Smithfield Foods Inc (SFD) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Smithfield Foods Third Quarter Conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. [OPERATOR INSTRUCTIONS]

As a reminder, this conference is being recorded and will be made available for replay after 12:30 Eastern time today through March 15th. You may access the AT&T Teleconference Replay System at any time by dialing 1-800-475-6701 and entering the access code 865105. Those numbers, once again, are 1-800-475-6701 with the access code 865105.

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

Good morning. Welcome to a conference call to discuss Smithfield Foods' fiscal year 2007 third quarter results. We'd like to caution you today that in today's call there may be forward-looking statements within the meaning of the Federal Securities laws. In light of the recent 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 Bo Manly, Executive Vice President and Interim Chief Financial Officer; Dick Poulson, Executive Vice President; and Larry Pope, President and Chief Executive Officer. This is Jerry Hostetter, head of Investor Relations.

Larry Pope will begin our presentation with a review of operations. Larry?

Thank you, Jerry. Good morning, ladies and gentlemen, and welcome to our third quarter call. I would like to say "I'm pleased to report..." but I guess I would say to you that I am reporting to you, this morning, our third quarter results at $60.4 million. Income from continuing operations are $.54 a share compared with $75 million, or $.67 in the same quarter -- third quarter of last year.

Carol, we've already got eight people in queue for questions.

On a year-to-date basis I've got a -- we are reporting $144 million, or $1.29 per -- $1.29 per share, compared with $175.6, or $1.57 per share.

I won't go through the complete net income. You will note that we've got some discontinued operating numbers below that resulting in the net income numbers.

You should also note -- I hope you did -- that we are reporting $.04 of the earnings in this quarter relate to an annualized adjustment in our income tax provision; a lowering of our estimated rate for the year.

And so I'll let Mr. Manly, as he makes his comments on the financial area, discuss that with you, but you should consider that as you review our numbers.

From our overall business standpoint -- I've made that pretty clear in the press release -- that I'm certainly not pleased with -- pleased with these results for the quarter. They are a continuing trend, I believe this is our eighth straight quarter of down reported earnings, which is certainly not something -- not something I'm proud to report to you today.

I think many of you know that the -- the hog production numbers are -- have fallen substantially -- I'll talk about that in a minute -- as well as cattle raising continues to be unprofitable and the fresh pork environment is certainly not something that -- that I'm satisfied with at all. And I want to talk about that for a minute.

We have been running at -- we have curtailed some of our hours at a number of our plants. As many of you know, we closed one of our slaughter plants in Virginia a little over a year ago now.

We have, as well, shuttered the second shift of our Sioux City, Iowa, plant in reaction to the adverse conditions, and we are not really running any Saturdays at this point, until the industry conditions on that side of the business improve.

It is something I am certainly quite bothered by, as we went through the fall, and while we were profitable, we were not profitable in the most -- what is traditionally the best time of the year. So the fresh meat business, on the pork side, continues to be very, very distressing in spite of the fact that we're killing 400,000 hogs a day.

And in fact, I think -- I think as you'll hear me at the end -- I think this industry is changing and becoming much more vertically integrated and operating much more as a vertically -- a vertically integrated industry, as opposed to just a kill and cut operations, independent of their raising operations.

So that part of -- that part of the business, what I call the "fresh meat" side of the business is -- is not -- is not good and it has not been good now, for quite some -- quite some time.

On the processed meat side of the business, that -- that I would tell you I am more than satisfied with. Our volume is up very substantially. If you read in the press release you noticed that our processed meats volumes were up 34%. That is certainly related to the -- the acquisitions of the Cook's business and the Armour Eckrich business this year. Those were very good acquisitions for the Company.

You saw me make reference to the fact that I am very pleased that, coming out of the box, those acquisitions have been very good for us. They have been immediately accretive. It's very much down the center of the strike zone in terms of what we know how to do. And we have -- we've been very, very impressed with the -- the early returns. It's still early and there's still some things we need to do in that business.

But we had a good Holiday season. Our Cook's business had improved margins there. Our overall business on the ham business was improved margins. I would tell you that our sales volume was down, at least in the traditional smoked ham business. Our volumes were actually down.

Our spiral ham business was up and our margins were up, but we think we were taking a leadership position there. That's a category that there has not been any investing in for a very long time in this industry.

And there is a trend away from the cut ham business to the spiral ham business, so we saw the volumes fall, which was not unexpected, but we did take some positions in terms of pricing there to improve the margins over where they've been for many, many years. And we improved our margins, but I would tell you that we did not -- we did suffer some volume impact of that, at least on the traditional business.

Beyond that, we are -- we have seen very substantial growth, again including some of the organic growth and some of it from the -- from the acquisitions.

But our dry sausage business is up dramatically, our smoked sausage business is up dramatically. Our precooked bacon business is up. Our precooked rib business is up. Our precooked sausage business is up. Those are the categories that I've been talking to you about now for two full years that we have got a concentrated effort on to change the mix of the product categories that make up the base of this business.

We will continue to be a sliced bacon and ham company for a very long time. It's a sizeable part of our business, and so it's not a part that we forget, but we are continuing to concentrate our business on moving those items that we can into categories that have -- that are cooked or further value added.

And I think we're doing a good job of that organically as well as making acquisitions that allow us to move up the value chain, and as well allows us to move into the brandage -- into the branded categories as opposed to the non-branded categories. And we are seeing movement -- we are seeing movement from the non-branded to branded and from private label to branded.

The Armour Eckrich and the Cook's business add about 850 million pounds on an annual basis of processed meats. The vast majority of that is branded product. And so the impact of that is immediate at the bottom line. It is improving our margins, it is improving our mix.

And I am extremely -- I am extremely pleased with what we have seen to date, in spite of the fact that we have not -- we have not streamlined all of our operations. You have seen us report to you some restructuring charges in our East Coast operations, which was getting our costs back in line.

We continue to be focused in the strongest way on improving our manufacturing processes, lowering the cost of producing this product, rationalizing our operating and manufacturing strategy to eliminate freight and to eliminate intra-plant movements.

And I think that we are having some -- I think we're having some benefit from that and it is impacting the bottom line, and as well the movement away from selling raw materials into the open market, hams and bellies.

I told you two years ago that we were going towards a strategy where we would not be selling surplus product into the open market. With the acquisition of Armour Eckrich and the Cook's I can confidently say to you today that we are buying hams and we are -- we are buying bellies everyday in the open market. That allows us to be more discriminating in the way which we go to market in those process categories and we are looking at those categories closely.

And we must -- we must as a company deliver on that end of the business. I think for those of you who were at Cagney with me last week, you heard me say it to you very clearly, and I'm saying to you again this morning, it is a focus of this Company. We are focusing very much on the -- on both the cost of production and the way in which we go to market on the processed meat side of the -- side of the business.

The beef business you can see shows -- shows very little -- not losses, but very little from a contribution side in the operating profit. That is -- that is the combination of the cattle feeding operations, both the cattle that we own directly and our 50%-owned joint venture with ContiGroup in Five Rivers, combined with our beef processing operations.

I would tell you that the processing operations are good -- or at least solid. I would not say good, they're satisfactory and they are improved over a year ago.

Cow -- cattle feeding continues to struggle. We did go through a rough winter. You know that -- you know that our feedlots were impacted by the severe winter storms. We did have some limited losses associated with that, but I do -- we do have some relatively high-cost cattle coming up, the industry does, and so I think cattle feeding is going to be challenging until this thing works its way back through the cow/calf operations.

And as well the exports on the beef side of the business continue to be very limited. While we are selling to Japan we have more -- we have more product available. We are not in a situation of needing some change in the law and the regulations related to shipments to Japan. We have sufficient quantities today that we could -- we could fill additional orders.

But as many of you know what's being imported into Japan, as of today, is largely for the food service business and the retail business has not returned at all. We would be prepared to service business as that business opens up. And, in fact, I was at dinner last night with a Japanese customer and we had extensive conversation on just that point.

The international side is one I'm very proud of. We've -- I think I've been challenged on the last couple of calls about the fact that our international operations we've been continuing to make sizeable investments in that for quite some time, and not just quarters, but years, and were we ever going to realize any benefit from being outside of the United States?

I am -- I am proud today to at least report to you the beginning of some contributions from our international operations. As I've made comments in the press release, nearly all of our international operations were profitable.

Our newly formed Groupe Smithfield, which is the combination of our previously owned French operations with the Sara Lee meat business, with our joint venture, Oaktree Capital Management, we are seeing some very nice things there; very, very, nice.

And we have not finished doing what we need to do to get that business right. We are changing it to improve upon it, but it is already contributing nicely.

Poland is performing and is profitable, but in my mind still not delivering what it should be. There's a lot of potential left in Poland.

Romania just opened its new plant that we had under renovation. It opened in November. That plant is -- is up and running, and was profitable in the first quarter. So I'm very pleased with the Romanian progress we're making.

And our Mexican operations -- it's a joint venture -- very solid. And our -- and our ownership of Compofrio in Spain is also showing improved numbers.

So, on the international front, you're just beginning to see some of the fruits of -- some of the fruits of those investments. And I don't think that you've seen nearly the ripe fruit, I think you've seen some early fruit.

Hopefully that -- hopefully this will be a -- progress will continue on all of those fronts and we will -- we will be demonstrating to you that the investments we made in those -- that part of the world were solid investments.

I've made reference many times to our optimism regarding Romania. I continue to be optimistic regarding Romania. Our French operations now are part of Sara Lee, there's a lot of opportunity there.

And Poland, as I've said before, was performing well -- was performing -- the underlying business was performing, unfortunately we had some overlaying issues in terms of -- of some avian bird flu and a product recall a year ago that masked what was happening, ultimately, in the business.

But I think some of that is beginning to show through and we've made management changes over there, not because we were necessarily upset with where they -- where we were before, but to improve the strength of our management team in that part of the world. And all of that, I think, is beginning to shed light on -- on our investments.

Clearly the big change for the quarter is hog production. Our hog production results are down very dramatically and -- and at first blush you would think that our raising costs have gone -- have gone completely out of control and -- and we've lost -- we've lost the benefit we have in hog production.

That's not the case. Two things are happening there. Our raising costs are -- have increased from $38 to $42, that's spelled out in the press release. We have had some adverse impacts of circovirus on the volumes.

But, as well -- it's very complicated and we'll try to limit the conversation, without making this the full subject of the conference call -- is some of the changing of the accounting we're doing from some of our commodity futures derivatives in the hog production end of the business.

We have been struggling with that accounting, and Mr. Manly's going to speak to you about that during his comments, but that did adversely impact our hog production results. And we simply feel like, in the interest of clarity and limiting complexity, that we had to -- we had to make a -- a completed change in the way we were accounting for these commodity contracts, and run that through our January results and simply make the complete conversion over to mark-to-market.

That did have an adverse impact on the results. And so what you're seeing in the hog production side is not just the impact of raising costs; it is the impact of raising costs combined with this significant adjustment on the mark-to-market side of the business.

Finally, the other side of the business is largely the turkey business, the Butterball business, now the combination of what was our 49%-owned with Carolina Turkeys, now that we put the Butterball business together with that, so we have 49% interest now in Carolina Turkeys/Butterball that's changed its name completely to Butterball now.

That's going to be a -- that's going to be very good for us, puts us in the number one position in the turkey business. Don't need to say very much about that. Anybody who knows anything about this business knows who the Butterball Turkey business is and knows that that's a brand that -- that's a brand you can build a business on and its been underappreciated before and we are reinitiating an emphasis on that brand. And I think that we are very optimistic about where that's going to be through the joint venture.

Before I give you much of my thoughts in terms of the future, I'm going to turn this over to Bo Manly and ask him to fill you in on some of the financial information, then he'll -- I'll speak to future after that.

Okay? Hey, Bo.

Thank you, Larry. Good morning, ladies and gentlemen. Before I review the details of the financial highlights for our third quarter I would like to quickly lay out several changes that had impacted various categories within our financial statements compared to the prior period as a result of the recent acquisitions and joint ventures.

First, the sales and operating profits of both Cook and Armour Eckrich are included in this quarter's pork segment results, but were not in the third quarter of fiscal 2006.

Second, the international segment operating profits includes the net income of Groupe Smithfield joint venture, beginning in August of this year.

Since that time, when Jean Caby's assets were contributed to the venture, Jean Caby's sales have been excluded.

The results of the Groupe Smithfield joint venture are accounted for with the equity method of accounting on the Income Statement under Equity In Income of Affiliates.

Third, the operating profit of the Butterball joint venture is reflected in Other Operating Profit segment and is also included on the Income Statement in the category of Equity and Income of Affiliates.

Since this is now crystal clear, let me proceed with the financial highlights.

Total sales for the quarter were up 12% compared to the same period a year ago. This increase was driven by an 18% increase in sales from pork operations reflecting the addition of packaged meat sales by Cook's and Armour Eckrich.

Within this segment sales of domestic packaged meats increased 34%, consistent with our goal to grow this area of the business.

International sales declined 18% year-over-year due to the elimination of Jean Caby sales.

Total operating profits for the quarter were $123 million, down from $150 million a year ago.

Hog production profits declined to $5 million from $65 million, reflecting increased feed costs and lower overall head marketed.

Profit growth in the international segment offset some of this decline with earnings increasing from $2 million to $24 million, reflecting strong performance at Groupe Smithfield and profitable results in Poland and Romania.

We continue to be optimistic about the short-term and long-term prospects of our international businesses.

As Larry mentioned, at this point in time we have transitioned to mark-to-market treatment of our commodity hedges. This could increase some fractional volatility of quarter-to-quarter results, while long-term results will be the same.

This will create greater transparency and reduce expenses related to the complex tracking of hedge accounting treatment.

Interest expenses for the third quarter increased to $45 million from $36 million a year ago. While our effective interest rates declined 44 basis points overall borrowings increased $703 million compared to a year ago.

The new borrowings were used to fund the acquisitions of Cook's and Armour Eckrich as well as fund the expansions of operations in Poland and Romania.

The Equity of -- in Income of Affiliates demonstrated improved quarterly results with earnings of $27 million compared to $3 million a year ago, lead by the inclusion of the results of the Butterball joint venture and Groupe Smithfield.

EBITDA for the third quarter was $182 million versus $207 million in the same period a year ago. Fiscal year-to-date EBITDA totaled $504 million compared to $540 million for the first three quarters in fiscal 2006.

I would like to note that the estimated quarterly tax rate declined from 27.5% in the second quarter to 22.1% in this quarter. The change in rate reduced tax expenses by $4.3 million or $.04 per diluted share.

This reduction was driven by two factors. First, the Company experienced a higher mix of profits from international earnings with lower average tax rates. Second, legislation promulgated in the third quarter retroactively restated tax credits that were fully applied during this period.

We expect the full year estimated tax rate for this year to be 28%.

Turning your attention to the Balance Sheet, capital expenditures for the quarter were $128 million compared to depreciation of $57 million. Year-to-date capital expenditures totaled $351 million compared to depreciation of $153 million.

Major drivers of capital expenditures were the continued expansion of Romanian hog farms and plant renovation, which became operational during this quarter, and the ready-to-eat ham plant in North Carolina, which continues to successfully ramp up volume following the initiation of operations in the second quarter.

At the end of this quarter total borrowings were $2.99 billion. Our borrowing level declined by $187 million from the end of the second quarter.

Total debt to capitalization declined to 57.6% at the end of the third quarter from 60.2% at the end of the second quarter.

On a pro forma basis, if we include the Balance Sheet impact of the pending Premium Standard Farm transaction, we estimate that the debt to total capital ratio will decline to approximately 54%.

At the end of the third quarter we had unused U.S. and Euro revolving credit facilities providing over $600 million of available liquidity.

Thank you very much for your attention. Larry, let me turn it back to you.

Thank you, Bo. You can tell that we've got an awful lot going on on the financial side of the business and I think something of some note is the fact that our cost of borrowing has actually -- in spite of the rising interest rate environment -- our cost of borrowing has actually gone down by about 40 basis points.

That's a tribute to our Finance Department and our -- some of these -- some of the debt that came due during this past year was higher-priced, older debt that we are replacing at lower cost of debt, so our cost of borrowing has actually gone down, not up. That's a -- and I say that as a point of reference for you.

Looking forward, I made the comments in the press release that I'm cautious over the near term. $4 corn, as you know, is a reality. More than $4 corn looks like it's a reality. How long that's going to be there, I don't know.

We certainly -- we are certainly concerned. We do have some -- some positions in place that will limit some of that risk to us in terms of raising costs. I would not tell you that we have -- we have hedged all of that risk away, we have not. But we have limited -- we have limited some of that.

If we continue in this environment we will have -- I made the comment at Cagney -- we will have $50 raising costs this year -- a year from today.

I do think we will see the -- one of the things that's dragging on our raising costs today is the impact of circovirus on our Eastern herds. I think that situation has stabilized and is improving. And over the next couple of quarters I think you will see those numbers reversing on that -- that particular side.

That does not mean our raising costs are going down. It simply means that the impact of circovirus won't have that drag to offset some of those -- some of that raising costs -- the impact of corn and soybean meal as they continue to further and further impact our cost.

But the futures market seems to have compensated for that. We've got a -- we've got a strong market, quite a ways out. You all know how the futures market looks, so it does not appear that live production is going to be unprofitable for the foreseeable future.

Yes, we might be -- we might be faced with lower profits on -- on hog production, but I don't think that we're -- don't think that we're looking at losses.

On the meat side of the business, I continue to find this fresh meat side of the business, particularly on the pork side, very challenging. We are doing what we can do from our side. We think we're acting with some discipline. We're simply reacting to the dynamics of the business. It is a difficult environment.

Prices -- given this increased corn market -- prices in this industry will have to go up. For those of you who don't know, I like to tell people the meat industry hasn't got a price increase in 30 years. In many cases pork loins and -- are selling for less that they were years and years and years ago and hams routinely used to sell for a dollar a pound. And when they got down to the levels we see today we used to freeze them because they were so inexpensive and now that seems to be the norm.

So I think that we will see some pressure. You do have the poultry markets out there, the freezer stocks -- as the recent freezer stocks are down. It should be helpful and indicative of a -- of the market moving up. I think we will be forced to push these prices through. Our competition has said the same thing. Whether the industry can do it, I don't know about that.

I mean, we're concentrated and focus on it, and that's going to be the challenge to us as these corn prices present themselves in a big way, whether we're able to maintain pricing levels to compensate for that. That will be the pressure.

On the beef side of the business our processing margins are satisfactory. I think we've got some good things coming on the beef side of the business, from a processing side.

I've -- these cattle prices -- these cattle futures are up. I think -- I think potentially, even in spite of the fact that we've got increased corn costs the prices that have been paid for feeder cattle will be -- are already adjusting. And that's the way it will adjust on the beef side, so the beef side can actually be a little better than it is on the cattle raising side.

Internationally, I don't see anything -- we may have a few things as -- as we go through some -- some re-altering of the business in Europe you may see a charge or two out there. If we get this international business right and some of these businesses we've bought.

But, fundamentally, our international business is improving and improving nicely. And so I'm optimistic that you've just gotten a glimpse of -- of what can be out there on the international side. And I hope to be reporting to you in future quarters the fact that these investments we've been making for these several years were good decisions.

We continue, as Mr. Manly said, we continue to invest heavily. In Romania, on the farming side -- and that part -- that model looks terrific. He and I were just there a couple of weeks ago, and we were reconfirming -- reconfirming the business case. And the business case continues to be very good there.

And Poland, with its increasing volumes coming in that -- in that country, I think we've got a -- I think we've got a good handle on that side of the business. I think we've got good management people in place. We've added to that, and so I'm -- I continue to be optimistic that the segment on international will continue to be an increasing piece of our profitability and help to add one more stabilized leg to this stool that's been out there, and the stool's been pretty short, so far. Hopefully that's going to become a bigger piece of the business and a stabilizing force.

With that being said, we're open for questions and would love to answer any of your concerns this morning.

Jerry?

Operator, would you please open the call to questions?

Thank you. [OPERATOR INSTRUCTIONS]

Your first question comes from the line of Jon Feeney from Wachovia. Please go ahead.

Good morning, guys.

Hey, Jon.

Larry, just one question. I wanted to -- you made a comment in there about you might see some charges or some more heavy lifting to do around these European acquisitions. Could you talk a little bit more about what you're seeing that you think you might need to clean up around -- around the European acquisitions right now?

Jon, let me -- let me -- well, with the Sara Lee meat business, we've got purchase accounting, so that part will be -- that part will be done through the Balance Sheet and the opening Balance Sheet, except for a few little charges that may happen.

We've got -- we've got an awful lot of plants. The combination of our French operations and the Sara Lee meats, we've got an awful lot of plants and so we've got to look at how we -- how we maximize the operating efficiencies in those plants.

So we've to -- we're going to have to make some changes over time here to -- to align the efficiencies and drive out the efficiencies. Obviously Sara Lee was -- Sara Lee wanted to exit that business. And -- and we've had -- got operations in the same country, so, without playing my hand too much, because I'm trying to be careful with that, I think that we've still got some realigning to do.

It's going to -- it's going to be modest -- it's going to be modest dollars, I think, unless -- unless we change the -- unless we change the way we're going. So I don't think it's going to be something that's going to be earth shattering, but I think -- I think that you might see something come through there.

Okay, thanks very much.

All right, Jon.

Your next question comes from the line of Tim Ramey of D.A. Davidson. Please go ahead.

Good morning. You alluded to the change in the mark-to-market impact in the quarter. Can you quantify that for us at all? It -- it, I think would be very helpful to try and understand the hog raising costs.

This is Bo Manly. As you know, we've always and will continue to -- to be rather close to the vest regarding our positions in the commodities market because of competitive considerations.

However, as we look at the change that occurred from an accounting perspective, and it really amounted to probably an increase in -- in charges in the $5 to $10 million range, changing from the mark-to-market -- to mark-to-market from hedge accounting treatment. So it -- it wasn't -- wasn't a huge swing, but certainly it is a change in the way we've approached that accounting side of the business that we felt was necessary to lay out to you folks.

Tim, one of the things you ought to understand -- and we've been working through this now for several quarters, is that the -- to get hedge accounting, the issues surrounding that are very complicated.

And more and more, in spite of the fact we haven't been discussing it on the calls here, more and more of our futures commodities contracts have not been -- have not qualified for hedge accounting.

And so we've been -- we've been marking a number of those to market over -- or continuing over quarters. And so what we made the decision this quarter was to let's just -- let's just make them all. Let's -- let's stop this debate with the auditors about what qualifies, what doesn't qualify. Let's just mark them all to market so we don't -- so we don't spend -- we've had to add staff to do this, and the complexities of the computer system surrounding this, I will suggest to you are significant.

And so what Bo's talking about is an impact of $5 or $10 million more. And some of that's even hard to determine, because we don't know what the auditors would have agreed to had we forced the issue on hedge accounting.

But we we're already treating a substantial portion of our commodity contracts on a mark-to-market basis, even prior to this quarter. And so it's -- it's an extremely complex area and it's taken -- it's taken me a long time, and I'm a financial guy, it's taken me a while to understand this. And so it -- it did have a negative impact.

And Bo's side of the -- that's the incremental -- but there was a larger charge than that, even in the quarter.

Okay. Would you have a sense of what your organic, excluding acquisitions, sales performance was in the quarter?

I think, Tim, what I'd ask you to do is give -- we've got Jeff Deel, our Chief Accounting Officer and Controller. Why don't we give Mr. Manly and Jeff -- while somebody asks another question -- why don't we give them about five minutes to see if we can get you that -- get you that answer? How about that?

Thank you very much.

Your next question comes from the line of Farha Aslam from Stephens, Inc. Go ahead.

Hi. Good morning.

Good morning.

Could you just detail for us just what your actual number of hogs were that you marketed in the quarter?

We should have that number.

Okay. And while we're looking that up, could you talk about--

Mr. Manly, go ahead.

In terms of -- we marketed about 6.3 million in terms of--

That's what we slaughtered.

--of our slaughter rates compared to 7 million the year before. In terms of hog production, we -- we sold 3.5 million a year ago. We sold 3.2 million this -- this current year.

In terms of international, we actually had a pickup year-over-year, so as a total company we were at 3.7 million a year ago and 3.5 million during this period of time.

Does that answer your question, Farha?

Yes, it does. And just trying to understand that circovirus issue. Because a couple of -- the last couple of quarters we're hearing it's getting better, but if you look, in the second quarter you were down 7% year-over-year in terms of hogs, and this quarter you're down 8%.

Looking into the fourth quarter and the first half of next year can we expect, sort of, again, negative numbers in terms of the numbers of hogs you're selling? Or do you look for that to improve?

I look for that to improve, Farha. Remember that you have to give the vaccines early on, and it takes -- takes the growing period for those animals to -- to effect themselves through the marketings. And so what -- what you're seeing today from marketings are problems that you had on your farms six months ago. And so it takes that kind of time frame to start seeing the benefit.

I think you'll see some improvement in this quarter, and you'll see even better improvement as we go into the first quarter of the next fiscal year and beyond.

If I could give just a short statement on -- on the operational side of it, vaccine became available on a very limited basis sometime shortly before the first of the year, and started to increase in quantities, however limited, as we moved into January. You -- you will administer that --that vaccine to a 3, 4, 5-week-old pig, and therefore you won't see the results in terms of improved livability and performance until that animal actually comes to market. And therefore -- that's going to be six months after -- almost six months after the administration of the vaccine. So you won't see, really, an -- a true impact from the effect of the vaccine flowing through -- as measured by animals to market -- probably until the second half of this calendar year, moving up into -- towards the first of next year, in terms of actual impact on slaughter numbers.

And that would be true for the whole industry.

That's very helpful. And then my final question is, just on ConAgra, you talked about you were pleased with the acquisition overall. But when you get into the plant, could you talk about the capacities that ConAgra's plants are running at? What you see ConAgra's cost of producing products, versus a Smithfield cost of producing products? And just detail where you see the opportunities in terms of the manufacturing network of ConAgra?

Well, when we were looking at the acquisition, Farha, we -- they -- the indications to us were that -- was that the plants were running at about 60% of capacity. As we looked out on it, we had some people who had previous experience with ConAgra, we saw that the capacity levels, we felt were lower than that.

Now, we have made some decisions which are -- which you should have already seen. We've -- we've disclosed. One of the plants, a hot dog plant that they were operating in Quincy, Michigan, we did not take that plant and elected to move those operations into our -- into our hot dog operations. As well, they had a Kansas City processing plant that was operating well below capacity and we have made an announcement that we are closing that plant as well.

So we have already -- we have already publicly rationalized two of the ConAgra plants that we purchased in order to improve -- we have to improve the capacity utilization of that.

Now, related to that, their overhead costs and costs of production, no surprise to you, are significantly higher than ours, and that is a focal point that -- in fact I had a meeting two weeks ago and -- with the management team and we focused on that exact point. That will be coming down toward a level -- and there's two things here.

One, it will benefit the ConAgra overhead costs, but it will also improve the operating costs of -- the ConAgra -- the Armour Eckrich business is now part of our John Morrell operations, and it is helping the John Morrell operations as we realign those two companies to utilize both capacities better.

And so I've -- that's part of my comments that I think you'll see our margins improving and our concentration on lowering costs. Their costs were high and there are some distribution costs associated with that product that are too high and we are well aware of that. We are changing that as we speak.

So that's why I am -- it's a branded program, it's good product. They've got good brands out there in spite of the fact that some others have made some -- some critical comments -- others in the industry have made some critical comments. I would suggest to them maybe their view wasn't the best.

We're set -- we're quite pleased with where we see some of the marketing end of this business and the marketing opportunities, we've just to get the costs -- and we know how to do that. I mean, that's what we are is a manufacturing company. So I'm really quite bullish at that end of the business.

Thank you for your comments.

There was a question earlier about base business versus new business.

Tim Ramey, I think, asked that question.

Yes, Tim. As we noted in -- in the conversation earlier our sales for all of Smithfield had increased 12% compared to the quarter a year ago. If we look at tonnage and -- and break that out in terms of base business versus total Smithfield business, our total Smithfield tonnage increased 5.8% for -- for the quarter -- excuse me, for the fiscal year. And our base business is actually down 1.6%, because of the decreases that Larry had spoken about in slaughter volumes and -- and fresh meat sales.

He may have -- Tim, were asking -- I think he was asking, do we get the sales numbers, do we do the sales numbers with excluding -- excluding Armour Eckrich in there?

Yes, dollar sales. Do we have that. Oh, you don't have that.

We can give it to you in tonnage, but--

Tim, we do not have that in dollar sales before us right now. I apologize.

Next question, please.

Your next questions comes from the line of Reza Vehabzadeh from Lehman Brothers. Please go ahead.

Good morning.

Good morning, Reza.

Based on that organic growth trend, I think you touched on a 34% growth in processed meat volume. And, Bo, you just mentioned some data on base business. So processed meat volumes for this third quarter, what was the -- what was the change year-over-year, excluding any acquisitions?

It would be basically flat. Down one-tenth of one percent on base business.

Okay. And that's on the processed meat side. What about the fresh pork side?

Fresh pork side was down 12%.

So, Reza, the reason the price would be down. That's -- clearly you can make your own decisions on market share there, by processing more hogs. We've made the one we've had [inaudible], and Bo, I think you were giving quarterly information. We've had--

Right.

--the plant here in Virginia, one of those closed now for -- it's quarter-on-quarter, it's the same, it was closed in both -- last year and this year.

But we've made the decision in the Midwest plants to run -- to run less hours and to not run Saturdays, and we've had the impact of the circovirus in the East, in terms of our Eastern operations. We've had some impact there in terms of volume.

But fresh meat is something that you can -- on the fresh meat side of the business you can decide what you want your volume to be, you simply kill more hogs. And that's an economic decision, not a market decision.

It seems like you have, on the international front, pretty good results out of Groupe Smithfield as well as -- as well as Poland. To what extent are those results sustainable, and to what extent are they affected by any kind -- I don't know -- unusual, unique trends in this quarter, if any?

And these results are a lot better than international have done over time, so I just want to know how much of that is sustainable and how much of that is unique to this quarter.

As we look at both of those operations, there were exchange gains on a currency basis in both of those numbers, however both businesses were solidly profitable and we do -- do anticipate that that will continue.

Okay. And then any outlook on pork processing margins on the fresh pork side in the six months? I mean do you expect continuation of similar trends, or anything different?

I don't know, Reza. I mean I continue to be -- I guess I hope -- I guess I could say we're going to do what we can do. All we can do is manage our end of the business.

We are trying to -- we are trying to manage for some discipline and not to -- not to flood this market. There is price -- there is pricing pressure on all the proteins. Although much of this meats moved up. And so we are -- we are trying to act with some restraint. I don't know that -- I don't know that the decision to close the second shift of Sioux City was part of that -- was part of that process, but I don't know that -- I don't know that near-term, I see the -- I don't know that I see the fresh meat environment getting substantially better. I cannot make that statement.

But clearly -- clearly for the industry is to be able to -- to pass along to the consumer $4 corn. And -- and that will be an issue that the packer has got to face and an issue that the retailer has to face. And they'll be a lot of dynamic changes as we do that.

We have sold meat at $60 live hog levels and done it profitable -- with profitable results, so the consumer has paid those types of prices before. But typically it's been on a seasonal basis. But that will be the challenge for the industry.

Well, one thing about it, we do know is that this industry does not have margins long enough that anybody can afford to absorb -- this industry cannot absorb $4 corn without passing it through pricing and -- and all three of the proteins, depending on -- and turkey, if you want to count that as a fourth -- we've all got the same ingredient, we've all got the same cost pressure, so -- and I like to tell people that food is such a small component of people's disposable incomes, it's not going to bankrupt this country to have a protein increase in pricing.

Again, we haven't got a price increase in many of the cuts in 30 years. So, I mean, it's not like we're -- it's not like we're looking at $60 oil and we're looking at $3 gasoline. We're looking at a -- in some cases a return to pricing levels of 15 years ago. So I think that everyone in the industry has got the same -- has got the same issue on every protein. And so I think that we all feel the -- the -- and it's a more -- and whether it be poultry or now, more so the pork industry, it's acting like -- it's acting like a vertically integrated industry more and more everyday.

And so $4 corn translates into pork loins and hams and pork bellies pretty darn fast. And so I -- that will be the challenge to all of us.

Thank you much.

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

Good morning.

Hi, David.

Just pursue the question of pricing, first of all, and I guess maybe my question would be related to meat supplies. Now with your broader perspective across the proteins do you see overall meat supplies close to flat over the coming year, with chicken maybe down a couple of percent? Beef had been looking up, but now maybe flat, and pork up a little. But do you see supplies in the U.S. maybe flat over the coming year?

I think, David, what we're going to see is the weights come back. I think you probably have already made that same observation. And so that's going to take some of the production, or some of the pounds, not the number of animals, but take some of that weight off this market. And I guess I would say yes to you, but in this whole winter -- winter issue in terms of this cattle has certainly had some impact on the beef -- the beef production side in terms of weight there.

I would -- I would tend to say yes to you, but I guess I'll leave it at that. I would tend to say yes. There's not much -- there's not much pressure to increase weights and there's not much pressure to increase numbers, that's for sure.

As a cattle feeder, how much do you think carcass weights could come down as we move through the year?

I don't know, David.

Okay. My other question would be -- if I may have a second here -- is on the pork exports and linking that to your international operations. Do you have a couple of plants that can export to the E.U.? How is the export market, or what you're doing with pork exports now tying in to you Western European operations? Is there much Arbitrage opportunity these days?

We are -- we are, as we speak today -- we are shipping product out of our -- out of our U.S. -- our two plants in the U.S. into our -- into our operations in France and into Poland as we speak today, David.

And we said we were going to do that, it's taken some time to get that done, and one of the things Mr. Manly has on his responsibility list, outside of his new CFO role, is the responsibility for making that happen. And Bo's done a very nice job of -- of working with our international operations to make that happen.

So the Arbitrage opportunity is there. And we are now -- we are now executing that. And we have -- we have shipped some hams -- well, I don't want to make that sound like it's all new -- we've shipped some hams into Poland before, because we got this product -- we've got this Krakus brand of deli product that we market back in this country and you have this tariff offset, so that was an opportunity maybe a year and a half ago. But we can ship hams into Poland, ship the finished goods right back out of here and miss the tariff on both sides of that, because it's an export credit.

But -- so we are -- we are definitely -- Bo, you might want to speak to that for a minute.

Well, I'd also like to point out that the industry is experiencing an increase in exports. If you look at our absolute volume of exports, we are down compared to a year ago.

That's not because we don't see the same opportunities that everybody else does, but frankly it's reflecting the fact that we have increased our processed meats capacity, and I'll use the example of hams going into the Cook's and Armour Eckrich process packaged meats operations, those were, in the past, perhaps being sold to -- to Mexico.

So we are utilizing our raw material to some degree differently than our competitors because of both internal operations and -- and processed meats activities, but Larry does talk about the sales to Europe and Arbitrage there.

It is not just a matter of having a plant that is qualified to sell product to the E.U. You have to take that all the way back to the farming level, because there are some restrictions in terms of the way in which those animals can be fed to meet European requirements.

And frankly, we view that as a core competency of Smithfield, compared to the rest of the industry, because we control all the aspects of feeding cycles. So we can do it in larger volumes and more efficiently in terms of lining up both the plant activities as well as the feeding activities.

And every animal that we grow today that qualifies for E.U. shipment is going over to the E.U. today, and we're looking for more opportunities to increase that going forward.

Great. Thank you very much.

Thank you, David.

Your next question comes from the line of Christine McCracken from Cleveland Research. Please go ahead.

Good morning.

Good morning, Christine.

Just wanted to see if you could make any comments relative to you acquisition of Premium? Timing? Is it still anticipated for the coming quarter? I don't know what you're able to say at this point, but if you could--

Christine, let me refer that -- Dick Poulson's on the phone, let me let -- at least, Dick -- Dick, why don't you respond to that?

Christine, the matter is working its way through the Department of Justice. We're being responsive their questions. There is some possibility it would close in the first calendar quarter. We certainly hope that it would close prior to end our fiscal year in April.

I guess I really can't say much more than that, but we're working through the process and I have no real concerns at this point.

Okay, so is it your expectation that you'll be able to keep both plants, or are you not able to comment on that?

I'd rather not comment on that. Sorry.

All right. No, that's fine. And then, just wondering if you could provide us with any kind of explanation behind your decision to proactively move toward crates in your production system? Is does add quite a bit of cost and it seems like the timing was a bit odd. I'm wondering if you could just comment on that decision?

Christine, we've been -- we have been having debate with that issue, internally here now for quite some time. That is not -- in fact, we've been debating that now for two years. It is not -- it is not like something we jumped up after Christmas and said, "Let's do something."

But we've been -- we've been struggling with that -- it is a conversation issue with our customers. Some of our customers who -- and as you know customers are more and more concerned about animal welfare. It is one the -- one of the -- I won't say lightning bolts, but it's certainly a high level -- or an early topic of conversation when you get there.

We have been doing some -- we have been looking at the issue, as I said, for two years. We've been doing some tests. We do it in Europe already, so we know how to do the process.

We've been evaluating what the costs are going to be. And so we made the decision that we're going to take a leadership role in this -- in this issue -- on this particular point. It's time somebody does that.

It's an issue that needs to get resolved. We need to work through this. It's going -- we're going to phase it in over ten years.

These gestation stalls are going to have to be replaced in the ordinary course of business, and so as we do that we can control the costs, as well as we will continue to evaluate the various pen sizes and the number of animals in the pens and the way in which we -- the management training programs that have to be out there.

Again, we've got the experience of Europe there. We've actually got some of our -- some of our suppliers even in this country who are -- who are doing a portion of this.

And so we're learning this. I think it's better to get in front of an issues, than it is to let the issue run over you. We will control the cost on this.

I do think the industry will be forced to go there whether they -- I guess they can do what they want, but I believe our leadership will certainly spur many others. As Maple Leaf and others have already said they're going to do.

And so I don't know if there was any particular timing thought process as much as it was we've been debating and debating and debating. And we've had conversation here that maybe we ought to go ahead and just step forward. We know that -- some of the tests we've done -- we -- we can raise these pigs and get about the same performance.

And I think that'll get better as we learn it better and we get into this thing. And we can control the timing on this.

So I think it's -- it's a natural process of the industry to change, and we're simply changing rather than somebody thrusting and legislating it upon us, we're going to take leadership in that end, just like we have on the environmental front, we've eliminated that issue.

We're going to eliminate the negative issues, at least related to Smithfield, to the extent we can and still remain competitive. And we're going to make -- we're going to make this Company a processed meats packaged goods company and get away from this -- all this discussion about -- about the negative aspects of the business and focus on the positive aspects.

And so I think it's a -- I'm very pleased we've made this. In fact, I'm the one who made it. So I'm -- I'll take responsibility.

Is it your expectation that you'd actually increase the number of barns you have or reduce the size of your population to adjust--

No, we would increase the size of the barns. We've got the permits. Most of the permits are what we call steady state live permits, which means we can still have the same weight. We may have to do some extensions onto the buildings, Christine, to make them bigger. But, no, we don't anticipate cutting back the herd levels and the animal levels as a result of this.

[inaudible - crosstalk]

Larry had talked about and addressed the issue of cost, and certainly we will take every opportunity as buildings become available on a normal maintenance basis to -- to make the changeover, so that -- that it minimizes the capital expense. At the same time, it'll require that that farm goes down for a short period of time while the facilities are being modified and therefore, frankly, you can use that as a tremendous opportunity in a very controlled basis over a long period of time to make genetics changes on the female side of your herd.

So we'll be able to use it both to fit into the normal maintenance program as well as make some genetic alternatives that will benefit us in the long run too.

So there's some -- some subtle positives that will come out of this as we -- we make these changes.

And I would tell you, Christine, in conclusion of this, we have just gotten enormously positive comments from everyone who's looked at this issue. Whether that our critics, whether that be industry or whether that be customers, we have just gotten enormously positive comments that -- that we have made the right decision.

All right. Thank you.

Your next question comes from the line of John McMillin from Prudential Equity. Please go ahead.

Good morning, everybody.

Thank you, John.

I glanced at your income statement. It looked like the benefit of corn hedges went to the tax rate. So I'm still--

Just if you could do that accounting, John. I don't think that's the accounting we did, but--

I know I'm so confused and -- first of all, I'm trying to gauge what hog production earnings would have been under the old accounting.

Whew!

John, I've spent -- I'm looking -- I'm looking -- I'm looking at Mr. Manly and Jeff Deel and with my eyes sort of wandering said, "I've asked the same question."

And as I mentioned earlier, if we had not made the change in our accounting treatment it would have had a positive impact of only $5 to $10 million on our Income Statement in that segment.

But I want to be clear, John--

In that segment?

Yes.

So, basically, instead of doing $5 million you would have done $15 -- $10 to $15 million in hog production earnings?

Approximately. Yes. That is correct.

Okay. And where did that 10 to 15 -- where did that $5 to $10 million go on the Income Statement. Or -- or was it just a benefit -- I mean a hurt to the total earnings in the quarter?

John, let me be clear. What Bo was saying, in the operating profit line -- guys correct me if I'm right here -- operating profit line under hog production, we're showing $4.5 million compared with $64.7 last year.

Yes.

Bo is telling you that had we not made this change, that number would have been between $5 and $10 million better than that. So it would have been $10 or $15 compared with $64.7.

Now, what I'm telling you, beyond that, is that we -- that's the -- that's the final change. We were already substantially down that road of changing this. Many of the contracts and many of the futures positions that we had already didn't qualify for hedge accounting.

Now, your question I think you asked, John, was had you not had to mark your futures contracts to market, what would your hog production results have been? I think that's actually the question you want answered.

Well--

And that one -- that one I would love to tell you is substantially larger than $5 to $10 million, but our auditors will have a heart attack if I use any other number on this telephone call.

Is that not right, Jeff?

So, basically the -- the--

Jeff will.

Have a heart attack? I mean the number's -- because -- these are futures positions on corn and hogs past the end of the quarter. They're open futures positions in the future periods. Now, we have -- many of those, in the past, John -- or we have increasingly -- they have qualified less and less in hedge accounting, so less of those were treated as hedges and more were treated on mark-to-market, already.

And we were already -- past the 50 yard line and so we got into this -- we've been having this debate during this quarter. And we made the decision, let's don't debate whether 40, 50, 60, 70% of these qualify as mark-to-market and the other hedge, let's just go to mark-to-market on all of our hedges and all of our contracts. Let's just go to market. That'll be a one time hit, and now the -- now all contracts for all future periods -- all non-financial contracts, John, because we do have some interest rate swaps that are -- they are hedge accounting.

So it is a number substantially larger than the $5 or $10 million that actually impacted this quarter.

You disagree, Bo?

No, that's absolutely right.

[inaudible - crosstalk]

I know you're asking for a factual number, John, and I've got a number in mind but the auditors have resisted us disclosing that number. But I don't know if there'll be any further disclosure in the 10-Q, Jeff, that would give him more clarity on that.

There will be.

So then basically you have a lot of corn hedges that -- that when you give a 42 number is that -- that includes the benefit of your corn hedges, correct?

It can, yes. And there's two different kinds of hedges there, John. There's the financial hedge, then there's the forward purchase commitment. And forward purchase commitments are not -- are not hedges. Those are simply where we've bought the corn ahead. They are not financial -- they're not futures contracts, they're future commitments. And so.

But when you came up with $4.5 million of pretax earnings in that segment, was it based off a $42 production cost number? Is that number based off of a $42 production cost number?

Yes.

Yes. And, John, you're not -- and I would suggest to you that you could do your own math, I cannot confirm or deny this, because the auditors will shoot me. But I think if you take $42 raising costs and you subtract $38 raising costs, and you multiply that by the number -- by the average weight of the hogs and by the number of hogs we marketed, you may find out that doesn't equal the differential between $64.7 and $5.

Yes.

You may -- you may be able to do that math, John. I'm suggesting you're capable of doing that math. And you will see there's a big hole there.

Yes. And what's that hole? What's the hole?

We've given you the raising costs, now we'll tell you that hole is some of the impact of our commodities mark-to-market adjustments.

Which seems to -- but the hole seems bigger than $5 to $10 million, doesn't it?

Yes, it does.

But what else is in there?

The $5 to $10 million is--

I'm so confused.

--the $5 to $10 million is the difference in value of contracts that would have been taken to the time period that the cash transaction took place -- or will take place, in the future, and that we would not recognize the profit or losses on the -- that group of futures contracts until the cash transaction took place.

Today, under mark-to-market, we do recognize those changes in those futures positions on that element on a current basis.

So, it's merely a timing issue. We -- we had the impact or profit or losses on those contracts, it was just when we report them.

Let me give you, John, an illustrative example, without numbers.

Okay.

Larry Pope. If we are holding commodity contracts in place for the next nine months, we have been having debate with our auditors as to how much of those nine months commodity positions are hedges and how much are mark-to-market. And so, I will tell you as of today, all of those nine months are mark-to-market. 100% of those. So all of our futures contracts for all the remaining periods going forward -- Jeff, help me if I'm incorrect -- have all been mark-to-market. So there is no--

Well, shouldn't that be a benefit, because most of these have to be buying corn, and any corn future contract, you've got to be making money in spades.

So if you mark them to market shouldn't there have been some kind of overall benefit to the Income Statement versus your accounting a year ago?

John, let me--

I'm sorry to interrupt you right there.

We're going into bizarre land here, now. So hang on. Any contracts that we had already put in place prior to this decision still is hedge accounting. Which means, as an example, had you put in place a corn futures contract prior to making the decision, that is not mark-to-market, because you've already previously determined that's a hedge.

So, I know if that didn't confuse you, then you are -- you are--

I think I understand. Okay, so if you did it before, if you've got some future that you did September, October, November, to $40, you're not marking those to market, it's just the new ones.

You've already decided from-- settled only.

Settled contracts only.

If you have contracts that have been settled. But the other side of this, John, let me go to a point that matters, here. Again. But we've been having debate with our external auditors over time in case of things like live hog contracts, that they have been saying fewer, and fewer, and fewer of those qualify as hedge accounting and you've got to mark those to market. So if you were marking to market only 10% of that nine months, then it became 30% and 40%.

And now they're saying -- or we've come to the conclusion it's 100%. So all of your futures positions on any hogs you've got -- we've decided to mark them all to market, as opposed to only a limited amount of those.

And this has been a -- this has been -- I'm not saying it's a contested issued with the auditors, it's a -- it's not confrontational, it's heavily -- it's hard to calculate, it's hard to decide, because then we come to a conclusion, when does a baby pig get qualified to hedge accounting and when does a feeder pig, and when does a weaned pig, and when does a market hog -- which ones qualify for hedges and which don't.

And we knew this would be confusing for you for the quarter. We did know that, John.

This is where we all miss Bill [Luder] who has the ability to put it all in one sentence, and kind of take a very complex thing and just put it in about six words. I guess I understand half of it. Now let me understand what you--

What I would tell you, John, is to go back and focus on the $42 raising cost.

Yes, I think that's it. So when you say in the press release that, going forward, your hog production segment based on futures is still profitable you're basically basing it off a $50 production cost, roughly, and then looking at futures contracts for hogs. Is that correct?

Well, I'm telling you if corn stays at this $4 -- $4 or $4, $10, $20, $30, who knows, that we will have a $50 raising cost a year from today. I didn't say we'll have $50 raising cost in the near future.

Yes. Okay.

And if you look at the futures markets out there, I mean you've got -- you've got $55, $56, $57. I don't know what they're doing today. I mean you've got strongly -- well above raising cost -- well above raising cost for the foreseeable future. So I don't think there's much risk that hog production's going to be unpopular. That's why I make the statement.

I got you. Thank you.

We've gone way over our one hour limit. We want to thank everyone for joining us this morning. Have a good day.

Ladies and gentlemen, that does conclude your conference for today.