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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended May 3, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
Commission file number: 0-2258
SMITHFIELD FOODS, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-0845861
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Commerce Street
Smithfield, Virginia 23430
(Address of principal executive offices) (Zip Code)
(757) 365-3000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.50 par value per share
(Title of Class)
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of Registrant's Common Stock
held by non-affiliates as of July 10, 1998 was approximately $844,100,548. This
figure was calculated by multiplying (i) the $29-5/16 last sales price of
Registrant's Common Stock as reported on The Nasdaq National Market on July 10,
1998 by (ii) the number of shares of Registrant's Common Stock not held by any
officer or director of the Registrant or any person known to the Registrant to
own more than five percent of the outstanding Common Stock of the Registrant.
Such calculation does not constitute an admission or determination that any such
officer, director or holder of more than five percent of the outstanding shares
of Common Stock of the Registrant is in fact an affiliate of the Registrant.
At July 10, 1998, 37,537,362 shares of the Registrant's Common stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the
Registrant's definitive proxy statement to be filed with respect to its Annual
Meeting of Shareholders to be held on August 27, 1998.
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TABLE OF CONTENTS
ITEM
NUMBER PAGE
PART I
1. Business............................................................ 3
General........................................................... 3
Business Strategy................................................. 4
Revenue by Source..................................................5
Fresh Pork Products .............................................. 5
Processed Meat Products........................................... 5
Raw Materials .................................................... 6
Customers and Marketing .......................................... 6
Trademarks ........................................................7
Distribution...................................................... 7
Competition ...................................................... 7
Employees .........................................................8
Regulation ....................................................... 8
2. Properties ..........................................................10
3. Legal Proceedings .................................................. 11
4. Submission of Matters to a Vote
of Security Holders ................................... 11
4A. Executive Officers of the Company ...................................12
PART II
5. Market for Company's Common Equity
and Related Stockholder Matters ..................................14
6. Selected Financial Data .............................................15
7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ....................16
8. Financial Statements and Supplementary Data .........................20
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ...........................20
PART III
10. Directors and Executive Officers of the Company .....................21
11. Executive Compensation ..............................................21
12. Security Ownership of Certain Beneficial Owners
and Management ...................................................21
13. Certain Relationships and Related Transactions ......................21
PART IV
14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K...........................................22
SIGNATURES ..............................................................S-1
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE ..........F-1
- 2 -
PART I
ITEM 1. BUSINESS
General
Smithfield Foods, Inc. ("Smithfield Foods" or the "Company"), as a
holding company, conducts its pork processing operations through five principal
subsidiaries: Gwaltney of Smithfield, Ltd. ("Gwaltney") and The Smithfield
Packing Company, Incorporated ("Smithfield Packing"), both based in Smithfield,
Virginia; John Morrell & Co. ("John Morrell"), based in Cincinnati, Ohio;
Patrick Cudahy Incorporated ("Patrick Cudahy"), based in Cudahy, Wisconsin; and
Lykes Meat Group, Inc. ("Lykes"), based in Plant City, Florida. The Company also
conducts hog production operations through its 86% owned subsidiary, Brown's of
Carolina, Inc. ("Brown's") and through a 50% interest in Smithfield-Carroll's
("Smithfield-Carroll's"), a joint hog production arrangement between the Company
and Carroll's Foods of Virginia, Inc., an affiliate of Carroll's Foods, Inc.,
one of the largest hog producers in the United States. Both Brown's and
Smithfield-Carroll's produce hogs for the Company's pork processing plants in
Bladen County, North Carolina and Smithfield, Virginia. The Company is also a
participant in the Circle Four joint hog production arrangement ("Circle Four")
with certain of the principal hog suppliers for the Company's Eastern
operations, which conducts hog production operations in Milford, Utah. The hogs
produced by Circle Four are sold to an unrelated party. In this report,
references to "Smithfield Foods" or the "Company" are to Smithfield Foods, Inc.
together with all of its subsidiaries, unless the context otherwise indicates.
The Company believes it is the largest combined pork slaughterer and
further processor of pork in the United States. Smithfield Foods produces a wide
variety of fresh pork and processed meat products which it markets domestically
and internationally to over 25 foreign markets, including Japan, Russia and
Mexico. Since 1975, when current management assumed control of the Company,
Smithfield Foods has expanded its production capacity and markets through a
combination of strong internal growth and selective acquisitions of regional and
multi-regional companies with well-recognized brand identities. The Company's
brands include Smithfield Premium, Smithfield Lean Generation Pork, Gwaltney,
John Morrell, Patrick Cudahy and Lykes.
To complement its hog slaughtering and further processing operations,
the Company has vertically integrated into hog production through Brown's and
Smithfield-Carroll's. These hog production operations collectively accounted for
10.8% of the hogs the Company slaughtered in fiscal 1998. In addition, the
Company obtains a substantial part of its hogs under market-indexed, multi-year
agreements with several of the nation's largest suppliers of high quality hogs,
strategically located in proximity to the Company's hog slaughtering and further
processing operations in North Carolina and Virginia. These suppliers accounted
for 42.9% of the hogs the Company slaughtered in fiscal 1998.
The Company's fresh pork and processed meats are available nationwide.
In a number of markets, the Company's brands are among the leaders in selected
product categories. In recent years, as consumers have become more health
conscious, the Company has broadened its product line to include leaner fresh
pork products as well as fat-free, lower fat and lower salt processed meats.
Management believes that leaner pork products combined with the pork industry's
efforts to heighten public awareness of pork as an attractive protein source
have led to increased consumer demand for pork products. In order to capture the
growing market for lower fat products, the Company has developed, and is
marketing on a national basis, a line of extremely lean, premium fresh pork
products under the Smithfield Lean Generation Pork brand to selected retail
chains and institutional foodservice customers.
Business Strategy
Since 1975, when current management assumed control, Smithfield Foods
has expanded both its production capacity and its markets through a combination
of strong internal growth and the acquisition of regional and multi-regional
-3-
companies with well-recognized brand identities. In fiscal 1982, the Company
acquired Gwaltney, then Smithfield Packing's principal Mid-Atlantic competitor.
This acquisition doubled the Company's sales and slaughter capacity and added
several popular lines of branded products along with a highly efficient hot dog
and lunch meats production facility. The proximity of Gwaltney to Smithfield
Packing allowed for synergies and cost savings in manufacturing, purchasing,
engineering and transportation.
This combination set the stage for a series of acquisitions of smaller
regional processors with widely-recognized brands. In fiscal 1985, the Company
acquired Patrick Cudahy, which added a prominent line of dry sausage products to
the Company's existing line of processed meats. In fiscal 1986, the Company
acquired Esskay, Inc., a firm with a broad line of deli products having
substantial brand loyalty in the Baltimore-Washington, D.C. metropolitan area.
In fiscal 1991, the Company acquired the Mash's brand name and a ham processing
plant in Landover, Maryland. In fiscal 1993, the Company acquired the Valleydale
brand name and a bacon processing plant in Salem, Virginia.
In December 1995, the Company acquired John Morrell, a major Midwestern
pork processor with primary markets in the Midwest, Northeast and Western United
States. This acquisition changed the Company's character from a large
multi-regional pork processor to one with national distribution. It also doubled
the Company's sales and slaughter capacity, added several popular lines of
branded processed meat products along with four efficient processing facilities
and more than doubled the Company's international sales. The Company believes
that John Morrell's strength in smoked sausage, hot dogs, lunch meats, bacon and
smoked hams complements the strong smoked meats, hot dog and bacon business of
the Company's Eastern operations. The acquisition of John Morrell also presented
substantial opportunities for cost savings in the areas of processing,
marketing, purchasing and distribution.
In November 1996, the Company acquired the assets and businesses of
Lykes. Lykes is a pork processor with primary markets in the South and
Southeast. Lykes produces branded processed meats, including bacon, hot dogs,
and breakfast and dinner sausages, under the Lykes and Sunnyland brands.
The Company's business is based around four strategic initiatives: (i)
vertical integration into hog production through Company-owned hog production
operations and long-term partnerships and alliances with large and efficient hog
producers; (ii) use of genetics which produce hogs that are among the leanest
commercially available to enable the Company to market highly differentiated
pork products; (iii) continued growth through strategic acquisitions; and (iv) a
heightened emphasis on expansion into international markets.
As a complement to the Company's hog processing operations, the Company
has vertically integrated into highly efficient hog production through Brown's
and Smithfield-Carroll's. In addition, the Company is supplementing the hogs it
obtains from these hog production operations with market-indexed, multi-year
agreements with several of the nation's largest suppliers of high quality hogs,
strategically located in proximity to the Company's hog slaughtering and further
processing operations in North Carolina and Virginia, including Carroll's Foods,
Inc., Maxwell Foods, Inc., Murphy Family Farms, Inc. and Prestage Farms, Inc.
In May 1991, Smithfield-Carroll's acquired from National Pig
Development Company ("NPD"), a British firm, the exclusive United States
franchise rights for genetic lines of specialized breeding stock.
Smithfield-Carroll's has sub-licensed these franchise rights to certain of the
Company's strategic partners. The hogs produced by these genetic lines are among
the leanest hogs commercially available, and enable the Company to market highly
differentiated pork products. Management believes that the leanness and
increased meat yields of these hogs will, over time, improve the Company's
profitability with respect to both fresh pork and processed meat. In fiscal
1998, the Company processed 2.5 million NPD hogs and expects to increase that
number substantially in future years.
Revenues by Source
The Company's sales are in one industry segment, meat processing. The
following table shows for the fiscal periods indicated the percentages of the
Company's revenues derived from fresh pork, processed meats, and other products.
-4-
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Fresh Pork................. 56% 59% 59% 51% 48%
Processed Meats............ 40% 37% 37% 45% 49%
Other Products............. 4% 4% 4% 4% 3%
--- --- ---- ---- ----
100% 100% 100% 100% 100%
=== === === === ===
The increase in percentage of revenues derived from fresh pork since
fiscal 1994 resulted principally from an increase in the number of hogs
slaughtered at its Bladen County, North Carolina plant. The meat industry is
generally characterized by narrow margins; however, profit margins on processed
meats are greater than profit margins on fresh pork and on other products.
Fresh Pork Products
The Company is one of the largest fresh pork processors in the United
States. The Company slaughters hogs at five of its plants (three in the
Southeast and two in the Midwest),with a current aggregate slaughter capacity of
78,300 hogs per day. The Company owns a fourth plant in the Southeast not
currently in operation, which has the capacity to slaughter an additional 6,500
hogs per day. A substantial portion of the Company's fresh pork is sold to
retail customers as unprocessed, trimmed cuts such as loins (including roasts
and chops), butts, picnics and ribs. The Company also sells hams, bellies and
trimmings to other further processors. The Company is putting greater emphasis
on the sale of value-added, higher margin fresh pork products, such as boneless
loins, hams, butts and picnics. In addition, the Company provides its own
processing operations with raw material of much higher quality and freshness
than that generally available through open market purchases.
The Company is marketing an extensive product line of NPD fresh pork
cuts (including boneless loins, shoulder cuts, chops, ribs and processed and
cubed pork) under the Smithfield Lean Generation Pork brand to selected retail
chains and institutional foodservice customers. Smithfield Packing has also
developed a case-ready pork program designed to supply supermarket chains with
pre-packaged, weighed, labeled and priced fresh pork, ready for immediate sale
to the consumer. Management believes that these initiatives, over time, will
result in greater brand identification and higher margins for the Company's
fresh pork products.
Processed Meat Products
The Company manufactures a wide variety of processed meats, including
smoked and boiled hams, bacon, sausage, hot dogs (pork, beef and chicken), deli
and lunch meats and specialty products such as pepperoni and dry salami. The
Company markets its processed meat products under labels that include, among
others, Smithfield, Smithfield Premium, Smithfield Lean Generation Pork,
Gwaltney, Patrick Cudahy and John Morrell, as well as Dinner Bell, Esskay,
Jamestown, Kretschmar, Luter's, Lykes, Peyton's, Tobin's First Prize and
Valleydale. The Company also sells a substantial quantity of processed meats as
private label products. The Company believes it is one of the largest producers
of smoked hams and picnics in the United States.
In response to growing consumer preference for more nutritious and
healthy meats, the Company has for several years emphasized production of more
closely-trimmed, leaner and lower-salt processed meats, such as 40
percent-lower-fat bacon. The Company markets a lower-fat line of value-priced
lunch meats, smoked sausage and hot dogs, as well as fat-free hot dogs and
fat-free deli hams.
- 5 -
Raw Materials
The Company's primary raw material is live hogs. Historically, hog
prices have been subject to substantial fluctuations. In addition, hog prices
tend to rise seasonally as hog supplies decrease during the hot summer months
and tend to decline as supplies increase during the fall. This is due to lower
farrowing performance during the winter months and slower animal growth rates
during the hot summer months. Hog supplies, and consequently prices, are also
affected by factors such as corn and soybean prices, weather and interest rates.
The Company produces its own hogs through Brown's and
Smithfield-Carroll's and purchases hogs from several of the nation's largest hog
producers strategically located in proximity to the Company's hog slaughtering
and further processing operations in North Carolina and Virginia, such as
Carroll's Foods, Inc., Maxwell Foods, Inc., Murphy Family Farms, Inc. and
Prestage Farms, Inc., as well as from other independent hog producers and
dealers located in the East, Southeast and Midwest. The Company obtained 10.8%
of the hogs it processed in fiscal 1998 from Brown's and Smithfield-Carroll's.
The Company's raw material costs fall when hog production at Brown's and
Smithfield-Carroll's is profitable and conversely rise when such production is
unprofitable. The profitability of hog production is directly related to the
market price of live hogs and the cost of corn. Hog producers such as Brown's
and Smithfield-Carroll's generate higher profits when hog prices are high and
corn prices are low, and lower profits (or losses) when hog prices are low and
corn prices are high. Management believes that hog production at Brown's and
Smithfield-Carroll's furthers the Company's strategic initiative of vertical
integration and reduces the Company's exposure to fluctuations in profitability
historically experienced by the pork processing industry. The Company has also
established multi-year agreements with Carroll's Foods, Inc., Maxwell Foods,
Inc., Murphy Family Farms, Inc. and Prestage Farms, Inc. which provide the
Company with a stable supply of high-quality hogs at market-indexed prices.
These producers supplied 42.9% of the hogs processed by the Company in fiscal
1998.
The Company purchases its hogs on a daily basis at its Southeastern and
Midwestern slaughter plants; at Company-owned buying stations in three
Southeastern and five Midwestern states; from certain Canadian sources; and
through certain exclusive dealer-operated buying stations in the Midwest. The
Company also purchases fresh pork from other meat processors to supplement its
processing requirements, and raw beef, poultry and other meat products to add to
its sausage, hot dogs and lunch meats. Such meat products and other materials
and supplies, including seasonings, smoking and curing agents, sausage casings
and packaging materials are readily available from numerous sources at
competitive prices.
Customers and Marketing
The Company has significant market presence nationwide, and strong
market positions in the Mid-Atlantic, Southeast, South and Midwest. The
Company's fundamental marketing strategy is to sell large quantities of
value-priced processed meat products as well as fresh pork to national and
regional supermarket chains, wholesale distributors and the foodservice industry
(fast food, restaurant and hotel chains, hospitals and other institutional
customers) and export markets. Management believes that this marketing approach
reaches the largest number of value-conscious consumers without requiring large
advertising and promotional campaigns. The Company uses both in-house
salespersons as well as independent commission brokers to sell its products. In
fiscal 1998, the Company sold its products to more than 3,500 customers, none of
whom accounted for as much as 10% of the Company's revenues. The Company has no
significant or seasonally variable backlog because most customers prefer to
order products shortly before shipment, and therefore, do not enter into formal
long-term contracts. Management believes that its registered trademarks have
been important to the success of its branded processed meat products.
The Company in recent years has placed major emphasis on growing and
expanding its international sales. In fiscal 1998, international sales comprised
approximately 6% of the Company's total dollar sales. The Company provides the
Japanese market with a line of unique branded, as well as other chilled and
frozen unbranded, fresh pork products. In connection with export sales to Japan,
the Company maintains a distributorship arrangement with Sumitomo Corporation of
America. To serve other international markets, the Company may also enter into
similar distribution and sales arrangements, as well as make international
acquisitions or establish strategic joint ventures not only for product sales
- 6 -
but also for hog production and pork processing. The Company also had export
sales to Russia, Mexico and to more than two dozen other foreign countries in
fiscal 1998. The Company expects continued growth in its international sales for
the foreseeable future. International sales are subject to factors beyond the
Company's control, such as tariffs, exchange rate fluctuations and changes in
governmental policies. The Company conducts all of its export sales in U.S.
dollars and therefore bears no currency translation risk.
The Company's processed meats business is somewhat seasonal in that,
traditionally, the heavier periods of sales for hams are the holiday seasons
such as Thanksgiving, Christmas and Easter, and the heavier periods of sales of
smoked sausage, hot dogs and lunch meats are the summer months. The Company
typically builds substantial inventories of hams in anticipation of its seasonal
holiday business.
The Company uses recognized price risk management and hedging
techniques to enhance sales and to reduce the effect of adverse price changes on
the Company's profitability. The Company's price risk management and hedging
activities currently are utilized in the areas of forward sales, hog production
margin management, procurement of raw materials (ham and bacon) for seasonal
demand peaks, inventory hedging, hog contracting and truck fleet fuel purchases.
Trademarks
The Company owns and uses numerous marks, which are registered
trademarks of the Company or are otherwise subject to protection under
applicable intellectual property laws. The Company considers these marks and the
accompanying goodwill and customer recognition valuable and material to its
business.
Distribution
The Company uses a private fleet of leased tractors and trailers, as
well as independent common carriers, to distribute both fresh pork and processed
meats to its customers, as well as to move raw material between plants for
further processing. The Company coordinates deliveries and uses backhauling to
reduce overall transportation costs. The Company distributes its products
directly from certain of its plants and from leased distribution centers located
in Connecticut, Indiana, Missouri, Kansas, Texas and California. In addition,
during fiscal 1998, the Company completed a distribution center adjacent to its
plant in Sioux Falls, South Dakota.
Competition
The protein industry generally, and the pork processing industry in
particular, are highly competitive. The Company's products compete with a large
number of other protein sources, including beef, chicken, turkey and seafood,
but the Company's principal competition comes from other pork processors.
Management believes that the principal competitive factors in the pork
processing industry are price, quality, product distribution and brand loyalty.
Some of the Company's competitors are larger, have correspondingly greater
financial and other resources and enjoy wider recognition for their branded
products. Some of these competitors are also more diverse than the Company. To
the extent that their other operations generate profits, such companies may be
able to subsidize their pork processing operations for a time.
Employees
As of May 3, 1998, the Company has approximately 19,500 employees,
approximately 10,800 of whom are covered by collective bargaining agreements
expiring between December 31, 1998 and May 5, 2002. The Company believes that
its relationship with its employees is good.
- 7 -
Regulation
Regulation Generally. Like other participants in the meat processing
industry, the Company is subject to various laws and regulations administered by
United States, state and other government entities, including the Environmental
Protection Agency ("EPA") and corresponding state agencies such as the Virginia
State Water Control Board ("VSWCB"), the Virginia Department of Environmental
Quality ("VDEQ"), the North Carolina Department of Environment and Natural
Resources ("DENR"), the Iowa Department of Natural Resources and the South
Dakota Department of Environment Natural Resources, as well as the United States
Department of Agriculture, the United States Food and Drug Administration and
the United States Occupational Safety and Health Administration. Management
believes that Smithfield Foods presently is in compliance with all such laws and
regulations in all material respects, and that continued compliance with these
standards will not have a material adverse effect on the Company's financial
position or results of operations. Furthermore, with respect to the litigation
and investigations discussed below, the Company believes that the ultimate
resolution of these suits will not have a material adverse effect on the
Company's financial position or annual results of operations.
Permit Violations At Smithfield Packing And Gwaltney Plants;
Administrative Consent Orders; Connection To HRSD System. The National Pollutant
Discharge Elimination System permit (the "discharge permit") for the Smithfield
Packing and Gwaltney plants in Smithfield, Virginia, as modified by the VSWCB in
1990, imposed more stringent effluent limitations on phosphorus and two species
of nitrogen (ammonia and Total Kjeldahl Nitrogen) than the wastewater treatment
facilities at those plants were designed to meet. To achieve compliance with
these new limitations, the Company agreed to discontinue wastewater discharges
into the Pagan River and connect its wastewater treatment facilities to the
regional sewage collection and treatment system operated by the Hampton Roads
Sanitation District ("HRSD"), when available. This agreement was embodied in an
administrative consent order issued by the VSWCB in 1991 (the "1991 Order"). The
VSWCB issued a second consent order (the "1994 Order") which concerned
compliance with other discharge permit terms pending connection to the HRSD
system.
The Company connected its Gwaltney and Smithfield Packing wastewater
treatment facilities to the HRSD system in June 1996 and July 1997,
respectively, which were the earliest dates that the HRSD could serve those
individual plants. To prepare for making these connections, the Company made
more than $2.7 million in capital expenditures to upgrade its existing
wastewater treatment facilities. The Company must continue to operate these
facilities to produce a wastewater suitable for treatment in the HRSD system
and, in addition, pay the HRSD approximately $1.8 million per year for
wastewater treatment. The Company will account for these wastewater treatment
costs as current period charges in the years in which such costs are incurred.
These wastewater treatment facilities no longer make any discharges
that are subject to regulation under the discharge permit. However, before being
connected to the HRSD system, these facilities exceeded applicable discharge
permit and consent orders limitations as discussed below.
Record-Keeping Violations. Under its discharge permit, the Company
regularly tested wastewater to determine compliance with applicable effluent
limitations. Federal and state laws require that records of such tests be
maintained for three years. Failure to maintain these records may result in the
imposition of civil penalties, and criminal sanctions may be imposed in the
event of false reporting or destruction of records. In July 1994, the Company
learned that records of many tests conducted from 1991 through early 1994 could
not be found. Despite a careful search, most of these records were never found
and are believed to have been destroyed. The employee responsible for the
supervision of the tests and the maintenance of the test records was replaced
and subsequently terminated. In October 1996, that former employee entered a
guilty plea and was convicted in the United States District Court for the
Eastern District of Virginia of 23 violations of the United States Clean Water
Act, including records destruction and making false reports. Eight of these
violations related to his duties as the Company's employee, while 15 violations
were committed during his outside consulting activities for public and private
entities unrelated to Smithfield Foods. Beginning in January 1998, several
Company employees responsible for wastewater treatment were subpoenaed and
testified before a federal grand jury in Norfolk, Virginia. Subsequently, the
grand jury issued subpoenas requiring production of various environmental
materials relating to the Company's Smithfield, Virginia wastewater and further
testimony by Company employees. Neither the Company nor any of its other present
or former employees has been charged with any criminal violation arising from
these matters, but there can be no assurance that charges will not be brought.
- 8 -
EPA Suit. On August 8, 1997, in United States of America v. Smithfield
Foods, Inc. et al. (Civil Case No. 2:96:cv1204), a federal judge for the United
States District Court for the Eastern District of Virginia imposed a $12.6
million civil penalty on the Company and its Smithfield Packing and Gwaltney
subsidiaries. The Company recognized a nonrecurring charge of $12.6 million
during the first quarter of fiscal 1998 with respect to this penalty. This suit
was brought by the EPA for violations of the federal Clean Water Act before the
Company's wastewater treatment facilities were connected to the HRSD system. The
court found 6,982 days of violation. The Company asserted in its defense that
approximately 5,500 of these violations were excused by the 1991 and 1994
Orders, which were issued by VSWCB in its role as primary enforcement authority
under the federal-state Clean Water Act program. The Court held that the EPA was
not bound by its awareness of, and failure to object to, those orders. The
Company has appealed this and other aspects of the court's decision to the
United States Court of Appeals for the Fourth Circuit in Richmond, Virginia.
There can be no assurance as to the outcome of such appeal or any subsequent
proceedings regarding this matter.
Suit by Commonwealth Of Virginia. On August 30, 1996, VDEQ filed a
civil suit under the laws of the Commonwealth of Virginia against Smithfield
Foods in the Circuit Court of the County of Isle of Wight, Virginia. This suit
alleged a total of 22,517 discharge permit violations at the Gwaltney and
Smithfield Packing facilities during the period from 1986 until such facilities
were connected to the HRSD system in 1996 and 1997, respectively. The difference
in the number of total violations charged by the EPA and the Commonwealth of
Virginia is mainly attributable to their different methods of counting
violations. The same categories of violations were involved in both suits,
except that the Commonwealth of Virginia did not charge the Company with any
permit violation excused by the 1991 and 1994 Orders. The Commonwealth's total
was larger in part because the Commonwealth counted every missing record as a
separate violation, and the EPA counted the number of days records were missing.
In addition, the Commonwealth's suit alleged a separate violation for each
failure to test chlorine levels every hour, failure to make certain required
reports, and failure on certain days to properly staff Smithfield's facilities.
While each violation is subject to a maximum penalty of $25,000, the
Commonwealth's civil penalties policy is designed to recapture any economic
benefit which accrued to the violator as a result of the noncompliance, and to
impose a surcharge penalty for having committed such violations. In addition,
the policy would increase the amount of penalties based upon the extent of
environmental damage caused by the violations.
At the beginning of the July 1997 trial of its case, the Commonwealth
contended that the Company should pay a total of $6 million for the violations
alleged, which included an alleged economic benefit of $4 million. In the middle
of the trial, however, the Commonwealth voluntarily dismissed its suit. One week
later, the Commonwealth refiled the same suit in Isle of Wight County Circuit
Court. On June 29, 1998, the Court overruled the Company's motions to dismiss
this second suit on double jeopardy and res judicata grounds. If the
Commonwealth's charges go to trial again, the Company will present evidence to
show and argue that, among other things, no economic benefit accrued to
Smithfield Foods as a result of, and that no environmental damage was caused by,
the violations. There can be no assurance as to the outcome of any such
proceeding.
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ITEM 2. PROPERTIES
The following table summarizes information concerning the principal
plants and other materially important physical properties of the Company:
APPROXIMATE
LAND AREA FLOOR SPACE
LOCATION OPERATION (ACRES) (SQ. FT.)
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Smithfield Packing Plant No. 1* Slaughtering and cutting hogs; 25.5 457,000
501 North Church Street manufacture of bacon products,
Smithfield, Virginia smoked meats, and dry salt meats;
production of hams and picnics
Smithfield Packing Plant No. 2 Production of bone-in and boneless 20.0 218,000
2501 West Vernon Avenue cooked and smoked ham and other
Kinston, North Carolina smoked meat products
Smithfield Packing Plant No. 3 Production of bone-in smoked ham 7.8 136,000
5801 Columbia Park Drive and other smoked meat products
Landover, Maryland
Smithfield Packing Plant No. 4* Slaughtering and cutting hogs; 860.0 966,000
Carolina Food Processors production of boneless hams and loins
Division (Bladen County)
Route #87
Tarheel, North Carolina
Gwaltney Plant No. 1* Slaughtering and cutting hogs; 56.4 556,000
601 North Church Street production of boneless loins, bacon,
Smithfield, Virginia sausage, bone-in and boneless cooked
and smoked hams and picnics
Gwaltney Plant No. 2 Production of hot dogs, lunch meats 13.1 200,000
3515 Airline Boulevard and sausage products
Portsmouth, Virginia
Gwaltney Plant No. 3 Manufacture of bacon, smoked 11.0 152,000
1013 Iowa Street sausage and boneless cooked hams
Salem, Virginia
John Morrell Plant No. 1* Slaughtering and cutting hogs and 88.0 2,350,000
1400 N. Weber Avenue lambs; production of boneless loins,
Sioux Falls, South Dakota bacon, bot dogs, lunch meats, smoked
and canned hams, and packaged lard
John Morrell Plant No. 2 Slaughtering and cutting hogs; 22.0 243,000
1200 Bluff Road production of boneless hams, loins,
Sioux City, Iowa butts and picnics
John Morrell Plant No. 3 Production of hot dogs, lunch meats, 21.0 177,000
801 East Kemper Road smoked sausage and smoked hams
Springdale, Ohio
- 10 -
APPROXIMATE
LAND AREA FLOOR SPACE
LOCATION OPERATION (ACRES) (SQ. FT.)
- ------------------------------------------------------------------------------------------------------------------------
John Morrell Plant No. 4 Production of bacon and smoked hams 60.0 150,000
South 281 Highway
Great Bend, Kansas
Lykes Meat Group Plant No. 1 Production of hot dogs, lunch meats 55.0 206,763
4811 Lykes Road and sausage products
Plant City, Florida
Lykes Meat Group Plant No. 2 Production of hot dogs, lunch meats, 78.0 312,466
603 Cassidy Road cured meats, bacon, boneless cooked
Thomasville, Georgia and smoked ham and other smoked
bone-in meat products
Patrick Cudahy Plant Manufacture of bacon, dry sausage, 60.0 1,090,000
3500 E. Barnard Avenue boneless cooked hams and refinery
Cudahy, Wisconsin products
- ------------------------
* Pledged as collateral under various loan agreements.
The Company, through Brown's, owns and leases hog production facilities
in North Carolina and South Carolina, and through Smithfield-Carroll's, owns hog
production facilities in North Carolina and Virginia.
The Company operates hog buying stations in North Carolina, South
Carolina and Virginia which have facilities for purchasing and loading hogs for
shipment to the Company's plants in Smithfield, Virginia and Bladen County,
North Carolina, and hog buying stations in Iowa, Kansas, Minnesota, Nebraska and
South Dakota, which have facilities for purchasing and loading hogs for shipment
to the Company's plants in Sioux City, Iowa and Sioux Falls, South Dakota.
ITEM 3. LEGAL PROCEEDINGS
Smithfield Foods and its subsidiaries and affiliates are parties in
various lawsuits arising in the ordinary course of business, excluding certain
matters discussed under "Business -- Regulation" above. In the opinion of
management, any ultimate liability with respect to these matters will not have a
material adverse effect on the Company's financial position or results of
operations. For a discussion of certain other regulatory and environmental
matters, see "Item 1. Business -- Regulation" above.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders, through the solicitation
of proxies or otherwise.
- 11 -
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth the name and age, position with the
Company and business experience during the past five years of each of the
executive officers of the Company. The Board of Directors elects executive
officers to hold office until the next annual meeting of the Board or Directors
or until their successors are elected, or until their resignation or removal.
POSITION BUSINESS EXPERIENCE
NAME AND AGE WITH THE COMPANY DURING PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------------
Joseph W. Luter, III (59) Chairman of the Board and Mr. Luter has served as Chairman
Chief Executive Officer of the of the Board and Chief Executive
Company Officer since 1975. Prior to May
1995, he also served as President
of the Company.
Lewis R. Little (54) President and Chief Operating Mr. Little was elected President
Officer of the Company, Lykes and Chief Operating Officer of the
and Smithfield Packing Company and Smithfield Packing
in November 1996 and President
and Chief Operating Officer of
Lykes in June 1998. From May
1993 until November 1996, he was
President and Chief Operating
Officer of Gwaltney. Prior to May
1993, Mr. Little served as
Executive Vice President of
Gwaltney.
Timothy A. Seely (48) President and Chief Operating Mr. Seely was elected President
Officer of Gwaltney and Chief Operating Officer of
Gwaltney in November 1996.
Prior to that time, he was Vice
President, Sales and Marketing,
Fresh Meats, of Gwaltney.
Roger R. Kapella (56) President and Chief Operating Mr. Kapella has served as
Officer of Patrick Cudahy President and Chief Operating
Officer of Patrick Cudahy since
1986.
Joseph B. Sebring (51) President and Chief Operating Mr. Sebring has served as
Officer of John Morrell President and Chief Operating
Officer of John Morrell since May
1994. Between 1992 and May
1994, he served as President and
Chief Executive Officer of Indiana
Packers Company. Prior to 1992,
Mr. Sebring was Executive Vice
President of Fresh Mark, Inc.
- 12 -
POSITION BUSINESS EXPERIENCE
NAME AND AGE WITH THE COMPANY DURING PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------------
C. Larry Pope (43) Vice President, Finance of the Mr. Pope was elected Vice
Company President, Finance of the Company
in July 1998. He joined the Company
as Controller in 1980 and served
as Vice President and Controller
from August 1995 to July 1998.
Aaron D. Trub (63) Vice President, Chief Financial Mr. Trub has served as Vice
Officer and Secretary of the President and Secretary of the
Company Company since 1978. Prior to
July 1998, he also held the position
of Treasurer. In July 1998, he was
elected Chief Financial Officer of
the Company.
Richard J. M. Poulson (59) Vice President and Senior Advisor Mr. Poulson joined the Company
to the Chairman as Vice President and Senior
Advisor to the Chairman in July
1998. Between 1994 and 1998, he
was a senior managing director of
the Appian Group, a private
merchant bank with offices in
Washington, D.C. and Paris.
Prior to 1994, Mr. Poulson was a
senior corporate partner with the
law firm of Hogan & Hartson, in
Washington, D.C. and London.
- 13 -
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
The Common Stock of the Company is traded in the national
over-the-counter market and is authorized for quotation on The Nasdaq National
Market under the symbol "SFDS."
The following table sets forth, for the fiscal periods indicated, the
highest and lowest sales prices of the Common Stock on The Nasdaq National
Market.
Range of Sales Prices
-------------------------
High Low
-------------------------
Fiscal year ended April 27, 1997
First quarter ................................... $15.00 $11.31
Second quarter .................................. 16.25 11.62
Third quarter ................................... 19.31 14.25
Fourth quarter .................................. 24.75 16.19
Fiscal year ended May 3, 1998
First quarter.................................... 31.12 22.00
Second quarter................................... 33.87 22.75
Third quarter.................................... 35.62 24.37
Fourth quarter................................... 36.37 28.62
Holders
As of July 10, 1998, there were 1,143 record holders of the Common
Stock.
Dividends
The Company has never paid a cash dividend on its Common Stock and does
not anticipate paying cash dividends on its Common Stock in the foreseeable
future. In addition, the terms of certain of the Company's debt agreements
prohibit the payment of cash dividends on the Common Stock. The payment of cash
dividends, if any, will be made only from assets legally available for that
purpose, and will depend on the Company's financial condition, results of
operations, current and anticipated capital requirements, restrictions under
then existing debt instruments and other factors deemed relevant by the board of
directors.
- 14 -
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below for the fiscal
years indicated were derived from the Company's audited consolidated financial
statements. The information should be read in conjunction with the Company's
consolidated financial statements (including the notes thereto) and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in, or incorporated by reference into, this
report.
FISCAL YEAR ENDED
---------------------------------------------------------------------------
May 3, April 27, April 28, April 30, May 1,
1998 1997 1996 1995 1994
---------------------------------------------------------------------------
(In thousands, except per share data)
INCOME STATEMENT DATA:
Sales........................................ $ 3,867,442 $ 3,870,611 $ 2,383,893 $ 1,526,518 $ 1,403,485
Cost of sales ............................... 3,479,828 3,549,673 2,203,626 1,380,586 1,287,880
--------------------------------------------------------------------------
Gross profit ................................ 387,614 320,938 180,267 145,932 115,605
Selling, general and administrative
expenses .................................. 219,861 191,225 103,095 61,723 50,738
Depreciation expense......................... 42,300 35,825 25,979 19,717 21,327
Interest expense............................. 31,891 26,211 20,942 14,054 11,605
Nonrecurring charge.......................... 12,600 - - - -
---------------------------------------------------------------------------
Income from continuing operations before
income taxes and change in accounting
for income taxes.......................... 80,962 67,677 30,251 50,438 31,935
Income taxes................................. 27,562 22,740 10,465 18,523 12,616
---------------------------------------------------------------------------
Income from continuing operations
before change in accounting for
income taxes.............................. 53,400 44,937 19,786 31,915 19,319
Income (loss) from discontinued operations... - - (3,900) (4,075) 383
---------------------------------------------------------------------------
Net income................................ $ 53,400 $ 44,937 $ 15,886 $ 27,840 $ 19,702
===========================================================================
DILUTED INCOME (LOSS) PER SHARE:
Continuing operations before cumulative
effect of change in accounting for
income taxes.............................. $ 1.34 $ 1.17 $ 53 $ 92 $ .55
Discontinued operations...................... - - (.11) (.12) .01
Cumulative effect of change in
accounting for income taxes............... - - - - -
-------------------------------------------------------------------------
Net income................................... $ 1.34 $ 1.17 $ .42 $ .80 $ .56
=========================================================================
Average diluted shares outstanding........... 39,732 38,558 35,000 33,923 33,697
BALANCE SHEET DATA:
Working capital.............................. $ 259,188 $ 164,312 $ 88,026 $ 60,911 $ 81,529
Total assets................................. 1,083,645 995,254 857,619 550,225 452,279
Long term debt and capital lease
obligations............................... 407,272 288,486 188,618 155,047 118,942
Shareholders' equity......................... 361,010 307,486 242,516 184,015 154,950
OPERATING DATA:
Fresh pork sales (pounds).................... 2,539,221 2,320,477 1,635,300 955,290 820,203
Processed meats sales (pounds)............... 1,370,232 1,218,835 839,341 774,615 661,783
Total hogs purchased......................... 17,952 16,869 12,211 8,678 7,414
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- 15 -
Management's discussion and analysis set forth below should be read in
conjunction with the Company's consolidated financial statements (including the
notes thereto) appearing elsewhere in this Form 10-K.
Introduction
The Company is comprised of a Meat Processing Group ("MPG") and a Hog
Production Group ("HPG"). The MPG consists of five pork processing subsidiaries,
Gwaltney, John Morrell, Lykes, Patrick Cudahy, and Smithfield Packing. The HPG
consists of Brown's and the Company's interests in Smithfield-Carroll's and
Circle Four.
Acquisitions
The Company has expanded through selective acquisitions of regional and
multi-regional meat processing companies with well-recognized brand identities.
The Company acquired John Morrell in December 1995 and Lykes in November 1996.
The Company's fiscal 1998 operating results include those of John Morrell and
Lykes for the full fiscal year. The Company's fiscal 1997 operating results
include those of John Morrell for the full year and those of Lykes for 25 weeks.
The Company's fiscal 1996 operating results include those of John Morrell for 18
weeks.
In December 1997, the Company reached an irrevocable agreement with
members of the Schneider family, the controlling shareholders, to purchase all
of their shares in Schneider Corporation ("Schneider") as part of an offer by
the Company to acquire all of the shares of Schneider. Schneider produces and
markets fresh pork and a full line of processed meats in Canada and had revenues
in its fiscal year ended October 1997 of US$512.7 million. A lawsuit contesting
the acquisition was filed by a Canadian competitor and other Schneider
shareholders. The court dismissed these claims, which have since been appealed.
If the Company is successful in the appeals process, management anticipates that
the acquisition will be completed in the second quarter of fiscal 1999.
Price-Risk Management
Substantially all of the Company's products are manufactured from
commodity-based raw materials, primarily live hogs. The cost of live hogs is
subject to wide fluctuations due to unpredictable factors such as the price of
corn and soybean meal (the principal feed ingredients for a hog), weather
conditions, economic conditions, government regulation and other unforeseen
circumstances. The pricing of the Company's fresh pork and processed meats are
monitored and adjusted upward and downward in reaction to changes in the cost of
the underlying raw materials. The unpredictability of the raw material costs
limit the Company's ability to forward price fresh pork and processed meat
products without the use of commodity contracts through a program of price-risk
management. The Company uses price-risk management to enhance its ability to
engage in forward sales contracts, where prices for future deliveries are fixed,
by purchasing (or selling) commodity contracts for future periods to reduce or
eliminate the effect of fluctuations in future raw material costs on the
profitability of the related sales. While this may tend to limit the Company's
ability to participate in gains from favorable commodity price fluctuations, it
also tends to reduce the risk of loss from adverse changes in raw material
prices. In addition, the Company utilizes commodity contracts for live hogs and
corn to manage hog production margins when management determines that conditions
are appropriate for such hedges. The particular hedging methods employed and the
time periods for the contracts depend on a number of factors, including the
availability of adequate contracts for the respective periods for the hedges.
The Company attempts to closely match the commodity contract expiration periods
with the dates for product sale and delivery. As a result, gains and losses from
hedging transactions are recognized when the related sales are made and the
hedges are lifted.
As of May 3, 1998 and April 27, 1997, the Company had deferred $1.9
million and $2.2 million, respectively, of unrealized hedging gains on
outstanding futures contracts. As of May 3, 1998 and April 27, 1997, the Company
had open futures contracts with fair values of $59.6 million and $44.3 million,
respectively. As of May 3, 1998 and April 27, 1997, the Company had deposits
with brokers for outstanding futures contracts of $10.9 million and $3.5
million, respectively, included in prepaid expenses and other current assets.
For open futures contracts, the Company uses a sensitivity analysis
technique to evaluate the effect that changes in the market value of commodities
will have on these commodity derivative instruments. As of May 3, 1998, the
potential change in fair value of open futures contracts, assuming a 10% change
in the underlying commodity price, was $2.1 million.
- 16 -
Operations
Fiscal 1998 represented 53 weeks of operations compared to fiscal 1997
and 1996, each of which represented 52 weeks of operations. Accordingly, sales
and all expense categories in fiscal 1998 reflect the impact of an additional
week of operations compared to fiscal 1997.
Fiscal 1998 Compared to Fiscal 1997.
Sales in fiscal 1998 were flat compared to fiscal 1997. Sales reflected
a 9.4% increase in sales tonnage offset by a 9.0% decrease in unit sales prices,
reflecting the impact of lower live hog costs. The increase in sales tonnage
reflected a 9.4% increase in fresh pork tonnage, a 12.4% increase in processed
meats tonnage and a 4.5% increase in the tonnage of other products. The increase
in fresh pork tonnage was primarily related to an increase in the number of hogs
slaughtered at the Company's Sioux City, Iowa and Bladen County, North Carolina
plants. The increase in processed meats tonnage was primarily related to Lykes.
Cost of sales decreased $69.8 million, or 2.0%, in fiscal 1998,
reflecting the increased sales tonnage offset by a 17.3% decrease in live hog
costs.
Gross profit increased $66.7 million, or 20.8%, in fiscal 1998 compared
to fiscal 1997. The increase in gross profit reflected sharply improved margins
on higher sales of both fresh pork (56.1% of dollar sales) and processed meats
(40.2% of dollar sales).
Selling, general and administrative expenses increased $28.6 million,
or 15.0%, in fiscal 1998. This increase was primarily due to Lykes and to higher
selling, marketing and product promotion costs associated with intensified
efforts to market branded fresh pork and processed meats.
Depreciation expense increased $6.5 million, or 18.1%, in fiscal 1998.
The increase was primarily due to completed capital projects at several of the
Company's processing plants and to Lykes.
Interest expense increased $5.7 million, or 21.7%, in fiscal 1998,
reflecting the higher cost of long-term debt placed during the past two fiscal
years and higher average borrowing costs related to higher levels of inventory
and accounts receivable in the first half of fiscal 1998.
A nonrecurring charge of $12.6 million in fiscal 1998 reflected the
imposition of civil penalties against the Company by the U.S. District Court for
the Eastern District of Virginia in a civil action brought by the U.S.
Environmental Protection Agency. The Company has appealed the Court's judgment
to the U.S. Court of Appeals for the Fourth Circuit.
Income before income taxes in fiscal 1998 was adversely affected by a
loss of $1.2 million at the HPG compared to a $20.7 million profit in fiscal
1997.
The effective income tax rate for fiscal 1998 increased to 34.0% from
33.6% in fiscal 1997, reflecting the impact of the $12.6 million nondeductible
nonrecurring charge offset by a lower tax rate on increased foreign sales,
benefits related to certain insurance contracts, and employment-related tax
credits. Excluding the nonrecurring charge, the effective income tax for fiscal
1998 decreased to 29.5% from 33.6% in fiscal 1997. The Company had no valuation
allowance related to income tax assets as of May 3, 1998, and there was no
change in the valuation allowance during fiscal 1998.
Excluding the nonrecurring charge, net income was $66.0 million, or
$1.66 per diluted share, in fiscal 1998. Including the nonrecurring charge, net
income increased to $53.4 million in fiscal 1998, or $1.34 per diluted share,
from $44.9 million, or $1.17 per diluted share, in fiscal 1997.
Fiscal 1997 Compared to Fiscal 1996.
- 17 -
Sales in fiscal 1997 increased $1.49 billion, or 62.4%, from fiscal
1996. This increase was due to the inclusion of the sales of John Morrell and
Lykes, significant increases in unit sales prices for both fresh pork and
processed meats, and increased sales of fresh pork related to an increase in the
number of hogs slaughtered at the Company's Bladen County, North Carolina plant.
The increase in unit sales prices reflected the pass-through of higher raw
material costs due to an 18.8% increase in live hog costs. The increase in sales
reflected a 41.9% increase in fresh pork tonnage and a 45.2% increase in
processed meats tonnage, primarily related to John Morrell and Lykes.
Cost of sales increased $1.35 billion, or 61.1%, in fiscal 1997,
reflecting the increased sales tonnage and increased live hog costs.
Gross profit increased $140.7 million, or 78.0%, in fiscal 1997
compared to fiscal 1996, reflecting the inclusion of the operations of John
Morrell and Lykes and increased overall margins at the Company's other operating
subsidiaries. The increase in gross profit reflected significantly improved
margins on sales of processed meats (37.3% of dollar sales) that were somewhat
offset by lower margins on sales of fresh pork (58.9% of dollar sales). Fresh
pork margins were adversely impacted by relatively high hog costs due to a
shortage of live hogs, excess industry slaughter capacity and strong competition
at the retail level from comparatively lower-priced beef and chicken.
Selling, general and administrative expenses increased $88.1 million,
or 85.5%, in fiscal 1997. This increase was primarily due to John Morrell and
Lykes.
Depreciation expense increased $9.8 million, or 37.9%, in fiscal 1997.
The increase was primarily due to John Morrell and Lykes.
Interest expense increased $5.3 million, or 25.2%, in fiscal 1997,
reflecting borrowings to finance the acquisition of Lykes, increased carrying
costs on higher levels of inventories and accounts receivable related to higher
live hog costs and the higher cost of long-term debt placed during the fiscal
year.
Income before income taxes was favorably affected by a $20.7 million
profit at the HPG in fiscal 1997 compared to a $10.8 million profit in fiscal
1996.
The effective income tax rate in fiscal 1997 decreased to 33.6% from
34.6% in fiscal 1996, reflecting a lower tax rate on increased foreign sales and
a reduction in the effective rate of state income taxes. The Company had no
valuation allowance related to income tax assets as of April 27, 1997, and there
was no change in the valuation allowance during fiscal 1997.
Income from continuing operations increased $25.1 million in fiscal
1997, reflecting the operating results of John Morrell for the full fiscal year,
significantly improved margins on processed meats and substantially increased
profitability of the HPG.
Reflecting the factors discussed above, net income increased to $44.9
million, or $1.17 per diluted share, in fiscal 1997, up from $15.9 million, or
$.42 per diluted share, in the prior fiscal year.
Financial Condition
The pork processing industry is characterized by high sales tonnage and
rapid turnover of inventories and accounts receivable. Because of the rapid
turnover rate, the Company considers its inventories and accounts receivable
highly liquid and readily convertible into cash. Borrowings under the Company's
credit facilities are used to finance increases in the levels of inventories and
accounts receivable resulting from seasonal and other market-related
fluctuations in raw material costs. The demand for seasonal borrowings usually
peaks in early November when ham inventories are at their highest levels, and
borrowings are repaid in January when accounts receivable generated by sales of
the hams are collected.
- 18 -
In July 1997, the Company entered into loan agreements with a bank
group providing for $350 million in revolving credit facilities, consisting of a
five-year $300 million revolving credit facility and a 364-day $50 million
revolving credit facility. In connection with this refinancing, the Company
repaid all borrowings under its previous $300 million credit facilities, which
were terminated. The 364-day $50 million revolving credit facility was
terminated in February 1998.
Average borrowings under the facilities were $149.7 million in fiscal
1998, $165.1 million in fiscal 1997 and $133.4 million in fiscal 1996 at average
interest rates of approximately 7% for each year. Maximum borrowings were $247.0
million in fiscal 1998, $215.0 million in fiscal 1997 and $179.8 million in
fiscal 1996. There were no borrowings under the facility as of May 3, 1998. The
outstanding borrowings were $150.0 million as of April 27, 1997 at an average
interest rate of 7%.
In February 1998, the Company issued $200 million in aggregate
principal amount of 10-year 7.625% senior subordinated notes. The net proceeds
from the sales of the notes were used to repay indebtedness under the Company's
$300 million revolving credit facility with the balance invested in short-term
marketable debt securities.
Capital expenditures totaled $92.9 million in fiscal 1998 and included
renovation and expansion of certain of the Company's processing plants, as well
as the acquisition of an idle slaughter plant in South Dakota and hog production
facilities in North Carolina. In addition, during fiscal 1998, the Company
acquired substantially all of the assets and business of Curly's Foods, Inc. and
certain of the assets and business of Mohawk Packing Co. for an aggregate $15.9
million in cash plus $11.8 million of assumed liabilities. The capital
expenditures and the business acquisitions were funded with internally generated
funds.
As of May 3, 1998, the Company had definitive commitments of $18.9
million for capital expenditures primarily to increase its processed meats and
value-added fresh pork capacities at several of its processing plants and to
replace and upgrade portions of its hardware and software in response to the
Year 2000. The Company plans to make capital expenditures in fiscal 1999 to
expand its hog production operations and to increase its processed meats
business through strategic acquisitions and joint ventures, both in the United
States and internationally. This will be funded by cash flows from operations
and borrowings under the $300 million revolving credit facility.
The Company's various debt agreements contain financial covenants that
require the maintenance of certain levels and ratios for working capital, net
worth, current ratio, fixed charges, capital expenditures and, among other
restrictions, limit additional borrowings, the acquisition, disposition and
leasing of assets, and payment of dividends to shareholders.
Year 2000
Management has assessed and is in the process of modifying or replacing
the Company's affected hardware and software and is evaluating whether external
service providers, significant vendors and customers are taking the appropriate
action to remedy problems associated with the Year 2000. Management expects to
have substantially all of the systems and application changes completed by the
end of fiscal 1999 (May 2, 1999) and believes that its level of preparedness is
appropriate. Management is currently in the process of quantifying the costs
associated with the Year 2000; however, the ultimate costs are still not
determinable. Costs are being charged to expense as incurred with the exception
of hardware and software costs that are capitalizable in accordance with
generally accepted accounting principles. The costs of the project and the
expected completion dates are based on management's best estimates, which were
derived using assumptions of future events, including the continued availability
of certain resources and other factors. However, there can be no guarantee that
these estimates will be achieved, and actual results could differ materially
from those anticipated. Specific factors that could influence the results may
include, but are not limited to, the availability and cost of personnel trained
in this area, and the ability to locate and correct all relevant computer codes
and similar uncertainties.
Cautionary Statement Pursuant to Safe Harbor Provisions of the
Private Securities Litigation Reform Act of 1995
- 19 -
This report may contain "forward-looking" information within the
meaning of the federal securities laws. The forward-looking information may
include, among other information, statements concerning the Company's outlook
for fiscal 1998, volume trends, industry conditions and expectations for capital
expenditures. There may also be other statements of exceptions, beliefs, future
plans and strategies, anticipated events or trends and similar expressions
concerning matters that are not historical facts. The forward-looking
information and statements in this report are subject to risks and
uncertainties, including availability and prices of raw materials, product
pricing, competitive environment and related market conditions, operating
efficiencies, access to capital and actions of governments, that could cause
actual results to differ materially from those expressed in or implied by the
information or statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements listed in Item 14(a) hereof
are incorporated herein by reference and are filed as a part of this
report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
- 20 -
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
(a) Information required by this Item regarding directors and all
persons nominated or chosen to become directors is incorporated by reference
from the Company's definitive proxy statement to be filed with respect to its
Annual Meeting of Shareholders to be held on August 27, 1998.
(b) Information required by this Item regarding the executive officers
of the Company is included in Part I, Item 4A of this report.
There is no family relationship between any of the persons named in
response to Item 10.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with respect to its Annual
Meeting of Shareholders to be held on August 27, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with respect to its Annual
Meeting of Shareholders to be held on August 27, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with respect to its Annual
Meeting of Shareholders to be held on August 27, 1998.
- 21 -
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) 1. and 2. Index to Financial Statements and Financial Statement
Schedule
An "Index to Financial Statements and Financial Statement Schedule" has
been filed as a part of this Form 10-K Annual Report on page F-1 hereof.
3. Exhibits
Exhibit 3.1 -- Articles of Incorporation of the Company, as
amended to date (incorporated by reference to Exhibit 2
to the Company's Current Report on Form 8-K filed with
the Commission on September 5, 1997).
Exhibit 3.2 -- By-Laws of the Company, as amended to date
(incorporated by reference to Exhibit 3 to the Company's
Current Report on Form 8-K filed with the Commission on
September 5, 1997).
Exhibit 4.1 -- Articles of Incorporation of the Company, as amended to
date (see Exhibit 3.1 above).
Exhibit 4.2 -- Form of Certificate representing the Company's Common
Stock, par value $.50 per share (including Rights
legend) (incorporated by reference to Exhibit 6 to the
Company's Current Report on Form 8-K filed with the
Commission on September 5, 1997)
Exhibit 4.3 -- Form of Certificate representing Rights
(incorporated by reference to Exhibit 5 to the Company's
Current Report on Form 8-K filed with the Commission on
September 5, 1997)
Exhibit 4.4 -- Rights Agreement dated as of May 1, 1998, by and
between the Company and Harris Trust and Savings Bank,
Rights Agent.
Exhibit 4.5 -- Five-Year Credit Agreement dated as of July 10, 1997,
among Smithfield Foods, Inc., the Subsidiary Guarantors
party thereto, the Lenders party thereto, and The Chase
Manhattan Bank, as Administrative Agent, relating to a
$300,000,000 secured five-year revolving credit facility
(incorporated by reference to Exhibit 4.5 of the
Company's Annual Report on Form 10-K for its fiscal year
ended April 27, 1997 filed with the Commission on July
25, 1997); and Amendment Number One to the Five-Year
Credit Agreement dated as of November 19, 1997
(incorporated by reference to Exhibit 4.5 to the
Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended February 1, 1998 filed with the Commission
on March 17, 1998).
Exhibit 4.5(a) -- 364-Day Credit Agreement dated as of July 10, 1997, among
Smithfield Foods, Inc., the Subsidiary Guarantors party
thereto, the Lenders party thereto, and The Chase
Manhattan Bank, as Administrative Agent, relating to a
$50,000,000 secured 364-day revolving credit facility
(incorporated by reference to Exhibit 4.5(a) of the
Company's Annual Report on Form 10-K for its fiscal year
ended April 27, 1997 filed with the Commission on July
25, 1997); and Amendment Number One to the 364-Day Credit
Agreement dated as of November 19, 1997 (incorporated by
reference to Exhibit 4.5(a) to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended February
1, 1998 filed with the Commission on March 17, 1998).
- 22 -
Exhibit 4.5(b) -- Collateral Agency, Pledge and Security Agreement
dated as of July 10, 1997, among Smithfield Foods,
Inc., the Subsidiary Guarantors party thereto, The Chase
Manhattan Bank, as Collateral Agent, relating to the
Company's five-year revolving credit facility and its
364- day revolving credit facility (incorporated by
reference to Exhibit 4.5(b) of the Company's Annual
Report on Form 10-K for its fiscal year ended April 27,
1997 filed with the Commission on July 25, 1997).
Exhibit 4.6 -- Note Purchase Agreement dated as of July 15, 1996, among
Smithfield Foods, Inc. and each of the Purchasers listed
on Annex 1 thereto, relating to $140,000,000 in senior
secured notes (incorporated by reference to Exhibit 4.7
to the Company's Form 10-Q Quarterly Report for the
fiscal quarter ended July 28, 1996); Amendment Number One
to the Note Purchase Agreement dated as of July 15, 1997
(incorporated by reference to Exhibit 4.6 of the
Company's Annual Report on Form 10-K for its fiscal year
ended April 27, 1997 filed with the Commission on July
25, 1997); Amendment Number Two to the Note Purchase
Agreement dated as of December 1, 1997 (incorporated by
reference to Exhibit 4.6 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended February
1, 1998 filed with the Commission on March 17, 1998); and
Amendment Number Three to the Note Purchase Agreement
dated as of January 30, 1998.
Exhibit 4.6(a) -- Joint and Several Guaranty dated as of July 15, 1996, by
Gwaltney of Smithfield, Ltd., John Morrell & Co., The
Smithfield Packing Company, Incorporated, SFFC, Inc.,
Patrick Cudahy Incorporated, and Brown's of Carolina,
Inc. (incorporated by reference to Exhibit 4.7(a) to the
Company's Form 10-Q Quarterly Report for the fiscal
quarter ended July 28, 1996); and Amendment Number One to
the Note Purchase Agreement dated as of July 15, 1997
(incorporated by reference to Exhibit 4.6(a) to the
Company's Annual Report on Form 10-K for the fiscal year
ended April 27, 1997 filed with the Commission on July
25, 1997).
Exhibit 4.6(b) -- Joint and Several Guaranty dated as of July 15, 1997, by
Lykes Meat Group, Inc., Sunnyland, Inc., Valleydale
Foods, Inc., Hancock's Old Fashioned Country Hams,
Inc., Copaz Packing Corporation, and Smithfield
Packing - Landover, Inc. (incorporated by reference to
Exhibit 4.6(b) to the Company's Annual Report on Form
10-K for the fiscal year ended April 27, 1997 filed with
the Commission on July 25, 1997).
Exhibit 4.7 -- Master Lease Agreement dated May 14, 1993 between
General Electric Capital Corporation and Brown's of
Carolina, Inc. (incorporated by reference to Exhibit 4.12
to the Company's Form 10-K Annual Report for the fiscal
year ended May 2, 1993).
Exhibit 4.7(a) -- Corporate Guaranty by Smithfield Foods, Inc. dated May
14, 1993 (incorporated by reference to Exhibit 4.12(a)
to the Company's Form 10-K Annual Report for the fiscal
year ended May 2, 1993).
Exhibit 4.8 -- Indenture between the Company and SunTrust Bank,
Atlanta (incorporated by reference to Exhibit 4.8 to the
Company's Current Report on Form 10-Q for the fiscal
quarter ended February 1, 1998 filed with the Commission
on March 17, 1998).
Exhibit 4.8(a) -- Purchase Agreement between the Company and Chase
Securities, Inc. (incorporated by reference to
Exhibit 4.8(a) to the Company's Current Report on Form
10-Q for the fiscal quarter ended February 1, 1998 filed
with the Commission on March 17, 1998).
Exhibit 4.8(b) -- Registration Rights Agreement between the Company and
Chase Securities, Inc. (incorporated by reference to
Exhibit 4.8(b) to the Company's Current Report on Form
10-Q for the fiscal quarter ended February 1, 1998 filed
with the Commission on March 17, 1998).
- 23 -
Exhibit 10.1 -- Subscription Agreement dated September 3, 1992 between
Smithfield Foods, Inc. and Carroll's Foods, Inc.,
covering 1,000,000 shares of Smithfield Foods, Inc.
Common Stock (incorporated by reference to Exhibit 10.1
of the Company's Form 10-K Annual Report for the fiscal
year ended May 2, 1993); and Amendment No. 1 to
Subscription Agreement dated January 31, 1995
(incorporated by reference to Exhibit 10.1 to the
Company's Annual Report on Form 10-K for the fiscal year
ended April 28, 1996 filed with the Commission on July
18, 1996).
Exhibit 10.2 -- Smithfield Foods, Inc. 1984 Stock Option Plan, as amended
(incorporated by reference to Exhibit 10.1 to the
Company's Form 10-K Annual Report for the fiscal year
ended April 28, 1991).
Exhibit 10.3 -- Smithfield Foods, Inc. 1992 Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the
Company's Form 10-K Annual Report for the fiscal year
ended May 2, 1993).
Exhibit 10.4 -- Smithfield Foods, Inc. Incentive Bonus Plan
applicable to the Company's Chairman of the Board and
Chief Executive Officer (incorporated by reference to
Exhibit 10.8 to the Company's Form 10-K Annual Report for
the fiscal year ended April 30, 1995 filed with the
Commission on July 28, 1995).
Exhibit 10.5 -- Smithfield Foods, Inc. 1997 Incentive Bonus Plan
applicable to the Company's President and Chief Operating
Officer (incorporated by reference to Exhibit 10.6 to the
Company's Form 10-K Annual Report for the fiscal year
ended April 28, 1996 filed with the Commission on July
18, 1996).
Exhibit 10.6 -- Smithfield Foods, Inc. 1998 Incentive Bonus Plan
applicable to the Company's Chief Operating Officer
(incorporated by reference to Exhibit 10.6 to the
Company's Form 10-K Annual Report for the fiscal year
ended April 27, 1997 filed with the Commission on July
25, 1997).
Exhibit 10.7 -- Smithfield Foods, Inc. 1998 Stock Incentive Plan.
Exhibit 21 -- Subsidiaries of the Registrant.
Exhibit 23 -- Consent of Independent Public Accountants.
Exhibit 27 -- Financial Data Schedule.
(b) Reports on Form 8-K
1. Current Report on Form 8-K for February 9, 1998, was
filed with the Commission on February 10, 1998, to
report, under Item 5, the closing of a private
offering of $200,000,000 aggregate principal amount
of 7-5/8% Senior Subordinated Notes due 2008.
- 24 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SMITHFIELD FOODS, INC.
Date: July 27, 1998 By: /s/ JOSEPH W. LUTER, III
--------------------
Joseph W. Luter, III
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on July 27, 1998.
SIGNATURE TITLE
Chairman of the Board and Chief Executive
/s/ JOSEPH W. LUTER, III Officer, and Director
- ------------------------------------------------
Joseph W. Luter, III
President and Chief Operating Officer,
/s/ LEWIS R. LITTLE and Director
- ------------------------------------------------
Lewis R. Little
Vice President, Chief Financial Officer
/s/ AARON D. TRUB and Secretary, and Director
- ----------------------------------------------- (Principal-Financial-Officer)
Aaron D. Trub
Vice President, Finance
/s/ C. LARRY POPE (Principal Accounting Officer)
- -----------------------------------------------
C. Larry Pope
Director
/s/ ROBERT L. BURRUS, JR.
- -----------------------------------------------
Robert L. Burrus, Jr.
Director
/s/ F. J. FAISON, JR.
- -----------------------------------------------
F. J. Faison, Jr.
Director
/s/ JOEL W. GREENBERG
- -----------------------------------------------
Joel W. Greenberg
Director
/s/ GEORGE E. HAMILTON, JR.
- -----------------------------------------------
George E. Hamilton, Jr.
- S-1 -
Director
- -----------------------------------------------
Richard J. Holland
Director
/s/ ROGER R. KAPELLA
- -----------------------------------------------
Roger R. Kapella
Director
/s/ WILLIAM H. PRESTAGE
- -----------------------------------------------
William H. Prestage
Director
/s/ JOSEPH B. SEBRING
- -----------------------------------------------
Joseph B. Sebring
- S-2 -
SMITHFIELD FOODS, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
PAGE(S)
-------------
FINANCIAL STATEMENTS
Report of Independent Public Accountants ............................................ F-2
Consolidated Balance Sheets for the Fiscal Years Ended April 27, 1997,
and May 3, 1998 .................................................................. F-3
Consolidated Statements of Income for the Fiscal Years 1998, 1997, and 1996 ......... F-4
Consolidated Statements of Cash Flows for the Fiscal Years 1998, 1997, and 1996 ..... F-5
Consolidated Statements of Shareholders' Equity for the Fiscal Years ended April 28,
1996, April 27, 1997, and May 3, 1998 ............................................ F-6
Notes to Consolidated Financial Statements .......................................... F-7 to F-22
FINANCIAL STATEMENT SCHEDULE
Independent Public Accountants' Report on Financial Statement Schedule .............. F-23
Schedule I -- Condensed Financial Information of Registrant ......................... F-24 to F-28
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS OF SMITHFIELD FOODS, INC.:
We have audited the accompanying consolidated balance sheets of Smithfield
Foods, Inc. (a Virginia corporation) and subsidiaries as of May 3, 1998, and
April 27, 1997, and the related consolidated statements of income, cash flows,
and shareholders' equity for each of the three years in the period ended May 3,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Smithfield Foods, Inc. and
subsidiaries as of May 3, 1998 and April 27, 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
May 3, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Richmond, Virginia
June 10, 1998
F-2
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
FISCAL YEARS ENDED
-------------------------------
MAY 3, APRIL 27,
1998 1997
--------------- -------------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents ..................................................... $ 60,522 $ 25,791
Accounts receivable less allowances of $1,541 and $1,499 ...................... 156,091 166,094
Inventories ................................................................... 249,511 253,276
Prepaid expenses and other current assets ..................................... 44,999 43,217
----------- ----------
Total current assets ........................................................ 511,123 488,378
----------- ----------
Property, plant and equipment:
Land .......................................................................... 15,157 13,964
Buildings and improvements .................................................... 240,032 205,523
Machinery and equipment ....................................................... 418,810 344,328
Construction in progress ...................................................... 31,873 50,578
----------- ----------
705,872 614,393
Less accumulated depreciation ................................................. (233,652) (187,518)
----------- ----------
Net property, plant and equipment ........................................... 472,220 426,875
----------- ----------
Other assets:
Investments in partnerships ................................................... 49,940 44,582
Goodwill, net of accumulated amortization of $1,964 and $1,716 ................ 12,360 4,062
Other ......................................................................... 38,002 31,357
----------- ----------
Total other assets .......................................................... 100,302 80,001
----------- ----------
$ 1,083,645 $ 995,254
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable ................................................................. $ - $ 77,500
Current portion of long-term debt and captial lease obligations ............... 8,511 7,800
Accounts payable .............................................................. 118,909 132,268
Accrued expenses and other current liabilities ................................ 124,515 106,498
----------- ----------
Total current liabilities ................................................... 251,935 324,066
----------- ----------
Long-term debt and capital lease obligations ................................... 407,272 288,486
----------- ----------
Other noncurrent liabilities:
Pension and postretirement benefits ........................................... 38,486 55,320
Deferred income taxes ......................................................... 11,745 7,260
Other ......................................................................... 13,197 12,636
----------- ----------
Total other noncurrent liabilities .......................................... 63,428 75,216
----------- ----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $1.00 par value, 1,000,000 authorized shares ................. - -
Common stock, $.50 par value, 100,000,000 and 25,000,000 shares authorized;
37,537,362 and 19,196,681 issued ............................................ 18,769 9,598
Additional paid-in capital .................................................... 96,971 113,661
Retained earnings ............................................................. 245,270 191,870
Treasury stock, at cost, 437,000 shares ....................................... - (7,643)
----------- ----------
Total shareholders' equity .................................................. 361,010 307,486
----------- ----------
$ 1,083,645 $ 995,254
=========== ==========
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FISCAL YEARS
----------------------------------------------------
1998 1997 1996
---------------- ---------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales ......................................................... $ 3,867,442 $ 3,870,611 $ 2,383,893
Cost of sales ................................................. 3,479,828 3,549,673 2,203,626
------------ ------------ -----------
Gross profit ................................................. 387,614 320,938 180,267
Selling, general and administrative expenses .................. 219,861 191,225 103,095
Depreciation expense .......................................... 42,300 35,825 25,979
Interest expense .............................................. 31,891 26,211 20,942
------------ ------------ -----------
Nonrecurring charge ........................................... 12,600 - -
Income from continuing operations before income taxes ......... 80,962 67,677 30,251
Income taxes .................................................. 27,562 22,740 10,465
------------ ------------ -----------
Income from continuing operations ............................. 53,400 44,937 19,786
Loss from discontinued operations, net of tax ................. - - (3,900)
------------ ------------ -----------
Net income .................................................... $ 53,400 $ 44,937 $ 15,886
============ ============ ===========
Net income available to common shareholders ................... $ 53,400 $ 43,699 $ 14,734
============ ============ ===========
Income (loss) per basic share:
Continuing operations ........................................ $ 1.42 $ 1.21 $ .55
Discontinued operations ...................................... - - ( .11)
============ ============ ===========
Net income ................................................... $ 1.42 $ 1.21 $ .44
============ ============ ===========
Income (loss) per diluted share:
Continuing operations ........................................ $ 1.34 $ 1.17 $ .53
Discontinued operations ...................................... - - ( .11)
============ ============ ===========
Net income ................................................... $ 1.34 $ 1.17 $ .42
============ ============ ===========
The accompanying notes are an integral part of these consolidated statements.
F-4
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEARS
-------------------------------------------
1998 1997 1996
------------- ------------- -----------
(IN THOUSANDS)
Cash flows from operating activities:
Net income .......................................................... $ 53,400 $ 44,937 $ 15,886
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ..................................... 45,872 39,057 28,299
Deferred income taxes ............................................. 14,752 7,810 (27,059)
(Gain) loss on sale of property and equipment ..................... 216 (3,288) 2,168
Changes in operating assets and liabilities, net of effect of
acquisitions:
Accounts receivable .............................................. 15,115 (12,606) (9,251)
Inventories ...................................................... 11,672 (30,008) (41,316)
Prepaid expenses and other current assets ........................ (10,550) (1,605) 1,535
Other assets ..................................................... (7,746) (10,410) 22,682
Accounts payable, accrued expenses and other liabilities ......... (25,194) 9,377 19,166
---------- ---------- ---------
Net cash provided by operating activities ............................ 97,537 43,264 12,110
---------- ---------- ---------
Cash flows from investing activities:
Capital expenditures ................................................ (92,913) (69,147) (74,888)
Business acquisitions, net of cash acquired ......................... (7,810) (34,835) (14,079)
Investments in partnerships ......................................... (5,357) (7,293) (2,486)
Net advances to joint hog production arrangements ................... - (113) 6,464
Proceeds from sale of property and equipment ........................ 1,153 4,141 82
---------- ---------- ---------
Net cash used in investing activities ................................ (104,927) (107,247) (84,907)
---------- ---------- ---------
Cash flows from financing activities:
Net (repayments) borrowings on notes payable ........................ (75,000) (33,063) 33,592
Proceeds from issuance of long-term debt ............................ 450,050 171,250 50,000
Principal payments on long-term debt and capital lease obligations (333,053) (76,974) (16,672)
Proceeds from issuance of preferred stock ........................... - - 20,000
Exercise of common stock options .................................... 124 1,270 768
Dividends on preferred stock ........................................ - (1,238) (1,152)
---------- ---------- ---------
Net cash provided by financing activities ............................ 42,121 61,245 86,536
---------- ---------- ---------
Net increase (decrease) in cash and cash equivalents ................. 34,731 (2,738) 13,739
Cash and cash equivalents at beginning of year ....................... 25,791 28,529 14,790
---------- ---------- ---------
Cash and cash equivalents at end of year ............................. $ 60,522 $ 25,791 $ 28,529
========== ========== =========
Supplemental disclosures of cash flow information:
Interest paid, net of amount capitalized ............................ $ 31,428 $ 25,751 $ 20,684
---------- ---------- ---------
Income taxes paid ................................................... $ 10,179 $ 15,043 $ 1,685
---------- ---------- ---------
Non-cash investing and financing activities:
Refinancing of long-term debt ..................................... $ - $ 59,707 $ -
---------- ---------- ---------
Conversion of preferred stock to common stock ..................... $ - $ 20,000 $ 10,000
---------- ---------- ---------
Common stock issued for acquisition ............................... $ - $ - $ 33,000
---------- ---------- ---------
Conversion of net advances to joint hog production
arrangements to investments in partnerships ...................... $ - $ 7,691 $ -
========== ========== =========
The accompanying notes are an integral part of these consolidated statements.
F-5
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL
------------------------ PAID-IN RETAINED TREASURY
SHARES PAR VALUE CAPITAL EARNINGS STOCK
---------- ----------- ----------- ------------ -------------
(IN THOUSANDS)
Balance, April 30, 1995 ..................... 16,834 $ 8,417 $ 49,804 $ 133,437 $ (7,643)
Net income ................................. - - - 15,886 -
Common stock issued for acquisition of
John Morrell & Co. ....................... 1,094 547 32,453 - -
Conversion of preferred stock .............. 465 233 9,767 - -
Exercise of stock options .................. 60 30 738 - -
Dividends on preferred stock ............... - - - (1,152) -
------ -------- -------- --------- ---------
Balance, April 28, 1996 ..................... 18,453 9,227 92,762 148,171 (7,643)
Net income ................................. - - - 44,937 -
Conversion of preferred stock .............. 667 333 19,667 - -
Exercise of stock options .................. 77 38 1,232 - -
Dividends on preferred stock ............... - - - (1,238) -
------ -------- -------- --------- ---------
Balance, April 27, 1997 ..................... 19,197 9,598 113,661 191,870 (7,643)
Net income ................................. - - - 53,400 -
Two-for-one stock split .................... 19,200 9,600 (9,600) - -
Exercise of stock options .................. 14 8 116 - -
Reclassification of treasury stock ......... (874) (437) (7,206) - 7,643
------ -------- -------- --------- ---------
Balance, May 3, 1998 ........................ 37,537 $ 18,769 $ 96,971 $ 245,270 $ -
====== ======== ======== ========= =========
The accompanying notes are an integral part of these consolidated statements.
F-6
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Smithfield Foods, Inc. and subsidiaries (the "Company") operate as a
producer, manufacturer, marketer, seller and distributor of fresh pork and
processed meats. The Company's principal hog slaughtering and further
processing operations are conducted through five wholly-owned subsidiaries:
Gwaltney of Smithfield, Ltd. ("Gwaltney"), John Morrell & Co. ("John Morrell"),
Lykes Meat Group, Inc. ("Lykes"), Patrick Cudahy Incorporated ("Patrick
Cudahy") and The Smithfield Packing Company, Incorporated ("Smithfield
Packing"). The Company also conducts hog production operations, principally
through its 86%-owned subsidiary, Brown's of Carolina, Inc. ("Brown's").
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company after elimination of all material intercompany balances and
transactions. Investments in partnerships are accounted for using the equity
method of accounting.
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts and disclosures in these
financial statements. Actual results could differ from those estimates.
FISCAL YEAR
The Company's fiscal year is the 52- or 53-week period ending on the Sunday
nearest April 30. The fiscal year ended May 3, 1998 includes 53 weeks while the
fiscal years ended April 27, 1997 and April 28, 1996 each include 52 weeks.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The carrying value
of cash equivalents approximates market value. At May 3, 1998, cash and cash
equivalents include $30,100,000 in short-term marketable debt securities.
INVENTORIES
The Company's inventories are valued at the lower of first-in, first-out
cost or market. Cost includes direct materials, labor and applicable
manufacturing and production overhead. Inventories consist of the following:
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
Fresh and processed meats ......... $ 171,090 $ 183,480
Hogs on farms ..................... 49,263 44,563
Manufacturing supplies ............ 18,538 15,732
Other ............................. 10,620 9,501
--------- ---------
$ 249,511 $ 253,276
========= =========
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost and depreciated over the
estimated useful lives of the assets. Buildings and improvements are
depreciated over periods from 20 to 40 years. Machinery and equipment is
depreciated over periods from 2 to 20 years. Repair and maintenance charges are
expensed as incurred. Improvements that materially extend the life of the asset
are capitalized. Gains and losses from dispositions or retirements of property,
plant and equipment are recognized currently.
Interest on capital projects is capitalized during the construction
period. Total interest capitalized was $2,530,000 in fiscal 1998, $2,640,000 in
fiscal 1997 and $2,021,000 in fiscal 1996. Repair and maintenance expenses
totaled $106,481,000, $89,670,000 and $59,951,000 in fiscal 1998, 1997 and
1996, respectively.
F-7
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
OTHER ASSETS
Goodwill is being amortized over no more than 40 years. Organization costs
are amortized over a five-year period. Deferred debt issuance costs are
amortized over the terms of the related loan agreements.
REVENUE RECOGNITION
Revenues from product sales are recorded upon shipment to customers.
PRICE-RISK MANAGEMENT
Substantially all of the Company's products are manufactured from
commodity-based raw materials, primarily live hogs. The cost of live hogs is
subject to wide fluctuations due to unpredictable factors such as the price of
corn and soybean meal (the principal feed ingredients for a hog), weather
conditions, economic conditions, government regulation and other unforeseen
circumstances. The pricing of the Company's fresh pork and processed meats are
monitored and adjusted upward and downward in reaction to changes in the cost of
the underlying raw materials. The unpredictability of the raw material costs
limit the Company's ability to forward price fresh pork and processed meat
products without the use of commodity contracts through a program of price-risk
management. The Company uses price-risk management to enhance its ability to
engage in forward sales contracts, where prices for future deliveries are fixed,
by purchasing (or selling) commodity contracts for future periods to reduce or
eliminate the effect of fluctuations in future raw material costs on the
profitability of the related sales. While this may tend to limit the Company's
ability to participate in gains from favorable commodity price fluctuations, it
also tends to reduce the risk of loss from adverse changes in raw material
prices. In addition, the Company utilizes commodity contracts for live hogs and
corn to manage hog production margins when management determines that conditions
are appropriate for such hedges. The particular hedging methods employed and the
time periods for the contracts depend on a number of factors, including the
availability of adequate contracts for the respective periods for the hedges.
The Company attempts to closely match the commodity contract expiration periods
with the dates for product sale and delivery. As a result, gains and losses from
hedging transactions are recognized when the related sales are made and the
hedges are lifted.
As of May 3, 1998 and April 27, 1997, the Company had deferred $1,867,000
and $2,183,000, respectively, of unrealized hedging gains on outstanding futures
contracts. As of May 3, 1998 and April 27, 1997, the Company had open futures
contracts with fair values of $59,645,000 and $44,291,000, respectively. As of
May 3, 1998 and April 27, 1997, the Company had deposits with brokers for
outstanding futures contracts of $10,888,000 and $3,512,000 respectively,
included in prepaid expenses and other current assets.
For open futures contracts, the Company uses a sensitivity analysis
technique to evaluate the effect that changes in the market value of commodities
will have on these commodity derivative instruments. As of May 3, 1998, the
potential change in fair value of open futures contracts, assuming a 10% change
in the underlying commodity price, was $2,124,000.
ENVIRONMENTAL EXPENDITURES
Environmental expenditures that relate to current or future operations are
expensed or capitalized as appropriate. Expenditures that relate to an existing
condition caused by past operations and do not contribute to current or future
revenue generation are expensed. Liabilities are recorded when environmental
assessments and cleanups are probable and the cost can be reasonably estimated.
Generally, the timing of these accruals coincides with the Company's commitment
to a formal plan of action (see Note 12).
SELF-INSURANCE PROGRAMS
The Company is self-insured for certain levels of general and vehicle
liability, workers' compensation and health care coverage. The cost of these
self-insurance programs is accrued based upon estimated settlements for known
and anticipated claims. Any resulting adjustments to previously recorded
reserves are reflected in current operating results.
F-8
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
INCOME PER SHARE
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share" ("SFAS 128"), effective for fiscal 1998.
SFAS 128 requires a dual computation and presentation of income per share (see
Note 13). The basic computation is based on average common shares outstanding
during the period. The diluted computation reflects the potentially dilutive
effect of common stock equivalents such as options and convertible preferred
stock during the period. All income per share amounts for all periods are
presented to conform to the SFAS 128 requirements. On September 26, 1997, a
two-for-one stock split of the Company's common stock was effected in the form
of a stock dividend. Accordingly, all historical share and per share amounts
have been restated to reflect the stock split.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components. Adoption of SFAS 130 in fiscal 1999 will have no impact on the
Company's net income or shareholders' equity.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
establishes standards for determining an entity's operating segments and for
disclosure of financial information on such segments. Adoption of SFAS 131 in
fiscal 1999 will have no impact on the Company's financial position or results
of operations, but will require expanded disclosure for identified operating
segments.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures
about Pensions and Other Postretirement Benefits -- an amendment of FASB
Statements No. 87, 88 and 106" ("SFAS 132"). In June, 1998, the FASB issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). SFAS 132 and SFAS 133 are not required to be adopted until fiscal
2000. The Company has not completed all of the analysis required to estimate
the impact of these statements.
NOTE 2 -- ACQUISITIONS
In November 1996, the Company acquired substantially all of the assets and
business of Lykes from Lykes Bros. Inc. for $34,835,000 in cash and the
assumption of $10,616,000 of current liabilities.
The following unaudited pro forma information combines the operating
results of the Company and Lykes, assuming the acquisition had been made as of
the beginning of each of the periods presented:
1997 1996
---------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
Sales ..................................... $ 3,948,091 $ 2,630,031
Income from continuing operations ......... 33,839 12,291
Net income ................................ 33,839 8,391
Income per basic share:
Continuing operations ................... $ .90 $ .33
Net income .............................. .90 .21
Income per diluted share:
Continuing operations ................... $ .88 $ .32
Net income .............................. .88 .21
The preceding pro forma amounts are not intended to be projections of
future results or trends and do not purport to be indicative of what actual
consolidated results of operations might have been if the acquisitions had been
effective as of the beginning of the periods presented.
The Company made several acquisitions in fiscal 1998 which, in the
aggregate, would not have a material effect on pro forma results.
F-9
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 2 -- ACQUISITIONS -- Continued
The Company accounted for the Lykes and other acquisitions using the
purchase method of accounting. The results of operations of these acquired
businesses are included in the accompanying consolidated statements of income
from the respective dates of acquisition.
NOTE 3 -- JOINT HOG PRODUCTION ARRANGEMENTS
SMITHFIELD-CARROLL'S
The Company has an arrangement with certain affiliates of Carroll's Foods,
Inc. ("CFI") to produce hogs for the Company's meat processing plants in North
Carolina and Virginia. The arrangement ("Smithfield-Carroll's") involves: (1)
Smithfield-Carroll's Farms, a partnership owned jointly by the Company and
Carroll's Farms of Virginia, Inc. ("CFAV"), which owns the hog raising
facilities, and (2) a long-term purchase contract between the Company and
Carroll's Foods of Virginia, Inc. ("CFOV"), which leases and operates the
facilities, obligating the Company to purchase all the hogs produced by CFOV at
prices equivalent to market at the time of delivery. A director of the Company
is the president and a director of CFI, CFAV and CFOV. In addition, the Company
has a long-term agreement to purchase hogs from CFI at prices which, in the
opinion of management, are equivalent to market.
As of May 3, 1998 and April 27, 1997, the Company had investments of
$29,357,000 and $27,943,000, respectively, in the Smithfield-Carroll's
partnership. Profits and losses are shared equally under the arrangement.
During fiscal 1997, the Company converted net advances to the arrangement of
$7,691,000 to investments in the arrangement.
Substantially all revenues of the partnership consist of lease payments
from CFOV which cover debt service, depreciation charges and other operating
expenses. For the fiscal years 1998, 1997 and 1996, revenues were $7,386,000,
$8,227,000 and $8,912,000, respectively.
Pursuant to the long-term purchase contract, the Company purchased
$79,087,000, $93,049,000 and $70,540,000 of live hogs from CFOV in fiscal 1998,
1997 and 1996, respectively. The contract resulted in decreased raw material
costs (as compared to market costs) of $359,000, $5,245,000 and $2,617,000 in
fiscal 1998, 1997 and 1996, respectively. In fiscal 1997, the Company received
$6,905,000 from CFOV in repayment of all outstanding demand loans. Pursuant to
the agreement with CFI, the Company purchased $246,371,000, $269,499,000 and
$201,878,000 of hogs in fiscal 1998, 1997 and 1996, respectively.
CIRCLE FOUR
The Company has an arrangement with certain of its principal hog suppliers
to produce hogs in the state of Utah for sale to an unrelated party. The chief
executive officers of two of the suppliers and the president of another served
as directors of the Company during fiscal 1998. As of May 3, 1998, the Company
had a 37% interest in the arrangement. As of May 3, 1998 and April 27, 1997,
the Company had investments of $16,198,000 and $12,673,000, respectively, in
the arrangement.
B&G
Brown's has an arrangement with a company owned by the daughter and
son-in-law of the chairman and chief executive officer of the Company. The
arrangement, B&G Farms LLC ("B&G"), involves the leasing of hog production
facilities to Brown's and the production of hogs by Brown's on a contractual
basis. In addition, the Company has a contract to purchase all of the hogs
produced by B&G at prices which, in the opinion of management, are equivalent
to market. Profits and losses are shared equally under the arrangement. As of
May 3, 1998 and April 27, 1997, B&G had advanced $1,504,000 and $1,430,000,
respectively, to Brown's for working capital. As of May 3, 1998 and April 27,
1997, the Company had investments of $1,147,000 and $1,291,000, respectively,
in B&G.
B&G's revenues consist of lease payments from Brown's, which cover debt
service and depreciation charges, and the profits or losses on the sale of
hogs. Pursuant to the contract, the Company purchased $7,944,000, $6,439,000
and $7,990,000 of hogs in fiscal 1998, 1997 and 1996, respectively.
F-10
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 3 -- JOINT HOG PRODUCTION ARRANGEMENTS -- Continued
The following summarized financial information represents an aggregation
of the financial position of the unconsolidated hog production operations of
Smithfield-Carroll's, Circle Four and B&G:
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
Current assets ...................... $ 25,738 $ 17,116
Property and equipment, net ......... 147,171 134,937
Other assets ........................ 1,988 6,978
--------- ---------
$ 174,897 $ 159,031
========= =========
Current liabilities ................. $ 21,773 $ 15,721
Long-term debt ...................... 72,290 71,094
Equity .............................. 80,834 72,216
--------- ---------
$ 174,897 $ 159,031
========= =========
NOTE 4 -- DEBT
Long-term debt consists of the following:
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
7.625% senior subordinated notes, due February 2008 ......... $ 200,000 $ -
8.52% senior notes, due August 2006 ......................... 100,000 100,000
8.34% senior notes, due August 2003 ......................... 40,000 40,000
8.41% senior notes, payable through August 2004 ............. 14,779 14,779
9.85% senior notes, payable through November 2006 ........... 11,333 13,000
8.41% senior notes, payable through August 2006 ............. 9,853 9,853
9.80% senior notes, payable through August 2003 ............. 7,500 8,437
10.75% senior notes, payable through August 2005 ............ 7,250 8,500
Long-term credit facility ................................... - 75,000
Other long-term debt ........................................ 6,126 4,036
--------- ---------
396,841 273,605
Less current portion ........................................ (7,020) (5,949)
--------- ---------
$ 389,821 $ 267,656
========= =========
Scheduled maturities of long-term debt are as follows:
(IN THOUSANDS)
---------------
Fiscal year
1999 ................... $ 7,020
2000 ................... 2,915
2001 ................... 3,170
2002 ................... 3,083
2003 ................... 10,473
Thereafter ............. 370,180
--------
$396,841
========
In July 1997, the Company entered into loan agreements with a bank group
for $350,000,000 in revolving credit facilities, consisting of a five-year
$300,000,000 revolving credit facility and a 364-day $50,000,000 revolving
credit facility. In connection with this refinancing, the Company repaid all
borrowings under its previous $300,000,000 credit facilities, which
F-11
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 4 -- DEBT -- Continued
were terminated. The borrowings are prepayable and bear interest, at the
Company's option, at various rates based on margins over the federal funds rate
or Eurodollar rate. The Company pays a commitment fee on the unused portion.
The 364-day $50,000,000 revolving credit facility was terminated in February
1998.
In February 1998, the Company issued $200,000,000 in aggregate principal
amount of 10-year 7.625% senior subordinated notes. The net proceeds from the
sale of the notes were used to repay indebtedness under the Company's revolving
credit facility with the balance invested in short-term marketable debt
securities.
In fiscal 1997, the Company privately placed $140,000,000 of senior
secured notes with a group of institutional lenders. The placement consisted of
$40,000,000 of seven-year 8.34% notes and $100,000,000 of 10-year 8.52% notes.
The proceeds of the financing were used to repay $65,200,000 of long-term bank
debt and to reduce short-term borrowings. In conjunction with the placement of
the senior secured notes, the Company refinanced $59,707,000 of existing
institutional long-term debt with the same institutional lenders. The
refinancing resulted in revised maturity dates and repayment schedules for the
refinanced debt; however, no additional proceeds resulted from this
refinancing.
Average borrowings under credit facilities were $149,723,000 in fiscal
1998, $165,071,000 in fiscal 1997 and $133,400,000 in fiscal 1996 at average
interest rates of approximately 7% for each year. Maximum borrowings were
$247,000,000 in fiscal 1998, $215,000,000 in fiscal 1997 and $179,800,000 in
fiscal 1996. There were no borrowings under the facility as of May 3, 1998. The
outstanding borrowings were $150,000,000 as of April 27, 1997, at an average
interest rate of 7%.
The senior subordinated notes are unsecured. The senior notes are secured
by four of the Company's major processing plants and certain other property,
plant and equipment. The credit facility is secured by substantially all of the
Company's inventories and accounts receivable. The Company determines the fair
value of long-term debt instruments for public debt using quoted market prices
and values all other debt using discounted cash flow techniques at estimated
market prices for similar issues.
As of May 3, 1997, the fair value of long-term debt, based on the market
value of debt with similar maturities and covenants, was approximately
$407,511,000.
The Company's various debt agreements contain financial covenants that
require the maintenance of certain levels and ratios for working capital, net
worth, current ratio, fixed charges, capital expenditures and, among other
restrictions, limit additional borrowings, the acquisition, disposition and
leasing of assets, and payments of dividends to shareholders.
NOTE 5 -- INCOME TAXES
Total income tax expense (benefit) was allocated as follows:
1998 1997 1996
----------- ----------- -----------
(IN THOUSANDS)
Income from continuing operations ......... $ 27,562 $ 22,740 $ 10,465
Discontinued operations ................... - - (2,600)
-------- -------- --------
$ 27,562 $ 22,740 $ 7,865
======== ======== ========
F-12
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 5 -- INCOME TAXES -- Continued
Income tax expense attributable to income from continuing operations
consists of the following:
1998 1997 1996
----------- ----------- ------------
(IN THOUSANDS)
Current tax expense:
Federal ..................... $ 11,315 $ 12,765 $ 8,850
State ....................... 2,043 2,805 1,530
-------- -------- --------
13,358 15,570 10,380
-------- -------- --------
Deferred tax expense (benefit):
Federal ..................... 15,684 9,424 (129)
State ....................... (1,480) (2,254) 214
14,204 7,170 85
-------- -------- --------
$ 27,562 $ 22,740 $ 10,465
======== ======== ========
A reconciliation of taxes computed at the federal statutory rate to the
provision for income taxes is as follows:
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS)
Federal income taxes at statutory rate ................. 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit ......... 1.0 1.7 3.9
Nondeductible settlements .............................. 4.5 1.6 -
Foreign sales corporation benefit ...................... (2.0) (1.4) (2.4)
Benefits of certain insurance contracts ................ (3.3) (3.6) (3.1)
Other .................................................. (1.2) 0.3 1.2
---- ---- ----
34.0% 33.6% 34.6%
==== ==== ====
The tax effects of temporary differences consist of the following:
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
Deferred tax assets:
Employee benefits ........................................... $ 23,264 $ 28,986
Alternative minimum tax credit .............................. 5,781 12,278
Tax credits, carryforwards and net operating losses ......... 12,773 11,807
Inventories ................................................. 1,286 1,377
Accrued expenses ............................................ 12,867 12,519
-------- --------
$ 55,971 $ 66,967
======== ========
Deferred tax liabilities:
Property, plant and equipment ............................... $ 36,488 $ 35,072
Investments in subsidiaries ................................. 719 3,154
Other assets ................................................ 6,875 2,100
-------- --------
$ 44,082 $ 40,326
======== ========
As of May 3, 1998 and April 27, 1997, the Company had $23,634,000 and
$33,901,000, respectively, of net current deferred tax assets included in
prepaid expenses and other current assets. The Company had no valuation
allowance related to income tax assets as of May 3, 1998 and April 27, 1997,
and there was no change in the valuation allowance during fiscal 1998 and 1997.
The tax credits, carryforwards and net operating losses expire from fiscal
1998 to 2012. The alternative minimum tax credits do not expire.
F-13
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 6 -- ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following:
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
Payroll and related benefits ................ $ 46,834 $ 43,723
Self-insurance reserves ..................... 24,794 18,112
Pension and postretirement benefits ......... 23,931 17,518
Other ....................................... 28,956 27,145
--------- ---------
$ 124,515 $ 106,498
========= =========
NOTE 7 -- SHAREHOLDERS' EQUITY AND PREFERRED STOCK
REINCORPORATION AND TREASURY STOCK
In August 1997, the Company's shareholders approved the reincorporation of
the Company in Virginia from Delaware. The purpose of the reincorporation was
to reduce annual franchise taxes and does not affect the Company's
capitalization or the manner in which it operates. Since Virginia law does not
recognize treasury stock, the shares previously classified as treasury stock
reverted to unissued shares resulting in a reduction in common stock and
additional paid-in capital for the cost basis of the shares.
AUTHORIZED COMMON SHARES
In August 1997, the Company's shareholders approved an increase in the
number of authorized common shares from 25,000,000 to 100,000,000.
STOCK SPLIT
As discussed in Note 1, the Company effected a two-for-one split of its
common stock in September 1997. Share amounts presented in the Consolidated
Balance Sheets and the Consolidated Statements of Shareholders' Equity reflect
the actual share amounts outstanding for each period presented. Stock option
agreements provide for the issuance of additional shares for the stock split.
All stock options outstanding and per share amounts for all periods have been
restated to reflect the effect of this split.
ISSUANCE OF COMMON STOCK
In fiscal 1996, the Company issued 2,188,546 split-adjusted shares of its
common stock to Chiquita Brands International, Inc. as part of the acquisition
of John Morrell.
PREFERRED STOCK
The Company has 1,000,000 shares of $1.00 par value preferred stock
authorized, none of which are issued. The board of directors is authorized to
issue preferred stock in series and to fix, by resolution, the designation,
dividend rate, redemption provisions, liquidation rights, sinking fund
provisions, conversion rights and voting rights of each series of preferred
stock.
In fiscal 1996, the Company authorized and issued 2,000 shares of Series C
6.75% cumulative convertible redeemable preferred stock in a private
transaction for $20,000,000. In fiscal 1997, all of these shares were converted
into 1,333,332 split-adjusted shares of the Company's common stock at $15.00
per share.
In fiscal 1996, all of the Series B 6.75% cumulative convertible
redeemable preferred stock, totaling $10,000,000, was converted into 930,232
split-adjusted shares of the Company's common stock at $10.75 per share.
F-14
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 7 -- SHAREHOLDERS' EQUITY AND PREFERRED STOCK -- Continued
STOCK OPTIONS
Under the Company's 1984 Stock Option Plan (the "1984 Plan"), officers and
certain key employees were granted incentive and nonstatutory stock options to
purchase shares of the Company's common stock for periods not exceeding 10
years at prices that were not less than the fair market value of the common
stock on the date of grant. Stock appreciation rights which are exercisable
upon a change in control of the Company are attached to the options granted
pursuant to the 1984 Plan. The 1984 Plan has expired with the exception of
outstanding options.
Under the Company's 1992 Stock Incentive Plan (the "1992 Plan"),
management and other key employees may be granted nonstatutory stock options to
purchase shares of the Company's common stock exercisable five years after
grant for periods not exceeding 10 years. The exercise price for options
granted prior to August 31, 1994 was not less than 150% of the fair market
value of the common stock on the date of grant. On August 31, 1994, the Company
amended and restated the 1992 Plan, changing the exercise price of options
granted on or after that date to not less than the fair market value of the
common stock on the date of grant. The Company reserved 2,500,000 shares of
common stock under the 1992 Plan. As of May 3, 1998, there were 394,000 options
available for grant under the 1992 Plan.
The following is a summary of transactions for the 1984 Plan and the 1992
Plan during fiscal 1998, 1997 and 1996:
STOCK OPTION AVERAGE PRICE
SHARES PER SHARE
-------------- --------------
Outstanding at April 30, 1995 ......... 3,132,200 $ 7.90
Granted ............................. 690,000 12.65
Exercised ........................... (119,200) 3.30
Cancelled ........................... (100,000) 11.53
--------- --------
Outstanding at April 28, 1996 ......... 3,603,000 8.86
Granted ............................. 160,000 15.67
Exercised ........................... (154,000) 3.11
Cancelled ........................... (540,000) 12.29
--------- --------
Outstanding at April 27, 1997 ......... 3,069,000 8.90
Granted ............................. 314,000 25.39
Exercised ........................... (17,000) 4.06
--------- --------
Outstanding at May 3, 1998 ............ 3,366,000 $ 10.47
========= ========
As of May 3, 1998, April 27, 1997 and April 28, 1996, the number of option
shares exercisable were 1,260,000, 1,278,000 and 1,432,000, respectively, at
average per share exercise prices of $4.06, $4.06 and $3.96, respectively.
The following table summarizes information about stock options outstanding
as of May 3, 1998:
OPTION SHARES
EXERCISE OUTSTANDING AVERAGE REMAINING AVERAGE
PRICE RANGE MAY 3, 1998 CONTRACTUAL LIFE EXERCISE PRICE
- ------------------ -------------- ------------------- ---------------
$ 4.06 1,260,000 1.0 $ 4.06
10.72 to 11.75 1,291,000 5.6 11.52
13.62 to 15.31 450,000 7.7 13.70
16.47 to 17.84 100,000 8.6 16.88
25.53 to 27.72 200,000 9.1 26.51
31.63 to 32.75 65,000 9.6 32.42
Stock options with an exercise price of $4.06 per share are the only
options exercisable as of May 3, 1998.
The Company has adopted the supplemental disclosure requirements of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). Accordingly, compensation costs are not
recognized for the stock option plans. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options granted in
fiscal 1998, 1997 and 1996 consistent with the provisions of SFAS 123, the
Company's income
F-15
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 7 -- SHAREHOLDERS' EQUITY AND PREFERRED STOCK -- Continued
from continuing operations and income per common share from continuing
operations would have been reduced to the pro forma amounts as follows:
1998 1997 1996
------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Income from continuing operations, as reported ......... $ 53,400 $ 44,937 $ 19,786
Pro forma income from continuing operations ............ 52,571 44,553 19,715
Income per common share from continuing operations,
as reported:
Basic ................................................ $ 1.42 $ 1.21 $ .55
Diluted .............................................. 1.34 1.17 .53
Pro forma income per common share from continuing
operations:
Basic ................................................ $ 1.40 $ 1.20 $ .55
Diluted .............................................. 1.32 1.16 .53
The weighted-average fair values of option shares granted were $11.88,
$7.62 and $6.01 for fiscal 1998, 1997 and 1996, respectively. The fair value of
each stock option share granted beginning in fiscal 1995 is estimated at date
of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions:
1998 1997 1996
------------- ------------- -------------
Expected option life ............... 6.0 years 6.0 years 6.0 years
Expected annual volatility ......... 35.0% 35.0% 35.0%
Risk-free interest rate ............ 6.3% 6.2% 5.8%
Dividend yield ..................... 0.0% 0.0% 0.0%
PREFERRED SHARE PURCHASE RIGHTS
As part of the reincorporation, the Company adopted a preferred share
purchase rights plan (the "Rights Plan") and declared a dividend of one
preferred share purchase right (a "Right") on each outstanding share of common
stock. Under the terms of the Rights Plan, if the Company is acquired in a
merger or other business combination transaction, each Right will entitle its
holder to purchase, at the Right's then current exercise price, a number of the
acquiring company's common shares having a market value of twice such price. In
addition, if a person or group acquires 20% (or other applicable percentage, as
summarized in the Rights Plan) or more of the outstanding common stock, each
Right will entitle its holder (other than such person or members of such group)
to purchase, at the Right's then current exercise price, a number of shares of
common stock having a market value of twice such price.
Each Right will entitle its holder to buy one one-thousandth of a Series A
junior participating preferred share ("Preferred Share"), par value $1.00 per
share, at an exercise price of $37.50 subject to adjustment. Each Preferred
Share will entitle its holder to 1,000 votes and will have an aggregate
dividend rate of 1,000 times the amount, if any, paid to holders of common
stock. The Rights will expire on May 31, 2001 unless the date is extended or
unless the Rights are earlier redeemed or exchanged at the option of the board
of directors for $.0001 per Right. Generally, each share of common stock issued
after May 31, 1991, will have one Right attached.
NOTE 8 -- PENSION AND OTHER RETIREMENT PLANS
The Company sponsors several defined benefit pension and defined
contribution plans covering substantially all employees. Pension plans covering
salaried employees provide benefits based on years of service and average
salary levels. Pension plans covering hourly employees provide benefits of
stated amounts for each year of service. The Company's funding policy for
pension plans is to contribute annually the minimum amount required under
ERISA. The pension plan assets are invested primarily in equities, debt
securities, insurance contracts and money market funds.
F-16
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 8 -- PENSION AND OTHER RETIREMENT PLANS -- Continued
The status of the Company's pension plans and the components of pension
expense are as follows:
MAY 3, 1998 APRIL 27, 1997
---------------------------- -----------------------------
OVERFUNDED UNDERFUNDED OVERFUNDED UNDERFUNDED
PLANS PLANS PLANS PLANS
------------ ------------- ------------ --------------
(IN THOUSANDS)
Accumulated benefit obligation ............................. $ 42,938 $ 185,420 $ 30,974 $ 170,850
========= ========== ========= ==========
Vested benefit obligation .................................. $ 34,508 $ 181,563 $ 26,483 $ 168,222
========= ========== ========= ==========
Plan assets at fair value .................................. $ 63,447 $ 139,945 $ 47,179 $ 123,417
Projected benefit obligation ............................... (48,664) (193,890) (38,805) (177,114)
--------- ---------- --------- ----------
Excess (deficiency) of plan assets over projected benefit
obligation ................................................ 14,783 (53,945) 8,374 (53,697)
Items not recorded on balance sheets:
Unrecognized net transition gain .......................... - - (90) -
Unrecognized net gain from experience differences ......... (11,121) (1,874) (6,799) (10,173)
Unrecognized prior service cost ........................... 797 - 992 88
--------- ---------- --------- ----------
Prepaid (accrued) pension costs ........................... $ 4,459 $ (55,819) $ 2,477 $ (63,782)
========= ========== ========= ==========
1998 1997 1996
------------ ------------ ----------
Net periodic pension cost included the following:
Service costs for benefits earned ........................ $ 4,103 $ 4,054 $ 2,662
Interest accrued on projected benefit obligation ......... 16,730 16,299 7,532
Actual return on plan assets ............................. (35,052) (15,556) (6,691)
Net amortization and deferral ............................ 18,606 878 (200)
--------- --------- --------
Net periodic pension cost .............................. $ 4,387 $ 5,675 $ 3,303
========= ========= ========
In determining the projected benefit obligation in fiscal 1998 and 1997,
the average assumed discount rate was 7% and 8%, respectively, while the
assumed rate of increase in future compensation was 4% in fiscal 1998 and 5% in
fiscal 1997. The average expected long-term rate of return on plan assets was
9% in fiscal 1998 and 1997.
The Company provides health care and life insurance benefits for certain
retired employees. These plans are unfunded and generally pay covered costs
reduced by retiree premium contributions, co-payments and deductibles. The
Company retains the right to modify or eliminate these benefits.
The status of the Company's postretirement plans are as follows:
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
Accumulated postretirement benefit obligation:
Retirees and dependents ..................................... $ 6,806 $ 8,226
Active plan participants .................................... 4,011 1,404
-------- --------
Total accumulated postretirement benefit obligation ......... 10,817 9,630
Unrecognized net gain (loss) ................................ (1,060) 651
-------- --------
Accrued postretirement benefit cost ........................... $ 9,757 $ 10,281
======== ========
In determining the accumulated postretirement benefit obligation in fiscal
1998 and 1997, the average assumed discount rate was 7% and 8%, respectively.
The assumed annual rate of increase in per capita cost of covered health care
benefits is
F-17
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 8 -- PENSION AND OTHER RETIREMENT PLANS -- Continued
7.5% for fiscal 1998, 6.5% for fiscal 1999 and 5.5% thereafter. An increase of
1% in the health care cost trend would increase the accumulated postretirement
benefit obligation as of May 3, 1998 by $1,228,000 and the annual expense by
$94,000.
The total cost of postretirement benefits was $894,000, $1,072,000 and
$673,000 in fiscal 1998, 1997 and 1996, respectively.
NOTE 9 -- LEASE OBLIGATIONS AND COMMITMENTS
The Company leases transportation equipment under operating leases ranging
from one to 10 years with options to cancel at earlier dates. In addition, the
Company has a long-term maintenance agreement related to this equipment.
Maintenance fees are based upon fixed monthly charges for each vehicle, as well
as the maintenance facility itself and contingent fees based upon
transportation equipment usage. The amounts shown below as minimum rental
commitments do not include contingent maintenance fees.
The Company has agreements, expiring in fiscal 2004 and 2008, to use two
cold storage warehouses owned by a partnership, 50% of which is owned by the
Company. The Company has agreed to pay prevailing competitive rates for use of
the facilities, subject to aggregate guaranteed minimum annual fees of
$3,600,000. In fiscal 1998, 1997 and 1996, the Company paid $6,228,000,
$5,372,000 and $4,641,000, respectively, in fees for use of the facilities. As
of May 3, 1998 and April 27, 1997, the Company had investments of $1,411,000
and $1,137,000, respectively, in the partnership.
In fiscal 1998, the Company entered into a 15-year agreement, expiring in
2013, to use a cold storage warehouse owned by a partnership, 50% of which is
owned by the Company. The Company has agreed to lease the facility, beginning
in fiscal 1999, for an amount which will cover debt service costs plus a
minimum guaranteed annual fee totaling $2,174,000 in fiscal 1999. As of May 3,
1998, the Company had an investment of $1,826,000 in the partnership.
Minimum rental commitments under all noncancelable operating leases and
maintenance agreements are as follows:
(IN THOUSANDS)
Fiscal year
1999 ............... $ 20,986
2000 ............... 18,774
2001 ............... 16,219
2002 ............... 21,535
2003 ............... 9,900
Thereafter ......... 34,651
---------
$ 122,065
=========
Rental expense was $24,839,000 in fiscal 1998, $24,270,000 in fiscal 1997
and $17,664,000 in fiscal 1996. Rental expense in fiscal 1998, 1997 and 1996
included $3,231,000, $3,593,000 and $3,389,000 of contingent maintenance fees,
respectively.
The Company has a sale and leaseback arrangement for certain hog
production facilities at Brown's. The arrangement provides for an early
termination at predetermined amounts in fiscal 2004.
Property, plant and equipment under capital leases as of May 3, 1998
consists of land of $1,911,000, buildings and improvements of $5,647,000, and
machinery and equipment of $6,550,000, less accumulated depreciation of
$6,001,000.
F-18
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 9 -- LEASE OBLIGATIONS AND COMMITMENTS -- Continued
Future minimum lease payments for assets under capital leases and the
present value of the net minimum lease payments are as follows:
(IN THOUSANDS)
Fiscal year
1999 .................................... $ 3,016
2000 .................................... 3,070
2001 .................................... 3,184
2002 .................................... 3,190
2003 .................................... 3,190
Thereafter .............................. 9,602
--------
25,252
Less amounts representing interest ...... (6,310)
--------
Present value of net minimum obligations 18,942
Less current portion .................... (1,491)
--------
Long-term capital lease obligations ..... $ 17,451
========
As of May 3, 1998, the Company had definitive commitments of $18,871,000
for capital expenditures primarily to increase its processed meats and
value-added fresh pork capacities at several of its processing plants and to
replace and upgrade portions of its hardware and software in response to the
Year 2000.
NOTE 10 -- RELATED PARTY TRANSACTIONS
A director of the Company is the chairman, president and chief executive
officer and a director of Prestage Farms, Inc. ("PFI"). The Company has a
long-term agreement to purchase hogs from PFI at prices which, in the opinion
of management, are equivalent to market. Pursuant to this agreement with PFI,
the Company purchased $168,829,000, $182,576,000 and $129,577,000 of hogs in
fiscal 1998, 1997 and 1996, respectively.
The chairman and chief executive officer and a director of Murphy Family
Farms, Inc. ("MFF") was a director of the Company until May 1998. The Company
has a long-term agreement to purchase hogs from MFF at prices which, in the
opinion of management, are equivalent to market. Pursuant to this agreement
with MFF, the Company purchased $366,397,000, $433,861,000 and $330,033,000 of
hogs in fiscal 1998, 1997 and 1996, respectively.
A director and the owner of 50% of the voting stock of Maxwell Foods, Inc.
("MFI") was a director of the Company until May 1998. The Company has a
long-term agreement to purchase hogs from MFI at prices which, in the opinion
of management, are equivalent to market. Pursuant to this agreement with MFI,
the Company purchased $118,041,000, $109,470,000 and $76,448,000 of hogs in
fiscal 1998, 1997 and 1996, respectively.
In fiscal 1998, 1997 and 1996, the Company purchased raw materials
totaling $18,524,000, $12,772,000 and $10,069,000, respectively, from a company
which was 48%-owned by the chairman and chief executive officer's children. In
the opinion of management, these purchases were made at prices that were
equivalent to market.
The Company is engaged in hog production arrangements with several related
parties. See Note 3 for additional information regarding these arrangements.
NOTE 11 -- DISCONTINUED OPERATIONS
In fiscal 1996, the Company completed the disposition of the assets and
business of Ed Kelly, Inc., its former retail electronics subsidiary, which is
reported separately as discontinued operations in the consolidated statements
of income. A loss from discontinued operations of $3,900,000 is reflected in
fiscal 1996.
F-19
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 12 -- REGULATION AND LITIGATION
Like other participants in the meat processing industry, the Company is
subject to various laws and regulations administered by federal, state and
other government entities, including the U.S. Environmental Protection Agency
("EPA"), the U.S. Department of Agriculture, the U.S. Food and Drug
Administration, the U.S. Occupational Safety and Health Administration and
corresponding state agencies in states where the Company operates. Management
believes that the Company presently is in compliance with all such laws and
regulations in all material respects and that continued compliance will not
have a material adverse effect on the Company's financial position or results
of operations. The Company believes that the ultimate resolution of the
litigation and investigations discussed below will not have a material adverse
effect on its financial position or results of operations.
Under the water pollution control laws of the United States and the
Commonwealth of Virginia ("Virginia"), the Company is required to maintain
certain test records for three years. Failure to do so may result in the
imposition of civil penalties. Criminal sanctions may be imposed in the event
of false reporting or destruction of records. In July 1994, the Company learned
that records of many tests conducted at its Smithfield, Virginia packing plants
from 1991 through early 1994 could not be found and may have been destroyed. In
1997, the employee responsible for such testing and record-keeping was
convicted in the United States District Court for the Eastern District of
Virginia on eight charges of records destruction and making false reports.
Since January 1998, several of the Company's employees responsible for
wastewater treatment operations have been called to testify under subpoena
before a federal grand jury in Norfolk, Virginia. The grand jury also issued
subpoenas requiring production of various environmental materials relating to
the Company's wastewater treatment operations at these plants. Neither the
Company nor any of its other present or former employees has been charged with
any criminal violation arising from these matters, but there can be no
assurance that such charges will not be brought.
On August 8, 1997, in a civil suit filed by the EPA against the Company,
the United States District Court for the Eastern District of Virginia imposed a
$12,600,000 civil penalty on the Company for Clean Water Act violations at its
Smithfield, Virginia packing plants. The Company recorded a nonrecurring charge
of $12,600,000 during the first quarter of fiscal 1998 with respect to this
penalty. The Company has appealed this decision to the United States Court of
Appeals for the Fourth Circuit. There can be no assurance as to the outcome of
such appeal or any subsequent proceedings regarding this matter.
Prior to the filing of the EPA suit, the Commonwealth of Virginia filed a
civil suit against the Company in the Circuit Court of the County of Isle of
Wight, Virginia under Virginia's water pollution control laws. Virginia's
action alleged 22,517 discharge permit violations at the Smithfield, Virginia
packing plants during the period 1986 until 1997. Most of these alleged
violations were also presented in the EPA suit. While each violation is subject
to a maximum penalty of $25,000, Virginia follows a civil penalties policy
designed to recapture from the violator any economic benefit which accrued as a
result of the noncompliance, plus a surcharge penalty for having committed such
violations. In addition, the policy may increase the amount of penalties based
upon the extent of environmental damage caused by the violations.
At the beginning of the July 1997 trial of its case, Virginia contended
that the Company had received an economic benefit of $4,000,000 due to its
noncompliance and should pay a total of $6,000,000 for the alleged violations.
In the middle of the trial, however, Virginia voluntarily dismissed its suit.
One week later, Virginia refiled the same suit in Isle of Wight County Circuit
Court. On June 29, 1998, the Court overruled the Company's motions to dismiss
this second suit on double jeopardy and res judicata grounds. If Virginia's
charges go to trial again, the Company will present evidence to show and argue,
among other things, that no economic benefit accrued to the Company as a result
of, and that no environmental damage was caused by, the violations. There can
be no assurance as to the outcome of any such proceeding.
F-20
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 13 -- INCOME PER SHARE
The computation for basic and diluted income per share is as follows:
INCOME SHARES PER SHARE
------------ -------- ----------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Fiscal 1998
Net income per basic share ...................................... $ 53,400 37,532 $ 1.42
Effect of dilutive stock options ................................ - 2,200 -
-------- ------ -------
Net income per diluted share ................................... $ 53,400 39,732 $ 1.34
======== ====== =======
Fiscal 1997
Net income per basic share ...................................... $ 44,937 - -
Less preferred stock dividends .................................. (1,238) - -
-------- ------ -------
Net income available to common shareholders per basic share ..... 43,699 36,121 $ 1.21
Effect of dilutive stock options ................................ - 1,144 -
Effect of dilutive convertible preferred stock .................. 1,238 1,293 -
-------- ------ -------
Net income per diluted share ................................... $ 44,937 38,558 $ 1.17
======== ====== =======
Fiscal 1996
Income from continuing operations ............................... $ 19,786 - -
Less preferred stock dividends .................................. (1,152) - -
-------- ------ -------
Income from continuing operations available to common
shareholders per basic share ................................... 18,634 33,865 $ .55
Effect of dilutive stock options ................................ - 1,135 -
-------- ------ -------
Income from continuing operations per diluted share ............ $ 18,634 35,000 $ .53
======== ====== =======
The summary below lists stock options outstanding at the end of each
fiscal year which were not included in the computation of income per diluted
share because the average exercise price of the options was greater than the
average market price of the common shares. These options, which have varying
expiration dates, were still outstanding at May 3, 1998.
1998 1997 1996
----------- ------------ ------------
(SHARES IN THOUSANDS)
Stock option shares excluded ....... 65,000 100,000 440,000
Average option price per share ..... $ 32.42 $ 16.88 $ 13.70
F-21
SMITHFIELD FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 14 -- QUARTERLY RESULTS OF OPERATIONS
FIRST SECOND THIRD FOURTH
------------- -------------- ---------------- --------------
(UNAUDITED
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Fiscal 1998
Sales ...................... $ 914,963 $ 982,699 $ 1,095,999 $ 873,781
Gross profit .............. 75,184 93,970 116,663 101,797
Net income (loss) .......... (6,541) 15,548 23,719 20,674
Net income per common share:
Basic .......................... $ (.17) $ .41 $ .63 $ .55
Diluted ........................ (.17) .39 .60 .52
Fiscal 1997
Sales ...................... $ 892,870 $ 969,226 $ 1,080,979 $ 927,536
Gross profit .............. 58,762 73,577 88,704 99,895
Net income ................. 746 9,017 15,734 19,440
Net income per common share:
Basic .......................... $ .01 $ .24 $ .43 $ .53
Diluted ........................ .01 .23 .40 .50
F-22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
TO THE SHAREHOLDERS OF SMITHFIELD FOODS, INC.
We have audited in accordance with generally accepted auditing standards
the financial statements included in the Form 10-K Annual Report of Smithfield
Foods, Inc. for the fiscal year ended May 3, 1998, and have issued our report
thereon dated June 10, 1998. Our audit was made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedule listed
on the Index to Financial Statements and Financial Schedule filed as a part of
the Company's Form 10-K Annual Report is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
The schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Richmond, Virginia
June 10, 1998
- F-23 -
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SMITHFIELD FOODS, INC.
PARENT COMPANY BALANCE SHEETS
AS OF MAY 3, 1998 AND APRIL 27, 1997
FISCAL YEARS ENDED
-------------------------------
MAY 3, 1998 APRIL 27, 1997
------------- ---------------
(IN THOUSANDS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .......................................................... $ 7,800 $ 38
Accounts receivable ................................................................ 324 3,675
Receivables from related parties ................................................... -- 1,414
Refundable income taxes ............................................................ 2,300 --
Deferred income taxes .............................................................. 23,634 33,901
Other .............................................................................. 15,921 5,137
--------- ---------
TOTAL CURRENT ASSETS ............................................................. 49,979 44,165
--------- ---------
Investments in and net advances to subsidiaries, at cost plus equity in undistributed
earnings ........................................................................... 679,266 444,149
--------- ---------
OTHER ASSETS:
Investments in partnerships ........................................................ 46,966 41,753
Property, plant and equipment, net ................................................. 18,327 9,838
Other .............................................................................. 26,353 16,476
--------- ---------
TOTAL OTHER ASSETS ............................................................... 91,646 68,067
--------- ---------
$ 820,891 $ 556,381
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable ....................................................................... $ -- $ 2,500
Current portion of long-term debt .................................................. 6,248 4,263
Accounts payable ................................................................... 2,795 5,167
Accrued expenses ................................................................... 45,232 28,617
Income taxes payable ............................................................... -- 1,789
--------- ---------
TOTAL CURRENT LIABILITIES ........................................................ 54,275 42,336
--------- ---------
Long-term debt ...................................................................... 387,732 192,384
--------- ---------
Deferred income taxes and other noncurrent liabilities .............................. 17,874 14,175
--------- ---------
Shareholders' equity ................................................................ 361,010 307,486
--------- ---------
$ 820,891 $ 556,381
========= =========
The accompanying notes are an integral part of these balance sheets.
F-24
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SMITHFIELD FOODS, INC.
PARENT COMPANY STATEMENTS OF INCOME
53 WEEKS ENDED 52 WEEKS ENDED 52 WEEKS ENDED
MAY 3, 1998 APRIL 27, 1997 APRIL 28, 1996
---------------- ---------------- ---------------
(IN THOUSANDS)
Sales ................................................... $ -- $ -- $ --
Cost of Sales ........................................... 9,589 1,820 (2,540)
--------- --------- --------
Gross Profit ............................................ (9,589) (1,820) 2,540
General and administrative expenses, net of allocation to
subsidiaries ........................................... 4,686 10,911 5,780
Depreciation expense .................................... 843 903 892
Interest expense ........................................ 24,578 16,434 2,556
Nonrecurring charge ..................................... 12,600 -- --
--------- --------- --------
Loss before income tax benefit and equity in earnings of
subsidiaries ........................................... (52,296) (30,068) (6,688)
Income tax benefit ...................................... (19,130) (12,562) (2,400)
--------- --------- --------
Loss before equity in earnings of subsidiaries .......... (33,166) (17,506) (4,288)
Equity in earnings of subsidiaries ...................... 86,566 62,443 20,174
--------- --------- --------
Net income .............................................. $ 53,400 $ 44,937 $ 15,886
========= ========= ========
The accompanying notes are an integral part of these statements.
F-25
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SMITHFIELD FOODS, INC.
PARENT COMPANY STATEMENTS OF CASH FLOWS
53 WEEKS ENDED 52 WEEKS ENDED 52 WEEKS ENDED
MAY 3, 1998 APRIL 27, 1997 APRIL 28, 1996
---------------- ---------------- ---------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................................... $ 53,400 $ 44,937 $ 15,886
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ............................... 1,461 1,040 1,162
Gain on sale of property and equipment ...................... -- (2,328) (1)
Changes in operating assets and liabilities:
Deferred income taxes and other noncurrent liabilities ..... 13,966 (37,308) 5,343
Accounts receivables ....................................... 3,351 (1,329) (2,171)
Receivables from related parties ........................... 1,414 45 6,615
Other current assets ....................................... (10,784) (3,367) (1,318)
Accounts payable and accrued expenses ...................... 14,243 15,696 260
Refundable income taxes .................................... (2,300) -- 3,458
Income taxes payable ....................................... (1,789) 1,560 229
Other assets ............................................... (10,495) (1,541) (4,778)
---------- --------- ----------
Net cash provided by operating activities ..................... 62,467 17,405 24,685
---------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .......................................... (9,332) (3,226) (2,987)
Proceeds from sale of property, plant and equipment ........... -- 3,424 38
Increase in investments in and advances to subsidiaries, net
of common stock issued to acquire John Morrell & Co. ........ (235,117) (80,800) (36,649)
Investment in partnerships .................................... (5,213) (5,660) (2,376)
---------- --------- ----------
Net cash used in investing activities ....................... (249,662) (86,262) (41,974)
---------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance (repayments) of short-term debt ........ -- (500) 500
Proceeds from issuance of long-term debt ...................... 447,150 140,000 --
Principal payments on long-term debt .......................... (252,317) (71,200) (2,420)
Exercise of options ........................................... 124 1,270 767
Issuance of preferred stock ................................... -- -- 20,000
Preferred dividends ........................................... -- (1,238) (1,152)
---------- --------- ----------
Net cash provided by financing activities ................... 194,957 68,332 17,695
---------- --------- ----------
NET INCREASE (DECREASE) in cash and cash equivalents ........... 7,762 (525) 406
CASH AND CASH EQUIVALENTS at beginning of year ................. 38 563 157
---------- --------- ----------
CASH AND CASH EQUIVALENTS at end of year ....................... $ 7,800 $ 38 $ 563
========== ========= ==========
The accompanying notes are an integral part of these statements.
F-26
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SMITHFIELD FOODS, INC.
NOTES TO PARENT COMPANY FINANCIAL STATEMENTS
May 3, 1998 and April 27, 1997
1. The Notes to Parent Company Financial Statements should be read in
conjunction with the Registrant's Notes to Consolidated Financial
Statements included herein.
2. Restricted assets of Registrant:
Existing loan covenants contain provisions which limit the amount of
funds available for transfer from the subsidiaries to Smithfield Foods,
Inc. without the consent of certain lenders.
3. Accrued expenses as of May 3, 1998 and April 27, 1997 are as follows:
(In thousands) 1998 1997
-------------- --------- ---------
Self-insurance reserves $21,834 $14,151
Other 23,398 14,466
-------- --------
$45,232 $28,617
======= ========
4. Long-Term Debt:
In fiscal 1998, the Registrant entered into loan agreements with a bank
group providing for $350,000,000 in revolving credit facilities,
consisting of a five-year $300,000,000 revolving credit facility and a
364-day $50,000,000 revolving credit facility. In connection with this
refinancing, the Registrant repaid all borrowings under its previous
$300,000,000 credit facilities, which were terminated. The 364-day
$50,000,000 revolving credit facility was later terminated.
In fiscal 1998, the Registrant issued $200,000,000 in aggregate principal
amount of 10-year 7.625% senior subordinated notes. The net proceeds
from the sales of the notes were used to repay indebtedness under the
Registrant's $300,000,000 revolving credit facility with the balance
invested in short-term marketable debt securities.
In fiscal 1997, the Registrant privately placed $140,000,000 of senior
secured notes. The proceeds of the financing were used to repay
$65,200,000 of long-term bank debt and for investments in and advances to
subsidiaries. In conjunction with the placement of these notes, the
Registrant refinanced $59,707,000 of existing long-term debt previously
recorded by its subsidiaries. The result of the refinancing was to
transfer debt to the parent and revise maturity dates and repayment
schedules for the refinanced debt. No additional proceeds resulted from
this refinancing.
As of May 3, 1998, the Registrant is guaranteeing $18,942,000 of capital
lease obligations of its subsidiaries and a $300,000,000 credit facility
that had no outstanding balance.
Scheduled maturities of the Registrant's long-term debt consists of the
following (in thousands):
Fiscal Year
1999 $6,248
2000 2,362
2001 3,134
2002 3,083
2003 10,473
Thereafter 368,680
-------
$393,980
========
5. The amount of dividends received from subsidiaries in fiscal 1998 and
1997 was $43,423,000 and $65,316,000, respectively.
6. In fiscal 1997, all of the Series C 6.75% cumulative convertible
redeemable preferred stock, totaling $20,000,000, was converted into the
Registrant's common stock.
F-27
7. In fiscal 1998, the Registrant's shareholders approved the
reincorporation of the Registrant in Virginia from Delaware. The purpose
of the reincorporation was to reduce annual franchise taxes and does not
affect the Registrant's capitalization or the manner in which it
operates.
8. Supplemental disclosures of cash flow information (in thousands):
Fiscal Year 1998 1997 1996
- ----------- ---- ---- ----
Interest paid, net of amount capitalized $20,901 $11,106 $ 1,807
====== ====== =====
Income taxes paid $10,179 $15,043 $ 1,685
====== ====== =====
Noncash investing and financing activities:
Refinancing of long-term debt $ - $59,707 $ -
====== ====== =====
Conversion of preferred stock to common stock $ - $20,000 $10,000
====== ====== =====
Common stock issued for acquisition $ - $ - $33,000
====== ====== ======
Conversion of receivables from related parties
to investments in partnership $ - $ 7,691 $ -
====== ====== ======
F-28