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Sanderson Farms, Inc. (NASDAQ:SAFM)

F4Q08 Earnings Call

December 4, 2008 11:00 am ET

Executives

Joe F. Sanderson, Jr. – Chief Executive Officer

D. Michael Cockrell – Chief Financial Officer

Lampkin Butts – President and Chief Operating Officer

Analysts

Farha Aslam - Stephens Inc.

Ken Goldman - JP Morgan

Christina McGlone - Deutsche Bank

Kenneth Zaslow - BMO Capital Markets

Heather Jones - BB&T Capital Markets

Christine McCracken - Cleveland Research Company

Christopher Bledsoe - Barclays Capital

Operator

Welcome to the Sanderson Farms, Inc. fourth quarter 2008 conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Joe Sanderson.

Joe F. Sanderson, Jr.

Good morning and welcome to Sanderson Farms’ fourth quarter and year end conference call. Lampkin Butts and Mike Cockrell are with me this morning. We issued a news release this morning announcing a net loss of $51.9 million, or $2.56 per fully diluted share, for our fourth fiscal quarter of 2008. During the fourth quarter of fiscal 2007 we earned $24.1 million, or $1.18 per diluted share. The $51.9 million net loss during the fourth quarter included an adjustment of $29.7 million net of income taxes, or $1.46 per share, to our live and processed inventories to reflect those inventories at the lower of cost of market. Mike will discuss that adjustment in detail in a moment

For the year ended October 31, 2008, we reported a net loss of $43.1 million, or $2.13 per diluted share. The year-end numbers also include the effect of the inventory adjustment. For 2007 we reported net income of $78.8 million, or $3.88 per diluted share.

Each of you should have received a copy of the release and accompanying financial summary. If you did not, they are available on our website at www.sandersonfarms.com.

I will begin the call with brief comments about the year and then turn the call over to Lampkin and Mike for a detailed account of the operating and financial results. After their remarks I will come back to discuss feed grain prices and our outlook for fiscal 2009 before opening the call for your questions. Before we make any further comments, I would like to ask Mike to give the cautionary statement regarding forward-looking statements.

D. Michael Cockrell

Before we begin the call this morning we need to caution you that the call will contain forward-looking statements about the business, financial condition, and prospects of the company. All forward-looking statements are based on management’s current expectations and beliefs as well as assumptions made by, and information currently available to, management. The actual performance of the company could differ materially from that indicated by forward-looking statements because of various risks and uncertainties. These risks and uncertainties are described in our most recent annual report on Form 10-K and in the company’s most recently filed quarterly report on Form 10-Q. We expect to file our annual report on Form 10-K for the year ended October 31, 2008, with the SEC on or before December 19, 2008.

Joe F. Sanderson, Jr.

While the Georgia dock and leg quarter prices were higher for the year, the overall chicken markets were lower during our fourth fiscal quarter when compared to the fourth quarter of last year and market conditions were less favorable during the quarter than during the third quarter of this fiscal year.

Feed grain prices, which I will discuss in more detail in a few minutes, provided significant headwinds throughout the year. Despite the deteriorating market conditions versus a year ago, our net sales for the full year were $1.7 billion, an increase of 17% compared to fiscal 2007. Our increased sales primarily reflect our growth in Waco.

Mike will explain the significant inventory adjustment that contributed to our net loss in a few moments, but first I will turn the call over to Lampkin for a discussion of our operations.

Lampkin Butts

As Joe mentioned, market prices for poultry products were mixed during our fourth quarter when compared to our fourth quarter last year, but overall prices were considerably lower. The average Georgia dock price during our fourth quarter was approximately 9% higher than last year’s fourth quarter, averaging $0.881 for the quarter.

For the year, the Georgia dock averaged $0.83 per pound, which represented an 8% increase over the $0.767 per pound averaged during fiscal 2007. The Georgia dock price is currently $0.87 per pound.

As many of you know, the Georgia dock price is a good indicator of the supply and demand dynamics for products sold at retail. While the spot market prices for products produced at our big-bird plants have been under significant pressure, the balance of supply and retail demand has been much better. This balance is reflected in the improvement in the Georgia dock price during 2008.

Bulk leg quarter prices increased approximately 17% for the quarter compared to last year’s fourth quarter and increased approximately 12% for the year. Leg quarters averaged $0.524 per pound during the fourth quarter and $0.464 per pound for the year, but the current Urner Barry quote is $0.27 per pound.

The deterioration in leg quarter prices over the past month and a half reflects the impact of current economic conditions around the world on our export customers. Credit issues are impacting our customers in Russia and other former Soviet Union countries, making it difficult for them to obtain the credit needed to buy our products.

The market for boneless breast meat has been very soft since July. Prices during our fourth quarter were lower by 22% when compared to the fourth quarter a year ago, or 18% lower than during our third fiscal quarter and were over 10% lower for the year.

The quoted market price for boneless breasts averaged $1.19 per pound during the fourth quarter and $1.35 per pound during the year.

Prices continued to soften through the quarter. The Urner Barry market price for boneless breast is currently $1.15 per pound, which is actually an improvement from the bottom of $1.06 per pound reached during October.

While the quoted market price for boneless stayed above $1.00 per pound, boneless was being discounted below $0.80 per pound this fall. The softness in the boneless breast market reflects the weakness in the market for almost all protein consumed away from home. This includes the demand for white meat from our casual dining customers as well as the softness in the market for chicken from our distribution customers.

Finally, jumbo wing prices during our fourth quarter averaged $0.88 per pound, down $0.27 from the average of $1.16 per pound during last year’s fourth quarter. For the year, jumbo wing prices were lower by 16% from an average of $1.11 per pound during fiscal 2007 to an average of $0.94 per pound during fiscal 2008. Jumbo wings currently trade for $1.05 per pound. The softness in wing prices reflects the same weakness for the same reasons as the soft boneless breast market. Normally wing prices firm after Labor Day as football season starts and fans begin moving into bars and watering holes to eat Buffalo wings and watch their favorite teams. That did not happen this fall.

This price weakness again reflects the very weak demand for any product consumed away from home and we expect the weak market to continue until either the chicken industry brings production in line with this weak demand or demand picks up as general economic conditions improve. Like with boneless breasts, we have seen a slight improvement in the market for wings over the past few weeks.

All this said, our average sales price for poultry products during the full fiscal year was actually higher by $0.015 over last year, increasing 2.3% for the year ended October 31, 2008, compared to the year ended October 31, 2007. Obviously, all of that increase was experienced during the first half of the year. This increase of $0.015 per pound in our average sales price for chickens was more than offset by the substantially higher feed grain cost we experienced, which added $0.07 per pound to the cost of chicken processed during 2008.

When you combine the prices with higher costs, margins were lower by almost $0.06 per pound in our chicken business.

Our costs for corn were higher during the quarter compared to last year’s fourth quarter, rising 43.5% while the cost for soybean mean increased 51.7% during our fourth quarter compared to last year.

For the year we paid over $239.0 million more for feed grain compared to fiscal 2007. The company’s current cost for these commodities have come down and we now expect to pay less for feed during 2009.

Based on current pricing, feed grain costs for the company during fiscal 2009 would be approximately $142.5 million lower than 2008 costs if we priced all of our remaining 2009 needs at today’s prices. Joe will have more to say on feed costs in a few minutes.

Just as we do near the beginning of each fiscal year, we met with our managers two weeks ago to identify opportunities in our plants, in the field, and in sales, that we will work to capture during 2009 and we expect our overall operating performance to continue to improve.

Our goal for 2009 is, as always, to operate at the top of our industry regardless of market conditions. We competed well in the industry during 2008 in terms of operating efficiencies and margins and we still have room for significant improvement.

While dark meat prices are down significantly from their highs for the year, leg quarter prices were strong during 2008. For the first nine months of the calendar year, total U.S. exports were higher by 21% when compared to calendar 2007. Most every export market experienced growth in volumes during the year, including an 8% increase in volume to Russian, a 15.2% increase in volume to China, and exports to Mexico were up almost 20%. During fiscal 2008 our sales into export markets totaled approximately $233.0 million, over 13.2% of our total sales dollars.

As many of you know, Russian authorities are currently considering a change in the quotas for United States chicken going forward. The current agreement with the United States provides that Russian importers can buy up to 930,000 metric tons of U.S. chicken each year. Through the first nine months of this year 670,000 metric tons of chicken were sold to Russia. We are on pace, then, to come well under the 930,000 metric tons allowed under the current agreement.

Sanderson Farms understands that good progress has been achieved between the United States and Russian governments regarding changes to the fifth year, 2009, of the bilateral meat and poultry trade agreement. The changes made to the agreement appear to be acceptable to both governments and we anticipate a joint announcement regarding the successful conclusion to the consultations will be made, although we cannot predict the time table.

Sanderson Farms anticipates that U.S. poultry export to Russia in 2009 will continue at levels near the 2008 quantity, estimated to be about 750,000 metric tons. However, other factors, such as the availability of credit and financing for poultry imports, or politics, could change this outlook.

The USDA is predicting decreased chicken production during calendar 2009, which is supported by leading indicators such as egg sets and breeder placements. Breeder chick placements over the last three months are down 3.1% when compared with the same three months a year ago and the projected breeder flock for May 2009 is down 1%.

Egg set numbers over the past few weeks have been running between 7% and 11% behind last year’s numbers. These numbers support the USDA’s estimate of a decrease in chicken production during calendar 2009.

At this point, I will turn the call over to Mike for a discussion of the quarter’s financial performance.

D. Michael Cockrell

Our financial performance during the fourth fiscal quarter and for the year both reflect the difficult environment facing our industry. Our net sales for the quarter totaled $460.2 million. That is up from the $426.9 million for the same quarter during fiscal 2007. The increase in net sales reflects an increase in the pounds of poultry products sold during our fourth fiscal quarter of 11% when compared to last year, but that number was offset by deteriorating market conditions.

For the fiscal year our net sales totaled $1.7 billion, or a 17% increase over the $1.5 billion for fiscal 2007. Our cost of sales for the year increased 30.6% compared to a year ago, and totaled $1.7 billion.

While our average sales price for poultry products during fiscal 2008 was up 2.3% compared to last year, the average cost per pound in our poultry business increased 16% compared to last year, reflecting the higher grain cost.

For the year, feed grain cost comprised 49% of our cost of goods sold and during fiscal 2007 grain costs comprised only 41% of our cost of goods sold.

Our cost of sales for the quarter ended October 31, 2008, increased 29.4% when compared to the same quarter during fiscal 2007. This increase is primarily a result of an increase in the poultry pounds sold during the quarter of 11%, or 63.6 million pounds, as well as higher feed grain costs.

During this year’s fourth fiscal quarter, we sold 638.0 million pounds of chicken and we sold 2.4 billion pounds of chicken for fiscal 2008. By contrast, we sold 574.5 million pounds of poultry products during last year’s fourth quarter and 2.0 billion pounds during fiscal 2007.

SG&A expenses for fiscal 2008 were down $6.2 million compared to 2007. This decrease was due in part to the start-up costs during fiscal 2007 related to our new Waco complex, which were booked as SG&A expenses prior to the beginning of operations at that plant in August 2007. These costs totaled $3.8 million.

While we paid no bonuses for fiscal 2008 and we also accrued no ESOP contribution for 2008, during 2007 we contributed $5.8 million to the ESOP and recorded $3.3 million for bonuses under the company’s bonus award plan. Both of those were booked as SG&A expenses last year.

These lower costs were partially offset by planned increases in our marketing budget and certain other administrative costs.

At the end of the fiscal year our balance sheet reflects stockholders’ equity of $354.0 million and net working capital of $188.8 million. The current ratio was 3.4 to 1.

Our long-term debt at year end was $225.3 million and our total debt to cap ratio was 39% at October 31, 2008. Our net debt to cap ratio was 38.6%.

For the year we spent $48.8 million on capital improvements and paid $11.6 million in dividends.

For fiscal 2008 our interest expense was $8.5 million, an increase of $5.3 million over the interest that was expensed during fiscal 2007. This increase reflects our higher outstanding debt and also reflects the absence of $2.1 million in capitalized interest during 2007 that was not present during 2008. That capitalized interest relates to our Waco construction.

During fiscal 2008 we spent approximately $48.8 million on planned capital projects and we now expect that for fiscal 2009 our capital expenditures will be approximately $17.2 million and we expect to fund that $17.2 million using cash on hand, internally generated working capital, cash flows from operations, and, as needed, liquidity under our revolver.

The company still has a $300.0 million unsecured revolver of which $139.0 million was available to us at October 31, 2008.

Our depreciation and amortization during 2008 totaled $41.9 million and we expect about $43.0 million for fiscal 2009.

During our fourth fiscal quarter the company recorded a net charge of $29.7 million, or $1.46 per share, to reduce our inventory values to the lower of cost or market. This charge consists of two primary parts. First, the company had on hand, at the end of the fiscal year, approximately 71.0 million pounds of leg quarters and paws that were awaiting shipment into the export market.

As market prices for leg quarters began to fall rapidly during October and November, we had to revisit the value of that frozen processed inventory on our books. As you all know, generally accepted accounting principles require that inventory be valued at the lower of cost or market. Given the high grain costs that contributed to a relatively high cost per pound for that product, the market price per pound fell below that product’s cost when leg quarters and paws began to fall at the end of the fiscal year. As a result, we adjusted our processed inventory by approximately $8.1 million net of income taxes on October 31.

The exercise we went through with our live inventories was a bit more complicated. At the end of the fiscal year the company had approximately 58.6 million live [chickens] on the ground across the company. Approximately 34.4 million of those live chickens were dedicated to our big bird deboning operations and 24.2 million head of chickens for our retail plants.

Some of those chickens were one day old, some two days old, some three, four, five and so forth up to 60 days old. As of today, many of those chickens have been grown to maturity, processed, and sold. Some are still on the ground awaiting to be finished, processed and sold during December.

Normally we carry our live inventory at cost and accumulate that cost as the birds are fed and grown. GAAP principles require that our live inventory be recorded on our books at the lower of cost or market, just as with processed inventory. With respect to the live birds, however, GAAP principles require a different assessment.

The applicable guidelines require a company to project the cost to complete all of its live inventory and then deduct from that total cost the amount it expects to realize from the sale of the mature live inventory. To the extent that the cost accumulated in the live inventory on our books at October 31 was deemed impaired, we wrote it down.

We have a high degree of comfort in what our cost will be to complete the grow out and processing of the live chickens and have estimated based on current and expected market conditions what we will realize when we sell the birds. That exercise led us to believe that the projected cost of our live inventory at maturity will be greater than its ultimate sales price, so we adjusted our live inventories down by $21.6 million, or $1.06 per share, net of taxes.

We have been conservative with our estimates but to the extent that actual market conditions change materially from our estimates between now and two weeks from now on December 19, when we file our 10-K and our audited financial statements, there is a chance that those numbers could change ever so slightly.

The fiscal 2008 inventory adjustment will have a positive effect on the first quarter of 2009 because we recognized during fiscal 2008 those losses that are inherent in our inventory at October 31 that will be sold during 2009 and otherwise would have occurred in 2009.

Of course, we can’t predict whether or not this positive effect will be offset in whole or in part by similar adjustments at the end of the first quarter of 2009 because that will depend upon inventory costs at that time and market factors that are presently not known.

With that, I will turn the call back over to Joe for some closing comments.

Joe F. Sanderson, Jr.

I would like to follow up on a couple of things mentioned by Lampkin and then we will open the call up for your questions.

Lampkin mentioned that based on current grain prices our feed grain costs will be approximately $142.5 million less during fiscal 2009 than they were during fiscal 2008 if we locked in prices on our remaining needs at current values. That estimate is based on today’s cash market price for grain but I caution anyone building a model that prices have been very volatile and I expect that volatility to continue.

I reported to you on the last call in August that we had priced none of our 2009 needs as of that date but would be looking for opportunities during the harvest to begin pricing some of our needs for fiscal 2009.

Grain prices have dropped, along with the prices of most commodities, and we have been pricing our fiscal 2009 soybean meal and corn needs. While the supply outlook for both corn and soybean meal has improved based on an expected reduction of demand caused by current economic conditions, the carryout is tighter on soybeans than corn.

Although grain prices will be lower during fiscal 2009, our company and our industry need help from the chicken markets to return to positive margins. While grain costs may save approximately $0.055 to $0.06 per pound on dressed chicken, chicken markets must move as well this year.

We have seen positive moves from our industry as egg sets and chick placements continue to drop. The question, of course, is whether or not the decreased supply chicken as a result of these cuts will be enough to balance supply with the decreased demand from domestic consumers.

As we reported in August, our company instituted our fall cutback in production a month early on October 1 rather than November 1. We also postponed the move to full production at Waco until 2009. Over the past few weeks we have also reduced our live weights to reduce pounds at all of our big bird deboning plants and have reduced our big bird headcount by another 100,000 head per week, or 2.4%.

When you combine our fall cutback with our reduced headcount and live weights, we will be producing 10% fewer pounds in January than we were in September. These cuts are concentrated at our big bird plants where we will be processing 14% fewer pounds in January than in September.

As Lampkin said, the primary area of reduced demand is for product going to food service and distribution customers who provide meat to consumers for consumption away from home. Until the American consumer begins eating out again, we expect the demand to remain soft. We have made no decisions yet regarding when we will restore our fall cutback or return our plants to full production. Moving Waco to full production will be our first priority, as poultry houses are completed at that division.

As most of you know, our production is divided between big bird deboning and retail. According to our benchmarking services, the big bird deboning market segment, on average, has been the most profitable market segment for most of the past 15 years.

The exceptions to this rule occur during times when the commodity market prices for boneless breast and dark meat are both very weak. We went through a period such as that during the cycle of 2006 and are in another of those cycles now. Starting in July the big bird deboning plants and Agri Stats were at a disadvantage to small bird plants and are now at a disadvantage to retail plants as well.

Cheap boneless paired with cheap leg quarters does not work, even with a significant cost advantage. Accordingly, our production cuts are concentrated at our big bird deboning plants.

While I have confidence that the fundamental rules of supply and demand and economics will work to maintain industry profitability over the long term, we recognize that these short-term swings are inevitable. However, we continue to manage this company as we always do, which is with the same goal, regardless of where we are in the chicken cycle.

With that, we will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Farha Aslam - Stephens Inc.

Farha Aslam - Stephens Inc.

You have $1.0 billion shell filing and you have one of your largest competitors that has just declared Chapter 11. Could you share with us your interest in acquiring chicken assets during this industry downturn and how you think about your balance sheet and stop price?

Joe F. Sanderson, Jr.

Well, our first priority is our balance sheet and we would do nothing to stretch, challenge, or put our balance sheet in any jeopardy whatsoever. Our stock price at $25, $28 is not the most attractive level to me to be issuing stock. We don’t know anything about any assets being available right now, either. So I think that is fairly hypothetical.

We put Kinston off because we felt like it might be stretching our balance sheet and I think that is always our first priority, protect our balance sheet. And with the stock price where it is right now, it doesn’t seem the most attractive time to be issuing any stock, regardless of the value or the price of any assets.

Operator

Your next question comes from Ken Goldman – JP Morgan.

Ken Goldman – JP Morgan

Could you give us some sense for given the current purchases of corn and soybean meal, at those levels, where you think you need to be in terms of Urner Barry prices for breasts and leg quarters and so forth?

Joe F. Sanderson, Jr.

Our sensitivity table, and this will be different for different companies and different size birds, but based on our mix and our operation, based on 2007 margins, the Georgia dock needs to be about $0.7875. Boneless breasts needs to be about 41.54, tenders need to be about $1.52, wings need to be about $1.25, leg quarters need to be about $0.42.

That will be different for different people, for different sized chickens and different operations.

Ken Goldman – JP Morgan

But it’s not unreasonable to think that those are close to what you would need also?

Joe F. Sanderson, Jr.

Those are what we need.

D. Michael Cockrell

Just to caution you about that, that’s what those markets need to average for the year, as Joe said, to return to 2007 margins, which some of the guys that do what you do have said are close to normalized margins. So to return to those 2007 margins we need to average those prices for the year.

Ken Goldman – JP Morgan

Just curious, you talked about the uncertainty of whether the current production cuts are sufficient. I am curious to get your opinion on whether they are sufficient. Do you think that the 8% egg set cuts plus whatever, assuming Pilgrims hasn’t started cutting yet, their cuts plus your cuts, plus if Tyson decides to change its mind, you could get 11% to 12% cuts on a regular basis. Would that be enough in your mind to get back to that level of profitability?

Joe F. Sanderson, Jr.

I don’t know. We went through October and USDA reported we actually did have 4% less head of chicken and the market got worse. Now October and November are historically poor-demand months. Always, historically, the market declines during that period of time. We are going into January where most of the time you get a little uptick in demand and better retail features, and we’re going into that month with I think 8% average less headcount, in January.

I am, frankly, anxious to get there and see what it is going to do. But I am anxious to experience 8% less headcount. I don’t think I have ever done that before. But this downturn in demand that we described in May and August is something we have never seen before and I don’t know the answer to that yet. But I am looking forward to seeing what January is going to be like.

Operator

Your next question comes from Christina McGlone - Deutsche Bank.

Christina McGlone - Deutsche Bank

I am curious you talking about leg quarters needing to be in the $0.40 range. I am just curious if the market can bear an increase in prices? I wanted to better understand the underlying demand in Russia, what’s going on with the credit issues, is it easing up, is the consumer in Russia seeing any—are we seeing an impact on them from what’s going on economically?

And second to that, with this pending announcement, would we have resolution of the chlorine issue as well?

Lampkin Butts

First, about Russia, the demand situation in leg quarters going into Russia is not resolved. Product is still going into the country but there is still a back up and prices are well below the $0.40 that Joe mentioned.

That has more to do with credit than anything else. And the credit is not resolved and it’s not significantly improved today.

$0.40 a pound for leg quarters is very doable, but not today, not in today’s economy in Russia and Eastern Europe and with the banking crisis.

As far as the resolution between USDA here and Russia, it is our understanding that there has been progress made and both countries appear to be agreeable to a resolution which would allow for 750,000 metric tons of quota for next year for the U.S. and the chlorine issue would not be an issue January 1. That issue would be put off for a year. Now that has not been finalized and both countries haven’t signed off on it so we can’t predict the date. But we feel good about it, it appears the countries are in agreement on that.

Joe F. Sanderson, Jr.

I would also add to that that there is a different relationship in the dollar and the ruble right now. And while we think maybe in January we might see a different market scenario, the currency situation is certainly going to be different in 2009, at least in the beginning of the year, than what we had in 2008.

The dollar supported U.S. exports most of 2008 and with the dollar strengthening it is not supporting exports today.

Christina McGlone - Deutsche Bank

So are our leg quarters more expensive than theirs in their domestic market?

Joe F. Sanderson, Jr.

Not right now, no. Not at $0.20 delivered port.

Christina McGlone - Deutsche Bank

And what about just the underlying demand because you would think if the product can get in there and it is cheaper than what their prices are, that demand would pick up, unless the economy is impacting their meat consumption.

Lampkin Butts

It looks to us like the demand on the street, so to speak, the demand from the consumer, it looks to us like it is okay. The inventory levels in Russia are not a burden. The product is just slow getting into the country because the importers’ liquidity has been cut in half. And that’s really that and the value of the dollar has caused it to back up.

I would say that earlier in the year, when leg quarters were sold for $0.60 a pound delivered port, those prices, there could have been some consumer push-back in Russia at those prices. But the product, getting in seems to be clearing at the consumer level satisfactorily.

Christina McGlone - Deutsche Bank

You mentioned the discounting for white meat below Urner Barry, are we still seeing that happen?

Lampkin Butts

We are seeing prices below Urner Barry but not $0.80 and below like we saw in October and parts of November. Urner Barry is at $1.15 and product is being sold $0.15 back of that. But that puts boneless, some spot lows at $1.00 versus $0.80 in October and part of November.

Christina McGlone - Deutsche Bank

I assume you will continue to see an inventory build in chicken cold storage and I am wondering if this USDA program that they haven’t quantified, but if that would help reduce those inventories meaningfully?

Lampkin Butts

It’s not a big number. It will help and we are grateful for it, we support it, every little bit helps, but this is not finalized. The bid opens on December 8 so nobody knows exactly how much they will buy but we estimate that between January and the first of March they could buy 50.0 million pounds worth of chicken products, which translates into less 1% of weekly production. It’s going to be helpful, it is going to get some stuff out of freezers, but it is not huge. Less than 1% of total production.

Operator

Your next question comes from Kenneth Zaslow - BMO Capital Markets.

Kenneth Zaslow - BMO Capital Markets

For next year, how much do you think your production will be lower, for the full year? Or flat? I think at one time it was supposed to be up 10%, how is it looking now?

D. Michael Cockrell

We can’t answer that for sure because as Joe said in the prepared comments, we have made no final decision about when to restore our cuts. So it’s going to depend on that. If we restored them in the spring sometime, you would run about 2% more pounds in fiscal 2009 than you did in fiscal 2008, but as you notice we didn’t even say that in the prepared remarks because it is just going to depend.

Kenneth Zaslow - BMO Capital Markets

So in a very conservative way, you would at most increase your production by 2%, which is an 8% change from last call, is that fair?

D. Michael Cockrell

I think if you are modeling, that would be reasonable, yes.

Kenneth Zaslow - BMO Capital Markets

I appreciate that you gave chicken prices for 8.5% margins, which is what people like to call normalized, but what about break-even levels? Where are we with that? I think we first have to get to break-even before we get to 8.5% margins, no?

D. Michael Cockrell

I don’t have those numbers prepared. We like to think we are going to return to those margins.

Kenneth Zaslow - BMO Capital Markets

If I think about the competitor that has clearly decided to go bankrupt, if you aren’t in the position to buy parts of their assets, is there any company out there that would be able to buy any of their assets and if there weren’t any companies out there to buy their assets, how does a company like this emerge from bankruptcy without downsizing their operation? Is it possible?

Joe F. Sanderson, Jr.

I can’t speculate about that. I have no idea about anybody else’s situation other than the three public companies. We’re not privy to that and I know there are some other good chicken companies out there and we chase them in Agri Stats every month but I have no idea about anybody’s balance sheets and intentions.

Kenneth Zaslow - BMO Capital Markets

I just think you would be one of the stronger balance sheets out there and I was just thinking if you don’t buy parts of it, it seems hard to believe that other companies will and I can’t imagine a restructuring that keeps the same size. But you really don’t have any commentary to that?

Joe F. Sanderson, Jr.

No, sir.

Kenneth Zaslow - BMO Capital Markets

If I think about the export demand, how much do you think the fall in the leg quarter prices is the LC problem and credit problem versus how much do you think it’s actually a reduction in global demand?

Lampkin Butts

I think the banking crisis and liquidity issue is the main factor. The global slowdown in the economy, I think it would have affected leg quarters. $0.60 leg quarters have never sustained for a long, long time but to go from $0.60 to $0.20, I think most of that drop was related to the importers’ liquidity.

Kenneth Zaslow - BMO Capital Markets

Is there a time table to which you think the liquidity will come back? When you talk to your trade partners, is there any feeling that the liquidity is coming back or is it still pretty dry? Can you give us a time table?

Joe F. Sanderson, Jr.

It feels like it is tied very much to U.S. as well and whenever it unfreezes in the U.S. I am guessing that the Eastern European and Russia and European will follow. I don’t think Europe and Eastern Europe and Russia are going to break free ahead of the U.S.

D. Michael Cockrell

The Russian importer, at a $0.30 leg quarter, they have half as much cash than they did earlier in the year.

Joe F. Sanderson, Jr.

Except for the change in currency.

D. Michael Cockrell

Except for the value of the dollar. But they still have got some high-priced product that hasn’t gotten in and gotten through their system.

Joe F. Sanderson, Jr.

Part of this is they are also protecting their inventory. They are unloading boats over there right now of $0.55 leg quarters. And they have got inventory that is $0.60, they’re unloading $0.55, and they are protecting and are going to dispose of those inventories and then they can’t get money to buy any more. It’s kind of the same thing they had when they had Avian influenza. It’s going to take two to three months to get it squared away and we don’t know about the credit.

Operator

Your next question comes from Heather Jones - BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

I have a question on domestic demand. You mentioned retail demand remains fairly decent, but I was wondering what you have seen in food service over the last couple of months? I am trying to determine, has there been a big further deterioration? It has been weak all year, and did you see another dramatic step down in the October/November period?

Heather Jones - BB&T Capital Markets

It is still weak. As you said, it has been soft all year. October and November was more of the same.

Heather Jones - BB&T Capital Markets

So you didn’t see worsening, it’s just more of the same?

D. Michael Cockrell

We did see worsening in some customers. But I would say overall it’s just still very soft.

Heather Jones - BB&T Capital Markets

As far as your cuts, it sounds like basically when the markets improve reversing those cuts is very much on the table. You mentioned the decline in breeder stocks. I was wondering if you have a feel for the egg set cuts we have seen, chick placement cuts, etc.? How much of that do you think is people just like you that are just waiting until the market improves and they’re going to bring it back and how much is it people that are in dire straits and so these are going to be maybe not permanent, but longer-term cuts?

Joe F. Sanderson, Jr.

I don’t think any of the cuts are permanent on the egg sets. The breeder stock, right now, is running 2% and 3% for three months. And that has got to stretch out six months before it is meaningful. I think all of the egg set cuts could be restored but it is going to take ten weeks before it can be meaningful and my guess is it will trickle back up, it won’t happen overnight.

You are going to have different companies that will be in different conditions with their balance sheet and their operations. Everybody won’t return to profitability the same month. You will have some better operators and better people in different market places that will return to profitability at different times. Better operators will return to profitability one month and somebody else may be four months later.

And it depends on how this market improves. It may improve gradually, which I would expect. I don’t think it turns on a dime. And your egg sets will creep back up, they won’t all jump back up at one time.

D. Michael Cockrell

You may also have an operator that has a balance sheet that is in jeopardy or is challenged and even if that person is a good operator and returns to profitability, he is still going to wait because he needs to heal up his balance sheet. We have seen that before in other cycles.

Heather Jones - BB&T Capital Markets

I understood that the egg sets are not permanent but if you had some kind of qualitative feel for, are the other guys cutting egg sets, are they at this for a longer period than you or is it going to be just like prior cycles where pricing improves and it’s back off to the races. Or could we be back in the same boat if the domestic economy doesn’t show significant improvement here, could we be back in a similar, maybe not this bad, but still break-even to loss making position in early 2010?

Joe F. Sanderson, Jr.

You could. I would never say you couldn’t. But when people start making money, when people start making a lot of money, the signal is set more eggs. That’s what they will do. That is the market signal and they will do it. But people that are heavily leveraged are going to be more cautious than people that are not.

Heather Jones - BB&T Capital Markets

Are you going to publicly announce that you are reversing these cuts or is it just sort of going to happen?

Joe F. Sanderson, Jr.

I will wait until we are on a conference call and somebody asks, probably. I will tell you this. We have more flexibility in Mississippi. We are not going to let the new growers at Waco—sometime in March, April, May, that plant is going to get up to 1.2 million and we are going to do that. We have more flexibility here but Waco is going to get up to 1.2 million whenever those houses are completed in Waco. And I don’t know if that is going to be March, April, May, June. Whenever it is.

Heather Jones - BB&T Capital Markets

What do you mean flexibility? With regards to your grower contracts?

Joe F. Sanderson, Jr.

Lay-out, times, sizes. Not contracts, but we have been running a tight lay-out in Mississippi and we have more flexibility here than we do in Waco.

Lampkin Butts

And those Waco growers are going to be brand new, they’re going to be bringing on their houses, and having made that investment they are going to want chickens.

Joe F. Sanderson, Jr.

We don’t have all the houses built in Waco.

Heather Jones - BB&T Capital Markets

But by April or so they will be done?

Joe F. Sanderson, Jr.

It depends on the weather over winter.

Heather Jones - BB&T Capital Markets

You said your availability on your credit facility as $131.0 million at the end of October. Can you update us with what it is now, given how bad November was?

D. Michael Cockrell

It hasn’t changed significantly.

Heather Jones - BB&T Capital Markets

I just wanted to make sure I am understanding this accounting correctly. So you have written your current inventories to the market, so if the market improves from here, which it seems like it is, on the inventories you already had in process, it should be profitable for fiscal Q1.

D. Michael Cockrell

It should be break-even. If our estimates were spot on, because as I said, we feel pretty comfortable about our cost side, we have had to project what we think the market is going to be in December and we have been conservative with that, but if we were spot on we would break even. Now, if the market improves above what we have estimated, we would actually make a profit on those birds.

Heather Jones - BB&T Capital Markets

So basically you are just pulling forward the losses from Q1, so assuming your estimates of where the market is going to be is correct, as far as us treating it as a model, it’s really not a non-recurring item like you are writing down goodwill or something. We’re just bringing in Q1 losses into Q4.

D. Michael Cockrell

That is the practical effect of it.

Joe F. Sanderson, Jr.

It’s for November and December, though.

Heather Jones - BB&T Capital Markets

Not January.

D. Michael Cockrell

The live birds, as I said, we’ve got a little less than 60.0 million birds that will be processed in November and December, and then putting the birds out now for January. But that’s correct, just November and December.

Joe F. Sanderson, Jr.

And your credit availability was $139.0 million, not $131.0 million.

Operator

Your next question comes from Christine McCracken - Cleveland Research Company.

Christine McCracken - Cleveland Research Company

I just wanted to touch on these leg quarters that are sitting in inventory. In the past, unwinding build-ups in inventory took quite a long time and I am wondering what is the industry doing this time around? Is it possible that we are trying more proactively to keep inventories low so that it doesn’t creep up and weigh on the market for the balance of the year? Is there anything that might be addressed by you, and others, that could keep it from being a big problem for the first half of next year?

Joe F. Sanderson, Jr.

We think you are going to see a significant build in November. And then we understand that, for whatever reason, there are pretty good inquiries for leg quarters arriving in January, in Russia. And it may be because of lower prices but we think the next cold storage inventory is going to be a pretty good build. And we actually see a peak on that out of Agri Stat, on a weekly basis. But we think that may, in January and February, get brought back down some with the lower production levels, and right now we think, for whatever reason, maybe because Lampkin said the prices are lower, they are going to get shipped. We don’t know yet.

Christine McCracken - Cleveland Research Company

And just in terms of the cuts that you are taking, it seems to be concentrated in the big birds. Historically, the rationale behind not cutting was that it did eat into our efficiencies. If you get to that level of cuts, it seems like it hurts you a bit on profitability. I’m just wondering how you balance that and if that has kind of worked its way into your decision-making process?

Joe F. Sanderson, Jr.

Our per pound cost and live production and our plant is going to go up, on a per-pound basis. But what you are doing is just reducing your absolute losses. 91% of this inventory adjustment was in big birds and 91% of our losses are coming out of big birds. And we were just cutting losses. We do a calculation every week about comparing and you get to a point where it makes sense to cut it, even though your per pound goes up you reduce your absolute losses. It has got to get to a certain point, $0.85 to $0.90 breast and $0.20 leg quarters, you have reached that threshold. It may be different if you get to $1.25 breast, it may look the other way. But at $0.85 and $0.20 it was crystal clear.

Christine McCracken - Cleveland Research Company

On your capex plans, did I hear you right that you are putting a $17.0 million number out there for next year?

D. Michael Cockrell

That’s correct. We approved our capital budgets in August and September and it is a very tight budget and our division managers were very agreeable and cooperative in battening down the hatches. It’s down significantly because we are not doing anything special this year.

Christine McCracken - Cleveland Research Company

That’s below maintenance cap levels, right?

D. Michael Cockrell

We have usually said $25.0 million and it may end up there by the end of the year. We have approved, though, capital budgets at this point at just over $17.0 million. If something breaks and somebody comes in and needs something, they know that Joe will let them have it to run their plants, but right now it is lean. But $25.0 million is what we have been suggesting what people use as a model on average every year for maintenance.

Operator

Your next question comes from Christopher Bledsoe - Barclays Capital.

Christopher Bledsoe - Barclays Capital

The capacity utilization levels that you have historically operated at, I suspect have been mid-to-high 90s and I’m just wondering if that is fair and after this cut what are we talking about and how low would you really be willing to go, if you don’t anticipate some directional improvement in profitability?

Joe F. Sanderson, Jr.

We’ll do what we need to do. We will cross that bridge when we get there, but like I said, we’re flexible, we’ll do what we need to do. We want to see January and see what this cut looks like and see what the supply and demand is going to be in January. We’re comfortable with the cuts we have in place and we think we are going to be in good shape in January.

D. Michael Cockrell

And you are right on with your capacity utilization historically speaking. We always cut 4% or so through the winter, some weeks more than that because of holidays, but then run 100% through the summer, and that comes right in the mid-90s. You’re right about that.

Christopher Bledsoe - Barclays Capital

Is there any feeling that your move here to more aggressively moderate production set the stage for others in the industry who maybe haven’t been on board to get on board, or is there any evidence out there that you are seeing, even anecdotally, suggesting that other large processers are getting on board that haven’t been on board?

Joe F. Sanderson, Jr.

No. We don’t know anything about anybody else. We did this for our shareholders and this company and our balance sheet and our P&L. We don’t know anything about anybody else.

Christopher Bledsoe - Barclays Capital

If I think about the big bird deboning model and the last 15 years of profitability, you would naturally expect that the excess returns relative to the other sub-segments, the excess returns out of big bird would draw in fresh capacity, as it has. That’s where a lot of your expansion has been. Are you starting to feel now like some of the excess returns in that sub-segment may be at risk over a longer term here? If so, does that warrant a closer look at your asset footprint?

Joe F. Sanderson, Jr.

At our business plan? I do not. What I believe is, that we are in an unusual situation with a very weak economy and a consumer that has been beat to death with high gas prices and falling home values and now unemployment and psychologically beat up by falling stock market and job loss and all of those things, and I think they have shrunk up, pulled back, and pulled in.

But I do not believe that what we saw in the 1990s and the habits and the life styles, I think people are eating at home right now and they are going to the grocery store and preparing or they are buying prepared food at the grocery store, but I do not believe that they have quit for the rest of their lives eating out. I think that is a life-style change that is different from my mother’s and I think that is a generational change and I think when the economy recovers—and I don’t think that’s going to be in 2009, I think it will be later—but I think when the economy recovers, they will go right back to eating out and will go back to eating out before they buy the car and buy the house and buy the big screen television. I think that will be one of the first things they do.

But we are flexible and if it changes we will change with it. We will do what we need to do. But, no, I don’t think this is a fundamental change. I think this is a bad time in the economy and a beat up consumer and I think we’ll bide our time through this and come out the other side of it.

Christopher Bledsoe - Barclays Capital

Just thinking about some of the letter of credit type of issues in the export market, I would have to believe that that would mean that inventories in the other side of the world are being depleted, as inventories here are growing. Is that consistent with what you are seeing, what you are hearing? Any way to quantify what those inventory levels are, in Russian particularly?

Lampkin Butts

It is consistent with what we’re hearing from Russia. We really don’t see a world-wide inventory number but we get reports from Russia about inventory levels. And the inventory levels there appear to be dropping and are at a very manageable level right now.

Christopher Bledsoe - Barclays Capital

If that continues and the letters of credit were to lock up, I guess it’s not unreasonable to think that this issue could become more of a humanitarian crisis of sorts. I’m a little surprised that we have not seen more attention to it, more broadly, maybe it will take the humanitarian issue, but is there any talk at all in different levels of government of intervention?

Joe F. Sanderson, Jr.

No.

Lampkin Butts

I think we’re a long way from that, as far as considered humanitarian.

Joe F. Sanderson, Jr.

We’re getting inquiries for January arrivals. They don’t want anything in December but we are getting inquiries for January arrivals at low prices. I assume they do have enough money to buy $0.20 leg quarters.

Christopher Bledsoe - Barclays Capital

Does getting the inquiries also mean that there is some level of comfort with the importers’ ability to obtain the letters of credit they need and to have those letters of credit accepted or is that an entirely different conversation?

Joe F. Sanderson, Jr.

No, they will have their credit.

Christopher Bledsoe - Barclays Capital

If I were a restaurant operator today I would be of the mindset that I would want to take advantage of some of the disconnect in the industry and the need for some processers to take on cash here, to lock in prices at pretty favorable levels. So I am curious of how much of what you are seeing from the restaurant operators is a move to lock in longer-term discounted prices relative to what they may otherwise be in 2009, on the prepared food side of the business?

Lampkin Butts

What we have seen from the casual dining arena is a willingness to pay higher prices for 2009 than 2008. Occasionally one can book their item at the same, but the majority of those that we deal with are looking at higher prices, from us and other processors.

Christopher Bledsoe - Barclays Capital

And there is still resolve around the industries’ move to a 90-day to 180-day type of pricing model?

Lampkin Butts

There are some of those out there and there are still some 12-month.

Joe F. Sanderson, Jr.

Most of it is 12 months but it is booked at higher prices.

Christopher Bledsoe - Barclays Capital

The credit issues, are they affecting the build out at all? Not so much [inaudible] credit but really more with the growers. The combination of the industry in the trough and just the general credit malaise, is it affecting the growers’ ability to get the financing they need for their houses and therefore to complete Waco and Kinston, when you decide to bring that back on line?

D. Michael Cockrell

We really haven’t seen that. Of course, most of our growers had all this lined up and done before the big part of this credit crunch hit and the psychological part hit, and so we haven’t seen that.

Christopher Bledsoe - Barclays Capital

I didn’t catch what you said you expect D&A to be for 2009.

D. Michael Cockrell

$43.0 million is what we expect for fiscal 2009.

Operator

This concludes the Q&A session.

Joe F. Sanderson, Jr.

Thank you for spending time with us this morning. On behalf of everyone at Sanderson Farms we wish you all a very happy holiday season and a happy and prosperous New Year.

Operator

This concludes today’s conference call.

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