Smithfield Foods - 10-Q quarterly report FY

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended July 27, 2003

OR

For the transition period from              to            

COMMISSION FILE NUMBER

1-15321

SMITHFIELD FOODS, INC.

200 Commerce Street

Smithfield, Virginia 23430

(757) 365-3000

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 is an accelerated filer (as defined in rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

Table of Contents

SMITHFIELD FOODS, INC.

CONTENTS

2

Table of Contents

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

SMITHFIELD FOODS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(Unaudited)

See Notes to Consolidated Condensed Financial Statements

3

Table of Contents

SMITHFIELD FOODS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

See Notes to Consolidated Condensed Financial Statements

4

Table of Contents

SMITHFIELD FOODS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

See Notes to Consolidated Condensed Financial Statements

5

Table of Contents

SMITHFIELD FOODS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

See Notes to Consolidated Condensed Financial Statements

6

Table of Contents

SMITHFIELD FOODS, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

7

Table of Contents

In fiscal 2003, the Company adopted the fair value method defined in Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation”, which is in compliance with the provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosures, an amendment to SFAS No. 123,” issued December 2002, to account for the Company’s stock option plans. The Company records compensation expense for stock options granted subsequent to April 28, 2002 based on their fair value as determined using the Black-Scholes option pricing model and weighted average assumptions. For the 13 weeks ended July 27, 2003 and July 28, 2002, the impact of recording compensation expense for stock options granted was less than one cent per diluted share. Stock options granted prior to April 29, 2002 continue to be accounted for under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) until they are modified or vested. Under APB 25, no compensation expense is recorded. Had the Company used the fair value method to determine compensation expense for its stock options granted prior to April 29, 2002, net income and net income per basic and diluted share would have been as follows:

8

Table of Contents

In June of fiscal 2003, the Company acquired an 80% interest in Stefano Foods, Inc. (Stefano’s) for $34.6 million in cash plus assumed debt. The balance of the purchase price in excess of the fair value of the assets acquired and the liabilities assumed at the date of the acquisition was recorded as goodwill totaling $23.2 million.

Had the acquisitions of Vall and Stefano’s occurred at the beginning of fiscal 2003, there would not have been a material effect on sales, net income or net income per diluted share for the 13 weeks ended July 28, 2002.

These acquisitions were accounted for using the purchase method of accounting and, accordingly, the accompanying financial statements include the financial position and the results of operations from the dates of acquisition.

The net impact of ineffectiveness related to the Company’s hedges was not material for the 13 weeks ending July 27, 2003 and July 28, 2002. No hedges were discontinued for the 13 weeks ending July 27, 2003 and July 28, 2002 as a result of it becoming probable that the forecasted transaction will not occur.

9

Table of Contents

In January 2003, the FASB issued FASB Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 expands consolidated financial statements to include certain variable interest entities (VIEs). VIEs are to be consolidated by the company which is considered to be the primary beneficiary of that entity, even if the company does not have majority control. FIN 46 is immediately effective for VIEs created after January 31, 2003 and is effective for the Company in the second quarter of fiscal 2004 for VIEs created prior to February 1, 2003. The Company is evaluating unconsolidated entities in which the Company has significant contractural, ownership, or other pecuniary interests to determine if they are VIEs that the Company must consolidate. Based on the Company’s preliminary analysis, there are certain entities that the Company may be required to consolidate in the second quarter of fiscal 2004. Consolidation of these entities would have no impact on net income or shareholders’ equity of the Company. While the consolidation of these entities would effect certain components of the Company’s balance sheet and income statement, the Company does not expect the application of FIN 46 to have a material impact on the Company’s consolidated financial statements.

In September of fiscal 2004, the company acquired 90% of the outstanding shares of Cumberland Gap Provision Company (Cumberland Gap) for approximately $56.9 million, subject to post-closing adjustments. Cumberland Gap is a processor of premium- branded hickory smoked hams, sausages and other specialty pork products and has annual sales of approximately $70.0 million.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

Smithfield Foods, Inc. and subsidiaries (the Company) is composed of four segments: Pork, Beef, International and the Hog Production Group (HPG). The Pork segment consists primarily of fresh pork and processed meats subsidiaries in the United States (U.S.). The Beef segment consists primarily of U.S. beef processing subsidiaries and the International segment consists primarily of meat processing

10

Table of Contents

subsidiaries in Canada, Poland and France. The HPG consists primarily of other hog production operations located in the U.S. and Poland. The Pork, International and HPG segments have certain joint ventures and other investments in addition to their primary operations.

The Pork segment includes the Company’s operations that process, package, market and distribute fresh pork and processed meats to retail, foodservice and export channels. Similarly, the Beef segment operations process, package, market and distribute beef products to the same channels. The Company’s International reporting segment includes its meat processing operations outside the U.S. and produces a wide variety of fresh and processed meats for retail, foodservice and export channels. The HPG segment supplies raw materials (live hogs) primarily to the Pork and International segments, as well as to other outside operations.

The Company changed its reporting segments at the end of fiscal 2003 to separately report the meat processing operations, as discussed above. Previously, the Company’s segments were the Meat Processing Group and HPG. The Company has reclassified the segment information for the first quarter of fiscal 2003 to conform to the fiscal 2004 presentation.

RESULTS OF OPERATIONS

13 weeks ended July 27, 2003 compared to 13 weeks ended July 28, 2002

Consolidated

The Company reclassified depreciation expense for the 13 weeks ended July 28, 2002, which was previously stated as a separate line item on the consolidated statements of income, into either cost of sales or selling, general and administrative expense. The consolidated results of operations discussion reflects this reclassification.

Sales increased by $205.5 million, or 10%, primarily the result of a combined 11% increase in average unit selling prices in the Pork, Beef and International segments and partially offset by a combined 1% decrease in sales volume in those segments. The unit price increases are primarily the result of the impact of sharply higher live hog prices on fresh pork prices. See the following section for comments on sales changes by business segment.

Gross profit increased $17.8 million, or 9%, primarily the result of higher margins in the HPG on a 22% increase in U.S. live hog market prices partially offset by increased raising costs in the HPG. This HPG increase was offset by gross margin decreases in the Pork and International segments due to the increase in U.S. live hog market prices exceeding the increase in average unit selling prices.

Selling, general and administrative expenses decreased $1.6 million, or 1%. This decrease was primarily due to lower advertising and promotion costs partially offset by an increase in pension costs.

Interest expense increased $4.3 million, or 17%. The increase is due primarily to the issuance of long-term debt in May of fiscal 2004 at an interest rate of 7.75% which was used to repay indebtedness on the revolving credit facility which had an average interest rate approximately 4.5% lower than the new debt. The increase also is due to the increase in average interest rates on the revolving credit facility and other variable rate debt compared to fiscal 2003 rates.

The effective income tax rate decreased to 34.0% as compared with 35.5%. This estimated tax rate used in the current year is greater than the actual fiscal 2003 rate of 33.0%. This increase is primarily due to an increase in earnings at higher marginal tax rates. The Company had a valuation allowance of $30.0 million related to income tax assets as of July 27, 2003 primarily related to losses in foreign jurisdictions for which no tax benefit is recognized.

Reflecting the foregoing factors, net income increased to $22.1 million, or $.20 per diluted share, in the 13 weeks ended July 27, 2003 up from net income of $11.8 million, or $.11 per diluted share, in the 13 weeks ended July 28, 2002.

11

Table of Contents

SEGMENT RESULTS

Pork Segment Results

Sales in the Pork segment increased $103.6 million on an 11% increase in the average unit selling price of pork products primarily the result of the impact of sharply higher live hog prices on fresh pork prices. Pork volumes were flat against the comparable quarter last year with a 5% increase in processed meats offset by a 5% decrease in fresh pork volumes. Pork sales were impacted during the quarter by higher shipments of fresh pork from Canada. This supply increase resulted from lower Canadian live cattle prices following the report of a single case of bovine spongiform encephalopathy (BSE) in that country in May 2003. The U.S. Department of Agriculture imposed a ban on the importation of ruminants and ruminant products from Canada, including beef, cattle and animal feed in response to the report. This sharply lower cattle market in Canada triggered a decline in Canadian demand for pork and an increase in Canadian fresh pork exports to the U.S., where prices were higher.

Pork segment operating profit decreased $23.7 million due primarily to a 22% increase in live hog market prices and a continued weak operating environment for fresh pork. Fresh pork margin decreases were partially offset by the Company’s continued emphasis on branded and value-added fresh pork categories and by lower advertising and promotion costs. Higher pension costs also contributed to the reduction in operating profit.

Beef Segment Results

Beef sales increased $46.4 million due primarily to a 13% increase in average unit selling price, partially offset by a 4% decrease in sales volume. The average unit selling price increased due to higher demand for higher quality choice cuts of beef, a segment of the industry in which the Company’s beef operations are particularly strong. This demand was driven by an oversupply of select (lower quality) cuts of beef. Another positive factor in the beef operations was improved rendered by-product values due to a strengthened export market. Also contributing to the higher selling price was the absence of beef and cattle imports from Canada due to the discovered case of BSE (See Pork Segment Results).

Operating profit increased $10.0 million due to higher average unit selling prices on higher pricing for quality choice cuts and rendered byproducts partially offset by an increase in live cattle prices.

12

Table of Contents

International Segment Results

International sales increased $51.0 million due to an 8% increase in average unit selling prices and a 7% increase in fresh meat and processed meats sales volume. The increase in average unit selling prices was primarily due to the impact of sharply higher live hog prices on fresh pork prices. Fresh meat sales volume increased dramatically due to realization of the vertical integration strategy at the Company’s operations in Poland. Through the continued expansion of the Company’s hog farms in Poland, the meat processing operations in Poland now receive an increased supply of high quality market hogs.

International operating profit decreased $6.1 million due primarily to the increase in live hog costs and the unfavorable market conditions for pork in Canada.

Hog Production Group Segment Results

HPG sales increased $61.9 million, primarily the result of a 22% increase in live hog market prices and a slight increase in production. HPG had sales of $245.7 million and $199.6 million for the 13 weeks ended July 27, 2003 and July 28, 2002, respectively, at current prices, to the Pork and International segments, which were eliminated in the Company’s Consolidated Condensed Statements of Income.

Operating profit increased $39.1 million primarily due to the increase in live hog prices in the current year partially offset by an increase in raising costs from higher feed costs.

LIQUIDITY AND CAPITAL RESOURCES

Cash used in operations totaled $9.4 million for the 13 weeks ended July 27, 2003 compared to cash provided by operations of $24.5 million in the same period last year. This decrease is due primarily to increased working capital commitments partially offset by higher earnings as compared to the prior year.

Cash used in investing activities increased to $83.8 million for the 13 weeks ended July 27, 2003 compared to $76.4 million for the comparable prior period. The increase in other investing activities includes a deposit in the current year required as part of the definitive asset purchase agreement between the Company and Farmland Industries, Inc. (Farmland) for the purchase of substantially all of the assets of Farmland Foods. The increase was partially offset by a decrease in capital expenditures in the current quarter and the acquisition of Stefano’s in the prior year. Capital expenditures in the current period totaled $32.6 million primarily related to fresh pork and processed meats expansion projects and additional hog production facilities. As of July 27, 2003, the Company had definitive commitments of $124.1 million for capital expenditures primarily for processed meats expansion, foreign farm expansion and production efficiency projects.

13

Table of Contents

Financing activities provided cash of $90.1 million in the current 13-week period compared to $78.3 million for the prior year. In the current period, the Company issued $350.0 million of 10-year, 7.75% senior unsecured notes. Net proceeds from the sale of these notes were used to repay indebtedness under the Company’s revolving credit facility. The Company used the availability under the revolving credit facility to fund investment activity in the 13 weeks ended July 27, 2003. The Company expects to continue to use availability under the revolving credit facility, together with internally generated funds, for capital expenditures and general corporate purposes, including expansion of its processed meats business and strategic acquisitions. As of July 27, 2003, the Company’s availability under the revolving credit facility was $494.6 million. The Company increased its borrowings on its revolving credit facility $113.0 million in the prior period to fund net investment activity and to repurchase 0.9 million shares of the Company’s common stock. The Company did not repurchase any of its own stock in the current quarter and as of September 5, 2003, 16.8 million shares of the Company’s common stock have been repurchased under an 18.0 million-share repurchase program.

Management believes that through internally generated funds and access to global credit markets, funds are available to adequately meet the Company’s current and future operating and capital needs.

In May of fiscal 2004, the Company notified Pennexx Foods, Inc. (Pennexx), a 41% owned case-ready meat provider, that it was in default under a $30.0 million line of credit agreement. At that time, the Company terminated its commitment to make further loans under the credit agreement and demanded repayment of $11.9 million, the amount outstanding. In June of fiscal 2004, the Company took possession of Pennexx’s assets due to Pennexx’s inability to pay amounts owed to the Company under the credit agreement. The Company also assumed $12.1 million of Pennexx equipment lease obligations. The Company is evaluating the value of the underlying assets securing this credit agreement and operating these assumed assets under the name Showcase Foods, Inc. as part of the Beef segment. The Company believes that the value of these assets will approximate the amount of the outstanding receivable under the credit agreement.

The Company is guarantor on a $20.0 million line of credit for Agroindustrial del Noreste, a 50% owned venture in Mexico. As of July 27, 2003, $3.0 million was outstanding on this line of credit.

In June of fiscal 2004, the Company filed a shelf registration statement with the Securities and Exchange Commission to register sales of up to $750.0 million of its debt, stock and other securities from time to time. Net proceeds to the Company from the possible sale of these securities would be used for general corporate purposes, including expansion of the Company’s processed meats business and strategic acquisitions.

In July of fiscal 2004, the Company entered into a definitive asset purchase agreement with Farmland under which the Company may acquire substantially all of the assets, and certain liabilities of Farmland Foods, Farmland’s pork production and processing business, for approximately $363.5 million in cash. The acquisition is subject to completion of the auction process and regulatory approval. Farmland Foods had sales for the three quarters ended May 31, 2003 of $1.6 billion.

In September of fiscal 2004, the Company acquired 90% of the outstanding shares of Cumberland Gap Provision Company (Cumberland Gap) for approximately $56.9 million, subject to post-closing adjustments. Cumberland Gap is a privately held leading processor of a full line of premium branded hickory smoked hams, sausages and other specialty pork products and has annual sales of approximately $70.0 million.

FORWARD-LOOKING STATEMENTS

This report contains “forward-looking” statements within the meaning of the federal securities laws. The forward-looking information includes statements concerning our outlook for the future, as well as other statements of beliefs, future plans and strategies or anticipated events, and similar expressions

14

Table of Contents

concerning matters that are not historical facts. Forward-looking information and statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in, or implied by, the statements. These risks and uncertainties include the availability and prices of live hogs and cattle, raw materials and supplies, food safety, livestock disease, live hog production costs, product pricing, the competitive environment and related market conditions, hedging risk, operating efficiencies, changes in interest rate and foreign currency exchange rates, access to capital, the cost of compliance with environmental and health standards, adverse results from on-going litigation, actions of domestic and foreign governments, the ability to make effective acquisitions and successfully integrate newly acquired businesses into existing operations and other risks and uncertainties described in the Company’s Annual Report on Form 10-K for fiscal 2003. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Item 4. Controls and Procedures

The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective. There were no significant changes in the Company’s internal control over financial reporting during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

All of the Board of Directors’ nominees for directors of the corporation were elected with the following vote:

A proposal to ratify the selection of Ernst & Young LLP as independent auditors of the Company for the fiscal year ending May 2, 2004 was approved by the shareholders with the following vote:

15

Table of Contents

Item 6. Exhibits and Reports on Form 8-K.

16

Table of Contents

17

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

18