Hormel Foods' (HRL) CEO Jeff Ettinger on Q1 2016 Results - Earnings Call Transcript

| About: Hormel Foods (HRL)

Hormel Foods Corporation (NYSE:HRL)

Q1 2016 Results Earnings Conference Call

February 16, 2016 10:00 AM ET

Executives

Jon Feeney - Janney Montgomery Scott LLC, CAGNY Co-Chair

Jeff Ettinger - Chairman and CEO

Jody Feragen - CFO

Jim Snee - President and COO

Jana Haynes - Director, IR

Analysts

Farha Aslam - Stephens Inc.

Rob Moskow - Credit Suisse-North America

Mario Contreras - Deutsche Bank

Jon Feeney

Good morning everyone. Once again, I’m Jon Feeney, CAGNY Conference Co-Chair. And once again, I have the pleasure of introducing Jeff Ettinger, Chairman and CEO, Hormel Foods. But first, I’d like to take this opportunity to thank Hormel for hosting lunch today, featuring many of their leading branded retail and foodservice items, that’ll be immediately after this presentation.

Hormel was nice enough to move up their strong earnings release this morning for this presentation, which you probably saw this morning, just like they’ve been nice enough to lead the industry in returns for the past 15 years and to grow dividends every year for the past 50.

For 125 years, they’ve been the protein Company everyone else would like to be. And through the recent acquisitions like Skippy and Muscle Milk, they’re very quickly becoming the food and CPG company everyone would like to be.

Today, their CFO, Jody Feragen will cover the highlights of their earnings in lieu of an earnings call first, while both Jeff and recently named President and COO, Jim Snee will follow up and focus on their long-term strategic efforts, of course followed by your questions.

So, Jody, welcome. Thank you, and take it away.

Jody Feragen

Thank you, Jon for that introduction. Before we get started this morning, I need to remind you that certain statements will be forward-looking and they are based on current conditions. And I would refer you to the risk factors in our 2015 annual report. Additionally, 2015 results are non-GAAP numbers that exclude certain adjustments and those too are detailed in the annual report and also in the back of the presentation deck that you received when you walked in today.

As Jon said, we did wait to deliver our record quarter for this morning, $0.43 per share, our 11th consecutive quarter of record earnings. And we were pleased that four of our five business segment contributed to the growth.

Now, sales were down 4% due to lower pork markets as well as the turkey harvest supply issues that we’ll talk about later. You’ll note that the earnings per share and all the earnings per share numbers in the presentation have been adjusted for the two-for-one stock split that our shareholders approved on January 26th and became effective on February 9th.

So, taking a look at the segments, Grocery Products segment operating profit was up 26%, really benefitting from improved operational and supply chain efficiencies. In the first quarter of 2015, we rationalized our plant in Stockton, California and moved that production into other facilities. So, they’re seeing a nice benefit from that and they’re also winning with favorable raw material costs. Sales were down 4%, as we saw some softness in the canned meats area but we were really pleased with the results of our HORMEL bacon toppings, our CHI-CHI foods products and our Wholly Guacamole items.

Refrigerated Foods had an outstanding quarter, segment profit up 65%. And really, it was great improvement -- a great performance across all our value-added businesses as well as strong pork operating margins. This segment also benefitted from the inclusion of the Applegate Farm operations. That was the business we acquired in July of 2015 and it continues to perform as we expected. I think you’ll hear a little bit more about that later in the presentation today. Sales were up 2% on a 5% volume increase as the higher sales were offset by those lower pork prices. We did see nice gains in our HORMEL refrigerated entrees, our HORMEL party trays in the retail side as well as OLD SMOKEHOUSE bacon and FIRE BRAISED meats from the foodservice side.

Jennie-O Turkey Store operating profit was down 2% for the quarter, really still recovering from the impact of highly pathogenic avian influenza that hit our farms in Wisconsin and Minnesota midway through 2015 last year. We are seeing improved performance and we would expect that by the end of our second quarter, they should be back at normalized operations, providing we see no further widespread outbreaks of AI. And then they’ll also benefit from lower feed costs as grain prices have been lower. Sales were down 15%; volume down 23% and really that was just a supply issue, as we are vertically integrated in the turkey side of the business.

Specialty Foods operating profit was up 44% on the 10% decline in sales. They too benefitted from favorable input costs and also some supply chain efficiencies, as we look to rationalize the MUSCLE MILK production into some of our existing facilities. We were pleased with the growth of our MUSCLE MILK products, particularly the ready-to-drink items. But, we did see decreased sales of some contract packaging sports nutritional items that were at a low margin basis.

International saw 1% increase in operating profit on a 7% decline in sales. We were very pleased with the strong SKIPPY sales, both on an export basis as well as SKIPPY sales within our China operation, but they couldn’t offset softer pork exports as we continue to battle challenging market conditions. Our China results were lower year-over-year. First quarter 2015, we were able to import SPAM and sell that in the domestic marketplace in China, that’s no longer an option, so they are up against those difficult comparisons. But, we are fully looking forward to our plants that we are building in China to provide us the opportunity to sell SPAM to that marketplace.

Some other financial metrics that we traditionally go over on our call, advertising spend was $48.1 million, up nicely from last year; we would expect full year to be up low double-digits area. Our effective tax rate was 33.6% and we’re expecting approximately 33.5% to 34% for the full year. Depreciation and amortization was slightly under $32 million while our capital expenditures were $33.5 million. As a reminder, we guided at the end of our fourth quarter that we were expecting approximately $250 million in CapEx, and you’ll hear about some of the projects later in the presentation.

From a market outlook perspective, we are expecting hog production to be up about 2%. And while we benefitted from historically high favorable pork operating margins in the first quarter, we would expect those to moderate as the year goes on. Turkey production, assuming no widespread outbreaks of avian influenza, expected to be up 5% to 6%. And as that production increases, we should see prices moderate in the back half. Grains will be favorable year-over-year versus 2015. And as a reminder, we traditionally looked to hedge between 25% and 75% of our needs on a two-year forward looking.

We have a very strong balance sheet. The $185 million of short-term debt that was on the balance sheet at the end of our fourth quarter related to the Applegate transaction was repaid. And we now have $250 million of long-term debt on our balance sheet which we really believe gives us the opportunity to continue to look at all types of investments. And I believe we could have $3 billion of additional debt on our balance sheet and still remain investment grade.

Our excellent earnings results coupled with our disciplined capital model has allowed us to generate cash flows over the last five years of 21% growth rates. And if you look at the trailing 12 months ended in the first quarter, we’re up over 65%, so, certainly generating the nice cash flow.

And our priorities have remained the same, pretty consistent year-over-year. We look to invest in our businesses as well as to return to our shareholders. We’ve invested about $2.8 billion in growing our business, some of that organic being capital investment. We’ll talk about adding capacity to meet some of the demand for our value added products, and then about $2.1 billion in strategic acquisitions. The way we look at these investments is the same regardless if I’m adding internal capacity or looking at a strategic acquisition, we build the base case business model, we use a long-term cost of capital and we do a discounted cash flow, and we believe that that allows us to make the best decisions for our shareholders.

Speaking of shareholders, we believe in returning to our shareholders our excess cash flow. Our share repurchase is a little more opportunistic given our ownership structure, but we certainly are pleased with our dividend results. And as Jon referenced, 50 consecutive years of dividend increases. Our Board of Directors approved a 16% increase for 2016 and our average growth rate over the near term has been about 18%, in excess of the excellent bottom-line that we’ve been able to deliver, as we try to get a payout ratio and the dividend yield closer to our Pepperidge [ph] food peers.

So, excellent earnings results; disciplined capital allows us to put up a return on invested capital that’s in the top quartile of our peer group. And with that I’m going to turn it over to Jeff Ettinger.

Jeff Ettinger

It’s our pleasure to be with you this morning to be able to share what was an outstanding quarter for Hormel Foods, and to be back at CAGNY after a few year hiatus and what you know what we’ve been up to and what our priorities are going forward in terms of our brands and our team.

As Jon was nice enough to mention, we’re also hosting the lunch. So, we don’t have a formal Q&A session after this but we’ll all be available including others of our team during the lunch to take any additional questions you might have.

One of the questions you could ask anybody in there is what does 5 and 10 mean to Hormel Foods. 5 and 10 have been our consistent goals within our corporation for the past 10 years, what we strive to achieve 5% revenue growth each year and 10% earnings or operating income growth. These are among the most aggressive goals within the food industry and even in our past presentations here at CAGNY that Jody and I have done, you should have consistently seen that these were our goals at those sessions as well.

Importantly, we’ve really done a nice job at achieving those aggressive goals. Our track record over the past five years on the topline is indeed at that 5% rate. We’re now a $9.3 billion Company. And in area of earnings, we’ve actually been able to exceed our 10% goal with the 12% CAGR capping out last year.

What I want to share with you is kind of how we’ve done that and a little bit of our thinking behind some of the decisions we’ve made that have led to these types of results. We’ve grown our Company on a topline basis and certainly significant profit contributions in three ways: Through M&A; through new product innovation; and by continuing to expand our traditional product portfolio.

In the area of M&A, we certainly had an active decade during the 2000s with a number of deals, somewhat smaller deals ranging from about $15 million to $200 million in deal value, over a broad spectrum of products. This array of deals enabled us to gain confidence in our ability to integrate and to look for new prospects but as we headed into the most recent timeframe, we kind of did make a couple of changes in our mentality toward acquisitions. We look for somewhat larger deal as our Company’s getting bigger and in order to move the needle, we recognized we needed to look at bigger opportunities. And so, four out the five largest deals in the Company’s history have come in the past four years. Wholly Guacamole at a total deal value of north of $200 million counting, an earn-out off, Skippy which we completed in 2013, a $700 million deal, Muscle Milk in 2014 was a $450 million deal and then most recently Applegate at $775 million.

In addition to the deals being larger, we also looked critically at our portfolio and said, you know, I mean our core portfolio, we love a lot of the items that have been with us a long time and we’re continuing to grow those items but honestly, it was a very American dominated portfolio with a lot of kind of traditional American food type items. Neither SPAM nor bacon items are probably going to be accused of being health oriented items any time soon and we recognized the consumers are more and more on the go, and our portfolio is really dominated by kind of sit down meal type items. So, all four of these acquisitions, and Jim’s going to give you more detail on these, really are aimed at making our portfolio more global, more multicultural to add that element of health and holistic attributes and to provide on the go solution.

Another decision you have to make when you acquire something is, how are you going to run this operation? We’re still headquartered in Austin, Minnesota, a small town, two hours south of Minneapolis and indeed for some of these properties, particularly businesses or brands that we buy from another company or corporation, we tend to fold those and run those in-house. And so that was true of the domestic Skippy business, it was true of the Lloyd’s barbecue line, it was true of the Country Crock Side Dishes who are now named Hormel Side Dishes.

For some of these recent deals however, we have looked at those deals and said look, to really optimize the consumer connection and the uniqueness of some of these opportunities provide, we may need to look at running them a little bit differently. We still try to find ways to harmonize and gain synergies on a back room basis in every chance we get. But in terms of that direct to consumer connection point, for example Skippy in China, it came at the plant in China from which we sell to most of Asia, and so they are Chinese team that have been in place for over 15 years, that’s taken on that business. Muscle Milk had a strong presence in Northern California, was kind of a young vibrant market and we wanted to maintain that, so we’ve left that team there supplementing with a few folks in the Hormel organization. MegaMex into which we put the Wholly Guacamole acquisition is a joint venture. Our partners are two companies from Mexico, Grupo Herdez and Grupo KUO. And so on a combined basis, we run that entity from Southern California, which certainly is a hot market for understanding the Mexican food experience.

And then very recently with Applegate, this team and this business really had both a unique supply chain of organic and antibiotic free natural products and also very strong consumer connection to -- and unique set of folks that we wanted to make sure we preserve that connection.

So in order to go with the theme of kind of providing you with a little bit of a behind the scenes mentality of what we’ve been seeking to do, I want to share with you now a video that kind of depicts what the Applegate experience is all about from the mouths of their team members.

[Audio/Video Presentation]

New product innovation is also a key element of our growth story at Hormel Foods. Indeed, our founder George Hormel founded the Company on the principle of innovate, don’t imitate. We’ve had a number of notable successes over the years including our party trays franchise, NATURAL CHOICE, our Bacon 1 items for the foodservice trade.

Within the retail world, we recently were recognized as an IRI Pacesetter for three of our items. This is a tracking of the last 52 weeks sales via the IRI organization of the best selling new products in the United States. And so, we were pleased that our MUSCLE MILK Pro Series, our REV snack wraps and our Wholly Guacamole minis all made this list.

In the nature, [ph] the editors from Progressive Grocer magazine bring in products from all over the country and have their editors try these items and see what they are excited by. And we were excited to see that we had eight items from our overall organization, ranging from Farmer John to Jennie-O Turkey Store, to our meat products group to our grocery products group that made this list.

The third area of growth I mentioned in top of M&A and innovation is continuing to emphasize the growth of our core items. More often when we’re talking to the press, we’re kind of known as Hormel ‘maker of SPAM’ still, so that’s a long term core item we’ve had. And I’m going to share [ph] a secret, SPAM is still growing it. It’s growing at 3% GAGR over the last five years in the U.S. and a 7% CAGR outside of the U.S. But in addition to SPAM, we own a number of other items within the portfolio that we’ve been able to create really nice household penetration growth, ranging from our flavor bacon portfolio to HERDEZ authentic Mexican sauces to Jennie-O Turkey Store lean ground tray pack and chubs [ph] items to our Hormel pepperoni items.

And the story is a little bit different for each of them in terms of what’s driven that growth. For the flavor bacons, these were items that frankly we borrowed from our foodservice team. We came up with these innovative flavors for the restaurant trade and they were so popular there that we created retail versions of the items. For HERDEZ it’s been geographic and consumer expansion, as authentic Mexican food is going into more and more cities in the U.S. and is seen as an authentic eating experience by more and more consumer who are working for that kind of local item.

For Jennie-O Turkey Store, it’s been the advertising, the Make the Switch campaign that has enhanced awareness of overall Jennie-O and has enabled us to ride the wave the consumers looking for more health oriented items. And even pepperoni minis that have been around for a 100 years, we’ve been able to grow households recently. And in that case, I think recipes have driven a lot of it, as we’ve encouraged consumers to put pepperoni pieces and slices on many more items.

I mentioned to you that this growth of our overall company, the top-line where all the items I just mentioned and that some of the bottom-line has come from the enhancement of these portfolio items but clearly some of that 12% CAGR on the bottom-line has come from cost efficiency gains. We don’t tend to have kind of active projects going on; we try to really watch this on a continual basis. Another one of the founding principles of George Hormel was continuous improvement, always seeking to find a way to do the job a little bit better day-in and day-out. One of the ways this manifests itself is through our best of the best projects. We encourage our teams from throughout the corporation to have projects during the course of the year to offset inflation and maybe even be able to provide enhanced bottom-line returns as well. We had over 1,500 such projects during the past year. And these projects drive cost control; they allow us to better utilize our raw materials; they can create yield improvements; and they can allow us to better utilize our capacity.

An example of those enhanced returns within two of our most vertical oriented units are seen in Refrigerated Foods and Jennie-O Turkey Store, as over the past five years Refrigerated Foods has enhanced our overall operating income percentage by 250 basis points, and at Jennie-O Turkey Store that’s about 590 basis-point increase.

One other way to see the leveraging of efficiency is the growth versus the kind of the overhead within the Company or the corporate team. So, we’ve grown the top line in the past five years at an aggregate 28% but our corporate staff team during that same timeframe grew at 14%. So, 50% leverage opportunity there. Or if you look at overall sales, the CAGR of 5.11 versus SG&A without advertising at 3.95, again about a 20% leverage point -- versus our sales versus that total cost picture.

One last aspect of the secret behind Hormel Foods that I’d like to share with you really relates to our team, where we are -- I mentioned to you we’re in a small town in Minnesota; we’re little bit of a throwback in that regard. When someone joins our organization, they tend to join it for a life and indeed our average tenure of our officer team at Hormel Foods is 26 years, that’s not 26 years of industry experience, that’s 26 years of experience at Hormel, which I think does make it somewhat unique in the industry.

We had our chance of -- I saw the earlier presentation from General Mills and they’re celebrating their 150th anniversary, which is fantastic. Hormel Foods is celebrating our 125th anniversary this year. And in anticipation of that event, I had a little gathering here recently with my two predecessors in the CEO, President roles at Hormel Foods, Joel Johnson and Dick Knowlton. We were taping some things for that 125th anniversary celebration and then we kind of had a little breakfast session for some of our favorite SPAM recipes and had a chance to share some of the things we thought have made the Company strong over the last few years. And I want to share a couple of minutes of that video with you right now.

[Audio/Video Presentation]

So, between Dick, Joel and I, we’ve been President of the organization for the past 35 years; it’s been our privilege to do that. But this last October we had an exciting announcement, it was the announcement of just the 10th President in our Company’s 125-year history. Jim Snee. And let me tell you a couple of things about Jim. So, this maybe the first time for many of you to be introduced to Jim. Jim also has 26 years of Hormel Foods. So, he hits the average on the nose; so, we don’t have to change that slide with him moving into this. He came up to our organization from the foodservice, sales and marketing team. He ran three different regions for our foodservice team. Jim was then asked to head up our corporate-wide purchasing function; after that he was inaugural Vice President of our affiliated foods group within Refrigerated Foods, running Farmer John, Burke and Dan’s Prize. And then for the past four and half years, he lead the International team. And during his tenure, his team grew segment profit for international from $26 million to $88 million.

Without further ado, I’m going to bring Jim up to podium, and he’s going to share with you many of the exciting initiatives we have going forward.

Jim Snee

Thank you, Jeff. First, since this presentation is doubling as our first quarter earnings call, I’d like to take this opportunity to update all of you on our outlook for the rest of 2016. And during our fourth quarter conference call, we set our 2016 earnings per share guidance at $1.43 to a $1.48 per share. And those numbers are adjusted for the recent stock split.

Now, while sales growth will continue to be challenged, as we navigate lower pork markets and the reduced turkey volumes at Jennie-O, especially through the first half of the year, we do expect our earnings to continue to be favorable. And our strong earnings performance in the first quarter led by Refrigerated Foods, Grocery Products, Specialty Foods as well as improvements in our Jennie-O Turkey segment, as we recover from the turkey supply pressures, has given us the confidence to raise our guidance for the full year to $1.50 to $1.56 per share. And that represents a 14% to 18% increase over 2015.

Now, while the Jennie-O Turkey Store business is still recovering from the impact of avian influenza last year, production volumes are expected to return to more normalized volumes by the end of the second quarter. And that will position them for strong growth in the back half of the year. Now, this expectation for normalized production volumes does assume that we do not have any new outbreaks of avian influenza in our operations, which are located in Minnesota, and Wisconsin. We look for continued favorable input cost for our Grocery Products and Refrigerated Foods segment. Refrigerated Foods will also benefit from strong pork operating margins. However, we do expect those pork operating margins to moderate as the year progresses. Specialty Foods should continue to benefit from an improved mix of higher value added items as our Muscle Milk franchise grows and we shift away from some lower margin business in other parts of that segment.

That team’s done a nice job capitalizing on operational efficiencies between our existing Century Foods business but also our recent acquired CytoSport business. And we expect Specialty Foods to continue to benefit from those efforts. And we do expect our International segment to be able to deliver improved results as the year progresses with improved export sales of both SPAM and SKIPPY.

Now in terms of total Company performance, one of the reasons we’re able to consistently set and hit our aggressive long-term growth goals is the balance that’s built into our business segments. And when you put it altogether, our business model supports growth that exceeds the average for packaged food companies but is also inherently less volatile than our protein peers.

Now, in the first quarter, you’ve heard it several times, we certainly are pleased to post another record in terms of earnings which grew at a significant double-digit rate with four of our five segments delivering earnings growth, really demonstrating our balanced model. But the long term success of this model really is borne out over time, as we’ve delivered year-over-year earnings growth in 27 of the past 30 years. And its financial consistency’s not only due to the diversity across the business segments but also the balance built throughout our business model. And so, we have product offerings that are both protein centric but also packaged foods and that has really served us well over time. And the deep investments that we’ve made in both our pork and turkey supply chains, allow us to better control the quality and consistency of our products and remove costs from our system. This is balanced by our position of buying other key inputs such as peanuts, avocados, and tomatoes on the outside. And that reduces our exposure to potentially volatile growing cycles but it also minimizes our capital investment.

And we have a very strong presence in both the retail and foodservice channels which allows us to serve consumers with meal solutions, both at home and away from home. And both our retail and foodservice businesses are strengthened by our dedicated sales force that concentrates exclusively on our family of brands. We have a strong sense of financial conservatism that serves the Company well. And as you saw earlier from Jody, we certainly have a strong balance sheet that gives us great flexibility.

Now, this conservative nature is complemented by a relentless pursuit of innovation that’s allowed us to maintain relevancy with consumers. And it drives our success in both process and product improvement. So, this right balance allows us to prosper in various commodity cycles, and our diversified portfolio helps insulate the business in various market conditions.

And we have purposely prioritized our investments to expand the growth platform that we think positions our Company for long term growth, while complementing our existing portfolio of very strong brands, ultimately creating a platform of foods that fit the many consumer needs.

Now, even with the faster growth that we’ve seen in our International business over the last several years, we acknowledge that our business is still primarily a U.S.-based business but we continue to seek opportunities to expand our global footprint. We also view multicultural items with new and adventurous flavors such as those items that you’d find in our MegaMex portfolio of items as a strong growth platform. We believe there are more opportunities to expand our multicultural food offerings going forward.

Additionally, our innovation and acquisition efforts have been focused on delivering foods that fit today’s busy, on the go lifestyles and the growing interest in products that are not only nutritious but has significant holistic attributes.

So, now let’s take a deeper look at each of these platforms.

Our International business has achieved significant top-line growth over the last five years. We’ve seen a 15% compound annual sales growth rate. And this segment is built on some long standing partnerships that we have with Purefoods in the Philippines, CJ in South Korea as well as a very a well-developed export business with iconic brands like SPAM and SKIPPY. And in China, we’ve developed businesses in both foodservice and retail channels, leading to our decision to expand production capacity in that country. We broke ground this past April on our new production facility in Jiaxing China that will be completed by the end of calendar 2016. This facility will not only produce refrigerated and frozen meat items but it will include in-country SPAM production, allowing us to manufacture SPAM family of products in-country for the first time in our history. And this significant investment will give us much needed capacity and allow us to meet the growing demand for our products in China from both consumers and foodservice operators. Now, while we’re pleased with the great work that our team has done to deliver this organic growth, we continue to seek opportunities to increase our global exposure in a more meaningful way.

I want to spend some time this morning, talking about some specific brands in our portfolio that support our growth platforms and the efforts made by our team to deliver innovation to meet the needs of today’s consumers with food best fit their lifestyle. As Jeff mentioned earlier, we have had and will continue to have aggressive expectation to grow our business at a rate of 5% on the top line and 10% on the bottom line. The brands I’ll be highlighting today are going to be key drivers to support this aggressive growth trajectory.

So, the Jennie-O has become a clear market leader through our team’s efforts to build awareness. Their innovation and marketing efforts have led to 15 different items that hold the number one or number two market share position in their respective categories. And their Make the Switch advertising campaign highlighting turkey’s versatility as an alternative to beef has been a huge success for the brand, driving both awareness and trial.

Consumer awareness for Jennie-O brand now exceeds 95% and it is driving purchase intent and share growth as consumers continue to look for fresh, nutritious meal solutions using Jennie-O Turkey products. In addition to the growing demand for these Jennie-O Turkey products, we believe our fresh supply chain focused on ground turkey is the best in the industry. And these efforts show up at the retailer, as Jennie-O share of ground meat business has shown fantastic growth over the last five years. We hold the number two item in the retail exactly meat category, the only turkey item in the top 10. We have worked hard to achieve that success and we have great retailer support, as they recognize the importance of these types of items and their growing demand from consumers. The healthy attributes of the Jennie-O Turkey product portfolio, our brand leadership and our rapidly growing share of the ground meats category position the Jennie-O Turkey segment to be a strong growth driver for our business for many years to come.

Now WHOLLY GUACAMOLE is part of our MegaMex portfolio of brands, and it’s another brand that meets the growing demand from consumers for fresh, natural, fun organic products. This cool, on trend brand holds a 42% market share in the refrigerated guacamole category. and much of that growth has been built through digital media campaigns in conjunction with a strong social media presence and aligns well with our targeted growth areas with its healthy and holistic attributes. And of course, it has multicultural appeal. And from an innovation perspective, our introduction of WHOLLY GUACAMOLE minis has been a huge success as it’s made this great product easy for consumers to take on the go and have anytime, anywhere they want.

So, when we acquired the SKIPPY brand in 2013, we knew there were immediate opportunities to capitalize on the brand’s existing recognition among consumers. We were able to make early distribution and share gains commensurate with the SKIPPY brand position. We also knew that we could grow the brand by going back to the basics with the commitment to advertising and innovation. And when we looked at innovation, we were not only looking for close in ideas but we wanted to bring to consumers the great flavor of SKIPPY beyond the jar. And we were able to do that with the introduction of SKIPPY P.B. Bites. It’s a terrific combination of SKIPPY peanut butter with a pretzel or peanut butter center for a delicious protein infused snack that’s perfect for on-the-go and anywhere snacking. SKIPPY peanut butter also enjoys the leading peanut butter brand from a natural perspective, allowing us to provide more choices for consumers. And while the team has done a lot of great work since the time of acquisition, we believe that there’re still many opportunities to grow and innovate with this iconic brand.

Now, our Specialty Foods team is capitalizing on the 2014 acquisition of the Muscle Milk brand. Muscle Milk holds the number one market share position in the ready-to-drink protein beverage category. And they’ve also been able to reinvigorate the brand’s innovation efforts, introducing new items like MUSCLE MILK Pro Series and MUSCLE MILK organic products. With innovation even more critical in this fast growing protein category, our team has developed a robust pipeline of exciting innovations that we’ll be sharing with you in the months to come. We’ve also been able to leverage our team’s capabilities to significantly expand distribution of Muscle Milk products with traditional retailers. And we expect our Muscle Milk franchise to continue to grow this premium protein category well into the future.

We got a peek at the Applegate brand earlier but I can tell you that we are still very excited about the addition of this great Applegate business to our portfolio of strong brands. Applegate is the number one brand in the natural and organic value-added protein category. And the acquisition was perfectly aligned with our interest in adding brands that resonate with consumers that are younger and more socially engaged. This acquisition has also expanded our distribution into the natural and specialty foods channel. It’s provided us a faster path to creating a significant presence in this high growth attractive margin segment. It also affords consumers more choice, providing access to foods that fit the demand for more holistic products.

Now, as we anticipated and we communicated when we announced the acquisition, our team continues to work on securing supply to meet the high demand for some of our Applegate products. The team continues to deliver nice growth with chicken-based products such as our Applegate natural breakfast sausage and Applegate organic and natural breaded chicken.

I believe Jody said it earlier, if not, I’ll say it for the first time that I’m pleased to share with you that our Applegate business continues to perform in line with our expectations. And so, our approach of supporting our core items, driving innovation and strategically investing in acquisitions has allowed us to create a product portfolio that resonates with consumers of all ages, foods that fit many different lifestyles. So, many of our core brands have been well-represented in shopping carts for years. Our efforts on new product innovation and acquisitions have been focused on keeping our products relevant with changing consumer needs and trends, brands such as Wholly Guacamole, Natural Choice, Applegate, Muscle Milk and Jennie-O have broad appeal with millennials and a younger, more socially engaged consumer.

This broad and balanced portfolio of brands is another key to our long-term sustained growth. And these are strong brands. We have 30 -- we have over 30 brands that hold the number one or number two market share in their respective categories, helped in no small part by our dedicated sales team’s effort to communicate the power of our brands and their value proposition in both the retail and foodservice channels. Many of these brands are familiar to consumers for generations. They’ve grown and strengthened over time and we strive to keep them as relevant with today’s consumer as when they were first introduced. And we remain committed to supporting these brands and strengthening these brands, and advertising is an important component. We expect a double-digit increase in our advertising spend this year on the heels of a similar sized increase last year.

Now, I’d like to show you an example of some of our most recent investments, which represents a nice mix of both traditional and digital media.

[Audio/Video Presentation]

We certainly have some creative individuals working across the Company on these ideas. Jeff shared with you earlier a slide sharing some of the great household penetration gains that we’ve made over the last five years. And while yes, we have made a lot of gains, another reason we’re optimistic about our ability to continue to deliver strong growth is that many of the products still have a long runway ahead of us. I spoke earlier about the growth in Jennie-O Ground Turkey products and they’re only scratching the surface with a household penetration rate of 9%. Items such as Applegate sliced meats, Hormel Natural Choice deli meats, Wholly Guacamole still all in the single digits with great consumer demand for these types of items, and even our iconic brands such as SPAM, Hormel pepperoni and Skippy peanut butter have significant runway growth ahead of them.

And Jody mentioned our CapEx plans earlier for fiscal 2016 of approximately $250 million. Now some key items in that plan are the China plant that I mentioned earlier as well as some production capacity expansion for select bacon item, including Hormel Bacon 1 fully cooked bacon which is an item that is developed for our foodservice group. Bacon continues to be on trend and it’s been a great growth vehicle for us. We’re also expanding production capacity for Jennie-O ground turkey products. Now, this was a project that we have scheduled last year but we put it on hold with the outbreak of avian influenza. So, we’re just refreshing it this year.

And then, not all projects are about production capacity or plant efficiencies. And to keep pace with our innovation efforts, new technology and to maintain our laser like focused on food, quality and safety, we are making a significant investment in our research and development facility, which will be on line at the end of this fiscal year.

And so our efforts to innovate and keep our products relevant with consumers have delivered strong financial results. And clearly we’ve been rewarded for those results in the marketplace. We’ve enjoyed stock performance that exceeds the S&P 500 and an index of our food peers. In fact, an investment at the end of our fiscal year 2010 would have tripled by the end of our fiscal year 2015. And while we are pleased with this stock performance, our team understands that we must remain focused on those things that we can control. We will continue to concentrate on building our branded, value added portfolios and making the right investments today that will drive sustainable growth in our business over the long-term.

So, thank you for your attention this morning. We are now prepared to take your questions. And I do want to introduce Jana Haynes, who is our Director of Investor Relations.

Question-and-Answer Session

Q - Unidentified Analyst

Thanks for taking the question. So, congratulations on another great quarter. Can you talk a little bit about M&A? Obviously your returns have been above and beyond any of your peers but your balance sheet is still under-levered; you mentioned $3 billion in dry powder. The last three deals on average have added I think 4% to your earnings growth on average. What do you expect M&A to add to your growth algorithm going forward?

Jeff Ettinger

We talk about 5% and 10% but we’ve said that that’s inclusive of M&A. I think over maybe a 10-year timeframe, the M&A is in more like 1 to 1.5 of the 5. Over the last five years, it’s been a little bit more robust as we have done some bigger deals. We clearly have the financial wherewithal to tackle more acquisitions. We’ve talked in the past and if you look at even the recent ones, some are corporate properties, so SKIPPY came from a corporation; Lloyds. From time to time companies are changing their portfolio. And we will certainly look at items within those portfolios that makes sense to Hormel. But a number of our more successful acquisitions have been family-owned business that frankly we try to establish a relationship over many years with a hope that at some point if that family has made the decision to sell the business that we might be a preferred buyer.

We certainly have a number of hooks in the water and keep looking for the things. We know we can handle financially, we also know we can handle in terms of the capacity of our Company to integrate and handle more businesses.

Jody Feragen

And I think importantly is the disciplined model that we put around when we are looking at whatever our investments are and taking a long-term view because we do buy things that we intend to keep for the next 125 years.

Jim Snee

And I would add that we would probably keep them tied to those growth platforms, I discussed. So, when we think about global multicultural, healthy holistic and on-the-go, those are going to be key drivers for us as we go in the future. Doesn’t mean that we wouldn’t look at a business that perhaps adds scale to an existing portfolio that we have but really we want to focus on those growth platforms in the years ahead.

Jana Haynes

Farha?

Farha Aslam

Results today really highlighted the success of your allocating raw material to the highest opportunity, particularly your Jennie-O Turkey Store had volumes that were down kind of 20% plus but your earnings were nearly flat. So, kind of as you look forward, what more opportunity do you see in both turkey and pork, going forward.

Jeff Ettinger

I think from a turkey perspective, clearly it’s exactly what you said. I mean the team has done a great job allocating those raw materials. But as we get in to the back half of the year, we will see that return to more normalized returns. We need to make sure that we’ve got our business, our distribution back to where was pre avian influenza because there were some rationalization that had to take place. And so, we’ve got the great fundamentals of the Jennie-O Turkey Store business. And now, if we can go back and put the supply on top of that we think that we are going to be well-positioned for future growth.

On the pork side, again, it’s a pork operating margins could have an impact in the back half of the year. But when you look across the Refrigerated Foods in total, we’re talking about meat products, foodservice, a number of different businesses that all -- they don’t all have the same direct impact. So, I mean we expect to be fine on the pork side.

Jana Haynes

Rob Moskow?

Rob Moskow

Thanks. Also I thought what helped the quarter were bacon margins, deli prices were way down and bacon retail seemed really high. Was that a big driver of refrigerated margin in the quarter, and is that also sustainable given the volatility in deli prices historically?

Jeff Ettinger

That was a piece of it. I mean clearly if you look at the portfolio of items that we have available, whether it’s Hormel pepperoni, bacon, certainly the Refrigerated Foods or the items in our foodservice group also has a bacon component to it as well. And so our team does do a good job of staying current on pricing, as it does, there is some volatility and fluctuation. So, I mean I think the margin management piece of it, the discipline our team, does a pretty nice job. And I would expect that we would keep that going forward.

Rob Moskow

Just to follow up, in turkey, is the industry going to come out of this AI event in the stronger position than it was before because maybe some excess capacity came out? I mean your pricing is up at a time when all other proteins are down. Can you explain how turkey pricing kind of takes [ph] once all that?

Jim Snee

I think turkey is kind of unique in the sense that it is a niche protein, even as greater job as our Jennie-O brand has done in proliferating the brand in the marketplace and adding these value added items, I mean it’s not the lead item that the retailers going to feature in their ads, except for Thanksgiving. So, I think the pricing model for us is really fairly consistent one. As long as we build innovative items with true points of difference, we can attain a good margin with those. And we clearly want to support that with the advertising position. Hard to tell from a macro standpoint. I mean this year the whole industry is obviously going to be closely watching this spring to see if there are any further outbreaks. You’re seeing cold storage stocks go up a little bit already. I think that frankly folks are holding to any surplus breast meat or other items they have in anticipation of a potential challenge. We didn’t see any recurrence within our region in the fall. There was a recent incident in Indiana but was a fairly limited one of a different strain. So I think the AI dynamic is going to continue to affect the marketplace at least through the spring and then if it turns out we have a clean spring and we’re kind of out of that mold, then things could change by next year.

Jana Haynes

Mario?

Mario Contreras

Mario Contreras, Deutsche Bank. So, I wanted to ask about your long-term targets; 5% sales, 10% earnings growth. It’s obviously implying a decent amount of margin expansion over time. But, if we look at your specific segment margin ranges, you are already kind of at the high-end or even above the high-end in some cases. So, can you talk a little bit about where you expect to see that margin expansion come from over time?

Jody Feragen

Well, certainly we’ll look to do some of that leveraging on the corporate and the G&A side of things, like Jeff talked about. But really it’s about focusing on what the consumers are looking for and trying to find the value-added products that fit within the growth platforms that we’ve put out there. Some will come from one of the things that we -- criteria we look for when we’re looking at M&A transactions or even those internal investments are -- we expect the margin profile over those investments over the long-term be accretive to the segments that they’re in. So, lots of different things working towards those goals.

Jeff Ettinger

As Jon mentioned in his introduction, we certainly have endeavored to shift the portfolio to become more and more of a prepared foods player but our aggregate margins are still well below the average of that universe. So, we think over time and we’ll certainly move the segment margins as we see a logic behind that; we think over time the total Company margins can definitely migrate northwards.

Jon Feeney

Well, thank you. I think that’s all the time we have on the webcast. Just as a reminder, lunch is immediately after this. I believe Hormel management team will be available for your questions. Let’s take this opportunity to thank Hormel once again for what is sure to be a great lunch and for their support of CAGNY, had a great presentation. Thank you.

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