Smithfield Foods Inc (SFD) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Smithfield Foods second quarter earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. The recording will be available from November 29th to December 6th at the following number, 1-800-633-8284. Once again that is 1-800-633-8284, entering reservation number 21356361.

I would now like to turn the conference over to Mr. Jerry Hostetter. Please proceed, sir.

Good morning. Welcome to a conference call to discuss Smithfield Foods' fiscal second quarter results.

We would like to caution you today that in today's call there may be forward-looking statements within the meaning of Federal Securities laws. In light of the risks and uncertainties involved, we encourage to you read the forward-looking information section of the Smithfield Foods Form 10-K for fiscal 2007. You can access the 10-K and our press release on our website at www.smithfieldfoods.com.

I would like to cover one administrative detail. We would like to provide the opportunity to as many analysts as possible to ask questions. As a courtesy, we request that only one follow-up question be asked, so that everyone can participate. Thank you.

With us today are Carey Dubois, 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, Jerry. Good morning everybody. Thank you for joining the call. I am pleased to report this morning second quarter earnings income from continuing operations of $18.7 million, or $0.14 a share, compared with $46.4 million, or $0.41 a share in the same quarter last year. As you can see from the press release for the six-month period we are at $80.7 million, compared with $86.3 million, and that is $0.60 a share compared with $0.77 a share.

I hope you took note the second paragraph of our earnings release where we pointed out that our second quarter results include charges which we had previously announced, related to a classical swine fever inventory reduction in our Romanian operations, which resulted in a $13 million after tax charge, as well as we have had substantial foreign currency revaluation charges during the quarter that are also being reflected, and they total $0.28 a share. We have been reporting both positives and negatives there, and realize that is part of our ongoing operations in terms of foreign currency exchange gains and losses, but we feel an obligation to report that to you.

Clearly the big story in the quarter is the fall-off in the results of our hog production operations. I think if you remember at the end of the first quarter, I predicted that there would be an awful lot of hogs I suspected coming to market this quarter. Those hogs have come to market.

It has been a very strong fall hog run, and that has resulted in a fall modest fall-off in the live hog market during the quarter, in the third quarter it has fallen off even more, and as well we have had an increase in our lot of production costs, as I think we pointed out to you in the press release. That is an increase from $0.41 up to $0.49, $0.08 a pound, but you should be realizing if you do the math, that those results do not reflect the impact of our hedging activities, which help offset and control some of those losses.

An awful lot the of that decrease in our live production operating profit relates to those losses in Romania, both in foreign currency exchange losses, and in the classical swine fever charges, the two of those together are about $30 million for that decrease in live production. The losses and the reductions, the reductions in the operating profit on the raising side was largely offset in pork processing. That part of the business I am extremely pleased with, and was extremely pleased in our first quarter.

Fresh pork during the quarter was marginal. These results from 22 million up to $62 million for the quarter are mainly the result of strong improvements in our packaged meats business, and I will talk about that in a minute or so after I work through the segments.

The beef business continues to be marginal. I think you heard from some of our competition that that end of the business is tough. There has been an increasing production level by some of our competitors. I am pleased to report that in spite of that, we are still continuing to report positive results in our beef processing operation, and a slight profitability in cattle raising.

If you might remember for the last several quarters we have been reporting the fact we have had losses in our cattle-raising operations, both what we own and through our Five Rivers joint venture cattle feeding operations. They are modest profits, but the time period that we talked about with having bought some feeder cattle at some fairly high prices, that is getting behind us, so I am pleased to report that at least we continue to report some profitability there.

On the international front, that continues just to be a very good story. Our group Smithfield joint venture now more than a year in passing is very good. Our western European operations are very solid. Our Polish operations have turned around very nicely.

I hope you took note we made an announcement during the quarter that one of our two Executive Vice Presidents, Robert Manly, he has taken on responsibility for overseeing our international operations. I think that business has an awful lot of potential.

Bo has an enormous amount of experience in the meat business, and his focus on that end of the business in a more concentrated way, I think will continue to allow us to mine those operations and take advantage of the synergies between those operations, as well as synergies between our European operations and the U.S. I am extremely pleased about that move, and I think it is a positive for this Company. I think our international continues to have a lot of potential, and I think for now about three straight quarters you have begun to see a bit of this.

Let me talk for a minute about the area that I am most excited about, and I pointed that out in our earnings release is our packaged meats business. This is an area that continues to just show enormous promise. I think that is a concentration of the Company, all of our management teams are focused on that end of the business.

We started the initiative about three years ago of using our raw materials internally. We have essentially completed that process, and are now opportunistically improving the margins of this in the business. I have told you before that I would rather be a smaller, more profitable company, rather than a larger less profitable company. We are focusing on that.

If you see the numbers in our press release, we point to some very, very big numbers, in terms of some important categories in this Company, from precooked bacon up over 100% for the year-over-year year. Yes, that came from the Armour-Eckrich acquisition, part of that, our smoked sausage business is up nearly 70%, and our dry sausage business is up over 125%, and even our cooked sausage is up nearly 25%. These ends of the businesses are just doing excellent.

And I can report to you that we have now owned the Armour-Eckrich business for now a full year. There have been a number of people who questioned whether that acquisition was a good one. I can report to you today it was a very good one, it has been accretive to our earnings and it has positioned us in the packaged meats business with some brand name and product categories that are well positioning us, as we are benefiting not just for tomorrow, but even for today.

We are focused, very focused, on increasing our capacity utilization. We are very focused on managing our costs inside the plants. Our approximate fixed over head costs quarter-over-quarter, this quarter compared to the second quarter last year, I can report to you they are not up, and I take that as a very strong positive in spite of $90 plus oil, and the pressures that we are having from other driving costs, we are managing our overhead costs to improve our efficiencies through these plants, and we are helping to offset all of those cost increases through some of our strategic sourcing, and some of our manufacturing realignment processes.

We announced just recently the fact that we were closing another Armour-Eckrich plant in Lufkin,Texas, and we were going to merge the operations from that underutilized facility in to some of our other plants. We are doing that as we speak, and that will once again help shield some of the cost pressures that we are feeling in the business, and I think that is going to benefit us at the bottom line, in terms of the margins on our packaged meats.

We commented in the press release that we have some ongoing marketing programs. Our program and our association with The Food Network celebrity Paula Dean continues to bear fruit for us. We are very pleased with that association with her now that has just passed a little over a year, as well as we are rolling out some new product categories, primarily related to the Armour-Eckrich business that are reintroducing some product categories that I think have an awful lot of potential for us, and one of the things we are striving to do as a company, I have said that to you many times, is that we are slowly moving towards a marketing company.

We are moving away from the total commodity influence on our business, and allowing our brand names and our product categories to create more pull on this business, as opposed to being a push business. Our base packaged meats business is only up 3%, and that is a controlled 3%. I think we are making very good strides in that end of the business. That drove our first quarter earnings. That is driving our second quarter earnings, and I will speak to the third quarter and going forward in a bit as well.

You should be aware our export business, I know the industry is experiencing some positive numbers on the export side. I can report to you today that we are experiencing excellent numbers on the export side of the business in a number of countries, and so that part of the business has helped move this meat during this quarter when we have had these record kill levels.

And you may have noticed, some of you may be aware that Smithfield actually processed hogs last Sunday. I guess that is a week ago, and we are now debating whether we would ever go to another Sunday kill. I think the last time there was a Sunday kill was nearly 10 years ago. We did have a home for the product, demand for the product is very strong, and we know that we have these large levels coming at us, and so we made the decision to run on a Sunday, which is relatively historic at two of our plants, so the demand side of the business is very good, and the freezer stocks I think speak a little bit to that issue.

Before I talk about the forward-looking part of the business, I am going to turn it over to Carey Dubois, and let Carey explain to you some of the financial numbers I know that you are interested in, and then I will take it back and give them a view forward.

Thank you, Larry. Good morning, everyone. Before I begin with the financial highlights, it is worth noting a couple of points that will be helpful in your quarter-over-quarter review of the financials. First and second quarter of fiscal year '07 only included three weeks of results for the Armour-Eckrich and the Butterball acquisitions. Additionally, the acquisition of Premium Standard Farms was a post-fiscal year '07 event, and therefore the last year's second quarter would not have included any of their results.

Turning our attention to the income statement, sales for the quarter were $3.5 billion, or 24% higher than the $2.8 billion for the second quarter last year. Sales were up across all of our business segments.

The pork segment sales increased 28%, primarily from the Armour-Eckrich and Premium Standard Farms acquisitions. While the 33% increase in sales for the hog production segment was largely attributed to the farms acquired through the Premium Standard Farms transaction. Internationally we were pleased to see sales volume increases in Poland and Romania, exceeding 20% and 45% respectively, as we continue to build out their fresh and packaged meat platforms.

Selling, general and administrative expenses were up $58 million quarter-over-quarter. It is important to point out the foreign currency fluctuations flow through this line item. In this quarter, $25 million, or 43% of this expense was related to foreign currency losses. The balance of the increased expenses was largely attributed to a full quarter of Armour-Eckrich, and the addition of Premium Standard Farms.

Operating profit was $88 million, down 20% from the $110 million one year ago. Key drivers for the quarter were an earnings improvement of $40 million, or 177% in pork, and a more than offsetting loss of $59 million in the hog production segment. As mentioned by Larry, over 50% of the hog production loss resulted from foreign currency fluctuations, and the impact of classical swine fever in Romania.

In fact, the total foreign currency loss for the quarter was $25 million as previously mentioned, and the inventory write-down and cleanup costs associated with the three disease affected farms in Romania was $13 million. This $38 million in charges in currency losses ultimately impacted the quarterly results by $0.28 per diluted share on an after tax basis. Adding back depreciation and amortization of $72 million, our earnings before interest, taxes and depreciation and amortization was $160 million, or flat for the quarter versus last year.

On the trailing twelve-month basis EBITDA was $725 million, versus last year's trailing number of $626 million. Interest expense increased $15 million over the same quarter last year. This increase was driven by an overall increase in our debt level, and relatively higher borrowing rates due to the calendar year 2007 financial market conditions.

For a second consecutive quarter we included a table in the press release, which separately breaks out the results of our three major joint ventures. The aggregate results in the table are reflected in the line item entitled, Equity and Income or loss of affiliates. These equity method investments contributed $28 million for the quarter, up 42% from the prior year. I wish to remind you in reviewing this table and corresponding line item on the income statement, that income is actually reflected as a negative number, and losses are shown as a positive number. This approach is necessary for the results to tie into the income statement format.

Taking a look at our balance sheet and cash flow statement, capital expenditures for the quarter were $125 million, as compared to $70 million of depreciation. Our debt level increased by approximately $250 million in the quarter to $3.7 billion. Key uses for the capital were the continued investments in working capital needs in eastern Europe, and our seasonal inventory build up in the United States.

Our debt to total capitalization ratio is 56%, versus 60% for the same quarter last year. We secured $100 million in short-term credit lines in October, and recently increased our U.S. bank revolver capacity by $75 million, to provide adequately liquidity at this as we move through our peak inventory period. We currently have over $450 million of available liquidity.

With that, I will turn it back over to Larry.

Thank you, Carey, and thank you for that report. As we will look into the third quarter and the remainder of the fiscal year, I certainly am extremely encouraged for the third quarter, as those of who you follow the industry know fresh pork margins today are nothing short of excellent. The drop in the hog market has not resulted in a similar drop in the meat markets, and as a result the margins on fresh pork have widened dramatically.

We are experiencing some very, very, very nice margins in the fresh meat side of the business, and that is affecting our third quarter results very, very strongly. As well, I think we announced we had a 60 million-pound Chinese carcass contract here that we are in the final stages of completing, and that has helped with the fresh pork business as well.

I can report to you today that our holiday ham season is as well having a stellar year. Certainly the benefit of a lower ham market has helped margins to some degree, but we have done a very, very good job, and I am extremely pleased with the margins that we are realizing across all of our product categories in this third quarter, and I anticipate a very strong result for certainly the November and December periods, which are traditionally very good on the processing side of the business.

I can report to you that they are excellent this year, and we will have to see after the first of the year. Exports as you would expect are very strong. Our exports were up for the quarter 29%, the industry is up 10. We will continue to have very good exports for the third quarter, can't speak to how the industry will be for that period, but I can tell you our numbers will be good, and our exports are in a number of categories.

Certainly China is at the top of that, but as well we have done a nice job of exporting in the EU, and I believe I know that Swift does have a plant that can export, but we are largely the only person exporting into the EU. We are essentially the only person exporting muscle cut meats into China, so those two markets are open to us, and not essentially open to the rest of the industry.

The Russian markets are extremely good. The Japanese market is extremely good, and I anticipate the Japanese market continuing to be very good through the third quarter, so that part of the business is holding its own, and carrying these heavy kills, and we have got places to go with this meat, and we have places to go with margins on that meat.

Clearly hog production results are going to be down. For the third quarter if you look at the futures markets, they indicate they we are going to continue to experience losses on our hog-raising operations. Looking a little bit farther, by February if the futures markets are right, we'll be back about breakeven in February, and as we move into the final part of the fourth quarter and into the first quarter of fiscal '09.

The profitability in the hog production looks to return as many of you might know from the markets that we have got a mid-$50 hog market in late spring/early summer, so that is our breakevens are probably going to get closer to the $50 market, $4 corn. We are reporting $49 in this quarter, and I think they are going to be in the $47 to $50 range, depending on where corn is, but we are going to continue to report an upper $40 range of raising costs, but the markets are there, and that should be solidly profitable.

The beef business is weak. It will continue probably to be weak. I think we are very competitive in the industry, so I think we will do better than the industry, but we will be influenced by industry dynamics.

The international side is very solid. I am extremely satisfied with our western European as I said and Polish operations. Romania clearly is the live production side of the business, as we have these farms not in full operation. They have a negative drag on the costs. Processing side of the business is okay. I am very comfortable there.

As well we are making continuing our concentration on product mix changes that I have discussed in the press release. We are continuing that, and that and our cost control with another plant closing, all of those lead me to be very optimistic on this packaged meats side of the business. We have got an initiative in place.

Our operating cuts are executing against that in a strong way, and that part of the business is continuing to move forward, not just for a month, and not just for a quarter, but that is a solid business direction, and I think moving us farther and farther away from this commodity discussion and the influence of these commodity markets every day.

At this point, I will be happy to take questions. Mr. Luter is here, and he would certainly be available for questions, and we welcome your comments.

Operator, would you open up the floor for questions please?

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Ken Zaslow. Please proceed with your question.

Good morning, everyone.

Good morning, Ken.

Good morning.

Just more of a broad question. You talk a lot about a lot of cost savings programs. I was wondering, what would it take for you to undergo a major cost restructuring effort, given that you have these 20 or so operating divisions, 70 or so brands, and seems like it may unleash a lot more value to shareholders if there is a rejiggering, and I know I am the outsider, and I don't know how to run the business, but it seems from an outsider's point of view there may be a lot of cost savings larger than these one or two plant closings.

Let me, that is something we have probably thought about for over 20 years. There are certainly two ways to run a business. You can have a centralized business and a decentralized business, and it always appears when you talk to the consultants, whichever direction, wherever your current structure is, the consultants believe the alternate structure is always better.

The one thing we are very careful about, and if you think about the business for a bit, we have independent operating companies. Parts of the business we control being legal and finance and taxation and certainly the control over some of the buying parts of the business, and our commodity market activity, but we want independent companies out there approaching these customers.

Because of the product categories and the regions and the brands, we all need to be very careful, and there is a lot of history out there from people who have tried to put it together, and it failed, so we are very careful about how we approach the front end of this business as we contact the customers.

The other side of that is we are looking at the back side of the business, and we are in the midst of the beginning process of whether we should combine some of our accounts payable and payroll processes and IT processes, but we are very, very careful about the front end of this, and the other piece of that is the customers want first, second and third level suppliers, if we merge companies together, we have a very good chance of losing distribution as a result of that, by the customers putting us together and simply reducing our distribution.

You are right. It is an easy question, and I can understand why you make it and we debate it, but I think we always come back to, it cost us a little money by our structure, but we believe the benefit by being closer and flexible to the customer and keeping those brand names alive in the geographic areas they are strong is worth the cost, more than the cost of the penalty of the cost.

My follow-up question is actually going to be a non sequitur. On the export side, you said that everything was excellent. Is there more to come in China?

I assumed it would be the first question, and you made it the first question, so let me address China to the group. We made an announcement in this quarter that we had a 60 million-pound contract with COFCO, which is a large state-owned trading company in China. Since that time we have been filling that order, and most of it has been filled in this quarter. We have also used this as a time for relationship building, and we have built up a very nice relationship with Cofco, as well a very nice relationship with some parts of the government, but I need to be very careful going forward, in terms of confidentiality with customer relationships.

We do not disclose our transactions and our business with individual customers, and so I am not going to be discussing with the general public our individual, and there has been a lot of debate about a second contract, do you have more business. You will not see me making any more comments related to that in respect to the confidentiality of our relationship with our customers. They have asked for that, and I am respecting that.

With that being said, I think the business is very promising in China. It is a big market. It is a huge market relative to the United States. I think there is a solid demand there, both today and particularly longer term. I can report to you today that there is a six-person inspection delegation from China in the United States, and they are in the process of reinspecting the five plants that we cannot ship into China today.

They are in the process of reinspecting those plants for reconsideration, to reopen those plants as designated plants that can export into China. We will see how that goes during this week as they do those inspections. They are in the middle of them.

One of the things we feel very positive about is we have the availability of Paylean-free ractopamine, I guess is the chemical name of the product. We can provide ractopamine-free product in large quantities to the Chinese market. That is a strong issue in that country. They are not going to change their mind I don't believe in terms of their demand. We as a supplier can supply a customer's need, and we are responding to that.

I know it is somewhat controversial, but it is an opportunity for us as a company, and where our customers ask us to provide products to them to their specifications, we are going to do it, if it makes sense and money for us to do that. I am planning a trip in the very near future to China, which I think will be to continue to explore the business, and to open more doors. I must tell you that I am not going to discuss any individual transactions.

The only thing I would tell you is we report the quarters going forward. I will report to you on how our exports are doing, and how they are doing by country, and I think that will give you some indication of how the business is going, and I will leave it by telling you I think it is very promising.

Thank you very much.

You are welcome.

Our following question comes from the line of Christine McCracken. Please proceed with your question.

Good morning.

Hi, Christine.

Just wanted to touch on hog production. Clearly USDA underestimated the number of hogs we would have this fall.

The industry is experiencing now pretty sizable losses, rising feed costs. Do you think that now going into the spring that we will see some herd liquidation, or do you think with the profits that you mentioned by February or something, and a couple years of good money in the bank, that producers will continue to expand?

Christine, Mr. Luter may want to comment on this but I will give you my opinion here. Certainly you are seeing liquidation in Canada. I don't think these producers are feeling much pain, and what pain they felt has only been very short lived here.

They made an awful lot of money, and they got an awful lot of money in their pockets. If you look at the futures market, if the futures market, so right, Christine, they are going to be back in the black pretty quick, and they are probably not much in the red from a cash flow standpoint even today. I am not hearing of any wholesale liquidation of live production in the United States.

Now we get some anecdotal information from our banker friends, and some people are talking about it. The numbers I don't have any handle at all, so I am sure there are those who are highly leveraged, who got debt to service that may be experiencing this, but I am not seeing any real big numbers that I think are going to turn the markets the other way.

Joe, do you have an opinion?

No. I think that export demand to all parts of the world will take up a lot of this increased production. We continue to be very optimistic about export sales everywhere, and I think the hog prices in the future will reflect the level of export demand.

And chief U.S. dollars will keep those exports moving.

At least for awhile. Just on a follow-up then, when you consider kind of the supply or I guess the slaughter capacity [of packard space] now at the packing plant, we are hitting up against kind of a ceiling, and yet Triumph have been out now, or they are delaying their second plant. I am wondering if we continue to expand even at a slightly slower pace, where are we going to put all of these hogs?

Do you want to take that, Joe?

I don't think you will have expansion.

I don't either.

Okay.

I think you will have a leveling off, but I don't think you will have expansion.

Christine, I guess what you have seen in the industry, we did go through the fall hog run here when we have had big numbers. Surprisingly big numbers, but the industry, the markets have held reasonably, and the market has processed those hogs.

As I said we processed two plants on a Sunday which I know is an historic situation, but I think today, and I do think that with Triumph, I think they did say they are going to expand the plant from like 16,000 to 18,000, so they are adding 2,000 of capacity which I am not suggesting 2,000 is a solution to this, but we still have some Saturday capacity out there, and the industry did okay even during the fall hog run.

And the kill levels will go down in the next two, three, four weeks as they do every year.

They will.

Thank you.

Thanks, Christine.

Our following question comes from the line of Farha Aslam with Stephens Inc.

Good morning.

Good morning, Farha.

Two questions. First one on hogs. Are you keeping the second line at, I believe your Sioux City plant is still running?

What we have got there is the second shift is only partially running, Farha, that is to accommodate the production of our Chinese product. We are using our second shift there. It is only partially manned, and it is just for Chinese production.

Do you anticipate closing that second shift down, come December or so?

We have had that shift on and off, Farha, so it is not, of course at this point we haven't made a decision to put it back on, although I did say it was temporary, but we actually curtailed that and it is not running even today.

Okay. Just one quick follow-up on Turkey. Can you share with us the trends in the business, what margin outlook you are seeing there?

Our margins are not as strong as the numbers I saw on Hormel. Part of that can be a bit of timing. The Butterball business is much more a whole bird business, and the third quarter is going to see a benefit moreso than the second quarter in the Hormel business is, and obviously they are seeing the big impact of the grains affecting that business.

I am pleased that we are still reporting positive numbers. I think the business is good. I think the piece of that that is always troubling is the higher grain costs.

Okay. Great. Thank you very much.

Our following question comes from the line of Diane Geissler with Merrill Lynch.

Good morning. Can you hear me?

Good morning, Diane.

Hi. If you could just comment please on the extent to which hedging helped you in your hog production group? You did talk about benefit there, if you can give us some kind of quantification?

Diane, that is a very complicated question, and my response to that is going to be one you probably won't like. I think I made that the last two quarters, Diane.

Judge me on the numbers. Hedging between what we do in forward buying grains, what we do in the commodities market, closing our contracts, marking to market is so complex that we can't get auditors to sign off on it, and it is part of the raising process. So I am only telling you it is part of our results, and I am not, I don't know that I can actually give you a number that I could get all of our accountants to agree what the number is, and finally, Ernst & Young wouldn't sign off on it.

I can tell you that it was a positive number. That is part of our strategy. We have a multi-leg strategy there. We buy grains ahead in the pure cash market, so hedging is a complicated answer here.

Okay. So the numbers that were referenced in your press release would be the spot cash prices, and then any differential we should assume is either on forward sales of hogs and/or grain hedging?

Grain hedging or forward grain buys. That is right.

And do you have positions in place for the third quarter and fourth quarter, or how far out are you extended?

Diane, we routinely have grain hedges well out into the future. We don't routinely have hog hedges quite as as far out in the future.

Any commentary you would have made earlier in the call about what you expected live hog versus raising costs would have been spot-based?

That is right. That is the way we calculate the business. The other part is so difficult to determine.

Okay. All right. I appreciate the comments. Thank you.

Thanks, Diane.

Our following question comes from the line of Jonathan Feeney with Wachovia. Please proceed with your question.

Good morning. Thank you. I guess just following up a little bit on Diane's question, Larry, looking forward, I guess this is somewhat of an unusual situation that we have such bad fundamentals in the spot market right now, but actually some really attractive spreads between what appears to be corn costs and overall costs and hog prices in the future.

I know you are not going to talk about the level at which you are hedging, but does that entice you to accelerate your forward selling of hogs, and buying of corn right now, or what is your philosophy about that spread going forward?

I guess that is the management decision that we look at every day, is if you see $55 hogs out there in the summer, do you take $55 hogs and lock that in? Certainly the incentive there is to do that, but it is all about where you think the markets are going to be, and where we think the hogs are going to be next summer. Certainly it is an area we are looking at. I will tell you that.

I just remember back I think I want to say it was 2004 when we had a great, great summer for hogs and corn was cheap, and basically all the analysts were modeling these huge, huge quarters for you guys, and then it turned out you sold hogs forward a little earlier than some of our counted on, the mentality was it sounded like you had a certain bogey in your head that you thought was a good return on your capital, and if you got to that spread level, you would say boom, we will hedge that out because that is a good return to shareholders. Not that you're going to disclose that, but do you have a number like that in your head?

We do have a working number. Yes, we do have a working number in our head.

That is lower than infinity?

What did you say?

That is lower than infinity? I was just joking.

That number is different. That number is different in July than it is in November.

Yes.

You are not going to make the same return on hog raising, so you expect better returns in the summer than you do in the fall. Our bogey is different depending on the season.

Okay. I am sorry. The only follow-up I had was on foreign currency. Could you walk us through the hit you took there? I assume we are feeling a benefit in the European operations that is offsetting? How does that work?

I will refer that to Carey.

Good morning, Jonathan. Basically the way we capitalize Romania is largely through hard currency debt, and/or a considerable amount of the capital structure. As you have seen, the delay took a hit against the Euro over the past quarter, so basically this was a noncash hit. It is basically what we call a translation loss.

Sure.

And it is important to remind you that last quarter we actually had a $17 million gain. Basically we gave all of that back this quarter.

Okay. When you think holistically looking at your European operations, presumably the reason you chose to fund in Euro is probably because you have a huge, long Euro exposure implicit in the business. Is it fair to say you are getting a translation gain on the income side with this European profit that you are making?

I think that is fair to say. I mean, clearly all you need is another quarter like we had in the first quarter and all of this would come roaring back. Obviously as the exposure grows there, we will investigate the use of various tools that we can use to actually dampen this volatility. There are things that we can do. As the exposure continues to grow, it is something that we are very sensitive to, and we will manage accordingly on a going-forward basis.

Okay. Thank you very much.

You are welcome.

Next question, operator.

Our following question comes from the line of Oliver Wood with Stifel Nicolaus. Please proceed with your question.

Great. Thanks a lot for taking my question. Just wondering, future charges related to disease in Romania, if any, last quarter you gave us guidance. I was just wondering if you can give us a sense of what sort of charge we could expect in the fiscal third quarter, and also how long these charges are expected to last?

I think I can report to you that what you would term as charges you probably unless I am mistaken, I am looking at Carey when I say that, don't believe that we are going to have any charges in terms of reported charges.

We believe that the Romanian swine fever issue, the cleanup is behind us, so we are back to 'normal operations' except that we are underutilizing the assets, so what we are going to have is an opportunity loss. You won't see any charges actually coming through as a result of that.

Got you. All right. Thank you.

Our following question comes from the line of Ann Gurkin with Davenport.

Continue on with Romania, what are you running now in terms of hogs processed per day?

I think we are running at 2,000 a day, which is 10,000 a week, and that is was what we were hoping by this time originally we might be up to 14,000, but 10,000 is about where we were running three or four months ago, so the break in swine fever has not had the impact you might think. It is not that we are not running hogs. It is not like the plant is empty, although we had two weeks there in this quarter. I guess it it has sort much been this quarter, when we didn't have anything going through the plant.

That is coming through the P&L. We are running 10,000 hogs a week through that plant. We had hoped we would have these other farms online and fully operational, and we would be ramping up to 14,000 by now. We just have not been able to do that.

We are still running at the levels we were running in the spring, which I don't want you to, we are not running big losses on the processing side of the business there. That is not where the losses are happening. They are happening on the farm side, not the processing side.

Okay. The export market, can I get an update on ham sales to Mexico?

Our Mexico business is up a couple of percentage points for the year, Ann, but Mexico is not the big, big market. It is a solid market for us. A lot of it is our fault. In terms of hams, we are not a big exporter of hams. The industry is, but we are not.

We are not a big exporter, because we don't have the ham to export. We use those hams ourselves, or those hams go to the EU now, which are better markets for us.

That is great. Thanks very much.

Next question, operator.

Our following question comes from the line of Zafar Nazim with JPMorgan. Please proceed with your question.

A couple of questions for you, Carey. First, the EBITDA number that you mentioned for the LTM of 725, is this pro forma for a full year of premium standard pounds earnings?

No. This is an actual number.

Actual. Second, on the equity earnings from the joint ventures you have in place, can you just tell us how much of this actually gets translated into cash?

For most of our joint ventures, the way that the funding has been put in place, we have basically dividend blockers on most of that, to the extent the businesses generate cash, we pursue to reduce the debt levels in those businesses, so we currently are not pulling any cash out of those businesses.

Okay. Thank you.

Our following question comes from the line of Resa [Vahabzadeh] from Lehman Brothers. Please proceed.

Good morning. Carey, on the debt levels, was it exactly $3.7 billion?

That is correct. That is correct.

Did you have any cash on hand as well?

Very little cash. We had about $80 million of cash at the end of the quarter. Just frictional cash held up in the various businesses.

Okay. As far as raising costs is concerned on the hog production business, how should we think about that? Should it be sequentially flat or up going forward net of hedging?

I think you're going to be somewhere as I said my comments, somewhere I don't think today our costs are going to get much below $47. I don't think they are going to get much above $50. I think we are going to trade in the $48.00, to $47.50 to $49.00 range.

Last question for Carey. CapEx for the year still 400, 420?

We are still managing, trying to manage to that number.

Is there a kind of a range?

What you are seeing is 125 million flowing through the quarter. Obviously there was some pent-up demand there in terms of CapEx that had already been approved, for example, six months prior. You are seeing that come through. We have slowed the pace of investments given what has happened to the hog markets, so we are watching that very carefully. We will do our best to try to manage that number.

Thank you much.

You are welcome.

Our following question comes from the line of Heather Jones. Please proceed with your question.

Thanks. Good morning. I have a quick question on the FX. Is that essentially balance sheet translation gains or losses quarter to quarter?

No, they are not. We were required to flow them through the P&L, given how they were booked locally. Again, they were noncash items. It is just the fact that with their weakening currency, they are basically their debt liability, to that extent it would be balance sheet, but the debt liability was perceived as growing, that is correct.

So the balance sheet changed locally and has to flow through the P&L?

That is correct.

Is this something until you make some structural changes over there, is this an impact whether it be a gain or a loss that we should see gar to quarter to quarter?

I would not expect to see this on a quarter to quarter basis. I think you will continue, as we expand our investments overseas, it will become an integral part of the business, where you will continue seeing some foreign currency fluctuations. What we will do is implement tools to try to dampen that as best we can.

Again, as you know most companies do not hedge their translation exposures, and to the extent that a tool, a hedging tool would be used, we would actually be creating an economic exposure for the Company where none basically exist today. We want to be careful. This was a translation that had nothing to do with payables or receivables, or did not involve a settlement of any transactions.

Okay. And then the following question on the hog production. Roughly on the cash basis of $3 per hundredweight raising loss, and that combined with the FX hit, estimate a pretty substantial cash loss for the quarter, and so it just seems like looking at prior quarters compared to this quarter, that the hedging gain was more sizable than normal, and I was wondering if you could speak to that, and I understand that you won't give details on your hedging position, but if this was more sizable than normal, can we expect similar trends going forward, or just if you could give us some color as far as that goes?

My comment I would make to you is that hedging is an integral part of our business and has been for many years, not several years, many years. We use the commodities market as an integral part of this business. I think that that is a part of the business that we do a very good job on. I think we have good insight into when to place hedges on the grains, and when to place hedges the hogs, and I think those come flowing through the P&L. Certainly the timing I can't tell you. My gosh, the markets move every day, and it can be millions every day.

But I think that you can expect that there will be hedging impacts on our hog production operations on a quarter to quarter basis. I think you can expect that. I think on a long-term basis over a year or two years, I think we can tell you those things ware going to be positive. I think we do a better job of using those markets to our benefit, and take timing some of our buys and our forward lock-ins on prices.

Right. Okay. Thank you.

I think our results will be better than the cash market will give you.

Right. Right. Okay. Thanks.

Our following question comes from the line of Bryan Hunt with Wachovia. Please proceed.

Yes. Thank you. I was wondering if you could talk about what percentage of hams and other raw product that you are purchasing externally today, versus where you were a year ago prior to the Premium Standard acquisition?

I don't have a number off the top of my head here. I am trying to go through some math in my head. We are probably only net buyers of 3 or 4 or 5%, but that is enough.

We are using everything internally, even including the increase that Premium Standard Farms brought to us in May, our packaged meats business is absorbing all of that, and I can tell you every week we are out there buying 10, 20, 30 loads of either hams or bellies in the open market.

And the other question really has to do with some comments you made at your Annual Shareholders meeting. I think it was mentioned in a transcript that you wanted to be investment grade. I was wondering if you could talk about over what timeframe you would like to achieve that target, and have you spoken to the agencies about target leverage points and other credit metrics to get there?

I guess I don't remember making that comment at the Shareholders meeting. I will trust you listened to the transcript and I haven't. I will trust that I think this industry, I think a number of people, maybe I made the comment a number of buyers are of the bonds, that when we issue a number of bonds of investment grade holders drop down, what I call to improve their yield on the coupons, and buy our bonds because they treat us as if we are investment grade, we are not investment grade, and I can tell you that the rating agencies have a negative opinion, because of the volatility of industry, they have a negative slant towards this industry in terms of rating.

Now let me turn my attention to, I think the related question you were asked. We do have an awful lot of debt on the books. And the 3.7 million that Carey made reference to a couple of times here. We are at 56% today. We would like to see that number certainly closer to 50%, and actually into the 40s. I made that comment a number of times.

I would like to be in the 40s, not in the 30s, in the 40s because debt is an important part of giving returns to shareholders. We need to, we are working towards controlling CapEx, and moving these debt levels back down to a level that is more acceptable to us. I don't believe that's going to, let me tell you, I don't believe that even getting to that level, I don't believe is going to get us to investment grade.

And is that going to be a function of generating free cash and paying down debt, or growing cash flow?

We have got to grow cash flow, and we have done an awful lot with CapEx, and I think that you're going to see, I think we already are seeing that our CapEx levels are moderating.

All right. Thank you for your time.

Our next question comes from the line of Edgar Roesch with Banc of America Securities. Please proceed with your question.

Good morning.

Good morning.

Just curious if you could give us some visibility because some of this increase in supply of hogs is coming from getting your arms around the circovirus. What is of timing of when that would start to flatten out on a year-over-year basis?

Flatten out meaning that the production levels at the farms are approaching the same as returning to more normal levels? I am not sure I know --?

Yes, and so that we are not comparing comparing against production levels that were hampered by the circovirus?

I think we are rapidly moving towards that as we speak, and you don't even hear any reference to me to circovirus in this conversation on today at all.

Okay.

First quarter that we thought we had the vaccine, we had the disease under control, and I think we do, and that issue is becoming lesser and lesser to us, so it is dropping off the radar screen.

You are still, correct me if I'm wrong, but are you still comparing to quarters last year where you had a significant negative impact?

Yes, we are. Yes, we are. That will be something a couple of more quarters. It is really the first quarter, this first quarter is when we started to catch the number back up. We still have two more quarters, third quarter and fourth quarter we will continue to be comparing against down quarters.

Great. Thank you. Follow-up question if I could on you are talking about thinking about Smithfield more as a marketing company, and I was just wondering, obviously you are getting a great mix shift as you are switching to more packaged meats.

Can you speak to the performance of your brands at retail, and also how you are doing at foodservice? Do you feel good about the brand strength, and are you gaining share, or is it currently just sort of carving out more profitable niches under the sales umbrella that you have?

I would tell you that our foodservice business is excellent. That is an area of the business that is excellent. I think that the marketing efforts on our brands we are focusing on the brands, and some of the branded categories we are gaining market share, and as well what we are doing which is equally important, is being more disciplined in the use of our available capacities. I am glad you asked the question.

That is the part of the business that no one ever focuses on, and I keep telling in all of my investor presentations, it is a giant piece of our business, and it fuels the P&L that no one ever pays any attention to, and I think if you look at our earnings for the quarter, and you see where the earnings are coming from, they are coming into the business, yet everybody always focuses on where corn prices are and hog prices, and they forget that $63 million we made in largely in the packaged meats business, and that is becoming more of a pull business.

Yes, we still have push attached to that, but the product shift is very good and very encouraging to me. Our brands are gaining significant strength. You can look at the Nielsen data out there, and that is a very powerful engine to this Company. Doesn't seem to get much traction with investors. Hopefully I will live long enough to convince you guys that we know something about the packaged meats business.

Sounds good. Thank you.

Our one hour is up now. Larry, did you want to make some closing remarks?

I do, Jerry. I think the business certainly we went through a quarter here when the earnings were down compared to the prior quarter, and the hog profitability of raising hogs has fallen off for the quarter. If the markets are right, that is going to return. We have got this business in almost every segment of the business, we have got this business positioned competitively very, very strong, whether I talk about the beef business, the international business, the hog-raising business, particularly our packaged meats business, and even our fresh meat business.

We are focused on the bottom line of this Company, and we are focusing on weathering these downturns in the market. Most are lamenting the fact that the beef business is crappy, and the fresh meat business and our costs are up. We are controlling those costs. We are expanding our margins, even as these markets are against us. Our beef business is very competitive.

Our hog production business is very competitive. Our market insight that we use the commodities market in forward buys, very solid business, so I leave you with a comment that the quarter overall is a bit disappointing for all of us, but it has got all of these currency fluctuations in there. It has got a classical swine fever charge in there in Romania.

As I look in to the third quarter, things are in excellent shape for this business. Our export business is in excellent shape. Our packaged meats business is in excellent shape, and so I am extremely encouraged by the business, in spite of reporting a number that is $0.14 versus $0.41 last year, and so I hope when I report to you in February, that you will be surprised, pleasantly surprised by where our results come out, but trust us in saying that I think this business is on very solid ground, and the controls we have over the business that we can manage in this are well in hand.

Thank you, Jerry.

Thanks, Larry, and thanks all of you for your interest today. Have a good day!

Ladies and gentlemen, that does conclude our conference call for today. We do thank you for your participation, and we ask that you please disconnect your lines.