Sanderson Farms, Inc.
Q2 2017 Earnings Call Transcript

Published: 25 May 2017

[Operator:]

Good day and welcome to the Sanderson Farms, Inc. Second Quarter Fiscal 2017 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Joe Sanderson. Please go ahead, sir.

[Joe F. Sanderson Jr.:]

Thank you. Good morning and welcome to Sanderson Farms second quarter conference call. We issued a news release this morning announcing net income of $66.9 million or $2.94 per share for our second fiscal quarter of 2017. This compares to net income of $47.6 million or $2.11 per share during last year's second quarter. I will begin the call with some general observations, but before I do, I will ask Mike to give the cautionary statement regarding forward-looking statements.

[Mike Cockrell:]

Thank you, Joe, and good morning everyone. This morning's call will contain forward-looking statements about the business, financial condition, and prospects of the Company. The actual performance of the Company could differ materially from that indicated by our forward-looking statements because of various risks and uncertainties. These risks and uncertainties are described in our most recent annual report on Form 10-K and in the Company's quarterly report on Form 10-Q, filed this morning with the SEC in connection with our second quarter, and in our press release published this morning. These documents are available on our Web-site at sandersonfarms.com if you need access to them. You are cautioned not to place undue reliance on forward-looking statements made this morning, as these statements speaks only as of today. We undertake no obligation to update or to revise our forward-looking statements. External factors affecting our business, such as feed grain cost, market prices for poultry meat, and the health of the economy, among others, may be different tomorrow and our view today may be different from a few days from now.

[Joe F. Sanderson Jr.:]

Thank you, Mike. Benign grain cost, continued strong demand for chicken at retail grocery stores, higher volumes and improved export markets drove our results during our second fiscal quarter. Our sales volume in fresh and frozen chicken was up by 11.5% compared to last spring's volume and reflects outstanding yields and new production in Palestine and St. Pauls. Our feed cost per pound of fresh chicken processed was essentially flat during the quarter compared to last year's second quarter, while our average net sales price per pound of chicken sold was up by 5%. Market prices continued to reflect good demand for chicken. In addition to strong demand at retail grocery stores, market prices for chicken wings improved counter seasonally during the quarter. Boneless breast meat prices made a move up in April and have continued to move higher in May. While export market headwinds remained, including politics, economic factors and the strength of the U.S. dollar, export demand continued to improve this spring. The relative strength of the U.S. dollar continues as a headwind. Politics still impact our relationship with China but we are hopeful that will change. Finally, while oil prices remain relatively low, they have moved above their bottom, giving more buying power to countries heavily dependent on oil revenue to fuel their economy. Some export partners who typically look to the EU for chicken have increased purchases from the United States as a result of the presence of avian influenza in Europe. As a result of these improvements, leg quarter market prices moved higher as we moved through the quarter and leg quarter inventories remained manageable. These favorable trends, should they continue, should support prices over the short term. Prices paid for feed grains were higher during the quarter compared to last year's second fiscal quarter, but improved feed conversion rates and feed formulation adjustments allowed us to partially offset those higher prices. In my view, grain prices still don't reflect the ample worldwide supply of grain and as a result we remain close to the market. Planting progress in the United States remained slightly below historical averages, but time remains to get seeds in the ground. Getting acres planted doesn't mean a lot for future grain prices and feed costs, but it is a necessary first step in realizing a good crop. That said, we have priced little of our needs past next week, and given where future prices closed yesterday on the Chicago Board of Trade, had we priced all of our needs through the end of fiscal year at yesterday's close, cash corn and soybean meal prices during fiscal 2017 would be $24.5 million higher than a year ago. These numbers do not include the additional volume of grain we will need to purchase this year to feed the additional chickens we have on the ground in Palestine and St. Pauls. These higher costs would translate into a very slight increase in feed cost per pound of chicken processed for the year. In addition to our cost, we will be closely watching the chicken market and production numbers. Weekly exits over the past few weeks continue to trend a bit above a year ago and pullet placements continue to run slightly ahead of year ago numbers. However, hatch rates are lower. It appears I might finally be right in my prediction that live weights are levelling off. Through March, our industry processed 1.9% more ahead and live weights have been essentially flat with last year. The current USDA estimate for 2% more broiler meat during calendar 2017 when compared to 2016 seems reasonable, but could prove to be higher should hatch rates and live weights continue to trend lower. Despite higher production, per capita availability of chickens to domestic consumers is up less than 0.5% as a result of higher export volume. I'm pleased to report that the startup of our new St. Pauls, North Carolina facility continues to go well and we expect to reach full production in St. Pauls during our first fiscal quarter of 2018. The successful startup reflects the success in our training program, which prepare young managers to run the new operation. We continue to train managers to start operations at our next new facilities in Tyler, Texas. Construction is scheduled to begin there in our third fiscal quarter and we plan to open the new facilities during our first fiscal quarter of 2019. At this point, I'll turn the call over to Lampkin for a more detailed discussion of the market and our operations during the quarter.

[Lampkin Butts:]

Thank you, Joe, and good morning everyone. As Joe mentioned, overall market prices for poultry products were higher during the quarter when compared to our second quarter last year. Market prices for chicken products sold to retail grocery store customers remained relatively strong during the quarter and continued to reflect good demand. Bulk leg quarter prices were higher for the quarter compared to last year's second quarter for reasons described by Joe, averaging $0.344 per pound during our second quarter this year compared to $0.294 per pound last year. Through March, industry export volumes were up approximately 8.7% for calendar 2017 compared to last year, and export values were higher by 9.4%. Leg quarter prices improved during our second quarter by 18.7% compared to our first quarter. The current unabated bulk leg quarter is $0.38 per pound. Prices for jumbo wings were higher during our second fiscal quarter than last year's second quarter. Jumbo wings averaged $1.79 per pound, up 5.1% from the average of $1.71 per pound during last year's second quarter. The current unabated quote for jumbo wings is $2.01 per pound. Boneless breast prices improved during April and have continued to move higher in May. Market prices were higher on average by 9.1% compared to the second quarter a year ago. The second quarter's average unabated price was $1.28 per pound. Today, the unabated quoted market for jumbo boneless breast is $1.72 per pound. The overall result of these market price changes was an increase of $0.035 per pound in our average sales price per pound of chickens sold. We sold 1.036 billion pounds of poultry during the second quarter, an increase from the 928.9 million pounds sold during last year's second quarter. We processed 1.037 billion pounds of breast poultry during the quarter, up 9.6% from the 945.8 million pounds we processed during last year's second quarter. We previously projected we would process 1 billion pounds during the quarter, and higher than projected yields and 17 million pounds processed on House of Raeford birds, offset by slightly lower live weights than originally projected, made up the difference from our projection. We now expect to process approximately 4.23 billion pounds of fresh chicken this fiscal year, an increase of approximately 12.4% compared to fiscal 2016. We estimate we will process approximately 1.083 billion pounds in our third fiscal quarter and approximately 1.129 billion pounds during our fourth quarter. We have factored into these estimates a lower target live weight, the improved yields in live bird performance we have experienced the past two quarters, as well as the birds we will process for House of Raeford. Both of these estimates could be impacted by weather, bird performance and other factors, some of which are beyond our control. Results and margins at our prepared food plant improved during the second quarter compared to the second quarter last year, and we expect further improvement during the second half of the year. We sold 42.9 million pounds of processed chicken at our prepared chicken plant during the first half of this year compared to 44.7 million pounds through the first half of last year. The average sales price through the first half of the year decreased $0.012 per pound compared to last year. Both live production and our processing plants have performed very well versus the industry peers during the first half of the year. We certainly have opportunities that we are anxious to capture, but I've been pleased with our operations. At this point, I'll turn the call over to Mike.

[Mike Cockrell:]

Thank you, Lampkin. The 15.9% increase in net sales for the quarter to $802 million from $692.1 million last year was the result of the increase in sales price per pound described by Lampkin and the increase in pounds of poultry products sold described by Joe. The increase in our cost of sales for the quarter ended April 30 as compared to the same three months last year was a result of an increase in pounds of poultry products sold of 106.7 million pounds or 11.5%, partially offset by the 1.2% decrease in prepared chicken sold. The $19.4 million increase in SG&A expenses for the first half of the year reflects increased accruals for advertising and marketing expenses, higher trainee cost, higher legal fees attributable to litigation and start up cost of St. Pauls. During the first fiscal quarter ended January 31 of this year, the Company determined that achievement of the applicable performance space criteria for the performance shares granted November 1, 2015 was probable. Accordingly, the quarter and year to date numbers both reflect compensation expense of $1.2 million and $4.5 million respectively related to those agreements. As we move through the third quarter, management will continue to evaluate the probability of an ESOP accrual and a bonus accrual. The probability of reaching $10.96 per share, which is the threshold target under the earnings per share bonus award program, is difficult to assess with only two quarters under our belt, but it will become clearer as we move through the summer. Recall that if we accrue a probable ESOP contribution, that amount will be approximately 4% to 4.5% of gross profit and will be required to accrue three quarters of any expected liability in our third quarter. For the third and fourth quarters, I have $43 million and $45 million respectively in my model for SG&A. These numbers reflect startup cost at Tyler, with advertising, trainee cost, legal fees and stock compensation expense remaining fairly steady with the first two quarters. These numbers reflect no ESOP and no bonus accrual. Based solely on what we know today, a $10 million accrual for the ESOP might be reasonable in the third quarter, but again, it's too early to determine whether o not a bonus accrual is probable. But to put some numbers around a potential bonus accrual, while we determined that hitting the threshold earnings per share target under our bonus award program was probable, that's $10.96 a share, it would cost right at $1.5 million. If we hit the top target of $12.02 per share, that would cost $31 million. The midpoint of $11.50 would be a $16 million accrual. The Company's effective tax rate for the quarter and the first six months ended April 30, 2017 was 35% and for the balance of the year we continue to model that same 35%. We now expect to spend approximately $156.9 million on CapEx during the fiscal 2017 and have spent $96.6 million through the first half of the year. Of this total, $24.2 million was in St. Pauls. We intend to use cash on hand and cash flows to fund the balance of our capital budgets. Our depreciation and amortization for the first half of the year was $46.9 million and we now expect approximately $98.7 million for the full year. Before opening the call for questions, I want to mention that we will host our Annual Investor Conference in New Orleans again this fall. The conference will open with dinner Thursday night at the same venue as always and the conference will start at 8 o'clock Friday morning, October 13th. The conference will be at the Monteleone this year and dinner on Thursday night at I said would be in the same spot. We hope many of you will join us in New Orleans for the conference and we will send information out and post it to our Web-site very soon, but for now please mark the date. Katie, that's our prepared remarks, if you want to open it up for questions.

[Operator:]

[Operator Instructions] Our first question comes from Farha Aslam. Farha, please go ahead.

[Farha Aslam:]

Congratulations on the very strong quarter. Question about bird weight and production, and clearly profitability in the industry is very strong, [indiscernible] were being held up by the bird weight issue and the performance of the current breed, could you share with us how long you anticipate that issue to continue, and kind of as you go forward longer-term, how do you think the industry will respond to the very good profit level?

[Joe F. Sanderson Jr.:]

We have anecdotal data about bird weight, mainly from Urner Barry. Urner Barry is writing and talking about lower bird weights. We have seen flat bird weight from USDA for January/February/March, they are flat. And Urner Barry is talking about lighter bird weights and he has more access to processors than we do. And we know we have brought our bird weights in our big bird plants down from 9.5 to 9 to try to address woody breast. We think the industry or some in the industry has done the same thing and we can see in agro stats there are no more 10 pound birds. And that's how we can see it. And it looks like the average weight in the deboning market segment is down some, and that's all we know right now. We also can look at USDA statistics and see that the average hatchability is down 1% from a year ago. You can see the exits running about 2.5% ahead of a year ago, but the chick placements are 1.5% ahead of a year ago. So it looks like the flock is older and it's not hatching as well. My expectations would be to address that issue is for pullet placements at some point to go up a little bit to address that issue, but not a lot because I think the industry is pretty close to processing capacity. So that's what I think.

[Farha Aslam:]

That's helpful.

[Lampkin Butts:]

This is Lampkin. We have seen some USDA numbers that show that number of hen being processed 8 pounds and up is down 9% and then the 6.5 to 8 are up 10%. So we do know that that many hen have shifted down into that less than 7.75 pound weight.

[Joe F. Sanderson Jr.:]

And we think that that's woody breast.

[Farha Aslam:]

Okay, so that's the breast issue. Okay, and then if we think about China, there is talk about a Chinese delegation coming to U.S. kind of midyear to look at plants, et cetera. In terms of the timing of China opening up to [indiscernible] poultry and what that would do to Sanderson's earnings?

[Lampkin Butts:]

It's our understanding that China has a delegation coming in June, primarily to discuss and look at regionalization of the United States for something like avian influenza. I think they've got to come in June and come back in September, but that AI ban was implemented in January of 2015 and we have not been optimistic until now, that that might be lifted. I don't know when, but f we are successful, it will probably be this fall, but first time we have been optimistic since January 15. When we lost that market, it was pretty [indiscernible], it was costing us $4.3 million a year. The markets that we see that we are missing out on are still right at $4 million a month.

[Farha Aslam:]

So, $4.3 million a month if China opens up?

[Joe F. Sanderson Jr.:]

It's about $4 million a month now. When you add at our new production in, pre-tax.

[Farha Aslam:]

I'm sorry, so it was $4.3 million before and then if we add your new production, that we add another $4 million?

[Joe F. Sanderson Jr.:]

No, no. The market is different today than it was, then we don't know what the market is going to be when the market opens back up. The market today reflects going through Hong Kong. And so, we don't know, we have no idea of what the market is going to be like if China opens when we don't know about a tariff. So, we don't know, it could be – it was $4.3 million but we had new production, additional production, and we can say what it was when we left.

[Lampkin Butts:]

What we see is just a net dock. We have no idea of the expense that the industry…

[Joe F. Sanderson Jr.:]

We are not going through [indiscernible]. We are not doing that right now.

[Lampkin Butts:]

I think that's a very conservative number.

[Farha Aslam:]

Okay, so $4.3 million a month would be a conservative number, or roughly $4 million?

[Joe F. Sanderson Jr.:]

Yes.

[Farha Aslam:]

Okay, that's very helpful. Thank you.

[Operator:]

Our next question comes from Ken Goldman of JP Morgan. Please go ahead.

[Ken Goldman:]

Two for me if I can, just if you could get a little bit of an update or if we can get a little bit of an update on your latest thoughts on tray pack pricing, what your customer are basing it on, are you still basing it off the last Georgia Dock price, I'm not sure if you had addressed that previously, how accurate do you think the new Urner Barry price is, just a little more color there would be I think helpful?

[Joe F. Sanderson Jr.:]

Most of our customers are still offered the last published Georgia Dock, which is 109.75. Now that's their base price and then a lot of them have sale prices that are agreed-upon whenever their contract will sign. Some of them have sale prices that are based off the Urner Barry prices, that are as you know going up every day now. And then some of them have negotiated sale prices. As we said, I believe – when did we describe, was it December or February when we described how much of our product is based off the Georgia Dock?

[Lampkin Butts:]

That was in February.

[Joe F. Sanderson Jr.:]

February. About 10% of our sales are actually based off Georgia Dock.

[Lampkin Butts:]

About half of our tray-pack.

[Joe F. Sanderson Jr.:]

A half of our tray-pack in terms of our sales are based off the Georgia Dock. In addition to that, we have gone out to our customers in the last month and asked for a raise because if there were a Georgia Dock, it would be going up right now and everybody knows it, and we have been successful in some places, in some places they said we are going to stick by our contract and use the Georgia Dock the last one that was published. But we have gotten some increases for the summertime from some of our accounts. We believe that we and our customers are going to have to look at the new Urner Barry for a while before everybody is comfortable with it. We ask Urner Barry to do this, to publish these numbers, but we think it will be the first of next year probably before everybody has seen it enough. It looks pretty good to me, but we think it will be next year before everybody's seen enough of it to become comfortable with it.

[Ken Goldman:]

Okay, that is very helpful, thank you for that. And then my quick follow-up is, wholesale beef prices have risen, I know you don't sell any beef obviously but you certainly track your competitive products, you're talking about chicken prices, maybe not across the board going up on the tray pack side and the wholesale side, but certainly in that direction. What are you seeing in terms of your customers' reactions, because we are hearing certain comments out there, I'll leave it at that, that maybe retailers are pushing back harder than usual, not passing through as much pricing, maybe pushing back like I said on their vendors, how would you describe the retail environment in terms of both accepting price increases and then passing them on to consumers, at least in the narrow area that you guys track?

[Lampkin Butts:]

Ken, we are not having any unusual pushback. Of course, our customers that are on the Georgia Dock have been [indiscernible] with that part of their program as flat, but no unusual pushback. The only thing I'm aware of is that the retailers, they have not passed along cheaper prices on particularly beef and pork. Chicken prices are down a little bit but they have mainly held on to their beef and pork margins other than some future prices.

[Joe F. Sanderson Jr.:]

And Ken, what you have for Memorial Day, you know [indiscernible]

[Lampkin Butts:]

Memorial Day is going to be about like normal. I mean they've got some beef, some chicken.

[Joe F. Sanderson Jr.:]

We think beef got most of the ads, but our orders for Memorial Day are so good that we are running two shifts on Memorial Day. We normally run one shift the Saturday before and then we are down Memorial Day, but we had to crank everything up to fill orders this year.

[Ken Goldman:]

I hope those people working on Memorial Day are getting overtime. Thank you, guys.

[Joe F. Sanderson Jr.:]

They are.

[Operator:]

Our next question comes from Ken Zaslow of the Bank of Montreal. Please go ahead.

[Kenneth Zaslow:]

Just a quick question, can you talk about the different product weight and the margin associated with big birds versus small birds and just how everything has gone between tray packs and how you kind of see that developing over the next call it 8 to 12 months?

[Joe F. Sanderson Jr.:]

Margins on big birds got ahead of tray pack beginning in March and they are way ahead of them in May, and we think that's going to last through Labor Day through September at least. They are way ahead of them in May, and for us, I mean margins are still good on tray pack but they are exceptional right now in big birds.

[Lampkin Butts:]

That's margin per head, Ken.

[Joe F. Sanderson Jr.:]

Yes, per head. When you put – where is boneless?

[Lampkin Butts:]

$1.72

[Joe F. Sanderson Jr.:]

$1.72 and $2 wing and a $0.38 leg quarter, put that all together and – where are tenders?

[Lampkin Butts:]

$1.95.

[Joe F. Sanderson Jr.:]

And $1.95 on tenders and benign grain cost, that's exceptional for big bird. And we think prices are maybe going up a little bit more on bonus and tenders. We think wings are kind of towards the top right now. Leg quarters may go up another $0.01 or so. But we are in at least through Memorial Day in the first of month, we are kind of getting close to the top on these prices for a while until heat hits, and when the heat hits, when you might see some other move, but wings are pretty close to topping out.

[Kenneth Zaslow:]

Can you tell me about what drove the wing prices so high, and although you think they are topping out, do you think they are stable at these current levels or you think they are going to start retreating seasonally, and I'll leave it there?

[Joe F. Sanderson Jr.:]

Ken, it's been a surprise to us. I mean we are – historically, wing prices start trending down after March madness. So this has been a surprise. We think it has to do with lighter bird weights and also the number of new restaurants that have been built over the last two years that are based off wing menus. We think the supply and demand, and I still think there will be a softening this summer, I still think we'll see a dip sometime this summer, but I don't think we are there yet.

[Operator:]

Our next question comes from Mike Piken from Cleveland Research. Please go ahead.

[Michael Piken:]

Just want to talk a little bit more about the age of the flock and specifically your breeding flock and do you guys have plans to sort of replace some of your old pullets and when do you think the rest of the industry is going to be looking to do that to improve hatchability rates and how much of a [indiscernible] potential is there?

[Joe F. Sanderson Jr.:]

Our breed of flock is current. We don't – our hatchability is normal and we don't have any older breeders, and ours is like it always has been. But I don't know – we started getting calls for eggs right after the first year and from two or three other integrators, and the indication was there were some health problems with their breeders, and they wanted to buy eggs from us, which we don't sell eggs, we don't have enough eggs to sell normally. And I don't know what kind of health problems they were having, but as we moved forward, you can look at the hatchability and the chick placements entailed that this flock is older and they are not hatching well. Last year the hatch was 84% all year. And I have no clue what's going on there, but there is some health issue or something with the overall flock, but nothing with ours.

[Michael Piken:]

Okay. Do you know if it's impacting a certain size bird more than the others, like is that part of the reason maybe big bid profitability has improved a little bit more?

[Joe F. Sanderson Jr.:]

No, I do not, I have no clue if it's one breed or not. I don't have an answer to that.

[Michael Piken:]

Okay. And then shifting gears, if you could just talk a little bit about your volume expectations for 2018, with or without Raeford, specifically how that might impact your 2018?

[Joe F. Sanderson Jr.:]

St. Pauls will be at capacity beginning in January. So Raeford birds won't have any impact in 2018, but St. Pauls will be at full capacity. So, do you all have 2018?

[Lampkin Butts:]

Processing growth chart, we'll have in just a minute.

[Joe F. Sanderson Jr.:]

They are getting it for you, Mike.

[Michael Piken:]

Okay, thanks, whenever, that's fine, you could pass it on. Thanks.

[Operator:]

In the meantime, our next question comes from Adam Samuelson from Goldman Sachs. Please go ahead.

[Adam Samuelson:]

Maybe first, I was wondering if you could quantify the profit impact if any from House of Raeford in the quarter, and then for the pounds that you're processing for the balance of the year, should we be considering those, just you have marketing control of that product and so your margin should be consistent with the other [tons] [ph] that are flowing through St. Pauls or are there any other…?

[Lampkin Butts:]

We are paying House of Raeford a flat fee per live pound, as we described in the 10-Q this morning, and that's really about all we can say about that contract. Now we take the market risk on the birds. The birds are ours and we sell them. They take the market risk on grain. We are paying a flat fee per live pound. The margins, just like they are on our other big bird products, are good right now.

[Adam Samuelson:]

That's helpful. And then maybe just on the market, I'm wondering, Joe, if you have any thoughts or you're seeing any impact in the industry data of higher antibiotic free and no human antibiotic production on the industry, whether that's on the hatch, if people aren't using the antibiotics on the hatchery anymore, if you think that's part of the cause of some of the people moving down in bird class size, just any thoughts of how that might be impacting available supplies, maybe certainly the egg production and availability in the industry has stepped up even if you're not producing yourself?

[Joe F. Sanderson Jr.:]

I think that may affect livability on flocks sold more than it would on hatchability. I mean we know that the total livability on no antibiotic birds is lower than if you use antibiotics, about 1% to 2% at least and in some cases 10%. And so I think there are fewer head delivered to the plant for sure with no antibiotics. And I think possibly at times you might have lower bird weights, but they can compensate for that by keeping birds in the houses longer. But mainly it probably affects feed conversion more than it does live weight. I think it could affect live weight to some degree.

[Adam Samuelson:]

Okay, that's helpful. I'll pass it on.

[Operator:]

Our next question comes from Heather Jones from The Vertical Group. Please go ahead.

[Heather Jones:]

So circling back to the retail business, could you give us a sense of what kind of price increases you've gotten just for modeling purposes? I understand that it sounds like you won't transition most of your business to a new price index until calendar 2018, but I mean did you get enough increases for the summer to make it meaningful, like do we need to get worried about that for our models?

[Joe F. Sanderson Jr.:]

You know how many?

[Lampkin Butts:]

Half-half. Of our customers, we have been to half, and half of those were good and we're waiting to hear from the other half. As our target modify, here's the thing, a portion of that business is sold at future prices. [Indiscernible] future prices are moving up, if they are being negotiated, these markets are higher, so they'll negotiate at a higher price or at this time [indiscernible] quote, those are higher. So, retail revenue is going to be up. I can't say how much, but it is going – it's not going to be flat because of the [indiscernible].

[Heather Jones:]

And you are talking about it's going to be up sequentially but it would sound like it's going to be up year-on-year as well. Could you have the pieces tied to the features like you said [indiscernible] strong?

[Joe F. Sanderson Jr.:]

Yes, that's right.

[Heather Jones:]

Okay. I mean because honestly if you look at some of these Urner Barry quotes, I mean am I out in La La Land to think that the piece that you have been able to get redone could be up more than 10% year on year?

[Joe F. Sanderson Jr.:]

No.

[Heather Jones:]

I'm not in La La Land?

[Joe F. Sanderson Jr.:]

Yes, it won't be up 10%.

[Heather Jones:]

It won't be up, that piece won't be up that much?

[Joe F. Sanderson Jr.:]

No.

[Heather Jones:]

Okay. Moving on to the weights, and also clearly woody breast is the biggest driver, so I have a two-part question. I understand that there are more foodservice companies that are going to be not only trying to get weights off the larger birds but actually potentially moving into other weight classes, like the much smaller birds. So one, how early do you think we are in this trend, and then secondly, a number of customers, both on the retail and the foodservice side have committed to adopting [GAAP] [ph] standards, which call for slower growth [indiscernible] and lower density, so I guess, I hesitate to say this given the nature of this industry, but if we can look out two or three years, it seems like there's a number of factors that are going to be a governor on supply and just if you could help us think about that?

[Joe F. Sanderson Jr.:]

I think there is another governor on supply and that is – if you want to look at what our next complex is going to cost, it's going to cost $190 million to $200 million and none of the big companies that could do that have indicated no intention of doing that, and I think that is a governor owned supply. There is a possibility that USDA could change line speeds. The regulation that governs line speeds. Right now there is [indiscernible] line speeds of 140 birds a minutes. We run 70 birds a minute. But everybody else runs 140 except a few plants that run 90 and a few plants that run, the original plants that tested the HIMP system at 175, they were grandfathered in at 175. I don't know how many plants that is, six or seven. And when the USDA was proposing the HIMP process, those consumer groups and the inspectors unions objected to it. So USDA pulled it, capped it at 140. There is possibility that USDA could go back in and reintroduce the 175. If that were to happen and it were to be passed, I think you could see some expansion, industry expansion by people going from 140 to 175. That would take a year to do that. They have to order breeder stock, they have to build chicken houses, they have to make some modifications in hatcheries and processing plants and you know a year ahead of time. I think it would be minor, but I think that's where your expansion would come from. I don't think anybody much is going to build a plant and I think the wait is over for a while. The primary breeders are going to have to breed this woody breast out, and that's going to take away a low feed conversion and maybe some yield to get this woody breast out. And the other things you mentioned, if that happens, the slower growing broiler and the smaller bird and the woody breast are all, we can't grow a 9.5 pound chicken right now, which was our target for this year, and the year before that we grew 9.25 pound chicken. We can't do that.

[Heather Jones:]

So as a follow up on your weights comment, do you think the reductions we're seeing now are the extent of the reductions we are going to see or do you think there is going to be more widespread adoption across the industry that could lead to pressure on weight for call it another year?

[Joe F. Sanderson Jr.:]

I don't know. Wendy's required all of their suppliers to go to a 7.5 pound chicken. That was the reason you saw that shift in class that Lampkin was describing, out of the 9 to the smaller class that USDA is showing. You might see some more of that. We didn't supply Wendy's, but we dropped our weights because of our customers. We did that on our own. We just couldn't tolerate a product quality problem with our customers. We did that before they – I mean we just, our own QC test told us we need to do. We did some other things too. We changed our batch and we changed our lighting problem to try to get this product quality thing straightened out.

[Lampkin Butts:]

And Heather, I'll take this opportunity to answer Adam's question, I think it was Adam, 4.4 billion pounds in 2018. That's up about 4% from this year. Sorry, Michael.

[Heather Jones:]

And the HIMP thing, you said a possibility, the way you said that makes me think that there are discussions ongoing right now as to that. I mean when could we see some color as to when they are going to allow that?

[Joe F. Sanderson Jr.:]

It will have to be published in the Federal Register and then – we don't, I don't think it's imminent.

[Heather Jones:]

You don't think it's imminent, it's not being discussed right now?

[Joe F. Sanderson Jr.:]

No.

[Heather Jones:]

Okay, perfect. Thank you.

[Operator:]

Our next question comes from Francesco Pellegrino from Sidoti & Company. Please go ahead.

[Francesco Pellegrino:]

I want to ask you a question about just what are your thoughts on maybe the long-term feasibility of the marketing program given what you have learned so far during 2017, something that we think about continuing in fiscal 2018 as well?

[Joe F. Sanderson Jr.:]

Our marketing program, advertising, we keep doing it, became we will keep doing it.

[Francesco Pellegrino:]

At an $8 million run rate per quarter?

[Joe F. Sanderson Jr.:]

I think that's reasonable for now. Frankly we have talked about second half of the year, but we really haven't started planning any strategy for next year, but I think that's reasonable to build a model on.

[Francesco Pellegrino:]

Okay. Just when I start thinking about how you guys are earning your bonus accrual, if you are going to pay out the 10 million to the ESOP plan, one of the questions that I had was sort of about like where your step-up function is going for your depreciation expense? I guess over the past three years on a quarterly basis, it looks like depreciation has increased by $10 million and that's per quarter, and I know we've had a lot of elevated spending over the past three or four years to support the business during some really great times and given how strong your balance sheet has been, but just given how quickly depreciation has sort of stepped up, given where your CapEx guidance is this year thinking about construction beginning in Tyler, Texas over this summer and then wherever your maintenance CapEx is right now for the business, where should depreciation be sort of topping out at?

[Joe F. Sanderson Jr.:]

We keep building plants, so it's not going to top out.

[Mike Cockrell:]

Our maintenance budget has increased. We've got about $100 million now and we are stepping that up $5 million a year just because we are adding assets. So in my model, you got a 100, then 105, 110, 115, just add $5 million to it because we keep adding plants. So depreciation of course is just a function of building these $200 million plants, like Joe described.

[Francesco Pellegrino:]

Right, but we are also lapping at period of time, whether it's 10, 15, 20 years ago where we didn't have this elevated CapEx spending. So we really don't have new high-priced assets coming off the books. So if we sort of just think about Tyler, Texas, maybe being – and I know that's not it, like it's quarterly depreciation topping out at $30 million right now beginning in fiscal 2018?

[Mike Cockrell:]

Actually I'm sorry, I'm not sure I'm following exactly what you're asking. Ask that again.

[Francesco Pellegrino:]

So, just when I look at all the assets that we are bringing online, including Tyler, Texas, is it reasonable to think that maybe quarterly depreciation to be anywhere between $27 million to $30 million beginning in 2018?

[Mike Cockrell:]

Yes.

[Francesco Pellegrino:]

Okay, all right that's it for me. Thank you, guys.

[Operator:]

Our next question comes from Akshay Jagdale of Jefferies. Please go ahead.

[Akshay Jagdale:]

Congratulations on a solid quarter. I wanted to ask about the breeder flock, with pullet placements having sort of decelerated on a 12 month trailing basis, so pullet placement growth was 4% or 5% last couple of years. Now it's 1%, 1% or 2%, depending on how you look at it. But the breeder flock has actually since October of last year it's up about 5% sequentially, right. And so, what do you make of that, is the last number that came up earlier this week, says it's up 1% year-over-year, I mean I guess the only answer, the logical answer is the age of the flock has been brought down that your hen slaughter is down, but what do you make of the breeder flock moving up as much as it has sequentially during a period when pullet placement growth has decelerated quite a bit?

[Joe F. Sanderson Jr.:]

I think a lot of the pullet placements in 2015 and 2016 was mainly building up for pullets and hens for the export of eggs to Mexico, and I think everybody thought they were going into the domestic supply flock when most of that growth was for two reasons, one of it, there was a change going on in the breeds where Aviagen was replacing two other breeds domestic flock and people were putting some extra breeders out because they didn't know what to expect from the Aviagen hen as she was replaced. And then the other extra in 2015 and 2016, two of the primary Mexican suppliers, integrators were putting their breeders in the United States and they were showing up in the domestic supply flock but they were really for eggs for Mexico. And so there really weren't – it looked like they were for the domestic supply flock but they really were not. They were for eggs for export. And all of that big buildup in 2015 and 2016, 7% to 8% of the breeder flock was for export, eggs for export, and I think that threw everybody off. The real domestic supply flock for pullets for the U.S. is about 1%. And as far as meat, broiler meat for this year, when you subtract the exports out, it's right at 0.25% when you put it all together. And pullets, I don't think you look at one number, one month, the last month they came out which was 97%, 93%, I don't think you look at that, I don't think that means anything. I think the next months maybe 106% and that 93% could be revised. Just one month doesn't mean anything.

[Akshay Jagdale:]

I realize, I was talking more on a trailing 12 month average basis, that's how we always look at pullet placements and pullet placements have decelerated, but my question was more about I get the whole Mexico issue, we are now tracking egg exports to Mexico which are down, but the breeder flock itself which includes both Mexico and U.S. breeders, right, we don't know exactly what percentage is for Mexico, was down year over year. So leaving aside what we're exporting in terms of eggs, the actual calculated or the reported number was down year-over-year for most of the back half of 2016, and now it's back up during a period when your additions of pullets has decelerated, right. So that's what I'm asking about. And at your Analyst Day, there was one presentation where they talked about the age of the flock and it was projected that 2017 was going to be, 2016 was the lowest in the last three, four years and 2017 was going to be slightly lower. So it just seems to me that the age of the flock is now at a more optimal level and to get there you have changed the rate of mature hen slaughter, if I may. So that's what I'm getting at but I don't know if you look at it that way.

[Joe F. Sanderson Jr.:]

We think the flock is older now. We don't think it's optimal, we think it is older. And the reason we do is because we look at the hatchability, and the hatches at 83%, we think they are holding pullets, holding hens longer because they are not getting eggs out. Now we don't know that for a fact. That's what we think. But we are showing all of 2016 the hen flock being 100% of 2015. This year it's about 100% so far for five months.

[Akshay Jagdale:]

So you don't agree with the EMI projection for the age of the flock I guess, you now think it's a flock's age is actually up?

[Joe F. Sanderson Jr.:]

I do.

[Akshay Jagdale:]

Okay. And then just while we are on talking about exports, I mean I think hatching exports sort of peaked and showing year-over-year decline a little bit. Any thoughts on what's happening there or do you have any sense of where that's headed?

[Joe F. Sanderson Jr.:]

We have no clue. I don't have a clue about what's going on in Mexico. It's primarily actually the rest of the world, I have a chart here in front of me, the rest of the world is down a little bit from its peak. Canada is about flat, but maybe up [indiscernible] and Mexico is down just a little bit. Mexico is down from its peak by maybe 1%. And of the total breeders, and it was accounting for – the whole world was running 8.5%, is down to 7.7% of total breeders. But I don't have a clue what's going on in Mexico or the rest of the world.

[Akshay Jagdale:]

Okay. And then one for Mike, and this is more of a longer-term question, you had a pretty detailed explanation of ESOP and all that stuff, which I'm sure I'm going to have to re-read, but that was helpful. But if you just look long-term, your SG&A to sales has gone up and that's a function of how well you're doing as a company, so that's great. But for somebody who is trying to model that portion of your P&L over a three to five year period, what do you think is a good number to use? I mean it seems like you were at 3.5% for a long period of time and now the last five years or so it's more like 5% with the increase in marketing, the increase in ESOP and all that stuff. So can you just help me out there, like if you were to model for your Company over a three to five-year period, SG&A to sales, what's the best guess over there?

[Joe F. Sanderson Jr.:]

You are at peak right now.

[Mike Cockrell:]

Yes, I think that's hard, Akshay. Ex bonus and ESOP, just take those out, because I don't have a clue. It's hard quarter to quarter, much less year-to-year, to know whether we are going to pay a bonus. But our legal fees are up, that's going to continue. Our trainee cost should be steady. Startup cost is going to move higher next year as we get St. Pauls. We are going to do another plant after that. Then you're going to have startup cost the next year. Advertising, I'm holding steady, but again, as we mentioned to another questioner, that strategy may change. But yes, I think Joe is right, this is peak right now I feel like because we have got…

[Joe F. Sanderson Jr.:]

As you get more volume though, it's going to decline. What I'm saying is you're at peak dollars. As you get more volume, that percentage goes down.

[Akshay Jagdale:]

What's the percent, do you have a sense of percent that's non-ESOP bonus related, because I know a part of the ESOP bonus also accrues…

[Joe F. Sanderson Jr.:]

Not in there right now.

[Mike Cockrell:]

Right, the bonus and ESOP are not in there. And when you go back and re-read the script, I've put those numbers out, but no, I don't have a percentage in front of me. I don't know what sales are going to be next quarter, Akshay.

[Akshay Jagdale:]

Got it, okay. I'll pass it on. Thank you.

[Operator:]

Our next question comes from Brett Andress of KeyBanc Capital Markets. Please go ahead.

[Brett Andress:]

Thanks for squeezing me in here, I just had one quick question. Your other cost per pound, they increased I think by about $0.005, or $0.015 I'm sorry, per pound and you called out that about half of that was related to St. Pauls I believe. I'm just trying to figure out what's your other half of that increase and I guess maybe was it related to maybe some of the overtime you ran during the quarter and how should we think about all the other cost that how that should trend through the back half of the year?

[Mike Cockrell:]

There were a couple of things going. There was some overtime premium in that number. Salaries went up, direct and indirect salaries both. Packaging was a little bit. It was, there is nothing one thing I can call out as most of it, Brett, but it was salaries, overtime, supplies, a little bit from repairs, but it was spread out among those.

[Brett Andress:]

Should we expect the St. Pauls, the impact of that to maybe be diminished as we work through the next two quarters?

[Mike Cockrell:]

Absolutely.

[Brett Andress:]

Okay, that's all I had. Thank you.

[Operator:]

Our final question comes from [Benjamin Serra] [ph] from Barclays. Please go ahead.

[Unidentified Analyst:]

Just I have two questions. One, could you just quickly confirm the CapEx number because I think I didn't get that for this year, so just to see what to put into model? I think I heard 156, but just to confirm.

[Mike Cockrell:]

That is correct.

[Unidentified Analyst:]

Okay, so we got that one. And then second, I mean you've mentioned prices are likely to come down on wings into the second half. So with that in mind, would you expect that the very strong levels of profitability you have seen in the first half, I mean especially on an operating profit margin level, that this is going to ease a little bit towards the end of the year but still turn out to be fairly strong? And also thank you very much for the good guidance on absolute SG&A expenses for the year. That helps a lot. But just to get a little bit of a sense as what you are expecting in terms of pricing and COGS, how that's going to evolve and how that's going to impact your margins, because [indiscernible] sensitivity here?

[Mike Cockrell:]

I think wings will soften sometime this summer. And then I think they will be going back up for football season.

[Joe F. Sanderson Jr.:]

Yes, they're going to have like 60 days, it's not going to be – I don't think – it's hard as they will hold steady for a while.

[Mike Cockrell:]

I don't think it's going down next week but sometime this summer.

[Joe F. Sanderson Jr.:]

$2 is a lofty place for wings to be but if they come down, it's not going to be for long and for much. I don't think they will come down a lot and I don't think they will come down alone. So you got two things going to happen. Normally by this time we are already packing wings and putting them in the freezer for the football season, mainly for January-February. We hadn't put a single wing in the freezer. So that has to be done and that's going to keep supply off the market. And I think that a lot of these restaurants out there, they are going full till, and so I don't think it will be hot like it is right now or like it has been. And then the other thing is, I think breast and tenders and leg quarters, they may slow down but they are not going to soften.

[Mike Cockrell:]

So those markets are very firm right now. Spot loads are trading at Urner Barry for boneless breast and real close to that tender, so those markets are very firm going into the summertime.

[Joe F. Sanderson Jr.:]

And so we think, I don't see those markets coming down much. I think there will be a cooling off period after the first of the month, but on the heels of that is July 4th. So we think the markets are going to be pretty good for a while.

[Unidentified Analyst:]

Okay, perfect. Thank you very much for that.

[Operator:]

I am showing we have no further questions at this time.

[Joe F. Sanderson Jr.:]

Good. Thank you and thank all of you for spending time with us this morning. We look forward to reporting our third quarter results in August. Thank you very much.

[Operator:]

This concludes today's conference. Thank you for your participation. You may now disconnect.