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

Nov.29.07 | About: Smithfield Foods (SFD)

Smithfield Foods, Inc. (NYSE: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 AmericaSecurities, LLC

Operator

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

Jerry Hostetter

Good morning. Welcometo a conference call to discuss Smithfield Foods fiscal second quarterresults. We’d like to caution you todaythat in today’s call there may be forward looking statements within the meaningof federal securities law. In light of the risks and uncertainties involved weencourage you to read the forward looking section of the Smithfield Foods Form10K for fiscal 2007. You can access the10K and our press release on our website at www.SmithfieldFoods.com. I’d like to cover one administrativedetail. We’d like to provide theopportunity to as many analysts as possible to ask questions. As a courtesy we request that only one followup question be asked so that everyone can participate. Thank you.

With us today are Cary Dubois, Chief Financial Officer; RichPoulson, Executive Vice President; Larry Pope, President and Chief ExecutiveOfficer and Joe Luter, Chairman. This is Jerry Hostetter, Head of InvestorRelations. Larry Pope will begin ourpresentation with a review of operations. Larry.

C. Larry Pope

Thank you Jerry. Goodmorning everybody. Thank you for joiningthe call. I’m pleased to report thismorning second quarter earnings income from continuing operations of $18.7 millionor $0.14 a share compared with $46.4 million or $0.41 a share in the samequarter last year. As you can see fromthe 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 ofour earnings release where we pointed out that our second quarter resultsincluded charges which we previously had announced related to the ClassicalSwine Fever inventory reduction in our Romania operations which resulted in a$13 million after tax charge as well as we have had substantial foreigncurrency reevaluation charges during the quarter that are also being reflectedand they total $0.28 a share. We onlyreport, we’ve been reporting both positive and negatives there and we realizethat is part of our ongoing operations as far as foreign currency exchangegains and losses but, we feel an obligation to report that to you.

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

The losses and reduction, sorry not loss but the reductionin the operating profit on the grazing side was largely offset in porkprocessing. That part of the business Iam extremely pleased with and was extremely pleased with our firstquarter. Fresh pork during the quarterwas marginal these results from $22 million up to $62 million for the quarterare mainly the result of strong improvements in our packaged meats business andI will talk about that in a minute or so after I work through thesegments. The beef business continues tobe marginal. I think you heard from someof our competition that-that end of the business is tough. There has been an increasing production levelby some of our competitors. I am pleasedto report that in spite of that we are still continuing to report positiveresults in our beef processing operation and DOW swipe profitability in cattleraising. If you might remember for thelast several quarters we’ve been reporting that we’ve had losses in our cattleraising operations both in what we own and through our Five Rivers Ranch CattleFeeding joint ventures cattle feeding operations. We’ve had very modest profits but the timeperiod 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 wecontinue to report some profitability there.

On the international front, that continues just to be a verygood story. Our group Smithfield JointVenture now more than a year in passing is very good. Our western European operations are verysolid. Our Polish operations haveturnaround very nicely. I hope you tooknote, we made an announcement during the quarter that one of our two executivevice presidents, Robert Manly has taken on responsibility for overseeing ourinternational operations. I think thatbusiness has got an awful lot of potential. Rob has an enormous amount of experience in the meat business and hisfocus 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 thesynergies between those operations as well as synergies between our Europeanoperations and the US. I am extremely pleased about that move and Ithink it’s a positive for this company. I think our international continues to have a lot of potential and Ithink for now about three straight quarters you have begun to see a bit ofthis.

Let me talk for a minute about the area I am most excitedabout and I pointed that out in our earnings release is our packaged meatsbusiness. This is an area that continuesto just show enormous promise and I think it’s a concentration of thecompany. All of our management teams arefocused on that end of the business. Westarted the initiative about three years ago of using our raw materialsinternally. We have officially completedthat process and are now opportunistically improving the margins of this end ofthe business. I had told you before thatI would rather be a smaller, more profitable company rather than a larger lessprofitable company. We are focusing onthat. If you see the numbers in ourpress release we point to some very big numbers in terms of some importantcategories in this company from precooked bacon which, is up over 100% for theyear, year-over-year yet that came from the Armour Eckrich acquisition part ofthat. Our smoked sausage business is upnearly 70%. Our ground sausage businessis up over 125% and even our cooked sausage is up nearly 25%. These ends of the businesses are just doingexcellent.

I can report to you that we have now owned the ArmourEckrich business for now a full year. There have been a number of people who have questioned whether or notthat acquisition was a good one. I canreport to you today that it was a very good one and it’s been a credit to ourearnings and it has positioned us in the package meat business with some brandname 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, weare very focused on managing our costs inside these plants. Our fixed overhead costs quarter-over-quarterthis quarter comparing to the same second quarter last year, I can report toyou 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 aremanaging our overhead costs to improve our efficiencies through these plantsand we are helping to offset all of those costs increases through some of ourstrategic sourcing and some of our manufacturing realignment processes.

We announced just recently the fact that we were closinganother Armour Eckrich plant in Luckton Texasand we were going to merge the operations from that under utilized facilityinto some of our other plants. We are doingthat as we speak and that will, once again, help shield some of these costspressure that we are felling in the business and I think that is going tobenefit us at the bottom line in terms of the margins on our packaged meats.

We’ve commented in the press release that we have someongoing marketing programs. Our programand our association with Food Network celebrity Paul Levine continues to bearfruit for us. We are very pleased withthat association with her now that it is just past a little over a year. As well as, we are rolling out some newproduct categories primarily related to the Armour Eckrich business that arereintroducing some product categories that I think have an awful lot ofpotential for us. One of the things thatwe’re striving to do as a company, I’ve said that to you many times, is that weare slowly moving towards a marketing company. We are moving away from this total commodity influence on our businessand allowing our brand names and our product categories to great more pull onthis 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 thatend of the business. That drove ourfirst quarter earnings, that’s driving our second quarter earnings and I’llspeak to the third quarter and going forward in a bit. As well, you should be aware our exportbusiness, I know the industry is experiencing some positive numbers on the exportside, I can report to you today that we are experiencing excellent numbers onthe export side of the business in a number of countries. So, that part of the business has helped movethis meat during the quarter when we’ve had these record kill numbers and youmay have noticed, or some of you may be aware that Smithfield actuallyprocessed hogs last Sunday, I guess that’s a week ago and we’re now debating ifwe would ever go to another Sunday kill. I think the last time there was a Sunday kill, I think, was nearly 10years ago. We did have a home, we didhave a home for the product, our demand for the product is very strong and weknow that we have these large levels coming at us so we made the decision torun on a Sunday which is relatively historic at two of our plants. So, the demand size of the business is verygood and the freezer stocks of the business speak a little bit to that issue.

Before I talk about the forward looking part of thebusiness, I’m going to turn it over to Cary Dubois and let Carey explain to yousome of the financial numbers I know that you’re interested in. And then, CaryI’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 highlightsit is worth noting a couple of points that will be helpful in yourquarter-over-quarter review of the financials. First, the second quarter of fiscal year 07 only included three weeks ofresults for the Armour Eckrich and the Butterball acquisitions. Additional, the acquisition of Premium StandardFarms was a post fiscal year 07 event and therefore the last year’s secondquarter will not have included any of those results.

Turning our attention to the income statement sales for thequarter were $3.5 billion or 24% higher than the $2.8 billion for the secondquarter last year. Sales were up acrossall of our business segments. The porksegment sales increased 28%, primarily from the Armour Eckrich and PremiumStandard Farms acquisitions. While the 33% increase in sale for the hogproduction segment was largely attributed to the farms acquired through thePremium Standard Farms transaction. Internationally, we were pleased to see sales volume increase in Polandand Romaniaexceeding 20% and 45% respectively. Aswe continue to build out their fresh and packaged meat platforms.

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

Operating profit was $88 million down 20% from the $110 milliona year ago. Key drivers for the quarterwere an earnings improvement of $40 million or 177% in pork and a more thanoffsetting loss of $59 billion in the hog production segment. As mentioned by Larry over 50% of the hogproduction loss resulted from foreign currency fluctuations and the impact ofClassical Swine Fever in Romania. In fact, the total foreign currency loss forthe quarter was $25 as previously mentioned and the inventory write down andthe clean up costs associated with the three disease affected farms in Romaniawas $13 million. This $38 million incharges and currency losses ultimately impacted the quarterly results by $0.28per 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 thequarter versus last year. On thetrialing 12 month basis [inaudible] was $725 million versus last year’strailing month number of $626 million. Interest expense increased $16 million over the same quarter lastyear. This increase was driven by anoverall increase in our debt level and relatively higher borrowing rates due tothe calendar year 2007 financial market conditions.

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

Taking a look at our balance sheet and cash flow statementcapital expenditures for the quarter were $125 million as compared to $70 ofdepreciation. Our debt level increasedby approximately $250 million in the quarter to $3.7 billion. Key uses for the capital were the continueinvestments and working capital needs in eastern Europe and our seasonalinventory build up in the United States. Our debt to total capitalization level is 56% versus 60% for the samequarter last year. We secured $100 millionin short term credit lines in October and recently increased our US Bankrevolver capacity by $75 million to provide adequate liquidity as move throughour peak inventory period. We currentlyhave over $450 million of available liquidity.

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

Jerry Hostetter

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

I can report to you today that our holiday ham season is, aswell, having a stellar year. Certainlythe 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 ourproduct categories in this third quarter and I anticipate a very strong resultfor certainly the November and December periods which are traditionally verygood on the processing side the business. I can report to you that they are excellent this year, we’ll have to seeafter the first of the year. Exports, asyou would expect, are very strong our exports were up for the quarter 29%, theindustry is up 10. We will continue tohave very good exports for the third quarter. I can’t speak as to how theindustry will be for that period but, I can tell you that our numbers will begood. Our exports are in a number ofcategories, certainly Chinais at the top of that but as well, we have done a nice job of exporting in theEU and I believe, I know Swift does have a plan that connects – we are largelythe 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 notessentially opened to the rest of the industry. The Russian markets are extremely good, the Japanese market is extremelygood and I anticipate the Japanese market continuing to be good through thethird quarter. So, that part of thebusiness is holding its own and carrying these heavy kills and we’ve got placesto 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 thefuture markets, they indicate they were going to continue to experience losseson our hog raising operations. Looking alittle bit farther by, February, the futures market is right we’ll be backabout break even in February and as we move into the final part of the fourthquarter and into the first quarter of fiscal 09, profitability of hogproduction looks to return. As many ofyou might know from the markets we’ve got $50 hog market in late spring earlysummer so that is our break even. Sowe’re probably going to get closer to the $50 market $4 corn. We are reporting $49 this quarter and I thinkthey 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, themarkets are, the markets are there and that should solidly be profitable.

The beef business is weak, will continue probably to beweak. I think we are very competitive in the industry so I think we will dobetter than the industry but we will be influenced by industry dynamics. The international side is very solid, I’mextremely satisfied with our western European and, as I said, our Polishoperations. Romaniais clearly the live production side of the business is we have these farms, notin 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 ourconcentration on product mix changes discussed in the press release, we arecontinuing that and that and our cost control with another plant closing, allthose lead me to be very optimistic on this packaged meat side of the business. We’ve got an initiative in place, ouroperating companies are executing against that in a strong way and that part ofthe business is continuing to move forward not just for a month and not justfor a quarter; that is a solid business direction and I think just moving usfather and farther way from this commodity discussion and the influence ofthese commodity markets everyday.

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

Question-and-Answer Session

Operator

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

Kenneth B. Zaslow –BMO Capital Markets – US

Thanks. Good morningeveryone.

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 talkabout a lot of cost savings programs. Iwas wondering what would it take for you to undergo a major cost restructuringafter given that you have these 20 or so operating divisions, 70 or so brands. It seems like it may unleash a lot more valueto shareholders if there’s a, you know, a rejiggering, and again, I know I’mthe outsider and I don’t know how to run the business. But, it just seems from an outsider’s pointof view there may be a lot of costs savings larger than these one or two plantclosings.

Jerry Hostetter

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

Now, the other side of that is we are looking up, we arelooking at the back side of the business and we are in the midst of thebeginning process of whether we should combine some of our accounts payable andpayroll processes and our IT process. But, we are very, very careful about thefront end of this and the other piece of that customers want first, second andthird level of a supplier and if we merge companies together we have a verygood change of loosing distribution as a result of that. By the customers putting us together andsimply reducing our distribution. So,you’re right it’s an easy question and I can understand why you make it and wedebate it. But, I think we always come back to, it costs us alittle bit of money by our structure but we believe we benefit more by beingcloser, more flexible to that customer and keeping those brand names alive inthe geographic areas they’re strong is worth the cost, more than the cost ofthe 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 saideverything was excellent, is there more to come in China?

Jerry Hostetter

I assumed it would be the first question and you made it thefirst question so, let me address Chinato the group. We made an announcement inthis quarter that we had a 60 million pound contract with Cotco which is a largestate owned trading company in China. Since that time we have been filling thatorder and most of it has been filled in this quarter. We’ve also used this as atime for relationship building and we have built up a very nice relationshipwith Cotco, as well as a very nice relationship with some parts of thegovernment. But, I need to be verycareful going forward in terms of confidentiality with customerrelationships. We do not disclose ourtransactions and our business with individual customers and so I’m not going tobe discussing with the general public our individual, I know there’s been a lotof 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 respectof the confidentiality of our relationship with our customers and they’ve askedfor that and I’m respecting that.

Now, with that being said, I think the business is verypromising in China. It’s a big market, it’s a huge marketrelative to the United States. I think there’s a solid demand there bothtoday and in particularly longer term. Ican report to you today that there is a six person inspection delegation fromChina in the United States and they are in the process of reinspecting – thefive plants that we cannot ship into China today they are in the process ofreinspecting those plants for reconsideration to reopen those plants asdesignated plants that can export into China and we will see how that goesduring 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 theability 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, theyare not going to change their mind, I don’t believe, in terms of theirdemand. We as a supplier can supplycustomers need and we are responding to that. I know it is somewhat controversial but, it’s an opportunity for us as acompany and when our customers ask us to provide products to them to theirspecifications we are going to do it if it makes sense in money for us to dothat.

I am planning a trip in the very near future to Chinawhich I think will be to continue to explore the business and to open moredoors. But, I must tell you that I amnot going to discuss any individual transactions. The only thing I would tell you is we reportthe quarter is going forward. I willreport to you upon how our exports are doing and how they’re doing by countryand I think that will give you some indication of how the business is going andI’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 ChristineMcCraken. Please proceed with yourquestion.

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 ofhogs we’d have this fall. The industryis experiencing now, pretty sizeable losses, rising feed costs. Do you think that now going into spring thatwe’ll see some herd liquidation? Or, doyou think, you know, with the profits that you mentioned by February orsomething and, you know, with a couple of years of good money in the bank thatproducers will continue to expand?

Jerry Hostetter

Christine, Mr. Luter may want to comment on this and I’llgive you my opinion here. Certainlyyou’re seeing some liquidation in Canada. I don’t think these producers are feelingmuch pain and what pain that they’ve felt has only been very short livedhere. They’ve made an awful lot of moneyand they’ve got an awful lot of money in their pockets. And, if you look at the futures market, ifthe futures market are right Christine, they’re going to be back in the blackhere pretty quick and they’re probably not much in the red from a cash flowstandpoint even today. So, I’m nothearing of any wholesale liquidations of live production in the United States. Now, we get some antidotal information from our banker friends and somepeople are talking about it, you know the numbers I don’t have any handle atall so I’m sure there are those who are highly leverage who’ve got debit toservice that maybe experienced this but, I’m not seeing any real big numbersthat 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 worldwill take up a lot of this increase production. We continue to be very optimistic of our export sales everywhere and Ithink 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 Iguess, slaughter capacity [inaudible] now, at the packing plant, we’re hittingup against kind of a ceiling and yet now Triumphs announced now that they’renot, they’re delaying their second plant. I’m just wondering if we continue to expand even at a slightly slowerspace, 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’llhave an expansion.

Jerry Hostetter

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

Joseph W. Luter

And, the kill levels will go down in the next two, threefull 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 Aslamwith Stephens Incorporated. Pleaseproceed 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, Ibelieve there are two city plants still running?

Jerry Hostetter

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

Farha Aslam –Stephens, Inc.

And do you anticipate kind of closing that second shift downcome 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 Idid say it was temporary but, we actually curtail that and it is not runningeven 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’reseeing there?

Jerry Hostetter

Our margins are not as strong as the numbers I saw onHormel. Part of that can be a bit oftiming, we are, the Butterball business is much more whole bird business andthe third quarter is going to see the benefit more so than the second quarter,the Hormel business is. And, obviouslythey’re seeing the big impact of the grains that’s affecting thatbusiness. I’m pleased that we are stillreporting positive numbers. I think thebusiness is good, I think the piece of that that is always troubling is thesehigher grain costs.

Farha Aslam –Stephens, Inc.

Okay. Great. Thank you very much.

Operator

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

Diane Geissler –Merrill Lynch\

Good morning. Can youhear me?

Jerry Hostetter

Good morning Diane.

Diane Geissler –Merrill Lynch\

Hi. If you could justcomment please on the extent to which hedging helped you in your hog productiongroup? You did talk about the benefitthere, if you could just give us some kind of quantification.

Jerry Hostetter

Diane, that is a very complicated question and my responseto that is going to be one you probably won’t like and I think I’ve made thatthe last two quarters. Diane, judge meon the numbers. Hedging between what wedo in forward buying grains, what we do in the commodities market, closing outcontracts, margin to markets, is so complex that we can’t get auditors to signoff on it. It is part of the raisingprocess so I’m only telling you it is part of our results and I don’t know if Ican actually give you a number that I could get all of our accountants to agreewhat the number is and finally, Ernst & Young wouldn’t sign off on it. So, I can tell you it was a positive numberbut, that’s part of our strategy. Wehave a multi leg strategy there. We buygrains 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 pressrelease would be the sod cash prices.

Jerry Hostetter

Yeah.

Christine L. McCraken– Cleveland Research Company

Then, any differential we should assume is either on forwardsales 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 youhave 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 thefuture. We don’t have, we don’troutinely have hog hedges quite as far out in the future.

Christine L. McCraken– Cleveland Research Company

Okay. So anycommentary you would have made earlier in the call about what you expected livehog versus raising costs would have been spot based?

Jerry Hostetter

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

Christine L. McCraken– Cleveland Research Company

Okay. Alright. Iappreciate the comments. Thank you.

Jerry Hostetter

Thanks Diane.

Operator

Our following question comes from the line of JonathanFeeney with Wachovia. Please proceedwith your question.

Jonathan P. Feeney –Wachovia Securities

Great. Goodmorning. Thank you. I guess, just following up a little bit onDiane’s question Larry, looking forward, I guess this is somewhat of an unusualsituation in that we had such bad fundamentals in the spot market right now butsome really attractive spreads between what appears to be corn costs andoverall costs and hog prices in the future. I know you’re not going to talk about the level at which your hedgingbut, does that entice you to accelerate your forward selling of hogs and buyingof corn right now? What’s your sort ofphilosophy about that spread going forward?

C. Larry Pope

I guess that’s a managerial decision that we look at everyday. If you see $55 hogs out there in the summer do you pay $55 hogs and youlock that in. I mean, certainly theincentive is there to do that but, that’s, you know all about where you thinkthe markets are going to be and where we think the hogs are going to be nextsummer 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 weremodeling these huge, huge quarters for you guys and it turned out you sold hogsa little bit forward earlier than some of us counted on and I guess, thementality was it sounded like you had a certain bogie in your head that youthought was a good return on your capital and if you got to that spread levelyou’d say, “Boom we’ll hedge that out because that’s a good return toshareholders.” I mean, do you have thatnow? Not that you are going to disclosethat 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 isin November. You’re not going to makethe same kind of return on hog raising, so you expect better returns in thesummer than you do in the fall. So, ourbogie is different depending on the season.

Jonathan P. Feeney –Wachovia Securities

Okay. I’m sorry. The only other follow up I had was on foreigncurrency. Could you walk us through thathit you took there. I assume we’refeeling 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 Romaniais largely through hard currency debt or a considerable amount of the capitalstructure. And, as you’ve seen, the LEUtook a hit against the Euro over the past quarter. So basically, this was a non cash hit, it wasbasically 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 weactually had a $17 million gain. Basically, we gave that all back this quarter.

Jonathan P. Feeney –Wachovia Securities

Okay. But, when youthink holistically at looking at your European operations, I mean, presumablythe 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’regetting a translation gain on the income side with the European profits you’remaking?

Cary J. Dubois

I think that’s fairly to say. I mean, clearly, all you need is anotherquarter like we had in the first quarter and all of this would come rollingback. Obviously, as the exposure growsthere we will investigation the use of various tools that we can use toactually dampen this volatility. Thereare things that we can do so, as this exposure continues to grow, it issomething that we are very sensitive to and will manage accordingly on a goingforward basis.

Jonathan P. Feeney –Wachovia Securities

Okay. Thank you verymuch.

Cary J. Dubois

You’re welcome.

Jerry Hostetter

Next question operator?

Operator

Yes, the following question comes from the line of OliverWood with Stifel Nicolaus. Pleaseproceed with your question.

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

Great. Thanks a lotfor taking my question. I was justwondering, 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 ofcharge we could expect in the fiscal third quarter and also how long thesecharges are expected to last.

Jerry Hostetter

I think I can report to you that what you would term arecharges 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 Feverissues, the cleanup is behind us so we are back to “normal” operations exceptthat we are under utilizing the asset. So, what we’re going to have is an opportunity loss. You won’t see any charges actually comingthrough 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 Gurkinfrom Davenport. You can please proceed.

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

Good morning. Tocontinue 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 10,000a week and that is what we were, we were actually hoping that at this timeoriginally that we might be up to 14,000. But, 10,000 is about what we were running three or four months ago andso, the break in Swine Fever has not had the impact that you might think. It is not that we’re not running hogs, itsnot 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 goingthrough the plant and that’s coming through the P&L. We’re running 10,000hogs a week through that plant. We hadhoped we would have these other farms online and fully operational by now andwe 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 theSpring. 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 theprocessing side.

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

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

Jerry Hostetter

Ham Mexico businessis, our Mexicobusiness is up a couple of percentage points for the year. But, Mexicois not the big, big markets. The solidmarket growth, a lot of its our fault, in terms of hams, we’re not a bigexporter 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 goto 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 Nazimwith JP Morgan. Please proceed with yourquestion.

Zafar Nazim – JPMorgan

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

Cary J. Dubois

No, this is an actual number.

Zafar Nazim – JPMorgan

Okay. And then,second on the equity earnings from the joint ventures you have in place, canyou 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 hasbeen put in place we have [inaudible] dividend blockers on most of that to theextent that the businesses generate cash we pursue to reduce the debit levelsin those businesses. So, we currentlyare not pulling any cash out of those businesses.

Zafar Nazim – JPMorgan

Okay. That’s it forme. Thank you.

Operator

Our following question comes from the line of RezaVahabzadeh 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. Thatwould be it.

Reza Vahabzadeh -Lehman Brothers, Inc.

And did you have any cash on hand as well?

Cary J. Dubois

Very little cash. Wehad 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 variousbusinesses.

Reza Vahabzadeh -Lehman Brothers, Inc.

Okay. Then, as far asraising costs is concerned on the hog production business, how should we thinkabout that? Should it be sequentiallyflat, or up going forward net of hedging?

C. Larry Pope

I think you’re going to be somewhere, as I said in mycomments, 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 thinkwe’re going to trade in that $48-$49 $47.50 to $59 range.

Reza Vahabzadeh -Lehman Brothers, Inc.

Right. Then, lastquestion 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 thequarter. Obviously, there was some pentup demand there in terms of cap ex that had already been approved, for example,six months prior. You’re seeing that comethrough. We have slowed the pace ofinvestments given what’s happen to the hog markets. So, we are watching that very carefully, wewill 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 HeatherJones. Please proceed with yourquestion.

Heather L. Jones – BB&T Capital Markets

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

Cary J. Dubois

No they’re not. Wewere required to flow them through the P&L given how they were bookedlocally.

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, basicallytheir debt liability, to that extent it would be balance sheet but the debtliability was perceived as growth, that is correct.

Heather L. Jones –BB&T Capital Markets

Right. So, thebalance 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 changesover there, is this an impact whether it be a gain or a loss that we should seequarter to quarter?

Cary J. Dubois

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

Heather L. Jones –BB&T Capital Markets

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

C. Larry Pope

My comment that I would make to you is that hedging is an integralpart of our business and has been for several, for many years not severalyears, many years. We use thecommodities market as an integral part of this business. I think that is a part of the business thatwe do a very good job on. I think wehave good insight into when to place hedges on the grains and when to placehedges 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 itcould be millions every day. But, Ithink you can expect that there will be hedging impacts on our hog productionoperations on a quarter-to-quarter basis. I think you could expect that and I think on a long term basis over ayear 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 thosemarkets to our benefit and timing some of our buys and our pull with lock inson 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 willget.

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 Huntwith Wachovia. Please proceed.

Brian Hunt – WachoviaSecurities

Yes, thank you. I waswondering if you could talk about what percentage of hams and other rawproducts that you’re purchasing externally today versus were you were a yearago 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 myhead. We’re probably only net buyers of3, or 4, or 5% but, that’s enough. That’s enough. We’re using everything internally even including, evenincluding the increase that Premium Standard Farms brought to us in May, ourpackaged meat business is absorbing all of that and I can tell you every weekwe’re out there buying 10, 20, 30 loads of either hams or bellies in the openmarket.

Brian Hunt – WachoviaSecurities

Alright. Then theother question really has to do with some comments you made at your AnnualShareholders Meeting. I think it wasmentioned in a transcript that you wanted to be investment grade, I waswondering if you could talk about over what time frame you would like toachieve that target and have you spoken to the agencies about target leveragepoints and other product measure to get there?

C. Larry Pope

I guess I don’t remember making that comment at theShareholders Meeting. I’ll trust you listenedto the transcript and I haven’t, so I’ll trust that. I think this industry, I think a number ofpeople, maybe I made the comment that a number of buyers of the bonds, thatwhen we issue bonds, the number of investment grade holders dropped down andwhat I called improved their yield on the coupon and buy our bonds because theytreat us as if we were investment grade. We are not investment grade and I can tell you that the rating agencieshave a negative opinion because of the volatility of the industry, they have anegative slant towards this industry in terms of rating. I do note, now let me turn my attention tohow 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 Carymade reference to a couple of times here. We would like to see, we’re at 56% today, we’d like to see that numbercloser, certainly closer to 50% and actually into the 40s. I’ve made that comment a number times, I’dlike to be in the 40s, not in the 30s, in the 40s because debt is an importantmark 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 downto a level that is more acceptable to us. But, I don’t believe that, let me tell you, I don’t believe that evengetting to that level, I don’t believe is going to get us to investment grade.

Brian Hunt – WachoviaSecurities

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

C. Larry Pope

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

Brian Hunt – WachoviaSecurities

Alright. Thank youfor your time.

C. Larry Pope

Uh-huh.

Operator

Our next question comes from the line of Edgar Roesch withBanc of American Securities. Pleaseproceed with your question.

Edgar Roesch – Bancof America Securities, LLC

Good morning.

Cary J. Dubois

Good morning.

C. Larry Pope

Good morning.

Edgar Roesch – Bancof 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 armsaround the Circo Virus. What is thetiming 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 farmsare approaching the same, returning to more normal levels? I’m not sure I know what you mean.

Edgar Roesch – Bancof America Securities, LLC

Yeah. And so thatwe’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 andyou don’t even hear any reference, to me, the Circo Virus in this conversationtoday at all.

Edgar Roesch – Bancof America Securities, LLC

Okay.

C. Larry Pope

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

Edgar Roesch – Bancof America Securities, LLC

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

C. Larry Pope

Yes, we are.

Edgar Roesch – Bancof 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 westarted to catch the number back up. So,we’ve still got two more quarters, third quarter and fourth quarter we’llcontinue to be comparing to down quarters.

Edgar Roesch – Bancof America Securities, LLC

Great. Thankyou. A follow up question if I could on,you know, you’re talking, thinking about Smithfield more as a marketing companyand I was just wondering – obviously, you’re getting a great mix shift asyou’re switching to more packaged meats. You know, can you speak to the performance of your brands at retail andalso how you’re doing at food service? Do you feel good about the brand strength and are you gaining share oris it currently sort of carving out more profitable niches under the salesumbrella 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 justexcellent. I think that the marketingefforts on our brands, we are focusing on the brands and in some of the brandedcategories we are gaining market share. While we are gaining, as well, what we are doing which is equallyimportant is being more disciplined in our use of our available capacity. And I can’t, I’m glad you asked the questionbecause that’s the part of the business that no one every focuses on and I keeptelling in all of my investor presentations that it is a giant piece of ourbusiness and it fuels the P&L that no one ever pays any attention to and Ithink if you look at our earnings for the quarter you see where the earningsare coming from. They’re coming out ofthat end of the business yet, everyone always focuses on what corn prices areand what hog prices are. They forget the$63 million we made largely in the packaged meat business and that’s becomingmore of a pulled business. Yes, we stillhave push attached to that but, the product shift is very good and veryencouraging to me. Our brands aregaining strength, significant strength. You can look at the Neilson data that is out there and that’s a verypowerful engine to this company and it doesn’t seem to get much traction withinvestors. Hopefully, I’ll live longenough to convince you guys that we know something about the packaged meatbusiness.

Edgar Roesch – Bancof America Securities, LLC

Sounds good. Thankyou.

Jerry Hostetter

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

C. Larry Pope

Well, I do Jerry. Ithink the business, certainly we went through a quarter here where the earningsare down compared to the prior quarter and the hog profitable of raising hogshas fallen off for the quarter. If themarkets are right, that’s going to return and we have got this business inalmost every segment of the business, we’ve got this business positionedcompetitively very, very strong. WhetherI talk about the beef business, the international business, the hog raisingbusiness, particularly our packaged meat business and even our fresh meatbusiness. We are focused on the bottomline of this company and we are focusing on weathering these down turns in themarket. Most are lamenting the fact thatthe beef business is crappy and the fresh meat business and our costs areup. We are controlling those costs. We are expanding our margins even as thesemarkets are against us. Our beefbusiness, very competitive. Our hogproduction business, very competitive. Our market insight that we use the commodities market [inaudible]. This is a very solid business and so I leaveyou with a comment that the quarter overall is a bit disappointing for all ofus but, it’s got all of these currency fluctuations in there. It’s got a Classical Swine Fever charge inthere in Romania. As I look into the third quarter things arein excellent shape for this business. Our export business is in excellent shape, our packaged meat business isin excellent shape and so I am extremely encouraged by the business in spite ofreporting a number that is $0.14 versus $0.41 last year. So, I hope when I report to you in Februarythat you’ll be pleasantly surprised by where our results come out. But, trust us in saying that I think thisbusiness is on very solid ground and the controls that we have over thebusiness that we can manage in this are well in hand. Thank you Jerry.

Jerry Hostetter

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

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!