As described throughout this document, USPB’s business involves the operation of an integrated cattle processing and beef marketing enterprise in which USPB’s unitholders and associates supply cattle that are processed at the facilities owned and operated by NBP. NBP markets and distributes the beef and beef products produced from both cattle supplied by USPB’s unitholders and associates and other cattle purchased by NBP from other sources. The financial results of NBP’s operations therefore are the single largest influence on USPB’s financial performance. Consequently, those factors and risks that impact the performance of NBP’s business have a direct and immediate influence on USPB’s performance. However, there are also some risks that are unique to USPB. This Risk Factors section is divided into two parts, with one subsection focusing on the risk factors that influence the performance of NBP and another subsection discussing certain risk factors that are directly applicable to USPB.
USPB’s business operations and the implementation of our business strategy are subject to significant risks inherent in our business, including, without limitation, the risks and uncertainties described below. The occurrence of any one or more of the risks or uncertainties described below could have a material adverse effect on our financial condition, results of operations, and cash flows. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, operations, industry, financial position, and financial performance in the future.
14
Risk Factors Associated With Operations of NBP
Outbreaks of disease affecting livestock can adversely affect demand for NBP’s products and the supply of cattle and thereby adversely affect its business.
NBP is subject to risks relating to animal health and disease control. An outbreak of disease affecting livestock, such as BSE (also commonly referred to as mad cow disease) or foot-and-mouth disease could result in restrictions on sales of products to NBP’s customers or purchases of livestock from its suppliers. Also, outbreaks of these diseases, or the perception by the public that such an outbreak has occurred or other concerns regarding such disease, whether or not resulting in regulatory action, can lead to cancellation of orders by NBP’s customers and create adverse publicity that may have a material adverse effect on consumer demand and, as a result, on NBP’s results of operations. Furthermore, an outbreak of disease could lead to widespread destruction of cattle, which could have a negative impact on NBP.
If NBP’s products or products made by others using NBP’s products become contaminated or are alleged to be contaminated, NBP may be subject to product liability claims and product recalls that would adversely affect its business.
NBP may be subject to significant liability potentially in excess of applicable liability insurance policy limits if the consumption of any of its products or products made by others using its products causes injury, illness or death due to contamination or otherwise. In addition, NBP may in the future recall products in the event its products are or may be contaminated, spoiled or inappropriately labeled. Contamination of NBP’s products or those of its competitors also may create adverse publicity or cause consumers to lose confidence in the safety and quality of NBP’s products that could negatively affect its business. NBP may encounter the same risks of contamination or negative publicity if a third party tampers with NBP’s products. Allegations of contamination of NBP’s products may also be harmful to NBP even if such allegations are untrue. The occurrence of any of these risks may increase NBP’s costs and decrease demand for its products, which could negatively affect its business, financial condition, results of operations and cash flows. Organisms producing food borne illnesses are generally found in the environment and there is a risk that as a result of food processing they could be present in NBP’s products. For example, E. coli is one of many food borne bacteria commonly associated with beef products. Once contaminated products have been shipped for distribution and consumption, illness or death may result if pathogens are present or increase due to handling or temperatures, and are not otherwise eliminated at the further processing, food service or consumer level. There can be no assurance NBP will not be required to perform product recalls, or that product liability claims will not be asserted against NBP, in the future.
NBP’s margins may be negatively impacted by fluctuating raw material and utility costs, selling prices, changes in its relationships with its suppliers and other factors that are outside of NBP’s control.
NBP’s margins are dependent on the price at which its beef products can be sold and the price it pays for raw materials, among other factors. These prices can vary significantly over a relatively short period of time as a result of a number of factors, including the relative supply and demand for live cattle and beef products, as well as the market for competing or complimentary products, such as pork and poultry. In addition, closure of international markets to U.S. beef product exports as a result of the December 23, 2003 BSE discovery negatively affected U.S. beef product margins, as certain by-products, classified as Specific Risk Materials (SRMs), have been banned from use in feedstocks and the human food chain. Some of these products previously enjoyed a market in foreign countries.
The supply and market price of the livestock that constitute NBP’s principal raw material and represent the substantial majority of its cost of goods sold are dependent upon a variety of factors over which NBP has little or no control, including fluctuations in the size of herds maintained by producers, the relative cost of feed and energy, weather and livestock diseases. In addition, NBP purchases approximately 55% of the cattle it processes on the open market. If NBP does not attract and maintain acceptable relationships with growers, the quantity, quality or pricing of its supply of cattle could be negatively affected.
Severe price swings in raw materials, and the resulting impact on the prices NBP charges for its products, have at times had, and may in the future have, a material adverse effect on NBP’s financial condition, results of operations and cash flows. If NBP experiences increased costs, it may not be able to pass them along to its customers. In addition, the costs for utilities, such as energy and water may fluctuate over time.
15
NBP’s international operations expose it to political and economic risks in foreign countries, as well as to risks related to currency fluctuations and could negatively affect NBP’s sales to customers in foreign countries and its operations and assets in such countries.
In the 18 weeks ended December 31, 2011, exports, primarily to Mexico, Japan, South Korea, Canada, China (for hides), Hong Kong, Egypt, and Taiwan accounted for approximately 10.9% of NBP’s total net sales and these sales on average had a higher margin than its sales generally. A reduction in its international sales would likely adversely affect its margins. In addition, NBP’s international activities expose it to risks not faced by companies that limit themselves to the domestic market. One significant risk is that the international operations may be affected by tariffs, other trade protection or food safety measures and import or export licensing requirements.
Risks associated with NBP’s international activities include:
changes in foreign currency exchange rates and inflation or deflation in the foreign countries in which NBP operates;
the closing of borders by foreign countries to the import of NBP’s products due to disease or other perceived health or food safety issues;
exchange controls;
changes in tariffs;
changes in political or economic conditions in a specific country or region, particularly in emerging markets;
trade restrictions imposed by countries with respect to the importation of NBP’s products, including actions taken in connection with trade disputes;
potentially negative consequences from changes in regulatory requirements; and
international conflict, including terrorist acts, which could significantly impact NBP’s financial condition and results of operations.
The occurrence of any of these events could increase NBP’s costs, lower demand for its products or limit its operations, which could have a material adverse effect on NBP’s business, financial condition, results of operations or prospects.
Compliance with environmental regulations could result in significant costs and failure to comply with environmental regulations and the use of hazardous substances, including at National Beef Leather’s tannery facility, could result in civil as well as criminal penalties, liability for damages and negative publicity.
NBP’s operations are subject to extensive and increasingly stringent regulations, including those relating to wastewater and storm water discharges, air emissions, waste handling and disposal and remediation of soil and groundwater contamination that are administered by the U.S. Environmental Protection Agency (EPA) and state, local and other authorities. In many areas, these laws and regulations are becoming increasingly stringent. Failure to comply with these laws and regulations can have serious consequences for NBP, including criminal as well as civil and administrative penalties and negative publicity. NBP has incurred and will continue to incur significant capital and operating expenditures to adapt to more stringent regulations and to avoid violations of these laws and regulations. Additional environmental requirements imposed in the future could result in currently unanticipated investigations, assessments or expenditures, and may require NBP to incur significant additional costs. Because the nature of these potential future charges is unknown, management is not able to estimate the magnitude of any future costs and NBP has not accrued any reserve for any potential future costs.
Some of NBP’s facilities have been in operation for many years. During that time, NBP and previous owners of these facilities have generated and disposed of wastes that are or may be considered hazardous or may have polluted the soil or groundwater at NBP’s facilities, including adjacent properties. The discovery of previously unknown contamination of property underlying or in the vicinity of NBP’s present or former properties or manufacturing facilities and/or waste disposal sites could require NBP to incur material unforeseen expenses. Occurrences of any of these events may have a material adverse effect on NBP’s business, financial condition, results of operations and cash flows.
16
In most locations, NBP’s processing facilities rely on municipal or other regional governmental agencies for its water supply and for the treatment of its wastewater discharges. These entities themselves are subject to environmental laws regarding the quality of their water discharges, and must meet permit limits. If permit limits become more stringent, upgrades and capital improvements to these municipal treatment facilities are likely. In those locations where NBP is a significant volume discharger, it is possible it may be asked to contribute toward the costs of such upgrades, or NBP may become subject to significant increases in water or sewer charges in order for such upgrade costs to be recouped.
NBP’s indebtedness could adversely affect its business and liquidity position.
As of December 31, 2011, NBP had $433.5 million of long-term debt, of which $29.3 million was classified as a current liability. As of December 31, 2011, NBP’s Credit Facility consisted of a $375.0 million term loan, $323.8 million of which was outstanding, a $250.0 million revolving line of credit loan, $92.1 million of which was outstanding, outstanding letters of credit of $23.0 million and available borrowings of $130.8 million, based on the most restrictive financial covenant calculations. In addition, as of December 31, 2011, NBP had outstanding industrial revenue bonds of $12.2 million and capital leases and other obligations of $5.4 million.
NBP’s indebtedness may increase from time to time in the future for various reasons, including fluctuations in operating results, capital expenditures and potential acquisitions.
NBP’s indebtedness, together with additional future indebtedness it may incur, and restrictive covenants contained in the Credit Facility could:
make it difficult for NBP to satisfy its obligations, including making interest payments on its debt obligations;
limit NBP’s ability to obtain additional financing to operate its business;
require NBP to dedicate a substantial portion of its cash flow to payments on its debt, reducing its ability to use cash flows to fund capital expenditures and working capital and other general operational requirements;
limit NBP’s flexibility to plan for and react to changes in its business and the beef processing industry;
place NBP at a competitive disadvantage relative to some of its competitors that have less debt than NBP;
limit NBP’s ability to pursue acquisitions; and
increase NBP’s vulnerability to general adverse economic and industry conditions, including changes in interest rates, changes in cattle prices or a downturn in NBP’s business or the economy.
The occurrence of any one of these events could have a material adverse effect on NBP’s business, financial condition and results of operations or cause a significant decrease in its liquidity and impair its ability to pay amounts due on its indebtedness.
The Credit Facility contains, among other things, restrictive covenants that will limit NBP’s and its subsidiaries’ ability to finance future operations or capital needs or to engage in other business activities. The Credit Facility restricts, among other things, its ability and the ability of its subsidiaries to:
incur additional indebtedness or issue guarantees;
create liens on NBP’s assets;
make distributions on or redeem equity interests;
make investments;
transfer or sell properties or other assets; and
engage in mergers, consolidations or acquisitions.
In addition, the Credit Facility requires NBP to meet specified financial ratios and tests under certain circumstances.
If NBP’s cash flow and capital resources are insufficient to fund its debt service obligations, NBP may be forced to reduce or delay capital expenditures, sell material assets or operations, obtain additional capital or restructure debt. NBP’s ability to generate cash and make scheduled payments or refinance NBP’s obligations depends on its successful financial and operating performance, which depend upon prevailing economic conditions and other factors, many of which are beyond its control.
17
NBP’s operating results could be negatively impacted by its hedging and derivative positions.
NBP uses derivative financial instruments and other hedging strategies in an attempt to reduce its exposure to various market risks, including changes in commodity prices. NBP holds certain positions that do not qualify as hedges for financial reporting purposes. These positions are marked to fair value, and the unrealized gains and losses are reported in earnings at each reporting date. Therefore, losses on these contracts will adversely affect NBP’s reported operating results. The use of such instruments may ultimately limit NBP’s ability to benefit from favorable commodity price movements, which may adversely affect reported operating results.
NBP generally does not have long-term contracts with its customers, and, as a result, the prices at which it sells its beef products are subject to market forces.
NBP generally does not have long-term sales arrangements with its customers and, as a result, the prices at which it sells products to them are determined in large part by market forces. NBP’s customers, mostly excluding those with which NBP has long-term contracts, place orders for products on an as-needed basis and, as a result, their order levels have varied from period to period in the past and may vary significantly in the future. The loss of one or more of NBP’s key customers, a significant decline in the number of orders from one or more of its key customers or a significant decrease in beef product prices for a sustained period of time could have a material adverse effect on NBP’s business, financial condition or results of operations.
Wal-Mart’s failure to continue purchasing from NBP could have a material adverse effect on its sales.
Sales to Wal-Mart Stores, Inc., (Wal-Mart), and its affiliate, Sam’s Club, represented approximately 9% of total net sales during the 18 weeks ended December 31, 2011. NBP’s contractual agreement with Wal-Mart expired on January 31, 2004, and NBP has not entered into a new agreement. If Wal-Mart and its affiliates do not continue to purchase from NBP, it could have a material adverse effect on NBP’s sales, financial position, results of operations and cash flows.
NBP is subject to extensive governmental regulation and its noncompliance with or changes in applicable requirements could adversely affect its business, financial condition, results of operations and cash flows.
In addition to the environmental regulations discussed above, NBP’s operations are subject to extensive regulation and oversight by the USDA (including GIPSA), the FDA, and other state, local and foreign authorities regarding the processing, packaging, storage, distribution, advertising and labeling of NBP’s products, including food safety standards. NBP’s domestic operations are subject to the PSA. This statute generally prohibits meat packers in the livestock industry from engaging in certain practices including violations of the PSA’s prompt payment provisions. In general (unless otherwise agreed in writing by NBP’s livestock suppliers), this statute requires us to make full payment for NBP’s livestock purchases in the case of cash sales before the close of the next business day following the purchase and transfer of possession of the livestock we purchase, or, in the case of a cash purchase on a carcass or ‘‘grade and yield’’ basis, that we make full payment of the purchase price not later than the close of the first business day following determination of the purchase price. On June 22, 2010, GIPSA published a proposed rule that would add new regulations under the PSA. Among other things, the proposed rule would eliminate the requirement that GIPSA or livestock producers demonstrate competitive harm to prove violations of Sections 202(a) and 202(b) of the PSA, which sections limit unfair, unjustly discriminatory or deceptive practices and undue or unreasonable preferences or advantages in livestock purchasing practices. Elimination of this requirement could have a significant impact on cattle procurement and marketing practices in the beef processing industry. In particular, it could impair NBP’s ability to pay premiums for cattle that meet the quality standards for NBP’s value-added or export programs, thus affecting how we (i) procure cattle for these programs and (ii) process and market value-added and exported products. We cannot predict whether the proposed rule or some modified rule will be adopted or the extent of the effect of any such rule on the beef processing industry or on NBP’s operations or financial results.
Recently, the food safety practices and procedures in the meat processing industry have been subject to more intense scrutiny and oversight by the USDA. Food safety standards, processes and procedures are subject to the USDA Hazard Analysis Critical Control Point program, which includes compliance with the Public Health Security and Bioterrorism Preparedness and Response Act of 2002. In hopes of reducing the development and spread to humans of dangerous antibiotic-resistant bacteria, the Obama administration announced in July 2009 that it would seek to ban routine use of antibiotics, which are fed to farm animals to encourage growth.
NBP is also subject to a variety of immigration, labor and worker safety laws and regulations, including those relating to the hiring and retention of employees. NBP’s failure to comply with applicable laws and regulations could subject it to administrative penalties and injunctive relief, civil remedies, including fines, injunctions, interruption of its operations, recalls of its products or seizures of its properties, as well as potential criminal sanctions or personal injury or other damage claims. These remedies, changes in the applicable laws and regulations or discovery of currently unknown conditions could increase NBP’s costs and limit its business operations.
Failure to successfully implement NBP’s business strategy may impede its plans to increase revenues, margins and cash flow.
NBP’s revenues, margins and cash flows will not increase as planned if it fails to implement the key elements of its strategy, and its ability to successfully implement this strategy is dependent at least in part on factors beyond NBP’s control. For example, the willingness of consumers to purchase value-added products depends in part on economic conditions. In periods of economic uncertainty, consumers tend to purchase more private label or less-expensive products. Thus, if NBP encounters periods of economic uncertainty, the sales volume for its value-added products could suffer. Also, NBP may not be successful in identifying favorable international expansion opportunities.
Changes in consumer preferences could adversely affect NBP’s business.
The food industry in general is subject to changing consumer trends, demands and preferences. NBP’s products compete with other protein sources, such as pork and poultry, and other foods. Trends within the food industry change often and the failure to anticipate, identify or react to changes in these trends could lead to, among other things, reduced demand and price reductions for NBP’s products, and could have a material adverse effect on NBP’s business, financial condition, results of operations and cash flows. In addition, NBP does not have any other material lines of business or other sources of revenue to rely upon if it is unable to efficiently process and sell beef products or if the market for beef declines. This lack of diversification means that NBP may not be able to adapt to changing market conditions or withstand any significant decline in the beef industry.