Hormel Foods 2014 Annual Report Download - page 32

30
open contracts are reported at their fair value with an unre-
alized loss of ($11.3) million, before tax, on the Consolidated
Statements of Financial Position as of October 26, 2014,
compared to an unrealized loss of $(6.3) million, before tax, as
of October 27, 2013.
The Company measures its market risk exposure on its
grain futures contracts using a sensitivity analysis, which
considers a hypothetical 10 percent change in the market
prices for grain. A 10 percent decrease in the market price
for grain would have negatively impacted the fair value of the
Company’s October 26, 2014, open grain contracts by $7.1
million, which in turn would lower the Company’s future cost
on purchased grain by a similar amount.
Long-Term Debt: A principal market risk affecting the
Company is the exposure to changes in interest rates on the
Company’s fixed-rate, long-term debt. Market risk for fixed-
rate, long-term debt is estimated as the potential increase in
fair value, resulting from a hypothetical 10 percent decrease
in interest rates, and amounts to approximately $4.0 million.
The fair value of the Company’s long-term debt was estimated
using discounted future cash flows based on the Company’s
incremental borrowing rates for similar types of borrowing
arrangements.
Investments: The Company holds trading securities as
part of a rabbi trust to fund certain supplemental executive
retirement plans and deferred income plans. As of October 26,
2014, the balance of these securities totaled $117.2 million.
A majority of these securities represent fixed income funds.
The Company is subject to market risk due to fluctuations in
the value of the remaining investments, as unrealized gains
and losses associated with these securities are included in
the Company’s net earnings on a mark-to-market basis. A
10 percent decline in the value of the investments not held
in fixed income funds would have a direct negative impact to
the Company’s pretax earnings of approximately $3.9 million,
while a 10 percent increase in value would have a positive
impact of the same amount.
International: The fair values of certain Company assets are
subject to fluctuations in foreign currencies. The Company’s
net asset position in foreign currencies as of October 26, 2014,
was $214.8 million, compared to $216.6 million as of October
27, 2013, with most of the exposure existing in Chinese yuan
and Philippine pesos. Changes in currency exchange rates
impact the fair values of Company assets either currently
through the Consolidated Statements of Operations as cur-
rency gains/losses, or by affecting other comprehensive loss.
The Company measures its foreign currency exchange risk
by using a 10 percent sensitivity analysis on the Company’s
primary foreign net asset position, the Chinese yuan, as of
October 26, 2014. A 10 percent strengthening in the value of
the yuan relative to the U.S. dollar would result in other com-
prehensive income of approximately $13.3 million pretax. A 10
percent weakening in the value of the yuan relative to the U.S.
dollar would result in other comprehensive loss of approxi-
mately $10.9 million pretax.
Quantitative and Qualitative Disclosure
About Market Risks
Hog Markets: The Company’s earnings are affected by
fluctuations in the live hog market. To minimize the impact
on earnings, and to ensure a steady supply of quality hogs,
the Company has entered into contracts with producers for
the purchase of hogs at formula-based prices over periods
of up to 10 years. Purchased hogs under contract accounted
for 94 percent and 98 percent of the total hogs purchased by
the Company in fiscal years 2014 and 2013, respectively. The
majority of these contracts use market-based formulas based
on hog futures, hog primal values, or industry reported hog
markets. Other contracts use a formula based on the cost of
production, which can fluctuate independently from hog mar-
kets. Under normal, long-term market conditions, changes
in the cash hog market are offset by proportional changes in
primal values. Therefore, a hypothetical 10 percent change in
the cash hog market would have had an immaterial effect on
the Company’s results of operations.
Certain procurement contracts allow for future hog deliveries
(firm commitments) to be forward priced. The Company
generally hedges these firm commitments by using hog
futures contracts. These futures contracts are designated
and accounted for as fair value hedges. The change in the
market value of such futures contracts is highly effective at
offsetting changes in price movements of the hedged item,
and the Company evaluates the effectiveness of the contracts
on a regular basis. Changes in the fair value of the futures
contracts, along with the gain or loss on the firm commitment,
are marked-to-market through earnings and are recorded on
the Consolidated Statements of Financial Position as a current
asset and liability, respectively. The fair value of the Company’s
open futures contracts as of October 26, 2014, was $0.6 million
compared to $(10.9) million as of October 27, 2013.
The Company measures its market risk exposure on its hog
futures contracts using a sensitivity analysis, which considers
a hypothetical 10 percent change in market prices. A 10
percent increase in market prices would have negatively
impacted the fair value of the Company’s October 26, 2014
open contracts by $6.1 million, which in turn would lower the
Company’s future cost of purchased hogs by a similar amount.
Turkey and Hog Production Costs: The Company raises or
contracts for live turkeys and hogs to meet some of its raw
material supply requirements. Production costs in raising
turkeys and hogs are subject primarily to fluctuations in
feed prices and, to a lesser extent, fuel costs. Under normal,
long-term market conditions, changes in the cost to produce
turkeys and hogs are offset by proportional changes in their
respective markets.
To reduce the Company’s exposure to changes in grain prices,
the Company utilizes a hedge program to offset the fluctuation
in the Company’s future direct grain purchases. This program
currently utilizes corn futures for JOTS, and these contracts
are accounted for under cash flow hedge accounting. The