HORMEL FOODS CORP quarterly report, Q3 FY2010

Business context and reporting period

Hormel Foods Corporation filed this unaudited Form 10-Q for its fiscal third quarter ended July 25, 2010, and the nine months then ended. It processes and sells branded and unbranded food products through Grocery Products, Refrigerated Foods, Jennie-O Turkey Store, Specialty Foods, and All Other. Comparisons below are with the corresponding 2009 periods unless noted.

Financial performance and position

For the first nine months, management also reported adjusted net earnings attributable to Hormel of $287.8 million and adjusted diluted EPS of $2.13, excluding the Valley Fresh closure and health-care-law tax charges. These are non-GAAP measures; reported GAAP results are shown above.

Cash flow and liquidity: Nine-month operating cash flow was $271.6 million, down from $332.1 million. Investing activities used $169.5 million and financing activities used $110.5 million; cash and equivalents decreased $8.3 million from the fiscal-year opening balance to $376.9 million. The cash-flow decline reflected working-capital outflows, especially inventory and receivables, despite higher earnings. The balance sheet also showed $50.2 million of short-term marketable securities. Current assets were $1,710.6 million and current liabilities $1,016.1 million.

Debt and capital returns: The $350.0 million long-term debt balance was reclassified as current and was scheduled for repayment in fiscal Q3 2011. Hormel replaced its $200 million revolving credit facility with a $300 million facility effective May 25, 2010, and reported compliance with debt covenants. Nine-month share repurchases were $53.2 million and dividends paid were $81.4 million. The fiscal 2010 annual dividend rate was $0.84 per share.

Material changes versus the prior comparable period

• All five segments increased sales in the quarter and nine-month period. Quarterly tonnage rose 2.2%; nine-month tonnage also rose 2.2%.
• Quarterly segment operating profit rose 13.0%. Jennie-O Turkey Store profit increased 92.6% and Refrigerated Foods 10.7%; Specialty Foods increased 19.5%. Grocery Products profit declined 22.9% amid higher raw-material costs.
• Quarterly gross margin was flat, while nine-month gross margin improved. Management cited strong pork cutout margins, turkey operational efficiencies, and improved Specialty Foods volumes as supports; higher inputs and shipping costs remained pressures.
• Net interest and investment expense increased to $6.2 million for the quarter and $17.5 million for nine months, principally because rabbi-trust investment returns were lower. Nine-month interest expense itself declined to $19.6 million from $21.3 million.

Outlook, commentary, risks, and unusual items

• Management expected substantial year-over-year Jennie-O growth through fiscal year-end, supported by improved turkey supply-demand conditions and operating efficiencies, while grain-price volatility remained a concern.
• Management warned that high pork and other raw-material costs could pressure margins in the fourth quarter if strong cutout margins weakened. Pricing actions may help but could affect volumes. Grocery Products was expected to remain under margin pressure.
• For the remainder of fiscal 2010, SG&A was expected to be about 8.8% of sales; the full-year effective tax rate was expected at 36.0%–37.0%, interest expense at approximately $26 million, and capital expenditures at approximately $90 million.
• Fiscal 2010 included a Valley Fresh plant closure charge: $9.7 million pretax (including asset and employee-related costs) and $6.3 million after tax. The plant in Turlock, California, was expected to close by fiscal year-end. A separate $7.1 million income-tax charge reflected the change in Medicare Part D subsidy tax treatment under new health-care laws.
• Hormel acquired the Country Crock chilled side-dish business effective February 1, 2010; management said integration and results were meeting expectations. The investment in MegaMex also contributed to sales and affiliate earnings.
• Risks highlighted include food-safety incidents, livestock disease, commodity and feed-price volatility, competition, economic conditions, acquisitions, regulation, litigation, environmental matters, labor costs, and international exposure. Management said known legal proceedings were not expected to materially affect financial condition, results, or liquidity.
• Unrecognized tax benefits, including interest and penalties, totaled $39.0 million; audit outcomes and timing of settlement could change this balance, but the filing said the potential change could not be reasonably estimated. 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.

Important facts for investors to verify

• Whether elevated pork, feed, and other input costs, and the durability of favorable cutout margins, changed subsequent-quarter profitability.
• Repayment timing and funding for the $350 million debt maturity, and continued compliance with credit-facility covenants.
• Underlying performance versus reported results, particularly the effects of the $13.4 million combined after-tax unusual charges and other non-GAAP adjustments.
• Working-capital trends, especially inventory and receivables, and whether operating cash flow recovered.
• Progress on the Valley Fresh closure, Country Crock integration, and the stated fiscal 2010 tax, interest, and capital-spending outlook.
• Potential changes in uncertain tax positions and exposure to commodity, food-safety, livestock-disease, and other disclosed risks.