Pilgrim’s Pride Corporation — Q1 2017 Form 10-Q
Business context and reporting period
The filing covers the 13 weeks ended March 26, 2017; the comparison period is the 13 weeks ended March 27, 2016. Pilgrim’s Pride produces and sells chicken products in the U.S., Mexico and Puerto Rico. JBS beneficially owned 78.6% of the company’s outstanding common stock.
On January 6, 2017, the company acquired GNP, a Minnesota poultry business, for a preliminary purchase price of $357.3 million. GNP contributed $97.8 million in sales and $4.6 million in net income during the quarter.
Financial results and liquidity
Dollar amounts are in millions, except per-share data and percentages.
- Sales: $2,020.5, up 2.9% from $1,962.9. U.S. sales rose 4.0%, primarily reflecting GNP and higher sales per pound, partly offset by lower volume at existing operations. Mexico sales fell 2.9%, mainly due to currency translation.
- Profit and margins: Gross profit was $215.2, down 9.4%; gross margin was 10.7%, versus 12.1%. Operating income was $152.4, down 19.3%; operating margin was 7.5%, versus 9.6%. Net income attributable to Pilgrim’s Pride was $93.9, versus $118.4; diluted EPS was $0.38, versus $0.46.
- Drivers: Cost of sales rose 4.6% to $1,805.3, outpacing sales growth. SG&A increased 28.8% to $62.9, including acquired GNP expenses and higher costs at existing operations. U.S. gross profit declined $28.0 million; Mexico gross profit increased $5.7 million.
- Cash flow: Operating cash flow was $61.5, compared with $185.5. Investing activities used $474.0, including $359.7 for GNP net of cash acquired and $114.5 of capital expenditures. Financing activities provided $322.4. Cash, cash equivalents and restricted cash ended at $35.2, down from $125.3 at fiscal year-end.
- Debt: Long-term debt, including current maturities and before financing costs, was $1,357.9, up from $1,023.7 at December 25, 2016. It included $500.0 of 5.75% senior notes due 2025, a $500.0 term loan, $314.6 drawn on the U.S. revolver and $42.9 under the Mexico facility. Average borrowings increased to $1.3 billion from $1.0 billion, primarily to fund GNP.
- Liquidity: Current assets were $1,419.3 and current liabilities $916.8. The company reported $30.8 of cash and $340.6 available under its U.S. revolving facility, plus $37.0 available under the Mexico facility. Management said operating cash flow and available credit should fund obligations, working capital, debt maturities and capital spending for at least 12 months. The company said it was in compliance with U.S. credit-facility covenants.
- Other items: Income tax expense was $47.9, with a 33.6% effective rate, versus $62.6 and 34.7%. The company repurchased 779,512 shares for $14.6 million during the quarter.
Material changes and management commentary
- GNP added scale and expanded the company’s U.S. footprint and presence in organic and antibiotic-free chicken products. The purchase accounting remains preliminary; recorded goodwill from the acquisition was $97.2 million.
- Management attributed lower overall profitability to higher costs relative to sales and higher SG&A. U.S. sales growth included GNP, while existing-operation sales volume declined. Mexico results benefited from higher prices and volume, partly offset by peso translation.
- Feed ingredient prices remain volatile. Management reported that chicken prices were then sufficient to offset feed costs, but cautioned that chicken prices could fall and feed costs could rise. Commodity derivatives are not designated as cash flow hedges; changes in fair value are recognized immediately in earnings. Derivative fair-value changes were a $2.9 million net loss in Q1 2017, versus a $4.1 million net gain in Q1 2016.
- Capital expenditures were higher than in the prior-year quarter, primarily for projects intended to improve efficiency and reduce costs. The credit facility caps annual capital expenditures at $500 million.
Risks, contingencies and unusual items
- Several antitrust cases allege that poultry producers conspired to restrict broiler chicken output and increase prices; a separate grower lawsuit alleges conspiracy to depress grower compensation. Related shareholder class and derivative actions also allege misconduct and misleading disclosures. The company disputes the claims, but says outcomes and timing cannot be predicted and adverse judgments could materially affect results or financial condition.
- The IRS previously asserted $74.7 million in claims. Settlements addressed approximately $29.3 million and were expected to result in no additional tax for those settled issues; final calculations were still being completed.
- Key operating risks include feed and chicken price volatility, disease outbreaks, product contamination and recalls, competition, labor matters, currency movements, weather, litigation and the ability to integrate GNP and achieve expected synergies.
- The company estimates maximum potential operating-lease residual-value guarantees of approximately $11.1 million; it recorded no liability because payment was not considered probable. Management also disclosed $16.9 million of unrecognized tax benefits, with future cash outflows and timing not reasonably estimable.
Important facts for investors to verify
- Whether GNP integration delivers anticipated operating benefits and synergies, and whether preliminary acquisition valuations change materially.
- Subsequent trends in sales volume, realized chicken prices, feed costs and margins, particularly in U.S. operations.
- Cash conversion and working-capital needs, capital spending, and the effect of acquisition-related borrowing on debt and interest expense.
- Available revolving-credit capacity and continued compliance with debt covenants.
- Developments, potential exposure and any changes in accruals relating to the poultry antitrust and related shareholder litigation.