Earnings Call: Q2 2021

Jul 29, 2021

Good morning, and welcome to the second quarter 2021 Pilgrim's Pride Earnings Conference Call and Webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. At the company's request, this call is being recorded. Please note that the slides referenced during today's call are available for download from the company's investor website at ir.pilgrims.com in the Events and Presentations section. After today's presentation, there will be an opportunity to ask questions. I would now like to turn the conference to Julie Kegley of Financial Profiles for Pilgrim's Pride. Thank you, and over to you. Good morning, and thank you for joining us today as we review our operating and financial results for the 2nd quarter ended June 27th, 2021. Yesterday afternoon, we issued a press release providing an overview of our financial performance for the quarter, including a reconciliation of any non-GAAP measures we may discuss. A copy of the release is available on our website at ir.pilgrims.com, along with slides for reference. These items also have been filed as Form 8-Ks and are available online at www.sec.gov. Presenting on today's call are Fabio Sandri, President and Chief Executive Officer, and Matthew Galvanoni, Chief Financial Officer. Before we begin our prepared remarks, I would like to remind everyone of our safe harbor disclaimer. Today's call may contain forward-looking statements that represent our outlook and current expectations as the day of this release. Other additional factors not anticipated by management may cause actual results to differ materially from those projected in these forward-looking statements. Further information concerning those factors has been provided in today's press release, our Form 10-K, and in our regular filings with the SEC. I'd now like to turn the call over to Fabio Sandri. Thank you, Julie. Good morning, everyone, and thank you for joining us today. For the second quarter of 2021, we reported net revenues of $3.6 billion, an adjusted EBITDA of $372 million, or a 10.2% margin compared to 4% a year ago, and an adjusted EPS of $0.63 per share. We are extremely pleased with the results of our core business during the quarter. Although the pandemic continued to affect our business, our second quarter revenues and adjusted EBITDA grew significantly versus the prior year. More importantly, our U.S. and Mexico revenues and adjusted EBITDA surpassed second quarter 2019 results. The results were driven by a resilient business model across all business units, including the U.S., Mexico, and Europe. The unique challenges of COVID-19 presented an opportunity to demonstrate the value and strength of our well-diversified portfolio, including our presence in multiple geographies and our ability to generate more consistent results despite specific market volatility. We remain guided by our principles of an uncompromising commitment to the safety of our team members, our duty to provide high-quality foods globally, and our responsibility to provide continued employment opportunities and benefits for our team members during the pandemic. We have offered employment incentives and bonuses in addition to bonuses to those who receive the vaccine. We hold safety protocols above all standards, and when coupled with high vaccination rates at our facilities, we are creating a work environment with our employee safety front and center. We thank the governors and other state authorities in many of the locations where we operate who have supported the vaccination of our workforce. Labor availability continues a significant challenge for us. The pandemic unemployment benefits still available in some states and Brexit impacts on the labor market in U.K. Although we are gaining ground in the U.S., labor shortages continue to affect our product mix by limiting our ability to produce higher-value products. We believe the labor challenges will further stabilize in the third quarter in U.S., with the U.K. labor market improving towards the end of the year. In the U.S. market, COVID continues to affect where people eat and how they buy their food. Retail remains strong, although down slightly from a very strong Q2 2020. Retail deli gained ground from the first quarter, benefiting from a slight increase in average trips per week. Although not at pre-COVID levels, shoppers are starting to feel more at ease going into stores. Food service in U.S. is seeing a rapid recovery as most restaurant restrictions were eased in Q2 and consumers increased mobility, bolstering Q2 food service demand back above 2019 levels. Fewer than anticipated commercial restaurants closed, driving demand as chicken purchases per operator increased. Food service demand is expected to taper after the initial surge of pent-up demand and summer travel comes to an end. Retail demand is expected to ease, although remaining above 2019 base levels as consumers keep freezers and pantries stocked. The non-commercial channel is expected to remain below 2019 levels until a new school year begins. Pilgrim's have adjusted volume and mix between channels to adapt to changing consumer demand, whether that's food service making a comeback or retail consumer shifting between curbside pickup and in-store shopping. We are well-positioned to adjust product and channel mix given our presence across all bird sizes, from large to small. Commodity large bird deboning continued its moment from the first quarter and generated the largest profit improvement year-over-year. This volume, revenue, and profit growth was driven by support from food service and a strong export market. We continue to strengthen the third quarter in this business, and we continue to see momentum in food service reopenings. Our case-ready business delivered volume and revenue growth versus the prior year, but it's pressured by the increase in grain and labor input costs. We have implemented price increases and operational improvements to address significant portion of these cost headwinds, and continue to partner with key customers to deliver both growth and value for them. The upward trajectory of food service reopening, strong QSR demand, and retail daily improvements drove year-over-year and sequential increases in our small bird volumes, revenues, and profitability. We see continued strength in this business unit with the further improvement in food service reopenings and the strong demand for QSR key customers. Our U.S. prepared food sales volume was up 3.5%. Operational performance improved year-over-year, despite increases in underlying raw material costs, and our branded retail growth has been extremely strong. Driven by investments in our Just Bare and Pilgrim's brand, our consumer packaged foods experienced over 200% growth in the second quarter. In addition, we have added branded distribution in major retailers where we previously didn't have a presence. In the second quarter, according to the USDA data, the U.S. chicken supply increased 2.4% year-over-year, lapping significant production declines in April 2020. Despite the increases, growth appears to be constrained due to poor hatchability. A comparison of USDA statistics for egg sets versus chicks placed illustrates the shortfall in hatching. Commodity pricing across all cuts have remained consistently strong, trending near the top or above historical ranges. Whole bird pricing remains stable, also near the top of historical ranges. Corn prices increased during the quarter, with the market focused on expected low old corn crop ending stocks and smaller than expected new crop planted area. In the latest WASDE report, USDA reported old crop ending stocks at 1.1 billion bushels, the lowest level since the 2012-2013 crop year. In the June planting intentions report, USDA reported new crop planted area at 92.7 million acres. Although an increase of almost 2 million acres from last year, it was below expectations. USDA is projecting new crop ending stocks could increase to 1.4 billion, with a production increase of nearly 1 billion bushels from last year. Given the strong export demand we are seeing for corn, we believe the market will remain very sensitive to weather changes for the balance of the summer, with relatively low old corn crop stocks. Unlike corn, soybean meal prices were under pressure since last quarter, weighted down by higher than expected domestic production. Soybean oil prices have increased sharply since the first quarter, causing higher processing rates, which result in an oversupply of soybean meal in the U.S. The USDA is forecasting old crop ending stocks at 135 million bushels, the lowest level since the 2013-14 crop, and a modest increase of 155 million bushels for new crop. Despite the relatively low soybean carryout, soybean meal prices remain moderated by the increased value of soybean oil, driven by the growing demand for renewable diesel. We expect to see relatively good supplies of domestic soybean meal as a result of renewable diesel initiatives, despite a relatively low soybean carryout. Looking at wheat, we're expecting a large rebound in production in Europe this year, including a more than 50% increase in U.K., our largest sourcing region. Combined with large supply increases in the other exporting countries, we feel very good about the wheat supplies heading into the fall. As we have said previously, our risk management approach is adaptive to the conditions and risk we see in the market, and we feel very comfortable with our current strategy based on the risk we see in the market today. Our U.S. business has managed increased labor costs and higher and more volatile grain prices through the benefit of a strong cutout and increased pricing to our customer base to recover this higher input cost, while effective operation are helping to control costs. Following our strategy of a diversified portfolio and balance of cost-plus, market, and fixed price contract structures provides us the platform to manage through the volatility of our input costs. At the close of Q2, industry chicken inventory was relatively flat to its position at the end of Q1. However, USDA indicated inventory was down 15% from previous years, even after marginal month-over-month increase in June. Combined dark meat inventories are down 10% year-over-year. Quarterly inventory levels has been unable to build despite year-over-year supply growth as healthy retail and food service demand have maintained consistent draw on supply. Turning to export markets, pork prices were 54% higher in Q2 compared to a year ago. Both pricing and demand exceeded expectations, and non-traditional export items were upgraded from frozen inventory. While the data is still incomplete for Q2, total USDA broiler export sales through May grew by approximately 4%. From a regional perspective, the industry enjoyed gains in most geographies, with the exception of the Middle East and Asia, where significant declines occurred due to COVID issues in some of the larger poultry importing countries. It is also noteworthy that China was down 16.5% on imports of U.S. broiler meat due to a softer pork market, port congestion issues, and larger than expected imports of poultry in Q4 2020. That being said, the pork market in China is displaying very strong demand and historically high prices. Export numbers are indicative of a more balanced trade scenario for the remainder of the year. Although some countries have experienced a resurgence of COVID issues, others are managing the pandemic well. We expect those with ongoing issues to improve in the second half of the year. It's still prudent to recognize that the dark meat shipments to China are very low relative to last year, which bodes well for the future dark meat demand. We are already seeing an uptick in China demand for U.S. whole legs as we enter Q3. Our Mexican operations delivered strong results in Q2, giving a well-balanced supply-demand equation. Our fresh business continued to improve its efficiency, while prepared food saw a double-digit growth, anchoring very strong performance in the QSR and food service channels. We continue to invest in our Pilgrim's Del Día and Alameda brands, and we expect chicken and prepared food consumption to continue to grow in the coming years. Our Mexican team continues to be relentlessly focused on delivering exceptional operational results. Moving to Europe, the Moy Park business has continued to produce steady results despite climbing grain prices through the first 6 months of the year. Moy Park delivered an improving EBITDA sequentially from the first quarter. The price formulas have addressed partially the increase in feed costs. However, along with grain costs, other operating costs like labor and utilities continued to climb during the quarter. We'll continue pursuing the recovery of these costs in the second half of the year. We continue to be pleased with Moy Park's relative performance in the industry for the past 12 months. Issues arising from Brexit, such as MIC changes and labor shortages, along with avian influenza consequences, affect our ability to export some of our dark meat production, impacting results. Moy Park was able to mitigate some of the severe feed and other cost impacts through further operational excellence initiatives that continue to deliver labor efficiencies, better agricultural performance, and improved yields while keeping tight control over SG&A costs. We have seen consistent improvement in Moy Park food service sales, as this sector shows significant recovery year-over-year, despite COVID-19 restrictions experienced throughout the second quarter. Although under continued cost pressures, Moy Park's performance is improving and will continue to do so as feed costs stabilize, COVID-19 costs come down, and restrictions are eased. The Pilgrim's U.K. business has been negatively impacted by increased grain costs and extremely low hog prices due to African swine fever in Germany, which negatively impacted exports to China, backing up supply in Europe. This business is benefiting from operational execution, but improvements are outweighed by sluggish pig pricing in U.K. Despite market challenge, including worsening labor availability in the U.K., we have now been profitable on an EBITDA basis for the last nine quarters in a row. During Q2, our year-over-year retail volume declined as the retail market fell versus last year, as food service normalized and category sales began to return pre-COVID levels. Our year-over-year volumes to China decreased due to the continued suspension of our export license at two plants as a result of COVID-19. We expect the licenses to be reinstated later this year. However, total sales volume showed 2% growth, where the decline in retail sales was compensated by sales into the food service market. We are optimistic about building our operational improvements by continuing to optimize our manufacturing footprint, extracting best-in-class operational excellence, capitalizing on export opportunities, optimizing our portfolio, and strengthening and growing business with key customers to drive innovation in value-added, higher margin areas. We have a great team in Europe dedicated to generating results by focusing on factors within our control while ensuring and protecting the safety and health of all team members. To further strengthen our portfolio in U.K. and our relationship with key customers and to continue executing against our growth strategy, we signed an agreement to acquire the meats and meal business of Kerry Consumer Foods. The meats and meal business acquisition will position Pilgrim's as the leading food company in U.K. and Ireland with a value-added protein and prepared food business anchored by a portfolio of strong brands. With 2020 sales of more than £725 million and 4,500 team members, the business' well-balanced portfolio of products, brands, and consumer base aligns with our growth strategy. This acquisition will support our strategy of developing a differentiated portfolio of diverse complementary business models, continue to relentlessly pursue operational excellence, and becoming a more valued partner with key customers with new and innovative products and creating an environment for safe people, safe products, and healthy outputs. We expect this transaction to close early in the fourth quarter of 2020. Finally, I'd like to point out that we recently released our 2020 sustainability report, which includes the 5-year results of our 2015 sustainability goals and aggressive new global targets that will guide our sustainability strategy over the next decade and beyond. The report details the company's progress in key priority areas: animal care, team members, environment, communities, customers and consumers, and suppliers across our operations in the U.K., Europe, Mexico, and the U.S. Pilgrim's has established ESG as core to our business strategy, adopting industry-leading initiatives that build on the company's longstanding commitments to sustainable food production and differentiated social initiatives. Pilgrim's is the first major global meat and poultry company to offer a sustainability-linked bond tied to efforts to reduce greenhouse gas emissions intensity across its global operations. In addition, we committed to achieve a net zero greenhouse gas emissions by 2040, the most ambitious commitment of its kind in the sector. We are committed to being the best and most respected company in our industry, and we want to serve as a leader that can help drive the entire supply chain forward. We remain focused on producing high-quality foods for people around the world in a sustainable manner that is both ambitious and collaborative while creating the opportunity of a better future for our team members. With that, I would like to ask our CFO, Matthew Galvanoni, to discuss our financial results. Thank you, Fabio, and good morning, everyone. For the second quarter of 2021, net revenues were $3.64 billion versus $2.82 billion a year ago, with an adjusted EBITDA of $372 million and a 10.2% margin compared to $112 million and a 4% margin in Q2 last year. We achieved $154 million adjusted net income, which includes a discrete income tax charge in the quarter of $32 million associated with the U.K.'s increased statutory income tax rate from 19% to 25%. We reported a GAAP net loss of $167 million versus a loss of $6 million in 2020. The most significant adjustment in the quarter was a $396 million accrual related to legal settlements. Adjusted EBITDA margins were 10.5% in the U.S., 18.9% in Mexico, and 5.2% in Europe. Our adjusted EBITDA in the U.S. in Q2 was $237.1 million versus $93.7 million a year ago and $236.4 million in 2019. Sales were up due to strong market pricing and slightly higher volumes compared to both 2020 and 2019. Gross profit margins were higher than 2020 due to significant COVID-19 impacts last year, however, were down compared to 2019 due to higher grain costs and labor inefficiencies. In Mexico, adjusted EBITDA in Q2 was $85.7 million versus a loss of $27.7 million a year ago and a positive $75.8 million in 2019. Net revenue was up due to higher market pricing and slightly higher volumes. The Mexican business has benefited from a balanced supply-demand dynamic. For Moy Park, adjusted EBITDA in Q2 was $33.5 million versus $34.7 million a year ago and $37.3 million in 2019. Pilgrim's U.K. had adjusted EBITDA of $15.7 million in Q2 compared to $12.3 million a year ago. Volumes have continued to improve during the year with the gradual reopening of the U.K. and European economies. Gross profit is down year-over-year as we've been able to pass through some, but not all, of the grain cost increases experienced in the first 6 months of the year. In total, we incurred COVID-related costs of approximately $12 million in the second quarter 2021. This is a decrease of approximately $37 million compared to the prior year. Our SG&A in the second quarter was higher than prior year, primarily due to legal costs associated with the various U.S. litigation matters and increased investment in our brands. We will continue to prioritize our capital spending plans this year to optimize our product mix and strengthen our partnership with key customers. We reiterate our commitment to invest in strong ROCE projects that will improve our operational efficiencies and tailor our operations to address key customer needs to further solidify competitive advantages for Pilgrim's. Our balance sheet continues to be robust given our relentless emphasis on cash flows from operating activities, focus on management of working capital, and disciplined investment in high-return projects. Our liquidity position remains very strong with more than $1.25 billion in total cash and available credit. At the end of the quarter, our net debt was $1.8 billion, with a leverage ratio of 1.6x last 12 months adjusted EBITDA. Our leverage is below our target ratio of 2 to 3 times. We continue to expect to generate strong operating cash flows this year. We expect 2021 interest expense to be approximately $110 million, exclusive of the debt extinguishment costs of $24 million we recorded in the second quarter and any interest expense associated with the financing of the pending Kerry transaction. We will stay focused on creating shareholder value as we optimize our capital structure to continue executing our growth strategy. Our capital allocation strategy will remain aligned with our growth strategy and each opportunity will be evaluated against our value creation standards. Operator, this concludes our prepared remarks. Please open the call for questions. Thank you very much. We will now begin the question and answer session. In the interest of allowing equal access, we request that you limit your question to two, then rejoin the queue for any follow-up. To ask a question, you may press star then one on your touch-tone telephone. If you are using a speakerphone, please pick up your handset before pressing the keys to minimize background noise. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. First question is from the line of Benjamin Theurer from Barclays. Please go ahead. Yeah, perfect. Thank you very much. Good morning, Fabio. Good morning, Matt. Congrats on the results. First question, just could you elaborate a little more in detail on that close to $400 million for litigation settlements? If I look at it on an LTM basis, we're now close to like $600 million, of which a lot was the price fixing last year. To understand if those incremental $400 million from the last quarter, is that already all settled in cash, or is a lot of that just in order to be prepared if there's more to come, and do you think this is it? That would be the first question. Morning, Ben. Yeah, we can't comment on active investigation or litigation. However, the company continues to cooperate with the Department of Justice on its investigation, and we'll continue to defend against the claims and to resolve its material litigation in the manner that we believe is the best interest of the company and its shareholders. Based on that is a combination of actual settlements and accruals that we expect to happen. Okay, it's not all what an actual settlement is. There's partially as an approval. Right. Okay, that's good. Second, just on the U.S., if we take a look at the underlying performance, it's been clearly on an improving trend, and it seems like you start to get pricing through and maybe a little bit of an easing on the cost side. Still, you've highlighted labor shortage and certain other issues on the cost side. How do you think about the current quarter and what's next once those benefits run out, in terms of getting labor back in, being more efficient on the facilities, and ultimately further pushing those price increases through, with your key customers? Where do you think the profitability is heading in the second half, just based on where the current environment is? Yeah. Thank you. It's a long answer, Ben. On the pricing and contracts, we have this differentiated portfolio. We've been talking about this for years, right. That protects us from the downside, and we have exposure to the commodity segments that enable us to capture upsides in the market. All of these different segments are behaving differently during the last year, to be honest, right. Commodity is really strong right now, and we are seeing a strong demand in the food service that is growing really fast, while retail continues to be strong. As of today, the commodity segments are way more profitable than all other segments. The small birds segment continue its strength with the growth of the QSRs, but the contracts that we have in those segments are more connected to grain pricing, and that profitability is very stable. We have a very stable part of our portfolio and a part of our portfolio that is really connected to commodity prices that we can achieve the results that we are achieving. Going forward, what we are seeing in the market is that retail will continue to be strong. I think consumers are back to older habits of more trips to the grocer, which will help also the deli section. The retail continues to be really strong. The food service is reopening. I think today we are seeing that the traffic is close to only 66% lower than the pre-pandemic levels. Very good level of profitability, while the non-commercial part of the food service is still 29%-30% down. We expect the schools to reopen very soon for the next year, which will boost the food service industry. Going forward, we expect to see retail continue to be strong and the commodity segments to be really demanded with giving the extra increase in the food service. Perfect. Thank you very much, Fabio. Sure. Thank you. The next question is on the line of Ben Bienvenu from Stephens. Please go ahead. Hey, thanks. Good morning, everybody. Morning, Ben. I want to ask first about the grain side of things and the feed cost, and then my second question is about Mexico. On the feed side of things, I appreciate your commentary on the current S&D. We noticed in your disclosures that you're not overly hedged from derivative coverage exposure, but you are as hedged as you've been in a few years. I'm curious, your thoughts there around how you're positioned relative to the market, any commentary you could provide on basis exposure as well, and what we should be considering relative to your positioning around all of that as we head into the back half of the year. Sure. Thank you, Ben Bienvenu. Well, like we said previously, our risk management strategy adapted to the risk we see on the market, and we feel very comfortable with where we are positioned right now. What we are seeing is that we are following the summer crop developments in U.S. very close, given the low stock situation we have for both corn and soybeans. While there has been some areas that have been drier than we would like, particularly in the Western Corn Belt, we think overall the U.S. crops are in an okay condition now, but require additional monitoring for sure. In addition to the condition in U.S. crops, and despite some volatility and recent cancellations, we are still seeing strong demand for U.S. corn and expect that to continue in the next years. Given all that, we're looking at an increase in feed costs of approximately $300 million in U.S. for the 2nd semester, with the tier 3 being impacted the most. While we are seeing that impacting our cost around $0.08 per live pound, what we are seeing is that the commodity and even the normal pricing and the cutout has increased by significantly more than that, almost $0.03. The commodity pricing has been able to offset these grain prices so far. Our positions, as you mentioned, are not the largest we ever had, as we are monitoring all these costs, and we believe that we have the right position right now. Okay. That's great. Thank you. My second question on Mexico, congratulations on the solid results. I'm curious, just given that that market can be temperamental from quarter to quarter, what you're seeing so far in the third quarter, you noted a stronger economic environment, more balanced S&D, better product mix, on the non-commodity piece of your business. Maybe just any color you could give as we look to the back half of the year on that business? Yeah. Temperamental is a good term. Thank you for that. We know that quarter-over-quarter, the performance can be very volatile. What we are seeing in Mexico is that we have a well-balanced supply and demand scenario right now, and we expect that to continue in Q3. Our fresh business continues to improve its efficiencies, and while the prepared foods saw a very strong double-digit growth anchored in a very strong performance of the QSRs and service channels. The economy is recovering well. We are watching the COVID cases pretty closely there, but we don't expect a major impact in the current positive recovery trend of the economy. As I mentioned, always, our team members and our team continues to be focused on delivering these operational results and committed to growth and support the growth of the Mexican economy. Awesome. Thank you, and best of luck in the back half. Thank you, Matt. Thank you. The next question is on the line of Michael Picken from Cleveland Research. Please go ahead. Yeah, good morning. Just wanted to talk a little bit more about the hatchability issues within the industry. When do you see that improving, and how is your hatchability doing, and what steps are you taking to improve that? Yeah. Thank you, Michael. Hatchability has been the issue in the industry, and that is constraining the industry to exceed the growth that everybody's expecting, which is less than 1% for 2020. The main reason for the hatchability issues is that when we try to solve the woody breast issue, as we remember 2 or 3 years ago, the genetic selection of this new breed prioritized quality, feed conversion, and carcass utilization rather than these productivity traits. Even with the largest flock that we are having right now, it is producing less eggs and less eggs are hatching. Some of that can also be explained by management, and we expect that we can manage better around, and we can recoup 0.5% to 1%. The gap today is close to 2.5%. Half of a percent to 1%, we believe that we can recoup with a better management of this new breed, but the rest will take a much longer term because we'll need a breed change. Great. Shifting gears, you talked a little bit about the adverse mix effects, and maybe if you could talk about the steps you're taking or your thoughts on automation and how much that might play into your future plans. Do you have any projected CapEx spending related to that if you are going to go to more automation? Thanks. Sure. Again, like you said, the labor market is really tight, and it has been not only constrained by the impact of discontinued governmental benefits, but now what we are seeing is that the reopening of the economy after the COVID-19 is putting a big competition for a very small labor pool. As we mentioned, we are considering all options. One, we are aggressively addressing the situation on the attraction, retention, and management of these absentees in our labor force, and of course, investing in the automation. We are happy to see that our staffing levels have improved over the last three months, and it's helped our mix effects. We will need to continue to invest in automation because we don't believe the labor force is going to increase significantly in the incoming future. We, over the last 2 years, reduced 2,200 positions with automations and expect to invest around $100 million in the next years to reduce around 5,600 positions. We are investing also in some new technology in big bird deboning, automating that big bird deboning, which is very unique. We expected those plans to be operational about this year. Is the question answered, Mr. Picken? It seems there's no response on the line. We will move to the next question. That is from the line of Adam Samuelson from Goldman Sachs. Please go ahead. Yes. Thank you. Good morning, everyone. Morning. Morning. I guess first question maybe keying off of Mike's question about hatchability. Just trying to get a sense. Your volumes in the U.S. were basically flat in the quarter. Industry production was up about 2.5%. I'm just trying to get a sense in terms of your internal productions. Is that the hatchability in your own operations? Is that the labor availability? Is that an issue around mix, maybe on the prepared poultry side for food service? Just help us think about your own volume shipments relative to industry and how you're thinking about your production in the back half of the year. Yeah. Of course, Adam, thank you. Yes, our production during the quarter was flat, a little bit up, but in total, flat year-over-year with the industry is increasing by 2.5%. We need to remember that during the pandemic, our production did not reduce as much as the industry. Despite being flat year-over-year, the industry is higher, but the industry reduced way more than us in Q2 last year. It's not a matter of hatchability. We're having the same issues in hatchability as everybody else. We are in line with the market. It was also related a little bit with the storm that we saw in Texas. It happened last quarter, but impacted a little bit of our feed conversion and the volumes this quarter. Got it. That is really helpful. Fabio, you talked earlier about the impact of feed inflation on your costs. You have kind of alluded to some of the labor challenges. I am just trying to think about maybe non-feed inflation in aggregate, whether it is labor, materials, packaging, how we should think about what your non-feed inflation is running at through the second quarter and what you think through the balance of the year, particularly as we kind of try to check that against the pricing side of things as we come off some of the seasonal peaks from here. Sure. I think, Adam, we're seeing inflation everywhere in our country and in other countries, right? I think it starts with the freight. We're seeing freight increasing by between 10% and 20% in terms of cost, and depending on the lane where we are in, and we are watching really close to any potential disruptive supply chain in the supply chain. The increase in freight for us in the quarter is about $15 million, but 65% of that freight is spent on deliveries directly to our customers, so most of which has been recouped. We need to mitigate through pricing. As you mentioned, we are seeing the supply and demand situation in a very favorable situation for the chicken prices. We believe that we can pass all those costs in terms of freight to our contracts. There's other increase in costs, as mentioned, which is labor. Labor, as I mentioned, is in a really short position right now. We increased our salaries close to $40 million in an annualized basis. With that, we're being able to improve our staffing levels. We are seeing soybean meal, soybean oil also on the prepared foods has increased in terms of inflation. All in all, we have this differentiated portfolio, again, we have a differentiated portfolio not only of products, also of contracts. While the supply and demand in chicken industry continues to be imbalanced, we believe that it can pass through these prices, these cost increases to our prices. As I mentioned in the other answer, the chicken demand continue to be really strong, we expect to be really strong for the next quarters. All right. That's all really helpful color. I'll pass it on. Thanks. Thank you. The next question is from the line of Peter Galbo from Bank of America. Please go ahead. Hey, guys. Good morning. Thanks for taking the question. Fabio, I just want to ask a couple of clarifying questions in regards to some of the prepared comments you gave. First, on the retail business, I know you said you're having pricing discussions at this point to offset some of the cost increases. I just wasn't sure if you had said you'll begin to be able to offset all of the cost increase or just partial on the retail side. Just as you were talking about kind of schools getting back in the fall and some of the commercial business, just what have you kind of seen early days? Are you seeing any kind of pre-ordering ahead, people worried about not being able to get product? Anything you can tell us kind of on that side of the business? Thank you. Yes, retail continues to be really strong, and we're seeing a lower demand today versus 2020 because of pantry loading. We are seeing demand greater than 2019 levels, which is very good for our production and our key customers. We have this key customer strategy. We have discussions with them all the time about pricing. As I was talking to Adam, there is a lot of pressure in terms of costs, both in feed and in non-feed costs. We've been discussing with them how can we pass this to the prices and help them continue with innovation and continue with supporting their features in terms of volume. We're seeing today a very tight market for the retail because labor in the retail operation is very intensive, and we've been very challenged in the labor situation, as we mentioned, right? The production in the retail segment has been constrained by labor. What we are doing is to support our key customers and giving them the best on time in full that we're seeing in years. We're seeing also some features increasing for the retail in the chicken side, because the delta between the chicken and the beef and pork has never been as big as it is right now. That is very supportive on the demand for chicken. Even with the increases that we are seeing, chicken continues to be the best value and the best option for the end user. Got it. Okay. On schools, maybe I missed the comment, some of the commercial side. Sure. On the what we call non-commercial, which is the schools and other segments, yes, we are seeing some pre-ordering, and we're seeing some expectation of a big increase there. As I mentioned, it's down close to 30% right now in that segment. We expect that to stabilize and get to normal levels by early 2022. Got it. Okay. I guess just putting that all together, right, as we're thinking about some of the sequential headwinds and tailwinds, right? Labor, I think you said is maybe improving sequentially on the margin. Feed, you're rolling through some of the higher costs. Just looking back historically at periods where chicken prices are relatively high, you've been able to earn a pretty substantial level of EBITDA in your higher EBITDA quarters, right? Second and third quarter. As we're thinking about modeling out the third quarter, is it fair to assume that you're expecting a similar level relative to 2Q? Is that putting it all together the right way, or are there other things we're missing? Yeah, we are seeing the supply and demand equation to be similar to Q2. Of course, as we enter the fall, we always see some decline in pricing. We're also seeing some reduction in the feed side. Of course, the cost of the feed in Q3 will still be impacted by the cost of what we purchased in Q2. We expect the mitigation or the reduction in feed cost to be more in Q4 than in Q3. We still see some elevated feed costs in Q3. We are seeing, once again, the supply and demand in a very good position. We are seeing some reopening of the food service as well. I think it will all depend as well on the COVID-19 numbers, if there is any more restriction and we go back to some sort of restriction in terms of movement or in terms of the food service, we can see the supply and demand to get less in the positive position that we are seeing right now. As of today, we are really optimistic about what we are seeing. Got it. No, that's very helpful commentary. Thanks very much. Thank you. Thank you. Next question is on the line of Kenneth Zaslow from Bank of Montreal. Please go ahead. Hey, good morning, everyone. Morning, Ken. Just a quick one on this one. I know we've talked about a lot, just trying to put it all together. The labor, how much do you think it impacted this quarter, not just the cost side, but also delivering? You did say the dark meat. How do we kind of put it together? Would you say that within 2022 it would be resolved and therefore 2022 should have a relative change relative to this year? Is that the way to think about it? I'm just trying to put it together. Sorry for beating a dead horse here. No, sure, Kenneth. No, again, labor is what we're trying to manage better. As we said, there is so many moving parts that it's really hard to define what is the impact, because there is impact in mix, right? Yeah debone as much as we want. There's impact in cost, of course, and yields. We are losing yields as well because as you don't debone everything the same day, so you roll fronts or you sell fronts, you're seeing a lot of yield losses. It is very significant. On the other hand, we are working with our key customers to simplify our mix as well. We are deboning less, we're putting some simple forms, reducing the number of SKUs. There's a lot of moving parts. I think the good news, and it's included in your point, is that we're expecting 2022 that to be resolved. We're investing in more automation, and we are seeing the labor force, and we're seeing the number of applicants increasing already as the governmental assistance is reduced. Expect that 2022, the labor market to be improved from the levels they are today. We believe that with all the operational improvements that we'll do in our business, we'll get to a better operation standard, let's say, to where we are today. Okay. My last question is what prevents Pilgrim's Pride from getting to the 2017 or that type of level margins in 2022? Do you just need the labor to come back? Is the position there already, or do you need other things to happen given that you've progressed on your strategy, you've progressed on your efficiencies, the market seems to be going that way? Is that a way to think about it? Is the labor the inhibitor to getting to that 2017 margin structure, or is there anything else that we should be thinking about? Well, 2017 was a strong year in the commodity segment. At the same time, we don't have the increase in the feed that we are seeing today with all the disruptions we have and the yield that we are seeing in the feed side. Of course, you're right on the operational side, we have a lot of opportunities given the labor situation where we are in, and I think that could create an environment where we get close to 2017 levels. That will also require the supply and demand to be in balance. If you look at in terms of supply, we're seeing very limited opportunity to increase supplies. We don't have any new plants coming online, and we still have the hatchability issue that we expect to get something back, but not the significant improvements in hatchability that we need to significantly increase the production for next year. We expect the production next year to increase close to 1%-2% as we are seeing this year. It all depend on supply demand, Ken. If we're seeing the economy really strong as we are seeing right now and the retail we expect to continue to be strong and the food service strong, yes, we can see 2017 level margins. Great. Thank you very much. Yeah. Thank you. This concludes our question and answer session. I would like to turn the conference back over to Fabio Sandri for closing comments. Over to you, sir. Thank you. I would like to take this opportunity to speak directly to our team members to thank you for your continued dedication to maintaining food production and supplying our customers during these extraordinary circumstances. You are the reason for our success. I would also like to thank everyone in the Pilgrim's family who makes our business possible, including our family farm partners, suppliers, and customers. Thank you all for joining us today. We appreciate your interest in Pilgrim's. Thank you very much. The conference has now concluded. Thank you for attending today's presentation. 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