Smithfield Foods, Inc. F3Q09 (Qtr End 02/01/09) Earnings Call Transcript

Mar.12.09 | About: Smithfield Foods (SFD)

Smithfield Foods, Inc. (NYSE:SFD)

F3Q09 Earnings Call

March 12, 2009 9:00 am ET

Executives

Jerry Hostetter - Head of Investor Relations

C. Larry Pope - President and Chief Executive Officer

Robert W. Manly - Chief Financial Officer

Analysts

Ken Goldman - JP Morgan

Christina McGlone - Deutsche Bank Securities

Christine McCracken - Cleveland Research

Farha Aslam - Stephens Inc.

Brett Hunley for Heather Jones - BB&T Capital Markets

Kenneth Zaslow - BMO Capital Markets

Reza Vahabzadeh - Barclays Capital

William Chappell - SunTrust Robinson Humphrey

Carla Casella - JP Morgan

Vincent Andrews - Morgan Stanley

Ann Gurkin - Davenport & Company

Operator

Welcome to the Smithfield Foods third quarter conference call. (Operator Instructions) As a reminder, this call is being recorded and will be available for replay starting at 11:00 a.m. ET today through midnight on March 26, 2009. You may access the AT&T replay system at any time by dialing 1-800-475-6701 and entering the access code 990972. International participants may dial 320-365-3844, access code 990972.

I would now like to turn the conference over to your host, Jerry Hostetter.

Jerry Hostetter

Welcome to a conference call to discuss Smithfield Foods fiscal 2009 third quarter results. We would like to caution you that in today's call there may be forward-looking statements within the meaning of federal securities laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the 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 call 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.

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.

C. Larry Pope

Good morning ladies and gentlemen and thank you for all listening in this morning. We have reported pretty sizeable losses this morning. The loss from continuing operation is $105.5 million, or $0.73 per share, compared with a profit of $57.4 million, or $0.43 per share, last June. For the nine months it’s a $164.0 million loss, or $1.17 per share, compared with $137.0 million profit, or $1.03 per share, last year. These are certainly very, again, very stark differences between the two periods.

I will try to point out that there is an awful lot of noise in these numbers and I hope that you have had opportunity to look at the impact of significant items that we reflected in the press release, trying to provide to you the information that is the result of a number of actions being taken by the management team in reaction to the markets and in reaction to the business, and as part of the strategy we’ve been executing now for some time.

Mr. Manley will be talking that to you about that during his report, but it is extremely important that you understand that the $0.73 per share loss that we are reporting for the quarter has an awful lot in it that needs to be considered as you understand and sort of reconcile these results.

On an overall standpoint, in spite of the fact that we are reporting $100.0 million loss, I am actually a little bit pleased. The results on much of the business came in better than I thought it would for the quarter and the parts of the business that we’re in a position to manage, I think we’re doing an excellent job of and in positioning ourselves as this hog market and this corn market turn in the opposite direction it’s been going for the last year, that we are positioned to perform very well going forward. And I want to say that at the outset of this.

The big driver of the results, from an operating standpoint, this quarter is clearly the hog production business. As many of you know who have followed the company for many years, hog production has carried us for many, many years and has been the shining star for several years. Now that that has reversed as of last summer, with the high-priced corn that we’ve talked about so many times, and the fact that the live hog market fell last fall just as we had predicted. At about this time last year I had indicated to you that I was concerned about the number of hogs coming to market in the fall and in fact, that did happen.

We did have some hedges in place that protected us to some degree but [BREAK IN AUDIO] bad decision in hedging our corn, and that looks to have been a bad decision, although it looks like many, many people made that same decision.

We are feeding through that. I think I did indicate to you at the end of the second quarter call that I expected a very rough third quarter. I can report to you today that I think that we are going to have another tough quarter in the quarter that we’re in now, as we go through the process of feeding out this corn through the end of the fiscal year, which is what I’ve indicated on a number of occasions, and that is continuing as we speak. Hopefully we will work through that by the end of the quarter.

On the meat side, we have a solid, fresh meat quarter. It was not as good as last year’s third quarter but last year was an extraordinarily good fresh meat quarter. On the packaged meat side the business set records. As you look at the earnings from the pork segment, and it shows $129.4 million, you have to consider that there’s $85.0 million of the restructuring charge related to the pork group that is in that number.

So if you add that back, most of that is non-cash related to the closing of the six plants that we announced earlier. It’s $214.0 million compared with $221.0 million, and on a year-to-date basis that’s $369.0 million compared with $310.0 million.

Those are extraordinarily good year-to-date pork operating profit results and I am extremely pleased with that. George Richter and the team and the management changes we made nearly a year ago are working out wonderfully. I could not be more pleased with the job he is doing and the job that the operating presidents are doing at the individual subsidiaries.

This is part of the business we have been trying to make the change in for several years. Our percent of sales is going up very nicely and I think if you take the $369.0 million, we’re on a run rate of $500.0 million in operating profit from the pork group and we are beginning to produce the numbers that I’ve been talking about now for quite some time.

On the fresh meat side, part of the driver of the continued good results in that end is the export business. I know there is a great deal of questions amongst many of you in terms of what’s happening on the export markets. I can report to you today that the export markets are still very robust, very strong.

From our numbers, we are down 2% for the quarter, but that’s because we had very large shipments of carcasses to China as part of their national reserve last year. If you take those out of last year’s third quarter and compare that with this year’s third quarter, our numbers are up 26%, and so the business on the export side of the fresh meat business is extremely good, and it is diverse; it is not into just one market.

We have seen big pickups in Mexico, which is a market we have not been participating to the same level as others, to Japanese markets, the Korean market, the Taiwanese market, the Australian market. Those are all very good markets for us.

As well, I know there has been a lot of debate about the Russian market, and the Russian market did cease to order here for a bit of the third quarter but I can report to you that business is back, although a number of the plants in this country have been delisted, I think Smithfield has about 60% of all the plants that can ship into Russia, so we do have the opportunity to continue to ship into that country, and we are shipping in there.

We have made a management change there in terms of our international group, and Jason Richter, who has been in the international department, is running that, reporting to Phil DuFour, our executive vice president, and I can tell you that team has come together very nicely, and that part of the business is seeing immediate results on the international front and I am extremely pleased with the job they are doing.

We are shipping at record levels. In fact, we would be pressed to ship an awful lot more export product from just the pure logistics. The numbers are really very, very good and I continue to believe that the export markets—I’ll talk about that in my comments about the future—but the export markets are very good.

I hope you saw that we have recently announced the restructuring of our pork group. That is part of the reason for the results. We have $85.0 million of charges in there. There will be an additional $30.0 million, which Mr. Manly will talk about, in next fiscal year. However, in spite of that we still anticipate improving the bottom line by $55.0 million next year, in spite of that $30.0 million.

That shows you the speed at which I think this restructuring will start to benefit us at the bottom line. It is something we have been talking about for a year. We will be spending about $53.0 million in capex. We will be installing or aligning all of our computer systems under an SAP platform and that will help us to get a very good handle on all of our costs and all of sales numbers and, I think, give us the opportunity to manage this business even better.

This is the culmination of a multi-year strategy. I have talked about this so many times, about the rationalizing of plants. This will move our capacity utilization up from 80% to 90%, which has been our target goal. This will get us to that goal and I think will make us a very, very packaged-meats processor, as well as the changes we’re making at the operating company level will make us more disciplined on the sales side. We will not be chasing any low-margin business and this will provide us the ability to utilize the plants and only to sell product that we can make something on. I am extremely excited about what I think that can do to the pork segment profitability, even at the levels we’re at now.

In terms of the international business, it’s a mixed bag. Eastern Europe, maybe to your surprise, continues to perform well, and improving. It’s a maturing business; it’s profitable; and it is improving.

On the Western European side we did complete the merger of our Groupe Smithfield and Campofrio. We now own 37% of that company and that business is not seeing the same type of comparative results and, in fact, theirs is down. They are seeing the impact of the recession in the United States that in many cases is as deep, or deeper, in Western Europe and it is impacting our packaged meats business. Bob Sharp, who is the CEO of Campofrio, does have a synergy program in place and a cost reduction although in Europe those things generally take a little longer to get in place and make happen.

Finally, I will comment on the balance sheet and the financial activities. We have not been resting on our laurels there either. Mr. Manley will spend a fair amount of time talking to you about that but in summary, we did get our loan agreements amended. We got 100% support from our bank group. We have paid down significant debt. We have sharply curtailed capital expenditures, and we continue to have very strong liquidity, which provides us the wherewithal to weather whatever storm may be in front of us.

We are keeping an eye on this and we are continuing to be vigilant in terms of looking in the balance sheet and in terms of managing the cash flows and the liquidity, in spite of the fact that I think that we’re going into an improving environment for the company, I am still weary of how this recession could impact everyone in every industry and as well the fact that credit markets are so difficult to maneuver these days, it’s important for us to make this a priority of this company.

With that being said, I will turn it over to Bo Manly for his comments and then I’ll give you my comments looking forward after that.

Robert W. Manly

A few quick housekeeping items. First, the third quarter of fiscal 2009 that we just finished is the 14-week quarter of 53-week year. Second, the income statement contained in this morning’s release, has a new line item: other income. This contains the gain on our Groupe Smithfield investment resulting from the merger with Campofrio as well as the pre-tax gain on the purchase of $94.0 million of public bonds.

During the third quarter, as Larry mentioned, Smithfield made significant improvements to the balance sheet. Total debt was reduced during the quarter by $317.0 million and reduced by over $700.0 million since the beginning of the fiscal year. This takes our debt to capitalization ratio down to 53%.

We maintained an average of over $900.0 million in available liquidity for the quarter and ended the period with total available liquidity of $960.0 million. And most importantly, we successfully negotiated covenant amendments to our U.S. and European revolvers through the third quarter of fiscal 2010. I will provide more detail on this later.

I am certain that you can appreciate all of the actions that we have undertaken in the last 12 months to react to our environment, to improve the balance sheet, right size our hog framing operations, and focus on core business. This culminated with the announcement last month of the pork restructuring plan.

Please let me emphasize the restructuring plan began over a year ago as part of an initiative to improve our overall return on capital investment, not as a response to any credit issues.

The restructuring plan will produce $55.0 million in EBT improvement net of expenses in fiscal 2010 and create annualized EBT improvement of $125.0 million in fiscal 2011 and beyond. The EPS impact should be about $0.50 per share.

The plan will result in a pre-tax charge of $85.0.0 million, or $0.38 per share, after tax to our third quarter pork segment earnings. Of this charge $73.0 million is non-cash.

Finally, we will spend $8.0 million in capital expenditures in fiscal 2009 and $45.0 million in 2010 associated with the restructuring plan.

The vast majority of EBT improvement will come from overhead and SG&A savings in packaged meats. It will not require that we sell one more pound of meat for any greater margin than we have in the past. It is an executable plan developed from the bottom up with strong buy-in from all levels of management.

There is a table on Page 2 in this morning’s press release entitled Impact of Significant Items. This table contains several adjustments that are of a non-recurring or special nature and illustrates the significant effect these items have on reported results for the quarter.

Reported GAAP earnings reflect a loss of $0.73 per share from continuing operations. After adjustments for these items in the table, earnings per share from continuing operations would be a $0.15 loss on a non-GAAP basis.

Leading this list of special items is the pork restructuring charge of $0.38 per share. The second item is the merger of our Groupe Smithfield joint venture, which resulted in a pre-tax gain of $56.0 million and $31.0 million after tax. This is a one-time after-tax improvement of $0.22 per share.

This gain represents the market value of additional Campofrio shares received as a result of the merger, less our basis in Groupe Smithfield Joint Venture. As a result of the merger, Smithfield’s interest in Campofrio increased from 24% to 37%.

The one-time gain on Groupe Smithfield’s transaction triggers a tax catch-up adjustment that lowered our effective tax rate to 19% for the quarter. This tax-rate adjustment negatively impacted net income by $20.0 million, or $0.14 per share, based on previously anticipated tax rates.

At the end of the third quarter the value of the company’s cattle inventory at our cattle-pro joint venture and our wholly-owned Holstein operations was revalued to the lower of cost or market. This inventory re-evaluation decreased income by $12.0 million after tax, or $0.08 per share.

During the quarter the company purchased $94.0 million of face value of 2009 public bonds in the open market. These bonds were purchased at a discount that resulted in an after-tax gain of $5.0 million, or $0.03 per share.

Mark-to-market adjustments related to open derivative contracts negatively impacted the quarter by $56.0 million pre-tax and $34.0 million after-tax. This had a negative impact on per share earnings of $0.23. These results are attributed to cash market activities in grain and hogs in future periods. I will describe our hedging activities in more detail later in this discussion.

In summary, this has been a very busy quarter—operationally, financially, and emotionally. We are disappointed that our GAAP results reflect negative performance with a quarterly per share loss of $0.73 and loss of $1.17 per share for the first nine months of the year, in large part due to restructuring charges combined with losses in hog production and cattle feeding.

Management believes that the calculation of non-GAAP loss from continuing operations of $0.15 per share, after adjustments, more accurately reflects the performance of the company.

We gain comfort in the fact that the underlying pork operations, particularly packaged meats, are performing well. We believe we will see livestock losses decrease after the fourth quarter, with lower corn and higher hog prices.

In other highlights for the quarter, we negotiated covenant amendments to our domestic and European revolvers. These amendments we approved by 100% of the members of the bank groups. The new amendments require EBITDA interest coverage of 1.2 to 1 for the fourth quarter, 1.35 to 1 for the first two quarters of the next fiscal year, 2.0 to 1 in the third quarter, and returning to 3.0 to 1 in the fourth quarter of fiscal 2010.

The covenant amendment was received for this last quarter but was not necessary. We are comfortable that the coverage ratios contained in the new covenant amendments will provide sufficient headroom as we move to improve profitability for hogs for the first half of fiscal 2010.

We told you these amendments would be expensive, and we were right. The agreement calls for a spread increase of approximately 225 basis points costing $4.0 million to $5.0 million more per quarter in interest. We estimate that the total 2010 interest expense will be approximately $235.0 million. In addition, we will amortize $12.0 million in bank fees over the next six remaining quarters of these revolvers.

Some of you have asked why we did not restructure the revolver to contain no covenant requirements whatsoever. We believe the amendments negotiated offered Smithfield the most cost-effective and efficient credit facility given current market conditions while maintaining the original borrowing capacity of the existing facilities.

For those of you that actually read the Q, you may notice that long-term public facilities have an interest coverage and incurrence test that must be achieved if the company desires to issue additional incremental public debt. Let me emphasize, these are not covenants.

The company did not meet this incurrence test at the end of the third quarter, however, the company has no current plans or need to incur more long-term debt. To the contrary; we’ve been paying down debt. We could, however, continue to refinance existing long-term debt at any time if we desire.

We anticipate that we will meet the incurrence test again in the third quarter of fiscal 2010.

The last follow-up item is pension funding. The fourth quarter pension expenses are estimated to $7.0 million. Funding requirements for the current quarter estimate to be $14.0 million. This is a $24.0 million savings compared to what we described to you in December. We anticipate that our fiscal 2010 pension expense will be $85.0 million and our funding requirements will be $74.0 million.

Management is comfortable that we have adequate liquidity to fund these pension requirements. We are supporting industry efforts to gain regulatory relief from certain funding requirements that provide time for pension asset values to regain recent losses in the market.

The analytic community, to include the Wall Street Journal of Monday this week, has put a lot of focus on pork exports as being a bellwether for future company performance and that of the protein industries in general. Our export activities and overseas operations provide a unique view of worldwide supply and demand.

We see indigenous pork supplies of major importing countries declining, we see pork production falling in major exporting countries. We believe supplies of beef and chicken worldwide are declining as well. Under normal conditions there are significant indications of future pork export opportunities.

During the third quarter demand from our export customers was strong and in certain critical markets significantly better than a year ago. We sold 70.0 million pounds of pork carcasses in China in the third quarter of fiscal 2008 representing 22% of our total exports. These carcass sales helped push our total exports to record levels. Our sales in the most recent quarter were off only 2% from record levels of a year ago. More importantly, if you took out incremental carcass trade a year ago, our total sales of base business are up 26%.

Our top four destination countries—China/Hong Kong, Japan, Mexico, and Korea—represents 79% of our total exports of base business. These increased between 11% and 75% year-over-year. Even China’s base business, without last year’s carcass trade, increased double digits. These trends continued through February, with Russia representing 5% of sales and now showing strong year-over-year results.

Needless to say, we are pleased with the export numbers for the third quarter. These represent the validation of the relative strength of our export markets.

As I indicated earlier, quarterly pork segment continuing profits were impacted by the $85.0 million restructuring charge, accounting for the largest portion of the decline in pork results from $221.0 million profit in the third quarter of 2008 to $129.0 million profit in the most recent quarter.

The decline in fresh pork margin was offset by continued improvements in packaged meats. The international segment operating profits declined in this quarter by $8.0 million compared to the same quarter a year ago due to lower equity of income of both Groupe Smithfield and Campofrio.

Losses in the hog production segment increased from $81.0 million in the third quarter of 2008 to $254.0 million in the quarter we just finished. Hog-raising costs increased from $49 per 100-weight a year ago to $62 in the third quarter of 2009. Live hog sales increased from $37 per 100-weight a year ago to $40 in the quarter just ended. We expect our cost of production in the fourth quarter to be comparable to costs in the third quarter.

Other segment income fell $16.0 million to a loss of $9.5 million compared to the third quarter of fiscal 2008 due primarily to write-downs in losses on cattle inventories. The cattle inventories declined from 680,000 head at the beginning of the quarter to 280,000 head at the end of the third quarter, dramatically reducing our future exposure to the cattle market. We project we will sell down cattle inventories to 65,000 by the end of the fourth quarter.

The results of the corporate segment for the quarter were flat compared to a year ago. Selling, general, and administrative expenses were $202.0 million in fiscal [2009] third quarter compared to $238.0 million in the year prior, or a decrease of 15%. The reversal bonus accrual accounts for the largest share of this decrease in expense.

On the year-to-date basis SG&A expense declined 3% compared to a year ago as decreases in compensation more than offset the extra week, higher related litigation costs, and current foreign currency losses.

Interest expense for the third quarter was $58.0 million, $5.0 million more than the same quarter a year ago, despite a lower rate for the quarter applied to a smaller borrowing base. The 14th week added over $4.0 million in interest expense. In the third quarter of fiscal 2008 we reduced interest expense $10.0 million as a result of classifying the beef group as discontinued operations. We expect fiscal 2009 full year interest expense to be $215.0 million and $235.0 million in fiscal 2010.

Losses from continuing operations for this quarter included a pre-tax hedging loss of $13.0 million. This included the mark-to-market loss for the quarter of $56.0 million. For the nine months year-to-date we have a pre-tax hedging gain of $29.0 million.

In our last conference call we told you we had established forward grain positions last summer that locked in our availability in corn costs through the end of this fiscal year at about $6 a bushel. These positions roll off in this current quarter, providing relief but this will still cause our grain costs to be above current market through April.

Turning to the balance sheet for a moment, we reduced our debt, capital leases, and notes payable to $3.2 billion at the end of the fiscal third quarter of 2009 from $3.9 billion at the beginning of the fiscal year. These reductions reflect management’s continued effort to improve balance sheet through asset sales, aggressive management of capital expenditures, issuing equity, and early repayment of long-term debt.

Working capital decreased $673.0 million since the first of the fiscal year, principally due to the sale of $518.0 million of beef group assets and the sale of 98.0 million of Holstein cattle inventories.

Year-to-date depreciation through the end of the third quarter was $207.0 million, compared to $194.0 million for the same period last year. We expect depreciation to be approximately $270.0 million for the full year and anticipate depreciation for fiscal 2010 to total about $265.0 million.

The company’s efforts to put constraints on capital spending since January of 2008 is having a significant impact. For the third quarter, capital expenditures were $40.0 million and $154.0 million for the first nine months of this fiscal year. This represents more than a 50% decrease in capital expenditures for the first nine months of this fiscal year compared to last year.

We anticipate that we will have capex of approximately $200.0 million for the full year, to include $8.0 million in restructuring expenditures. This compares to an annual depreciation of $270.0 million for this year and $460.0 million in capital expenditures in the last fiscal year of 2008.

We will continue to tightly manage total capital expenditures in fiscal 2010 to remain below next year’s depreciation. We will start the new fiscal year with significantly less carrying capex to include restructuring costs compared to this year.

The tax rate for fiscal 2009 third quarter is 19%. For the full year we expect the effective tax rate to range between 28% and 30%. We project the fiscal 2010 tax rate to range between 36% and 38%. The company has reduced total debt by $723.0 million since the beginning of the year. This has brought the debt to capitalization ratio down from 56% to 53% at the end of the current quarter. We reiterate our goal of a debt to capital ratio of less than 50%.

As indicated earlier, we are in compliance with all covenants and we project to be in compliance with all the newly negotiated revolver covenants through the maturity of the facilities.

The weighted average base of shares outstanding for the third quarter was 143.6 million shares compared to 134.3 million shares outstanding in the same period a year ago.

In summary, this third quarter, and the last nine months, were the most difficult in Smithfield’s history. This is clearly the bad news. The good news is we had positive cash flow from operation for the first nine months, we continued to hit record results in package meats, we slashed capex and are maintaining spending disciplines, we have sold non-core assets to pare down debt, and continue to look for additional non-core divestiture opportunities.

We paid back over $700.0 million in debt and are committed to balance sheet improvements. We remained a robust level of liquidity, ending the quarter with $960.0 million in available lines of credit, we have secured new covenant amendments for the four quarters coming up.

While hog losses will persist through the fourth quarter of fiscal 2009, losses are projected to decline as we move into the first half of fiscal 2010.

Finally, we have initiated a pork restructuring plan which will enhance annual EBT by $125.0 million. We expect dramatic improvement in performance as we move past the fourth quarter of this year and into fiscal 2010.

I thank you very much for your attention. I will turn this back to Larry at this time.

C. Larry Pope

As you can tell, Bo made a very thorough discussion of many of the financial information that many of you look for and there is an awful lot there that you have to digest and I think he’s done an awfully good job of trying to understand that and communicate that to you. We will attempt to always be transparent to you as the investors.

Looking at the future here, we want to reiterate that I think this is going to be a tough fourth quarter. We expect continued substantial losses in the hog production side. I continue to be very optimistic about what’s happening on the meat processing side. This is a trend that just continues to impress me quarter after quarter after quarter after quarter.

I think often times with these guys, we have conversations internally, what should we do now, what should we do next. And as I look forward I think about what would I want the future to be in terms of how we could change, and what would change from the current circumstances.

And as I look forward, many of the things that I would want to occur are already occurring. As an example, we would want lower input costs. As we look forward, the grain markets are going to be below the grain markets they were this past year. And in fact, grain today is significantly below where corn was last time, same point last year.

Oil, which is an ingredient that we use both in our packaging and our plant operations and our trucking operations, oil is less than half of where it was last year, this point in time. And so those input costs are going to be down, it looks like, going forward.

Beyond that, I would want the pricing of our product to be better. And I can tell you, in spite of the fact I am disappointed where the hog market is today relative to our costs, hogs are still significantly above last year’s levels at this point in time. So last year we were in the upper $30’s--$38—today we’re $44. So we are significantly above.

Last year at this point I was very concerned about what I thought the supply was going to be and I think Bo and I commented a number of times how we were concerned about what we thought the fall hog run might do to the markets, and we were right. In fact, we put hedges on related to the hog-production operations as some protection against that.

As I look forward today into the summer and into the fall and going forward, I have a completely different view. If you look, it appears that proteins of all types are going to be down, and down significant numbers. Beef, poultry, turkey, and pork are all going to be sizeable single-digit numbers down and that makes me feel a lot better as we look forward into the fall that we are probably not looking at the same type of hog market this coming fall that we saw last year.

Beyond that I see the export markets continuing to be open and the competition that we might have from other countries, including those in Europe and in Canada, are simply having sizeable cutbacks bigger than what we’re having in this country, so the opportunities for us to export into countries that routinely buy from international markets are going to be available to the United States more so than other countries, and our product is cheaper.

We still have a very significant competitive advantage from a pricing standpoint. All of that leads me to say that the future is going to be better than the past. And I feel comfortable with that statement.

The product we are killing at record levels, or have been until very recently when the kill levels have dropped off in the last 5, 6, 7, 8 days, and we think this is a trend that will continue even deeper as we go further into the spring, the product is not backing up in the freezers. We are continuing to move all this product.

The export markets look open, look fine. Our international department, although we can only see four to six weeks out into the future, all signs point to that the export markets will continue to be there, in spite of this credit crisis.

And that being the case, it looks like there’s going to be markets available, we’re going to have a declining cost structure, and improving pricing structure, and that makes me have an awful lot of confidence about where next year’s going to be in spite of the fact that this fourth quarter is still going to continue to be saddled with this high-priced corn going through the P&L.

That’s how I see it. I think we have a bright future. Our balance sheet is fine. We’ve got our loan agreements renegotiated. We’ve got plenty of money to pay the bills and we have got the ability to run this business the way we want to run this business. We are not being restricted in any way by our banking organizations. And so now we are making conscious decisions to be pretty responsible in that and we are managing capex.

And as Bo made the comment, we are going to spend $50.0 million on this pork restructuring plan, and still anticipate having capital expenditures next year significantly below depreciation. I think that is good stewardship of the balance sheet and we’re very conscious of that. So we will not lose sight of that going forward.

With that being said, we’ll open it up for questions.

Question-and-Answer Session

Operator

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

Ken Goldman - JP Morgan

I think, as you are aware, you have addressed it a lot, the covenants are on investors’ minds. I know you don’t give particular guidance, but you’re half way through the fourth quarter, you mentioned it would be “tough,” how tough would it be? Would you be disappointed if you lost $0.75 to $1.00?

C. Larry Pope

I would be disappointed if we lost anything. But I think we are going to have continuing hog losses and I think we’re going to have nice pork profits. We don’t give guidance but I think we will have a loss of some size. I haven’t done the math on that but that’s possible.

These cut-outs change every day and my goodness gracious, we were losing $15 a head at the beginning of this week and we’re probably going to end the week—it won’t be break-even, but we’ll probably cut those losses in half or two-thirds. And when you’re killing 120,000 hogs a day, that makes a big difference in the P&L every single day. That’s how fast this business changes.

Ken Goldman - JP Morgan

Let me ask it this way then. So far, given what you’ve seen in the quarter, do you think that hog-production margins will be similar to what they were in the third quarter?

C. Larry Pope

Yes, I do. That part I do think is true.

Operator

Your next question comes from Christina McGlone - Deutsche Bank Securities.

Christina McGlone - Deutsche Bank Securities

My question is around pork-processing margins. They have been very negative lately and then recently improved somewhat, but mainly it seems like the packers are pushing back and paying less for hogs. So I’m curious what the sustainability is here with pork-processing margins still negative, if we’ll see slaughter pull back even more, and what does that mean for hog futures, the outlook?

C. Larry Pope

I think two things are going to happen. One, I think that you’re going to see less hogs available to market. So there are going to have be cutbacks because there are simply not going to be the hogs there to process and if you’ve seen any of the information out there, it says that we’re going to be down 100,000 to 120,000 or 130,000 hogs a week. So we think we’re going to have 4%, 5%, or 6% less coming to market. So I think that the hog market is going to move up as a result of that.

Now, the question is are the meat cuts going to move up with that, are we going to have red cut-outs? I think it is as simple as that.

I think that we do see, and at least our sales organization in telling me, that they think they’ve seen the bottom of the meat pricing and that they think the meat pricing is going to move up nicely from here. I will wait and see that.

That’s why I just made the comment to Ken. I mean, this fresh meat business moves back and forth very rapidly, but many of the cuts like pork bellies and hams and extraordinarily cheap and that helps us on the export front in a big way. But those markets have got to move up and packers are going to be forced to move pricing up because I think the price of hogs is going to go up whether they like it or not.

Christina McGlone - Deutsche Bank Securities

You said nice pork profits in the fourth quarter, so even with the negative cut-out you’re still able to generate nice profits in the segment. How come?

C. Larry Pope

Our packaged meats business. I think I must make this speech every single time I speak to any analyst group. Everybody only focuses on the corn side and the hog side and the fresh meat side. My goodness, guys, we have a giant packaged meats business that we have been focusing on now for a couple of years, and as I made the comment in my opening comments, if you look at our pork segment numbers, we’re $369.0 million in nine months, we’re tracking at a $500.0 million pork segment operating profit, which is the result of the improvements that we’ve made in packaged meats and that’s where our restructuring is focused as well, which should generate another $125.0 million a year in that.

So my point would be, it’s going to be sales of ham and bacon and sausage. Those parts of the business are doing extraordinarily well. In fact, we have record profits for this quarter there.

Operator

Your next question comes from Christine McCracken - Cleveland Research.

Christine McCracken - Cleveland Research

You’re very optimistic on the outlook for hog markets, it seems over and above what we would expect seasonally. I’m a little surprised only because while Smithfield has done a good job taking down production, the rest of the industry hasn’t really followed.

I’m just curious, do you think at this point that the industry still needs to take out capacity or do you think that regardless of whether or not anyone asks, that we’ve seen enough of a hard reduction, to see a normal return to profitability in hog production?

C. Larry Pope

Absolutely, and I hate using the word absolute. I think it’s an overused word in the English language. But we absolutely need to have some further reduction in the supply. I think we’ve taken the lead here, because we’ve been the big producers have been criticized for not taking the lead. We did that. We announced 5% in February. We quietly increased it to 10% starting in June. And I was hopeful that some others in the industry, and you get some anecdotal information but the data doesn’t show it at all. In this country of origin labeling stopping the Canadian hogs from coming across the border, that’s the only other thing that’s helping.

So I guess to give you the short answer, we need more supply contraction. And even with these big losses, it doesn’t seem that the producers out there have heard this message, or at least adhering it, at all. I get no feedback from much of anybody that they are still making much of a cutback.

And so I know I’m bullish only because I’m coming off such a terrible base. I do not think that hog production is going to be a big piece of next year’s profitability. In fact I wouldn’t be at all surprised if we actually lost a little money raising hogs next year.

But I don’t think we’re going to lose at these kinds of levels, this $400.0 million and $500.0 million level. I think the loss is going to be radically below that. And I think that the meat business is going to be very good, so I think the combination of that makes it good for Smithfield.

But I’m not that optimistic about the hog side of the business. I am not.

Christine McCracken - Cleveland Research

In terms of productivity, we’re hearing reports that there has been significant kind of weight gain and besides the weather, obvious herd improvement practices. I’m wondering, is that offsetting, do you think, some of the cuts that you and others might have made through the year and is that a possible concern?

C. Larry Pope

It is. I mean, I do think that everybody has seen improved performance. We have essentially cured PCV from the herds by the vaccine, and at least in a number of places, PURS has quieted down, it’s not nearly as hot, so I think everybody is seeing better performance.

And I do think that is having an impact.

Christine McCracken - Cleveland Research

Any idea how much?

C. Larry Pope

I don’t have a number on that. You do the talking to people just like we do and it depends on who talk to and there is no data on that.

Operator

Your next question comes from Farha Aslam - Stephens Inc.

Farha Aslam - Stephens Inc.

Part of the reason for your confidence in terms of meeting the debt covenants, have you recalculated and excluded more items from that covenant calculation?

Robert W. Manly

We do have two items in there, in terms of the Groupe Smithfield gain and the beef gain, but other than those issues, we’ve been consistent in terms of the way that we’ve applied the covenants.

Farha Aslam - Stephens Inc.

And despite the fact that there is a potential loss in the hog production group going into next year, you still feel comfortable with your fiscal second quarter 20/10 covenant?

Robert W. Manly

Obviously, things can change, but at the present time we still have a very high level of confidence that we’ve got sufficient headroom to make all of the covenants that we’ve renegotiated in this last round.

Farha Aslam - Stephens Inc.

And that assumes current market conditions or does that anticipate any improvement in the pork margin? How are you thinking of that?

Robert W. Manly

We basically have our typical seasonal trends baked into our forecast, which is going to mean that we will be tighter in margins on the processing side this summer, with slightly improved margins on hog raising in the summer, as prices go higher, and then we start to pick up profits in the meat-processing side in the fall.

So we’ve got our normal seasonality into these forecasts.

C. Larry Pope

I think we’re using the futures markets that are out there, but that’s indication we’ve got it where the market is going to be.

Robert W. Manly

That may get tweaked $0.50 100-weight, at most, plus or minus on the futures market, is typically how we approach it.

Operator

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

Brett Hunley for Heather Jones - BB&T Capital Markets

Quick question on the debt pay-down. Can you share with us if that was indeed the October 2009 notes? Or can you share with us what debt positions were taken out during the quarter?

Robert W. Manly

They were all in 2009. We kept everything that would be within a 12-month maturity.

C. Larry Pope

We had plenty of liquidity and we knew we were going to have to pay back those bonds anyway and they were selling at a deep discount so we just anticipated those notes that were coming due anyway in October and put the money in the bank.

Brett Hunley for Heather Jones - BB&T Capital Markets

Just looking at the mark-to-market adjustments during this quarter, do you recall if last year those adjustments were included or excluded from the numbers?

Robert W. Manly

They’re included. They’re always included.

Operator

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

Kenneth Zaslow - BMO Capital Markets

In terms of the hog raising at $62 per head, once the lower corn goes through, what do you expect the hog raising cost to be, order of magnitude, next year? Is it going to be down $5, $10? How do you think about it?

C. Larry Pope

I think we’re going to be sequentially ratcheting down in sort of the upper $50’s to the mid-to-lower $50’s, to the low $50’s. So I think we’re going to be closing in $0.07, $0.08, or $0.09 below that.

Robert W. Manly

We’re looking over fiscal 2010 to lower that in the neighborhood of $0.09 to $0.10 per 100-weight.

Kenneth Zaslow - BMO Capital Markets

In your commentary you did say the pork margins could potentially continue to expand into 2010 because of restructuring. Your margin, excluding the restructuring charges, were 7.6%. So you’re reaching your stride here and this kind of more of a sustainable level on an ongoing basis? Is that how to think about it? Because it would be pretty amazing.

C. Larry Pope

I agree with that math. But I think you are looking at the third quarter, which is historically the very best quarter in terms of the packaged meats business. On a year-to-date basis, if you make the adjustment, or at 4.6 and I think if you go back and look you will see that that number has moving up and up and up.

I don’t believe next year that we will be at 7.6% for next fiscal year.

Kenneth Zaslow - BMO Capital Markets

But for the year-over-year you’re thinking your margins can still, taking the quarters together and do it on an annual basis, do you think margins can continue to expand?

C. Larry Pope

Yes, I do.

Operator

Your next question comes from Reza Vahabzadeh - Barclays Capital.

Reza Vahabzadeh - Barclays Capital

Can I get some details on the total debt and any cash you might have on balance sheet as of the end of the quarter?

Robert W. Manly

Yes, let me pull something out here.

Reza Vahabzadeh - Barclays Capital

And while you’re doing that, Larry, based on the comment you made just now regarding raising costs, does that mean that you kind of need $48 to $50 on a live-hog basis to break even going forward, as in fiscal 2010?

C. Larry Pope

We’re going to need more than $50 raising costs next year to break even. We always think of things relative to the ISM market. We get about $1.50 to $1.75 per 100-weight above that. We’re going to need a little more than on average.

Reza Vahabzadeh - Barclays Capital

So like low $50’s basically?

C. Larry Pope

Yes, very low $50’s.

Robert W. Manly

To respond to your first number, we had $91.0 million of cash on hand at the end of the quarter and our total debt, to include notes payable, etc., was $3.158 billion.

Reza Vahabzadeh - Barclays Capital

And the revolver, the total liquidity that you refer to in the press release, that includes the cash or excludes it?

Robert W. Manly

No, that is merely available credit lines. No cash.

Reza Vahabzadeh - Barclays Capital

The LT and EBITDA in your bank credit agreement is what number? Do you have it handy?

Robert W. Manly

It’s a very complex calculation. We could probably get into it later but it would take more time than we have to explain it on this call.

Operator

Your next question comes from William Chappell - SunTrust Robinson Humphrey.

William Chappell - SunTrust Robinson Humphrey

The last nine months have been certainly challenging but you have had some extraordinary moves in terms of divestitures, restructuring, what have you. As you look forward, is there anything left to do, or that you could do if the next nine months are equally challenging? Or have you kind of thrown everything in the kitchen sink at the problems to date?

C. Larry Pope

We have not thrown everything and I will tell you, and I think Mr. Manly will confirm that, that I have a conversation with this organization, we have a half a dozen other things that we are looking at. I am not going to disclose those in this call because we may not do any of them. But we are not closing off because am optimistic that next year is going to be substantially better than this year, but who in the world knows?

I mean, the credit markets are closed. This recession is deepening, not tending to bottom out. And demand for our product is still very strong, domestically. Most people think that it’s not. Our demand is strong. Even our food service business, which surprises most people, was actually up for the quarter. And that’s because we have got such a diverse customer base that it went from one tablecloth to the Subways and the McDonalds, the quick service people. But we’ve got lots of options.

Robert W. Manly

I’ve got to say, I couldn’t have taken on the role of CFO in a much more interesting time than I have, but I have certainly learned some in a very short tenure, and that is you better have a contingency plan to your contingency plan to your contingency plan. So yes, we do have more options, but as Larry said, they’re options.

Operator

Your next question comes from Carla Casella - JP Morgan.

Carla Casella - JP Morgan

The $84.0 million of restructuring, is that all included in cost of goods sold, or how much of that would be in SG&A?

Robert W. Manly

It’s all in cost of goods sold.

Carla Casella - JP Morgan

And the cow inventory write-down is in the other income?

Robert W. Manly

No. We actually have two areas where we get impact from cow. One is through the joint venture and through income of affiliates, and then the second runs through cost of goods sold.

C. Larry Pope

If you look at the press releases I think that you will see back where Mr. Manly has done the reconciliation of the income in equity of affiliates, you will see, it’s called cattle-co, of $10.9 million. So that’s coming through that line. And the rest is coming through cost of goods sold.

Carla Casella - JP Morgan

The rest of the $18.8 million charge.

Robert W. Manly

That’s correct.

Carla Casella - JP Morgan

On the business side, at this point, when we look at how much was sold into food service versus retail, how would that vary? I’m assuming it’s all pork processing. I’m wondering how much of the packaged or fresh is food service versus retail? Can you break it out by the two different groups?

C. Larry Pope

We’re about a 75% retail, 25% food service company. So that’s the macro. I don’t have the numbers in front of me telling what is the breakdown between fresh meat and packaged meats between food service and retail.

Robert W. Manly

We can get that number for you.

C. Larry Pope

Make a note to call Mr. Manly back offline here and we will provide that to you.

Operator

Your next question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Larry, it sounds like you’re saying that hog raising may not be profitable in fiscal 2010 at all which would be consistent with where we see the cash curves, but what ultimately is going to get this business back in the black? It sounds like it would have to be a combination of production cuts and some help on the input side. And if you’re the only ones really cutting in a meaningful way right now, what gives you the confidence that there will be further industry productions cuts, especially if we are going to be hopefully getting back to near break-even or cash flow break-even models?

C. Larry Pope

Well, I would tell you that I do have some concerns that—that corn’s not going back to $2.50. I mean, I think the reality is we’ve got to live with higher priced corn. And this has got to be reflected in live hog prices.

The good side is no one is in this business like cattle raising, as some sort of a life style. Everybody is in the hog production business to make money. And if they’re not making money they’re not going to be in this business in the long haul because the banks are not going to allow it.

This business has been profitable forever. In fact, it’s been a very good business to be in. And this industry does have a tendency to adjust. And I think that it will adjust. I am not sure it’s going to adjust this coming fiscal year. It might but it’s not yet. And so I am a bit concerned that we are going to lose money next year and I hope that there will be some more reductions as people continue to lose money, potentially next year, and this industry will right size itself.

But the other side is demand might come back. We’re all looking at lower demand and that returns it will be back. But it is an issue. I think you raise a very solid question is that is the profitability of hog production going to be as good going forward as it has been in the past.

Vincent Andrews - Morgan Stanley

This $0.14 tax hit, I just want to understand. Your release says that it lowered your tax rate.

Robert W. Manly

Yes.

Vincent Andrews - Morgan Stanley

And I get it that it’s incremental taxes that you had to pay, but how does it lower your tax rate?

Robert W. Manly

You have to understand that we’re in a loss period. So the tax rate, a higher tax rate benefits you because in theory you’re getting money back from the government on a negative tax to offset your loss. So if you actually have to pay taxes, it will then mathematically lower that rate. It’s a mathematical calculation associated with the fact that we’re losing money. So it’s a function of where we sit in an unfortunate situation where we’re losing money.

Operator

Your last question comes from Ann Gurkin - Davenport & Company.

Ann Gurkin - Davenport & Company

There was some discussion in February about your commitment to being vertically integrated and you were reviewing various facilities. Could you update on that?

C. Larry Pope

I’m missing the question. Bo, did you get the question?

Robert W. Manly

I’m wondering if it has to do with some conversations that we’ve had at Cagney over the past 30 days. In terms of vertical integration relative to the extent of vertical integration?

Ann Gurkin - Davenport & Company

Correct. You’re commitment to being fully vertically integrated or perhaps keeping all your facilities that maybe you’re selling product outside of your internal systems?

C. Larry Pope

As we just made the comment a few minutes ago, that is some of the options that we are looking at. One of the things I’m taking a very serious look at is whether we should be raising hogs just to raise hogs to sell to somebody else. And so we do have operations, as you know, in Utah and in Texas and in Oklahoma and in Colorado that sell hogs to outsiders and we’re looking at whether that’s a business we want to be in.

So I think that’s the question you’re asking and I think, as we just indicated, we are looking at options and that’s one of the things that we’re talking about.

Ann Gurkin - Davenport & Company

I believe you recently had a Board meeting and your Chinese investors were over here. Any update you can give us on your relationships with Cosco and the Chinese investment?

C. Larry Pope

Well, they have got an investment, they’r e not increasing their investment. Their chairman is on our Board. They brought three of their management people with them where we had some further conversations. We continue to have a very cordial relationship. We continue to do business with them. We’re talking to them, I would tell you frequently.

Now let me clear the air. We do not have any deal for any additional carcasses into China and I do not expect any. Although we are doing business with them on meat, final cuts that we have not routinely done business in China. We are doing final cut meat business with those folks and so the business has grown with them. We are building that relationship and it is growing and it is cordial.

Operator

There are no further questions in the queue.

Jerry Hostetter

We appreciate your time and interest today. Thanks for joining us.

Operator

This concludes today’s conference call.

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