Hormel Foods Corp (HRL) — Q2 2019 Earnings Call Transcript

Good morning. Welcome to the Hormel Foods conference call for the second quarter of fiscal 2019. 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 Investors section. On our call today is Jim Snee, Chairman of the Board, President and Chief Executive Officer; and Jim Sheehan, Executive Vice President and Chief Financial Officer. Jim Snee will provide a review of each segment's performance for the quarter and our outlook for the remainder of 2019. Jim Sheehan will provide detailed financial results and further assumptions relating to our outlook. The line will be opened for questions following Jim Sheehan's remarks. As a courtesy to the other analysts, please limit yourself to one question with one follow-up. If you have additional questions, you’re welcome to get back in the queue. An audio replay of this call will be available beginning at 11 AM today Central Standard Time. The dial-in number is 800-263-0877, and the access code is 505-1059. 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. We've referred to Pages 31 through 36 in the company's Form 10-Q for the quarter ended January 27, 2019 for more details. It can be accessed on our website. Additionally please note the company uses non-GAAP results to provide investors with a better understanding of the company’s operating performance by excluding the impact of certain non-recurring items affecting comparability. Discussion on non-GAAP information is detailed in our press release located on our corporate website. Please note that during our call, we will refer to these non-GAAP results as adjusted earnings. I will now turn the call over to Jim Snee.

Thank you, Nathan. Good morning, everyone. As a global branded food company, we remain focused on our long-term strategy we call our formula for success. This includes building strong brands, developing innovative new items, making strategic acquisitions, and creating intentional balance. We have strengthened our competitive position in the past three years through intentional actions such as evolving through a broader global branded food company, accelerating our foodservice business, modernizing our supply chain, and divesting non-strategic assets. Today these actions leave us with a better business, a strong balance sheet, consistent cash flows, and the ability to make a transformational acquisition when the opportunity presents itself. Many of our businesses continued to exceed expectations and demonstrate our strategy is working. We’ve recognized progress is not always linear. So we are focused on executing against our plans in the marketplace while delivering the longer-term results our shareholders expect. This morning we announced second quarter earnings per share of $0.52. Adjusted earnings per share were $0.46, a 5% increase compared to last year. Three segments delivered volume and sales growth resulting in a volume increase of 1% and sales increase of 1%. There are many bright spots I want to highlight as we look at our top line results. First, our foodservice business across the company had a very strong quarter, delivering mid-single digit sales growth. Products such as Hormel Bacon 1 cooked bacon, Hormel Fire Braised meat, Austin Blues authentic barbecue, and Jennie-O foodservice business all delivered strong growth. Each year food service becomes more important to us as we find new and innovative products that deliver value to operators. Next, our portfolio of grocery products had a solid quarter with growth coming from offerings such as the SPAM family of products, Herdez salsas, SKIPPY peanut butter, Dinty Moore Stew, Black Label bacon beds, and Hormel microwave meals. These brands, along with many others in our portfolio, continued to demonstrate that growth is occurring in the center of the store. We issued record value-added sales within refrigerated foods as we continue to convert lower margin commodity products into higher margin value-added products. And that result is a double-digit decline in commodity sales and an increase in value-added sales. Once again, this is consistent with the long-term trajectory of refrigerated foods and reflects the clarity, focus, and alignment this team exhibits. Looking at the segments, grocery products had a strong quarter as sales increased 2% on a 3% volume increase. Segment profit increased 12% due to higher volume and margin across many of our brands, including SPAM and Dinty Moore, in addition to lower expenses for CytoSport. We completed the divestiture of CytoSport on April 15. During the quarter, we took a measured and calculated response to a competitor's price decrease in order to defend our SKIPPY peanut butter franchise. Our responsibility as a branded food company is to elevate the category through brand building and innovation. We believe competing on the basis of price alone is not how a branded food company should operate. Throughout this process, our commitment to use revenue growth management techniques to optimize our promotional strategies has been very well received by our retail partners. We continue to be encouraged by our new Skippy PB&J Minis. Our market test was successful, and we are currently rolling out the product nationwide. In addition, our current pipeline of out-of-the-jar innovation for nut butters is very robust. Refrigerated foods sales increased 1% on flat volumes. While segment profit declined, it was driven by a 65% decline in commodity profits and rapidly increasing input costs such as bellies and trim. Brands such as Hormel Bacon 1, Fire Braised, Austin Blues, and Black Label all had an excellent quarter. We continue to be encouraged by the new Hormel Deli solutions division, especially the performance of the Columbus brands and our prepared foods portfolio of products. Our Applegate and Natural Choice brands continued to grow as consumers look for better-for-you options that fit their lifestyles. International volume declined 7%, sales declined 9%, and segment profit declined 31%. The key driver of the decline continues to be lower fresh pork exports volume and pricing caused by global trade uncertainty related to tariffs. We also experienced higher freight costs, primarily related to flooding near Fremont, Nebraska, which affected our ability to ship export products. We saw continued growth in our China business led by key brands such as SPAM and SKIPPY. Jennie-O Turkey Store volume increased 2%, while sales were flat. We delivered growth in our foodservice business led by our Jennie-O sliced Turkey products. Segment profit declined 45%, driven by start-up costs at our Melrose Hulbert plant, higher feed costs, and lower retail sales. The Melrose plant is now the most automated production facility we own, and certain automation components are new to Hormel Foods and the industry. Within one week we switched from a highly manual plant to an automated plant and the process took more time than we expected picking up to full speed. The extremely cold weather compounded the problem as we were unable to move forward into the facility during certain days. The additional start-up cost this quarter was $0.01 earnings per share. We are now very close to hitting our efficiency targets and expect lower net production costs in the years to come. The lingering effects of two voluntary recalls for lean ground Turkey during the first quarter led to the loss of retail distribution. Throughout the recall event, we have maintained a close watch on key brand health metrics and are pleased to report all measures show the Jennie-O brand is strong. Starting in the third quarter, we will reactivate promotional activity and advertising in order to gain back our lost distribution. We continue to work with the Turkey industry on the issue of salmonella. Our efforts across the entire supply chain have helped decrease levels of salmonella in our facilities. We have also maintained our leadership role in educating consumers on how to safely handle and prepare raw Turkey. From an industry perspective, we continue to see lower placements, but cold storage levels remain at elevated levels. Market prices are starting to show modest increases. As we think about our first half, excluding the one-time gain on the CytoSport divestiture, strong results from Grocery Products and favorable SG&A were offset by higher than expected plant start-up costs at Jennie-O Turkey Store and margin compression in International and Refrigerated businesses. Overall, the business finished below our expectations for the first half. As we look forward, the biggest unknown in the protein industry is related to the outbreak of African swine fever in China. As I take the opportunity to walk you through the dynamics of the African swine fever, our expectations, the actions we are taking, and the expected impact on our financial results will give you a deeper understanding of our business results and context for our guidance. First, the best industry information shows that China has lost between 150 million and 200 million hogs. This is equivalent to more than the entire pork production in the United States. In addition, China is the largest pork producer and consumer of pork in the world. Second, due to the losses of hogs in China, we have seen hog prices in China increased by approximately 28% during our second quarter. Prices will likely continue to move higher as cold storage stocks in China are drawn down. Finally, the United States will play a vital role in filling the global supply gap. In response to the higher demand and increased exports, domestic prices have already increased and will likely increase further. We started to see the market effects of ASF in our second quarter. We saw rapid increases in key input costs for hogs, the USDA composite cutout, bellies, and trim during the quarter. We expect all these markets to increase in the coming months. Jim Sheehan will provide our high-level assumptions for the markets during his comments. In response to these input cost increases, and the cost increases we expect to come, we announced pricing action on the majority of our pork-related products portfolio across Refrigerated Foods, Grocery Products, and International. Depending on the category, our announced pricing generally takes 30 to 75 days to become effective on the shelf at retail. As such, most pricing actions will be effective in the back half of the third quarter. Within foodservice, we're able to adjust pricing every two weeks, allowing us to stay closer to any market changes. Our prior experiences, such as with PEDV in 2014, suggest our brands can operate and grow in both low and high market conditions. However, the speed at which markets move can cause short-term margin expansion and compression as our prices lag input cost changes. The second quarter demonstrated this dynamic as near-term margins were pressured. We expect similar periods of margin pressure as markets move higher in the back half of 2019. We do expect short-term volume declines, but they will vary by category. We have taken proactive actions to maintain volumes such as adjusting our promotional activity and shifting our advertising to support key brands. Once again, we will be leveraging our direct sales force to communicate directly with our customers on how ASF will affect our categories. Pricing discussions with customers are never easy, but finding the right solutions for our customers truly differentiates our company. Animal health issues are not new to us; in fact, this will be our third situation in the last five years. Each event comes with its own unique challenges and issues. ASF will be different than PEDV in 2014 and different than high-path avian influenza in 2016. But the lessons we learned in those events will be important as we manage through ASF. I'm confident our experienced management team will continue to guide our company forward and our dedicated team of employees will help deliver our key results. Turning to our guidance for fiscal 2019. Higher forecasted input costs and the lag in pricing are expected to impact Refrigerated Foods, Grocery Products, and International earnings in the second half. We have lowered our expectations for Jennie-O as we reinvest to gain back our retail distribution. Our guidance also includes a positive $0.02 net impact to the year for the divestiture of CytoSport. Taking all factors into account, we are lowering our full-year guidance to $1.71 to $1.85 per share and our sales guidance to $9.5 billion to $10 billion. At this time, I will turn the call over to Jim Sheehan to discuss our financial information relating to the quarter and our earnings guidance in addition to key assumptions for the remainder of fiscal 2019.

Thank you, Jim. Good morning. Volume and net sales for the quarter grew 1%. Volume was 1.2 billion pounds as growth from Grocery Products and Jennie-O Turkey Store offset the decline in International. The record sales of $2.3 billion was due to strength in Grocery Products and record value-added sales in Refrigerated Foods. Net earnings for the second quarter were $282 million, up 19% from last year. Diluted earnings per share was $0.52; adjusted earnings per share was $0.46, up 5%. The CytoSport transaction was closed April 15. The gain was $0.06 per share and recognized a net unallocated expense and taxes. The second half impact earnings for 2019 is a reduction of approximately $0.04 per share. Full-year sales for CytoSport were expected to be approximately $300 million. SG&A excluding advertising was 5.7% of sales compared to 7.2% last year. The decline was driven by the one-time benefit from the CytoSport sale and reduction in selling expense. Advertising for the quarter was $35 million, a decline from $37 million last year. Advertising investments are expected to be down modestly due to the sale of CytoSport. Operating margins were 13.3% compared to 12.9% last year. The increase was primarily due to lower SG&A and stronger results from grocery products. The effective tax rate was 11.1%, down from 20% last year. The gain from CytoSport sales drove the decline. The full-year effective tax rate is expected to be between 17.5% and 19.5%. Year-to-date cash flow from operations was $366 million, down 18%. The decrease is due to higher levels of working capital, primarily from building inventory and anticipation of higher raw material costs. For the quarter, capital expenditures were $48 million compared to $87 million last year. We expect to spend approximately $310 million in 2019. Weather issues delayed the expansion of the Burke facility, which will shift capital spend into 2020. We paid the 363rd consecutive quarterly dividend, effective May 15 at an annual rate of $0.84 per share, a 12% increase over the prior year. Share repurchases in the quarter were $23 million, representing 562,000 shares. We will continue to repurchase stock to offset dilution from stock option exercises and based on our internal valuation. We received $474 million from the CytoSport transaction. We used the proceeds to pay $375 million of short-term debt related to the purchase of Columbus Craft Meats. Net debt is negative. The company remains in a strong financial position to fund strategic investments. Domestic hog supply and production are balanced. Industry expansion continues as global demand increases. The supply shortage in China, caused by African swine fever, should drive domestic prices higher. We expect to operate in a high-cost and volatile environment for multiple quarters. Hog markets increased year-over-year, rising more than 50% throughout the second quarter. The USDA composite cutout value increased 20%. The company’s grain-based contracts and balanced approach to hog procurement provided some protection against the rapid market increases during the quarter. Prices for belly and lean trim increased as much as 40% during the quarter before declining in the last few weeks. The guidance range for the remainder of the year is based on the following market expectations. The range reflects our view of the impact of ASF in China without an outbreak in the United States. We expect hog prices and the USDA composite cutout to decline 10% to 30% from the current price levels, while maintaining a high level of volatility. The last time markets were at this level was 2014 during the domestic PEDV outbreak. Belly prices have historically been the most volatile of our key inputs. We expect costs to rise to a new price range of 30% to 40% higher than the current range. Our guidance includes continued volatility within the expected range. Being trim markets are doubled from February to around $80 per hundredweight; we expect 10% to 20% increases compared to the current prices. Although there are various opinions on the impact of ASF on future pork markets, we feel providing our outlook provides better insight into our guidance. Turkey pork placements were down 4% from the last six months and down 5% year-to-date. Fresh meat and cold storage remains elevated, 7% above last year. Compared to last year, Turkey breast prices were up 28% and whole bird prices rose 6%. Meat cost was higher by 7% during the quarter. We continue to make excellent progress on Project Orion, a strategic initiative to streamline and transform how we operate as a global branded food company. This project will generate efficiencies across the entire company and represents the next step in the execution of our long-term growth strategy. At this time, I'll turn the call over to the operator for the question-and-answer portion of the call.

Can you just give a little more color on your pricing actions relative to cost increases? And you said that it had cost increases and expected costs increases in line. You gave a little bit of color on what some of those expectations are. But how much are you leaning in on pricing? Would it color all of that? Would it more than color all of that? What’s the right way to think about where you land from a margin standpoint?

Sure. I’ll go ahead and start around pricing, and then I’ll let Jim talk a little bit more about some of the market conditions. As we saw the run-up in markets in the second quarter, we were quick to react and took some very proactive pricing actions across a number of our key categories that are obviously pork-related. What was interesting in the quarter is we saw the quick run-up and then we saw a moderation of pricing. And so when we say expected pricing going forward, we do project that pricing will return to the levels that we saw in Q2, in some cases maybe a little higher. The other thing to remember, Michael, and we've talked about this a lot is that lag in pricing. So again depending on the channel foodservice a little closer to the market, when you think about Refrigerated Products that’s all further out, and then GP, Grocery Products are stable portfolios that really take the longest to be reflected. So we feel good about the pricing actions that we’ve taken. For us, it’s really that volatility that creates the compression or in some cases expansion, but it’s really getting to the new level. Once we get to a new level that becomes a little more stabilized; then that’s when we get margins back to normalized level. So it’s really the volatility that creates the disruption. And I’ll turn over to Jim maybe for a little more market clarity.

Certainly. Michael, we expect to see volatility as these prices continue to grow. To give you an example of challenges, the belly market for instance in the second quarter had a low of 120 and a high of 215. And it wasn’t a consistent line. You’d see increases and then you see sudden drops, and that creates a lot of difficulty in getting the timing of the pricing correct. We expect those challenges to continue. We expect that volatility for us to create a challenge in the pricing as we go forward.

Even if there is volatility, you have some clarity on costs. What about on the consumer side? Do you have an understanding of their capacity to handle further price increases? And what are the limits where you might start to notice significant declines in volume, and how does that compare to five years ago with the PEDV?

I think this is going to be a little bit different than PEDV. It was probably a more short-lived scenario. I mean, all the prognosticators are saying that this could be a little longer term. So I think there are some key learnings that are very applicable and there are some things that are a little bit different. Any time you take pricing, especially in the short-term, you do have an impact on volume. We’re talking about a number of different categories. So the volume impact; the elasticities are very different across all of those categories. The most recent reference point we have, of course, would have been the fourth quarter of 2017, where we had a significant run-up in key markets. And again, we put our elasticity models to work. The good news is in many cases, we were able to outperform what was projected. But we've done all the homework and understand that there will be some volume implications as we take pricing.

I appreciate, Jim, the color on your outlook for the individual promos as well as your outlook on hogs. You alluded to some comments around duration, but with what you know now, what is the duration of volatility that you're expecting? And for what period of time are you thinking about elevated prices sustaining?

Yes, I mean that's part of the uncertainty that we're dealing with. There's a point of view that says you could see this being a multi-year event. And that's really what we're preparing for. But, I think in the short term, especially, it's really interesting how the dynamics and the information is changing so rapidly. As we're talking to others in the industry, you hear points of view where the market's getting ready to run very soon. And then you talk to others who say, maybe freezer stocks in China are a little higher than anticipated and it's going to take a while to clear them. So there's really a lot of uncertainty around when, how much, how fast, how long, and what happens in the competitive landscape, who decides to export, who is focused on value-added. So with all that uncertainty, we're giving you our best estimate. But we really want to focus on is the certainty and what we know to be true. And that's really our ability to price to new market level. And then, as always, we're going to do what's in the best interest of the company, the customers, consumers, and food service operators. So we really need to focus on the things that we can control, and then really just do our best to try to understand the uncertainty that's in the marketplace.

On the Jennie-O business, some operational challenges that you mentioned in the quarter, and some go-forward investment around regaining retail distribution. What does that timeline look like for getting back to some of those distribution points? And then, I'd love to hear kind of what you guys think about the Turkey outlook with a little bit more detail as well as kind of the magnitude of the cost of re-establishing those retail distribution points?

Sure. I mean it starts with the fact that the impact of the voluntary recall was that we lost distribution. The other thing that we've had to understand is what's happened with the brand, and so what we know is that the brand strength is still very strong among consumers and where we have product on shelf, which is still quite expensive, because we're the number one brand, our velocities are good. The velocities haven't decreased at all. So obviously, having the number one brand really does matter. So as we think about the back half of the year, I mean, we see this as an entire back half play in terms of regaining distribution. Even though we have the number one brand, it doesn’t happen overnight. And as you mentioned, there will be some impact with the investments that we need to make. But we feel confident that by reactivating promotional activity, really engaging with our advertising, and going customer by customer, we're still very positive on the Jennie-O Turkey Store business. As we think back to this business where it comes from, it's clearly the best performing acquisition we've ever made; the combination of Jennie-O and Turkey Store. So we are not resting on our laurels or looking back, it’s really about how we are going to carry this business forward. We have some work to do, but when we regain the distribution, we know the brand is strong and we know that the velocities are there in the lean ground space.

Good morning and thanks for taking my questions. First on your cash balance. So clearly, it continues to build on the sale of CytoSport, so just curious how you guys are thinking about deploying that excess cash?

I think that the focus is the same and it’s investing and growing the business.

Yes, Rupesh. And I would tell you, as we mentioned in our comments, that we're in a really good position, should we find, obviously, the right acquisition, and we referenced a transformational acquisition. So we've talked about the level that the size of the deal that we could do that we would be comfortable with still holds true. The key is, as always, we've got a number of deals that we're looking at that we're reviewing that are in the pipeline. It's getting them to the finish line. And then the other part is, in terms of having the one deal that fits that price range can sometimes be difficult. So as Jim mentioned, it is this constant view of how do we reinvest and grow in the business whether that's through value-added capacity expansion or through external strategic acquisitions. I mean, our team is as focused as ever on both of those.

And then on the Refrigerated Foods segment, so there is another big decline in commodity profits. So I was just curious if you can just give us a little more color on what's driving that decline and whether the company is now worse off or better following the Fremont plant sale?

Yeah, I mean we're better off than we were three years ago. I mean, as we've said, this is a better business today. The moves that we've made to really strengthen our earnings power put us in a strong position. The Refrigerated Foods piece has been the fifth consecutive quarter of steep declines in commodity profits, and even though we had record value-added sales, it still wasn't enough to overcome that. And then, of course, to tell you the combination of the margin compression from the run-up in markets, but as we think about the portfolio, especially in Refrigerated Foods, I mean it is as strong as it's ever been and well positioned for future growth.

Rupesh, one area I'd point you to is that the hog markets increased about 50% year-over-year in the second quarter, where the composite carcass value, the basis of what we purchase from the WholeStone Group increased about 20%. So I think that's consistent with the strategy of reducing the level of volatility in this transaction.

I would like to address that you lowered the fiscal '19 guidance by $0.06, which includes a net $0.02 benefit from the CytoSport divestiture. This indicates a $0.08 adjustment prior to that, and it seems like corporate might perform better this quarter. Can you break down the change in outlook by the different business segments? The Jennie-O business has faced more challenges, particularly with input pressures on pork affecting the entire portfolio, so how should we interpret the change in outlook across the operating segments?

Well, Adam, I'll start on the discussion about the decrease in unallocated funds. It's down due to the CytoSport transaction and some benefit from interest income, but also because our general administrative expenses and certain selling expenses are less than our actual spending. This is because we allocate those expenses based on a fixed amount in our budgets, and we've done a commendable job managing those expenses. This reduction is consistent with the decline we're seeing in our SG&A costs.

Yes, then as we think about the businesses, Adam, I mean, the key takeaway is that our first half was lower than expected, but the majority of that gap is in the second half due to ASF and the business at Jennie-O Turkey Store. So as you think about each segment, Grocery Products will have a slight decline. As you think about higher trim markets and we haven't talked about the Skippy pricing yet, but that will have an impact in the second half of the year. For Refrigerated Foods, we expect continued strong results from our brands across all the channels, but there will be a lag in pricing. So we would expect to see a slight decline in Refrigerated Foods in the back half. And really the same holds true for International through the ASF and tariff issues. And then as we've talked about Jennie-O Turkey Store, because of the reinvestment in lean ground and we're still not seeing improvement in the markets like we'd like to see. So we are seeing some improvements, but they continue to be slow. So it's a little bit across the board and but the majority of the gap is in the back half.

And then I guess my second question is more just about the competitive in the U.S. pork market. As we think about the prospect of higher pork exports, do you feel that puts you in any sort of competitive disadvantage where some of your bigger packer and processed meat competitors are a bit more vertically integrated and more tied to the export market, might have more visibility in terms of product flow before you fully see that is from thinking specifically in the event of the U.S exporting cold carcasses to China and the net impact that would have on belly and trim markets. But just broadly, does not having a bigger export business today put you at a competitive disadvantage given the market landscape?

Yes, what I would say, Adam, is you've got short-term issues and then long-term strategies. And so there are different operating models that will certainly be able to capitalize on some of those short-term opportunities better than we can. But from where we sit, we're in the business we want to be in and we know that there's going to be that volatility, less supply, increased costs, and as we've talked about, it's that lag that hurts us, that compresses us in the short term. But we know and we've demonstrated our ability to price to the new market levels with the businesses, the brands, the portfolios that we've chosen to participate in. And so advantage, disadvantage, I guess it really depends on the business you want to be in and how you want to run short-term, long-term, but we feel good about where we are. We just really need to get through the ups and downs of the markets and then we'll be fine.

Can you provide insights on how your customers across various channels are preparing for the potential supply disruption? We're noticing that restaurant operators are increasingly eager to secure prices or volumes. Additionally, we're observing adjustments in menus and offerings towards alternative proteins. Your comments on pricing elasticity and contract lengths are appreciated, but is there a concern that customers, anticipating a shortage, might already be changing their purchasing behavior and may not be as willing to accept price increases at this time?

Jeremy, we believe we are quite close to the foodservice market. We haven't observed our foodservice operators engaging in substitution or attempting to secure supplies as others have. Your initial comment is accurate; during such situations, there is a tendency to want to lock in prices. However, from our perspective, that's the last thing we want to do. We prefer to align our pricing in food services more closely with the market, and that is something we achieve every day. We have avoided long-term pricing agreements, believing they do not benefit either party. Our emphasis remains on providing solutions, ensuring we can assist operators with their challenges in developing appealing menu options for their customers, as well as addressing their labor, insurance, and safety concerns. While it's not quite business as usual due to a different mindset, much of our work continues to reflect what's happening in the marketplace.

I appreciate the color you had on your expectations for raw material inflation. Just given all the internal changes in the Refrigerated Foods division over the last couple of years, I think there's been some hazing this in terms of your net sensitivity to different pricing. So maybe if I can ask on the cost side of the equation, meaning, assuming you take price, what is the earnings sensitivity to let's say a 10% increase in bellies and trim?

The answer I would give you, Jeremy, is that it’s more about the volatility in the changes rather than the magnitude of those changes. As this process develops, I think we’ll see reduced volatility in the markets and fewer rumors, as people will have a clearer understanding of the facts surrounding ASF. Currently, we are witnessing significant fluctuations in the markets from day to day. Once we reach a level of greater stability, there will be fewer rumors and speculation, allowing us to manage this effectively. The increase in price is not the main concern; it’s the level of volatility we experience. For example, from the beginning of the quarter to the end, we observed that while the price only changed by 6%, it fluctuated between 120 and 215 during that quarter, which is challenging to manage. My recommendation would be to focus more on volatility since it can sometimes be beneficial, but it also creates noise in a quarter. For instance, if we raised prices but our input costs dropped in the last few weeks, it might make the quarter appear better than it actually is or vice versa. It’s better to evaluate our performance over the long term and disregard the short-term noise caused by volatility. I hope this is helpful.

I appreciate all the comments about the volatility and the fundamental challenges, but I am a little confused as to your messaging here on your pricing because how decisive have you been able to be with your customers on these price increases that you've taken, like are you telling them that, hey, we're taking these price increases. But in a couple of weeks, we might have to take more based on our outlook or are you saying, hey, there's a lot of volatility. So this might not stick? It's a little unclear to me like how decisive you can actually be in how you're communicating to your customers?

Yes, that's a great question, Rob. And we have been very decisive with our customers in terms of the pricing that we've taken across multiple categories. Although there is all this uncertainty, again, as I said about the when, the how much, how long, there is a consensus that the markets are going to increase. And so we have been decisive with pricing, in terms of what the markets do and when it's reflected. We have gone customer by customer and worked on a promotional basis to make sure that pricing is not negatively impacting the categories, but it's important to get that pricing out front and center as soon as possible. So the pricing actions have been decisive, working closely with them on a customer by customer basis as the markets move with that volatility is something that we watch very closely. So hopefully that gives you a little more color on how we're thinking about the pricing.

Okay. And then in the grocery division, is it easier in the grocery division to kind of just take the price increase and have it stick because the underlying meat is a smaller component of the overall cost of the product? Is that a fair statement?

I wish it was. As you know, we know the pricing conversations are always hard. And so I wouldn't say that it's any easier. It is a smaller component, you're correct. But you've got to have the market data or the industry facts to support your case. And I think that's really I would say that they're fairly equivalent in terms of Grocery Products or Refrigerated Foods.

I have a couple of questions. First, regarding 2020, how much of the turkey issues do you expect to be resolved so that you can benefit from any recovery in that year? Also, why wouldn't you see any advantage from African swine fever affecting the turkey operation in 2020? Second, concerning your pricing for Skippy, what kind of elasticity have you experienced, and how do you anticipate that will change?

Thank you for your questions, Ken. As we look ahead to 2020, you are correct that we expect to benefit from a few factors. Firstly, we will be focused on regaining our distribution in the latter half of this year, leveraging our strong brand and sales momentum. This should positively impact our retail business. The foodservice segment at Jennie-O Turkey Store also performed well in the last quarter, and we anticipate continued growth in that area. Your observation about turkey is also valid. However, it’s difficult to predict outcomes at this point. There is a perspective suggesting that, given the impact on pork, other proteins like chicken, beef, and turkey might see benefits as well. We haven’t integrated much of this into our future forecasts since we recognize the need to restore distribution. Nonetheless, it remains a potential variable to consider, particularly concerning African swine fever. Regarding Skippy’s pricing, we have implemented a price decrease and have collaborated closely with each customer, as our primary aim is to be responsible stewards of the category. We've relied heavily on revenue growth management to assist retailers in category growth. Our commitment remains on brand development and innovation, although the current market is challenging. We prefer not to compete solely on price, focusing instead on enhancing brand value and innovation. We're making strides, with a strong brand and exciting new products on the way to elevate peanut butter experiences. We mentioned in our prepared remarks our satisfaction with the successful rollout of Skippy PB&J minis nationwide, which we believe will positively influence the brand. While there are some short-term challenges, we are confident in emerging from this period even stronger.

My questions are actually related. You mentioned your outlook on hog and belly pricing for the rest of this year, and I'm interested in your thoughts for 2020. You talked about the 150 million to 200 million hogs that conventional wisdom suggests have been lost in China, which is a significant number, far exceeding the impact of PED. In your early considerations about 2020, do you anticipate that hog prices will increase significantly? Also, regarding the elasticity of volume for your products, while it may be a common discussion, I believe most would agree this situation is unprecedented. I’m curious about how you are considering the impact of substantial cost increases on volume and your business.

Yes. You've raised an important question, and I believe there are many ways to approach it. We are facing unprecedented conditions that are likely to persist longer than we've experienced before. If demand remains steady, we might indeed see another increase in prices. However, I believe that at some point, due to demand elasticity, we could witness a decline in demand or a shift towards other protein sources, as Ken mentioned earlier. This creates a lot of uncertainty regarding how consumers will interact with various protein options, making it challenging to accurately predict the ultimate effects.

I was wondering if you could compare and contrast. You mentioned that you've experienced three health events in the last five years, with PED seeming to be the most relevant one. Since your business has changed significantly, having divested from Farmer John's and Fremont, coupled with your Jennie-O business and your reduced control over the hogs, do you feel your business is better positioned compared to 2014? Because you don't control the hogs, you might be more exposed to the belly cut-out but less exposed to the lean hogs. Could you share your thoughts on how the business is positioned relative to 2014?

The business in our opinion for where we want to be is much better positioned because our goal is not to be a commodity company or commodity organization. And as I've said several times already, this is a better business today through the intentional changes that we've made. Some of the things we're talking about are short-term and commodity in nature. Going back to the first part of your question, in terms of what have we learned, clearly from PEDV, what we learned was how important it is to be proactive with your pricing. And so, I mean, I would say that we certainly have led the charge in the industry in terms of being proactive with our pricing. But I think that's important just because it gets the right mindset into the marketplace and then as things change, we've got other levers we can pull to help customers and consumers, but when it's all said and done, this company, this portfolio is in a much better place than it was in 2014. And as I've said pretty broadly within our four walls, I've never had as much confidence and as much faith in our business, our strategy, and our people.

I just have a couple. The first one is as a quick follow-up to Rob's question. In that you're quite a bit closer to the market with your foodservice business, does that allow you to adjust prices downward as well, if the market volatility would suggest to you should do that? I think that's a harder plan to implement at retail. But do you have flexibility to work with your customers on the downside as well?

Yes, Eric, that's a correct assessment. The foodservice channel does give us that flexibility, but it's also very typical. So because we're closer to the market, we take the ups and downs, and that's clearly understood in the channel and in the marketplace.

Okay. The last two points are more about secondary effects. You've been very proactive with your pricing strategy in the market, and your competitors are dealing with similar challenges. Are they aligned with your approach? Additionally, and perhaps more importantly, what feedback are you receiving from your hog producers? Is the farming community preparing to ramp up production as well? Considering the low grain prices and the anticipated increase in demand, which currently remains speculative, has this shifted the producers' perspectives on their plans for the next few years?

Eric, I'll take the first part and then Jim Sheehan can answer the second half. As I said and you agreed, I mean we have been proactive with our pricing and we were the first ones out of the gate. We are starting to see some competitive follow-up, which obviously supports our position and helps support the overall pricing models. So it's happening slower than we would have liked. But it's starting to happen. Jim, I'll let you answer.

Yes, I'll speak to that. Our producers appear to be in a very good position to meet any demand for increased hog production. We feel that they're in a very good position and we're confident that we will have the supply of hogs if any.

Just wanted to ask on the Jennie-O side, the lost shelf space, who are you losing that to, and as you look to win it back, what's kind of the pitch for displacing it? It's a little surprising. I guess how well velocities have hung in to see this level of distribution losses. So what are your retailers telling you? Who are they giving it to and kind of what's the pitch to win it back?

Yes, there are definitely other competitors in that space. It ultimately depends on which retailer is filling the gap. The narrative we present revolves around what has happened to their category in our absence. In most instances, the news isn't favorable for them, which highlights the importance of brand strength. The leading brand remains significant. The voluntary recall is a contributing factor to our current situation, and we recognize that. However, our research indicates that the brand remains strong. In locations where we have maintained distribution, we are seeing that sales volumes are holding steady, which is crucial. This forms the basis of our discussions with retailers. However, it’s important to note that regaining shelf space is not instantaneous. We can't simply show up and expect to be reinstated; we need to earn our way back, and we are committed to doing so. Once we regain that space, we are confident in our ability to assist them in growing their category.

And I also wanted to follow-up on the hog side; you referenced the run-up in spot pricing. I think in the past you've had maybe a little bit less volatility than spot pricing because you're in negotiated pricing in your hedges. Have you decreased that exposure? I mean, is this a situation where as those hedges roll off? We look for more inflation inside of the fourth quarter than in the third quarter or should we be thinking about it a little differently than that?

Probably, the biggest difference you've seen between the first quarter and second quarter is we believe will go into the back half is in the first quarter grain-based contracts were a drag to us. They were more expensive than other formula pricing that we had. It's an advantage to us right now. Those are coming in at a little bit lower cost. We still take future positions. We still work with our producers. Of course, when we made the change in the structure of Fremont, we took a look at rebalancing the type of contracts we have, and we think we're in a really good position right now. We have a nice balance.

Just a quick one. So, obviously, with the disruption in China, roughly $150 million to $200 million, which you expect and your exposure on the sales side, what have you seen on Chinese demand for different products? Have you seen people switching? Have you still seen the similar demand dynamics as in the past? Sorry, I'm a little tired. Just to understand how the Chinese consumers are reacting and how you feel about demand going forward on the Chinese side, just in order to understand a little bit what the opportunity could be for imported products from ours and how that most likely is going to shake out on a global basis? That would be great to get some color.

Yes, great question, Ben. So I mean we have seen and you've probably heard that there has been an increase in chicken consumption in China. But consumers in China are still eating pork, and so our in-country business still remains very strong both the retail and foodservice refrigerated meat business. We've also seen, and as we mentioned, strong growth in our SPAM and Skippy business, but I do think that you hit on something that we're watching very closely is that we are trying to understand the consumer demand and what the impact of ASF is having on them at this point. We haven't seen it flow through in the business, but it is something obviously that's top of mind.

And then just one quick one on your updated tax guidance, is it fair to assume that the second half is basically unchanged to what the initial guidance was, and that reduction for full year is solely driven by the lower effective tax rate of the second quarter?

That's correct, Benjamin.

So I was just wondering if you can talk about what percentage of the international business pork exports are? Is that less significant now with the Fremont sale? And I'm just wondering if that will help offset some of the cost pressures we're seeing in the pork business because some of the other pork producers are seeing increased margins year-over-year in their pork export business?

Yes, so a couple of things there, Rebecca. Our transaction with the Fremont facility really has no impact on our ability to supply the international export pork business. I mean, it's still an important part of the overall portfolio. And so when it's down to the extreme that it was this quarter, it impacts the overall business and so obviously we've been in a very intentional, very focused on our ability to grow our multinational businesses, both in China and Brazil. And so we, of course, we've got our plant expansion, our new plant in Jiaxing to support that growth in country putting in our first ever SPAM production line that we own outside the United States. And so, I mean that's really what we're focused on in terms of our international business and over time our goal is for our pork exports to become less and less meaningful, and less and lesser part of our international business.

Okay. So you don't expect that a material impact on your results for the back half of the year even as those margins improve; it really won't impact anything?

I mean it depends, right. And obviously we've got the impact of ASF, but you've also got tariff issues still. I mean, there's still a lot of moving parts. So it could still have an impact on our international group. But again, it's really hard to tell at this time.

Well, I want to thank all of you for your participation today. Obviously, we've covered a lot of ground and talked a lot about the uncertainty that exists in the marketplace. But through all of the uncertainty that exists in the marketplace, as I mentioned earlier, I've never had more confidence and faith in our team, our business, and our strategies and their ability to continue to deliver key results for our company. I want to wish you all a safe Memorial Day weekend. And thank you for your time today.