Smithfield Foods Inc (SFD) 2007 Q2 法說會逐字稿

Welcome to the Smithfield second quarter conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded and will be available for replay after 12:30 Eastern time today through December 14. You may access the AT&T teleconference replay system by dialing 1-800-475-6701 and entering the access code 850681. I would now like the turn the conference over to your host, Mr. Jerry Hostetter. Please go ahead.

Good morning. Welcome to our conference call to discuss Smithfield Foods fiscal year 2007 second quarter results. We would like to caution you 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 2006. With us today are Dan Stevens, Chief Financial Officer; Dick Poulson, Executive Vice President; Larry Pope, President and Chief Executive Officer; and Joe Luter, Chairman. 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 and good morning, ladies and gentlemen. I am pleased to report this morning that we have got second-quarter earnings of $44.7 million or $0.40 a share. That compares with $51.6 million or $0.46 a share in the second quarter of last year. I remind you as you read the earnings report this morning to recognize that last year's second quarter included a charge of $16.3 million related to some restructuring that we were doing, and that reflected about -- that impacted about $0.09 a share. You need to make that adjustment as you look at last year's numbers.

As all of you are aware, Smithfield has been involved in an awful lot of things going on this current quarter. I thought I would take a few minutes before I talk about the actual operating performance to go through some of the activities that have gone on this quarter to give some of you some feel for the business level inside this organization. As you all are aware, Mr. Luter and myself made a change in responsibilities effective October -- September the 1st, and I became Chief Executive Officer. Mr. Luter I guess I would say stepped back to Chairman. I am not sure it was a very big step, but I became the Chief Executive Officer and responsible for the Company going forward on a day-to-day basis.

Beyond that, I think you're aware that we closed the Sara Lee meat business operations in Western Europe affecting several countries there, entered into a joint venture with Oaktree Capital Management and a 50/50 joint venture in an organization we now refer to as Group Smithfield and I think that was very positive in terms of our go-forward in Western Europe, and we put our French operations into that organization, merged the two together, and we're moving forward on that front, and that added about a billion euros in sales and packaged processed meats for the Company in Western Europe. We also closed on the ConAgra red meat business, the Armour Eckrich business as most people know it which is a 600 million-pound branded packaged meat business previously owned by ConAgra, and we have taken that business and put it under the John Morrell organization but operating as a separate division on what we are going forward as the Armour Eckrich banner. And again, that's going well.

Independently of that but in the same transaction we through our 49% ownership of Carolina Turkeys, purchased the Butterball business from ConAgra, that was then merged in with our Carolina Turkeys joint venture in North Carolina. They changed their name to Butterball LLC, and that moved us with our joint venture partner up to the number one position in the turkey business with the number one brand in the turkey business. That was again a very positive for the Company in terms of a branded and packaged goods business during the quarter.

We also announced a deal to buy Premium Standard Farms. As you know the second largest hog producer in the country on September 18. We believe that acquisition when it is completed gives us an awful lot of comfort in terms of security for livestock for our Midwest operations that we have been integrated in from our standpoint, and we're very pleased and look forward to that closing. We are currently in the second request stage with the Justice Department, so there is an awful lot of review going on at this point, and that transaction we hopefully will close in some relative time although I am not necessarily prepared to give you a date at this point.

We've also -- we also announced that we will be starting construction on a new beef plant in the Midwest and Oklahoma. That's something that ties in very nicely with the acquisitions that we made with the Connie Group in terms of the feed lot operations here a year or so back, and we believe that could put us in the forefront on the beef processing business at least on a plant operations standpoint, and we're looking forward to starting construction early in 2007 on that beef plant. We have completed the new -- our new what we term K-2 ham processing plant in Kinston, North Carolina. It is a $100 million ham processing plant that we started some fifteen, eighteen months ago. We believe that puts us in the very forefront in terms of cost structure in the cooked ham business. That plant was completed and started operations the first week of September and is going very well.

As well we have just recently completed the renovation of our -- I guess our older but renovated pork processing plant in [Temshore], Romania. That plant has now gone through the start-up faces and we have been testing hogs through that plant now for several weeks, we're at the point now we're opening that plant on a regular basis and processing hogs at the level of 2,000 a day or 10,000 a week. We're very pleased that that plant came in right very close to budget and very close to the timetable we expect in realizing that's in Eastern Europe in an emerging market.

As well we announced on September 19, part of a marketing campaign that we were starting a marketing relationship with Paula Deen a celebrity from the Food Network which we believe is very helpful to our Smithfield organization and Smithfield packing company organization in forwarding that branding position and many of the East Coast retailers Paula Deen is a very strong celebrity and is a household name for the average consumer, and that's going very well in terms of our entrances and our association in what Paula can do for this organization.

Finally, we have now completed from a manufacturing standpoint our East Coast rationalization strategy for Smithfield Gwaltney, as we've pointed out a couple of times in several prior quarters starting last year we began taking charges as we rationalized plants from the slaughter plant in Smithfield, Virginia, to other processing plants on the East Coast in an effort to get the raw materials to closer to the point of that manufacturer and closer so that there were less interplant transfers. We have done that. Virtually all that rationalization has been done with the opening of the new Kinston two plant. Virtually all of that has been done, and we believe that has repositioned Smithfield on the East Coast and taken some substantial costs out of the OPED and interplant transfer costs there, and we believe that process that we've been working through and has been both adversely affecting earnings on one-time charges has also been adversely affecting earnings from a day-to-day operations standpoint largely that has been done, and that should be benefiting us going forward.

We have an awful lot going on. I think many of you -- many of the analysts have been noting that and many of the money managers that I have been interacting with have made the same comment that Smithfield has an awful lot they're trying to integrate and an awful lot they're trying to manage. I am trying to give you a feel today that some of those projects that we have to manage we are making very substantial progress on, and I believe that they are positioning us as you will hear me say when I do my forward-looking part in a little bit they're positioning us very strongly as we go forward with this company, and most if not all of this is branded and packaged goods business that I believe are going to propel us forward very strongly.

Unfortunately the market has not been with us, and as you have seen from our competitor's releases, times have been tough in this industry. On the pork side of the business and on the beef side of the business, and on the chicken side of the business. Proteins have had a difficult time delivering any kind of reasonable return to their shareholders. I am reasonably satisfied with this quarter given this environment that's affecting all of us. I think Smithfield has performed well through this tough -- through this tough part of the cycle, and I do think we're in a very tough part of the cycle. Fresh pork margins have been weak and have been weak now for quite some time. What's disturbing even as I speak today, fresh pork margins are even weak during the fall season, and this is traditionally the most profitable period of the year for fresh pork, and we're seeing very weak fresh pork results in generally the best times of the year, and I will talk about that a little bit later.

We continue to have relatively high live hog prices. Those have benefited us on the hog production side of the business, but they have certainly adversely impacted the fresh meat business. As well as we indicated in our release in our Eastern operations, we have had some lower numbers from a live production standpoint that have lessened the number of animals available to the slaughter operations which have had an adverse impact on the pork side of the business by having lower numbers and to some part of the quarter lower weights going through the plants, and that's had an adverse effect. In addition to the fresh pork, processed meats have been under some pressure, and that again is a reflection of some of the push this industry has had to fill up plants and to utilize capacity, and I think that's a strategy that we've all got to think through going forward, and I am going to make comments about where we are at this point.

If you read our release, you will notice that our overall tonnage in our processed meats is up 9%. It is up significantly in the categories where we have said for some time that we're going to concentrate on which is the fully cooked end of the business and the highly processed end of the business closest to consumer convenience. You will note that our base business is down. That is not an accident. We have made a conscious decision that we're going to reposition this business now that we have -- we're in a position to be a net buyer of hams and bellies, we have made a conscious decision that we are not going to go out and reach for business just to utilize capacity and just to utilize hams and bellies off of our cut because those hams and bellies at this point have got to be purchased from somebody else. We're in a position now to look at the business and not from just an overhead contribution standpoint, from a bottom line standpoint and to focus this business more toward product and product categories and volumes that make bottom line contributions not just contributions to overhead, so that volume drop that you're seeing in the quarter that we reported is not a mistake. That is part of the strategy that we've got going forward.

This adverse environment has presented opportunities to us. Mr. Luter has made the comment now for many, many years, and I totally agree with that, that there are many more opportunities in bad times than there are in good times. These bad times have brought us opportunities. They've brought us the opportunity to purchase the Cook's ham business this spring, the opportunity to negotiate and complete the Sara Lee business in Western Europe, the ability to purchase both the red meat and the turkey meat business from ConAgra who did not want to be in this what they perceived as low margin packaged goods business. That's given us an opportunity to secure those businesses at prices that are attractive, and many of you said in the past you thought those prices were attractive. They're all branded opportunities. They're all businesses that are core businesses to Smithfield. We know the businesses extremely well from a manufacturing standpoint. We know the distribution systems. We understand the packaging, and those are businesses I think that meet our criteria for the kinds of business that we routinely can purchase, integrate, and make successful, so while it is bad news from an overall standpoint, I think this has allowed us to position this company very very favorably going forward.

Let me turn for a minute to hog production. Our hog production results are down from 103 million in the second quarter of last year to 76 million in the second quarter of this year. We indicated in the release that we have continued to battle the Circovirus issue in our eastern operations, and it is largely an East Coast issue. I pointed out to you the fact that our costs have risen. That's the result of we're all aware of the increase in grain costs. We'll talk about that later, and the impact of lower numbers of animals being finished as a result of the impact of Circovirus on the finishing process of the business.

However, we have been talking for some time about a vaccine that is out there. That vaccine has been in the trial stages. I've talked about it before. We're now seeing some positive, some significantly positive benefits of those vaccines. They have been limited at this point to very small quantities, of recent the vaccine availability has increased fairly significantly, and we are taking advantage of that -- of those availabilities, and we are using those vaccines in our East Coast operations, and we are seeing some substantial benefit from that. Certainly that does come at some cost. These vaccines are not free, but the overall benefit of that is very significant, so I can tell you today that I think we have contained it. I cannot tell that you we've eliminated it, and I cannot tell you that it comes at no cost, but it is a very modest cost to us going forward, and it is certainly -- we've been searching for a good solution for this, and it does appear that we do have something that does substantially improve our situation.

On the beef side of the business, I will pass on grain costs and corn for just a few minutes. I was going to but I am going to pass on that until we get to the end. On the beef side of the business that continues to be tough. You know that. You see the competitors releases. I think we're doing better. I think we're doing better than others. Our numbers reflect that while the business has been tough, we continue to show at least satisfactory results there, certainly nothing we're proud of but it is not in any way dragging the Company down, and our number quarter over last year is up significantly. We outlined that in the press release, that that's an improvement on both the cattle-raising side of the business and on the beef processing side of the business that have both improved on a quarter over quarter business. You know that the Japanese market is open although it is being accessed very slowly, and I guess the Korean market at some point will become a real market to all of us on the beef side today it is not -- it is certainly not delivering much and nor is the Japanese side. There is some upside potential to that side of the business.

Let me turn for a minute to the international side. That is from an overall standpoint a modest number in terms of $8 million in terms of operating profit, that's certainly a significant improvement from last year's loss. However, that is not nearly where we expect it to be. Our polish operations which I mentioned to you a number of times has been troubled for a year, better than a year now, year-and-a-half, with a product recall, and then followed up by Avian bird flu. All of that is pretty much behind us. Poland is profitable these days and profitable fairly significantly, and we've returned to the levels we were prior to any of that. You're aware that we made a management change there several months ago. I certainly won't give our new management all the credit for this turn around. It is an industry turn around that has been occurring, and some of the things that we had already put in place simply had to work their way through the process, but I feel confident sitting with you today absent some always industry issue or some abnormality that Poland is on its way and back on the track that it was prior to eighteen months ago.

Our Groupe Smithfield organization is profitable. We have been reporting losses on the French front now for quite some time. The losses were unacceptable. The addition of the Sara Lee business in the beginning merger and integration of our Jean Caby operations into the Sara Lee business is going very well. We have relocated Mr. Sharp really from the states. He has relocated to Paris and Bob is responsible for running the Groupe Smithfield organization, and he is in the process of building some of that management team, and that needs more time, and needs more time and more integration, but today that organization overall is profitable, and it is contributing to that $8 million number in the quarter.

I will report to you that Romania is unprofitable but just marginally even given the changes that we're making in that part of the world starting up this new plant which is really just starting but the building of that plant running out of an older plant building up the organization, going through the trading process, Romania has not been much of a drag, and I think once you add in the production side of the business, the live production side of the business which shows up in hog production at this point, Romania is quite profitable. We're making it on the live production side in Romania today, not in the plant, but I am confident that this new plant coming up while it will be adding overhead is resulting from a much larger plant, we are positioning ourselves, and we have gone through this three-year ramp up of our Romanian business with very small impact to this organization. I think that Mr. Luter has mentioned, I have mentioned many, many, many times that the economics associated with Romania are absolutely compelling, and I think we're on the cusp of recognizing and benefiting from some of the that, and we've gone through the pains of starting up in an Eastern European country and in a large measure have not suffered significantly at all.

That's -- we have relocated the gentleman, Morton Jensen who was running Poland to Romania on a full time basis and Morton has been there now for three months. He absolutely, positively knows this business dead on. He understands how to build the plant and how to run a fresh meat operation. I have 100% confidence now in our Polish management and Romanian management that we have the right people in place, and I think we're going to see good things from that side of the water.

That sort of covers where we are from a business standpoint. I have got one more thing I want to talk about before I turn this over to Dan as I finish my comments on the current status. Today we are also at this point in the process of making an organizational announcement this morning. Dan Stevens who is currently the Chief Financial Officer for the Company will be relinquishing those responsibilities effective January the 1st, 2007, and I have asked Dan to focus his attention on our European operation and specifically in the near term for Dan to be what we're terming the Senior Financial Advisor to our Groupe Smithfield organization.

At this point Groupe Smithfield does not have a CFO, and Bob Sharp has just relocated to Europe. We have got a very large investment in Western Europe in particularly in that part of the world. Dan has extensive European experience, and in fact he was based out of Geneva just shortly before coming to Smithfield for five years prior to coming to Smithfield. When Dan was recruited to Smithfield some eight or nine years ago, one of the faults in mind was that Dan had large international experience, and that we as a company as we were going in that direction we needed to get somebody with some strong financial background who knew that end of the business which at that point I was the Chief Financial Officer and I admit I was not skilled enough, and Dan has excelled there. Dan has been working in that area a great deal and in fact was on the early forefronts of our venture into Poland with AnimeX and so Dan is extremely familiar with both the markets and the customers and the products as was the a packaged goods company Ralston Purina with their Ever Ready battery division in Geneva for five years. He is very familiar with the customers that we do business with, and I have asked Dan to plan on relocating into Western Europe starting in early next year.

Dan is being replaced on an interim basis by Robert W. Manly. Many of you may know him as Bo Manly. For those of you in the industry as you know Bo came to Smithfield in early August as an Executive Vice President and was previously the President of premium standard farms for the past ten years, and was with Smithfield Foods as an Executive Vice President and the President of Smithfield packing company for ten years prior to that. I have known Bo personally for 20 years and have an awful lot confidence in his ability, have an awful lot of confidence in Dan's abilities. Bo comes to us with a very strong academic background although it is 29 years dated I guess Bo, but has had a very strong academic background, does have a relative financial background but a very strong business background. I think this is a very good decision for the Company. It is a decision I think that I need to make, it's the right move for this company as we move forward.

I want to make clear at this point that there is no financial issue here to be concerned about. There is no pending restatement of any financial statements. The fact that we're making the change with Dan is no indication that there is any financial concern from you as an investor standpoint. It is simply part of a move that I need to make as an organization. I need to put people in the right positions to best benefit this company going forward, and I think that I will be going out on a more permanent basis, seeking a new Chief Financial Officer, and Bo is only going to be doing this on an interim basis, but I think on a longer-term we're going to have a stronger organization on -- in both the CFO, no digs at Dan, and a stronger organization as we expand on this Western European and Eastern European strategy which we are committed to. There will be a press release coming out. In fact, it may be out as we speak, and so as you read that I wanted to put some color on this as you read the release. With that being said, before I make my comments about the -- how I see us going forward, I am going to turn this over to Dan. Dab, why don't you give us a financial update.

Thanks, Larry. Back to Larry's comments about the European job, I am really looking forward to that opportunity. Obviously Europe is an area where we've had a lot of growth recently and we're going to be facing a number of challenges over the next few years and I am looking forward to that opportunity. As Larry mentioned my background prior to Smithfield was in the international area and especially in branded consumer products, so it is an area that I know very well, and it is an area where I think I can add a lot of value during this transition phase and also gives me an opportunity to get back closer to the sales and the operations side of the business which is something I am really looking forward to. All right.

On the press release before I go to the financial highlights for the quarter, I thought I would cover some of the changes in the sales and operating profit tables and the financial statements as a result of the recent acquisitions that Larry just walked you through. The pork segment sales and operating profit for the quarter and year-to-date this year includes the Cook's acquisition which we closed in April. The annualized sales for Cook's are about $330 million which we had disclosed in the previous press release at the time of the closing. The pork segment also include the Armour Eckrich business and the operating of that business for the last three weeks of the quarter. Historically the Armour Eckrich business has been about 1.2 billion in annual sales.

The international segment operating profit includes the net income of Groupe Smithfield from August this year when we closed that deal, but it does exclude the sales of the Jean Caby business which was contributed as part of the joint venture, and that along with the rest of Groupe Smithfield is now accounted for in the equity method of accounting. Historically as a reminder our Jean Caby sales ran about $100 million per quarter. Beginning October the other segment operating profit includes our portion of the results of the Butterball business which is part of the ConAgra transaction which was acquired by Carolina Turkeys in which we have a 49% interest. Looking at the income statement the results of both Groupe Smithfield and the consolidated Butterball business are shown in the line equity and income of affiliates which had a significant change from quarter to quarter.

Some of the other key financial highlights for the quarter, sales for our quarter were down to 2.8 billion besides the drop in fresh meat volume in the pork segment, partial offset by the increased acquisition or the sales from the acquisitions the two biggest drivers are the sale out of third party cattle inventory in last year's second quarter and as well in the international segment the exclusion of the Jean Caby sales. The equity and income of affiliates line, as I mentioned, increased on improved results in the Five Rivers cattle feeding business and our turkey operations as well as the inclusion of Groupe Smithfield. Our interest expense was up about $7 million quarter to quarter. That increase is attributable entirely to increased borrowings compared to the same period last year. Our average borrowing rate actually came down slightly quarter to quarter. Our EBITDA for the quarter was 159 million, in this year's second quarter compared to 180 million last year and for the year EBITDA is 323 million compared to 341 million last year. Trailing twelve basis our EBITDA is just under 628 million compared to just over 760 million for the trailing twelve months last year.

A quick look at the balance sheet. Our capital expenditures for the quarter were just over 116 million compared to depreciation expense of 51 million and for the year capital expenditures are just over 220 million compared to depreciation expense of 110. As we've mentioned before the two biggest projects driving the capital expenditures number in both the quarter and the year-to-date are the ham planted in North Carolina and as Larry mentioned the buildout of the production operations and the plant renovations in Romania.

In the quarter our borrowing level increased to about 460 -- increased by about $460 million to 3.2 billion. The increase reflects the acquisition of the Armour Eckrich business as well as the cash contributions to the Groupe Smithfield joint venture as well as our normal seasonal working capital buildup. With the increased borrowings our debt to total capitalization moved up to right around 60%. However, if you look at it on a pro forma basis including the pending Premium Standard Farms transaction which is principally a stock transaction our debt to total capitalization should be closer to 55% following that transaction. Finally, during the quarter we put in place $250 million of short-term credit lines following the Armour Eckrich acquisition to support our short-term working capital needs. We anticipate that we'll take these out with a public bond deal that we would expect to do sometime this quarter. With those lines and our unused availability on the U.S. and the European revolving credit facilities we currently have just under $500 million of available liquidity. With that I'll turn it back over to Larry.

Wow, Dan, I think there is a lot going on in the operations side and there's an awful lot going on in the financial side. We're a busy company.

Looking forward, I am sure the concern on everyone's mind on this call and many of the people in this room with me from the Company's standpoint we're all looking at 3 and $4 corn, and I am sure that scares most everybody in this business. The protein business, whether you're in the poultry business or in the red meat business that's certainly a concern. We're certainly paying an awful lot of attention to that. I know that has got all of us concerned about where that might put our cost of production going forward and how that might impact margins both on the production side, and how that might flow through to the meat side.

As you consider those in the Company, I think near term you need not be as concerned as you might going forward. I made the comment in the release that if these corn prices and soybean meal prices continue where they're at, certainly our raising costs are going up significantly if they persist. You're all aware that we have -- we routinely put some hedging contracts in place and buy some of our inputs, grain inputs ahead some significant periods, and so I don't believe that we're going to be impacted to the level that these markets are indicating. I wouldn't say to you that our costs are not going up, but they're not going up nearly to the impact that these markets would indicate that they're going to be. However, there is no question that you can only hedge so far out, and if this is for real and this is long-term, our costs will be fully impacted by these grain costs if they stay there.

I take some confidence in the fact that this is a pass-through industry. If it affects everyone in the protein business, then everyone in the protein business will have to react to it. The markets for both livestock and meats routinely move up and down as these costs change, something that with the kind of margins we got in this business, it is not something we can simply hold on to. We don't have margins big enough that we can absorb these kinds of cost impacts, and we don't. This industry doesn't do that. I feel assured that we will react to that. Will there be some near term upsets to that, I am sure there will be. Will there be some margin periods that will be distasteful to the industry, they are today. But it will correct. It has to correct because the business simply cannot survive absorbing these kinds of costs, and I am not sure how much of the speculative positions that are in these numbers, but grain is certainly something that is on everyone's mind.

As well I continue to be bothered by the -- these weak fresh pork margins even as we're in the fall season and in the very best part of the year. Our margins are not where they need to be. The beef industry has cut back and acted with some restraint. The poultry side has done the same. I don't see much cutback on the pork side. I guess some of our competitors see something I don't see. From my standpoint we got the integration model, and it is showing up in the price of live hogs, so we may not be making much on the fresh pork side of the business, but we're making it back on the live hog production side of the business, and this industry continuing to kill 410 plus up above 420. I think it was 421 yesterday. I don't know what they see that I don't see, maybe we just don't understand the business and we don't know how to run it. Maybe we're just not that good. I am surprised that this industry does not cut back on their kill levels and does not make some decisions. They have done it on the beef side. They have done it on the chicken, and at this point there hasn't seemed to be much impact on the pork side, so that is bothersome even as we're in the season it is bothersome.

We are fully engaged in the integration of these acquisitions. There has been a lot of talk and concern that Smithfield has so much going on that they won't be able to handle it. I feel very comfortable, and I hope I have outlined to you some eight or ten things that we've done even in this quarter, the changes I just announced organizationally. We are reacting to all of this. We are making changes by putting the people in place. We are making the rationalization decisions that need to be made. Mr. Luter some 25 years ago started this company on an acquisition trail to grow this business to make us a leader in the protein industry. We do this routinely. We know how to do this. We know how to buy business that are under performing and make the operational decisions in those businesses to turn those businesses from less than stellar performance into very solid performers. We have done this over and over and over and over, and I can tell you that I am comfortable that we know the issues to deal with and that we are making the decisions to make those businesses profitable.

While we may have some large transaction, whether that be the Sara Lee in Europe, and I've explained some of the management changes to the ConAgra business integrating that into Morrell and making the change over to Butterball into the Carolina Turkeys business, the Cook's business, integrating that into the Farmland organization, the rationalizing of our East Coast operations, this is what we call the blocking and tackling. This is where the money is made in this business. It is not glamorous. It doesn't have fancy titles and words attached to it, brut it is the basics of putting the manufacturing processes in place to make us a highly competitive organization. We are aware that our products -- most of our products played in the middle markets and where price does matter to our ultimate consumer and to our customers. We know we have to be very strong on the manufacturing side of the business.

That's what we are. That's what we do. That's how we recruited people including Mr. Manly who came on board here in August and our VP of Operations Mr. Marsh, two years ago, and I am close to making another commitment to another person in Western Europe in terms of manufacturing there. We understand how to do this. This is a part of the business, we're buying this business, I credit Mr. Luter very strongly. We've bought these business at relatively attractive prices. If we can turn these advertises to deliver what they should deliver, these should be very solid contributors to the bottom line of this company and today they're not.

I am -- I think that we're focusing on transitioning the business from filling up the plants to a business where we've got the raw material. We've got a home for the raw material off these cut floors. We're putting in place branded strategies, packaged goods strategies, cooked product strategies. We're building the facilities with the Kinston -- with the new Kinston plant. We're in the process of making several significant changes wit the Midwest that puts us in a position to be very strong from a competitive standpoint in manufacturing these products to deliver margins that I think are going to be what they should be. Unfortunately they're not there today. The competitive landscape is simply not what it can be.

I am sure you saw -- if you haven't I am sure you saw the article this morning. There is an article on [Car Four] the Wall Street Journal. There is an article on Wal-Mart in the New York Times. Both of those discussing their strategies, so our customers are changing and they're reacting to some of their issues. We as well are reacting to them and trying to position ourselves so that we are a significant supplier, or we are what we call a flexible supplier to our customers on both sides of the Atlantic. We are also coordinating closely between what goes on in Europe and what goes on in the United States. We are looking at this not on a, I will say a global market but more importantly a European and the United States market. We understand that, and we understand how to maximize the bottom line to that.

We have put in place a vertical integration strategy here. That vertical integration strategy clearly is demonstrating that it works. Mr. Luter had this idea many, many years ago well in front of the industry, and I think that we have a giant foundation from processed meats to the turkey business to the European business both Eastern Europe and Western Europe to the fresh pork business to the beef business to the cattle raising business. We have got an enormously strong foundation. We used to say a multi-legged stool. I guess that stool now has more than three or four legs it has got six or seven. We will never be in a position where all of those will be performing at their peak performance level. It is the value of Smithfield Foods.

We're going to be a protein supplier to the world, and we're building an organization and we're building a cost structure and we're building an integration structure that I think is going to bode us very well, very well as we go forward these next years I am proud to say that I have been lucky enough here to be able to take the reigns in some of the most exciting times in this company's history, and I give all of those accolades to Mr. Luter for having built this, and now it is my responsibility to deliver against those and to make this organization hum and hum and to work and deliver the kind of margins that are out there and that this big model and this big organization can. I am extremely confident that we as an organization and we as a management team are highly focused and do know what to do and how to do it, and hopefully that we will be given these disruptions that are going to be associated with the corn market, and these disruptions associated with the fresh meat environment there. These things are -- they come and go in this industry, and Mr. Luter has taught me very well, don't get so concerned about some of those passing processes that they are simply clouds in the sky. They will go by. But make sure that you focus on building the business correct, and that's what we're doing for the long-term. We have always done that for the long-term, and I think that has done very well for this company in the past and I think will be extremely good for this company going forward, so I am optimistic. With that being said, I would like at this point, Jerry, to turn it over for questions.

Operator, we'll take questions now please.

[OPERATOR INSTRUCTIONS] Our first question is from the line of John McMillin from Prudential Equity Group.

Good morning, everybody.

Good morning, John.

Dan, good luck over there. Nothing could be tougher than zinc carbon batteries, so whatever challenge you've had, you've seen tougher. You're basically saying, Larry, that this $41 raising costs that we saw in this first quarter isn't really going up that much over the next couple of quarters at least?

John, I will tell you that we're not going to keep these raising costs at $41. They are going up. You're right. If you do the math, and I could probably do the simple math for you--.

Why don't you.

Okay. I will do the simple math and realize that I do this at a -- I think Joe is 20,000 foot, so maybe I am only at 10. $0.30 a bushel generally equals about $0.01 a pound, John. Depending on where you believe these corn markets are going to be, the kind of money we're talking about $1 a bushel could be $0.03 a pound. We have got some of that hedged off, and you knew that. I am certainly not going to go into details there, and we don't, but I can tell you that we're not going to experience anywhere near that. I think it will be creeping up from here. I am not going to tell you that -- it is not going to be a run away raise in costs.

And I think you said on the last conference call you were already using this back scene to limit -- basically what happened between the last quarter and this quarter in terms of the containment of that flu? I guess I was led to believe that this was under control.

I don't think I said that. I can go back and pull the release.

I am sorry.

Maybe I can find it and tell it.

Maybe it was putting it in standard forms. I can't keep track these days.

Maybe Bo can explain that.

Exactly. He didn't bring the flu over, did he?

I hope not. Bo didn't bring the flu. I think the comment in the last quarter, John, I told you there was a vaccine available. We had about 75,000 doses. That is a two-dose vaccine. They're now coming out with a one-dose vaccine. It was a two dose vaccine and so that's 75,000 doses that only allowed us to inoculate some 35,000 or 40,000 pigs which is, as you know a very insignificant number relative. I told you that the early signs of that looked promising, but that we didn't have enough of the vaccine to see that in full operation, and that those animals hadn't gone through the full process to make sure that that was going to work, but it did look promising. Even today I would tell you we don't have enough vaccine, but it is becoming much more readily available, and now we're talking about millions of doses, not 10s and 20's and 1000s of doses. It will -- these manufacturers are reacting because it is profitable business, and the impact is significant. We are seeing the death loss associated with this in the finishing stages dropping dramatically as a result of that. It looks like it works.

And, Dan, the 55% debt to cap number that you used is assuming you don't have to sell [Inaudible] or anything else. It is assuming you can -- it is not assuming any divestures?

That's right, John, just taking a pro forma basis Premium Standards historical and our historical.

I don't know that we've indicated we're looking at any divestitures.

Well, the government--.

You're talking about PSF.

Yes.

If we had to spin off some part of PSF or something.

Well, $100 million is a lot of money and I think you would probably want to get the deal done. The tax rate. I calculate the tax rate a little under 30%. Can you comment why that was lower than it was -- what it has been at least what I expected?

A couple things there, John. One is, the results of Groupe Smithfield for example that's a net of tax basis. The other contributing factor there is for example, Poland where we've had tax loss carry forward in the past, we had operating losses, we're now earning income. We have not tax affected those losses in the past so we get the benefit going forward of basically zero tax on those profits and the third thing is we've had some favorable IRS audits.

Thank you. I hope Joe is on the call as well.

I am here, John.

Good. You got out right in the nick of time with this $4 corn?

I am not that concerned. The costs will be passed through, John. We've dealt with $10 100 weight hogs, we've dealt with $69 100 weight hogs and been profitable in both scenarios. I am not as concerned about it as a lot of people.

Your next question is from the line of Diane Geissler from Merrill Lynch.

Good morning.

Hi, Diane.

Most of the things we heard about on the beef side from your competitors with regard to the seed is that, there is an expectation the final few pounds you put on use the most feed. Would you expect to see feed costs stay where they're at, that we're going to see lower weight market animal? I mean is the market weight going to be lower now and do you envision a production cut from sort of--?

You're on the beef side now, right?

I am also talking on the pork side. Will you just not finish them to the weights that we've seen over the last few years if seed costs stay where they're at?

Diane, I think there is a different dynamic on the pork side than there is on the beef side. The last few pounds on the pork side are generally the most profitable pounds because they come very fast, so they come in just very short days there, and they're just the pure incremental costs associated with the grain, and so you get good conversion, you're getting very strong conversions at the end of the pig side, not necessarily the same on the beef side. No, I don't think that you will necessarily -- I don't know if you will see them going to larger and larger weights, but I don't think that you will see significant cutbacks on the pork side.

We should continue to look for production increases on the hog side in terms of -- I think the industry figure is 1 to 1.5% increase in '07?

I think that's probably right, Diane.

That's correct.

That would be your forecast as well, what you're looking at internally.

Yes, yes.

Okay. That's it. Thank you.

Thanks, Diane.

Your next question is from the line of David Nelson from Credit Suisse. Please go ahead.

Good morning.

Good morning, Dave.

If I could go back to the hog supply question, I guess my question is related to what you are seeing in Canada with the problems and challenges they've had up there. Most of the hog feeders in, say Iowa, have been dependent on Canadian feeder pigs. We've heard of rationalization programs up there. If you could comment on what you are seeing there, if that is declining? I guess you're seeing the growth in the U.S.?

I think you got the feeder pigs coming at this pont, David. We don't see the sell slaughters, as you know sell slaughters are not picking up significantly and that usually takes a little bit of time for that to have an impact. It is certainly impacting Canada first. I think all of that is going to -- Canada is going to see that on a modest basis. The U.S. producers are continuing to still beef as you well know, still pretty profitable raising hogs. It is not like they're losing money. We shouldn't be out there thinking that hog producers at these levels are not making money. I don't want to give that scenario because it is still a profitable business, and we just turned in pretty solid profits, and if you look at the futures markets going out into the first half of next year even with these corn prices at anything hog production is going to still be very profitable. I think this thing is going to take some time to work through.

What was better in beef to cause that to turn around?

We had on the cattle raising side from our side, David, as well as our beef operations were better. We fundamentally had better beef operating results.

Okay. So it came from both. I guess lastly, Larry, you mentioned again the weakness in fresh pork, and on the last call Joe talked about -- I don't know if it was a structural, but an inherent improvement in maybe hog prices or higher hog price as a result of some slaughter capacity expansion. Is there an inherent [correlary] to this slaughter capacity expansion of having weak fresh pork margins? It speaks to the integrated model you have.

That's right. There is no question I think fresh meat margins would be dramatically better this year if that new plant had not been built. But because the people that are vertically integrated are aggressively killing hogs six days a week despite the fact there is little if any margin shows that they're looking at it from an integrated basis, David.

Great.

As we do.

Okay. Thank you very much.

Thanks, David.

Thank you very much. Next we'll hear from the line of Christine Mccracken with Cleveland Research. Please go ahead.

Good morning.

Hi, Christine.

Larry, could you talk to the recent weakness we've seen in ham prices? I was a little surprised with the seasonal dynamic relative to previous years, and maybe could you talk to how that's affected your pork margins?

Well, I guess I would say to you Christine, one of the things that's happened is we're killing these 410 and 420,000 hogs, and a lot of people took some positions on hams, and this market was strong late -- this summer and late summer, and so I am surprised at it. I am quite -- I'm surprised that there are so many hams out there on the fresh meat market that are being sold to be honest with you. Now, our ham business, although we're using our hams in effect buying hams, our ham business is down. We have taken the position that we're simply -- we have been processing hams to use them off the cut floor, so we made a conscious decision that we're not going to do that any more. We may have been part of the issue in terms of not going out there and forcing these sales. I am a little surprised at that and clearly $0.60 and $0.70 hams where they should be $0.80 and $0.90 and I thought they would be to be honest with you. The impact cut out. That's the second grade math at that point. I am surprised at it.

And loins seem to be a little stronger lately. Is there anything to that, that market might be turning around?

If I got off on the loin market we probably wouldn't get through until lunch time. I think that market -- you may say it is strong--.

Stronger than lately.

If you were internal to Smithfield you wouldn't hear me make that comment.

Fair enough. I guess it is all relative.

I think it is all relative, and the thing people forget about, is the fact that, Christine, we have got this new USDA sheet, if you turn the clock back three years and you see that people used to sell loins at 20 and 30 over that sheet, this loin market hasn't been where it was several years ago. It hasn't been anywhere near those numbers. It is really not where it should be. This whole cut out is not where it should be clearly relative to parts of hogs.

There is nothing you can point to that explains that other than the shifts I guess in slaughter?

Well, I think the other side of the weights continue to go up, Christine, so there is more meat, and the impact -- we got these other competing proteins. Chicken is out there. Chicken is extremely cheap, so that certainly acts as a ceiling point on where pork loins can go. You know those two complete.

Then just real quickly on the beef plant, could you bring us up to date on your plans there?

Yes. We have the land. We have done the engineering work. We are in a position, Christine to start that plant after the first of the year. The exact timing is not quite firm at this point but we continue to be committed to building that plant starting in early 2007.

First quarter of 2007?

Yes, we do.

Thanks.

Your next question comes from the line of Jonathan Feeney from Wachovia.

Good morning.

Good morning.

Larry, on the -- just to follow-up on Christine's question about the beef plant, what is it that you -- we talked about this for a little bit. What is it that you are seeing as far as a three to five-year beef strategy here and why the sense of urgency? It seems like the market is sort of coming your way and a couple of players are actually closing down facilities. What are you tying to get done here?

Well, I think we have made our position pretty clear here. We didn't buy these feed lots.

It can always be clearer Larry.

I don't think Joe Luter generally says comments that are not relatively clear. Joe doesn't mince many words. I will repeat part of that. We didn't buy these feed lots to essentially sit here and feed cattle, feed cattle out and supply other processing plants. We have a strategy in place. I have announced it several times. Mr. Luter has echoed it in his comments many times. We want to be a bigger player in the beef industry. We've got the feed lots available right in the area where we're five of them right in very close proximity to where we're building this plant. We can feed that plant right out of those feed lots so we will have a transportation savings associated with that. We will be employing all of the latest and greatest in terms of technologies inside that plant. I think we will have very attractive costs of putting the meat in the box, and I believe the industry is getting better. This plant is not a tent. It is not going to pop up in 60 days. It is going to take a couple of years to get this plant built. The Japanese market continues to improve. The Korean market will go its way, but it will improve. You know the new situation in Russia and how that's already improving.

You're right. The beef business is coming to us. The beef business has been a rational business. Until the export markets closed down, we had the mad cow issue, the beef business was a very strong business, and very profitable for us, and I think that we are -- Smithfield is very good at building plants and operations that put us at a competitive advantage, and I think that two years from today you're -- we're going to have a conversation. Give us a few months to open and get it right, but let's say two and a half years from today we're going to be able to tell you that we have got a very efficient plant in the Midwest that is going to compete in the beef industry and you are going to say why put in more capacity, doesn't that hurt the industry and hurt others in the industry? Maybe it does. Maybe it does, I guess I am running our business not their business. I think that our business is to return profits to our shareholders, and I believe that our new beef plant in that part of the world with the feed lots sitting in close proximity is going to be very good for our shareholders. Is that clear?

Sounds good. Just one other follow-up. You made a comment at the end of your prepared remarks about thinking that hog and pork prices would pretty quickly come up. I guess, and maybe if Joe could comment, too, as you look back I think in the mid-90's, maybe like '96 or so we had a period of incredibly high corn prices where it was real tough on the producers for a period of time and given that we're over -- I don't want to say overdue, but that's sort of what we are for a period of some production losses in the hog -- if you look at history every four years or something like that. Is there some possibility that you face two, three, four, maybe really ugly quarters before hogs and pork pricing can go up?

Do you want to take that? Go ahead.

It is always a possibility, but always keep in mind that generally that hog production profits and hog process and profits are countercyclical, and if you ask me do I think in the next three or four years will hog production profits come under some pressure, the answer is probably yes. Do I think that the hog processing business will become more profitable in the next three or four years than it has been in the previously couple of years? I think the answer would be yes. But here again, it really goes back to the expansion plans that take place in the hog production side. That will determine it, and that we've dramatically increased the production -- not dramatically but 1.5% last year, looks like it's going to be another 1.5% this year, the export markets have supported that production increase, but this business never stays the same, and the profitability goes up and down in both segments of the business and also in the processed meat segment, and that's why it is a big advantage of having, as Larry mentioned a multi-legged stool, and we probably have six or seven legs on that stool today, but all of those legs are not going to be equally strong or equally weak at the same time in my judgment.

Okay. Fair enough. Thank you very much.

Your next question comes from the line of Pablo Zuanic from JP Morgan.

Larry, I also want to ask you further about the basket we hear, but first on your math, I am a bit confused with that, you said $1 per bushel implies a $0.03 change per pound in raising costs. I had really $0.06 to $0.07. But to start, on your raising costs of $41, what's the corn price that I should be assuming that you're using there? When you say $41 raising cost, does that mean corn at $2? Because you've been at 41 for a while.

It was. We made the comment several times that people get that confused. You ought to understand that we don't buy corn at the market that you're seeing as a publicly traded -- at the publicly quoted markets.

Well, the futures are much higher. If you're buying at $4, that's even worse, isn't it?

You're still not listening. We were never buying at $2. We buy very little corn at $2. We've got enormous quantities of corn that we've got to buy in advance. Plus we've got basis differences and freight differences relative to our operation. We're never buying corn at $2. If you're doing $2 versus $4, forget that math. Because we never were at $2. I believe that that 41 and $42 is about $2.60 is the base for corn. That's more realistic in terms of where we are with basis adjustments, but, and you're doing your $4 math, but corn has got 3.70 and 3.90 today, further out there it is 3.60, I believe, I don't know where it's trading this morning, 3.60 next December. So the realistic difference between the 2.60 and the 3.60 is $1 a bushel which starts to look like $0.03 a pound.

On that point -- and then I am looking at hog futures, if I am not wrong I am looking at hog futures lean weight at 72 by May, June next year, we're around 62 right now in terms of live weight that's $7. From what you're telling me your hope that actual margins could be higher if I were to talk hog futures, and you have a $7 plus there and your raising costs based on what you're saying would be going up only by about about $3.

I think that's correct, Larry.

We believe today even with the corn prices where the futures market is we can make more money next year than we do now. I think that's right.

Just on that point normally the USDA and futures are not always in the same numbers but normally they point in the same direction. It is interesting to me that in the guess of hog prices the USDA is predicting lower hog prices in '07, futures are predicting higher prices. Obviously you think that futures are right, but why should -- the only way the pass through works and hog prices go up is that the supply side adjusts and that's what we're seeing in chicken but in the case of hogs you yourself have said that you actually expect to to be up 1%. You're complaining about the kill rates. Tell us a bit about the lead time and how quickly you expect the supply side to adjust. Because without the supply side adjusting, with hog prices still going at 1% I don't really see how futures can be right.

You also got to look at the demand side of that Pablo, you got to look at the export side of that, all of those effect the demand side. I don't know. I guess -- there is also timing issues in terms of when you secure the livestock, when you have polls against the livestock relative to the market because the markets can get out of whack simply due to timing.

But on that pont you're saying that it is mathematically or I guess economically conceivable that we could have hog price--?

Pablo, we're sitting here today with more hogs than we had last year, and hog prices are above last year which is mathematically incorrect.

And hog futures prices are distorted many times in regard to what's taking place today. For instance, next June if the futures stay where they are today it means we'll be getting around $55 a 100 weight for our pigs next June, which looks very, very good. Will they end up at $55 in June, some people say no, it is over priced, and yet some people say it is under priced. That's what makes markets. You got to keep in mind the futures market does not always indicate hard mathematical statistical facts. You have to understand that. You have got a lot of emotion in this market. Let's take the corn market. You've got a very, very strong corn market. Well, historically you have a strong corn market when the yields have been low and there is a shortage. Well, we just came out of a very good year from a production standpoint, so you can make the argument that corn prices today is not based on facts, it is based on emotion as a result of all this product supposedly going towards ethanol in the future.

Bottom line you're saying hog future prices may be too high but you're still confident that you'll at least be able to maintain your hog production margins?

The future prices may be too high, they may be too low. We don't know.

Thanks. Just to follow-up--.

That's the nature of the business, it always has been the nature of the business, and always will be. You cannot -- I mean if you could go out and use mathematical models to predict the futures market with accuracy, you can make an awful lot of money.

Okay.

That's not the case. That's not the way the markets work on any commodity in the world today that I am aware of. A lot of it is emotion that goes against hard statistical data.

I am sorry you missed my point, Joe, I understand your argument, but at the end of the day you guys have to use futures if you're going to be hedging your hog positions and your corn positions, right?

Well, we do use the futures.

Right. So based on futures your hog production margins should at least stay flat or go up?

We could buy corn today at this level and sells hogs today at this level and not see any serious reduction in profitability.

Is there a limit to how much you can use futures? I mean you can't sell your 14 million hogs at $55 hogs, right?

Well, we have permission to go to 45,000 contracts, and that pretty much end in the next nine months, and if we decide to do that we can hedge 100% of our production. We don't do that often. But -- in fact, I don't think we have ever done 100%. To answer your question, yes, we can use the futures market to cover virtually all of our future production.

That's good. just a follow-up on Swift. Buying Swift will also imply buying the port processing business. Now that you're buying Premium Standard Farms, you are already over 30% market share in port processing. If you were to buy Swift some day I assume you would not hold onto a port processing side, because of antitrust issues. Is that correct?

Yes. I think it is correct to assume that we buy premium standard we could not buy the Swift pork operations. We may decide to buy a plant and sell a plant, but no, if we buy Premium Standard we would not be able to buy all of Swift's pork operations. We don't see any problem on the beef side, and we don't see any problem on the Australian side.

Okay. In terms of acquisition of Premium Standard Farms, is that taking longer than you expected from an approval standpoint?

No.

Okay. The last question, Joe, all of these deals over the last twelve months I could say it was a method of window opportunity or some could also say you're stepping down, you wanted to get all of these things done before you stepped down?

Well, it's not -- that's not -- one did not have anything to do with the other. We would have done the same deals if I was 50 years old and was looking at another 15 years,so it really -- my stepping down date had nothing to do with the timing of these acquisitions, nothing whatsoever.

Thank you very much.

Your next question is from the line of Farha Aslam from Stephens Inc.

Good morning.

Good morning.

A question on your acquisitions. Now that you've gotten into them, taken a look at them, could you just give us some color on how much you're spending on integrating these businesses and how much synergies you think you might be able to get now that you've got your hands into the businesses?

I would tell you to the extent we have integration costs that are substantial we would be outlining those to you in earnings releases as part of the extraordinary or unusual charges. As you noticed there are not many of them.

Not at all.

And we're not going to and I made that a conscious decision. We're not going to sit here and report to you $0.01 here and $0.02 there and those kinds of things. That's a normal cost of doing business. We're at the level that doesn't really matter. Are we having integration costs, of course we are. I'm simply not going to go through -- that's nowhere in the earnings and we accept those as part of our operating results. I would tell you from my standpoint the synergies that I think are there on whether it be the Sara Lee or the ConAgra red meat, or the Butterball turnkey business, and that's a conversation with all three of the people running all three of those businesses. I think they're better. I feel they are better than what we saw when we were doing the deals.

Okay.

All right.

All right. And then are you seeing any increase in dairy cattle being taken to your beef processing plants? Have you seen a spike? Or has this been gradual?

I don't know that I have that information handy. I would have to come back to you. I don't know of anything specifically, no, but I am not telling you that's a true statement because I haven't tracked that -- I don't know if anyone else know that. Bo whether you know that or Dan you know that or Mr. Luter you know that.

I don't know that.

No.

We can follow-up.

I don't think there is much dairy liquidation, but I don't know that. I'll be honest with you.

Just my final question is on pork exports. What do you think pork exports are going to look like next year?

It all depends on the price. They continue to be very strong for the industry. Ours are not up to the level of the industry, and it has largely been hams into Mexico and to Russia and we have got some of the Russian business really not so much of the the Mexican business. Because we don't have the ham. It has been a very strong market. The export markets continue to be very strong for the industry. It helps move some of this volume so it depends on where the cuts go. It is a competitive market on the world market and as long as this product stays in check and these corn prices don't reflect through in terms of pricing, I think the export markets will be good if they get out of price range. Depending on where the dollar goes as well, then they will drop back. For now the market seems solid.

Thank you very much.

We've run well over our usual one hour. We want to thank everyone for joining us today. Have a good day.

Ladies and gentlemen that does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.