial part of that slaughter level to maximize out our Gwaltney plant and our North Carolina Tar Heels plant that has never been operating at full capacity because we simply didn't have the livestock.

We looked across the future, realizing that we're not going to be in a position to put in any more farms, not in a position to really grow the live production volume, so we need to make the decision to control our costs and to manage this business and maximize the fresh meat side of the business. We made that decision, and those operations stopped at the end of October. I think we will see an immediate benefit on the fresh meat side of the business of having made that decision. The impact there is to cut back about -- to reduce the number of total slaughter hogs -- about 500,000 across our system, which would take us from about 27% to 26 or 26.5%. So that's the impact of that from a total business standpoint.

On the processed meats side of the business, our business is up 2% on a total basis, which is not a giant number. But other things are happening within those numbers that give me a lot of comfort. And the parts of the business that are the most profitable for us are the parts that are growing very nicely, and we are seeing trade-offs. As an example, our bone-in ham business is down but our spiral ham business is up very, very nicely. If you noticed in the press release, we indicated the parts of the business that we thought were seeing these double-digit growth business. Our bone-in ham business is down 12% but our spiral ham business is up 20%, and that's certainly a value-added product proposition that does very, very nicely for us. We see our fresh sausage business down some, but our precooked sausage is up 11%. That's the kind trade-off we want. As well, we see our precooked bacon business continuing to grow very nicely, up 20% year-over-year; it's been up 20% year-over-year for several years now running. That's the kind of trades want to go, from raw bacon to precooked bacon.

In the precooked ribs business, which is the deli business and the ribs that you see in some of the retail outlets, that's taking raw ribs and cooking those -- that volume is up 52%. Those are very, very nice changes in mix, plus organic growth by itself. That gives me a lot of comfort in terms of our processed meats business and where we are and where we're going.

As well, you probably read in the press release -- you read that our case-ready business on the price side is up more than 40% quarter-to-quarter. We've gotten some new business there; that's been business that's been -- we've been working. We have not had so much talk about case-ready for some time but some of that business has now hit and that is impacting us as we speak in the quarter.

As we look and talk about this operation that we made the decision in Salem, Virginia, we made a decision internally that this company has been built on low-cost production, so we're looking very, very fiercely inside what I call inside the four walls of how we run our operation. We're paying off an awful lot of attention these days to how we manlize (ph) and how we lay out lines. We've got some very specialized consultants in here helping us to maximize the efficiencies running down our lines. We've got a new process in place called strategic sourcing; I was just last night with our purchasing -- all of our purchasing executives, where we are developing and implementing strategies to maximize our purchasing power and to rationalize SKUs and to rationalize the products that we buy from our vendors to maximize the P&L opportunity for both our vendors and ourselves to put us as a low-cost producer going forward.

Energy costs and fuel costs are a bigger part of this business; they are impacting everybody. We're paying attention to distances; we're paying attention to the logistics of the organization. We made the decision, in terms of the Salem plant, that it was out of the distribution system; it is too far out to take raw material and too far to come back with finished goods. So we made -- and as well, we had some capital costs from a food safety standpoint -- (technical difficulty) -- so we made the decision to shutter those operations and move them closer and move them to capacity -- (technical difficulty) -- already have in place. I think that's going to pay us dividends.

We've announced that we've got a $350 million capital expenditure plan in place. Dan Stevens will talk in a minute about where we stand on our depreciation charges, which are up. But that's part of our strategy to change the operational -- (technical difficulty) -- these plants. We're putting in equipment that can take people off the lines, that can improve our yields, that can improve our throughput in these plants. I am committed to doing that. We've got the earnings power to do that; we've got to cash flows to do that. We are committed to making ourselves a low-cost producer so we can be competitive in the traditional categories and especially competitive in these new, value added categories that are growing very, very nicely. We've indicated that we've got five precooked baking bacon lines coming online in the third quarter; they will be in place by the end of January. We have 13 in place today; we will have 18 in place by the end of January. I wish I could sit on this call and tell you all five lines are sold out. I won't make that statement to you, but I will tell you that a substantial part of those lines are already committed. That business is very strong, gives us some for growth in there. Don't be surprised if I'm talking to you in another conference call about the fact we will order more precooked bacon lines. That's a part of the business, very good for us, very good for our customers. We are committed to being the best and the cheapest or the most competitive in that end of the business, and we're making the capital investments to do that.

We've made precooked sausage capital expenditures that just came online this quarter. We've made -- we've got precooked -- our precooked rib business -- we've made capital expenditures there. We've got another capital expenditure ongoing as we speak. We are executing in the Midwest our operations to renovate two of our major Midwest plants to make them highly efficient and to put in technology that maximizes throughput and minimizes labor cost. That's (indiscernible) calendar year 2006. As well, we've got some people looking at our operations in terms of manning layouts that are going to start benefiting us in really early 2006.

One final note that I'm not sure whether many of you know this -- we have recently received approval for two of our plants to ship into Western Europe. They have been EU approved. There is only one other plant today, which is a Swiss plant, that (indiscernible) is eligible to ship product into Western Europe. We've gotten our target on North Carolina plant and our Crete, Nebraska plant's certified to ship product into Western Europe. That represents an opportunity for us to once again access a market that many in the industry, including ourselves, have not had access to to ship fresh product out of the United States into Western Europe and access those markets. As the markets give us the opportunity from a pricing standpoint, we will be executing against that strategy.

So, I think the future is bright. I will talk about that a minute, but I will turn it over to Dan for a second to talk about the other financial information I know you are interested in.

Okay, thanks, Larry. Good morning, everyone.

I'm just going to cover quickly some of the key financial highlights for the quarter.

Let's take a look at our income statement. Our sales were 2.9 billion in the quarter, up from some 2.7 billion in the second quarter of last year. Over half of that increase is due to a one-time sell-out of the cattle from the cattle-feeding operations that we acquired from ConAgra last year. Going forward, those sales, for the most part, are going to be recognized by Five Rivers cattle feeding, our joint venture with ContiBeef. Most of the rest of the increase in sales is due to acquisitions that we did last year in Europe, in Poland and Romania.

In the pork segment, sales were down slightly on lower volumes and pricing. In the hog production segment, sales were off of course because of lower average hog prices.

Our selling, general and administrative expenses increased about $18 million in the quarter compared to last year. That increase reflects three things. One, we had the impact of the acquisitions in our international segment; and secondly, we had some higher advertising and promotion expenses, primarily in our pork segment; and last, we had some foreign currency gains in last year's second quarter that we didn't have in this year's second quarter.

Our interest expense is up about $5 million in the quarter compared to last year's second quarter. This reflects both an increase in short-term variable rates as well as an overall increase in our average borrowings compared to last year's second quarter.

Our earnings before interest, taxes, depreciation and amortization and including an impairment charge related to the plant shutdowns that Larry just mentioned, was just over $180 million for the quarter, compared to 168 million in last year's second quarter. On a trailing 12-month basis, EBITDA was over 800 million compared to 660 million for the trailing 12 months last year.

Cash flow from operations was just over $60 million for the first half of the year, compared to a use of cash of 76 million last year. Obviously, both periods reflect very strong earnings for the first half of each year, as well as our normal seasonal investment in working capital that we have this time of year.

I think what's different this year is the cash generated from the sell-out of the cattle inventory that I mentioned before.

Finally, as Larry mentioned, GAAP earnings per share were $0.46 in the quarter compared to $0.52 last year. If you adjust for the charges in both periods, earnings per share were $0.55 compared to $0.57 last year second quarter. Year-to-date reported earnings per share are $0.90 versus $1.01, but again, adjusting for the charges here $0.99 versus $1.06 last year.

Let's take a look at our balance sheet. Our capital expenditures for the quarter were right at $90 million, compared to depreciation expense of 56, and for the year, we spent about 158 million in capital expenditures, well ahead of our depreciation expense of just over 100 million.

I think that probably a lot of you have seen, on our Web site, copies of our most recent investor presentation. In it, we outlined a number of capital projects and processed meat capacity expansion projects that Larry referred to that total some $350 million. The spending on these projects will keep our capital expenditures higher than our depreciation expense for the next 12 to 18 months. Most of these projects relate to, as Larry mentioned, precooked bacon, ribs, sausage capacity, as well as deli and lunch meats. All of these projects we anticipate should have very good returns and very quick paybacks.

When you see our balance sheet for October, you'll see that our borrowing levels increased about $176 million during the year. As you know, our second quarter is typically our peak borrowing period because of the increase in our working capital requirements heading into the holiday season. But we've also had some other cash uses during the year, including the remaining funding of the cash portion of our contribution to the Five Rivers cattle-feeding joint venture. We've also had, as I mentioned, capital expenditures in excess of depreciation of some $60 million for the year.

In addition, as we talked last quarter, we did repurchase 230,000 shares of the Company's common stock in the first quarter, and we also made open-market purchases of Company stock of about 1.5 million shares that was then contributed to the Company's pension fund.

Our debt-to-total capitalization stayed right around 56%, which is slightly higher than where it was at year-end but right about where we were at this time last year.

Finally, as you will recall, we closed on a new, $1 billion U.S. revolving credit facility last quarter, which gives us over $600 million of available borrowing capacity at the end of the quarter.

That's all I have, but obviously we can cover any financial questions that might have during the Q&A.

Thank you, Dan.

Looking forward, I know there continues to be concern about where the hog market is going to go and how long these livestock prices are continuing at the level that they have. We've certainly seen a nice run on the live side for quite some time now. There has continued to be discipline in that part of the industry. If you look forward at the futures, and that's my best indication, those look like they are going to be -- they are strong into February. I think February hogs are $50 and if you look towards the summer, they're more like $53.

Corn is -- corn has been relatively cheap. You know, we take positions periodically, so I feel comfortable that we've got our raising cost well under control. It has been declining. I think we reported in the quarter what our raising costs are. Given those two dynamics, I think we've got a situation where, for the remainder of the fiscal year, hog production profitability is going to be fine and really strong, even as we go into first quarter next year and into second quarter next year. Our live production profitability looks very good. I think that's going to be a good part of the business. It is contributing handsomely and it will continue to be an important part of the P&L.

We are -- as in the meat-processing side of the business, the second quarter did not end up quite as strong as we wished. August and September were quite good for us; October was weaker than we thought it would be. That's the nature of the business we are in. November is a very good -- is a good month for us. The holiday season is going to be very good for us. But we are against -- from a comparable standpoint, we had some very, very solid earnings third quarter last year; I think we reported $0.87 a share. So we've got a strong comparable in front of us for the third quarter, and really (indiscernible) numbers today look very, very good. We are comfortable that we're going to have solid, solid earnings in most parts of the business, absent beef, at this point.

We've said many times that it's impossible to predict quarter-to-quarter earnings for this company, given the dynamics of the fresh meat side of the business. I know you all want to know what next quarter is going to be and what fourth quarter is going to be. That is just -- as I said, October -- if you'd asked me at the end of August what I thought for the second quarter, I would have probably given you a better number, not realizing these numbers can change so rapidly. But they are very good today and we can only tell you where we are at, and we will manage the business as well as we possibly can, given the dynamics of the industry. But for the near-term, it looks solid, and I feel like we're making the right decisions, particularly on the processed meats side of the business, on a hog production side of the business. We've got that business well in hand. Our production group does as good a job as anybody does in this industry, and I say the same for the beef. We're making the investments on the processed meats side of the business to build the base of this business stronger and stronger and stronger. I am very comfortable those are good decisions we're making, and they are going to pay handsome dividends to us as these operational improvements and these CapEx get in place and start to really hit stride there. I think these things are going to be very powerful for us. So, that's how we see the next quarter and the rest of the year.

At this point, we will be glad to take any questions.

Jerry?

Operator, we will now open the floor to questions, please.

Thank you. (OPERATOR INSTRUCTIONS). David Nelson with Credit Suisse.

International was still a bit soft; I guess that could get better. Maybe that will be booked on your domestic market with the EU plant approvals. Could you comment on international, what's going on there, what you might see in the medium term, please?

Dave, this quarter, we were a bit disappointed on the international part; that's the operations side. There's two different -- I think you know that. On international side, there is the existing operations and then there's what I call the future, which is the Romanian connection.

We were disappointed. We've had severe pricing pressure in France that we have been wrestling with. I think we may have announced, in our last quarterly conference call -- I can't remember -- we did make a change in management in France. We thought we needed some new blood, and in fact, we've got a guy that was running Sara Lee's meat operations who is now running our French operations, a guy named Luc Van Gorp, and I'm impressed with Luc. He understands that market very, very well and I think he's making some immediate improvements.

I can't tell you that we are over, that we are passed any problems but it is turning around nicely.

As well, Poland -- Poland had a tough quarter. We had some livestock, some very high livestock prices in Poland which adversely impacted our fresh meat results. I don't think there's anything fundamental there at all, but we had some sharply higher prices there compared to Western Europe. We've had the strengthening (indiscernible), which impacted the ability for Poland to ship back into Western Europe and export. So that -- over the near-term, that was -- that hurt on the Polish front.

Romania, we continue to be very excited about what we think can happen there. It's a longer-term project, and today, it's a trading opportunity and we're putting in farms and we are processing a few hogs. (technical difficulty).

Does the permit process is going forward as hoped?

Yes, it is. In fact, we would like to tell the story. We've got more permits in place than we've got equipment to put on the ground, so that has taken some time. Again, that's not next week; we are anticipating today that, for those of you who don't know, we've got a plant that we've bought -- a processing plant (indiscernible) that we are in the process of getting ready to operate. It's a big plant. It is not operating today. We have a small plant that is operating, very small. But we are anticipating that to start operations the first of December of next year, and we are on track with that. We've already let some contracts and that plant is being renovated, the farms are already -- some of the farms are already in place and the hogs are coming. So, Romania has a plan and we are executing to plan. It's just a year away.

Okay. On beef, how much of the negative here was packing versus cattle-feeding?

Dan, have you got that number -- (multiple speakers)?

Yes. David, it's split about 50-50 -- (multiple speakers).

Thank you. Then, as we're coming into the holidays here, it's a key time for -- I don't have to -- selling processed -- selling hams, obviously. Larry, you commented on a good season but you had some strong comps a year ago. How would you match up your outlook for this year as for the holiday ham season?

Our holiday ham season, David, is going to be better than last year. I mean, that's the short answer. There's other parts. Hams don't carry the whole P&L, but our hams have been very good. It's going to be a good ham season for us.

Fantastic. Thank you very much.

John McMillan with Prudential Equity Group.

Good morning, gentlemen. Maybe we will get Joe involved here. Joe, in the year-ago quarter, while you didn't give specific guidance, you did talk about a third quarter a year ago that would be substantially or meaningfully better than your second quarter. Are you kind of prepared or do you think you can do that this year, to say that this next quarter, from what you can see now, has the potential to be better than the 55 operating you just reported?

Well, I will go into my familiar speech, John. Let's go back three months ago. Excuse me, yes, (indiscernible), which was July/August/September. Hold on one second. I've got cold medicine; my mind is clogged up. I've got a very severe cold; I don't know if you can tell that in my voice.

Bottom line, if you look at last year, August, September and October, and look at this year, as I said at the quarterly meeting last quarter, three months ago, that the quarter looked very, very strong. Well, it was strong, as Larry mentioned, except when we got to the last month of the quarter, which was October; it was a very, very weak month compared to October last year. Now, starting off this next quarter, November looks very, very good. We don't have the earnings for the month of November at this point, but it does look very good compared to November of last year, which was a strong month last year. So, bottom line, if I had to guess, I would guess that the third quarter is going to be as good as the third quarter last year.

Wow.

Now, I think we will do -- we won't make as much money in the hog production side, but I think we will make more money on the hog-processing side, also in processed meats. (multiple speakers) -- at same time, I'm just not and I've refused for 30 years now, John, and I'm not going to change; I'm just not going to predict quarter-to-quarter earnings because the people that play that game get embarrassed over and over and over again -- talking about my competitors and other people that want to step forward and make predictions.

This is -- we don't make decisions and we don't get too concerned about quarter-to-quarter earnings. What happens in one particular quarter is not the beginning of a trend. This is a business that has lots of ups and downs and a lot of variables that affect our earnings, but I will repeat it. If you look at our earnings over the last 30 years, it's one straight line upwards but you can't look at it quarter-to-quarter. That's an old story but I keep repeating it because I'm -- people continue to try to put pressure upon me to predict next quarter's earnings and I've just refused to play that game.

Well, I just do it -- in a year-ago number -- a year-ago quarter, you did kind of break your rule by predicting essentially better numbers and I guess you are half-doing it now.

I think your question -- and I don't want to go back. I think your question was, do we believe that third quarter is going to be better than second quarter. Is that not the question you asked?

Yes.

Well, sure! The third quarter is going to be better than the second quarter, but is it going to be better than the third quarter of last year? If I had to guess today, I would say it would be somewhere equal. It might be up a little bit; it may be down a little bit. But in my opinion and all I've got is one month into the quarter and we know what our ham business looks like, and things look pretty good. We are making a lot less money on hog productions for the obvious reason that hog prices are down, but we are doing better in the other segments of the business, which always happens, as I've said many times, that these two different parts of our business are countercyclical, which should even out the earnings stream. That's exactly what's happened.

Before we became vertically integrated, we were happy to break even in the first quarter of the year, and we had very wide swings in earnings between the first quarter and the third quarter. But that has evened out quite a bit in the last few years, for the simple reason that we have adopted the vertical integration model. That will happen. If hog prices go down, there's a very, very strong likelihood that hog-processing profits will go up.

Just a couple of other questions -- it appears, in your press release where you're talking about no -- I mean, there's concern, Larry, that you bought corn too early. But I guess if you bought the corn too early, you'd have to mark those contracts to market at the end of the quarter, which you didn't do. So I know you don't want to give your exact, specific hedging but am I reading this correctly, that if you bought corn too early, you would have to mark it to market at the end of the quarter -- and you didn't do that?

No, John, that's not true. Our forward purchasing arrangements and our grain forward contracts are -- they qualify for hedge accounting.

John, I don't know if you understand what we're saying here. As we buy forward, we match those purchases with the point in time that the hogs take in the grain. So we're not marking. We do not mark those, contracts, they are not market-based contracts; they are hedge positions on future grain.

I want to address the bigger question there, John. I think the thought you guys -- so many people have is that if corn goes down, that immediately has an impact on our P&L. That is not the way it works; that's number one. Because we have long-term -- remember that we've got grain at that -- hogs (indiscernible) at the beginning of life and the hogs -- actually the sal is eating and the grain that we are eating at the end of the hog's life. So, you've got a long, nearly a year cycle in there. So all that has an impact.

Secondly, we were such a big buyer, we would have to take long-term positions and we're not necessarily spot-buying when the market drops. We're spot buying lots of corn at that price. We can't run the business that way. I think we've said that a couple of times. So we're never going to be in a position of hitting the bottom of the market on pricing. We are also never going to be exposed on the top side of this market. What we do is we manage raising costs and I want to be very clear with that, and I'm very comfortable, as we said in here. Our raising costs are $40, and those numbers have been trending down as grain has continued to trend down. Our raising costs trend down and they lag and are slower, but I'm comfortable, as we go into 2006, that our raising costs are going to be under $40 a hundredweight. We've got our positions. We don't give hedging positions. We manage our grain exposure.

But just another couple of quick questions, if I could? To the extent the Japan market opens and there's some age verification requirements, do you feel you're in a competitive advantage in that situation?

Ask the question one more time, John.

I'm sorry. It's just, as the Japan market opens, it's clear that they are going to put an age-verification on the cattle. Do you feel you're in a competitive or an advantaged situation?

Yes, I do, John. I think you knew the answer to that question. Yes, I do think that the fact that we control our own cattle, that we've got traceable programs and the fact that just the nature of the program we run, I think that the Japanese market opening -- we would have a competitive advantage there. I think it would be very good for us.

Joe, I don't know the answer to this question. Well, I guess I do. You've got to be looking at Sara Lee's European beef business. Can you comment at all, Joe, in terms of --?

No. Are we looking at it? The answer is yes, but along with an awful lot of other people, and -- but I really can't comment beyond that but obviously the business is for sale. I think it will be sold and there are a number of interested parties and we happen to be one of the parties.

As far as the avian flu in chicken, are you seeing any kind of -- I know you don't sit here in a pork business hoping for illness abroad to help you pork business, but I guess, as I sit here and see concern over eating chicken, I wonder whether it might help pork. Are you seeing any of that?

I don't think so at this point. The number of chickens that have been destroyed are still a very, very small number, percentage-wise, John. Obviously, if there were a severe outbreak and severe repercussions from that outbreak, it would help the other meat proteins, pork and beef. That's true. There's a lot of speculation, I think, in that regard, and I think it is a fact in what the futures markets are saying. You know, corn has gotten very, very cheap, but I think it's probably overblown, as most of these things tend to be over a longer period of time.

Let me do say one thing, John, though. If the Japanese market opens up -- this is just my opinion -- it will, in my opinion, it will affect the price of cattle more than it's going to effect the increased profitability of processing those cattle for the simple reason the cattle are still very, very (indiscernible) in this country and no one is running their plants at full capacity. Until that happens, I think that, even if the Japanese market does open up, I think it's going to result just in higher cattle prices, which will help our feedlot operations. But in my opinion, it's not going to have a major positive impact upon the processing. That won't occur for another couple of years, in my judgment, until the cattle numbers build back up.

Christine McCracken with FTN Midwest Research.

I'm looking at the export numbers, and clearly that has been an important part of the demand story over the past year. Can you talk about what you are seeing today, particularly this current quarter, given the fact that you have a fairly even comparison, given the fact there's no gate into Japan?

Christine, when you mean this quarter, do you mean the quarter -- the third quarter or are you talking about back in the second quarter? I'm not sure. I just don't want to answer the question incorrectly.

Well, you know, I guess, on a year-over-year basis, this fall, we've had obviously a better I guess trade situation going into Japan; that should continue, I assume, through March. So I guess, as it relates to last quarter and then going forward?

Well, that part of the business, the Japanese part of the business, has been good -- really been good for everybody. In fact, the export markets have been good for everybody. If you read our numbers, you'll see that we actually indicate, for the quarter, that we're down just a little bit, but that's because we've had such strong, strong numbers that, from our standpoint, we look -- the other markets are not more important in Japan because Japan is a very important market and it's wide open and our business there is very good. But other markets, we've not had as good a success in the quarter. Some of that is a strategy. One place that the industry is seeing a lot of export opportunities into Mexico with ham (sic). We're not shipping into Mexico, and our Mexico exports are down but there's a very logical reason. We have a very large smoked ham business in the fall. We don't have hams to sell. At this point, we're keeping those hams for ourselves and turning them into spiral hands as opposed to selling them as fresh hams in the export market. So this time of year, we won't be strong in those ham opportunity markets. That's the nature of the business, and it's a benefit; it's not a detriment.

On the other side, we have not done as well this quarter in the markets that we have been very active in, in Eastern Europe. There's been pricing pressure over there; I indicated that a little earlier. The market pricing has simply not allowed us to be as competitive, just because of the difference in prices. Given freight -- consideration for storage and freight, our shipments into Romania have not been like they were. That's a near-term problem.

But fundamentally, I want to go back. I think the export markets are very good. Japan is very good. I think all of the exports, depending on where that dollar goes -- and a weak dollar helps everybody, at least in this part of the world. I think the export markets will be good for us, and I think it will be good for the industry.

Are those exports to Japan more profitable, given the current situation?

I guess I would tell you that they are profitable, how about that, Christine? (LAUGHTER).

Okay. Export markets now are absorbing about 13% of total production; it's become a very large number. It looks like, this past year, it has absorbed an incremental 3% of supply, which, on production growth of 1% or so, it seems like the U.S. market has been a little weaker. You know, is that a fair assumption and why would that be the case?

Well, you know, one of the things you had is you've got heavier weights out there, which puts more meat on the market, so you have to account for that in terms of the 1% that you are talking about, in terms of the number of hogs.

Then, you're asking, have the markets been -- the markets have been a little weaker for all of the cuts. You know where the meat cuts are; they are down year-over-year, most of them. But they were very, very, very high last year. So they are going to track live hog prices to some degree, and you could say live hog prices track meat prices.

There has been some modest weakening in the demand side, and that has impacted the commodity prices I think to some degree. But I do think we had price levels last year that simply were way out there. I mean, we had bellies at $1.10 and $1.20 out there, and those are prices that -- and we had loins way up there. They are prices that people -- you get consumer resistance. Some people have been afraid of that this year, and I don't know. I mean, there's always a discussion about what happened to fuel prices and whether that's impacted consumer spending. I don't know that we have -- I don't know that we have information strong enough to definitively say that has had an impact on the business. But that's sort of intuitive.

Sure. From your perspective though, do you see retailers or even foodservice operators coming back to pork, given the current price situation? Is this something that could help you as you move into the spring?

You know, I always want to say yes to that, Christine. (LAUGHTER). I'd love to answer -- (multiple speakers) - I'd love to answer that with a resounding yes, but there's a lot of protein out there and they have a lot of alternatives and chicken is not running away from us. I think I would tell you that it's steady and stable -- pork is -- but I wouldn't tell you that the people are flocking back to -- you know, we're not having a mad rush to pork. I would not tell you that.

A little poultry, ham (ph). In terms of the Triumph explosion, the Cargill destruction, this fire this past week, have those impacted your business at all?

Well, it certainly took the hog market down pretty quickly! (LAUGHTER). Well, I mean there's a third dynamic there as well, Christine -- Thanksgiving. The week of Thanksgiving, you've got one day down and most people make it up on Saturday. But this time of the year, we are routinely already running Saturdays. So you had that -- you had those three things that impacted on a short-term basis. I do think it's a very short-term basis. Hogs have been up the last two days. I think that was a one-week phenomenon. Triumph is coming up. I guess it's going to come up in January. Hog prices are moving right back up, and I expect all you've seen is just a very, very short-term blip.

And you've got some seasonal. I mean, you've got some weather issues going on and I don't know if you are aware how bad the weather has been in the Midwest this week, but it's been blizzards out there, so you can have what we call weather markets. You can't be -- a one-day, two-day, three-day thing can happen because of any one of -- one, two or three different factors can impact that. But I think, fundamentally, the hog market is already moving right back up.

Then one last question, just on the overcapacity situation you referenced in your comments. You guys are kind of doing your part to at least clean up the operations, consolidate a little bit. Do you expect others to start shutting capacity in any way? Is that something you anticipate coming?

Joe, you may have a better feel for that. I'm not hearing that, Christine. Mr. Luter, I don't know if you have any comment on that.

No, we're not seeing that. There's some increased capacity coming on, and if it's 8000 a day, that represents roughly 2% of the market. I think still the plants will be operating at -- if not at capacity, at near capacity, so I really don't see that one plant having that major of an impact. It will have an impact but I don't think it will be major, Christine. These things have a way of leveling out.

Thanks, I will leave it there. Thank you.

Farha Aslam with Stephens, Incorporated.

Hi, good morning. I'm just trying to get a feel for how strong pork is in the third quarter. In '04, you had margins of kind of 5.4% level, and then last year, it was down at about the 2.4% level. Just if you had to ballpark it, about where would you want to be for this next quarter?

As high as we can be! (LAUGHTER).

Can you get back up to that 5.4% level? Does that seem reasonable, the 5 -- let's say 5%-plus operating margins in pork?

I guess I would tell you, Farha, that the third quarter can be a very, very good quarter. It is a season of the year; it is the season of the year for processing. Hog prices are generally lower; demand is very strong; the holiday business is usually very strong. All of those drive very solid margins on the fresh meat side of the business and generally the processed meats as you sell those through the -- you do a ham season.

I guess I would tell you that there can be -- you certainly could duplicate 2004, and that wasn't, in my mind, some off-the-chart type of number. So fundamentally, I think we can be repetitive of those kind of numbers -- if that answers the question.

Somewhat. Then just kind of back to the beef business and the talk about Japan opening up and that causing cattle prices to increase, I'm hearing that it's actually going to cause breeder cattle prices to increase to the degree that feedlot operators still will be running a negative, despite Japan. Can you who just kind of give color on that situation?

Well, short-term, you will have increased profitability in the feedlots, because these are cads that you bought six, seven months ago. So, if it's long-term then obviously it will depend upon what the live cattle market is, you know, six, seven, eight months from now. As I mentioned earlier, it's no question in my mind that when Japan opens up, it's going effect the live market, both in feeder cattle and live cattle. To what degree, I'm not sure. (indiscernible) a lot will depend upon many factors. But, I do think it's going to be tough in the beef business for another couple of years.

I think the real -- if you're looking for sort of the bright spot (indiscernible) in the next couple of years is that, on the beef side of the business, I think we have the capability of having an operating profit of at least $100 million a year. Right now, we are losing a little bit of money, so there you've got a $100 million swing there. We are committing substantial resources in Eastern Europe, and there's no question in my mind that's going to be as good for us as the decision we made 10, 12, 13 years ago to put in poms (ph) in the United States. That's what has really enabled us to enjoy the success that we have enjoyed the last decade.

I see the same thing happening in Eastern Europe. I think we will have a strong competitive advantage in the domestic market in Eastern Europe. Keep in mind, Romania, which should be the breadbasket over Europe, imports its meat today from Western Europe and from the United States, so that's like Iowa importing pork because they don't have enough pork and we're going to have the only major plant over there for a considerable length of time. So, I think, going forward, the real bright stars are going to be, compared to what we're doing today, will be Eastern Europe and will be in the beef business. If we can just maintain our current levels in our other parts of the business, that's going to ensure some pretty positive numbers going forward. That's as I see it.

We are a company that has always invested for the long-term, not for the next quarter, not for the next six months but for the long-term. It has served us very, very well. There is a price to be paid because you put in big dollars in carrying interest costs and you are carrying startup costs and actually losing money on those operations for a period of time. But at the end of the day, they produce superior numbers. Let me give you one example. We've got around 65,000 sals in Utah. We lost money, three or four or five years in Utah. But now it's a very profitable part of that business. That's the kind of company we are. I'll just say one more time, we make decisions based on long-term results and that's why our numbers have been what they've been for the last 30 years.

Well, you've got a following out there, Joe. Just kind of one final question on the tax rate for this year -- (technical difficulty) -- kind of 33.2 to be the number for the rest of the year?

Yes, that's about right. We generally do it on an annualized basis, and we don't see anything on the tax side that is going to change that rate dramatically.

Great. Interest expense should come in at about 155 or so?

Yes. You can pretty well annualize what you've seen in the second quarter, yes.

Pablo Zuanic with JP Morgan Chase.

Good morning, everyone. I just want to get more color in terms of the economics on the -- for the processed meats business, and then I have a follow-up for Joe on the international side.

I'm looking here at pork cattle spreads that, for the third quarter, were about $7 per head. Last year, in the third quarter, they were negative $1.3 per head, if my numbers are right. But I'm looking at your pork processing margins, not factoring in the charges, going up only 2.1 to 2.4% year-on-year. So, although we want to give you credit for the further processed meat side of the business, and I think I understand conceptually what you're trying to do there, I am at a loss in terms of trying to quantify what's the benefit. I mean, it seems that the fresh side had a very good quarter year-on-year that's reflected in the margins, so that means that the further (ph) processed side had a bad quarter year-on-year. Can you expand on that, Larry, please?

Yes, I mean, I can't track your numbers because my numbers don't track your numbers.

What are your cattle spreads, for example? I mean, they were much better year-on-year, right?

Our cattle spreads were marginally better, year-on-year. One of the things that we've been struggling with, Pablo, that we made the comment -- we made the decision this year, because we've got the overhead cost associated with running three slaughter plants in the East, we've not seen any $8 a head improvement in our fresh meat results year-over-year, nothing even resembling that kind of -- those kinds of numbers. So I'm not sure. Maybe you and Dan Stevens can have a conversation off-line after this and figure out the rationale for your numbers. But no, we're not seeing -- we're not seeing something like those kinds of numbers. If we were, I mean, if you started doing the math, it would be -- I guess if I would say 27 million hogs, you'd be talking about 6.5 million hogs times $8; that would the $50 million and change in fresh meat results. I wish it were true.

But on that point, is anything different about your situation from the rest of the industry or would you say that your comment applies to the rest of your industry also?

I don't believe industry margins were up any $8 a head. I mean -- and I will tell you that our processed meats business did not have a bad quarter. So now with that being said, I'm going to tell you, I said at the outset that our processed meats margins were solid. They are not where they need to be and where they were, say, two years ago. We still got higher raw material costs, and we've got plant energy costs and transportation costs; we've not been able to fully recover those in terms of our selling prices. Those are impacting margins, but even given that, even given that, our processed meats margins are solid. We did not have a bad quarter on the processed meats side of the business.

Now, can you comment in terms of the total EBIT on the pork processing business? What percentage came from what you call further processed meats, just ballpark?

No, we don't. Because of the way we transfer meat back and forth off of the fresh meat to the processed meats side, Pablo, we feel it's misleading to you guys at this point to break out fresh versus processed because it can be a bit arbitrary in terms of the way we calculate it. Anything I would give to you, I would be concerned that you would take that as the gospel and in fact it's a way in which we go through our transfer process.

We make decisions based upon what our fresh meat opportunities are to go into processed meats, so we can change those transfer prices. So that impacts the margins on the processed meats side and I would rather not do that.

Okay, and just a follow-up -- when you say that you've seen what is a virtually integrated company and just (indiscernible), what does that mean in practical terms? Does that mean that if you're having a very good quarter on the hog production side, that you'll be aggressive in terms of pricing your bacon, and that other (indiscernible) that are not integrated could be squeezed? Is that what that is supposed to mean?

Well, it means that you can make a decision; you can make a decision to run your plants, on the processed meats side, on the processing side of the business when you traditionally would not make that decision -- and we have been making that decision. We have been running our plants on Saturday when sometimes the fresh meat results by themselves would dictate that you not do that because of the profitability on the hog production side of the business. We would make a decision to run the plants on Saturday, where if we didn't own hogs, I wouldn't run on Saturday because I lose money by running the plant, slaughtering on Saturday -- I make it up plus some by being able to use the hogs on the hog-production side of the business.

Thanks. Just a follow-up for Joe on the international side -- I'm just trying again trying to give the Company credit in terms of being (indiscernible) based on your international opportunity. But when I think about Poland and Romania, it seems that Poland, the growth there for you has been more stable there. You're definitely facing more competition. Long-term, should we think of Poland mostly as a small country (indiscernible) Romania should be a big contributor? I mean, if that's the case, what are the competitive threats there in the market? You've said in the past that you are pretty much the only one that is building up hog farms there. I assume that could change in the future, but you're definitely not just producing there to sell to Romania and Eastern Europe. I imagine the big market eventually, it's in Western Europe. At some point, I assume the Brazilians are going to be allowed to ship pork to Western Europe; maybe they are already. I assume they are just as cost-competitive. So I'm just wondering, Joe, if you can just comment in terms of what are the (indiscernible) you see to your Romanian venture over the next three, four years and if you can just put some numbers in terms of four or five years out, how big is that operation going to be, at least in terms of hogs?

Yes, okay. Well, we view -- we went into Poland first. Poland entered the EU several years ago. Romania will enter next year or the year after, one of the two. The bottom line is that you do have a lot of competition in Poland; it is close to Western Europe; it borders Germany, as you well know. Romania is a more distant place, but at the same time, grain is cheaper in Romania, but the big advantage in Romania is that the previous government there destroyed the entire pork industry in Romania. We've had to really rebuild it from scratch. So, we're putting in hogs just as fast -- or farms just as fast as we can. I'm very, very excited about the possibility simply because Romania is a pork or a meat-deficit country. Because of the distances involved and the cheap grain prices and the competitive labor rates, there's no question in my mind that Romania is going to be the brightest star at Smithfield Foods five years from today. We are investing significant sums on the hog-growing side. Plus, we really have the only major plant in Romania. We're spending money to upgrade that plant to be able to start operations there in about the year's time. Simply because we will have the product there in Romania going out two, three, four, five, six years from today with transportation costs being what they are and probably going up, in all likelihood -- and that's in regard to meat and grain -- we are just very, very excited about the possibilities there. We think it's going to be very, very good for the country of Romania. We think it's going to be very, very good for Smithfield Foods. I will tell you that I think Romania is our number one area for growth for the next five years.

But ballpark, can you say, for example, in five years, how many hogs do you expect to have there, approximately? Again, if I'm in France and I have the opportunity to buy from Brazil or Romania, you're saying that definitely they will get a much better price from Romania?

Well, there's no question that even with the cheap grain in Brazil, if we grow hogs in Romania, they will compete very, very well against all imported pork products, in my judgment. The grain will be very cheap in Romania, as I mentioned earlier, but because of the distances involved and probably tariffs involved in regard to non-EU potential exporters into Europe, I don't see Brazil or the United States being serious competition.

Right, and can you just give a number?

In regard to numbers, we're trying to get to 100,000 sals just as quick as possible in Romania. That will give us approximately 8,000 hogs per day. The plant will process 16,000 a day on a two-shift basis. That being the case, that would justify an additional 100,000 sals, so we're talking about probably 200,000 sals. At that point, we will make a decision beyond that. It will really depend upon export opportunities that will be available to Romania at that point. But the 200,000 sals I think will just cover what the local domestic demand will be and with a little bit of demand east of Romania going into the Ukraine and into Russia, where there's still a very large meat deficit position. So, I view Romania as our number one target where we have the most opportunity in the next five years. That's not to say that we don't have opportunities in Poland and we don't have opportunities even in the United States, but Romania, I see it as our biggest growth opportunity.

Thank you. That's very helpful.

Our time is up. We thank everyone for joining us today. Joe will give you the opportunity for closing comments if you'd like.

No, I think the main thing is that we are spending a lot of money; we are investing our profits back into the business. We have an awful lot of our competitors today that are out there that are not investing back in the business and in fact are spending less than depreciation, milking the company so to speak. We are investing back into this industry because we see opportunities there and Smithfield Foods, vis-à-vis our major competitors out there, I see us as getting stronger, not weaker because we have confidence in what we do and are part of the protein business. We continue to be very, very optimistic. We've had a very good past and it's my job -- is to try to find opportunities where the future looks as good as the past. With the opportunities that I've talked about in Eastern Europe and other export markets and processed meat expansion to where we use all of our raw materials domestically, our brightest days are ahead of us. That's what we are focused on, and we are focused on two, three, four, five years from now, not on the next three, six, nine months. That's what we are all about, and we don't expect to change.

Thank you, Joe, and we thank everyone for joining us today. Have a good day. Good-bye.

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