• THE REQUEST: Complete a sustainability report on farms, particularly contract farms

• THE REASON: Concern about risk of liability and regulatory pressure

• THE IMPACT: On long term shareholder value, unknown

“[W]e’ve found that what gets measured gets managed,

and that reporting on these issues is a way for companies to assess where they stand, what the issues are, and where

they need to make improvements.”

Mindy S. Lubber, Executive Director of CERES

Smithfield Foods, Inc.

• Previous Interaction with the Company

– In March 2003, NCF and Amalgamated Bank filed a resolution asking Smithfield to report on the environmental impacts of its hog production operations.

– Although the company agreed to expand environmental reporting on its hog processing operations, it would not commit to reporting on the environmental impacts associated with either company-owned or contract farms.

Smithfield Foods, Inc.

• 2004 Shareholder Season

– Given the company’s vertically integrated business model, which relies heavily on both company-owned and contract farms, the filers felt that the company’s refusal to report on these vital aspects of its operations warranted the submission of another resolution in 2004.

– NCF and Amalgamated submitted a resolution asking the company to prepare a sustainability report examining the environmental impacts of both company-owned and contract farms.

Smithfield Foods, Inc.

• Why Smithfield Foods?

– Smithfield is the market leader in the hog industry, which has undergone significant changes in recent years.

– Smithfield’s business model has changed substantially over the last 5 years and now relies heavily on the use of contract farms.

Smithfield Foods, Inc.

• Smithfield is now the undisputed leader in the hog industry.

– SFD is the largest hog producer and pork processor in the world.

– SFD is the number one processor of hogs in the US, processing approximately 20% of the US slaughter.

– The company’s Hog Production Group (HPG) operates numerous hog production facilities with approximately 843,000 sows producing about 14.5 million market hogs a year.1

Smithfield Foods, Inc.Relative Size of Major Domestic Hog Producers - 2003

225,000 212,000

122,000 104,500

735,000

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

Smithfield PremiumStandard

Seaboard Prestage Farms Cargill

Nu

mb

er o

f S

ows

Source: www.smithfieldfoods.com

Smithfield Foods, Inc.• The hog industry has experienced dramatic changes.

– Recently, the Southern States and isolated areas of the West have become increasingly important.

– North Carolina now holds the lead in terms of the number of sows farrowing.2

– Traditionally, hog farms were located in or near chief grain production regions.

– With changes in relative pricing it is now cheaper to ship grain than to

ship full-grown hogs.

– Hog farms are now clustered around processing plants.

Smithfield Foods, Inc.

• The number of hog farms in the US has fallen dramatically while the size of the average hog farm has greatly increased.

– Department of Agriculture statistics indicate that there were 73,000 hog farms nationwide at the end of 2002. This compares with 248,700 in 1992 and 482,190 in 1982.3

– As hog operations have grown in size, they have become increasingly specialized and have clustered regionally to facilitate the transport of animals among facilities in the supply chain.4

– Industry-wide, approximately 60% of hogs are now produced under contract.5

Smithfield Foods, Inc.

• The company’s business model has changed significantly in the last six years.

– The company has grown substantially through acquisitions, particularly in hog production.6

FY04 FY03 FY02 FY01 FY00FY99

(All Figures in Millions)

Total hogs processed 24.7 21.0 20.1 20.6 20.4 19.2

Total hogs produced 14.5 12.9 12.2 11.8 7.5 2.0Source: 2004 10-K

Smithfield Foods, Inc.

• Smithfield believes that its vertically integrated business model provides it with a competitive advantage.

– Smithfield is now approximately 60% vertically integrated, with the HPG raising 14.5 million of the 24.7 million hogs processed in 2004.7

– SFD believes that vertical integration provides substantial economies of scale through:

• high volume production

• increased control over raw material quality, consistency and food safety

• operational, logistical and transportation efficiencies due to the close proximity of its hog production operations to its processing facilities.8

Source: 2004 10-K, 2003 10-K

Smithfield Foods, Inc.

• “Management believes that the HPG furthers the company’s strategic initiative of vertical integration and reduces its exposure to fluctuations in profitability historically experienced by the pork processing industry.” (2004 10-K)

– Currently, approximately 65% of the HPG’s market hogs are raised on contract farms.9

– During the 2003 calendar year, Smithfield’s hogs were produced on 1,900 contract farms and only 650 company-owned farms.10

Smithfield Foods, Inc.

• Hog production generates significant amounts of waste.

– On a dry weight basis, total livestock manure is about 5 times as much as the amount of municipal solid waste generated each year.11

– The majority of environmental damage connected with hog farming is associated with waste disposal.

– Problems include the emanation of noxious odors from open-air sewage lagoons and the pollution of rivers and ground water.

Smithfield Foods, Inc.

• The company currently supplies investors with very little data on the environmental impacts of its company-owned farms and reports absolutely nothing on the environmental impacts of contract farms.

– In its 2003 Stewardship Report, the only farm-related metric was water usage. This data was given only for company farms, not contract farms.

– The company claims that it cannot collect and report metrics for its contract farms because it views them as independent businesses.

Smithfield Foods, Inc.

• Although SFD views contract farms as independent businesses, the company exercises a significant degree of control over their operation.

– Farmers enter into 7 to 10 year contracts to grow hogs for Smithfield. Under these multi-year contracts, a farmer provides the initial facility investment, labor and front line management in exchange for a service fee.

– The company owns the animals throughout the production process.

– The company optimizes diets for its hogs at each stage of the growth process, processes feed for its hogs and designs hog confinement facilities.

– The company transports the hog to and from the site of the contract farms.

Slide taken from Smithfield Foods, Inc. Presentation to CAGNY Conference, February 17, 2003

Available on Smithfield’s website, www.smithfieldfoods.com

Integrator Liability• Despite the fact that the company claims that its contract

growers are independent farmers, there is growing legal opinion that contract suppliers are not independent.

– In an opinion issued in 2001, the Oklahoma Attorney General stated that, “Where an integrator directs in detail the manner in which raising of the crop is to be performed the contract grower is the employee of the integrator.”12

– In a case that observers say could have sweeping ramifications, farmers are suing O.K. Industries, alleging that they are actually working as employees and are due a range of pay and benefits.13

– Others in the legal community have also recognized the risk that the relationship between integrators and contract farmers may be deemed to be an employer-employee relationship.14

Integrator Liability

• Integrators are also facing court cases in which they are being charged with responsibility for environmental violations occurring on their contract farms.

– In November of 2003, US District Court Judge Joseph McKinley ruled that Tyson Foods could be held responsible for pollution stemming from 80 contract farms in western Kentucky.15

– A similar case is pending against Seaboard Farms before the 10th U.S. Circuit Court of Appeals in Colorado.16

– An attorney for Sierra Club, which filed both the Tyson and Seaboard suits, has stated that the Tyson case will be used as a model for litigation aimed at holding integrators liable for pollution.17

Integrator Liability• In addition, legislation affecting the viability of Smithfield’s

integrated model has been repeatedly introduced at both the state and federal levels. At the federal level:

– Legislation barring packers from owning livestock has been repeatedly introduced in Congress.

– The Clinton Administration proposed new standards to regulate factory farms which included a provision that would have held corporate livestock owners liable for damage caused by animal waste on contract farms.18

– An EPA rule proposed in 2001would have held animal owners – not just contract producers – responsible for animal waste under a new permitting system. Though this provision was dropped from the final rule under the Bush Administration, NRDC, Sierra Club, Waterkeeper Alliance and the American Littoral Society are engaged in lawsuits challenging the EPA’s decision.19

Integrator Liability• At the state level:

– A three judge panel recently ruled that an Iowa law banning packers from owning the animals they slaughter may be legal and sent the case back to trial in a district court.20

– In South Dakota, a bill signed in 1998 imposes legal responsibility and tort liability for environmental damages caused by the negligent entrustment of livestock to another or negligent control or specification of design, construction or operation of livestock facilities.21

– Former Kentucky Governor Paul Patton issued regulations on feeding lots which included language on integrator liability.22

– The Maryland Department of the Environment attempted to hold chicken processors responsible for helping growers dispose of litter.23

Integrator Liability

• Several states have also negotiated consent decrees with hog companies.

– A 1999 Consent Decree between Premium Standard Farms and the State of Missouri calls for the company to develop “Next Generation” waste disposal technology and to invest $25 million in the process.24

– In July of 2000 Smithfield entered into a Consent Decree with the Attorney General of North Carolina. The agreement committed SFD to a total of $65 million in environmental initiative funding over a 25 year period, with $15 million going to fund research and development of alternative waste disposal methods.25

Integrator Liability

• Some experts estimate that the establishment of integrator liability could have an enormous impact on the meat and poultry industry.

– Potential regulations governing CAFOs under the Clean Water Act could cost producers nearly $1 billion a year according to the EPA.26

– In March of 2000, Kentucky Agriculture Commissioner Billy Ray Smith warned that the liability issue could doom the livestock industry in Kentucky.27

– “Forcing companies such as Perdue Farms or Tyson Foods to ensure compliance [with co-permitting regulations] would cut thin profit margins, industry leaders say.”28

Sustainability Reporting

• There is increasing recognition of the need to supplement financial reporting with social and environmental reporting.

– “[N]onfinancial reporting . . . is quickly taking its place alongside financial reporting as indispensable to assessing company value and future prospects.” (International Herald Tribune, A task for Davos: The Measure of a Good Company)

– “Environmental risks and liabilities are among the conditions that, if undisclosed, could impair the public’s ability to make sound investment decisions.” (United States Government Accountability Office, Report to Congressional Requesters, Environmental Disclosure: SEC Should Explore Ways to Improve Tracking and Transparency of Information)

Sustainability Reporting

• The benefits of non-financial reporting are numerous.

– Non-financial reporting gives investors a better understanding of a company’s business model and the risks and opportunities associated with its operations.

– Non-financial reporting also enables companies to:

• Increase the bottom line through identification of areas of waste

• Better identify trouble spots – and unanticipated opportunities – in supply chains, and with customers or regulators

• Reduce share price volatility and uncertainty caused by untimely or incomplete disclosure

• Ensure that brand and reputation are not eroded by the activities of others along the supply chain

• Gain valuable information on changing stakeholder interests and demands for legislation

Sustainability Reporting• Non-financial reporting is also called for by an SEC

interpretation on MD&A dated December 29, 2003. According to this document:

– Companies should identify and discuss key performance indicators, including non-financial performance indicators, that their management uses to manage the business and that would be material to investors.

– Companies must identify and disclose known trends, events, demands, commitments and uncertainties that are reasonably likely to have a material effect on financial condition or operating performance.

Smithfield Foods, Inc.

• Smithfield’s investors are concerned about the potential environmental liabilities associated with Smithfield’s integrated business model.

– Smithfield is doing good things in some areas, including the implementation of EMS programs on all company-owned farms.

– However, the company has refused to monitor and gather information on its contract farms.

– As long term shareholders, we are concerned by the increasing judicial and regulatory pressures facing the company.

Smithfield Foods, Inc.• As long term shareholders, we want to ensure that our

company is in a position to benefit from, not be blind-sided by, the changing judicial and regulatory environment.

– The company describes its business model as completely integrated, with the notable exception of contract farm liability.

– A number of recent court cases have focused on co-permitting and integrator liability.

– Several states are examining the environmental impacts of hog farms and a few have entered into consent decrees with hog companies.

Given these regulatory and judicial developments, we feel it is imperative that the company begin to assess and report on the environmental impacts of its hog production operations.

References

1 Smithfield Foods. 2004. Form 10-K.

2 United States Department of Agriculture. Hogs: Background. Economic Research Service. http://www.ers.usda.gov/Briefing/Hogs/background.htm Accessed on July 12, 2004.)

3 Eggemeier, Pam. 2004. Feed Prices Squeezing Struggling Hog Farmers. The Journal-Standard, March 7.

4 Ribaudo, Marc. Managing Manure: New Clean Water Act Regulations Create Imperative for Livestock Producers. Amber Waves: U.S. Department of Agriculture Economic Research Service. http://www.ers.usda.gov/AmberWaves/scripts/print.asp?page=Feb03/Features/ManagingManure.htm Accessed on July 12, 2007.

5 Gillam, Carey. 2003. Complaints of Contract Farm Abuses Increasing. Reuters, September 29.

6 Smithfield Foods. 2004. Form 10-K.

7 Smithfield Foods. 2004. Form 10-K.

8 Smithfield Foods. 2003. Form 10-K.

9 Smithfield Foods. 2004. Form 10-K.

10 Smithfield Foods. 2003. 2003 Stewardship Report.

11 Sector Star. Meat & Poultry Processing. Sector Overview. http://www.sectorstar.org/sector/MeatProcessing/overview.cfm Accessed on July 20, 2004.

12 Edmondson, W.A. Drew. 2001. Office of the Attorney General State of Oklahoma. Opinion No. 01-17. 2001 WL 505604 (Okl.A.G.).

13 Gillam, Carey. 2003. Complaints of Contract Farm Abuses Increasing. Reuters, September 29.

14 Kelley, Christopher. 2001. Notes on an Agricultural Production Contract, with a Model Contract Attached. Arkansas Law Notes 11. 2001 Ark.L.Notes 11.

References

15 Leonard, Christopher. 2004. Lawsuit Turns Focus on Tyson Contract Deals. Arkansas Democrat-Gazette, May 9.

16 Leonard, Christopher. 2004. Suits Over Regulating Livestock Ammonia up to Federal Judges. Arkansas Democrat-Gazette, May 5.

17 Leonard, Christopher. 2004. Lawsuit Turns Focus on Tyson Contract Deals. Arkansas Democrat-Gazette, May 9.

18 OMB Watch. 2003. OMB Waters Down Standards on Factory-Farm Runoff, May 28, http://www.ombwatch.orh/article/articleprint/1540/-1/132/ Accessed on July 14, 2004.

19 Breen, Tim. 2001. Ag Waste: Efficacy, Expense of Evolving Regs Questioned. Greenwire, Wastes & Hazardous Substances Vol. 10, No. 9.

20 Vansickle, Joe. 2004. Packer Feeding Law Upheld. National Hog Farmer, June 15.

21 Halverson, Marlene. 2000. The Price We Pay for Corporate Hogs. Institute for Agriculture and Trade Policy.

22 Mead, Andy. 2000. Legislators Hear from both Sides on Factory Farms, At Issue: How Much to Regulate Them. The Lexington Herald-Leader, March 11, Pg. C1.

23 The Baltimore Sun. 2003. Chicken Farmers Support Decision; Md. Drops Effort to Force Big Poultry Firms to Share Costs of Waste Disposal. June 16, Easton, Pg. 1B.)

24 Meat News. 2004. Environmentally Friendly Pork. February 17, http://www.meatnews.com.

25 Smithfield Foods. 2003. Form 10-K.

26 Breen, Tim. 2001. Ag Waste: Efficacy, Expense of Evolving Regs Questioned. Greenwire, Wastes & Hazardous Substances Vol. 10, No. 9.

27 Mead, Andy. 2000. Legislators Hear from both Sides on Factory Farms, At Issue: How Much to Regulate Them. The Lexington Herald-Leader, March 11, Pg. C1.

References

28 The Baltimore Sun. 2003. Chicken Farmers Support Decision; Md. Drops Effort to Force Big Poultry Firms to Share Costs of Waste Disposal. June 16, Easton, Pg. 1B.