SMITHFIELD FOODS INC 10-Q

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 Operations contained in our report on Form 10-K for the twelve months ended December 28, 2014 . EXECUTIVE OVERVIEW 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 Smithfield®, Eckrich®, Farmland®, 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 five reportable segments: Fresh Pork, Packaged Meats, Hog Production, International and Corporate. The Fresh Pork segment consists of our U.S. fresh pork operations. The Packaged Meats segment consists of our U.S. packaged meats operations. The Hog Production segment consists of our U.S. hog production operations. 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 in Mexico, our hog production operations located in Poland and Romania, our interests in hog production operations in Mexico, and our former investment in CFG. The Corporate segment provides management and administrative services to support our other segments. In February 2015, we announced an organizational realignment and key senior management appointments that unify all of our independent operating companies, brands, marketing and employees under one corporate umbrella. We believe moving to a more centralized structure allows for a more efficient and effective approach to customers, best utilizes management talent, maximizes the manufacturing platform and plant efficiency and optimizes marketing, innovation and brand management. Second Quarter Summary of Results Net income for the second quarter of 2015 was $104.2 million compared to net income of $142.9 million for the second quarter of 2014 . The following summarizes the operating results of each of our reportable segments and other significant changes impacting net income for the second quarter of 2015 compared to the second quarter of 2014 : ▪ Fresh Pork operating results decreased by $44.8 million primarily as a result of lower fresh pork market prices. ▪ Packaged Meats operating profit increased by $ 78.8 million as a result of lower raw material costs and higher sales volume. ▪ Hog Production operating profit decreased by $89.9 million primarily as a result of lower live hog market prices driven by higher hog supplies. ▪ International operating profit decreased by $19.1 million primarily due to lower pork market prices in Europe, a decrease in results from our joint ventures in Mexico and the impact of foreign currency translation due to a stronger U.S. dollar. 21 EBITDA for the second quarter of 2015 was $245.2 million compared to $317.3 million in the second quarter of 2014. EBITDA for the first half of 2015 was $478.6 million compared to $571.5 million for the first half of 2014. EBITDA is a non-GAAP measure. We believe EBITDA is a useful measure to our investors because it excludes the effects of financing and investing activities by eliminating the effects of interest and depreciation costs. EBITDA is not intended to be a substitute for our comparable GAAP measures and should not be used by investors or other users of our financial statements as the sole basis for formulating decisions as it excludes a number of important cash and non-cash charges. The following table provides a reconciliation of net income to EBITDA for all periods presented: Three Months Ended Six Months Ended June 28, 2015 June 29, 2014 June 28, 2015 June 29, 2014 (in millions) Net income $ 104.2 $ 142.9 $ 201.2 $ 248.2 Interest expense 31.5 40.4 66.2 81.2 Income tax expense 51.1 76.9 94.8 128.3 Depreciation and amortization expense 58.4 57.1 116.4 113.8 EBITDA $ 245.2 $ 317.3 $ 478.6 $ 571.5 Sale of CFG In June 2015, we completed the sale of our entire equity interest in CFG to Alfa for $354.0 million in cash. As of the date of the sale, the book value of our investment in CFG was $298.7 million . Additionally, we had $54.6 million of unrealized currency translation losses on our balance sheet related to our investment in CFG. As a result of the sale, we recognized a pre-tax gain of $0.7 million in non-operating (gain) loss in our consolidated condensed statements of income. Tender Offer In January 2015, we commenced a cash tender offer for our 7.75% senior unsecured notes due July 2017, 5.25% senior unsecured notes due August 2018, 5.875% senior unsecured notes due August 2021 and 6.625% senior unsecured notes due August 2022, subject to a maximum aggregate purchase price up to $275.0 million (2015 Tender Offer). As a result of the 2015 Tender Offer, we paid $275.0 million to repurchase $258.1 million of principal and recognized losses on debt extinguishment of $12.8 million in non-operating (gain) loss in the consolidated condensed income statement, including the write-off of related unamortized premiums and debt issuance costs. Animal Health The U.S. Department of Agriculture (USDA) identified Porcine Epidemic Diarrhea Virus (PEDv) in the United States for the first time in 2013. During 2014, the U.S. pork market was significantly impacted by the spreading of PEDv, a disease that only infects pigs, not humans or other livestock, which has been an industry-wide issue and continues to have a presence in U.S. swine. Our herds in several regions in which we operate were affected in 2014 as PEDv spread throughout the U.S. There are confirmed cases of PEDv in the U.S. in 2015; however, the outbreak currently is much less severe than in 2014. The USDA and the industry continue to monitor the situation. During 2015, herds in several of our geographic regions have also been impacted by outbreaks of Porcine Reproductive and Respiratory Syndrome Virus (PRRSv). While PRRSv is not new to the swine industry, the impact of these outbreaks has been more severe than observed in recent years. We are subject to risks related to our ability to maintain animal health and control PEDv and PRRSv. We are unable to predict the extent these diseases will impact our operations or market prices in the future. 22 Renewable Fuel Standard The federal Renewable Fuel Standard (RFS) program requires that bio-fuels be blended into transportation fuels at ever-increasing volumes up to 36 billion gallons in 2030. In October 2010, the Environmental Protection Agency (EPA) granted a “partial waiver” to a statutory bar under the Clean Air Act prohibiting fuel manufacturers from introducing fuel additives that are not “substantially similar” to those already approved and in use for vehicles of model year (MY) 1975 or later. Prior to the EPA's decision, the ethanol content of gasoline in the United States was limited to 10 percent (E10), which created a barrier, commonly referred to as the “blendwall,” to the expansion of blended bio-fuels as prescribed by the RFS. The EPA's decision allows fuel manufacturers to increase the ethanol content of gasoline to 15 percent (E15) for use in MY 2007 and newer light-duty motor vehicles, including passenger cars, light-duty trucks and medium-duty passenger vehicles. In January 2011, the EPA granted another partial waiver authorizing E15 use in MY 2001-2006 light-duty motor vehicles. Judicial challenges to these rulemakings by a coalition of industry groups were dismissed. In 2013, the EPA issued a proposed rule that would have reduced the volume of renewable fuels mandated by statute and reflected the EPA’s estimate of what would actually be produced in 2014. In April 2015, the EPA entered into a proposed consent decree which would have them propose the 2015 RFS by June 1, 2015 and to finalize the 2014 and 2015 RFS targets by November 30, 2015. On May 29, 2015, the EPA proposed to establish the annual percentage standards for cellulosic biofuel, biomass-based diesel, advanced biofuel and total renewable fuels that apply to all gasoline and diesel produced or imported in years 2014, 2015 and 2016 as well as the volume of biomass-based diesel for 2017. The proposed volumes are below statutory levels, but above historical output of renewable fuels. The EPA plans to finalize those standards by November 30, 2015. Representative Bob Goodlatte (R-VA) has re-introduced legislation in the 114th Congress that would eliminate the conventional (corn starch) ethanol mandate, cap the blendwall at E10, and require the EPA to set cellulosic standards at production levels. Additionally, Sens. Dianne Feinstein (D-CA) and Pat Toomey (R-PA) have introduced similar legislation which would eliminate the conventional ethanol mandate. 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, the 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 2013 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. On March 28, 2014 and on July 29, 2014, the U.S. Court of Appeals for the District of Columbia Circuit rejected a judicial challenge to these rulemakings by a coalition of industry groups. As of February 9, 2015, industry opponents dropped their lawsuit against the USDA. 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. An appeal of the DSB's ruling brought by the U.S. was rejected. Canada and Mexico are seeking a combined $3.3 billion in retaliatory tariffs against a range of U.S. agricultural and manufactured product exports, including frozen and chilled pork products. The WTO DSB has referred the case to arbitration which is expected to conclude in late summer or early fall 2015. At the conclusion of arbitration, Canada and Mexico will be permitted to impose retaliatory tariffs equal to a sum determined by the arbitrator. The U.S. House of Representatives passed legislation, H.R. 2393 the "Country of Origin Labeling Amendments Act of 2015," on June 10, 2015. If enacted, this legislation would repeal the WTO non-compliant sections of the COOL statute, thus settling the dispute and eliminating the threat of retaliatory tariffs from Canada and Mexico. The U.S. Senate is considering this legislation, as well as other proposals to amend the COOL statute. 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. 23 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. Our most exciting growth prospect is the ongoing development of our packaged meats business. Although we have experienced meaningful and consistent improvement in packaged meats margins, we believe significant growth potential remains. We will continue to strengthen our consumer-focused marketing programs and promote innovation to improve our product mix toward branded, value-added products. We expect these actions to result in continued broad-based gains in packaged meats sales, volume, market share, distribution and margins. With our organizational realignment, we are taking steps to build on our record results in 2014 as we continue to solidify Smithfield's position as a global leader in branded packaged meats. There is a plethora of benefits to moving to a centralized structure and unifying all our resources and brands together as “One Smithfield,” which should position us to take advantage of growth opportunities in the following ways: • Leveraging Smithfield's size and scope in pork industry; • Maximizing our manufacturing platform and distribution system; • Approaching the market more efficiently and effectively; • Best utilizing management talent across company; • Aligning our operations to provide better customer service; • Optimizing operations in areas like brand management, manufacturing, sales, and marketing; and • Strengthening marketing, brand building and innovation across all brands. We will continue to sharpen our strategic focus and drive operational improvements across our entire platform, including our fresh pork, hog production and international divisions. We are focused on growth and believe that Smithfield is in an ideal position to continue to achieve strong results for the remainder of 2015. 24 RESULTS OF OPERATIONS Consolidated Results of Operations The table presented below compares our results of operations for the second quarters of 2015 and 2014. Three Months Ended June 28, 2015 June 29, 2014 % Change (in millions) Sales $ 3,486.6 $ 3,814.0 (9 )% Cost of sales 3,068.1 3,345.5 (8 )% Gross profit 418.5 468.5 (11 )% Selling, general and administrative expenses 232.6 219.2 6 % Income from equity method investments (0.2 ) (10.9 ) (98 )% Operating profit 186.1 260.2 (28 )% Interest expense 31.5 40.4 (22 )% Non-operating gain (0.7 ) — N/A Income before income taxes 155.3 219.8 (29 )% Income tax expense 51.1 76.9 (33 )% Net income $ 104.2 $ 142.9 (27 )% Sales and gross profit ▪ Sales decreased primarily as a result of lower market prices across all of our segments and the impact of foreign currency translation as a result of a stronger U.S. dollar. ▪ Gross profit decreased primarily as a result of lower sales, partially offset by lower pork processing raw material costs. Income from equity method investments ▪ Equity income decreased primarily as a result of lower hog prices in Mexico. Interest expense ▪ The decrease in interest expense is primarily due to lower debt balances in the current year as a result of various debt repayment activities. Non-operating gain ▪ During 2015, we recognized a pre-tax gain of $0.7 million on the sale of our equity interest in CFG. Income tax expense ▪ The effective tax rate was 33% and 35% for the second quarters of 2015 and 2014, respectively. For both the current year and prior year, taxable income relative to permanent items, the mix of income between jurisdictions, and the expiration of certain federal tax credits impacted the effective tax rate. 25 The table presented below compares our results of operations for the first half of 2015 and 2014. As used in the table, "NM" means "not meaningful." Six Months Ended June 28, 2015 June 29, 2014 % Change (in millions) Sales $ 7,103.1 $ 7,236.1 (2 )% Cost of sales 6,278.5 6,370.9 (1 )% Gross profit 824.6 865.2 (5 )% Selling, general and administrative expenses 454.5 434.6 5 % Income from equity method investments (4.2 ) (26.0 ) (84 )% Operating profit 374.3 456.6 (18 )% Interest expense 66.2 81.2 (19 )% Non-operating (gain) loss 12.1 (1.1 ) NM Income before income taxes 296.0 376.5 (21 )% Income tax expense 94.8 128.3 (26 )% Net income $ 201.2 $ 248.2 (19 )% Sales and gross profit ▪ Sales decreased primarily as a result of lower market prices across all of our segments and the impact of foreign currency translation as a result of a stronger U.S. dollar. ▪ Gross profit decreased primarily as a result of lower sales, partially offset by lower pork processing raw material costs. Income from equity method investments ▪ Equity income decreased primarily as a result of lower hog prices in Mexico. Additionally, equity income decreased due to a significant tax benefit recognized through our former investment in CFG in 2014. Interest expense ▪ The decrease in interest expense is primarily due to lower debt balances in the current year as a result of various debt repayment activities. Non-operating (gain) loss ▪ During 2015, we recognized a loss on debt extinguishment of $12.8 million as a result of the 2015 Tender Offer, partially offset by a $0.7 million pre-tax gain from the sale of our equity interest in CFG. Income tax expense ▪ The effective tax rate was 32% and 34% for the first half of 2015 and 2014, respectively. For both the current year and prior year, taxable income relative to permanent items, the mix of income between jurisdictions, and the expiration of certain federal tax credits impacted the effective tax rate. 26 Segment Results The following information reflects the results from each respective segment for the second quarters of 2015 and 2014. Three Months Ended June 28, 2015 June 29, 2014 % Change (in millions) Sales: Fresh Pork $ 1,364.5 $ 1,605.8 (15 )% Packaged Meats 1,545.6 1,728.2 (11 )% Hog Production 784.6 857.0 (8 )% International 352.5 426.0 (17 )% Total segment sales 4,047.2 4,617.0 (12 )% Intersegment sales (560.6 ) (803.0 ) (30 )% Consolidated sales $ 3,486.6 $ 3,814.0 (9 )% Operating profit (loss): Fresh Pork (15.1 ) 29.7 (151 )% Packaged Meats 176.3 97.5 81 % Hog Production 39.1 129.0 (70 )% International 14.8 33.9 (56 )% Corporate (29.0 ) (29.9 ) 3 % Consolidated operating profit $ 186.1 $ 260.2 (28 )% Fresh Pork ▪ Sales decreased 15% due to a 24% decrease in average selling prices, partially offset by a 12% increase in volume. ▪ Operating results decreased to a $2 loss per head from a $5 profit per head due to lower fresh pork market prices. ▪ We processed 7.4 million hogs in 2015, an increase of 15% from the prior year. Packaged Meats ▪ Sales decreased 11% due to a 12% decrease in average selling prices, partially offset by a 2% increase in volume. Current year sales volume totaled 677.0 million pounds. ▪ Operating profit increased to $0.26 per pound from $0.15 per pound due to lower raw material costs. Hog Production ▪ Sales decreased 8% due to lower domestic live hog market prices which were partially offset by favorable hedging results. Head sold during the year amounted to 3.8 million , an increase of 9% from the prior year. ▪ Operating profit decreased to $10 per head from $37 per head due to lower sales, partially offset by favorable hedging results and lower feed costs. International ▪ Sales decreased due primarily to changes in foreign exchange rates, which negatively impacted sales by $79.5 million , or 19% . On a constant currency basis, sales increased 1% due to an 8% increase in volume to 374 million pounds, driven largely by a 7% increase in hogs processed and a 12% increase in poultry processed in Europe, partially offset by a 6% decrease in average selling prices. We processed 1.1 million hogs in 2015. ▪ Operating profit was negatively impacted by lower pork market prices in Europe along with lower equity income from our Mexican joint ventures. Foreign currency translation also negatively impacted operating profit by approximately $4.1 million due to a stronger U.S. Dollar. 27 The following information reflects the results from each respective segment for the first half of 2015 and 2014. Six Months Ended June 28, 2015 June 29, 2014 % Change (in millions) Sales: Fresh Pork $ 2,698.6 $ 2,992.9 (10 )% Packaged Meats 3,255.2 3,276.7 (1 )% Hog Production 1,591.0 1,706.5 (7 )% International 682.7 800.7 (15 )% Total segment sales 8,227.5 8,776.8 (6 )% Intersegment sales (1,124.4 ) (1,540.7 ) (27 )% Consolidated sales $ 7,103.1 $ 7,236.1 (2 )% Operating profit (loss): Fresh Pork 18.1 88.6 (80 )% Packaged Meats 348.8 218.8 59 % Hog Production 32.7 138.5 (76 )% International 30.7 70.8 (57 )% Corporate (56.0 ) (60.1 ) 7 % Consolidated operating profit $ 374.3 $ 456.6 (18 )% Fresh Pork ▪ Sales decreased 10% due to a 16% decrease in average selling prices, partially offset by an 8% increase in volume. ▪ Operating profit decreased to $1 per head from $6 per head due to lower fresh pork market prices. ▪ We processed 15.1 million hogs in 2015, an increase of 10% from the prior year. Packaged Meats ▪ Sales decreased 1% due to a 7% decrease in average selling prices, partially offset by a 7% increase in volume. Current year sales volume totaled 1.4 billion pounds. ▪ Operating profit increased to $0.25 per pound from $0.17 per pound due to lower raw material costs. Hog Production ▪ Sales decreased 7% due to lower domestic live hog market prices which were partially offset by favorable hedging results. Head sold during the year amounted to 7.8 million , an increase of 4% from the prior year. ▪ Operating profit decreased to $4 per head from $18 per head due to lower sales, partially offset by favorable hedging results and lower feed costs. International ▪ Sales decreased 15% due primarily to changes in foreign exchange rates, which negatively impacted sales by $131.4 million , or 16% . On a constant currency basis, sales increased 2% due to an 8% increase in volume to 720 million pounds, driven largely by a 7% increase in hogs processed and a 16% increase in poultry processed in Europe. We processed 2.2 million hogs in 2015. ▪ Operating profit was negatively impacted by lower pork market prices in Europe along with lower equity income from our Mexican joint ventures. Foreign currency translation also negatively impacted operating profit by approximately $6.6 million due to a stronger U.S. Dollar. 28 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 June 28, 2015 , our liquidity position was approximately $1.7 billion , comprised of approximately $1.4 billion in availability under our credit facilities, $195.0 million in cash and cash equivalents and $100.0 million in unutilized loans. 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 June 28, 2015 Facility Capacity Borrowing Base Adjustment Outstanding Letters of Credit Outstanding Borrowings Amount Available (in millions) Inventory Revolver $ 1,025.0 $ — $ — $ — $ 1,025.0 Securitization Facility 325.0 — (88.5 ) — 236.5 International facilities 176.0 (0.5 ) — (35.2 ) 140.3 Total credit facilities $ 1,526.0 $ (0.5 ) $ (88.5 ) $ (35.2 ) $ 1,401.8 In April 2015, we entered into a new $1.025 billion asset-based revolving credit facility agreement (the Inventory Revolver Credit Agreement) which replaced our previous $1.025 billion senior secured revolving credit facility which would have matured in June 2016. The Inventory Revolver Credit Agreement provides for an option, subject to obtaining additional loan commitments and certain other conditions, to increase the available commitments by up to $375 million in the future. It also provides for a multicurrency subfacility for Canadian Dollars, Japanese Yen, Euros, British Pounds Sterling and U.S. Dollars of up to the foreign currency equivalent of $100 million, a subfacility of up to $50 million for swingline borrowings and a subfacility of up to $150 million for issuances of letters of credit. Availability under the Inventory Revolver Credit Agreement is based upon borrowing base valuations of our U.S. inventory, live sows and certain accounts receivable. The Inventory Revolver Credit Agreement is scheduled to mature on May 1, 2020. Loans under the Inventory Revolver Credit Agreement bear interest at LIBOR plus a margin ranging from 1.75% to 2.75% per annum, or, at our election, at a base rate plus a margin ranging from 0.75% to 1.75% per annum, with either such margin varying according to the ratio of our consolidated funded debt to consolidated EBITDA. Letters of credit issued under the Inventory Revolver Credit Agreement accrue fees at a rate equal to the applicable margin for LIBOR loans. In addition, we are required to pay a commitment fee for the average daily unused commitments under the Inventory Revolver Credit Agreement, at rates ranging from 0.30% to 0.50% per annum depending on the ratio of our consolidated funded debt to consolidated EBITDA. 29 The obligations under the Inventory Revolver Credit Agreement are guaranteed by substantially all of our U.S. subsidiaries and are secured by a first-priority lien, subject to permitted liens and exceptions for excluded assets, on substantially all of our and our subsidiary guarantors' personal property, including accounts receivable (other than those sold and financed pursuant to the Securitization Facility), inventory, cash and cash equivalents, deposit accounts, intercompany notes, intellectual property and certain capital stock and interests pledged by us and our subsidiary guarantors, and all proceeds thereof. The Inventory Revolver Credit Agreement contains affirmative and negative covenants that, among other things, limit or restrict our ability and the ability of our subsidiaries to create liens and encumbrances; incur debt; make capital expenditures; make acquisitions and investments; dispose of or transfer assets; and pay dividends or make other payments in respect of our capital stock; in each case, subject to certain qualifications and exceptions. In addition, the Inventory Revolver Credit Agreement contains financial covenants requiring us to maintain a total consolidated leverage ratio (ratio of consolidated funded debt to consolidated capitalization) of, subject to certain exceptions, not more than 0.50 to 1.0, a minimum interest coverage ratio (ratio of consolidated EBITDA to consolidated interest expense) of not less than 2.50 to 1.0 and limitations on capital expenditures. The Inventory Revolver Credit Agreement also includes usual and customary events of default for facilities of this nature, and provides that, upon the occurrence and continuation of an event of default, payment of all amounts payable under the facility may be accelerated, the lenders’ commitments may be terminated and the lenders may foreclose upon the collateral. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the facility will automatically become due and payable and the lenders’ commitments will automatically terminate. Rabobank Term Loan In May 2015, we refinanced the Rabobank Term Loan and extended its maturity date from May 1, 2018 to May 1, 2020. After the refinancing, the total capacity of the Rabobank term loan was $150.0 million, with $50.0 million outstanding. We may draw the additional $100.0 million until April 15, 2016. We may elect to prepay the loan at any time, subject to the payment of certain prepayment fees in respect of any voluntary prepayment prior to April 15, 2017 and other customary breakage costs. Interest accrues, at our option, at LIBOR plus 3.25%. Cash Flows Operating Activities Six Months Ended June 28, 2015 June 29, 2014 (in millions) Net cash flows from operating activities $ 59.7 $ (74.2 ) The following items explain the significant changes in cash flows from operating activities: ▪ Cash paid to outside hog suppliers decreased due to lower domestic live hog prices. ▪ In the current year, we received $ 127.0 million for the settlement of derivative contracts and for margin requirements compared to $ 298.8 million paid in the prior year. ▪ In the current year, we received a cash dividend of $14.3 million from one of our Mexican joint ventures. ▪ Cash paid for grain and other ingredients purchased by the Hog Production segment increased approximately $21.4 million from the prior year. ▪ In the current year, we contributed $200.0 million to our qualified pension plans. 30 Investing Activities Six Months Ended June 28, 2015 June 29, 2014 (in millions) Proceeds from sale of equity interest in CFG $ 354.0 $ — Capital expenditures (145.3 ) (98.5 ) Net proceeds (expenditures) from breeding stock transactions (29.7 ) 9.7 Business acquisitions — (11.0 ) Proceeds from the sale of property, plant and equipment 2.8 2.3 Other (23.9 ) 3.4 Net cash flows from investing activities $ 157.9 $ (94.1 ) The following items explain the significant investing activities: ▪ In June 2015, we sold our entire equity interest in CFG for $354.0 million in cash. ▪ Capital expenditures during both years primarily related to plant and hog farm improvement and expansion projects, including the replacement of gestation stalls with group pens, which is more fully explained under "Additional Matters Affecting Liquidity" below. ▪ In April 2014, Kansas City Sausage (KCS) bought a meat processing business for $11.0 million . Financing Activities Six Months Ended June 28, 2015 June 29, 2014 (in millions) Proceeds from the issuance of long-term debt $ — $ 13.0 Principal payments on long-term debt and capital lease obligations (409.3 ) (27.7 ) Proceeds from Securitization Facility 290.0 185.0 Payments on Securitization Facility (290.0 ) (135.0 ) Net proceeds (payments) on revolving credit facilities (13.3 ) 48.3 Payment of dividends (30.0 ) — Other — (0.5 ) Net cash flows from financing activities $ (452.6 ) $ 83.1 The following items explain the significant financing activities: ▪ In the current year, we repurchased $258.1 million of senior unsecured notes in connection with the 2015 Tender Offer. Additionally, we repaid $150.0 million on our Rabobank term loan. ▪ In the current year, we paid a $30.0 million dividend to our parent company. ▪ In the prior 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. 31 Financial Position Our balance sheet as of June 28, 2015 , as compared to December 28, 2014 , was impacted by the following significant changes: ▪ Investments decreased $351.6 million mainly due to the sale of CFG, a $14.3 million cash dividend received from one of our Mexican joint ventures and currency translation adjustments, a result of a stronger U.S. Dollar. ▪ Accounts payable decreased $258.0 million mainly due to the timing of payments. ▪ Net long-term pension liability decreased $275.4 million mainly due to a $200.0 million voluntary contribution to fund our qualified pension plans. We also elected to perform an interim remeasurement of our plan obligations and assets as of June 26, 2015 which resulted in a $76.1 million decrease to the pension obligation. Guarantees As part of our business, we are a party to various financial guarantees and other commitments. 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 primary obligor 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 June 28, 2015 , we continued to guarantee $7.2 million of leases that were transferred to JBS S.A. in connection with the sale of Smithfield Beef, Inc which closed in October 2008. 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 $325 million to $380 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/best in class operations. These expenditures are expected to be funded with cash flows from operations and/or borrowings under our 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 anticipate the full cost of our transition to group pens will total 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 2014, we had completed conversions to group housing for over 71% of our sows on company-owned farms. We remain on track to finish conversion to group housing for all sows on company-owned farms by the end of 2017. Our hog production operations in Poland and Romania completed their conversions to group housing facilities a number of years ago. In January 2014, we announced the recommendation that all of our contract sow growers join us in converting their facilities to group housing systems for pregnant sows. We asked contract sow growers to convert by 2022 and offered a sliding scale of incentives to accelerate that timetable through the receipt of contract extensions upon completion of the conversion. 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 Report on Form 10-K for the twelve months ended December 28, 2014. 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 June 28, 2015 , margin deposits ranged from $(15.4) million to $80.7 million (negative amounts representing margin deposits we have received from our brokers). The average daily amount on deposit with our brokers during the six months ended June 28, 2015 was $49.3 million . As of June 28, 2015 , the net amount on deposit with our brokers was $40.5 million . 32 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. 33 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 report on Form 10-K for the twelve months ended December 28, 2014. 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 WH Group Limited, 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 our report on Form 10-K for the twelve months ended December 28, 2014. 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.