What changed in this filing

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Item 2. Management’s Discussion and Analysis

2016-08-16 compared with 2016-04-28 · 111 added, 92 removed, 191 unchanged (52% of the section changed)

21 unchanged sentences

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.

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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.

First Quarter Summary of Results

Net income for the first quarter of 2016 was $121.0 million compared to net income of $97.0 million for the first quarter of 2015 .

The following summarizes the operating results of each of our reportable segments and other significant changes impacting net income:

Fresh Pork operating profit increased by $66.7 million primarily as a result of lower raw material costs.

Packaged Meats operating profit increased by $ 34.6 million as a result of higher sales volume and lower raw material costs.

Hog Production operating results decreased by $77.1 million primarily as a result of favorable hedging results in the prior year and lower live hog market prices in the current year.

International operating profit decreased by $1.7 million primarily due to unfavorable foreign currency translation.

Second Quarter Summary of Results

Net income for the second quarter of 2016 was $ 137.8 million compared to net income of $104.2 million for the second quarter of 2015 .

The following summarizes the operating results of each of our reportable segments and other significant changes impacting net income for the second quarter of 2016 compared to the second quarter of 2015:

Fresh Pork operating profit increased by $73.0 million primarily as a result of higher fresh pork market values relative to hog prices.

Packaged Meats operating profit decreased by $ 3.4 million primarily as a result of lower sales volume.

Hog Production operating results decreased by $23.9 million primarily as a result of favorable hedging results in the prior year.

International operating profit increased by $4.4 million primarily due to improved results in our Mexican joint ventures.

The following table provides a reconciliation of net income to EBITDA and adjusted EBITDA for all periods presented.

EBITDA and adjusted EBITDA are non-GAAP measures.

We believe EBITDA is a useful measure to our investors because it excludes the effects of financing and investing activities by eliminating interest and depreciation costs.

We believe EBITDA is a useful measure to our stakeholders because it excludes the effects of financing and investing activities by eliminating interest and depreciation costs.

We also believe adjusted EBITDA is a useful measure as it excludes the effect of non-operating activities.

1 unchanged sentence

Three Months Ended

April 3, 2016

March 29, 2015

Six Months Ended

June 28, 2015

(in millions)

Interest expense

1 unchanged sentence

Depreciation and amortization

Non-operating loss

Non-operating (gain) loss

Adjusted EBITDA

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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.

On May 29, 2015, the EPA proposed renewable volumetric obligations (RVOs) 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.

On November 30, 2015, the EPA finalized RFS standards for 2014, 2015 and 2016 at higher levels than the proposed volumes, but below statutory targets.

On November 30, 2015, the EPA finalized RVO standards for 2014, 2015 and 2016 at higher levels than the proposed volumes, but below statutory targets.

The 2016 standard is set at 18.1 billion gallons of renewable fuels, or 10.1% of the motor fuel pool.

On May 18, 2016, the EPA proposed 2017 RVOs, which again were below statutory levels but above the previous year’s output.

The proposed volumes for 2017 are 18.8 billion gallons of renewable fuels.

The EPA is expected to issue their final rule in November 2016.

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.

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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 .

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 $3.2 billion in retaliatory tariffs against a range of U.S.

agricultural and manufactured product exports, including frozen and chilled pork products.

In December 2015, a WTO Arbitration Panel report set retaliatory tariffs against the United States at just over $1 billion.

In December 2015, Congress passed and the President signed into law the Fiscal Year 2016 omnibus spending legislation which included legislative language to repeal the WTO-noncompliant components of the COOL statute.

Although Canada and Mexico still have the right to initiate retaliatory tariffs against the U.S.

under WTO rules, there is no indication that they intend to do so and the revocation of mandatory COOL for meat has essentially settled the dispute.

On July 14, 2016, Congress passed legislation creating a national standard of disclosure for food products containing genetically modified organisms (GMO) or bioengineered ingredients.

The legislation, which is expected to be signed into law, will preempt any state laws on GMO labeling and disclosure, such as those that went into effect in Vermont on July 1, 2016.

The bill requires mandatory disclosure of GMO ingredients in food, giving food manufacturers the option of disclosing that information online or via on-package labels.

Foods where meat, poultry, and egg products are the main ingredient are exempt from labeling requirements.

Furthermore, food derived from livestock is not considered to be bioengineered based solely on whether the animal consumes feed derived from a GMO product.

Department of Agriculture has two years to develop regulations and implement the legislation.

At this time, we do not know the full economic implications of this legislation on the industry or the company.

The commodity markets affecting our business fluctuate on a daily basis.

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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 strong results in 2015 as we continue to solidify Smithfield's position as a global leader in branded packaged meats.

With our organizational realignment, we are taking steps to build on our strong results in 2015 and thus far in 2016 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:

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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 in 2016.

We are focused on growth and believe that Smithfield is in an ideal position to continue to achieve strong results for the remainder of 2016.

RESULTS OF OPERATIONS

Consolidated Results of Operations

The table presented below compares our results of operations for the first quarters of 2016 and 2015 .

The table presented below compares our results of operations for the second quarters of 2016 and 2015 .

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

Three Months Ended

April 3, 2016

March 29, 2015

(in millions)

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Interest expense

Non-operating gain

Income before income taxes

Income tax expense

Sales and gross profit

Sales remained relatively flat compared to the prior year.

Gross profit increased primarily as a result of higher domestic meat prices and lower hog raising costs, which were partially offset by the effect of more favorable hedging results in the prior year.

Selling, general and administrative expenses

The decrease in SG&A is primarily attributed to lower marketing and advertising costs.

Income from equity method investments

Equity income increased primarily due to improved results in our Mexican joint ventures, which were attributable to lower feed costs.

Six Months Ended

(in millions)

Cost of sales

Selling, general and administrative expenses

Income from equity method investments

Operating profit

Interest expense

Non-operating loss

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Sales and gross profit

Sales decreased primarily as a result of lower average selling prices of domestic fresh pork products and lower domestic live hog market prices.

Sales decreased primarily as a result of lower average selling prices of domestic fresh pork, more favorable hedging results in the prior year and lower domestic meat volume, which was partially offset by higher average selling prices of domestic packaged meats products.

Gross profit increased primarily as a result of lower pork processing raw material costs and lower hog raising costs.

Selling, general and administrative expenses (SG&A)

Selling, general and administrative expenses

The decrease in SG&A is primarily attributed to lower marketing and advertising costs.

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Equity income in the prior year was negatively impacted by our former investment in CFG.

Current year equity income was negatively impacted by 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 in the prior year.

Equity income also increased due to improved results in our Mexican joint ventures, which were attributable to lower feed costs.

Non-operating loss

During 2015, we recognized a loss on debt extinguishment of $12.8 million as a result of the 2015 Tender Offer.

Income tax expense

Our effective tax rate was 32% and 31% for the first quarters of 2016 and 2015, respectively.

Both the current and prior year effective tax rates were impacted by taxable income relative to permanent items and the mix of income between jurisdictions.

Additionally, the prior year effective tax rate was impacted by the expiration of certain federal tax credits.

The non-operating loss in the prior year is primarily related to a loss on debt extinguishment of $12.8 million as a result of the Tender Offer.

Segment Results

The following information reflects the results from each respective segment for the first quarters of 2016 and 2015 .

The following information reflects the results from each respective segment for the second quarters of 2016 and 2015 .

Three Months Ended

April 3, 2016

March 29, 2015

(in millions)

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Consolidated operating profit

Sales decreased 16% due to a 13% decrease in average selling prices and a 4% decrease in volume.

Operating profit increased to $13 per head from $4 per head due to lower raw material costs.

We processed 7.7 million hogs in 2016, relatively unchanged from the prior year.

Sales decreased 1% primarily due to lower volume.

Operating profit increased primarily due to higher fresh pork market values relative to hog prices.

Hogs processed in the current quarter remained relatively unchanged from the prior year quarter.

Packaged Meats

Sales increased 2% due to a 2% increase in volume.

Average selling prices remained relatively unchanged from the prior year.

Current year sales volume totaled 742.8 million pounds.

Operating profit increased to $0.28 per pound from $0.24 per pound due to lower raw material costs.

Sales increased 7% due to a 10% increase in average selling prices, partially offset by a 3% decline in volume.

Operating profit remained relatively unchanged, but declined as a percentage of sales as we were not able to fully pass on a significant increase in raw material costs.

Hog Production

Sales decreased 23% due to favorable hedging results in the prior year, lower domestic live hog market prices and a 2% decrease in head sold.

Head sold during the year amounted to 3.9 million .

Operating results decreased to a $21 loss per head from a $2 loss per head due to lower sales, partially offset by lower feed costs.

Sales decreased 14% due primarily to more favorable hedging results in the prior year quarter and a 2% decrease in head sold.

Operating profit decreased due to lower sales, partially offset by lower feed costs.

International

Sales decreased 4% due primarily to changes in foreign exchange rates, which negatively impacted sales by $29.9 million , or 9% .

On a constant currency basis, sales increased 5% due to a 11% increase in volume to 382.8 million pounds, driven largely by a 14% increase in hogs processed and a 14% increase in poultry processed in Europe, partially offset by a 5% decrease in average selling prices.

We processed 1.2 million hogs in 2016.

Operating profit was negatively impacted by foreign currency translation of $1.7 million due to a stronger U.S.

On a constant currency basis, operating profit was relatively unchanged from the prior year.

Sales increased 5% primarily due to an 11% increase in volume, partially offset by the impact of foreign currency translation and lower average selling prices.

The volume increase was driven largely by a 12% increase in hogs processed and a 16% increase in poultry processed.

Foreign currency translation lowered sales 3% , primarily due to a stronger U.S.

Operating profit increased due to higher equity income from our Mexican joint ventures, primarily due to lower feed costs, which was slightly offset by lower operating profit in Europe, primarily due to higher raw material costs.

Six Months Ended

(in millions)

Packaged Meats

Hog Production

International

Total segment sales

Intersegment sales

Consolidated sales

Operating profit (loss):

Packaged Meats

Hog Production

International

Consolidated operating profit

Sales decreased 8% primarily due to a 7% decrease in average selling prices and a 2% decrease in volume.

Operating profit increased primarily due to higher fresh pork market values relative to hog prices.

Hogs processed so far in 2016 remain relatively unchanged from the prior year.

Packaged Meats

Sales increased 5% primarily due to an increase in average selling prices from the prior year.

Current year sales volume was relatively unchanged from the prior year.

Operating profit improved as a result of higher sales and lower advertising expenses.

Operating profit margin was relatively unchanged from the prior year.

Hog Production

Sales decreased 18% primarily due to more favorable hedging results in the prior year, lower domestic live hog market prices and a 2% decrease in head sold.

Operating results decreased primarily due to lower sales, partially offset by lower feed costs.

International

Sales increased 1% despite a 6% negative foreign currency impact due to a stronger U.S.

On a constant currency basis, sales increased 7% due to an 11% increase in volume, driven largely by a 13% increase in hogs processed and a 15% increase in poultry processed, partially offset by a 3% decrease in average selling prices.

Operating profit increased primarily due to higher equity income.

Equity income in the prior year was negatively impacted by $4.9 million in losses from our former investment in CFG while results from our Mexican joint ventures improved year over year, primarily due to lower feed costs.

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 April 3, 2016 , our liquidity position was approximately $1.6 billion , comprised of approximately $1.3 billion in availability under our credit facilities and $260.6 million in cash and cash equivalents.

As of July 3, 2016 , our liquidity position was approximately $1.4 billion , comprised of approximately $1.3 billion in availability under our credit facilities and $119.3 million in cash and cash equivalents.

Sources of Liquidity

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Credit Facilities

April 3, 2016

Borrowing Base Adjustment

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Operating Activities

Three Months Ended

Six Months Ended

(in millions)

1 unchanged sentence

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

In the current year, we contributed $125.0 million to our qualified pension plans.

In the current year, we paid $ 5.5 million for the settlement of derivative contracts and for margin requirements compared to $ 101.7 million received in the prior year.

The current year included net tax payments of $ 51.0 million for domestic income taxes as compared to net

tax refunds of $ 32.7 million in the prior year.

Cash received from customers decreased due to lower sales.

Cash paid for grain and other ingredients purchased by the Hog Production segment increased approximately $22.1 million from the prior year.

In the current year, we contributed $125.0 million to our qualified pension plans compared to $200.0 million in the prior year.

The current year included net tax receipts of $18.0 million for domestic income taxes compared to $67.3 million paid in the prior year.

In the current year, we received $ 18.8 million for the settlement of derivative contracts and for margin requirements compared to $ 127.0 million in the prior year.

In the prior 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 decreased approximately $29.0 million from the prior year.

Investing Activities

Three Months Ended

Six Months Ended

(in millions)

Proceeds from sale of equity interest in CFG

Capital expenditures

Net expenditures from breeding stock transactions

Proceeds from the sale of property, plant and equipment

Net cash flows from investing activities

1 unchanged sentence

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 June 2015, we sold our entire equity interest in CFG for $354.0 million million in cash.

Financing Activities

Three Months Ended

Six Months Ended

(in millions)

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The following items explain the significant financing activities:

In the current year, we received proceeds of $30.0 million to finance certain activities in Romania.

In the current year, we paid a $73.6 million dividend to our parent company.

In the current year, we received proceeds of $30.0 million from a long-term, local currency financing in Romania.

In the prior year, we paid $258.1 million of principal payments as a result of the Tender Offer as well as $150.0 million on our Rabobank term loan.

In the prior year, we drew $145.0 million, net of repayments, on our Securitization Facility, primarily to repay other long-term debt, as noted above.

Financial Position

Our balance sheet as of April 3, 2016 , as compared to January 3, 2016 , was impacted by the following significant changes:

Our balance sheet as of July 3, 2016 , as compared to January 3, 2016 , was impacted by the following significant changes:

Accounts payable decreased by $307.0 million mainly due to the timing of payments.

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 April 3, 2016 , we continued to guarantee $6.4 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.

Inventory increased by $112.6 million attributable to an increase in seasonal ham inventory as we prepare for the holiday season.

The Company has $426.2 million of senior unsecured public notes maturing on July 1, 2017.

While we may choose to use other sources of capital to fund this upcoming maturity, adequate liquidity resources are available to address this maturity in its entirety.

Additional Matters Affecting Liquidity

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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 three months ended April 3, 2016 , margin deposits ranged from $39.9 million to $57.8 million (negative amounts representing margin deposits we have received from our brokers).

The average daily amount on deposit with our brokers during the three months ended April 3, 2016 was $48.0 million .

As of April 3, 2016 , the net amount on deposit with our brokers was $48.8 million .

During the six months ended July 3, 2016 , margin deposits ranged from $14.3 million to $87.1 million .

The average daily amount on deposit with our brokers during the six months ended July 3, 2016 was $46.3 million .

As of July 3, 2016 , the net amount on deposit with our brokers was $42.0 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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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