Tyson Foods' Q1 Earnings Conference Call: Full Transcript

Operator:

Welcome to the <b>Tyson Foods, Inc.</b> TSN Quarterly Investor Earnings Call. At this time, all participants are in a listen-only mode. Questions will be taken after the presentation and to ask a question you may press star followed by the number one. This call is being recorded. If you object, please disconnect down. I will now turn the call over to Jon Kathol, Vice President of Investor Relations.

Jon Kathol:Vice President, Investor Relations and Assistant Secretary:

Good morning and thank you for joining us today for Tyson Foods’ conference call for the second quarter of the 2016 fiscal year. On today’s call are Donnie Smith, President and Chief Executive Officer; and Dennis Leatherby, Executive Vice President and Chief Financial Officer.

Our remarks today include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. I encourage you to read the news release issued earlier this morning and our filings with the Securities and Exchange Commission for a discussion of the risks that can affect our business. To be fair to other analysts in the queue, we ask that you limit yourself to one question and one follow up during the Q&A portion of our call. If you have additional questions, please get back to the queue and we’ll answer as many of your questions as time allow.

I will now turn the call over to Donnie Smith.

Donnie Smith:President and Chief Executive Officer:

Thanks Jon. Good morning, everyone. Our transformation continues and our momentum is building with another record setting quarter characterized by strong performances across all segments. Versus Q2 last year, operating income grew 27% to $704 million with an operating margin of 7.7%, both records for a second quarter which is typically our most challenging.

We delivered adjusted EPS of $1.07. Our strategies for growth are working. Our team is focused on innovation and building our portfolio of leading products and brands who are adjusting to consumer trends and shifts in the market place and we’re capturing synergies.

Total synergies for the quarter were $144 million. Year-to-date, synergies are $265 million and are ahead of pace to exceed $500 million by the end of the fiscal year. Total synergies since the acquisition are $450 million. Dotting into the specifics for the quarter, Prepared Foods, Chicken, and Pork were in or above their normalized margin ranges, while beef just it’s missed its range after recovering from losses a year ago.

Total volume was up 2.1% excluding the divestiture of our Mexico chicken operation. Top line sales were down across the board as the deflationary environment continued for beef, pork, and chicken prices. Prepared Foods operating income was $197 million with a 10.9% return on sales timed to previous record. Operating income improved due to product mix changes and lower input cost.

Total volume compared to Q2 last year was down three tenth of a percent. Sales dollars were down 3.6% due to lower inputs and pricing actions at retail as we positioned our portfolio to accelerate volume growth in the back of the year. Our data indicates that our efforts to drive volume momentum is having the intended effect as volumes were up 4% for the most recent four week period in the quarter on the back of significant share gains driven primarily by Ball Park hot dogs, Jimmy Dean breakfast sausage, and Hillshire Farm smoked sausage and lunchmeat.

In Q2, we captured $111 million in synergies in the Prepared Foods segment with $41 million incremental to Q2 of last year. We expect to set segment operating margin to be at the low of the normalized range in fiscal 2016 as we continue putting a good portion of the synergies back into the business for innovation, new product launches, and strengthening our brands to support long term growth.

The chicken segment produced operating income of $347 million and a 12.7% return on sales was a Q2 record. Volume was up 1.7% while sales dollars were down 3.3%.

Over the past five years, we’ve differentiated our chicken business by being more consumers driven. We have upgraded our mix to more value added and branded products. We diversified our pricing mechanisms. We have optimized our cost structure by investing in our operations with good ROI projects.

We have implemented our ‘Buy vs. Grow’ strategy and we are providing industry leading quality and customer service. Because of the actions we have taken and because of the improvement to produce higher, more stable margins, we are raising the normalized range to 9% to 11%. Although we are taking the range up to 11% on the top and I will hurry on to say that we expect the chicken segment to come in above 12% for 2016 and while it’s early to talk about fiscal ‘17, we expect a similar operating environment next year.

Moving on to the beef segment, despite a challenging quarter beef showed significant improvement over Q2 last year. Operating income was $46 million with a 1.3% return on sales, volume was up 2.8% due to an increase in lab cattle process as a result of higher fed cattle supplies while sales dollars were down 11.9%. We are pleased with the performance of our beef business and we expect the segment’s operating margin to be in its normalized range of 1.5% to 3%.

Pork had a great quarter with $140 million in operating income and an 11.8% return on sales. Demand for pork was strong and volume was up 3.1% compared to the same period last year resulting in improved capacity utilization. As pricing declined, sales dollars were down 1.2%. With the increased hog supplies in fiscal ‘16 we believe the Pork segment’s operating margin will be above its normalized range at around 10%.

Let’s move from our segments to consumer and channel trends. As we mentioned last quarter, our efforts to expand retail branded total points of distribution and close pricing gaps were implemented slower than planned but we see the tide turning. According to RRR, total Tyson retail volume excluding raw frozen chicken and ground beef jobs is up 3% in the latest four-week period versus flat in the 52-week driven of course by growth in the core non. So, clearly momentum is building and we feel great about our growth driving initiatives throughout the upcoming summer season.

In addition to volume, core non share is up as well. Dollar shares up seven tenth of a share point and volumes share is up 1.6 share points in the most recent four-week. In the macro environment consumer sentiment is strong and disposable personal income continues to rise. Economic optimism is driving growth in the fresh department and attractive fresh meat and pricing is also a factor as volumes are up nearly 3% for the latest 13 weeks.

In food service, MPD is reporting growth in both traffic and check size. While we play across all layers of food service, we are especially well aligned with the national food service change that are shown in the service change that is showing the most growth. Within broad line distributors, Chicken is up 6%. Among branded chicken companies, Tyson has the number one share by far and each of the 8 major categories and we’re growing share in 5 of 8 categories.

To keep our products relevant with consumers, we must keep refreshing our offerings through flavor and formula updates line extensions and disruptive innovation. In July, we’ll be introducing Jimmy Dean stuffed hash browns and Ball Park frozen sandwich meat including pork, meatballs, and steakhouse burgers. Retailer acceptance has been very good and selling is going well.

In September we’re launching an extension of Hillshire snacking platform and we’ll roll out our new Tyson naturals line of frozen chicken products featuring all natural ingredients and no antibiotics ever. As we innovate, we’ll align with customers to grow where the growth is. Non-store retail or ecommerce is projected to grow three times faster than the rest of market so we have begun innovating with the ecommerce shopper and retailer in mind. We’ll continue to partner with leading US retailers testing click and collect models.

Additionally as we announced at CAGNY, we’re expanding our relationship with Amazon Fresh to sell fresh protein as well as partner with them around innovation. We plan to launch Tyson taste makers aligned with chef inspired meal kits premium proteins for home delivery with Amazon Fresh this fall.

We’ve a lot to be excited about in 2016 and we’re generating momentum to carry us through 2017. Our portfolio is aligned with consumer trends and marketplace shifts. The retail core non continues outpacing total food and beverage with volume growth is accelerated. We’re growing with growing customers.

Our food service portfolio is positioned with growing national accounts and categories and broad line distribution. We’re innovating with new products across all channels. Our innovation pipeline is extensive and driven by consumer insights. We’re valuing up our product mix.

We’re driving growth. We’re in a good macro environment, we’re capturing synergies, we’re buying back stock. We’re on track for another record year and we’re raising 2016 adjusted earnings guidance to $4.20 to $4.30 a share which would give us a full year EPS CAGR of at least 21%. All that adds up to a great fiscal year and we expect 2017 to be even better.

Through a game changing acquisition and continuous improvement, Tyson Foods is a different company. Now let’s go to Dennis.

Dennis Leatherby:Executive Vice President and Chief Financial Officer:

Thanks Donnie and good morning everyone. Q2 was another record quarter as we delivered robust results across each of our segments. With record second quarter EPS and operating income, we continue to deliver the growth, synergies, innovation and operating income that is transforming Tyson from a protein company to a demand driven protein centric food company. We were able to repurchase 6.9 million shares for $400 million in Q2.

So far, during the third quarter of this year, we repurchased approximately 3 million shares for $200 million. In total over the past 10 months, we have now repurchased over 22 million shares for approximately $1.1 billion, underscoring our commitment to continue returning cash to shareholders.

Q2 revenues were $9.2 billion representing a decrease of 8% due to continued declines in beef, pork, and chicken prices. However, volumes grew 2.1% when excluding the divestiture of our Mexico operation in the prior year. Total company return on sales was 7.7%, a record for the second quarter. Operating income was $704 million representing a 27% increase over adjusted operating income from Q2 a year ago and is also a record for the second quarter.

Our record second quarter adjusted EPS have $1.07 represents a 43% increase over $0.75 adjusted earnings per share in Q2 last year.

I would also like note that on an adjusted basis, our last 12 months’ EPS is $3.85. Our operating cash flow through two quarters was $1.1 billion and we spent $355 million on capital expenditures. This outpaced our depreciation by $50 million as we continued to invest in projects with a focus on delivering high ROIC.

Our effective tax rate in the second quarter was 32.7% on a GAAP basis and 34.5% on an adjusted basis. Net debt to EBITDA for the past 12 months was 1.8 times. Including cash of $254 million, net debt was $6.1 billion. Total liquidity was $1.2 billion which in line with our minimum liquidity target.

During the second quarter, we retired 6.6% $638 million 2016 notes that were due and since the acquisition of Hillshire in August 2014, we have reduced our gross debt by about $2.1 billion. Our rapid leverage reduction in under two years reflects our commitment to maintaining investment grade credit ratings. Net interest expense was $63 million during Q2. For the quarter, our diluted shares outstanding were $393 million.

Now here are some additional thoughts on fiscal 2016. We expect revenues of approximately $37 billion which includes the impact of our fiscal 2015 divestures and declines in beef, pork and chicken prices. Through six months we captured $265 million of synergies and are ahead of pace to exceed $500 million by the end of the fiscal year. Additionally total synergies since the Hillshire acquisition are $450 million.

Net interest expense should approximate $245 million. We currently estimate our adjusted effective tax rate to be around 35%. CapEx is expected to approximate $850 million as we continue to focus on projects that create long term shareholder value.

Prior to adjusting for any additional share repurchases subsequent to this call and based on our average share price in Q2, we expect our average diluted shares to be around 390 million. As we have demonstrated, our capital allocation priorities are governed by our disciplined focus on driving long term shareholder value. Our priorities for deploying our significant operating cash flow are for investing in consumer preferred portfolio driven by innovation and brand building along with growing our businesses organically through our operational efficiency and capital expansion projects, acquiring businesses that support our strategic objectives and returning cash to shareholders through share purchases and dividends all while maintaining plenty of liquidity, investment grade credit ratings and continuing to expand our debt capacity.

As we have discussed on our earnings calls over the past few years, we have been transforming our chicken business. We have grown our branded products which are anchored in consumer insights and innovation. We have reduced our commodity sales as we recreated a model that is 90% full and only 10% push to the market and we have implemented our ‘Buy vs Grow’ strategy where we can purchase up to 10% of our chicken meat on the open market to margin up. These initiatives have helped transform our chicken business to create a higher or stable margin structure for what we believe is a new level of profitability for the stick segment.

As a result, we are increasing the chicken segment’s normalized range to 9% to 11% as this will more accurately reflect the impact of the sustainable fundamental business improvements in our chicken segment as we accelerate growth.

In closing, we delivered record results in our second quarter which is typically softer and seasonally more challenging. As mentioned in this morning’s release, we are raising our adjusted EPS guidance range to $4.20 to $4.30 per share for fiscal 2016 up from our previous range of $3.85 to $3.95. This new range is up more than 30% over 2015 adjusted EPS. This new range also represents a compounded annual growth rate up at least 21% adjusted EPS for the four year period of 2012 to 2016.

We are excited about the momentum we have going into fiscal 2017 as we continue to transform our business of leading brands and advantaged categories that put us in a unique position to drive long term shareholder value. That concludes our prepared remarks. Charmaine, we’re ready to begin Q&A.

Question & Answer

Operator:

Thank you, sir. Our first question comes from the line of Mr. David Palmer of RBC Capital Markets. Sir your line is open.

You may begin.

David Palmer:RBC Capital Market:

Thanks. Good morning. Donnie thanks for the detailed update and the guidance for ‘16. I know it’s early but at I know investors minds will be racing ahead to 2017 and thinking about how you are going to lap this strong year.

You anticipate 10% plus EPS growth next year, is that in the cards? And if so, what is coming in to focus that’s going to help you get there and what are some of the major unknowns or potential offsets that you are thinking about? Thanks.

Dennis Leatherby:

Thanks David. So first of all it’s great to finish what looks will be another record year for us in ‘16. Something of a 30% increase over last year and well beyond our stated goal of least 10% EPS growth overtime. So as we look forward we feel great about the momentum that we’re generating. So let’s talk a little bit about what we know.

So we know we’re driving growth. If we see in the most recent four week data in RRR we’re gaining momentum as we move into and closer to Memorial Day and on through the summer season and that feels really good. And this is improved there were some private label volumes that we did not renew but we feel great about our opportunities to grow going forward. So we like our mix.

We’re invested a lot in the long term growth great advertising a lot of investment and innovation. We announced a new process and plant for our chicken business. We needed some further processing capacity in the par-fry arena. We’re getting that around this now.

We have got capacity in fully cooked so we feel great about that.

As we look into our Prepared Foods group, we’ve got really strong merchandising lined up for the summer season. I think that will help carry a lot of momentum into the fall and in to next year, great innovation pipeline. So we’ll have some good innovation to continue to add next year. Our chicken business has really improved.

I feel real good about volume growth in the back-half of our year in chicken.

Pork looks like it’s going to have another good year in ‘17. We’ve got what looks like to be good supply of hogs coming our way. Beef same story we’ve got good supply of cattle coming out where it looks like in ‘17. So if you add all that up with great cash flow and our ability to continue to invest in a business, it feels really solid for ‘17.

Now for the stuff we don’t know, the commodity related stuff rain etc. We don’t know that yet but no reason to believe that we won’t have -- you got a plan go on ahead for a normal crop year. So no reason not to believe that wouldn’t happen now.

David Palmer:

Well thanks a lot. Thank you very much.

Dennis Leatherby:

Yes. Thanks.

Operator:

Thank you Mr. Palmer. Our next question comes from the line of Adam Samuelson of Goldman Sachs.

Adam Samuelson:Goldman Sachs:

Thanks. Good morning, everyone. Maybe first I want to talk Jon and Dennis and team on the new chicken margin range the 9% to 11% maybe help think about or just a clarity on what you think the bigger drivers of the 200 basis points upgrade would have been and if your looked at 2016 performance, you would see that you are still operating at least a 100 basis points above the high end maybe think about the areas that would cause you to drip down into the lower -- back into the range moving forward. Thank you.

Jon Kathol:

Yes so Adam what we do is just we run a series of statistical models that take into account the change in our business model. They would include mix, various spicing mechanisms, the supply and demand environment around grain and that kind of think. And they look at all of those fundamentals over the very long term and so when looking at the model, it showed clearly that it was time for us to raise our normalized range. As far as the over performance goes, we’ve got very strong volume this year.

We feel good about that. Obviously our grain position is favorable this year at the low-end of what we expect the five year range of grain to be and that helps over deliver a bit and if you look going forward at what -- in my calls it’s that level of fundamentals primarily driven around the grain but I’d tell you, we’ve done a very good job of utilizing the price discovery mechanisms afforded us to take a lot of the grain volatility out of our business. We’ve priced much more of our product off in some kind of grain based through mechanism so we feel good about the diversity of our pricing mechanisms, the price discovery mechanisms that we can employ on the grain side to stabilize those margins. So that’s our view on the guidance.

Adam Samuelson:

That’s very helpful and then if I could have a follow up, as I look at the second quarter typically used with prepared remarks, usually the second quarter is the seasonal quarter low point for the year but I would bet any even just a second level performance to the back-half, you’d be at about the high end of the guidance range. So maybe help us think about what normal seasonality for your business wouldn’t apply in ‘16 or there was something unusual in the first half of ‘16 that was extra beneficial?

Dennis Leatherby:

So we’re obviously all saw a really good start. Our Prepared Foods business has performed very well. The volume was a little bit like for us particularly in Q2 getting our price guess reflected on the shelf took a little longer that we had expected and that cost us a little bit of volume and but that’s about the only thing that you can say and it might have been be a little softness in pizza toppings but that’s about the only thing you can say negative about our Prepared Foods business. It is doing very well and it is really building momentum.

The chicken segment, great quarter. A lot of things came our way. Grain was good, volume was up a little bit, we have improved our mix so that feels really good, beef so much better than last year, good cattle supply around us and it looks like that we will continue on through the rest of the summer. So I feel good about where we are certainly I think we are in good spot for now on our guidance.

Adam Samuelson:

Great. Thanks very much.

Operator:

Our next question comes from the line of Ken Goldman of JPMorgan. Sir your line is open.

Ken Goldman:JPMorgan:

Hi good morning everyone and thanks for taking my question. Hey Donnie, just in response to Dave Palmer’s question or to follow up, you said that the company’s goal is for 10% plus EPS growth overtime. That’s the same terminology used in CAGNY but it is a little different than what Tyson previously said which was for 10% plus every single year. I think so I just wanted to clarify.

Personally for me it’s more reasonable to expect 10% plus on average than every single year but I just wanted to again clarify is the goal double-digit growth ‘16, ‘17, ‘18 every single year or is it more of that sort of CAGR or over a longer period you expect to get that.

Dennis Leatherby:

Well we’ve tried to be pretty consistent about saying 10% EPS growth overtime. But our goal is to always grow our earnings, grow our volume. We’ve got a great growth story and we want to take every advantage of that we can. We’ve got a great consumer relevant portfolio.

We’ve got super innovation pipeline lined up and so yes we should be able to expect good EPS growth. It’s too early to call what we think ‘17 will be here but for all the things I mentioned in for David’s question, feel great about our opportunity for ‘17 to be even better.

Ken Goldman:

Okay and then for my follow up, Pilgrim’s announced it’s going to convert an entire facility into organic chicken. I was just curious for your take on this. Is this something Tyson would consider given the consumer shifts out there or is organic less of a priority for the company right now.

Donnie Smith:

Well we go where the consumer leads us. I mentioned a little earlier, we’re building a new plant. We’ve got great demand for that process and so we’re building that plant for long term growth. We’ve got some great organic products today in our portfolio.

So far we’re able to source that meat outside of our production but we’ll continue to focus on the consumer and where there is no antibiotics ever or natural offerings organic whatever it may be we’re going to be a consumer led company and we will respond accordingly.

Ken Goldman:

Thank you, Donnie.

Operator:

Our next question comes from Farah Aslam of Stephens Inc. Your line is open.

Farha Aslam:Stephens, Inc.:

Hi. Good morning. First question’s on Prepared Foods, in the release you highlighted that you have a three-year pipeline. Would that involve incremental more spending than what you are doing today or is there a way you can turn back and how should we think about those Prepared Foods margins going forward over the next few years.

Donnie Smith:

Yes. I think we feel good about our ability to grow our Prepared Foods business while maintaining 10% to 12% margins. And that’s really what we want to do. Could we push the margin structure a little hard, yes we could but we have the opportunity to grow our customers want us to grow and so we feel like that 10% to 12% range gives us the growth opportunity that that business can afford the consumer.

So I feel really good about the map spending that we have focused on our business. We spend that disproportionately in categories so not all of the brands get the exact same amount of spending so we spend disproportionately of where we can get growth Jeff and Eric and Tim and the teams have a great plan set up to be able to drive growth in the back half and carry that momentum on into ‘17.

We are doing a super job on our pricing now we have got merchandising lined up for the summer season. We have got like three year pipeline and there is a lot of versatility in that pipeline about our ability to if one particular innovation may take longer to get to market than we expected and there is others in the pipeline that can fill that slot so we can continue to give the customer the kind of innovation that they need to keep the categories fresh. So we feel like we are set up really well.

Farha Aslam:

That’s helpful. And as a follow up on Pork, you highlighted that you have good hog supplies coming to you but we also have incremental processing capacity that’s coming on line over the next kind of three to four years. Do you anticipate that increased capacity will impact your pork margins or will the availability of hogs continue to match the capacity so you should continue to have some pretty strong pork margin.

Donnie Smith:

Yes the pork industry’s been shifting and developing for years. We have got strong relationships with our suppliers and by way on the customer side. Our math shows that the supplier growth and the demand growth are in relative balance over the next few years. We are still in the right locations.

We still got a great supply base close to us. We got great customer demand for the product and in our Prepared Foods business as we continue to grow that will have even more opportunities to create value. So we feel really good about how our pork business is lined up for the next few years.

Operator:

Our next question comes from the line of Akshay Jagdale of Jefferies. Your line is open.

Akshay Jagdale:Jefferies:

Good morning and congratulations. So I wanted to ask about Prepared Foods. Can you help us quantify or just give us some sense of how much of the savings or tailwinds that you have from lower commodity costs over the last couple of years which is in excess of $500 million and the synergies which are cumulative $500 million thorough the end of this year. How much of that is being passed on to consumers in the form of lower pricing but that’s in your food service business and or Prepared Foods and also how much of it roughly is being reinvested in that just can you give me some sense of that and then I have a follow up.

Donnie Smith:

Okay so the thing about Prepared Foods about half our Prepared Foods business is food service and a pretty sizable majority of our food service business has pass through pricing relationship so a lot of that commodity pricing does get passed along. If you look -- well another thing to note too, about 80% of so of the synergy capture is in Prepared Foods, the rest is spread out across the rest of our segments. And I’d say we spend about 5% or so on map and we’re investing really heavily in growth. We’ve got a lot of innovation.

We’ve talked about getting our price gaps right, we’ve gotten our price gaps right, and we’re seeing the volume response that we suspected we would see. So that’s a great investment for us and we’ll continue to do that to grow our Prepared Foods business. That business is built for growth. We’ve got great brands in great categories and we’ve got a very good growth story and we’re going to continue to invest.

Akshay Jagdale:

Perfect and then just to follow up on that train of thoughts, so Prepared Foods you mentioned four-week data Nielsen, can you give us a sense of what it was in the quarter and then more importantly with all these investments long term, what should be the algorithm for that particular piece of your business so the core nine should grow at what rate longer term once all these investments start to pay off?

Donnie Smith:

Yes so, again I am going to use the I’ll go to the last 12-week data and we had the exact saying spread between the 12-week data and the 52-week data as we did the 4-week, so I am looking at if we look just at the -- let me use all of our branded portfolio minus the raw frozen IQF and then I am going to take out ground beef, both of those are UPC’s but the consumer is warming those in a tray instead of the UPC items and so that volume is moving out of the RRR data is showing negative in the RRR data but we are not losing the sale we’re just selling in fresh category. So, when we look at our branded business minus IQF and ground beef jugs for the 12 week period, we’re showing 3% volume growth versus being flat in the 52 week.

So we see the exact same thing and looking back at Q2, took us a little longer than we wanted to get the pricing gaps realized on the shelf and now that we’re there, I expect to see good momentum all through the summer selling season especially in light of the merchandising we’ve got set up and the advertising that we’ve got employed so feel really good about that growth prospect longer term our brands we used to phrase we have advantage brands and advantage categories and we do. The categories where in outpaced food and beverage growth and I think over time you should expect us to grow at about 1.5 times the category growth.

And so when you run that algorithm, you are in categories that are outgrowing total food and beverage and you are out as the brand leader in a lot of those categories you are outrunning that growth by one and half times. That sets up very well to add a lot of shareholder value overtime.

Akshay Jagdale:

Perfect. I’ll pass it on. Thanks.

Operator:

Our next question comes from the line of Mr. Tim Ramey of Pivotal Research. Your line is open sir.

Tim Ramey:Pivotal Research:

Good morning thanks and my congratulations Donnie. Hey it wasn’t that long ago we reduced the range the -- at least to me perhaps the most important and encouraging number of the morning was the beef performance in its seasonally weakest quarter with volume growth and that range is a big range to say 1.5% to 3% for the full year. Do you have any kind of preview as what the selling for grilling season looks like or any kind of update on what we should be thinking about the summer because it looks this could be a source of significant growth.

Donnie Smith:

Yes with the drop in the cut out and a little bit more stabilization if you can call it that and that futures it feels like that the retailers have been much more willing to feature beef coming for Memorial Day forward. 50s have been pretty cheap, so ground beef is a good value if you look at the latest 13 weeks, ground beef is up about 6% or so on a 15% decrease in price. You continue it accelerates just to tad to about 6.5% in the four-week view on about the same kind of a price decline. So this cheaper cut out is going to mean better beef volume I think plus we’ve got supply around us.

There is still a bit of retention. You’re seeing -- about 44% or so of the slaughter so we’re still growing hard a bit. It looks like to us that for the year now obviously bigger in the back half, for the year, we are actually about 2% increase in the fed cattle supply this year and we think that’s the number for the next two years.

Again as we know, we’re very well positioned for the big feed -- we’re the big hot capacity feeds are so yes it feels good to have the worst behind us in beef and some good supply coming to us and that will help certainly our margin.

Tim Ramey:

And just a quick one on the capital structure. You’ve done a great job of bringing back that capacity, you’ve done a great job with the Hillshire acquisition. What’s from your perspective what does the landscape look like in terms of other packaged food or just the overall deal outlook is there something out there or is it getting more difficult.?

Donnie Smith:

I don’t think deal flow is as robust as it’s been over the last four or five years but we have a very consistent view that we look first of all for strategic fit and then we look at in absence of that and I think one of the great things about our business theme is that we’ve got a very good organic growth story and so as we look it as the landscape no need for us to push into a deal that does strategic that kind of thing so all though the landscape is little then it has been we continue to look we want to grow and we want to grow organically and we want to grow inorganically and Dennis a great balance sheet and a lot of capacity for we do that in the main time stock is great way to return cash for shareholders and we’ll staying on that and stay pretty consistent with uses of capital like we have been for the last couple of years

Tim Ramey:

Thanks so much.

Operator:

Thank you. Our next question comes from the line of Mr. Jeremy Scott from CLSA.

Jeremy Scott:CLS

Good morning. I just wanted to ask, switching gears a bit indeed the -- of the market in China you know the USDA has been sounding the alarm on commercial supplies given the inability to source -- from the US I think the current forecast calls for down double-digits in 2016 and 2017 so from your vantage point and number one is that an accurate assessment of the state of the market and what that can mean for your operations and down the road when and if this export bans are lifted, could we see while meat imports into China. Thank you.

Donnie Smith:

Hard to say on that last part. I wouldn’t venture to take a guess there.

We are seeing higher Pork prices in China which typically lead to higher chicken prices but chicken demand has remained a bit soft and we have not seen the price of chicken respond like it normally does in proportion to Pork. I would tell you this though that our international team are focused on driving value in fresh branded chicken and I think they are making good headway they are seeing good momentum.

Any of the market factors like a lower chicken supply that would ultimately lead to higher wholesale markets would only benefit our business. But in the meantime we are certainly not standing back on a low we are working hard to grow our business and to grow a great branded fresh offer.

Jeremy Scott:CLS

Okay but from your vantage point, does that magnitude drop in production sound reasonable?

Donnie Smith:

Yes. Oh I am sorry, yes.

Jeremy Scott:CLS

Okay. Thank you.

Operator:

Our next question comes from the line of Mr. Brett Hundley.

Brett Hundley:BB&T:

Hey. Good morning guys. Congratulations on a great quarter. I have, Dennis and Donnie, I have a initial question for you on the balance sheet.

Your net debt ticked back up this quarter went up about $570 million plus from fiscal Q1 and I know you generate a lot of strong cash flow in the back half for the year and so Dennis I am just kind of curious to get a sense of maybe how net debt can trend into end of the year and if there is a target where you’d like to exit the year from a leverage standpoint and somewhat related to that, are you okay putting debt on the balance sheet to buy back stock or would you rather just use cash flow.

Dennis Leatherby:

Great questions I feel this part first off that we did expect that net debt to grow up seasonally. As you may recall we have cattle and hog deferrals that flip from the end of December into March that we have pay off typically $300 million to $400 million a year. That’s not unusual. We did say we had a lot of extra cash going in to this quarter on purpose because we intended the pay off the 2016 notes which were $638 million.

So that answers that part of the question.

As far as net debt for the rest of the year I will say that it will be generally in the area where we are now maybe up or down $50 million or $100 million and to answer the question about borrowing the buyback stock, we would rather not. We think it’s a better use to our resources to invest in growth first and foremost and use the rest to buy back stock and continue to build our debt capacity.

Brett Hundley:

That’s great I really appreciate that and then just as a follow on, when you think about using the balance sheet for M&A, kind of wanted to follow on to Tim’s question. It appears to us that there is not a ton of attractive assets for sale here in the US domestically and if they are they are quite expensive and so I am wondering if we might see any kind of I won’t call it a pivot but a pivot from you guys where you might focus more on international M&A opportunities the landscape seems interesting there and I just wanted to get some color from you guys or an update on what you might look at would it be more on the fresh side or would you want to continue to focus on the consumer and value add? Where are you looking, just any parameters you can give us would be really helpful. Thank you.

Dennis Leatherby:

Brad certainly, international would also or is also a M&A focus. Our strategy is to grow value added poultry and Prepared Foods in international. And so and think value added poultry and Prepared Foods when you think international. So those are the type of businesses that we would be looking at and focusing on because that’s as Sally often reminds us about 96% of the population is outside of the US and food consumption is going to grow around the world so we want to be positioned to be able to grow for the long term and that means international as well.

So, you are absolutely thinking right to think that international acquisitions would be targets as well.

Brett Hundley:

And may be just real quick is it fair to say that international presents more opportunities than domestic right now?

Donnie Smith:

It’s hard to say Brett. That’s a no call there.

Brett Hundley:

Thanks, I’ll leave it there.

Operator:

Our next question comes from the line of Mr. Robert Moskow of Credit Suisse.

Robert Moskow:Credit Suisse:

Hi. Thank you. I wanted to ask about the synergies you have visibility into an increase in fiscal ‘17 to get to more than 700. Can you talk about what’s going to be incrementally better to drive those synergies higher supplier for prepared foods and then also I think you said you just trying to is that impacted your capacity innovation and all or maybe just but how is that

Donnie Smith:

thanks for the question so we on the synergies to biggest factors so far is been operation improvement frankly and the legacy Tyson prepared foods business as we move forward our procurement synergies it come a larger component so thank packing cooking ingredients maintenance prepared items and all those things and so we feel really good about where we are going forward on the synergy landscape and they move the synergy captured will move more from the operational and the operational components into the procurement component and then the last piece will be in the network optimization the logistics component that will come within the later in certain payment and some of that over ‘18 I think second half your question

Robert Moskow:

just the you said you walked away from some private label business I wanted to know with that in tax the utilization and the plans with remember that was a big part of your synergies

Donnie Smith:

yes so yes it is but when we look at that you look at your contribution margin and that was some business that we you know I guess little bit hard to say with Tyson business we need to do without now we are rapidly working to replace that volume and I think as we move on through the rest of this year and going into ‘17 we will replace that business with other business and so it had a short term effect on capacity utilization but there was all build in to our ‘16 plans and we got we have every opportunity to get some business back around -- to fill in that board and that’s where our sales team working really hard to get that done.

Robert Moskow:

Okay great. So just to repeat Donnie it was part of your ‘16 plan or was it a kind of surprise to about ‘16?

Donnie Smith:

No, it was built in as we come into as came into ‘16. We did not renew the business last year for this year so we knew that capacity would be break in this year and we’ve working on still in that -- so yes it was part of the ‘16 plan.

Robert Moskow:

Alright. Thank you.

Operator:

Our next question comes from the line of Mr. Michael Piken of Cleveland Research.

Michael Piken:Cleveland Research:

Yes. Good morning. Congratulations on a good quarter. I just wanted to see the latest data from USDA regarding reader -- fairly sizable increase in the number of poultries hatched last month and I am just wondering is this potentially the start of a trend? I know you don’t want to extrapolate too much from one month but just your view on terms of our expansion may play out heading into fiscal ‘17 would be helpful?

Donnie Smith:

Yes so you are right. You don’t read too much into one month. It is better to look perhaps three months average but what we are hearing is that you are seeing an increased in AI in Mexico so my guess is that a lot of those are down to supply eggs for that market. That’d be my guess.

I don’t see any indication that there is an increase coming in the US excess now or about 98% of a year ago. So you can kind of see what the next quarter looks like so my guess is a lot of that’s going to Mexico.

Michael Piken:

Okay terrific and I guess as a follow up question I mean as you sort of think about the business over the next couple of years and are you seeing any change in terms of how your customers are doing purchasing in terms of what are people looking for grain-based type contracts or less -- given that there is not too much expansion forecast or is it still kind of the same type of contract you can see in a store in food service and retail. Thanks.

Donnie Smith:

Yes. We really don’t see any changes. We have evolved our pricing mechanisms over the last three or four years and I am assuming that we will continue to evolve them over time to make sure that we can ensure supply and work with our customers on pricing mechanisms that work for both of us. I think a big key for our business and I know our teams are focused on this is to make sure that we have got the very best quality out there and we have outstanding service and our teams are doing a super job at that right now.

So we will continue to work on those things as we move forward.

Michael Piken:

All right. Thank you very much.

Operator:

Our last question comes from the line of Mr. Ken Zaslow of Bank of Montreal.

Ken Zaslow:Bank of Montreal:

Hey. Good morning everyone. Just two questions; one is, is there a natural limit to your chicken margin? You are going from 5% and 7% and 7% to 9%, 9% to 11% and you see a company kind of do the similar thing with Turkey business. Can you talk about how the progression can go beyond this higher margin structure?

Donnie Smith:

Ken, our business is build for growth and frankly I would much rather have 9% to 11% chicken business that’s growing and outgrowing the categories that we’re in than to push the margin structure and end up having to sacrifice growth to do that. So that’s how we look at it. We’re actively working on getting -- we’ve got a lot of fully equipped capacity available right now. We’re actively working on putting a lot of capacity around us.

I think the team has done a superb job changing the mix that we are seeing some shift from frozen and to fresh at retail and our folks are all over that. That’s actually good for our business. So I think as we looked out and run our models for the next five years what we are trying to do is get some large portion on standard deviation of the mean and that kind of thing build into the model to be to reflect a business that can grow and maintain stable higher margin.

Ken Zaslow:

Okay and then if I think about 2017, when I look at it just on a big picture level, if your chicken margins are going to stay roughly where they are, your beef is probably coming off the bottom of the cycle and you are going to grow Prepared Foods business. So it does seem like there is opportunity for you to actually have reasonable growth in 2017. Is that not a fair way of just taking a stab at it?

Donnie Smith:

You got it and I think two, with adequate supply of pork and we port in inadequate supply of pork that means you should have favorable raw materials again next year in our Prepared Foods business which should allow us to be able to grow that business and have a favorable margin structure. So we feel great about the way ‘17’s shaping us.

Ken Zaslow:

Thank you.

Operator:

Thank you. We do not have any more questions on the queue. I would like to hand the call back to our speakers.

Donnie Smith:

Well standby reemphasize and think an important point. As we continue growing our volume and our earnings everything else will fall in line. Growth is and will be our primary focus. Thanks everybody for joining us today and I hope you have great week.

Operator:

Thank you. That ends today’s conference call. Thank you all for participating. You may now disconnect.