Smithfield Foods Inc (SFD) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Smithfield Foods Fourth quarter conference call.

At this time, all lines are in a listen-only mode. Later, there will be a question-and-answer session and instructions will be given at that time. If you do need assistance during the call today, please press the star followed by the zero and an operator will help you offline.

As a reminder, today's call is being recorded and will be available for replay starting today, Thursday June 8th at 12;30 p.m. Eastern time. It will be available through Thursday June 15th at midnight Eastern time.

You may access the AT&T Executive Playback Service by dialing 1-800-475-6701 from within the United States or Canada and then enter the access code of 830863. That number once again, 1-800-475-6701 with the access code of 830863. Again, this information will be given at the close of the call as well.

At this time then, I would like to turn the conference over to Mr. Jerry Hostetter. Please go ahead, sir.

Good morning. Welcome to a conference call to discuss Smithfield Foods fiscal year 2006 fourth quarter and full-year 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 very much, Jerry. Good morning, ladies and gentlemen.

I'm pleased to report this morning fourth quarter earnings of $1.1 million, or $0.01 a share compared with $85.4 million, or $0.76 a share in last year's fourth quarter. For the year we're reporting 172.7, or $1.54 a share and 296.2 million, or $2.64 a share.

I hope you had opportunity in reading the press release to note several special items in this quarter's results that we hope you take note of. Particularly, we are reporting our second restructuring charge related to our East Coast strategy for Smithfield Packing Company. That amounted to $10 million and equates to $0.05 a share.

As well, I hope you noticed that we are reporting some discontinued operations in this quarter's results. This is a result of a signed letter of intent that we have in place to sell our Quik-to-Fix operations in Texas. As I've reported to you many times in the past, we have had difficulty with that operation and it doesn't fit strategically with the business that we've been in, and so we've made the decision to sell the business, and in fact we believe we have that sold.

Finally, we highlighted in the earnings release the fact that we made a cattle inventory market adjustment in this quarter's results to the tune of nearly $14 million. Dan Stevens will speak more fully to that as he makes his comments, but this relates to a write-down of our cattle inventories and our feedlots, and is a fairly complicated accounting adjustment that it deals with the futures markets and the ultimate selling price of this livestock out through the Summer and into the Fall.

But we did have to make an adjustment in this quarter's results that should lower the carrying value of that inventory going forward by some $14 million. And given where the cattle markets are looking, much if not all of that will come back to us in our first quarter and our second quarter.

So from that standpoint, we are reporting $0.01 a share as net income and $0.03 a share as discontinued, so our continuing operations is $0.04 a share. And then we consider the East Coast restructuring charge that we've taken be another $0.05 and then finally, this cattle adjustment for about $0.08 a share. So we see the quarter is more like a $0.17 quarter compare to a $0.76 quarter last year.

On an overall basis we were disappointed with the quarter. We suffered many of the same ills and pressures that our competitors have already previously reported.

I know the Tyson results and the Premium Standard results are out there, you've seen those, and many of those factors in terms of the excess proteins are affecting us as well. You know the levels of beef and you know the levels of chicken that have been out there, and they have acted as an inhibitor in terms of pork pricing, and so we have suffered in our fresh pork operations and as well the margins in our processed meats. I am pleased that, even given those pressures, we have continued to deliver profitability, I think that speaks very well to the integrated model that we've got.

Our live production operations have now for quite some time been delivering very solid profits to the bottom line. They continue to deliver very solid profits. And I'll speak to that later about where I see this going even into the first quarter and second quarter of next year.

In terms of the segments, our Pork segment is reporting $30 million in lower Pork segment profits for the quarter. That includes the $10 million restructuring in the East Coast, and so we see that as more of a $20 million -- $20 million less in terms of profits there.

I can tell you that we have completed the acquisition of Cook's towards the end of the fiscal year. With that, that put us in a position to complete our strategy of utilizing our hams and bellies going forward internally as opposed to being sellers of hams and bellies.

Now we are in a position with our capacities in place and our operations to essentially use all of our bellies and to use all of our hams internally, except for those selected customers that we have very strong relationships with on raw materials.

We did start this strategy two years ago. We did not complete it last year. We have completed it this year, and Cook's was a big part of that solution on the ham side.

On the beef side of the business, it has been weak. You know about closed markets. Mexico, as you know, has had some opening, and Korea is talking and Japan continues to talk.

But with that being said, our beef operations of recent have been profitable, and nicely profitable. I have been -- looked at other's results and read about the profitability of others in the beef industry. I am extremely pleased with the efficiency and the cost that we have in place for our beef operations. I think we have routinely delivered substantially better results on the beef side of the business than our competitors have.

Internationally, we continue to struggle with our French operations. As you know, we have begun some conversation with Sara Lee toward the potential acquisition of Sara Lee's meat assets in Western Europe. Those discussions are continuing as we speak. We're not in a position to make much more comment than that, except to say that if that were to come to pass, then we would be in a position to merge those operations with our French operations and I think put us in a very strong position going forward to strengthen our existing operations.

Our Polish operations have had a somewhat tough year starting off earlier in the year with a product problem. We think it was political, but a product problem early in the year followed by avian bird flu in our white meat operations later in the year.

From an operation standpoint, the Company has been doing relatively okay. We have made one management change as we speak and we've announced that of recent. And so I think our Polish operations are just fine and have been improving pretty steadily since the first of the calendar year.

Now, hog production operations, that continues to be the shining bright star in our operating results. We continue to have very good cost controls in place on the raising side of the business. Our earnings are down pretty substantially from a segment number. That's largely -- more than largely the result of the live hog market.

That is, live hog market has come down much more than our results have come down. As our raising costs on an annual basis are down $2 a hundredweight from last year, and we continue to control those costs in spite of the fact that many of you are aware that we have been battling this circovirus, too, related to [Vs] issue in some of our Eastern operations and it has had some impact in some of our farms in the Eastern part of the country.

Even given that, we have still managed to control our costs, I think, very solidly and we look forward going from this point forward to continued tight controls over our raising costs. So while it is having an impact, it is not having any kind of a substantially detrimental effect. And you can see the impact on the segment P&L that we're doing just fine.

In terms of our other operations, our biodiesel project that we've been working on now for three years, I can report to you today it is up and running. We are not running at full capacities, but we are, in fact, have completed that R&D project and that project is now moving from a call center to a revenue and profit center. And as well the other part, our turkey operations, continue to deliver solidly both for the quarter and for the year-to-date.

Before I talk about where I think we're going from this point forward, I'll turn this over to Dan Stevens and let him give you a financial report, and then I'll come back to you and talk to you about the first and second quarter. Dan?

Thanks, Larry. Good morning, everyone. I'm just going to start off by kind of clarifying some of the points from a financial reporting standpoint.

You saw in our press release with our intent to sell the Quik-to-Fix business that we've reclassified it to discontinued operations. That's both in the income statement and the sales and operating profit schedule.

So the Pork segment sales and operating profit have been adjusted to exclude the results of Quik-to-Fix and show that it's discontinued operations for both the current and prior periods. As given a point of reverence, sales last year for Quik-to-Fix were just over $100 million.

Also, Larry mentioned the restructuring charge of $10 million, or $0.05 a share related to the East Coast strategy. That, as he mentioned, is included in the Pork segment; and the other thing I wanted to point out is that is a non-cash charge related to the write-off of fixed assets.

We also mentioned in the press release, we took a $13.8 million accounting adjustment in the Beef segment related to the write-down of cattle inventories to market prices. That came about when the markets dropped in March and April.

The thing I wanted to point out is that even though market prices rebounded in the first quarter, the write-down does not come back to the P&L immediately, but it does get recognized over the next couple of quarters as the cattle are sold, assuming that the market prices stay at or above where the current futures prices are today. So in other words, the write-down actually becomes the new cost basis for the inventory and is recognized when those cattle are sold.

Taking a look at some of the other key factors in the income statement this quarter. Sales were down some $220 million in the quarter compared to last year's fourth quarter. Most of that decline is in the Pork segment because of lower average selling prices which were driven by the 17% decline in average hog prices.

The other major change in sales this year is that last year we had about $65 million in sales in last year's fourth quarter in company-owned cattle that were sold to third parties. Those sales are now part of the cattle feeding joint venture which is accounted for in the equity method of accounting. So we picked up our share of the earnings in the joint venture, but we're not consolidating the sales from that operation any longer.

Our selling, general and administrative expenses you probably saw were down about $25 million in the quarter. Most of that is due to lower variable compensation expense, but we also had some foreign currency gains in last year's fourth quarter and we also had lower IT-related costs this year and as well, we had lower costs related to our Sarbanes-Oxley compliance effort last year.

For the year our operating profit was 46 million. If you add back depreciation and amortization of 52 million, as well as the non-cash impairment charge, our earnings before interest, taxes, depreciation and amortization from continuing operations was 106 million in the quarter compared to 218 million in last year's fourth quarter.

For the year, EBITDA was 648 million from continuing operations compared to 781 million last year. Decline in earnings is -- almost all of that is coming in this year's fourth quarter.

Take a look at the cash flow and the cash flow statement and the balance sheet at year-end. Our cash flow from operations for the year was just over 500 million compared to just over 90 million last year. After you consider capital expenditures this year of about 390 million, our free cash flow was right around 110 million.

This year, our cash flow from operations benefited substantially from the sellout of company-owned cattle, where last year, as you recall, we were still building those inventories.

Our capital expenditures for the quarter were right at $130 million compared to depreciation expense of just about 50. And for the year, as I mentioned, we spent some 390 million in capital expenditures compared to a depreciation expense of just over 200 million.

For the quarter and for the year, the increased spending levels have really been a result of our processed meat expansion projects, especially our deli ham plant down in North Carolina, as well as our Romanian vertical integration project, which has been our biggest capital expenditure investment in our international operations.

And although we've cut back some of our projects and we deferred some other projects, we're still going to have higher spending levels going into our fiscal 2007. I would expect that capital expenditures for next year are going to be at or near the same levels we saw this year.

Otherwise, our excess free cash flow went towards funding the cash portion of our contribution to the cattle feeding joint venture. As well, we acquired 1.7 million shares of Company stock that were repurchased in the open market. I think I mentioned previously that 1.5 million of those shares were then contributed to the Company's pension plans earlier in the year.

From a debt standpoint, Larry mentioned we closed on the Cook's ham acquisition during the quarter. That increased our debt levels at the end of the year to just under $2.6 billion. That's up from $2.3 billion at the end of last year and at the end of our third quarter.

The increase debt pushed our debt to total capitalization to 56%, which is just slightly higher than the 55% that we reported at the end of last year.

And lastly, following the funding of the Cook's acquisition during the quarter, we have just under $500 million in availability from a liquidity standpoint on the revolving credit line.

Those are the key financial highlights. With that, I'll turn it back over to Larry.

Thank you, Dan.

Let me talk about the future by about talking about the past for just a second and a fundamental business strategy. We are not, as a Company, satisfied with this past quarter's results. And I hope you take away from this call that Smithfield Foods is not sitting here and not doing something. In fact, I think we're doing an awful lot.

The markets did impact us. We're subject to the markets just like the rest of the industry. But I believe, as well, this was a tougher quarter from us on an operations standpoint in the past, and we are making changes to react to that. So from our standpoint, we're doing something.

Number one, we are selling our operations in Texas to improve our results and eliminate that drag going forward. Number two, we are concerned about our costs on the East Coast. We started a strategy in the second quarter by ceasing slaughter operations at one of the plants in Smithfield, Virginia, and as well, making another rationalization with one other plant. As of today, we have announced the closing of one of our Florida plants that we purchased a while back. We are closing that to bring our operations closer to the center of the raw material on the East Coast to, once again, make an impact on our costs and to add to the efficiency of our East Coast operations.

I can't tell you where the fresh pork markets are going to go. The Summer is usually tough. Processed meats continues to be tough for everybody in this competitive environment. It has been tough in the past, of recent, because of the impact of the lower-priced poultry products that are out there. Those prices have changed. You know where leg quarters have come up, you know where chicken breast have come up substantially. Some of those prices are moderating so we expect some improvement in the processed meats. I hope I can tell you we're at the bottom of that.

We are, at this point, launching a whole new brand look for our John Morrell operations. That was a brand that needed a freshening look. We have launched a complete new look on the packaged end of that business and I hope you see it in the marketplace, I think you'll be in impressed.

We're on the cusp of opening our new state-of-the art ham plant in Kinston, North Carolina, which is substantially lower the cost of producing our cooked hams for the deli segment of the business. As well, we are on the beginning stages of a new renovation project of our Sioux Falls flagship plant of John Morrell, which needs a facelift from the sausage operations stand as well as adding some low cost Armor Inox system for ham cooking and potentially precooked bacon operations. As we've mentioned many, many times, those ends of the business continue to have double-digit growth. Everything in precooked area is doing very, very well. The demand is strong, the volumes were up double-digits, and the margins, as you can imagine, were substantially better than that in the commodity end of the business.

We continue to invest in what we believe is an outstanding opportunity in Romania. We are on track to open the plant we purchased a year, two years ago. November the 1st, we are processing today some 3 or 4,000 hogs a week. We'll be processing 7 or 8,000 hogs by November and up to 10,000 by next February or January. The farms are going in, the hogs are alive. This plant will come up, and I think the basic economics of that operation are just exceptional. Certainly, we will have to deal with start-up issues with that, but we are positioning ourselves in Eastern Europe to be a major, major player. Mr. Luter has said many times that he thinks the opportunities there are some of the best we've had in the Company's history. I totally agree with that.

I believe that we have put the people in place, we continue to strengthen that management team. We continue to make the commitments to that to do it right the first time, and I think that's going to be a -- today, our international operations are a drag on our earnings, and our hog production operations and our domestic operations are carrying that, but I think as time goes forward, those things will change. The commitments we're making on the other side of the water are going to position this Company in a very strong way so that that international segment of this P&L is going to be a major contributor to this Company.

Beyond that, we continue to make improvements in our Polish operations. We're putting in more farms there, which give us more livestock for those plants, increase the efficiency of our Polish operations. And I think that only gets better and better by the day.

We do have the potential opportunity for Sara Lee. Sara Lee's operations, which again, we're doing something to help our French operations, strengthen our market position, the volumes of processed meats Sara Lee has in Western Europe, I suggest to you, it's very substantial. And I think that this can be a big, big help to our -- not just our French operations, but our position in the Western European markets with the Western European retailers.

As well, we have had some of our competitors who've announced some cost-cutting programs. We put in place a strategic sourcing and purchasing function some eight or nine months ago to concentrate on the cost areas of this business. Those are just now beginning to deliver some substantial benefit.

So I think that we are focused in a big way to get our costs, which have been difficult to pass on to the consumers and the customers at this point, given the competitive environment. We are focused on the fact that we cannot let these inflationary costs take away from the bottom line. We have had difficulty passing them on so we know that we must control those, and we are focused on reducing those costs where we can, realizing that $70 oil is still $70 oil.

If you look of very recent, the hog market has certainly come in up in a very dramatic way. I don't know if you saw even last night the hog market closed at $53. The fresh meat cuts have come up substantially, chicken prices have come up substantially. So I think that going forward the markets, if you believe the futures markets, hog profits are going to be very solid for at least three, four, five months into the future.

Our hog production is going to deliver very solid. It's at the same level as last year. So I expect if you look at last year's first and second quarter earnings from the hog production, we ought to be there. It's incumbent upon us to make the other parts of this business to maximize what we can out of this fresh pork and processed meats.

And finally, I think for the near-term, beef is going to be very good. I think we've got some good things in front of us. I think the pork markets could be a little sloppy here as we go through the Summer. And I think until we work off these excess proteins there's going to be pressure on passing through any of these costs, but I think, from my standpoint, I am extremely optimistic in terms of where I think we're going. I think this Company is deadly solid. I think Mr. Luter has been very, very focused in making sure we make the right long-term decisions for this Company.

We continue to make the right long-term decisions. We don't do knee-jerk reactions to something we see in the marketplace this week or this month. We continue to stay focused. And I believe that's what delivers the long-term value to the shareholders.

You can tell I'm optimistic in spite of a $1 million quarter which I'm very disappointed at. I look at the numbers and analyze on –- it’s a lot better quarter than $1 million, but do not think that we are sleeping at the switch. Do not think we are satisfied and we're sitting back on our laurels. We are not, and we are very engaged and taking steps to make sure the future is there.

With that, Mr. Luter is here and the rest of us, and we'd be glad to take your questions. Jerry?

Operator, would you please open the floor to questions?

Surely. [OPERATOR INSTRUCTIONS] We have our first question from the line of Leonard Teitelbaum with Merrill Lynch. Please go ahead.

Good morning. Could you help me out with the accounting here just a little bit. The cattle feeding operation -- and I'm sure this is the old -- you've got to mark the futures to market every month and every quarter, right?

Actually, Leonard, this has to do with the cattle inventory. It's not their position that they've taken on derivative or commodity instruments. This is actually their --

The market value?

Sold to outside parties. Sorry?

Well, if that's the case, I thought these were going to be hedged coming in and hedged going out. Is that incorrect, then?

No. The portion that was hedged would have been reduced or would not have been included in that lower cost to market adjustment.

Okay. (multiple speakers) Those were open, basically uncovered animals that you had in various stages of feeding in the lots, is that right?

That's correct.

All right. Then how does that reconcile with the statement on Page 3 where you talk about your -- the Beef segment reported a modest loss, okay, and the first year of participation in the cattle feeding joint venture, the Company's production expense produced a modest profit.

What's the breakdown between the joint -- if this is part of the joint venture you picked that up only as -- on an equity base, so I'm just having trouble following the funds flow from the beef operation that's reported as a segment and the write-down of inventory.

Leonard, keep in mind that the beef operations that we have today and the joint venture are not vertically integrated. So the sales from the feedlots are to outside third parties.

That I got.

Okay. And your question was --

You've got the statement that says that your Beef segment, where I thought this was being captured in the income statement obviously is wrong. Why don't I follow up offline on this thing?

Leonard, one of the things I'll say to you, maybe I can help you a bit. If you see in the segment P&L, we are reporting a $7.8 million loss in beef. If you make an adjustment for $13.8 million write-down of inventory, that yields a $6 million profit in the Beef segment absent this inventory adjustment. And this inventory adjustment, I don't know if I can explain it any better than Dan can.

I've got that part. What I'm trying to figure out is are we going to have this in some form or fashion every quarter, and I don't see how we can. And that was going to be my follow-up question on it.

Isn't this going to be a continuing adjustment that we have to try and monitor?

Well, it will. As the cattle is sold, Leonard, that reserve -- assuming, again, assuming that cash prices stay where they are today, that reserve will reverse. And we will be --

I appreciate that, but you're going to have more animals coming in. What I'm trying to find out is you'd like to segregate this out as a one-time, one and done deal. I can understand your position on that. If this was going to be a recurring cost of doing business of marking open inventory to market, which you have to do, then I'm trying to work out in my own mind whether this is a recurring data point or not. And that's really the basis for the question.

Well, Leonard, your -- I mean the decision is whether or not you consider it recurring or not recurring is obviously up to you. We're attempting to tell you why, or give you an explanation as to why the Beef segment results were the way that they were.

And we came out with the prerelease at the end of the April, and I think one of the reasons for that was because we had just taken a fairly large lower cost to market accounting adjustment to the cattle inventory. So really the intent here is to explain the Beef segment results, not necessarily steer you in a direction to recognize it as recurring or non-recurring.

Thank you very much.

Thank you. We have a question from the line of John McMillin with Prudential. Please go ahead.

Hello, everybody. I'm actually on the other side of the pond so it's the afternoon over here. If I strip out -- if I work myself to a nine -- I guess you reported a tax rate of 32%, but if I strip the charges, it looks like the tax rate is closer to 39%. I don't know if you reviewed that, but is that correct? If I kind of work myself to a $0.09 operating number, doesn't the tax rate go up a little bit?

It does, John, it goes up to about 38.5%.

Okay. So I'm right there.

That's your marginal tax rates. That's your federal rate plus the effective state rate.

Can you give me the -- you said your production costs were down $2. Does that include the impact of this circovirus and the obvious deaths? That had to raise unit production costs a little bit.

John, the short answer to that is yes. We do have the circovirus and I'm going to be glad I know we have limited time here, the circovirus discussion could probably take an hour in and of itself. It's a complicated discussion.

Bottom line, yes, our raising costs are down $2 a hundredweight for the year in spite of the fact that we do have increased both death losses as well as increased cull rates. Those are reflected in our raising costs and we are still reflecting a $2 hundredweight reduction.

Can we shorten it? Can you just give me the numbers for the quarter in terms of your production costs and the livestock prices realized? I mean, the hog prices realized?

Our production costs for the quarter were just slightly over $40, and that includes the circovirus impact. Remember that circovirus, or let me point out, circovirus is, it's really not circovirus. It's the circovirus, the related diseases that occur from circovirus.

Circovirus is a very common illness and has been around for many, many, many years. It's the follow-on illness that is the mystery part of this. And that's just in our Eastern operation. So we've got substantial operations in the Midwest that are not being impacted in any way at all. And in fact, not all of our Eastern operations are even being impacted by this.

So that from our standpoint, it is just a -- and I don't to downplay it, I do not want to downplay it because it increased our raising costs for the quarter about $1.25, so it did have an impact. But we have offsetting efficiencies.

Remember that for two years here, we've had PRRS impacts in these farms. So some of that has lessened so that the comparative number's not as bad, and we've had favorable grains. So from our standpoint -- Mr. Luter is pointing out, he's right, we've closed some of our -- we've made some changes about three years ago, that are having impacts now, we closed some of those higher cost farms, as you remember, we lessened [some], reduced the number of sows we had in place. We've done some things in our operations to improve it.

Now if it hurt you by about $5 million in the quarter and now the kind of the disease -- the virus season's over, and even if you don't have a vaccine that works yet, it's not going to hurt you anywhere to that extent going forward, correct?

I would tell you that we are having -- I want to tell that you we are having a seasonal improvement. The impact of circovirus is about half what it was now as it was three months ago. But we are still having an adverse impact in our Eastern operations. So do not go away from this call thinking we have no impact of the circovirus disease in our Eastern operations. Do not go away from this.

Seasonally it is certainly benefiting livability, and disease issues are lessened in the summertime just because of the seasonal improvement. But we are still having elevated mortality rates and elevated cull rates in some of our farms in the East.

So if you got $40 production costs down from, let's say, $42, what was the hog price realization?

For the quarter hogs were -- the ISM, the ISM is off some $8. From $50 lat year to $42.

Joe, while I got you --

You did catch my point here a minute ago, John. The hog market closed last night at 53.

Yeah.

Up substantially from where we were for the quarter.

I keep track of that, even over here. Joe, you can speak louder. The corn crop looks good. The hog markets look good. I guess there'll be some drags, and I know you're not going to tell me your exact hedges in each, but are you -- can you kind of give us some hints how you view crops and the sustainability of this kind of $53 number that we're currently seeing?

Well, I think it's fair to say that we did not expect the $53 hog market the first week in June two months ago, John. The markets are higher than what we expected. So as I've told you many times that we're not smart enough to predict the hog market. We never have been, and we never have been able to predict it correctly on any kind of consistent basis. And that's true today.

It appears that pork at this level -- we're killing close to 400,000 a head a day. We've got a $53 Iowa-Southern Minnesota hog market which really means that the quality of hogs that we raise, we're actually in the farms and getting about $55, john, not $53. So you have to factor that in, please.

The markets are stronger, but we do expect as we move into the Fall, there's no question this Fall the market will fall as it does just about every Fall. If there's any significant expansion in hogs in the next six to twelve months, it's going to have an impact, a negative impact on the pricing of these hogs. There's no question about it.

So the bottom line, I can't give you a whole lot of hope. As I've said many times, this is not an industry that you can predict what market conditions are going to be in the future. And some of my -- some of our competitors who have tried or attempted to do it spend as much time correcting previous predictions as they did with the original predictions. And I'm just not going to play that game. Because really we're talking about quarter-to-quarter, and as I've said many, many times, we just don't want our business too concerned about quarter-to-quarter.

I've said many times that we will disappoint you on an occasional quarter. This past quarter happens to be one of them. But we take the long view, it served us very well for 35 years now, and we're going to continue down that same path, hopefully.

Good. Thanks a lot.

Thanks, John.

Thank you. We have a question from the line of, pardon me, Christine McCracken with FTN Midwest. Please go ahead.

Good morning.

Hi, Christine.

Joe, you had just touched on expansion. We're clearly seeing some expansion in parts of the Midwest. Is it your view that that expansion will be fairly modest through the balance of the year? Can you give us any indication?

That's my opinion. I don't know of any major expansion that's taken place -- but it probably might be a little bit. I checked some numbers yesterday, actually, and I think that the total number of hogs killed calendar year-to-date in this country is about 1, 1.5% above the first five months of last year.

If you look at the population growth, that's not a big expansion that's taking place, but if I had to guess, I think the expansion will be .5 to maybe 1% for the next year. Obviously, the longer the prices stay up, the more optimistic people become and there's always a tendency to expand. It's the old law of supply and demand, it's always been with us in the past and I think it will always be with us in the future.

In terms of circovirus or [PCVR] and the losses that the industry is seeing overall, do you think that played a role in keeping that number fairly low or can you talk maybe about --

It's had some impact, I don't think it's been major. Obviously probably, it's my opinion, this may sound radical to you, Christine, but I think if you went out and shot and buried 5% of the hogs in the United States, the industry would make money.

Christine, let me make at least a point there. I think that we have probably been -- the Eastern part of the country is seeing the most impact of this, not the Midwest. And we're probably being impacted more than any other producer and probably any other processor.

And another -- two years ago, we were talking about PRRS, we had a PRRS problem. Today, we do not have a PRRS problem but I heard in the last week one of our major competitors has got a major outbreak in PRRS. So diseases on hog farms have been around forever and they come and go, and we monitor it very, very closely. We have many veterinarians full-time to make sure that we react immediately so that these various viruses or diseases do not get to dramatic proportions.

But this risk has always been with us. We've always been able to manage it, managed it and -- you know, what's going to happen in the future, I don't see anything major out there.

I would be much more concerned if we were in the poultry business. You've got the avian flu, which potentially would have substantially more impact upon the poultry industry than what we have to fear in the pork industry today.

Just looking at the futures for corn, obviously, it's really early still in the season, but obviously with the growth in ethanol that we've seen, there's quite a bit of pressure on corn maybe further out. Is that something you think could keep a lid on expansion? And how do you adjust your business for the expectation that corn prices could move substantially higher?

Prices move substantially higher, normally it dampens farmers’ enthusiasm to expands the herds. And cheap corn, people tend to expand the herds, higher-priced corn, they tend to sell the corn rather than feeding it to livestock because of the favorable prices. That's a general statement.

Having said that, people don't move in and out of the hog raising business as rapidly as they did a few years ago because of all the fixed costs associated with raising hogs today compared to the way that people raised hogs 15, 20 years ago, Christine. But, yes, corn -- the price of corn does have an impact on the decision-making of hog farmers, but it's not nearly as severe as it used to be.

Just one --

I think corn seems to be fully priced. We're very much aware the amount of corn that's going into ethanol production and will that have an impact? The answer is yes.

But at the same time, I'm not too concerned because if you look at what food and meat in particular costs as a percentage of a person's take-home pay today, I think the total food cost is less than 20% whereas 30, 40, 50 years ago, it was 50 or 60%. So I'm not too concerned if corn goes to $3 a bushel. It's not going to raise the price of meat to the point that people are going to stop buying meat, in my judgment.

Good. In terms of the EU, just to switch gears for a second, you guys have obviously said in the past that you expected Europe to be a much bigger piece of your overall portfolio. You talked about today your progress on the Sara Lee acquisition. Wondering if other assets became available, is that something that you'd consider at this point in addition to Sara Lee? It sounds like some things might be coming available.

And secondly, are you happy with the returns that you've been getting? Obviously, this quarter wasn't a bright spot, I guess, but perhaps due to some outside reasons. But are you happy with the returns you're getting on your current European assets, and does it make sense in the long run to continue to expand your exposure in Europe?

In Europe or everywhere, Christine?

Just Europe.

Oh, just Europe, okay. We do not have any sizable acquisitions on the horizon in Europe beyond Sara Lee, if that will answer that question.

Europe is a long-term play as vertical integration was a long-term play for us 15 years ago, Christine. And despite the short-term negative impact upon our earnings, I am convinced that Eastern Europe, particularly Romania, is the Iowa of Europe. Romania should be as predominant in Europe as Iowa is in the United States because that's where the cheapest grains are. And today with Romania being a net importer of meat is the same as Iowa importing meat from California or from New York. It makes no sense whatsoever, and I've got total confidence that Romania is going to be very, very bright for us long-term despite the fact that there are obviously costs and losses to get the business going over there.

But we're running the business the same way we did 15 years ago and we're not going to be making decisions based on fear of worrying about hurting the earnings for one or two years, and we make long-term decisions for long-term results, and that's what's enabled us to get to where we are today. I see no reason to change that philosophy simply because it has a negative short-term impact upon our earnings.

All right. I'll leave it there. Thanks.

Thank you. We have a question now from the line of Farha Aslam with Stephens. Please go ahead.

Hi, good morning. Could I have more color on your hog processing business? When you look at -- how many hogs did you raise or sell this quarter? Roughly.

I guess we raised somewhere around, Dan, you may have the numbers very handy, 3.5 million. Does that sound close?

3.4.

3.5 million we raised and sold, and we processed somewhere north of 4 million, no, 4.5. No, I'm wrong, 6.5.

So that gets me to roughly -- I can figure out where about 20 million of your U.S. hog profits are. There's another about 28 million based on kind of what you said the hog markets are doing versus your raising costs. I was just wondering, what is in that 28 million positive swing that gets me to 47?

Farha, if you look -- I'm struggling here. Dan, I'm looking at the segment profits in the 47 million -- are you talking about the $47.3 million?

Yes.

That's the profits that we made on our farms selling those 3.5 million of hogs on the farms to the plants. The segment up there, Pork, is the profits we make in the plants processing the animals and the profits we make selling the bacon, ham and sausage.

So if you sell about 3.5 million hogs and you sold them at about $42, roughly? To the plants?

No, actually, we will sell based on whatever the -- or we recognize as the transfer price from the farms to the plant, Farha. We recognize whatever the Iowa-Southern Minnesota market price is plus a grain yield premium. So it's just a little bit above the Iowa-Southern Minnesota price.

So would that be maybe $2 premium?

$2. Yes, that's a good estimate.

So that would -- still, that gets me to about -- with a $40 raising cost and 3.5 million hogs to about 18 to $20 million of U.S. hog profits.

The other piece of that, Farha, is that these are operating profits that the impact of interest. The segment profits are not the fully loaded costs. They are the fully loaded costs minus the interest cost charges into that.

And finally, that hog production number also includes the impact of our -- also includes the impact of our international operations.

And has the number of hogs in the international -- or the profitability in international hogs increased this quarter, or is it around 25 to $30 million?

The other piece --, I think what you're getting to, Farha, is there's a piece missing and that piece relates to our commodity activity. There is an amount of gains and losses related to commodity activity that does go through our hog production segment.

So you can say some of that was gains on your commodity hedging activities?

Yes. The differences -- the math that you're trying to do, the difference that you're seeing between that math and the hog production segment, a lot of that has to do with commodity gains and losses.

Okay. And if we kind of work that into next quarter, can we kind of assume that you're going to make about $30 per hundredweight in terms of hogs going into the July quarter?

I think it's more like, closer to $30 per head, not --

Sorry, $30 per head.

I think we're looking at some numbers just a bit shy of that. I believe last year's first quarter, Dan, I don't have that, but I believe we made about $100 million.

115.

115, Jerry's telling me, in hog production segment profits last year. And we believe we would be in that neighborhood for this quarter.

And do you see your hog raising costs going into next year being about $40 for the year, or do you think with corn going up and some of the disease issues you've had that growing costs increasing next year?

At least over the next three to five months, Farha, I think we're going to be $40 to not more than $41. I think it will be in there. And as we get farther out, I do believe those grain impacts, if the grain prices end up being where they are today, and there's some debate about that, yes, those grain costs will become an impact on our raising costs, and it will raise our raising costs something like $1 a hundredweight or better if these grains that are out there on the futures become the ultimate price.

Okay. And looking just into beef going into next year, the Summer is obviously very good. Can you kind of give us some color going into the Fall? Do you expect a contraction of cattle? How is that going to impact your cattle operations versus your beef processing operations?

I guess, Farha, you summarized my thoughts exactly. I think for the next while, cattle is going to be good. It's seasonally good, you know that. I do think we're going to have higher price -- both placement of cattle and the feedlots are going to be higher priced. I think there could be -- unless conditions change, I think the beef profitability going farther out towards the fourth quarter could be sharply lower.

Okay. And any material changes in your corporate expense line in '07 versus '06?

Farha, this is Dan. No, we're not projecting any significant -- obviously the hope amongst the group in this boardroom is that variable compensation expense will be up, but other than that, I don't see any significant changes.

Okay. And interest expense going into next year, what's a good number to use?

This quarter is probably a pretty good run rate. We're -- depending, of course, on what floating rates do over the next 12 months, but our fixed floating is fairly steady. Our borrowings are, absent any other significant acquisitions after the investment in the Sara Lee asset, will be up a little bit, but this quarter is probably a fairly good indicator of what our expectations for interest expense will be next year.

Okay. And what can we use for tax rate?

We generally, given the tax credits, the tax positions that we take, we generally fall in that 33 to 35 range.

Okay. Thank you very much.

Thank you.

Thanks. We have a question then from the line of Tim Ramey with D.A. Davidson. Please go ahead.

Good morning. Just back to the discussion on Europe. Assuming a Sara Lee acquisition, we know we're not going to talk about the probabilities, but assuming it, is that a -- is that strategy focused on helping your Western European operations, or is this back to kind of the cross ref that Joe has talked about in the past to Eastern Europe and supplying, you know, supplying pork out of Romania?

They're both important factors.

Okay.

I think, Tim, you are -- what we ought to -- and we can't talk about that acquisition, but certainly Sara Lee has some very strong brand presence in Western Europe and we are certainly impressed with that brand presence that we don't have quite that strength in our Western European operations, in France, in particular. So I think it will strengthen our market position there and just make us more important to those big retailers in Western Europe, and as well, provide an opportunity for our Eastern European operations. As it makes sense. We need to be clear in saying that makes sense.

I was thinking their operations were largely private label in France.

They've got some very strong labels.

Okay. That sounds great. Back to the cattle feeding question. I know you're not going to tell analysts whether they should or shouldn't put stuff into the extraordinary category, but doesn't it make sense to just let this flow through and not try and adjust for short-term swings in the market every quarter?

Tim, I would respond to that. Dan might have or Mr. Luter may have their own opinion. I would say yes to that. We are not expecting you to make these big, what I call, one-time or extraordinary adjustments. It is simply, and Dan made the point very clearly I thought, we had made a prerelease of where we though we might be and so we did have this adjustment. It does relate to future periods, not really the current period. I don't think you should make adjustments for it. We're simply going through the rational for why the results are where they're at.

Understood. I agree. Thank you.

Thanks. We have a question now then from the line of Pablo Zuanic with JP Morgan. Please go ahead.

Hi. Good morning. This is Aksheh [inaudible] I have a question on Pablo's behalf. Just relating the issue of oversupply of meat and it's effect on prices being depressed. And you alluded to this earlier in that we've seen chicken, or leg quarter prices come up about 60% in the last 12 weeks. Has that helped pork prices, like cut out prices at all?

The short answer to that, Pablo, is absolutely yes. That's a very simple yes answer. The pork loin market has come up nicely. The ham market has come up substantially. And chicken competes with pork, as you well know. Some of that had to do with export markets. Absolutely, there has been some control and contraction in terms of the chicken industry. I think they've done a nice job of recent, it's helping the business, it's helping all the proteins. And short answer to that is yes. I mean, the cut out prices on the meat are up substantially.

Great. Thank you. All my other questions are answered. Thanks.

Thank you. We have a question then from the line of Reza Vahabzadeh with Lehman Brothers. Please go ahead.

Good morning. On the France issue, the challenges in the last quarter or two, is that a function of overcapacity in that country? Is it an issue of fragmentation? Is it an issue of just market position? Can you just kind of very quickly touch on that?

Yes. It's a matter of overcapacity, it's a matter of existing French labor laws which make it extremely expensive to shut down on a plant or rationalize your plants. We were hoping they were going to change those laws in France, but it looks like the children are running economic policy in France rather than the government, and there hasn't been a change. But we do expect -- it may not happen this year or next year, but we certainly expect in the next two or three years that France will have to change some of their restrictive policies in regard to free movement of capital and labor in France if they're going to be able to compete with the world.

Having said all of this, I've said many times that there are more opportunities in bad times than there are in good times, and things are not going well in France. But I do think over the long term, France will get its act together and then make the necessary steps to keep France competitive with the rest of the world.

Would you say to the European operations are already operating at sort of tough levels of EBIT performance, or is there more downside, or are we going to bounce back up some?

If I had to guess, I think we're somewhere near the lows, when it will turn around, I'm not exactly sure. But as you know we have operations in -- we have a minority interest in a major company in Spain, Campofrio, and they're doing reasonably well, but they're not doing as well as they were expected to. But things are tough in Western Europe. You've got the assimilation of Eastern Europe into Western Europe, but there's no question in my mind that as Eastern Europe becomes more affluent, they will put a sizable part of that increased wealth in that diet and that should serve us very, very well. So we have put most of our money in Eastern Europe, not Western Europe. But we did have the Sara Lee opportunity come up and we decided to pursue it. It was sort of a once-in-a-lifetime opportunity.

I know you talked about a joint venture type of an operation in Europe with respect to Sara Lee. If you have a joint venture operation, can you still extract synergies despite a joint venture type of an entity with your base business? Does it make it a bit more complicated but still doable?

No, no. Synergy is -- we will be able to do because we are contributing our French assets into the -- if we buy Sara Lee, into the Sara Lee operations, and our partner has agreed to that transfer.

I see. Okay. And then, just to clarify, Larry, from your comments, it sounded like you were somewhat sanguine for the hog operation's profitability near-term and for some time, but you're still pretty cautious on pork processing margins in the near-term?

Well, if history is any judge, Summertime is the weakest period of the year for fresh pork margins, for sure. So there's nothing unusual about that.

Yes, I believe that fresh pork margins could be weak really for the entire Summer. And I would tell you that until we get through all these process or excess proteins, think that the processed meat margins can probably be weak for at least the Summer, but I'm very optimistic as we get into the Fall. I think we're going to have a very strong processed meats Fall period for the holiday season. I realize that's quite a ways away, but in our business, we're working on that as we speak.

So I think a little farther out -- not the first quarter, maybe even most of the second, but I believe that our processed meat margins in our processed meats business continues to grow very nicely. The cooked product very nicely. And I think we're going to have a very good Fall.

And then lastly, in terms of acquisitions, you mentioned there's not much available for sale in Europe outside of Sara Lee, but how would you describe the M&A environment in the U.S.?

Well, let's see. As you well know, ConAgra has announced that they're going to sell that processed meat operation. We expect to be an active participant in that bidding process.

Sooner or later, I believe that Swift will be put on the market one way or the other. Whether it happens this year or three or four years from now, I certainly think it will happen, certainly, within the next five years. I see those as two of the biggest opportunities that are out there. There may be some other assets that will come available, I just don't know. But there are two very sizable operations that in my opinion will be on the market in the not too distant future.

Great. Thank you.

Our time is up for today. We thank everyone for joining us. And have a nice day.

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