Hormel Foods - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

HORMEL FOODS CORPORATION

1 Hormel Place
Austin, Minnesota 55912-3680
Telephone - (507) 437-5611

None

(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

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PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

HORMEL FOODS CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(In Thousands of Dollars)

See notes to consolidated financial statements

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HORMEL FOODS CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(In Thousands of Dollars)

See notes to consolidated financial statements

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HORMEL FOODS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
(Unaudited)

See notes to consolidated financial statements

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HORMEL FOODS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands of Dollars)

(Unaudited)

See notes to consolidated financial statements

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HORMEL FOODS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (In Thousands, Except Per Share and Percentage Amounts)

(Unaudited)

NOTE A                 GENERAL

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Operating results for the interim period are not necessarily indicative of the results that may be expected for the full year.  The balance sheet at October 30, 2004, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 30, 2004.

Stock-Based Compensation

In the fourth quarter of fiscal 2003, the Company adopted the fair value method of accounting for employee stock options in accordance with Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”  At that time, the Company elected to use the prospective method to recognize stock-based compensation expense.  The Company has continued to use the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for employee stock options granted prior to fiscal year 2003.  Based on that methodology, the Company recognized $1,196 and $2,098, net of tax, for stock options expense in the three and six month period ended May, 1, 2005, respectively.

In the first quarter of fiscal 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment.”  In April 2005, the Securities and Exchange Commission (SEC) issued further guidance delaying the effective date of this pronouncement.  Based on the SEC guidance, the Company will adopt the statement in the first quarter of fiscal 2006.  The provisions of the statement require that the Company begin expensing options using the modified-prospective transition method at that time.  As a result of beginning to expense grants issued prior to fiscal 2003 that will not be fully vested at that time, the Company will incur an immaterial amount of additional expense in the first quarter of fiscal 2006 than previously projected under the prospective method.

In calculating the fair value of options granted in fiscal 2005, the Company has increased the expected life assumption to 8.0 years from 7.0 years used in 2004.  Additionally, the Company reduced the volatility assumption to 22.0% from 24.4% used in 2004.

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Pro forma amounts as if the Company had used the fair value method in accounting for employee stock options are as follows:

Guarantees

The Company enters into various agreements guaranteeing specified obligations of affiliated parties.  Currently, the Company provides a standby letter of credit for obligations of an affiliated party that may arise under worker compensation claims.  The Company’s guarantees either terminate in one year or remain in place until such time as the Company revokes the agreement.  Total guarantees provided by the Company, as of May 1, 2005, amounted to $1,940.  These potential obligations are not reflected in the Company’s consolidated balance sheet.

New Accounting Pronouncements

In March 2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107 to provide supplemental guidance in adopting SFAS No. 123 (revised 2004).  The bulletin provides guidance in accounting for share-based transactions with non-employees, valuation methods, the classification of compensation expense, accounting for the income tax effects of share-based payments, and disclosures in Management’s Discussion and Analysis subsequent to the adoption of SFAS No. 123 (revised 2004).  The Company is evaluating this guidance in conjunction with the adoption of SFAS No. 123 (revised 2004) and does not expect the bulletin will have a material impact on the Company’s results of operations or financial position.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation,” and supercedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.”  The statement requires that entities measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, as calculated using an accepted valuation model.  In addition, the statement rescinds the use of the prospective transition model for expensing employee stock options.  The expected impact of adopting this statement is discussed above under the heading “Stock-Based Compensation.”

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In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – an amendment of ARB No. 43, Chapter 4.”  The statement requires that idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as a current-period charge to earnings.  Previous guidance mandated that these costs be charged to earnings on a current basis only under certain circumstances.  The statement is effective for annual periods beginning after June 15, 2005, and adoption is not expected to have a material impact on the Company’s results of operations or financial position.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – an amendment of APB Opinion No. 29.”  The statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange.  The statement is effective for fiscal periods beginning after June 15, 2005, and adoption is not expected to have a material impact on the Company’s results of operations or financial position.

NOTE B                 ACQUISITIONS

On December 29, 2004, the Company purchased all of the outstanding stock of Clougherty Packing Company (Clougherty), for $188.3 million in cash, including related costs.  Clougherty was a privately held Southern California pork processor and is the maker of the Farmer John brand of pork products popular throughout the Southwestern United States.  The acquisition is expected to strengthen the Company’s presence in that geographic area and complements many of the Company’s existing product families.  Clougherty’s operating results are reported in the Refrigerated Foods segment.  Allocation of the purchase price, including related costs and an accrual of $10,000 related to final closing adjustments that will be paid during the third quarter, is presented in the table below.  The allocation is preliminary, pending completion of Clougherty’s annual audit and post-closing working capital adjustments.

On January 31, 2005, the Company acquired Arriba Foods, Inc. (a/k/a Mexican Accent), for $48.0 million in cash, including related costs.  Based in New Berlin, Wisconsin, Mexican Accent manufactures and distributes a wide variety of premium Mexican flour tortillas, corn tortillas, salsas, seasonings, and tortilla chips for retail markets and the foodservice industry.  These products are marketed under the Manny’s,Gringo Pete’s, and Mexican Accent brands, and are expected to strengthen the Company’s presence in the ethnic products category.  Mexican Accent’s operating results are reported in the Grocery Products segment.

On March 30, 2005, the Company acquired privately held Mark-Lynn Foods Inc. (Mark-Lynn) of Bremen, Georgia, for $43.2 million in cash, including related costs.  Mark-Lynn manufactures and distributes a wide array of food products including salt and pepper packets, ketchup, mustard, sauces and salad dressings, creamers, sugar packets, jellies, desserts, and drink mixes.  Mark-Lynn will be managed by the Diamond Crystal Brands business unit, and enhances the Company’s foodservice focus within the Specialty Foods segment.

On April 4, 2005, the Company completed the acquisition of Lloyd’s Barbeque Company (Lloyd’s), for $50.1 million in cash, including related costs.  Lloyd’s has manufacturing operations in St. Paul, Minnesota, and offers a full range of barbecue products including original shredded pork, chicken and beef tubs, honey hickory shredded pork and chicken, barbecue pork spareribs, beef backribs, and pork babyback ribs, all under the Lloyd’s brand name.  Lloyd’s products complement the Company’s existing offerings within the Refrigerated Foods segment, and is expected to enhance market share, particularly in the retail refrigerated entrée category.

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Operating results for each company above are included in the Company’s Consolidated Statement of Operations from the date of acquisition.  Pro forma results of operations are not presented, as the effects of each acquisition are not considered individually material to the consolidated Company.

NOTE C                 GOODWILL AND INTANGIBLE ASSETS

The changes in the carrying amount of goodwill for the three and six month periods ended May 1, 2005, are presented in the tables below.  Goodwill acquired during the quarter in the Grocery Products, Refrigerated Foods, and Specialty Foods segments represents the preliminary purchase price allocation for the Mexican Accent, Lloyd’s Barbeque Company, and Mark-Lynn Foods acquisitions, respectively.  Purchase accounting adjustments for the quarter relate to the Clougherty acquisition made in December 2004, and include fair value adjustments on inventory, fixed assets, and intangible assets, net of a $10,000 accrual related to final closing adjustments that will be paid during the third quarter.

The gross carrying amount and accumulated amortization for definite-lived intangible assets are presented below.  The increase for the six months ended May 1, 2005, represents the preliminary valuation of intangible assets acquired from Clougherty and Mexican Accent.

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Amortization expense was $2,200 and $4,223 for the three and six months ended May 1, 2005, respectively, compared to $1,750 and $3,500 for the three and six months ended April 24, 2004.  Estimated annual amortization expense for the five fiscal years after October 30, 2004, is as follows:

The carrying amounts for indefinite-lived intangible assets are presented in the table below.  The increase for the six months ended May 1, 2005, represents the preliminary valuation of trademarks and other indefinite-lived intangibles acquired from Clougherty and Mexican Accent.

NOTE D                 SHIPPING AND HANDLING COSTS

Shipping and handling costs are recorded as selling and delivery expenses.  Shipping and handling costs were $85,175 and $168,578 for the three and six months ended May 1, 2005, respectively, compared to $72,334 and $145,340 for the three and six months ended April 24, 2004.  The increase is primarily due to higher fuel related charges as compared to the prior year, as well as increased shipping and handling costs associated with acquisitions made in the current year.

NOTE E                 EARNINGS PER SHARE DATA

The following table sets forth the denominator for the computation of basic and diluted earnings per share:

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NOTE F                 COMPREHENSIVE INCOME

Components of comprehensive income, net of taxes, are:

In fiscal 2004, the unrealized loss on available-for-sale securities and the foreign currency translation adjustment were a result of the Company’s second quarter sale of its investment in Campofrio Alimentacion, S.A.

NOTE G                 INVENTORIES

Principal components of inventories are:

NOTE H                 DERIVATIVES AND HEDGING

The Company uses hedging programs to manage risk associated with commodity purchases and certain foreign currency transactions.  These programs utilize futures contracts and swaps to manage the Company’s exposure to price fluctuations in the commodities markets and fluctuations in foreign currencies.

Cash Flow Hedges:  The Company from time to time utilizes corn and soybean meal futures to offset the price fluctuation in the Company’s future commodity purchases.  The Company has entered into various NYMEX-based swaps to hedge the purchase of natural gas at certain plant locations.  The Company also utilizes currency futures contracts to reduce its exposure to fluctuations in foreign currencies related to the receipt of royalties that are computed in British pounds.  The financial instruments are designated and accounted for as cash flow hedges, and the Company measures the effectiveness of the hedges on a regular basis.  The Company has determined its hedges to be highly effective.  Effective gains or losses related to these cash flow hedges are reported as other comprehensive income (loss) and reclassified into earnings, through cost of products sold (commodity positions) or net sales (currency futures), in the period or periods in which the hedged transactions affect earnings.  The Company typically does not hedge its commodity purchases beyond 18 months and currency exposure beyond 12 months.

As of May 1, 2005, the Company has included in accumulated other comprehensive loss hedging gains of $687 (net of tax) relating to its positions.  The Company expects to recognize the majority of these gains over the next twelve months.  Losses in the amount of $1,050 and $3,637, before tax, were reclassified into earnings in the three and six months ended May 1, 2005, respectively.

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Fair Value Hedges: The Company utilizes futures contracts to minimize the price risk assumed when forward priced contracts are offered to the Company’s commodity suppliers.  The intent of the program is to make the forward priced commodities cost nearly the same as cash market purchases at the date of delivery.

The futures contracts are designated and accounted for as fair value hedges, and the Company measures the effectiveness of the hedges on a regular basis.  The Company has determined its hedge programs to be highly effective.  In the second quarter of 2005, the Company recorded an immaterial amount of ineffectiveness to earnings related to hedge positions.  Changes in the fair value of the futures contracts, along with the gain or loss on the hedged purchase commitment, are marked-to-market through earnings and are recorded on the consolidated statement of financial position as a current asset and liability, respectively.

As of May 1, 2005, the fair value of the Company’s open futures contracts was $916.  Gains on closed futures contracts in the amount of $445 and $1,429, before tax, were recognized in earnings during the three and six months ended May 1, 2005, respectively.

NOTE I                  PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

Net periodic benefit cost for pension and other postretirement benefit plans for the three and six months ended May 1, 2005 and April 24, 2004 consists of the following:

During the third quarter of fiscal 2004, the Company determined its prescription drug plan to be actuarially equivalent to Medicare Part D, based on an analysis of the net company cost, and adopted the provisions of the Medicare Prescription Drug, Improvement and Modernization Act of 2003.  This resulted in a reduction of the Company’s accumulated postretirement benefit obligation of $41,451.  That amount represents an actuarial gain that is being amortized over future service periods.  Any subsidies or reductions in covered claims will reduce periodic service costs.  Future guidance issued by the federal government for determining actuarial equivalency could require the Company to review this determination and change previously reported information.

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NOTE J                 SEGMENT REPORTING

The Company develops, processes, and distributes a wide array of food products in a variety of markets.  Under the criteria set forth by the accounting standard SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company reports its results in the following five segments: Grocery Products, Refrigerated Foods, Jennie-O Turkey Store, Specialty Foods, and All Other.

The Grocery Products segment consists primarily of the processing, marketing, and sale of shelf-stable food products sold predominantly in the retail market.  This segment also includes the results of Mexican Accent, which was acquired in the second quarter of fiscal 2005.

The Refrigerated Foods segment includes the Meat Products and Foodservice business units.  The segment consists primarily of the processing, marketing, and sale of branded and unbranded pork products for the retail, foodservice, and fresh customer markets.  This segment also includes the Precept Foods, LLC operation, which offers fresh case-ready pork and beef products to its retail customers.  Precept Foods, LLC is a 51 percent owned joint venture between Hormel Foods Corporation and Cargill Meat Solutions Corporation (formerly Excel Corporation), a wholly owned subsidiary of Cargill, Incorporated.  Clougherty Packing Company, which was acquired on December 29, 2004, is also included in this segment.  The Meat Products business unit also includes the results of operations for Lloyd’s Barbeque Company, which was acquired in April 2005.

The Jennie-O Turkey Store segment consists primarily of the processing, marketing, and sale of branded and unbranded turkey products for the retail, foodservice, and fresh customer markets.

The Specialty Foods segment includes the Diamond Crystal Brands, Century Foods International, Hormel HealthLabs, and Specialty Products operating segments.  This segment consists of the packaging and sale of various sugar and sugar substitute products, salt and pepper products, dessert mixes, gelatin products, and private label canned meats to retail and foodservice customers.  This segment also includes the processing, marketing, and sale of nutritional food products and supplements to hospitals, nursing homes, and other marketers of nutritional products. Effective November 1, 2004, the Hormel HealthLabs operating segment was consolidated into Diamond Crystal Brands.  Mark-Lynn Foods, which was acquired in March 2005, is included in the results of operations for Diamond Crystal Brands.

The All Other segment includes the Dan’s Prize and Hormel Foods International operating segments.  These businesses produce, market, and sell beef products, and manufacture, market, and sell Company products internationally.  This segment also includes various miscellaneous corporate sales.  Previously, this segment also included Vista International Packaging, a manufacturer of food packaging (i.e., casings for dry sausage), which was sold effective June 30, 2004.

Sales between reporting segments are recorded at prices that approximate cost.  Equity in earnings of affiliates is included in segment profit; however, the Company does not allocate investment income, interest expense, and interest income to its segments when measuring performance.  The Company also retains various other income and unallocated expenses at corporate.  These items are included below as “Net interest and investment income” and “General corporate expense” when reconciling to earnings before income taxes.

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Sales and operating profits for each of the Company’s business segments and reconciliation to earnings before income taxes are set forth below:

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Selling and delivery expenses for the second quarter and six months of fiscal 2005 were $167,674 and $337,191, respectively, compared to $155,787 and $307,427 last year.  These increases are primarily due to increased shipping and handling over the prior year, driven by increased tonnage volume, higher fuel related charges, and new acquisitions in 2005.  As a percent of net sales, selling and delivery expenses decreased to 12.8 and 13.1 percent for the fiscal 2005 second quarter and six months, respectively, compared to 13.6 and 13.5 percent in the comparable periods of 2004.  This decrease reflects price increases exceeding increases in selling expenses throughout 2005, the impact of newly acquired businesses with lower selling and delivery expense ratios, and a charge of $4,194 recognized in the second quarter of 2004 for early retirement packages related to a reorganization of the Company’s sales force.  The Company expects selling and delivery expenses, as a percent of sales, to approximate 13.0 percent throughout fiscal year 2005.

Administrative and general expenses were $41,236 and $81,858 for the second quarter and six months, respectively, compared to $38,601 and $75,219 last year.  As a percentage of sales, administrative and general expenses for the quarter and six months were 3.1 and 3.2 percent, respectively, compared to 3.4 and 3.3 percent for the comparable quarter and six months in fiscal 2004.  Increases for the quarter and six months include administrative expenses and intangible asset amortization related to new acquisitions, and increased professional services primarily related to Sarbanes-Oxley Section 404 internal controls compliance and internal business restructuring projects.  Stock option expenses also increased $560 and $736 for the quarter and six months, respectively.  A decrease of approximately $1,200 in the Company’s bad debt expense offset these increases during the second quarter.  The Company expects administrative and general expenses, as a percent of sales, to approximate 3.1 percent for fiscal year 2005.

Equity in earnings of affiliates was $1,000 and $3,927 for the second quarter and six months, respectively, compared to $2,439 and $4,145 last year.  The decrease in this earnings line for the quarter is primarily due to the Company’s 40.0 percent owned Philippine joint venture, Purefoods-Hormel Company (down $912).  The Company’s 49.0 percent owned joint venture, Carapelli USA, LLC, has performed favorably in fiscal 2005, increasing $141 and $366 for the quarter and six months, respectively.  Minority interests in the Company’s consolidated investments are also reflected in these figures, and have decreased $656 compared to the comparable six months of the prior year.

The effective tax rate for the second quarter and six months of fiscal 2005 was 37.3 and 37.2 percent, compared to 36.3 and 36.4 percent for the comparable quarter and six months of fiscal 2004.  The Company expects the fiscal 2005 effective tax rate will approximate 37.2 percent.  The effective tax rate increase over fiscal 2004 is primarily due to the relationship of permanent tax differences to expected income for the year.

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Segment Results

Segmented net sales and profits for each of the Company’s segments are set forth below.  Additional segment financial information can be found in Note J of the Notes to Consolidated Financial Statements.