Smithfield Foods Inc (SFD) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Smithfield Foods first-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. (OPERATOR INSTRUCTIONS). As a reminder, today's conference is being recorded. The replay will begin today, Wednesday, August 23 at 12:30 PM Eastern time and will be available for one week, through next Wednesday, August 30 at midnight Eastern time. You may access the AT&T executive playback service by dialing 1-800-475-6701 and then enter the access code of 839396. (Operator repeats numbers).

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

Good morning. Welcome to our conference call to discuss Smithfield Foods fiscal year 2007 first-quarter results. We'd like to caution you that, in today's call, there may be forward-looking statements within the meaning of federal Security laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Smithfield Foods 10-K for fiscal year 2006.

With us today are Dan Stevens, Chief Financial Officer, Richard Poulson, Executive Vice President, C. Larry Pope, President and Chief Operating Officer, and Joseph W. Luther 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 am pleased to report first-quarter earnings for Smithfield Foods for this year of $24.6 million compared with $49 million last year, $0.22 a share compared with $0.44 last year. I hope you had opportunity to read the press release and you will note a couple of items that need to be considered as you look at these numbers, including some discontinued operating results related to the operating results for the quarter for our Quick-to-Fix foods and the eventual sale of that, which we did complete on August 15 of this past week. Those numbers total $0.13 a share and total $14.3 million. Adjusting for that, we are at 38.9 million compared with $49 million last year.

In addition, we made reference to the fact that we have written down -- made an adjustment to our investment related to hog production operations in Brazil, recording a $4.2 million pretax charge -- writing that investment down to a level that we believe that we are in the process of divesting ourselves of that 50% interest. So we are adjusting that to the price we anticipate receiving here over the next several months from our joint venture partner in Brazil. That is recorded in continuing operations and is part of the $38.9 million.

In terms of the business, hog production profitability continues to carry the day for Smithfield Foods. We're entering well into the third year of very strong live hog prices. These live hog prices, combined with our control of our raising costs, continue to drive very solid profitability for this company, particularly in that segment of the business. You will note that our pork operating profits are essentially double those of last year. Included in that is $6.5 million of commodity gains related to some of our hedging activities in the meat category, and it relates forward into the fall. However, from an accounting standpoint, we are marking that to market. Dan Stevens might address that more in his comments, but you need to understand that that's in those numbers.

Fresh pork is not where we would like for it to be. Fresh pork numbers are depressed, although vastly improved from last year, so the numbers are comparatively good although not where I think they should be. As well, our processed meats business is not where I think it should be as well. We are profitable, but we're not where I think these margins need to be. I'll talk about that as we talk about some of the things going forward in just a minute or so.

Several of the categories we've talked about a number of times -- continue to be good for us, from spiral hams; we had a very good quarter in lunch meat, the dry sausage, the precooked sausage and precooked ribs. All those precooked categories continue to be very, very good for this company and it's a continuing direction for us on the processed meats area.

So the traditional categories are to some degree going the other direction. Those margins are tight. There's an awful lot of competition in that area, and those margins are being squeezed. That's the reason our overall processed meats margins are not where they need to be -- is in the traditional categories, not in the new convenience and fully-cooked categories.

On the beef side, our earnings are down slightly from last year. That's the combination of our beef processing operations -- we're really quite profitable, and our cattle-raising operations have been unprofitable of late. I'll talk about where I see that going in the future here in just another minute.

Internationally as well, our numbers are improved. Last year, we did have a charge related to Poland, related to a product problem in our Polish operations that impacted $5 million on last year, so you need to consider that as you see the $5.2 million loss in the segment reporting last year. It was $5 million related to that, and that's behind us and we are moving forward.

I remind you that we completed the Cook's Foods acquisition toward the end of the fourth quarter, so all of the Cook's sales and the Cook's operating results are in our first-quarter numbers. We are incurring losses in that operation; it is seasonal losses, which is that's a highly seasonal business with the cut ham and spiral ham business. We expect to lose money in the first quarter and portions or part of the second quarter and pick that back up pretty strongly towards the end of the second quarter and into the third quarter as we move into the fall holiday season.

We have completed the acquisition of the Sara Lee meats group in Europe and we have changed the name to Group Smithfield, which represents those processed meats operations in Western Europe that Sara Lee was previously operating. We're just beginning the hard work of integrating our French operations with those French operations. I will remind you that we have a 50% partner with us and so we've got an awful lot of work to do there, although we think the opportunity there is very solid.

You are fully aware that we have an acquisition on the table for ConAgra Foods related -- for their red meat, the Armour and Eckrich brands, as well as the very strong Butterball Turkey brand. On this call, I'm not going to spend any time talking about that acquisition. We are the middle of our Justice Department filings; the acquisition is not done. We anticipate that being completed somewhere in our second quarter, so I would ask you, in your questions, to please refrain from asking us too much in that area as we're really not in much of a position to respond to that.

From a strategic standpoint, we put forward about two years ago the fact that this company was going to make it a point and a strategy to utilize our hams and bellies internally. We have continued to move in that direction, both organically through some of the investments we've made in the ham category, as well as the investments we've made in the precooked bacon category with the acquisition of Cook's and now the pending acquisition of ConAgra. We will find ourselves on net buyer of hams and bellies on a regular basis. It has taken us a little over two years to accomplish this goal, but I think we are clearly there. This should give us the opportunity to maximize the value of those particular two cuts, where before we have been selling them in the open market, in the commodity markets and having to sell those at the best price we can. We now will be in a position to sell those or take those products and put them into our process, make them into Cook's product or into branded processed meats. That's a direction we started two years ago and I'm pleased to say today that we are there.

These additions combined with where we are today should give us a giant processed meats business, and the 3 billion-pound-plus range should make us a major, major supplier to the deli, the foodservice and the retail categories. We've wanted to become much more important to our customers. The combination of Cook's and ConAgra in the U.S. make us a very large foodservice supplier, as well as a full range of products to our retail customers. I think it's going to be very, very good for us once we get through this process.

In terms of Europe, we have been -- with our French operations and our Eastern European operations, we've not been much of a branded company. This European acquisition will move us much more into the branded arena, which is the area where the margins are better, as well as create that opportunity for us to have the combination of our European, Eastern and Central operations supplying and manufacturing, over time, some of the products potentially for the Western European markets and tying those two together in terms of going to customers with both fresh pork and processed meats. That will take time. It's not something that you're going to see immediate results from. In fact, you may even see adverse results from this but we do think it's the right strategy. Mr. Luter has made this comment many, many times and I think we're on the right track here. We've made some big steps in the United States; we're making big steps in Europe. I think we are positioning ourselves very, very solidly for one year, two years and three years out.

One point I want to touch on involves cost. There's been a lot of discussion in all the industries about the cost in doing business. Our costs have been going up. I know others in our industry have been talking about cost-control programs they've been putting in place. We've been on that initiative. I don't think we say an awful lot about it. We've been taking steps and you can see some of those steps over the last year, as we get our costs where we believe we have to be to be fiercely competitive going forward. First, the latest that in that is the sale of the Quick-to-Fix foods business. We exited that business; we could not get the costs where we needed to be, and one of their close competitors, Advance Foods -- we've done a deal with them and that's behind us.

We've been on an initiative, what we call an East Coast strategy, for our Eastern operations, of rationalizing both some of the slaughter processes and now the processed meats business in the East. You've seen us take a couple of restructuring charges as we've made decisions to rationalize out plants. We are continuing to do that and we're reaching the end of that process. At this point, we've ceased one of the slaughter operations in Virginia; we've announced several plant closings. As we make the decision to move these plants closer and closer to that raw material, eliminating the inter-plant freight and the inter-plant transfers, as well as we've been upgrading our manufacturing. I talked to you several times about the fact that we've been upgrading our manufacturing capabilities -- and our manufacturing capabilities are -- we are improving them faster than we can develop the sales opportunities, so we've actually had utilization issues in some of the plants because of some of our capacity abilities. So, we've been making continual progress there and I'm pleased with that.

A year and a half ago, I established a strategic sourcing function within the Company to identify new ways to buy non-protein-related supply items for this company. We've made large progress in that area. That's just a continuing business.

Then finally, we started a process about eight months ago, what I call production benchmarking, but it's streamlining our manufacturing operations by bringing in a couple of people from outside (indiscernible) their very, very technical knowledge in terms of how to layout these plants and how to index products down the line to get 12 and 15 and 20% improvements in our line efficiencies in terms of product from the beginning through the coolers and into the box. All of that we believe we are incurring some of the cost today as we make those changes. Those aren't huge, huge numbers but they have disruptions to our operations. We are focused on that. We are in the process of finalizing the completion of our new ham-processing plant in Kinston, North Carolina. I fully expect that plant to be operational in the month of September. I believe that will give us, I believe, the best head-processing plant in the world. We immediately would be ramping that up to 60-70% of capacity. We have the business there. It drives an awful lot of cost out the ham-processing end of the business, and that's a very competitive, very competitive category. This should make us very competitive in that category.

So, I felt like I needed to react to that because we are seeing some of the cost increases that others have talked about, and we know we have to drive these costs out. Smithfield has always prided itself on being a low-cost producer, and so we continually stay to the task of looking across these operating companies. We do have comparative reports across all the companies and all the operations so that we can see the manufacturing and overhead cost associated with each one of these plants. We have very detailed reports and we take those very seriously, and that's our day-in/day-out job that we don't say too much about except when these numbers get to a level and some of the energy costs that everyone talks about are impacting us. They have resulted in lower margins, and it's a competitive market. It is difficult to pass on any of these price increases through to the market. So we realize we have to be vigilant in our cost control and staying to the task of identifying every cost increase and doing something about it.

Overall, for the quarter, I'm not going to say I'm pleased with the results. I'm not pleased with the results. Comparatively, they look pretty good on the segment reporting. I think there's a lot of opportunity to grow these numbers. Many of the numbers comparatively looked good at sort of the external reporting level. There's an awful lot of opportunity behind those numbers. I am satisfied with the quarter -- well, reasonably satisfied. I would tell you that I'm not happy with this quarter, and we understand where the opportunities are and I'm not by any means bragging that Smithfield had any tremendous quarter here. But I do think there's a lot in there and there's a lot coming.

Before I sort of speak to the future, what I'd like to do is turn this over to Dan Stevens, who will give you some of the financial information and then I will give you my outlook going forward. Dan?

Okay, thanks, Larry. Good morning, everyone. I will just cover some of the key financial highlights for the quarter.

If you take a look at our income statement, as you saw in our press release, our sales for the quarter were 2.8 billion compared to 2.9 billion in the first quarter of last year. The 150 million or so decline is really attributable to two reasons. The beef segment sales were down as a result of cattle feeding last year, where we had to sell a lot of our cattle inventory in last year's first quarter. Now, as you know, most of those sales are running through our joint venture investment in Five Rivers. The rest of the decline was in the pork segment, where we had lower volumes, although our average selling prices in the segment were slightly better than last year.

If you take a look at our sales going forward, with the contribution of our French business to the new European joint venture, the sales of our French business, which run about 100 million a quarter, will come out of our P&L and we will just be picking up our share of the earnings in the joint venture in our equity and earnings line in the P&L.

Our selling, general and administrative expenses were up about $2.5 million. This does include the Cook's Ham business acquisition that Larry mentioned that we did at the end of last year. But we also had higher advertising and promotion spending this quarter compared to last year.

Interest expense was up about $3.5 million, quarter-to-quarter, but pretty much in line with what we had told you at the end of last year. The increase is really all attributable to increased borrowings compared to the same period last year. Our average borrowing rate actually came down slightly, quarter-to-quarter, compared to last year.

As you saw in the release, operating profit for the quarter was 98 million. If you add back depreciation and amortization of 61 million and the non-cash increment charged that Larry mentioned of 4 million, our earnings before interest, taxes, depreciation and amortization was 163 million this year, which is just about the same as the 162 million for the same period last year. On a trailing 12 basis, the EBITDA is just around 650 million compared to just over 780 million for the same trailing 12-month period last year.

Our cash flow from operations was a use of cash of 23 million in the quarter, compared to a source of cash of right around 100 million last year. The lower cash from operations is obviously impacted by the lower earnings this year, but we also had a pretty significant buildup in working capital. Part of that is seasonal for the Cook's Ham business that we didn't have last year, and part of it is a buildup in our own company-owned cattle inventory.

If you take a look at our balance sheet, our capital expenditures for the quarter were just over 106 million compared to depreciation expense of 59 million, so obviously significant CapEx spending again this quarter. The two biggest projects that are driving the capital expenditure number are the ready-to-eat ham plant in North Carolina that Larry mentioned, as well as the continuing buildout of the production operations and the plant renovation in Romania.

I would say, even though we've slowed the approval of expansion capital expenditure projects, I would expect that we will continue to be spending in excess of depreciation for at least the next couple of quarters, given where we are on our committed capital projects.

Our borrowing level increased by about $140 million to $2.7 billion. The increase is the result of higher working capital levels and the increased capital expenditure investments.

Following the quarter end, we did close on the European joint venture investment, as Larry mentioned. That will increase our borrowings in the second quarter by about another $63 million relating to our cash contribution to the TV. With the increased borrowings, our debt-to-total capitalization moved up to just below 57%, which is just slightly ahead of the 56% debt-to-total cap that we had at year-end.

Finally, this week, we are closing on a 300 million year revolving credit facility in Europe, which -- that will be used to support our expansion projects in Europe. We did this deal in order to give us additional capacity in an area where we really expect to have significant growth over the next few years. This new facility will add about $380 million of worldwide borrowing capacity.

Just one last thing before I hand it over to Larry -- he had mentioned the mark-to-market adjustment that we recognized in the pork segment. I think, as most of you know, the accounting rules are very, very strict and very well defined in that area. And in the case of our open commodity positions in the pork segment, we actually did not qualify for hedge accounting, so even though the accounting rules sometimes differ somewhat from the business purpose behind the hedges, it did require us to take a mark-to-market adjustment in the pork segment this quarter for open commodities positions that just didn't qualify for some very strict documentation requirements to qualify for hedge accounting treatment.

So with that, I will hand it back to Larry.

Thank you, Dan.

As you can tell, we've got an awful lot going on, both in the United States and overseas, and I think, from a financial side, we're taking some steps. Dan didn't make the point that one of the benefits of doing a European financing -- and we're thinking about that more and more -- is that we are borrowing some of these monies in foreign currencies in an order to match up some of these exposures that we've got in foreign currencies with foreign-denominated debt. That helps us, from a cash flow, in terms of the reporting, and so we thought that was an appropriate step to take and as we continue to invest more and more in that part of the world, we will be looking to that part of the world as for a source of capital going forward. It's the right thing for Smithfield Foods to do as we go forward.

Looking beyond the quarter, Mr. Luter and I talk oftentimes. He and I both get depressed when you go through the summertime in the meat business and the margins don't seem to be where they should be. I lament the fact that, gosh, I can't seem to get the margins where they should be and the fresh port numbers are not where I wish they would be. Then the weather cools down and life -- kids go back to school and the numbers seem to get better.

Looking out past Labor Day and into the fall and the holiday season, I'm generally optimistic in spite of some of my pessimism today, only because it's the hot doldrums of the summer. Hog production is going to be very, very good. I am surprised sometimes how strong this hog market has been; I am as well surprised at where these meat cuts are. I mean, hams are trading at $0.80 and $0.80-plus and we're in the summertime. I don't believe that hams have ever traded at $0.80 in the month of August, but they are. In fact, there's pressure as we speak for prices higher than that. Live hog market is $55 as we speak. Many of you track the futures market, so you know that the futures are very strong on the live hog side well out through the rest of the calendar year, well into 2007. So the live production side of this business is going to be very good and going to be very good for quite some time into the future. I see really nothing that's going to change that. Unfortunately, we have had, as I outlined in the press release, we have had some increased raising cost. We're dealing with Circovirus in our eastern operations and a touch in the Midwest, and I understand others are as well. That is having some impact on our raising costs, but we continue to control those to the extent we can. I think our operating President, Jerry Godwin, and his group have done a good job of managing through this process, but we have not solved this problem. I want to say that to you upfront. But, that's going to be very good. Live production -- it's been fueling good results. I think it's going to be very, very good for the next three, six, nine months. It's hard to tell at this point.

The fall is always much better for fresh pork, as many of you know who track this industry, so the fresh port numbers should improve as we go into the fall. Processed meats, I don't need to say anything except the holidays are always very, very good for us on the ham side. This year, we're going to have the Cook's earnings coming to us from their ham business. We've got the existing 49% ownership in Carolina Turkeys. As I said, we should close on the ConAgra transaction here in probably in September. Those earnings from the Butterball business -- and you all know that the Butterball is the premium turkey brand in the marketplace; it commands a premium price. So that should be very, very good for us as we go into the holiday season on the turkey business and on the ham business; that processed meats end of the business should be very, very strong for us.

On the beef side, I think beef processing margins are good now; cattle raising is not. I believe that this thing might very well flip as we move through into the winter and we may have a situation where beef processing is not good but it looks like cattle raising is going to be very, very good, if you look out there for the futures markets in terms of where cattle prices are going. So I think the combined group of cattle raising and the processing side are going to be fine on the beef side.

Internationally, we continue to get better. We probably will see some bumps related to merging our French operations together with what we call Group Smithfield now in France, so you may see a hiccup or two coming through on that, but we're going to be making progress on the national front, both in Romania where we will be opening this new processing slaughter plant November 1. We're on track to do that and I expect we will be very close to that date if not exactly on that date. You are aware that Romania is still slated to go into the EU January 1 of '07 and all indications we have at this point, that's going to happen. That's going to be very good for us in limiting imported product from non-EU countries, which should be sending us market opportunities right into that country, right on time when there will be import tariffs coming in for product going into Romania. we should have a competitive advantage by producing that product in the Romania -- inside that domestic market and marketing inside that. As well, we will be marketing fresh product as opposed to frozen product in that country, so I think -- again, I'm optimistic that's going to come up very, very well and as I say, make money day one and everybody laughs and says that probably won't happen. But I am extremely bullish in terms of where I think that's going to be.

Freezer stocks -- I think the July freezer report just came out. On the pork side, those numbers are down. We're going in on tight -- we're going into the fall with tight supplies, which gives me every indication that these markets are going to be good for all of these cuts as we go into the fall season. So I am really pretty bullish and pretty optimistic in terms of where we go forward from here.

Longer-term, I think we are making the right decisions in terms of investing in Western Europe. I think we're making the right decision to build this giant processed meats business to utilize our raw materials internally for this company. We built Bladen County back in the early 1990s. We went more towards the fresh side of the business. We've been committed to getting back to being -- selling more processed meats that we have raw materials. I think Mr. Luter has had a strategy now for better than ten years; it's an excellent strategy. We've been able to integrate these operations into ours, keep those management teams in place, redirect what they do. I think we're building ourselves one giant, nice company on the fresh meats side and the processed meats side, and we're making the investments overseas that will give us the ability to arbitrage what I've (indiscernible) internally. We are arbitraging the world. We're going to put hams where it makes the best sense to sell hams. We're going to sell bacon in the best channel and the best market where it makes sense to sell bacon. We're going to look across our operating companies and make product in one place and market and distribute it in another, and I think that is excellent for this company and there's a lot of integration issues. It's a day-to-day business. There's a lot going on. We are certainly challenged every day, but I think we're building one nice company for the future and I think we're doing it smartly. We're keeping the balance sheet, keeping the balance sheet in check. We are financing as we need to. We've taken the opportunity to access these capital markets at favorable rates. I think we have built ourselves something I'm very proud of and unfortunately my results for the quarter don't quite demonstrate where I think we are on a longer-term basis, and it's the dog days of the summer. But I believe, for the next year and two years and three years, I have some profit targets that would scare most people. Whether we can achieve them or not, we will see, but I am extremely bullish and optimistic about where we're going from here.

With that, we will open it up for questions. Mr. Luter is on the phone so we will take your questions at this point. Jerry?

May we have the first question, operator?

(OPERATOR INSTRUCTIONS). John McMillin, Prudential Equity.

Good morning, everybody. Joe, all the best. You've been a moneymaker and you've been entertaining to boot, so come back every year or so in these conference calls and entertain us if nothing else.

Joe, as you kind of look to the next three to five years and you kind of address big-picture issues, you know, is the greatest challenge for Smithfield -- is there enough corn? Is there enough money to do everything you want to do? Is there enough people? How would you kind of layout the longer-term challenges that the Company is faced as you kind of depart here?

Well, I'm departing, John, but I'm going to still be around. Okay? That's number one.

Number two, I think the biggest change that I see in the next one or two or three years is the impact of vertical integration in the United States on pork and then eventually on beef. What you're seeing today, we are premium standard (indiscernible) with Seaboard and with the new startup plan in the jury Missouri with Triumph and they have indicated they're going to build a second plant, plus ourselves, we are the four people that grow a substantial number of hogs in this country. All of these people are beginning to make decisions on the profitability of the total company and not just in fresh meat production, and not just in hog production. What you are seeing is very aggressive bidding for hogs when the profitability is not there on the fresh meats side. But it's made up by pushing hog prices higher than what they would normally be. We are seeing (indiscernible) cut outs today but yet we are killing 395,000, almost 397,000 I believe day before yesterday. I don't know what the kill was yesterday but I suspect it was north of 395, which are prehistoric high kill numbers for the month of August and the product is moving out. The profitability is good on the production side, but it is not satisfactory on the fresh side, but I think you are going to see that for the long-term.

This may be self-serving but I really don't see a bright future for people that don't own a substantial number of hogs going forward, simply because of the aggressive bidding for these hogs. We have people that are killing hogs on Saturday with red cutouts, but it is keeping the hog prices high. This is a fundamental change that we are seeing and it's being really accelerated by the building of the new plant by a group of hog farmers in Missouri.

Okay, Larry, scare us! Can you scare us?

Scare you?

When you said your numbers, your profit targets were scary.

(LAUGHTER)

Be careful, Larry. You don't want to go to jail.

I know.

Okay.

John, you know that. I guess Joe and I have had the conversation a million times. If I wasn't optimistic about tomorrow, I shouldn't have this job. I think that the opportunities here are very solid, and I think that we've got a lot to do to get to them, but I think we've had a history of delivering good results. I think, again, with Mr. Luter's strong direction here, I think we've built something here that's -- that I'm pretty proud of, and I know he's proud of. I think that, as Joe said, people out their killing hogs today and not making anything on it. They are out there selling processed meats and also not making much on that, either. People are filling up plants just to keep plants running. I think, over time, we've got the raw material. We can rationalize some of this low margin, some of this low-margin business now that we are in a net buyer. I think that we can make something on this meat as opposed to just selling meat and paying the bills.

Great. Two more quick questions -- the hog -- you gave feed costs in the press release. What was your hog prices realization?

In terms of what did we sell? Well, I think -- (multiple speakers)

Well, feed costs were up $1.50. I just wondered what were hog prices.

$51 I think is what the ISM average for the quarter, John, and you know that we realize about $1.50 or $2 a hundredweight above that.

Last year's number?

Almost exactly the same, almost exact -- so the differential in the hog profits is really two things. It's the increased costs that we weren't able to recover. The sales price is almost exactly the same, John. It's just that we had $1.50 increased raising costs and we had a few less hogs as a result of Circovirus, the mortality on the finishing side limiting the number of hogs that we had.

I think yesterday, John, I think we got $57 a hundredweight.

That's right. I think you're right, Joe.

Joe, it doesn't sound like you are turning it down on that too much (LAUGHTER). You know, retiring CEOs (indiscernible) shouldn't watch the market every five minutes.

Well, it's been my life, John, and as I said, I'm going to be a pretty active Chairman of the Board, but I think, by appointing Larry CEO, this is the next logical step in an orderly management transition. Larry and I will be, I'm sure, having quite a bit of conversations -- (multiple speakers) -- next year.

I will have to agree with Joe on that.

I just hope he keeps talking to us!

I think he will.

The final question, just on these commodity hedges, my understanding is if you kind of own the corn, you don't have to mark the hedges to market, but if you have a commodity contract, you have to identify the costs and kind of mark-to-market. Just when you talk about documentation, I just didn't understand -- if you could just kind of add some details on that. I guess that is about -- what does that work to, about $0.04 benefit? But just if you can kind of -- (multiple speakers).

Dan, do you want to elaborate on that?

These were not grain -- John, these were not grain contracts. These were actual commodity cuts. These were principally hams. We had gone long on some open commodity positions for hams, and because we couldn't come up with the appropriate documentation -- obviously we sell a lot of hams in the fall season, but because we couldn't demonstrate the firm commitment for the sale of those hams, we were not able to -- we just didn't qualify for hedge accounting, as John said.

We're going to have an excellent ham Christmas for one reason. We have bought some very, very cheap hams compared to what current market prices are today.

But you've had to realize that benefit upfront?

Just a small portion of, John.

John, one of the things that you have to do is match those up almost with a customer order, and as you know, it's a bit early in the season to have an actual customer order in ham -- (multiple speakers) -- had to mark-to-market. But as Joe says, I think we are in a very strong position relative to ham -- where we will have our hams priced or have our hams bought for the fall -- that I think he's right. We are going to make -- should make some solid margins on these hams this fall.

(multiple speakers)

But some of these accounting rules, John, are bizarre, but we have to comply with them 100%, but we don't necessarily agree with some of the rules. We think it really confuses rather than educates people such as yourself, but -- (multiple speakers).

John, we've even had a debate with our auditors as to whether bellies are an inappropriate hedge for bacon, which seemed pretty obvious to those of us in the meat business but by doing these correlation analysis, sometimes depending on the markets, they don't correlate exactly correct and so they say buying bellies as a hedge against your future bacon sales is not necessarily a legitimate hedge. We sort of shake our heads at that kind of comment.

Which makes no sense.

Thanks for all of this.

David Nelson, Credit Suisse.

Good morning. I'd just like to try to reconcile Larry's -- your comments about some of the weakness in fresh pork and processed meats being I guess number one a seasonal issue and maybe secondarily internal cost issues that you talked about, trying to streamline -- then Joe's comments about a more structural change that I certainly see with new packing plants coming on, not just Triumph but PSF adding capacity at [myelin]. I guess the key is the entire integrated chain. Can you comment someone how you see that netting out? I would think, given the number of hogs you raise versus the number of hogs you slaughter, that would be a net positive. Would you agree with that?

I would, yes, John. Larry can speak for himself.

David, and I guess the thing I was making a comment on fresh pork -- it's seasonally. Fresh pork -- the summertime is the worse time of the year. You know that; I don't need to repeat that hardly to anyone. In the processed meats, the other side we've had with processed meats, David, and Joe made reference to that, is the fact that the demand for these hogs and these kill levels has been tremendous.

The other thing is that we've had these cuts to move up, bellies being an example; ham being the most obvious example today. These cuts have moved to levels no one predicted, so we always are selling forward on processed meats. So, we weren't selling hams through the summer at a $0.75 and $0.80 market -- well, $0.80 is of recent but $0.70 and $0.75 ham markets, we weren't selling against that. We were selling forward, and bacon is the same thing. It takes time for those to catch up. So our processed meat margins haven't been there. But the export demand for this product has been excellent, not necessarily from our side. Our exports are not what the industry has experienced -- is experiencing, because we don't have the raw material, particularly hams, to sell to Russia and to Mexico. So we've been calling some of the margins and I said some of our costs are a little bit elevated. But that's why I say our margins are down now.

One point, too, is if you look, David, at last year, we were killing hogs very aggressively in the summertime, and the hog market was pretty good. This summer, by design, we've cut our kills and we have run at less capacity than most all of our competitors and probably all of our competitors this summer, because Triumph opening up their new plant has taken up that capacity. We could have killed a lot more hogs this summer than we did. Yesterday, as I mentioned, I think we killed 397 -- the day before yesterday, we killed 397,000 and we are still not working over time, and we're not working any Saturdays. So, you know, we will be able to -- you know, if we decided today that we want to up our kills, we would push the hog market up $2 or $3 a hundredweight, in my judgment, David, but at the same time, I think we would increase the global [blood] on the processing side and we have elected not to do that. But there's still there's a lot more capacity out there. We estimate there's capacity to process north of 410,000 hogs a day. I think we'll see those numbers this fall. But as I say, I am more convinced than ever that the vertical integration strategy is going to give us a tremendous strategic advantage, not just ourselves but the other three people that I've mentioned also. But quite frankly, you know, this is a strong statement but I don't think there's going to be any money in the fresh meat side of the business going forward unless you have a livestock operation. That's pretty aggressive but that's my current thinking.

If I could move onto hog production, is the negative impact of Circovirus -- is that getting less bad and if so, about how much? Have you been affected in the Midwest by [pers] at all? Is the whole situation getting less bad for you?

David, I would tell you that the situation is not getting less bad, but it's not getting worse, either. We continue to see it in just localized areas, so I can't tell you that it's gotten a lot better, but I can tell you that it hasn't gotten any worse. We continue to work with these vaccines and I would just be repeating last quarter's call so I won't bore everybody with that. It is an issue that's affecting -- well, I think it's more affecting in the industry than maybe I know, but we know it's affecting some of the others in the industry; it is affecting them a little in our Midwest at this point, not significantly. It is the driving -- it is the vast majority of the reason our raising costs are up this quarter. The change from $40 last year to $41.50 -- I think the cost there was about $1.25 a hundredweight was the impact of the Circovirus on our raising cost.

Okay. Maybe my third and last question would be on international. I guess a quickie first of all in Romania -- is that new plant you're talking about -- is that Timisoara?

It is.

Okay, good. Then in Poland, I guess it's been a long time coming; you've been there awhile now, maybe eight years. Just the lack of profitability there is a little frustrating. When do you see that tide turning?

Well, I would tell you, David, some of the issues that we've had in Poland -- we've had profitable years. Last year's profits -- I could talk about some mistakes we made on our distributions. I want to say that Poland -- we are putting the business and sometimes we run at right. We made some mistakes in distribution last year, but beyond that, last year, I think we were politically motivated. We had a product problem in one of our plants; I think it was totally politically motivated, cost us 5 or $6 million, maybe 7 or 8. As well, we had this bird flu impact in Eastern Europe, and the cases were there in that part of the world, so it adversely affected our poultry operations in Poland. That came in sort of November, October/November/December. That impacted the latter part. We are, at this point, profitable in Poland and I'm expecting -- again, it's the business so what happens in the business? But I think --.

David, one thing -- for the last six or seven years, we've had one man over there that has sort of been in charge of Eastern Europe, but we've recently hired the top pork guy; he came out of Maple Leaf in Canada, who is a Polish national, and he is now running our Polish operations. He's on the ground over there and he will be giving 100% of his attention to Poland, whereas in the past, the management has been overstrained at the top with Morten Jensen handling Romania and Poland. Morten is really concentrating hard on Romania. Then we have we think proven top management in Poland. I think we were very, very fortunate to find in someone that is Polish, that speaks Polish, that's got a Polish background, that's got the experience that he has. And we are expecting -- we expect Poland to be pretty good going forward. We've paid our price, but as I've told the industry, we will make decisions and take losses for three, four, five years for the future. I think we've turned the corner in Poland and things are going to be a lot better in Poland going forward than they have in the past.

Great, thank you very much.

Christine McCracken, Cleveland Research.

Good morning. I just wanted to delve a little deeper into the results in pork processing and kind of the relationship with production. Historically, you know, when we've added capacity on the processing side, we've seen some expansion. On the production side, you know, you talked about kind of this record long period of profitability for production and yet we haven't seen much expansion. Can you comment? Is this attributable to the Circo kind of losses that we've seen on some reduction in Canadian imports, or is this kind of a change in the industry that you expect to continue?

Joe, do you want to take that or do you want me?

No, go ahead, Larry.

Well, guess what you're asking, Christine, is that you see Triumph opening a plant and yet we don't see new farms going in or sals going in in the country. I guess that's simpler. Is that basically the question you were asking?

Yes.

Okay. Well, I think Triumph has made that decision, that they are going to -- these hog produces have made the decision; they're going to move up the chain. That's not new news. That's been tried and tried and as they decide they want to take those hogs and try to become vertically integrated. I think it's much harder, I think it's much harder to put in hog farms. Every year, I think it's harder to put in a farm than it was the year before. Getting permits to do these is more and more difficult. I think as well, financially, these guys have seen, when they expand, as they expand, the profits disappear. I don't know that I think the world has changed. I think the pressure has been there now. We're into now a third year of strong live hog prices and the pressure to expand I think has been there now for some time, and there has been restraint. I think it's a combination potentially of these guys from a bank standpoint and maybe getting a little smarter. But I think it's also the impact of some disease issues out there and the fact that they can't get the permits or they can't get community support to put in a new farm, but I do believe and I know Joe has said that a number of times -- with these kinds of prices going on for long periods of time, I think there's a lot of pressure to expand live production. I think that one way or the other, I think we'll see expansion. I'm surprised it's taken -- I think it's taken a long time; I'm surprised it's taken that long.

Right. Then just in terms of these losses that these processes, fresh guys continue to see, yourselves included, or at least breakeven, you know, how long do you expect that to be able to continue before you see some consolidation or closures amongst some of those fresh guys?

I mean, Joe, you may have a different opinion than I do. Christine, I don't know that I see anybody on the horizon who is threatening to shut down a slaughter plant. I don't think I've heard that from anyone in any industry. So I think that's -- and these plants now are in firm hands and lots of them have processing operations, processed meats operations behind them, so they've got some place to go with the meat. I mean, I sit here every day and the people in our organization see me shake my head and say, what in the world are these fools doing killing this many hogs and running on Saturday when they know the numbers are red? Maybe they see something I don't see. I mean, the demand for these cuts is strong, so they can sell it either domestically or export. I mean, I can't get inside somebody else's head, but I can tell you that I don't see any end of this process, and I think Joe is right. I think Triumph has announced they are going for the second shift and then potentially the second plant, so I think the pressure on live hog prices is going to be there for quite some time, and I think Joe is absolutely right. There's not going to be much money in fresh meat until this thing sorts out, and I don't see it sorting out anytime soon.

Then just, Joe, on your comments relative to beef and your expectation that that industry will continue to integrate much like it has in pork, I'm wondering. You know, is that really what's driving your decision to stay in beef feeding to some extent, you see that kind of evolving and kind of what timeframe do you put on that -- (multiple speakers)?

Well, we believe in a vertical point number one; we believe in the vertical integration model. We think it will work in beef. The model in beef is different from the model in pork because you know we don't own the calf operations, Christine, but at the same time, we do have these feedlots. We did not buy these feedlots just to feed cattle. We will be buying or building a plant and we will be making an announcement I suspect within 30 days of which direction that we are going.

Any heads up on what that might (indiscernible)?

I've gone as far as I want to go. Just wait 30 days and you'll have the answer.

All right. Interesting. Why is the decision to exit Brazil?

When we bought Carroll's, they had the Brazilian operation. It was a joint venture with a Brazilian partner. Brazil is just up and down. The markets are open one day and closed the next, as there's been extreme volatility in it. Quite frankly, the Brazilian guy liked it better than we did. It was very, very small; it was a long way away and it became an aggravation and we just decided that it didn't fit into our long-term plans.

We have looked at Brazil but we saw more opportunity in Eastern Europe than Brazil. Brazil is totally dependent upon the export market, and we just are very, very hesitant about ever investing in a company that's totally dependent upon the export market because politics can come in and just completely destroy a well thought out business plant. Countries that do have that total dependence such as Canada and Brazil -- it just has a level of volatility that makes us uncomfortable.

Excellent. Just one last question -- you mentioned how strong the ham business has been, that you expect it to continue. You know, we're headed into the holiday season I think with exceptionally low stocks of hams, I think down 22% or so from a year-ago levels. I'm wondering how you see that shaking out. Is there some kind of threshold at which you see some substitution, or do you expect it to be just a fantastic ham season?

Well, I think -- my personal feeling, I think as far as Smithfield, we will probably sell more hams but -- I think probably -- between now, operations at Cook's, we might sell a few less than we did last year, but we think they will be at better margins. We were not aggressive at all this summer in booking hams because we thought the ham market was going to be very, very strong. A lot of our competitors didn't see it that way and booked a lot of hams this fall at prices that we refuse to sell at. The market has gone up dramatically higher than even we expected. So I think we made the right decision in not being aggressive in booking hams this summer, but we think we will be running pretty close to full capacity this fall, but maybe we might be running a few less than we did last year. But we think we will have margins that will be on better than last year. Quite frankly, we are happy that we didn't take on this business this summer because, quite frankly, where the market is today, it would be at a loss.

It sounds like the right decision. Thanks.

Jonathan Feeney, Wachovia.

Good morning, Larry. Good morning, Joe. Joe, first, I wanted to follow up on Christine's question about -- you are thinking about Brazil in terms of your international strategy. You mentioned the total dependence on exports and the politics being too much, but when I think of the huge global company you guys are becoming, would a larger, more substantial presence in the cost-advantaged production of Brazil at some point be warranted by Smithfield, considering how big you're getting, maybe to be able to absorb that volatility?

Well, we've looked at it and it's just we can only do so much at any particular point in time, and with what we want to do in Romania in the next couple of years, we just don't have the resources to go into Brazil in a big, big way. As I said, I think, eventually, hopefully, politicians will be less political in shutting down borders, but you know, that remains to be seen.

Do I think, 20 years from today, that we will be in Brazil? The answer is yes. But I'm not so sure that we would go into Brazil in the next two, three, four years. But who knows? There's been some activity in regard to Brazil with the possible sale of Pertigo. Sedea made an offer; it was turned down. As you know, [Gogill] bought Sierra in Brazil. Brazil is going to be a player going forward but right now, I just don't like the risk/reward at this point in time.

Okay, thanks. Larry, you talked about, on a pro forma basis after all these acquisitions, being in excess of a 3 billion-pound pork company. Can you give me an estimate of what you think your total hog slaughter in terms of head might be into that 3 billion pound scenario? That is will you grow it? Then, down the road, do you see -- I think Joe wisely mentions the benefits of vertical integration. Will that then become a catalyst for more production gains?

Well, we rationalized a little bit of capacity on the slaughter side here. We have been at a level of about 27 million in terms of slaughter. I think that will be back; it's cut back a little. Maybe between 25 and 26 is where we're going to be. That really isn't a big change.

The 3 billion pounds I talked about is 3 billion pounds of processed meats. I want to be clear. That's not fresh pork; that's processed meats. I think people underestimate just how big we are on the processed meats side of the business.

So, yet you actually are shrinking hog slaughter at a time you are growing your --?

Right, that's right. As a result of that, we -- that's not a result. I mean the other things we've done. We made the decision. In the East, we've had a moratorium on the ability to put in hog farms in the East now for many years, so we had three slaughter plants in the East and we simply didn't have the hogs to fill up three plants, so we made the decision just about a year ago now to rationalized one of the two slaughter plants in Smithfield, fill up the other one in Smithfield and then fill up our Bladen County -- our plant in North Carolina in Bladen County, which had never, ever run at capacity. So what we're really doing now is running two plants in the East at full capacity as opposed to three plants at less than full capacity. It did take a little bit of total slaughter out but not much.

Interesting. When you look at -- you mentioned, Larry, some of your precooked and some of the more high-margin recent initiatives is performing very well, but the traditional even branded meats businesses are struggling. Clearly, that's showing up in the number of properties that are available on the market. I mean I guess, given that trends in the industry are sort of forcing, perhaps forcing the hand of some of these sellers, like I guess why buy rather than build, in terms of, you know, in terms of brand? It seems like you guys are in a power position. Why not just wait for those markets to come to you more as opposed to going out and making this ConAgra deal or the Sara Lee Europe deal?

Well, just because -- you know how expensive it is to go out and build brands, and I take two examples very prominent and I'm going to talk about -- I could talk about a third one for second. I mean, the Butterball turkey brand is an enormously good brand and the premier brand in the turkey business. As well, the Eckrich brand particularly in that upper Midwest area is a very strong brand. It's a sizable regional brand but it's not a national brand. You've got the Armour brand that ConAgra owned which has gone into -- in disrepair, I would like to say, but some of the work we've done of late tells us that brand is well-recognized by the consumer. It's just been -- it's been underappreciated and not been supported, so you can buy these brands. We can basically buy assets, as many of you guys have written up in your analysis. We bought these assets at attractive prices well below what we were projected to buy this capacity for.

We're not paying much for the brands along the way and so it gives us the ability to rationalize brands, to go into markets and take those categories and grow that Eckrich brand where it makes sense and to rationalized brands out where it doesn't make sense. But fundamentally, you're right. These traditional categories are not growing, and the margins are being squeezed. Some of these that are not doing well in that are coming to us at prices that make sense to us. We are not chasing them down the street. These are coming to us because it's the right decision for both the buyer and the seller.

Okay. Then just finally, Larry, you mentioned twice that we could see a hiccup in the new Group Smithfield in Europe at some point. I mean, can you be any more specific about some of the challenges where that hiccup could come from in integrating the former Sara Lee businesses with your assets over there?

Well, we know we've got some 14 or 15 plants in France that we need to make sure we are structured right there, as well as we've got a little bit of a problem in the Netherlands that we've got to work through, that -- and that business was -- I mean the business is solidly profitable and as I think I had said, I think it might be -- it's going to be profitable. It's just not going to be profitable to the level we get it until we rationalize and we are in a nonbranded business. That's largely a branded business. So as we move operations between the plants where it makes the best sense, I'm sure there will be some disruption cost associated with that. As you well know, if you do anything in France with people, it's always an expensive decision. So I think you will see some of that coming through, and I'm just giving you a heads up on that.

Okay, great. Thank you very much.

We are well past our one hour limit. We thank everyone for joining today. Joe, we would like to provide you with the opportunity for some closing remarks.

Well, you know, I think anything I would say, Jerry, I would probably be repeating myself. You know, it's been a great I guess 39-year run totally, but I repeat, I am not leaving. I will be Chairman of the Board and I expect to be very active and working very closely with Larry and the key people at Smithfield Foods. I'm very optimistic about the future. I think we have made the right long-term decisions, and I don't think we have begun to pick the fruit from some of these long, long-range decisions but I am confident that we will. There's no question in my mind that beef profits are going to get better totally. I'm very excited about having a vertically integrated beef business going forward. I'm convinced that the investment that we have made in Poland and that we're making in Romania today is going to turn out very, very well. Costs in Romania are going to be substantially below anybody else in Europe. Romania still today is a pork deficit country, so what we're doing in Romania today, we will not be dependent upon exporting any product outside of Romania. The demand is there domestically and we can compete very, very well with companies like Danish Crown that are all the way up in Denmark with higher costs in every area than what we will have in Romania. So I'm very, very optimistic that Romania is going to be very, very good for us going forward. I think we had the right model and as this industry is going to always be here and I think that we are strategically positioned to be at the very top of this particular industry that we are in. So, I'm leaving with a great deal of satisfaction and high hopes for the future.

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

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