Smithfield Foods Inc (SFD) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2006 Premium Standard Farms earnings conference call. My name is [Raeika] and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Mr. Steve Lightstone, Chief Financial Officer. Please proceed, sir.

Good morning, everyone, and welcome to our third-quarter earnings conference call.

We would like to inform you that today's call may include forward-looking statements within the meaning of federal Securities laws. These statements are subject known and unknown risk, uncertainties and other factors, including those referred to in today's press release and in our filings with the SEC, that may cause actual results to be materially different than those included in the forward-looking statements.

With me on the call this morning are John Meyer, our Chief Executive Officer, and Bo Manly, our President and Chief Operating Officer.

I will now turn the call over to John Meyer.

Good morning, everyone, and thank you for joining us this morning.

We're pleased to report strong third-quarter results. Net income for the quarter of fiscal '06 was 13.8 million or $0.44 per share, compared to 23 million or $0.74 per share in the same period last year. In the third quarter of fiscal 2005, last year, we saw historical high hog prices and, more specifically, the second highest levels in the last decade, which made for a difficult year-over-year comparison. However, we feel that our results for the quarter reflect current market conditions and are in line with our expectations.

Despite an approximately 17% decline in hog prices year-over-year, our net income in the quarter increased by 12.5% over the second quarter. Favorable grain prices, as well as improved productivity in the production and processing segments and favorable hog hedging helped to offset declining prices. These results also reflect the benefit of our integrated model.

During the quarter, we were pleased to announce our decision to expand the Milan, Missouri plant. Bo will discuss the specifics of this expansion during his comments, but the most important part to take away is that the expansion will result in a 35% increase in Milan's capacity and a 15% increase in total processing capacity in early fiscal 2008.

During the past quarter, we have implemented a number of strategic and operational changes in an effort to offset the decline in hog prices. Some of these changes include continuing to improve efficiency in both our production and processing operations, introducing higher-margin products, and expanding our international sales. In addition, we continue to focus on adding further processing and value-add capacities through organic growth and acquisitions.

For the first nine months of the year, net income was 41.4 million, or $1.32 per diluted share, compared with a net income of 44.3 million or $1.43 per diluted share in the same period last year. Our net income includes an after-tax charge of 21.7 million or $0.43 per diluted share for the early extinguishment of debt. Year-to-year net sales increased 3.5% to 701.4 million from 677.7 million in the first nine months of fiscal '05. Sales in the first nine months of fiscal '06 were bolstered by continued strong export sales and increased utilization of our Clinton, North Carolina plant.

Similar to last quarter, I would like to spend some time discussing our general outlook for both the coming quarter and fiscal 2007. Based on the December USDA Hog & Pig report, current favorable supply trends within the pork industry are likely to continue but with domestic demand at levels below last year, we are seeing hog prices move closer to more historical levels. Additionally, despite recent declines in cash hog prices and near-term hog futures, longer-term hog futures continue to remain at levels that we expect.

We expect strong international demand for our products to continue into fiscal 2007 and will outpace expected growth for the industry. We still believe that the news surrounding the U.S. beef processing industry in Japan will have minimal impact on PSF. In Mexico, we continue to see solid support for our products, and we expect to add new quality customers going forward. Although domestic demand has been somewhat lower than last year, we are encouraged by the latest cold storage report for pork, which showed pork cold storage for December at its lowest level since 2000. Pork supplies went down 10 million in December, when typically supplies increase by a large amount. Additionally, we have a number of programs in the pipeline to bolster demand, including our case-ready products marketed for the Hispanic community, a new set of marinated pork products; we've also established a relationship that combines upscale membership warehouse Costco and the nationally known marinade company, Chinablue. Bo will go into further details about some of these programs during his comments.

As we have previously stated, we feel it is in our best interest to not reveal our exact hedging positions. However, we are active hedgers, when we feel strongly about certain market directions, and we believe, at times, it's prudent to reduce our risk level.

In addition to recently announced expansion of our Milan, Missouri plant, we will continue to pursue growth opportunities, both organically and through acquisitions. We're currently looking at possible acquisition opportunities, which will add further processing and/or value-added capacities to our operation.

For the coming quarter and into fiscal 2007, we expect to see a continuation of the current market conditions and anticipate hog and wholesale pork prices to continue to move towards more historical levels. Based on this information, we feel our results for the fiscal fourth quarter of 2006 will be lower than our third-quarter results.

Now, I will hand the call back over to Steve, who will walk through some of the financials in more detail.

Thanks, John.

Sales were 242.9 million in the third quarter of fiscal 2006, a decrease of 1.6% compared to 246 million for the same period last year. This decline can be attributed to lower hog and pork prices that equaled approximately 23.6 million. This decline was partially offset by an increase in volume of 16.2 million, combined with the 3.5 million improvement from favorable hog hedging compared with last year. As we expected, hog and pork prices were significantly less this quarter compared to the historically high levels experienced during the third quarter of fiscal 2005, causing the 23.6 million decline in prices. During the quarter, we recorded a gain of 800,000 as result of our hog hedging activities, compared to a charge of 2.7 million during the third quarter of fiscal 2005, for a total improvement year-over-year of 3.5 million.

Net income for the quarter was 13.8 million or $0.44 per share, versus 23 million or $0.74 per share in the third quarter of fiscal 2005. Net sales for the first nine months of fiscal 2006 increased 3.5% to 701 million from 677 million in the same period last year. Net income year-to-date was 41 million or $1.32 per share, compared with 44.3 million or $1.43 per share in the first nine months of fiscal 2005. The results for the first nine months included a 21.7 million charge from the early extinguishment of debt, representing an after-tax charge of $0.43 per share. As you will remember, we paid off 173 million of the 9.25% senior notes with cash and a combination of a new 125 million, ten-year, 5.9% bank term and revolving loans.

In the Processing segment for the quarter, sales decreased 2.8% to 222 million in the third quarter, compared to 228 million in the same period last year. Pork product sales prices decreased 6.8% from the third quarter of last year, as the industry and we continued to experience lower-priced meat prices, compared with last year, when both domestic and export demand were exceptionally strong. These lower prices were offset somewhat by a 4.3% increase in volume.

For the third quarter of fiscal 2006, operating income for the Processing segment increased 61.5% to 6.3 million from 3.9 million earned last year. This increase was a result of lower cost, better throughput, and firmer meat prices versus hog prices.

For the Production segment, sales decreased by 10.3% for the quarter to 151.2 million compared to 168 million last year. This resulted from a 17% decrease in hog sales prices, offset by an increase of 5.9% in volume. As a result of lower feed costs and improved productivity on the farms, we lowered our hog production cost by 2.8% during the quarter. As a result, operating income of 22.7 million for the quarter was lower than the 43.5 million of operating income last year. Given the significant decline in hog prices, we are very pleased with these results.

Our revolving credit is fully paid off today, and interest cost for the first nine months of fiscal 2006 were 7.1 million versus 15.8 million in fiscal 2005, less than half of last year's cost. Today, we're building cash. We produced 65.7 million of operating cash flow year-to-date, and our total debt at the end of the quarter was 127.7 million, the lowest level since the 1998 formation of PSF.

Our strong balance sheet gives us the needed flexibility to grow our business. Our net capital spending in the third quarter was 7.3 million, which is in line with our full-year projections to spend approximately 36 million of total capital.

With that, I will now turn the call over to Bo Manly, our President.

Thank you, Steve. Good morning, everybody.

I have several exciting areas to discuss today, and we will start with exports. We continue to outperform industry export volume growth. For the quarter, our export volume increased 31% versus an industry growth rate estimated to be 9%. For the full nine months of this fiscal year, our export volume grew 45%.

The U.S. beef processing industry continues to be challenged as a result of Japan's decisions to reopen its borders to U.S. beef only to close the borders again a month later. We still feel that recent decisions made by Japan will have a minimal effect on the pork industry and PSF.

The percentage of PSF export sales dollars increased from 10% of total meat sales in fiscal 2005 to 14% in the first nine months of fiscal 2006 with continued strong growth in Japan and Mexico. Domestically, we've implemented a number of programs to bolster demand. Following a lengthy product development process, we began shipping the 27-item Hispanic case-ready line in December. We have developed two retail customers, one regional and one national. We are entering a test program in February with a third national retailer. Presently, we are also shipping these case-ready items to distributors in Puerto Rico.

In other exciting activities, we are announcing today a new sales initiative with Costco to merchandise a new line of marinated pork products with chef personality to Richard Wong and his successful marinated sauce company, Chinablue. These items will be merchandised under the brand Shanghai Basic.

We previously outlined our mission to increase exports and further processed and value-added components to our sales mix. We remain focused and have made strides towards these goals during the last nine months, including our decision to expand our Milan, Missouri plant and increase throughput at our North Carolina facility.

We began preparations to expand the processing capabilities in Milan, and the expansion will increase processing capacity at the Milan plant by approximately 35%, allowing us to process, at peak times, approximately 10,000 head per day, versus the current processing level of 7,400 head. This will increase total capacity for the Company about 15%. We expect to begin processing at the higher output levels but next spring and do not foresee any interruption to firm production levels during the expansion process. The expansion will cost approximately $23 million and will help us move towards a more balanced mix between our Processing and Production segments.

Some of the supply of hogs required to expand the Milan plant will come from our additional supply being generated from our more productive Missouri farms, and the remainder will come from an outside provider network. Currently, at our North Carolina plant, we are already buying 25% of its volume from a handful of independent process-verified suppliers. This model has been successful in the past, and we're confident that it will translate well to our Milan facility.

We are very pleased with our third-quarter Processing segment results, especially compared to our results in that segment for the second quarter of this year. Our gross margin for the third quarter was 3.6%, compared to only 1.7% for the second quarter and 2.2% for the third quarter of fiscal 2005. These results reflect improved throughput at the plants, improved sales prices from our various initiatives, and lower costs.

At this point, I would like to turn the discussion back over to John. Thank you, everybody, and have a great day.

Thanks, Bo and Steve.

Because of the cyclicality of the industry, our business is sensitive to short-term market price movements. We believe that it is important for our investors to review our performance over longer periods of time rather than on a quarter-to-quarter basis. Similar to last quarter, if you look at the results from the first non months of fiscal 2006, you'll get a better view of our business than just by looking at this quarter.

We continue to focus on adding new streams of income from the Processing segment that will reduce the effects of the market price movements in the future. We have begun to make progress in this strategy by increasing our processing capacity, as well as pursuing growth through acquisitions that will add further processing and value-add capacities to our business.

We're pleased with the results for this quarter. We were able to effectively manage costs in addition to increasing production and order to offset declining hog and wholesale pork prices. As we draw near to the end of fiscal 2006, we believe we have positioned PSF well for the future.

At this point, I would like to open up the call for questions.

(OPERATOR INSTRUCTIONS). At David Adelman, Morgan Stanley.

John, I'm curious. At current spot prices and at current costs, is the Company -- would the Company be profitable?

At current markets and current costs, yes.

Okay. Secondly, the arrangement with Costco, I was curious. Who owns that, the brand itself?

The brand is owned by Chinablue, but we have exclusive arrangements, contractual arrangements to produce all pork products with Chinablue for Costco, as well as any other customers.

Okay. Can you comment about overall expense control on the SG&A side with lower profits? I think SG&A, well, at least in the quarter, was up $1 million.

Yes, I think we had could expense control. Most of that SG&A increase for the quarter reflects things like Sarbanes-Oxley and the new 123R expensing of options and restricted shares. Those are the two big pieces.

Okay. Then lastly, Steve, actually two cash flow related questions, if you could, both through the nine months. I think working capital was a use of cash of about $15 million. Can you comment on why that's the case? Then secondly, cash income taxes paid through the nine months were about $20 million higher than GAAP taxes. Can you comment on that as well, please?

Well, let me take the second one first. The difference in actual taxes and GAAP taxes is the fact that we just got some, on the depreciation side, we've got some changes happening. For a period of time, until we start investing again, you'll see us paying higher cash taxes and GAAP taxes.

On the working capital, I think the biggest part of that, David, is probably the fact that we continue to have good productivity at the farms and continue to produce more inventory than we have in the past. (multiple speakers) -- take a look at that to see what other difference -- that's the biggest piece I remember.

Okay, thank you very much.

Pablo Zuanic, JP Morgan.

This is actually (indiscernible) asking a question on Pablo's behalf. Just regarding your pork-processing margins, historically they haven't followed what the industry margins have been. Can you just comment on that? I mean, in terms of this quarter, I think you reported about 3% margins in the processing unit. The way we calculate margins for the industry, we have this quarter around 7.4% for the industry. Can you just comment on that?

I can't speak to 7.3 or 7.4% for the industry at this point in time. I don't recall it being -- are you just talking the spreads between cut-out and hog prices, or are you talking the actual numbers being realized by the other businesses in the industry?

No, the way we calculate the margins is based on profit per head. We also use a fixed-cost component, so although they are not reported profits for other companies, it's kind of an industry margin per say that we calculate. But historically, I mean, it hasn't cracked your profits or your margins haven't cracked with that. Is there a reason for that?

I have to get more specific on your particular question, which I would be happy to do some time, but I can't speak to exactly what you're talking about there.

Okay, so we will follow-up with you guys, then.

Another question on the hedging games -- I know you mentioned -- is there any way you could quantify what the gains are? I know you mentioned that and maybe I missed it, but if you could quantify that and maybe also comment on how long your hedging contracts are, per say?

On the first part, I did mention the fact that we, for the quarter, we had 800,000 of gains in hog hedging. But that compared to a 2.7 million loss on hog hedging in the third quarter of last year, so I said that it was a swing of 3.5 million for the quarter.

As John mentioned, we don't get specific on the details of the hedging of how long we go out or the specifics of the contracts. So, on that second part, I won't get into specifics on that.

Okay, thank you.

Homer [Escovaldesen], Piper Jaffray.

Could you talk about your sales to foodservice and maybe opportunities outlook for that?

We continue to place assets against that segment, both in terms of people as well as production capabilities, and have entered into long-term relationships in the past 60 days with some regional foodservice chains in particular product categories and continue to be very optimistic and continue to make progress going forward.

Then another question on the tax rate -- it looks like the taxes was a little bit lower this quarter. Could you talk about that, and then just what is a good tax rate to use for going forward?

Can you repeat that one more time, please?

Yes, just the tax rate that would be a reported GAAP tax rate was a little bit lower in this quarter year-over-year.

Yes, we commented on that on the last quarter. We are getting the benefit of the Job Creation Act I believe is the actual term for it, so we reported consistently lower tax results, starting with, I believe, the second quarter.

Oh, okay.

That's where it's coming from and we will continue to still get slightly improved benefits as we move forward.

Okay, good. Thank you.

Robert Moskow, Credit Suisse First Boston.

I just wanted to know. In your release, you say that increased volume of 16.2 million and favorable hog hedging offset the decline in pricing, in hog prices. In that sentence, are you referring to the $0.8 million gain from hog hedging, or is that a different number there that helps offset the decline in price?

It's the 0.8, the 800,000 and gain for the year, but when you compare to the third quarter of last year, you've got a swing of 3.5 million. So it's an improvement of 3.5 million.

Okay. I know you're not giving any guidance on your hedging into Q4, but you did said that earnings would be down. Where do you expect the -- in which segment do you expect the earnings to be down more -- production or hog processing?

Well, just as -- I mean, production is the most sensitive when you see hog prices moving lower.

Thank you very much.

(OPERATOR INSTRUCTIONS). John McMillin, Prudential.

Good morning. Congratulations. I guess we are finished with the underwriters again. Just in terms of the hog hedges, Steve, I guess these are just marked to market at the end of the quarter; that's the number you're giving us. Not gains realized versus cash?

That is correct. Since we are on a marked to market approach at the end of each month and the end of each quarter, we are marking to market all open hedge positions. Of course during that time, we also take actual gains on the ones that are being closed out during that period. The number reported is the total combined.

Obviously, you wouldn't say that next quarter is going to be down unless you felt it was going to be meaningfully down. Is that a fair statement?

Actually, we're making that statement based on what we're seeing on demand right now and what we are seeing in the hog futures.

Right. When you talk about hog contracts at historical levels, I'm looking at a December contract lean at 53. I mean, basically when you say historical, you mean kind of average level?

Yes, that's really what we mean.

As compared with the above-average levels you've kind of enjoyed.

Exactly.

-- in the past. Okay. I read something about a circle virus that was impacting the hogs. Can you educate me on this? Do you know anything about it?

Well, it's relatively new in terms of in this country, and there's still a lot of questions about it. We've seen it, in the industry, circulate around some this year. It takes on different forms, and it basically has to do with the immune system, as I understand it. Fortunately for us, we've not encountered big issues with it in our operations, but it's one of those that the industry continues to learn more about.

Okay. Just on potential acquisitions, as you know, there's some packaged meat businesses for sale that would kind of give you a third leg to your company. Can you talk about it at all, or the willingness to kind of add a third leg to them with what's in the field house?

Yes, we are, as we've stated in the past we and continue to state, we are interested in that portion of the industry. You know, where we've been frankly spending our time is trying to find the right fit in that segment and making some progress on that. But we are looking at a number of different opportunities that arrive day-to-day, first of all evaluating the fit with our business. But we are interested in that segment, definitely.

You know, if you stripped out turkey and gave that to someone else, ConAgra's business might only cost 3, 4, 5, $600 million. Do you have that kind of capability?

Yes, we think, if the right opportunity presented itself, we could stretch to get there.

Okay, thanks a lot.

Patrick Stowe, Priority Capital.

Good morning. I'm just wondering if you can give me maybe some big-picture thoughts as you talk about expanding the capacity of the Milan plant. I feel like I read releases about new processing capacity going online over the next two to three years from competitors. In an environment where we hear about kind of lackluster domestic demand and export demand that's been strong but is still small relative to the total processing capacity in the country, where do you see this additional capacity going? Are you taking market share, or can you just give me some thoughts on that?

Yes. From our standpoint, as we look at the increase in capacity at Milan, really that's where -- it comes from two places; market share is certainly one of them. The other is that there will be some slight increase in population demand, and then of course, you've got the export component that we would like to continue to grow in as we have in the past. So, you're right; there have been a number of announcements here in the past year about some capacity expansion for the slaughter side.

From our standpoint, you know, we look at our customer base and our prospects and we feel like there's some good potential and room for growth as it pertains to our business.

Do you see this maybe over the next one to two years, just increasing in slaughter capacity creating somewhat of a shortage and increase in hog prices?

You know, that's the $64,000 question. Common sense, when you look at it, would say that, for example, one of these plants is going to be filled with, as I understand it, existing animals that are being processed by someone today. So, you'd have to believe that people are going to want to fill the slots that have opened up as a result of that, which -- could that cause some additional demand for live pigs? Yes, we think it could, short-term.

Okay. I guess just with your existing processing capacity, are you guys running pretty much full utilization, or do you still have some room t o get some more throughput through what you have currently?

We are running full, particularly at our Milan, Missouri plant. We've come off a period of time at both facilities as we come through the fall and early winter where we are operating our plants six days a week at absolute 100% capacity. We will trail off to slightly lower levels as we move into spring on a seasonal basis, which we do every year. So we are actually ahead of plan at the current production rates that we are at today, but we would consider ourselves running full (indiscernible).

Do you feel like that's pretty much true across the industry?

You know, we are killing anywhere from 2 to 4% more pigs per week, as an industry, compared to a year ago, so I have to assume that, with the nominal amount that we've had with the addition of the (indiscernible) plant in terms of capacity, that everybody is killing about the same numbers that they were a year ago. So I don't necessarily have any insight in terms of actual throughput rates at any other individual plants, but I think everybody is about the same as they were a year ago, maybe a little bit higher volume.

Right. Great. Thanks for the info and good luck to you.

(OPERATOR INSTRUCTIONS). At this time, you have no further questions. I would like to turn the conference back to John Meyer for closing remarks.

Okay, we'd like to thank everyone for their interest and attendance. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.