UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x   Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

Commission File No. 001-14704

 

TYSON FOODS, INC.

(Exact Name of Registrant as specified in its Charter)

 

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Securities Registered Pursuant to Section 12(g) of the Act: Not Applicable

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

On April 1, 2006, the aggregate market value of the registrant’s Class A Common Stock, $0.10 par value (Class A stock), and Class B Common Stock, $0.10 par value (Class B stock), held by non-affiliates of the registrant was $3,390,273,593 and $322,725, respectively. Class B stock is not publicly listed for trade on any exchange or market system. However, Class B stock is convertible into Class A stock on a share-for-share basis, so the market value was calculated based on the market price of Class A stock.

On December 2, 2006, there were 273,911,430 shares of the registrant's Class A stock and 80,883,320 shares of its Class B stock outstanding.

 

Page 1 of 95 Pages

The Exhibit Index appears on pages 85 through 91

 

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TYSON FOODS, INC.

INCORPORATION BY REFERENCE

The following indicated portions of the registrant's definitive Proxy Statement for the registrant's Annual Meeting of Shareholders to be held February 2, 2007 (the Proxy Statement) are incorporated by reference into the indicated portions of this Annual Report on Form 10-K: 

Part III

The information set forth under the captions "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.

The information set forth under the captions "Executive Compensation and Other Information" and “Report of Compensation Committee” in the Proxy Statement.

The information set forth under the captions "Security Ownership of Certain Beneficial Owners," "Security Ownership of Management" and “Equity Compensation Plan Information” in the Proxy Statement.

The information set forth under the captions “Audit Fees,” “Audit-Related Fees,” “Tax Fees” and “All Other Fees” in the Proxy Statement.

 

 

 

 

 

 

 

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TYSON FOODS, INC.

PART I

ITEM 1. BUSINESS

 

GENERAL

Tyson Foods, Inc. and its subsidiaries (collectively, the Company or Tyson), with world headquarters in Springdale, Arkansas, produce, distribute and market chicken, beef, pork, prepared foods and related allied products. The Company commenced business in 1935, was incorporated in Arkansas in 1947, and was reincorporated in Delaware in 1986. The Company has historically grown by acquisitions, its most recent being the acquisition of IBP, inc. (now called Tyson Fresh Meats, Inc. (TFM)) in 2001. In addition to being the world's largest processor and marketer of chicken, beef and pork products, the Company is also the second largest publicly traded food company in the Fortune 500 with one of the most recognized brand names in the food industry.

 

The Company operates a totally integrated poultry production process. Through its wholly-owned subsidiary, Cobb-Vantress, Tyson is the number one poultry breeding stock supplier in the world. Tyson invests in breeding stock research and development which allows the Company to breed into its flocks the natural characteristics found to be most desirable. The Company's integrated operations consist of breeding and raising chickens, as well as the processing, further-processing and marketing of these food products and related allied products, including animal and pet food ingredients.

 

The Company is also involved in the processing of live fed cattle and hogs and fabrication of dressed beef and pork carcasses into primal and sub-primal meat cuts, case-ready products and fully-cooked beef and pork products. In addition, the Company derives value from allied products such as hides and variety meats for sale to further processors and others.

 

The Company produces a wide range of fresh, value-added, frozen and refrigerated food products. The Company's products are marketed and sold to national and regional grocery retailers, regional grocery wholesalers, meat distributors, clubs and warehouse stores, military commissaries, industrial food processing companies, national and regional chain restaurants or their distributors, international export companies and domestic distributors who service restaurants, foodservice operations such as plant and school cafeterias, convenience stores, hospitals and other vendors. Sales are made by the Company's sales staff primarily located in Springdale, Arkansas, and Dakota Dunes, South Dakota. Additionally, sales to the military and a portion of sales to international markets are made through independent brokers and trading companies.

 

FINANCIAL INFORMATION OF BUSINESS SEGMENTS

The Company operates in five business segments: Chicken, Beef, Pork, Prepared Foods and Other. The contribution of each business segment to net sales and operating income, and the identifiable assets attributable to each business segment, are set forth in Note 17, “Segment Reporting” of the Notes to Consolidated Financial Statements included herein at pages 74 through 76.

 

DESCRIPTION OF BUSINESS SEGMENTS

 

Chicken:  The Company’s chicken operations primarily are involved in the processing of live chickens into fresh, frozen and value-added chicken products. The Chicken segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world. The Chicken segment also includes sales from allied products and the Company’s chicken breeding stock subsidiary.

 

Beef:  The Company's beef operations primarily are involved in the processing of live fed cattle and fabrication of dressed beef carcasses into primal and sub-primal meat cuts and case-ready products. It also involves deriving value from allied products such as hides and variety meats for sale to further processors and others. The Beef segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world. Allied products are also marketed to manufacturers of pharmaceuticals and technical products.

 

Eight of the Company’s fed beef plants include hide processing facilities. The uncured hides from the Company’s other fed beef plants are transported to these facilities, which include brine curing operations and, in four locations, chrome hide tanneries. The chrome tanning process produces a semi-finished product that is shipped to leather goods manufacturers worldwide. Brine-cured hides are sold to other tanneries. Tyson is the largest chrome tanner of cattle hides in the United States.

 

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Pork:  The Company's pork operations involve processing live market hogs and fabricating pork carcasses into primal and sub-primal cuts and case-ready products. This segment also includes the Company's live swine group and related allied product processing activities. The Pork segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world. It also sells allied products to pharmaceutical and technical products manufacturers, as well as live swine to pork processors.

 

Additionally, the Company has farrow-to-finish swine operations, which include genetic and nutritional research, weaned and feeder pig sales, feeder pig finishing and the marketing of live swine to regional and national packers conducted in Arkansas, Missouri and Oklahoma.

 

Prepared Foods:  The Company's prepared foods operations manufacture and market frozen and refrigerated food products. Products include pepperoni, bacon, beef and pork pizza toppings, pizza crusts, flour and corn tortilla products, appetizers, prepared meals, ethnic foods, soups, sauces, side dishes, meat dishes and processed meats. The Prepared Foods segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world.

 

Other:  The Company’s Other segment includes the logistics group and other miscellaneous operations.

 

RAW MATERIALS AND SOURCES OF SUPPLY

 

Chicken:  The primary raw materials used by the Company in its chicken operations consist of live chickens that are raised primarily by independent contract growers. The Company's vertically-integrated chicken process begins with the grandparent breeder flocks. Breeder farms specialize in producing the generations of male and female strains, with the broiler being the final progeny. The breeder flocks are raised to maturity in grandparent growing and laying farms where fertile eggs are produced. The fertile eggs are incubated at the grandparent hatchery and produce male and female pullets (i.e., the parents). The pullets are sent to breeder houses, and the resulting eggs are sent to Company hatcheries. Once the chicks have hatched, they are sent to broiler farms. There, contract growers care for and raise the chicks according to Company standards while receiving advice from Company technical service personnel until the broilers have reached the desired processing weight. The adult chickens are hauled to processing plants, and the finished products are sent to distribution centers and then transported to customers. The Company operates its own feed mills to produce scientifically-formulated feeds. In fiscal 2006, corn and soybean meal were major production costs in the poultry industry, representing roughly 37% of the cost of growing a live chicken. In addition to feed ingredients to grow the chickens, the Company uses cooking ingredients, packaging materials and cryogenic agents. The Company believes its sources of supply for these materials are adequate for its present needs and the Company does not anticipate any difficulty in acquiring these materials in the future. While the Company produces substantially all of its inventory of breeder chickens and live broilers, from time-to-time it purchases live, ice-packed or deboned chicken to meet production requirements.

 

Beef:  The primary raw materials used by the Company in its beef operations are live cattle. The Company does not have facilities of its own to raise cattle in the United States. The Company has cattle buyers located throughout cattle producing areas who visit feed yards and buy live cattle on the open spot market. These buyers are trained to select high quality animals, and their performance is continually measured by the Company. The Company also enters into various risk-sharing and procurement arrangements with producers who help secure a supply of livestock for daily start-up operations at its facilities. The Company's Canadian subsidiary, Lakeside Farm Industries, Ltd. (Lakeside), primarily has cattle feeding facilities, a beef carcass production and a boxed beef processing facility. In 2006, Lakeside's feedlots provided approximately 21% of that facility's fed cattle needs.

 

Pork:  The primary raw materials used by the Company in its pork operations are live swine. The Company raises live swine to sell to outside processors and supplies a minimal amount of live swine for its own processing needs. The majority of the Company's live swine supply is obtained through various procurement arrangements with independent producers. The Company also employs buyers who purchase hogs on a daily basis, generally a few days before the animals are required for processing.

 

Prepared Foods:  The primary raw materials used by the Company in its prepared foods operations are typically commodity based raw materials, including fresh and frozen chicken, beef and pork, corn, flour and frozen vegetables. Some of these raw materials are provided by the Chicken, Beef and Pork segments and also may be purchased from numerous suppliers and manufacturers.

 

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SEASONAL DEMAND

The demand for the Company's chicken and beef products generally increases during the spring and summer months and generally decreases during the winter months. The Company's pork and prepared foods products generally experience increased demand during the winter months, primarily due to the holiday season, while demand decreases during the spring and summer months.

 

CUSTOMERS

Wal-Mart Stores, Inc. accounted for approximately 12.5% of the Company’s fiscal 2006 consolidated sales. Sales to Wal-Mart Stores, Inc. were included in the Chicken, Beef, Pork and Prepared Foods segments. Any extended discontinuance of sales to this customer could, if not replaced, have a material impact on the Company's operations; however, the Company does not anticipate any such occurrences. No other single customer or customer group represents greater than 10% of fiscal 2006 consolidated sales.

 

BACKLOG OF ORDERS

As of September 30, 2006, there was no significant backlog of unfilled orders for the Company's products.

 

COMPETITION

The Company's food products compete with those of other national and regional food producers and processors and certain prepared food manufacturers, including Cargill Incorporated, Foster Farms, Gold Kist, Inc., Hormel Foods Corporation, Kraft Foods, Inc., National Beef Packing Company LLC, Perdue Farms Inc., Pilgrim’s Pride Corp., Sanderson Farms, Inc., Sara Lee Corporation, Smithfield Foods, Inc. and Swift and Company. Additionally, the Company's food products compete in international markets around the world. The Company's principal marketing and competitive strategy is to identify target markets for value-added products, to concentrate production, sales and marketing efforts to appeal to and enhance the demand from those markets and, utilizing its national distribution systems and customer support services, seek to achieve a leading market position for its products. Past efforts have indicated customer demand generally can be increased and sustained through application of the Company's marketing strategy, as supported by its distribution systems. The principal competitive elements are brand identification, breadth and depth of the product offering, product quality, customer service and price.

 

INTERNATIONAL

The Company exported to more than 80 countries in fiscal 2006. Major export markets include Canada, Central America, China, the European Union, Japan, Mexico, Russia, South Korea and Taiwan.

 

The Company continues to explore growth opportunities in Argentina, Brazil, China and Mexico, and believes each offers potential in terms of expanding or developing processing facilities. The Company's Mexican subsidiary, Tyson de Mexico, continues to show growth with a focus on further processed chicken products. The Company’s Canadian subsidiary, Lakeside, has cattle feeding facilities, a beef slaughter operation, a boxed beef processing facility, a farming operation and a fertilizer operation. The Company’s chicken breeding stock subsidiary, Cobb-Vantress, has business interests in Argentina, Brazil, the Dominican Republic, India, Japan, the Netherlands, the Philippines, Spain, the United Kingdom and Venezuela. The Company also owns a majority interest in and operates a chicken further processing facility in China. The Company has a minority interest in a Chinese pork processing facility. The Company continues to be involved in a technical service agreement with Grupo Melo in Panama to assist Grupo Melo with the production of further processed chicken products and to allow it to license the Tyson brand. Additional information regarding the Company’s export sales, long-lived assets located in foreign markets and income (loss) from foreign operations is set forth in Note 17, “Segment Reporting” of the Notes to Consolidated Financial Statements included herein at pages 74 through 76.

 

RESEARCH AND DEVELOPMENT

The Company conducts continuous research and development activities to improve finished product development, to develop ways to automate manual processes in its processing plants and growout operations and to improve the strains of primary chicken breeding stock. The annual cost of such research and development programs is less than one percent of consolidated annual sales.

 

REGULATION AND FOOD SAFETY

The Company's facilities for processing chicken, beef, pork, prepared foods and milling feed and for housing live chickens and swine are subject to a variety of federal, state and local laws relating to the protection of the environment, including provisions relating to the discharge of materials into the environment, and to the health and safety of its employees. In fiscal 2006, the Company incurred expenses of approximately $100 million primarily related to the normal operation and maintenance of wastewater treatment facilities,

 

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where the Company biologically treats these wastes, and the associated land application of wastes generated at these treatment facilities. The Company incurred $10 million in capital expenditures related to its wastewater treatment facilities in fiscal 2006 and anticipates capital expenditures of approximately $19 million in fiscal 2007 for environmental projects related to the wastewater treatment facilities. Except as disclosed in Item 3., Legal Proceedings, the Company believes it is in substantial compliance with such applicable laws and regulations, and the Company is not aware of any violations of, or pending changes in, such laws and regulations likely to result in material penalties or material increases in compliance costs.

 

The Company works to ensure its products meet high standards of food quality and safety. In addition to our own internal Quality Assurance oversight and review, the Company’s chicken, beef, pork and prepared foods products are subject to inspection prior to distribution, primarily by the United States Department of Agriculture (USDA) and the United States Food and Drug Administration (FDA). Notwithstanding these efforts, food producers are at risk their products may contain pathogens.

 

The Company is exposed to risk if its products are determined to be contaminated or cause illness or injury. These risks include (1) the cost of adverse publicity and product recalls, including the associated negative consumer reaction; (2) exposure to related civil litigation; and (3) regulatory administrative penalties, which can include injunctive relief and other civil remedies, including plant closings. The Company's chicken, beef and pork processing facilities are participants in the government's Hazardous Analysis Critical Control Point (HACCP) program and are subject to the Sanitation Standard Operating Procedures and the Public Health Security and Bioterrorism Preparedness and Response Act of 2002. The cost of compliance with such laws and regulations has not had a material adverse effect on the Company's capital expenditures, earnings or competitive position and it is not anticipated to have a material adverse effect in the future.

 

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EMPLOYEES AND LABOR RELATIONS

As of September 30, 2006, the Company employed approximately 107,000 employees. The Company believes its overall relations with its workforce are good.

 

Set forth below is a listing of the Company facilities which have employees subject to collective bargaining agreements together with the names of the union parties to the collective bargaining agreements, the number of employees at the facilities subject thereto and the expiration dates of the collective bargaining agreements currently in effect.

 

 

 

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UFCW - United Food and Commercial Workers Union

RWDSU - Retail, Wholesale, Department Store Union

PMU - Production and Maintenance Union

IUOE - International Union of Electrical Workers

USWA – United Steel Workers of America

CTM - Confederacion de Trabajadores de Mexico

FNCSI - Sindicato Industrial de Trabajadores de Nuevo Leon

CROM - Confederacion Reginal Obrera de Mexico

CROC - Confederacion Reginal de Obreros y Campesinos

 

(1) Contracts are currently under negotiations.

 

The Company is not experiencing any strike or work stoppage that had a material impact on operations.

 

MARKETING AND DISTRIBUTION

The Company's principal marketing objective is to be the primary provider of chicken, beef, pork and prepared foods products for its customers. The Company identifies distinct markets and business opportunities through continuous consumer and market research. The Company’s branding strategy focuses on one national protein brand, the Tyson® brand, as well as a number of strong regional brands. All communications stress the quality, convenience and protein power benefits of the Company’s products while supporting and building brand awareness. Communication efforts are built around the “Powered by Tyson™” strategy and utilize a fully integrated and coordinated mix of activities designed to connect with customers and consumers on both a rational and emotional level. The Company utilizes its national distribution system and customer support services to achieve the leading market position for its products.

 

The Company has the ability to produce and ship fresh, frozen and refrigerated products. The Company's nationwide distribution system extends to a broad network of food distributors, which is supported by cold storage warehouses owned or leased by the Company, by public cold storage facilities and by the Company's transportation system. The Company ships products from Company-owned consolidated frozen food distribution centers, from a network of public cold storages, from other owned and leased facilities and directly from plants. The Company's distribution centers facilitate accumulating fresh and frozen products so that it can fill and consolidate less-than-truckload orders into full truckloads, thereby decreasing shipping costs while increasing customer service. In addition, customers are provided with a wide selection of products that do not require large volume orders. The Company's distribution system enables it to supply large or small quantities of products to meet customer requirements anywhere in the continental United States.

 

PATENTS AND TRADEMARKS

The Company has filed a number of patents and trademarks relating to its processes and products that either have been approved or are in the process of application. Because the Company does a significant amount of brand name and product line advertising to promote its products, it considers the protection of such trademarks to be important to its marketing efforts. The Company also has developed non-public proprietary information regarding its production processes and other product-related matters. The Company utilizes internal procedures and safeguards to protect the confidentiality of such information and, where appropriate, seeks patent protection for the technology it utilizes.

 

INDUSTRY PRACTICES

The Company's agreements with its customers are generally short-term, primarily due to the nature of its products, industry practice and the fluctuation in demand and price for such products. In certain instances where the Company is selling further processed products to large customers, the Company may enter into written agreements whereby the Company will act as the exclusive or preferred supplier to the customer for periods up to five years and on pricing terms which are either fixed or variable.

 

 

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AVAILABILITY OF SEC FILINGS AND CORPORATE GOVERNANCE DOCUMENTS ON INTERNET WEBSITE

The Company maintains an internet website for investors at http://ir.tyson.com. On this website, the Company makes available, free of charge, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to any of those reports, as soon as reasonably practicable after providing such reports to the Securities and Exchange Commission. Also available on the website for investors are the Company’s corporate governance principles, Audit Committee charter, Compensation Committee charter, Governance Committee charter and code of conduct. The Company’s corporate governance documents are available in print, free of charge to any shareholder who requests them.

 

CAUTIONARY STATEMENTS RELEVANT TO FORWARD-LOOKING INFORMATION FOR THE PURPOSE OF "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

 

Certain information in this report constitutes forward-looking statements. Such forward-looking statements include, but are not limited to, current views and estimates of future economic circumstances, industry conditions in domestic and international markets, Company performance and financial results, including, without limitation, debt-levels, return on invested capital, value-added product growth, capital expenditures, tax rates, access to foreign markets and dividend policy. These forward-looking statements are subject to a number of factors and uncertainties that could cause the Company’s actual results and experiences to differ materially from the anticipated results and expectations expressed in such forward-looking statements. The Company wishes to caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. Tyson undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Among the factors that may cause actual results and experiences to differ from the anticipated results and expectations expressed in such forward-looking statements are the following: (i) fluctuations in the cost and availability of inputs and raw materials, such as live cattle, live swine, feed grains (including corn and soybean meal) and energy; (ii) the Company’s ability to realize anticipated savings from its cost reduction initiatives; (iii) market conditions for finished products, including competition from other global and domestic food processors, the supply and pricing of competing products and alternative proteins and the demand for alternative proteins; (iv) risks associated with effectively evaluating derivatives and hedging activities; (v) access to foreign markets together with foreign economic conditions, including currency fluctuations, import/export restrictions and foreign politics; (vi) outbreak of a livestock disease (such as avian influenza (AI) or bovine spongiform encephalopathy (BSE)), which could have an effect on livestock owned by the Company, the availability of livestock for purchase by the Company, consumer perception of certain protein products or the Company’s ability to access certain domestic and foreign markets; (vii) successful rationalization of existing facilities, and the operating efficiencies of the facilities; (viii) changes in the availability and relative costs of labor and contract growers and the ability of the Company to maintain good relationships with employees, labor unions, contract growers and independent producers providing livestock to the Company; (ix) issues related to food safety, including costs resulting from product recalls, regulatory compliance and any related claims or litigation; (x) changes in consumer preference and diets and the Company’s ability to identify and react to consumer trends; (xi) significant marketing plan changes by large customers or the loss of one or more large customers; (xii) adverse results from litigation; (xiii) risks associated with leverage, including cost increases due to rising interest rates or changes in debt ratings or outlook; (xiv) changes in regulations and laws (both domestic and foreign), including changes in accounting standards, tax laws, environmental laws and occupational, health and safety laws; (xv) the ability of the Company to make effective acquisitions and successfully integrate newly acquired businesses into existing operations; (xvi) effectiveness of advertising and marketing programs; (xvii) the effect of, or changes in, general economic conditions; and (xviii) those factors listed under Item 1A. “Risk Factors” included in the Company’s September 30, 2006, Annual Report filed on Form 10-K.

 

ITEM 1A. RISK FACTORS

 

These risks should be considered carefully with the information provided elsewhere in this report, which could materially adversely affect our business, financial condition or results of operations. The risks described below are not the only risks the Company faces. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.

 

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Fluctuations in commodity prices and in the availability of raw materials, especially feed grains, live cattle, live swine and energy, could negatively impact the Company’s earnings.

 

Our results of operations and financial condition are dependent upon the cost and supply of raw materials such as feed grains, live cattle, live swine and ingredients, as well as the selling prices for our products, many of which are determined by constantly changing market forces of supply and demand over which we have limited or no control. Corn and soybean meal are major production costs in the poultry industry, representing roughly 37% of the cost of growing a chicken. As a result, fluctuations in prices for these feed ingredients can significantly affect our earnings. The production of feed ingredients is affected by, among other things, weather patterns throughout the world, the global level of supply inventories and demand for grains and other feed ingredients, as well as the agricultural policies of the U.S. and foreign governments.

 

We do not have facilities of our own to raise cattle in the United States; however, our beef facility in Canada has a feed yard that supplies approximately 21% of its live cattle needs. At times in the United States, we raise a small number of cattle under contract at feed yards owned by third parties; however, most of the cattle we process are purchased from independent producers. We have cattle buyers located throughout cattle producing areas who visit feed yards and buy live cattle on the open spot market. We also enter into various risk-sharing and procurement arrangements with producers who help secure a supply of livestock for daily start-up operations at our facilities. The majority of our live swine supply is obtained through various procurement arrangements with independent producers. We employ buyers who purchase hogs on a daily basis, generally a few days before the animals are required for processing. In addition, we raise live swine and sell feeder pigs to independent producers for feeding to processing weight, and have contract growers feed a minimal amount of Company owned live swine for our own processing needs. Any decrease in the supply of cattle or swine on the spot market could increase the price of these raw materials and further increase our per head cost of production due to lower capacity utilization, which could adversely affect our financial results.

 

Market demand and the prices we receive for our products may fluctuate due to competition from global and domestic food processors.

 

We face competition from other global, national and regional food producers and processors. The factors on which we compete include:

 

 

Demand for our products also is affected by competitors’ promotional spending, the effectiveness of our advertising and marketing programs and the availability or price of competing proteins, which at times affect demand for our products.

 

We attempt to obtain prices for our products that reflect, in part, the price we must pay for the raw materials that go into our products. If we are not able to obtain higher prices for our products when the price we pay for raw materials increase, we may be unable to maintain positive margins.

 

Outbreaks of livestock diseases can significantly affect our ability to conduct our operations and demand for our products.

 

The demand for our products can be affected significantly by outbreaks of livestock diseases, and such occurrences can have a significant impact on our financial results. Efforts are taken to control disease risks by adherence to good production practices and extensive precautionary measures designed to ensure the health of livestock. However, the outbreaks of disease and other events, which may be beyond our control, either in our own livestock or cattle and hogs owned by independent producers who sell livestock to us, could significantly affect demand for our products, consumer perceptions of certain protein products, the availability of livestock for purchase by us and our ability to conduct our operations. Moreover, the outbreak of livestock diseases, particularly in our

 

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Chicken segment, could have a significant effect on the livestock we own by requiring us to, among other things, destroy any affected livestock. Furthermore, an outbreak of disease could result in governmental restrictions on the import and export of our fresh chicken, beef or other products to or from our suppliers, facilities or customers. This could also result in negative publicity that may have an adverse effect on our ability to market our products successfully and on our financial results.

 

H5N1. There has been substantial publicity regarding a highly pathogenic strain of avian influenza, known as H5N1. H5N1 has been affecting Asia since 2002 and has been found in other parts of the world as recently as 2006. It is widely believed H5N1 is spread by migratory birds, such as ducks and geese. There also have been some cases where H5N1 is believed to have passed from birds to humans, as humans came into contact with live birds infected with the disease. Public concerns about H5N1 led, for a period of time, to a reduction in demand and price for our poultry products outside of the United States. Although H5N1 has not yet been identified in North America, there have been outbreaks of other low pathogenic strains of avian influenza in North America, including in the United States in 2002 and 2004 and in Mexico for the past several years that, from time to time, have impacted our operations. Further, these low pathogenic outbreaks have not generated the same level of concern or received the same level of publicity or been accompanied by the same reduction in demand for poultry products in certain countries as that associated with the highly pathogenic H5N1 strain. Accordingly, even if the H5N1 strain does not spread to North America, there can be no assurance it will not significantly adversely affect demand for North American produced poultry internationally and/or domestically, and, if it were to spread to North America, it could adversely affect our ability to conduct our operations and/or demand for our products, in each case in a manner having a significant adverse effect on our financial results.

 

BSE. In December 2003, the U.S. Department of Agriculture (USDA) announced a single case of bovine spongiform encephalopathy (BSE) had been diagnosed in a Washington State dairy cow. The origin of the animal was subsequently traced to a farm in Canada. Shortly after the announcement, several countries (including Japan and South Korea) closed their borders to the importation of edible beef products from the United States. Responding to the loss of export markets, live cattle prices in the United States declined by approximately 18% during the following week. Also in 2003, the Canadian government announced the first confirmed case of BSE in Canada which led the USDA to close the United States’ border to the import of live Canadian cattle. This reduced the supply of live cattle available for processing at our domestic facilities and contributed to lower facility capacity utilization. The confirmed case in Canada also led several countries to close their borders to the import of edible beef products from Canada, which affected the international sales of our Lakeside, Alberta, facility. In June 2005, the USDA announced a second confirmed case of BSE in the United States and in March 2006, announced the third confirmed case, furthering uncertainty as to whether or when certain closed markets may reopen, and whether or when existing open markets may close. A number of these countries subsequently reopened their borders to U.S. and Canadian beef; however, some of the countries, including Japan and South Korea, have restrictive conditions which limit the types of product that can be imported.

 

We are subject to risks associated with our international operations, which could negatively affect our sales to customers in foreign countries, as well as our operations and assets in such countries.

 

In fiscal 2006, the Company exported our products to more than 80 countries and incurred a loss before taxes from foreign operations of $36 million. Our major export markets include Canada, Central America, China, the European Union, Japan, Mexico, Russia, South Korea and Taiwan. Our export sales for fiscal 2006 totaled $2.1 billion. In addition, we had approximately $197 million of long-lived assets located in foreign countries, primarily Canada and Mexico, at the end of fiscal 2006.

 

As a result, we are subject to various risks and uncertainties relating to international sales and operations, including:

 

 

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political and economic conditions;

 

The occurrence of any of these events in the markets where we operate or in other developing markets could jeopardize or limit our ability to transact business in those markets and could adversely affect our revenues and operating results.

 

We depend on the availability of, and good relations with, our employees.

 

We have approximately 107,000 employees, of whom approximately 33,000 are covered by collective bargaining agreements or are members of labor unions. Our operations depend on the availability and relative costs of labor and maintaining good relations with employees and the labor unions. If we fail to maintain good relations with our employees or with the unions, we may experience labor strikes or work stoppages which could adversely affect our operating results.

 

We depend on contract growers and independent producers to supply us with livestock.

 

We contract primarily with independent contract growers to raise the live chickens processed in our poultry operations. A majority of our cattle and hogs are purchased from independent producers who sell the livestock to the Company under marketing contracts or on the open market. If we do not attract and maintain contracts with our growers, or maintain marketing relationships with independent producers, our production operations could be negatively affected.

 

If our products become contaminated, we may be subject to product liability claims and product recalls.

 

Our products may be subject to contamination by disease-producing organisms or pathogens, such as Listeria monocytogenes, Salmonella and generic E. coli. These pathogens are found generally in the environment; therefore, there is a risk they, as a result of food processing, could be present in our products. These pathogens also can be introduced to our products as a result of improper handling at the further processing, foodservice or consumer level. These risks may be controlled, but may not be eliminated, by adherence to good manufacturing practices and finished product testing. We have little, if any, control over proper handling procedures once our products have been shipped for distribution. Even an inadvertent shipment of contaminated products may be a violation of law and may lead to increased risk of exposure to product liability claims, product recalls (which may not entirely mitigate the risk of product liability claims), increased scrutiny and penalties, including injunctive relief and plant closings, by federal and state regulatory agencies, and adverse publicity, which could exacerbate the associated negative consumer reaction. Any of these occurrences may have an adverse effect on our financial results.

 

Our operations are subject to the general risks of litigation.

 

We are involved on an on-going 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 relating to commercial, labor, employment, antitrust, securities or environmental matters. Litigation trends and the outcome of litigation cannot be predicted with certainty and adverse litigation trends and outcomes could significantly adversely affect our financial results.

 

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Our level of indebtedness and the terms of our indebtedness could negatively impact the Company’s business and liquidity position.

 

At September 30, 2006, we had approximately $4.0 billion of indebtedness outstanding. However, when adjusted for the $750 million short-term investment which the Company had on deposit at September 30, 2006, and was used for the repayment of its $750 million 7.25% Notes due October 1, 2006, the Company’s net debt position at September 30, 2006, was $3.2 billion. The Company had a borrowing capacity of $1.1 billion, consisting of $481 million available under our $1.0 billion unsecured revolving credit facility and $591 million under our accounts receivable securitization program at September 30, 2006. We expect our indebtedness, including borrowings under our credit agreements, may increase from time to time in the future for various reasons, including fluctuations in operating results, capital expenditures and possible acquisitions. Our consolidated indebtedness level could significantly affect our business because:

 

 

In addition, our debt agreements require us to meet specified financial ratios and limit our ability to enter into various transactions. Our ability to meet those financial ratios can be affected by events beyond our control, and there can be no assurance we will meet those ratios. If we default on any of our indebtedness, or if we are unable to obtain necessary liquidity, our indebtedness would be due and payable immediately, and our business could be significantly adversely affected.

 

Domestic and international government regulations could impose material costs.

 

Our operations are subject to extensive federal, state and foreign laws and regulations by authorities that oversee food safety standards and the processing, packaging, storage, distribution, advertising and labeling of our products. Our facilities for processing chicken, beef, pork, prepared foods and milling feed and for housing live chickens and swine are subject to a variety of federal, state and local laws relating to the protection of the environment, including provisions relating to the discharge of materials into the environment, and to the health and safety of our employees. Our chicken, beef and pork processing facilities are participants in the government’s Hazardous Analysis Critical Control Point (HACCP) program and are subject to the Public Health Security and Bioterrorism Preparedness and Response Act of 2002. In addition, our chicken, beef, pork and prepared foods products are subject to inspection prior to distribution, primarily by the USDA and the United States Food and Drug Administration. Loss of or failure to obtain necessary permits and registrations could delay or prevent us from meeting current product demand, introducing new products, building new facilities or acquiring new businesses and could adversely affect operating results. Additionally, we are routinely subject to new or modified laws, regulations and accounting standards. If we are found to be out of compliance with applicable laws and regulations in these or other areas, we could be subject to civil remedies, including fines, injunctions, recalls or asset seizures, as well as potential criminal sanctions, any of which could have a significant adverse effect on our financial results.

 

A material acquisition could affect our operations and financial condition.

 

We continually evaluate potential acquisitions and we may seek to expand our business through the acquisition of companies, processing plants, technologies, products and services from others, which could include material acquisitions. A material acquisition may involve a number of risks, including:

 

 

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exposure to unforeseen or undisclosed liabilities of acquired companies; and

 

We may not be able to address these problems and successfully develop these acquired companies or businesses into profitable units of our company. If we are unable to do this, expansion could adversely affect our financial results.

 

Market fluctuations could negatively impact the Company’s operating results as we hedge certain transactions.

 

Our business is exposed to fluctuating market conditions, and we use derivative financial instruments to reduce our exposure to various market risks including changes in commodity prices, interest rates and foreign exchange rates. We hold certain positions, primarily in grain and livestock futures, that do not qualify as hedges for financial reporting purposes. These positions are marked to fair value, and the unrealized gains and losses are reported in earnings at each reporting date. Therefore, losses on these contracts adversely affect our reported operating results if commodity prices are decreasing. Although these hedges protect us from upward movements in prices for commodity products, the use of such instruments may limit our ability to participate in cost savings from declining commodity prices.

 

Deterioration of economic conditions could negatively impact the Company’s business.

 

Our business may be adversely affected by changes in national or global economic conditions, including inflation, interest rates, availability of capital markets, consumer spending rates, energy availability and costs (including fuel surcharges), and the effects of governmental initiatives to manage economic conditions. Any such changes could significantly adversely affect the demand for our beef, poultry and pork products, or the cost and availability of our needed raw materials, cooking ingredients and packaging materials, thereby adversely affecting our financial results.

 

Changes in consumer preference could negatively impact the Company’s business.

 

The food industry in general is subject to changing consumer trends, demands and preferences. Trends within the food industry change often, and failure to identify and react to changes in these trends could lead to, among other things, reduced demand and price reductions for our products, and could have an adverse effect on our financial results.

 

The loss of one or more of our largest customers could negatively impact the Company’s business.

 

Our business could suffer significant set backs in revenues and operating income if our customers’ plans and/or markets should change significantly, or if we lost one or more of our largest customers, including, for example, Wal-Mart Stores, Inc., which accounted for approximately 12.5% of our revenues in fiscal 2006. Many of our agreements with our customers are generally short-term, primarily due to the nature of our products, industry practice and the fluctuation in demand and price for our products.

 

Extreme weather or natural disasters could negatively impact the Company’s business.

 

Extreme weather or natural disasters, including droughts, floods, excessive cold or heat, hurricanes or other storms, could impair the health or growth of our livestock or interfere with our operations due to power outages, fuel shortages, damage to our production and processing facilities or disruption of transportation channels, among other things. Any of these factors could have an adverse effect on our financial results.

 

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Members of the Tyson family can exercise significant control.

 

Members of the Tyson family beneficially own, in the aggregate, 99.97% of our outstanding shares of Class B Common Stock. $0.10 par value (Class B stock) and 1.50% of our outstanding shares of Class A Common Stock, $0.10 par value (Class A stock), giving them control of approximately 75.06% of the total voting power of our outstanding voting stock. In addition, three members of the Tyson family serve on our Board of Directors. As a result, members of the Tyson family have the ability to exert substantial influence or actual control over our management and affairs and over substantially all matters requiring action by our stockholders, including amendments to our restated certificate of incorporation and by-laws, the election and removal of directors, any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change in control otherwise favored by our other stockholders and could depress our stock price. Additionally, as a result of the Tyson family’s significant ownership of our outstanding voting stock, we have relied on the “controlled company” exemption from certain corporate governance requirements of the New York Stock Exchange; therefore, we have elected not to implement rules that provide for a majority of independent directors, or a nominating committee to identify and recommend nominees to our Board of Directors. Pursuant to these exemptions, our compensation committee, which is made up of independent directors, does not have sole authority to determine the compensation of our executive officers, including our chief executive officer.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None

 

ITEM 2. PROPERTIES

 

The Company currently has sales offices and production and distribution operations in the following states: Alabama, Arkansas, Arizona, California, Georgia, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Mississippi, Missouri, Nebraska, New Jersey, New Mexico, New York, North Carolina, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington and Wisconsin. Additionally, the Company, either directly or through its subsidiaries, has facilities in or participates in joint venture operations in Argentina, Brazil, Canada, China, the Dominican Republic, India, Japan, Mexico, the Netherlands, the Philippines, Puerto Rico, Russia, Singapore, South Korea, Spain, Taiwan, the United Arab Emirates, the United Kingdom and Venezuela.

 

Chicken:  The Company's chicken operations consist of 53 processing plants. These plants are devoted to various phases of slaughtering, dressing, cutting, packaging, deboning or further-processing. The total slaughter capacity is approximately 49 million head per week. In addition, the Company owns nine rendering plants with the capacity to produce 29 million pounds of animal protein products per week and 18 ground pet food processing operations in connection with chicken processing plants capable of producing 10 million pounds of product per week. In addition, there are two blending mill operations, 38 feed mills and 64 broiler hatcheries with sufficient capacity to meet the needs of the chicken growout operations. During fiscal 2006, the feed mills operated at 79% of capacity, the hatcheries operated at 86% of capacity and the processing plants operated at 95% capacity.

 

Beef: The Company's beef operations consist of 13 beef production facilities, four of which include case-ready operations, and a Canadian cattle feedlot. These plants are devoted to various phases of slaughtering live cattle, fabricating beef products and some treat and tan hides. One of the beef facilities contains a tallow refinery and three of the case-ready operations share facilities with the Pork segment. The carcass facilities reduce live cattle to dressed carcass form. The processing facilities conduct fabricating operations to produce boxed beef and allied products. The slaughtering processes operated in fiscal 2006 at approximately 77% of their capacities. The total slaughter capacity is approximately 232,000 head per week.

 

Pork:  The Company's pork operations consist of nine pork production facilities, three of which include case-ready operations. These plants are devoted to various phases of slaughtering live hogs and fabricating pork products and allied products. The three case-ready operations share facilities with the Beef segment. The processing facilities operated in fiscal 2006 at approximately 81% of their production capacities. The total slaughter capacity of these facilities is approximately 442,000 head per week. Additionally, the Company’s live swine operations have 47 farrowing barns, 92 nursery houses, 77 finishing houses and two boar facilities. The Company also utilizes live swine contract growers. The swine growout operations are supported by one dedicated feed mill supplemented by production from the chicken operation’s feed mills.

 

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Prepared Foods:  The Company's prepared foods operations consist of 26 processing plants that process fresh and frozen beef, pork, chicken and other raw materials into pizza toppings, branded and processed meats, appetizers, prepared meals, ethnic foods, soups, sauces, side dishes, pizza crusts, flour and corn tortilla products and meat dishes. These processing plants have the capacity to produce approximately 60 million pounds per week and operated in fiscal 2006 at approximately 69% of capacity.

 

Other:  The Company's other operations consist of eight distribution centers, as well as 12 cold storage facilities used by the beef and pork divisions, 43 cold storage facilities at chicken processing plants, three cold storage facilities at chicken rendering plants and five cold storage facilities used by prepared foods plants with a total capacity of approximately 325 million pounds.

 

The Company owns its major operating facilities with the following exceptions: one chicken emulsified plant is leased month to month; two hatcheries are leased under agreements expiring at various dates through 2008; 456 chicken breeder farm houses are leased under agreements expiring at various dates through 2007; 31 chicken breeder farm houses are leased month to month and 24 broiler farm houses are leased year to year. Additionally, the Company’s live swine operation leases 24 farrowing barns, 20 nursery houses and 46 finishing houses, expiring at various dates through 2009. One prepared foods distribution center and one prepared foods further processing facility are leased month to month, and one prepared foods further processing facility is leased until 2020.

 

Management believes the Company's present facilities are generally adequate and suitable for its current purposes; however, seasonal fluctuations in inventories and production may occur as a reaction to market demands for certain products. The Company regularly engages in construction and other capital improvement projects intended to expand capacity and improve the efficiency of its processing and support facilities.

 

ITEM 3. LEGAL PROCEEDINGS

 

Refer to the discussion of certain legal proceedings pending against the Company under Part II, Item 8, Notes to Consolidated Financial Statements, Note 20: “Contingencies,” which discussion is incorporated herein by reference. Listed below are certain additional legal proceedings involving the Company and its subsidiaries.

 

On October 23, 2001, a putative class action lawsuit, R. Lynn Thompson and Deborah S. Thompson, et al. vs. Tyson Foods, Inc., was filed in the District Court for Mayes County, Oklahoma, on behalf of all owners of Grand Lake O' the Cherokee's littoral (lakefront) property. The suit alleged the Company "or entities over which it has operational control" conduct operations in such a way as to interfere with the putative class action plaintiffs' use and enjoyment of their property, allegedly caused by diminished water quality in the lake. Plaintiffs sought injunctive relief and an unspecified amount of compensatory damages, punitive damages, attorney fees and costs. Simmons Foods, Inc. and Peterson Farms, Inc. were joined as defendants. On October 4, 2005, the Court of Civil Appeals of the State of Oklahoma reversed the decision of the District Court, holding the claims of plaintiffs were not suitable for disposition as a class action. This decision ultimately was upheld by the Oklahoma Supreme Court and remanded to the District Court with instructions the matter proceed only on behalf of the three named plaintiffs. On May 24, 2006, three of the Plaintiffs filed a Third Amended Petition, which drops Plaintiffs’ class allegations, but seeks injunctive relief, restitution and compensatory and punitive damages in an unspecified amount in excess of $10,000. The Company and the other Defendants have filed answers and motions to dismiss a number of Plaintiffs’ claims.

 

In January 1997, the Illinois Attorney General filed People vs. IBP, inc. in the Circuit Court for the 14^th Judicial Circuit, Rock Island, Illinois, Chancery Division alleging IBP’s (now TFM) operations at its Joslin, Illinois, facility are violating the “odor nuisance” statutory provisions enacted in Illinois. During a July 14, 2006, Status Conference, TFM and the State reported the parties had reached an agreement in principle to resolve the case. The agreement provides for certain technical work to be performed and equipment installed at the Joslin facility, the payment of a civil penalty and the payment of certain monies for environmentally beneficial projects in the community, the total of which is not expected to exceed $1.7 million. Negotiation of settlement documents is continuing.

 

In May 2004, TFM met with U.S. Environmental Protection Agency (USEPA) staff regarding alleged wastewater and late report filing violations under the Clean Water Act relating to the 2002 Second and Final Consent Decree that governed compliance requirements for TFM’s Dakota City, Nebraska, facility. During that meeting, TFM was verbally informed of USEPA’s intent potentially to assess stipulated penalties for those alleged violations, with a maximum penalty of approximately $338,000. No formal written demand for stipulated penalties pursuant to the Consent Decree has been presented at this time. TFM vigorously disputes these allegations. Additional discussions with USEPA regarding a potential settlement of this matter are expected.

 

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On August 12, 2005, the Company elected to participate in the USEPA Air Compliance Agreement (ACA). Participation requires payment of a penalty of $100,000 and an additional contribution to a monitoring fund that will underwrite a study of air emissions from poultry farming operations. The contribution to the monitoring fund will be made in proportion to the total number of all participants (including the Company and parties not related to the Company) who elect to participate in the ACA. It is estimated that aggregate contributions to the monitoring fund will not exceed $2 million. The Company’s election to participate in the ACA was subject to review and approval from the USEPA Environmental Appeals Board (EAB). On August 14, 2006, the EPA and the EAB approved Tyson’s ACA and Tyson paid $100,000 to the EPA on September 19, 2006.

 

On January 9, 2003, the Company received a notice of liability letter from Union Pacific Railroad Company (Union Pacific) concerning the Company’s alleged contributions of waste oil to the Double Eagle Refinery Superfund Site in Oklahoma City, Oklahoma (Double Eagle Site). On August 22, 2006, the United States and the State of Oklahoma filed suit against Union Pacific seeking in excess of $22 million to remediate the Double Eagle Site in the matter United States of America, et al. v. Union Pacific Railroad Co., in the U. S. District Court for the Western District of Oklahoma. The Company joined a PRP Group on October 31, 2006, which is in settlement discussions with the United States and the State of Oklahoma. The Company’s participation in this PRP Group should prevent it from being sued for contribution and indemnification by Union Pacific. The Company’s payment likely will not exceed $625,586.20.

 

On June 19, 2005, the Attorney General of Oklahoma filed a Complaint in the U.S. District Court for the Northern District of Oklahoma against the Company, three subsidiaries and other poultry integrators. Subsequently, a First Amended Complaint (Amended Complaint) was filed and served. The Amended Complaint asserts state and federal causes of action and seeks injunctive relief and damages (past and future) for alleged pollution to the Illinois River Watershed from the land application of poultry litter by the defendants, and contract growers who are not named in the Amended Complaint. The Company and other defendants have filed answers and motions to dismiss several of the claims. The Company and other defendants also have filed third-party complaints that assert claims against other persons and entities whose activities may have contributed to the pollution alleged in the Amended Complaint. In addition to the motions and third-party claims, the Company and its defendant subsidiaries also have asserted various defenses to claims asserted in the Amended Complaint. Discovery has recently begun, and no trial date has been set.

 

In August 2004, the Company received a subpoena requesting the production of documents from a federal grand jury sitting in the Western District of Arkansas. The subpoena focused on events surrounding a workplace accident that resulted in the death of an employee at the River Valley Animal Foods rendering plant in Texarkana, Arkansas, on October 10, 2003. That workplace fatality had previously been the subject of an investigation by the Occupational Health and Safety Administration (OSHA) of the Department of Labor. On April 9, 2004, OSHA issued citations to the Company and Tyson Poultry, Inc., d/b/a River Valley Animal Foods, alleging violations of health and safety standards arising from the death of the employee due to hydrogen sulfide inhalation. The citations consist of five willful, 12 serious, and two recordkeeping violations. OSHA seeks abatement of the alleged violations and proposed penalties of $436,000. The OSHA proceeding was stayed pending the completion of the grand jury investigation. Since the receipt of the document subpoena, a number of company employees have provided grand jury testimony or informal interviews to government investigators. Federal officials have not yet indicated whether they intend to pursue any action against the Company in connection with this investigation.

 

In July 2002, certain cattle producers filed Herman Schumacher, et al. vs. Tyson Fresh Meats, Inc., et al. in the U.S. District Court for the District of South Dakota, seeking certification of a class of cattle producers and naming as defendants TFM and three other beef packers. Plaintiffs claimed that in 2001, during the first six weeks the USDA began its mandatory price reporting program, defendants knowingly used the inaccurate boxed beef cutout prices (cutout prices are determined by the USDA through a formula that averages the prices of the various box beef cuts reported by all packers) calculated and published by USDA to negotiate the purchase of fed cattle from plaintiffs at prices substantially lower than would have been economically justified had plaintiffs known the accurate higher cutout prices. Plaintiffs contend defendants’ conduct constituted an unfair or deceptive practice or was engaged in for the purpose or with the effect of manipulating or controlling prices in violation of the Packers and Stockyards Act (PSA), 7 U.S.C. §192. Plaintiffs also sought damages under state law unjust enrichment principles. The USDA stated that during the period in question the beef packers correctly reported beef sales information to the USDA and TFM believes it acted appropriately in its dealings with cattle producers. Trial in this matter commenced on March 31, 2006, and a jury verdict was returned against TFM and two of the other three defendants. The jury verdict against TFM was for $4,000,000, but this amount was based on all sales and not just those of the class. TFM, together with the other defendants, filed a motion in the District Court seeking judgment as a matter of law.  That motion was

 

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TYSON FOODS, INC.

denied.  Although no final judgment has yet been entered in the District Court, one of the other defendants has appealed (to the Eighth Circuit Court of Appeals) the denial of defendants' motion for judgment as a matter of law, which motion has also been dismissed by the Court of Appeals. The parties are now waiting for the District Court to enter a final judgment, which the Company anticipates will be appealed.

 

On January 12, 2006, the Delaware Chancery Court consolidated two previously filed lawsuits, Amalgamated Bank v. Tyson and Meyer v. Tyson, and captioned the consolidated action In re Tyson Foods, Inc. Consolidated Shareholder's Litigation. The Consolidated Complaint names as defendants the Tyson Limited Partnership and certain present and former directors of the Company. The Company also is named as a nominal defendant, with no relief sought against it. The lawsuit contains five derivative claims alleging the defendants breached their fiduciary duties by: (1) approving consulting contracts for Don Tyson and Robert Peterson in 2001 and for Don Tyson in 2004; (2) approving and inadequately disclosing certain "other compensation" paid to Tyson executives from 2001 to 2003; (3) approving certain option grants to certain officers and directors with alleged knowledge the Company was about to make announcements that would cause the stock price to increase; (4) approving and not adequately disclosing various related-party transactions from 2001 to 2004 that plaintiffs allege were unfair to the Company; and (5) making inadequate disclosures that resulted in an SEC consent decree. The Consolidated Complaint asserts three additional derivative claims for: (6) breach of the 1997 settlement agreement in Herbets v. Tyson, et al., No. 14231 (Del. Ch.); (7) civil contempt of the court's order and final judgment in Herbets v. Tyson; and (8) unjust enrichment regarding the benefits obtained by the defendants through the various transactions challenged in the Consolidated Complaint. The Consolidated Complaint also makes a putative class action claim that the Company's 2004 proxy statement contained misrepresentations regarding certain executive compensation. On March 2, 2006, Defendants filed a Motion to Dismiss the Consolidated Complaint. Plaintiffs’ filed a response on May 8, 2006, and Defendants filed a reply brief on June 9, 2006. Oral arguments on the motion to dismiss were heard on September 20, 2006. The court has not yet issued a ruling.

 

On May 15, 2006, a lawsuit titled Adelina Garcia, et al. v. Tyson Foods, Inc. and Tyson Fresh Meats, Inc. (Garcia), was filed in the U.S. District Court for the District of Kansas. The action was filed by 262 current and former hourly employees of TFM’s beef slaughter facility in Holcomb (Finney County), Kansas. Plaintiffs filed suit on behalf of themselves and other allegedly similarly situated employees, claiming defendants failed to pay employees for all hours worked, including overtime compensation in violation of the FLSA and Kansas law. Three plaintiffs also have asserted claims under Kansas law for breach of contract, quantum meruit and violation of the Kansas Wage Payment Act, K.S.A. § 44-312, and seek to act as class representatives for a class action under Federal Rule of Civil Procedure 23 on behalf of all current and former hourly employees who worked at the plant in the preceding five years who were allegedly not paid for all time worked. In particular, the suit alleges employees should be paid for the time it takes to change into protective work uniforms and safety equipment worn by employees, and walking to and from the changing area, work areas and break areas. Plaintiffs are seeking back wages, liquidated damages, pre- and post-judgment interest, attorneys’ fees and costs. At present, approximately 700 persons have filed consents to join the case. No trial date has been set. On September 29, 2006, the Company filed a motion for partial summary judgment under the FLSA based on the holdings of Reich v. IBP, inc., No. 88-2171-EEO, 1996 WL 445072 (D. Kan. July 30, 1996), aff’d, Metzler v. IBP, inc., 127 F.3d 959 (10^th Cir. 1997) and related proceedings, where the compensability of donning and doffing certain clothing and protective gear worn by these Company employees was fully litigated. Plaintiffs submitted Rule 56(f) discovery to the Company to obtain further information before responding to the motion for partial summary judgment.

 

On June 30, 2006, a lawsuit titled Dimas Lopez, et al. v. Tyson Foods, Inc. was filed in the U.S. District Court for the District of Nebraska. The action was filed by 20 current and former hourly employees of the beef slaughter facility operated by TFM in Lexington, Nebraska. Plaintiffs filed suit on behalf of themselves and other allegedly similarly situated employees. This lawsuit is similar to Garcia in that employees claim they were not paid their minimum hourly rate of pay for all hours worked in addition to overtime as required by the FLSA and Nebraska law. Plaintiffs have asserted state-law claims under the Nebraska Wage and Hour Act, R.R.S. Neb. § 48-1201-1209, and the Nebraska Wage Payment and Collection Act, R.R.S. Neb. §§ 48-1228-1232, and they seek to act as class representatives for a class action under Federal Rule of Civil Procedure 23 on behalf of current and former production and support employees at the plant since July 1, 2001. The 20 named plaintiffs also assert claims under the FLSA. In particular, the suit alleges employees should be paid for time spent preparing, donning, doffing and sanitizing sanitary and safety equipment and clothing, obtaining tools, equipment and supplies, “working” steels and “mousetraps” and performing other job-related functions, before and after paid time, and during both paid breaks and unpaid meal-period breaks. Plaintiffs are seeking unpaid straight-time wages and overtime wages, liquidated damages and statutory penalties, interest, attorneys’ fees, costs and declaratory and injunctive relief. On October 24, 2006, the Company filed a motion for partial summary judgment under the FLSA based on the holdings of Reich v. IBP, inc., No. 88-2171-EEO, 1996 WL 445072 (D. Kan. July 30, 1996), aff’d, Metzler v. IBP, inc., 127 F.3d 959 (10^th Cir.

 

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1997) and related proceedings, where the compensability of donning and doffing certain clothing and protective gear worn by these Company employees was fully litigated. Plaintiffs filed a response to the motion for partial summary judgment on November 16, 2006, and the Company filed its reply on November 27, 2006.

 

On October 23, 2006, a lawsuit titled Sheila Ackles, et al. v. Tyson Foods, Inc. was filed in the U.S. District Court for the Northern District of Alabama.  The action was filed by 62 current and former hourly employees of the Company's Heflin, Alabama, poultry processing plant.  Plaintiffs filed suit on behalf of themselves and other similarly situated employees, claiming the Company failed to pay employees for all hours worked, including overtime compensation in violation of the Fair Labor Standards Act.  Plaintiffs seek to act as class representatives on behalf of all current and former employees who were allegedly not paid for time worked.  In particular, the suit alleges employees should be paid for the time it takes to engage in pre-and post-shift activities such as passing through plant security, changing into and out of protective and sanitary clothing, obtaining equipment and walking to and from the changing area, work areas and break areas.  Plaintiffs seek back wages, liquidated damages, pre-and post-judgment interest, attorneys' fees, costs and injunctive relief.  The Company’s Answer was filed on December 5, 2006.  Discovery has not commenced, and no trial date has been set.

 

On April 2, 2002, four former employees of the Company’s Shelbyville, Tennessee, chicken processing plant filed the case of Trollinger et al. v. Tyson Foods, Inc. in the U. S. District Court for the Eastern District of Tennessee. The case was filed as a putative class action against the Company, raising allegations under the Racketeer Influenced and Corrupt Practices Act (RICO), and specifically alleged the Company, in conjunction with employment agencies and recruiters, engaged in a scheme to hire illegal immigrant workers in 15 of its processing plants to depress wages paid to hourly wage employees at those plants. On July 16, 2002, the District Court dismissed the case. Following appeal, on June 3, 2004 the Sixth Circuit Court of Appeals reversed the District Court’s decision and remanded the case for further proceedings. Discovery has been on-going since September 2004. In June 2005, plaintiffs filed a second amended complaint. The second amended complaint included different plaintiffs, narrowed the list of plants at issue to eight and added the allegation the Company conspired with certain Hispanic civil rights groups to hire illegal immigrant workers. In addition, the second amended complaint added John Tyson, Richard Bond, Greg Lee, Archibald Schaffer III, Kenneth Kimbro, Karen Percival, Tim McCoy and Ahrazue Wilt, all of whom are current or former officers or managers of the Company, as defendants. On August 5, 2005, plaintiffs sought certification of a putative class of all hourly wage employees at the eight Company plants since 1998 who were legally authorized to be employed in the United States, which the defendants opposed. On October 10, 2006, the District Court granted plaintiffs’ motion for class certification. On October 24, 2006, defendants filed with the Sixth Circuit Court of Appeals a petition for interlocutory review of the District Court’s class certification decision. That petition is pending. No trial date has been set. A class management conference has been scheduled for January 29, 2007.

 

Other Matters: The Company has approximately 107,000 employees and at any time has various employment practices matters. In the aggregate, these matters are significant to the Company, and the Company devotes significant resources to handling employment issues. Additionally, the Company is subject to other lawsuits, investigations and claims (some of which involve substantial amounts) arising out of the conduct of its business. While the ultimate results of these matters cannot be determined, they are not expected to have a material adverse effect on the Company's consolidated results of operations or financial position.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

 

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EXECUTIVE OFFICERS OF THE COMPANY

Officers of the Company serve one year terms from the date of their election, or until their successors are appointed and qualified. No family relationships exist among these officers. The name, title, age and year of initial election to executive office of the Company's executive officers are listed below:

 

 

Mr. Richard L. Bond was appointed President and Chief Executive Officer in May 2006, after serving as President and Chief Operating Officer since 2003 and Co-Chief Operating Officer and Group President, Fresh Meats and Retail since 2001. Mr. Bond was initially employed by IBP, inc. (IBP) in 1980. IBP merged into a wholly-owned subsidiary of the Company on September 28, 2001. Mr. Bond is also a member of the Company’s Board of Directors.

 

Mr. J. Alberto Gonzalez-Pita was appointed Executive Vice President and General Counsel in 2004, after serving as General Counsel and Vice President for International Legal, Regulatory & External Affairs at BellSouth Corporation since 1999.

 

Mr. Craig Hart was appointed Senior Vice President, Controller and Chief Accounting Officer in 2004 after serving as Vice President of Special Projects since 2001. Mr. Hart was initially employed by IBP in 1978.

 

Mr. Dennis Leatherby was appointed Senior Vice President, Finance and Treasurer in June 2006, after serving as Senior Vice President, Finance and Treasurer and Interim Chief Financial Officer since 2004 and Senior Vice President, Finance and Treasurer since 1998. Mr. Leatherby was initially employed by the Company in 1990.

 

Mr. Greg W. Lee was appointed Chief Administrative Officer and International President in 2003, after serving as Co-Chief Operating Officer and Group President, Food Service and International since 2001. Mr. Lee was initially employed by the Company in 1980.

 

Mr. James V. Lochner was appointed Senior Group Vice President, Fresh Meats and Margin Optimization in May 2006, after serving as Senior Group Vice President, Margin Optimization, Purchasing and Logistics since 2005, Group Vice President, Purchasing, Travel, and Aviation since 2004 and Group Vice President, Fresh Meats since 2001. Mr. Lochner was initially employed by IBP in 1983.

 

Mr. William W. Lovette was appointed Senior Group Vice President, Poultry and Prepared Foods in 2005, after serving as Group Vice President, Foodservice since 2001. Mr. Lovette was initially employed by the Company in 1982.

 

Mr. Wade Miquelon was appointed Executive Vice President and Chief Financial Officer in June 2006, after serving as Chief Financial Officer for Procter & Gamble’s Western European business since October 2003 and CFO and Senior Director for Procter & Gamble’s 42 country ASEAN, Australia and India Region since 2001.

 

Mr. John Tyson was appointed Chairman of the Board of Directors in May 2006, after serving as Chairman of the Board of Directors and Chief Executive Officer since 2001. Mr. Tyson was initially employed by the Company in 1973.

 

 

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TYSON FOODS, INC.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company currently has issued and outstanding two classes of capital stock, Class A stock and Class B stock. Holders of Class B stock may convert such stock into Class A stock on a share-for-share basis. Holders of Class B stock are entitled to 10 votes per share while holders of Class A stock are entitled to one vote per share on matters submitted to shareholders for approval. As of December 2, 2006, there were approximately 36,500 holders of record of the Company's Class A stock and 14 holders of record of the Company's Class B stock, excluding holders in the security position listings held by nominees.

 

DIVIDENDS

Cash dividends cannot be paid to holders of Class B stock unless they are simultaneously paid to holders of Class A stock. The per share amount of the cash dividend paid to holders of Class B stock cannot exceed 90% of the cash dividend simultaneously paid to holders of Class A stock. The Company has paid uninterrupted quarterly dividends on its common stock each year since 1977 and expects to continue its cash dividend policy during fiscal 2007. In both fiscal 2006 and 2005, the annual dividend rate for Class A stock was $0.16 per share and the annual dividend rate for Class B stock was $0.144 per share.

 

MARKET INFORMATION

The Class A stock is traded on the New York Stock Exchange under the symbol "TSN." No public trading market currently exists for the Class B stock. The high and low closing sales prices of the Company’s Class A stock for each quarter of fiscal 2006 and 2005 are represented in the table below.

 

 

ISSUER PURCHASES OF EQUITY SECURITIES

The table below provides information regarding purchases by the Company of its Class A stock during the periods indicated.

 

 

 

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ITEM 6. SELECTED FINANCIAL DATA

 

ELEVEN-YEAR FINANCIAL SUMMARY

 

 

 

 

 

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ITEM 6. SELECTED FINANCIAL DATA (Continued)

 

ELEVEN-YEAR FINANCIAL SUMMARY

 

 

 

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Notes to Eleven-Year Financial Summary

 

 

 

 

 

 

 

 

 

 

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

 

Overview

 

Tyson Foods is the world’s largest meat protein company and the second largest food production company in the Fortune 500 with one of the most recognized brand names in the food industry. Tyson produces, distributes and markets chicken, beef, pork, prepared foods and related allied products. The Company’s operations are conducted in five segments: Chicken, Beef, Pork, Prepared Foods and Other. Some of the key factors that influence the Company’s business are customer demand for the Company’s products, the ability to maintain and grow relationships with customers and introduce new and innovative products to the marketplace, accessibility of international markets, market prices for the Company’s chicken, beef and pork products, the cost of live cattle and hogs, raw materials and grain and operating efficiencies of the Company’s facilities.

 

The Company faced very challenging operating conditions in fiscal 2006. Demand pressures caused mainly by outbreaks of avian influenza, primarily in Europe and Asia, Hurricane Katrina and other export market disruptions in the Company’s Chicken and Beef segments, led to an oversupply of proteins worldwide and negatively affected the average sales prices and operating results of each of the Company’s protein segments. Operations also were affected negatively by higher energy costs, and significant operating margin reductions at the Company’s operations in Canada and Mexico.

 

Net loss for fiscal 2006 was $196 million, or $0.58 per diluted share, compared to earnings of $372 million, or $1.04 per diluted share, in fiscal 2005. Pretax loss for fiscal 2006 includes $63 million of costs related to beef, prepared foods and poultry plant closings and $19 million of charges related to the Company’s $200 million cost reduction initiative and other business consolidation efforts. These charges include severance expenses, product rationalization costs and related intangible asset impairment expenses. Additionally, the Company completed a review of its tax account balances, and as a result, recorded a charge in the fourth quarter of fiscal 2006 of approximately $15 million. Also, net loss for fiscal 2006 includes a charge of $5 million, or $0.02 per diluted share, related to the cumulative effect of a change in accounting principle due to the Company’s adoption of Financial Accounting Standards Board (FASB) Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of FASB Statement No. 143. Combined, these items increased fiscal 2006 diluted loss per share by $0.21.

 

Pretax earnings for fiscal 2005 include $33 million of costs related to a legal settlement involving the Company’s live swine operations, $14 million of costs for poultry and prepared foods plant closings, $8 million of losses related to Hurricane Katrina, $12 million received in connection with vitamin antitrust litigation and a gain of $8 million from the sale of the Company’s remaining interest in Specialty Brands, Inc. Net income in fiscal 2005 includes a non-recurring income tax net benefit of $15 million. The net benefit includes the reversal of tax reserves, partially offset by an income tax charge related to the repatriation of foreign income. The effective tax rate of the Company was affected further by the federal income tax effect of the Medicare Part D subsidy in fiscal 2005 of $55 million because this amount is not subject to federal income tax. Combined, these items increased fiscal 2005 diluted earnings per share by $0.03.

 

The Company's accounting cycle resulted in a 52-week year for fiscal years 2006 and 2005, and a 53-week year for fiscal 2004.

 

Outlook

 

Management’s primary goal during this difficult operating environment is to return the Company to profitability. One of the measures being taken to achieve this goal is to manage and reduce costs. The Company initiated a $200 million cost reduction initiative in the fourth quarter of fiscal 2006. Approximately 90% of the initiative has been implemented, and the Company began realizing savings in the first quarter of fiscal 2007.

 

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Although returning the Company to profitability is its primary short-term goal, management also remains focused on the following primary elements of its long-term strategy: creating more value-added products, improving operational efficiencies and expanding internationally. During the year, the Company strongly examined its business as well as various opportunities and took the necessary steps to better position itself to meet its long-term goals. The Company’s Discovery Center is nearing completion and should be operational in the second quarter of fiscal 2007. The Discovery Center is expected to bring new market-leading retail and foodservice products to the customer faster and more effectively. It is a state-of-the-art facility, which includes 19 research centers as well as a USDA-inspected pilot plant. In fiscal 2006, the Company announced the rationalization of three beef plants and two prepared foods plants. Additionally, the Company completed several major capital projects in fiscal 2006, including a case-ready plant in Sherman, Texas, and an expansion at the Dakota City, Nebraska, location. The Company realized certain operational efficiencies in fiscal 2006 related to its rationalization and expansion efforts and expects continued efficiencies in fiscal 2007. In November 2006, the Company announced a new business unit, Tyson Renewable Energy, which has been exploring ways to commercialize the Company’s supply of animal fat into bio-fuels. The new unit also is examining the potential use of poultry litter to generate energy and other products. With regard to the Company’s international expansion goals, the Company expects to close on a transaction during fiscal 2007, which would establish a joint venture with a poultry company in China. Additionally, the Company expects to complete two joint venture transactions in South America in 2007; one involving a poultry operation in Brazil, and the other involving a beef operation in Argentina.

 

The Company expects operating margin improvements in each segment in fiscal 2007. Although the Company’s Chicken segment will be affected negatively by higher grain prices in fiscal 2007 compared to fiscal 2006, the Company’s mix of value-added products and expected price increases should supply some insulation. The Company expects live cattle supplies and live hog supplies to increase in fiscal 2007, which should allow the Company to achieve greater operational efficiencies in its processing plants. Additionally, the Company anticipates improved market share in the Prepared Foods segment in fiscal 2007.

 

Based on the Company’s outlook for fiscal 2007, diluted earnings per share are estimated to be in the range of $0.50 to $0.80, and sales are estimated to be in the range of $26 billion to $27 billion. The Company expects to reduce its capital spending from the $531 million spent in fiscal 2006 to approximately $400 million in fiscal 2007. Additionally, the Company anticipates stronger cash flow and lower interest expense in fiscal 2007 and plans to use the improved cash flow to reduce its debt position.

 

2006 vs. 2005

 

Certain reclassifications have been made to prior periods to conform to current presentations.

 

Sales decreased $455 million or 1.7%, with a 3.9% decrease in average sales price and a 2.3% increase in volume. The oversupply of proteins led to decreased average sales prices in all segments. Additionally, fiscal 2006 sales were affected negatively by realized and unrealized net losses of $5 million, compared to realized and unrealized net gains of $24 million recorded in fiscal 2005 from the Company’s commodity risk management activities related to its fixed forward boxed beef and pork sales.

 

Cost of Sales increased $337 million or 1.4%. As a percent of sales, cost of sales increased from 93.4% to 96.4%. The increase in cost of sales as a percentage of sales primarily was due to the decrease in average sales prices, while average live prices and production costs did not decrease at the same rate. Energy costs increased in all segments by approximately $167 million compared to the same period last year. Additionally, fiscal 2006 includes $49 million of realized and unrealized net losses related to the Company’s forward futures contracts for live cattle and hog purchases, compared to $33 million of realized and unrealized net gains recorded in fiscal 2005. Cost of sales was impacted positively by realized and unrealized net gains of $6 million in fiscal 2006 resulting from the Company’s commodity risk management activities related to grain purchases compared to realized and unrealized net losses of $27 million in fiscal 2005.

 

Selling, general and administrative expenses increased $7 million or 0.8%. As a percent of sales, selling, general and administrative expenses increased from 3.6% to 3.7%. The increase primarily was due to an increase in stock compensation expense, information system services costs and increased sales promotion expenses. The increases were offset partially by decreased charitable contributions, decreased legal and other professional fees and a fiscal 2006 bad debt recovery. Also, insurance proceeds received in fiscal 2005 decreased prior year costs.

 

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Other charges include $63 million of plant closing related costs and $9 million of severance accruals related to the Company’s $200 million cost reduction initiative. The plant closing costs relate primarily to closing the Company’s Norfolk and West Point, Nebraska, and Independence and Oelwein, Iowa, operations. In February 2006, the Company announced its decision to close its Norfolk, Nebraska, beef processing plant and its West Point, Nebraska, beef slaughter plant. These facilities closed in February 2006. Production from these facilities shifted primarily to the Company’s beef complex in Dakota City, Nebraska. In January 2006, the Company announced its decision to close two of its processed meats facilities in northeast Iowa. The Independence and Oelwein plants, which produced chopped ham and sliced luncheon meats, closed in March 2006.

 

In August 2006, the Company announced its decision to close its Boise, Idaho, beef slaughter plant and to scale back processing operations at its Pasco, Washington, complex. This decision resulted in the elimination of approximately 770 positions. The closure and process change occurred in October 2006 and did not result in a significant charge to the Company.

 

In July 2006, the Company announced its decision to implement approximately $200 million in cost reductions as part of a strategy to return to profitability. The cost reductions include staffing costs, consulting and professional fees, sales and marketing costs and other expenses. Virtually all of the cost reduction initiatives are expected to be completed by December 2006, with savings beginning principally in fiscal 2007.

 

Other charges in fiscal 2005 include $33 million relating to a legal settlement involving the Company’s live swine operations and $14 million in plant closing costs primarily relating to the closings of the Company’s Cleveland Street Forest, Mississippi; Portland, Maine; and Bentonville, Arkansas; operations. In July 2005, the Company announced it had agreed to settle a lawsuit resulting from the restructuring of its live swine operations. The settlement resulted in the Company recording an additional $33 million of costs in the third quarter of fiscal 2005. In July 2005, the Company announced its decision to make improvements to one of its Forest, Mississippi, facilities, which included more product lines, enabling the plant to increase production of processed and marinated chicken. The improvements were made at the former Choctaw Maid Farms location, which the Company acquired in fiscal 2003. The Company’s Cleveland Street Forest, Mississippi, poultry operation ceased operations in March 2006. Also in July 2005, the Company announced its decision to close its Bentonville, Arkansas, facility. The production from this facility was transferred to the Company’s Russellville, Arkansas, poultry plant, where an expansion enabled the facility to absorb the Bentonville facility’s production. In December 2004, the Company announced its decision to close its Portland, Maine, facility. The plant ceased operations February 4, 2005, and the production from this facility was transferred to other locations.

 

Interest income increased $20 million, primarily due to the interest earned on the $750 million short-term investment held on deposit with a trustee used for the repayment of the 7.25% Notes maturing on October 1, 2006.

 

Interest expense increased $31 million or 13.1%. The increase primarily was due to the increase in average total debt of 15.8%; however, average total debt increased by approximately 3.2% after adjusting total debt for the $750 million short-term investment. The increase was offset partially by a decrease in the overall weighted average borrowing rate from 7.1% to 7.0%.

 

Other income increased $12 million compared to fiscal 2005, primarily resulting from improvements in foreign currency exchange gain/loss activity of approximately $7 million and a $7 million gain recorded on the write-off of a capital lease obligation related to a legal settlement. These items were offset partially by an $8 million gain recorded in fiscal 2005 from the sale of the Company’s remaining interest in Specialty Brands, Inc.

 

The effective tax rate was a 34.8% benefit for fiscal 2006 compared to a 29.5% provision for fiscal 2005. The fiscal 2006 effective tax rate was reduced by 5.1% due to expense recorded in fiscal 2006 as a result of the tax account balance review as discussed in Note 15 in the Notes to Consolidated Financial Statements. The fiscal 2006 effective rate also was reduced by 1.8% due to the federal income tax effect of the Medicare Part D subsidy loss for fiscal 2006 since this loss is not deductible for federal income tax purposes. The fiscal 2005 effective rate reflects a reduction of 4.1% due to the release of income tax reserves that management deemed were no longer required and a reduction of 3.6% related to the 2005 estimated future Medicare Part D subsidy. In addition, the fiscal 2005 effective rate reflected an increase of 4.2% relating to the repatriation of earnings of foreign subsidiaries as allowed by the American Jobs Creation Act.

 

Cumulative effect of change in accounting principle, net of tax, includes a transition charge of $5 million related to the Company’s adoption of FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations.”

 

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Segment Information

Tyson operates in five business segments: Chicken, Beef, Pork, Prepared Foods and Other. The Company measures segment profit as operating income.

 

Chicken segment is involved primarily in processing live chickens into fresh, frozen and value-added chicken products. The Chicken segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world. The Chicken segment also includes sales from allied products and the chicken breeding stock subsidiary.

 

Beef segment is involved primarily in processing live fed cattle and fabricating dressed beef carcasses into primal and sub-primal meat cuts and case-ready products. It also involves deriving value from allied products such as hides and variety meats for sale to further processors and others. The Beef segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world. Allied products also are marketed to manufacturers of pharmaceuticals and technical products.

 

Pork segment is involved primarily in processing live market hogs and fabricating pork carcasses into primal and sub-primal meat cuts and case-ready products. This segment also represents the Company's live swine group and related allied product processing activities. The Pork segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world. It also sells allied products to pharmaceutical and technical products manufacturers, as well as live swine to pork producers.

 

Prepared Foods segment includes the Company's operations that manufacture and market frozen and refrigerated food products. Products include pepperoni, beef and pork pizza toppings, pizza crusts, flour and corn tortilla products, appetizers, prepared meals, ethnic foods, soups, sauces, side dishes, meat dishes and processed meats. The Prepared Foods segment markets its products domestically to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets throughout the world.

 

Other segment includes the logistics group and other miscellaneous operations.

 

 

 

 

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Chicken segment sales decreased 4.4% and operating results decreased $529 million in fiscal 2006 compared to fiscal 2005. Fiscal 2006 operating results include charges of $9 million related to the Company’s cost reduction initiative, other business consolidation efforts and plant closing costs. Fiscal 2005 operating results include $12 million of plant closing costs and $8 million of hurricane- related losses. The decline in sales and operating results primarily was due to lower average sales prices, predominantly caused by an oversupply of proteins in the marketplace. Additionally, the Chicken segment’s operating results were affected negatively by higher energy costs and decreased margins at the Company’s operations in Mexico. Fiscal 2006 chicken operating results include realized and unrealized net gains of $6 million from the Company’s commodity risk management activities related to grain purchases compared to realized and unrealized net losses of $27 million recorded in fiscal 2005.

 

Beef segment sales increased 1.8% and operating results decreased $284 million in fiscal 2006 compared to fiscal 2005. Fiscal 2006 operating results include charges of $52 million related to plant closing costs, the Company’s cost reduction initiative and other business consolidation efforts. Fiscal 2005 operating results include $10 million received in connection with vitamin antitrust litigation. The operating results decline primarily was due to lower average sales prices, predominantly caused by an oversupply of proteins in the marketplace. Additionally, the Beef segment’s operating results were affected negatively by significant operating margin reductions at the Company’s Lakeside operation in Canada. Also, fiscal 2006 operating results include realized and unrealized net losses of $40 million from the Company’s commodity risk management activities related to its fixed forward boxed beef sales and forward live cattle purchases, compared to realized and unrealized net gains of $13 million recorded in fiscal 2005.

 

Pork segment sales decreased 5.8% and operating results remained flat in fiscal 2006 compared to fiscal 2005. Fiscal 2006 operating results include charges of $2 million related to the Company’s cost reduction initiative and other business consolidation efforts. Fiscal 2005 operating results include $33 million related to a legal settlement involving the Company’s live swine operations and $2 million received in connection with vitamin antitrust litigation. Lower average sales prices, predominantly caused by an oversupply of proteins in the marketplace adversely affected sales and operating results. The lower average sales prices were offset partially by lower average live prices. Additionally, fiscal 2006 operating results include realized and unrealized net losses of $15 million from the Company’s commodity risk management activities related to its fixed forward boxed pork sales and forward live hog purchases, compared to realized and unrealized net losses of $22 million recorded in fiscal 2005.

 

Prepared Foods segment sales decreased 3.9% and operating results decreased $33 million in fiscal 2006 compared to fiscal 2005.

Fiscal 2006 operating results include charges of $19 million related to plant closing costs, other business consolidation efforts and the Company’s cost reduction initiative. Fiscal 2005 operating results include $2 million related to plant closing costs. The decline in sales and operating income primarily was due to lower average sales prices.

 

2005 vs. 2004

 

Certain reclassifications have been made to prior periods to conform to current presentations.

 

Sales decreased $427 million or 1.6%, with a 0.7% increase in average sales price and a 2.3% decrease in volume. The decrease in sales primarily was due to reduced sales in the Company’s Beef segment, resulting from the effects of import and export restrictions. Additionally, sales were affected negatively by decreased sales volumes in each of the Company’s protein segments, primarily due to one less week of sales in fiscal 2005. These declines were offset partially by higher average sales prices in the Company’s Chicken, Pork and Prepared Foods segments.

 

Cost of Sales decreased $264 million or 1.1%. As a percent of sales, cost of sales increased from 92.9% to 93.4%. The decrease in cost of sales primarily was due to decreased grain costs of approximately $312 million in fiscal 2005 compared to fiscal 2004, partially offset by higher live costs in the Pork segment, higher raw material costs in the Prepared Foods segment and higher energy costs. Additionally, the Chicken segment recorded realized and unrealized losses of $27 million in fiscal 2005 resulting from the Company’s commodity risk management activities related to grain purchases, compared to realized and unrealized gains of $127 million in fiscal 2004. The fiscal 2004 gains in part were due to grain commodity risk management activities not designated as SFAS No. 133 hedges. Also, lower domestic cattle supplies and restrictions on imports of Canadian cattle for most of fiscal 2005 caused lower production volumes and higher operating cost per head.

 

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Selling, general and administrative expenses increased $48 million or 5.5%. As a percent of sales, selling, general and administrative expenses increased from 3.3% to 3.6%. The increase primarily was due to an increase of approximately $28 million in corporate advertising expenses, which primarily was related to the Company’s “Powered by Tyson™” campaign. In addition, there were increases in personnel-related costs and contributions and donations.

 

Other charges include $33 million related to a legal settlement involving the Company’s live swine operations and $14 million in plant closing costs, primarily related to the closings of the Company’s Cleveland Street Forest, Mississippi; Portland, Maine; and Bentonville, Arkansas; operations. In July 2005, the Company announced it had agreed to settle a lawsuit resulting from the restructuring of its live swine operations. The settlement resulted in the Company recording an additional $33 million of costs in the third quarter of fiscal 2005. In July 2005, the Company announced its decision to make improvements to one of its Forest, Mississippi, facilities, which included more product lines, enabling the plant to increase production of processed and marinated chicken. The improvements were made at the former Choctaw Maid Farms location, which the Company acquired in fiscal 2003. The Company’s Cleveland Street Forest, Mississippi, poultry operation ceased operations in March 2006. Also in July 2005, the Company announced its decision to close its Bentonville, Arkansas, facility. The production from this facility was transferred to the Company’s Russellville, Arkansas, poultry plant, where an expansion enabled the facility to absorb the Bentonville facility’s production. In December 2004, the Company announced its decision to close its Portland, Maine, facility. The plant ceased operations February 4, 2005, and the production from this facility was transferred to other locations. Other charges in fiscal 2004 include $40 million in plant closing costs, primarily related to the closings of the Company’s Jackson, Mississippi; Manchester, New Hampshire; Augusta, Maine; and Berlin, Maryland; operations. Also included in other charges for fiscal 2004 were $25 million in charges related to intangible asset impairments and $21 million related to fixed asset write-downs.

 

Interest expense decreased $43 million or 15.4%, primarily resulting from an 8.7% decrease in the Company’s average indebtedness. In addition, the Company incurred $13 million of expenses in fiscal 2004, related to the buy back of bonds and the early redemption of Tyson de Mexico preferred shares. Excluding these charges, the overall weighted average borrowing rate decreased from 7.4% to 7.1%.

 

Other expense decreased $17 million compared to fiscal 2004, resulting from improvements in foreign currency exchange gain/loss activity of approximately $9 million, primarily from the Company’s Canadian operations, and an $8 million gain recorded in fiscal 2005 from the sale of the Company’s remaining interest in Specialty Brands, Inc.

 

The effective tax rate decreased from 36.6% in fiscal 2004 to 29.5% in fiscal 2005. The fiscal 2005 effective rate reflects a reduction of 4.1% due to the release of income tax reserves management deemed were no longer required. The fiscal 2005 effective rate also reflects a reduction of 3.6% due to the federal income tax effect of the Medicare Part D subsidy in fiscal 2005 because this amount is not subject to federal income tax. In addition, the rate reflects an increase of 4.2% relating to the repatriation of earnings of foreign subsidiaries as allowed by the American Jobs Creation Act, offset by 2.9% relating to the reversal of certain international tax reserves no longer needed due to the effects of the repatriation under the American Jobs Creation Act. During the fourth quarter of fiscal 2005, the Company repatriated $404 million of foreign earnings invested outside the United States under the American Jobs Creation Act. See Note 15 in the Notes to Consolidated Financial Statements for further discussion of these issues. The estimated Extraterritorial Income Exclusion (ETI) amount reduced the fiscal 2005 effective tax rate by 2.6% compared to 0.5% in fiscal 2004. The increase in the fiscal 2005 estimated ETI benefit resulted from an increase in the estimated fiscal 2005 profit from export sales primarily due to increased profit on export sales, along with an adjustment to the estimated fiscal 2004 benefit.

 

 

 

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Chicken segment sales decreased 0.8% in fiscal 2005 compared to fiscal 2004. The decline in sales primarily was due to lower volumes, caused largely by one less week of sales in fiscal 2005, partially offset by higher average sales prices and improved product mix. Chicken segment operating income increased $34 million in fiscal 2005 compared to fiscal 2004. Fiscal 2005 operating income includes $12 million of plant closing costs and $8 million of hurricane-related losses. Fiscal 2004 operating income includes $13 million of plant closing costs and $13 million of charges related to fixed asset write-downs. Fiscal 2005 operating income was affected positively by decreased grain costs of $312 million. However, the fiscal 2005 benefits from decreased grain costs were offset partially by realized and unrealized net losses of $27 million from the Company’s commodity risk management activities related to grain purchases, compared to realized and unrealized net gains of $127 million recorded in fiscal 2004. Additionally, fiscal 2005 operating income was affected negatively by higher energy costs.

 

Beef segment sales decreased 2.8% in fiscal 2005 compared to fiscal 2004. The decline in sales primarily resulted from the effects of import and export restrictions. Those restrictions contributed to lower international sales volumes and lower average domestic sales prices in part due to the mix of products allowed for export. Additionally, fiscal 2005 had one less week of sales, compared to fiscal 2004. Fiscal 2005 operating income decreased $139 million compared to fiscal 2004. Fiscal 2005 operating income includes $10 million received in connection with vitamin antitrust litigation. Fiscal 2004 operating income includes BSE-related charges of $61 million and $5 million of charges related to intangible asset impairments and fixed asset write-downs. The decrease in operating income primarily was due to lower domestic cattle supplies and restrictions on imports of Canadian cattle for most of fiscal 2005, which resulted in lower production volumes and raised the operating cost per head. Additionally, fiscal 2005 operating income was affected negatively by decreased volumes and margins at the Company’s Lakeside operation in Canada. Also, fiscal 2005 operating results include realized and unrealized net gains of $13 million from the Company’s commodity risk management activities related to its fixed forward boxed beef sales and forward live cattle purchases, compared to realized and unrealized net gains of $51 million recorded in fiscal 2004.

 

Pork segment sales increased 1.9% in fiscal 2005 compared to fiscal 2004. The increase in sales resulted primarily from higher average sales prices, both domestically and internationally, compared to fiscal 2004. The higher average sales prices, driven primarily by higher average live hog prices, were offset partially by a decrease in volumes, caused largely by one less week of sales. Fiscal 2005 operating income decreased $93 million compared to fiscal 2004. Fiscal 2005 operating income includes costs of $33 million related to a legal settlement involving the Company’s live swine operations and $2 million received in connection with vitamin antitrust litigation. Fiscal 2004 operating income includes $1 million of charges related to fixed asset write-downs. The decrease in operating income primarily was due to higher average live hog prices and lower volumes, which increased the operating cost per head and more than offset the increase in average sales prices.

 

Prepared Foods segment sales decreased 3.1% in fiscal 2005 compared to fiscal 2004. The decline in sales primarily was due to lower volumes, caused largely by one less week of sales and the rationalization of lower margin product lines, partially offset by higher average sales prices. Fiscal 2005 operating income increased $50 million compared to fiscal 2004. Fiscal 2005 operating income includes $2 million of plant closing costs. Fiscal 2004 operating income includes $27 million of plant closing costs and $27 million of charges related to fixed asset write-downs and intangible asset impairments. Fiscal 2005 operating income was negatively impacted by increased raw material prices.

 

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LIQUIDITY AND CAPITAL RESOURCES

In fiscal 2006, net cash of $287 million was provided by operating activities, a decrease of $712 million from fiscal 2005. The decrease primarily was due to a decline in net income of $605 million, excluding the non-cash effect of deferred income taxes, and the net change in the working capital effect of $147 million. The Company used cash primarily from borrowings and operations to fund $531 million of property, plant and equipment additions, to pay dividends of $55 million on the Company’s Class A and Class B stock and to repurchase $42 million of the Company’s Class A stock in the open market, which purchases were made to satisfy the Company’s stock compensation programs. The expenditures for property, plant and equipment were related to acquiring new equipment and upgrading facilities to maintain competitive standing and position the Company for future opportunities. The Company’s foreseeable cash needs for operations growth and capital expenditures are expected to be met through cash flows provided by operating activities.

 

 

In the second quarter of fiscal 2006, the Company issued $1.0 billion of new senior unsecured notes, which will mature on April 1, 2016 (2016 Notes). The 2016 Notes carried an initial 6.60% interest rate, with interest payments due semi-annually on April 1 and October 1. In fiscal 2007, the Company used $750 million of the proceeds for the repayment of its outstanding $750 million 7.25% Notes due October 1, 2006. The remaining proceeds were used for general corporate purposes. The Company’s short-term investment at September 30, 2006, includes $750 million of proceeds from this new issuance and earnings of $20 million on the investment.

 

On July 24, 2006, Moody’s Investors Services, Inc. (Moody’s) downgraded the Company’s credit rating applicable to the 2016 Notes from “Baa3” to “Ba1.” This downgrade increased the interest rate on the 2016 Notes from 6.60% to 6.85%, effective on the first day of the interest period during which the rating change required an adjustment to the interest rate (i.e., the issuance of the 2016 Notes). Accordingly, in the fourth quarter, the Company recorded an additional $0.7 million for the interest period from March 22, 2006, to July 1, 2006. This downgrade will increase annual interest expense and related fees by approximately $5 million, including $2.5 million related to the 2016 Notes.

 

On July 31, 2006, Standard & Poor’s (S&P) also downgraded the Company’s credit rating applicable to the 2016 Notes from “BBB” to “BBB-.” This downgrade did not result in an increase in the interest rate on the 2016 Notes, nor did it result in an increase in interest expense or related fees for other debt.

 

On September 18, 2006, Tyson Fresh Meats, Inc. (TFM), a wholly-owned subsidiary of the Company, guaranteed the 2016 Notes. This guarantee does not extend to the other unsecured senior notes of the Company. Moody’s and S&P did not change the July 2006 credit ratings applicable to the 2016 Notes. However, Moody’s issued a new credit rating of “Ba2,” and S&P issued a new credit rating of “BB+” related to the other unsecured senior notes not guaranteed by TFM. These new ratings did not impact the interest rate applicable to the 2016 Notes. However, other interest expense and related fees for other debt increased by less than $3 million.

 

It is possible one or both of the debt rating agencies may further downgrade the Company’s bond rating applicable to the 2016 Notes.  S&P currently rates this long-term debt “BBB-,” with a negative outlook. Moody’s currently rates this debt “Ba1,” with a negative outlook. The pretax impact to earnings of each further downgrade would be approximately $5 million annually, per rating agency, of which $2.5 million would be related to increased interest expense on the 2016 Notes.

 

Total debt at September 30, 2006, was approximately $4.0 billion, an increase of $984 million from October 1, 2005. However, when adjusted for the $750 million of proceeds on deposit, debt would have been $3.2 billion, an increase of $234 million from October 1, 2005. Additionally, the Company has an unsecured revolving credit facility totaling $1.0 billion that supports the Company’s short-term funding needs and letters of credit. The $1.0 billion facility expires in September 2010. This agreement was amended on July 27, 2006, which reduced the availability of the unsecured revolving credit facility. See below for further description. Also, at September 30, 2006, the Company had a receivables purchase agreement with three co-purchasers to sell up to $750 million of trade receivables.

 

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These agreements were restructured and extended in the fourth quarter of fiscal 2006 and now consist of $375 million expiring August 2007 and $375 million expiring in August 2009. At September 30, 2006, there was $79.5 million outstanding on each of the commitments. At October 1, 2005, there were no amounts drawn under the receivables purchase agreement. Outstanding debt at September 30, 2006, consisted of $3.4 billion of debt securities, a $345 million term loan and other indebtedness of $246 million.

 

 

The revolving credit facility, senior notes, notes, term loan and accounts receivable securitization contain various covenants, the more restrictive of which contain a maximum allowed leverage ratio and a minimum required interest coverage ratio.

 

On July 27, 2006, the Company entered into a third amendment to its five-year credit revolving facility and the three-year term loan facility of its subsidiary, Lakeside Farms Industries, Ltd. These amendments modified the minimum required interest coverage ratio, temporarily suspended the maximum allowed leverage ratios and implemented temporary minimum consolidated EBITDA requirements. The Company was in compliance with all of such covenants at fiscal year end.

 

In connection with these amendments, the Company’s availability under its unsecured revolving credit facility decreased, and if the Company’s credit rating is further downgraded, prior to the delivery of the second quarter fiscal 2007 compliance certificate, the Company is required to have certain subsidiaries guarantee the revolving credit facility and term loan. The amended agreement allows for maximum availability under the revolving credit facility of 50% of inventory, reduced by letters of credit issued and amounts outstanding under its term loan. The amount available as of September 30, 2006, was $481 million.

 

The Company’s foreseeable cash needs for operations and capital expenditures are expected to be met primarily through cash flows provided by operating activities. Additionally, at September 30, 2006, the Company had unused borrowing capacity of $1.1 billion, consisting of $481 million available under its $1.0 billion unsecured revolving credit agreement and $591 million under its accounts receivable securitization. At September 30, 2006, the Company had construction projects in progress that will require approximately $182 million to complete. Capital spending for fiscal 2007 is expected to be approximately $400 million.

 

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have any off-balance sheet arrangements material to its financial position or results of operations. The off-balance sheet arrangements the Company has are guarantees of debt of outside third parties involving a lease, grower loans and residual value guarantees covering certain operating leases for various types of equipment. See Note 8, “Commitments” of the Notes to Consolidated Financial Statements for further discussions of these guarantees.

 

CONTRACTUAL OBLIGATIONS

The following table summarizes the Company’s contractual obligations as of September 30, 2006:

 

 

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RECENTLY ADOPTED ACCOUNTING STANDARDS AND REGULATIONS

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS No. 123R). The pronouncement requires companies to measure and recognize compensation expense for all share-based payments to employees, including grants of employee stock options, restricted stock and performance-based shares, in the financial statements based on the fair value at the date of the grant. In the first quarter of fiscal 2006, the Company adopted SFAS No. 123R using the modified prospective method. Under the modified prospective method, compensation cost is recognized for all share-based payments granted after the adoption of SFAS No. 123R and for all awards granted to employees prior to the adoption date of SFAS No. 123R and unvested on the adoption date. Accordingly, no restatements were made to prior periods. Prior to the adoption of SFAS No. 123R, the Company applied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” in accounting for its employee stock compensation plans. Accordingly, no compensation expense was recognized for its stock option issuances as stock options are issued with an exercise price equal to the closing price at the date of grant. Also, prior to the adoption of SFAS No. 123R, the Company issued restricted stock and recorded the fair value of such awards as deferred compensation amortized over the vesting period. The fair value of each option grant is established on the date of grant using the Black-Scholes option-pricing model for grants awarded prior to October 1, 2005, and a binomial lattice method for grants awarded subsequent to October 1, 2005. The change to the binomial lattice method was made to better reflect the exercise behavior of top management. The Company recognized compensation expense (net of tax) of $9 million and $15 million in fiscal 2006 related to stock options and restricted stock, respectively. As of September 30, 2006, the Company had $38 million of total unrecognized compensation cost related to stock option plans that will be recognized over a weighted average period of 2.2 years and $42 million of total unrecognized compensation cost related to restricted stock awards that will be recognized over a weighted-average period of 1.5 years.

 

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of FASB Statement No. 143 (FIN 47). Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143), was issued in June 2001 and requires an entity to recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. SFAS No. 143 applies to legal obligations associated with the retirement of a tangible long-lived asset that resulted from the acquisition, construction, development and/or the normal operation of a long-lived asset. The associated asset costs are capitalized as part of the carrying amount of the long-lived asset. FIN 47 clarifies the term “conditional asset retirement obligation” as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future

 

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event that may or may not be within the control of the entity. FIN 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. The Company adopted FIN 47 as of September 30, 2006. See Note 2, “Change in Accounting Principle” in the Notes to Consolidated Financial Statements for the impact of the adoption of FIN 47.

 

In September 2005, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty.” The issues were the circumstances under which two or more inventory purchase and sales transactions with the same counterparty should be viewed as a single exchange transaction within the scope of Accounting Principles Board Opinion 29, “Accounting for Nonmonetary Transactions” and circumstances under which nonmonetary exchanges of inventory within the same line of business should be recognized at fair value. The Company adopted EITF Issue No. 04-13 in the third quarter of fiscal 2006. The adoption of this Issue did not have a material impact on the Company’s consolidated financial statements.

 

RECENTLY ISSUED ACCOUNTING STANDARDS AND REGULATIONS

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006; therefore, the Company expects to adopt FIN 48 at the beginning of fiscal 2008. The Company is currently in the process of evaluating the potential impact of FIN 48.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 provides guidance for using fair value to measure assets and liabilities. This standard also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years; therefore, the Company expects to adopt SFAS No. 157 at the beginning of fiscal 2009. The Company is currently in the process of evaluating the potential impact of SFAS No. 157.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS No. 158). SFAS No. 158 requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its consolidated balance sheet and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. This standard also requires companies to measure the funded status of a plan as of the date of its annual consolidated balance sheet, with limited exceptions. SFAS No. 158 is effective for financial statements issued for fiscal years ending after December 15, 2006; therefore, the Company expects to adopt SFAS No. 158 at the end of fiscal 2007. Based on the information available at September 30, 2006, the Company expects an increase in assets of $6 million, an increase in liabilities of $8 million and an adjustment to accumulated other comprehensive income of $2 million when it adopts SFAS No. 158.

 

In September 2006, the Securities and Exchange Commission staff published Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 addresses quantifying the financial statement effects of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. SAB 108 is effective for fiscal years ending after November 15, 2006; therefore, the Company expects to adopt SAB 108 at the end of fiscal 2007. The Company is currently in the process of evaluating the potential impact of SAB 108.

 

CRITICAL ACCOUNTING ESTIMATES

The preparation of consolidated financial statements requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following is a summary of certain accounting estimates considered critical by the Company.

 

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Financial instruments: The Company is a purchaser of certain commodities, such as grains, livestock and natural gas in the course of normal operations. The Company uses derivative financial instruments to reduce its exposure to various market risks. Generally, contract terms of a hedge instrument closely mirror those of the hedged item, providing a high degree of risk reduction and correlation. Contracts designated and highly effective at meeting the risk reduction and correlation criteria are recorded using hedge accounting, as defined by Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133), as amended. If a derivative instrument is a hedge, as defined by SFAS No. 133, depending on the nature of the hedge, changes in the fair value of the instrument will be offset either against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of an instrument’s change in fair value is recognized immediately in earnings as a component of cost of sales. Instruments the Company holds as part of its risk management activities that do not meet the criteria for hedge accounting, as defined by SFAS No. 133, as amended, are marked to fair value with unrealized gains or losses reported currently in earnings. The Company generally does not hedge anticipated transactions beyond 12 months.

 

Contingent liabilities: The Company is subject to lawsuits, investigations and other claims related to wage and hour/labor, livestock procurement, securities, environmental, product, taxing authorities and other matters, and is required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of reserves and disclosures required, if any, for these contingencies are made after considerable analysis of each individual issue. These reserves may change in the future due to changes in the Company’s assumptions, the effectiveness of strategies or other factors beyond the Company’s control.

 

Accrued self insurance: Insurance expense for health and welfare, workers’ compensation, auto liability and general liability risks are estimated using experience and actuarial estimates. The assumptions used to arrive at periodic expenses are reviewed regularly by management. However, actual expenses could differ from these estimates, which could result in adjustments to amounts recorded.

 

Pension and other postretirement benefits: The Company provides a range of benefits to its employees and retired employees, including pensions and postretirement healthcare benefits. The Company records annual amounts related to these plans based on calculations specified by generally accepted accounting principles, which include various actuarial assumptions, such as discount rates, assumed rates of return on plan assets, compensation increases, turnover rates, mortality rates, retirement rates and healthcare cost trends. The Company reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on the current rates and trends when it is deemed appropriate to do so. The Company generally recognizes the effect of these modifications immediately into earnings rather than amortizing the effect over future periods. See Note 12, “Pension and other postretirement benefits” of the Notes to Consolidated Financial Statements for a sensitivity discussion of the assumed healthcare cost trend rates.

 

Impairment of long-lived assets: The Company is required to assess potential impairments to its long-lived assets, which are primarily property, plant and equipment. If impairment indicators are present, the Company must measure the fair value of the assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment of Disposal of Long-Lived Assets,” to determine if adjustments are to be recorded.

 

Impairment of goodwill and other intangible assets: In assessing the recoverability of the Company’s goodwill and other intangible assets, management relies on a number of factors including operating results, business plans, economic projections, anticipated future cash flow, assumed royalty rates and marketplace data. There are inherent uncertainties related to these factors and management’s judgment in applying these factors to the assessment of recoverability. The Company has elected to make the first day of the fourth quarter the annual impairment assessment date for goodwill and other intangible assets. Goodwill valuations have been calculated using an income approach based on the present value of future cash flows of each reporting unit. Other intangible asset valuations have been calculated for trademarks using a royalty rate method based on the present value of future cash flows and for patents and in-process technology using the cash flow method based on the present value of future cash flows. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairment in future periods. The Company could be required to evaluate the recoverability of goodwill and other intangible assets prior to the required annual assessment if the Company experiences disruptions to the business such as end market conditions, unexpected significant declines in operating results, divestiture of a significant component of the Company and market capitalization declines. These types of events and the resulting analysis could result in goodwill impairment charges in the future. The Company recorded impairments of other intangible assets of $3 million, $4 million and $25 million in fiscal 2006, 2005 and 2004, respectively.

 

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Marketing and advertising costs: The Company incurs advertising, retailer incentive and consumer incentive costs to promote its products through its marketing programs. These programs include cooperative advertising, volume discounts, in-store display incentives, coupons and other programs. The recognition of the costs related to these programs requires management’s judgment in estimating the potential performance and redemption of each program. These estimates are based on many factors, including experience of similar promotional programs. Actual expenses may differ if the performance and redemption rates vary from the estimated rates.

 

Income taxes: The Company estimates its total income tax expense based on statutory tax rates and tax planning opportunities available to the Company in various jurisdictions in which the Company earns income. Federal income taxes include an estimate for taxes on earnings of foreign subsidiaries expected to be remitted to the United States and be taxable, but not for earnings considered indefinitely invested in the foreign subsidiary. Deferred income taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting using tax rates in effect for the years in which the differences are expected to reverse. Valuation allowances are recorded when it is likely a tax benefit will not be realized for a deferred tax asset. Changes in tax laws and rates also could affect the recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on the Company’s results of operations, cash flows or financial position. In addition, the calculation of tax liabilities involves uncertainties in the application of complex tax regulations across the tax jurisdictions where the Company operates. The Company records tax liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes will be due. The Company adjusts these reserves in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

MARKET RISK

 

Market risks relating to the Company’s operations result primarily from changes in commodity prices, interest rates and foreign exchange rates, as well as credit risk concentrations. To address certain of these risks, the Company enters into various derivative transactions as described below. If a derivative instrument is a hedge, as defined by SFAS No. 133, as amended, depending on the nature of the hedge, changes in the fair value of the instrument will be offset either against the change in fair value of the hedged assets, liabilities or firm commitments through earnings, or recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of an instrument’s change in fair value, as defined by SFAS No. 133, as amended, will be recognized immediately in earnings as a component of cost of sales. Additionally, the Company holds certain positions, primarily in grain and livestock futures that do not meet the criteria for SFAS No. 133 hedge accounting. These positions are marked to market, and the unrealized gains and losses are reported in earnings at each reporting date. The changes in market value of derivatives used in the Company’s risk management activities surrounding inventories on hand or anticipated purchases of inventories are recorded in cost of sales. The changes in market value of derivatives used in the Company’s risk management activities surrounding forward sales contracts are recorded in sales.

 

The sensitivity analyses presented below are the measures of potential losses of fair value resulting from hypothetical changes in market prices related to commodities. Sensitivity analyses do not consider the actions management may take to mitigate the Company’s exposure to changes, nor do they consider the effects such hypothetical adverse changes may have on overall economic activity. Actual changes in market prices may differ from hypothetical changes.

 

Commodities Risk: The Company is a purchaser of certain commodities, such as grains, livestock and natural gas in the course of normal operations. The Company uses commodity futures to reduce the effect of changing prices and as a mechanism to procure the underlying commodity. However, as the commodities underlying the Company’s derivative financial instruments can experience significant price fluctuations, any requirement to mark-to-market the positions that have not been designated or do not qualify as hedges under SFAS No. 133 could result in volatility in the Company’s results of operations. Generally, contract terms of a hedge instrument closely mirror those of the hedged item providing a high degree of risk reduction and correlation. Contracts designated and highly effective at meeting this risk reduction and correlation criteria are recorded using hedge accounting. The following table presents a sensitivity analysis resulting from a hypothetical change of 10% in market prices as of September 30, 2006, on the fair

 

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value of open positions. The fair value of such positions is a summation of the fair values calculated for each commodity by valuing each net position at quoted futures prices. The market risk exposure analysis includes hedge and non-hedge positions. The underlying commodities hedged have a correlation to price changes of the derivative positions such that the values of the commodities hedged based on differences between commitment prices and market prices and the value of the derivative positions used to hedge these commodity obligations are inversely correlated. The following sensitivity analysis reflects the impact on earnings for changes in the fair value of open positions.

 

 

Interest Rate Risk: At September 30, 2006, the Company had fixed-rate, long-term debt of $3.4 billion with a weighted average interest rate of 7.4%. The Company has exposure to changes in interest rates on this fixed-rate, long-term debt. Market risk for fixed-rate, long-term debt is estimated as the potential increase in fair value, resulting from a hypothetical 10% decrease in interest rates. A hypothetical 10% decrease in interest rates would have increased the fair value of the Company’s fixed-rate, long-term debt by approximately $87 million at September 30, 2006, and $47 million at October 1, 2005. The fair values of the Company’s long-term debt were estimated based on quoted market prices and/or published interest rates.

 

At September 30, 2006, the Company had variable rate, long-term debt of $545 million with a weighted average interest rate (as of September 30, 2006) of 6.1%. The Company hedges exposure to changes in interest rates on certain financial instruments. Under the terms of various leveraged equipment loans, the Company enters into interest rate swap agreements to effectively lock in a fixed interest rate for these borrowings. The maturity dates of these leveraged equipment loans range from fiscal years 2007 to 2009 with interest rates ranging from 4.7% to 5.4%. Because of the positions taken with respect to these swap agreements, an increase in interest rates would have a minimal effect on interest expense for fiscal years 2006 and 2005.

 

Foreign Currency Risk: The Company has non-cash foreign exchange gain/loss exposure from fluctuations in foreign currency exchange rates as a result of certain receivables and payable balances. The primary currency exchanges the Company has exposure to are the Canadian dollar, the Mexican peso, the European euro, the British pound sterling and the Brazilian real. The Company periodically enters into foreign exchange forward contracts to hedge some of its foreign currency exposure. A hypothetical 10% change in foreign exchange rates amounts to approximately $4 million at September 30, 2006, and $5 million at October 1, 2005.

 

Concentrations of Credit Risk: The Company's financial instruments exposed to concentrations of credit risk consist primarily of cash equivalents, short-term investments and trade receivables. The Company's cash equivalents and short-term investments are in high quality securities placed with major banks and financial institutions. Concentrations of credit risk with respect to receivables are limited due to the large number of customers and their dispersion across geographic areas. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. At September 30, 2006, and October 1, 2005, approximately 13.0% of the Company’s net accounts receivable balance was due from one customer. No other single customer or customer group represents greater than 10% of net accounts receivable.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

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CONSOLIDATED BALANCE SHEETS

 

See accompanying notes.

 

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY