Hormel Foods Corporation — Q3 FY2015 Form 10-Q
Reporting period: Third quarter and first nine months ended July 26, 2015; comparisons are with the periods ended July 27, 2014. Balance-sheet comparisons are with October 26, 2014. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Net sales | $2.189 billion | $2.285 billion | $6.863 billion | $6.772 billion |
| Gross profit | $409.4 million | $364.0 million | $1.314 billion | $1.141 billion |
| Gross margin | 18.7% | 15.9% | 19.1% | 16.9% |
| Operating income | $231.2 million | $214.5 million | $774.8 million | $668.3 million |
| Net earnings attributable to Hormel | $146.9 million | $138.0 million | $498.9 million | $431.4 million |
| Diluted EPS | $0.54 | $0.51 | $1.85 | $1.60 |
| Operating cash flow | Not presented separately for the quarter | $690.2 million | $394.4 million |
- Quarterly sales declined 4.2%, while net earnings attributable to Hormel rose 6.5%. Nine-month sales increased 1.3%, and attributable earnings increased 15.6%.
- Quarterly tonnage rose 2.8% to 1.21 billion pounds; nine-month tonnage rose 3.7% to 3.80 billion pounds. Lower pork-market pricing, HPAI-related turkey losses, and the prior-year Precept joint venture contributed to the quarterly sales decline.
- Quarterly SG&A increased to $184.6 million from $153.0 million, or 8.4% of sales versus 6.7%. Management cited higher advertising and employee costs and $8.6 million in Applegate transaction costs.
Segments and material changes
- Grocery Products: Q3 sales increased 7.9% to $388.1 million and segment profit rose 57.2% to $53.1 million, supported by favorable input costs, Hormel chili and SKIPPY sales, and additional MegaMex products.
- Refrigerated Foods: Q3 sales fell 11.4% to $1.056 billion, while profit rose 8.5% to $97.7 million. Lower pork prices and the end of Precept weighed on sales; lower input costs and value-added product growth supported profit.
- Jennie-O Turkey Store: Q3 sales declined 12.1% to $336.5 million and profit fell 45.4% to $35.4 million due to HPAI-related flock losses and lower volume. Nine-month sales and profit remained above the prior year.
- Specialty Foods: Q3 sales increased 30.7% to $282.8 million and profit rose 79.5% to $31.2 million, reflecting CytoSport, acquired in August 2014, and improved cost structure and synergies.
- International & Other: Q3 sales decreased 6.5% to $125.1 million, while profit increased 3.0% to $19.3 million. Nine-month profit declined 11.4%, including $9.5 million of charges from exiting international joint ventures.
- Applegate Farms was acquired July 13 for a preliminary $771.8 million. It contributed $12.4 million of Q3 sales; goodwill and purchase-price allocation remained preliminary. Goodwill increased to $1.979 billion from $1.226 billion, primarily reflecting Applegate.
Cash, debt, and liquidity
- Cash and cash equivalents were $349.2 million, versus $334.2 million at October 26, 2014. Current assets were $2.004 billion and current liabilities were $1.245 billion.
- Debt totaled $600 million: $350 million short-term debt and $250 million long-term debt, compared with $250 million of long-term debt and no short-term debt at fiscal year-end. The new short-term borrowing funded the Applegate acquisition. The company reported compliance with all debt covenants.
- Nine-month operating cash flow was $690.2 million. Investing activities used $846.7 million, including the Applegate purchase; financing activities provided $173.9 million. Capital expenditures were $96.8 million.
- Dividends paid were $184.8 million for the nine months. The fiscal 2015 annual dividend rate increased to $1.00 per share. The company made no share repurchases during the first nine months.
Outlook, risks, and unusual items
- Management expected fiscal 2015 earnings growth, but provided no specific full-year EPS target in this filing. It forecast full-year SG&A of approximately 8.0% of sales, an effective tax rate of 34.5%–35.0%, and capital expenditures of approximately $155–$165 million.
- Management expected a strong Specialty Foods finish and continued Grocery Products profit growth; Refrigerated Foods was expected to benefit from value-added sales and lower input costs. Jennie-O was expected to face year-over-year declines as HPAI recovery and farm repopulation continued. International pork exports remained a headwind. Applegate was expected to be neutral to FY2015 earnings after transaction costs and fair-value adjustments, with a full year of sales in FY2016.
- Approximately two-thirds of affected turkey farms had been repopulated; management expected the process to finish in Q4. The filing cautions that HPAI and other livestock disease outbreaks could adversely affect supply, volumes, demand, and margins.
- Other material exposures include volatile pork, poultry, feed, and other commodity prices; international market and trade conditions; food safety, regulatory, litigation, labor, acquisition-integration, and environmental risks. Union agreements covering approximately 3,400 employees were due to expire in Q4 FY2015, with negotiations ongoing.
- Unrecognized tax benefits, including interest and penalties, totaled $24.7 million; the IRS examination of the FY2013 federal return was ongoing. The company also disclosed $43.5 million of standby letters of credit, including $3.5 million for an affiliate, not recorded as balance-sheet liabilities. Known legal proceedings were not expected to have a material financial effect.
- Non-GAAP nine-month adjusted earnings were $514.5 million and adjusted diluted EPS was $1.90, versus $431.4 million and $1.60 in the prior year. Adjustments excluded Stockton plant-closure and international joint-venture exit charges; the $8.6 million Applegate transaction costs remained in the FY2015 adjusted measure.
Investor verification priorities
- Track HPAI recovery, turkey processing volumes, and Jennie-O margins against management’s Q4 expectations.
- Review Applegate’s final purchase-price allocation, integration, and contribution to earnings and cash flow.
- Assess whether earnings and margin gains persist after the effects of lower input costs, acquired businesses, and unusual charges.
- Monitor short-term borrowing, acquisition-related debt repayment, operating cash generation, and covenant headroom.
- Follow pork-export conditions, commodity costs, labor negotiations, and the outcome of tax audits and uncertain tax positions.