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Smithfield Foods (NYSE:SFD)

F1Q 2012 Results

September 8, 2011 9:00 a.m. ET

Executives

Keira Lombardo - VP, Investor Relations and Corporate Communications

C. Larry Pope - President and CEO

Robert Manly - EVP and CFO

Analysts

Ken Zaslow - BMO Capital Markets

Christine McCracken - Cleveland Research

Ryan Oksenhendler - Bank of America

Christina McGlone - Deutsche Bank

Heather Jones - BB&T Capital Markets

Tim Ramey - D.A. Davidson

Lindsay Drucker Mann - Goldman Sachs

Akshay Jagdale - KeyBanc Capital Markets

Farha Aslam - Stephens

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Smithfield Foods fiscal 2012 first quarter earnings conference call. [Operator instructions.] I’d now like to turn the conference over to Keira Lombardo. Please go ahead.

Keira Lombardo

Good morning. Welcome to the conference call to discuss Smithfield Foods’ fiscal 2012 first quarter results. We would like to caution you that in today’s call there may be forward-looking statements within the meaning of federal securities laws.

In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the company's Form 10-K for fiscal year 2011. You can access the 10-K and our press release on our website at smithfieldfoods.com.

On our call today are Larry Pope, president and chief executive officer and Bo Manly, chief financial officer. This is Keira Lombardo, vice president of investor relations. Larry will begin our call this morning with a review of operations, followed by Bo, who will review the company’s financial results. Then, Larry will provide our outlook for the future, after which the line will be open for questions. Larry?

Larry Pope

Thank you very much Keira, and welcome everyone on the call. Bo and I are sitting in Boston, Massachusetts, for a back to school conference, as you probably have seen we made disclosure of. It’s pouring down raining outside, but I can tell you from where I sit, the sun is shining very brightly at Smithfield Foods.

I am extremely pleased with the results that we just published this morning. I hope you had an opportunity to pore through the earnings release. There are some very important highlights that we pointed out front. A lot of the word “record” in those earnings, and I’m extremely pleased with the job this management team has done this first quarter as we start our new fiscal 2012.

I hope you saw the earnings at $82 million, or $0.49 a share compared with $76 million or $0.46 a share last year. I’m sure you took note of the adjustments, particularly a litigation charge that we took during the quarter, all totaling $0.20. On an adjusted basis the earnings are $0.69 compared with $0.46, represents a 50% improvement over some strong results for last year’s first quarter. And I also remind you that last year was a record year for the company.

This is the fifth straight record quarter for the company. We are starting off this new fiscal year sort of coming out of the box very strong in almost every segment of the business, exclusive of our international business, which certainly struggles a bit as a result of the recession going on in Europe.

If you look deeper into the numbers, the pork segment numbers are just outstanding. They’re nothing short of that, both the fresh pork and the processed meats. Our pork group is reporting $136 million versus $113 million.

That’s a 20% improvement over extraordinarily good results last year and again, it’s not just one segment. We did have a bit of a favorable benefit in last year’s fresh pork numbers for about $8 million the way hedges were accounted for, so our fresh pork numbers, even year over year, are very comparable to last year’s fresh pork numbers, in spite of the fact the live hog prices were up some $11 a hundred weight.

I think many of you know that the summertime is not the good time of the year for the fresh pork business, and so given the seasonal effect, combined with rising live hog prices, I’m extremely pleased with the results on our fresh pork business.

I’m sure you all know that it has a lot of impact from the export markets. We are benefiting very nicely from those markets, particularly the Asian markets are very strong, very robust, and look to be very robust going forward. So I am optimistic on the fresh pork side of this business. And in fact, we’re moving into a seasonally good period of the year.

So that part of the business, combined with the operating efficiencies that the management team is doing in a number of the plants, that part of the business is just excellent. And clearly the part that you know I focus on every quarter is the packaged meats business, and this is a more than a shining bright star.

This is sort of the big sunlight here that we’ve been working on now for five years - that I continue to talk about every quarter for five years - is the progress this company has made on the packaged meats side of the business. To be reporting $101 million compared with $67 million last year, or a 50% improvement, which equates to $0.17 a pound compared with $0.11 a pound last year is nothing short of stellar for this management team.

It’s not all about sales price and such. It has to do with the way we’re running our marketing programs and the way we’re running our plants. That is benefiting our bottom line in this end of the business.

George Richter and the Pork Group Team have done an outstanding job quarter after quarter and year after year in realigning the way in which our processed meats and packaged meats business functions, both on the logistics from the manufacturing side, the sales side, and, as we begin to focus more and more and more on our branding strategies, it is showing up in the bottom line.

I don’t think these are one-off quarters. We’ve now got about 15 of those behind us, so I don’t think our packaged meats success is the result of some luck. In fact, I think others have been reporting how their packaged meats business is struggling. We are pleased with our packaged meats business. In spite of the fact that raw material costs have moved up, our margins have continued to move up.

In terms of the breakdown of the sales volume, we are very pleased with the overall sales volumes being down 1%. However, our retail branded volume, which is on our 12 key brands where we are focusing our efforts, that business is up 3%.

Our food service business is a little soft. I think others have reported. There’s nothing special in that, except that the whole food service industry is suffering a bit and we are a recipient of that since it’s a sizable piece of our business. In fact, I think the National Restaurant Association just published something recently indicating that the sentiment of the restaurant operators is the lowest it’s been in nearly a year. And so there is some softness on that side of the business and we’ve seen that of late.

I would tell you that our brands are in the right place. We’re value priced brands. Consumers are trying to stretch their dollars, and our brands are right where those consumers are looking to expand their purchase for the dollars they spend. We are right on the strategy I’ve been talking about for four years.

I would tell you embedded within that, we still have increased marketing dollars going toward our brands and we’re still expanding the bottom line as well as the margins. It is a terrific story. I hope you have an opportunity to focus on it in terms of what the sales dollars and the volumes are. That’s part of a trend that’s been here with us for a while. It’s the focus of this management team.

It’s the reason we rationalized plant several years ago to put ourselves in a position to utilize our capacity. We are continuing to evaluate some very low margin business and we are rationalizing out that low margin business and putting our dollars behind the brands that we know will carry us forward.

And not to our, I guess, surprise, but we’re certainly pleasantly pleased with it, but the fact that our brands are holding, and our brands are pulling. So in this environment, as we continue to market behind that, we’re finding there’s a lot more behind these brands than we had previously thought, and our brands continue to expand, even in an environment where many of the categories that we compete in are not growing. Our branded business is growing.

Turning your attention to the hog production side of the business, you do see a modest comparison with last year. That does include, I’m sure you saw in the press release, that the results were negatively impacted by a $39 million charge related to the Missouri litigation suits.

By way of background, when we bought Premium Standard Farms back in 2007, PSF was defending 275 separate but related nuisance suits in the state of Missouri. Almost all of these suits have been brought by the same attorneys on behalf of clients living close to those PSF farms.

Over the last few weeks, a number of things have happened that have impacted our view of these suits, and at the same time we have created an environment in which we may be able to get this behind us. We won a defense verdict in one case and lost an appeal in another. In late August, a new favorable nuisance law took effect right at the end of August, one that is more balanced and supportive of agribusiness.

Partly as a result of this change in the law, we have also made substantial progress in settlement negotiations with the other party, so much so that we now believe a global settlement with these plaintiffs is probable. And for that reason we have increased our reserve to cover this. If a global settlement is reached, we will be seeking recoveries under various PSF insurance policies and believe we could eventually recover a subsequently portion of any settlement payment.

Now, since this is pending and outstanding litigation, that’s about as much as I’m going to say about this. I’m optimistic that we will get this behind us soon and I’m optimistic we have our accrual where it needs to be. But given the nature of this litigation, we’re not in much of a position to give a lot more color on that except to tell you that it relates to several years in the past and recent changes have forced us to reevaluate what our accrual should be.

So making an adjustment for that $39 million as well as a very small impairment charge we also had, our hog production business results were up very solidly and I will remind you that we have a cost improvement initiative underway at Murphy-Brown that we have projected to be a three-year plan to reduce our costs by some $90 million.

We are just about halfway through that process at this point, and I would tell you that we are a little over halfway through the benefits and have taken the vast majority, if not all, of the charges to the P&L related to that. So we should be only on the benefit side of that, and I am fully confident that Jerry Godwin and his group will deliver that $90 million probably ahead of the three-year schedule and certainly I don’t expect any surprises on the negative side in terms of charges.

The big issue I know you’re all concerned about is where we’re going with the grains. We all can see where the futures markets and the cash market is on the corn market. We’re all aware that $7-plus corn is around us. $8 corn could be just around the corner from us. We have made the comment on many previous occasions that we have got substantial hedges in place to protect us against a run up in the corn market.

If you look at the results for the quarter, you’re probably pleasantly surprised by how favorable they are to probably what your model shows. Those are the result of those hedges that we put in place a substantial time in the past. As well, we have hedges going forward.

So should $8 corn arrive, and more than $8 corn, I hope to tell you that we will be one of the last to pay it. If it stays at $8 we will have to pay $8 corn, but it will be substantially into the future. I think we’re in good shape, very good shape, for the rest of this fiscal year in terms of our corn positions.

So I’m not too terribly concerned about what happens to the corn market in the relative near term. That should limit any expansion going on. We don’t see an expansion, and in fact if you look at sow liquidations in the industry, those have popped up solidly. If there’s anything going on, I think there’s further contraction going on, as well as the cost of corn outside of the United States.

I don’t see any expansion on the horizon at all, which bodes very good for this business, given that I think you’ll see reductions on the beef side. The chicken industry seems to have made some adjustments and from that standpoint I think that the fundamental dynamics on that side of the business are pretty darn solid, except for the fact that we probably will see some pretty high priced grain and that’s going to certainly increase everybody’s raising costs. However, I’ll talk in my outlook, in the futures markets it’s compensating for some of that.

So before I give my outlook, Bo, why don’t I turn it over to you and give them a little more color?

Robert Manly

Great, Larry. Good morning ladies and gentlemen. I’m pleased to report the fifth consecutive quarter of year over year record profits.

Net income was $82 million, compared to $76 million in the same quarter a year ago. All domestic business segments contributed strong operating profits, more than offsetting declines in our international business. The Pork Group continues its streak of record performance, particularly in our core brands, while the hog production operating group had profits with solid increases.

EPS for the quarter is $0.49. There are noteworthy items impacting this period’s earnings and EPS, which include pre-tax, $39 million in charges for litigation, a $6 million Campofrío transaction expense, a $4 million hog production asset impairment, and a $4 million after-tax for a change in projected tax rate.

Excluding these charges, adjusted earnings are $0.69 per diluted share on a non-GAAP basis. We continue to strengthen our balance sheet and management for improved shareholder value. During the first quarter, we retired the remaining $78 million balance of our 2011 bonds. During Q1 we also repurchased $34 million in Smithfield stock.

We replaced an expensive short term ABL loan with two significantly more efficient and cheaper short-term facilities that increase our borrowing capacity $200 million to a total of $1.2 billion. In addition, we reduced long term unfunded liabilities by making an extraordinary $100 million contribution to our qualified pension plan.

Now for a few details. Consolidated sales for the quarter were $3.1 billion, up 7% from the same quarter a year ago. All segment sales were up year over year, benefiting from higher meat and livestock values per pound. An 8% increase in packaged meat pricing overcame a 1% decline in packaged meat volume. While the lower volume is disappointing, this decline represents our rotation to a more profitable sales mix, as evidenced by a 3% growth in volume in our core brands.

We are proud our core brand volume growth helped drive margins to record first quarter levels at $0.17 per pound. We were able to price through a 5% increase in cost of goods sold, with a 7% increase in packaged meat sales values.

International sales were well up compared with last year. While average unit sales values increased, the sales improvement is, in large part, due to currency translations. Volume was down slightly, reflecting soft demand in western and central Europe.

Gross margin for the company rose to a record first quarter 13.2%, up 12.7% from a year ago. These results were led by a record first quarter performance by the Pork Group and significant improvement in hog production results.

Fresh pork operating profit reverted back toward the norm from record profit levels a few quarters ago. Operating profit declined to $6 per head, but still at the high end of the normalized range. Packaged meat operating profits reached record levels in the first quarter, reflecting a more profitable sales mix and a 3% growth in our core brands. Packaged meats operating profit margins were $0.17 per pound, up from $0.11 a year ago despite higher raw material costs.

Given the economic headwinds facing the U.S. consumers today, management believes it’s prudent to modify our projection to 3% expected packaged meats growth rate. All production operating profits include a $39 million pre-tax charge related to our Missouri farm nuisance litigation.

On a GAAP basis, all production operating profit was $70 million, up 9% year over year. If the results are adjusted for the litigation charge, operating profit would approximate $110 million and equate to about $30 per head, up almost 70% over a year.

Our raising costs were $63 per hundred weight for the quarter, compared to $54 a year ago. Our raising costs are projected to increase in the coming quarters as higher grain costs creep into a small but unhedged portion of our feed requirements. We believe our grain procurement and risk management positions will allow us to maintain a raising cost in the mid to high $60s for the balance of the year. This is slightly higher than the mid-$60 raising costs we projected previously.

The recent decline of the past weeks in the cash hog and futures markets indicates that Q2 hog production profits will likely decline, but hold at the bottom end of the normalized $10-15 per head range. Hog production could show losses in Q3 and Q4, but in total we believe results for the full year will show modest profits, but below the normalized range.

International segment operating profits declined year over year. Meat processing margins were squeezed by increased raw material costs and soft demand in western and central Europe. Hog production margins also suffered as high grain prices rolled through our feeding operations across the globe.

These factors cause international segment operating profit to fall to breakeven levels compared to $25 million operating profit in Q1 of last year. This condition could persist in the coming quarters if poor U.S. grain harvests keep world grain prices high and European economies continue to flounder, squeezing demand.

Changes in the other segment operating profit were due to our exit of the turkey business in the second quarter of last year. The increase in the corporate segment operating profit charge to $33 million is principally accounted by a $6 million charge associated with the terminated Campofrío transaction.

All principal remaining elements of our equity method investments continue to demonstrate positive results, but slipped from $11 million last year to Q1 to $5 million in the recent quarter. Higher raw material costs and soft demand eroded Campofrío performance. The sale of the Butterball eliminated their contribution on a year over year basis as well.

The current quarter effective tax rate was 34%. This is slightly higher than our earlier annual projection of 32-33%. The rate increase is principally due to a change in earnings mix with a higher percentage of our earnings from domestic sources with higher tax rates compared to our international income with lower rates.

Given the mix of earnings, we are raising our outlook for full year effective tax rate to be between 32-34%. Depreciation for the quarter was $60 million. We continue to project full year depreciation of $251 million.

First quarter interest expense was $48 million, down $21 million, or 30%, compared to a year ago. Interest expense will trend slightly lower in the coming quarters, reflecting the maturity of the final portion of our 2011 bonds, as well as rate reductions related to our new short term credit facilities.

This is the final element of our internal goal to reduce the rate of annual interest expense by $100 million. This milestone has been accomplished.

The balance sheet story principally reflects four related items: Decrease in cash, decrease in long term debt, reduction in accrued pension liabilities, and the purchase of Smithfield shares.

Cash declined $225 million since the beginning of the first quarter. This cash was used for, among other things, retirement of long term debt an extraordinary pension contribution, and the purchase of Smithfield stock. The accrued liabilities also include the $39 million charge to the litigation reserve.

Strong profits, cash flow, and disciplined capital management over the past several quarters has created the strongest balance sheet and credit metrics in Smithfield memory. The increased liquidity provided by our new credit facilities, as well as cash on hand of $150 million at quarter end, provided a total liquidity of $1.2 billion with no short term borrowings.

Net debt to total capitalization decreased to 35%. Debt to EBITDA improved to 1.7x. EBITDA to interest coverage was 5.5x. These credit metric improvements and improved industry fundamentals prompted Moody’s, Standard & Poors, and Fitch to improve the ratings for both company debt and individual bonds during fiscal 2011.

We are pleased that Moody’s again upgraded our rating in August to effectively what is a BB rating. With the prospect of continued strong earnings and cash flow this year, as well as expanded liquidity from the new revolver, created the shareholder value with our cash reserve as the highest priority.

With a cash need of an immediate M&A prospect no longer on the future, we deployed excess cash in several strategic initiatives to create shareholder value during the first quarter and carried over into the second quarter.

With the new board authorization during Q1, Smithfield purchased 1.5 million shares at a cost of $34 million. Subsequent to quarter end, we purchased another 1.6 million shares for $31 million. Shares purchased since the beginning of the fiscal year totaled 33.1 million shares. This leaves approximately $85 million in unused repurchase authorization.

We will likely continue to buy additional shares when, in management’s opinion, share prices are undervalued. We earmarked $78 million for final retirement of our August 2011 bonds. In addition, since the end of Q1, we repurchased $13 million of our bonds, continuing to deleverage the balance sheet and reducing future interest expense. Our current domestic debt reduction since the beginning of the year totals $91 million, while we added $24 million in [unintelligible] debt credit facilities.

We made an extraordinary pension contribution during the first quarter of $100 million. While before the contribution we had a very comfortable statutory funding percentage of 87% of future liabilities, this extraordinary contribution created shareholder value in several ways.

Ultimately we owe the money, it’s just a matter of when we pay it. But importantly, this maneuver helped reduce fiscal 2012 pension expense $25 million below last year. It also reduces our long term liabilities very efficiently, with pre-tax dollars improving credit metrics with the rating agencies.

During our last conference call, we projected full year 2012 capital expenditures to total $245 million. Over the past three years, conservative capital management costs, capital expenditures did cumulatively fall, almost $200 million below depreciation. We have indicated on many occasions that this was not sustainable.

Several quarters of strong cash generation and a solid forward outlook give management to conference to now accelerate capex to $300 million this fiscal year to build new packaged meats capacity for growth and to play catch up on postponed maintenance capex.

In conclusion, we continue to be excited about the record results of our first quarter and the trajectory into Q2 and beyond. The Pork Group continues to focus on its record pace. Packaged Meat remains focused on investment in our core brands. Fresh Pork should achieve strong performance, buoyed by robust exports. Hog Production Group should be profitable for the full year with strong results in the first half and lower in the second. International operations continue to face high feed and gradient and raw material costs and a recessionary environment in Europe.

We are spending money to expand our packaged meats capacity. Our balance sheet, liquidity, and debt capacity have transformed our financial condition from a liability to a competitive weapon. We have never been better positioned to grow shareholder value across the entire integrated platform and capture value around the globe.

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

Larry Pope

Thank you Bo. I think Bo put an awful lot of color around some of my comments, and as I even sit there and listen to his comments, and sometimes I just marvel at some of the numbers and how good they are. And I’ve been, for many of you who have known me, I’ve been well over 30 years with this company, and I’ve never seen the company in as strong a position from a balance sheet standpoint. As you know, I have a financial background, so I can relate to the financials as much as anyone. But when you take the combination of a very strong balance sheet, combine that with I think our organization has done over the last several years in positioning itself in the marketplace, we are in a very, very strong position, and I am extremely optimistic.

I never thought I’d be pleased to say that we’re looking at $60 hogs, $60-65 hogs, and I was going to be pleased. Every time we’ve ever been there before, that was sort of a disaster on the meat processing side of the business. And as anyone in the business knows, $60 hogs usually mean losses in the fresh meat business and little to no profit in the packaged meats business. And here we are reporting extraordinarily good packaged meats margins and very good fresh meats numbers. And of course our hog production business obviously benefits from that.

Looking forward, we’re going into the good time of the year for the fresh pork business. That should seasonally get better. It generally does in the fall. As well, the export business looks to be getting better. As the data’s coming out from government reports, exports are increasing. We’ve got very solid exports going forward.

You’re aware of the tariff relief in Korea, which again should help the export side of the business. I think many of you know we’ve got some very strong Asian business outside of Korea which looks to be very good as we go forward.

So the fresh meat’s going to be great. We’re coming into our packaged meats time of the year when the holiday ham season hits us. That’s always a good time of the year for the company. Comparatively, as you look at last year’s second and third quarter, we’ve got some pretty big mountains to climb, but we’ve got the management team in place who is fully prepared to deal with that. In fact, I don’t think I’ve seen the team this motivated and pumped up in a very long time.

So I think the Pork Group is well on its way to having a - I’m not predicting its fifth straight year of Pork Group record profits, but they’ve got a darn good start, and things look very good for the next quarter or two quarters. So we will have to see, but I think you should expect me on the next call, and on the following call, to be reporting some good numbers on the pork segment side of the business.

Internationally, as Bo said, we’ll struggle. And on the hog production side, we will deal with it as it comes. We’ve got very strong hedges in place. I think it’s going to have a bigger impact on the rest of the industry. Whatever happens with corn is going to impact the industry more than it is us. So we are well protected and as Bo says, we’re probably going to be a bit profitable this quarter.

We could lose money, but for the year I think our hog production business will be profitable. And I can’t believe I said that following a couple years ago when corn hit $6.50 and the industry went tumbling out of control. Here we are talking about corn well over $7 a bushel, and we’re not concerned that we’re going to lose money for the year. That’s the change in the dynamics. That’s the result of supply and demand getting back in balance.

If you can’t tell from my attitude, I’m in a great mood. It’s a great time to be running this company, and I’m extremely pleased with the management team we’ve got in place. We’ve got guys and ladies who know what they’re doing. We understand what to do. We’ve got a strategy in place to further improve our brands. You will hear me again and again focus on that. That is where we’re going, in the packaged meats business, to deliver to you more consistent earnings.

Tim Schellpeper and Mike Brown, who run the two big slaughter operations are doing a darn good job on both sides of that on the fresh meat side of the business. It’s showing up consistently on the fresh meat side of the business. It’s fun to be the boss and get the credit. I don’t deserve all the credit. These guys who run this business deserve the credit. But it is a nice time to be in the business.

Keira, at this point, we’d love to take questions.

Question-and-Answer Session

Keira Lombardo

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

Operator

Thank you. [Operator instructions.] First we’ll go to the line of Ken Zaslow from BMO Capital Markets. Please go ahead.

Ken Zaslow - BMO Capital Markets

My first question is can you talk about your ability as well as how much Smithfield has been able to sell forward hogs? And just talk about that a little bit. I know you were talking about the hedging side of the corn, but I’m just curious what you’re doing on the hog side.

Larry Pope

Let me repeat what I think I did last quarter. We have been more concerned about the grain market than we have the hog markets. And we thought there was more opportunity for risk on the grain side than the hogs. And so what our position has been, the strategy has been, to put bigger hedges in place to protect us on the corn side. And we’ve been sort of neutral on the hog side. We do have some hedges in place on the hogs. And I’m going to tell you they’re favorable hedges. We’ve got [unintelligible], but it’s not a lot. And we don’t have a strong position going forward in live hogs. We have a strong position on the grain side. I hope that helps you a little bit.

Ken Zaslow - BMO Capital Markets

And on the packaged meats side, the seasonality obviously comes into play. But generally do you think that you’ve reached the level in which you have now sustainable margins? Is there a level where you can move up? Is there a level moving down? And how do you think about it, and again absent the seasonality of it, on the packaged meat side, how do you think about the margin structure going forward?

Robert Manly

Let me respond to your second question. We continue to maintain that our packaged meats results will be in a normalized range between $0.10 to $0.15 per pound. We were benefitted this quarter, we exceeded that at $0.17, but I think as we look out in the future we’re comfortable with that $0.10 to $0.15 range.

Larry Pope

However, I do think that we are looking at, I’m surprised to say, the higher end of that. We’re staying north of $0.10 by a ways. $0.17 is a strong, strong, quarter here. So I don’t want to set anybody’s mind that we’re moving the normalized range north of $0.15 towards $0.20. We’re not communicating that to you. But we’re seeing some good margins here.

Operator

Next we’ll go to the line of Christine McCracken from Cleveland Research. Please go ahead.

Christine McCracken - Cleveland Research

Larry, I was a little surprised that fresh meat sales and profitability weren’t a little stronger. And you talked about some of the factors impacting the quarter. Not to say it wasn’t a good quarter, just some of the trends late in the quarter I think were a little better. I’m wondering is it just a function of timing? You talked about the seasonality of it and the expected strength of exports as we move to the back half of the calendar year. But is it the domestic market? Did you have an impact from the extreme heat and maybe a weaker growing season? Or is there some kind of storm impact in there? Maybe you can just talk a little bit about where we were in the quarter relative to some of the calculated margins in fresh meat.

Larry Pope

Wow, that was a lot of questions there.

Christine McCracken - Cleveland Research

I had to fit it all in one. [Laughter]

Larry Pope

You did a very good job with the use of the comma. I guess I would say that the fresh pork business has gotten much better, even since the end of the quarter, so I don’t know whether you’re getting the timing wrong. I was satisfied with where we were.

And you know we track our sales relative to how the rest of the competition is doing on the fresh pork side. So I will tell you I’m always amazed by some of the competition and some of the numbers, the way they calculate their fresh pork results. But our numbers are looking, on a comparative basis, in terms of trending, we’re fine.

I don’t know about any [grilling] season. In terms of exports, our exports have gotten better, and they will continue to be better. We were up 13% for the quarter, that’s trending up. So you’re going to see more than that unless something - we’ve really got a lot of that booked at this point. So you’re going to see a good second quarter as well on the exports, and I think our fresh pork is going to be even better. So I was very pleased with our fresh pork. Bo, you have any comment?

Robert Manly

I think the fact that we are seeing greater [disappearance] from the U.S. of our pork as well as our competitors’ pork. I think the balance looks very good for fresh pork as we look at the coming quarters.

Larry Pope

I’ll tell you one thing, Christine, that impacts us. On the East Coast, we’re going through this cost improvement initiative with Murphy-Brown. Part of that’s realigning these farms. So we’re having farms that are down, and the Smithfield Packing Company, Tim Schellpeper’s group, is being shorted hogs. They have been short hogs most of this summer. And they’ve had the overhead absorption associated with that, which we sort of back that out, thinking about that. Once this cost initiative is finished, the flows will come back up. So Tim will benefit very nicely from that. But that’s negatively impact at our east coast operations. And of course we all saw some weight fall off with the heat. But that’s hurting us a little bit and maybe that’s impacting - We just make the adjustment for it. But I think we are having an impact of that. And we’ll still have that. For another full year, until this cost initiative gets finished, and these farms get realigned and restocked, Tim’s going to have this problem affecting him on the east coast.

Operator

Next we’ll go to the line of Ryan Oksenhendler from Bank of America. Please go ahead.

Ryan Oksenhendler - Bank of America

A question on packaged meats, in terms of how you get to your 3% target volume growth from the year. I think food service is about 25% of your business, and so if you look at your volumes for the quarter, that was probably down in the 6-8% range. So in terms of getting to your target from the year, is it a function of that moderating, and a little bit of growth in the retail sector, or is it huge growth in market share gains in the retail and food service, down in that range.

Larry Pope

Your number on food service is right in the ballpark, and you’re right on both numbers, so you know the business well, it’s obvious from that. I compliment you for that. We are coming into season. The other thing is we started these marketing campaigns and we know that they’re going to take time to hit the ground. We’re seeing benefits from our marketing programs sooner than we thought we would be seeing some of those.

The other side that we’re seeing, that I know is going to surprise you, we’re seeing our brands expansion outside the United States. We’ve got some good branded business outside the United States, particularly Canada, and that’s growing very solidly. And so we’re making a real mark north of the border here. And so I think that we’ve got momentum coming behind these brands that we have focused just this calendar year on increasing the support for these brands.

And we’re getting hits sooner than I thought we’d get them. You don’t usually get this kind of movement on retail this quick. We’re already seeing the movement this quick. And so our marketing guys, I’ll tell you the other side, the operating companies have hired a couple of new high-powered marketing guys, one for Farmland and the other one for Smithfield Packing Company. These guys come with enormous experience and talent.

And so we are beefing up that end of the business. These guys have got some good ideas, some new ways for us to market. They’ve re-sharpened our focus in terms of how we go to market. They’re bringing immediate benefit and showing us ways to market our brands better. And so we see things coming forward. I think we’ve got some products coming out that we are very excited about. We’ve got a new bacon product just around the corner that I think you’ll see that I think’s going to be a home run for us. So I’m excited.

We have had to modify from 3-5% back to 3%. The reality of the food service business is what it is, and the slowdown in the overall economy as we moved into the summer I think has taken the whole country by surprise. And so we’re seeing a little bit there, but we’re still optimistic, in spite of the fact that these categories. I mean, uncooked bacon was down some 7-8% the last IRI report I saw. Our bacon’s moving nicely. So those are the things that I think are going to make this number - I’m comfortable we’re still going to deliver.

Ryan Oksenhendler - Bank of America

And then I guess just a quick follow up. The profit numbers are actually - $0.17 is unbelievable. I think you were targeting $18 million in marketing. Would you consider raising that?

Larry Pope

I don’t think we’re going to raise that this year, no. I think our marketing plans are in place this year. No, I don’t think we will increase it above that.

Operator

Next we’ll go to the line of Christina McGlone with Deutsche Bank. Please go ahead.

Christina McGlone - Deutsche Bank

Bo, I just want to go back to what you were saying on hog producing, because I missed a little bit of it. So you were saying that Q2 would be down sequentially but you’d still be within the normalized 10-15% although at the bottom. And then you were saying Q3 and Q4 could lose money because of the drop in hogs. Is that correct?

Robert Manly

That’s correct. But overall, we’re still projecting that the results of the first half of the year are going to far outweigh any negative we see in the back half.

Christina McGlone - Deutsche Bank

Okay. And then Larry, are you starting to see signs of contraction because of the fall in hog prices and the fact that corn’s been so high, or is it just you’re not seeing expansion?

Larry Pope

No, I think we’re seeing contraction. I think in terms of published data that you can see, you can see the sow slaughter. Sow slaughter has turned dramatically and then this $8 corn has scared people pretty substantially. Anecdotally we know that there are people who are smaller producers who are saying, I’m not going to do this anymore.

Robert Manly

If you look at the slaughter data that Larry was talking about for sows, probably for the first quarter or two quarters of this calendar year we were actually tracking with slightly lower slaughter compared to a year ago. Last 13 weeks has gone from 2% below a year ago to 5% slaughter rate above a year ago, which I think in most people’s calculation would represent a liquidation mode, not hard but it’s still there. And you have one or two competitors - Cargill will probably will expand some sows. But I think that’s going to be overshadowed by the other reductions we see in the smaller producers.

Larry Pope

If I were a producer sitting there today and I’ve seen what’s happened in this hog market of recent, and I see what the USDA predictions are on the grain crop for the year, which continue to deteriorate, I would be shaking a little bit if they haven’t taken any protection, and many of those producers don’t take any type of protection at all. And you add that to where I think the banking environment is out there for farmers in terms of additional extensions of credit, I don’t think the situation is very good.

So I think all that’s positive for the business, because I think beef’s going to be down too. We’ve got a shortage of protein today. I think we’re going to have a bigger shortage of protein tomorrow. Not just in the United States. The cheap U.S. dollars out there, and you’ve got some of these places still continuing to grow, particularly Asia. The demand for U.S. pork is going to continue to be very robust. And that’s not just pork.

And so I think that’s going to create an environment that should be very good for this business. Generally, once the cycle has been this long it starts to trend down pretty dramatically. We start to see the other side. Bo and I are looking at each other and things look pretty good from where we sit. Agree with that Bo?

Robert Manly

Yes I do.

Christina McGlone - Deutsche Bank

And I guess as a follow up, what’s the adjustment with the tax rate, that $0.02? Is that because you’re going back to where you guided us? What exactly is that?

Robert Manly

I apologize if I wasn’t perfectly clear. I think earlier we were giving guidance in the 32-33% range. That has taken an uptick with the change in mix of our greater proportion of our earnings coming from domestic sources at higher rates, and it may tick up 1% compared to where we were before. So we put another percentage point in our outlook.

Larry Pope

So write your congressman and tell him when U.S. profits are up our tax rates go up, which means rates are lower outside the United States. So maybe we can get a revision of the corporate income tax rate and all our investors could benefit. How about that?

Christina McGlone - Deutsche Bank

And the personal income tax rate. [Laughter]

Robert Manly

We’ll just tack that on with the ethanol legislation.

Operator

Next we’ll go to the line of Heather Jones with BB&T Capital Markets. Please go ahead.

Heather Jones - BB&T Capital Markets

On the fresh pork side, margins improved considerably for the industry late in your quarter. Going forward, should we expect your profits to improve or impact from this Murphy-Brown realignment, is that going to significantly impact profitability there for the whole year?

Larry Pope

I think our fresh pork number should get better. Because we’ve got the same negative impact in the first quarter, so second quarter should sequentially and seasonally get better. I think you should expect better fresh pork numbers.

Heather Jones - BB&T Capital Markets

And I think on your Q4 call you had targeted within the normalized range for the year of 3-7. Is that still a fair number or should we expect above that range given how strong exports have been?

Robert Manly

Obviously we haven’t completed the second quarter so we’re somewhat crystal balling, but I think what our direction would be is we’re going to be at the high end of that normalized range and may even exceed that depending up on what happens in the final weeks of the quarter.

Larry Pope

I think that’s right. I think where we’re showing in the first quarter, we could be over that $7 range. In fact I expect we will be. But Bo was talking about on an annualized basis. This is the good time of the year. We’re coming into the fresh meat period now. So we could have the inverse going into the fourth quarter.

Heather Jones - BB&T Capital Markets

So above normalized range for Q2 and possibly Q3, but full year we’re looking more at the high end.

Larry Pope

I think that’s right.

Operator

Next we’ll go to the line of Tim Ramey from D.A. Davidson. Please go ahead.

Tim Ramey - D.A. Davidson

A couple of mix questions. As you’ve talked about the increase in exports, I think exports were 16% of volume, 13% of revenue last year. Do you have a sense of what that might go to this year? And then also, it’s a second question but it’s sort of the same mix thing. The percentage of hog sold externally, will that decline in 2012?

Larry Pope

We calculate our export sales a bit differently than the math you’re doing. We do it as a percentage of the fresh pork, because that’s the available product. And I think I saw for the quarter we’re looking at like 26% of our fresh pork volume went on the export market. So it’s gotten to be a very sizable number. But the industry’s moved up, so we’re looking at - you ought to be thinking of exports now in the 25% of our fresh pork volume. That’s the kind of number this industry has moved to, and I don’t see anything moving that down. If anything, I think that number will move up. I’m not predicting a number here, but I could see it getting to 30% on some quarters here. In terms of the external hogs, Bo, do you have any -

Robert Manly

Yeah, I think part of the hog cost improvement program Larry had mentioned in our HBG group, a lot of that has to do with making sure we get the right hog at the right plant at the right time, and a lot of that is increasing our focus on selection rates, which should improve the percentage of pigs going to our plants from our hog operations, because they’re going to be in a tighter weight range and fit the specifications our plants need.

Tim Ramey - D.A. Davidson

So is there some number that is just structural that says, you know, there’s always going to be 10% or 15% of the hogs sold externally, no matter how good you are, or how well the plants are sited, or could that number go much lower?

Robert Manly

You’ve got to remember, we had that big group of hogs out in Utah. They’re producing over a million pigs a year, and very few, if any, of those come back to our plant. Most of those are headed for the west coast. We’ve got a long term contract on those.

Operator

Next we have a question from the line of Lindsay Drucker Mann from Goldman Sachs. Please go ahead.

Lindsay Drucker Mann - Goldman Sachs

I just wanted to get a little bit more clarification on your raising costs and hedges. So if you were to sort of mark-to-market for where spot prices re today, or even if we were to just think about $7.50 corn and $14 beans, what raising cost number would that mean for you guys?

Robert Manly

I’m not sure I necessarily want to project a hypothetical, but certainly $7 corn is going to require something north of $70 in terms of breakeven.

Larry Pope

I wouldn’t be surprised by $72 or something like that.

Robert Manly

It could even be higher than that.

Larry Pope

And that’s one of the issues that the industry, and a hog farmer who does not have his grain hedged, that’s the kind of raising costs they’re looking at. As we’ve said before, we’ve taken some very strong positions, so I don’t think we’re going to be there. In fact, as Bo has indicated in his comments where we’re going to be. We’re certainly going to be in the $60s, so we’ve still got to buy corn well over $6, but nowhere near $7 and certainly nothing north of $8. So we’ve got an advantage to the industry and that’s the benefit of our hedging programs.

Lindsay Drucker Mann - Goldman Sachs

So as you think about buying corn forward, once your hedges roll off, are you laying on fresh hedges here at new levels, for longer-dated purchases, or are you taking the view that - I know at your investor conference you guys talked about normalized corn prices closer to $5 levels. So are you taking the view that we get some pullback in terms of corn prices going forward?

Robert Manly

At this point, we don’t comment on our future derivative positions, and we’re not going to comment on what our tactics are today. I apologize.

Lindsay Drucker Mann - Goldman Sachs

Okay. Then just maybe additionally on the cost side, with the Murphy-Brown cost savings program, $90 million, where does that put you on the cost curve relative to the range of producers?

Robert Manly

I guess there are a couple of benchmarks out there. One that I think the analyst community uses fairly well is the ISU cost model. And I think before we were probably a penny above that, maybe our east coast operations may have been a couple of cents, but I think the cost savings initiative will create an environment where our Midwestern operations will be producing pigs below that as you average. And we’ll probably be equivalent to the ISU average on the east coast once everything’s all said and done.

Operator

Next we have a question from the line of Akshay Jagdale from KeyBanc Capital Markets. Please go ahead.

Akshay Jagdale - KeyBanc Capital Markets

Just wanted to follow up on the packaged meats volume question that was asked earlier. I’m not sure if I understand you correctly, Larry. Am I correct in saying that this quarter volumes disappointed and from what I can understand it’s mainly because of the food service industry volumes being weak. So if I’m wrong there please correct me. But what I still don’t understand going forward is you’re projecting improvement in volume trends, significant improvement in volume trends, and I’m not sure where that’s going to come from. Are you investing more money? Are you going to reduce your prices and gain market share? I’m not clear on that? Can you help me with that?

Larry Pope

I will. Certainly you’re never disappointed when your overall volume declines, and it’s down 1%, so that’s not a huge decline. That’s a small decline. And yes, I am certainly bothered by the food service, but I can’t make people eat food that they don’t buy.

So where we do feel very good is on the retail side of our business, which is 75% of our business is on the retail sector. And what we are seeing is strong growth in our branded business and our key brands and so I think that’s what’s going to drive that 3%. In fact, that’s up 3% for this quarter, even in this quarter that’s up. As most categories were down, our retail business is doing well.

So we’re optimistic about where we think our marketing programs will put that, and I’m well aware we just reported a down quarter, yet we’re still projecting up for the year, which means we’ve got to get on with it in terms of bringing the average up to 3%. But we’re optimistic that the programs we put in place, that these guys have done, is going to benefit us.

And so I guess you should ask the question do I think the food service business is going to return. We’re not looking for just the food service business to bring this volume back. We’re expecting our retail business to grow even further. Because even if they don’t eat at the restaurant, they still eat. So they go to the grocery store, instead of food service, which means we still get the sale. We just get it at the retail counter as opposed to getting at the fast food or the fast casual.

Akshay Jagdale - KeyBanc Capital Markets

And just a follow up on the retail environment, can you just remind us how much of your retail packaged meats business is private label? And beyond that, what do you see in terms of trends trending down, etc. Because clearly your business seems to be outperforming, and the results in packaged meats profitability-wise were really outstanding. So I’m just trying to understand whether that’s purely Smithfield-specific, or there’s some trade down that you may be benefiting from.

Larry Pope

I think our key brands are about 65% of our retail business, and then we’ve got our private label business. Our key brand brings us to about 65, then we’ve got our remaining brands that take us up about another 10% to about 75%. So our private label business is about 25% I think.

Akshay Jagdale - KeyBanc Capital Markets

Are you seeing any trade down from consumers?

Larry Pope

You mean trade down from the premium brands to our brands?

Akshay Jagdale - KeyBanc Capital Markets

Yeah, is your private brands business growing exceptionally faster, or significantly faster, than branded? Or have you seen any trends in that mix, per se, that make you believe that perhaps consumers are trading down in this environment when meat prices are going up to private label brands?

Robert Manly

The response to your extra questions are that our private label business is down. And that is part of the mix change that we’re consciously trying to implement, putting greater emphasis on our core brands, less on our non-core brands, and less on our private label. So there may be a trading down to private label amongst other competitors, but our volumes are down in private label and non-core, and up 3% in our core brand business where we’re putting our marketing dollars.

Larry Pope

And that is not to say that we’re walking away from private label business. We are open and available for our customers who have a branding program surrounding that. We will do a private label. We want to be the full pork supplier to our customers, but private label is not a focus of our business.

We believe our brands have lots of strength, latent power there, that we think we can extract. I think we have demonstrated that again and again, and our customers are seeing the benefit of this, because they’re selling it. So it’s not that we’re walking away from private label. However, we have rationalized out some capacity.

So we’re not chasing private label business to fill our plants up. We’ve got good business, and in fact Bo made reference to the fact that we’ve approved capital expenditures at this point to increase our packaged meats business because we’ve got some very good opportunities out there on the higher end, particularly things like dry sausage, where there’s opportunities there. Those are very nice margin businesses that we’re putting money in.

So I think it’s a shift in the business, and we’ve been talking about it for four years now, and this is our fifth year, and our results are there to demonstrate that our strategy seems to be working fine. Even in this tough time, even I’m a bit surprised how strong our brands are performing in a very tough environment, and I know what the competition is saying, and I know what the category is saying, because I’ve seen IRI data just like you do. It’s not people trading in any particular way, except they’re trading toward our brand because it’s a value priced brand that we can compete with the private label.

Operator

And next we’ll go to the line of Farha Aslam from Stephens. Please go ahead.

Farha Aslam - Stephens

First, a housekeeping question. Just your interest expense for the year, what do you expect that to be?

Robert Manly

$245 million.

Farha Aslam - Stephens

$245 million was last year, right? But this year you would expect it to be lower?

Robert Manly

I’m sorry…

Farha Aslam - Stephens

Maybe I can ask my real question and we can circle back on this one.

Robert Manly

Very good.

Farha Aslam - Stephens

Okay. Larry, you had mentioned that you’re seeing an increase in sow slaughter rates. When do you expect that to show up in the hog price? And is the reason why you’ve been more conservative on your hog positions is that you expect hog prices to possibly go up in the second half of the year?

Larry Pope

You hit the second question dead on the head. We thought there was an equal opportunity for hog prices to go up as there was for them to go down, so you don’t necessarily hedge if you think you’ve got an equal weight opportunity. We try to do a risk analysis of what’s the upside potential versus downside risk and such. And we’ve seen in the live hog market it seems to sort of indicate where the fundamentals are.

I think there’s a lot of potential for the hog market to go back up as beef production drops off, as poultry production drops off. I think there is liquidation going on. I think it is going to be six more months before that’s going to show up in any kind of measurable way. So it’s out there in next February and March and April. It’s not anything this quarter.

In fact, I think hog prices might very well trend down, as they seasonally do. They may trend down solidly. I’m thinking it’s into the spring of next year is when you’ll start to see the impact. And in fact you’re seeing some of it. You’ve got some pretty high futures next summer, and I think there may be some significant opportunity of those futures to even go higher than that. So I think there’s some upside potential to this live hog market.

Farha Aslam - Stephens

Your commentary about losses in the second half could prove to be conservative in your hog production group if you get that rally.

Larry Pope

You know, Farha, making the prediction about the hog market next February and March, and you’re sitting in the first week of September, that is a very difficult thing to do. But I think there’s the potential, yeah. I think there’s the potential for a rally, particularly if these exports stay strong. They look strong. There’s going to be a lot of demand for these hogs. So it could be there. It could happen quickly. Bo, you want to give your answer?

Robert Manly

Yes, I apologize. I got caught up in my notes here. Last year we had $245 million interest expense, as you correctly pointed out. This year, full year, we’re expecting $185 million or a $60 million decrease. On a quarterly basis, we did hit $48 million, and I think if we went back about five quarters you’d see us right around $70 million in interest expense. So we anticipate as we move forward through the balance of this year, that we could trend closer to that $45 million, $46 million quarterly interest expense.

Keira Lombardo

At this time we’re going to have to conclude the Q&A portion and turn it back over to Larry for some closing remarks please.

Larry Pope

Thank you Keira. Ladies and gentlemen, thank you for joining this morning. It is truly a pleasure to deliver these kinds of results to the market. I know some of these are surprising, and bucking the trend of others in the industry. We’ve been working on this for a long time, and I would tell you that a number of people in our organization, my management team, are pumped up. We think there’s a lot of potential left in these brands and we’re just now getting to it in a serious way in spite of the fact that we’ve got four record years in terms of the Pork Group.

I wouldn’t be at all surprised if we have a fifth record year in the Pork Group, and it will be driven by the packaged meats business and strong exports in the fresh meat side of the business. We’ll manage the hog production side and we’ll have to wait for the world to turn on the international side. But in the near term, I am very bullish and optimistic in terms of where we position this company and the cost structure improvements in place and the marketing plans that are just beginning to hit.

We’re not going to go stupid on the marketing, but we’re going to commit more to it. We’ve got a better plan, we’ve got better people doing it, and I look to be reporting to you again and again on the success of these programs. It’s a great day to be at Smithfield. It makes me feel so good from a couple of years back. Bo and the finance group have done a terrific job on the balance sheet. We are poised to go, and I think the future looks very bright, both for the year and beyond that. So thank you very much for listening this morning.

Keira Lombardo

Thank you operator. Can you give the replay information please?

Operator

Ladies and gentlemen, this conference is available for digitized replay after 11 am eastern time today, through September 22, at midnight. You may access the digitized replay service at any time by calling 1-800-475-6701 and entering the access code of 213186. International participants may dial 320-365-3844. That does conclude your conference for today.

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