Hormel Foods Corporation — Q2 FY2011 Form 10-Q
Reporting period: Three and six months ended May 1, 2011. Comparisons are with the periods ended April 25, 2010. Dollar amounts are in millions unless otherwise indicated. The company’s two-for-one stock split took effect February 1, 2011; historical per-share figures were restated.
Business context and results
Hormel processes and markets branded and unbranded food products through Grocery Products, Refrigerated Foods, Jennie-O Turkey Store (JOTS), Specialty Foods, and All Other. All five segments increased sales in Q2.
| Metric | Q2 FY2011 | Q2 FY2010 | Six months FY2011 | Six months FY2010 |
|---|---|---|---|---|
| Net sales | $1,959.0 | $1,699.8 | $3,880.6 | $3,427.2 |
| Gross profit | $326.2 | $280.5 | $700.2 | $598.9 |
| Operating income | $172.8 | $137.6 | $408.5 | $313.3 |
| Net earnings attributable to Hormel | $109.6 | $77.9 | $258.4 | $189.1 |
| Diluted EPS | $0.40 | $0.29 | $0.95 | $0.70 |
Q2 sales rose 15.3%, while tonnage increased 7.0%; first-half sales rose 13.2% and tonnage 5.3%. Gross margin was 16.7% in Q2 and 18.0% for the first half, compared with 16.5% and 17.5%, respectively, a year earlier. SG&A was 8.2% of Q2 sales and 7.9% of first-half sales, down from 8.6% and 8.5%.
On a U.S. GAAP basis, attributable earnings increased 40.7% in Q2 and 36.7% for the first half. The prior-year comparison includes a $6.3 million after-tax plant-closure charge and a $7.1 million tax charge. Excluding those items, management reported adjusted diluted EPS growth of 17.6% for Q2 ($0.40 versus $0.34) and 26.7% for the first half ($0.95 versus $0.75).
Segments and material changes
- Refrigerated Foods: Q2 sales rose 16.5% and segment profit 26.5%; first-half sales rose 14.9% and profit 32.4%. Strong pork operating margins and sales growth drove results.
- JOTS: Q2 sales rose 25.1% and profit 45.2%; first-half sales rose 19.3% and profit 84.2%. Value-added growth, favorable commodity-meat margins, and efficiency gains contributed.
- All Other: Q2 sales increased 44.9% and profit 104.3%, supported by pork and SPAM exports, royalties, currency effects, and improved China operations.
- Grocery Products: Q2 sales increased 1.4%; reported segment profit increased 18.2%. However, compared with adjusted prior-year profit excluding the Valley Fresh closure charge, management said profit declined, as high input costs offset gains including stronger MegaMex results.
- Specialty Foods: Q2 sales rose 4.1%, but segment profit fell 10.9%, reflecting high raw-material costs and product-mix changes.
Higher pork and beef costs pressured value-added products, particularly in Grocery Products and Specialty Foods. Shipping and handling costs also increased, in part due to fuel. Strong hog spreads supported pork operations during much of the quarter, but had recently moved toward more historical levels.
Cash flow, debt, and liquidity
- First-half operating cash flow was $275.9 million, versus $179.3 million a year earlier; higher earnings and working-capital changes contributed.
- Investing activities used $32.5 million, versus $147.0 million in the prior-year period. Capital expenditures were $35.9 million; management estimated full-year FY2011 capital expenditures of $100–$110 million.
- Financing activities provided $202.4 million, including proceeds from a $250 million issue of 4.125% notes due 2021. The company planned to repay $350 million of notes due June 1, 2011.
- At May 1, cash and cash equivalents were $913.7 million and short-term marketable securities were $51.0 million. Debt comprised $350 million of current maturities and $250 million of long-term debt. The company said it was in compliance with debt covenants.
- First-half dividends paid were $61.9 million; the FY2011 annual dividend rate increased to $0.51 per share. Share repurchases were $34.7 million.
Outlook, risks, and unusual items
Management expected higher raw-material costs to continue pressuring value-added businesses in the second half. Pork margins were expected to remain above historical levels but below the prior year; JOTS was also expected to face higher grain costs and a more difficult second half than its exceptionally strong prior-year results. Pricing and productivity efforts were intended to offset costs, though management noted a lag and concern that price increases could affect volumes.
Management expected FY2011 SG&A of approximately 8.0% of sales, an effective tax rate of 34.0%–35.0%, and interest expense of approximately $22–$23 million. The filing does not provide a clear full-year earnings or EPS forecast. It also noted continued brand advertising and expected strong pork exports to support All Other.
Key exposures include volatility in pork, poultry, grain, fuel, and other commodity costs; effectiveness and accounting treatment of hedges; food safety and livestock disease; competition, customer demand, labor negotiations, regulation, litigation, and international-market risks. The company carried $43.0 million of unrecognized tax benefits, including interest and penalties; timing and outcome of tax audits were uncertain. A renewable $4.8 million standby letter of credit guarantees an affiliate’s workers’ compensation obligations and is not recorded as a balance-sheet liability. Management said known legal matters were not expected to materially affect financial condition, results, or liquidity.
Prior-year unusual items included the Valley Fresh plant closure and the tax charge related primarily to Medicare Part D tax treatment. In the current period, soybean meal futures were de-designated from cash-flow hedge accounting after becoming no longer highly effective; subsequent gains or losses are recognized in earnings as incurred. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether lower pork margins and elevated grain and other raw-material costs weigh on second-half segment profits as management anticipated.
- Whether pricing actions, productivity initiatives, and sales volumes sufficiently offset inflation without materially reducing demand.
- The scheduled $350 million debt repayment, resulting debt balance, and ongoing liquidity after the June 2011 maturity.
- How much of reported year-over-year earnings growth reflects operating performance versus the prior-year closure and tax charges; compare GAAP and adjusted figures consistently.
- Developments in tax audits and the $43.0 million unrecognized-tax-benefit balance, and any changes in commodity hedge effectiveness or related earnings volatility.