Hormel Foods Corporation

Good morning. Welcome to the Hormel Foods conference call for the second quarter of fiscal 2020. 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 Snead, Chairman of the Board, President and Chief Executive Officer, and Jim Sheehan, Executive Vice President and Chief Financial Officer. Jim Sneem will provide an overview of the company's response to the COVID-19 pandemic, a review of the company's current and future operating condition, and commentary regarding each segment's performance for the quarter. Jim Sheehan will provide detailed financial results and commentary regarding the company's current and future financial condition. The line will be open for questions following Jim Sheehan's remarks as a courtesy to the other Analyst, please limit yourself to one question with one follow-up. If you have additional questions, you are welcome to get back to 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 888-254-3590, and the access code is 7355932. 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 30 through 35 in the company's form of 10-Q for the fiscal quarter ended January 26, 2020. in addition to a supplemental risk factor related to the COVID-19 pandemic included in our Form 8-K file this morning. Both 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. These non-GAAP measures include organic volume, organic sales, adjusted pre-tax earnings, adjustment diluted earnings per share, and operating free cash flow. Discussion on non-GAAP information is detailed in our press release located on our corporate website. I will now turn the call over to Jim Snee. Thank you, Nathan. Good morning, everyone. First off, I want to take this opportunity to express my sincere appreciation for to the essential workers showing up every day in food manufacturing facilities across the industry. They should be recognized for the heroic and purposeful work they are doing, and they have my most sincere appreciation and gratitude. I also want to acknowledge the food industry employees who are showing their commitment every day with the work they do, whether it be at grocery stores, food pantries, restaurants serving patrons or takeout, delivery, or curbside pickup. And of course, a big thank you to the healthcare workers and first responders who are keeping all of us safe. Throughout this pandemic, our number one priority has been to keep our team members safe, especially those who are not in a position to work remotely. Our COVID leadership team, including operations, quality control, communications, legal, R&D, and human resources have worked tirelessly to ensure we have the appropriate enhanced safety measures in place, including personal protective equipment for all plant team members, temperature and wellness screenings, frequent disinfecting of high touch areas, reconfiguration of common areas and workstations, revised shift scheduling, reducing production line speeds, new guidelines on carpooling, more extensive social distancing measures throughout each facility, and, where possible, providing remote work opportunities and improved access to COVID-19 testing. I am continually amazed in our management team's ability to find innovative ways to enhance employee safety in our facilities. Throughout this crisis, we have also been transparent with our team and the public about all we are doing to put safety first. As part of our industry-leading safety measures, we have also developed an awareness campaign we call Keep COVID Out. a program that reinforces various preventative measures at our production facilities and in the communities where we live and work. As a global branded food company, we play a critical role in providing safe, high-quality food during this unprecedented time. As we all know, it has not been business as usual over the past several weeks, and we will likely be in this new normal for some time. I am very proud of how all our team members have stepped up and reacted to the rapidly changing dynamics in our industry. Before I get into the quarterly results, I want to take a moment to tell you a few things about our approach over the last several weeks that really stand out for me. I've told our team that we were made for this, and the following are examples of what really makes this company so uncomfortable. As we progressed into the initial stages of the pandemic, our senior leadership team agreed that we would do everything we could to protect the jobs of our thousands of team members. Each day, I heard examples of our supply chain team going above and beyond to shift production between plants or relocate where certain jobs could be done. In many cases, these changes had never been done before. Balancing workloads across plants in the manner we did was not the most cost-effective decision, but it was the right decision. Another example of what makes this company uncommon is our commitment to making the best long-term decisions for our team members, suppliers, customers, and shareholders. Because of our stable cash flows and strong balance sheet, We will not neglect any strategic investments during this uncertain time. We have completed a comprehensive review of our capital projects and in some cases have slightly delayed project completion because the additional capacity isn't needed right now. However, we continue to move forward with many investments that will enhance our long-term performance. One such investment is Project Orion. Our team's ability to effectively and efficiently work remotely has allowed us to keep Project Orion on track, and we have made the decision to go live on our financial system update in June. I know everyone on our finance team is committed to making the important cutover a success. We are confident we will see the benefits from our financial system go live, just as we are seeing from our HR system upgrade completed in January. I also want to take a few minutes to highlight key areas that are helping us weather this storm. First, our creation of one supply chain three years ago has been instrumental in helping us manage this crisis from one pivot point at an executive level. The quick decisions we made early on could not have been made in the same way if we were operating four or five different supply chains. Second, the significant investments we made several years ago in our e-commerce team, infrastructure, and capabilities positioned us to quickly grow in this emerging channel. During the quarter, our tracked purchases through IRI were up over 100%, and our brands are significantly outpacing category growth and capturing market share in many categories across both center store and perimeter. Finally, our decision late last year to transition the entire enterprise to one IT platform made virtual coordination much easier than it otherwise would have been. While our decision to transition right before the pandemic was serendipitous, Our IT services group deserves a lot of credit for seamlessly transitioning thousands of team members to working remotely in less than a week. Now looking at our sales results for the quarter, the balance we have purposely built into our business is a competitive advantage that has allowed us to perform well in many different economic situations, including the current crisis. For the quarter, volume increased 4% and organic volume increased 7%. We delivered record sales for the quarter with an increase of 3%. Organic sales increased 6% and three of our four segments delivered increases in sales. From a channel perspective, total retail sales increased 16% during the quarter. We saw multiple different waves of demand in our retail businesses as the pandemic has unfolded. In the first wave, we saw tremendous demand for nearly all of our center store brands. Our initial assessment was consumers were stocking up, but as the weeks progressed, we continue to see sustained double-digit increases. The second wave of demand took place as shelter-in-place restrictions were enacted across the country and consumers shifted from dining in restaurants to purchasing more perishable products across the perimeter of the store. We continue to see perimeter sales increase at double-digit rates over last year. Throughout the escalation in demand, we've seen a large increase in the number of new buyers and households purchasing our branded products. What I'm particularly proud about is the number of new buyers that are making repeat purchases of our brands. This is an important leading indicator as consumers are using our products, enjoying the experience, and repurchasing our brands. I'm also encouraged by our team's ability to capture share in channels that were open and available, namely the retail channel. From a total company perspective, we significantly outperformed the category, private label, other large brands, and small brands. Our ability to capture market share is a testament to our brands and direct sales force. and also to our operations and supply chain team's ability to ensure our products are on the shelf. One dynamic from the pandemic that is affecting all of us is what is happening across the food service industry. It's heartbreaking to see distributors, restaurants, hotels, and many other food service venues struggle to survive. I've seen estimates of thousands of restaurants across the United States could close as a result of this crisis. Every entrepreneur behind each restaurant has a unique story of why and how they chose to open their restaurant. Many of these restaurateurs are community members trying to make their neighborhood a better place to live and work. And these closings are tragic. Our food service divisions have been doing their part to help the food service industry. Within days of the crisis, our formal food service group offered a rebate program to help offset operators' food costs. This program was successful and exceeded our expectations. We're also working very closely with our distributor partners to support their needs and have recently received accolades for our efforts. And finally, we've talked a great deal about how our direct sales force is a distinct competitive advantage, and no time is that more true than right now. Our sales team has been on the virtual front lines, helping operators quickly adjust to takeout, delivery, and curbside pickup with best-in-class guides and tips, and sometimes being the only supplier to personally check in with a restaurateur during this difficult time. Like others in the industry, we saw a sharp decline in our food service business starting in late March. For the quarter, our enterprise food service sales were down 21%. As you think about our domestic food service business, it is primarily sold through the refrigerated foods and Genio turkey store segments. Prior to the outbreak, our food service business represented approximately 40% of sales in both segments. And the majority of our operator customers are in key segments, such as mid-scale and casual dining, lodging, K-12 schools, colleges and universities, and healthcare. Each food service segment is experiencing different dynamics during the shelter-in-place restriction. and each will have a different recovery timeline coming out of the pandemic. Even though it is early in the third quarter, we are starting to see orders picked up across our food service businesses. From a financial perspective, we delivered earnings per share of 42 cents. Jim Sheehan will provide more details of the moving pieces But I do want to mention that our earnings fully reflect $0.05 per share in investment losses and increased supply chain costs related to COVID-19. The high-level dynamic during the quarter was similar in each segment, namely demand shifts from food service to retail and higher operational costs. However, each segment did experience some unique circumstances, and I want to highlight those areas. Grocery products volume increased 7%, and sales increased 8%. Organic volume increased 19%, and organic sales increased 20%. We saw exceptional growth from nearly every brand. with some products delivering very strong double-digit growth, including the Spam family of products, Skippy peanut butter, and Hormel chili. Two keys to grocery product success during the quarter was the sales and marketing team's focus on limiting production to our priority high-volume items and frequent conversations with our customers regarding assortment and product availability. We know our center store brands are perfectly suited for valued consumers who need affordable, high-quality products for their families. With millions of Americans now unemployed, our shelf-stable products are as important to consumers as they've ever been. Earnings for grocery products increased 22% despite the divestiture of Cytosport last year. Strong volumes and improved mix were the key drivers to the double-digit increase. Genio Turkey Store delivered a strong quarter with volumes up 19%, sales up 12%, and segment profit up 54%. Strong retail, whole bird, and commodity sales more than offset declines in food service. The Genio sales and marketing group made excellent progress, regaining distribution prior to the pandemic, which put them in a strong position to succeed. During the quarter, Genio lean ground turkey sales increased by double digits. Higher sales and operational improvements across the supply chain were the key drivers to earnings growth. International volume decreased 2% and sales increased 2%. Branded exports, primarily spam, offset declines in our China food service business. Segment profit increased 62% due to higher branded export margins and increased income from affiliates. I'm pleased to report our China plant operations are now fully up and running to support our retail and food service businesses as the country continues on its path for reopening. Our food service business in China is improving off the lows we saw during the pandemic, and we are seeing very strong demand from Spam, Skippy, and our refrigerated products at retail. The team in China is working through higher pork prices but are taking the necessary pricing actions to offset cost increases. Refrigerated foods volume was flat, and organic volume was down 1%. Sales decreased 1%, and organic sales declined 3%. Retail demand was led by products such as Hormel Black Label Bacon, Applegate Natural and Organic Products, Columbus Grab and Go Charcuterie, and Hormel pepperoni. We also finalized the acquisition of Sadler's Smokehouse during the quarter. The majority of Sadler's sales are into the food service channel, but I've been impressed by the way in which this team has quickly pivoted their production to meet the growing needs in retail. One unique trend we are seeing in the marketplace is consumers searching for products that can replace a restaurant experience. Brands like Sadler's Smokehouse and Lloyd's Barbecue fit that need perfectly. In fact, our retail lines at Sadler's and Lloyd's have been operating at capacity to meet the demand for their products. Our food service business saw double-digit declines during the quarter. However, we are very confident that as the food service industry starts to open up, Our product lines featuring pre-cooked, pre-sliced, and pre-marinated products will thrive as operators look to simplify preparation and reduce handling of products. Our deli business experienced consumer dynamics that were a blend between retail and food service. Products like Columbus Grab and Go charcuterie performed well as consumers searched for unique and flavorful products. We did see declines in the behind-the-glass and prepared food businesses as many retailers closed these areas to redeploy labor to other sections of the store. Earnings were down 17% due to lower food service sales and higher operational costs as we paused production at two plants during the quarter. Jim Sheehan will provide more details regarding input cost volatility the refrigerated foods team experienced during the quarter. As we look forward, we are withdrawing our full-year sales and earnings guidance. The decision to withdraw guidance reflects uncertainty created by COVID-19 in several key areas, including consumer behavior at retail and food service, volatility in our input costs, and supply chain disruptions. Our team is focused on these indicators to guide our decisions and investments in the coming weeks and months. First, we are paying close attention to consumer behavior across our entire portfolio. We're watching consumer buying patterns in the retail channel with metrics such as household penetration and repeat rates. We're also watching how consumers emerge from shelter-in-place restrictions across the country and re-engage the food service industry. In addition to monitoring restaurant traffic, we're observing how other segments in the food service industry, such as lodging, colleges and universities, and K-12 education, reopen. We're also actively managing through the volatility we're seeing in raw material markets. As I mentioned, Jim Sheehan will provide a detailed assessment of the hog and pork industry, but the recent periods of operational pause and startup in processing facilities across the industry are creating dramatic swings in input costs. I have the highest confidence in our ability to pass along the necessary pricing, but we may experience short-term margin compression or expansion. as raw material markets adjust to the rapid changes in supply and demand. Finally, while we have implemented industry-leading safety measures, we have experienced operational challenges at some of our facilities due to COVID-19, and we are strategically managing through operational disruptions on a daily basis. These operational disruptions have led to incremental supply chain costs. During the second quarter, our costs increased by approximately $20 million, primarily related to team member bonuses, enhanced safety measures, and lower production volumes. In the second half, we expect to incur another $60 to $80 million of incremental costs that are temporary, and these costs will be weighted to the third quarter. In closing, I want to emphasize three points. First, our company was built for this. We have the right strategy, sound business fundamentals, best-in-class management, and the financial strength to thrive in this dynamic marketplace. We will not do anything to jeopardize our strong financial position. We are well equipped to weather this storm and will be stronger because of it. Third, we have said from the very beginning of this pandemic that our goal was to do our best to do everything right. From people safety to supporting our partners and customers to ensuring America has food on its shelves, to donating millions of dollars and millions of meals to hunger-related causes. Everything we are doing is in perfect alignment with our purpose of inspired people, inspired food. At this time, I will turn the call over to Jim Sheehan to discuss our financial information relating to the quarter, provide commentary regarding key input cost markets, and an update on our financial position.

Thank you, Jim. Good morning. Net sales increased 3% to $2.4 billion, a record for the second quarter. Organic sales were up 6%. Segment profit increased 5% to $310 million. As double-digit growth from grocery products, Genio Turkey Store and International more than offset a decline in refrigerated foods. Pre-tax earnings were $286 million, down 10%. Excluding the Cytosport gain last year, adjusted pre-tax earnings declined 5%. This decrease included significant losses on investments. The effective tax rate was 20.6% compared to 11.1% last year. Last year's rate benefited from a tax gain on the Cytosport sale. Earnings per share for the quarter was 42 cents, down 19%. Adjusted earnings per share was down 9%. Selling, general, and administrative expenses increased year over year. Lower expenses last year were due primarily to the gain from the Cytospart sale. Advertising for the quarter was $35 million, flat to last year. Net unallocated expenses for the quarter increased $46 million. The increase was due primarily to $16 million related to the Cytosport pre-tax gain and $19 million in lower investment results from last year. Operating margins were 12.1% compared to 13.3% last year. Additional costs included the important investments in COVID-19-related employee safety measures and production professional bonuses. Both reflect our commitment to our production professionals and ensuring their safety. The company continued to generate strong and stable cash flows despite the impact of COVID-19. Cash flow from operations and free cash flow more than doubled in the quarter compared to the prior year. We recently renewed our self-stable registration statement and are considering near-term opportunities to access the debt market at favorable interest rates to provide ample liquidity to take advantage of strategic opportunities. The company's strong cash flow and balance sheet along with the investment grade credit rating allows us to manage risk as well as make strategic and long-term investments to drive shareholder return even in times of uncertainty. We are confident we will remain in a strong position to fund our capital needs including the dividend, capital expenditures, and pension contributions as we grow the business. We paid our 367th consecutive quarterly dividend effective May 15th at an annual rate of $0.93 per share. an 11% increase over 2019. Capital expenditures in the quarter were $80 million compared to $48 million last year. Large projects for the remainder of the year include the Burke Pizza topping plant expansion, a new dry sausage facility, and Project Orion. The company's target for capital expenditures in 2020 is $340 million. We completed the purchase of Sadler's Smokehouse for $269 million during the quarter using cash on hand. Share repurchases in the quarter were $12 million, representing 300,000 shares. We repurchased stock to offset dilution from stock option exercises and based on our internal valuation. The quarter was impacted by contrasting dynamic forces. Within an eight-week period, the industry experienced the decline in food service demand, creating an oversupply of protein. This was quickly followed by plant disruptions, which resulted in significant protein shortages. At the peak in early May, the industry was operating at 40% below capacity. The changing dynamics of supply and demand caused harsh slings in hog and commodity values, which have continued into the third quarter. To illustrate the volatility, the USDA composite pork cutout declined 40% from March 23rd to April 9th. Since April 9th, prices have increased by as much as 140% to levels not seen since DEDV in 2014. Likewise, bellies have traded between $40 and $270 per hundredweight since the beginning of April. Beef trim traded at both 10-year lows in 10-year hives over the same period. The most recent USDA supply and demand report estimates a 1% decline in hog production for the year, after estimating a 5% increase in the prior month's report. We feel the hog and commodity values in the near term will be determined by industry processing capacity. Additional plant disruptions will depress hog values and increase commodity values. Alternatively, if the industry is capable of operating at near capacity levels, hog prices and commodity values should moderate. Worldwide demand for pork remains strong. We continue to monitor African swine fever in China, Southeastern Asia, and Europe. According to the USDA, exports are expected to increase greater than 10%. In the near term, we are closely analyzing two key factors, hog processing levels and consumer confidence as restaurants reopen. We are currently using multiple predictive analytic models to monitor and forecast both factors. We are actively managing industry capacity issues by leveraging the three ways we source raw materials, internal processing, contracted sourcing, and purchasing primals on the open market. The supply chain strategy is designed to mitigate volatility, though margins could expand and contract as pricing lags, changes in cost. This can shift profitability between quarters. Fundamentals in the turkey industry were mixed in the second quarter, but recent data indicates improving conditions. Consistent with the park industry, in the near term we are focused on the ability to maintain turkey operations in the industry and add our facilities. Hole placements in the last six weeks have experienced meaningful declines. This should continue to reduce cold storage levels, which had already significantly declined. We expect whole bird pricing to remain elevated compared to last year for the remainder of the year. Turkey breast pricing was significantly lower in the second quarter, but pricing has improved in the third quarter. We successfully implemented the Oracle Human Capital Management System of Project Orion in January. As Jim Stee said, our team is credited with advancing Project Orion as we work remotely with minimal project delays. We are proceeding with the Finance Go Live in June. Our team is already benefiting from enhanced analytics and improved demand planning. In June, we will introduce additional capacities such as robotic process automation and real-time data integration. Further implementation for the supply chain will take place later in 2020 and 2021. At this time, I'll turn the call over to the operator for the question and answer portion of the call.

If you would like to ask a question at this time, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. Pause for just a moment to allow everyone an opportunity to signal for questions. Our first question from Tom Palmer with J.P. Morgan.