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EX-10.4 - COMPENSATION FOR NAMED EXECUTIVE OFFICERS - SMITHFIELD FOODS INCex10-4.htm
EX-10.3 - FORM OF PERFORMANCE SHARE UNIT AWARD - SMITHFIELD FOODS INCex10-3.htm
EX-32.2 - EXHIBIT 32.2 - SMITHFIELD FOODS INCex32-2.htm
EX-31.1 - EXHIBIT 31.1 - SMITHFIELD FOODS INCex31-1.htm
EX-31.2 - EXHIBIT 31.2 - SMITHFIELD FOODS INCex31-2.htm
EX-32.1 - EXHIBIT 32.1 - SMITHFIELD FOODS INCex32-1.htm
EXCEL - IDEA: XBRL DOCUMENT - SMITHFIELD FOODS INCFinancial_Report.xls



 

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

         
FORM 10-Q
         
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended August 1, 2010
 
COMMISSION FILE NUMBER 1-15321
         
 
GRAPHIC
SMITHFIELD FOODS, INC.
         
 
200 Commerce Street
Smithfield, Virginia 23430
(757) 365-3000
 
         
 
Virginia
 
52-0845861
 
 
(State of Incorporation)
 
(I.R.S. Employer Identification Number)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  x    No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer                                x
Accelerated filer                                    
¨
Non-accelerated filer                                  ¨
Smaller reporting company                    
¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x
 
At August 30, 2010, 166,013,232 shares of the registrant’s Common Stock ($.50 par value per share) were outstanding.


 
 

 
 
 
SMITHFIELD FOODS, INC.
TABLE OF CONTENTS
 
     
   
PAGE
 
 
PART I—FINANCIAL INFORMATION
 
Item 1.
          3
     
 
          3
     
 
          4
     
 
          5
     
 
          6
     
Item 2.
17
     
Item 3.
          32
     
Item 4.
          32
     
     
 
PART II—OTHER INFORMATION
 
Item 1.
          33
     
Item 1A.
          35
     
Item 2.
          36
     
Item 3.
          36
     
Item 4.
          36
     
Item 5.
          36
     
Item 6.
          37
   
          38
 
 

 
 
 
2

 


PART I—FINANCIAL INFORMATION


SMITHFIELD FOODS, INC.
(in millions, except per share data)



   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
   
(unaudited)
 
Sales
  $ 2,901.3     $ 2,715.3  
Cost of sales
    2,533.6       2,616.6  
Gross profit
    367.7       98.7  
Selling, general and administrative expenses
    201.0       183.8  
Equity in income of affiliates
    (10.9 )     (10.3 )
Operating profit (loss)
    177.6       (74.8 )
Interest expense
    68.6       60.5  
Other loss
    -       7.4  
Income (loss) before income taxes
    109.0       (142.7 )
Income tax expense (benefit)
    32.7       (35.0 )
Net income (loss)
  $ 76.3     $ (107.7 )
                 
                 
Net income (loss) per share:
               
Basic
  $ .46     $ (.75 )
Diluted
  $ .46     $ (.75 )
                 
Weighted average shares outstanding:
               
Basic
    166.0       143.6  
Diluted
    167.2       143.6  


 
See Notes to Consolidated Condensed Financial Statements



 
 
 
3

 


SMITHFIELD FOODS, INC.
(in millions, except share data)
 


   
August 1,
2010
   
May 2,
2010
 
   
(unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 542.4     $ 451.2  
Accounts receivable, net
    673.4       621.5  
Inventories
    1,755.0       1,860.0  
Prepaid expenses and other current assets
    303.4       387.6  
Total current assets
    3,274.2       3,320.3  
                 
Property, plant and equipment, net
    2,302.6       2,358.7  
Goodwill
    816.9       822.9  
Investments
    598.8       625.0  
Intangible assets, net
    388.5       389.6  
Other assets
    215.4       192.4  
Total assets
  $ 7,596.4     $ 7,708.9  
                 
LIABILITIES AND EQUITY
               
Current liabilities:
               
Notes payable
  $ 33.6     $ 16.9  
Current portion of long-term debt and capital lease obligations
    120.0       72.8  
Accounts payable
    368.2       383.8  
Accrued expenses and other current liabilities
    583.8       718.4  
Total current liabilities
    1,105.6       1,191.9  
                 
Long-term debt and capital lease obligations
    2,857.5       2,918.4  
Other liabilities
    829.8       838.4  
                 
Redeemable noncontrolling interests
    2.0       2.0  
                 
Commitments and contingencies
               
                 
Equity:
               
Shareholders' equity:
               
Preferred stock, $1.00 par value, 1,000,000 authorized shares
    -       -  
Common stock, $.50 par value, 500,000,000 authorized shares; 166,013,232 and 165,995,732 issued and outstanding
    83.0       83.0  
Additional paid-in capital
    1,628.8       1,626.9  
Stock held in trust
    (65.6 )     (65.5 )
Retained earnings
    1,615.0       1,538.7  
Accumulated other comprehensive loss
    (462.2 )     (427.5 )
Total shareholders’ equity
    2,799.0       2,755.6  
Noncontrolling interests
    2.5       2.6  
Total equity
    2,801.5       2,758.2  
Total liabilities and equity
  $ 7,596.4     $ 7,708.9  



See Notes to Consolidated Condensed Financial Statements


 
 
 
4

 


SMITHFIELD FOODS, INC.
(in millions)
 


   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
     (unaudited)  
Cash flows from operating activities:
           
Net income (loss)
  $ 76.3     $ (107.7 )
Adjustments to reconcile net cash flows from operating activities:
               
Equity in income of affiliates
    (10.9 )     (10.3 )
Depreciation and amortization
    58.3       61.0  
Impairment of assets
    0.6       34.1  
Changes in operating assets and liabilities and other, net:
    (21.6 )     89.4  
Net cash flows from operating activities
    102.7       66.5  
                 
Cash flows from investing activities:
               
Capital expenditures
    (30.8 )     (30.4 )
Other
    14.8       4.2  
Net cash flows from investing activities
    (16.0 )     (26.2 )
                 
Cash flows from financing activities:
               
Proceeds from the issuance of long-term debt
    -       604.3  
Net proceeds (repayments) on revolving credit facilities and notes payable
    28.2       (134.8 )
Principal payments on long-term debt and capital lease obligations
    (23.7 )     (75.9 )
Proceeds from the issuance of common stock
    0.2       -  
Debt issuance costs
    -       (48.1 )
Net cash flows from financing activities
    4.7       345.5  
                 
Effect of foreign exchange rate changes on cash
    (0.2 )     1.8  
Net change in cash and cash equivalents
    91.2       387.6  
Cash and cash equivalents at beginning of period
    451.2       119.0  
Cash and cash equivalents at end of period
  $ 542.4     $ 506.6  


See Notes to Consolidated Condensed Financial Statements
 


 
 
 
5

 

SMITHFIELD FOODS, INC.
 

 
NOTE 1: GENERAL
 
Smithfield Foods, Inc., together with its subsidiaries (the “Company,” “we,” “us” or “our”), is the largest hog producer and pork processor in the world. We produce and market a wide variety of fresh meat and packaged meats products both domestically and internationally. We conduct our operations through five reporting segments: Pork, International, Hog Production, Other and Corporate. In the first quarter of fiscal 2011, we moved certain operations from our Hog Production segment into our International segment.  See Note 14—Segment Data for information on these changes.
 
You should read these statements in conjunction with the audited consolidated financial statements and the related notes which are included in our Annual Report on Form 10-K for the fiscal year ended May 2, 2010. The enclosed interim consolidated condensed financial information is unaudited. The information reflects all normal recurring adjustments which we believe are necessary to present fairly the financial position and results of operations for all periods included.
 
The three months ended August 1, 2010 correspond to the first quarter of fiscal 2011 and the three months ended August 2, 2009 correspond to the first quarter of fiscal 2010. Certain prior year amounts have changed to conform to current year presentations.
 
 NOTE 2: ACCOUNTING CHANGES AND NEW ACCOUNTING GUIDANCE
 
In June 2009 and December 2009, the Financial Accounting Standards Board (the FASB) issued guidance requiring an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This guidance requires an ongoing assessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. We adopted this guidance in the first quarter of fiscal year 2011 and determined that it had no impact on our consolidated condensed financial statements.
 
NOTE 3: INVENTORIES
 
Inventories consist of the following:
 
   
August 1,
2010
   
May 2,
2010
 
   
(in millions)
 
Live hogs
  $ 841.6     $ 853.5  
Fresh and packaged meats
    707.2       786.0  
Manufacturing supplies
    66.9       70.5  
Grains and other
    139.3       150.0  
Total inventories
  $ 1,755.0     $ 1,860.0  
                 

NOTE 4: DERIVATIVES FINANCIAL INSTRUMENTS
 
Our meat processing and hog production operations use various raw materials, primarily live hogs, corn and soybean meal, which are actively traded on commodity exchanges. We hedge these commodities when we determine conditions are appropriate to mitigate price risk. While this hedging may limit our ability to participate in gains from favorable commodity fluctuations, it also tends to reduce the risk of loss from adverse changes in raw material prices. We attempt to closely match the commodity contract terms with the hedged item. We also enter into interest rate swaps to hedge exposure to changes in interest rates on certain financial instruments and foreign exchange forward contracts to hedge certain exposures to fluctuating foreign currency rates.
 
We record all derivatives in the balance sheet as either assets or liabilities at fair value. Accounting for changes in the fair value of a derivative depends on whether it qualifies and has been designated as part of a hedging relationship. For derivatives that qualify and have been designated as hedges for accounting purposes, changes in fair value have no net impact on earnings, to the extent the derivative is considered perfectly effective in achieving offsetting changes in fair value or cash flows attributable to the risk being hedged, until the hedged item is recognized in earnings (commonly referred to as the “hedge accounting” method). For derivatives that do not qualify or are not designated as hedging instruments for accounting purposes, changes in fair value are recorded in current period earnings (commonly referred to as the “mark-to-market” method). We may elect either method of accounting for our derivative portfolio, assuming all the necessary requirements are met. We have in the past, and will in the future, avail ourselves of either acceptable method. We believe all of our derivative instruments represent economic hedges against changes in prices and rates, regardless of their designation for accounting purposes.
 

 
 
 
6

 
 
We do not offset the fair value of derivative instruments with cash collateral held with or received from the same counterparty under a master netting arrangement. Changes in commodity prices could have a significant impact on cash deposit requirements under our broker and counterparty agreements. As of August 1, 2010, prepaid expenses and other current assets included $65.3 million representing cash on deposit with brokers to cover losses on our open derivative instruments. We have reviewed our derivative contracts and have determined that they do not contain credit contingent features which would require us to post additional collateral if we did not maintain a credit rating equivalent to what was in place at the time the contracts were entered into.
 
We are exposed to losses in the event of nonperformance or nonpayment by counterparties under financial instruments. Although our counterparties primarily consist of financial institutions that are investment grade, there is still a possibility that one or more of these companies could default.  However, a majority of our financial instruments are exchange traded futures contracts held with brokers and counterparties with whom we maintain margin accounts that are settled on a daily basis, and therefore our credit risk is not significant. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. As of August 1, 2010, we had credit exposure of $6.1 million on non-exchange traded derivative contracts, excluding the effects of netting arrangements. As a result of netting arrangements, our credit exposure was reduced to $1.8 million. No significant concentrations of credit risk existed as of August 1, 2010. 
 
The size and mix of our derivative portfolio varies from time to time based upon our analysis of current and future market conditions. The following table presents the fair values of our open derivative financial instruments in the consolidated condensed balance sheets on a gross basis. All grain contracts, livestock contracts and foreign exchange contracts are recorded in prepaid expenses and other current assets or accrued expenses and other current liabilities within the consolidated condensed balance sheets, as appropriate. Interest rate contracts are recorded in accrued expenses and other current liabilities or other liabilities, as appropriate.
 
   
Assets
   
Liabilities
 
   
August 1,
2010
   
May 2,
2010
   
August 1,
2010
   
May 2,
2010
 
   
(in millions)
   
(in millions)
 
Derivatives using the "hedge accounting" method:
                       
Grain contracts
  $ 27.6     $ 11.5     $ 1.2     $ 3.4  
Livestock contracts
    -       -       23.0       40.8  
Interest rate contracts
    -       -       7.2       8.1  
Foreign exchange contracts
    0.5       3.0       5.5       -  
Total
    28.1       14.5       36.9       52.3  
                                 
Derivatives using the "mark-to-market" method:
                               
Grain contracts
    5.6       5.5       15.9       6.5  
Livestock contracts
    4.5       5.8       24.8       87.6  
Energy contracts
    -       -       0.9       4.0  
Foreign exchange contracts
    0.1       0.5       2.1       0.2  
Total
    10.2       11.8       43.7       98.3  
Total fair value of derivative instruments
  $ 38.3     $ 26.3     $ 80.6     $ 150.6  
 
Hedge Accounting Method
 
Cash Flow Hedges
 
We enter into derivative instruments, such as futures, swaps and options contracts, to manage our exposure to the variability in expected future cash flows attributable to commodity price risk associated with the forecasted sale of live hogs and the forecasted purchase of corn and soybean meal. In addition, we enter into interest rate swaps to manage our exposure to changes in interest rates associated with our variable interest rate debt, and we enter into foreign exchange contracts to manage our exposure to the variability in expected future cash flows attributable to changes in foreign exchange rates associated with the forecasted purchase or sale of assets denominated in foreign currencies. We generally do not hedge anticipated transactions beyond twelve months.
 

 
 
 
7

 

During the three months ended August 1, 2010, the range of notional volumes associated with open derivative instruments designated in cash flow hedging relationships was as follows:
 
   
Minimum
   
Maximum
 
Metric
Commodities:
             
Corn
    20,447,900       50,190,000  
 Bushels
Soybean meal
    403,031       516,000  
 Tons
Lean hogs
    182,640,000       226,600,000  
 Pounds
Interest rate
    200,000,000       200,000,000  
 U.S. Dollars
Foreign currency (1)
    58,755,092       89,021,606  
 U.S. Dollars
__________________
 
(1)
Amounts represent the U.S. dollar equivalent of various foreign currency contracts.
 
When cash flow hedge accounting is applied, derivative gains or losses from these cash flow hedges are recognized as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings. Derivative gains and losses, when reclassified into earnings, are recorded in cost of sales for grain contracts, sales for lean hog contracts, interest expense for interest rate contracts, and selling, general and administrative expenses for foreign exchange contracts. 
 
The following table presents the effects on our consolidated condensed financial statements of pre-tax gains and losses on derivative instruments designated in cash flow hedging relationships for the fiscal periods indicated:
 
   
Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivative (Effective Portion)
   
Loss Reclassified from Accumulated Other Comprehensive Loss into Earnings (Effective Portion)
   
Loss Recognized in Earnings on Derivative (Ineffective Portion)
 
   
Three Months Ended
   
Three Months Ended
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
   
August 1,
2010
   
August 2,
2009
   
August 1,
2010
   
August 2,
2009
 
   
(in millions)
   
(in millions)
   
(in millions)
 
Commodity contracts:
                                   
Grain contracts
  $ 14.8     $ (20.2 )   $ (4.0 )   $ (59.5 )   $ (0.2 )   $ (2.5 )
Lean hog contracts
    (5.0 )     8.5       (10.5 )     -       (0.3 )     -  
Interest rate contracts
    (0.5 )     2.7       (1.1 )     (1.5 )     -       -  
Foreign exchange contracts
    (5.6 )     6.1       (1.9 )     (7.5 )     -       -  
Total
  $ 3.7     $ (2.9 )   $ (17.5 )   $ (68.5 )   $ (0.5 )   $ (2.5 )
 
For the fiscal periods presented, foreign exchange contracts were determined to be highly effective. We have excluded from the assessment of effectiveness differences between spot and forward rates, which we have determined to be immaterial.
 
As of August 1, 2010, there were deferred net losses of $13.3 million, net of tax of $6.3 million, in accumulated other comprehensive loss. As of May 2, 2010, there were deferred net losses of $24.5 million, net of tax of $15.5 million, in accumulated other comprehensive loss. We expect to reclassify $19.4 million ($11.8 million net of tax) of the deferred net losses on closed commodity contracts into earnings within the next twelve months. Because the value of open contracts is subject to change, we are unable to estimate the gains or losses to be reclassified into earnings within the next twelve months.
 
Fair Value Hedges
 
We enter into derivative instruments (primarily futures contracts) that are designed to hedge changes in the fair value of live hog inventories and firm commitments to buy grains. We also enter into interest rate swaps to manage interest rate risk associated with our fixed rate borrowings. When fair value hedge accounting is applied, derivative gains and losses from these fair value hedges are recognized in earnings currently along with the change in fair value of the hedged item attributable to the risk being hedged. The gains or losses on the derivative instruments and the offsetting losses or gains on the related hedged items are recorded in cost of sales for commodity contracts and interest expense for interest rate contracts.
 

 
 
 
8

 

During the three months ended August 1, 2010, the range of notional volumes associated with open derivative instruments designated in fair value hedging relationships was as follows:
 
   
Minimum
   
Maximum
 
Metric
Commodities:
             
Corn
    2,495,000       5,330,000  
 Bushels
Lean hogs
    129,720,000       431,440,000  
 Pounds
__________________
 
(1)
Amounts represent the U.S. dollar equivalent of various foreign currency contracts.
 
The following table presents the effects on our consolidated condensed statements of income of gains and losses on derivative instruments designated in fair value hedging relationships and the related hedged items for the fiscal periods indicated: 
 
   
Gain (Loss) Recognized in Earnings on Derivative
   
Gain (Loss) Recognized in Earnings on Related Hedged Item
 
   
Three Months Ended
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
   
August 1,
2010
   
August 2,
2009
 
   
(in millions)
   
(in millions)
 
Commodity contracts
  $ 5.0     $ 8.1     $ 3.9     $ (7.8 )
Interest rate contracts
    -       0.6       -       (0.6 )
Foreign exchange contracts
    -       1.1       -       (0.5 )
Total
  $ 5.0     $ 9.8     $ 3.9     $ (8.9 )
 
During the first quarter of fiscal 2011, we amortized into earnings $22.1 million of losses on commodity derivative contracts as the underlying cash transactions affected earnings.
 
Mark-to-Market Method
 
Derivative instruments that are not designated as a hedge, have been de-designated from a hedging relationship, or do not meet the criteria for hedge accounting are marked-to-market with the unrealized gains and losses together with actual realized gains and losses from closed contracts being recognized in current period earnings. Under the mark-to-market method, gains and losses are recorded in cost of sales for commodity contracts, and selling, general and administrative expenses for interest rate contracts and foreign exchange contracts.
 
During the three months ended August 1, 2010, the range of notional volumes associated with open derivative instruments using the “mark-to-market” method was as follows:
 
   
Minimum
   
Maximum
 
Metric
Commodities:
             
Lean hogs
    277,920,000       1,011,960,000  
 Pounds
Corn
    1,490,000       45,643,300  
 Bushels
Soybean meal
    82,500       335,834  
 Tons
Soybeans
    115,000       225,000  
 Bushels
Wheat
    -       85,000  
 Bushels
Live cattle
    760,000       1,400,000  
 Pounds
Pork bellies
    -       2,040,000  
 Pounds
Natural gas
    2,040,000       2,490,000  
 Million BTU
Foreign currency (1)
    79,383,852       114,175,772  
 U.S. Dollars
__________________
 
(1)
Amounts represent the U.S. dollar equivalent of various foreign currency contracts.
 

 
 
 
 
9

 

The following table presents the amount of gains (losses) recognized in the consolidated condensed statements of income on derivative instruments using the “mark-to-market” method by type of derivative contract for the fiscal periods indicated:
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
   
(in millions)
 
Commodity contracts
  $ 36.2     $ 12.1  
Foreign exchange contracts
    2.4       (6.2 )
Total
  $ 38.6     $ 5.9  
 
The table above reflects gains and losses from both open and closed contracts including, among other things, gains and losses related to contracts designed to hedge price movements that occur entirely within a quarter. The table includes amounts for both realized and unrealized gains and losses. The table is not, therefore, a simple representation of unrealized gains and losses recognized in the income statement during any period presented.
 
NOTE 5: PORK RESTRUCTURING AND HOG PRODUCTION COST SAVINGS INITIATIVE
 
Pork Restructuring
 
In February 2009 (fiscal 2009), we announced a plan to consolidate and streamline the corporate structure and manufacturing operations of our Pork segment (the Restructuring Plan).  The plan included the closure of six plants, the last of which was closed in February 2010 (fiscal 2010). This restructuring is intended to make us more competitive by improving operating efficiencies and increasing plant utilization. As of August 1, 2010 (fiscal 2011), the Restructuring Plan was substantially complete with cumulative restructuring and impairment charges of $107.2 million. In the first quarter of fiscal 2011, we incurred charges totaling $1.7 million and anticipate incurring approximately $2 million of charges in the second quarter of fiscal 2011. As of August 1, 2010, the balance of accrued expenses on the consolidated condensed balance sheet was $9.0 million.
 
Hog Production Cost Savings Initiative
 
In the fourth quarter of fiscal 2010, we announced a plan to improve the cost structure and profitability of our domestic hog production operations (the Cost Savings Initiative). The plan includes a number of undertakings designed to improve operating efficiencies and productivity. These consist of farm reconfigurations and conversions, termination of certain high cost, third-party hog grower contracts and breeding stock sourcing contracts, as well as a number of other cost reduction activities. Certain of the activities associated with the Cost Savings Initiative are expected to occur over a two to three-year period in order to allow for the successful transformation of farms while minimizing disruption of supply. 
 
All of the charges presented above have been recorded in cost of sales in the Hog Production segment. The following table summarizes the balance of accrued expenses, the cumulative expense incurred to date and the expected remaining expenses to be incurred related to the Cost Savings Initiative by major type of cost.
 
   
Accrued Balance
May 2, 2010
   
Current Period Expense
   
Payments
   
Accrued Balance
August 1, 2010
   
Cumulative Expense-to-Date
   
Estimated Remaining Expense
 
Cost savings activities:
 
(in millions)
 
Contract terminations
  $ 1.8     $ -     $ (0.2 )   $ 1.6     $ 2.8     $ 22.9  
Other associated costs
    -       0.2       (0.2 )     -       0.2       9.2  
Total cost savings activities
  $ 1.8       0.2     $ (0.4 )   $
1.6
      3.0       32.1  
                                                 
Other charges:
                                               
Accelerated depreciation
            0.3                       4.1       1.8  
Impairment
            -                       2.5       -  
Total other charges
            0.3                       6.6       1.8  
Total cost savings activities and other charges
          $ 0.5                     $ 9.6     $ 33.9  
 
 
 
10

 
 
NOTE 6: INVESTMENTS
 
Investments consist of the following:
 
Equity Investment
 
% Owned
 
August 1,
2010
   
May 2,
2010
 
       
(in millions)
 
Campofrío Food Group (CFG)
   37%   $ 387.8     $ 417.3  
Butterball, LLC (Butterball)
  49%     101.1       99.8  
Mexican joint ventures
  50%     76.6       75.1  
All other equity method investments
 
Various
    33.3       32.8  
Total investments
        $ 598.8     $ 625.0  
 
Equity in (income) loss of affiliates consists of the following:
 
       
Three Months Ended
 
Equity Investment
 
Segment
 
August 1,
2010
   
August 2,
2009
 
       
(in millions)
 
CFG (1)
 
International
  $ (3.2 )   $ (3.6 )
Butterball
 
Other
    (1.3 )     0.6  
Mexican joint ventures
 
International
    (4.9 )     (5.6 )
All other equity method investments
 
Various
    (1.5 )     (1.7 )
Equity in income of affiliates
      $ (10.9 )   $ (10.3 )
____________________ 
 
(1)
CFG prepares its financial statements in accordance with International Financial Reporting Standards. Our share of CFG’s results reflects U.S. GAAP adjustments and thus, there may be differences between the amounts we report for CFG and the amounts reported by CFG.
 
As of August 1, 2010, we held 37,811,302 shares of CFG common stock. The stock was valued at €7.28 per share (approximately $9.48 per share) on the close of the last day of trading before the end of our first quarter of fiscal 2011. Based on the stock price and foreign exchange rate as of August 1, 2010, the carrying value of our investment in CFG, net of the pre-tax cumulative translation adjustment, exceeded the market value of the underlying securities by $58.5 million. We have analyzed our investment in CFG for impairment and have determined that the fair value of our investment exceeded the carrying value as of August 1, 2010. We have estimated the fair value based on the historical prices and trading volumes of the stock, the impact of the movement in foreign currency translation and the premium applied for our noncontrolling interest in CFG. Based on our assessment, no impairment was recorded.
 
NOTE 7: DEBT
 
Our various debt agreements contain covenants that limit additional borrowings, acquisitions, dispositions, leasing of assets and payments of dividends to shareholders, among other restrictions.
 
Our senior unsecured and secured notes limit our ability to incur additional indebtedness, subject to certain exceptions, when our interest coverage ratio is, or after incurring additional indebtedness would be, less than 2.0 to 1.0 (the Incurrence Test).  As of August 1, 2010, we did not meet the Incurrence Test.  Due to the trailing twelve month nature of the Incurrence Test, we do not expect to meet the Incurrence Test again until the second quarter of fiscal 2011 at the earliest.  The Incurrence Test is not a maintenance covenant and our failure to meet the Incurrence Test is not a default. In addition to limiting our ability to incur additional indebtedness, our failure to meet the Incurrence Test restricts us from engaging in certain other activities, including paying cash dividends, repurchasing our common stock and making certain investments. However, our failure to meet the Incurrence Test does not preclude us from borrowing on our asset-based revolving credit agreement that supports short-term funding needs and letters of credit (ABL Credit Facility) or from refinancing existing indebtedness. Therefore we do not expect the limitations resulting from our inability to satisfy the Incurrence Test to have a material adverse effect on our business or liquidity.
 
 
11

 
 
Our ABL Credit Facility contains a covenant requiring us to maintain a fixed charges coverage ratio of at least 1.1 to 1.0 when the amounts available for borrowing under the ABL Credit Facility are less than the greater of $120 million or 15% of the total commitments under the facility (currently $1.0 billion). We currently are not subject to this restriction and we do not anticipate that our borrowing availability will decline below those thresholds during fiscal 2011, although there can be no assurance that this will not occur because our borrowing availability depends upon our borrowing base calculated for purposes of that facility.
 
NOTE 8: GUARANTEES
 
As part of our business, we are a party to various financial guarantees and other commitments as described below. These arrangements involve elements of performance and credit risk that are not included in the consolidated condensed balance sheets. We could become liable in connection with these obligations depending on the performance of the guaranteed party or the occurrence of future events that we are unable to predict. If we consider it probable that we will become responsible for an obligation, we will record the liability on our consolidated balance sheet.
 
We (together with our joint venture partners) guarantee financial obligations of certain unconsolidated joint ventures. The financial obligations are: up to $76.8 million of debt borrowed by Agroindustrial del Noroeste (Norson), of which $66.3 million was outstanding as of August 1, 2010, and up to $3.5 million of liabilities with respect to currency swaps executed by another of our unconsolidated Mexican joint ventures, Granjas Carroll de Mexico (Granjas). The covenants in the guarantee relating to Norson’s debt incorporate our covenants under the ABL Credit Facility. In addition, we continue to guarantee $13.3 million of leases that were transferred to JBS in connection with the sale of Smithfield Beef. Some of these lease guarantees may be released in the near future and others may remain in place until the leases expire through February 2022.
 
NOTE 9: INCOME TAXES
 
Our effective tax rate was 30% and 25% for the first quarter of fiscal 2011 and 2010, respectively. The variation in the effective tax rate during these periods was due primarily to the mix of foreign earnings (which have lower effective tax rates) and domestic earnings in fiscal 2011 compared to fiscal 2010, the benefit of the Federal manufacturer’s deduction and the forecasted utilization of foreign tax credits in fiscal 2011. 
 
NOTE 10: PENSION PLANS
 
The components of net periodic pension cost consist of:
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
   
(in millions)
 
Service cost
  $ 9.2     $ 5.6  
Interest cost
    18.8       18.4  
Expected return on plan assets
    (16.0 )     (12.3 )
Net amortization
    8.5       5.1  
Net periodic pension cost
  $ 20.5     $ 16.8  

 
NOTE 11: SHAREHOLDERS’ EQUITY
 
Stock Options
 
In the first quarter of fiscal 2011, we issued 17,500 shares of common stock upon the exercise of stock options. We issued 160,100 shares of common stock upon exercise of stock options in fiscal 2010. As of August 1, 2010, 2,636,270 stock options were outstanding.
 
 
12

 
 
Performance Share Units
 
In June 2010 (fiscal 2011), we granted 370,000 performance share units under the 2008 Incentive Compensation Plan (the Incentive Plan). Each performance share unit represents and has a value equal to one share of our common stock. Payment of the vested performance share units generally will be in our common stock. The performance share units will vest ratably over a two-year service period provided that the Company achieves a certain earnings target in either fiscal 2011 or fiscal 2012. Also, in June 2010 (fiscal 2011), we granted a number of performance share units to certain employees in our Pork Group. The actual number of performance share units is based on the achievement of certain sales volume growth targets for the Pork segment and will range from aggregate awards of 105,000 to 175,000 performance share units provided the Company achieves a certain earnings target for fiscal 2011. The fair value of the performance share units was determined based on our closing stock price on the date of grant of $17.57. The fair value is being recognized over the expected life of each award. If the expected life of each award is inconsistent with the actual vesting period, for example, because the earnings target is met in a period that differs from our expectation, then compensation expense will be adjusted prospectively to reflect the change in the expected life of the award.
 
We granted 722,000 performance share units in fiscal 2010. The maximum number of performance share units outstanding as of August 1, 2010 was 1,427,000.
 
Comprehensive Income
 
The components of comprehensive income (loss), net of tax, consist of:
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
   
(in millions)
 
Net income (loss)
  $ 76.3     $ (107.7 )
Hedge accounting
    11.3       45.8  
Foreign currency translation
    (51.3 )     46.8  
Pension accounting
    5.3       2.5  
Total comprehensive income (loss)
  $ 41.6     $ (12.6 )
 
NOTE 12: FAIR VALUE MEASUREMENTS
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We are required to consider and reflect the assumptions of market participants in fair value calculations. These factors include nonperformance risk (the risk that the obligation will not be fulfilled) and credit risk, both of the reporting entity (for liabilities) and of the counterparty (for assets).
 
We use, as appropriate, a market approach (generally, data from market transactions), an income approach (generally, present value techniques), and/or a cost approach (generally, replacement cost) to measure the fair value of an asset or liability.  These valuation approaches incorporate inputs such as observable, independent market data that management believes are predicated on the assumptions market participants would use to price an asset or liability. These inputs may incorporate, as applicable, certain risks such as nonperformance risk, which includes credit risk.
 
The FASB has established a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The fair value hierarchy gives the highest priority to quoted market prices (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of inputs used to measure fair value are as follows: 
 
 
§
Level 1—quoted prices in active markets for identical assets or liabilities accessible by the reporting entity.
 
 
§
Level 2—observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
 
 
§
Level 3—unobservable for an asset or liability. Unobservable inputs should only be used to the extent observable inputs are not available.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
The fair value hierarchy gives the highest priority to quoted marketprices (Level 1) and the lowest priority to unobservable inputs (Level 3). Financial assets and liabilities have been classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
 
 
13

 
 
The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were measured at fair value on a recurring basis as of August 1, 2010.
 
   
Fair Value Measurements
   
Level 1
   
Level 2
   
Level 3
 
   
(in millions)
 
Assets
                       
Derivatives:
                       
Commodity contracts
  $ 1.7     $ -     $ 1.7     $ -  
Foreign exchange contracts
    0.6       -       0.6       -  
Money market fund
    430.1       430.1       -       -  
Insurance contracts
    40.7       40.7       -       -  
Total
  $ 473.1     $ 470.8     $ 2.3     $ -  
                                 
Liabilities
                               
Derivatives:
                               
Commodity contracts
  $ 29.8     $ 29.5     $ 0.3     $ -  
Interest rate contracts
    7.2       -       7.2       -  
Foreign exchange contracts
    7.6       -       7.6       -  
Total
  $ 44.6     $ 29.5     $ 15.1     $ -  
 
The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were measured at fair value on a recurring basis as of May 2, 2010.
 
   
Fair Value Measurements
   
Level 1
   
Level 2
   
Level 3
 
   
(in millions)
 
Assets
                       
Derivatives:
                       
Foreign exchange contracts
  $ 3.5     $ -     $ 3.5     $ -  
Money market fund
    325.4       325.4       -       -  
Insurance contracts
    32.5       32.5       -       -  
Total
  $ 361.4     $ 357.9     $ 3.5     $ -  
                                 
Liabilities
                               
Derivatives:
                               
Commodity contracts
  $ 119.5     $ 112.2     $ 7.3     $ -  
Interest rate contracts
    8.1       -       8.1       -  
Foreign exchange contracts
    0.2       -       0.2       -  
Total
  $ 127.8     $ 112.2     $ 15.6     $ -  
 
When available, we use quoted market prices to determine fair value and we classify such measurements within Level 1.  In some cases where market prices are not available, we make use of observable market-based inputs (i.e., Bloomberg and commodity exchanges) to calculate fair value, in which case the measurements are classified within Level 2. When quoted market prices or observable market-based inputs are unavailable, or when our fair value measurements incorporate significant unobservable inputs, we would classify such measurements within Level 3.
 
We invest our cash in an overnight money market fund, which is treated as a trading security with the unrealized gains recorded in earnings.
 
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
 
Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances, for example, when there is evidence of impairment.
 
 
14

 
 
In fiscal 2011 and fiscal 2010, we wrote down certain assets to their estimated fair values. Certain of these assets have since been sold. The fair value of the remaining assets, which consist primarily of property, plant and equipment, was determined to be approximately $50.8 million as of August 1, 2010 and May 2, 2010. The fair value measurements of these assets were determined using relevant market data based on recent transactions for similar assets and third party estimates, which we classify as Level 2 inputs. Fair values were also determined using valuation techniques, which incorporate unobservable inputs that reflect our own assumptions regarding how market participants would price the assets, which we classify as Level 3 inputs.
 
Other Financial Instruments
 
We determine the fair value of public debt using quoted market prices. We value all other debt using discounted cash flow techniques at estimated market prices for similar issues. The following table presents the fair value and carrying value of long-term debt, including the current portion of long-term debt as of August 1, 2010 and May 2, 2010.
 
   
August 1, 2010
   
May 2, 2010
 
   
Fair
Value
   
Carrying Value
   
Fair
Value
   
Carrying Value
 
   
(in millions)
 
Long-term debt, including current portion
  $ 3,110.8     $ 2,949.7     $ 3,229.3     $ 2,963.0  
 
The carrying amounts of cash and cash equivalents, accounts receivable, notes payable and accounts payable approximate their fair values because of the relatively short-term maturity of these instruments.
 
NOTE 13: CONTINGENCIES
 
Insurance Recoveries
 
In July 2009 (fiscal 2010), a fire occurred at the primary manufacturing facility of our subsidiary, Patrick Cudahy, Incorporated (Patrick Cudahy), in Cudahy, WI.  The fire damaged a portion of the facility’s production space and required the temporary cessation of operations, but did not consume the entire facility. Shortly after the fire, we resumed production activities in undamaged portions of the plant, including the distribution center, and took steps to address the supply needs for Patrick Cudahy products by shifting production to other Company and third-party facilities. 
 
We maintain comprehensive general liability and property insurance, including business interruption insurance, with loss limits that we believe will provide substantial and broad coverage for the losses arising from this accident.  We are working with our insurance carrier to determine the extent of loss. We received advances totaling $70.0 million toward the ultimate settlement in the final three quarters of fiscal 2010.
 
In the first quarter of fiscal 2011, we received an additional $5.5 million in proceeds. The receipt of these additional proceeds was applied against out-of-pocket costs and other losses incurred as a result of the fire. Therefore, the resulting impact of the fire on our consolidated condensed statement of income was insignificant for all periods presented. The magnitude and timing of the ultimate settlement is currently unknown. However, we expect the level of insurance proceeds to fully cover the costs and losses incurred from the fire.
 
Litigation
 
There have been no signifiant developments regarding the litigation disclosed in Note 18 to our Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended May 2, 2010, nor have any signficant new matters arisen during fiscal 2011.
 

 
 
 
15

 
 
NOTE 14: SEGMENT DATA
 
We conduct our operations through five reportable segments: Pork, International, Hog Production, Other and Corporate, each of which is comprised of a number of subsidiaries, joint ventures and other investments.
 
The Pork segment consists mainly of our three wholly-owned U.S. fresh pork and packaged meats subsidiaries. The International segment is comprised mainly of our meat processing and distribution operations in Poland, Romania and the United Kingdom, our interests in meat processing operations, mainly in Western Europe and Mexico, our hog production operations located in Poland and Romania and our interests in hog production operations in Mexico. The Hog Production segment consists of our hog production operations located in the U.S. The Other segment is comprised of our turkey production operations, our 49% interest in Butterball, and through the first quarter of fiscal 2010, our live cattle operations. The Corporate segment provides management and administrative services to support our other segments.
 
Prior to the first quarter of fiscal 2011, our hog production operations in Poland and Romania and our interest in hog production operations in Mexico were included in our Hog Production segment. In the first quarter of fiscal 2011, these operations were moved into our International segment to more appropriately align our operating segments with the way our chief operating decision maker (CODM) now assesses performance of these segments and allocates resources to these segments. The fiscal 2010 results presented below have been restated to reflect this change in our reportable segments.
 
The following table presents sales and operating profit (loss) by segment for the fiscal periods indicated:
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
   
(in millions)
 
Sales:
           
Segment sales—
           
Pork
  $ 2,413.5     $ 2,251.8  
Hog Production
    648.3       476.4  
International
    316.3       294.4  
Other
    30.4       71.2  
Total segment sales
    3,408.5       3,093.8  
Intersegment sales—
               
Pork
    (7.5 )     (8.4 )
Hog Production
    (490.1 )     (362.0 )
International
    (9.6 )     (8.1 )
Total intersegment sales
    (507.2 )     (378.5 )
Consolidated sales
  $ 2,901.3     $ 2,715.3  
                 
Operating profit (loss):
               
Pork
  $ 113.3     $ 101.0  
Hog Production
    63.8       (180.2 )
International
    24.5       25.4  
Other
    1.2       (4.6 )
Corporate
    (25.2 )     (16.4 )
Consolidated operating profit (loss)
  $ 177.6     $ (74.8 )

NOTE 15: SUBSEQUENT EVENT
 
In August 2010 (fiscal 2011) and through September 8, 2010, we repurchased a portion of our senior unsecured notes due August 2011 for $71.3 million. We have classified the carrying amount of these notes totaling $69.4 million within current portion of long-term debt and capital lease obligations on the consolidated condensed balance sheet as of August 1, 2010. A loss of approximately $1.9 million on the repurchase of this debt will be recognized in the second quarter of fiscal 2011. We anticipate interest savings of approximately $2.8 million through the original maturity date of these notes as a result of these repurchases.
 
 
 
 
 
16

 
 
 
You should read the following information in conjunction with the unaudited consolidated condensed financial statements and the related notes in this Quarterly Report and the audited financial statements and the related notes as well as Management’s Discussion and Analysis of Financial Condition and Results of Operation contained in our Annual Report on Form 10-K for the fiscal year ended May 2, 2010.
 
Unless otherwise stated, the amounts presented in the following discussion are based on continuing operations for all fiscal periods included. Certain prior year amounts have been reclassified to conform to current year presentations.
 
EXECUTIVE OVERVIEW
 
We are the largest hog producer and pork processor in the world. 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.
 
The Pork segment consists mainly of our three wholly-owned U.S. fresh pork and packaged meats subsidiaries. The International segment is comprised mainly of our meat processing and distribution operations in Poland, Romania and the United Kingdom, our interests in meat processing operations, mainly in Western Europe and Mexico, our hog production operations located in Poland and Romania and our interests in hog production operations in Mexico. The Hog Production segment consists of our hog production operations located in the U.S. The Other segment is comprised of our turkey production operations, our 49% interest in Butterball, and through the first quarter of fiscal 2010, our live cattle operations. The Corporate segment provides management and administrative services to support our other segments.
 
Prior to the first quarter of fiscal 2011, our hog production operations in Poland and Romania and our interest in hog production operations in Mexico were included in our Hog Production segment. In the first quarter of fiscal 2011, these operations were moved into our International segment to more appropriately align our operating segments with the way our chief operating decision maker (CODM) now assesses performance of these segments and allocates resources to these segments. The fiscal 2010 results presented below have been restated to reflect this change in our reportable segments.
 
First Quarter of Fiscal 2011 Summary
 
Net income was $76.3 million, or $.46 per diluted share, in the first quarter of fiscal 2011, compared to a net loss of $107.7 million, or $(.75) per diluted share, in the same quarter last year. The following significant factors impacted first quarter of fiscal 2011 results compared to the first quarter of fiscal 2010:
 
 
§
Pork segment operating profit increased to $113.3 million, the fourth consecutive year of record first quarter results, driven by substantially higher fresh pork market prices.
 
 
§
International segment operating profit was relatively consistent with prior year results.
 
 
§
Hog Production segment operating profit increased $244.0 million due to a substantially higher meat values and a decrease in raising costs.
 
 
§
Other segment operating profit was higher due to improved results at Butterball and lower feed costs in our turkey growout operations. 
 

 
 
 
17

 

Outlook
 
The commodity markets affecting our business are extremely volatile and fluctuate on a daily basis. In this erratic and unpredictable operating environment, it is very difficult to make meaningful forecasts of industry trends and conditions. The outlook statements that follow must be viewed in this context.
 
 
§
Pork—Despite tight hog supplies and high live hog prices, which typically place pressure on fresh pork margins, we achieved very solid processing margins in the first quarter of fiscal 2011.  As we enter the second quarter, fundamentals in the fresh pork complex are very strong.  The segment should benefit from lower industry slaughter levels and relatively low protein freezer stocks.  Accordingly, we remain optimistic about our fresh pork performance moving into the balance of fiscal 2011. We expect export volumes to remain solid.  Healthy levels of export demand will provide additional domestic price support and help the overall fresh pork complex.
 
Pricing discipline, rationalization of low margin business, lower raw material costs and the benefits of the Restructuring Plan (as defined below) pushed packaged meats profits to record highs in fiscal 2010.  In the first quarter of fiscal 2011, margins retreated from fiscal 2010’s record highs, but still remained historically strong. For the balance of fiscal 2011, we expect our packaged meats business will continue to be solidly profitable, notwithstanding comparatively higher raw material costs associated with higher live hog prices. Margins are still expected to be strong in historical terms. We expect margins in this end of the business to average in excess of $.10 per pound.
 
In summary, we are optimistic about the Pork segment for the balance of fiscal 2011. We expect the actions we have taken on the sales, operating and restructuring fronts will support segment profitability. With the Restructuring Plan largely completed, we are re-focusing our efforts on sales and marketing initiatives designed to drive profitable top line growth.
 
 
§
International—We continue to be pleased with the performance of our international meat operations, especially in Poland where we had record profits in fiscal 2010 despite very high live hog prices. We expect our international meat operations to continue improving their operating performance as we move through fiscal 2011. We also expect a positive contribution from our investment in CFG, as defined below. However, CFG will be operating in an adverse environment of high unemployment and recessionary conditions across Western Europe, which may hinder its ability to produce good results.
 
On the international live production front, our wholly-owned live production operations in Poland, Romania and Mexico performed well in fiscal 2010. As we move through fiscal 2011, we expect continued positive contributions from our live swine operations in Poland and Mexico.  We also expect a net positive contribution from our Romanian farms for the balance of the year, as anticipated production and productivity increases offset a loss of government subsidies in that country.
 
 
§
Hog Production—Finally, in the first quarter, after a considerable and extended period of sizable losses in the hog production industry, the cycle has turned and the environment has improved significantly. Modest contractions in the U.S. sow herd contributed to tightened supplies which, in turn, has resulted in higher live hog market prices. We do not foresee significant herd expansion on the horizon, which should help stabilize prices at healthier levels than fiscal 2010. Live production fundamentals appear to be favorable for the foreseeable future.
 
Our domestic raising costs spiked to all-time highs in the second quarter of fiscal 2009, reaching a quarterly average of $63 per hundredweight. Since that time, raising costs have moderated substantially to the mid-$50’s per hundredweight. While we may see some seasonal moderation, we expect raising costs will remain in the mid-$50’s per hundredweight throughout fiscal 2011. Beyond that, we have also developed a plan, described more fully below, to improve our long-term cost structure. We expect the cost savings plan will reduce our base raising costs by approximately $2 per hundredweight. However, the plan may take several years to complete before the benefits are fully realized.
 
 
 
18

 
 
Livestock producers continue to feel the negative impacts of the current ethanol policy in the United States. Currently, it is estimated that 30% of the U.S corn crop is diverted from livestock feed and other consumer products to the ethanol industry. Although we are encouraged by the EPA’s recent announcement to delay its decision on the ethanol industry’s petition to raise the allowable ethanol blend in gasoline from 10% to 15%, we remain concerned about these proposals and their impact on the long-term profitability of livestock production in this country. If such proposals are approved, the portion of the U.S. corn crop diverted to ethanol production could increase to as much as 40%. The impact to the protein industry would be higher feed costs and, ultimately, higher food prices for consumers.
 
 
§
Other—The Other segment is comprised almost entirely of our wholly-owned turkey operations and our 49% interest in Butterball. As more fully described under "Additional Matters Affecting Liquidity—Butterball Buy/Sell Option," we have activated the buy/sell provision in our Butterball joint venture. The outcome of the buy/sell decision will dictate whether this segment will continue to be a reportable segment throughout fiscal 2011 and beyond.  If we are successful in our bid to purchase the remaining 51% interest, we will acquire control of Butterball and include 100 percent of its results from operations in our consolidated financial statements. If we sell our interest, the segment will likely cease to exist.
 
 
Recent Regulatory Developments
 
In June 2010, the United States Department of Agriculture, Grain Inspection, Packers and Stockyards Administration (GIPSA) published a proposed rule adding new regulations under the Packers and Stockyards Act. If adopted as proposed, the new regulations could have a significant impact on marketing and procurement practices in the meat production and processing industry, including on integrated hog producers and processors, like us.  We cannot presently assess the full economic impact of the proposed regulations on the meat processing industry or on our operations.  For more information regarding these proposed regulations, see “Item 1A. Risk Factors” herein.
 
 
RESULTS OF OPERATIONS
 
Significant Events Affecting Results of Operations
 
Hog Production Cost Savings Initiative Update
 
In the fourth quarter of fiscal 2010, we announced a plan to improve the cost structure and profitability of our domestic hog production operations (the Cost Savings Initiative). The plan includes a number of undertakings designed to improve operating efficiencies and productivity. These consist of farm reconfigurations and conversions, termination of certain high cost, third-party hog grower contracts and breeding stock sourcing contracts, as well as a number of other cost reduction activities. Certain of the activities associated with the Cost Savings Initiative are expected to occur over a two to three-year period in order to allow for the successful transformation of farms while minimizing disruption of supply.
 
 
 
19

 
 
All of the charges have been recorded in cost of sales in the Hog Production segment. The following table summarizes the balance of accrued expenses, the cumulative expense incurred to date and the expected remaining expenses to be incurred related to the Cost Savings Initiative by major type of cost.
 
   
Accrued Balance
May 2, 2010
   
Current Period Expense
   
Payments
   
Accrued Balance
August 1, 2010
   
Cumulative Expense-to-Date
   
Estimated Remaining Expense
 
Cost savings activities:
 
(in millions)
 
Contract terminations
  $ 1.8     $ -     $ (0.2 )   $ 1.6     $ 2.8     $ 22.9  
Other associated costs
    -       0.2       (0.2 )     -       0.2       9.2  
Total cost savings activities
  $ 1.8       0.2     $ (0.4 )   $
1.6
      3.0       32.1  
                                                 
Other charges:
                                               
Accelerated depreciation
            0.3                       4.1       1.8  
Impairment
            -                       2.5       -  
Total other charges
            0.3                       6.6       1.8  
Total cost savings activities and other charges
          $ 0.5                     $ 9.6     $ 33.9  
 
We do not believe the benefits of the Cost Savings Initiative will have any significant impact on our results of operations in fiscal 2011. Beginning in fiscal 2012, we expect a gradual improvement in profitability of our Hog Production segment as a result of the Cost Savings Initiative. We expect that by fiscal 2014, the benefits of this initiative will be fully realized and we currently estimate profitability improvement of approximately $2 per hundredweight.
 
Hog Farm Impairments
 
In fiscal 2008 and fiscal 2009, we announced that we would reduce the size of our U.S. sow herd by 10% in order to reduce the overall supply of hogs in the U.S. market. In June 2009 (fiscal 2010), we decided to further reduce our domestic sow herd by 3%, or approximately 30,000 sows, which was accomplished by ceasing certain hog production operations and closing certain of our hog farms. In addition, in the first quarter of fiscal 2010, we began marketing certain other hog farms. As a result of these decisions, we recorded total impairment charges of $34.1 million, including an allocation of goodwill, in the first quarter of fiscal 2010 to write-down the hog farm assets to their estimated fair values. The impairment charges were recorded in cost of sales in the Hog Production segment.
 
 
 
20

 
 
Consolidated Results of Operations
 
Sales and cost of sales
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
   
%  Change
 
   
(in millions)
       
Sales
  $ 2,901.3     $ 2,715.3       7 %
Cost of sales
    2,533.6       2,616.6       (3 )
Gross profit
  $ 367.7     $ 98.7       273 %
Gross profit margin
    13 %     4 %        
 
The following items explain the significant changes in sales and gross profit:
 
 
§
Average unit selling prices in the Pork segment increased 15% driven primarily by a reduction in the supply of pork products and stable demand in the market.
 
 
§
Domestic live hog market prices increased to $58 per hundredweight from $42 in the prior year reflecting tighter supply in the industry.
 
 
§
Domestic raising costs decreased to $54 per hundredweight from $58 per hundredweight in the prior year driven by lower feed prices.
 
 
§
Cost of sales in the first quarter of fiscal 2010 included $34.1 million in impairment charges related to certain hog farms, which are more fully explained under “Significant Events Affecting Results of Operations” above. 
 
 
Selling, general and administrative expenses (SG&A)
 
   
Three Months Ended
   
August 1,
2010
   
August 2,
2009
   
%  Change
   
(in millions)
       
Selling, general and administrative expenses
  $ 201.0     $ 183.8       9 %
 
The following items explain the significant changes in SG&A:
 
 
§
Pension expense and other compensation related expenses increased $3.7 million and $4.7 million, respectively.
 
 
§
A reduction in the amount of government subsidies recognized for our Romanian hog production operations increased SG&A by $7.8 million.
 
 
§
Changes in the cash surrender value of life insurance policies resulted in a year-over-year increase in SG&A of $4.6 million.
 
 
 
21

 
 
Equity in (income) loss of affiliates
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
   
%  Change
 
   
(in millions)
       
Campofrío Food Group (CFG)
  $ (3.2 )   $ (3.6 )     (11 )%
Butterball, LLC (Butterball)
    (1.3 )     0.6       317  
Mexican joint ventures
    (4.9 )     (5.6 )     (13 )
All other equity method investments
    (1.5 )     (1.7 )     (12 )
Equity in income of affiliates
  $ (10.9 )   $ (10.3 )     6 %
 
The increase of equity in income of affiliates was primarily due to an improvement in Butterball's results due to lower feed costs.
 
 
Interest expense
 
   
Three Months Ended
   
August 1,
2010
   
August 2,
2009
   
%  Change
   
(in millions)
       
Interest expense
  $ 68.6     $ 60.5       13 %
 
The increase in interest expense was primarily due to higher interest rates on debt and the amortization of debt issuance costs associated with the issuance of debt in the first quarter of fiscal 2010.
 
 
Other loss
 
   
Three Months Ended
   
August 1,
2010
   
August 2,
2009
   
%  Change
   
(in millions)
       
Other loss
  $ -     $ 7.4       NM  
 
As described more fully under “Liquidity and Capital Resources” below, we terminated commitments under our $1.3 billion secured revolving credit agreement (the U.S. Credit Facility) in the first quarter of fiscal 2010, and recognized a $7.4 million charge related to the write-off of amendment fees and costs associated with the U.S. Credit Facility as a loss on debt extinguishment.
 
 
Income tax expense (benefit)
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
 
Income tax expense (benefit)
  $ 32.7     $ (35.0 )
Effective tax rate
    30 %     25 %
 
The variation in the effective tax rate during these periods was due primarily to the mix of foreign earnings (which have lower effective tax rates) and domestic earnings in fiscal 2011 compared to fiscal 2010, the benefit of the Federal manufacturer’s deduction and the forecasted utilization of foreign tax credits in fiscal 2011. 
 
 
22

 
 
Segment Results
 
The following information reflects the results from each respective segment prior to eliminations of inter-segment sales.
 
Pork Segment
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
   
%  Change
 
   
(in millions, unless indicated otherwise)
       
Sales:
                 
Fresh pork (1)
  $ 1,151.4     $ 1,046.8       10 %
Packaged meats
    1,262.1       1,205.0       5  
Total
  $ 2,413.5     $ 2,251.8       7 %
                         
Operating profit (loss):
                       
Fresh pork (1)
  $ 46.0     $ (5.0 )   NM %
Packaged meats
    67.3       106.0       (37 )
Total
  $ 113.3     $ 101.0       12 %
                         
Sales volume (pounds):
                       
Fresh pork
                    (6 )%
Packaged meats
                    (6 )
Total
                    (7 )
                         
Average unit selling price (dollars):
                       
Fresh pork
                    17 %
Packaged meats
                    12  
Total
                    15  
                         
Average domestic live hog prices (per hundred weight) (2)
  $ 58.21     $ 42.30       38 %
____________________ 
 
(1)
Includes by-products and rendering.
 
(2)
Represents the average live hog market price as quoted by the Iowa-Southern Minnesota hog market. 
 
In addition to the information provided in the table above, the following items explain the significant changes in Pork segment sales and operating profit:
 
 
§
Sales and operating profit were positively impacted by substantially higher average unit selling prices driven by a reduction in the supply of pork products and stable demand in the market.
 
 
§
Fresh pork operating profit was $7 per head compared to a loss of $1 per head last year as fresh pork market prices increased to record seasonal levels and slaughter levels declined 11%.
 
 
§
Packaged meats operating profit margins were $.11 per pound compared to $.17 per pound last year.  The decrease reflects substantially higher raw material costs, which we were unable to fully pass on to consumers.
 
 
 
23

 
 
Hog Production Segment
 
   
Three Months Ended
 
   
August 1,
2010
   
August 2,
2009
   
%  Change
 
   
(in millions, unless indicated otherwise)
       
Sales
  $ 648.3     $ 476.4       36 %
Operating profit (loss)
    63.8       (180.2 )     135  
                         
Head sold
    3.83       3.97       (4 )%
                         
Average domestic live hog prices (per hundred weight) (1)
  $ 58.21     $ 42.30       38 %
Raising costs (per hundred weight)
    53.52       57.79       (7 )
 ____________________ 
 
(1)
Represents the average live hog market price as quoted by the Iowa-Southern Minnesota hog market.
 
In addition to the information provided in the table above, the following items explain the significant changes in International segment sales and operating profit:
 
 
§
Sales and operating profit were positively impacted by substantially higher live hog prices due to a reduction in the supply of market hogs. The decline in head sold reflects the contraction in our sow herd.
 
 
§
Operating profit was positively impacted by lower raising costs, driven by lower grain prices.
 
 
§
Operating loss in the first quarter of fiscal 2010 included $34.1 million in impairment charges related to certain hog farms, which are more fully explained under "Significant Events Affecting Results of Operations" above.

 
§
Operating profit in the first quarter of fiscal 2011 included approximately $11.3 million in gains on the sale of breeding stock compared to approximately $6.1 million in losses in the first quarter of fiscal 2010.
 
 
 
24

 
 
International Segment
 
   
Three Months Ended
 
   
August 1, 2010
   
August 2, 2009
   
%  Change
 
   
(in millions, unless indicated otherwise)
       
Sales:
                 
Poland
  $ 241.8     $ 221.3       9 %
Romania
    46.6       48.2       (3 )
Other
    27.9       24.9       12  
Total
  $ 316.3     $ 294.4       7 %
                         
Operating profit (loss):
                       
Poland
  $ 17.4     $ 9.8       78 %
Romania
    (0.2 )     7.3       (103 )
Other (1)
    7.3       8.3       (12 )
Total
  $ 24.5     $ 25.4       (4 )%
                         
Poland:
                       
Sales volume (pounds)
                    30 %
Average unit selling price
                    (16 )
Head processed
                    38  
Head sold
                    16  
Raising costs (per hundredweight)
                    (6 )
                         
Romania:
                       
Sales volume
                    11 %
Average unit selling price
                    (12 )
Head processed
                    -  
Head sold
                    -  
Raising costs (per hundredweight)
                    (26 )
 ____________________ 
 
(1)
Includes our equity method investments in Mexico and the results from our investment in CFG.
 
In addition to the information provided in the table above, the following items explain the significant changes in International segment sales and operating profit:
 
 
§
The increase in sales volume in Poland was due to an improved fresh pork environment along with a strong demand in packaged meats. The decrease in selling price was due to a change in product mix between fresh and packaged products.
 
 
§
In Romania, we recognized $7.8 million less in government subsidies for hog production than the prior year due to an expiration of the subsidy program in the second half of fiscal 2010.
 
 
§
Foreign currency losses were $2.7 million lower than the prior year.

 
§
Equity income from our equity method investments decreased $1.1 million.
 
 
 
 
25