Methods of Distribution
We use a combination of private fleets of leased tractors and trailers and independent common carriers and owner operators to distribute live hogs, fresh pork and beef, packaged meats and other meat products to our customers, as well as to move raw materials between plants for further processing. We coordinate deliveries and use backhauling to reduce overall transportation costs. In the U.S., we distribute products directly from some of our plants and from leased distribution centers in Missouri, Pennsylvania, North Carolina, Virginia, Kansas, Wisconsin, Indiana, Illinois, Connecticut, California, Michigan, Arizona and Texas. We also operate distribution centers adjacent to our plants in Bladen County, North Carolina, Sioux Falls, South Dakota, Crete, Nebraska, Green Bay, Wisconsin and Souderton, Pennsylvania. Internationally, we distribute our products through a combination of leased and owned warehouse facilities.
Trademarks
We own and use numerous marks, which are registered trademarks or are otherwise subject to protection under applicable intellectual property laws. We consider these marks and the accompanying goodwill and customer recognition valuable and material to our business. We believe that registered trademarks have been important to the success of our branded fresh pork and packaged meats products. In a number of markets, our brands are among the leaders in select product categories.
Seasonality
The meat processing business is somewhat seasonal in that, traditionally, the periods of higher sales for hams are the holiday seasons such as Christmas, Easter and Thanksgiving, and the periods of higher sales for smoked sausages, hot dogs and luncheon meats are the summer months. The Pork segment typically builds substantial inventories of hams in anticipation of its seasonal holiday business. In addition, the HP segment experiences lower farrowing performance during the winter months and slower animal growth rates during the hot summer months. Our beef operations also enjoy a stronger spring and summer period during the traditional “grilling season.”
Competition
The protein industry in general, and the pork and beef processing industries in particular, are highly competitive. Our products compete with a large number of other protein sources, including chicken and seafood, but our principal competition comes from other pork and beef processors.
We believe that the principal competitive factors in the pork and beef processing industries are price, product quality and innovation, product distribution and brand loyalty. Some of our competitors are more diversified than us. To the extent that their other operations generate profits, these more diversified competitors may be able to subsidize their meat processing operations during periods of low or negative profitability.
FINANCIAL INFORMATION OF SEGMENTS
Financial information for each reportable segment, including revenues, operating profit and total assets, is disclosed in Note 12 in “Item 8. Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements.”
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RISK MANAGEMENT AND HEDGING
We are exposed to market risks primarily from changes in commodity prices, as well as interest rates and foreign exchange rates. To mitigate these risks, we utilize derivative instruments to hedge our exposure to changing prices and rates. For further information see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Derivative Financial Instruments.”
BUSINESS DEVELOPMENTS
The following business developments have occurred since the beginning of fiscal 2008:
Acquisition
In May 2007 (fiscal 2008), we acquired PSF for approximately $800.0 million in stock and cash including $125.4 million of assumed debt. PSF is one of the largest providers of pork products to the retail, wholesale, foodservice, further processor and export markets. PSF is a recognized leader in the pork industry through its vertically integrated business model that combines modern, efficient production and processing facilities, sophisticated genetics, and strict control over the variables of health, diet and environment. PSF has processing facilities in Missouri and North Carolina. PSF is also one of the largest owners of sows in the U.S. with operations located in Missouri, North Carolina and Texas. PSF’s results from pork processing operations are reported in our Pork segment and results from hog production operations are reported in our HP segment.
Discontinued operations
Smithfield Beef
In March 2008 (fiscal 2008), we entered into an agreement with JBS S.A., a company organized and existing under the laws of Brazil (JBS), to sell Smithfield Beef, our beef processing and cattle feeding operation that encompassed our entire Beef segment, to JBS for $565.0 million in cash.
The sale to JBS will include 100% of Five Rivers. We also entered into an agreement with CGC in March 2008 (fiscal 2008) to acquire from CGC the 50% of Five Rivers that we do not presently own in exchange for 2.167 million shares of our common stock. This transaction with CGC will occur immediately before the JBS transaction, is conditioned upon the JBS transaction taking place, and will make CGC a beneficial owner of more than 9% of our common stock. Paul J. Fribourg, a member of our board of directors, is Chairman, President and Chief Executive Officer of CGC. Michael J. Zimmerman, an advisory director of the Company, is Executive Vice President and Chief Financial Officer of CGC.
The JBS transaction excludes substantially all live cattle inventories held by Smithfield Beef and Five Rivers as of the closing date, together with the associated debt. Live cattle currently owned by Five Rivers will be transferred to a new 50/50 joint venture between us and CGC, while live cattle currently owned by Smithfield Beef will be transferred to another subsidiary of ours. The excluded live cattle will be raised by JBS after closing for a negotiated fee and then sold at maturity at market-based prices. Proceeds from the sale of the excluded live cattle will be paid in cash to the Smithfield Foods/CGC joint venture or to us, as appropriate. We believe that most of the live cattle inventories will be sold within six months after closing, with substantially all sold within 12 months after closing. The proceeds from the sale of Smithfield Beef’s live cattle inventories and our interest in Five Rivers’ cattle inventory, net of the associated debt, are expected to be in excess of $200 million.
The respective transactions are subject to customary adjustments, including working capital adjustments. The transactions are also subject to regulatory review. We are currently in the process of responding to the second request from the Antitrust Division of the Department of Justice. Barring regulatory delays, we anticipate the transactions will close during the second quarter of fiscal 2009. Accordingly, the results of Smithfield Beef are now being reported as discontinued operations. We expect that the net proceeds of the transactions will be used for debt reduction.
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Smithfield Bioenergy, LLC (SBE)
In April 2007 (fiscal 2007), we decided to exit the alternative fuels business. In May 2008 (fiscal 2009), we completed the sale of substantially all of the assets of SBE for $9.8 million. As a result of these events, we recorded an impairment charge of $9.6 million, net of tax of $5.4 million, during fiscal 2008 to reflect the assets of SBE at their estimated fair value. The results of SBE are reported in discontinued operations.
Other Developments
Classical Swine Fever (CSF)
In August 2007 (fiscal 2008), outbreaks of CSF occurred at three of our thirty-three hog farms in Romania. During the second quarter of fiscal 2008, we recorded approximately $13.0 million of inventory write-downs and associated disposal costs related to these outbreaks. CSF is a highly contagious, viral disease that affects pigs but has no effect on human health. We worked closely with Romanian authorities to contain the outbreaks and to destroy and dispose of animals on the three affected farms. We do not believe there are any future material costs remaining. We believe that we are eligible for reimbursement for certain costs associated with the euthanasia and disposal of the affected animals under governmental programs designed to compensate animal owners affected by disease. Romanian authorities have initially denied our claim for reimbursement of such costs. However, we are still actively pursuing reimbursement. Any potential cost reimbursement would only be recognized in the financial statements in the period in which it is received. There are no assurances that any funds will ultimately be collected.
Reduction of U.S. Sow Herd
On February 19, 2008 (fiscal 2008), we announced a plan to reduce our U.S. sow herd by four to five percent, or 40,000 to 50,000 sows. We believe that this will ultimately result in 800,000 to 1,000,000 fewer market hogs annually. We began phasing in these reductions immediately. We do not believe we will incur significant costs associated with the implementation of this plan. We may consider additional sow reductions if market conditions deteriorate.
REGULATION
Regulation in General
Like other participants in the industry, we are subject to various laws and regulations administered by federal, state and other government entities, including the United States Environmental Protection Agency (EPA) and corresponding state agencies, as well as the United States Department of Agriculture, the United States Food and Drug Administration, the United States Occupational Safety and Health Administration and similar agencies in foreign countries. Management believes that we currently are in compliance with all these laws and regulations in all material respects and that continued compliance with these laws and regulations will not have a material adverse effect on our financial position or results of operations.
Water
In February 2003, the EPA promulgated regulations under the Clean Water Act governing confined animal feeding operations (CAFOs). Among other things, these regulations impose obligations on CAFOs to manage animal waste in ways intended to reduce the impact on water quality. These new regulations were challenged in federal court by both industry and environmental groups. Although a 2005 decision by the court invalidated several provisions of the regulations, they remain largely intact. Similarly, the State of North Carolina Department of Environment and Natural Resources (NCDENR) has issued general permits intended to protect state waters from impacts of large animal feeding operations. Although compliance with the federal regulations and state permits required some changes to our hog production operations resulting in additional costs, such compliance has not had a material adverse effect on our hog production operations.
In the fall of 2007, the Waterkeeper Alliance and others filed a rulemaking petition with the North Carolina Environmental Management Commission (the Commission) requesting that the Commission initiate a
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rulemaking to require monitoring of potential or suspected discharges from swine farms in North Carolina. On May 8, 2008, the Commission accepted the petition and directed staff to form a stakeholder group to assist staff in developing a proposed rule for the Commission’s consideration at a later date. Although compliance with a new monitoring rule in North Carolina could impose additional costs on our hog production operations, such costs are not expected to have a material adverse effect of on our hog production operations. However, there can be no assurance that the rulemaking will not result in changes to the existing monitoring rules which may have a material adverse effect on our financial position or results of operations.
Air
The EPA is also focusing on the possible need to regulate air emissions from animal feeding operations. During calendar year 2002, the National Academy of Sciences (the Academy) undertook a study at the EPA’s request to assist the EPA in making that determination. The Academy’s study identified a need for more research and better information, but also recommended implementing without delay technically and economically feasible management practices to decrease emissions. Further, our hog production subsidiaries have accepted the EPA’s offer to enter into an administrative consent agreement and order with owners and operators of hog farms and other animal production operations. Under the terms of the consent agreement and order, participating owners and operators agreed to pay a penalty, contribute towards the cost of an air emissions monitoring study and make their farms available for monitoring. In return, participating farms have been given immunity from federal civil enforcement actions alleging violations of air emissions requirements under certain federal statutes, including the Clean Air Act. Pursuant to our consent decree and order, we have paid a $100,000 penalty to the EPA. Prior to the acquisition of PSF in May 2007, PSF’s Texas farms and company owned farms in North Carolina also agreed to participate in this program. The National Pork Board, of which we are a member and contribute funds, will be paying the costs of the air emissions monitoring study on behalf of all hog producers, including us, out of funds collected from its members in previous years. The cost of the study for all hog producers is approximately $6.0 million. New regulations governing air emissions from animal agriculture operations are likely to emerge from the monitoring program undertaken pursuant to the consent agreement and order. There can be no assurance that any new regulations that may be proposed to address air emissions from animal feeding operations will not have a material adverse effect on our financial position or results of operations.
The State of Missouri promulgated a rule that came into effect on January 1, 2002 to regulate odor emissions from large animal feeding operations such as the PSF operations in Missouri. This rule required PSF to develop plans to reduce odor emissions and to submit such plans to state authorities, which it has done. This rule also required PSF to make certain changes to reduce odors at the property line to certain established levels. We do not anticipate material costs to comply with the rule as promulgated.
Greenhouse Gases
Despite the recent failure of federal legislation establishing a cap-and-trade mechanism for regulation of greenhouse gas (GHG) emissions, we believe there will be continued interest in the future in potential regulation of GHG emissions. GHG emissions occur at several points across our operations, including production, transportation and processing. It is not possible at this time to predict the structure or outcome of future legislative or regulatory efforts to address such emissions or the eventual cost to us of compliance.
Regulatory and Other Proceedings
From time to time we receive notices from regulatory authorities and others asserting that we are not in compliance with such laws and regulations. In some instances, litigation ensues. The Waterkeeper Alliance, an environmental activist group from the State of New York, has filed or caused to be filed a series of lawsuits against us and our subsidiaries and properties. These suits are described below.
In February 2001, the Waterkeeper Alliance, Thomas E. Jones d/b/a Neuse Riverkeeper and Neuse River Foundation filed two lawsuits in the United States District Court for the Eastern District of North Carolina against us, one of our subsidiaries, and two of that subsidiary’s hog production facilities in North Carolina,
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referred to as the “Citizens Suits.” The Citizens Suits alleged, among other things, violations of various environmental laws at each facility and the failure to obtain certain federal permits at each facility. The lawsuits have been settled and resolved with the entry of a consent decree, which was approved and entered by the court in March 2006 (fiscal 2006).
The consent decree provides, among other things, that our subsidiary, Murphy-Brown LLC, will undertake a series of measures designed to enhance the performance of the swine waste management systems on approximately 260 company-owned farms in North Carolina and thereby reduce the potential for surface water or ground water contamination from these farms. The effect of the consent decree will not have a material adverse effect on our financial position or results of operations. The consent decree resolves all claims in the actions and also contains a broad release and covenant not to sue for any other claims or actions that the plaintiffs might be able to bring against us and our subsidiaries related to swine waste management at the farms covered by the consent decree. There are certain exceptions to the release and covenant not to sue related to future violations and the swine waste management technology development initiative pursuant to the Agreement described below under “Environmental Stewardship.” We may move to terminate the consent decree on or after March 2013 provided all of the consent decree obligations have been satisfied.
Prior to our acquisition of PSF, it had entered into environmental judgments and a consent decree with the State of Missouri and with the federal government and a citizens group. The decrees generally required that PSF pay penalties to settle past alleged regulatory violations, and the judgments and decree and the voluntary agreement require that PSF research, develop, and implement new technologies for environmental controls at the Missouri operations.
In 1999, PSF entered into a consent judgment to settle a suit filed by the State of Missouri. The settlement required PSF to invest $25.0 million in capital expenditures to develop and implement “Next Generation Technology.” The proposed technologies were to be approved by a panel of independent university experts and were to be developed and implemented by 2004. In 2002, the State of Missouri filed a suit against PSF for alleged new violations of environmental regulations, the settlement of which modified the 1999 consent judgment by (i) specifying that Next Generation Technology be installed on the 11 largest farms, and (ii) extending the schedule to implement Next Generation Technology from 2004 until 2010, in each case to ensure that the technology PSF installs will be effective in reducing potential impacts to the environment.
In 2001, PSF entered into a consent decree with a citizens group and the U.S to resolve alleged violations of the Clean Air Act, Clean Water Act and the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). This consent decree was built upon the 1999 consent decree with the State of Missouri referenced above and requires that the Next Generation Technology employed meets certain performance standards, such as a 50 percent reduction in nitrogen concentration of the effluent applied to area fields over a prescribed time period. PSF paid a civil penalty in the amount of $350,000 in connection with this settlement.
In 2004, PSF estimated that it would invest approximately $33.0 million in additional capital for Next Generation Technology by the 2010 deadline to comply with the requirements of both the state consent judgments and the federal consent decree. As of April 27, 2008, we estimate such costs to be $34.3 million, of which $22.4 million had been spent. Included in this commitment is a fertilizer plant in northern Missouri that converts waste into commercial grade fertilizer. Construction of the fertilizer plant has been completed at a cost of $10.3 million. Recent decisions in fiscal 2009 by the panel of university experts mentioned above suggest that our obligations under the state consent judgments and the federal consent decree could significantly exceed the $34.3 million estimate. At this time, PSF is reviewing the panel’s decisions and is developing further technology proposals for consideration by the State and the expert panel; however, the technology development process is ongoing and it is not possible at this time to predict the outcome or the eventual cost to us of complying with the state consent judgments and the federal consent decree.
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Pursuant to permits and consent judgments with regulatory agencies, we also anticipate upgrades to wastewater treatment plant systems at Smithfield Beef’s Souderton facility and at certain Smithfield Packing facilities totaling approximately $11 million.
Environmental Stewardship
In calendar year 2000, in furtherance of our continued commitment to responsible environmental stewardship, we and our North Carolina-based hog production subsidiaries voluntarily entered into an agreement with the Attorney General of North Carolina (the Agreement) designed to enhance water quality in the State of North Carolina through a series of initiatives to be undertaken by us and our subsidiaries while protecting access to swine operations in North Carolina. These initiatives focused on operations of our hog production subsidiaries in the State of North Carolina, particularly areas devastated by hurricanes in the fall of 1999.
Under the Agreement, we assumed a leadership role in the development of environmentally superior and economically feasible waste management system technologies. Pursuant to the Agreement, we committed to implement environmentally superior and economically feasible technologies for the management of swine waste at our farms in North Carolina following a determination made by an expert from North Carolina State University, with advice from peer review panels appointed by him, that such technologies are both environmentally superior and economically feasible to construct and operate at such farms. We provided $15.0 million to fund the technology research and development activities under the Agreement. We also agreed to provide certain financial and technical assistance to those farms under contract to our subsidiaries as necessary to facilitate their implementation of such technologies determined to be environmentally superior and economically feasible. These technology research activities have now been completed and the technology development, environmental enhancement and conversion agreement portions of the Agreement remain in place. Although none of the technologies evaluated under the Agreement were found to be economically feasible for existing farms, a specific solids separation/nitrification/denitrification/soluble phosphorous removal system in combination with any one of four specified solids treatment systems was found to meet the environmental performance standards established under the Agreement. These combinations of technologies were found to be both economically feasible and environmentally superior for new farms. We are committed to building on the technology research and development work completed under the Agreement, and are in the process of evaluating options for continued technology development work in North Carolina.
The Agreement also reflects our commitment to preserving and enhancing the environment of Eastern North Carolina by providing a total of $50.0 million to assist in the preservation of wetlands and other natural areas in eastern North Carolina and to promote similar environmental enhancement activities. This commitment is being fulfilled with annual contributions of $2.0 million over a 25 year period beginning in 2000.
In 2000, PSF entered into a similar agreement with the Attorney General of North Carolina where it agreed to pay $2.5 million to a fund for technology development, for environmental assessment activities, and for the defrayal of costs incurred by the state related thereto.
We have assumed a leadership role in the development of environmental management systems, and except for certain acquisitions (including those in Romania), some international operations and new facilities, all of our hog production operations and meat processing operations have developed and implemented environmental management systems meeting the requirements of the International Organization for Standardization 14001 (ISO 14001). ISO 14001 is a standard which establishes a coordinated framework of controls to manage environmental performance within an organization. To obtain ISO 14001 certification, an organization must meet a rigorous and comprehensive set of requirements and criteria developed by experts from all over the world and submit to independent audits of its environmental management systems by third parties.
In addition, throughout the Pork and International segments and our discontinued beef operations, we promote a variety of pollution reduction projects related to energy and water conservation, recycling and pollution prevention.
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Animal Welfare Program
We have a formalized animal welfare program which we believe is one of the most comprehensive animal welfare programs in our industry.
Our animal welfare program includes processes and procedures relating to the safety, comfort and health of our animals. We retained the services of two internationally recognized experts on animal behavior and animal handling, who verified that our animal welfare program is credible, science-based and auditable. Going forward, the audit component of our animal welfare program will be rolled into the National Pork Board PQA Plus program, a national certification program designed to ensure that U.S. pork producers understand and carry out their responsibilities to ensure food safety and animal well being.
Our animal welfare program includes procedures designed to monitor animal well-being at all stages of the animal’s life through a series of checklists, inspections and audits. Through this program, our production personnel receive specific training in the proper methods and practices for the promotion of animal well-being. Adherence to proper animal welfare management is also a condition of our agreements with contract farmers.
In January 2007 (fiscal 2007), we announced a program to phase out individual gestation stalls at our sow farms and replacing the gestation stalls with group pens. We anticipate this will occur over the next 12 to 13 years. We have begun this process with surveys to determine the best approach at each farm. In the first calendar quarter of 2008, we completed surveys at approximately two dozen farms. Three group housing designs at farms located in North Carolina, Colorado and Utah were nearing completion in mid-calendar 2008. We currently estimate the total cost of our transitions to group pens to be $300 million. We believe this decision represents a significant financial commitment and was made as a result of the desire to be more animal friendly, as well as to address certain concerns and needs of our customers. We do not expect that the switch to penning systems at sow farms will have a material adverse effect on our operations.
EMPLOYEES
The following table shows the number of our employees and the number of employees covered by collective bargaining agreements in each segment, as of April 27, 2008:
| Employees | Employees Covered by Collective Bargaining Agreements | |||
| Pork |
35,300 | 23,800 | ||
| International |
9,200 | 2,600 | ||
| HP |
7,500 | — | ||
| Other |
100 | — | ||
| Corporate |
200 | — | ||
| Smithfield Beef (discontinued operations) |
5,800 | 2,400 | ||
| Totals |
58,100 | 28,800 | ||
We believe that our relationship with our employees is satisfactory.
Labor organizing activities occasionally occur at one or more of our facilities. For example, we were involved in proceedings regarding union representation of employees at our facility at Tar Heel, North Carolina. This activity would determine whether approximately 5,500 employees at Tar Heel would be union represented. In a proceeding involving the Tar Heel plant, the National Labor Relations Board (NLRB) found that we engaged in certain unfair labor practices in connection with a prior representation election and ordered, among other things, that we allow a new election to be held. We appealed the NLRB’s findings with respect to unfair labor practices to the United States Court of Appeals for the District of Columbia Circuit, which denied that appeal in May 2006. Accordingly, we have now complied with the NLRB’s order. No NLRB-sanctioned representation election has been scheduled at the Tar Heel plant, but we will participate in the election process at such time.
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In October 2007 (fiscal 2008), we and Smithfield Packing filed a civil action against the United Food and Commercial Workers Union (UFCW) and several affiliates, alleging violations of the federal Racketeer Influenced & Corrupt Organizations Act (RICO) and other state laws. In our complaint, we allege that, on or around June 2006, the union and some of its affiliates launched a “Corporate Campaign” against us, seeking to exert pressure on us to agree to allow union representation of the employees at Tar Heel without conducting an NLRB-sanctioned secret ballot election. We allege this campaign encompasses a wide range of activities, including the creation and promotion of misinformation about us and our business (in an attempt to damage our reputation and brands), boycotts of our products, physical protests against us, our customers and spokespersons, and the exertion of political pressure on us at the local, state and federal levels. We further allege that the UFCW and its co-defendants conspired to engage in a public smear campaign in order to extort our recognition of the UFCW as the exclusive collective bargaining representative of hourly employees at Smithfield Packing’s Tar Heel Plant. We seek more than $5.9 million in monetary damages in addition to injunctive relief. A hearing on defendants’ motion to dismiss was held in January 2008. The court denied defendants’ motion. The case is currently in discovery. We have informed the UFCW that we intend to pursue vigorously our claims against the UFCW and its co-defendants.
AVAILABLE INFORMATION
Our website address is www.smithfieldfoods.com. The information on our website is not part of this annual report. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports are available free of charge through our website as soon as reasonably practicable after filing or furnishing the material to the SEC. You may read and copy documents we file at the SEC’s Public Reference Room at 100 F Street, N.E., Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains a website that contains annual, quarterly and current reports, proxy statements and other information that issuers (including us) file electronically with the SEC. The SEC’s website is www.sec.gov.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
See Note 12 in “Item 8. Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements” for financial information about geographic areas.
| ITEM 1A. | RISK FACTORS |
The following risk factors should be read carefully in connection with evaluating our business and the forward-looking information contained in this Annual Report on Form 10-K. Any of the following risks could materially adversely affect our business, operations, industry or financial position or our future financial performance. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, operations, industry, financial position and financial performance in the future.
Our results of operations are cyclical and could be adversely affected by fluctuations in the commodity prices for livestock and grains.
We are largely dependent on the cost and supply of livestock and feed ingredients and the selling price of our products and competing protein products, all of which are determined by constantly changing and volatile market forces of supply and demand as well as other factors over which we have little or no control. These other factors include:
| • | competing demand for corn for use in the manufacture of alternative fuels, |
| • | environmental and conservation regulations, |
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| • | import and export restrictions, |
| • | economic conditions, |
| • | weather, including weather impacts on our water supply and the impact on the availability and pricing of grains, |
| • | energy prices, including the effect of changes in energy prices on our transportation costs and the cost of feed, and |
| • | crop and livestock diseases. |
We cannot assure you that all or part of any increased costs experienced by us from time to time can be passed along to consumers of our products directly, in a timely manner or at all.
Livestock prices demonstrate a cyclical nature over periods of years, reflecting the supply of livestock on the market. Further, the raising costs of livestock are largely dependent on the fluctuations of commodity prices for corn and other feed ingredients. For example, our fiscal 2008 results of operations were negatively impacted by higher feed and feed ingredient costs which increased cash-basis hog raising costs by 18% versus the prior year period, a decrease in domestic live hog market prices from $48 per hundredweight in fiscal 2007 to $44 per hundredweight in fiscal 2008 due to the increased level of supply in the market and increased transportation and energy costs due in part to rising fuel prices.
Additionally, commodity pork prices demonstrate a cyclical nature over periods of years, reflecting changes in the supply of fresh pork and competing proteins on the market, especially beef and chicken. For example, our fiscal 2006 fourth quarter and fiscal 2007 first half financial results were impacted negatively by an over-supply of protein that decreased selling prices of our fresh and packaged meats.
We attempt to manage certain of these risks through the use of our risk management and hedging programs. However, these programs may also limit our ability to participate in gains from favorable commodity fluctuations. Additionally, a portion of our commodity derivative contracts are marked-to-market such that the related unrealized gains and losses are reported in earnings on a quarterly basis. Therefore, losses on those contracts would adversely affect our earnings. This accounting treatment may cause significant volatility in our quarterly earnings. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Derivative Financial Instruments” for further information.
Any perceived or real health risks related to the food industry or increased regulation could adversely affect our ability to sell our products.
We are subject to risks affecting the food industry generally, including risks posed by the following:
| • | food spoilage or food contamination, |
| • | evolving consumer preferences and nutritional and health-related concerns, |
| • | consumer product liability claims, |
| • | product tampering, |
| • | the possible unavailability and expense of product liability insurance, and |
| • | the potential cost and disruption of a product recall. |
Adverse publicity concerning any perceived or real health risk associated with our products could also cause customers to lose confidence in the safety and quality of our food products, which could adversely affect our ability to sell our products, particularly as we expand our branded products business. We could also be adversely affected by perceived or real health risks associated with similar products produced by others to the extent such risks cause customers to lose confidence in the safety and quality of such products generally.
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Our products are susceptible to contamination by disease producing organisms, or pathogens, such as Listeria monocytogenes, Salmonella, Campylobacter and generic E. coli. Because these pathogens are generally found in the environment, there is a risk that they, as a result of food processing, could be present in our products. These pathogens can also be introduced to our products as a result of improper handling at the further processing, foodservice or consumer level. Our manufacturing facilities and products are subject to extensive laws and regulations in the food safety area, including constant government inspections and governmental food processing controls. We also have systems in place designed to monitor food safety risks throughout all stages of our vertically integrated process. However, we cannot assure you that such systems, even when working effectively, or compliance with governmental regulations will eliminate the risks related to food safety. Any product contamination could have a material adverse impact on our financial statements. In addition, future material changes in food safety regulations could result in increased operating costs or could be required to be implemented on schedules that cannot be met without interruptions in our operations.
Environmental regulation and related litigation and commitments could have a material adverse effect on us.
Our past and present business operations and properties are subject to extensive and increasingly stringent laws and regulations pertaining to protection of the environment, including among others:
| • | the discharge of materials into the environment, |
| • | the handling and disposition of wastes (including solid and hazardous wastes), and |
| • | the emission of greenhouse gases. |
Failure to comply with these laws and regulations or any future changes to them may result in significant consequences to us, including civil and criminal penalties, liability for damages and negative publicity. Some requirements applicable to us may also be enforced by citizen groups. See Note 11 in “Item 8. Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements” for further discussion of regulatory compliance as it relates to environmental risk. We have incurred, and will continue to incur, significant capital and operating expenditures to comply with these laws and regulations.
In addition, pursuant to a voluntary agreement with the State of North Carolina, we committed to implement environmentally superior and economically feasible technologies for the management of swine waste at our farms in North Carolina provided a determination is made by an expert from North Carolina State University that such technologies are both environmentally superior and economically feasible to construct and operate at such farms. We also acquired PSF in fiscal 2008, which entered into environmental consent decrees in the State of Missouri requiring PSF to research, develop and implement new technologies to control wastewater, air and odor emissions from its Missouri farms. See “Item 1. Business—Environmental Stewardship” and “Item 1. Business—Regulation” for further information regarding these obligations. We cannot assure you that the costs of carrying out these obligations will not exceed previous estimates or that requirements applicable to us will not be altered in ways that will require us to incur significant additional costs. In addition, new environmental issues could arise that would cause currently unanticipated investigations, assessments or expenditures.
Health risk to livestock could adversely affect production, the supply of raw materials and our business.
We take precautions to ensure that our livestock is healthy and that our processing plants and other facilities operate in a sanitary manner. Nevertheless, we are subject to risks relating to our ability to maintain animal health and control diseases. Livestock health problems could adversely impact production, the supply of raw material and consumer confidence in all of our operating segments. From time to time, we have experienced outbreaks of certain livestock diseases, such as the outbreaks of classical swine fever at three of our hog farms in Romania in August 2007 and the outbreak of circovirus at our U.S. facilities that began in late fiscal 2006. We may experience additional occurrences of disease in the future. Disease can reduce the number of offspring produced, hamper the growth of livestock to finished size and require in some cases the destruction of infected
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livestock, all of which could adversely affect our production or ability to sell or export our products. Adverse publicity concerning any disease or health concern could also cause customers to lose confidence in the safety and quality of our food products, particularly as we expand our branded pork products.
In addition to risks associated with maintaining the health of our livestock, any outbreak of disease elsewhere in the U.S. or even in other countries could reduce consumer confidence in the meat products affected by the particular disease, generate adverse publicity and result in the imposition of import or export restrictions. For example, the discovery of isolated cases of BSE in the U.S. beginning in December 2003 led to bans imposed by key Asian markets on beef imports from the U.S. Restrictions imposed by these markets are gradually lifting but continue to limit the amount of beef products that can be exported to them from the U.S. Similarly, the presence of classical swine fever in Romania has resulted in a ban of indefinite duration on sales of Romanian pork to other EU member states.
In the past, outbreaks of avian influenza in various parts of the world have reduced the global demand for poultry and thus created a surplus of poultry both domestically and internationally. This poultry surplus placed downward pressure on poultry prices which in turn reduced pork and beef prices both in the U.S. and internationally.
Governmental authorities may take further action restricting our ability to own livestock or to engage in farming or restricting such operations generally, which could adversely affect our business.
A number of states, including Iowa and Missouri, have adopted legislation that prohibits or restricts the ability of meat packers, or in some cases corporations generally, from owning livestock or engaging in farming. In the second quarter of fiscal 2006, we entered into a settlement agreement with the State of Iowa whereby the state agreed not to enforce its restrictive legislation on us for a period of ten years. As a part of our settlement, we committed to pay $200,000 per year for 10 years to support various programs benefiting the swine industry in Iowa. We also agreed to purchase a specified minimum number of hogs to be processed by us in Iowa and South Dakota on the open market for two years. In connection with our acquisition of PSF in fiscal 2008, we acquired six farms in Missouri outside of the counties exempted from Missouri’s anti-corporate farming law. Under an agreement we reached with the Attorney General of the State of Missouri, we have promised to divest these farms within 24 months of the PSF acquisition. We cannot assure you that we will be able to divest these farms on terms that are fair to us.
Other states have similar legislation restricting the ability of corporations or others from owning livestock farms or engaging in farming. In addition, Congress has recently considered federal legislation that would ban meat packers from owning livestock. We cannot assure you that such or similar legislation affecting our operations will not be adopted at the federal or state levels in the future. Such legislation, if adopted and applicable to our current operations and not successfully challenged or settled, could have a material adverse impact on our operations and our financial statements.
In fiscal 2008, the State of North Carolina enacted a permanent moratorium on the construction of new hog farms using the lagoon and sprayfield system. The moratorium limits us from expanding our North Carolina production operations. This permanent moratorium replaced a 10-year moratorium on the construction of hog farms with more than 250 hogs or the expansion of existing large farms.
Our level of indebtedness and the terms of our indebtedness could adversely affect our business and liquidity position.
As of April 27, 2008, we had:
| • | approximately $3,878.1 million of indebtedness, |
| • | guarantees of up to $95.5 million for the financial obligations of certain unconsolidated joint ventures and hog farmers, and |
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| • | aggregate unused capacity under our revolving credit facilities totaling $313.8 million, taking into account outstanding borrowings of $1,666.4 million and outstanding letters of credit of $141.8 million and including $100.0 million of our $250.0 million of uncommitted lines of credit and interim facility commitments that have not been drawn. |
We expect our indebtedness may increase from time to time in the future for various reasons, including fluctuations in operating results, capital expenditures and potential acquisitions or joint ventures. In addition, due to the volatile nature of the commodities markets, we may have to borrow significant amounts to cover any margin calls under our risk management and hedging programs. Our consolidated indebtedness level could significantly affect our business because:
| • | it may significantly limit or impair our ability to obtain financing in the future, |
| • | a downgrade in our credit rating could restrict or impede our ability to access capital markets at attractive rates and increase our borrowing costs. For example, Moody’s Investors Service recently placed its ratings of our debt on review for possible downgrade, |
| • | it may reduce our flexibility to respond to changing business and economic conditions or to take advantage of business opportunities that may arise, and |
| • | a portion of our cash flow from operations must be dedicated to interest payments on our indebtedness and is not available for other purposes, which amount would increase if prevailing interest rates rise. |
In addition, our U.S. Credit Facility, Euro Credit Facility and senior secured note agreements contain financial covenants tied to leverage, interest coverage and working capital. Our debt agreements also restrict the payment of dividends to shareholders and under certain circumstances may limit additional borrowings, investments, the acquisition or disposition of assets, mergers and transactions with affiliates.
As currently structured, a breach of a covenant or restriction in any of these agreements could result in a default that would in turn cause a default under other agreements, allowing the affected lenders to accelerate the repayment of principal and accrued interest on their outstanding debt, if they choose, and, in the case of the revolving credit agreements, terminate their commitments to lend additional funds. The future ability of us and our operating subsidiaries to comply with financial covenants, make scheduled payments of principal and interest, or refinance existing borrowings depends on future business performance that is subject to economic, financial, competitive and other factors, including the other risks described herein.
Further, we expect that the net proceeds from the sale of Smithfield Beef, our beef processing and cattle feeding operation, as well as the sale of Smithfield Beef’s live cattle inventories and our interest in Five Rivers’ cattle inventory, net of associated debt, will be used for debt reduction. However, we are currently responding to a second request from the Antitrust Division of the Department of Justice relating to these transactions and we cannot be assured that these transactions will obtain regulatory clearance or that all the other conditions to closing will be satisfied. Although we currently expect the transactions to close in the second quarter of fiscal 2009, if they do not, or the sales are delayed, our short and long-term liquidity positions will be negatively impacted and we may need to seek additional sources of liquidity. We cannot assure you that such additional sources of liquidity will be available to us on terms we believe are acceptable.
Our acquisition strategy may prove to be disruptive and divert management resources and may result in financial or other setbacks.
We have made numerous acquisitions in recent years and regularly review opportunities for strategic growth through acquisitions. We have also pursued strategic growth through investment in joint ventures. These acquisitions and investments may involve large transactions or realignment of existing investments such as when we contributed our French operations into Groupe Smithfield. These transactions present financial, managerial and operational challenges, including:
| • | diversion of management attention from other business concerns, |
| • | difficulty with integrating personnel and financial and other systems, |
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| • | lack of experience in operating in the geographical market of the acquired business, |
| • | increased levels of debt and associated reduction in ratings of our debt securities, |
| • | potential loss of key employees and customers of the acquired business, |
| • | assumption of unknown or contingent liabilities, |
| • | potential disputes with the sellers, and |
| • | for our investments, potential lack of common business goals and strategies with, and cooperation of, our joint venture partners. |
In addition, acquisitions outside the U.S. may present unique difficulties and increase our exposure to those risks associated with international operations.
We could experience financial or other setbacks if any of the businesses that we have acquired or may acquire in the future have problems of which we are not aware or liabilities that exceed expectations. See “Item 3. Legal Proceedings—Missouri litigation.” Although we are continuing PSF’s vigorous defense of these claims, we cannot assure you that we will be successful, that additional nuisance claims will not arise in the future or that the reserves for this litigation will not have to be substantially increased. For example, as also discussed in “Item 3. Legal Proceedings—Missouri litigation,” we and certain of our contract growers are defendants in a lawsuit filed in Missouri in fiscal 2008 based on the laws of nuisance and involving 13 plaintiffs.
We are subject to risks associated with our international sales and operations.
Sales to international customers accounted for approximately 18% percent of our net sales in fiscal 2008. We conduct foreign operations in Poland, Romania and the United Kingdom. In addition, we are engaged in joint ventures mainly in Western Europe and Mexico and have significant investments in Spain. As of April 27, 2008, approximately 32% of our long-lived assets were associated with our foreign operations.
As a result, our international sales, operations and investments are subject to various risks related to economic or political uncertainties including among others:
| • | general economic conditions, |
| • | imposition of tariffs, quotas, trade barriers and other trade protection measures imposed by foreign countries, |
| • | the closing of borders by foreign countries to the import of our products due to animal disease or other perceived health safety issues, and |
| • | enforcement of remedies in foreign jurisdictions and compliance with applicable foreign laws. |
Furthermore, our foreign operations are subject to the risks described above as well as additional risks and uncertainties including among others:
| • | fluctuations in currency values, which have affected, among other things, the costs of our investments in foreign operations, |
| • | translation of foreign currencies into U.S. dollars, and |
| • | foreign currency exchange controls. |
Occurrence of any of these events in the markets where we operate or in other markets we are developing could jeopardize or limit our ability to transact business in those markets and could adversely affect our operating results.
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Our operations are subject to the general risks of litigation.
We are involved on an ongoing basis in litigation arising in the ordinary course of business or otherwise. Trends in litigation may include class actions involving consumers, shareholders, employees or injured persons, and claims related to commercial, labor, employment, antitrust, securities or environmental matters. Moreover, the process of litigating cases, even if we are successful, may be costly, and may approximate the cost of damages sought. Litigation trends and expenses and the outcome of litigation cannot be predicted with certainty and adverse litigation trends, expenses and outcomes could have a material adverse impact on our financial statements.
We depend on availability of, and satisfactory relations with, our employees.
As of April 27, 2008, we had approximately 58,100 employees, 28,800 of which are covered by collective bargaining agreements. Our operations depend on the availability, retention and relative costs of labor and maintaining satisfactory relations with employees and the labor unions. Further, employee shortages can and do occur, particularly in rural areas where some of our operations are located. Labor relations issues arise from time to time, including issues in connection with union efforts to represent employees at our plants. The United Food and Commercial Workers Union (UFCW) has engaged in a campaign to represent employees at our Tar Heel, North Carolina plant, where we have experienced work stoppages, walkouts and attempts to organize boycotts. We and one of our subsidiaries filed a civil action in fiscal 2008 against the UFCW and several affiliates, alleging violations of the federal RICO Act and other state laws. In our complaint, we allege that the UFCW and its co-defendants conspired to engage in a public smear campaign in order to extort our recognition of the UFCW as the exclusive collective bargaining representative of hourly employees at our Tar Heel, North Carolina plant. If we fail to maintain satisfactory relations with our employees or with the unions, we may experience labor strikes or other consequences similar or in addition to the type of activities discussed above. In addition, the discovery by us or governmental authorities of undocumented workers, as has occurred in the past, could result in our having to attempt to replace those workers, which could be disruptive to our operations or may be difficult to do.
Immigration reform continues to attract significant attention in the public arena and the U.S. Congress. If new immigration legislation is enacted, such laws may contain provisions that could make it more difficult or costly for us to hire U.S. citizens and/or legal immigrant workers. In such case, we may incur additional costs to run our business or may have to change the way we conduct our operations. Also, despite our past and continuing efforts to hire only U.S. citizens and/or persons legally authorized to work in the U.S., increased enforcement efforts with respect to existing immigration laws by governmental authorities may disrupt a portion of our workforce or our operations at one or more of our facilities, thereby negatively impacting our business.
We cannot assure you that these activities or consequences will not have a material impact in the future.
We have significant credit exposure to certain customers.
Our ten largest customers represented approximately 29% of net sales for fiscal year 2008. We do not have long-term sales agreements (other than to certain third-party hog customers) or other contractual assurances as to future sales to these major customers. In addition, continued consolidation within the retail industry, including among supermarkets, warehouse clubs and food distributors, has resulted in an increasingly concentrated retail base. To the extent these trends continue to occur, our net sales and profitability may be increasingly sensitive to a deterioration in the financial condition of, or other adverse developments in our relationship with, one or more customers.
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An impairment in the carrying value of goodwill could negatively impact our consolidated results of operations and net worth.
Goodwill is recorded at fair value and is not amortized, but is reviewed for impairment at least annually or more frequently if impairment indicators arise. In evaluating the potential for impairment of goodwill, we make assumptions regarding future operating performance, business trends, and market and economic conditions. Such analyses further require us to make judgmental assumptions about sales, operating margins, growth rates, and discount rates. There are inherent uncertainties related to these factors and to management’s judgment in applying these factors to the assessment of goodwill recoverability. Goodwill reviews are prepared using estimates of the fair value of reporting units based on market multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) or on the estimated present value of future discounted cash flows. We could be required to evaluate the recoverability of goodwill prior to the annual assessment if we experience disruptions to the business, unexpected significant declines in operating results, divestiture of a significant component of our business and market capitalization declines. These types of events and the resulting analyses could result in non-cash goodwill impairment charges in the future. Impairment charges could substantially affect our reported earnings in the periods of such charges. In addition, impairment charges would negatively impact our financial ratios and could limit our ability to obtain financing in the future. As of April 27, 2008, we had $864.6 million of goodwill, which represented approximately 9.8% of total assets.
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| ITEM 2. | PROPERTIES |
The following table lists our material plants and other physical properties. Based on a five day week, our weekly pork slaughter capacity was 578,000 head, and our processed meats capacity was 60.7 million pounds, as of April 27, 2008. During fiscal 2008, the average weekly capacity utilization for pork slaughter and pork processing was 105% and 81%, respectively. We believe these properties are adequate and suitable for our needs.
| Location |
Segment |
Operation | ||
| Smithfield Packing Plant* Bladen County, North Carolina |
Pork | Slaughtering and cutting hogs; production of boneless hams and loins | ||
| Smithfield Packing Plant Smithfield, Virginia |
Pork | Slaughtering and cutting hogs; production of boneless loins, bacon, sausage, bone-in and boneless cooked and smoked hams and picnics | ||
| Smithfield Packing Plant Kinston, North Carolina |
Pork | Production of boneless cooked hams, deli hams and sliced deli products | ||
| Smithfield Packing Plant Clinton, North Carolina |
Pork | Slaughtering and cutting hogs; fresh pork | ||
| Lykes Meat Group Plant (operated by Smithfield Packing) Plant City, Florida |
Pork | Production of hot dogs, luncheon meats and sausage products | ||
| John Morrell Plant Sioux Falls, South Dakota |
Pork | Slaughtering and cutting hogs; production of boneless loins, bacon, hot dogs, luncheon meats, smoked and canned hams and packaged lard | ||
| John Morrell Plant Sioux City, Iowa |
Pork | Slaughtering and cutting hogs; production of boneless loins | ||
| Curly’s Foods, Inc. Plant (operated by John Morrell) Sioux City, Iowa |
Pork | Raw and cooked ribs and other BBQ items | ||
| Armour-Eckrich Meats (operated by John Morrell) St. Charles, Illinois |
Pork | Manufactures bulk and sliced dry sausages | ||
| Armour-Eckrich Meats (operated by John Morrell) Omaha, Nebraska |
Pork | Manufactures bulk and sliced dry sausages and prosciutto ham | ||
| Farmland Plant Crete, Nebraska |
Pork | Slaughtering and cutting hogs; fresh and packaged pork products | ||
| Farmland Plant Monmouth, Illinois |
Pork | Slaughtering and cutting hogs; production of bacon and processed hams, extra tender and ground pork | ||
| Farmland Plant Denison, Iowa |
Pork | Slaughtering and cutting hogs; production of bacon and processed hams | ||
| Farmland Plant Milan, Missouri |
Pork | Slaughtering and cutting hogs; fresh pork | ||
| Cook’s Hams Plant (operated by Farmland Foods) Lincoln, Nebraska |
Pork | Production of traditional and spiral sliced smoked bone-in hams; corned beef and other smoked meat items | ||
| Patrick Cudahy Plant Cudahy, Wisconsin |
Pork | Production of bacon, dry sausage, boneless cooked hams and refinery products | ||
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| Location |
Segment |
Operation | ||
| Animex Plant Szczecin, Poland |
Int’l. | Slaughtering and deboning hogs; packaged and other pork products | ||
| Animex Plant Ilawa, Poland |
Int’l. | Fresh meat and packaged products | ||
| Animex Plant Starachowice, Poland |
Int’l. | Slaughtering and deboning hogs; packaged and other pork products | ||
| Animex Plant Elk, Poland |
Int’l. | Slaughtering and deboning hogs; packaged and other pork products | ||
| Morliny Plant Morliny, Poland |
Int’l. | Packaged and other pork and beef products | ||
| Smithfield Procesare Plants Timisoara, Romania |
Int’l. | Deboning, slaughtering and rendering hogs | ||
| PROPERTIES OF DISCONTINUED OPERATIONS | ||||
| Packerland Packing Plant Green Bay, Wisconsin |
Slaughtering and cutting cattle; production of boxed, processed and ground beef | |||
| Packerland Plainwell Plant Plainwell, Michigan |
Slaughtering and cutting cattle; production of boxed, processed and ground beef | |||
| Sun Land Packing Plant Tolleson, Arizona |
Slaughtering and cutting cattle; production of boxed beef | |||
| Moyer Packing Plant Souderton, Pennsylvania |
Slaughtering and cutting cattle; production of boxed, processed and ground beef | |||
| * | Pledged as collateral under the Uncommitted Line of Credit Agreement dated May 16, 2008, and ancillary documents, by and between Smithfield Packing, Citibank, N.A. and us. |
The HP segment owns and leases numerous hog production and grain storage facilities as well as feedmills, mainly in North Carolina, Utah and Virginia, with additional facilities in Oklahoma, Colorado, Texas, Iowa, Illinois, South Carolina, Missouri, Poland and Romania. A substantial number of these owned facilities are pledged under loan agreements.
| ITEM 3. | LEGAL PROCEEDINGS |
We and certain of our subsidiaries are parties to the environmental litigation matters discussed in “Item 1. Business—Regulation” above. Apart from those matters and the matters listed below, we and our affiliates are parties in various lawsuits arising in the ordinary course of business. In the opinion of management, any ultimate liability with respect to the ordinary course matters will not have a material adverse effect on our financial position or results of operations.
MISSOURI LITIGATION
PSF is a wholly-owned subsidiary that we acquired on May 7, 2007 when a wholly-owned subsidiary of ours merged with and into PSF. As a result of the acquisition of PSF, Continental Grain Company (CGC, formerly ContiGroup Companies, Inc.) is now a more than 7% beneficial owner of our common stock. Paul J. Fribourg, CGC’s Chairman, President and CEO, is now a director of ours and Michael J. Zimmerman, CGC’s Executive Vice President and Chief Financial Officer, is now an advisory director to the Company.
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In 2002, lawsuits based on the law of nuisance were filed against PSF and CGC in the Circuit Court of Jackson County, Missouri entitled Steven Adwell, et al. v. PSF, et al. and Michael Adwell, et al. v. PSF, et al. In November 2006, a jury trial involving six plaintiffs in the Adwell cases resulted in a jury verdict of compensatory damages for those six plaintiffs in the amount of $750,000 each for a total of $4.5 million. The jury also found that CGC and PSF were liable for punitive damages; however, the parties agreed to settle the plaintiffs’ claims for the amount of the compensatory damages, and the plaintiffs waived punitive damages.
On March 1, 2007, the court severed the claims of the 54 remaining Adwell plaintiffs into separate actions and ordered that they be consolidated for trial by household. In the second Adwell trial, a jury trial involving three plaintiffs resulted in a jury verdict in December 2007 in favor of PSF and CGC as to all claims. In February 2008, plaintiffs sought and were granted a continuance of the next Adwell trial, which had been set for March 31, 2008. Then in March 2008, plaintiffs voluntarily dismissed without prejudice the claims of both plaintiffs in another Adwell case, which had been set for trial on June 2, 2008. The next trial is set for October 20, 2008, and the parties are currently conducting discovery. As a result of the severance and subsequent actions taken by plaintiffs, there will be 21 additional separate trials in Adwell, each involving one to six plaintiffs.
In March 2004, the same attorneys representing the Adwell plaintiffs filed two additional nuisance lawsuits in the Circuit Court of Jackson County, Missouri entitled Fred Torrey, et al. v. PSF, et al. and Doyle Bounds, et al. v. PSF, et al. There are seven plaintiffs in both suits combined, each of whom claims to live near swine farms owned or under contract with PSF