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Smithfield Foods Inc. (NYSE:SFD)

Q4 2012 Earnings Call

June 14, 2012 9:00 am ET

Executives

Larry Pope – President, Chief Executive Officer

Bo Manly – Chief Financial Officer

Keira Lombardo – Vice President, Investor Relations, Corporate Communications

Analysts

Farha Aslam – Stephens Inc.

Christina McGlone – Deutsche Bank

Ken Goldman – JP Morgan

Ken Zaslow – Credit Suisse

Heather Jones- BB&T Capital Markets

Diane Geissler – Credit Agricole

Christine McCracken – Cleveland Research

Robert Moskow – Credit Suisse

Ryan Oksenhendler – Bank of America Merrill Lynch

Lindsay Drucker Mann – Goldman Sachs

Akshay Jagdale – Keybanc

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Smithfield Foods Fiscal 2012 Fourth Quarter Earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. [Operator instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Ms. Keira Lombardo. Please go ahead.

Keira Lombardo

Thank you. Good morning. Welcome to the conference call to discuss Smithfield Foods’ Fiscal 2012 Fourth Quarter and Full-Year Results. We would like to caution you that in today’s call there may be forward-looking statements within the meaning of federal securities laws. In light of the risks and uncertainties involves, we encourage you to read the forward-looking information section of the Company’s 10-K for fiscal year 2011. You can access the 10-K and our press release on our website at Smithfieldfoods.com.

On our call today are Larry Pope, President and CEO, and Bo Manly, CFO. This is Keira Lombardo, Vice President of Investor Relations. Larry will begin our call this morning with a review of operations, followed by Bo who will review the Company’s financial results. Then Larry will provide our outlook for the future, after which the line will be opened for questions.

Larry?

Larry Pope

Thank you very much, Keira. Welcome and good morning to all of you on the call. I’m pleased to report another very solid quarter, our fourth quarter of fiscal 2012. This morning we’re reporting 79.5 million or $0.49 a share compared with 98.4 million or $0.59 a share last year. For the year, we’re reporting 361 million or $2.21 versus 521 million or $3.12 last year.

I’m sure you took note of one adjustment affecting this quarter’s results, and Bo will probably speak to that more fully; but we are in the midst of resolving potentially some litigation and we are reversing some charges as a result of insurance settlements for $0.06 a share, so that favorably benefited the quarter. As well, there are some adjustments in last year’s numbers that I think we’ve made that clear in the press release.

This is the Company’s second-best year, second only to last year, so we have had two very good years for the Company and solid quarters, virtually every one of the last eight quarters. From a company and management standpoint, we think this company is in very good shape and in a solid position to deliver going forward.

This quarter, as you can see as you look through the numbers, is all about the pork complex. It’s a combination of both the farms and the fresh pork. Certainly those numbers were down a bit. We did see some weakness in the pork complex in the fourth quarter and it accelerated as we went through the quarter, particularly into March and into April, and as I’ll make in my outlook comments, it has continued into May. So that is really the story behind all of the results and the comparison between the prior year.

We believe pretty strongly that’s the result of some increased hog supplies during this period. Most of you know the hog supply has been up a couple of percentage points. There was some softness in demand, and that’s driven largely, we believe, due to retail spreads as we had this increased supply which kept live hog prices really in line with last year and below where we would have expected them to be. As our pricing went to the retailers, we were not able to see increased volume as we would have expected retail prices to come down; they did not. As such, we did not get the movement through the retail sector that we thought we would have gotten, and so that impacted our press pork results and kept our live hog prices lower than we would have expected.

That being said, some of that is reversing. Bo and I made some comments at the BMO conference that we saw some of that reversing in May. I’ll talk about that a little more in the outlook section, but the fact is it still continued even as we speak until this week to continue to be very soft.

You should be aware, and I hope you took note, of the export shipments. I know there’s a lot of concern out there in terms of what’s happening on the export fronts. The exports are very strong and very robust, and so that is not what’s driving this fresh pork complex and not what’s driving the hog complex. Exports in many countries – and it’s not just a China story or a Japan story or a Mexico story – our export business continues to be very good and I think I’ll make some good comments about that in the outlook section as well.

I think I feel like a bit of a broken record when I talk about packaged meats. It seems like every quarter I’m coming to you, telling you packaged meats had another quarter. Well, I guess I should tape-record the prior quarter and just keep playing it back, guys. This company continues to do extremely well on the packaged meat side of the business, and whether we have high raw materials or low raw materials, our sales and marketing organizations have strengthened dramatically and our programs are working with our retailers and our food service customers. You see the comparison between the quarter at 108 million operating profit compared to 80, and you see for the year even with lower overall results, our packaged meats business is up $50 million from 350 to $400 million, and we’re printing $0.16 a pound for the quarter and $0.15 for the year. We’re right at the very, very top.

I’m going to say it again more than once that I hope you took note that we are raising our guidance. A number of you have asked, have you given consideration to raising your guidance? The answer is yes, we have given consideration, and we believe that our packaged meats business is at the point that we can give you a little better assurance that the future in packaged meats is going to be better.

During this year, the Company has increased its marketing spend double-digits, in solid double-digits. We’ve added people and programs and media and marketing and advertising and promotion monies. That’s part of a strategy. We started a strategy some seven, eight or nine years ago to improve our margins in our packaged meats business. I think we’ve demonstrated we can do that. We are now wrapping that around into a consumer-based marketing program by adding the marketing people in place and then adding the programs to support that. That is taking hold. We are happy about the movement we’ve seen in our core brands. Our base business is flat, although our food service is up and our retail is down a bit. But the fact is our bacon business and our hot dog business is very solid and we’ve seen growth in the brands. That gives us a lot of comfort that this packaged meats business is where we want it to go, and I think as we go forward – you saw a statement, I don’t want to get too far ahead of myself, except to say I think there’s more good to come here and we are extremely pleased about that.

We are announcing this morning a share buyback new authorization of $250 million. I think you saw through the press release that we bought a total up through the fiscal year and after of about $240 million-some. The total of those two is nearly $500 million. We’ve bought back 7% of the Company’s outstanding stock, and part of that shows up in the income statement. We are a believer in this company. We are a believer in this stock, and I know there are some who are not. In fact, I think the Wall Street Journal this morning is referring to Smithfield as an out-of-date pork chop. Obviously, that gets sort of rocket fuel for me, and I think that we are just now beginning to deliver growth in an area which we’ve grown this packaged meats. If you can’t accept any volatility in this company, the maybe you ought to be someone who shouldn’t own the stock, and I can understand that. I think we’ve made a lot of progress in taking volatility out by building a huge base of packaged meats to this business, but I have not promised you that there will never be a rainy day. All we’ve got from my standpoint as I look across several years, all this is a blip on the radar screen because of few hogs over a warm winter came to market a little earlier in March and April.

Our outlook for the year is still darn good, so from my standpoint the Company is a buyer. We’ve been an aggressive buyer the whole year. We’ve been an aggressive buyer after the end of the fiscal year, and we’re announcing this morning that we’re a buyer again. I sort of think back to 2008, 2009 when the Company was having multi-hundred million dollar loss years. I think I could have won a lot of money off of a lot of investors in Smithfield if I told you we were going to make $750 million last year and $550 million. I think I could have made a lot of money in 2008, 2009 because our management team, we had a phrase that you must be present to win. We had a great plan, and in order to execute that plan we had to do some things financially to get there. We knew we had the plan in place and I feel very optimistic and comfortable today we’re delivering against that plan, so I hope the writer of the Wall Street Journal, I hope he writes another article a little bit down the road and let’s see if he has the same thing to say.

In terms of our buyback program, the Company has excellent liquidity. We’ve bought all this stock back. We’ve still got nearly $300 million in cash plus giant, a lot of credit borrowings. We will pay for this out of cash. We have increased our capital expenditures beyond depreciation. This past year, I think Bo is going to say, we spent some $50 million beyond depreciation, and we paid down $138 million worth of debt, so we are not sacrificing the business. Even with this buyback, we’re not sacrificing anything with this company in terms of our future potential. In fact, I’m committing more money to marketing and I’m committing more money to packaged meats, and I’m still very optimistic about an aggressive buyback.

With that being said, I think the business is in good shape, and Bo, why don’t you give them some color in terms of the numbers.

Bo Manly

Thank you, Larry. Good morning ladies and gentlemen. Smithfield’s fourth quarter net income was $80 million or $0.49 per diluted share compared to last year’s fourth quarter net income of 98 million and EPS of $0.59. Q4 margins in packaged meats were outstanding, but results late in the quarter fell below expectation in fresh meat and hog production which did not benefit from the normal seasonal spring price increases. Strong packaged meats results throughout fiscal 2012 led company performance to the second-best year in Smithfield Foods’ history, with net income of 361 million or $2.21 per diluted share. This compares to last year’s record income of 521 million and EPS of $3.12. Earnings and EPS of the full fiscal year include a number of noteworthy items mentioned in previous reports impacting performance for this year and last. When these items are applied, non-GAAP full-year adjusted EPS was $2.59, within 15% of last year’s record adjusted EPS of $3.03.

During the past two years, we have focused on reducing leverage and improving the strength of the balance sheet while reorganizing our manufacturing footprint and sales structure as well as shed non-core assets to make ourselves more competitive, customer focused and brand-centric. We repaid $138 million of bonds during fiscal 2012. At the same time, we focused on improving shareholder value through greater deployment of idle cash to buy back company stock. $79 million of stock purchases in the fourth quarter brought the total stock purchases in fiscal 2012 to 189 million. We’ve continued to buy over $52 million in stock since the beginning of Q1 as well. This brings the total share repurchase since the beginning of fiscal 2012 through yesterday to $242 million, 11.8 million shares, or 7% of total shares outstanding.

At the present time, we have just about blown through the two previous share buyback approvals totaling $250 million. As Larry reported, management believes the stock is undervalued at these prices, and yesterday the Board approved another $250 million buyback authorization.

Now for the details. Consolidated sales for fiscal 2012 fourth quarter were 3.2 billion, up 3% over the same period a year before. The quarter-over-quarter sales increase was driven by 9% higher fresh pork volume and 10% higher net live hog prices. On a full-year basis, higher meat values across the whole chain and incremental fresh pork volume drove sales to 13.1 billion, 7% higher than the prior year. Continuing strong export sales throughout the year helped spur 4% greater fresh pork sales tonnage.

Management is disappointed with the fourth quarter results, specifically fresh pork and hog production which pulled total Company fourth quarter gross profit down from 15% last year to 11% this past Q4 while gross profit results in packaged meats and international were improved quarter-over-quarter. Well, what happened? The normal seasonal improvement in cutout fresh pork results and lift to live hog prices and futures always seem just beyond our grasp. Great weather accelerated growth rates, increasing hog supplies which in turn pressured cutout values and live prices. Pink slime issues pulled down beef and pork trimming values and drug cutout values lower. $4 per gallon gas ripped dollars out of consumers’ pockets this spring, dampening overall demand in cutout. Retailers reduced pork feature activities, slowing sales tonnage but enhanced retail margins. All of this played some role.

On a full-year basis, total Company gross profit declined from 14% in fiscal 2011 to 12% in 2012. Lower fresh pork and hog production results hurt full-year margins while packaged meats’ full-year gross profit percentage held steady despite higher raw material costs. Coming off of last year’s record fresh pork operating profits, results remained historically strong for the full year at $8 per head, slightly above the normalized range but down compared to $15 per head in fiscal 2011. Lackluster domestic demand and slightly more industry volume pushed Q4 operating profits from $17 per head in last year’s fourth quarter to $2 per head this year. This difficult business environment has continued into the beginning of the current quarter, but we are optimistic about demand. U.S. consumers have more disposable income thanks to lower gas prices. Grilling season has begun and we have lower supplies of beef and chicken competing in the market. Exports remain strong. Wholesale prices and live hog values have finally appreciated in recent days.

Exports continue to give us optimism for fresh pork results in fiscal 2013. Exports were a big part of the fresh pork success over the past two years. In fact, export volume year-over-year increased 24% in fiscal 2012. Yes, we had large carcass shipments last fall and winter, but our fourth quarter exports increased 13% with little or no carcass activity. The first five weeks of Q1 showed an 8% gain as well. Year-over-year comps will begin to ramp up in Q4, but they are not entirely out of reach as our base export business has grown and new markets have been very promising. Fresh pork will have challenges in the front of this fiscal year. We believe we will achieve a normalized range of $3 to $7 on a full-year basis, however.

Packaged meats operating results were the highlight of both fourth quarter and full-year. Quarterly operating margin grew from 5% to 7% year-over-year and total operating profits grew 36%. Profit per pound increased from $0.12 to $0.16. On a full-year basis, packaged meat operating profit grew 16% to 402 million, finishing the most recent year with an average of $0.15 profit per pound, at the high end of the normalized range. We continue to put a significant amount of resources to growing the volume and earnings of this business. We continue to increase map spending at double-digit rates. We have dramatically increased the ranks of packaged meats sales and marketing personnel domestically and internationally. We continue to invest in state-of-the-art efficient processing facilities and have significantly stepped up our new product development.

Two areas that are particularly satisfying in the packaged meats category – the strength of our core brands and pricing power. While volumes in Q4 were relatively flat, full-year results showed 2% growth in our core brands. We increased average sales prices and tweaked product mix, more than offsetting a 5% across the board year-over-year increase in cost of goods sold.

The trajectory and momentum we have generated in packaged meats gives us confidence to raise our expectations for a new higher normalized range for packaged meats to be between $0.12 to $0.17 net profit per pound, $0.02 higher than our previous range. We expect fiscal 2013 packaged meats operating profits to be in the top half of the new normal range.

The big packaged meats question mark is growth. We have expended significant resources the past year following pork restructuring to manage volume growth while building margins. Market headwinds and higher raw material costs did not enable us to successfully execute both growth and margin initiatives. While we increased total operating profits by boosting overall margins and volume of core brands, we have not yet grown total tonnage; however, we’re beginning to see a book of packaged meats business building in this first quarter and a new product pipeline that should translate to sustained year-over-year growth of 2 to 3%.

Hog production operating profits in Q4 were $6 per head when the proceeds from our Missouri settlement litigation are factored out, representing performance below the normalized range and compared to $21 per head in Q4 a year ago. Larger hog supplies and softer demand hurt live product margins. On a full-year basis, operating profits were, however, in the normalized range at $12 per head this year versus $14 per head in fiscal 2011. A full-year comparison reflects a $10 per hundredweight higher raising cost year-over-year to $64. We believe our hog raising cost at the beginning of fiscal 2013 will be in the mid-60s and begin to decline starting in the fall as cheaper post-harvest cash corn moves through our feeding complex. Cheaper corn will continue to decrease hog raising costs to the high 50s by next spring. Full-year fiscal 2013 raising costs should average in the low 60s.

The last week’s hog future strip would imply hog production operating profits for fiscal 2013 to be below the $10 floor of the normalized range. We have seen significant price appreciation in live hogs and meat in just this week, pushing profits back into the normalized range. If higher cash prices translate to the futures market, opportunities will exist to take risk out of the fall hog market and lock in hog raising margins in the normalized range for the full year.

International operating profits were modest at $19 million in the fourth quarter, but better compared to the same period a year ago. These improved results were led by large turnaround in Polish and Romanian hog production. For the full year, international results are below last year’s record by $34 million after adjustment is made for the $39 million charges taken earlier this year to reflect our share of Campofrio’s restructuring efforts.

In fiscal 2013, operating profit in the international segment will move to the high end of the normalized range – 50 to $125 million operating profit – based on anticipated higher profit in Animex and improved live hog prices in Europe and Mexico. The operating profit for the corporate segment for the quarter and full year are basically equivalent year-over-year if the impact of the $121 million Patrick Cudahy fire insurance recovery is factored into last year’s full-year results.

Q4 SG&A declined 3% year-over-year while a full-year comparison reflects a 27 million or 3% increase due in large part to issues related to the Missouri nuisance lawsuit. Interest expense decreased $9 million or 17% for the fourth quarter and 69 million or 28% full year compared to the same period a year ago. The decline in interest expense reflects the Company’s successful efforts to reduce leverage and interest expense. We anticipate interest expense for the full fiscal 2013 will total approximately $170 million.

Income from affiliates in the fourth quarter declined from $6 million to $1 million in fiscal ’12 due to reduced profitability in our Mexican swine joint ventures. On a full-year basis, we experienced a loss of $10 million in fiscal 2012 compared to a $50 million profit the prior year. Lower results in our Mexican JVs and the $39 million Campofrio restructuring charge are the causes for the year-over-year affiliate shortfall.

Our income tax rate in the recent fourth quarter was 29% while our full-year ETR was 32%. Taxes in the fourth quarter were beneficially impacted by resolution of outstanding R&D tax issues with the agency. We are presently forecasting our full-year fiscal 2013 effective tax rate to be between 32 and 34%.

A review of our year-end balance sheet reveals $324 million in cash and total liquidity, exceeding 1.4 billion. We continue to employ our strategy to use available cash flow to create return to shareholders through stock buybacks while we deleverage the balance sheet with bond retirements. In addition to the share buybacks last fiscal year, we retired 138 million of our bonds.

The new $250 million share buyback authorization reflects management’s continuing belief that stock repurchase is the best use of current cash on hand and excess operating cash flow over the coming months with no likely need to access short-term borrowings. We have no scheduled domestic debt maturities this year and have only nominal amounts of Polish debt to roll over during fiscal 2013.

Our credit metrics and ratings continued to improve throughout the year. At the end of fiscal 2012, our net debt to capital ratio was 31%, trailing 12 months interest coverage was about 6 times, and debt to adjusted EBITDA ratio was below 2. This is likely the strongest balance sheet in Company history.

Depreciation in fiscal 2012 was 243 million, and we believe this coming year depreciation will total about 245 million. Capital expenditures in fiscal 2012 totaled 291 million. We anticipate CAPEX of 300 million again this fiscal year.

In conclusion, Smithfield has finished the second-best year on record for fiscal 2012, and is poised for a strong fiscal 2013. We see this as a year of profitable packaged meats growth and we anticipate expansion of new customers in export markets for fresh pork. We will continue to lock in margins and control downside commodity risk in our hog production business. We look for solid livestock profits in Europe and improved meat business in Poland and Romania. We continue to enhance shareholder value and enterprise value with balance sheet discipline and our share repurchase program.

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

Larry Pope

Thank you, Bo. I think that was a pretty good report, and I think Bo gave a lot of color to the quarter and I appreciate that. As we look forward into fiscal 2013, I can tell you that I feel better about this business and the sustainability of the future of this company than I have in nearly 30 years. As I said, the changes and the fundamental base that we’ve built to this company, I think is extremely strong. As we look forward in terms of what the global hog supplies are going to be, there’s probably going to be a little bit more pork in the United States. We’re still looking for some declines all around the world in Europe or even in the Americas, with possibly the exception of China, and I’m not sure the data coming out of China, anyone knows whether it’s growing or shrinking. But the competitive landscape for our product, I think is going to be very good, and the proteins beyond pork, as you all are fully aware, are probably going to be down so that’s going to put pork in a competitive position relative to the other proteins in terms of demand.

I don’t see anyone in any kind of expansion outside of the U.S. is going to take that export business away from the United States, and so that should create an environment where exports should continue to be good and the U.S. dollar is going to continue to be good.

The big news for you looking forward is the packaged meats business Bo made reference to. I’m going to say that’s the focus of this company every day. Bo told you that we’re going to protect ourselves on the hog production side of the business where we can to protect margins. We’re not necessarily trying to maximize those margins, and I feel good today that the fresh pork complex is going to right itself back up and we’re going to have a solid fresh pork year within the normalized range.

So the big news is the packaged meats business going to continue to deliver? We think it is and we’re giving you guidance to raise your estimates. We’re going to continue to spend more money on marketing to support these brands, and we believe this year that we’re going to have growth in the volume end. We are going to be bringing forth new products, more than this company has brought in many a day. I think you’re going to see that and they are going to be well received, we believe, and they are going to have solid margins attached to them.

The issues we face on an export basis is what happens when we go around the track and we have to lap ourselves this fall? Well as Bo said, we’ll see. The export markets look good and we think there’s still a lot of export potential out there that has not yet shown itself.

The current quarter is a bit weak. We’re halfway through it and we’re certainly not as pleased with May as we wish we could have been, so you could have a bit of a weak first quarter here; but that’s not dampening our enthusiasm for the whole fiscal year, and as Bo said, we’re looking forward to an excellent year. I put all that in the final context of saying I’m prepared to put my money where my mouth is. We’re buying back stock on an aggressive basis. We’re authorizing a new $250 million which matches what we’ve already authorized in two separate authorizations this year, so Smithfield is prepared to buy the stock at this price. And beyond that, the compensation plan for the senior executives has also changed and a significant portion of the senior executive compensation within this company is tied to either the performance of this stock going forward or the growth of our packaged meats. The equity awards to our executives are tied to growing this business, focusing on the packaged meats part of the business, but delivering shareholder value to you. So I’m riding in the same boat you are and even more closely aligned with you than I ever have been, so this management team is focused on delivering shareholder value. We’re committed to doing it one way or the other. I think we’re going to do it through the business side on the growth and the margins; but if that doesn’t work, we’ll do it through the share repurchase program and we are actively there. We have the cash to do it and we believe Wall Street does not appreciate the changes that this company has made over the last several years. If you don’t appreciate it and are expecting no dips and no rainy days, then we’ll buy the shares back. We’re prepared to buy them.

So with that being said, Keira, we’re open for questions.

Keira Lombardo

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

Operator, please open the lines for questions.

Question and Answer Session

Operator

Thank you. [Operator instructions] The first question comes from the line of Farha Aslam. Please go ahead.

Farha Aslam – Stephens

Hi, good morning. Just a little more color on the hog production group in the first quarter. You’re now about halfway done. I believe you had had some hogs as well as grain. Could you provide more color on what you expect that EBIT per head for that first quarter as well as for—again, could you remind me what you’re expecting for the full year for 2013, and what needs to happen for you to get to your target level?

Larry Pope

I’ll take that. Bo will give you more color. Farha, I’ll tell you that I think we’re expecting our returns in the first quarter to be inside that normalized range, Bo, even given weakness in the first part of the quarter – is that right?

Bo Manly

That’s right. Farha, I think probably one of the disappointing things that I pointed out in my discussion was the lack of appreciation in cutout value and live prices that typically we see in the spring. I think that got postponed. We came into our May period, and frankly as I think your question points out, we had losses in hog production at the front end of this quarter. They have turned to positive over the past week and are well in the normalized range today. We think that there is upward potential as we move to the back half of this quarter for further appreciation and cutout. Obviously we’re looking for decreases in our hog production costs which would match up with the future strip to indicate frankly we’re just a few dollars away from being able to look at normalized margins on a hedgeable basis for the balance of the year. So we see further appreciation coming in both cutout and live prices over the short term, and that should give us some opportunities to take risk off the table, particularly for this fall as far as the hog markets are concerned.

Farha Aslam – Stephens

Okay, thank you.

Operator

The next comes from the line of Christina McGlone. Please go ahead.

Christina McGlone- Deutsche Bank

Good morning. My question is that it seems like we had gone through a period that we were in this kind of sweet spot in the pork complex where you saw basically prices high enough for everyone in the chain to make money. And now, it seems that we’re flipflopping between hog production group and fresh pork margins, so as the hog production group strengthens in the near term, it seems like fresh pork margins are deteriorating; and then if we look to the fall, fresh pork margins will get better but I think hog production margins could deteriorate on a spot basis. So I’m curious – what changed where both before could perform well and be profitable, and now it seems like a flipflop situation?

Larry Pope

Well Christina, I’ll take one point and Bo can answer his own. What you just outlined was what is called the seasonality of the hog business when traditionally the hog production side of the business does better than the meat processing side in the summer, and in the fall department you get the fall hog run, hog prices come down a bit, and the fresh cutout is usually pretty good, so that’s just the seasonality of the business. So I think the whole complex has come down a bit as we got more pork supplies coming to the market, and so that’s before—I think the last two years, we’ve had a little bit of a shortage in supply. We’ve got some of that filled back up at this point, but I don’t want to overplay this thing because I think we’re taking a three-month situation and extrapolating that into future events. We did have what we believe was some accelerated pull-forward on hogs in the spring, and Bo and I talked about a hole we thought was coming, and we saw a little bit of that in May. We’re seeing a fairly sizeable hole right now. The hog market is jumping up dramatically right now and plants are running short because they simply can’t get the hogs, even at $70. I think the hog market printed $71 last night, so—and the cutouts up to $89. So the meats responded as well, so I think—I’m not predicting the future because there’s volatility in this whole pork complex, but I’m simply saying the ship is righting itself as we speak right now, what we thought would have happened earlier than that.

Bo Manly

And I think, Christina, what you described in terms of the balance or the movement between hog production and fresh pork margins is one of the bases of the integrated model, that typically that will happen in a short-term relationship. But I guess your overall question is what has changed, and what allows the chain to make money at all parts of the system? I think you find when you have increases in demand, whether that’s domestic or international, that that’s the opportunity when the whole chain is able to make margin across the entire system because you’ve increased that spread between the price of meat and the price of corn. So those are the time periods when you see incremental improvements in demand; otherwise, I think you’re going to see, as we add hogs, take hogs out of the industry or the worldwide supplies, and as changes take place in slaughter capacity, you’ll probably see some margin moving back and forth between hog production and the packing plant. That’s one of the reasons why we’re building such a strong packaged meats base, is that that base will then give us the ability to weather any of the short-term volatility you may see between those two segments.

But overall, I think the best thing we’ve seen is the export growth really giving us another trade channel with which to spread out overall pork supplies, so all that is very positive and I think you’re seeing a normal reaction as we’ve added a few more hogs in the system in terms of bringing some pressure into the hog production and fresh meat complex. But I think as Larry points out, there are signs that overall demand is improving, both on an international basis as well as domestic.

Larry Pope

And Christina, I want to make one final point. One of the things that went out of whack here for the spring period was the spread between wholesale pricing and retail pricing. So even as we priced the product through, we didn’t see the retail reaction of that because the retailers widened their margins so you didn’t see the supply-demand impact that you would routinely see. Now that spread has fallen some to more normalized levels, and so the meat has moved up very nicely from that and things seem to be moving back a little bit more towards equilibrium.

Christina McGlone – Deutsche Bank

Thank you.

Operator

Next from the line of Ken Goldman. Please go ahead.

Ken Goldman – JP Morgan

Hi, good morning everyone. I’m curious about the percent of hogs you’re buying from local farms today versus a couple of years ago. It’s our understanding that some Carolina farmers, for example, have either shut down or moved to the midwest, and that may force companies like you to either buy more hogs from the midwest than you previously did, or increase your own sow production to supply some plants. I’m just curious if you can comment on this trend, whether it’s valid or not, and maybe whether along with a higher basis for feed, whether it renders North Carolina just a little bit less attractive than what it used to be. Not that you still can’t make a lot of money doing what you’re doing – you obviously can. I’m just curious if things have changed a little bit.

Larry Pope

Ken, I don’t—there hasn’t been much of a change in North Carolina. This has been a concentrated production area now for a number of years. The small producers have been gone for, my goodness, five, six, seven, 10 years I guess almost. There is a basis difference on grain, that’s for sure. On the east coast, there’s only a handful of producers who are 95% or maybe even higher than that of the production – not even a handful, I guess it may be five. But they are aligned essentially with Smithfield or Hatfield or Greenwood Packing Company. There isn’t much on the east coast – it is what it is. It does have a grain disadvantage to the midwest, but I don’t think I’ve seen any changes in the—

Bo Manly

Well I think, Larry, there may have been some of the independents that weren’t necessarily aligned with ourselves or some of the other packers that had historically sent pigs back to the midwest, that have wound up in financial difficulties two and three years ago, were assimilated by some of the other independents, the larger folks, that we did have relationships with. And they chose, because we said folks, we’ve got limited capacity here, to move some of those pigs to the midwest. So I think really what you’re just seeing is perhaps a change in ownership necessarily, but the same pig movement which is a little bit more visible because of who it is that’s shipping hogs back to the midwest.

Larry Pope

The only thing that we are doing, Ken, that you may have heard –we’re buying a few hogs out of the—not too far into the midwest, but a little bit with the hog production restructuring program we’re doing. But all of that is done now, essentially, and we’re restocking back now, so we’ll have increased supplies this fall. We expect to have more hogs on the east coast this fall.

Ken Goldman – JP Morgan

That’s very helpful. Thank you.

Operator

Next from the line of Ken Zaslow. Please go ahead.

Ken Zaslow – Credit Suisse

Hey, good morning everyone. So I guess my question is do you think that fiscal 2013 EPS will be vastly different than fiscal 2012, given the puts and takes throughout the division? And what evidence do you have or confidence do you have that fresh pork margins will improve?

Larry Pope

That sounded like you were asking for us to make a forecast, I think, Ken; but maybe I just didn’t understand you. And you know how difficult it is to predict that. I think we feel good about the packaged meats business – we’re raising guidance on that. We’re telling you there’s some volatility on the fresh pork and the hog production. From where we sit today, we think 2013 is going to be a good year, a very solid year. How about that? That’s about as far as I’m going to go, but I feel very good about this next year.

Ken Zaslow – Credit Suisse

And then what evidence do you have to actually give you confidence that fresh pork margins will improve sequentially throughout the year?

Larry Pope

Strong exports, $71 hog today, good programs with our retailers, and lower grain costs in the future, and a futures market that says that hog market’s going to be fine. And I guess beyond that, you’ve got chicken and beef that are going to be down significantly.

Bo Manly

And I think that there is also some optimism that the U.S. consumer may have some greater disposable income from less gasoline prices and improvement in the economy.

Larry Pope

I mean, if you look forward, the fundamentals are moving in our direction – less chicken, less beef, and lower grain should be pretty good for the pork business.

Ken Zaslow – Credit Suisse

So if pork is looking better, hogs you’re kind of locking in where you can, international is going to be at the high end, you’ve got share repurchases. Again, I’ll ask the same question I asked first – is there a reason that 2013 will be vastly different than 2012? I mean, the puts and takes, doesn’t seem like there’s a big difference.

Larry Pope

It looks good to me, Ken.

Ken Zaslow – Credit Suisse

Okay. Great, thank you.

Operator

Next from the line of Heather Jones. Please go ahead.

Heather Jones – BB&T Capital Markets

Good morning. I have a question on your packaged meats business. Given that you’re tying more of your—or you’re raising more of your normalized range and you’re tying more of your management incentives to its performance, was wondering if you could give us some better color on how you determine the transfer price as far as the raw input costs of packaged meat. Is there an industry standard that you use, or just if you could give us more color on how that rolls.

Larry Pope

We try to look at what we think we could buy the raw material on an FOB basis in, so I would tell you it’s what we would call market with the alternative market and what we think we could buy it for or we could sell it for, and so it’s a pretty clean cut there, Heather. I want to make one comment that I think is important, and it’s on packaged meats – we continue to think this packaged meats business is going to be better. We’re in the midst of building a new hot dog and sausage plant in North Carolina that we think is going to be a state-of-the-art and a food-safe plant that our customers as they hear about this, with the co-extrusion operations and such, I think it puts us in a superior competitive position a hot dog business that’s a very competitive business. I think that’s just how we’re investing in that business, but I wanted to say that because we didn’t say that as part of our comments. Our transfer prices are at market, so there’s no hidden agenda in terms of that at all.

Heather Jones – BB&T Capital Markets

So in a period of declining or weaker wholesale prices and retail prices tend to be stickier, then your retail packaged meats business should be better?

Larry Pope

Generally that’s right. Generally, that’s right.

Heather Jones – BB&T Capital Markets

Okay, thank you.

Operator

Next comes from the line of Diane Geissler. Please go ahead.

Diane Geissler – Credit Agricole

Morning. I just wanted to talk a little bit or ask a little bit about the decision within the Board regarding the share repos and your dividend policy. I know historically you’ve looked at yourself as a growth company and that would suggest no dividend; but for about half of what you’re reauthorizing for, you could institute a $0.75 dividend which in today’s share price would be about a 4% yield. So I guess I’m just curious about the decision-making process at the Board level on share repo versus dividends. Could you talk about that a little bit?

Larry Pope

I think today we look at where the stock is trading, Diane, at a seven multiple. That sort of does reverse to me and implies a 14% return, so we think the share repurchase is a better decision than a dividend. The Board has evaluated a number of times the option of declaring a dividend. We do feel better about the business and have active discussion at this point.

The other driving a dividend is we’re not sure what the future tax laws are going to be. You’re in the midst of a debate about how dividends are going to be taxed going forward, so we’d like more clarity on that and we think investing in a share buyback is a better decision for the shareholder today than declaring dividends which could impact our ratings with the credit agencies.

So it’s not overlooked; it’s not like we didn’t see it and haven’t talked about it. It’s just we think today, share repurchases are a better decision. We think it’s better for you.

Diane Geissler – Credit Agricole

Okay, thank you. If I could just—Bo, did you mention what you thought your interest expense would be for fiscal ’13? I may have missed it.

Bo Manly

Yes, I did. It should be about $170 million.

Diane Geissler – Credit Agricole

Okay, great.

Operator

Next from the line of Christine McCracken. Please go ahead.

Christine McCracken – Cleveland Research

Good morning. Just on your fresh pork margins, you talked about how the wide retail spreads are hurting your domestic demand, and I’m curious – given relatively high inventories in storage, or what appear to be high inventories of storage coming into this summer, how weak early summer demand was, can you talk about how this has changed given the relatively sizeable increase in pork prices we’ve seen here over the last week or so, and whether or not retail is going to shift pricing, promotional strategy over the balance of the summer?

Larry Pope

Christine, that was certainly more than one question. You loaded that one question with a lot.

Christine McCracken – Cleveland Research

Well, it really has to do with overall domestic demand. I mean, really, how is that going to improve if prices of pork are going up here pretty dramatically?

Larry Pope

Well, let me give you a little bit of color on cold storage. Remember that the opportunity to hedge bellies has gone away in the futures market, and last year these food service organizations got caught pretty short on this belly situation. So now in order to put a hedge away, to effect a hedge, you’ve got to do a physical hedge and put the bellies in storage, and we’ve still got programs with food service people in order to protect that margin. You have to literally put the bellies in the freezer to do that. And hams are up as well substantially – there’s a lot of export demand for those hams, and I suspect as you look forward to the next freezer reports, you’re going to see that ham inventory has dropped but they’re going out of the country. So the hams are leaving, the bellies are going to fill food service programs that are out there.

But I get your point – with the ham market moving up so much and the belly market is up to $1.14 and the loin market has moved up, are we going to see some retail resistance at those kinds of increased prices? The answer to that obviously should be yes. The only offset, and I’m not sure it’s a strong offset, is that retail prices were already relatively high from before because the lower prices didn’t translate into lower retail. So that’s a part we got—I hear your point. That’s the point we’ve got to manage, these retail price points, and make sure that this product continues to move through retail. That’s part of our challenge through the summer, and I hear you very clearly.

Christine McCracken – Cleveland Research

All right, I’ll leave it there. Thanks.

Operator

Next from the line of Robert Moskow. Please go ahead.

Robert Moskow – Credit Suisse

Hi, thank you. A couple of questions tied up in one. I notice that you processed 4% more hogs in the quarter; the industry processed 2%. If you’re having these issues at retail with demand being slow, why were your processing levels that high? Can you give us an outlook for fiscal ’13 on the number of heads you’re going to be processing? And I guess the second part of it is it’s curious to me that demand at retail was rather weak. You know, right now we have lower beef supply; right now we have lower chicken supply, so why wouldn’t the pork demand have benefited from that, and I guess why were retailers resistant to lowering their prices on pork to try to capitalize on it? Thanks.

Larry Pope

Robert, if they’re selling 9% less beef and they’re selling less chicken, they’re going to sell something to create the gross margins in the store, so they maintained the gross margins on the pork when they have pork prices being priced down from wholesale prices going down. One of the ways they can maintain margins in the store is to keep their pork prices at a margin level that can cover some of the shortfall in the volumes, and they’ve made decisions to take more margin and less volume. We’re seeing some of that.

So I don’t know if that answers the question, but certainly with higher pork prices you’re going to see demand impact, and they’re seeing higher beef prices and higher chicken prices and relatively high pork prices, but without more dollars coming in in their paychecks, something’s got to give so everybody is having to give on the volume side. I don’t know if I’ve answered your question, and maybe you want to ask it again.

Robert Moskow – Credit Suisse

Maybe I will. So I guess the outlook is supposed to be getting better here on fresh pork. I’m not quite sure what’s going to happen to make it get better, you know, Larry? Is it going to be—you mentioned several factors that hurt fresh pork. If you had to name one or two that’s really helping the margins get back to normalized, what would be the top two things?

Bo Manly

I’ll jump in. A couple of things, and I think I mentioned them earlier, was that we had issues in terms of demand that were impacted by pink slime. That hurt beef trimmings and hurt pork trimmings and took cutout values lower. We had very high gas prices, which have reacted and those are coming back to potentially put more dollars in the consumers’ pockets. So I think that there were things that hurt the cutout that were extraneous to our business or to our operations, and at the same time I think we’ve seen an improvement potentially in domestic demand from what consumers’ disposable income is.

Larry Pope

Well, I think the real simple high level is we’ve got less hogs now. Slaughter levels are down. We had slaughter levels up and $4 gas; we’ve now got slaughter levels down and $3.50 gas. There’s less meat available. Now there is less pork available, and you’ve seen in just very recent days—if you looked at the cutout, it jumped dramatically. As soon as the hole shows up on slaughter levels, you’ve got plants running four days a week. You’ve got people cutting back (inaudible). You’ve got Saturdays disappearing, which means the meat isn’t going to be there to be sold, and so there won’t be this heavy push from the packers into the retail. Meat won’t be there, so supply and demand will work. That’s routinely what happens. We thought it would have happened a month or so ago, and it didn’t. We’ll see whether this stays or not.

Robert Moskow – Credit Suisse

Because I was seeing a 5% increase in volume pounds on average in May. You’re saying that in June, there’s no longer any Saturday activity and the pounds are all going to be down in June?

Larry Pope

I am saying that, Rob.

Robert Moskow – Credit Suisse

Okay. That, to me, could be the biggest driver. Thank you very much.

Operator

Next from the line of Ryan Oksenhendler. Please go ahead.

Ryan Oksenhendler – Bank of America Merrill Lynch

Good morning guys. So in terms of fresh pork, going back to this, in terms of demand you’re seeing some weakness because retail price is still high. But as pork prices continue to go up as supplies decline, you expect to get back into a balance, where we were maybe six to 12 months ago because pork price—you know, you’re not seeing demand destruction because pork prices has peaked, right? You know, they could still go higher because they were. Is that true?

Larry Pope

Could you ask that question again? I’ll be honest with you – I’m not sure I understood it.

Ryan Oksenhendler – Bank of America Merrill Lynch

Everyone is concerned—you know, you’re saying (inaudible) supply so pork prices will go higher, particularly retail, so that’s going to impact—you know, how your margins are going to open up. But how prices have pulled back a little bit over the last few weeks, that pork prices can go back higher, because there is concern that beef prices got to almost $2 a pound, that prices couldn’t go any higher to offset higher cow prices.

Bo Manly

If you look at meat values, we’ve had significant appreciation in the past week, so I’m not quite sure when you talk about decreasing prices over the short term. We don’t see it – we see prices increasing.

Larry Pope

That’s right. I think you’re seeing something we’re not necessarily seeing.

Ryan Oksenhendler – Bank of America Merrill Lynch

I mean, I can follow up offline about that. But just in terms of your raising costs for next year, is that based off of the current futures prices, or is that based on your view that the grain markets move up or down based on the corn crop?

Bo Manly

It’s based on both of those. We have a position in terms of both physical commodities as well as futures, which lock in a certain portion of our raising costs; and then we look to the futures market in terms of the unbought position or the unhedged portion to make estimates as far as what the balance will be at that point in time. So it’s a combination of both.

Larry Pope

We’ve made the comment all along the way that we’ve been very protective in terms of the grain input costs into our raising complex, so we’ve had very strong hedging positions on corn and soybean meal that has benefited our cost and will benefit us in next fiscal year. We have remained on the very light side on hog in terms of selling the hogs, because we thought the futures market would yield a better profit as we moved forward; so obviously we’re looking at those markets today as they move in a direction as we thought they might. I think from our standpoint, we’ve protected the input costs. I think, Bo, we feel pretty good about our projections on the raising costs.

Bo Manly

We do, and at the same time we do have a little bit of window here. If corn prices continue to move down, we’ll buy in cheaper corn for the unbought portion of our position. So we’ve got the ability to move—

Larry Pope

To improve that future cost.

Bo Manly

Improve it - yes.

Larry Pope

That’s right.

Ryan Oksenhendler – Bank of America Merrill Lynch

Can you give us an idea of how much you have hedged for next year?

Bo Manly

We generally don’t do that.

Larry Pope

I would just tell you we’re more than 50%. It’s all I’ll tell you.

Ryan Oksenhendler – Bank of America Merrill Lynch

Thank you very much.

Operator

Next from the line of Lindsay Drucker Mann. Please go ahead.

Lindsay Drucker Mann – Goldman Sachs

Thanks, guys. I was just hoping you could give us your outlook for your own internal hog raising—you know, the hog production, pork production numbers, because I know that you’ve got your inventories and how many heads you expect to bring to market, but you also have your productivity program. So what’s your internal pork production forecast for fiscal ’13?

Bo Manly

We’re looking at about a 3 to 4% increase. Most of that will be coming from our east complex, although there will be some fractional improvement in the midwest as well.

Lindsay Drucker Mann – Goldman Sachs

And how much of that is heads versus weights versus just general productivity?

Bo Manly

That’s all heads, and that’s all productivity.

Lindsay Drucker Mann – Goldman Sachs

Okay, all heads – and that would include better litter count and that sort of thing?

Bo Manly

Well, we’re bringing back—actually, there were several farms that we had depopulated as part of the cost savings initiative, and those have been revitalized, refreshed. We’ve changed the pen gestation in those facilities, and now they are coming back online. So as Larry mentioned earlier, we were buying a few more pigs from the midwest to try and fill in those holes, but overall now from this point we should have quarter-over-quarter increases. We’re looking somewhere conceivably another 400,000 heads versus where we were this last year.

Larry Pope

And that’s really the cost improvement program. As we realigned those farms, you have to take farms down to retrofit them. Now the farms have essentially been retrofitted and we’ve got sows back in and all the pairings done, so we’ve simply got to get the pigs back up and that will start this fall.

Bo Manly

And they will come back with lower cost of production.

Larry Pope

They’ll come back with a lower cost of production – that’s right.

Lindsay Drucker Mann – Goldman Sachs

And the better productivity wouldn’t lead to higher weights, either?

Larry Pope

It could.

Bo Manly

That’s more a function of available finishing capacity, more so.

Lindsay Drucker Mann – Goldman Sachs

Okay, got you. And then just quickly – did you have any mark-to-market gains or losses in the quarter?

Bo Manly

Negligible.

Lindsay Drucker Mann – Goldman Sachs

Okay. Thanks.

Operator

Next from the line of Akshay Jagdale. Please go ahead.

Akshay Jagdale – Keybanc

Good morning. Thanks for taking the question. I just—again, I know you’ve gotten a lot of questions on fresh pork, but my questions are also regarding fresh. So Larry, you talked about supply of hogs changing in June, and that should positively impact the pork complex. But correct me if I’m wrong – as the supply of hogs has come down, the hog price has gone up and the cutout has also gone up, but not enough to sort of offset the increase in the hog price. So at the end of the day, the supply of hogs changing has yet to positively impact the cutout margin. Is that correct?

Larry Pope

Well, you just counted the pork complex as the meat business. Hog raising is part of the pork complex.

Akshay Jagdale – Keybanc

Sure, sure. Yeah.

Larry Pope

You forgot half the pork complex.

Akshay Jagdale – Keybanc

Correct. So on the hog production side, I clearly see that the profitability picture has improved quite a bit, especially in June; but in terms of fresh pork, because of the supply situation changing, the margins have yet to get better. So what I’m really trying to get at is for your fresh pork margins to get better from here on, it would have to come really from demand, correct?

Bo Manly

Yes.

Larry Pope

Yeah, I’d say that’s right.

Bo Manly

I’d say you’re right in that regard, and we are optimistic about domestic demand, Akshay, and we are also optimistic about exports. We’ve talked about the year-over-year comps that we’re going to have to try to bust through as we get to this fall, but as I mentioned, we have never been so excited about our base export business. We have grown that tremendously over the past year and a half and we have got more resources in the field. We are learning more and more about new markets and new opportunities in some of the emerging areas – Colombia, Panama, et cetera – that are having positive traction in terms of volume. So yeah, we had big carcass movements last fall but we’re pretty optimistic that we’re within reach of being able to hit those benchmarks again, even without a carcass opportunity.

Akshay Jagdale – Keybanc

And just on follow-up, in terms of exports being strong, obviously we see the data from the USDA with the lag, but what I was really curious about is why haven’t we seen ham prices as a whole – bone-in and boneless together – be stronger than they have been because exports have been stronger and ham prices have been pretty weak, and so have bellies, which has sort of really been an enigma to me given what you’re saying about export demand and also—you know, retail demand is weak, but that should impact the hams. You’re exporting a lot of them, so why are ham prices weak if exports have been so strong?

Bo Manly

Akshay, the export ham market is dominated by our business with Mexico, our industry’s business with Mexico and our own. That, frankly, fluctuates tremendously based upon their markets down there, based upon what the U.S. ham market is.

Larry Pope

And you’ve got an exchange rate in Mexico that’s 14 pesos—

Bo Manly

That’s right, and that has hurt that dramatically, and so I think if we can get the Mexican exchange rate back into line, that their demand should pick up. I won’t say that’s the only secret to success in the ham business, but it is a huge factor. And I think Larry has talked about the belly business here and what we think will happen there, but we’re very optimistic. Our bacon business has been outstanding, and we’ve gained share where others haven’t and where the industry is retrenched. So we’re pleased with the bacon business and we do see optimism for hams if we can get a little bit better peso valuations.

Keira Lombardo

Operator, we’re going to end the call here and turn it over to Larry Pope for concluding remarks, please.

Larry Pope

Well, thank you all for listening this morning. I’m aware that these earnings probably came in below what you as the analysts had projected. I suggest to you that it’s a fresh pork phenomena through a relative time period there. It is impacting this first quarter a bit. It doesn’t change where I think the fundamentals of this company are going at all. It doesn’t change what I think the exports are at all. I think that we’re going to bring you some news as we go through this next fiscal 2013 and I think you’re going to be pleased with it, so if you’re thinking about short-term quarter-to-quarter, you probably ought to be a seller. If you’re long-term, if you’re willing to hold the stock for a bit, I think you’re going to be rewarded. If you’re not, you’ll be probably part of our repurchase program. So thank you very much. For part of that, management is tied to improving shareholder value, and I think we’re playing this game for the long term and I think we’re winning, and we’ll look forward to our first quarter call. Thank you very much for your time this morning.

Operator

Ladies and gentlemen, this conference will be available for replay after 11:00 am today through June 28. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code of 248004. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844 using the access code of 248004.

That does conclude our conference for today. Thank you for using AT&T executive teleconference service. You may now disconnect.

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