Hormel Foods Corporation

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Hormel Foods First Quarter 2020 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded Thursday, February the 20th, 2020. I would like to turn the conference over to Nathan Ennis, Director of Investor Relations. Please go ahead, Mr. Ennis.

Good morning. Welcome to the Hormel Foods Conference Call for the first quarter of the We released our results this morning before the market opened around 6.30 a.m. Eastern. If you did not receive a copy of the release, you can find it on our website at HormelFoods.com under the Investor section. On our call today is Jim Snee, Chairman of the Board, President and Chief Executive Officer, and Jim Sheehan, Executive Vice President and Chief Financial Officer. Jim Snee will provide an overview of the Sadler's Smokehouse acquisitions, a review of each segment's performance for the quarter, and our outlook for the remainder of 2020. Jim Sheehan will provide detailed financial results and further assumptions relating to our outlook. The line will be open for questions following Jim Sheehan's remarks. As a courtesy to the other analysts, please lend yourself to one question with one follow-up. If you have additional questions, you are welcome to get back into the queue. An audio replay of this call will be available beginning at 11 a.m. today, Central Standard Time. The dial-in number is 888-204-4368, and the access code is 4720526. It will also be posted to our website and archived for one year. Before we get started, I need to reference the Safe Harbor Statement. Some of the comments made today will be forward-looking, and actual results may differ materially from those expressed in or implied by the statements we will be making. Please refer to pages 7 to 9 in 28 in the company's Form 10-K for the year ended October 27, 2019 for more details. It can be accessed on our website. Additionally, please note the company uses non-GAAP results to provide investors with a better understanding of the company's operating performance by excluding the volume and sales impact of the Cytosport divestiture. Discussion on non-GAAP information is detailed in our press release located on our corporate website. Please note that during our call, we will refer to these non-GAAP results as organic volume and organic sales. I will now turn the call over to Jim Snead. Thank you, Nathan. Good morning, everyone. At our Investor Day last October, we outlined our 2020 path forward, which included growing our deli and food service brands as a top priority. This morning's announcement of an agreement to acquire Sadler Smokehouse is another step forward on this initiative. Sadler Smokehouse, based in Henderson, Texas, has been making authentic Hormel has been fortunate to have the Sattler organization as a key supplier for over two decades. When the Sattler family decided it was time to sell the business, they knew Hormel Foods was the company to call. Over the past few months, we've been working on finalizing this deal, and I am personally excited to welcome their brand, products, and team members of the Hormel Foods family. Authentic barbecue remains on trend in the U.S. The number of menu mentions has increased at a strong pace over the past 10 years, and today, barbecue extends well beyond the traditional barbecue restaurant format. With Sadler's as a key supplier, we have been able to capture this favorable trend through our Austin Blues barbecue brand. Austin Blues is a line of genuine, slow-smoked beef pork and chicken products for the food service and deli channels. As one of our premium prepared protein brands, Austin Blues has seen great success and growth. We are doing the difficult work of preparing the product so the operator doesn't have to. However, they still get the flexibility to customize the product with their own signature sauce. We see similarities between this acquisition and the acquisitions of the Burke Corporation in 2008 and Fontanini Italian Meats and Sausages in 2017. Both Burke and Fontanini have been very successful contributors to our food service growth and each has required capacity expansions to keep up with the growing demand. Feathers will strengthen our position in food service and we see a tremendous opportunity to further extend their authentic barbecue products into both the retail and deli channels with our dedicated sales forces, innovation capabilities, and track record of brand stewardship. We expect to close the acquisition in March, and Jim Sheehan will provide more details relating to the financials in his prepared remarks. Now, let's turn to our first quarter results. which were in line with our expectations as we delivered earnings per share of 45 cents. Volume decreased 1%, while organic volume increased 2%. Sales increased 1%, and organic sales increased 4%. Three of our four segments, refrigerated foods, Genio Turkey Store, and international, delivered volume and sales growth. It is encouraging to see Genio Turkey Store deliver a second consecutive quarter of volume, sales, and earnings growth. We have made capital and marketing investments into many brands which are driving these results. These brands include, but are not limited to, BAM, Hormel Black Label, Bocconini, Columbus, Hormel Bacon One, and Hormel Firebraze. Looking at the segments, refrigerated foods grew volume 3% and sales 6%. We generated strong demand across many of our value-added businesses, including retail and food service. In addition to some of the brands I just listed, Hormel Q81 and Hormel Gatherings also showed nice growth. A notable contributor this quarter was Applegate, which is doing really well in both the retail and food service channels with their line of natural and organic products. Their snacking platform is growing with products like the Applegate charcuterie plate made with their natural meats and cheeses. We also feel really good about Applegate's meat and plant blend products and have seen success in the food service channels. We will continue to innovate in this space with new and exciting offerings for consumers. Refrigerated foods grew earnings 3%, led by growth in our food service business and higher commodity profits. Refrigerated foods benefited from lower belly prices during the quarter, but that benefit was offset by significantly higher pork and beef trim prices. While volatility in input costs negatively impacted our retail and deli divisions due to the longer lead times for pricing, our food service team reacted swiftly to the changing market conditions. Our balanced pork supply chain is intentionally designed to take volatility out of our total pork costs during extreme market conditions, and that played out this quarter as expected. While hog market prices were lower during the quarter, the balanced mix of hog contracts and our long-term supply contract at Fremont limited some of the upside profit potential that we may have captured five or 10 years ago. With our new structure to reduce volatility, we didn't capture the entire upside, but we also expect to minimize the downside when opposite market conditions occur. This supply chain is the right structure for our business, and Jim Sheehan will expand upon my comments. Looking forward, the fundamentals in refrigerated foods continue to be very strong. The large categories we compete in, such as pizza toppings and bacon, continue to grow as consumer and operator demand remains favorable. Pizza and bacon are not only ubiquitous in both at-home and away-from-home eating occasions, they are also showing excellent growth. Differentiated brands like Firebraze, Bacon One, Fontanini, Columbus, and Black Label are all outpacing industry growth, and we continue to make long-term investments into those product lines. Studio Turkey Store delivered a second consecutive quarter of volume, sales, and profit growth. Higher volumes and pricing for the commodity and Holberg businesses drove the improved results. Operational improvements across their supply chain also contributed to growth. It is encouraging to see the efforts to realign our cost structure start to pay off, as we described in our recent investor day. and we do expect this trend to continue throughout the year. The sales and marketing teams have done a good job regaining GENEO lean ground turkey distribution. In conjunction with these efforts, we have broadened our advertising campaign for GENEO and continue to see positive results from those investments. We are taking the necessary steps to fully restore our position in the lean ground turkey category. and with two consecutive quarters of growth at Jenny O Turkey Store, we now have strong momentum across the business. Grocery products volume declined 14% and sales declined 11%, primarily due to the divestiture of cytospore. Organic volume decreased 4% and organic sales decreased 1%. We continue to see growth in the SPAM family of products, holy guacamole, and Derdez salsas and sauces, and also expect this trend to continue. We saw lower organic volume during the quarter and attribute some of the decline to the timing of the SNAP disbursement last year. While hard to quantify the exact impact, higher shipments during late January in 2019 did not repeat with the same magnitude this year. Earnings for grocery products declined 28% due to the divestiture of cytosporid, higher raw material costs, a decline in contract manufacturing profits, and lower volumes. Skippy Peanut Butter continued to experience headwinds this quarter as the category was negatively impacted by a competitor's deflationary pricing actions last year. We will lap the pricing declines after the second quarter. And we remain focused on building the Skippy brand through effective promotional strategies, advertising, and continued innovation. Another dynamic in grocery products is our strategy shift on Hormel Chili. Historically, Chili was heavily promoted during the football season. Using revenue growth management, we learned that many of the promotions during this timeframe drove volume but did not provide acceptable returns for us or our retail partners. This year, we made the strategic shift to reallocate some promotional expenses to advertising investments. This shift impacted results in the quarter, but we believe it will ultimately lead to a stronger and more profitable Hormel Chili brand for us and our retail partners. International volume and sales increased for the quarter, primarily due to fresh pork exports and strong growth in China. However, segment profit declined by 20% as significantly higher pork prices negatively impacted our businesses in China and Brazil. In addition to our affiliated businesses, in South Korea and the Philippines. Our global team continues to take the necessary pricing actions to offset cost increases. Like the rest of the world, we are monitoring the coronavirus outbreak in Asia. First and foremost, we are concerned for the safety of our employees in the region. We are working closely with our management team in China as the situation unfolds. Our team members across all functions of our business in China, from sales and marketing to plant professionals, observed the extended Lunar New Year holiday and started to return to work as of February 10. However, we still have a majority of our employees who have not returned to work due to self-quarantine and transportation restrictions. Similar to other companies in China, all aspects of our in-country supply chain are operating more slowly and at higher cost than normal. From a sales perspective, the demand for our food service products, which represent the majority of our sales in China, has dropped off considerably as patrons are not eating out. On the other hand, we have seen a large uptick in retail sales of shelf-stable products like Spam and Skippy, as consumers dying at home. We do expect a very difficult second quarter for international, primarily due to the impact of the coronavirus. However, if the outbreak is contained soon, the second half of the year could be more favorable as we refill the sales pipeline and get our plants back to running at full speed. Taking all these factors into account, We are maintaining our full year earnings guidance at $1.69 to $1.83 per share and our sales guidance at $9.5 to $10.3 billion. At this time, I will turn the call over to Jim Sheen to discuss our financial information relating to the quarter and key assumptions for fiscal 2020. Thanks, Jim. Good morning. Net sales for the quarter were $2.4 billion, up 1%. Organic net sales were up 4%, with three to four segments showing growth. Pre-tax earnings were $290 million, down 5%. The decline was driven primarily by the sale of situs work. The effective tax rate was 16.3% compared to 21.3% last year. The rate was impacted by the large volume of stock option exercises in the quarter. This is a timing issue and does not impact our expected full-year tax rate, which remains between 20.5% and 22.5%. Earnings per share for the quarter was 45 cents, one cent above last year and in line with our expectations. For the quarter, SG&A, excluding advertising with 6.7% of sales, compared to 7.1 percent, excluding the two-cent legal settlement benefit in 2019. Net unallocated expense for the quarter decreased by $9.7 million. Last year, we incurred expenses associated with the Fremont sale. We expect net unallocated expense to be between $40 and $60 million for the year. Advertising investments for the quarter were $35 million. up from $34 million, excluding Cytospor. Operating margins were 11.8% compared to 13% last year. Lower gross margins for grocery products was the primary driver. We generated cash from operations of $188 million during the quarter, a 1% increase. We paid our 366th consecutive quarterly dividend effective February 18th. at an annual rate of 93 cents per share, an 11% increase over 2019. Capital expenditures were $58 million. We expect capital expenditures for the year to be approximately $360 million. Large capital projects include the Burke Facility expansion, which will be completed in the summer, a new Columbus dry sausage facility, and Project Orion. Working capital increased as we continued to build inventory in anticipation of the upcoming relocation of the value-added production lines from Fremont to other Hormel facilities and higher input costs due to African swine fever. The company did not repurchase stock in the first quarter. As Jim mentioned, we announced the acquisition of Sadler's early this morning. The purchase price is $270 million dollars with a $40 million cash tax benefit. This makes the effective purchase price $230 million. The deal includes the Sadler's brand and a production facility in Henderson, Texas. The acquisition will be funded with cash on hand and will report into the refrigerated food segment. The transaction is an asset deal which results in the $40 million cash tax benefit from the asset valuation step-up. Hormel is one of the largest customers of Sadler's as they produce numerous items for our Austin Blues product line. Annual sales excluding Hormel are approximately $140 million. Sadler's operating margins are in line with the total company average. We estimate this deal will be neutral to slightly dilutive in 2020 as we plan to make immediate investments into the business and production facilities. In total, raw material costs were up from last year with volatility across many commodities which can shift profitability between quarters. As a reminder, approximately half of our pork raw materials are sourced through the purchase of hogs and half are sourced externally based on primal values. Our cost of hogs increased over last year driven by two factors. Hogs purchased on the cutout formula were above last year and significantly exceeded the spot market. We also experienced higher costs for hogs purchased on future contracts. Hogs purchased on market-based formulas were down from last year, but not enough to offset the cutout formula in future contracted hogs. USDA composite value of hogs increased 12% over last year. This is the valuation method for raw materials contracted through our former Fremont facility. Our strategic shift to purchase pork raw materials at market prices through a long-term partnership with Fremont was a key driver to the reduction in volatility. However, due to strength in the trim and ham markets, total pork costs through this partnership were higher than last year. Beef and trim markets were up from last year. bellies were down in the quarter. We have previously discussed price in action in refrigerated foods retail and deli lagged the market by 30 to 45 days. The outlook for the remainder of 2020 assumes higher protein prices for key inputs with periods of volatility. As we look at the fundamentals in the hog industry, the most recent USDA supply and demand report estimates a 4.5% increase in production and a more than 15% increase in exports. The forecasted additional supply of pork is in line with the increase in export demand. Pork in cold storage was at record levels at the end of the year. African swine fever continues to impact global hog supply in China, Southeast Asia, and Europe. Worldwide demand for U.S. pork remains high, with the industry setting an all-time record for exports in December. Recently, we have seen downward pressure on domestic hog and pork prices. Since the start of our second quarter, market hogs in the USDA composite value have declined by more than 10%. Bellies and pork trim have been lowered by as much as 30%. The outbreak of the coronavirus in China may be a contributing factor. Turkey market conditions continue to improve as industry measures show bulk placements down 3% for 2019. Overall turkey inventory in cold storage is down 23% compared to last year, with breast meat inventory down 18%. Feed costs for the first quarter were flat last year. We anticipate higher feed costs for the remainder of the year, driven by lower levels of protein in the corn crop relative to prior years. This is requiring us to reformulate our feed with higher cost ingredients. We began the implementation of Project Orion in January with the global rollout of the Oracle Human Capital Management System, which updates our payroll, benefits, talent management, and workforce management. Additional integrations for finance and supply chain are taking place throughout 2020. Incremental costs associated with the phased implementation are fully reflected in the guidance for the year. At this time, I'll turn the call over to the operator for the question and answer portion of the call.

Thank you. If you would like to ask a question, please signal by pressing start button on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach your equipment. Press star 1 to ask a question. And now we take our first question from Benjamin Serrer from Berkeley. Hey, good morning.