DERIVATIVE FINANCIAL INSTRUMENTS

Our meat processing and hog production operations use various raw materials, primarily live hogs, corn and soybean meal, which are actively traded on commodity exchanges. We hedge these commodities when we determine conditions are appropriate to mitigate price risk. While this hedging may limit our ability to participate in gains from favorable commodity fluctuations, it also tends to reduce the risk of loss from adverse changes in raw material prices. We attempt to closely match the commodity contract terms with the hedged item. We also periodically enter into interest rate swaps to hedge exposure to changes in interest rates on certain financial instruments and foreign exchange forward contracts to hedge certain exposures to fluctuating foreign currency rates.

We record all derivatives in the balance sheet as either assets or liabilities at fair value. Accounting for changes in the fair value of a derivative depends on whether it qualifies and has been designated as part of a hedging relationship. For derivatives that qualify and have been designated as hedges for accounting purposes, changes in fair value have no net impact on earnings, to the extent the derivative is considered perfectly effective in achieving offsetting changes in fair value or cash flows attributable to the risk being hedged, until the hedged item is recognized in earnings (commonly referred to as the “hedge accounting” method). For derivatives that do not qualify or are not designated as hedging instruments for accounting purposes, changes in fair value are recorded in current period earnings (commonly referred to as the “mark-to-market” method). We may elect either method of accounting for our derivative portfolio, assuming all the necessary requirements are met. We have in the past availed ourselves of either acceptable method and expect to do so in the future. We believe all of our derivative instruments represent economic hedges against changes in prices and rates, regardless of their designation for accounting purposes.

We do not offset the fair value of derivative instruments with cash collateral held with or received from the same counterparty under a master netting arrangement. As of January 27, 2013, prepaid expenses and other current assets included $20.2 million representing cash on deposit with brokers to cover losses on our open derivative instruments and accrued expenses and other current liabilities included $0.9 million representing cash deposits received from brokers to cover gains on our open derivative instruments. Changes in commodity prices could have a significant impact on cash deposit requirements under our broker and counterparty agreements. Additionally, certain of our derivative contracts contain credit risk related contingent features, which would require us to post additional cash collateral to cover net losses on open derivative instruments if our credit rating was downgraded. As of January 27, 2013, the net liability position of our open derivative instruments that are subject to credit risk related contingent features was not material.

We are exposed to losses in the event of nonperformance or nonpayment by counterparties under financial instruments. Although our counterparties primarily consist of financial institutions that are investment grade, there is still a possibility that one or more of these companies could default. However, a majority of our financial instruments are exchange traded futures contracts held with brokers and counterparties with whom we maintain margin accounts that are settled on a daily basis, thereby limiting our credit exposure to non-exchange traded derivatives. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. As of January 27, 2013, we had credit exposure of $23.4 million on non-exchange traded derivative contracts, excluding the effects of netting arrangements. As a result of netting arrangements, our credit exposure was reduced to $2.5 million as of January 27, 2013. No significant concentrations of credit risk existed as of January 27, 2013.

The size and mix of our derivative portfolio varies from time to time based upon our analysis of current and future market conditions. All derivative contracts are recorded in prepaid expenses and other current assets or accrued expenses and other current liabilities within the consolidated condensed balance sheets, as appropriate.

The following table presents the fair values of our open derivative financial instruments in the consolidated condensed balance sheets on a gross basis.



	Assets				Liabilities
	January 27, 2013		April 29, 2012		January 27, 2013		April 29, 2012
	(in millions)				(in millions)
Derivatives using the "hedge accounting" method:
Grain contracts	$	41.3	$	35.3	$	22.4	$	9.6
Livestock contracts	8.5		22.9		3.9		—
Foreign exchange contracts	1.3		1.9		0.1		—
Total	51.1		60.1		26.4		9.6

Derivatives using the "mark-to-market" method:
Grain contracts	10.5		9.1		3.0		1.0
Livestock contracts	1.4		7.4		1.0		7.2
Energy contracts	2.7		—		3.7		12.2
Foreign exchange contracts	0.8		2.4		0.3		0.7
Total	15.4		18.9		8.0		21.1
Total fair value of derivative instruments	$	66.5	$	79.0	$	34.4	$	30.7

Hedge Accounting Method

Cash Flow Hedges

We enter into derivative instruments, such as futures, swaps and options contracts, to manage our exposure to the variability in expected future cash flows attributable to commodity price risk associated with the forecasted sale of live hogs and fresh pork, and the forecasted purchase of corn, wheat and soybean meal. In addition, we enter into interest rate swaps to manage our exposure to changes in interest rates associated with our variable interest rate debt, and we enter into foreign exchange contracts to manage our exposure to the variability in expected future cash flows attributable to changes in foreign exchange rates associated with the forecasted purchase or sale of assets denominated in foreign currencies. As of January 27, 2013, we had no cash flow hedges for forecasted transactions beyond April 2014.

When cash flow hedge accounting is applied, derivative gains or losses are recognized as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings. Derivative gains and losses, when reclassified into earnings, are recorded in cost of sales for grain contracts, sales for lean hog contracts, interest expense for interest rate contracts and selling, general and administrative expenses for foreign exchange contracts. Gains and losses on derivatives designed to hedge price risk associated with fresh pork sales are recorded in the Hog Production segment.

During the nine months ended January 27, 2013, the range of notional volumes associated with open derivative instruments designated in cash flow hedging relationships was as follows:



	Minimum	Maximum	Metric
Commodities:
Corn	30,885,000	114,525,000	Bushels
Soybean meal	273,496	755,444	Tons
Lean hogs	—	569,920,000	Pounds
Foreign currency ⁽¹⁾	15,922,580	71,979,138	U.S. Dollars

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⁽¹⁾	Amounts represent the U.S. dollar equivalent of various foreign currency contracts.

The following table presents the effects on our consolidated condensed financial statements of pre-tax gains and losses on derivative instruments designated in cash flow hedging relationships for the fiscal periods indicated:



	Gains (Losses) Recognized in Other Comprehensive Income (Loss) on Derivative (Effective Portion)						Gains (Losses) Reclassified from Accumulated Other Comprehensive Loss into Earnings (Effective Portion)						Gains (Losses) Recognized in Earnings on Derivative (Ineffective Portion)
	Three Months Ended						Three Months Ended						Three Months Ended
	January 27, 2013			January 29, 2012			January 27, 2013			January 29, 2012			January 27, 2013			January 29, 2012
	(in millions)						(in millions)						(in millions)
Commodity contracts:
Grain contracts	$	(33.7	)	$	(4.3	)	$	40.6		$	6.0		$	(1.4	)	$	—
Lean hog contracts	7.5			23.7			(3.5		)	7.0			—			0.4
Foreign exchange contracts	0.3			(10.1		)	1.4			(3.6		)	—			—
Total	$	(25.9	)	$	9.3		$	38.5		$	9.4		$	(1.4	)	$	0.4

	Nine Months Ended						Nine Months Ended						Nine Months Ended
	January 27, 2013			January 29, 2012			January 27, 2013			January 29, 2012			January 27, 2013			January 29, 2012
	(in millions)						(in millions)						(in millions)
Commodity contracts:
Grain contracts	$	95.8		$	(20.9	)	$	62.2		$	74.1		$	2.0		$	(0.1	)
Lean hog contracts	6.4			53.0			54.3			12.1			0.3			(0.7		)
Interest rate contracts	—			—			—			(2.4		)	—			—
Foreign exchange contracts	0.1			(5.6		)	0.8			(3.2		)	—			—
Total	$	102.3		$	26.5		$	117.3		$	80.6		$	2.3		$	(0.8	)

For the fiscal periods presented, foreign exchange contracts were determined to be highly effective. We have excluded from the assessment of effectiveness differences between spot and forward rates, which we have determined to be immaterial.

During the first quarter of fiscal 2012, we discontinued cash flow hedge accounting on a number of grain contracts as it became probable that the original forecasted transactions would not transpire. As a result of this change, the table above for the nine months ended January 29, 2012 includes gains of $12.0 million on grain contracts de-designated from hedging relationships that were reclassified from accumulated other comprehensive loss into earnings in the first quarter of fiscal 2012.

As of January 27, 2013, there were deferred net gains of $41.9 million, net of tax of $26.3 million, in accumulated other comprehensive loss. We expect to reclassify $43.2 million ($26.4 million net of tax) of deferred net gains on closed commodity contracts into earnings within the next twelve months. We are unable to estimate the gains or losses to be reclassified into earnings within the next twelve months related to open contracts as their values are subject to change.

Fair Value Hedges

We enter into derivative instruments (primarily futures contracts) that are designed to hedge changes in the fair value of live hog inventories and firm commitments to buy grains. When fair value hedge accounting is applied, derivative gains and losses are recognized in earnings currently along with the change in fair value of the hedged item attributable to the risk being hedged. The gains or losses on the derivative instruments and the offsetting losses or gains on the related hedged items are recorded in cost of sales for commodity contracts.

During the nine months ended January 27, 2013, the range of notional volumes associated with open derivative instruments designated in fair value hedging relationships was as follows:



	Minimum	Maximum	Metric
Commodities:
Lean hogs	—	286,800,000	Pounds
Corn	3,015,000	13,930,000	Bushels

The following table presents the effects on our consolidated condensed statements of income of gains and losses on derivative instruments designated in fair value hedging relationships and the related hedged items for the fiscal periods indicated:



	Gains (Losses) Recognized in Earnings on Derivative					Gains (Losses) Recognized in Earnings on Related Hedged Item
	Three Months Ended					Three Months Ended
	January 27, 2013			January 29, 2012		January 27, 2013			January 29, 2012
	(in millions)					(in millions)
Commodity contracts	$	0.5		$	2.3	$	(0.6	)	$	(2.0	)

	Nine Months Ended					Nine Months Ended
	January 27, 2013			January 29, 2012		January 27, 2013			January 29, 2012
	(in millions)					(in millions)
Commodity contracts	$	(18.2	)	$	13.4	$	10.6		$	(7.0	)

We recognized losses of $6.9 million and $0.2 million for the three months ended January 27, 2013 and January 29, 2012, respectively, and losses of $2.4 million and gains of $4.5 million for the nine months ended January 27, 2013 and January 29, 2012, respectively, on closed commodity derivative contracts as the underlying cash transactions affected earnings.

For fair value hedges of inventory, we elect to exclude from the assessment of effectiveness differences between the spot and futures prices. These differences are recorded directly into earnings as they occur. These differences resulted in gains of $0.3 million for the three months ended January 29, 2012, and losses of $7.5 million and gains of $6.0 million for the nine months ended January 27, 2013 and January 29, 2012, respectively.

Mark-to-Market Method

Derivative instruments that are not designated as a hedge, have been de-designated from a hedging relationship, or do not meet the criteria for hedge accounting are marked-to-market with the unrealized gains and losses together with actual realized gains and losses from closed contracts being recognized in current period earnings. Under the mark-to-market method, gains and losses are recorded in cost of sales for commodity contracts, and selling, general and administrative expenses for foreign exchange contracts.

During the nine months ended January 27, 2013, the range of notional volumes associated with open derivative instruments using the “mark-to-market” method was as follows:



	Minimum	Maximum	Metric
Commodities:
Lean hogs	320,000	121,920,000	Pounds
Corn	1,680,000	22,960,000	Bushels
Soybean meal	40,314	109,605	Tons
Soybeans	155,000	935,000	Bushels
Wheat	—	2,000,000	Bushels
Natural gas	9,940,000	11,030,000	Million BTU
Diesel	—	2,016,000	Gallons
Crude oil	18,000	144,000	Barrels
Foreign currency ⁽¹⁾	23,089,235	124,136,878	U.S. Dollars

——————————————


⁽¹⁾	Amounts represent the U.S. dollar equivalent of various foreign currency contracts.

The following table presents the amount of gains and losses recognized in the consolidated condensed statements of income on derivative instruments using the “mark-to-market” method by type of derivative contract for the fiscal periods indicated:



	Three Months Ended						Nine Months Ended
	January 27, 2013			January 29, 2012			January 27, 2013		January 29, 2012
	(in millions)						(in millions)
Commodity contracts	$	3.0		$	(14.5	)	$	11.9	$	10.8
Foreign exchange contracts	(0.2		)	2.7			4.0		7.3
Total	$	2.8		$	(11.8	)	$	15.9	$	18.1

The table above reflects gains and losses from both open and closed contracts including, among other things, gains and losses related to contracts designed to hedge price movements that occur entirely within a quarter. The table includes amounts for both realized and unrealized gains and losses. The table is not, therefore, a simple representation of unrealized gains and losses recognized in the income statement during any period presented.