Item 2. Management’s Discussion and Analysis
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following information in conjunction with the unaudited consolidated condensed financial statements and the related notes in this Quarterly Report and the audited financial statements and the related notes as well as Management’s Discussion and Analysis of Financial Condition and Results of Operation contained in our Annual Report on Form 10-K for the fiscal year ended April 28, 2013 .
EXECUTIVE OVERVIEW
On September 26, 2013 (the Merger Date), pursuant to the Agreement and Plan of Merger dated May 28, 2013 (the Merger Agreement) with Shuanghui International Holdings Limited, a corporation formed under the laws of the Cayman Islands (Shuanghui), the Company merged with Sun Merger Sub, Inc., a Virginia corporation and wholly owned subsidiary of Shuanghui (the Merger Sub), in a transaction hereinafter referred to as the Merger. As a result of the Merger, the Company survived as a wholly owned subsidiary of Shuanghui.
Upon completion of the Merger, Shuanghui acquired all outstanding shares of Smithfield and the Company's shareholders received $34.00 in cash (the Merger Consideration) for each share of common stock held prior to the effective time of the Merger. Additionally, all outstanding stock-based compensation awards, both vested and unvested, were converted into the right to receive the Merger Consideration, less the exercise price of such awards, if any. The total consideration paid in connection with the Merger was approximately $4.9 billion .
Shuanghui is the majority shareholder of Henan Shuanghui Investment & Development Co., which is China's largest meat processing enterprise and China's largest publicly traded meat products company as measured by market capitalization. Shuanghui is a pioneer in the Chinese meat processing industry with over 30 years of history. Shuanghui's businesses include hog production, meat processing, fresh meat and packaged meats production and distribution. The merging of Shuanghui's distribution network with our strong management team, leading brands and vertically integrated model will allow us to provide high-quality, competitively-priced and safe U.S. meat products to consumers in markets around the world. As part of Shuanghui's international platform, we expect our best practices in large-scale farming, food safety standards, environmental stewardship and animal welfare to set the global industry standard.
We are the largest hog producer and pork processor in the world. In the United States, we are also the leader in numerous packaged meats categories with popular brands including Farmland®, Smithfield®, Eckrich®, Armour® and John Morrell®. We are committed to providing good food in a responsible way and maintaining robust animal care, community involvement, employee safety, environmental, and food safety and quality programs.
We produce and market a wide variety of fresh meat and packaged meats products both domestically and internationally. We operate in a cyclical industry and our results are significantly affected by fluctuations in commodity prices for livestock (primarily hogs) and grains. Some of the factors that we believe are critical to the success of our business are our ability to:
▪
maintain and expand market share, particularly in packaged meats,
▪
develop and maintain strong customer relationships,
▪
continually innovate and differentiate our products,
▪
manage risk in volatile commodities markets, and
▪
maintain our position as a low cost producer of live hogs, fresh pork and packaged meats.
We conduct our operations through four reportable segments: Pork, Hog Production, International and Corporate, each of which is comprised of a number of subsidiaries, joint ventures and other investments. The Pork segment consists mainly of our three wholly owned U.S. fresh pork and packaged meats subsidiaries: The Smithfield Packing Company, Inc., Farmland Foods, Inc. and John Morrell Food Group. The Hog Production segment consists of our hog production operations located in the U.S. The International segment is comprised mainly of our meat processing and distribution operations in Poland, Romania and the United Kingdom, our interests in meat processing operations, mainly in Western Europe and Mexico, our hog production operations located in Poland and Romania and our interests in hog production operations in Mexico. The Corporate segment provides management and administrative services to support our other segments.
26
Summary of Results
Net loss for the three months ended October 27, 2013 was $4.2 million , consisting of net loss of $16.6 million for the Successor period and net income of $12.4 million for the Predecessor period, compared to net income of $10.9 million in the second quarter of fiscal 2013 . The following summarizes the operating results of each of our reportable segments and other significant changes impacting net loss for the three months ended October 27, 2013 compared to net income for the three months ended October 28, 2012:
▪
Pork segment operating profit decreased $123.8 million as a significant increase in domestic live hog prices was only slightly offset by both higher packaged meat sales prices and higher fresh meat market prices.
▪
Results in the Hog Production segment improved 141% as a result of significant increase in domestic live hog prices.
▪
International operating profit decreased $21.1 million due significantly higher raising costs and lower average selling prices.
▪
As a result of the Merger, we recognized professional fees of $34.7 million and additional interest expense of $17.3 million during the three months ended October 27, 2013. See "Significant Events Affecting Results of Operations" below for further discussion.
Porcine Epidemic Diarrhea Virus (PEDv)
The USDA has identified PEDv in the United States for the first time in 2013. PEDv is an industry-wide issue and has a significant presence in U.S. swine. Our herds are proportionately affected as PEDv continues to spread throughout the U.S. We are subject to risks related to our ability to maintain animal health and control PEDv. We are unable to predict whether, or to what extent, the disease will impact our operations or market prices in the future.
Renewable Fuel Standard
On November 15, 2013, the Environmental Protection Agency ( EPA) proposed the volume requirements and associated percentage standards that would apply under the Renewable Fuel Standard (RFS) program in calendar year 2014 for cellulosic bio-fuel, biomass-based diesel, advanced bio-fuel, and total renewable fuel. EPA’s proposal reduces the volume of renewable fuels mandated by statute and reflects EPA’s current estimate of what will actually be produced in 2014. EPA will consider public comments before setting the final standard. Although the long-term impact of the RFS is currently unknown, studies have shown that expanded corn-based ethanol production has driven up the price of livestock feed and led to commodity-price volatility. We cannot presently assess the full economic impact of the RFS program on the meat processing industry or on our operations.
Country of Origin Labeling
Following a World Trade Organization (WTO) panel ruling on a complaint by Canada and Mexico that existing U.S. country- of-origin labeling (COOL) requirements violated the United States’ WTO obligations, USDA published a new rule effective May 23, 2013, Mandatory Country of Origin Labeling of Beef, Pork, Lamb, Chicken, Goat Meat, Wild and Farm-Raised Fish and Shellfish, Perishable Agricultural Commodities, Peanuts, Pecans, Ginseng, and Macadamia Nuts . 78 Fed. Reg. 31367 (May 24, 2013) (the 2013 Rule). The rule requires, in part, that labels on covered meat products must list separately, in sequence, the specific country where the animal was “born,” the country where it was “raised,” and the country where it was “slaughtered.” The rule also prohibits combining or commingling of meats with different “Born, Raised, and Slaughtered” combinations in the same package at retail. USDA also provided a six month educational period for retailers until November 23, 2013.
Judicial challenges to these rule-makings by a coalition of industry groups are pending in the United States District Court for the District of Columbia. The Canadian and Mexican governments are also challenging the 2013 Rule before the Dispute Settlement Body of the WTO. If the Canadian and Mexican WTO challenge is successful, then USDA will be faced with the choice of re-formulating another country of origin regulation, seeking amendments to the underlying statute, or subjecting U.S. industries to substantial retaliatory tariffs. Although the long-term impact of COOL is currently unknown, industry groups have indicated that the rules impose additional costs on the industry including costs associated with segregation of livestock, record-keeping and new packaging and labeling along with potential retaliatory trade measures under WTO rules. We cannot presently assess the full economic impact of COOL on the meat processing industry or on our operations.
27
Outlook
The commodity markets affecting our business fluctuate on a daily basis. In this operating environment, it is difficult to forecast industry trends and conditions. The outlook statements that follow must be viewed in this context.
We will continue to execute our long-term strategic growth plan to improve earnings and migrate the Company more towards a value-added consumer packaged meats company. We believe this plan will produce broad-based gains in volume, market share and distribution across our core brands and key product categories. The combination of those gains, an improving product mix toward differentiated, branded and value-added products, as well as loosening export market restrictions in our fresh pork business and higher contributions from our international meat processing business, should provide significant long-term growth potential for Smithfield.
The remainder of calendar 2013 should reflect strong pork margins above the normalized range for fresh pork and within our packaged meats normalized range. Seasonally low hog prices will offset improved efficiencies and productivity in our Hog Production segment with operating margins expected below the normalized range. International segment results should show improvement.
RESULTS OF OPERATIONS
Significant Events Affecting Results of Operations
Shuanghui Merger
In connection with the Merger, we incurred $20.7 million and $18.0 million of professional fees during the Successor and Predecessor periods, respectively. The $18.0 million incurred in the Predecessor period includes $4.0 million which were previously recognized in the three months ended July 28, 2013. These fees are recognized in merger related costs on the consolidated condensed statements of income. In addition, the Merger Sub deferred $17.3 million of debt issuance costs for a financing arrangement. We recognized these deferred costs in interest expense during the Successor period upon termination of the financing arrangement following the Merger. All of these charges are reflected in the results of our Corporate segment.
Shuanghui's cost of acquiring the Company has been pushed-down to establish a new accounting basis for the Company. The preliminary allocation of consideration to the net tangible and intangible assets acquired and liabilities assumed by Shuanghui in the Merger reflects preliminary fair value estimates based on management analysis, including preliminary work performed by third-party valuation specialists, which are subject to change within the measurement period as valuations are finalized. Our earnings for the Successor period were negatively impacted by $17.1 million as a result of the fair value step-up of our assets and liabilities, including a $24.8 million increase in cost of sales as a result of the fair value step-up of our inventory.
Acquisition of Kansas City Sausage, LLC
In May 2013, we acquired a 50% interest in Kansas City Sausage Company, LLC (KCS), for $36.0 million in cash. Upon closing, in addition to the cash purchase price, we advanced $10.0 million to the seller in exchange for a promissory note, which is secured by the remaining membership interests in KCS held by the seller. Additionally, we entered into a revolving loan agreement with KCS, under which we agreed to make loans from time to time up to an aggregate principal amount of $20.0 million . The aggregate amount of any obligations incurred under the revolving loan agreement is secured by a first priority security interest in all of the assets of KCS.
KCS operates in Des Moines, Iowa and Kansas City, Missouri. In Des Moines, KCS produces premium raw materials for sausage, as well as value-added products, including boneless hams and hides. The Kansas City plant is a modern sausage processing facility and is designed for optimum efficiency to provide retail and foodservice customers with high quality products. With our strong ongoing focus on building our packaged meats business, and with 15% of the U.S. sow population, this joint venture is a logical fit for the Company. It is expected to provide a growth platform in two key packaged meats categories — breakfast sausage and dinner sausage — and to allow us to expand our product offerings to our customers. These categories represent over $4.0 billion in industry retail and foodservice sales annually.
28
KCS is managed by its Board of Directors, which makes decisions that most significantly impact the economic performance of KCS. We have the right to nominate and elect the majority of the members of the Board of Directors of KCS, and based on the associated voting rights, we have determined that we have a controlling financial interest in KCS. As a result, the acquisition of our interest in KCS was accounted for in the Pork segment using the acquisition method of accounting. Currently, KCS generates approximately $200 million in sales annually.
Consolidated Results of Operations
The tables presented below compare our results of operations for the three and six months ended October 27, 2013 and October 28, 2012 . As used in the tables, "NM" means "not meaningful."
Three Months Ended October 27, 2013 and October 28, 2012
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
July 29 - September 26,
2013
Three Months Ended
October 27,
2013
October 28,
2012
%
Change
(in millions)
Sales
$
1,139.1
$
2,286.2
$
3,425.3
$
3,225.8
6
%
Cost of sales
1,046.8
2,101.0
3,147.8
2,848.5
11
Gross profit
92.3
185.2
277.5
377.3
(26
)
Selling, general and administrative expenses
63.4
140.5
203.9
205.7
(1
)
Merger related costs
20.7
14.0
34.7
—
NM
Income from equity method investments
(1.2
)
(1.2
)
(2.4
)
(6.7
)
(64
)
Operating profit
9.4
31.9
41.3
178.3
(77
)
Interest expense
31.1
22.8
53.9
41.5
30
Loss on debt extinguishment
—
—
—
120.7
(100
)
(Loss) income before income taxes
(21.7
)
9.1
(12.6
)
16.1
(178
)
Income tax (benefit) expense
(5.1
)
(3.3
)
(8.4
)
5.2
(262
)
Net (loss) income
$
(16.6
)
$
12.4
$
(4.2
)
$
10.9
(139
)%
Sales and Gross Profit
▪
Sales increased primarily as the result of higher average selling prices in Pork and Hog Production segments.
▪
Gross profit decreased primarily as the result of an 18% increase in domestic live hog prices. As noted in "Significant Events Affecting Results of Operations," the current year also included an additional $24.8 million in cost of sales during the Successor period as a result of the fair value step-up of our inventory.
Merger Related Costs
▪
As noted in "Significant Events Affecting Results of Operations," we incurred professional fees during the Successor and Predecessor periods in the current year as a result of the Merger.
Income from Equity Method Investments
▪
The decline in profitability in the current year is primarily driven by lower selling prices in the meat processing operations and unfavorable foreign currency transaction losses at our Mexican joint ventures.
Interest Expense and Loss on Debt Extinguishment
▪
As noted in "Significant Events Affecting Results of Operations," interest expense for the Successor period includes $17.3 million of debt issuance costs originally deferred by the Merger Sub.
▪
In the prior year, we recognized losses of $120.7 million on the repurchase of $694.4 million of our outstanding senior notes due in May 2013 and July 2014.
29
Income Tax Expense
▪
Taxable income relative to permanent items and the mix of income between jurisdictions for the Successor period impacted the effective tax rate. The Predecessor periods are also impacted by income relative to permanent items for the period, the mix of income between jurisdictions, and state income tax credits.
Six Months Ended October 27, 2013 and October 28, 2012
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
April 29 - September 26,
2013
Six Months Ended
October 27,
2013
October 28,
2012
%
Change
(in millions)
Sales
$
1,139.1
$
5,679.5
$
6,818.6
$
6,317.1
8
%
Cost of sales
1,046.8
5,190.1
6,236.9
5,607.6
11
Gross profit
92.3
489.4
581.7
709.5
(18
)
Selling, general and administrative expenses
63.4
341.7
405.1
406.8
—
Merger related costs
20.7
18.0
38.7
—
NM
(Income) loss from equity method investments
(1.2
)
0.5
(0.7
)
(7.4
)
(91
)
Operating profit
9.4
129.2
138.6
310.1
(55
)
Interest expense
31.1
64.6
95.7
84.0
14
Loss on debt extinguishment
—
—
—
120.7
(100
)
(Loss) income before income taxes
(21.7
)
64.6
42.9
105.4
(59
)
Income tax (benefit) expense
(5.1
)
12.7
7.6
32.8
(77
)
Net (loss) income
$
(16.6
)
$
51.9
$
35.3
$
72.6
(51
)%
Sales and Gross Profit
▪
Sales increased primarily as the result of higher average selling prices in Pork and Hog Production segments.
▪
Gross profit decreased primarily as the result of a 12% increase in domestic live hog prices. As noted in "Significant Events Affecting Results of Operations," the current year also included an additional $24.8 million in cost of sales during the Successor period as a result of the fair value step-up of our inventory.
Merger Related Costs
▪
As noted in "Significant Events Affecting Results of Operations," we incurred professional fees during the Successor and Predecessor periods in the current year as a result of the Merger.
(Income) Loss from Equity Method Investments
▪
The decline in profitability in the current year is primarily driven by lower selling prices in the meat processing operations and unfavorable foreign currency transaction losses at our Mexican joint ventures.
Interest Expense and Loss on Debt Extinguishment
▪
As noted in "Significant Events Affecting Results of Operations," interest expense for the Successor period includes $17.3 million of debt issuance costs originally deferred by the Merger Sub.
▪
In the prior year, we recognized losses of $120.7 million on the repurchase of $694.4 million of our outstanding senior notes due in May 2013 and July 2014.
Income Tax Expense
▪
Taxable income relative to permanent items and the mix of income between jurisdictions for the Successor period impacted the effective tax rate. The Predecessor periods are also impacted by income relative to permanent items for the period, the mix of income between jurisdictions, and state income tax credits.
30
Segment Results
The following information reflects the results from each respective segment for the three and six months ended October 27, 2013 and October 28, 2012 .
Three Months Ended October 27, 2013 and October 28, 2012
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
July 29 - September 26,
2013
Three Months Ended
October 27,
2013
October 28,
2012
%
Change
(in millions)
Sales:
Pork:
Fresh Pork
$
420.1
$
876.9
$
1,297.0
$
1,237.3
5
%
Packaged Meats
540.2
1,054.7
1,594.9
1,483.6
8
Total Pork
960.3
1,931.6
2,891.9
2,720.9
6
Hog Production
280.5
566.7
847.2
734.0
15
International
137.6
267.6
405.2
358.6
13
Total segment sales
1,378.4
2,765.9
4,144.3
3,813.5
9
Intersegment sales
(239.3
)
(479.7
)
(719.0
)
(587.7
)
22
Consolidated sales
$
1,139.1
$
2,286.2
$
3,425.3
$
3,225.8
6
%
Operating profit: (1)
Pork:
Fresh Pork
$
18.4
$
(14.2
)
$
4.2
$
94.7
(96
)%
Packaged Meats
15.0
51.3
66.3
99.6
(33
)
Total Pork
33.4
37.1
70.5
194.3
(64
)
Hog Production
(1.5
)
14.9
13.4
(32.6
)
141
International
5.8
14.0
19.8
40.9
(52
)
Corporate
(28.3
)
(34.1
)
(62.4
)
(24.3
)
157
Consolidated operating profit
$
9.4
$
31.9
$
41.3
$
178.3
(77
)%
——————————————
(1)
Fresh pork and packaged meats operating profits represent management's estimated allocation of total Pork segment operating profit.
Pork Segment
▪
Current year sales increased despite 3% lower volume in the Pork segment. The increase was driven by an overall 9% increase in average selling prices.
▪
Current year fresh pork operating profit significantly decreased despite an 8% increase in average selling prices primarily as a result of an 18% increase in domestic live hog prices.
▪
Packaged meats operating profit in the current year decreased as a 12% increase in selling prices was more than offset by higher raw material costs.
▪
Operating profit in the Successor period for packaged meats was $20.7 million lower due to the fair value step-up of our inventory. See "Significant Events Affecting Results Operations" for further discussion.
Hog Production Segment
▪
Current year sales and operating profit benefited from an 18% increase in domestic live hog prices.
31
International Segment
▪
As a result of fluctuations in foreign exchange rates, sales and operating profit in the current year were higher by 5% and 2% , respectively.
▪
Sales were positively impacted by a 16% increase in current year volume which was offset by a 4% decrease in average selling prices.
▪
Current year operating profit was negatively impacted by an 11% increase in raising costs in both Poland and Romania along with lower equity income from our Mexican joint ventures.
Corporate Segment
▪
Current year results include fees related to the Merger. See "Significant Events Affecting Results of Operations" for further discussion.
Six Months Ended October 27, 2013 and October 28, 2012
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
April 29 - September 26,
2013
Six Months Ended
October 27,
2013
October 28,
2012
%
Change
(in millions)
Sales:
Pork:
Fresh Pork
$
420.1
$
2,240.3
$
2,660.4
$
2,498.3
6
%
Packaged Meats
540.2
2,541.7
3,081.9
2,822.2
9
Total Pork
960.3
4,782.0
5,742.3
5,320.5
8
Hog Production
280.5
1,439.1
1,719.6
1,462.8
18
International
137.6
643.6
781.2
705.4
11
Total segment sales
1,378.4
6,864.7
8,243.1
7,488.7
10
Intersegment sales
(239.3
)
(1,185.2
)
(1,424.5
)
(1,171.6
)
22
Consolidated sales
$
1,139.1
$
5,679.5
$
6,818.6
$
6,317.1
8
%
Operating profit: (1)
Pork:
Fresh Pork
$
18.4
$
(50.7
)
$
(32.3
)
$
82.7
(139
)%
Packaged Meats
15.0
149.2
164.2
230.2
(29
)
Total Pork
33.4
98.5
131.9
312.9
(58
)
Hog Production
(1.5
)
81.4
79.9
(9.5
)
NM
International
5.8
15.9
21.7
56.7
(62
)
Corporate
(28.3
)
(66.6
)
(94.9
)
(50.0
)
90
Consolidated operating profit
$
9.4
$
129.2
$
138.6
$
310.1
(55
)%
——————————————
(1)
Fresh pork and packaged meats operating profits represent management's estimated allocation of total Pork segment operating profit.
Pork Segment
▪
Current year sales increased as the result of increases in average selling prices and volume of 7% and 1% , respectively.
•
Current year fresh pork operating profit significantly decreased despite a 6% increase in average selling prices primarily as a result of a 12% increase in domestic live hog prices
▪
Packaged meats operating profit in the current year decreased as a 10% increase in selling prices was more than offset by higher raw material costs.
32
▪
Operating profit in the Successor period for packaged meats was $20.7 million lower due to fair value step-up of our inventory. See "Significant Events Affecting Results of Operations" for further discussion.
Hog Production Segment
▪
Current year sales and operating profit benefited from a 12% increase in domestic live hog prices and a 4% increase in volume.
International Segment
▪
As a result of fluctuations in foreign exchange rates, sales and operating profit in the current year were higher by 3% and 2% , respectively.
▪
Sales were positively impacted by a 17% increase in current year volume which was partially offset by a 6% decrease in average selling prices.
▪
Current year operating profit was negatively impacted by 12% and 13% increases in raising costs in both Poland and Romania, respectively, along with lower equity income from our Mexican joint ventures.
Corporate Segment
▪
Current year results include fees related to the Merger. See "Significant Events Affecting Results of Operations" for further discussion.
33
LIQUIDITY AND CAPITAL RESOURCES
Summary
Our cash requirements consist primarily of the purchase of raw materials used in our hog production and pork processing operations, long-term debt obligations and related interest, lease payments for real estate, machinery, vehicles and other equipment, and expenditures for capital assets, other investments and other general business purposes. Our primary sources of liquidity are cash we receive as payment for the products we produce and sell, as well as our credit facilities.
We believe that our current liquidity position is strong and that our cash flows from operations and availability under our credit facilities will be sufficient to meet our working capital needs and financial obligations for at least the next twelve months. As of October 27, 2013 , our liquidity position was approximately $801.7 million , comprised of $667.6 million in availability under our credit facilities and $134.1 million in cash and cash equivalents.
On July 31, 2013, the Merger Sub issued $500.0 million aggregate principal amount of 5.25% senior notes due August 1, 2018 and $400.0 million aggregate principal amount of 5.875% senior notes due August 1, 2021 (together, the Merger Sub Notes). The Merger Sub incurred $20.4 million in transaction fees in connection with issuance of the Merger Sub Notes, which are being amortized over the life of the Merger Sub Notes. As a result of the Merger and the transactions entered into in connection therewith, we have assumed the liabilities and obligations of the Merger Sub, including the Merger Sub's obligations under the Merger Sub Notes. Proceeds from the Merger Sub Notes were held in escrow prior to the Merger Date and used in funding the Merger. The proceeds were used to fund a portion of the total consideration paid , repay certain outstanding debt of the Company and pay certain transaction fees associated with the Merger.
Sources of Liquidity
We have available a variety of sources of liquidity and capital resources, both internal and external. These resources provide funds required for current operations, acquisitions, integration costs, debt retirement and other capital requirements.
Accounts Receivable and Inventories
The meat processing industry is characterized by high sales volume and rapid turnover of inventories and accounts receivable. Because of the rapid turnover rate, we consider our meat inventories and accounts receivable highly liquid and readily convertible into cash. The Hog Production segment also has rapid turnover of accounts receivable. Although inventory turnover in the Hog Production segment is slower, mature hogs are readily convertible into cash. Borrowings under our credit facilities are used, in part, to finance increases in the levels of inventories and accounts receivable resulting from seasonal and other market-related fluctuations in raw material costs.
Credit Facilities
Successor
October 27, 2013
Facility
Capacity
Outstanding Letters of Credit
Outstanding Borrowings
Amount Available
Inventory Revolver
$
1,025.0
$
—
$
(485.0
)
$
540.0
Securitization Facility
275.0
(90.3
)
(120.0
)
64.7
International facilities
144.8
—
(81.9
)
62.9
Total credit facilities
$
1,444.8
$
(90.3
)
$
(686.9
)
$
667.6
34
Cash Flows
Operating Activities
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
April 29 - September 26,
2013
Six Months Ended
October 27,
2013
October 28,
2012
(in millions)
Net cash flows from operating activities
$
(41.9
)
$
(25.8
)
$
(67.7
)
$
(190.5
)
The following items explain the significant changes in cash flows from operating activities:
▪
Cash received from customers increased due to increased average selling prices in the Pork segment.
▪
In the current year, we paid $26.1 million for the settlement of derivative contracts and for margin requirements compared to $93.7 million received in prior year.
▪
Cash paid to outside hog suppliers increased due to a 12% increase in domestic live hog market prices.
Investing Activities
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
April 29 - September 26,
2013
Six Months Ended
October 27,
2013
October 28,
2012
(in millions)
Acquisition of Smithfield Foods, Inc. common stock
$
(4,896.6
)
$
—
$
(4,896.6
)
$
—
Capital expenditures
(13.8
)
(139.8
)
(153.6
)
(127.7
)
Acquisitions, net of cash acquired
—
(32.8
)
(32.8
)
(23.1
)
Net proceeds (expenditures) from breeding stock transactions
2.1
(5.3
)
(3.2
)
(13.4
)
Proceeds from the sale of property, plant and equipment
1.3
1.7
3.0
10.7
Advance note
—
(10.0
)
(10.0
)
—
Net cash flows from investing activities
$
(4,907.0
)
$
(186.2
)
$
(5,093.2
)
$
(153.5
)
The following items explain the significant investing activities for the six months ended October 27, 2013 and October 28, 2012 :
▪
As part of the Merger, Shuanghui paid approximately $4.9 billion in connection with the Merger to acquire all of our outstanding common stock and settle all vested and unvested stock-based compensation awards.
▪
Capital expenditures during both the current and prior year primarily related to plant and hog farm improvement projects, including the replacement of gestation stalls with group pens, which is more fully explained under "Additional Matters Affecting Liquidity" below.
▪
In May 2013 , we paid $32.8 million , net of cash acquired, for a 50% interest in KCS. Also, we advanced $10.0 million to the seller of KCS in exchange for a promissory note, which is secured by the remaining membership interests in KCS held by the seller.
▪
In October 2012, we paid $23.1 million , net of cash acquired, for a 70% interest in American Skin Food Group, LLC.
35
Financing Activities
Successor
Predecessor
Combined
Predecessor
September 27 - October 27,
2013
April 29 - September 26,
2013
Six Months Ended
October 27,
2013
October 28,
2012
(in millions)
Net proceeds from equity contribution
$
4,162.1
$
—
$
4,162.1
$
—
Proceeds from the issuance of long-term debt
900.0
—
900.0
1,019.2
Principal payments on long-term debt and capital lease obligations
(200.5
)
(458.7
)
(659.2
)
(711.4
)
Proceeds from Securitization Facility
—
170.0
170.0
—
Payments on Securitization Facility
—
(50.0
)
(50.0
)
—
Net proceeds (payments) on revolving credit facilities
(11.0
)
490.3
479.3
66.7
Repurchase of common stock
—
—
—
(212.3
)
Debt issuance cost and other
(20.1
)
0.1
(20.0
)
(17.9
)
Net cash flows from financing activities
$
4,830.5
$
151.7
$
4,982.2
$
144.3
The following items explain the significant financing activities for the six months ended October 27, 2013 and October 28, 2012 :
▪
As part of the Merger, we received approximately $4.2 billion , net of certain transaction costs, in equity contributions from Shuanghui.
▪
Merger Sub issued the Merger Sub Notes as part of the financing for the Merger. Also, the Merger Sub incurred $20.4 million in transaction fees in connection with issuance of the Merger Sub Notes, which are being amortized over the life of the Merger Sub Notes. As a result of the Merger and the transactions entered into in connection therewith, we have assumed the liabilities and obligations of the Merger Sub, including the Merger Sub's obligations under the Merger Sub Notes.
▪
In September 2013, we repaid our $200.0 million floating rate unsecured term loan due in February 2014.
▪
In July 2013, we repaid the outstanding principal balance on our 4% senior unsecured convertible notes totaling $400.0 million .
▪
In May 2013, we repaid the remaining outstanding principal amount on our 7.75% senior unsecured notes totaling $55.0 million .
▪
In the current year, we drew $485.0 million on our Inventory Revolver and $120.0 million on our Securitization Facility to repay other long-term debt, as noted above.
▪
In August 2012, we issued $1.0 billion of our 2022 Notes at a price equal to 99.5% of their face value. We used $804.9 million of the $981.2 million in net proceeds from the debt offering to repurchase of $694.4 million of our outstanding senior notes due in May 2013 and July 2014.
▪
We repurchased 10,823,296 shares of our common stock for $212.3 million as part of a previously approved share repurchase program.
▪
We incurred $18.0 million in transaction fees in connection with the issuance of the 2022 Notes, which are being amortized over their ten-year life.
Interest Rate Spread
As of October 27, 2013 , the interest rates on borrowings under the Inventory Revolver and the Securitization Facility were LIBOR plus 3.25% and the lender's cost of funds of 0.23% plus 1.15% , respectively. The Inventory Revolver interest rate spread is based on a pricing-level grid in the agreement and is determined by our Funded Debt to EBITDA ratio (as defined in the Second Amended and Restated Credit Agreement, dated as of June 9, 2011, among the Company, specified subsidiaries of the Company, Rabobank Nederland, New York Branch, as Administrative Agent, specified lenders, and the other specified agents and arrangers, as amended).
36
Guarantees
As part of our business, we are a party to various financial guarantees and other commitments as described below. These arrangements involve elements of performance and credit risk that are not included in the consolidated condensed balance sheets. We could become liable in connection with these obligations depending on the performance of the guaranteed party or the occurrence of future events that we are unable to predict. If we consider it probable that we will become responsible for an obligation, we will record the liability on our consolidated balance sheet.
As of October 27, 2013 , we continued to guarantee $9.7 million of leases that were transferred to JBS S.A. in connection with the sale of Smithfield Beef, Inc. This guaranty may remain in place until the leases expire through February 2022.
Additional Matters Affecting Liquidity
Capital Projects
We anticipate annual capital expenditures in the range of $300 million to $350 million over the next several years to upgrade facilities with new machinery and equipment in order to improve our competitive cost structure and achieve least cost and best in class operations. These capital expenditures are expected to be funded with cash flows from operations and/or borrowings under credit facilities.
Group Pens
In January 2007, we announced a voluntary, ten-year program to phase out individual gestation stalls at our Company-owned sow farms and replace the gestation stalls with group pens. We currently estimate the total cost of our transition to group pens to be approximately $360.0 million, including associated maintenance and repairs. This program represents a significant financial commitment and reflects our desire to be more animal friendly, as well as to address the concerns and needs of our customers. As of the end of calendar year 2012, we had completed conversions to group housing for over 38% of our sows on Company-owned farms. We will continue the conversion as planned with the objective of completing conversions for all sows on Company-owned farms by the end of 2017.
Risk Management Activities
We are exposed to market risks primarily from changes in commodity prices, and to a lesser degree, interest rates and foreign exchange rates. To mitigate these risks, we utilize derivative instruments to hedge our exposure to changing prices and rates, as more fully described under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Derivative Financial Instruments” in our Annual Report on Form 10-K for the fiscal year ended April 28, 2013 . Our liquidity position may be positively or negatively affected by changes in the underlying value of our derivative portfolio. When the value of our open derivative contracts decreases, we may be required to post margin deposits with our brokers to cover a portion of the decrease. Conversely, when the value of our open derivative contracts increases, our brokers may be required to deliver margin deposits to us for a portion of the increase. During the six months ended October 27, 2013 , margin deposits posted by us ranged from $21.7 million to $106.4 million . The average daily amount on deposit with brokers during the six months ended October 27, 2013 was $58.6 million . As of October 27, 2013 , the net amount on deposit with brokers was $26.4 million .
The effects, positive or negative, on liquidity resulting from our risk management activities tend to be mitigated by offsetting changes in cash prices in our core business. For example, in a period of rising grain prices, gains resulting from long grain derivative positions would generally be offset by higher cash prices paid to farmers and other suppliers in spot markets. These offsetting changes do not always occur, however, in the same amounts or in the same period, with lag times of as much as twelve months.
37
Contractual Obligations and Commercial Commitments
The following table provides information about our contractual obligations and commercial commitments as of October 27, 2013 by providing an update to the commitment table set forth in our Annual Report on Form 10-K for the fiscal year ended April 28, 2013 .
Payments Due By Period
Total
< 6 Months
7-30 Months
31-54 Months
> 54 Months
(in millions)
Long-term debt
$
3,412.9
$
4.0
$
127.7
$
1,184.6
$
2,096.6
Interest
1,163.2
92.7
366.1
310.2
394.2
Capital lease obligations, including interest
29.4
0.7
2.3
1.6
24.8
Operating leases
156.4
23.7
58.2
35.8
38.7
Capital expenditure commitments
25.8
25.8
—
—
—
Purchase obligations:
Hog procurement (1)
5,364.0
776.1
2,181.8
1,508.6
897.5
Contract hog growers (2)
1,407.3
268.4
483.8
288.3
366.8
Grain procurement (3)
414.3
387.1
27.2
—
—
Other (4)
286.1
10.8
26.4
27.8
221.1
Total
$
12,259.4
$
1,589.3
$
3,273.5
$
3,356.9
$
4,039.7
——————————————
(1)
Through the Pork and International segments, we have purchase agreements with certain hog producers. Some of these arrangements obligate us to purchase all of the hogs produced by these producers. Other arrangements obligate us to purchase a fixed amount of hogs. Due to the uncertainty of the number of hogs that we are obligated to purchase and the uncertainty of market prices at the time of hog purchases, we have estimated our obligations under these arrangements. Future payments were estimated using current live hog market prices, available futures contract prices and internal projections adjusted for historical quality premiums.
(2)
Through the Hog Production segment, we use independent farmers and their facilities to raise hogs produced from our breeding stock. Under multi-year contracts, the farmers provide the initial facility investment, labor and front line management in exchange for a performance-based service fee payable upon delivery. We are obligated to pay this service fee for all hogs delivered. We have estimated our obligation based on expected hogs delivered from these farmers.
(3)
Includes fixed price forward grain purchase contracts totaling $128.6 million . Also includes unpriced forward grain purchase contracts which, if valued as of October 27, 2013 market prices, would be $285.7 million . These forward grain contracts are accounted for as normal purchases. As a result, they are not recorded in the balance sheet.
(4)
Includes guaranteed royalty payments totaling $250.0 million to Nathan's Famous Inc. (Nathan's) over an 18 year contractual term that commenced in March 2014. In December 2012, John Morrell signed an agreement with Nathan's to become Nathan's exclusive licensee to manufacture and sell branded hot dog, sausage and corn beef products in the retail market. Under the terms of the agreement, guaranteed minimum royalty payments are $10.0 million for the first year and increase at a compounded average annual rate of 3.2% over the contract term.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated condensed financial statements requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are based on our experience and our understanding of the current facts and circumstances. Actual results could differ from those estimates. There have been no significant updates to our critical accounting policies and estimates described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended April 28, 2013 .
38
FORWARD-LOOKING STATEMENTS
This report contains “forward-looking” statements within the meaning of the federal securities laws. The forward-looking statements include statements concerning our outlook for the future, as well as other statements of beliefs, future plans and strategies or anticipated events, and similar expressions concerning matters that are not historical facts. Our forward-looking information and statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in, or implied by, the forward-looking statements. These risks and uncertainties include, but are not limited to: the availability and prices of live hogs, feed ingredients (including corn), raw materials, fuel and supplies, food safety, livestock disease, live hog production costs, product pricing, the competitive environment and related market conditions, risks associated with our indebtedness, including cost increases due to rising interest rates or changes in debt ratings or outlook, hedging risk, adverse weather conditions, operating efficiencies, changes in foreign currency exchange rates, access to capital, the cost of compliance with and changes to regulations and laws, including changes in accounting standards, tax laws, environmental laws, agricultural laws and occupational, health and safety laws, adverse results from litigation, actions of domestic and foreign governments, labor relations issues, credit exposure to large customers, the ability to realize the anticipated strategic benefits of the acquisition of Smithfield Foods, Inc. by Shuanghui International Holdings Limited, t he ability to make effective acquisitions and successfully integrate newly acquired businesses into existing operations, and other risks and uncertainties described under Part I, Item 1A. “Risk Factors” in Smithfield's Annual Report on Form 10-K for the fiscal year ended April 28, 2013 . Readers are cautioned not to place undue reliance on forward-looking statements because actual results may differ materially from those expressed in, or implied by, the statements. Any forward-looking statement that we make speaks only as of the date of such statement, and we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.