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Smithfield Foods, Inc. (NYSE:SFD)

F2Q09 Earnings Call

December 4, 2008 9:00 am ET

Executives

Bo Manly - Chief Financial Officer

Dick Poulson - Executive Vice President

Larry Pope - President and Chief Executive Officer

Jerry Hostetter - Head of Investor Relations

Analysts

Ken Goldman - JP Morgan

Diane Geissler - Merrill Lynch

Ken Zaslow - BMO Capital Markets

Christine McCracken - Cleveland Research

Tim Ramey – D.A. Davidson

Farha Aslam - Stephens, Inc.

Operator

(Operator Instructions) Welcome to the Smithfield Foods Second Quarter Conference Call. I would now like to turn the conference over to your host Mr. Jerry Hostetter.

Jerry Hostetter

Welcome to a conference call to discuss Smithfield Foods fiscal 2009 second quarter results. We'd like to caution you that in today's call there may be forward looking statements within the meaning of federal securities laws. In light of the risks and uncertainties involved, we encourage you to read the forward looking information section of the Smithfield Foods Form 10-K for fiscal year 2008. You can access the 10-K and our press release on our website at www.SmithfieldFoods.com.

Each quarter there are several analysts waiting to ask questions as our calls end after one hour. We would like to provide the opportunity to as many analysts as possible to ask questions, and as a courtesy we request that you ask only one follow up question so that everyone can participate. We thank you for that.

With us today are Bo Manly, Chief Financial Officer, Dick Poulson, Executive Vice President and Larry Pope, President and Chief Executive Officer. This is Jerry Hostetter, Head of Investor Relations. Larry Pope will begin our presentation with a review of operations.

Larry Pope

While we are in some historic times as a country and as an industry the last six months have been very telling on virtually every CEO and every businessman in every industry in this country and beyond this country. I can assure you we have felt some of this pressure. I know many of you this morning have a lot of questions, there’s been an awful lot written about the industry, about some of the others in our industry and recent announcement about Pilgrims Pride certainly has given rouse to a lot of writing.

This morning both through the press release and through this conference call we hope to answer a lot of those open questions that might be relative to Smithfield Foods. I hope you think this management team has always straightforward and transparent. This morning we plan to be as transparent as we possibly can. Certainly we have competitive information that we are not able to disclose but to the extent that we can satisfy some of your concerns and answer some of those questions that seem to be lingering out there we want to make sure we do that.

Bo Manly and myself will probably take more time than is normal in terms of our comments before we take questions in order to address your questions even before you get to them. Certainly we read what’s out there and the best way for us to resolve that is to simply give you that information straightforwardly and then from there hopefully those of you who do not for some reason get to ask your question will have your question answered during our comment period. That’s certainly our intent.

Before I go much further into the segments let me go through just the basics and talk about the segments. I hope you noticed from the press release that we have changed the format. We have given the highlights of the quarter and some of the pertinent information that we thought might be valuable to you right up front at the beginning of the press release similar to the way some others have been presenting their information in a way that’s hopefully more clear and transparent to you. I hope you noticed that, I hope that’s helpful to you and makes the information easier to glean as you read through the narrative.

In terms of the overall results, net income for the quarter is $4.2 million or $0.03 a share compared with $17.4 million or $0.13 a share last year. You can read the year to date numbers for the first six months. The income from continuing operations reflects a $30 million loss or $0.21 a share compared with $23.4 million or $0.17 a share in the same quarter of last year.

You should know that this quarter does include an impairment charge in our European operations as you may remember from some time back we’ve been talking about the fact that there were some restructuring that needed to be done in our Western European operations, that is underway. As you know, in many of those countries its much more difficult to accomplish some of those restructurings and it takes an awful lot more time than you would ordinarily like for it to than in the United States.

While it’s taking some time for us to present that to you, the fact is that we’ve had that plan in place for some time it’s just taking a significant amount of time to roll that out.

You also realize that the beef business is not in these numbers and Mr. Manly will speak more clearly to that but we are reflecting a discontinued operations gain for the quarter and for the year to date which reflects a number of things including the operating results, cattle feeding and the sale of the beef business. I will leave that to Bo as he makes his comments to you but it is a positive number for both the quarter and the year to date.

The quarter can essentially be summarized very succinctly in a very quick phrase, “corn prices” and the impact of corn costs and grain costs on our hog production operations combined with an oversupply of live hogs that needs to be rectified and hopefully is being rectified and we are part of that solution. That’s a summary of why the results are where they’re at. I’ll talk about that in much more detail in the hog production group. I would like at this point to walk you through the other segments and then focus on hog production a little in just a few minutes.

The pork segment which is the slaughter and the package meats business continues to be a very bright light and a shining light in the company’s operating results. You see that our results were reflecting operating profits of $93.4 million compared with $62.9 million last year and our year to date results follow that same trend. This is a 50% improvement over the same period for the quarter and for the year to date.

I think for a number of quarters we’ve been reporting to you that our pork segment is performing very well. We are extremely pleased with what’s going on in that segment of the business. There is no question that there are benefits coming from the export market that are impacting the industry and our fresh meat results but as well the changes we have been making now for a couple of year that I have been talking about now for many quarters are being reflected in these pork segment profits.

I want you to make sure as you think about these numbers that the pork segment is not just the impact of the positive export markets. Our fresh pork margins have been excellent and in fact are clearly the best fresh pork margins as many and other have said in the industry these are the best fresh pork second quarter margins in the summer that anyone’s ever seen. Ours, I would tell you we’re in line with the industry. In fact, I believe our improvement is better than the industry because of some of the things that we’ve been doing operationally.

We have put in a management team that has focused on the fresh meat side of the business. I think I told you a couple of quarters ago that we had focused on package meets which we continue to and that we were turning our attention towards the fresh meat side of the business. We have been turning our attention in that direction and I’m telling you that the impact of that is being reflected through these numbers and I believe will continue to be reflected in terms of comparisons to others in the industry. I think we are making substantial progress in that area and I’m very pleased with it.

On the export side the industry has just seen some exceptionally good growth. We have seen every bit of that everyone else has. We all know that the Japanese and the Chinese and the Mexican and the Russians and the Koreans and the Taiwanese business has all been more than double digit increases for all of us and in some cases they are triple digit increases. Some markets we are represented more strongly than in others.

I can tell you that one of those markets has been exceptionally good for Smithfield and that demand has certainly helped the domestic market in taking some of this product off the domestic market as we have had more pork to sell. Those markets have helped all of us and I want to talk about my future comments about export markets going forward because I know there’s an awful lot out there written about what’s going to happen from this point forward. I’ll reserve my comments on that until we get there.

The package meat side of the business which has been a big focus for quite some time the margins were very solid. They were slightly below last years record margins when we had a lot of cheap raw material. This year the raw material costs are up significantly on such things as pork trimmings, those are up and yet in spite of that our margins have been very good in that end of the business.

We have taken actions to reduce the cost of manufacturing these products as well as we have instituted sales disciplines in this organization that are bearing fruit in that end of the business and they will continue to be there. We are not growing the volume, I have mentioned that to you over a year ago that we were going to focus on making money on the business we sold, that we were going to rationalize out some of this volume that was simply contributions to overhead.

The fact that some of our volume in some of our categories is down is not an accident. That is part of a plan. I will tell you that its part of an ongoing plan that you will see me talk about when we get to third quarter if I don’t make some release in advance of that of the continuing efforts that we’re doing in that area. I think that we are positioning ourselves extremely well.

Categories such as consumer trend changes toward pre-cooked products particularly in the rib area as they’ve been extremely good as well the category of hot dogs where we have seen declining volumes for some time has reversed course and the hot dog business is now one of the fastest growing categories for us.

The important point in terms of where we’re positioned, Smithfield sells in the value space. We are not the top of the market; we are in that 80% category what I call value conscious consumers. We sell products to the everyday consumer and we sell the product when it’s being featured. I think that we compete at the manufacturing and the cost of production line and that’s an area where we think we have a core competency of this management team. As the consumers reevaluate their buying decisions I think those decisions will be trending towards our product as opposed to others in the industry.

The company has a highly diversified customer base. We sell every retailer; some of our largest customers are some that you would expect who are benefiting from this recessionary time. Some of those customers that are seeing the growth, we’re seeing that same growth. I think many of you know that the company is largely a retail company.

Our business breaks down about 75% retail versus 25% food service. You know that the food service business for all of us is down 3%, 4%, 5%, ours is close to 5%. There’s even movement inside of that food service with certain customers and you know the trend that’s going on there. As consumers go back to the grocery store to buy as opposed to eating out they are returning to our core business. We are seeing some of that return in terms of where that product is going.

There is no question that the retailers are under pressure in terms of price increases to control those price increases and certainly we are going to feel some of that pressure from our customers. I’m not going to sit here and tell you that we are going to be able to pass through price increases very easily but we are in a position where I think our cost structures are improving dramatically. I think there is still plenty of costs to be driven out of our organization in terms of the manufacturing plant core operations that are underway, backroom and duplicate costs that we are incurring that we have focused on.

From my standpoint changes we’ve already put in place here this last year and year and a half and two years are now beginning to show up in the bottom line. While I know we will see cost pressures from our customers we are positioned well I think to continue to supply those customers and continue to supply them profitably in this package meats end of the business.

On the international side you will note that the numbers are a bit better than last year 11 versus 9. We continue to move forward, that’s sort of a mixed bag our Group Smithfield business in Western Europe has seen some of the economic impact of the move away from highly branded products toward private label and what’s known as [premipre] or first priced business. We are seeing some pressures on the margins there.

Conversely our Eastern European operations are seeing better numbers as it is our Campofrio. I can report to you today that we continue to move forward very nicely towards the merger of the Group Smithfield/Campofrio deal, that merger is in its final stags. I expect to be reporting to you in the third quarter that that merger has been completed and that our two investments in Western Europe will be merged into one. The results of that will be the largest package meats company in Western Europe with sales in several billion dollars which we’ve been working on for several years now.

Smithfield will be a 30% shareholder in that publicly traded company and to give you some feel for how that is relative to our other investments in the United States the capitalization of Campofrio is nearly the same market capitalization of Smithfield Foods, the whole Smithfield Foods organization today given where the stock price is at and we will own 37% of that company.

Given the market positions that we will have in a number of countries in all of the major Western European countries we will have a major market position. We will be positioned very, very well with that merged company and we will have access to capital into Western Europe should we decide to make moves beyond that in the future. Although today I can report to you that we are not in the midst of looking at any acquisitions by this company. We’re in a mode of making the right defensive measures for the company and protecting the balance sheet. Mr. Manly will speak a great deal more about that.

Romania and Poland continue to make progress, that end of the business has seen some pressure, although last year we went through the adverse impact of classical swine fever in our operations and our plant that is behind us and we’re returning the other direction. Grain costs have completely reversed in Eastern Europe where they were substantially higher than the United States and we were seeing very poor cost issues in terms of raising costs there. We’re seeing the reverse of that as we go forward. That’s a very positive.

Now let me turn to the hog production, that’s certainly been a topic of big concern to everyone in the industry. It’s the driver of our costs this quarter. We are seeing very high raising costs, $63 versus $49 last year. We did go out and buy a significant amount of $6.00 corn this summer. Just like many others in our industry did and many other in many other industries with a number of commodities including oil around the world.

I am as surprised as anyone on this call that we saw corn prices move from better than $4.00 last December to $7.50 this summer and here we are sitting back one year later and corn is trading well below last Decembers price. I think no one saw this and I thought there was a major concern with the floods in the Midwest this spring and the concern about crop yields, the worldwide demand that was going on there was a huge concern among everyone including many people on this call about how are we going to protect ourselves against the complete disaster.

We did take protective measures, we did buy corn. After the fact that has been a very expensive insurance policy we bought. It was a decision that was the right decision at that point in time. Looking back, should we have done it. No, just like so many others who made decisions relative to a number of commodities it was a decision that should have been left as it was. Regardless of that our raising costs would have still been up significantly.

Corn costs have been up the whole year so our costs would not have been anywhere near close to last years levels had we not made that decision. Beyond that our productivity is very good. We have cut back our sow herds as you remember we made an announcement last February that we were cutting back our sow herds 4% to 5%. As I have reported to you this morning we have now reduced those herds some 7% and are moving forward. I’ll talk about that when I look forward.

It’s a tough environment for us to manage. These markets are literally impossible to foresee. They have been impossible for us to manage through other than take positions and then go forward from there. I am satisfied with that in terms of how we reacted to it.

The final point in terms of the other category represents our turkey business and that is the Butterball Turkey business which is down significantly feeling the same impact of these grain costs. As well, we have made reductions in our turkey production going forward, double digit reductions there. We are positioning that business very well forward and I’ll talk about that again in my forward looking statements.

It’s been a tough quarter for the company. It is probably going to be a tough two more quarters for us as this grain cost moves through but beyond that the light at the end of the tunnel is in my mind very bright and I am highly encouraged by what I see us doing internally and how I see these markets once we get on the other side of this corn at the end of our fiscal year.

I could talk to you about a number of financial issues but rather than me give you that information Bo Manly has an awful lot more to provide to you and with that being the case Bo let me turn it over to you and then I’ll make some comments when you’re finished.

Bo Manly

As a housekeeping reminder the beef group results were classified as discontinued operations at the end of our fiscal 2008 year. Earnings for fiscal 2009 as Larry had indicated for the second quarter totaled a profit of $4.2 million or $0.03 per share compared to a profit of $17.4 million or $0.13 per share for the same period a year ago.

For the first six months of this fiscal year Smithfield lost $8.4 million or $0.06 per share compared to a $72 million profit and $0.54 per share for the first six months of fiscal 2008. Earnings from continuing operations for the second quarter totaled a loss of $30 million or $0.21 per share compared to a profit of $23.4 million or $0.17 per share for the same period a year ago. For the first six months continuing operations lost $58.5 million or $0.42 per share compared to $80 million profit or $0.60 per share for the first six months fiscal 2008.

Earnings from discontinued operations for the second quarter totaled a profit of $34.2 million or $0.24 per share compared to a loss of $6 million or $0.04 per share in the same period a year ago. For the first six months discontinued operations earned $50.1 million or $0.36 per share compared to $8 million loss or $0.06 per share for the first six months of fiscal 2008.

Before I focus on general financial details of the quarter I would like to skip the normal sequence of the CFO reporting and go directly to what I’ll call the big three. These topics include liquidity, covenants and secondarily pensions. I would like to emphasize that we had no better crystal ball than anyone else on this call but we did foresee many of the headwinds facing our industry and have been aggressively managing these issues for several quarters.

We have evaluated and continued to analyze which are our core strategic assets of our business and which are not. This led to the sale of our beef business and feed yard last December and subsequent closure of the deal with JBS at the very end of last quarter. We’ve added equity to our balance sheet during the first quarter with the sale of stock to Costco. We also believe that our relationship with them will generate long term strategic opportunities for Smithfield in China.

We’ve replaced uncommitted lines of credit and bridge loans with long term debt facilities. We’ve reduced SG&A through hiring and salary freezes, suspended bonuses, curtailed travel, selling aircraft, consolidated corporate marketing functions and other actions. We have dramatically slowed capital expenditures to a rate below depreciation. We have no acquisitions on the table for the first time in quite a while.

We are pushing to find more and more sale synergies and leverage between our operating companies to improve price realizations, lower overhead and increase capacity utilizations to reduce manufacturing costs. These efforts at the operating company level have been led by George Richter the former CEO of Farmland in his new role as President of the Pork Group. George’s effort have begun to bear fruit particularly as we move into the second half of this fiscal year and into fiscal 2010.

Perhaps most importantly we have not waited for the industry to cure its burdensome overcapacity in light of current world economic and pork demand. We took a leadership role in herd reduction in the US last winter. We’ve currently implemented a 7% reduction in our domestic herd and are moving to a 10% reduction before the end of the fiscal year.

While this has reduced some pig marketing’s in this fiscal year the full impact of the reduction of pig marketing’s will result next year. Frankly, we are disappointed that more of our competitors in live production in the US have not been equally as aggressive.

We have clearly not maintained an attitude of business as usual. We are actively managing our balance sheet. Specifically as of October 26, the end of the fiscal 2009 second quarter, we had available liquidity of $920 million. This reflects the collection of proceeds from the beef transaction in the week prior to quarter close. As of yesterday, December 3, we had available liquidity of $895 million.

In addition to our cash availability we are entering our seasonal period of greatest cash generation. As we speak, we are at the height of our ham season. We are turning millions of pounds of finished hams into inventory to receivables to cash over the next 45 days. This will generate approximately $100 million in additional cash. We will market the majority of our cattle inventories over the next few months and anticipate generating $50 million in cash each of the next two quarters.

As we sell and replace hogs eating high priced corn with pigs eating cheaper corn we could ring out another $50 million of cash out of swine production working capital over the remainder of the year. We will continue managing capital expenditures below depreciation for the foreseeable future. Let me say, in the strongest terms that we have more than sufficient liquidity to provide for all our capital needs comfortably for the balance of this fiscal year and through fiscal 2010.

The second item on the big three list is covenant compliance. We are very disappointed that rumors have gone so far as to predict our imminent demise. We are currently comfortably in compliance with all applicable covenants and waivers. We are projecting that we will continue to be comfortably in compliance with all relevant covenants through the end of this fiscal year.

As those that follow the art of covenant compliance are undoubtedly aware we currently have a waiver under our US revolver with release from a 3.0 to 1 EBITDA to interest coverage ratio to a 2.0 to 1 ratio. This waiver is effective through the end of this fiscal year. Our projections indicate that we are very comfortable with maintaining compliance with the 3.0 to 1 ratio in the second half of fiscal 2010. With the trailing 12 month nature of the covenant calculation we are projecting a very close compliance with the 3.0 coverage ratio in the first half of fiscal 2010.

We are projecting that if there is a major deterioration in cost or demand from our current forecast it may be necessary to seek an extension of current waiver in the first six months of the fiscal year. While the first half of fiscal 2010 seems a long way off and a lot of water will flow under the bridge we are not comfortable in light of the present environment to wait and see if the markets prove us right and we are able to maintain compliance through fiscal 2010.

Contrary to conventional wisdom which says do not ask your banker for something you do not need absolutely until you absolutely need it we have elected to engage several major players in our bank group in ongoing discussions on this specific topic. We want to put this issue behind us well in advance of the point in time when we will know if we need the extension of the current waiver or not. We think this action is firmly in the best interest of the company, the shareholders and our lenders. We believe that an extension, if needed, can be obtained.

The final element of the big three is the status of Smithfield pension programs. At the end of fiscal 2008 the fair value of our pension assets were $847 million and 83% fully funded versus projected obligations to slightly over $1 billion. Our estimated pension expense for fiscal 2009 is $30 million while the prior three year average expense was $28 million. The average funding for the prior three years has been $32 million.

The final pension calculation for fiscal 2009 will be determined by the asset values at 12/31/09. The asset values in the plan have suffered during recent deterioration in the equity and real estate markets. Analysis by our pension consultants indicates that our incremental funding requirement could be as high as $62 million for the balance of the fiscal year, to catch up to anticipated shortfalls in plan asset value. We firmly believe we have more than adequate liquidity to be able to comfortably fund the projected incremental pension requirements.

A great deal of press has been devoted to extremely burdensome pension obligations that could threaten companies with large unfunded pension requirements and low liquidity levels. We do not believe we are in this category and believe the government will modify funding requirements to help companies weather this issue. Government actions in this regard could lessen the incremental funding requirements we have projected.

I have provided perhaps more information than we normally would on such a call but we feel the more transparency is better and feel confident the company has or will make provisions to come through the current hog cycle and world economic conditions with a stronger balance sheet, improved competitive cost structure and a high degree of focus on our core business.

Now I would like to return to the normal financial discussions. Sales for fiscal 2009 second quarter totaled $3.1 billion compared to $2.7 billion last year, a 15% increase. Sales in the pork segment increased 10% in the second quarter compared to the same period a year ago. Likewise, hog production in other segments showed sales increases. Increased sales resulted from primarily higher unit hog prices as well as turkey, fresh pork and packaged meats.

The international segment sales increased 47% in the second quarter compared to a year ago. This increase was due to higher premium prices, increased value in foreign currencies. Selling and general administrative expenses were $209.7 million in fiscal 2009 second quarter. This compared to $216.6 million in the year prior, a decrease of 3%. Management began applying pressure to lower SG&A late in fiscal 2008. These initiatives many of which I mentioned earlier are beginning to bear fruit.

To focus for a moment on corporate profit segment in addition to what Larry indicated, the corporate segment shows an increase in expense from $18.2 million a year ago to $33.3 million this last quarter. This increase expense of $15 million is due to several factors including a $9 million foreign exchange loss, $3 million loss on asset values of life insurance and $4 million in miscellaneous one time write offs and reversals. Foreign exchange is the main driver in the year to date results as well.

Interest expense for the quarter was $52.1 million, $3.8 million more than the same quarter in fiscal 2008. The average interest rate for this quarter was 4.3% compared to 5.7% the second quarter fiscal 2008. The rate decline was offset by higher average borrowings during the quarter resulting in higher overall interest expense. Given a static interest environment, management believe lower debt levels result in lower interest expenses going forward.

As we mentioned in the 10-Q Smithfield takes advantage of hedge accounting treatment on a selected basis when possible to account for risk management activities. Management believes that hedge treatment most accurately reflects the fundamentals and timing of our business. The loss from continuing operations for this period includes a pre-tax gain of $38.2 million from all hedging activities during the quarter. Included in that $38 million gain is approximately $108 million in market to market gains principally related to hog hedges for future periods that flowed through the second quarter P&L.

We experienced hedging losses on our grain position during the past quarter as well. We anticipate future hedging losses principally from open grain hedges and forward purchase contracts will impact hog costs in the third and fourth quarters. This will result in the $6.00 plus per bushel grain costs through the end of the fiscal year.

This highlights the inconsistency of hedge accounting and operating objectives and economics of providing price protection in future periods of inputs and outputs. We’re able to carry a hedged position on grain to the P&L of the future period in which grain is purchased. Whereas we are forced to mark to market the financial impact of a hog hedge in the current period regardless of when that hog will be sold.

Looking at the balance sheet for a moment our total debt, capital leases and notes payable were $3.5 billion at the end of fiscal quarter 2009. This compares to $3.9 billion at the beginning of the fiscal year. These reductions reflect management’s efforts to improve the balance sheet through asset sales, aggressively managing capital expenditures, issuance of equity and pre-payment of debt. Depreciation and amortization for the quarter was $68.3 million compared to $67.4 million last year.

The company has put considerable restraints on capital spending since the beginning of the calendar year. Capital spending continues to decline each quarter. Capital spending in the first quarter of fiscal 2009 was $83 million and $32 million in the most recent quarter. Capital expenditures for the first six months of 2009 were $115 million compared to $229 million in the same six months of fiscal 2008. Management intends to keep capital expenditures at or below the depreciation levels for the foreseeable future. We expect full year depreciation to total $270 million.

The company’s effective tax rate for fiscal 2009 second quarter was 41% versus 37% in the same period in fiscal 2008. The variation in the effective rate is due to the receipt of several tax credits in the quarter and treatment of FIN 48 discrete items that had the affect of increasing the effective tax rate in a period of loss and reduces the effective tax rate in a period of income. For the full year we expect the effective tax rate to range from between 34% to 36%.

The company’s debt to EBITDA ratio is 7.4 to 1 for the 12 month period ended October 2008 versus 5.8 to 1 for the full fiscal year ending April 2008. The debt to capitalization ratio was 54% for the quarter down from 56% at the end of the first quarter fiscal 2009. We continue to strive to a debt to capitalization ratio of 50%.

As I mentioned earlier we are in compliance with all covenants. We are projecting that we will continue to be in compliance with all relevant covenants through the end of the fiscal year.

The basic weighted average number of shares outstanding for the second quarter was 141.5 million shares up from 134.3 million shares at the end of the second quarter of fiscal ’09 reflecting the Costco share purchase during the first quarter of this year.

Let me conclude my remarks today by saying that Smithfield has initiated a host of actions to improve sales margins, lower manufacturing costs and cut overhead. We have shed non-core assets, we have dramatically shrunk capital expenditures, we have created greater liquidity and a stronger business base in Western Europe through the Campofrio with Smithfield merger. We’ve lowered our debt levels, sold equity, increased available liquidity.

We have aggressively taken actions to ensure covenant compliance for the next two years. We have more than adequate resources to fully comply with all pension requirements and we’ve been an industry leader in the reduction of swine production capacity. We are very optimistic that these actions will dramatically improve our fiscal performance in fiscal 2010 and beyond.

Thank you very much for your time and attention. I’ll turn it back to Larry.

Larry Pope

I hope you all took that as a very complete and informative narrative from Bo. I think that gives the answer to a lot of questions. As I think about this past quarter I’m not pleased as much as anyone else is but I am satisfied we’re doing something about the situation. We are not just sitting and waiting as others have done for something to change or hoping someone else will make the conditions improve.

Bo just outlined a number of actions that we’re taking from a company standpoint and I want to reinforce what we said many of those actions were taken long before the environment of the last 60 or 90 days. The salary reductions Bo talked about started last February when we made the announcement of 4% to 5% and we are now at 7% at the end of the quarter. We are at 8% at the end of November and we will be at 10% by the end of January. These actions have to be taken well in advance and we anticipated this nearly one year ago.

We made the decision several months ago in compliance with the country of origin labeling to say that we would only process US born and raised animals as a way to help this industry. We have reduced our turkey production a number of months ago. On the meat processing front more than two years ago we started the process of analyzing our plants and rationalizing how we went to market.

We made a management change in terms of the structure of our operating companies back this past May long before we knew any of this situation might be there. In July we made the tough decision to go to market to raise both debt and equity when our stock had dropped from a $25 and $30 range to $18 we still went to market, raise the debt, issued the equity in order to protect this balance sheet.

We made the decision to sell the beef business one year ago. It took a bit longer to get it documented but we made the decision. In fact, I was commenting to you a year and a half ago about our position in the beef business that was made nearly a year ago. As Bo indicated we started capital spending reductions long ago. It takes a long time to slow down a big train but that train has slowed dramatically by the time we get to the need we have radically reduced the level of our capital spending. As Bo indicated we’ll continue to maintain a tight reign on capital spending until we see this thing reverse.

We did make one decision in terms of buying corn which now looking back as I said, was an expensive insurance policy but the offset to that is that we hedged some of the hogs as well. It isn’t a one for one relationship and that doesn’t cover up the corn impact but it does act as an offset. Beyond that, our meat processing business has helped offset from the margins in that the costs we’ve incurred on the hog production. We do have vertical integration in effect and it is working. Our losses are not nearly what they should have been.

As I look back over the past year I take a lot of comfort in the fact that we anticipated things in advance. We took a lot of actions that now are starting to bear fruit even as others are debating to take action. We knew this long before financial crisis hit just 60 days ago. We’ve proactively moved on several fronts to improve the industry, our position and our financial health. I’m proud of what we’ve done in this management team and I think those who follow the company know this is the nature of this management team.

Looking forward its going to be a tough two more quarters. We’ve got to chew through this $6 corn that we bought this summer, it is going to be coming through our costs and we are not going to see significant cost reduction in our raising costs for the next two quarters. That may be a surprise to many of you it’s the nature of feeding hogs over long periods of time.

On the export front there are a lot of questions out there. We continue to see a very bright export market in spite of the fact that others are reporting that the export markets are essentially closed. We don’t see that. Our Japanese business is very robust. Our Chinese business is strong as is Mexico and Korea. The Russian markets are closed for the moment, although there is talk even this week as many of you know about them doubling the quota going in in terms of pork. That’s a market to yet be determined.

It’s not the biggest market for us as it is in the poultry business it’s just another market for us and we don’t have the Russian business. Beyond the herd reductions in Canada and the EU have been substantially higher than the US those are our two export competitors and so we should be very competitive from a supply standpoint and the prices in Europe are dramatically higher than they are in the United States, pork prices. We should be very competitive.

The futures markets say that this thing is going to clear by next summer. A lot of production is going to be down we anticipate. I expect our continued improvement of our operating costs will be reflected in the meat processing. Campofrio will be a publicly traded entity we’ll be under at that point. I look forward to fiscal 2010 as a very good period for the company. We’re in the food business, as this recession takes hold it should come to us more than it does anyone else.

We’re in the basic business of feeding average Americans and pork is moderately priced. As the recession hits some it should it hit no more certainly even less than others. We will have to see how that goes. From my standpoint I think this management team is taking as many actions as were possible to protect our shareholders and to give the opportunities for us to reward you going forward.

At this point we’ll take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ken Goldman - JP Morgan

Ken Goldman - JP Morgan

I do appreciate that you are being more aggressive than some of your competitors in terms of cutting the herd and in terms of taking the covenant risk right on even before it even happens, I think that’s the right way of doing it and I wish everyone else would do it that way. I do have a question about covenants, how confident are you that if you do need a waiver you can get one? How deep into the process of discussion with bankers are you? When can we expect to hear yea or nay on that process?

Bo Manly

As you can all appreciate absolutes are hard to provide anybody at this point in time. We have been engaged in this process for over a month recognizing some of the issues that have been brought up for the industry. We are benefited I believe by some of the better people in our space, so to speak, I’ll speak particularly to Production Farm Credit that has almost 50% of the revolver which their mandate is to supply credit to the agricultural community and they’ve been very supportive of this and we’re very confident that we’ll be able to get the waivers if necessary.

We’ve had those discussions and continue ongoing. I think it could be frankly as much as 60 to 90 days before it ultimately gets resolved and you never really know until you actually get somebody’s signature on the page. We don’t look at it as a huge hurdle and our numbers are still very good looking forward in terms of projections and are very consistent with our lenders outlook to the future as well. There’s pretty good agreement there all the way around.

Operator

Your next question comes from Diane Geissler - Merrill Lynch

Diane Geissler - Merrill Lynch

To reiterate the comments here about the candor really appreciate that I find it very helpful. On the $6 corn that’s going to run in through the P&L here I just want to make sure I understand your comments regarding the hedging on the corn versus the hedging on the hogs. Is it accurate to say that whatever gain that you’ve booked on the hogs you took this quarter and then the grain hedges will continue to be negative in the third and fourth quarter and that’s at play? Maybe a little bit more detail on the difference between the two?

Larry Pope

Let me answer that as transparently as I can. The answer is yes. That’s the nature of the hedge accounting which all of us dislike. Yes, our hedging profits on a hog have been reflected in the quarter. Conversely we do have the grain hedge coming through that will be impacted that’s why I’m telling you costs will not be down significantly in the next two quarters.

The other point I’d make is an awful lot of this grain loss has been funded. These are margin calls as you know on the commodities markets but we funded it an awful lot of it. Some we have forward purchase commitments but to the extent we’ve got commodity hedges out there as you know those commodity hedges come due every day. We have funded from a liquidity standpoint our cash costs going forward will not equal our reported raising cost because we have already funded it.

Diane Geissler - Merrill Lynch

How should we think about what the absolute price received on the hogs is in the back half of the year?

Larry Pope

Why don’t you tell me?

Diane Geissler - Merrill Lynch

You do this for a living. I sit at a desk in New York City and look at computer screens all day.

Larry Pope

Usually hogs start to rally this time of year so I’m optimistic in terms of where hog prices are going from here. I will tell you as I think I said that in my press release, if I didn’t I’ll tell you now. We are continuing to monitor these markets and protect this company. I’m going out there now by telling you I think the futures markets are a little undervalued where I think the real market is going to be that’s my thought, it doesn’t mean its right.

If these markets rally, its seems like they couldn’t go much lower we will look at the futures markets in terms of hedging opportunities going forward. We got a cheap hog market today and generally as you go forward from here the hog market rally and I think you know that.

Operator

Your next question comes from Ken Zaslow - BMO Capital Markets

Ken Zaslow - BMO Capital Markets

In your press release you put out that hog production should be turned profitable in the first quarter of fiscal 2010. If I look at the hog futures and the corn futures in light of your full disclosure what type of margins would that actually imply for you guys in that quarter, it seems like it would be pretty high.

Larry Pope

It’s not as high as you think. It would be profitable. The issue is that you’ve got this trailing corn thing that keeps on giving or taking either way. Even as you eat through $6 corn you’re still going to have some of this. I think we’re going to have solid margins as we get into the quarter but you should not take the pure futures and the pure cash market because that will probably give you better than $20 margin.

I don’t think the early part of the quarter is going to be that but I think what is happening is we’re working through this process and I think what should be the other side of that is I think the meat processing margins should be pretty good too. That’s part of my turning hog production is going to turn profitable which we’re going to have is also the meat processing business I think is going to be very solid. I know we always focus on corn and hogs and I spend an awful lot of time focusing on where we’re going on the package meats and the processed meat side of the business.

Ken Zaslow - BMO Capital Markets

You wouldn’t be surprised if that indicates about $10 to $15 per head type profitability it sounds like is that not fair.

Larry Pope

It could. Yes, it could.

Ken Zaslow - BMO Capital Markets

When you go to your banker and they worry about the covenants and I know the market is worried about the covenants can’t you just show them that and say we’re going to be profitable, we’re going to be able to pay it back, our loans, is that how it works?

Larry Pope

That’s exactly how we plan to do it. They can see the markets like we can. We’ve got smart people in our bank group. Absolutely we’re going to say guys here’s where we’ve been. The problem which Bo outlined very clearly is that we’ve got this trailing 12 month calculation so the earnings that we’re producing even this quarter are already in next years calculations, that’s the nature of the calculation.

We’re in a far better position than the vast majority of many industries in this country who are going to have to go see their bankers. Our future looks good, other people are going into the recession as you know in the hog production side we’ve already been through the recession.

Ken Zaslow - BMO Capital Markets

What should we expect for diluted shares outstanding and interest expense?

Bo Manly

Diluted shares outstanding we’re still looking at 141 million shares outstanding. Interest expense I think we’re looking at $209 million for the year. The note I have is that we’re looking at the debt reductions that have taken place as far as principal is concerned and we’re looking for around $191 million in interest expense a little bit lower than what I told you.

Larry Pope

For next fiscal year?

Bo Manly

For the trailing 12 months.

Ken Zaslow - BMO Capital Markets

No, I’m looking for going forward.

Bo Manly

We’ll get back to you if that’s possible.

Operator

Your next question comes from Christine McCracken - Cleveland Research

Christine McCracken - Cleveland Research

On the hog supply there’s been a pretty dramatic drop in the number of hogs we’re getting in from Canada tied to this country of origin labeling issue. I’m wondering as you look at your plants are you seeing any dramatic supply constraints and/or maybe benefits in other plants where you may be have an advantage over your competitors in being able to source hogs where they might not be able to.

Larry Pope

I wish I could tell you that we were having trouble getting hogs. We’re not having a lot of trouble getting hogs today. The industry has lots of supply today. That’s going to really surface because we haven’t changed our country of origin requirements here. I believe it’s the end of March when we’ve said that we would not take any more of what would be potentially feeder pigs from Canada because we gave the contract growers and our suppliers time to work through the inventory that they would have already bought in feeder pigs. We thought that was only fair.

We really haven’t seen that impact of the Canadian reduction at least from the country of origin side. In terms of supply, these hogs move around and we’re getting hogs everyday at the plants with really no issue today. I wish I could tell you we were but we’re not having trouble getting them.

Christine McCracken - Cleveland Research

If you look at the number of slaughter hogs that have come in now at about 60% I think there’s definitely been an impact on overall supply I guess I’m just wondering where its showing up.

Larry Pope

I think you’ve had pretty strong productivity in the domestic herds here. The reductions that people have including us have not yet fully taken effect here. I don’t think that you’re seeing all these. You are seeing on slaughter hogs clearly you’re seeing that but you’re not seeing it from the feeder pigs they’re still coming in. I think productivity has offset that for now.

Bo Manly

At least the way we look at it we would factor in about a six month lag time between the point at which we would see any reduction or increase in Canadian import impacting the slaughter side of the business. If you look at the pattern that we saw last spring and early summer we’re just about to get the impact of these big reductions from Canada starting to roll through I would say as we get further into December and certainly as we move into our third quarter we’ll start to see those as you’re vocalizing that we should.

Operator

Your next question comes from Tim Ramey – D.A. Davidson

Tim Ramey – D.A. Davidson

Let me just echo the comments of others that we appreciate the candor, the stock is up 25% that kind of flies in the face of some others who have been more opaque. You didn’t give us good news today but we like the candor. One of the questions I had was that as we get into a tighter covenant and liquidity situation is that going to affect your ability to hedge and have you backed away from some of those forward purchases how is that playing out in the marketplace for you.

Larry Pope

The cash requirements associated with these hedging positions as you know can be material although we’ve got an awful lot. We’ve got a lot of liquidity. One of the things that we have looked more at is the forward purchase commitments which are really off the commodities market. That simply goes out to the grain suppliers and you buy the grain and you don’t even have, just a forward purchase commitment.

No, we think that we’ve got plenty of liquidity if these markets present themselves where we can protect ourselves on the raising side we would be just as interested in taking some of these positions this is not the time to not look at these markets because we’re looking. I don’t know here corn is going. If I were to make a prediction there is a formula between oil and corn so you tell me where oil is going I can almost tell you where corn is going it appears.

No, we would have not looked away from the commodities but we have started to look more with toward purchase commitment.

Tim Ramey – D.A. Davidson

As you think about the earnings power of the company you have backed away and sold a few things but you’ve also talked about cutting your costs and focusing on more blocking and tackling types of things. What would you say about the change in the earnings power of the company in a theoretical normal cycle?

Bo Manly

Let’s look specifically at what we exited in terms of the beef business. I think that we’ve seen tremendous roller coasters in terms of beef profitability at the plant level we’ve seen even greater roller coasters in profitability, the feed yards. I think frankly from an earning stabilization it will be beneficial to us in terms of a big portion of the assets that we exited in terms of consistency of earnings going forward.

I would say that I look at the things that George Richter is doing to look at improving sales realization, reducing manufacturing costs and reducing overhead as being all very, very accretive to our pork bottom line and very exciting.

Larry Pope

You asked the question how much is that. I think from some respect Bo would probably tell you the beef business hadn’t made us a lot of money over the year. It’s had great years both directions, great profits and great losses. The cattle raising has not been a good business for us to be in. We don’t make predictions but I think the things we’re doing now and we have been doing. I want to say that again, are significant and they’re showing up in this pork segment, I think they’re significant.

Bo Manly

Our timing to exit the beef processing side of the business we’ll look back five years from now and say it was fortuitive so we got out look at where we think industry trends are going to be.

Larry Pope

You guys have made a number of comments about the fact that our profit returns relative to sales don’t compare comparably with some of our competitors. I hope I’ll be able to report to you as we go forward quarter after quarter our numbers are going to get comparatively better and better. I hope I’ll be able to tell you that.

Operator

Your last question comes from Farha Aslam - Stephens, Inc.

Farha Aslam - Stephens, Inc.

Following along with Ken’s questions given the commodity markets have been so volatile could you share with us your thoughts on what margins would be in hog profits per head?

Larry Pope

If you look back over the long periods of time is that $10 to $15 a head that’s $0.04 to $0.05 to $0.06 a pound is what that industry has yielded over a dozen years, 15 years.

Bo Manly

Certainly not what it was 20 years ago before the expansion took place. I think we’ve normalized earnings in a much tighter range.

Larry Pope

I think its going to be closer to the $10 range going forward than I think it is the $15 or more. That probably doesn’t speak well for us if you know what I mean. I think that industry has consolidated a point that is not going to as wide a range as there was in the past. I hope that answers it, it’s as honestly as I can give it to you.

Farha Aslam - Stephens, Inc.

Do you think fresh meats and packaged meats are still going to be about $0.01 to $0.02 for fresh meats and packaged meats are still going to be $0.04 to $0.07 a pound?

Larry Pope

What did you put on fresh meat?

Farha Aslam - Stephens, Inc.

I put $0.01 to $0.02 a pound on fresh meat.

Larry Pope

Yes, I hope that I would tell you they are going to be better than that. I think they’re going to better than that on the fresh meat size the changes we have made and I would hope that I would tell you the package meat is going to be on the higher end of that number than the lower end of that number. You could tell how bullish I am on that side of the business.

Jerry Hostetter

Our time is up, we appreciate everyone for joining us today and we hope you have a good day.

Operator

That does conclude our conference for today. Thank you for your participation you may now disconnect.

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