Smithfield Foods F2Q08 (Qtr End 10/28/07) Earnings Transcript

Smithfield Foods, Inc. (SFD)

F2Q08 Earnings Call

November 29, 2007 9:00 am ET

Executives

Jerry Hostetter – Head of Investor Relations

Cary J. Dubois - Chief Financial Officer

Richard J. Poulson - Executive Vice President

C. Larry Pope - President and Chief Executive Officer

Joseph W. Luter – Chairman

Analysts

Kenneth B. Zaslow – BMO Capital Markets – US

Christine L. McCraken – Cleveland Research Company

Farha Aslam – Stephens, Inc.

Diane Geissler – Merrill Lynch\

Jonathan P. Feeney – Wachovia Securities

Oliver E. Wood – Stifel Nicolaus & Company, Inc.

Ann H. Gurkin – Davenport & Co. of Virginia, Inc.

Zafar Nazim – JP Morgan

Reza Vahabzadeh - Lehman Brothers, Inc.

Heather L. Jones – BB&T Capital Markets

Brian Hunt – Wachovia Securities

Edgar Roesch – Banc of America Securities, LLC

Presentation

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Smithfield Food Second Quarter Earnings Conference Call. (Operator Instructions) I’d now like to turn the conference over to Mr. Jerry Hostetter. Please proceed sir.

Jerry Hostetter

Good morning. Welcome to a conference call to discuss Smithfield Foods fiscal second quarter results. We’d like to caution you today that in today’s call there may be forward looking statements within the meaning of federal securities law. In light of the risks and uncertainties involved we encourage you to read the forward looking section of the Smithfield Foods Form 10K for fiscal 2007. You can access the 10K and our press release on our website at www.SmithfieldFoods.com. I’d like to cover one administrative detail. We’d like to provide the opportunity to as many analysts as possible to ask questions. As a courtesy we request that only one follow up question be asked so that everyone can participate. Thank you.

With us today are Cary Dubois, Chief Financial Officer; Rich Poulson, Executive Vice President; Larry Pope, President and Chief Executive Officer and Joe Luter, Chairman. This is Jerry Hostetter, Head of Investor Relations. Larry Pope will begin our presentation with a review of operations. Larry.

C. Larry Pope

Thank you Jerry. Good morning everybody. Thank you for joining the call. I’m pleased to report this morning second quarter earnings income from continuing operations of $18.7 million or $0.14 a share compared with $46.4 million or $0.41 a share in the same quarter last year. As you can see from the press release, for the six month period we are $80.7 million compared with $86.3 million and that’s $0.60 a share compared with $0.77 a share. I hope you took note the second paragraph of our earnings release where we pointed out that our second quarter results included charges which we previously had announced related to the Classical Swine Fever inventory reduction in our Romania operations which resulted in a $13 million after tax charge as well as we have had substantial foreign currency reevaluation charges during the quarter that are also being reflected and they total $0.28 a share. We only report, we’ve been reporting both positive and negatives there and we realize that is part of our ongoing operations as far as foreign currency exchange gains and losses but, we feel an obligation to report that to you.

Clearly, the big story in the quarter is the follow up in results of our Hog production operations. I think if you remember at the end of the first quarter I predicted that there would be an awful lot of hogs I suspected coming to market this quarter. Those hogs have come to market, it has been a very strong fall hog run and that has resulted in a fall, modest fall off in the live hog market during the quarter. In the third quarter it has fallen off even more and as well, we have had an increase in our live production costs as I think we pointed out to you in the press release, that’s an increase from $0.41 up to $0.49, $0.08 a pound. But, you should be realizing, if you do the math, those results do not reflect the impact of our hedging activities which help offset and control some of those losses. An awful lot of that decrease in our live production operation operating profit relates to those losses in Romania both in foreign currency exchange losses and in the Classical Swine Fever charges, the two of those together were about $30 million in that decrease of live production.

The losses and reduction, sorry not loss but the reduction in the operating profit on the grazing side was largely offset in pork processing. That part of the business I am extremely pleased with and was extremely pleased with our first quarter. Fresh pork during the quarter was marginal these results from $22 million up to $62 million for the quarter are mainly the result of strong improvements in our packaged meats business and I will talk about that in a minute or so after I work through the segments. The beef business continues to be marginal. I think you heard from some of our competition that-that end of the business is tough. There has been an increasing production level by some of our competitors. I am pleased to report that in spite of that we are still continuing to report positive results in our beef processing operation and DOW swipe profitability in cattle raising. If you might remember for the last several quarters we’ve been reporting that we’ve had losses in our cattle raising operations both in what we own and through our Five Rivers Ranch Cattle Feeding joint ventures cattle feeding operations. We’ve had very modest profits but the time period we had talked about with having [inaudible] some fairly high prices, that is getting behind us and so I am pleased to report that at least we continue to report some profitability there.

On the international front, that continues just to be a very good story. Our group Smithfield Joint Venture now more than a year in passing is very good. Our western European operations are very solid. Our Polish operations have turnaround very nicely. I hope you took note, we made an announcement during the quarter that one of our two executive vice presidents, Robert Manly has taken on responsibility for overseeing our international operations. I think that business has got an awful lot of potential. Rob has an enormous amount of experience in the meat business and his focus on that end of the business in a more concentrated way will, I think, continue to allow us to mind those operations and take advantage of the synergies between those operations as well as synergies between our European operations and the US. I am extremely pleased about that move and I think it’s a positive for this company. I think our international continues to have a lot of potential and I think for now about three straight quarters you have begun to see a bit of this.

Let me talk for a minute about the area I am most excited about and I pointed that out in our earnings release is our packaged meats business. This is an area that continues to just show enormous promise and I think it’s a concentration of the company. All of our management teams are focused on that end of the business. We started the initiative about three years ago of using our raw materials internally. We have officially completed that process and are now opportunistically improving the margins of this end of the business. I had told you before that I would rather be a smaller, more profitable company rather than a larger less profitable company. We are focusing on that. If you see the numbers in our press release we point to some very big numbers in terms of some important categories in this company from precooked bacon which, is up over 100% for the year, year-over-year yet that came from the Armour Eckrich acquisition part of that. Our smoked sausage business is up nearly 70%. Our ground sausage business is up over 125% and even our cooked sausage is up nearly 25%. These ends of the businesses are just doing excellent.

I can report to you that we have now owned the Armour Eckrich business for now a full year. There have been a number of people who have questioned whether or not that acquisition was a good one. I can report to you today that it was a very good one and it’s been a credit to our earnings and it has positioned us in the package meat business with some brand name and product categories that are well positioning us as we’re benefiting, not just for tomorrow, but even for today. We are focused, very focused on increasing our capacity utilization, we are very focused on managing our costs inside these plants. Our fixed overhead costs quarter-over-quarter this quarter comparing to the same second quarter last year, I can report to you that they are not up and I take that as a very strong positive in spite of $90 plus oil and the pressures that we are having in other driving costs we are managing our overhead costs to improve our efficiencies through these plants and we are helping to offset all of those costs increases through some of our strategic sourcing and some of our manufacturing realignment processes.

We announced just recently the fact that we were closing another Armour Eckrich plant in Luckton Texas and we were going to merge the operations from that under utilized facility into some of our other plants. We are doing that as we speak and that will, once again, help shield some of these costs pressure that we are felling in the business and I think that is going to benefit us at the bottom line in terms of the margins on our packaged meats.

We’ve commented in the press release that we have some ongoing marketing programs. Our program and our association with Food Network celebrity Paul Levine continues to bear fruit for us. We are very pleased with that association with her now that it is just past a little over a year. As well as, we are rolling out some new product categories primarily related to the Armour Eckrich business that are reintroducing some product categories that I think have an awful lot of potential for us. One of the things that we’re striving to do as a company, I’ve said that to you many times, is that we are slowly moving towards a marketing company. We are moving away from this total commodity influence on our business and allowing our brand names and our product categories to great more pull on this business as opposed to being a push business. Our base packaged meat business is only up 3% and that is a controlled 3% so, I think we’re making very good strides in that end of the business. That drove our first quarter earnings, that’s driving our second quarter earnings and I’ll speak to the third quarter and going forward in a bit. As well, you should be aware our export business, I know the industry is experiencing some positive numbers on the export side, I can report to you today that we are experiencing excellent numbers on the export side of the business in a number of countries. So, that part of the business has helped move this meat during the quarter when we’ve had these record kill numbers and you may have noticed, or some of you may be aware that Smithfield actually processed hogs last Sunday, I guess that’s a week ago and we’re now debating if we would ever go to another Sunday kill. I think the last time there was a Sunday kill, I think, was nearly 10 years ago. We did have a home, we did have a home for the product, our demand for the product is very strong and we know that we have these large levels coming at us so we made the decision to run on a Sunday which is relatively historic at two of our plants. So, the demand size of the business is very good and the freezer stocks of the business speak a little bit to that issue.

Before I talk about the forward looking part of the business, I’m going to turn it over to Cary Dubois and let Carey explain to you some of the financial numbers I know that you’re interested in. And then, Cary I’ll take it back and give them the view forward.

Cary J. Dubois

Thank you Jerry and good morning everyone. Before I begin with the financial highlights it is worth noting a couple of points that will be helpful in your quarter-over-quarter review of the financials. First, the second quarter of fiscal year 07 only included three weeks of results for the Armour Eckrich and the Butterball acquisitions. Additional, the acquisition of Premium Standard Farms was a post fiscal year 07 event and therefore the last year’s second quarter will not have included any of those results.

Turning our attention to the income statement sales for the quarter were $3.5 billion or 24% higher than the $2.8 billion for the second quarter last year. Sales were up across all of our business segments. The pork segment sales increased 28%, primarily from the Armour Eckrich and Premium Standard Farms acquisitions. While the 33% increase in sale for the hog production segment was largely attributed to the farms acquired through the Premium Standard Farms transaction. Internationally, we were pleased to see sales volume increase in Poland and Romania exceeding 20% and 45% respectively. As we continue to build out their fresh and packaged meat platforms.

Selling general and administrative expenses were up $58 million quarter-over-quarter. It is important to point out the foreign currency fluctuations fell into this line item. In this quarter $25 million or 43% of this expense was related to foreign currency losses. The balance of the increase expenses was largely contributed to a full quarter of Armour Eckrich and the addition of Premium Standard Farms.

Operating profit was $88 million down 20% from the $110 million a year ago. Key drivers for the quarter were an earnings improvement of $40 million or 177% in pork and a more than offsetting loss of $59 billion in the hog production segment. As mentioned by Larry over 50% of the hog production loss resulted from foreign currency fluctuations and the impact of Classical Swine Fever in Romania. In fact, the total foreign currency loss for the quarter was $25 as previously mentioned and the inventory write down and the clean up costs associated with the three disease affected farms in Romania was $13 million. This $38 million in charges and currency losses ultimately impacted the quarterly results by $0.28 per diluted share on an after tax basis. Adding back depreciation an amortization of $73 million, our earnings before interest, taxes and depreciation an amortization was $160 million, or flat for the quarter versus last year. On the trialing 12 month basis [inaudible] was $725 million versus last year’s trailing month number of $626 million. Interest expense increased $16 million over the same quarter last year. This increase was driven by an overall increase in our debt level and relatively higher borrowing rates due to the calendar year 2007 financial market conditions.

For a second consecutive quarter we included a table in the press release which separately breaks out the results of our three major joint ventures. The aggregate result in the table are reflected in the line item entitled Equity In Income or Loss Of Affiliates. These equity method investments contributed $28 million for the quarter, up 42% from the prior year. I wish to remind you in viewing this table and corresponding line item on the income statement that income is actually reflected as a negative number and losses are shown as a positive number. This approach is necessary for the results to tie into the income statement format.

Taking a look at our balance sheet and cash flow statement capital expenditures for the quarter were $125 million as compared to $70 of depreciation. Our debt level increased by approximately $250 million in the quarter to $3.7 billion. Key uses for the capital were the continue investments and working capital needs in eastern Europe and our seasonal inventory build up in the United States. Our debt to total capitalization level is 56% versus 60% for the same quarter last year. We secured $100 million in short term credit lines in October and recently increased our US Bank revolver capacity by $75 million to provide adequate liquidity as move through our peak inventory period. We currently have over $450 million of available liquidity.

With that, I will turn it back over to Jerry.

Jerry Hostetter

Thank you Cary and thank you for that report. As we look into the third quarter and the remainder of the fiscal year I am certainly extremely encouraged for the third quarter. As those of you who follow the industry know, fresh pork margins today are nothing short of excellent. The drop in the hog market has not resulted in a similar drop in the meat markets and as a result the margins on fresh pork have widen dramatically and we are experiencing some very, very nice margins on the fresh meat side of the business and that’s affecting our third quarter result very, very strongly. As well, I think we had announced that we had a 60 million pound Chinese carcass contract that we are in the final stages of completing and that has helped with the fresh pork business as well.

I can report to you today that our holiday ham season is, as well, having a stellar year. Certainly the benefit of having a lower ham market has helped margins to some degree but, we have done a very, very good job. And, I am extremely pleased with the margins we have realized across all of our product categories in this third quarter and I anticipate a very strong result for certainly the November and December periods which are traditionally very good on the processing side the business. I can report to you that they are excellent this year, we’ll have to see after the first of the year. Exports, as you would expect, are very strong our exports were up for the quarter 29%, the industry is up 10. We will continue to have very good exports for the third quarter. I can’t speak as to how the industry will be for that period but, I can tell you that our numbers will be good. Our exports are in a number of categories, certainly China is at the top of that but as well, we have done a nice job of exporting in the EU and I believe, I know Swift does have a plan that connects – we are largely the only person exporting into the EU. We are essentially the only person exporting muscle cut meats into China. So, those two markets are open to us and not essentially opened to the rest of the industry. The Russian markets are extremely good, the Japanese market is extremely good and I anticipate the Japanese market continuing to be good through the third quarter. So, that part of the business is holding its own and carrying these heavy kills and we’ve got places to go with this meat and we’ve got places to go with margins on that meat.

Clearly, hog production results are going to be down. For the third quarter if you look at the future markets, they indicate they were going to continue to experience losses on our hog raising operations. Looking a little bit farther by, February, the futures market is right we’ll be back about break even in February and as we move into the final part of the fourth quarter and into the first quarter of fiscal 09, profitability of hog production looks to return. As many of you might know from the markets we’ve got $50 hog market in late spring early summer so that is our break even. So we’re probably going to get closer to the $50 market $4 corn. We are reporting $49 this quarter and I think they are going to be in that $47-$50 range depending on where corn is. But, we’re going to continue to report upper $40 range of grazing costs. But, the markets are, the markets are there and that should solidly be profitable.

The beef business is weak, will continue probably to be weak. I think we are very competitive in the industry so I think we will do better than the industry but we will be influenced by industry dynamics. The international side is very solid, I’m extremely satisfied with our western European and, as I said, our Polish operations. Romania is clearly the live production side of the business is we have these farms, not in full operation, they have a negative drag on the costs. Processing side of the business is okay. I am very comfortable there. As well, we are making, continuing our concentration on product mix changes discussed in the press release, we are continuing that and that and our cost control with another plant closing, all those lead me to be very optimistic on this packaged meat side of the business. We’ve got an initiative in place, our operating companies are executing against that in a strong way and that part of the business is continuing to move forward not just for a month and not just for a quarter; that is a solid business direction and I think just moving us father and farther way from this commodity discussion and the influence of these commodity markets everyday.

At this point, I’ll be happy to take questions. Mr. Luter is here and he’d certainly be available for questions and we welcome your comments.

Question-and-Answer Session

Operator

Our first question comes from the line of Ken Zaslow, please proceed with your question.

Kenneth B. Zaslow – BMO Capital Markets – US

Thanks. Good morning everyone.

Jerry Hostetter

Good morning Ken.

Cory

Good morning.

Kenneth B. Zaslow – BMO Capital Markets – US

You know, just kind of more of a broad question, you talk about a lot of cost savings programs. I was wondering what would it take for you to undergo a major cost restructuring after given that you have these 20 or so operating divisions, 70 or so brands. It seems like it may unleash a lot more value to shareholders if there’s a, you know, a rejiggering, and again, I know I’m the outsider and I don’t know how to run the business. But, it just seems from an outsider’s point of view there may be a lot of costs savings larger than these one or two plant closings.

Jerry Hostetter

Ken, that is something we have probably thought about for over 20 years and there are certainly two ways to run a business. You can have a centralized business and you can have a decentralized business and it always appears when you talk to the consultants whichever direction you, wherever your current structure is, consultants believe the alternative structure is always better. One thing we are very careful about, and if you think about the business for a bit, we have independent operating companies. Parts of the business we control being legal and finance and taxation and certainly control over some of the buying parts of the business in our commodity market activity. But, we want independent companies out there approaching these customers. Because of the product categories and the regions and the brands, we all need to be very careful and there’s a lot of history out there from people who have tried to put it together and it failed. And so, we’re very careful about how we approach the front end of this business as we contact ht customers.

Now, the other side of that is we are looking up, we are looking at the back side of the business and we are in the midst of the beginning process of whether we should combine some of our accounts payable and payroll processes and our IT process. But, we are very, very careful about the front end of this and the other piece of that customers want first, second and third level of a supplier and if we merge companies together we have a very good change of loosing distribution as a result of that. By the customers putting us together and simply reducing our distribution. So, you’re right it’s an easy question and I can understand why you make it and we debate it. But, I think we always come back to, it costs us a little bit of money by our structure but we believe we benefit more by being closer, more flexible to that customer and keeping those brand names alive in the geographic areas they’re strong is worth the cost, more than the cost of the penalty of the costs.

Kenneth B. Zaslow – BMO Capital Markets – US

My follow up question is actually going to be a non [inaudible]. On the export side you said everything was excellent, is there more to come in China?

Jerry Hostetter

I assumed it would be the first question and you made it the first question so, let me address China to the group. We made an announcement in this quarter that we had a 60 million pound contract with Cotco which is a large state owned trading company in China. Since that time we have been filling that order and most of it has been filled in this quarter. We’ve also used this as a time for relationship building and we have built up a very nice relationship with Cotco, as well as a very nice relationship with some parts of the government. But, I need to be very careful going forward in terms of confidentiality with customer relationships. We do not disclose our transactions and our business with individual customers and so I’m not going to be discussing with the general public our individual, I know there’s been a lot of debate about is there a second contract? Do you have some more business? You will not see me making any more comments relating to that in respect of the confidentiality of our relationship with our customers and they’ve asked for that and I’m respecting that.

Now, with that being said, I think the business is very promising in China. It’s a big market, it’s a huge market relative to the United States. I think there’s a solid demand there both today and in particularly longer term. I can report to you today that there is a six person inspection delegation from China in the United States and they are in the process of reinspecting – the five plants that we cannot ship into China today they are in the process of reinspecting those plants for reconsideration to reopen those plants as designated plants that can export into China and we will see how that goes during this week as they do those inspections. They are in the middle of them. One of the things that we feel very positive about is that we have the ability of paling [inaudible] I guess is the product, we can provide [inaudible] free products in large quantities to the Chinese market. There is a strong issue in that Country, they are not going to change their mind, I don’t believe, in terms of their demand. We as a supplier can supply customers need and we are responding to that. I know it is somewhat controversial but, it’s an opportunity for us as a company and when our customers ask us to provide products to them to their specifications we are going to do it if it makes sense in money for us to do that.

I am planning a trip in the very near future to China which I think will be to continue to explore the business and to open more doors. But, I must tell you that I am not going to discuss any individual transactions. The only thing I would tell you is we report the quarter is going forward. I will report to you upon how our exports are doing and how they’re doing by country and I think that will give you some indication of how the business is going and I’ll leave it by telling you that I think it is very promising.

Kenneth B. Zaslow – BMO Capital Markets – US

Thank you very much.

Jerry Hostetter

You’re welcome.

Operator

Our following question comes from the line of Christine McCraken. Please proceed with your question.

Christine L. McCraken – Cleveland Research Company

Good morning.

Jerry Hostetter

Hi Christine.

Cary J. Dubois

Hi Christine.

Christine L. McCraken – Cleveland Research Company

I just wanted to touch on hog production. Clearly USDA underestimated the number of hogs we’d have this fall. The industry is experiencing now, pretty sizeable losses, rising feed costs. Do you think that now going into spring that we’ll see some herd liquidation? Or, do you think, you know, with the profits that you mentioned by February or something and, you know, with a couple of years of good money in the bank that producers will continue to expand?

Jerry Hostetter

Christine, Mr. Luter may want to comment on this and I’ll give you my opinion here. Certainly you’re seeing some liquidation in Canada. I don’t think these producers are feeling much pain and what pain that they’ve felt has only been very short lived here. They’ve made an awful lot of money and they’ve got an awful lot of money in their pockets. And, if you look at the futures market, if the futures market are right Christine, they’re going to be back in the black here pretty quick and they’re probably not much in the red from a cash flow standpoint even today. So, I’m not hearing of any wholesale liquidations of live production in the United States. Now, we get some antidotal information from our banker friends and some people are talking about it, you know the numbers I don’t have any handle at all so I’m sure there are those who are highly leverage who’ve got debit to service that maybe experienced this but, I’m not seeing any real big numbers that I think are going to turn the market the other way. Joe, do you have an opinion?

Joseph W. Luter

No, I think that export demand on all parts of the world will take up a lot of this increase production. We continue to be very optimistic of our export sales everywhere and I think the hog prices in the future will reflect the level of export demand.

Jerry Hostetter

And cheap US dollars will keep those exports moving.

Christine L. McCraken – Cleveland Research Company

At least for a while. Just on a follow up then, when you consider kind of the supply, or I guess, slaughter capacity [inaudible] now, at the packing plant, we’re hitting up against kind of a ceiling and yet now Triumphs announced now that they’re not, they’re delaying their second plant. I’m just wondering if we continue to expand even at a slightly slower space, where are we going to put all these hogs?

Jerry Hostetter

Do you want to take that Joe?

Joseph W. Luter

I don’t think you’ll have expansion.

Christine L. McCraken – Cleveland Research Company

Oh.

Joseph W. Luter

I think you’ll have a leveling off but, I don’t think you’ll have an expansion.

Jerry Hostetter

Christine, I guess, what you have seen in the industry is we did go through the fall hog run here when we’ve had big numbers, surprisingly big number but the industry, the markets have held reasonably and the market has processed those hogs, as I said, we processed two plants on a Sunday which I know is a historic situation. But, I think today, and I do think that with Triumph they did say they were going to expand the plant from say 16 to 18,000 so, they’re adding about 2,000 capacity. Which, I’m not suggesting 2,000 is a solution to this but, we still have some Saturday capacity out there left and the industry did okay even during fall hog run.

Joseph W. Luter

And, the kill levels will go down in the next two, three full weeks as they do every year.

Jerry Hostetter

They will

Christine L. McCraken – Cleveland Research Company

Alright. Thank you.

Jerry Hostetter

Thanks Christine.

Operator

Our following question comes from the line of Farha Aslam with Stephens Incorporated. Please proceed with your question.

Farha Aslam – Stephens, Inc.

Hi. Good morning.

Jerry Hostetter

Good morning Farha.

Farha Aslam – Stephens, Inc.

Two questions, first one on hogs. Are you keeping that second line as, I believe there are two city plants still running?

Jerry Hostetter

What we’ve got there, the second shift is only partially running. Farha that is to accommodate the production of our Chinese product. We’re using our second shift there, it’s only partially manned and it’s just for Chinese production.

Farha Aslam – Stephens, Inc.

And do you anticipate kind of closing that second shift down come December or so?

Jerry Hostetter

We have had that shift on and off Farah. At this point we haven’t made a decision to put it back on, although I did say it was temporary but, we actually curtail that and it is not running even today.

Farha Aslam – Stephens, Inc.

Okay. Then, just one quick follow up on Turkey. Can you just share with us the trends in that business? Kind of just what margin outlook you’re seeing there?

Jerry Hostetter

Our margins are not as strong as the numbers I saw on Hormel. Part of that can be a bit of timing, we are, the Butterball business is much more whole bird business and the third quarter is going to see the benefit more so than the second quarter, the Hormel business is. And, obviously they’re seeing the big impact of the grains that’s affecting that business. I’m pleased that we are still reporting positive numbers. I think the business is good, I think the piece of that that is always troubling is these higher grain costs.

Farha Aslam – Stephens, Inc.

Okay. Great. Thank you very much.

Operator

Our following question comes from the line of Diane Geissler with Merrill Lynch. Mrs. Geissler, please proceed with your question.

Diane Geissler – Merrill Lynch\

Good morning. Can you hear me?

Jerry Hostetter

Good morning Diane.

Diane Geissler – Merrill Lynch\

Hi. If you could just comment please on the extent to which hedging helped you in your hog production group? You did talk about the benefit there, if you could just give us some kind of quantification.

Jerry Hostetter

Diane, that is a very complicated question and my response to that is going to be one you probably won’t like and I think I’ve made that the last two quarters. Diane, judge me on the numbers. Hedging between what we do in forward buying grains, what we do in the commodities market, closing out contracts, margin to markets, is so complex that we can’t get auditors to sign off on it. It is part of the raising process so I’m only telling you it is part of our results and I don’t know if I can actually give you a number that I could get all of our accountants to agree what the number is and finally, Ernst & Young wouldn’t sign off on it. So, I can tell you it was a positive number but, that’s part of our strategy. We have a multi leg strategy there. We buy grains ahead in the pure cash market so hedging is a complicated answer here.

Christine L. McCraken – Cleveland Research Company

Okay. So, the numbers that were referenced in your press release would be the sod cash prices.

Jerry Hostetter

Yeah.

Christine L. McCraken – Cleveland Research Company

Then, any differential we should assume is either on forward sales of hogs, spending or grain hedging.

Jerry Hostetter

Grain hedging or forward grain buys, that’s right.

Christine L. McCraken – Cleveland Research Company

Okay. Then, do you have positions in place for the third quarter and fourth quarter? How far out are you extended?

Jerry Hostetter

Diane, we routinely have grain hedges well out into the future. We don’t have, we don’t routinely have hog hedges quite as far out in the future.

Christine L. McCraken – Cleveland Research Company

Okay. So any commentary you would have made earlier in the call about what you expected live hog versus raising costs would have been spot based?

Jerry Hostetter

That’s right. That’s the way we calculate the business because the other part is just so difficult to determine.

Christine L. McCraken – Cleveland Research Company

Okay. Alright. I appreciate the comments. Thank you.

Jerry Hostetter

Thanks Diane.

Operator

Our following question comes from the line of Jonathan Feeney with Wachovia. Please proceed with your question.

Jonathan P. Feeney – Wachovia Securities

Great. Good morning. Thank you. I guess, just following up a little bit on Diane’s question Larry, looking forward, I guess this is somewhat of an unusual situation in that we had such bad fundamentals in the spot market right now but some really attractive spreads between what appears to be corn costs and overall costs and hog prices in the future. I know you’re not going to talk about the level at which your hedging but, does that entice you to accelerate your forward selling of hogs and buying of corn right now? What’s your sort of philosophy about that spread going forward?

C. Larry Pope

I guess that’s a managerial decision that we look at every day. If you see $55 hogs out there in the summer do you pay $55 hogs and you lock that in. I mean, certainly the incentive is there to do that but, that’s, you know all about where you think the markets are going to be and where we think the hogs are going to be next summer so it’s an area we’re looking at, I’ll tell you that.

Jonathan P. Feeney – Wachovia Securities

Well, I just remembered back in, I think, it was 2004 when we had a great, great summer for hogs and corn was cheap and basically all the animals were modeling these huge, huge quarters for you guys and it turned out you sold hogs a little bit forward earlier than some of us counted on and I guess, the mentality was it sounded like you had a certain bogie in your head that you thought was a good return on your capital and if you got to that spread level you’d say, “Boom we’ll hedge that out because that’s a good return to shareholders.” I mean, do you have that now? Not that you are going to disclose that but, do you have a number like that in your head?

C. Larry Pope

We do have a working number. Yes we do have a working number in our head.

Jonathan P. Feeney – Wachovia Securities

That’s lower than infinity?

C. Larry Pope

What did you say?

Jonathan P. Feeney – Wachovia Securities

That’s lower than infinity. I was just joking.

C. Larry Pope

But, that number is different. That number is different in July than it is in November. You’re not going to make the same kind of return on hog raising, so you expect better returns in the summer than you do in the fall. So, our bogie is different depending on the season.

Jonathan P. Feeney – Wachovia Securities

Okay. I’m sorry. The only other follow up I had was on foreign currency. Could you walk us through that hit you took there. I assume we’re feeling a benefit in the European operations and that’s offsetting? How does that work.

C. Larry Pope

I will refer back to Cary.

Cary J. Dubois

Good morning Jonathon. Basically, the way we capitalize Romania is largely through hard currency debt or a considerable amount of the capital structure. And, as you’ve seen, the LEU took a hit against the Euro over the past quarter. So basically, this was a non cash hit, it was basically what we call a translation loss.

Jonathan P. Feeney – Wachovia Securities

Sure.

Cary J. Dubois

And, it’s important to remind you that last quarter we actually had a $17 million gain. Basically, we gave that all back this quarter.

Jonathan P. Feeney – Wachovia Securities

Okay. But, when you think holistically at looking at your European operations, I mean, presumably the reason that you chose to fund in Euro is probably because you have a huge, you know, long Euro exposure that is implicit in the business. So, is it fair to say, I guess, that you’re getting a translation gain on the income side with the European profits you’re making?

Cary J. Dubois

I think that’s fairly to say. I mean, clearly, all you need is another quarter like we had in the first quarter and all of this would come rolling back. Obviously, as the exposure grows there we will investigation the use of various tools that we can use to actually dampen this volatility. There are things that we can do so, as this exposure continues to grow, it is something that we are very sensitive to and will manage accordingly on a going forward basis.

Jonathan P. Feeney – Wachovia Securities

Okay. Thank you very much.

Cary J. Dubois

You’re welcome.

Jerry Hostetter

Next question operator?

Operator

Yes, the following question comes from the line of Oliver Wood with Stifel Nicolaus. Please proceed with your question.

Oliver E. Wood – Stifel Nicolaus & Company, Inc.

Great. Thanks a lot for taking my question. I was just wondering, future charges related to the [inaudible] in Romania, if any. Last quarter you gave us some guidance. We were just wondering if you could give us a sense of some sort of charge we could expect in the fiscal third quarter and also how long these charges are expected to last.

Jerry Hostetter

I think I can report to you that what you would term are charges you probably, unless I’m mistaken, I’m looking at Cary when I say that, don’t believe that we’re going to have any charges in terms of reported charges. We believe that they Romania Swine Fever issues, the cleanup is behind us so we are back to “normal” operations except that we are under utilizing the asset. So, what we’re going to have is an opportunity loss. You won’t see any charges actually coming through as a result of that.

Oliver E. Wood – Stifel Nicolaus & Company, Inc.

I got you. Alright. Thank you.

Operator

Our following question comes from the line of Ann Gurkin from Davenport. You can please proceed.

Ann H. Gurkin – Davenport & Co. of Virginia, Inc.

Good morning. To continue on with Romania, what are you running now in terms of hogs processed per day?

Jerry Hostetter

I think we’re running right at 2,000 per day which is 10,000 a week and that is what we were, we were actually hoping that at this time originally that we might be up to 14,000. But, 10,000 is about what we were running three or four months ago and so, the break in Swine Fever has not had the impact that you might think. It is not that we’re not running hogs, its not like the plant is empty, although we had two weeks there in this quarter, well I guess that’s sort of in this quarter that we did not have anything going through the plant and that’s coming through the P&L. We’re running 10,000 hogs a week through that plant. We had hoped we would have these other farms online and fully operational by now and we would be up, ramping up to 14,000 by now. We have just not been able to do that. So, we are still running at the levels that we were running in the Spring. We’re not running big losses, we’re not running big losses on the processing side of the business there. That’s not where the losses are happening. They are happening on the hog side not on the processing side.

Ann H. Gurkin – Davenport & Co. of Virginia, Inc.

Okay. And then, the export market can I just get an update on ham sales to Mexico?

Jerry Hostetter

Ham Mexico business is, our Mexico business is up a couple of percentage points for the year. But, Mexico is not the big, big markets. The solid market growth, a lot of its our fault, in terms of hams, we’re not a big exporter of hams. The industry is but, we’re not. We’re not a big exporter because we don’t have the hams to export. We use those hams ourselves or, those hams go to the EAU now which is a better market for us.

Ann H. Gurkin – Davenport & Co. of Virginia, Inc.

Sounds great, sounds great. Thank you very much.

Jerry Hostetter

Next question operator.

Operator

Our following question comes from the line of Zafar Nazim with JP Morgan. Please proceed with your question.

Zafar Nazim – JP Morgan

Yes, I have a couple of questions for you, okay. First, the [inaudible] number you mentioned for the [inaudible] of 725 is there pro forma for a full year of Premium Standard Farm’s earnings?

Cary J. Dubois

No, this is an actual number.

Zafar Nazim – JP Morgan

Okay. And then, second on the equity earnings from the joint ventures you have in place, can you just tell us how much of this is actually just now turned into cash?

Cary J. Dubois

For most of our joint ventures the way that the earning has been put in place we have [inaudible] dividend blockers on most of that to the extent that the businesses generate cash we pursue to reduce the debit levels in those businesses. So, we currently are not pulling any cash out of those businesses.

Zafar Nazim – JP Morgan

Okay. That’s it for me. Thank you.

Operator

Our following question comes from the line of Reza Vahabzadeh from Lehman Brothers, please proceed.

Reza Vahabzadeh - Lehman Brothers, Inc.

Good morning. Cary, on the debt levels, is it exactly $3.7 billion? I’m just trying to get it exact.

Cary J. Dubois

That’s correct. That would be it.

Reza Vahabzadeh - Lehman Brothers, Inc.

And did you have any cash on hand as well?

Cary J. Dubois

Very little cash. We had about $80 million of cash at the end of the quarter.

Reza Vahabzadeh - Lehman Brothers, Inc.

Okay.

Cary J. Dubois

With additional cash, you know, held up in the various businesses.

Reza Vahabzadeh - Lehman Brothers, Inc.

Okay. Then, as far as raising costs is concerned on the hog production business, how should we think about that? Should it be sequentially flat, or up going forward net of hedging?

C. Larry Pope

I think you’re going to be somewhere, as I said in my comments, somewhere, I don’t think today our costs are going to get much below $47, I don’t think they’re going to end up getting much above $50 and I think we’re going to trade in that $48-$49 $47.50 to $59 range.

Reza Vahabzadeh - Lehman Brothers, Inc.

Right. Then, last question for Cary. Cap ex for the year so, $400, $420?

Cary J. Dubois

We’re still managing, trying to mange that number.

Reza Vahabzadeh - Lehman Brothers, Inc.

Is there kind of a range?

Cary J. Dubois

I mean what you’re seeing is $425 million going through the quarter. Obviously, there was some pent up demand there in terms of cap ex that had already been approved, for example, six months prior. You’re seeing that come through. We have slowed the pace of investments given what’s happen to the hog markets. So, we are watching that very carefully, we will do our best to try to manage that number.

Reza Vahabzadeh - Lehman Brothers, Inc.

Thank you much.

Cary J. Dubois

You’re welcome.

Operator

Our following question comes from the line of Heather Jones. Please proceed with your question.

Heather L. Jones – BB&T Capital Markets

Thanks. Good morning. I had a quick question on the SX, so is that essentially balance sheet translation gains or losses quarter-to-quarter?

Cary J. Dubois

No they’re not. We were required to flow them through the P&L given how they were booked locally.

Heather L. Jones – BB&T Capital Markets

Right.

Cary J. Dubois

But again, they were non cash items. It’s just the fact that with the weakening currency their, basically their debt liability, to that extent it would be balance sheet but the debt liability was perceived as growth, that is correct.

Heather L. Jones – BB&T Capital Markets

Right. So, the balance sheet changed locally and it has to flow through the P&L?

Cary J. Dubois

That is correct.

Heather L. Jones – BB&T Capital Markets

So, is this something until you make some structural changes over there, is this an impact whether it be a gain or a loss that we should see quarter to quarter?

Cary J. Dubois

I would not expect to see this on a quarter-to-quarter basis. I think you’ll continue, as we expand our investments overseas it will become an [inaudible] part of this business where you’ll continue to see some foreign currency fluctuations. What we will do is implement tools to try and dampen that the best we can. Again, we, as you know, most companies do not hedge their translation exposures and to the extent that a hedging tool would be used, we would actually be creating an economic exposure for the company where non basically exist today. So, we want to be careful. This was a translation it had nothing to do with payables or receivables, or it did not involve a settlement of any transactions.

Heather L. Jones – BB&T Capital Markets

Okay. Then, the following question on the hog production, roughly on the cash basis of $3.00 per 100 weight raising loss and that combined with the FX hit, estimate a pretty substantial cash loss for the quarter. And, so it just seems looking at prior quarters compared to this quarters that the hedging gain was more sizeable than normal and I was wondering if you could speak to that. And, I understand that you won’t give details on your hedging position but, if this was more sizeable than normal could we expect similar trends going forward? Or, if you could just give us some color as far as that goes.

C. Larry Pope

My comment that I would make to you is that hedging is an integral part of our business and has been for several, for many years not several years, many years. We use the commodities market as an integral part of this business. I think that is a part of the business that we do a very good job on. I think we have good insight into when to place hedges on the grains and when to place hedges on the hogs and I think those come flowing through the P&L. Certainly the timing, I can’t tell you. My guys at the markets move every day and it could be millions every day. But, I think you can expect that there will be hedging impacts on our hog production operations on a quarter-to-quarter basis. I think you could expect that and I think on a long term basis over a year or two years I think we can tell you those things are going to be positive. I think we do a better job of using those markets to our benefit and timing some of our buys and our pull with lock ins on prices.

Heather L. Jones – BB&T Capital Markets

Right. Okay. Thank you.

C. Larry Pope

I think our results will be better than the cash market will get.

Heather L. Jones – BB&T Capital Markets

Right. Right. Okay. Thanks.

C. Larry Pope

Uh-huh.

Operator

Our following question comes from the line of Brian Hunt with Wachovia. Please proceed.

Brian Hunt – Wachovia Securities

Yes, thank you. I was wondering if you could talk about what percentage of hams and other raw products that you’re purchasing externally today versus were you were a year ago prior to the Premium Standard acquisition?

C. Larry Pope

I don’t have a number off of the top of my head here. I’m trying to go through some math in my head. We’re probably only net buyers of 3, or 4, or 5% but, that’s enough. That’s enough. We’re using everything internally even including, even including the increase that Premium Standard Farms brought to us in May, our packaged meat business is absorbing all of that and I can tell you every week we’re out there buying 10, 20, 30 loads of either hams or bellies in the open market.

Brian Hunt – Wachovia Securities

Alright. Then the other question really has to do with some comments you made at your Annual Shareholders Meeting. I think it was mentioned in a transcript that you wanted to be investment grade, I was wondering if you could talk about over what time frame you would like to achieve that target and have you spoken to the agencies about target leverage points and other product measure to get there?

C. Larry Pope

I guess I don’t remember making that comment at the Shareholders Meeting. I’ll trust you listened to the transcript and I haven’t, so I’ll trust that. I think this industry, I think a number of people, maybe I made the comment that a number of buyers of the bonds, that when we issue bonds, the number of investment grade holders dropped down and what I called improved their yield on the coupon and buy our bonds because they treat us as if we were investment grade. We are not investment grade and I can tell you that the rating agencies have a negative opinion because of the volatility of the industry, they have a negative slant towards this industry in terms of rating. I do note, now let me turn my attention to how I think the related question you were at. We do have an awful lot of debt on the books and the $3.7 billion that Cary made reference to a couple of times here. We would like to see, we’re at 56% today, we’d like to see that number closer, certainly closer to 50% and actually into the 40s. I’ve made that comment a number times, I’d like to be in the 40s, not in the 30s, in the 40s because debt is an important mark of giving returns to shareholders. But, we need to, we probably need to, we’re working towards controlling cap ex and moving these debt levels back down to a level that is more acceptable to us. But, I don’t believe that, let me tell you, I don’t believe that even getting to that level, I don’t believe is going to get us to investment grade.

Brian Hunt – Wachovia Securities

And, is that going to be a function of generating free cash and paying down debt, or growing cash flow?

C. Larry Pope

Well, we’ve got to grow cash flow and we’ve done an awful lot with cap ex and I think you’re going to see, I think we already are seeing that our cap ex levels are moderating.

Brian Hunt – Wachovia Securities

Alright. Thank you for your time.

C. Larry Pope

Uh-huh.

Operator

Our next question comes from the line of Edgar Roesch with Banc of American Securities. Please proceed with your question.

Edgar Roesch – Banc of America Securities, LLC

Good morning.

Cary J. Dubois

Good morning.

C. Larry Pope

Good morning.

Edgar Roesch – Banc of America Securities, LLC

Just curious if you can give us some visibility because, some of this increase in the supply of hogs is coming from getting your arms around the Circo Virus. What is the timing or when that would start to flatten out on a year-to-year basis?

C. Larry Pope

Flatten out meaning that the production levels at the farms are approaching the same, returning to more normal levels? I’m not sure I know what you mean.

Edgar Roesch – Banc of America Securities, LLC

Yeah. And so that we’re not comparing to production levels that were hampered by the Circo Virus.

C. Larry Pope

I think we are rapidly moving towards that as we speak and you don’t even hear any reference, to me, the Circo Virus in this conversation today at all.

Edgar Roesch – Banc of America Securities, LLC

Okay.

C. Larry Pope

[Inaudible] first quarter we thought we had the vaccine, we thought we had the disease under control and we do and that issue is becoming lesser and lesser to us so it is dropping off the radar screen.

Edgar Roesch – Banc of America Securities, LLC

But you’re still, correct me if I’m wrong but, you’re still comparing to quarters last year where you had a significant negative impact.

C. Larry Pope

Yes, we are.

Edgar Roesch – Banc of America Securities, LLC

Okay.

C. Larry Pope

Yes we are. And now, probably a couple of more quarters, it’s really this first quarter when we started to catch the number back up. So, we’ve still got two more quarters, third quarter and fourth quarter we’ll continue to be comparing to down quarters.

Edgar Roesch – Banc of America Securities, LLC

Great. Thank you. A follow up question if I could on, you know, you’re talking, thinking about Smithfield more as a marketing company and I was just wondering – obviously, you’re getting a great mix shift as you’re switching to more packaged meats. You know, can you speak to the performance of your brands at retail and also how you’re doing at food service? Do you feel good about the brand strength and are you gaining share or is it currently sort of carving out more profitable niches under the sales umbrella that you have?

C. Larry Pope

Well, I think I would tell you that our food services is excellent. That’s an area of the business that is just excellent. I think that the marketing efforts on our brands, we are focusing on the brands and in some of the branded categories we are gaining market share. While we are gaining, as well, what we are doing which is equally important is being more disciplined in our use of our available capacity. And I can’t, I’m glad you asked the question because that’s the part of the business that no one every focuses on and I keep telling in all of my investor presentations that it is a giant piece of our business and it fuels the P&L that no one ever pays any attention to and I think if you look at our earnings for the quarter you see where the earnings are coming from. They’re coming out of that end of the business yet, everyone always focuses on what corn prices are and what hog prices are. They forget the $63 million we made largely in the packaged meat business and that’s becoming more of a pulled business. Yes, we still have push attached to that but, the product shift is very good and very encouraging to me. Our brands are gaining strength, significant strength. You can look at the Neilson data that is out there and that’s a very powerful engine to this company and it doesn’t seem to get much traction with investors. Hopefully, I’ll live long enough to convince you guys that we know something about the packaged meat business.

Edgar Roesch – Banc of America Securities, LLC

Sounds good. Thank you.

Jerry Hostetter

Our hour is up now and Larry did you want to make some closing remarks?

C. Larry Pope

Well, I do Jerry. I think the business, certainly we went through a quarter here where the earnings are down compared to the prior quarter and the hog profitable of raising hogs has fallen off for the quarter. If the markets are right, that’s going to return and we have got this business in almost every segment of the business, we’ve got this business positioned competitively very, very strong. Whether I talk about the beef business, the international business, the hog raising business, particularly our packaged meat business and even our fresh meat business. We are focused on the bottom line of this company and we are focusing on weathering these down turns in the market. Most are lamenting the fact that the beef business is crappy and the fresh meat business and our costs are up. We are controlling those costs. We are expanding our margins even as these markets are against us. Our beef business, very competitive. Our hog production business, very competitive. Our market insight that we use the commodities market [inaudible]. This is a very solid business and so I leave you with a comment that the quarter overall is a bit disappointing for all of us but, it’s got all of these currency fluctuations in there. It’s got a Classical Swine Fever charge in there in Romania. As I look into the third quarter things are in excellent shape for this business. Our export business is in excellent shape, our packaged meat business is in excellent shape and so I am extremely encouraged by the business in spite of reporting a number that is $0.14 versus $0.41 last year. So, I hope when I report to you in February that you’ll be pleasantly surprised by where our results come out. But, trust us in saying that I think this business is on very solid ground and the controls that we have over the business that we can manage in this are well in hand. Thank you Jerry.

Jerry Hostetter

Thanks Larry and thank all of you for your interest today. Have a good day.

Operator

Ladies and gentlemen that does conclude our conference call for today. We do thank you for your participation and ask that you please disconnect your lines.

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