Tyson Foods Inc - Class A (TSN) — Q2 2022 Earnings Call Transcript

Hello and welcome to the Second Quarter Fiscal 2022 Earnings Conference Call for Tyson Foods. Prepared remarks today will be provided by Donnie King, President and Chief Executive Officer; and Stewart Glendinning, EVP and Chief Financial Officer. Additionally, David Bray, Group President, Poultry; Noelle O'Mara, Group President, Prepared Foods; Shane Miller, Group President, Fresh Meats; and Chris Langholz, Group President, International, will join the live Q&A session. We have prepared presentation slides to supplement our comments, which are available on the Investor Relations section of the Tyson website and through the link to our webcast. During this call, we'll make forward-looking statements regarding our expectations for the future. These statements are subject to risks, uncertainties and assumptions, which may cause actual results to differ materially from our current projections. Please refer to our forward-looking statement disclaimers on Slide 2 as well as our SEC filings for additional information concerning risk factors that could cause our actual results to differ materially from our projections. Please note that references to our earnings per share, operating income and operating margin in our remarks are on an adjusted basis unless otherwise noted. For a reconciliation of these non-GAAP measures to their corresponding GAAP measures, please refer to our earnings press release. I'll now turn the call over to Donnie.

Thank you, Megan, and thank you to everyone for joining us for the call. Earlier today, we reported strong second quarter and first half fiscal year '22 results. Our results would not have been possible without the work of our team members. I'm grateful for their dedication and diligent efforts this quarter as we continue to manage a complex and dynamic operating environment. We delivered double-digit sales and earnings growth driven by strong market fundamentals, acceleration of our productivity actions and improving operational execution across our segments. Our diverse protein portfolio, omnichannel capabilities, leading brands and value-added products all contributed to our results. Strong performance in our Beef segment, continued recovery in Prepared Foods and an improvement in Chicken supported improved sales and earnings. Our retail core business lines, which include our iconic brands, Tyson, Jimmy Dean, Hillshire Farm and Ball Park, have driven strong share performance in the retail channel since the onset of the pandemic. This quarter, we delivered share gains in bacon, hot dogs and snacking. We also continue to see recovery in the foodservice channel with our relative strength in QSRs and K-12, supporting continued share gains in branded value-added chicken. Overall, consumer demand for protein has remained strong, and we are taking deliberate actions by segment to improve our volumes to better meet customer needs, including investing in new capacity, brands, product innovation and our team member experience. We are seeing our investments in team members making an impact. Despite continued labor challenges during the Omicron surge this quarter, we're seeing lower turnover and absenteeism. We have invested in higher wages, benefits and other workplace enhancements, such as flexible schedules, childcare and transportation. The construction of new plants continues to progress. This additional capacity will enable our team to address capacity constraints and better serve growing demand for protein across all segments. Along with ramping up utilization of our newest plant in Humboldt, Eagle Mountain and Thailand, we have 4 plants expected to commence operation in the fourth quarter of fiscal year '22. In addition to the new sites, we're continually upgrading capacity as needed with approximately 10 projects planned in the third quarter, representing 25 million pounds of volume in Prepared Foods alone. In addition, we are working closely with our customers to ensure that the fair value of our products incorporates the inflationary cost pressures impacting our business. For the first half, our cost of goods sold rose 15% relative to the same period last year. Every part of our business has been impacted by inflation. We experienced higher costs across our supply chain for all inputs from feed ingredients, live animals and other raw materials to cooking oils and basic supplies. We're also managing higher costs of labor and transportation due to robust demand, higher fuel costs and limited availability. As part of our effort to combat inflation and increase profitability, I'm pleased by our accomplishments to drive costs lower by accelerating our productivity actions. Also, our balance sheet and liquidity position remain healthy, providing optionality to invest in growth across our portfolio and return cash to shareholders. We have a disciplined approach to deploying capital with a focus on total shareholder return. Our first half results clearly demonstrate that we are making progress on our growth objectives and that we remain focused on outpacing the overall market, improving operating margins and driving stronger returns for our shareholders. Now turning to the financial results. Let me give you some highlights. Sales improved 16% in the second quarter and 20% during the first half. Our sales gains were largely driven by higher average sales price and mix improvement. Average sales price trends reflect disciplined revenue management strategies in the context of a volatile, high-inflation environment. Like many other companies, we've seen varying levels of heightened inflation, notably in grains, labor, live animals, raw material and transportation costs. As I mentioned earlier, our teams have worked together with our customers to manage inflationary pressures. We delivered solid operating income performance, up 57% during the second quarter and 47% for the first half. The performance in the first half was due to strength in Beef, Chicken and Prepared Foods. Overall, our operating income performance translated to $2.29 in earnings per share for the second quarter, up 71% and $5.16 in earnings per share for the first half of 57%. Looking at our results on volume. We remain confident that our actions will improve our performance, but we are not where we expect to be by now as we faced the Omicron surge in the quarter and other labor and supply chain challenges. Due to these factors, our total volume was down slightly for the first half versus last year. Chicken remained a bright spot, where volume was up 2.1% through the first half compared to the same period last year. This improvement was driven by solid fundamental demand as well as operational improvements. There is much more work to be done as we focus on filling our existing capacity. We are pulling multiple levers to drive sequential improvement in our performance, and as a result, I'm confident that we will see continued volume performance in the second half. In Prepared Foods, volumes were down 4% in the first half compared to the same period last year. Approximately 1/3 of this decline was related to the pet treats divestiture with the remainder of the result of a challenging supply environment and uneven recovery of the foodservice channel. We are working to improve these results over the remainder of FY '22 as we continue to take actions to expand and improve capacity utilization. In Beef, volumes were down 2.9% in the first half compared to the same period last year. However, beef volumes increased quarter-over-quarter due to higher harvest weights. We expect continued volume improvements for the remainder of our fiscal year '22 as new team member recruitment strategies support an improved labor position and higher throughput. In Pork, impacts associated with a challenging labor environment contributed to a 2.3% decline in volume in the first half compared to the same period last year. We expect tightness in live hog inventories to affect our second half volume. In International/Other, our investments in capacity, innovation and brands are supporting our market share growth objectives and volume improvement. Overall, we will continue to take actions across our business to optimize our existing footprint, add new capacity, adjust our product mix and align our portfolio with customer and consumer needs. Although we have reduced our expectations for the full year, we still expect to grow our total company volumes in fiscal year '22. We continue to take meaningful action toward becoming the most sought-after place to work, and we're making significant investments to attract and retain team members. Our U.S.-based workforce is comprised of team members from more than 160 countries. In April, we announced that we are investing over $1 million in several non-profit groups to expand legal and citizenship support for the team members aspiring to become U.S. citizens. This will allow us to scale a program from 7 Tyson facilities to serve 40 company locations in 14 states. We recently announced an expansion of the Upward Academy program as our latest investment in our team members. Starting the summer, U.S. team members will have access to free education, including master's, undergraduate and associate degrees, career certificates as well as classes in literacy and technology fundamentals. Tyson will pay 100% of the cost of tuition, books and fees with an estimated investment of $60 million over the next 4 years. Ensuring the health and safety of our global team is a top priority. We continue to challenge ourselves to be an organization that stays ahead of unforeseen events and adjusting our protocols to keep our team members healthy and safe. We have educated and encouraged team members to get vaccine boosters and have offered over 100 clinics across our office and plant locations. We are also investing to support team member well-being more proactively in our rural communities. We now have 7 on or near-site Tyson health centers opened and operating. These clinics provide comprehensive health care services, including preventive screenings, chronic condition coaching, mental health counseling, lab services and sick visits at little to no cost to most of our team members or their spouses and dependents. Overall, we're confident that our actions will increase Tyson staff levels and position us for future growth, and we will continue to explore innovative benefit offerings that make our team members' lives better. We're making excellent progress on our productivity program, which will deliver more than $1 billion in recurring productivity savings by the end of fiscal year '24. Based on current progress, we now expect to deliver more than $400 million of savings in fiscal year '22, which is on the high end of our previously disclosed range for the year. Last quarter, I highlighted our work in Prepared Foods to build a digital manufacturing platform that utilizes data to simplify complexity and optimize processing. I also shared our work to enhance the mix and allocation of our trucking fleet resources to enable better on-time deliveries to customers. This quarter, deployment of our Tyson production system approach has improved our yield across all segments versus a year ago. Additionally, our procurement program is addressing total company spend, including direct material as well as plant and corporate indirect areas. This program continues to deliver savings in line with expectations. Our digital solutions journey has also progressed. In our supply chain, we are leveraging new processes and digital tools to quickly identify gaps in fulfillment. Meeting the demands of our customers on time and in full is of the utmost priority, and we are continuing to maximize our service levels. The early results of our finance automation and digitization work also remain promising. For example, this program is providing more accurate billing and improved collections for Tyson while lowering our intensive labor. We are also investing aggressively in automation and technology to help address some of our most difficult roles in repetitive tasks. This is a well-planned program of automation to use common designs and equipment across our plants to optimize costs, maintenance and asset utilization. The debone automation program is continuing to scale in plants, and our proprietary debone automation solution is also beginning to roll out in select facilities. Looking ahead, we're starting to scale new programs like pack-out robotics to continue automating highly manual processes and deliver savings. Chicken remains a top priority, and we continue to execute against our roadmap to restore top-quartile profitability for this segment. We've been committed to returning our operating margins to a 5% to 7% level by the middle of FY '22. This quarter, we delivered a 5% adjusted operating margin, in line with our previously communicated plan. Critical to improving our profitability is maximizing our fixed cost leverage, being staffed to standard and having enough workers to run our plants full. Since September, we have seen an improvement in our hatch rate that is consistent with the expectations that we shared at our December Investor Day. We are committed to growing our harvest capacity utilization, and we outpaced the industry in the second quarter. Achieving improved chicken harvest and higher capacity utilization will allow us to build on the volume growth delivered by Chicken in the first half. In parallel to actions to improve volume, we have also worked with customers to manage inflationary pressures by adjusting pricing to achieve a fair value for our products. This will be important to ensuring we deliver sequential improvement in our operating margins in the second half of fiscal year '22, especially with continued increases in key input costs such as labor and feed ingredients. As I mentioned a moment ago, we are also making good progress on our automation objectives for the segment. This includes the rollout of debone automation and a range of other equipment, which will enhance our productivity and cost-effectiveness. We have come a long way in a short period of time, and I'm pleased with the progress we are making in Chicken. To recap, we have strong consumer demand, a powerful and diverse portfolio across geographies and channels, and a team that is positioned to take advantage of the opportunities in front of us. Five imperatives on this slide show how we will achieve our commitments and drive value creation for our shareholders. This starts first with our commitment to our team members with a focus on ensuring their health, safety and well-being as well as investing in improving our team member experience. Second, we are working to enhance our portfolio and capacity to better address demand. This includes increasing the contribution of branded and value-added sales. As a result, we expect our volume to outpace overall market growth over the next several years. Third, we are aggressively restoring competitiveness in our Chicken segment and continue to achieve key milestones on our roadmap to top-quartile profitability. Fourth, we are driving operational and functional excellence and investing in digital and automation initiatives. This is at the heart of our productivity program, where we are accelerating our efforts and now expect to deliver more than $400 million in savings this year. Fifth, to address projected demand growth over the next decade, we're using our financial strength to invest in our business. We're on track to invest $2 billion in fiscal year '22 with a disproportionate share focused on new capacity and automation objectives. We also continue to return cash to shareholders. Through the first half, we returned approximately $850 million in dividends and share repurchases. As a final comment before turning the call over to Stewart, I want to highlight that Tyson Foods understands we have a critical role to play in the global food system to make it more resilient, more sustainable and more equitable for current and future generations. Just recently, we completed a materiality analysis that will inform our long-range strategy. These insights from key stakeholders shape our strategic framework and provide direction on the expectations of our company. I will now turn the call over to Stewart to walk us through more detail on the financial results for the second quarter.

Thank you, Donnie. Let me turn first to a summary of our total company financial performance. We're pleased to report strong results in the second quarter and first half of this fiscal year. Sales were up in the second quarter and the first half, benefiting from our pricing initiatives to offset inflation as well as improved product and channel mix. Volumes were down slightly through the first half impacted by continued labor challenges and a temporary disruption from the Omicron variant surge. Looking at our sales results by channel. Retail drove $424 million of top-line improvement in the second quarter relative to the same quarter last year. Through the first half, retail sales have improved by $773 million. In the second quarter, improvements in sales through the foodservice channel drove an increase of $684 million, and domestic export sales to international markets were $311 million stronger than the prior year period as we leveraged our global scale to grow our business. Second quarter adjusted operating income of $1.2 billion was up 57% relative to the same quarter last year, led by increases in Chicken, Beef and Prepared Foods. First half adjusted operating income of $2.6 billion was up 47%, supported by increases in Beef and Chicken. Driven by the strong increase in operating income, second quarter adjusted EPS of $2.29 grew 71% compared to the same period last year. Second quarter earnings per share also benefited from lower net interest expense and higher other income. Slide 11 bridges year-to-date operating income for the second quarter, which was $422 million higher than fiscal 2021. Volumes were down 1.5% in the second quarter. Volume improvement in Chicken, International/Other and Beef was offset by declines in Pork and Prepared Foods, where continued labor and supply chain challenges impacted throughput. Our pricing mix and portfolio efforts led to higher sales during the quarter, which offset the higher input costs. We saw continued inflation across the business, in some instances, up 25% or more. Notable examples were labor feed ingredients, live cattle, lean hogs and freight costs. SG&A was $46 million unfavorable to the same period last year due to increased team member-related costs and investments in advertising and promotional spend in support of our brands. As a final note, both cost of goods sold and SG&A expenses in the quarter were partially offset by productivity savings.

Moving to the Beef segment. Segment sales were approximately $5 billion for the second quarter, up 24% versus the same period last year. Sales growth in the quarter was driven by continued robust demand for Beef products, which supported higher average sales prices and volume. The cutout and our average sales price remained relatively strong during the quarter despite some consumer demand shifting toward lower-cost beef cuts. Quarterly volume improved compared to the prior year despite the Omicron surge experienced by the business. We expect volume to continue to improve in the second half of this fiscal year as new team member recruitment strategies support improved staffing and higher throughput levels. On expenses, we incurred greater costs during the second quarter versus the comparable period a year ago as live capital costs increased approximately $545 million in the quarter. We had sufficient livestock available in the quarter driven by higher herd liquidation due to drought conditions. As of February, 54% of capital inventory were in areas experiencing drought conditions, which may lead to additional herd liquidation through the remainder of the fiscal year. We delivered segment operating income of $638 million in the quarter, up 43% versus the comparable period. This improvement was driven by solid global demand for Beef products, supporting a higher cutout as well as higher specialty product values, which were partially offset by higher operating costs. Our operating margin of 12.7% was higher than the same quarter last year but was down on a sequential basis versus the last 2 quarters as cost increases led to a narrowing of the spread. Looking next at the Pork segment. Sales were approximately $1.6 billion for the quarter, up 6% versus the same period last year. Average sales price increased 10.8%, but volumes were 4.8% lower relative to the same period last year. Average sales price was up due to higher input costs, while volumes were lower due to labor challenges from the Omicron surge, which led to lower processing throughput. Segment operating income was $59 million for the quarter, down 12% versus the comparable period. Overall, operating margins for the segment declined to 3.8%. The operating income deterioration was driven by softer exports, higher input costs and labor challenges. Moving now to Prepared Foods. Sales were approximately $2.4 billion for the quarter, up 11% relative to the same period last year. Total volume was down in the quarter given labor and supply chain challenges and uneven foodservice recovery and the sale of our pet treats business. Sales growth outpaced volume growth driven by higher average sales price. Consumer demand has remained durable even as we worked to manage inflation through price increases. Overall, consumer response to higher price levels is below historical expectations as our brand strength and category relevance has enabled continuing strong demand. Raw material costs, logistics, ingredients, packaging and labor all increased our cost of production. To offset higher costs, we have executed productivity, revenue management and commercial spend optimization initiatives while ensuring the continued development of brand equity through increased marketing and trade support. Operating margins for the segment were 11% or $263 million for the quarter, up 21% versus the same quarter last year. Moving on to the Chicken segment's results. Sales were $4.1 billion for the quarter, up 15%. Volumes improved in the quarter due to strong consumer demand and operational improvements. Our teams have been focused on streamlining our plants to deliver higher volumes. We expect to deliver further volume improvements in the second half of fiscal 2022 as harvest numbers improve and continue to optimize the operational efficiency of our plants. Average sales price improved 14.4% in the quarter compared to the same period last year. This increase was primarily due to price recovery offsetting inflationary costs. On pricing, we made meaningful progress to shift our pricing mechanisms toward more variable structures and are now seeing those benefits. We restructured our pricing strategies given our experience in fiscal 2021 to be more agile in response to market and inflationary conditions. Chicken delivered adjusted operating income of $203 million in the second quarter of fiscal '22, representing an operating margin of 5%. Operating income increased in the second quarter due to increased sales volume and higher average sales prices, partially offset by the impacts of inflationary market conditions, including increased supply chain costs and a challenging labor environment. In the second quarter of fiscal '22, we experienced $100 million of higher feed ingredient costs and $101 million of net derivative gain as compared to $10 million of net derivative gains in the second quarter of fiscal 2021. During the fiscal month of April, the beginning of our third quarter, we have achieved an approximate 5% operating margin, excluding mark-to-market derivative impacts. Restoring competitiveness in our Chicken business remains a top priority, and we are making progress on achieving our long-term targets for adjusted operating margin, but we still have work to do. Turning to Slide 16. Our healthy cash flows have continued to support a broad capital allocation approach. We are focused on building financial strength, investing in our team members, investing in our business and returning cash to shareholders. Consistent with our expectations, our operating cash flows were down slightly in the first half of the year due to planned investment in working capital. Consistent with our priority to build financial strength and flexibility, we used our existing liquidity to retire $1 billion of debt in the second quarter. Since the start of the pandemic, which this quarter now marks 2 years ago, we have reduced gross debt by approximately $3.8 billion. We maintained our leverage ratio at 1.1x net debt to adjusted EBITDA, demonstrating our powerful balance sheet and our continued capital allocation optionality. Investing in our business for both organic and inorganic growth will continue to be an important priority and will help Tyson increase production capacity and market capabilities. This will support strong return on capital generation for our shareholders. Finally, as our track record has demonstrated, we are committed to returning cash to shareholders through both dividends and share buybacks. We bought back $175 million of shares at an average price of $88.50 per share during the second quarter. This is in addition to the $348 million of shares repurchased during the first quarter. Let's now discuss the fiscal '22 financial outlook. Based on the strong first half results, we're raising our total company sales guidance to a range of $52 billion to $54 billion. In support of our sales growth, we now expect 1% to 2% volume growth on a year-over-year basis as we work to optimize our existing footprint and run our plants full. Looking at AOI margin target ranges for our segments. In Chicken, our operational turnaround is working, and we expect full year margins to be between 5% and 7%. Based on our first half performance, we now expect the full year margin in Prepared Foods to be in the range of 8% to 10%. In Beef, we are raising our AOI margin to 11% to 13%. We still expect the first half of the year to be meaningfully stronger than the back half as industry and labor conditions are expected to normalize in the second half. We expect that cattle price increases will reduce the overall margin in the back half. In Pork, we expect similar performance during fiscal '22 to what we accomplished during fiscal 2021, equating to a margin of between 5% and 7%. As is normal seasonality for Pork, we expect the first quarter to be the strongest. In International/Other, we anticipate reduced results from our foreign operations in fiscal '22 due to supply chain disruptions and other impacts related to COVID-19. Our expectations for CapEx, net interest expense and tax rate remain unchanged. Our net leverage is expected to remain well below 2x net debt to adjusted EBITDA, providing optionality, inorganic investment and additional return of cash to shareholders over the course of the year.

I'll now turn the call back over to Megan for Q&A instructions.

Donnie, I wondered you mentioned your expectation for sequential improvements in operating margins in the back half of the year. I just wanted to clarify, does this mean that you expect your operating margin in 3Q to be above 2Q, so above 8.9%, and then for 4Q to be above that once again? Or are you simply saying that the second half will be above the first half with, I guess, no comment on the cadence of 3Q versus 4Q? I know it's hard to measure these things. I just wanted to be sure what you were suggesting there.

Yes. Let me pick that up for Donnie. This is Stewart. I think you can take it as the first half is going to be not as strong as the second half. We haven't got obviously into giving you quarter-by-quarter. But we expect our business to strengthen over the back half. You'll recall from the prepared remarks that we expect our Beef to start to weaken in the second half. So some of that quarter-by-quarter timing will depend a little bit on the timing update.

Okay. That's helpful. And then how are you thinking about the timing of the cattle cycle right now? What I mean by that is you mentioned that you expected the herd liquidation to continue the rest of the year. Again, no one has a crystal ball on these things. But do you have even a rough estimate for when you might expect the liquidation cycle to end next year?

Thanks, Ken. This is Donnie. We expected to see lower supply than what we're currently experiencing. An interesting data point is that cattle and feed recorded over 12 million, which is a record high since March 1. There is still some volatility in that figure. Drought conditions and grain costs are definitely affecting supply. However, we believe that in the second half of the year, the spread in our Beef business will tighten. I also want to emphasize that we think it will be at a much higher level, estimating it to be between 6% to 8% in a normalized range these days. It's performing fairly well at the moment, and while it's not going to be a record second half, we believe it will be a very good one.

So I just wanted to dig a little bit more into Chicken and thinking through the margin expectations in the back half of the year specifically and then what that implies as you move into fiscal '23. I think in the prepared comments, you talked about April being at 5% kind of even after any mark-to-market impact on grain. How do we think about the different levers to further margin improvement in Chicken through the back half of the year, whether it's volume in terms of the hatch and your throughput in the slaughter plants, mix, pricing actions versus some of the incremental inflation as we look at grain and some of your other purchasing puts?

Thanks, Adam. Let me say a few words, and I'll flip it to David Bray to add a few details. It was a year ago this quarter that I talked about the turnaround in Chicken, and in fact, talked about being at a 5% to 7% business. I will tell you, in this quarter, January, from an Omicron resurgence was painful across all of our businesses. But we've improved sequentially throughout the quarter. The back half of the year, in Chicken specifically, the thing that we need is greater volume, greater efficiency from the assets that we currently have. And we've announced a further processing plant that will come online next year that will add some incremental capacity. But our productivity program is working. We are becoming more efficient, and our volume is growing. And I would expect you to see that to continue to grow and develop over the balance of the year. I would tell you, in short, we're on point. And let me put it to David, and he can add.

Adam, thank you for the question. I think, first and foremost, what I do want you to hear is that we have made progress within the Chicken segment. But we also know that we have much, much more work to do, and we're focused against that. I would also tell you that we said that we would deliver sequential improvement throughout the fiscal year, and we have. We also shared that we would see improved volumes sequentially. And quarter-over-quarter, we have seen improved volume. And we also said that we would outpace the market for growth. And within the Q2 timeframe, we did that as well. In Q2, our harvest head was up 2.9%, and our harvest volume was up 4.9%, which actually allowed pricing to gain share in the Q2 timeframe of about 0.75 points. We've also improved our adjusted operating income and our AOI margins sequentially quarter-over-quarter, and this was the case whether we include or exclude any impacts of derivatives against our business. And so again, I would tell you, we're making progress. We have more work to do. We are focused, and our goal has not changed: to be the best chicken company as we focus on the levers of our business. We're continuing to work hard to staff our plants. And today, I would tell you the poultry segment is staffed to standard. We're continuing to work on servicing our customers, growing our business and to drive overall operational improvements.

If I could add one more thing, on Friday, we closed on April, and it was a 5-day close, which is a new record, thanks to Stewart, Philip Thomas, and the team. In Chicken specifically, April was a good month. Stewart mentioned around 5% in his prepared remarks, but I can tell you from the close that it's better than 5%. So I'll leave it at that.

All right. That's really helpful. And if I can maybe just follow up in Chicken. I'm just trying to think about the internal kind of actions you're taking and what you have under your control is very clear. And I'm trying to make sure we can calibrate how the external environment has evolved in terms of record breast meat prices. Maybe some declines in wings, kind of risk around avian influenza and what that could potentially do to exports relative to the grain markets and just trying to think about how changes in that external environment would or would not impact how you think about chicken moving forward.

Thanks, Adam. Over a year ago, we established our four main focus areas: staffing our plant, servicing our customers, growing our business, and restoring industry-leading operating performance. This remains our plan. Currently, there are various variables affecting the poultry industry. However, I can confirm that demand is robust. For instance, the price of boneless chicken breast meat was around $3.60 last Friday, which indicates significant strength in the market for chicken. Additionally, grain prices are elevated, which we have noted. In response, Dave and his team are implementing shorter-term contracts to safeguard both Tyson and our customers. I'll now turn it over to David to see if he has anything further to add. David?

Yes, I think just from the grain standpoint, despite what we're seeing from volatility in grain, the turnaround in Chicken is progressing as planned. And again, a large part of that is based off of our variable pricing structures. We're able to move much faster than we have in the past, and that's been a big benefit to us. Relative to avian influenza hub, yes, we are watching that closely, and it is always a risk within this business. But I would tell you that we mitigate that risk through the use of our biosecurity measures and that they are in place across all of our facilities right now. This includes testing every block that we have for AI before it leaves the farm. We are operating under heightened measures in some geographic areas of the country right now, and the heightened measures would basically be we're limiting the amount of people and trips that are taken to our farms as well as making sure that the people that do go to the farms are in clean vehicles, and we will continue to monitor that. To that, I would tell you that any bird loss related to disease impacts our growers, and it impacts our plants as well, but these have been relatively minimal to our business to date.

I want to follow up on Adam's questions about the Chicken business. Your commentary on April indicates strong performance, and your guidance suggests this will continue. Can you provide details on what occurred during the quarter regarding the cost-plus mechanism? We understand the implications of derivative gains, but could you explain when and why you decide to hedge your grain? Additionally, looking ahead for the rest of the year, can you discuss the hedges you have in place and any potential benefits, particularly in relation to how rising grain prices might affect your pricing strategy? I'm trying to grasp the various factors we should be aware of as we track the market moving forward.

Yes, this is Stewart. I'll address the question about hedging. We primarily hedge when we have fixed price obligations, especially for longer-term agreements, to avoid exposure to fixed prices with fluctuating commodity bases. This year, we have seen a shift, which we've discussed in past calls. We've moved towards more variable or commodity-driven pricing, reducing the need for hedging. However, it's important to remember that these pricing mechanisms have various triggers, so they won't be adjusted daily. Thus, we will continue to hedge in the short term to ensure that during the lag period where we are committed to pricing, we have protection from fluctuations in grains and other commodities. Is that clear?

Very helpful, thank you. Pivoting to the Prepared Foods business, the margin results this quarter are very solid. I recognize that you and your peers are facing cost price dynamics. The latter half of the year suggests there may be some margin pressure, followed by possible expansion. Could you discuss your thoughts on price elasticities in this business, your ability to manage operations effectively, and how as you navigate through some of the volume losses from the pet treat sector, you plan to improve fixed cost absorption and maintain your margin balance as we progress through this year and into next year?

Thank you, Ben. I will touch on a few key points before handing it over to Noelle for more details. As noted in our statement, the first half of the year showed a decline due to lower production throughput. January was particularly challenging due to the Omicron resurgence and labor issues. Additionally, we sold some pet treats during this time. We anticipate an improvement in volume. Retail demand remains strong, although our foodservice business has seen uneven recovery, with specific areas underperforming. For instance, our pizza topping, Philly, and tortilla businesses did not meet expectations. Now, I will turn it over to Noelle, who will discuss the elasticities further.

Thanks, Donnie. So as Donnie referenced, demand really does continue to be strong driven by our strong brand equities and our diverse portfolio. And we do see that demand continues to exceed supply in a majority of our categories. We've made significant improvements in our labor vacancy rates. We expect to be back to prepandemic levels. In the second half, we also have investments coming online that we referenced in the prepared remarks on capacity. As Donnie referenced in foodservice, we are seeing a bit of uneven recovery. Overall, I would say it's showing momentum. Where we did see impacts is in January and February, where the Omicron variant surge had a brief negative impact as consumer mobility waned and foodservice traffic declined. This, along with some of the other dynamics from a labor perspective in the industry, slow recovery at the beginning of the year. But as we look at March traffic, the data shows that we are returning to pre-Omicron recovery levels as COVID cases drop back to a bit more normative levels. But broadly speaking, QSRs and stores continue to lead the recovery relative to other channels. We're also seeing great momentum in K-12 and continue to be optimistic in the overall recovery. And as referenced, we continue to make significant impacts on cost transformation. And so you'll continue to see a focus on that holistically for us across the business as we continue to improve labor, as we continue to expand our capacity, as we continue to invest in our portfolio and our leading brands and expect to deliver 8% to 10% ROS for the year.

Maybe we could start with Beef. You guys have obviously seen your business, I think, disaggregate a bit from some of the third-party sources. And I do think a lot of that probably comes from your export business and maybe some of the byproduct business. But can you talk about maybe those two specifically in the quarter and how we should think about them going forward as we monitor external data versus kind of what your reporting stronger results that you're reporting in Beef?

Peter, I'll make a couple of comments, and I'll pick it to Shane to make a couple. In our Q2, sales volume did increase. We had improved staffing and higher harvest weight. We talked a lot about the fact that we're buying a higher grade of animal, the process. Grades have improved significantly through the last couple of decades, and that continues to be the case for us. But as you pointed out, we're seeing a lot of help from our specialty products group, particularly in the fat and tallow area, our relationships with Jacobs Stearns that we've had there, we're able to take a lot of that product. And with the price of diesel and fuels, we're able to now to get some really bring value out of those products, and that's providing some tailwinds for us in our Beef business. But I'll flip it to Shane, and he can add a little bit more color to that.

Yes. Thanks, Donnie, and thanks, Peter, for the question. Donnie hit on a couple of the categories. Obviously, specialty products, which is everything that's coming off of the drop or the harvest side of our operations, has improved. We continue to see better value coming from the fasten oil category. But also if you think about areas like proteins, you think about herbs, think about some of the variety meats that are typically sold into the export arena, we're seeing very strong demand globally from the product mix that we're supplying to the marketplace. This is still a cyclical business. We believe over that continuum that beef demand will continue to be very strong from a global perspective. And on top of that, if you think about the value that we're bringing to the marketplace and also to ultimately to the consumer, the meat quality and the cattle genetics that are being supplied to us today have never been better. So I think as we look forward here, strong quality, great product mix and diversification of customers and programs will lend to stronger support.

That's helpful. And then, Donnie, I just wanted to reconcile some of your comments in Chicken around your hatch improvement plan being on track. I think for total company, though, you took the volume guide down and just wanted to understand what that implied around back half chicken volumes. I think previously, we had talked about them being up maybe double digits to kind of make the year. So just wanted to reconcile kind of those two aspects.

Sure. There are several developments taking place. Our hatch has improved, and we are performing better than the industry average today, which we couldn't say a year ago. We've seen progress in that area. Additionally, we have reduced our outside meat purchases, significantly affecting our overall volume, particularly in Chicken. You might remember that we experienced a fire in Huntsville, Alabama, which impacted our volume not only for the rendered products we produce but also our ability to source those externally, which had a substantial effect as well. These are some key points related to volume. I can share that we experienced growth in the quarter and the first half of the year. However, we did not grow at the pace we aimed for. We intended to surpass market growth, which we achieved, but it still didn't meet our expectations for overall volume. I'll let David elaborate on this further.

Yes. I think one other comment to that is we have seen several weeks, 5 weeks, of continuous improvement within our live operations. And one big component of what's going to continue to improve for us is we are on track with the delivery of the new male into all of our farms. And so we feel very optimistic about that. It's a male that we know very well. With that, we will continue to see improved hatch rates within our facilities as well as improved weight gain across with the new male coming in.

Donnie, Stewart, congrats on the results. First question, just if you could elaborate a little more about the productivity program and the savings realizations which you had, the roughly $400 million you've mentioned. Can you give us a breakdown on like sector basis, how we should think about where our focus has been mainly put within more recently? And where do you think low-hanging fruits are for the back half to deliver here? That would be my first question.

Thank you. I want to start by reminding you of what we discussed during our Investor Day. We projected that by 2024, we would save over $300 million through operational and functional excellence. Additionally, implementing digital solutions in our supply chain was expected to yield another $250 million, and automation could result in $450 million in savings. Currently, I can confirm we are on track to deliver nearly $400 million in our first year. We continuously find new opportunities to enhance our results. It's important to note that we are facing unprecedented inflation, which we haven't experienced in generations. Therefore, our efforts are not solely focused on adjusting prices due to inflation; we are also striving to improve productivity, efficiency, and reduce costs. In our poultry business, we aim to be in the top quartile or better, and we believe there's still room for improvement. We are making progress with initiatives such as optimizing our trucking fleet, our procurement program to manage total company expenses, and enhancements in gas and fulfillment. Our deboning automation projects in poultry are on track, and in fact, are progressing ahead of schedule. We're optimistic about our direction, ensuring we have competitive pricing and striving to be among the best in all areas we operate.

Okay. Perfect. And then my follow-up is actually just a quick one for Noelle. On one of her comments she made around the adjusted operating margin in Prepared Foods to get this to the 10% level. So obviously, if we look into, first half was very strong, roughly 9.5%. So that's already the higher end of the range. So how should we think about that 8% to 10%? Is it really achievable at a higher level? Because I think you said something like you want to be at 10%. So you want to be at 10%, but there might be some uncertainty which could bring it down for whatever reason, which we don't know today, but we should more plan on 10% than maybe 8%. Is that fair?

So what I'd start by saying is, to your point, and you've heard this in the prepared remarks and Stewart emphasized as well that we had a better-than-expected first half really driven by the actions that we took on price to offset inflationary impacts, the improvements that we saw in labor, the cost transformation starting to come through as well as mix. As I referenced a few minutes ago, the demand expectations that we see continues to outpace supply. And with labor momentum and the capacity investments, we do expect volume improvements as we continue through the second half. We also anticipate continued foodservice recovery. As we look towards the back half on the inflationary side, we do continue to expect inflationary pressures through the back half, which is why it's sort of top of mind on the cost transformation efforts that Donnie just referenced. And so holistically, we're confident about the 8% to 10% ROS range.

Can I ask about the labor cost issue? First, do you have any numbers on labor costs as a percentage of COGS, particularly in Chicken, along with your vacancy rates and their trends over time? More broadly, you've been enhancing pay and benefits for the past two years since the summer of 2020. The pandemic seems to be easing, yet the labor challenges continue. You mentioned the diversity of your team members. Is there a more fundamental problem related to stricter integration policies that has affected your recruitment pool for these roles? Additionally, regarding the labor aspect from a cultural and morale viewpoint, your automation plans indicate a reduction of 3,000 jobs over the next three years leading up to fiscal '24. How do you attract and retain employees during this automation phase? I'm trying to understand if this labor issue is likely to remain problematic despite your efforts to enhance working conditions.

Thank you for your question. I’d like to address a few points. We fully understand the importance of creating an attractive workplace, and we aim to be the most desired place to work. It's clear that our team members have the option to work anywhere they choose, so we need to provide compelling reasons for them to stay with us. I mentioned in the last call that my goal isn’t to address the overall labor challenges in the United States, but rather to resolve the specific labor issues we face at Tyson Foods, and we are making progress. There isn't a one-size-fits-all solution. For instance, while childcare is valuable to some, others may prioritize transportation or healthcare. To address these needs, we have established on-site or nearby health clinics that our team members and their families can access at little or no cost. This is one way we can stand out as an employer. We continue to invest in wages and benefits, along with offering over 100 booster clinics. We believe these efforts are resulting in lower absenteeism and turnover rates. We have also announced support for team members seeking legal citizenship assistance through non-profits. Recently, we introduced the Upward Academy program, committing $60 million over the next four years for educational opportunities, including master’s, bachelor’s, and associate’s degrees, life skills training, and English courses, to help distinguish Tyson as an employer. We are dedicated to achieving this goal. Last year, we distributed thank you dollars to all our team members at year-end, which we were pleased to do, as our team is the foundation of this company. Our highest priority is investing in and taking care of them while ensuring their safety.

So when you talk about the Prepared Foods business, it sounds like there's a lot of internal improvement. How does this margin structure that you've created for this year kind of forecast how you're going to be going forward in 2023 and 2024? Does this give you more confidence? Or are you more tempered because of the inflation? I got a sense of both those sides throughout the conference so far. So I'm just trying to figure out. I would have thought it would have been more bullish longer term, but it sounds like you were tempering it a little bit on the inflation. I'll leave it there for now.

Thank you, Ken. I'll begin, and then I'll let Noelle chime in if she has anything to add. It's vital for everyone that we are pricing our product to reflect fair market value. That's one aspect. However, another aspect that we can fully control is enhancing our operations to maintain our best-in-class standard. This includes labor, yields, spending, productivity, and operating our lines efficiently. Additionally, we should remember that we all have 168 hours in a week. The challenge is how we can operate for more hours and improve the utilization of our existing assets. We're examining all these factors. I want to emphasize that productivity shouldn't just be seen as a means to counter inflation; rather, it should be viewed as an integral part of our company culture. It’s something that will continually benefit us and will always be relevant to our operations. Now, I'll pause and let Noelle provide further insights.

Thank you, Donnie, and thanks for the question, Ken. So what we've talked about through Investor Day and as we've come together on these calls, we continue to believe in our confidence that this portfolio is a double-digit ROS business. And the foundations of those building blocks continues to be the same. Demand continues to be strong across retail as well as the expected continued foodservice recovery. As we look holistically, the top line acceleration will come from actions that we're taking to increase capacity both in our existing footprint as well as through expansion in our network, including step-change investments in automation that Donnie referenced. We're also taking significant actions to transform our cost base, and we'll continue navigating the increase of inputs with pricing to offset inflation as necessary. And so you do recognize that there is inflationary dynamics that we're mindful of as well as continuing to keep a very close watch on the elasticities as we go throughout the second half. But as we look holistically in terms of the strength of this business, the demand outlook, coupled with investments across our portfolio, mixed opportunities within the business, which includes organic discriminating investments as well as inorganic portfolio shaping and aggressive cost transformation, we're confident in our path to deliver sustainable double-digit margins. And then for the year, as we referenced, we do expect to be in that 8% to 10% ROS range.

Great, I appreciate that. My second question is about the long-term cattle cycle. There have been several new capacity announcements recently for 2023 and 2024. How do you view this new capacity in relation to cattle supply and demand? Additionally, how does this affect your outlook on margins in the long term, beyond just this year?

Thank you, Ken. I will start off and then turn it over to Shane for additional insights. Regarding incremental capacity, competition motivates us to improve, and we welcome it. However, the cattle supply is affected by the drought and herd liquidation, among other factors, which will impact the cattle supply moving forward. It's essential to recognize that not all cattle are the same; we collaborate with our ranchers and feeders to source premium cattle. While we pay more for premium cattle, we also achieve a better cutout value for it. We previously discussed specialty products like fast oils and hides, which enhance overall cutout value. We've experienced exceptional margins over the last couple of years, but we don't expect to maintain that level. It represented a temporary situation and a shock to the system. Nonetheless, we anticipate operating within a 6% to 8% margin range going forward due to the factors mentioned earlier. With that, Shane, is there anything I missed that you would like to add?

Thank you for the question. Donnie, you covered most of the key points. I want to emphasize that from a genetics perspective, the quality our feeding partners are providing in the marketplace is at its highest level. The drought conditions affecting over 50% of the country are ongoing, leading to significant cow liquidation this year, which will impact future supplies over the next few years due to the current shortage of grass and forage. As Donnie mentioned, we anticipate increased competition for livestock moving forward. Our priority is to staff our operations efficiently, improve our supply chain, strengthen customer relationships, and deliver top performance. The industry is highly competitive, as it has always been. Ultimately, diversifying our programs and customer base is crucial. We are providing solutions through our case-ready business, which includes two new plants added this past year that will contribute to our overall success. We are noticing rising cattle prices, which we expected, and we are navigating that situation. Your observation is accurate: we will face more competition in the future.

Ken, it's Stewart. I want to add one more point. It's important to consider how this shapes the year. Ken Goldman asked about sequential improvement, which I specifically related to Chicken based on Donnie's comments about that category. However, regarding Beef, I want to highlight that we need to pay attention to it in the latter part of the year when evaluating Tyson overall. The first half has performed well, showing a total of 16% improvement, which is a strong result for us. However, we expect to see some decline in the latter half of the year. In the upcoming quarters, we will provide guidance for future years. I want to reiterate that during our Investor Day and recent calls, we've consistently stated that global demand for beef remains robust as long as cattle supplies are adequate. Over the long term, we believe that Beef will perform better than it has historically.

Thanks again for your interest in Tyson Foods. We look forward to speaking to you again soon.