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Smithfield Foods, Inc. (NYSE:SFD)

F1Q09 Earnings Call

August 26, 2008 9:00 am ET

Executives

Jerry Hostetter - Investor Relations

Larry Pope – President and Chief Executive Officer

Robert W. Manly – Chief Financial Officer

Analysts

Ken Zaslow - BMO Capital Markets

Ken Goldman - J.P. Morgan

Jonathan Feeney - Wachovia Capital Markets, LLC

Christine McCracken - Cleveland Research

Vincent Andrews - Morgan Stanley

[Raisa Vehavsada] - Lehman Brothers

Heather Jones - BB&T Capital Markets

Ann Gurkin - Davenport & Co. of Virginia, Inc.

Operator

Welcome to the Smithfield Foods first quarter conference call. (Operator Instructions) I would now like to turn the conference over to Jerry Hostetter.

Jerry Hostetter

Welcome to a conference call to discuss Smithfield Foods fiscal 2009 first quarter results.

We'd like to caution you that in today's call there may be forward-looking statements within the meaning of federal securities laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Smithfield Foods Form 10K for fiscal year 2008. You can access the 10K and our press release on our website at www.SmithfieldFoods.com.

Each quarter there are several analysts waiting to ask questions as our calls end after one hour. We would like to provide the opportunity to as many analysts as possible to ask questions, and as a courtesy we request that you ask only one follow up question so that everyone can participate.

With us today are Bo Manley, Chief Financial Officer, and Larry Pope, President and Chief Executive Officer. This is Jerry Hostetter [break in audio] Investor Relations.

Larry Pope will begin our presentation with a review of operations.

Larry Pope

I'm here this morning to report our results for the first quarter, as Jerry pointed out. We are reporting this morning a loss from continuing operations for the first quarter of $28.5 million or $0.21 per share compared with $56.6 million or $0.43 in the same quarter last year.

The bottom line is $12.6 million or a $0.09 a share loss and $54.6 or $0.41 a share in last year.

I hope you took an opportunity to note that in the loss from continuing operations we have a marked-to-market adjustment of $20.1 million or $0.15 a share in unfavorable marked-to-market related to a portion of our hedging derivatives activities. As well, our interest in Campofrio in Europe, they are taking a charge related to the write-down of some assets in Russia for $5.5 million or $0.04 a share pending the sale of that business to a buyer. I'll let Mr. Manly speak more about that in his report.

Overall, the business, as many of you know, has been tough. Grain costs have now been elevated for some time and they are continuing to surface very strongly through our hog production operations in terms of raising costs. And I'll speak about that in a minute, but that is severely impacting our business and is a large factor in terms of where our results are both this quarter and last quarter.

In terms of some of the segments of the business, the fresh pork business has been exceptionally good. We have some substantial increase in volume of more than 30%. As well we had - the cutouts have been terrific. Those have been driven by export business, which has been extremely good for ourselves and the rest of the industry. As we pointed out in the press release, our exports were up nearly 125%. The carcass values are the highest in the history of the business.

Pork is cheap on the world markets, as many of you know. That has fueled some of this export business. While hog prices and the pork cutout in this country is very high, it's even higher in places like Mexico and in Europe, and that has made pork look cheap around the world. And I think that's going to continue, so the problems that are occurring in terms of the grains relative to the markets in this country are even more severe outside of the United States and all of the proteins are responding to that. That has turned out to be substantial.

We are exporting at record levels. We are exporting every bit as much as the industry and in many cases more. As I pointed out in our press release, the countries that we're seeing substantial increases, like China and Russia and Japan and the EU, Korea, all are seeing big, big numbers in terms of increases over last year. And that has worked to our benefit as it's taken product off the domestic market, in spite of the fact that kill levels being up. With exports now in the 20% range of product being produced in this country, that takes an awful lot of pressure off of this domestic market, and that has allowed us to deal with these increased costs on the raising side.

And, as many of you know, livestock prices did increase slightly during the quarter, and increased fairly significantly towards the end of the quarter, and what is very satisfying about that was our ability to pass those prices through. And the market has been reacting to that and the cutouts have continued to be black.

I'll talk in a minute about our relationship with the COFCO trading company in China. That has been helpful. As many of you know, we've been doing business with that organization now for nearly a year. We've got a good relationship with those folks and in fact one of - their chairman is coming on as one of our Board members to be standing for election even tomorrow.

So in the fresh meat side of the business, it has been very, very good and, in fact, this quarter might well have been the best first quarter in fresh meat, certainly in a very long time if not in history. In July, it very likely was the best fresh pork month maybe in the history of this industry.

Now to the Packaged Meats business, that's solid. Our margins are down somewhat, not as much as I thought they might have been. The cuts, the raw material for those, are up very dramatically, such things as trimmings and hams have risen dramatically over last year. And those are not able to be passed on fully in terms of pricing, but there again I'm pleasantly surprised with our ability to pass on prices through in terms of retail and food service business and our margins in the Packaged Meats business continued to be solid as well as we continued to get growth in some of the focused areas that we've been on now for some time.

And I think about those all the time, whether - that's the spiral ham business and the cooked rib business. And our pre-cooked business is not up, in fact, it's down just a little bit, but that business is still extremely strong for us. And our Packaged Meats business continues to be very, very good for this company, and I'm pleased with the progress we're making in that area.

In terms of the other segments of the business, the international piece in terms of the segments that are being reported in the earnings release show a $5.9 operating profit compared to $14.9, however that does have the Campofrio adjustment in there of $5.5 million, so you need to think about that as you think about the comparative results of our international operations. And again, that relates to the sale of a portion of a business of Campofrio that they are counting as discontinued operations and they do have a contract to sell that.

Our Western European business is struggling. The grain cost and the high cost of the proteins in terms of the raw materials in the Packaged Meats, which is really what our Western European business "Groupe Smithfield" is, have been stressed. That is very difficult to pass on all of those cost increases when you look at the markets in the EU. And while we're looking at a $60 hog market in the United States, they're looking at more like a $90 hog market in Western European and in Eastern Europe. So the impacts are even more severe and more dramatic in terms of trying to pass on price increases through to the ultimate retailer and consumer.

That's tough. The Polish business is tough as they deal with even higher priced raw material. But the Mexico business is not bad, and in fact our Mexican livestock raising operations have not done poorly. I'm pleased with that. And our Romanian business, in spite of that, we're breaking even in our Romanian pork slaughter operations. Even on the fact that we're dealing with the problems of [inaudible] swine fever from last year, I am pleasantly surprised with that.

So again, the fresh meat side of the business all around the world is really doing pretty good. The Packaged Meats business, which is more resistant to price adjustments, is having more trouble, but surprisingly not as much as I might have thought at this point in time. That's why I make the statement that I'm really relatively pleased in spite of the fact we're reporting a loss for the quarter, I am relatively pleased with the way in which we're operating this business.

Hog production is clearly the big downturn in the business between years, and that has been coming for some time now. The grains that have moved up all this calendar year are fully baked into our raising costs, and as we laid out in the press release, our raising costs for the quarter are $0.61 a pound, which are very high numbers. We've got $6, in fact, $7 corn in some of those numbers.

And many of you might ask about where are you from a hedging standpoint, didn't you buy your corn ahead? As you all know, we're marking to market so many of those adjustments get made in differing quarters. And I've talked about that in the past, in fact, made reference to it in last year's January quarter that, as those grains moved up, accounting for most of that puts that in a different quarter. And so I made the comment then we will be seeing the full impact of $6 corn and now more than $6 corn in this quarter. As you know, corn moved up into the mid-$7 range, and some of that got into this quarter and will be into the next quarter as we feed those into the animals before they ultimately come through in the cost of sales end of the business.

So hog production numbers, raising costs are up substantially. Live hog prices were up very modestly for the quarter, although up significantly toward the end of the quarter. And as many of you know, live hog prices today are $60 or right at it. I think they were down last night, but they're roughly $60 and are above where they were at the end of July.

Two other points I'd like to make reference to. You may have noticed that we went forward with a capital market transaction in early July. We raised $400 million in a convertible note issue. In addition, we issued $7 million shares to COFCO Trading Limited, which is our trading partner in China. We felt like we needed to strengthen the balance sheet. Again, Mr. Manly will speak to that. We felt like we needed to strengthen the balance sheet to ensure the liquidity and to make sure that we had the full balance sheet we needed as we go through these volatile and rising periods of these grain costs.

In addition, we've got two new directors standing for election tomorrow at our annual shareholders' meeting. I alluded to Frank Ning, who is the Chairman of COFCO. Frank is coming onto our Board and will add a new dimension. We're looking forward to Frank's input in giving us that international perspective and an Asian perspective in a country where there's so much opportunity and more than 50% of all the pork in the world is consumed. Frank brings with him a tremendous experience. We plan to have a lot communication. We're building relationships with that organization, and we think that could be very good for Smithfield Foods.

In addition, Dave Nelson, who many of you on this call probably know personally or certainly have heard of, we've asked Dave Nelson to come aboard. He is now with a European hedge fund, Altima Partners. David knows the industry, as most of you know, from his 10 years or so with C. S. First Boston and NatWest before that. We think David brings with him a tremendous wealth of knowledge of the basics of this business, certainly from the U.S. perspective, and he is now building an international knowledge base that we think can add to this Board and add to the management team to help us understand how to navigate these world markets.

So we're excited about two new directors coming on the Board. We think it strengthens the overall company and our base from which we can - we have resources to tap that can help us take this business forward.

Finally, I announced some management changes at the beginning of this fiscal quarter. We created a position, the President and Chief Operating Officer of the Pork Group. George Richter, who was previously the President of Farmland, has taken over that position and has responsibility today for all of our pork operations domestically.

In addition, I created a Executive Vice President position at the corporate level, where Joe Luter, IV, who was the President of Smithfield Packing Company, one of our subsidiaries, was promoted to Executive Vice President with a concentration on the sales and marketing coordination of the total organization, which is Joe IV's very strong talent.

We replaced him with Tim Schellpeper, who was the VP of Operations in Farmland, and Jim Sbarro, who was the Sales and Marketing VP for Farmland became the President of Farmland.

So I think at the operating company level we created a very strong management team and a young management team. Both Tim, Jim and Joe Luter, IV all are in their early 40s and have a tremendous amount of experience at that young age, and they're all showing that very quickly and I'm very pleased with that. George's little bit of gray hair and long years of experience, I think, will mature that group, and he is bringing that Pork Group together and I think very quickly. They are already delivering, as you see our results on the Pork Group, more than 100% above last year. I think there's much, much more to come behind that.

Finally, we made a change in the Chief Financial Officer's position from Carey Dubois to Bo Manly. Many of you know Bo, both with Smithfield and multiple stays with us as well as his time with Premium Standard Farms. Bo's a very talented individual and I think brings some stability and some maturity to our financial side of the business, an area that I'm very close to over the years.

And so I think all of that management team together is gelling very well and coming together very quickly. This is not taking big time to make the organizational changes and get people to know each other. These guys are all hitting the ground running, and they're all making substantial improvements to the area in which they're responsible. And I am already seeing it demonstrated in terms of the bottom line results.

So with that, I'll turn it over to Mr. Manly for some comments from his side, on the financial side, then I'll give you some forward-looking thoughts.

Robert W. Manly

Before I move into my remarks, let me address one housekeeping item. You may notice our income statement now reflects a separate operating profit line. We decided to show that line separately on the face of our statements to conform our presentation to the format most commonly used by other publicly traded companies. This change in presentation is nothing more than a geography change. We simply dropped interest expense down below the operating profit line. All periods presented conform to this new presentation.

Now that housekeeping's out of the way, let me state total earnings for fiscal 2009 first quarter showed a loss of $12.6 million or a loss of $0.09 per share compared to a profit of $54.6 million or profit of $0.41 per share for the first quarter of fiscal 2008.

Earnings from continuing operations for the first quarter totaled a loss of $28.5 million or a loss of $0.21 per share compared to income of $56.6 million or $0.43 per share for the same period a year ago.

The operations of Smithfield Beef Group have been reclassified as discontinued operations as of this quarter in fiscal 2009. The prior years' statement of income have been adjusted as well to reflect the Beef Group's discontinued status.

Income from discontinued operations for fiscal 2009 first quarter totaled profit of $15.9 million or a net of tax of $0.12 per share compared to a loss of $2 million or a loss of $0.02 per share compared to the same period a year ago.

Dollar sales from continuing operations for fiscal 2009 first quarter totaled $3.1 billion compared to $2.6 billion last year, an increase of 20%. The sales increase for the pork segment resulted from higher volume and prices for fresh pork. Higher sales for the Hog Production Group were driven by higher live prices for hogs as well as higher volume from improved circovirus health status. Only 12 weeks of [PFS] sales and earnings were included in the prior year's results, impacting both the Pork segment and Hog Production Group as well.

Higher prices for packaged meat in Europe, higher fresh meat volumes year-over-year in Poland and Romania, and consolidation of Agroalim, our Romanian distribution joint venture, all contributed to the 64% increase in International sales segment during this quarter.

Selling and general administrative expenses were $190.6 million in the fiscal 2009 first quarter compared to $165 million the year prior, an increase of 16%, principally due to year-over-year changes in exchange rates. Currency gains in the first quarter of fiscal 2008 were $26 million versus gains of $10 million in this fiscal year. Without the impact of currency gains, SG&A increased $10 million or 5% year-over-year.

Interest expense for the quarter was $44.5 million, $3.1 million more than the same quarter in fiscal 2008. The average interest rate for the quarter was 6.1% compared to 6.8% the same quarter in fiscal 2008.

Our long-term debt and capital leases were $4 billion at the end of the current quarter compared to $3.4 billion at the end of the first quarter of fiscal 2008.

Depreciation and amortization for the quarter was $68.9 million compared to $64.7 million last year.

The company has put constraints on capital spending for the balance of the year. Spending for the first quarter - excuse me, spending for the year will be less than the full year depreciation. Capital expenditures for the quarter were $83 million, exceeding depreciation, principally due to a high level of carryover capital expenditures from fiscal 2008. Capital expenditures will be below depreciation in the coming quarters. Let me reiterate, Capex will be below depreciation for the full year.

Farm expansion in Eastern Europe has been throttled back until grain and meat prices achieve profitable equilibrium.

Our effective tax rate for fiscal 2009 first quarter was 32% versus 35% in fiscal 2008. For the full year we expect the effective tax rate to be between 34% and 36%.

The company's debt-to-EBITDA ratio was approximately 6.1 for the 12-month period ending July 2008 versus 5.8 for the full fiscal year ending in April 2008. The debt-to-capitalization ratio was 56% for the quarter, steady with the debt-to-capitalization ratio for the fiscal 2008. We anticipate that the proceeds of Smithfield Beef Group will be used to reduce debt and these ratios will improve. Smithfield is in compliance with all debt covenants.

As Larry mentioned, Smithfield had two capital market transactions during the most recent quarter. During the first week of July Smithfield issued $400 million of 4% coupon convertible debentures. Simultaneously with this sale, Smithfield sold warrants and bought call options that created a minimum stock conversion price of $30.54 per share. After all fees and costs associated with this transaction, the company netted $337 million. These proceeds, along with other sources of liquidity, enable the company to replace $350 million in other short-term liabilities.

In addition, during July Smithfield sold 7 million shares or 4.9% of outstanding shares in a private placement to COFCO for $122 million. We believe this transaction signifies the strategic importance of this long-term relationship with its trading partner. The basic weighted average number of shares outstanding for the first quarter was 135.5 million, up 132.7 million at the end of the first quarter of fiscal 2008, reflecting the COFCO share purchase late in the quarter.

Subsequent to our last analysts call, there may have been some degree of confusion about precise levels of liquidity and concerns about available liquidity moving forward. To be clear, available liquidity at the end of fiscal 2008 was $314 million. Liquidity at the end of fiscal 2009 first quarter was $504 million, benefiting from cash generated by the stock transaction as well as improved cash generated by the business. We believe, unless there is a major shift in underlying commodity markets, the current outlook provide sufficient operating liquidity for the near term regardless of whether or not the Smithfield Beef Group transaction takes place.

As we mentioned in the 10-K, Smithfield is taking advantage of hedge accounting treatment on a selective basis when possible to account for our risk management activities. Management believes that hedge treatment most accurately reflects fundamental and timing of our business.

The loss from continuing operations for the first quarter includes an after-tax negative marked-to-market adjustment of $20.1 million or $0.15 per diluted share, representing losses in the futures market associated with upcoming periods that do not qualify for hedge accounting.

As Larry pointed out, if this marked-to-market adjustment of $0.15 is combined with the $0.04 from discontinued operations at Campofrio, Smithfield results for fiscal 2009 first quarter show a slight loss of $0.02 per share.

I'd like to thank you very much for your attention, and I will now turn this back to Larry. Thank you.

Larry Pope

Obviously, we've got a great deal going on. That was a nice report from you, Bo. There's an awful lot going on. As you can see, Mr. Manly has taken the helm of the financial area very well, and I'm very pleased with that.

As we look forward from here and you look into the beginning of the second quarter, hog prices look better and corn is moderated so the thought is well, things are much better. However, as most of you know who have been in this business, as we move into the fall portion of the year hogs generally trend down as we have the fall hog run upon us and we expect that to occur certainly in September and as we go deeper into the fall. So while live hog prices are high today, I do not expect that to continue.

As well, corn has moderated from its height in the $7.50 range or closer to $8 back to just over $6 and for awhile was well below that. However, our raising costs, as you know, have delayed impacts as they have long feeding times for these animals, and so the effects of any corn changes take long periods of time to arrive and to leave. And so while corn may be moderating, we have still got lots of high-priced corn that we have fed into these animals and are continuing to feed relatively high-priced corn, so I expect to have continued elevated raising costs, as I pointed out in the press release.

Fresh pork has been very good, and I expect that fresh pork will continue to be good. Whether it will continue at these levels or not, I don't know. Generally the first quarter's weak for fresh pork. That was not the case. As you go into the fall and the winter, fresh pork is generally good, so I expect fresh pork will be good for the company.

Our Packaged Meats business will probably be below last year. I expect this high-priced raw material to be with us. As a result of that, I expect as we attempt to push through these price increases on the Packaged Meat side, that's going to be difficult. And so I expect there to be some continued pressure on our Packaged Meats business, both in the United States and in our European operations.

I expect exports as well to be very good. They have been exceptionally good. As you know, the U.S. dollar is strengthening to some degree, and so at this point it's difficult to tell how strong these exports will continue to be and where these markets on the foreign - these foreign markets will continue to yield U.S. pork as cheap commodity.

But, as we've said a couple of times, these are very uncertain times and these markets have been volatile like they've never been volatile before, and to see the movements that we're seeing in the grain markets and in the live hog markets that are occurring is staggering to us on a daily basis. And so it's extremely difficult for us to give any kind of good vision and clarity in terms of what we think the future is except to give you a point in time reference, and that's what I'm giving you this morning.

As Bo indicated, we have cut back our capital expenditures in reaction to the reduced profitability, and Capex will be running no more and below depreciation compared with the prior two years, in which capital expenditures have been $200 million above depreciation. That is coming to a halt and has come to a halt now for some three months. And we'll continue there until the business turns around.

We do expect the Groupe Smithfield-Campofrio merger to go forward. We are finalizing the last details, and we are very hopeful at the end of the second quarter or worst case, the early part of the third quarter, that the CampofrioGroupe Smithfield merger will be cleared and will occur.

As well, we should be hearing relatively shortly now from the Justice Department. We are in the latter stages of the second review process. We expect to hear from the Justice Department shortly relative to any concerns that have on the Beef transaction, and we still fully expect the Beef transaction to close in the second quarter, although Bo has pointed out that we believe that, absent some catastrophe, that we have certainly the balance sheet and the liquidity even if that does not occur.

One point that I feel compelled to make as part of the current operations and the future is our frustration with the ethanol and the energy policy in this country. We continue to be bothered by this policy that we believe is not good legislation and is not good economic nor energy policy, but has tremendous impacts on this business and all of us in the protein industry feeding livestock. As you know, the mandate that's out there and the subsidy that's been out there certainly favors the conversion of corn into fuel and in effect we are competing with oil prices to feed our livestock. And this has certainly had a substantial impact on the run up in the corn markets, both in the U.S. and around the world.

And so we continue to push for government to review this issue and to review the logic and the economics behind this policy that we believe is flawed. And absent that impact on our business, I believe that this business would be in exceptionally good shape and we would be doing even better than we are today. But unfortunately, that is a reality which we live with, and until these markets adjust correctly for this everywhere, we're going to be suffering and laboring under a policy that forces us to compete with the oil companies for corn.

And so much of this corn - it now looks like it's going to be a third of this crop is going to be converted into ethanol - that kind of impact on the grain markets is substantial, and it is pressuring our whole margin structure and it's going to result in substantial food inflation in this country that both Smithfield and many of our competitors are saying across this industry.

And so I don't know if you can do anything about it. Probably you can't. I'm only venting some frustration this morning that I think we're running the business very well and many parts of this business are in terrific shape. Unfortunately, I've got an outside dynamic that we're having to deal with that is frustrating the P&L of this company.

With that being said, I think our management changes are focusing on plant rationalizations and cost controls, as I said, this new management team has hit the ground running. I think there's going to be more about that in the coming quarters. You might very well read about some more plant rationalizing that we're going to likely do. We haven't made any final plans there, but we are looking at that. I think we're getting our cost structure, more and more competitive, and I think we're going to be a very good competitor and have a very good cost structure here going forward and I'm very pleased with that.

With that being said, Jerry, we'll welcome calls from anyone out there.

Jerry Hostetter

We will open the floor to calls.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ken Zaslow - BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

Looking through your press release one of the things I saw that was - it seemed like you were a little bit less enthusiastic about the future, and I guess what surprises me is you don't really talk about the sow liquidation or the gilt liquidation. Can you talk about where you see that going and how that's going to influence the future for you, because it seems like that was a clear absence from your press release.

Larry Pope

Well, I was looking at sow liquidations here yesterday, Ken, and I think the last 21 weeks we had 15 weeks in which sow liquidations were north of 10%, five or six weeks when sow liquidations were well below 10%. It's a little fickle number, and it seems like whenever the corn markets drop a little bit or the hog market goes up, sow liquidation that week drops off. And we've had all these issues out there, as you may be aware of, of sows backing up and not being able to be processed.

I think it continues to be a positive. I hope we aren't - I hope through some of these grain moderations that some of those that were making decisions about whether to get out of this business or to reduce their sow herds don't give a second thought to that because we do need to control the supply.

I can assure you that the announcement that we made last February, where we're reducing our sows, that process continues and we have not wavered in that at all. So we're doing our share in terms of what we think needs to be done. I think the sow liquidation numbers continue to say the industry is liquidating, although you saw some numbers coming out of Canada didn't necessarily think the liquidation was occurring as fast and there wasn't as much take up of the government program, and so some of the numbers, the sow liquidations, don't necessarily translate into exactly the herds coming down by those numbers.

It's positive and I think it's correcting. I wish the numbers were bigger. How about that?

Ken Zaslow - BMO Capital Markets

Do you think that in 2009 calendar that you'll have less hogs supply? You still think it needs to be a more dramatic cut to get your hog production margins positive?

Larry Pope

Well, I think two things have got to work in terms of hog production margins. I think hogs are going up. The futures markets say hogs are going up. I think there's going to be less hogs in 2009 than there are in 2008. We'll be fine because the hog market's going to be driven by the export markets. If the export markets stay there, the hog market will stay there.

The other side, which is a wild card, continues to be a wild card, is these grain markets. They continue to be so volatile that it's so difficult to predict the future because we can't get a handle where grain costs are going to be on any kind of a long-term basis at all, and so profitability's probably going to be more driven by grain than it is by hogs.

Operator

Your next question comes from Ken Goldman - J.P. Morgan.

Ken Goldman - J.P. Morgan

I'm wondering if you can provide a little bit of extra color on the agreement with COFCO. It seems clear you've been working with them for a little bit of time, but I'm wondering if you could be a little more specific on the upside there, perhaps in terms of volume, in terms of what really you get back for the shares that you're giving up to them.

John F. Prim

That's an easy answer. We don't get anything back today. We have had a relationship with them since early last fall, and we've been doing some business with that organization. I think they want to demonstrate their commitment to wanting to be a long-term partner with us, and they've been talking to us about making a capital investment in Smithfield now for quite some time. For more than six months we've been talking about that.

And so this is very much just a sale of common stock to that organization. We thought we needed, again, needed to strengthen the balance sheet. We looked at the convertible note issue. COFCO had been talking to us for some time, so we said this might be the opportune time for you to come in and be a shareholder, to make that capital commitment. They were pleased to do that.

So there is no - today that is not tied to anything else. But I will tell you Frank is coming on the Board with us. We're having discussions even this week with them on longer-term opportunities that we might have for selling of meat or investing in China with those folks. I think this could be the beginning of a very long-term relationship. We don't know where it goes at this point except that we've got the largest people in China, and it is a state-owned company who wants to do business with us. And we're the largest producer in the world, and we want to do business in that country. So the combination should work out well.

And they're trying to put some glue on the relationship by saying let us make a long-term investment, give you some capital that you need, but let's also make a long-term investment so that we can be partners for the long term. And I think that's all there is today, so I want to be clear about that.

Operator

Your next question comes from Jonathan Feeney - Wachovia Capital Markets, LLC.

Jonathan Feeney - Wachovia Capital Markets, LLC

Larry, I wanted to follow up on your commentary on hog supply in answer to Ken's question because you mentioned demand. And this kind of export demand is excellent, bordering on breathtaking, and the question I would have is, you know, what would make you confident that export demand can even match current levels, you know, in '09, in calendar '09, versus '08 considering the strength of the dollar. And I've got one follow up after that.

Larry Pope

I guess what gives me some comfort today is these European markets are extremely strong. And so from a competitive standpoint, the U.S. is highly competitive. And they're having liquidations in Europe as well and many countries are having, you know, very substantial liquidation. And so I believe that the supply is going to be down, the hog supply is going to be down in Western European, and that's the primary competitor. You do have Brazil out there. Canada's becoming much less of a long-term issue on the export market.

So I think that - and demand is there. I mean, you know, lots of the world has got increasing demand and, as you well know, exports have been actually accelerating. So I think there's a very good likelihood that exports could continue to be strong now for some time.

Bo, do you see it any differently?

Robert W. Manly

No, I think, Larry, you're right in terms of this being a very broad-based export situation where yes, we had some extremely impressive volume increases with China and Hong Kong, but I think the thing that gives us the most optimism is the fact that Russia's been very strong. Mexico has been extremely strong. Western European, we're hitting record levels of shipments to France, to the U.K. as well, and look for more opportunities going forward.

Frankly, right now the limitation to exports to Europe is the fact that we're bumping up against quota limitations that the EU presents, and we'll be asking the EU over the next six to nine months to review that process and see if we could increase the quota of product coming from the United States into Eastern Europe.

John F. Prim

But we've seen shipments into Australia that we were losing to others, particularly Canada. Those Australian exports have come back to the U.S.

Now, again, a lot of that's tied to the U.S. dollar. If the U.S. dollar substantially strengthens, that could change the world. And I think the U.S. dollar will strengthen; I'm just not sure it's going to strengthen, you know, over some relative short period here. And I know it has a little bit, but I'm not sure that we're going to see a big strengthening and make us uncompetitive. I don't see it.

Robert W. Manly

No. But at the same time you've got Western Europe with easily a 5% decrease in sow numbers. You've got Central Europe, Romania, Hungary and that part of the world, probably closer to a 15% to 20% decrease. China has had some increases, but they'll still be below historical levels. And Mexico, while it's a difficult number to get, I guess our sources would say we've probably seen a 10% decrease in sow numbers in Mexico. So the sow numbers have left the worldwide industry to create opportunities for pork, and we'll still be competitive price wise in the world market.

Larry Pope

I guess that was a long answer to a short question.

Jonathan Feeney - Wachovia Capital Markets, LLC

Just one other question. You mentioned a couple of times Western European, hog prices being high and that challenging the profitability of your processing business yet, you know, when I think about the longer-term vision around Poland and Romania production, this should be the perfect conditions for you guys to be making money. And I know in producing hogs over there or, you know, at least having access to lower-cost raw materials over there  I know it's not a vertical integration model but, you know, why aren't you able to buy advantageously in Poland or Romania right now and maybe protect more margin?

Larry Pope

Why aren't we buying raw materials out of Eastern Europe or Central Europe, shipping those to Western Europe and processing them? I guess that's your question.

Jonathan Feeney - Wachovia Capital Markets, LLC

Yes, that's right.

Larry Pope

Well, that's a longer-term plan here. And there are, again, if you're familiar with Europe, you know that's not as easily said as done.

The other side is that we've had - in Eastern Europe, you've got some extremely high-priced livestock. It's actually higher in those countries than it is in Western European. There's been some drought conditions in the past  it looks like it's going to be a good chop this year - but you've actually had more severe price increases in Eastern Europe than you have had in Western Europe.

This whole thing, between these grains and these hogs, across many of the major places, these dynamics are setting new records everywhere. As I said, the carcass value in this country's the highest it's ever been. And you would think that, with killing more hogs that we wouldn't have that, but the fact is there's a liquidation, there's a shift going on in many places in the world that these dynamics are changing the way these guys work.

And so while I agree with you on the surface, when you go look a the detail it doesn't work out like that today. Longer term I think you could be exactly right and our positioning in Eastern Europe could work out to be just perfect.

Operator

Your next question comes from Christine McCracken - Cleveland Research.

Christine McCracken - Cleveland Research

Just on the packing margins, you know, we were a little disappointed with the results there relative to your peers in the industry that maybe have an even greater percentage of their sales into processed meats. I'm serious. Is there any impact from I guess a negative mix shift with a lot of these fresh meat sales going into export, you know, given the 33% increase, I think, in volumes that you're seeing in fresh meats? Is that a factor there or is there something unique about your business that depressed margins for you specifically?

Larry Pope

Christine, maybe I'm - Bo, I'm not sure I understood that question. I'm not sure there are depressed margins anywhere. That's what - you're doing some mathematical calculation that I'm not sure I'm following that's giving you concern. Help me to understand what you just asked, or did you get it, Bo?

Robert W. Manly

If you looked at packaged meat margins, we don't see much change in terms of a percentage basis. I think what we're seeing in the United States to some degree, similar to what we see in Western European, is that you do have some trading down of the consumer from the branded products to more private label, which I think is the consumer reacting to higher overall price levels in the marketplace.

Larry Pope

Christine, our profits on the Pork segment more than doubled. And as I explained, we made less money - we still made money - we made less money on the Packaged Meat side of the business. Our fresh pork results were up substantially.

Christine McCracken - Cleveland Research

Looking at it just as a comparison, looking at Tyson over 5% margins on a business that technically should have yielded the same type of margin, I'm a bit disappointed. And I guess that's my cause for confusion. Looking at where the cutout was, looking at where margins should have come in, I'm disappointed in less than a 2.5% margin on that business.

Is there something unique about your mix of business that puts that number significantly below Tyson specifically and down significantly from last quarter?

Larry Pope

No, I don't think so. I don't think so, Christine. Now we had - I will tell you that our Packaged Meats margins were not as good as last year's first quarter and they were not as good as our fourth quarter margin. That's because of the impact of the trimmings and hams specifically, not pork bellies, but those raw material costs are fully embedded in these Packaged Meats margins. But again, our Packaged Meats margin, the first quarter's not a particularly good quarter for our Packaged Meats business. As you know, we have a lot - a baked ham business, and that's not in this quarter at all; there's not much of it.

But no, our margins on a comparative basis to last year are not - they're down but not dramatically down, and our fresh pork is up significantly. And I know the point you're making is that Tyson's are up more than yours are, and I can't explain that. I can only explain ours.

But no, there is nothing fundamentally wrong with ours, I can tell you that.

Christine McCracken - Cleveland Research

And there's no negative mix implications of selling a lot more product into export? That's my question.

Larry Pope

Well, our slaughter levels were up 14%. The actual number of hogs we processed was up 14%. Our fresh pork volume was up 33%. So there's some mix issue in - the difference is because all of that 14% essentially was sold in the export markets as fresh product because our Packaged Meats business was stable. So the raw material that was coming out of fresh meat going into Packaged Meats was about [inaudible]. So all of that incremental 14% went in the form of fresh pork in terms of largely export business. I mean, a lot of it was some of this Chinese business that we've got which, you know, is good business for us.

So maybe it's just that pure math that's working out there.

Operator

Your next question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

I'm wondering if I could just ask, you know, as we think about the volatility in the commodities markets and now with the dollar, is there a scenario where the dollar continues to strengthen as oil comes down and so forth but corn prices do not move lower with the dollar and you have weakening exports but you still have higher raising costs? Is that something you're concerned about?

Larry Pope

I wouldn't sit here and tell you that's a situation that couldn't occur. I mean, I do think that we have an awful lot of this business tied to the export market. We do have - I mean, it is very unusual to see live hog prices going up again and again and again in the face of increasing slaughter levels. More supply doesn't generally mean higher prices, it means the inverse of that, and exports have been the key to that. And the combination of a cheap U.S. dollar and shrinking supplies outside the United States combined with increasing demand outside the United States has caused all that to happen.

So if we were in a situation where the U.S. dollar strengthened significantly, I mean, that is a negative to this business. I think that is true. And if we had a situation where corn continued to stay elevated, I mean, that's a negative - that's a scenario in which the margins would not be as good. I think that's right.

Vincent Andrews - Morgan Stanley

Okay, and if I could just follow up quickly, obviously with exports, I mean, part of it is driven by the dollar but obviously part of it is driven by their own GDP growth. You also called out in the press release kind of overall economic activity and I'm just wondering, you know, are you at all concerned about China slowing or any of the emerging markets slowing relative to export demand? Let's just assume the dollar is all - all else equal.

Larry Pope

No, I mean, I think there's a lot of economic growth outside of the U.S., so I'm not really worried about that one. Now let me speak to a second - I'm really not very worried about that one.

I'll tell what the one that has some - we started looking at, is the U.S. economy. But many times that's a positive to us as people come back home to eat. Although we're not seeing the food service business fall off at this point. We're not - our food service business is up. I do think there's going to be some migration toward the lower fast food as opposed to the more casual dining and even some of the white tablecloth. But it's coming back to retail and in some of the categories, such as hot dogs  which have not been particularly good for us - we're seeing a movement back to hot dogs.

So in many cases we can be sort of countercyclical to the economy and actually see some pickups in a weak economy. But that's an uncertain situation. That's an uncertain situation, but I do know that the world is changing and so we're paying attention to that and looking at the product we produce.

Vincent Andrews - Morgan Stanley

So it's really just the U.S. economic environment that you're -

Larry Pope

We're paying more attention to that than we are the world market.

Operator

Your next question comes from [Raisa Vehavsada] - Lehman Brothers.

Raisa Vehavsada - Lehman Brothers

Just a couple of housekeeping questions, Bo. The debt number that you mentioned, the $4 billion, that's all debt, short-term and long-term, including your discontinued ops?

Robert W. Manly

It would not include discontinued ops. It would include all other short and long-term debt plus capital leases.

Raisa Vehavsada - Lehman Brothers

And so on a consolidated basis, what would be the total debt level if you have that handy?

Robert W. Manly

I believe it is the $4 billion.

Raisa Vehavsada - Lehman Brothers

$4 billion is including the discontinued ops?

Robert W. Manly

No, it would be without discontinued ops. And for discontinued ops, can we get back to you?

Raisa Vehavsada - Lehman Brothers

Yes, sure. And then you mentioned a liquidity number, which is helpful, but is that all revolver availability or is that revolver availability as well as, you know, cash on hand?

Robert W. Manly

It would represent revolver capabilities as well as cash on hand.

Raisa Vehavsada - Lehman Brothers

Okay, and so how much cash on hand did you have?

Robert W. Manly

It would be rather de minimis. We're looking at about $60 million in cash and cash equivalents.

Raisa Vehavsada - Lehman Brothers

You talked about the marked-to-market hedging loss in this first quarter. Did you have a marked-to-market hedging gain on your commodity hedges last year in the first quarter or loss for the same time last year?

Robert W. Manly

It was not a gain for last year. It was about an $8 million loss for last year.

Raisa Vehavsada - Lehman Brothers

And then do you have an [LTM EBITDA] - trailing 12 months EBITDA for the Beef business, by any chance?

Robert W. Manly

Not at this point in time. We can get that to you, so we've got two follow up points with you.

Raisa Vehavsada - Lehman Brothers

Okay, and just to circle one last question on the Packaged Meat margins, Larry, your comments suggest that they are running at, you know, reasonable levels but they're facing some headwinds because of commodity costs, so they're not necessarily, you know, weakening precipitously.

Larry Pope

That is correct. And one of the things we are not doing - we are striving to do - from a reporting standpoint we would like to be reporting to you Packaged Meats margins and that's one of my goals to get accomplished here and Mr. Manly in his new position, because we want to report that to you. We think that's important information, but all that's got to get through our auditors and the SEC. And so we can only report to you in vague terms because we can't specifically report those numbers to you because we can't get the auditors to sign off on those numbers.

Robert W. Manly

One clarification, that debt number does include debt from discontinued operations.

Operator

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

Heather Jones - BB&T Capital Markets

As far as your Packaged Meats margins, could you give us an estimate of the timeframe over which you think you can start passing through these higher costs, the trimmings, hams, etc.

Larry Pope

Heather, I think we are passing through the majority of those cost increases. That's a surprise to me.

Your question would be when do I think that we will return to normal margins I think is a better way of asking the question.

Heather Jones - BB&T Capital Markets

Correct.

Larry Pope

I think the thing that's got to happen first is these markets have got to settle. They've got to stop going up. As long as you're chasing it, you can't keep up. And then if you give this thing, in my estimation, Heather, give this thing six months after they've settled, and we'll be back to our margins again.

Heather Jones - BB&T Capital Markets

And I estimated it looks like industry packaging margins about doubled from last year, and so if I do about the same for you all, it looks like you had about a $0.02 to $0.03 pound deterioration in further process. Does that sound about right?

Larry Pope

No, it's not that much.

Heather Jones - BB&T Capital Markets

And finally you had mentioned that you don't think hog prices are going to stay this high, however live hog prices have been very strong, I guess due to continuation of strong export sales even into August. And so I'm just wondering what causes you to believe that that's not going to continue? I understand your concern about the futures and maybe they're discounting too strong an environment, but even cash hog prices have been really robust.

Larry Pope

Heather, traditionally once you get past Labor Day you get what's called the fall hog run when we have increased numbers of hogs coming to market as the temperatures cool in the fall. And so that increase in supply generally 9 years out of 10 drives live hog prices down in the fall. It's very common, and that's what I think is going to happen here in about another week or two weeks. And in fact, the hog market was down significantly yesterday. But that's what's giving me - if history is any gauge at all, then it'll be down as a result of just the pure seasonal effect.

Heather Jones - BB&T Capital Markets

Okay, so seasonally. But like we've been seeing 20% to 25% year-on-year increases so adjusting for the seasonal increase, do you still expect to see strong year-on-year prices? I understand the seasonal affect.

Larry Pope

Yes, I do. And I expect they'll be strong after we get through the season into January and February. Next year I think they'll be very strong.

Jerry Hostetter

Operator, we've got time for one last question, please.

Operator

Your last question comes from Ann Gurkin - Davenport & Co. of Virginia, Inc.

Ann Gurkin - Davenport & Co. of Virginia, Inc.

Larry, if you can just help me understand. As I was looking out to the second quarter, it was my impression that Smithfield had taken advantage of the spike in live hog prices that we saw earlier this year to forward sell some of that volume. So I guess, given your comments in the release, is it the grain component that's throwing that projected margin off? Can you help me understand that a little bit?

Larry Pope

Well, I think, Ann, if you - I mean, certainly you know we don't give hedge positions except to say that we do know where the markets are, how about that? And if you look at the markets this fall, where they've been, and you look at where grain is projected relative to raising cost - and I think our raising costs will continue to be elevated - that shows an adverse, even if you put hedges in place, you still aren't profitable in hog production.

Ann Gurkin - Davenport & Co. of Virginia, Inc.

And then secondly, in relation to Butterball, you talked about you're evaluating cutbacks. Can you comment on what level of projected cutback you might be facing?

Larry Pope

Let me say that it's significant, Ann, but I do not - I mean, I know a number, I just don't want to comment on it because it affects how others react to it. But let me say that we are reacting to the supply issue significantly. How about that?

Robert W. Manly

There was a question earlier about 12-month trailing EBITDA for the Beef segment and that number is $97 million for a 12-month trailing EBITDA for Beef. And just to clarify, $4 billion is the total debt of the company.

Larry Pope

Thanks, everyone, for joining us today. Have a good day.

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Source: Smithfield Foods, Inc. F1Q09 (Qtr End 07/27/08) Earnings Call Transcript

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