What changed in this filing

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Item 2. Management’s Discussion and Analysis

2014-11-07 compared with 2014-08-11 · 114 added, 90 removed, 225 unchanged (48% of the section changed)

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Fresh Pork, Packaged Meats, Hog Production, International and Corporate.

See Note 12—Reportable Segments for additional information about changes to our reportable segments during the current quarter.

See Note 12—Reportable Segments for additional information about changes to our reportable segments during the current year.

The Fresh Pork segment consists of our U.S.

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The Corporate segment provides management and administrative services to support our other segments.

Second Quarter Summary of Results

Net income for the three months ended June 29, 2014 was $142.9 million compared to net income of $32.4 million in the three months ended June 30, 2013 .

The following summarizes the operating results of each of our reportable segments and other significant changes impacting net income for the three months ended June 29, 2014 compared to net income for the three months ended June 30, 2013 :

Fresh Pork operating profit increased by $48.6 million primarily as a result of higher fresh pork market prices.

Packaged Meats operating profit decreased by $ 14.3 million as raw material costs increased significantly and could not fully be passed on to customers.

Third Quarter Summary of Results

Net income for the third quarter of 2014 was $155.3 million compared to net income of $35.4 million for the third quarter of 2013 .

The following summarizes the operating results of each of our reportable segments and other significant changes impacting net income for the third quarter of 2014 compared to net income for the third quarter of 2013 :

Fresh Pork operating loss improved by $10.4 million primarily as a result of higher fresh pork market prices.

Packaged Meats operating profit increased by $ 33.7 million as a result of higher average selling prices.

Hog Production operating profit increased $91.1 million primarily as a result of significantly higher live hog market prices and lower feed costs.

International operating profit increased by $30.4 million due to higher sales and lower raw material costs in our European operations as well as an increase in equity income from our joint ventures in Mexico.

International operating profit increased by $23.0 million due to higher sales volume and lower raw material costs in our European operations as well as an increase in equity income from our joint ventures in Mexico.

Porcine Epidemic Diarrhea Virus (PEDv)

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Court of Appeals for the District of Columbia Circuit rejected a judicial challenge to these rulemakings by a coalition of industry groups.

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.

The Canadian and Mexican governments challenged the 2013 Rule before the Dispute Settlement Body (DSB) of the WTO.

On October 20, 2014, the DSB issued panel reports finding in favor of Canada and Mexico and against the United States' 2013 Rule.

Trade Representative is considering an appeal of the WTO determination.

If the Canadian and Mexican WTO challenge is ultimately successful, then USDA will be faced with the choice of re-formulating another country of origin regulation, seeking amendments to the underlying statute from Congress, or subjecting U.S.

industries to substantial retaliatory tariffs.

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The outlook statements that follow must be viewed in this context.

Market fundamentals continue to be supportive of our business on a number of fronts.

Domestic protein demand is impressive.

Although Russia has banned US pork imports, international demand from other countries remains strong.

This, combined with lower domestic protein production, should support high hog and pork prices for the duration of 2014 and beyond.

Notwithstanding a bullish hog production outlook, PEDv concerns seem to have thwarted market expansion for now.

In addition, corn is currently trading at the lowest level in three years.

This should translate into normalized fresh pork margins and high, above normalized hog production margins in 2014.

We remain focused on maximizing our existing business through increased consumer marketing programs, product innovation and capital investment to further establish ourself as a leader in consumer packaged meats.

We expect to deliver packaged meats margins in the normalized range in 2014.

We see enormous growth potential for our US business through organic improvement, particularly in packaged meats.

Synergy opportunities with WH Group are advancing.

For example, Smithfield branded premium chilled fresh pork sold at Smithfield kiosks in Mainland China has been well received by consumers with strong sales and customer traffic.

We opened three new kiosks in July, bringing our total number of kiosks to 21, and plan to continue to expand throughout China to cover the major first-tier and second-tier cities by the end of the year.

The early success of our Smithfield kiosks in China underscores the synergistic effect of our merger with WH Group.

As part of WH Group’s global platform, we will continue to create value through organic growth and synergy initiatives, while leveraging the benefits of positive market fundamentals in the US.

We will continue to sharpen our strategic focus and drive operational improvements across our entire platform.

Our most exciting growth prospect is the ongoing development of our packaged meats business.

With the integration of two of our independent operating companies, we have improved our competitive cost structure and aligned our organization to better serve our customers’ needs.

We will continue to strengthen our consumer-focused marketing programs and promote innovation to improve our product mix toward branded, value-added products.

Consequently, we expect to deliver modest volume growth and very solid packaged meats margins, even in the midst of the highest raw materials cost we have ever experienced.

Barring a reemergence of PEDv, we could see modest pork production expansion in 2015, although lower prices should spur additional export demand.

Identifying and executing synergistic opportunities with WH Group and Shuanghui, our sister company in China, also remains a priority and an opportunity to bolster profitability.

At the same time, our cost structure should benefit from a record large U.S.

corn and soybean crop.

With the harvest well underway, corn and soybeans continue to trade near 5-year lows.

All of this should allow us to maintain normalized fresh pork margins and above normalized hog production margins.

We believe a combination of operating initiatives and synergies should continue to fuel earnings for us for the remainder of 2014 and into 2015.

RESULTS OF OPERATIONS

Consolidated Results of Operations

The tables presented below compare our results of operations for the three and six months ended June 29, 2014 and June 30, 2013 .

The tables presented below compare our results of operations for the three and nine months ended September 28, 2014 and September 26, 2013 .

As used in the tables, "NM" means "not meaningful."

Three Months Ended June 29, 2014 and June 30, 2013

Three Months Ended September 28, 2014 and September 26, 2013

Three Months Ended

June 29, 2014

June 30, 2013

September 28, 2014

September 26, 2013

(in millions)

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Selling, general and administrative expenses

(Income) loss from equity method investments

Merger related costs

Income from equity method investments

Operating profit

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Sales increased primarily as a result of higher domestic pork market prices.

Gross profit increased primarily as a result of higher sales and lower hog raising costs, which more than offset the increase in pork processing raw material costs.

Gross profit increased primarily as a result of higher average selling prices and lower hog raising costs, which more than offset the increase in pork processing raw material costs.

Selling, general and administrative expenses (SG&A)

The increase in SG&A is primarily attributable to higher variable compensation expenses stemming from higher year-over-year operating results and an increase in professional fees.

These increases in SG&A were partially offset by lower pension expense.

The increase in SG&A is primarily attributable to higher variable compensation expenses stemming from higher year-over-year operating results, partially offset by lower pension expense.

Merger related costs

We incurred approximately $18 million in professional fees during the prior year as a result of the Merger.

Income from equity method investments

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Income tax expense

Our effective tax rate was 35% and 28% for the three months ended June 29, 2014 and June 30, 2013 , respectively.

For the three months ended June 29, 2014, taxable income relative to permanent items, the mix of income between jurisdictions, and the expiration of certain federal tax credits as of December 31, 2013 impacted the effective tax rate.

The three months ended June 30, 2013 were impacted by income relative to permanent items, the mix of income between jurisdictions, state income tax credits and federal legislation during that period that reinstated certain federal tax credits retroactively to January 1, 2012.

Six Months Ended June 29, 2014 and June 30, 2013

Six Months Ended

June 29, 2014

June 30, 2013

Our effective tax rate was 26% and 21% for the three months ended September 28, 2014 and September 26, 2013 , respectively.

For the three months ended September 28, 2014 , taxable income relative to permanent items, the mix of income between jurisdictions, and the expiration of certain federal tax credits as of December 31, 2013 impacted the effective tax rate.

The three months ended September 26, 2013 were impacted by income relative to permanent items, the mix of income between jurisdictions, state income tax credits and federal legislation during that period that reinstated certain federal tax credits retroactively to January 1, 2012.

Nine Months Ended September 28, 2014 and September 26, 2013

Nine Months Ended

September 28, 2014

September 26, 2013

(in millions)

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Selling, general and administrative expenses

Merger related costs

Income from equity method investments

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Selling, general and administrative expenses (SG&A)

The increase in SG&A is primarily attributable to higher variable compensation expenses stemming from higher year-over-year operating results and an increase in professional fees.

These increases in SG&A were partially offset by lower pension expense.

The increase in SG&A is primarily attributable to higher variable compensation expenses stemming from higher year-over-year operating results, partially offset by lower pension expense.

Merger related costs

We incurred approximately $18 million in professional fees during the prior year as a result of the Merger.

Income from equity method investments

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Income tax expense

Our effective tax rate was 34% and 17% for the six months ended June 29, 2014 and June 30, 2013 , respectively.

For the six months ended June 29, 2014, taxable income relative to permanent items, the mix of income between jurisdictions, and the expiration of certain federal tax credits as of December 31, 2013 impacted the effective tax rate.

The six months ended June 30, 2013 were impacted by income relative to permanent items, the mix of income between jurisdictions, state income tax credits and federal legislation during that period that reinstated certain federal tax credits retroactively to January 1, 2012.

Our effective tax rate was 31% and 19% for the nine months ended September 28, 2014 and September 26, 2013 , respectively.

For the nine months ended September 28, 2014 , taxable income relative to permanent items, the mix of income between jurisdictions, and the expiration of certain federal tax credits as of December 31, 2013 impacted the effective tax rate.

The nine months ended September 26, 2013 were impacted by income relative to permanent items, the mix of income between jurisdictions, state income tax credits and federal legislation during that period that reinstated certain federal tax credits retroactively to January 1, 2012.

Segment Results

The following information reflects the results from each respective segment for the three and six months ended June 29, 2014 and June 30, 2013 .

Three Months Ended June 29, 2014 and June 30, 2013

The following information reflects the results from each respective segment for the three and nine months ended September 28, 2014 and September 26, 2013 .

Three Months Ended September 28, 2014 and September 26, 2013

Three Months Ended

June 29, 2014

June 30, 2013

September 28, 2014

September 26, 2013

(in millions)

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Consolidated operating profit

Current year sales and operating profit increased due to higher fresh pork market prices which more than offset higher raw material costs.

Current year sales increased 11% due to a 24% increase in average selling prices partially offset by a 10% decrease in volume.

Current year operating loss improved to $2 per head from $3 per head due to higher fresh pork market prices, which more than offset higher raw material costs.

We processed 6.1 million hogs in the third quarter of 2014, a decrease of 9% from the prior year, largely attributable to PEDv.

However, average hog weights were up 4% , which helped to offset the overall decline in volume.

Packaged Meats

Current year sales increased 19 % due to a 13% increase in average selling prices and a 6% increase in volume, primarily attributable to the timing of Easter.

Operating profit in the current year decreased as raw material costs increased significantly and could not fully be passed on to customers.

Current year sales increased 15 % due to a 11% increase in average selling prices and a 4% increase in volume.

Current year sales volume totaled 630.4 million pounds.

Current year operating profit improved to $.18 per pound from $.13 per pound due to higher average selling prices, which more than offset higher raw material costs.

Hog Production

Sales were relatively unchanged from the prior year as the impact of higher domestic live hog market prices was offset by lower sales volumes.

PEDv was a significant factor in the volume decline and significantly impacted the market prices.

Current year sales decreased due to lower sales volumes partially offset by higher domestic live hog market prices.

Head sold during the year amounted to 3.3 million hogs, a decrease of 13% from the prior year.

PEDv was a significant factor in the volume decline and favorably impacted market prices.

Current year operating profit benefited from a 17% increase in domestic live hog market prices and lower feed costs.

International

Sales were positively impacted by a 12% increase in volume which was partially offset by a 6% decrease in local currency average selling prices.

These changes were driven primarily by a 17% increase in hogs processed in Poland.

Current year sales were positively impacted by a 14% increase in volume of 372.1 million pounds, primarily driven by a 12% increase in hogs processed in Europe, and partially offset by a 7% decrease in average selling prices.

We processed 1.1 million hogs in the third quarter of 2014.

The effects of foreign currency translation also positively impacted sales by approximately $19 million.

Current year operating profit was positively impacted by higher sales and lower feed costs in Europe along with higher equity income from our Mexican joint ventures.

Operating results in the Corporate segment were improved from last year, which included acquisition related expenses associated with the WH Group and Kansas City Sausage transactions.

Six Months Ended June 29, 2014 and June 30, 2013

Six Months Ended

June 29, 2014

June 30, 2013

Operating results in the Corporate segment were improved from last year, which included acquisition related expenses as a result of the Merger.

Nine Months Ended September 28, 2014 and September 26, 2013

Nine Months Ended

September 28, 2014

September 26, 2013

(in millions)

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Consolidated operating profit

Current year sales and operating profit increased due to higher fresh pork market prices which more than offset higher raw material costs.

Current year sales increased 17% due to a 20% increase in average selling prices partially offset by a 3% decrease in volume.

Current year operating profit improved to $4 per head from a loss of $1 per head due to higher fresh pork market prices, which more than offset higher raw material costs.

We processed 19.6 million hogs in 2014, a decrease of 6% from the prior year, largely attributable to PEDv.

However, average hog weights were up 4% , which helped to offset the overall decline in volume.

Packaged Meats

Current year sales increased 8% due to a 10% increase in average selling prices and 2% lower volumes.

Operating profit in the current year was unchanged as we were able to pass higher raw material costs to customers.

Current year sales increased 10% due to higher average selling prices.

Volumes were relatively unchanged from the prior year.

Current year sales volume totaled 1.9 billion pounds, which remained relatively unchanged from prior year.

Current year operating profit increased to $.17 per pound from $.15 due to higher average selling prices, which more than offset higher raw material costs.

Hog Production

Sales were relatively unchanged from the prior year as the impact of higher domestic live hog market prices was offset by lower sales volumes.

Current year sales were relatively unchanged from the prior year as the impact of higher domestic live hog market prices was offset by lower sales volumes.

Head sold during the year amounted to 10.8 million , a decrease of 8% from the prior year.

PEDv was a significant factor in the volume decline and significantly impacted the market prices.

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International

Sales were positively impacted by a 19% increase in volume which was partially offset by an 11% decrease in average selling prices.

These changes were driven largely by a 17% increase in hogs processed in Poland.

Current year sales were positively impacted by a 18% increase in volume of 1.1 billion pounds, driven largely by a 13% increase in hogs processed in Europe, and partially offset by a 10% decrease in average selling prices.

We processed 3.1 million hogs in 2014.

The effects of foreign currency translation also positively impacted sales by approximately $44 million.

Current year operating profit was positively impacted by higher sales and lower feed costs in Europe along with higher equity income from our Mexican joint ventures.

Operating results in the Corporate segment were improved from last year, which included acquisition related expenses associated with the WH Group and Kansas City Sausage transactions.

LIQUIDITY AND CAPITAL RESOURCES

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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 June 29, 2014 , our liquidity position was approximately $1.0 billion , comprised of approximately $930.0 million in availability under our credit facilities and $109.4 million in cash and cash equivalents.

As of September 28, 2014 , our liquidity position was approximately $1.0 billion , comprised of approximately $953.8 million in availability under our credit facilities and $58.8 million in cash and cash equivalents.

Sources of Liquidity

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Credit Facilities

June 29, 2014

September 28, 2014

Outstanding Letters of Credit

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Operating Activities

Six Months Ended

Nine Months Ended

September 28,

September 26,

(in millions)

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The following items explain the significant changes in cash flows from operating activities:

Cash received from customers increased due to higher domestic fresh pork market prices.

Cash paid for grain purchased by the Hog Production segment decreased approximately $459.3 million from the prior year.

Cash received from customers increased due to higher average meat selling prices.

Cash paid for grain and other ingredients purchased by the Hog Production segment decreased approximately $606.4 million from the prior year.

Cash paid to outside hog suppliers increased due to a 21% increase in average domestic live hog prices.

Cash paid to outside meat suppliers increased due to higher fresh meat market prices, particularly pork and beef.

The current year included net tax payments of $ 102.8 million for domestic income taxes as compared to net

refunds of $ 17.9 million in the prior year.

In the current year, we paid $ 104.7 million for the settlement of derivative contracts and for margin requirements compared to $ 26.3 million in the prior year.

Cash paid to outside hog supplier increased due to a 23% increase in average domestic live hog prices.

The current year included net tax payments of $ 82.2 million for domestic income taxes as compared to net refunds of $ 2.8 million in the prior year.

Cash interest payments increased approximately $ 53.3 million .

Investing Activities

Six Months Ended

Nine Months Ended

September 28,

September 26,

(in millions)

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Proceeds from the sale of property, plant and equipment

Advance note and other

Net cash flows from investing activities

The following items explain the significant investing activities for the six months ended June 29, 2014 and June 30, 2013 :

The following items explain the significant investing activities for the nine months ended September 28, 2014 and September 26, 2013 :

Capital expenditures during both years 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 $32.7 million, net of cash acquired, for a 50% interest in Kansas City Sausage Company, LLC (KCS).

In April 2014, KCS bought a meat processing business for $11.0 million.

In April 2014, Kansas City Sausage Company, LLC (KCS) bought a meat processing business for $11.0 million.

In 2013, we paid $33.7 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.

Financing Activities

Six Months Ended

Nine Months Ended

September 28,

September 26,

(in millions)

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Net cash flows from financing activities

The following items explain the significant financing activities for the six months ended June 29, 2014 and June 30, 2013 :

In the current year, we drew $55.0 million on our Inventory Revolver and $50.0 million, net of repayments, on our Securitization Facility, primarily to cover margin requirements on our commodity derivative contracts.

In May 2013, we repaid the remaining outstanding principal amount on our 7.75% senior unsecured notes totaling $55.0 million.

In the prior year, we drew $225.0 million on our Inventory Revolver and $170.0 million, net of repayments, on our Securitization Facility as well as issued $200.0 million in long-term debt to repay the aforementioned notes and for working capital needs.

The following items explain the significant financing activities for the nine months ended September 28, 2014 and September 26, 2013 :

In the current year, we drew $65.0 million, net of repayments, on our Securitization Facility, primarily to cover margin requirements on our commodity derivative contracts.

In July 2013, we repaid the outstanding principal balance on our 4% senior unsecured convertible notes totaling $400.0 million, and in May 2013, we repaid the remaining outstanding principal amount on our 7.75% senior unsecured notes totaling $55.0 million.

In the prior year, we drew $485.0 million, net of repayments, on our Inventory Revolver and $120.0 million, net of repayments, on our Securitization Facility as well as issued $200.0 million in long-term debt to repay the aforementioned notes and for working capital needs.

Interest Rate Spread

As of June 29, 2014 , the interest rate on borrowings under the Inventory Revolver and the Securitization Facility were LIBOR plus 3.25% and the lender's cost of funds of 0.20% plus 1.15% , respectively.

As of September 28, 2014 , the interest rates on borrowings under the Inventory Revolver and the Securitization Facility were LIBOR plus 3.0% and the lender's cost of funds of 0.20% 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 other specified agents and arrangers, as amended).

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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 June 29, 2014 , we continued to guarantee $8.9 million of leases that were transferred to JBS S.A.

As of September 28, 2014 , we continued to guarantee $8.0 million of leases that were transferred to JBS S.A.

in connection with the sale of Smithfield Beef, Inc which closed in October 2008.

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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.

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 June 29, 2014 , margin deposits ranged from $38.5 million to $382.0 million .

The average daily amount on deposit with our brokers during the six months ended June 29, 2014 was $190.2 million .

As of June 29, 2014 , the net amount on deposit with our brokers was $252.2 million .

During the nine months ended September 28, 2014 , margin deposits ranged from $38.5 million to $382.0 million .

The average daily amount on deposit with our brokers during the nine months ended September 28, 2014 was $195.7 million .

As of September 28, 2014 , the net amount on deposit with our brokers was $152.3 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.

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by WH Group, the 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 Transition Report on Form 10-K for the eight months ended December 29, 2013.

"Risk Factors" in our Transition Report on Form 10-K for the eight months ended December 29, 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.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis