Smithfield Foods Inc (SFD) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Smithfield Foods fiscal 2011 first quarter earnings 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 to you at that time. (Operator Instructions). And as a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Keira Ullrich. Please go ahead.

Good morning. Welcome to the conference call to discuss Smithfield Foods fiscal 2011 first quarter results. We would like to caution you that in today's call there may be forward-looking statements within the meaning of federal securities laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Company's 10K for fiscal year 2010. You can access the 10K in our press release on our website at smithfieldfoods.com.

On our call today are Larry Pope, President and Chief Executive Officer, and Bo Manly, Chief Financial Officer. This is Keira Ullrich, Director of Investor Relations. Larry will begin our call this morning with a review of operations, followed by Bo, who will review the Company's financial results. Then Larry will provide our outlook for the future, after which the line will be opened for questions.

Larry, please go ahead.

Thank you very much, Keira, and thank you, ladies and gentlemen, for joining this morning. It's certainly a pleasure to be coming before this group reporting first quarter record earnings for the Company. It's been a tough two years, and it's certainly very pleasing to me and this management team to this morning be coming and releasing these kinds of numbers.

If you read the press release, our earnings for the quarter were $76.3 million, or $0.46 a share, compared with $107.7 million loss in the same first quarter of last year, or $0.75 a share loss. No surprise to those who follow the industry and the Company that the earnings are largely driven by a dramatic change in the live production side of the business. Those earnings are nearly $250 million better than they were a year ago, and many of you have seen that through the futures markets, and knew we were tracking at that kind of a level.

On the meat processing side of the business, it has continued to be good, quarter after quarter and year after year. I think as Bo will say in more detail in his comments, this is the fourth first quarter record for the meat processing business in a row, so it's not a new trend on the meat processing side. We are pleased to see that we have earnings this year even above last year in spite of these sharp increases in live hog costs. So that's the meat side of the business.

Those of you we reported before, the pork restructuring is essentially done. The last part of that was some final implementations of the SAP software across the entire system. That has been done, and the final implementation was done during the quarter. We expect that deal at $125 million in cost savings on an annual basis.

As well, we previously announced a hog cost improvement initiative on our live production side of the business. That is underway. Farms are being renovated, and as a part of that, we have restarted our program of the conversion of sows away from crate gestation into pen gestation, and those sow farms that are part of this renovation project will be converted as we go through this process.

The trends and the fundamentals in this business are very good at this point. All sides of the business are very profitable, and we see that part of the business going forward very good. Freezer stocks, I'm sure many of you have followed that, for all the proteins are down, with pork being down more than all the other proteins, which we think positions the industry and the Company very favorably going forward.

As many of you have seen from our other releases, the fresh pork side of the business is excellent. Traditionally, this time of the year, fresh pork can be quite weak, and in many times is a loss. This year we're reporting excellent results, and we anticipate continuing good results on that side of the business. Amazing what a small drop in supply does on the fresh pork side of the business. As well, we closed the Sioux City plant here at the end of the last fiscal year, at the end of April, and that seems to have been good for the industry, and certainly good for us.

Packaged meats, Bo will talk some more about, but I am very pleased with how this Company has delivered. We are still delivering against my $0.10 goal, and as you see for the quarter, we are above that $0.10. As we've been explaining and discussing for some time, the fact that $4 corn had to be priced forward into raw material costs, and ultimately into meat prices. That is happening at this point. In fact, we're seeing record cut-out values, and record prices for many of the primal cuts. We have lost a little bit of sales volume on the retail side of the business, and at the same time, picked up volume on the food service side as this business continue -- rotates back towards the food service business that many people are talking about.

A couple of things I should also comment on. You may have noticed that we have made some changes in the management team. I will comment on three of those for just a minute. Our Treasurer did leave the Company at the end of July, and we have since secured a new Treasurer, which we will be coming forward, and I think we're excited about the new Treasurer coming on board this Company with a tremendous resume, and just very shortly.

In addition, Dick Poulson, our Executive Vice President, announced his retirement. As you know, Dick was heavily involved in the mergers and acquisitions part of the business. Dick is well beyond retirement age, and made the decision that he wanted to leave the Company effective September 1, and we wish Dick very well.

Finally, we did make a change in the President of Farmland. Jim Sbarro has left the Company. There were some personal issues with Jim that could not be resolved, and as a result of that, we have had to be -- been forced to make a change at Farmland. We have not announced a successor to Jim at this point, but anticipate doing that within the next seven days.

Finally, we've continued to focus on the balance sheet, and I think we've made some comments in our press release regarding our liquidity position, as well as some of the actions we've taken to reduce some of the outstanding public debt. Our liquidity position and our cash position are in terrific shape, and will be getting better. We are generating lots of cash from the operations at this point, and are continuing to be committed towards the improvement of this balance sheet over the foreseeable future, to both lower the debt levels and to lower our interest costs.

With that being said, I will pass it onto Bo for his comments relative to all the operations, and then I'll give you a look forward once Bo is finished. Bo?

Thank you, Larry, and good morning, ladies and gentlemen. It gives me immense pleasure to report Smithfield's fiscal 2011 first quarter net income was a record $76 million, or $0.46 per share. This compared to a loss of $108 million, or a negative $0.75 in the first quarter of fiscal 2010. This turnaround, as Larry indicated, is principally due to higher meat values throughout the chain, and the turnaround in domestic hog production earnings.

Profits in all operating segments contributed to these record first quarter earnings. In fact, the earnings of the pork group were the fourth consecutive record first quarter earnings. 3% fewer market hogs, extremely low frozen pork inventories, solid export demand, and lower amounts of competing protein all contributed to higher prices throughout the pork chain.

In all domestic operating segments, higher unit prices offset lower volume of live pigs, fresh pork, and packaged meat. Total sales for the quarter were $2.9 billion, a 7% increase compared to the prior year quarter, led by sales increases in the pork group. Average selling prices in the pork segment increased 15%. Unit prices in fresh pork and packaged meats increased 17% and 12% respectively, driving a 7% increase in total pork group sales compared to the first quarter last year.

Fresh pork slaughter volume declined 11%, principally due to the closure of the Sioux City fresh pork plant in the fourth quarter of last year. Packaged meat volume declined 6% as higher raw material prices pressured margins, and volume of SKUs with negative contribution were trimmed, particularly in hot dogs.

Total consolidated operating profit for the first quarter was $178 million, a turnaround of $252 million compared to the prior year quarter. As we indicated earlier, the improvement was led by $64 million hog production earnings, a reversal of $244 million from the prior year.

The total operating profit was further bolstered by record fresh pork cut-out values that pushed fresh pork quarterly operating profit to $46 million compared to a loss of $5 million in the first quarter last year. Not surprisingly, higher raw material prices pressured packaged meats margins and profits. However, we are pleased that despite record or near record high prices for bellies, hams and trimmings, we were able to maintain margin discipline, enjoy higher levels of manufacturing efficiency, and achieve EBIT margins of $0.11 per pound, $0.10 PBT.

Packaged meats operating profit for this quarter was $67 million, or 5% of sales compared to $106 million operating profit, 9% of sales, and $0.17 per pound EBIT in the same quarter a year ago. Lower available hog supplies pushed industry average live hog prices to $58 per hundredweight in the first quarter, compared to a $42 average a year ago. Our pre-interest raising costs for the quarter were $54 per hundredweight, compared to $58 per hundredweight last year. The first quarter's cost increased slightly by $0.53 per hundredweight since our most recent fourth quarter. This 1% cost increase was principally due to the impact of seasonally fewer pigs sold. Lower throughput pushed fixed unit costs slightly higher during the May through June period versus the prior quarter. The hog production group averaged $17 per head operating profit during this period.

Corn and meal hedges will help insulate raising costs during our upcoming second and third quarters from recent grain price increases. The Murphy-Brown segment continues to aggressively pursue its long-term cost savings initiative to lower raising cost $0.02 per pound, particularly in the east, to ensure we have a highly competitive hog raising cost model. Absent a runaway grain scenario, supplies of pork domestically and worldwide look to be tight for at least 18 months or so, supporting pig prices and maintaining hog production profits, in its historically normal range. Quite a different tone compared to the previous 24 months.

We see some repopulation of empty sow spaces in the US, but no new buildings or capacity anywhere in North America. Banks and the availability of credit will control the pace of any future changes in industry capacity.

The international segment improved operating profits at Animex in Poland, which offset lower profits in international swine production results. The other segment profit reflects improvements in Butterball and turkey grow-out operations. Overall, the impact of our hedging activities, both closed contracts and mark to market, was slightly positive, and did not have a meaningful impact on quarterly earnings.

SG&A increased $17 million during the quarter, or 9% compared to a year ago. The increase is mainly caused by higher compensation accruals and pension expenses, termination of the remaining start-up subsidies, and noncash charges in life insurance values. Interest expense increased $8 million quarter-over-quarter to $69 million, reflecting the higher interest rates on bonds issued last summer. We project our full-year fiscal interest expense to be between $260 million to $270 million, assuming no amount of significant early debt retirement.

Depreciation and amortization for the quarter were $58 million, down slightly from the same quarter a year ago, reflecting two years of lower CapEx. Full-year depreciation is anticipated to be $230 million. Capital expenditures for the quarter were $31 million. The pace of capital expenditure will likely increase in coming quarters. We will continue to manage total CapEx at or below full-year depreciation.

The current effective tax rate for the quarter is 30%. The effective tax rate for the full fiscal year is expected to remain in this range. With regards to the balance sheet, little has changed from the beginning of the fiscal year. We've accumulated cash in anticipation of either a purchase of the remaining Butterball assets by the end of the calendar year, or retirement of our 7% 2011 maturity bonds early next fiscal year. We may look to opportunistically repurchase bonds from time to time. Since the beginning of the second quarter, we have retired over $50 million in 2011 bonds.

Liquidity and cash were at all-time highs at quarter-end, with $542 million in cash, and additional borrowing capacity provide total liquidity of $1.3 billion. While some letters of credit are backed by our ABL, we have no cash drawn on the facility. Our financial ratios are beginning to show the benefits of improved operating performance. Our net debt to capitalization ratio declined to 47% from 48% last quarter, and 52% last year.

An approximate non-GAAP EBITDA of $236 million makes our debt to EBITDA coverage ratio improve from nine times at the beginning of the quarter to six times at quarter-end, and 46 times a year ago. EBITDA to interest coverage also improved to 1.95 from 1.28 since the beginning of the first quarter. We anticipate these ratios will continue to improve significantly as we move towards year-end.

As a follow-up in the past quarter, it marked the anniversary of the devastating fire at our Patrick Cudahy facility in Wisconsin. We continue to work with the insurance carriers to ensure we are fairly compensated for our losses. The fire has had minimal impact on our income statement.

There is one housekeeping item I need to highlight. There is a change in the reporting of our international hog production operations. Previously, the results of the international hog production were combined with US hog operations. Beginning this quarter, these results will now be shown in the international segment, aligning their respective processing counterparts in Poland, Romania and Mexico. Prior year segment results have been adjusted to reflect this change. This change will add greater clarity to the domestic results of the hog production group, and match the international swine production with local processing to more closely match the manner in which management views these integrated international operations.

In closing, the satisfaction of one quarter of record profits does not completely wipe out the difficult memories of the last 24 months, but it sure does feel good. And better yet, the prospects for the balance of the year appear very strong.

Thank you very much for your kind attention. Now, back to Larry.

Thank you, Bo, and that was a good report. As Bo said, it's fun to be in the business now. For the last two years, we've struggled to deal with dynamics inside the hog production side of the business that there wasn't much we could do about it. It's fun to get up in the morning, and it's fun to see that tomorrow is going to be a better day than yesterday, and that's the way it looks today.

We're off to a terrific first quarter start. I think it's going to be a very good year for the Company. Traditionally, the second quarter gets better, the third quarter gets better than the second quarter, and as we sit here today, many of you who follow the business know that the results on the fresh meat side of the business continue to be absolutely outstanding. The freezer positions that are out there, the export demand that looks to be solid going forward in all the countries that we do business with gives me a tremendous amount of optimism about where this Company is going.

As Bo indicated, we have taken protection in the event these markets turn the other way on the grain side, or the live production side in terms of hog prices with the fall hog run, we've taken some steps to protect ourselves so that we don't -- we aren't caught off-guard and the P&L gets whacked as a result of some of that. We are fully protected everywhere, but we've made sure that this P&L is being protected.

Cash flows look great. I know that there's a question out there about what's going to happen with the Butterball business. Saturday is the end of the buy/sell notice period. And at this point, we fully expect from the, at least what we're getting from our sources, is that we're going to be the seller, not the buyer. We would be pleased to be the buyer, and would be anxious to run that business, but it is a buy/sell. The other side makes the decision, and all indications are that we are going to be the seller.

From my standpoint, I am -- we've been focused a lot internally to this point. We are turning our attention the other direction now. I am beginning to look outside in a big way, focusing now on customers, and I'm going to be leaving the offices on a frequent basis now, visiting our customers, and building the relationships with them. We think we have a good story to tell, and that's what I'm going to be spending my time on the road visiting all of our major customers, as well as spending a great deal of time inside our plants with our people, recharging this organization to go forward.

There are a lot of challenges. Even though these numbers are good, I promise you, there are significant savings and opportunities on the sales side, and in the operations side of this business that we have identified, and we are going forward with. I am excited for the first time in a good while about what I see this business. The rough road appears to be behind us.

The nice, smooth road looks to be in front of us, and the sun is shining, and I could not be more pleased with the management team we have in place. Regardless of the management changes we've made, I think we will end up in a very strong position as we go forward with this team, and I think we have positioned this Company over these last two years, changing the discipline on the sales side of the business, and improving our cost structure, so we are going to be a very competitive organization, and I am very pleased where we're at. With that being said, I think it could be a strong year. I don't want to say a record year, but it certainly could be.

And at this point, Keira, I'd look forward to any questions anybody might have.

Thank you, Larry. In order to provide the opportunity to as many analysts as possible to ask questions, we request that you ask only one question. If you have another question, please get back in the queue.

Operator, please open the line for questions.

(Operator Instructions) First we will go to the line of Farha Aslam from Stephens, your line is open.

Hi, good morning.

Good morning, Farha.

Could you explain to me your hedge position again? It said in the quarter you didn't benefit from hedges, but yet it seems that you made significant profits, more than what your average price and raising costs would indicate. And then could you explain your forward hedges in terms of your commentary about hog and grain?

Farha this is Bo. I will try to encapsule. We had hedge position covering grains and hogs that did not change much during the quarter, so we did not have any significant impact this quarter from our hedge positions, positive or negatively. There was a slight positive position overall. Going forward, we have protections through this fall. We do have some upside capacity in terms of ability to capture any additional upside, but we do have bottom side protection Larry described. And we feel very good about our grain position through this crop into the new crop.

Great, thank you.

Thank you. Our next question comes from the line of Vincent Andrews from Morgan Stanley. Your line is open.

Thank you, and congratulations on your quarter. I actually had follow-up on the hedging. I just -- I've been getting some questions, and I think there's some confusion out there relative to comments you made last quarter about the changing to your hedging policy. So, if you could just sort of -- and I just wanted to make sure there was no change this quarter relative to what you said last quarter. So, could just remind us, broadly speaking as you go forward, what it is you are going to be doing?

Let me take that and Bo, you follow up as well. Vincent, I guess we miscommunicated in the last quarterly report. We didn't say we were abandoning hedging. We said we were going to try to be more disciplined and closer to the cash market, which means we were going to be closer in with our hedges. And as well, we were going to attempt to put our hedging program such that it could be accounted for under the hedging method of accounting as opposed to having these heavy mark-to-market accounting adjustments on a quarterly basis, and that's what we've done.

And I think Bo has just alluded to the fact that for the quarter, we didn't have much of a change. The hedge works the way it's supposed to work. It comes through and matches the contracts with the marketing of the hogs and the corn and the grain being fed. So, if there was a misunderstanding there, it was not that we were abandoning hedging, it was that we were going to apply our strategy relative to future contracts so it didn't whipsaw these earnings back and forth on a quarterly basis, and I think we just demonstrated to you in this quarter we did that.

I think from an accounting perspective, to the extent that we indicated that we are trying to get as much of our portfolio into treatment as hedges and not mark-to-market. So, we're trying to minimize our mark-to-market exposure, but continuing to layer on the financial risk management side of a true accounting hedge.

Does that help, Vincent?

Yes, that did, and I will get back into the queue. Thanks again.

Thank you. And our next question comes from the line of Ken Goldman from JPMorgan. Your line is open.

Good morning.

Good morning, Ken.

So, it's an interesting time in pork, in the industry overall. Historically, it's been a rare occurrence that hog prices remained so high at the same time that pork processing margins remain high as well. So, I'm wondering if you could help us understand a bit of the drivers behind this. I've heard everything from they're not sustainable to some people believe that Smithfield is acting more like a packer than a farmer now, and that's making a big difference. But to tell you the truth, I'm not quite sure exactly what's at play here. So, really, any insights could you provide on the sustainability of industry pork margins given high hog prices would be very helpful.

I'll take my comment, I'm sure Bo will have a comment as well. I would tell you that tightened supplies have a lot to do with this. We got less hogs out there, and so it shows you how sort of inelastic some of this is in that demand. We have -- we've certainly been impressed with where some of these raw materials have gone. There's no better example than where the belly market has gone to $1.50. The industry continues to be out of belly. So there are people -- they're still short of pork bellies in spite of the fact that they're well beyond record highs. And the other side is that the export markets, I think we often times underestimate those when you have that kind of volume leaving the country.

There's all kinds of noise around the exports, but the bottom line is the fundamentals there are very strong. There's been declines in supplies all around the world. Mexico, Canada, Europe. So, there's a shortage of pork all around the world. And that creates tremendous pressure on these prices, and that's been good for this industry. And I don't see a lot of that changing over the near term. I don't see very much in the futures market doesn't indicate very much is going to change there. Do you have any comment, Bo?

I think that it is an unusual situation where all parts of the chain, from the corn producer to the hog producer to the fresh pork operator to the packaged meats operator makes money. I don't know that in 30 years I've seen that. I'm not sure in terms of sustainability. Does one robin make a spring? Probably not. But I think that we've seen tremendous demand at this point, and I think we've seen a lot of discipline on pricing. And I think that, as I commend earlier, the banks will control and the credit markets will control expansion, not only here in the US, but overseas as well.

So, I think one missing element has been margins at retail. I think probably the retailer has not had an opportunity to pass along all the price increases. Food service has done that fairly well through formula pricing. But I think there still is another bit to be absorbed by the consumer as the retailer continues to roll through these higher prices.

Ken, I will finally comment, you made the comment, maybe Smithfield is starting to act like a packer, sort of a hog producer. I don't know that we ever were not acting like a packer. I think that we have, over the last several years, put a focus on managing the margin in this business and walking away from low-margin business. And even Sioux City, Iowa, the plant we closed was a low-margin fresh pork plant. If so, I think the whole industry is, not that we're controlling it in any way. In fact, I think no one controls this for sure. But I think that we're in a situation where we were having to sell a lot of surplus meat coming out of Sioux City. We're not doing that any more. And that little bit of difference in this industry seems to have had an impact, and it seems to have affected everybody in the industry in the same way.

I think you may also have a situation here where probably you've got, as Larry mentioned, a very good balance between slaughter capacity and live animal supply. And we have taken, and I think some of our brothers in the industry have taken a lot of processed meats capacity offline, too. So, I think there's probably a better balance there and that there's less people chasing fresh margins and less people having to be forced to chase packaged meats margins. It's a good balance right now.

Thank you.

Thank you, and our next question comes from the line of Robert Moskow from Credit Suisse. Your line is open.

Hi, thanks for the question. So, I guess what I was a little confused about was, I think before your reported fourth quarter, I think you had said that there were some hedges on hog prices that were working against you, and I thought that that was going to spill over into the fiscal first quarter. And then when I look at my model compared to what I thought hog producers were earning, I thought your numbers were actually a little lower than what -- like the John Lawrence model would indicate, and I know there's some discrepancies there. Can you help me with those two things, Bo?

Sure. I think in terms of the hedging situation we did report, I think it was $58 million in mark-to-market losses associated with hog production side of the business. I think there was slightly -- total hedging losses were slightly higher than that. But we said those were -- as the market -- futures market ran up in advance of our year-end, we suffered those mark-to-market losses. Those positions then got transferred either as closed positions -- closed market positions at or around those price levels, or we converted those animals to cash at those levels. So, it was really the market ran up, we had mark-to-market losses on our futures position and we translated those very quickly over the coming months to cash hogs and closed those positions out. So I think it was a matter of timing, if you are concerned about any impact on this quarter. But obviously, we closed those contracts out at our near the levels we ended the calendar year -- or, the fiscal year at. As far as the other parts of your question, can you be a little bit more specifics or help me out on those?

Well, I guess our model is indicating that margins could have been as good as $29 a head for US producers. You are at $17. I think last time we were on the call you said that that model probably overstated the profitability because it understated the true raising costs of the animals.

There are many models out there. We've put a lot of effort into trying to understand those better, if we weren't looking at them in great detail before, but we've done a fair amount of analysis on those. And many of them are static models, they don't change, they don't have hedging activities with them, they don't have the impact of volume on fixed costs, up or down. So, there's a lot of reasons why somebody might not track exactly to a model. We feel very comfortable that we had record profits.

We know that there were some profits reported by others out there in the industry. We don't know what their last stock positions were, whether they had ledger contracts, whether they had hedge positions that could have helped them, whether they were buying cheap Canadian hogs. There are a whole bunch of reasons, but it's very difficult to speculate on others' positions or how we would track any particular model at a specific point in time. But if you wanted to come down and bring your model, we could certainly try to point some things out to you that may be further enhanced, but it's very difficult at any point in time to necessarily take anybody else's results or model results and compare it to ours.

Well, I think Bo, as well, those results often times are calculated on a zero basis corn market, so everything is sitting in the center, calculated in the center of Iowa, where not very much of the industry is dead center of Iowa. So, almost everybody has got some corn basis difference to that. And they've got freight from those farms back to plants on those hogs, so they have an impact of that. And I would tell you in our east coast operations, which are significant to us, we have a significant basis difference relative to grain. We're a long way from the grain, and we have a higher raising costs because of getting the grain to the east coast. So, by definition, we're going to be significantly different than that model, and we have had -- we'd tell from you our side, some of the performance on our particular east coast operations have not been where we wanted them to be.

That's the reason the cost improvement initiative was announced here just in the last quarter, because we think there's an opportunity there. We know exactly. We just need to renovate some farms to get there, and we will. So all those have impacts on that comparison, and I think almost no one can compare directly with that model.

And one last follow-up. You said that typically your results get better in second and then even better in third. Do you think that that -- second quarter, I can imagine hog production could be better, but by third it probably won't be. Is your point that third quarter is a very strong pork quarter because of the seasonality of the business, the holiday season, and that will -- could we see quarters getting better from here, from $0.46?

We certainly don't like making -- certainly don't get into projections, except generally in the second -- going into the second and the third quarter you get the fall hog run, which generally lowers hog prices. So, the hog profitability drops, but the meat processing profitability improves in the second quarter, and then the whole ham season in the fall, going into Thanksgiving and Christmas are traditionally very good for the Company, and the cut-out is usually very good. So, that was the basis, I was talking largely from a meat processing side, not a hog production side.

Okay. I'll follow-up later. Thank you very much.

Thank you. Our next question comes from the line of Christina McGlone from Deutsche Bank. Your line is open.

Good morning. I wanted to get an understanding on, given you said you were hedged corn and meal through new crop, how should we be thinking about raising costs looking out now?

We really aren't going to give you much direction beyond one quarter out, and we feel comfortable we'll probably remain in this range that we're in over the next quarter. We do have protection from the run up that took place most recently in the grain side through this crop. But beyond that, we're not going to give you a prediction.

Okay, and then just a follow-up. Larry, in terms of the packaged meat volume, I think awhile back you had talked about volumes being up this fiscal year, but given what you said about the SKU pruning and the margin contraction on some lines, should we be thinking now that packaged meat volumes will fall this year?

I think they could. It's a little early in the year to tell, and we've still got this fall period that's, generally, again, a big part of the year. So, I wouldn't go so far as to make a prediction at this point. We are experiencing some of that, but if some of that compares with the prior year when we had not finished all the restructuring of closing the plants. So, in the first quarter, we're doing a comparison to a period in which plants were open versus when we rationalized plants and capacity out. So, at this point, why don't you ask me that question as I get a little deeper into the year.

Okay, thank you.

Thank you. Our next question comes from the line of Akshay Jagdale of KeyBanc Capital. Your line is open.

Good morning, congratulations on a good quarter.

Thank you.

Good morning, Akshay.

Good morning. My question is about the sustainability of hog production margins, but before you answer that, I just wanted to frame my question a bit. Your pork processing division has really done well, and you deserve credit for that. I think a lot of investors now really believe that that's a stable earnings stream, but on the hog production side, I think we still get a lot of questions as to what's normal and what do we need to have to have normal earnings.

So, Bo, I think you mentioned today that $17 a head is what you guys think is normal. So can you just help us understand that in the context of supply and demand? Last quarter you said you would have wished that the herd was down 3% more than what it is today. And we certainly know on the demand side that exports are strong. But just trying to get a sense of where you get this normal number and how you are thinking of it, especially given that historically, this division, the hog production division, hasn't produced those kind of profits sustainability, so.

Akshay, appreciate that thoughtful question. Yes, we had two bad years in hog production, but I think if you go back prior to that, I think you'll see significant profitability in that particular area, and that's really where we draw our feelings in terms of long-term profitability in the pork production segment, is really where has that been over time? Because really, it's got to produce a return on investment, otherwise ourselves and others will contract capital from that side of the business. So, we really looked at our historical earnings going back beyond the last two years to develop what we think is normal range for hog production.

And I think to clarify, Bo, I believe you said in the prior quarters that $10 to $15 on an EBIT basis is where we think this hog raising business can be. So, I'm -- Akshay, I'm not sure where you got the $17. As Bo was saying, that's the normalized. I don't think we have said that. And there's going to be -- I think one of the things we have said again and again and again, we believe that side of the business is going to be more volatile, given the impact of the ethanol policy of this country on corn pricing, that that's going to be much more volatile than it has in the past, and that's one of the reasons we have cut back our exposure to the live production side of the business, because we don't think it is going to be as profitable as it was in the past, and we think there's going to be a lot more volatility surrounding that.

Okay, I'll get back in line. Thank you.

Thank you. Our next question comes from the line of Christine McCracken from Cleveland Research. Your line is open.

Good morning.

Good morning, Christine.

I just wanted to get a little bit deeper into the reclassification of the European and Mexican production into international. I was wondering, is there anything specific that drove that decision? Obviously, it's really just a paper move, but I'm wondering if you continue -- you remain committed to that business long-term? Is there anything structurally different about how you're operating those businesses? Just a little bit more around that decision.

Christine, a couple of things. It has no reflection at all in terms of our enthusiasm for the international markets. We remain committed to those. Actually, those operations have all been profitable last year, continue to all be profitable in total. So, it was not a matter of what was it trying to move any negative parts of our business to offshore, so to speak. What it did, though, was that it was giving different signals in different directions than our domestic hog production operations, and we felt in order for you to better understand our business as well as ourselves, that we needed to bifurcate those two distinctly different operations, international and domestic swine production. They operate on different hog markets, they operate on different grain markets. There is some [inter-reaction] to them over the long run, but they operate independently in the short run.

We really look at Poland, for example, as an integrated operation. The plants could not operate at the productive level that they're at without the hog farms, and the hog farms could not operate at their current level without the capacity and the throughput from the plants. It's the same way in Poland, it's the same way at our Norson operations in Mexico as well. That those plants can't operate without the hog farms. Hog farms can't operate without the plants. So we, out of necessity, look at those as integrated operations and feel that we should be reporting them to our shareholders that same way.

And Christine, you add to that the foreign currency fluctuation that you have going through those businesses, and you can have one piece in the meat processing and another piece in the hog raising side, and we often times look at Romania or Poland or the Mexico operations. And as we talked about the business and meet with the guys in the business, we're meeting with both at the same time and saying, guys, we have got to add them together. Romania is 100% vertically integrated. Norson is too. Poland is not, but it has a substantial piece of it. And so we said, guys, this is just making the people look at hog production, they can't do the math; because it's got so much going on, the international side. Guys, we run this stuff together, so let's put it in international so it won't confuse you, the analyst, as much as we were having a hard time explaining some of the hog production side because the international was making it skewed in ways that didn't make it any sense. So, we hope we made it easier for you.

We appreciate the transparency. Thank you, I'll get back in the queue.

Sure.

Thank you. Our next question comes from the line of Ken Zaslow from BMO Capital Markets. Your line is open.

Good morning, everyone.

Ken, how are you?

Good. There's a lot of talk about the supplies of all the proteins, the chicken, the beef and the pork. My question is, can you help us understand, do you think that beef and pork prices would drag up chicken prices, or do you think that chicken prices, because the supply is a little bit higher, will drag down beef and pork prices? And how do you put that in historical context and which way it will go?

Yes. (laughs) That's a complicated question. The chicken or the egg concept there. But I think they're all dynamics. They're all proteins, so they're all competing with each other. And I don't know if Bo has any comment on that. But -- and with the supplies, you can just skip turkey, because turkey is down as well. But all these things are having -- all these things are helping each other, and I know that the big concern out there is on the poultry side, and what's the poultry industry going to do. And I guess there's some belief that it will -- supplies will increase, but I think for the near term, all of these are going to be -- all of these are going to be lower supplies, and they're all going to be bolstering each other with some little bit of offset on the poultry side. Do you have any comment, Bo?

Larry, I've got an economics degree, but I think I missed a class in cross-protein elasticity price models.

(inaudible)

It is a very complicated issue Ken, and I don't know that there's any true answer other than to relate that they're all related, and increased supplies of one commodity and lower prices does have an impact over the long run on the other proteins.

Okay, thank you.

Thank you. And our next question comes from the line of Diane Geissler of CLSA. Your line is open.

Good morning.

Hi, Diane. How are you?

I'm good. I just -- one point of clarification and then I'll ask my real question. When you made the comment earlier about the raising costs, and you said you weren't going to go out further than one quarter on comments but that you saw that it was similar to current raising costs, are you saying that you think your second quarter raising costs will look like your first quarter raising costs, so $54 a hundred weight?

Yes.

Okay, and then I guess in light of the fact that we can expect raising costs to remain high, appreciate that you're hedged, but probably not everybody is and grain continues to rally. Would your expectation be that we would see continued cuts? I know there was sort of a period where the sow liquidation slowed, and everybody is make money now, but when you look into 2011 and beyond, what is the vibe in the marketplace with regard to number of animals that will be raised over the next one to two years? Do you have a viewpoint on that?

Diane, I'll give you mine, and Bo may have -- I think we have what I will call creeping expansion, which has increased the number of animals inside the houses where many of these farmers cut back. They're stocking densities. I think they're increasing their stocking densities some. And I would have said I thought there would be some lean towards expansion here, but this run-up in these grains I think has once again reminded these producers that this profitability in this business can go away very quickly here. We're not hearing -- I'm not hearing of anybody who has actually got any plan to, what I call real expansion. I haven't heard anybody talking about it. Have you, Bo?

No, the only thing we've heard is fill-in business, where you had empty sow stalls and empty buildings, but no new construction at this point. And that was echoed by bankers that were visiting us as recently as yesterday. So, I really don't see any -- you may have a percent to 2% internal expansion as herds become more productive or we fill in a sow space here and there, but very modest. And you may even have some issues right now where we're holding back gilts that would have gone into slaughter, but they're being held for sows. But it's nothing major at this point. So, I think we're going to be very much controlled for the next year to year and a half in terms of --

Diane, my guess is that guys -- these farmers are behind on their principal payments to farm credit, and farm credit is saying catch up your principal payments before we start talking about loaning you any more money. And I just don't know where, with the banking environment like it is, I'm not sure I know where farmers are going to be able to get any increased financing. Now, if they're making money, so they could pay us out of their operations, but I don't think there's a lot of excess cash around for people to be building any new farms.

Okay, so it sounds like a little at the margin within existing --

That's what I think.

(inaudible) but no new expansion.

I think Bo said the same thing.

Okay, terrific. Thank you.

Thank you. Our next question comes from the line of Heather Jones from BB&T Capital Markets. Your line is open.

Good morning, congratulations on the quarter.

Thank you.

Had a quick question on your fresh pork business. If I remember correctly, in Q4 you had a $14 million or $15 million negative hedging impact on that business. Did you have that -- did that reverse itself in Q1?

There was no reversal, per se. Those were farmer hedges where the farmer had fixed the forward price to us, and frankly, there would be an offsetting pickup in the value of the animal when it was delivered to the plant perfectly offsetting any hedge losses that we had against that position.

So the negative hit was undone in Q1? Negative hit in Q4? Because I believe you all called that out in Q4, as a negative hit in the fresh pork business.

That's correct. And those animals came to market and were sold to the plants, and we picked up a profit in the cash market.

Okay. So my second question is going forward into Q2, Q3, would you still, given the fact that you've had that benefit in the Q1, would you still expect your Q2 fresh pork business to sequentially improve?

Those hedges more than likely were delivered during the summer. They were farmers positions that they wanted to mitigate their risk at that. I would say that we're looking at the same factors impacting our second and third quarter.

I think she's asking the question that we had that benefit coming through the first quarter. I think, Heather, you asked, we had that benefit in the first quarter.

Right.

Do we anticipate that we'll have that -- that we'll be able to do as well in fresh pork, realizing that that benefit won't be there as we --

Exactly.

And I think Heather, at this point I would tell you yes. I think that's the sequential benefit that we think. We think fresh pork is good. It's better -- fresh pork is better as we move into second quarter than it was in first quarter. Fundamentally, we're four, five weeks into the second quarter, and fresh pork has been better this quarter than it was last quarter.

Okay. Excellent. Thank you.

Thank you. Our next question comes from the line of Timothy Ramey from DA Davidson. Your line is open.

Good morning. Bo, you mentioned that you had the bankers in yesterday, and I thought one of the most important comments of your release was the repurchase of debt and potential contraction of the balance sheet. What are the bankers telling you about your kind of need to hold liquidity and your willingness or your ability to repurchase debt, particularly if it should come to pass that you get a $200 million check in a few weeks?

Very insightful comment, Tim, but the bankers I think are telling us, and everybody that we've met, you need less leverage. And we're working towards that, and we're moving towards $1 billion less on our balance sheet. They would love to put together all types of means of which to utilize our cash balances to buy back debt. We're looking at opportunities where we can do that opportunistically, but at this point, we're waiting to find out exactly what will or won't happen with Butterball. We feel we've got cash balances to be able to handle any contingency if we were a buyer or if we're a seller, then we'll just be that much more aggressive in terms of bond repurchases later in next fiscal year.

But I think, Tim, to summarize Bo's comments, the bankers are telling us and the rating agencies are telling us, continue to delever, continue to delever. And I have been in this business 30 years. As you know, was in the finance end of the business many of those years, and we always had to leverage as much as we had today or more and felt comfortable. Today, the market is sending us enormous signals to delever the balance sheet. And while I'm not that smart, we are trainable, and so we can learn. And if that is what propels the stock and helps the shareholders get a return, that's the direction we are going to go. And so we have not been actively looking at increasing the leverage on the balance sheet. And if there was an opportunity presented itself, we'd certainly pursue it, but at this point, the focus is get the balance sheet in better shape in spite of the fact I consider it in great shape today. It needs to be in better shape, and that's what Bo is doing and doing a terrific job of it.

Great, and just corporate, can I assume that that's bonus accruals finally coming through? You guys going to get paid a bonus this year?

Well, I got my fingers crossed, Tim. That is part of the compensation, as well as several other items I mentioned.

I think there's some pension charges --

Yes, pension expenses increase --

You know what I think that Bo didn't make the point of but you see in the press release, we announced that we got $50 million of the bonds we bought back in. We used cash for that and still have record liquidity. We've also made some sizable contributions into our pension plans for some of the unfunded liabilities. So, the cash from operations has been very strong, and we expect that to continue to be very strong, and we're going to -- we've got some more pension obligations just to catch some of that up, and all that is, we think, employing the cash very strategically here.

Great. Like the plan. Thanks.

Thank you. And our next question comes from the line of Lindsay Drucker Mann from Goldman Sachs. Your line is open.

Good morning, everyone.

Good morning, and thank you for your new coverage.

Excited to be covering you guys, especially on a quarter like this. So, just one question on the last conference call. I think you talked about some very tight supplies in China and how that was an opportunity that you were hoping to capitalize on. Could you give us an update on what you are seeing in that market and where you do see those opportunities for your business?

I would tell you that I think -- I don't remember specifically, Keira, I guess we were talking about the live hog market in China. It is up, but it's not the levels I thought it might have been. But China is open, both the Hong Kong market and the mainland market is open. We are shipping into China regularly today. I would tell you that all the export markets, it's -- you read an awful lot of stuff in the papers about things happening with the poultry industry, tariffs going on in Mexico, Russia having a little tetracycline issue. All that is, in my mind, sort of noise that closes markets down, get de-listing of plants, then you petition and you get the plants relisted again.

All these markets have fundamental demands. There's fundamentally a demand out there for the product, and so while we go through these little blips in the road, these bumps, parts of the industry is closing, the other guy is opening, he's getting the business, then we're getting the business. China is a very good market. Russia, Mexico, Canada, Japan, these are all very good markets, and this export market is very good today, and we see good things in that. China included in that.

I would point out that both on a tonnage basis and on a dollar basis, our exports to China for the first quarter were up dramatically.

Now, that's largely, not exclusively, our fault. We don't have a lot of muscle meat going in there. We anticipated that we might get some muscle meat primal cuts in there, which we have not done. It's really a byproducts market, but it's a good byproducts market.

Okay, and then a quick follow up. Were you guys impacted in your productivity at all from the heat during the period?

Yes, we were. But probably more -- and you might not have even realized it, but they had extremely high temperatures in central Europe this summer, impacting ferrowing rates in both Poland and in Romania. Nothing extremely unusual. It will happen from time to time, but we'll probably have a 5% or 10% decrease in productivity for about a three-month period of time, but --

In that part of the world.

In that part of the world, but it was nothing dramatically unusual here in the United States. We call it summer infertility, is the technical breeding term for it.

Okay, thanks very much.

Sure.

Thank you. Our next question comes from the line of Ryan Oksenhendler of Bank of America. Your line is open.

Hello, guys.

Hi, Ryan.

A question on packaged meats. One of your competitors recently said on their conference call that they are going to take some pricing due to the higher costs, and they expect margins to actually be up this year, whereas you guys, you are still putting up really good margins, but it seems like a significant decline from last year. You're at $0.17, $0.18 a pound, now down to around $0.11. So I'm curious why the difference there in terms of if some of your competitors are taking pricing to maintain or even grow margins, why can't you? Is it that you are more leveraged to private label, or is it that you are in different categories? Can you explain the difference there?

I will take a shot at that, and Bo may have his own observation. I hope they do. That will help everybody in the industry. But these run-up in these raw materials has been phenomenal. Almost every raw material input into a packaged meats product is up at least 50%, if not up 100%. Everyone is taking price increases. So, to say that you are going to take price increases, everybody in this industry is taking price increases. If you don't think so, go to the grocery store and try to buy a pound of bacon. You will find out it's quite a bit more expensive today than it was three months ago.

So everyone has increased prices. But I do agree with some of that statement. A lot of our product is formula-based, and formula-based means it changes as the raw material changes, but it is indexed back. It takes time to index in. I believe that our packaged meats margin will go up from here as this full impact goes through the pricing formulas. And so tomorrow and next quarter, we might see better margins, then we have to see what the consumer's reaction to in terms of buying product. But I understand their comment, and I think some of that is true. I would agree with some of that. Bo, you have any comment?

Just that there's some tremendous seasonal impact on some with ourselves, with the ham business in the fall, the summer bacon business. And depending upon what your mix is, you may have some different seasonal impacts moving in and out of your P&L.

Thanks. Just one quick follow-up, if I may. In terms of hog production, how many hogs do you plan on raising this year?

About 17 million.

And that's domestically.

Yes.

Okay. Thank you very much.

Operator, we'll take one last question, please.

Thank you. And that will be from the line of Carla Casella, and she's from JPMorgan. Your line is open.

Hi, I had some clarification questions. One, did you give the cash balance, and did you buy any of the bonds back during the quarter, or was it only after quarter end?

The purchases were only after quarter end, and we had I think $542 million in cash at quarter end.

And it looks like you didn't take any charges this quarter for the cost savings initiatives. Is that correct?

Carla, I would tell you we took some small charges, including some charges associated with the pork restructuring, but I have said many times on these calls, we're not going to get into something that's $4 million, $5 million, $6 million, that's just operating business. So, it's not significant enough that we thought was worth calling out.

Okay, great. Thanks for the clarification.

Thank you. And with that, speakers, I'd like to turn it back over to you for any closing comments.

From Smithfield's standpoint, we think we're off to a great year. It has been a very tough two years for this Company, and this management team has been focused on the long-term and focusing on improving our cost structure and our sales and marketing discipline. I think that's showing again and again and again in this meat processing side of this business. I am extremely excited about what we see in front of us. The futures markets look very strong for us, and all the wind seems to be at our back. And so from that standpoint, I am optimistic about what the year could turn out to be, and I look forward to making the second quarter and third quarter calls, and thank you all for today.

And ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.