Dunham Winoto - Pilgrim's Pride Corp. William W. Lovette - Pilgrim's Pride Corp. Fabio Sandri - Pilgrim's Pride Corp..

Farha Aslam - Stephens, Inc. Ken Zaslow - BMO Capital Markets (United States) Heather Jones - The Vertical Trading Group LLC Jeremy Scott - Mizuho Securities USA LLC Benjamin M. Theurer - Barclays Capital Casa de Bolsa SA de CV Adam Samuelson - Goldman Sachs & Co. LLC.

Good morning, and welcome to the Second Quarter 2018 Pilgrim's Pride Earnings Conference Call and Webcast. All participants will be in listen-only mode. At the company's request, this call is being recorded.

Please note that the slides referenced during today's call are available for download from the Investor Relations section of the company's website at www.pilgrims.com. After today's presentation, there will be an opportunity to ask questions.

I would now like to turn the conference over to Dunham Winoto, Director of Investor Relations for Pilgrim's Pride. Please go ahead..

Good morning, and thank you for joining us today, as we review our operating and financial results for the second quarter ended July 1, 2018. Yesterday afternoon, we issued a press release providing an overview of our financial performance for the quarter, including a reconciliation of any non-GAAP measures we may discuss.

A copy of the release is available in the Investor Relations section of our website, along with the slides we will reference during this call. These items have also been filed as 8-Ks and are available online at www.sec.gov. Presenting to you today are Bill Lovette, President and Chief Executive Officer; and Fabio Sandri, Chief Financial Officer.

Before we begin our prepared remarks, I'd like to remind everyone of our Safe Harbor disclaimer. Today's call may contain certain forward-looking statements that represent our outlook and current expectations as of the day of this release.

Other additional factors not anticipated by management may cause actual results to differ materially from those projected in these forward-looking statements. Further information concerning those factors has been provided in today's (sic) [yesterday's] (00:02:02) press release, our 10-K and on our regular filings with the SEC.

I'd now like to turn the call over to Bill Lovette..

large bird cut-out, live production and breeder costs, investments in brands and prepared-foods (00:04:48) growth, as well as salary and wage increases given to our team members. These impacts to profitability were partially offset by improvement in portfolio mix, fee conversion rate, plant costs and yields.

Customer demand and margins within our small bird and case-ready operations have remained strong and our leading share in these markets have continued to give us a competitive advantage relative to our peers with a more narrow market approach.

On the other hand, industry environment within the commodity big bird deboning segment during Q2 was counter-seasonal and very challenging.

Even though supply of large bird deboning volume was only marginally up compared to a year ago, based on our analysis of public market data, we believe retailers in general were featuring less chicken in favor of more beef and pork to drive their top-line performance, which had a measurable impact on overall chicken demand in retail.

While this dynamic was not materially affecting the market balance of the case-ready birds, it was impacting the supply and demand of the commodity sector.

And although, it's difficult to determine with certainty when retailers are going to revert to spending more of their promotional dollars back to chicken, based on historical trends, we believe the shift could begin as soon as late summer since chicken continues to be very competitive relative to other proteins and is also a very good traffic generator for many retailers.

In foodservice, while consumers are favoring chicken options with a continued upward trend of chicken servings year-over-year, traffic in foodservice has not increased with chicken demand being outpaced by growth and availability.

To further insulate our margins from market fluctuation, even within the main bird size categories, we have multiple strategies in place to improve our product diversity and market exposure.

One example is our Sanford, North Carolina facility, which we had converted from a commodity big bird deboning plant to a specialty organic case-ready plant last year. And it has continued to exceed our expectations and profitability target.

We also recently converted one of our big bird deboning plants to full No-Antibiotics-Ever (00:07:06) to reduce the impact from commodity, working with key customers to support their growth and expectations to improve our margin profile and provide a more consistent performance despite market fluctuations.

Amid continued uncertainties regarding the direction of international trade in the U.S., export chicken prices have remained stable and inventories also gone down, which we view as positive.

Chicken remains an excellent source of protein and a great value for many consumers in the international marketplace and we believe future growth prospects are unlikely to materially change considering the U.S. access to low-cost grain and a technological advantage.

Our Prepared Foods business is continuing to rebound and growing at a solid pace of 13% (00:07:54) revenue and 6% volume. During the past few years, we've been investing in our U.S. prepared-foods plants, operations and our people to expand our capacities and our capabilities.

We are continuing in the build-out stage for innovation, marketing to drive strong growth for the future. The investments and focus have driven the increase in performance and potential for further growth remains. We remain fully committed to Prepared Foods to give us an improved margin profile, while reducing earnings volatility.

We're also heavily investing to support the future growth of our well-regarded Just BARE chicken brand and it steadily exceeded our expectations with key customer segments.

Just BARE chicken remains the top choice of consumers on AmazonFresh in Q2 and we continue to increase marketing support for the brand via strategic partnerships that allow us to grow our efforts in supply chain improvements, future innovation, and increased opportunity for natural (00:08:57) national growth.

Just BARE chicken has recently expanded our rotisserie distribution in the Northeast and Midwest markets, increasing brand awareness and distribution growth. We continue to see significant market opportunities and we've made considerable progress toward our ultimate goal of national distribution.

In Q2, we completed the transition to a new clean package design for the majority of our product line that better supports the market growth potential for Just BARE chicken.

We see many benefits from the change, including significantly improved on-shelf impact scores based on internal testing, a reduction in packaging cost, and increased production flexibility, which is necessary to support a national expansion.

We've had a very strong performance at our Mexican operations in Q2, driven by very good demand and also supply constraints within the industry due to less favorable growing conditions in Mexico.

The performance is a continuation of our Mexican operations' consistent outperformance over the main competitor in the past few years, demonstrating that the strength of our market or strength of our portfolio and the dedication of our team members, we grew faster than the market in volume growth during the quarter to generate a very robust EBITDA performance.

That was an improvement sequentially from an already strong Q1, partially offsetting the results for less favorable peso/dollar exchange rate as well as higher fee input cost, which we sourced from the U.S.

While our market strength supported (00:10:33) the strong performance in Q2, our team's focus on operational excellence and offering differentiated products also contributed to the improvements in the operations.

We continue to place a high priority on Mexico given our expectations that demand will remain on a very robust growth trajectory given the steady rise in disposable income of Mexican consumers. The market environment in Mexico can be volatile quarter-to-quarter, but historically for the full year we recorded very good margin performance consistently.

For Q3, we expect normal seasonality for the region and expect another year of strong growth in earnings for Mexico in 2018.

As a part of our strategy to strengthen our competitive position, we maintain the pace of new innovative product introductions, our Prepared Foods are growing at double-digit rate and generating great results on premium Pilgrim's and Del Dia brand. Both brands have continued to receive very favorable acceptance by consumers.

Despite our strong position, we are continuing to look for new opportunities to growing fresh (00:11:42), especially at retail. Production at our Veracruz complex is continuing to ramp up, in line with our expectations and we're on track to double the size of that facility, including the feed mill and the hatchery by the year end.

Our Mexican team remains committed to relentlessly pursue operational and management excellence in every aspect of our business. Longer term, we believe Mexico represents an excellent growth prospect as demand for protein continues to outstrip supply.

Our European operations have continued to report an improved performance compared to last year with a 5% growth in volume and 70 basis point rise in EBITDA margins compared to last year, as ideal weather for barbeque across the UK drove strong demand for our fresh chicken.

Our team members also improved the operations and contributed to the strong performance by continuing to focus on cost optimization, cost control, excellent consumer relationship, synergy capture, and a culture of constant innovation.

The business has an established reputation for providing fresh, high quality and locally farmed poultry products and is based on best-in-class production platform. We're always looking for opportunities to improve these operations while maintaining the consistent margin performance.

The integration process is going well and we are ahead of our $50 million in expected synergy targets over the next two years, with the detailed projects to support these now being clearly defined and starting to be executed.

We've benchmarked operational efficiency and productivity and have found more opportunities to create value through feed formulation, yield management and labor efficiency in our European operations.

Our focus on Key Customer strategy continues with progress in Q2 with customers to give us a more resilient margin structure, which we will continue to enhance through ongoing operational improvement initiatives. We will continue to invest to optimize our production facilities across Europe to make them more efficient and competitive.

Although early, the increase in operational focus is already starting to pay off as our European operations have improved their relative performance over the competition. Beyond that we're looking to deploy capital and opportunities across Europe to drive future growth and further improved diversification.

We're investing in value-added operations to support further innovation with a significant investment to expand our gluten-free capability on a target to be commissioned in Q3, targeting a growing consumer trend for gluten-free products.

The plant-based protein market is growing strongly in the UK as a part of watered Flexitarian Diet approach and we believe the innovation we're developing in Europe can be adapted to other markets we're in, giving us yet another way to tap in the consumer desire for an alternative form of protein.

The plant-based protein product range of Moy Park includes veggie burgers, spring rolls and taquitos, cheese sides, veggie ingredients, donuts and pies for foodservice and retail channels. Although still small, we expect volume from this segment to grow strongly over the next few years driven by robust consumer demand.

We continue to support our customer's development and expect to see further growth this year by interest in meat-free snacking.

While the retail landscape in the UK is undergoing an evolution, we're already seeing positive results from this acquisition with significant share gain late last year at a large retailer and several other projects with key customers in the first half of this year to further optimize these relationships, highlighting how our newly acquired operations are already benefiting from our team's enhanced focus on our key customer strategy.

We'll continue to extend our key customer strategy to Europe as we see incremental joint value creation opportunities here and we have seen in the U.S. and Mexico, which will drive greater earnings performance.

Moving on to commodities, corn and soybean prices rally to (00:15:57) start Q2, driven by drought-related production losses in South America before falling significantly in June, reflecting uncertainty over the escalating trade conflict between the U.S. and China.

In July, USDA lowered their expected Chinese soybean exports by 8 million tons and increased their U.S. soybean carryout by nearly 200 million bushels to a record 585 million bushels.

Although corn stocks are expected to decrease in 2018-2019, trade uncertainly and better than expected crop position or crop conditions also brought corn prices to their yearly lows in July. With prospects for better than expected corn yields and major headwinds from U.S. soybean exports, feed input prices are likely to remain low in the short-term.

To further reduce the impact of volatility, we've covered our soy and corn needs through this growing season. In Europe, we have positions that will protect us well in late – until late in this year. We will continue to monitor the progress of the U.S. crop, as well as volatile trade situation between U.S.

and China to determine the appropriate course of action for our positioning in the growing markets. For 2018, the USDA is expecting total U.S. chicken industry production to grow at a rate less than last year's.

While the overall size of the breeder flock may seem high relative to historic levels, part of that – this increase is the primary breeders segment, given the breeder market share shifts and recent change to a new generation of breeders. This shift to new breed is yet to be completed.

Our most recent data on egg productivity, hatchability and chick mortality driven by the breed shift have remained challenged and limit egg supplies. We believe the loss in productivity is structural in the order of 1.4% decline in broiler chicks hatched per layer.

Considering this loss of productivity, higher mortality, the supposed (00:18:00) growth in total heads and the magnitude that USDA is projecting, there is a requirement for significantly more breeders than in the past. Also, we believe that the tight labor conditions in the U.S.

will govern the pace of industry capacity additions in the near-term to mid-term. Despite more availability of other proteins, the outlook for chicken demand is – in the less commoditized segments this year remains solid overall as supply and demand remains in good balance. With the U.S.

economy continuing to be strong, very low unemployment, together with higher disposable incomes, households are looking for better quality, higher price cuts in meat and also more overall consumption. While U.S.

retailers are putting more emphasis on competing protein in terms of future activities, we believe our relationships with key customers give us an added level of protection. Globally, chicken remains the fastest growing protein in demand and U.S. chicken continues to be very competitive.

While we're already well-balanced in terms of our bird size exposure, we will continue to look for opportunities to shift our product mix and reduce the commodity portion of our portfolio by offering a more differentiated product to key customers, while also optimizing our existing operations to pursuing our operational improvement targets.

We believe our key customer approach is strategic and creates a basis to further accelerate growth in important categories by providing a more customized and innovative products to give us a clear competitive advantage. Given our experience with state-of-the-art deboning equipment in Europe and the U.S.

and our quest to continuously improve the work environment safety of our team members, we've made steady advances in developing robotic solutions for our processing facilities. Our focus has been on addressing process steps where both ergonomics and employee fatigue due to repetitive motion are key concerns.

We're excited about the progress to-date and are in a position to test a proprietary commercial scale proof-of-concept robotic technology in a labor intensive process area, where no automated solution exists today. As we shared last quarter, current plan is to test this technology in the later – latter part of Q3, which remains unchanged.

We believe our commitment in developing advanced automation technology will not only create a sustainable competitive advantage, but also allow us to economically address the ongoing issue of labor availability in our industry.

In the coming months, we'll also release our Pilgrim's 2017 sustainability update, which will detail our 2017 performance in an important environmental, social and economic topics and provide an update on our progress toward meeting our 2020 sustainability goals.

We're confident that our focus on sustainability will continue to position Pilgrim's as a global leader – industry leader in the production of high quality sustainable chicken products. And with that, I'd like to ask our CFO, Fabio Sandri to discuss our financial results..

Thank you, Bill, and good morning, everyone. Before I begin, as a reminder, because we closed the acquisition of Moy Park during Q3 of last year, the U.S. GAAP guidelines requires us to report the consolidated historical full quarter of Moy Park into our financials.

In the filing, our year-to-date and year-ago results have also been adjusted accordingly. Under this requirement, considering Moy Park both in 2018 and 2017, we reported $2.84 billion in net revenue during the second quarter 2018, resulting in adjusted EBITDA of $283 million or up 10% margin.

That compares to $2.75 billion in net revenue and an adjusted EBITDA of $449 million or up 16.3% margin the year before. Adjusting for the $24 million grain derivative loss and one-time events, our adjusted EBIT was $212 million or up 7.5% margin compared to $375 million or up 13.6% margin the year before.

Net income was $107 million versus $234 million in the same quarter of 2017, or up 54% year-over-year decrease resulting in an adjusted earnings per share of $0.53 compared to $0.90 in the same quarter of last year. Adjusted operating margins were 7% in U.S., 17% in Mexico, and 5% in Europe. Our fresh chicken operations in U.S.

operated well under the market conditions of Q2. Our EBIT in the U.S. was $124 million when adjusted for the derivative market-to-market or 7% margin for Q2.

Small-bird and case-ready continue to be strong for us and demand was in line with normal seasonality in the non-commodity sectors with small-bird pricing measured by EMI at near all-time highs as chicken has continued to be a compelling value proposition to customers despite higher availability of other proteins.

On the other hand, the large-bird deboning commodity was (00:23:16) seasonal and challenging during the most of the quarter, while rebounding at the end. As Bill mentioned, we believe the commodity sector was hurt by increase in emphasis by the retailers and foodservice of non-chicken promotions.

Our sales in the prepared segment continued to improve relative to last year with an increase of 6% in volume.

Despite the counter-seasonal trend of the commodity segment, we have the portfolio diversification to all bird sizes, including small-birds and case-ready and also international operations, which is designed to minimize the volatility and protect the downside.

The environment in Mexico was very strong in Q2, exceeding our expectations due to our improved operations and a strong demand for chicken. Our EBIT in Mexico for Q2 was $62 million or up 17% margin.

While the market was supported, we also have a very strong team in Mexico who have been over-delivering performance for us in terms of relative performance to the major competition in past few years, due to their strong operational focus and excellent determination.

Considering the strain in momentum in the start of 2018, we believe Mexico will have another strong year despite normal volatility during the quarters.

And our long-term outlook for Mexico remains very positive as we believe the country will continue to be a platform for future growth in chicken consumption, as consumers seeks better diet and higher disposable income.

To support the growth in Mexico, we continue to invest in our production at the new Veracruz complex which is tracking well and its performance is exceeding our expectations and we expect to double the size of the operation, including expenses in the feed mill and hatchery by the end of this year.

As part of our target to improve our differentiation in Mexico, we have been increasing our focus on prepared foods, including adding products using the premium Pilgrim's brand.

Our investments have continued to produce very good results with Prepared Foods volume 34% higher than a year ago and our Pilgrim's and Del Dia brands capturing roughly 35% of the prepared food market.

To maintain our growth and continue to innovate, we launched fresh chicken under the premium Pilgrim's brand including 'no antibiotics ever', which have continued to see strong demand.

Our strategy is supportive of the goal to increase our higher margin differentiated products while having product coverage from entry level to premium, both in fresh and prepared remix (00:25:42). In Europe, during Q2, our operations continue to improve sales and margins. Our adjusted EBIT in the UK, Europe was $27 million or 5% margins for Q2.

Integration is going well and we are excited with the geographic diversification and growth potential for us, while evolving our portfolio and creating a sustainable advantage through opportunities to capture the upside in the market but protecting the downside.

We're slightly ahead of our target of $50 million in synergies over the next two years, including optimizing the product portfolio, operational synergies and implementing zero based budgeting.

We have increased the efficiencies of the value chain by enhancing sourcing and production, improving life (00:26:26) cost, yield improvements and the global management of feed sourcing. We will leverage our marketing and sales infrastructure to optimize the SG&A costs.

We have a very good history of successfully capturing synergies and delivering significant improvement. In those cases we have meaningfully exceeded our initial synergy targets while building on and improving the performance of the business beyond just the underlying markets.

We are confident to have the technology and be in place to similarly continue to grow the profits our European operations and leverage their expertise and experience to improve the rest of our global operations.

Despite of the evolution of the retail market in UK, we are already seeing some positive results from the acquisition with significant share gain at a large retailer and several other projects with key customers in the first half and we continue to strengthen our additional relationship while supporting an improvement in the financial performance of the business.

During Q2, our SG&A reached 3.1% of sales, reflecting the inclusion of support for expanding the Just BARE brand nationally, the investments for our new prepared foods products both in U.S. and Mexico as well as the addition of the new European operations.

We recognized a one-time derivative loss of $24 million to reflect our position amidst what was a very volatile grain market, which increased at the beginning of Q2 before declining significantly at – as we ended the quarter, driven by noise around challenging international trade expectations.

As we mentioned, as of today, we have coverage of – on feed through the end of the growing season in U.S. and for much of the remainder of the year in Europe.

We remain on track to reach our target of $210 million in operation improvements and synergies for 2018, reflecting the benefits of the acquisition and supporting the evolution of our mix and production capabilities and improving our ability to service key customers throughout the globe.

We'll continue to prioritize our capital spending plans this year to optimize our product mix that is aimed at improving our ability to supply innovative, less commoditized products and strengthening our partnership with key customers.

We expect to invest between $300 million and $350 million in CapEx to account for the inclusion of the GNP and Europe within the budget. We reiterate our commitment (00:28:49) to invest on strong return on capital employed projects that will improve our operational efficiencies and tailor customer needs to further solidify our competitive advantage.

Our balance sheet continues to be strong, given our continued emphasis on cash flow from operating activities, focus on management of working capital and disciplined investment in the high-return projects.

During the quarter, our net debt reached $2 billion with a leverage ratio of 1.6 times pro forma last 12 months' EBITDA, below our optimal range of 2 times to 3 times.

Our leverage remains at the low level and we expect to continue to generate strong cash flows, increasing our financial capability to pursue our strategic intentions strategic intentions.

The outlook for 2018 interest expense remains at about $130 million on a normalized basis, reflecting the payment of the Moy Park corporate bonds, the issuance of the add-on on bonds replacing it and the new credit facilities in U.S. and Europe.

We once again received great support from our lending partners with the offering significantly oversubscribed to amend and extend the prior term loan and revolver facilities in U.S., simplifying our total debt structure and reducing our total interest cost. We have a strong balance sheet and a relatively low leverage.

We remain focused on exercising great care in ensuring that we create shareholder value by optimizing our capital structure while preserving the flexibility to pursue our growth strategy.

And we continue to consider and evaluate all relevant capital allocation strategies that will match the pursuit of our growth strategy and we continue to review each (00:30:29) prospect accordingly to our value creating standards. Operator, this concludes our prepared remarks. Please open the call for questions..

We will now begin the question-and-answer session. The first question comes from Farha Aslam of Stephens Inc. Please go ahead..

Hello?.

Hello. Good morning, Farha..

Hi. Good morning.

So could we talk about your grain costs? Clearly we took a mark-to-market extraordinary charge in the quarter; how does that flow through your P&L in the subsequent periods this year? And any hedges on grain we could discuss kind of going forward?.

Thanks for the question, Farha.

So our – would say our commodity risk management team continues to do a very good job in managing our commodity risk, and so during the development and growing season for corn and soybeans, given the drought conditions that South America experienced and the lowering of the carry-outs by USDA, we thought it prudent to hedge our grain purchases with buying commodities futures contracts and we did that at the beginning and throughout the mid part of the quarter.

But as you know, the trade environment changed significantly with the discussions among Chinese trade partners and European trade partners and that caused both corn and soybean markets to go down significantly at a very, very rapid pace. And in so doing, the value of those futures contracts decreased significantly.

Our commodity team did a great job as I said in rolling those futures into physical corn and soybean mill from a forward (00:33:20) purchases, and so even though we took a one-time mark-to-market loss on those futures contracts, what we have now is a forward-bought physical feed ingredients at prices under the current market and we have that position well into the harvest season.

So, we feel like we're very well-positioned from a competitive standpoint on our feed cost going through the rest of this growing season..

So, Farha, there is no impact on future performance or future results because we took the market-to-market position of $24 million in this quarter. So is, as of, we will buy the grain at market prices in the future (00:34:14)..

But we did convert most of those futures contracts into physical, again at prices lower than the current market is today..

That's helpful.

And then when you think about the pricing pressure in the commodity market, is that impacting pricing in the value-added market? And how should we think about pricing for retail and pricing for value-added into 2019, given the current commodity pressure?.

Yes, I'm going to assume the term commodity refers to the large-bird deboning chicken segment..

Yeah..

And in that thing it certainly doesn't help pricing on virtually any chicken products if they had to be priced today with the exception I would say of the small-bird components, because those two markets are really not tied together.

It has affected some of the case-ready pricing and the primary impact there is, during the summertime, we've seen product that comes from the big-bird segment going into case-ready plants and get packed for the fresh retail market.

When demand did not grow seasonally, as it typically does this year, then that commodity breast meat primarily did not flow into those case-ready plants and backed up into the other market channels, distributor and foodservice and so forth, and so that put an immense amount of pricing pressure on those spot sales or the most commoditized portion of the chicken market.

So, yes, I would agree that it has pressured all chicken products with the exception of small-bird components..

Yeah. Just to support that, Farha, if you look at UB (00:36:16), which is the commodity index, it is down 22% year-over-year, while the prices, according to the EMI, small-bird indexes are higher than last year and actually higher than the five-year average and close to all-time highs.

Also, the gap between the small-bird breast and the big-bird breast is the highest we've ever seen..

That's helpful. Thank you..

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

Hey. Good morning, everyone..

Good morning..

Good morning, Ken..

So I just have one question.

When you think about the chicken margin outlook, what is the most likely course to reverse or improve the chicken margin outlook, particularly in the commodity side? Do you think it's more about that we need to see margins actually get worse, so you're going to see a production cut? Or do you think that the promotional activity will pick up and you'll start to see a resurgence of margins? Or is there another avenue where (00:37:24) is kind of like middling level, right, that's neither terrible nor great, but we want to see some sort of inflection point.

So what do you think is the catalyst to make it change?.

A couple of things, Ken. We definitely need to see more retail future activity for chicken as we've lost some of our share of that future activity to beef and pork as we've previously said. And we think that we'll see a pickup in that activity as we go later into the summer. Typically, we do see that in August going into September.

The other component that I would say is related to profitability and margin is declining feed cost. As you know, we started the year thinking that for us at least we would see as much as $150 million cost impact to corn and soy.

Well, the trade talk has taken that out and whereas we saw an increase in feed cost through most of Q2, we believe based on the positions that we have today, we're going to see a decline in feed costs. So more future activity bringing greater demand at retail and then lower feed cost are the two components that I would offer..

Just to give more color on what you have mentioned, our live operation was impacted in U.S. by $48 million because of the higher grain cost and the higher chick cost despite better conversions than last year..

And do you think that there would be – I mean, you don't think there's a level at which we would get a production cut, because again that kind of like modest profitability for everybody, so there doesn't seem to be anything – so you think the way the margins get better is, just do you think the dynamics get better; you don't need a production cut.

Is that a fair assessment of what you're saying?.

I'm not sure about a production cut. I will say that we continue to be pressured by the lack of productivity or the fall of productivity of our breeder flock. For sure, we think that's a natural cap. We also see a natural cap in the labor supply issue that all manufacturing and the whole economy faces in the U.S.

So, I think those two things will definitely create a ceiling on production increases..

Great. I appreciate it. Thank you very much..

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

Good morning. This is not one of my questions, but just something you just said, Fabio, I want to clarify. You said something about $48 million impact from higher feed and chick costs in U.S. and yet in the 10-Q, it says that feed costs were up $60 million – $61 million in all.

So, I'm just trying to figure out the disparity between those two?.

That's because – sure, sure and that's because that's not volume adjusted. We have 1.5% more volume in U.S., so that is the total impact....

Okay. Okay..

...when you look at just – I'm talking about rate and the impact of the chick cost and higher feed, and again despite better conversions..

Okay. So, moving on the questions, talking of supply constraints, so we've seen an improvement in livability, hatchability; it's better than – sorry, it's down year-on-year, but it's better than it was earlier in the year, but was wondering if you could give us an update on what you're seeing on the breeder side.

And just everyone's well aware of the multitude of plants that are coming on late this year into 2019, and yet we have these breeder constraints, and just I'm wondering how you're reconciling the two in your mind?.

Yes. So, on the current production footprint, while you're right, we've seen an improvement from where we were with the chick per hen productivity, and we believe that the change is structural and we're not going to get back to where we were say two years to three years ago.

So that's going to continue to put somewhat of a ceiling on our ability to grow with our current footprint, notwithstanding the fact that we do have more complexes coming on. But in that regard, starting up a new complex with a new labor pool is going to be I think difficult at best.

And we've heard anecdotally of some operations that have been in operation for a couple of years now that still aren't up to full capacity for no other reason than the lack of labor availability. So, we don't think that that's going to change in the next two years to three years..

But I mean, if you look at the – if you just take the stated capacity of the new plants that are being added, and let's just say that's a – it's a low single-digit increase, but not one – let's just say, it's 2% to 3%.

If you look at these breeder constraints and the other constraints, I mean, how do you think the industry gets to the point where it can populate those plants given these broader constraints? How does that happen, or does the existing footprint have to shrink? I just – I'm having difficulty reconciling the two in my mind..

I think that's a very good question. I don't have the answer to that, Heather, because we're not one of the companies that is building a new complex right now. So I would direct you to ask those who are. We've tried to further switch some of the breeds that we still want to change out.

And we've been told by the breeder that we desire to have this going to be well into mid next year before we can even get some of the new breed that we're trying to purchase..

I think just like you mentioned, Heather, the ramp up of this plants will take longer, not only because of the breeders, but also because of the labor and we are seeing that happening in other segments and with the chicken plants that have been recently opened.

Just the ramp-up will take, instead of the normal nine months, will take almost two years because....

Okay..

...of the breeders and because of the staffing..

And then my second question is on (00:44:41) relative performance.

So when I look at where I model – think Tray-Pack should have been for the quarter, small bird, big bird, and then just what I assume a relatively conservative assumption of prepared foods, it seems like your relative performance deteriorated some, even adjusting for that mark-to-market, it deteriorated some in Q2.

So, you mentioned some prepared foods investments, you mentioned some (00:45:09) production costs; like, can you help us to understand what drove that and when that should reverse itself?.

Yeah. The gap in U.S. like I started to disclose was around $48 million with high feed and chick cost, again despite better conversions than last year. Our operations actually improved by $10 million with the operation improvement initiatives and increased volume, more than offsetting the increase in salary we gave to our team members.

Our SG&A was $10 million higher on investments, just like you mentioned in our Just BARE brand and some admin expenses.

If you look at the commodity cut-out, it was 22% lower than last year and affected directly our big bird segment, impacting the bottom line by close to $120 million, while our non-commodity segments and operational improvements in yields that's manifested in (00:46:04) sales improve our mix and price by $20 million.

So if you look at the gap between last year and this year, these are the main buckets..

Okay. All right. Thank you so much..

The next question comes from Jeremy Scott at Mizuho. Please go ahead..

Hi. Good morning..

Good morning..

Good morning..

Hope you can expand on what you mean by refining your portfolio strategy in the U.S. Maybe you can answer in the context of short-term versus long-term.

In the short-term, how do you mitigate the pricing risk in big bird? I think in the past you talked a little bit about buy-versus-grow, but just wondering to what extent that is effective when you have overall sales volume weakness.

And then, over the longer term, when you look at the market today versus a decade ago and how your customer demands have changed, is the mid-cycle earnings power of a large big bird plant, deboning plant structurally lower today or are we reading too much into this cyclical swamp in breast meat?.

I'll offer a few examples. If you remember February of 2017 or last year, we converted a large bird deboning operation that was largely just sold on the commodity spot market. We spent $130 million on the operation, converted it to an organic tray pack plant.

That's changed the profitability of that operation significantly and continues to stay in line with our expectations. We have some case-ready plants, one newly acquired one to be specific, where we don't have enough capacity to put all the meat in a fresh retail trade.

We're going to spend some capital dollars to finish out the packaging portion of that plant so that we can get an optimum amount of meat in a tray, and that's yet another example of changing our mix.

In the large bird deboning segment, there are certain value-added products even in those plants that we can develop and grow to take out the spot market effect, if you will, for those operations. So it's a continuing evolution of upgrading our mix and developing a more diverse portfolio even within our segments..

One example of that is the conversion of one of our plants to No-Antibiotics-Ever (00:48:52) which is the first conversion that we've done in the big bird segment. We are leading the other segments in that category, but we just now converted one big bird operation.

To that another example is to use, just like Bill mentioned, more foodservice in a box with some branding and some specific trimming (00:49:13) to specific customers targeting a much higher value-added operation even within the commodity segment..

Can you talk a little bit about the elasticity of your organic and ABF pricing when you have commodity price declines of such magnitude?.

Sure. When we convert a facility to No-Antibiotics-Ever, the pricing on that product is pretty well set. We don't do that as a speculative activity thinking that we're just going to go out and sell it and someone is going to pay us more.

We already have agreements with customers when we do that to pay us a defined premium relative to the traditional type products. So there's no question when we do that that we're going to have a higher margin for the long-term..

And then, the $25 million increase in freight, can you talk a little bit about your conversations with your customers and maybe the process around passing that through, or is that just – you expect it following its own pattern (00:50:30) as long as it remains as high?.

Yeah, it hasn't changed since we reported last quarter. We think that we'll realize an increase of about $30 million through the year, and then we'll recover somewhere in the low- to mid-$20 million of that. So most of that we're going to do to recover and it's not going to be a material impact to profitability..

Based on what you're seeing today, do you expect that to be a tailwind in 2019?.

We don't think the driver shortage, which is the root cause of this, is going to get any better in 2019. So we think it's going to continue to be a challenge and we'll have to work with our customers to make sure that our products are priced in such a way that we cover those increase in freight cost..

Got it. Thank you..

The next question comes from Ben Theurer of Barclays. Please go ahead..

Hey, good morning, Bill, Fabio. So thanks for taking my question. Just wanted to quickly follow-up on your strategy going forward and I guess you've talked a lot about it, but obviously there was the impact from the derivative and then you decided to roll it into physical. You took about (00:51:57) $24 million hit.

So if we actually adjust for that that is roundabout a 250-basis-point impact on your cost of sales just in the U.S.

So going forward, are you basically just literally not going to engage that much in the derivatives market? We can really account for the write-off in 2Q as a one-time event, because we've not been seeing you guys adjusting for that in the past and it just popped up now as an adjustment.

So really want to make sure that we're not going to see derivatives. I mean, I understand you do (00:52:30) future positioning by physical feed ingredient, but just to understand where we are on that going forward and then I have a follow-up on that..

Sure. Well, we view the use of derivatives as a risk management tool and I would tell you given the right market atmosphere where we're going to continue to use those as a tool when we see the need. Fact of the matter is we took the opportunity given the rapid fall in price on corn and soybean meal to convert those into physical purchases.

And so, through most of the harvest season in this crop year, we've locked in our feed ingredient cost. But if markets change and we see the need to employ purchase of derivative contracts or financial products again, then we'll employ that strategy as needed..

Okay..

I think the reason for the call out was just to demonstrate the performance of the business during the quarter, not with some impact from future purchases, because these are future purchases, not purchases from this quarter. I think that was the reason for the call out..

Okay.

And the roughly 250 bps assumption, that's correct, right?.

Yes..

Okay. Yeah, and then my follow-up question, so if we adjust for that, I mean, clearly we are in an environment where cost of sales is higher. But you've mentioned something, I just want to understand this right so that we get the outlook for the second half properly.

So you've mentioned feed cost now is actually at a lower level than a year ago and that's how it looks like if you just take a look at this year pricing, but what you've locked in, what percentage does that compare roughly to your actual cost you had in the second half so that we get an understanding at least from the feed ingredient point of view, how does cost of sale looks like on a year-over-year basis for the back half of 2018?.

Because of the market-to-market of $24 million, what we believe now the reality is that then we start with normal market prices in Q3 and that was the reason for the market-to-market hit. And when we transformed this $24 million from derivatives to physical, it's actually at a little better condition than the market is today.

So expect to have a little bit of a benefit from that $24 million market-to-market loss last quarter..

Okay. Understood. Thank you very much..

The next question comes from Adam Samuelson of Goldman Sachs & Company. Please go ahead..

Yes. Thank you. Good morning, everyone..

Good morning, Adam..

A lot of grounds have been covered today.

Wanted to ask you a little bit about the second half and I think last question covered kind of the view on a much more balanced year-over-year fee cost outlook for the back half, but thinking about the impact of the commodity businesses and big bird on the back half, I mean, the big bird cut-out remains 20%-plus below year ago levels.

Can you go through some of the outlook for the different cuts within that as we go into the fall? And thinking about is it really we need retail features (00:56:12) to kind of start stacking in a little bit more boneless breast meat to put some support into that market, at least relative to where we've been on a year-on-year basis or are we looking at a point where boneless in the fall can be $1 and like quarters remain – will start (00:56:32) tracking below year ago levels and the wing comps get easy, but still the big – you still have pretty challenging competitors (00:56:38) on the cut-out for several more quarters?.

Right. So we would view, Adam, the commodity market or the large bird deboning market in general as remaining challenging for the rest of the year. Although, we would believe that sometime yet the summer we may see some lift from retail features, but fact of the matter is we're sort of short on time that we can enjoy that as we get through Labor Day.

And I think that you called it fairly correctly with potentially wings getting a lift, I would say tenders could get a lift, but by and large we think that the back half of the chicken will remain fairly steady and the breast meat conformer to that (00:57:35) will remain fairly weak through the rest of the year..

Adam, if you look at the comparable last year, during Q2 and Q3 you have a very strong summer with very strong wing and very strong breast meat prices. But at the fall, we saw a big drop in prices last year as well. So the comps will get a lot easier for sure..

That's fair. But just given even without the feed cost kind of normalizing or settling out on a year-on-year basis, you still have the other kind of cost dynamics, which remain kind of in place.

And I'm just wondering, I mean, given the implications of that for the industry, I mean, doesn't that put the big bird deboning industry in the red by the fourth quarter, given the normal seasonality of prices?.

It's possible, but from our standpoint, we're not going to stand still. We're going to continue to work on our mix, develop more value-added products in that segment such that we can get a better return (00:58:42) so the spot market would avail to us..

Okay. And then, just a quick question on Mexico, if I may. I know seasonally second quarter is always strong and you improved this quarter, but on a year-on-year basis, I mean is the decline – help me just think about the decline year-on-year in the Mexico business.

I know currency wasn't helpful, but beyond that just some of the pieces in Mexico and how to bridge that..

We think we're going to have another great year in Mexico. And if you've noticed through each year, the quarters are fairly lumpy, but as I remember seeing the numbers yesterday, we're amazingly consistent.

When you compare year-to-year, we don't think 2018 is going to be a lot different than – that has been (00:59:37) the last couple of years with great performance for the whole year..

Yeah. Just like you mentioned, there is some volatility on quarter-to-quarter with Q3 not being as strong as the Q2 and Q4. If you remember last year, we have unseasonable weak Q4 because of the hurricanes and because of the earthquake in Mexico and also the volatility in exchange rate. And we expect to have a stronger Q4 this year.

So when you look at total of the year, we expect as strong of a year as we have last year..

Okay. That's helpful. I appreciate the color. Thank you..

This concludes our question-and-answer session. I would like to turn the conference back over to Bill Lovette for closing remarks..

Thank you. And we look forward to a second half of 2018 to remain positive on the outlook for chicken consumption globally. Despite the volatility in the commodity sector, we believe chicken continues to be the most compelling protein everywhere around the world.

With our newly acquired European operations and last year's acquisition of GNP, we're much better represented globally and well-positioned to improve our margin profile and reduce volatility despite specific market conditions.

We will continue to look for opportunities, including Europe to refine our portfolio and offer differentiated customized products while pursuing our key customer strategy in support of our vision and becoming the best and most respected industry, creating the opportunity of a better future for our team members.

I'd like to thank everyone in the Pilgrim's family as well as customers and also thank you for your interest in our company today. Thank you for joining us..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..