Hillshire Brands Management Discusses Q4 2013 Results - Earnings Call Transcript

Aug. 8.13 | About: Hillshire Brands (HSH)

Hillshire Brands (NYSE:HSH)

Q4 2013 Earnings Call

August 08, 2013 9:30 am ET

Executives

Melissa Napier - Senior Vice President of Investor Relations

Sean M. Connolly - Chief Executive Officer, Director, Member of Executive Committee and Chief Executive Officer of North American Retail & Food Service Business

Maria Henry - Chief Financial Officer and Executive Vice President

Analysts

Kenneth B. Zaslow - BMO Capital Markets U.S.

Robert Moskow - Crédit Suisse AG, Research Division

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Kenneth Perkins - Morningstar Inc., Research Division

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Jason English - Goldman Sachs Group Inc., Research Division

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

John J. Baumgartner - Wells Fargo Securities, LLC, Research Division

Christine McCracken - Cleveland Research Company

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Operator

Good morning, and welcome to the Fourth Quarter and Full Year Fiscal '13 Earnings Conference Call for Hillshire Brands. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Melissa Napier, Treasurer and Senior Vice President of Investor Relations for Hillshire Brands. Thank you. Melissa, you may begin.

Melissa Napier

Thanks, Candy. Good morning, everyone. Welcome to our fiscal 2013 earnings call. Our fourth quarter and full year fiscal results were released at 6:30 a.m. Central Time this morning. You can find that release, along with the slides that we'll be reviewing today, posted to our website under the Investor Relations section. We expect that our 10-K will be filed with the SEC on or before August 28.

I'm joined today by Sean Connolly, our CEO; and Maria Henry, our CFO. Sean and Maria will provide their perspectives on the performance of the business during the quarter and for the full fiscal year. We'll also provide our outlook for fiscal 2014. We'll take your questions after management's prepared remarks conclude.

[Operator Instructions] I'd like to refer you to the forward-looking statement currently displayed and remind you that during today's call, we may make forward-looking statements about future operations, financial performance and business conditions. Actual results may differ from those expressed or implied in these statements. Also, during this presentation, we may refer to non-GAAP financial measures. Explanations of these non-GAAP financial measures are included in our release.

I'll now turn the call over to Sean.

Sean M. Connolly

Thanks, Melissa. Good morning, everyone, and thanks for joining us this morning. Before we summarize our full year performance, as I often do, I want to ground everyone in the big picture. Hillshire Brands is a focused food company with category-leading brands. We're equally committed to delivering growth and profitability. Accordingly, we believe in a very disciplined approach to brand building and innovation across our core brands. And we also believe in reducing costs in order to fuel our growth agenda. With 1 year of our plan complete, I feel very good about the progress we're making to build a leading food company.

In so many ways, it's been a gratifying first year. We took on an enormous amount of change, and we've made real progress on our business, our team and our culture. While we're proud of what we accomplished, we recognize it's only 1 year and we have a lot more to do. Nevertheless, we delivered very solid results in fiscal '13. Simply put, our strong businesses became stronger and our soft spots have begun to move in the right direction. Our EPS came in well above our original guidance range, but we are clear-eyed that this was driven by significant commodity deflation and onetime SG&A favorability, mostly in the first half of the year. When you strip away those unexpected tailwinds, the year came in squarely in line with our original expectations. Importantly, our brand building and innovation investments unmistakably strengthened our core brands, and our innovation program overall has been jump-started as we now have a rebuilt innovation pipeline and a much more disciplined process.

Finally, the team demonstrated a keen recognition that they need to fuel our demand drivers by delivering their cost savings targets. Not only did they deliver, they also identified new efficiency opportunities.

In the marketplace, our overall consumption trends improved meaningfully in fiscal year '13. As you can see on this slide, Jimmy Dean, Ball Park, Gallo and Aidells were standout performers. Hillshire Farm was well on its way to overall growth prior to our lunchmeat packaging challenges. More on that in a minute. But other businesses still need attention. As an example, our State Fair Corn Dog business softened late in the year amidst intensifying price-based competition. Now with our core businesses in relatively good shape compared to when we began this journey, we are well positioned to provide more attention to some of these smaller brands that have dampened our overall results.

I'm often asked, is your investment in MAP having the impact you expected? The answer in fiscal '13 was absolutely yes. Let me remind you that we historically underinvested in MAP at a rate of about 3.5%. Our goal is to get that number to 5% by fiscal '15. In this past year, we stepped up our investment to 4.4%. As you can see on the right, that increase was highly focused against a small number of businesses, most notably Jimmy Dean. And I'm pleased to report that each of these investment areas delivered very good growth. We are highly disciplined with the spend, meaning we spend where we have confidence in a return and we always look to drive more efficiency into these investments.

With respect to innovation, we took a big step forward in fiscal '13. First, we put a dedicated team in place to overhaul the innovation process and rebuild the pipeline. This team is led by our first Chief Innovation Officer. We set clear expectations that by fiscal '15, we would be generating between 13% and 15% of our annual revenue from innovations launched in the prior 3 years. We have already moved the needle here, climbing to 11% in fiscal year '13 from our past history of 9%. And the 2 products you see here are both examples of innovation success in fiscal '13. In the case of Jimmy Dean Delights, this is an example of how we're successfully strengthening our core brands. We launched several new items of Delights last year, including the flatbreads line you see here. We increased MAP over 50%, and we saw sales growth of over 30% on what the scanner data will show you is now roughly a $150 million Delights franchise in retail sales.

In the case of Ball Park Flame Grilled Burgers, we have a good example of successfully delivering on our strategy to extend our power brands into adjacent categories. In this case, taking Ball Park into frozen. And when we backed this great product with MAP support, we saw sales take off, which is exactly what you want when you have strong repeat rates like this product does.

And to pay for our demand-generation investments, we have embraced a rigorous approach to cost management. We remain on track to deliver $145 million of cost efficiencies spread over the first 3 to 4 years of our company's existence. Importantly, we achieved our targeted $40 million cost savings in fiscal '13 and the plans are in place to execute against the remaining $105 million. I should point out that there's more to this work than the monetary savings. We're also building core capabilities on how to do more with less and that bodes well for sustainable growth and profitability. At the end of the day, I'm very pleased with the significant cultural shift toward embracing an efficiency mindset.

Now I'm sure many of you are curious where we stand in our efforts to resolve the Hillshire Farm lunchmeat packaging issue that emerged last quarter, so I'll take a few minutes here to give you a full report. First, I'm pleased to inform you that we fixed the manufacturing challenges we encountered. The meat is nicely layering into the new package. It looks great and the lines are running better than ever. But we've also made a necessary change to optimize our package graphics to increase consumer impact in stores. Specifically, we now believe we lost visual impact on store shelves due to the switch to the clear package lid. While consumers consistently articulated a preference for the clear lid in numerous quantitative tests, their actual purchase behavior noticeably changed when we made the switch. As we dug into the disconnect between what consumers were saying and what they were doing, it became clear that there was a positive benefit to the red lid that the consumer could not articulate. We concluded that they were habitually drawn to the vivid red Hillshire Farm brand block in the retailer's shelf set. We then immediately mobilized to design a new red lid to fit the new, wider package structure that we had moved to. We believe the revised package with the red lid gives us the best overall solution, in that reverting to the red color gives us the shelf impact we're seeking and the new wider package structure also enables the consumer to clearly see the nicely layered meat through the transparent backside of the package.

By the way, I see a silver lining in this experience for us. In the old days, it would've taken us the better part of a year to navigate a course correction like this. In this case, we were able to be in the market with a new solution in less than 10 weeks. But what you really want to know is, is it working? And the answer is yes. And to make the point, I'll delve into more detail than I typically do, but I think you'll find the more granular data helpful. What you're looking at here is multi-outlet scanner data on baseline volume consumption for our 7 to 9 ounce Hillshire Farm lunchmeat tub. Recall, base volume is the volume you sell outside of price promotions, and it's the best proxy for underlying brand health. What you see here, left to right, is a number of things. First, that our base volume in fiscal '13, which is the red line, was encouragingly performing well above fiscal '12, which is the blue line, prior to the package switch. Then you see the rapid drop-off and sustained decline, while we were using the clear lid. But then most critically, you see a strong rebound in performance on the right side as we moved to the new red lid. Now better service levels played a role here, but the point is, it's working. What we need now and expect now is to see a similar rebound in promoted volume, which is still down as competitors became aggressive in filling the merchandising void that our issue created. We're confident we'll get that clicking in quarter 1. Overall, we remain very confident in the growth potential of the Hillshire Farm brand in the lunchmeat space.

I've said previously that we wouldn't solve all of our challenges in year 1, and we didn't. But we did make progress, and we expect more this year. In the last year, our bakery operation successfully navigated challenges associated with being an early adopter of the Food Safety Modernization Act requirements and is now among the best positioned frozen bakery assets in the industry. While early days, the Foodservice bakery team's innovation in upscale desserts appears to be working. And on the retail side, we're enhancing our frozen bakery competitiveness via investments in improved price gaps and new product innovation.

In our Sara Lee Deli meats business, we've seen the larger bulk deli business gain traction behind improved product quality. You can't see this in the scanner data, but this business is nearly stable after being a chronic decliner previously. On the smaller pre-sliced Sara Lee Deli meat line, which is the piece you see in the scanner data, we still have work to do, as our share of shelf has declined in recent years with the expansion of the superpremium segment.

Our State Fair Corn Dog business is one we don't talk about often, but this is an important category for us. It's an on-trend, convenient food. We are the market leader. We have the best quality product in the space. And until recently, we were the only national brand. We saw our growth trends here, however, turn to decline in the second half of fiscal '13 as a competitor invested heavily behind wider distribution and deep price discounting. Accordingly, we've mobilized to restore growth through ramped up innovation and ensuring we're price competitive in the marketplace. These investments, while the right thing to do to protect the business, will be a drag on results this year, and Maria will elaborate more on that in a few minutes.

Let me now provide some overall perspective on how to think about fiscal '14. First, recall the comps this year will be very atypical, particularly in the first half, where we dramatically outperformed normal trends last year in fiscal '13. In fact, in a major reversal from the first half of last year, we now face material near-term inflation. Further, we will be wrapping nonrecurring favorable items in SG&A. So clearly, our fiscal '14 results will be tipped to the back half.

Second, we remain unwavering in our commitment to doing what is right for long-term value creation. Accordingly, we'll continue our disciplined investment in brand building through efficient MAP spend. And we take the need for discipline here seriously. In fact, we've eliminated significant nonworking spending while increasing our planned in-market working MAP presence in fiscal '14.

Third, we have a robust innovation agenda we're investing behind, and we've aligned it with customer launch windows for our categories. Q3 will be a significant window for us this year, and we'll share more on these innovations at a later date.

Fourth, we worked hard to build our market-leading positions, and we will work hard to defend them. Most often, that will be strategic through brand building and innovation. Sometimes, it will be more tactical in response to competitive flareups. The point is, we favor non-price-based competition but we will ride the right horse for the course.

Finally, our work is not done strengthening soft spots on smaller brands, and we will do just that. When you put it all together, our fiscal year '14 plan reflects both the realities of the near-term climate plus our commitment to long-term value creation. We are out to build a fully competitive company that can endure. So we're committed to doing things the right way. Frankly, our fiscal '14 profitability expectations are roughly in line with where we originally expected the business to be by the end of fiscal year '14, despite the near-end [ph] environment being a bit more competitively intense than we had originally envisioned. We expect to build momentum as the year progresses, both on the top line, where our innovation programs kick in, in the second half, and on the bottom line, as early on we will navigate inflation and significant onetime wraps and then benefit from our cost programs and easier comps in the second half.

The upshot of all of this is we are confident in the potential of our business and its cash flows and are now in a position to return additional capital to shareholders. As you saw in our announcement this morning, and Maria will elaborate further, we are pleased to be increasing our dividend and are also targeting $200 million in share repurchases over the next 2 years.

Finally, before I turn it over to Maria, expect us to continue to pursue targeted M&A opportunities as a central part of our value creation strategy. Maria, over to you.

Maria Henry

Thanks, Sean. Good morning, everyone. Thanks for joining us. As you've seen in our numbers and just heard from Sean's comments, our fourth quarter financials, both the top and the bottom line, were challenged by some unusual items, but our underlying business continues to make progress and we were able to end the year with EPS slightly ahead of our updated increased guidance. I'll walk you through some of the financial details.

There were 3 unusual things that had a significant impact on our fourth quarter results. The lunchmeat transition, which we expected, and 2 that were unexpected: the onetime Q4 reduction in inventory levels held by a major customer; and favorable expenses in corporate from adjustments that are primarily related to employee comp and benefits and franchise state taxes. These 3 items make it difficult to see the underlying trends of our business. But excluding these items, we would've generated positive sales growth in the low-single digits, with a single-digit earnings decline. Beyond those 3 items, we also experienced commodity inflation for the first time in fiscal 2013. This is in contrast to the substantial favorability we were getting from lower input costs in earlier quarters. As we've discussed before and consistent with our strategy, we invested a portion of the first half favorability we had back into our business, both in MAP and targeted investments in marketing and innovation. We ended the year with a strong cash balance, and for the year, we delivered fiscal '13 earnings ahead of our original guidance with the help of favorable input costs. Outside of that benefit, earnings performance was generally on track with what we originally expected.

Now let's take a look at the quarter's financial results. Our adjusted net sales declined 2.1% on a 1% decrease in volume. If you exclude commodity meat sales, our adjusted net sales would have been down 2.6% on a volume decline of 2.6%. Lower sales were driven by our Retail segment for the reasons just discussed, our Foodservice/Other segment grew in the quarter. Gross profit dollars and rate were down for the quarter versus last year on lower volumes and higher input costs. For the year, our gross profit rate ended at 29.9%, up from our 28.5% baseline in fiscal '12, reflecting the substantial benefit of lower input costs earlier in the year.

You see on this slide that our fourth quarter MAP investment was $47 million. You shouldn't take this as a run rate, as the $47 million includes reinvestment of some of the first half favorability into MAP. The 70% year-on-year MAP growth rate reflects not only the additional level of investment, but also the fact that last year's fourth quarter MAP spend was unusually low at only 2.8% of sales. Our SG&A, excluding MAP, ended up being down 3% for the year, with our segments up and corporate down. This reflects savings offsetting the stranded costs coming into our P&L and the benefit of onetime items. You'll recall that I told you to expect corporate expense to end at $50 million for the year. However, we came in at $41 million on some favorable adjustments in the fourth quarter. Our normal corporate run rate is about $15 million dollars a quarter.

The result of all of this, lower sales and gross margin on unusual events, inflationary input costs, higher MAP investment and lower SG&A, resulted in our operating income being down 23.2% for the fourth quarter. But looking at the total year, our adjusted operating income was strong, up 12.5% versus prior year, resulting in an adjusted margin of 9.3%. And we closed out fiscal '13 at $1.72 of adjusted EPS, which was up 18.6%.

Now let's look at the segments. Our Retail segment sales were down 3.8%, and operating income was down 32.3% in the fourth quarter. The positive performance of our Jimmy Dean, Ball Park and Aidells businesses were offset by the items we've been discussing: the lunchmeat transition, customer inventory issue, higher input costs and increased investment versus a year ago. For the year, retail sales were up slightly and operating income was up 5.5%.

In our Foodservice/Other segment, fourth quarter volume grew 4.4%, driven by sales of commodity meat. Total net sales were up 2.7%. Excluding commodity meat, Foodservice net sales were up 1.3%. Within Foodservice, sales grew in bakery as we lapped the difficult fourth quarter last year when we were going through the transition of our bakery plant in Tarboro, North Carolina. The foodservice environment continues to be challenging. And beyond the broader industry challenges, desserts, in particular, have been a tough space. That said, we have an excellent Foodservice team, and they continue to execute our strategy to grow through innovation and to take share in targeted spots. We've identified specific channels, product categories and customers where we see solid growth potential. We have strategies to capitalize on the opportunity in each of these areas, and we're seeing success. In the fourth quarter, our convenience store sales were up double digits. Our high-end desserts business grew double digits with good momentum. And we're having success with targeted promotional activity with national accounts. In addition to our focus on growth, we're executing strategies to offset industry margin pressure through innovation, superior value proposition and product mix improvement. For the year, the Foodservice/Other segment was relatively flat on the top line and had an operating segment profit margin of 7.3%.

Moving on to cash. We closed the year with $400 million of cash. During the quarter, we settled a $40 million legacy swap obligation, which is why our cash balance is down from $416 million at the end of the third quarter. Overall, we ended the year with good cash flow and a strong balance sheet. We're under 2x levered with adjusted EBITDA of $509 million on gross debt of $951 million. This provides us with the flexibility to increase our cash to shareholders and pursue our M&A strategy as a path to leverage our assets and capabilities to create shareholder value.

At this point, you know we're increasing our dividend to $0.70 per share, and that we're targeting to deploy $200 million of capital to repurchase shares over the next 2 years. Let me put that in perspective of our overall capital allocation strategy. We intend to continue to invest in our business as our top priority. Our investments in brand building, innovation, capability development and efficiency programs are targeted at creating long-term sustainable growth and profitability. Now that we're through our first year as a standalone company, and we're also through 2/3 of our legacy cash obligations, and now we have a better feel for what we have and the underlying cash flows of our business, we are taking our annual dividend up by 40% to $0.70 a share. This puts our payout ratio in the low 40s. And at yesterday's stock price, the dividend would put our yield at about 2%. In addition to the increase in the dividend, we're targeting $200 million of share repurchases over the next 2 years. I'm not going to speculate on the exact timing of the repurchases, as we'll look to do them opportunistically and balance the expected returns against our other opportunities on a regular basis.

As a reminder, we have authorizations in place to repurchase $1.2 billion worth of shares plus another 2.7 million shares, so the $200 million number is a statement of intent, it's not a new authorization. With our strong balance sheet, the good underlying cash flow of the business and including the impact of the dividend increase and the anticipated share repurchases, we still have the flexibility we need to actively pursue targeted M&A opportunities. We believe there is significant value creation potential here. But as you know, we don't control action-ability and timing of acquisitions, so we'll continue to monitor our capital position and balance our opportunities to produce the highest shareholder returns over time.

Given where we are with our leverage position, we don't expect to pay down debt in the near term.

Looking forward, we expect sales to increase slightly in fiscal 2014 overall and that we will end the year with solid growth momentum. The sales outlook incorporates our expectation that we'll continue to invest behind growth and innovation and that we will achieve continued strong performance on our businesses that are growing. Additionally, we are anticipating a positive benefit from new innovation that will roll out during the fiscal year, particularly in the second half. Our outlook also anticipates the return to growth of Hillshire Farm lunchmeat later in the year after we have navigated through tough near-term competitive dynamics. And finally, our top line guidance reflects our expectation that we will stabilize the softer spots in our portfolio.

The positive growth that we expect from these actions and in these areas will be offset by a number of things: First, we expect our level of commodity meat sales, turkey in particular, to decrease significantly versus fiscal 2013. This puts close to a point of pressure on the year-over-year comparison for total company net sales.

Next, we will rigorously defend our market position against intensified competition in corn dogs and lunchmeat, as Sean discussed earlier. This will put pressure on pricing, and hence, net sales for pieces of our business.

And finally, while we will continue to strengthen our soft spots in our portfolio, we are not expecting growth in our bakery business, which represents about 10% of our total revenue.

As you know, we don't give annual MAP guidance. But that said, we expect total marketing investment to be up year-on-year to support the growth our business. Generally, marketing investment includes MAP, plotting behind innovation and trade promotion activities. Exactly which of those areas will increase and by how much will depend on what we see us as we carefully monitor the competitive environment and assess the readiness of our innovations.

Our earnings outlook for fiscal 2014 is flat to down mid-single digits. Incorporated into this outlook is the sales estimate I just spoke about: higher input costs for the year; continued investment behind brand building and innovation; the benefit of our savings initiative helping to offset inflation and defensive pricing actions; and the lapping of onetime benefits we experienced in SG&A in fiscal 2013. As you think about our fiscal '14 earnings growth guidance, I remind you that fiscal '13 was an unusual year. And when we compare our earnings outlook against our fiscal '12 baseline, we are clearly making progress with our profit model. We're expecting our gross margin rate to be higher and our SG&A cost to be lower than where we started out. Additionally, our operating margin expectations for fiscal '14 are in line with what we expected in our original 3-year plan.

Let me comment on some other areas of guidance. We are expecting a tax rate of 35%, net book interest expense of about $40 million and corporate expenses of $60 million, excluding significant items. We expect our CapEx to be at the high end of our previously stated range of 3.5% to 4% of net sales, as we invest behind productivity initiatives and growth. For significant items, we are anticipating P&L charges in cash outlays of $85 million to $95 million for fiscal 2014. This estimate incorporates cash related to our legacy obligations, as well as the costs associated with our productivity program. Post fiscal '14, this would put our remaining significant items estimate at $35 million to $40 million on the P&L and $55 million to $60 million in cash obligations.

So let me sum it up. We delivered strong financial results in our first year out. Our earnings outperformance versus original guidance reflects substantial benefit from favorable input costs and SG&A favorability. Heading into this year, we're expecting a more challenging operating environment. So if we achieved the high end of our guidance with earnings equal to fiscal '13, those earnings will have been achieved very differently in each of the 2 years. Importantly, we are making progress versus our starting point as a standalone company, and our margin expectation for fiscal 2014 is in line with our original 3-year plan. And finally, while we don't provide quarterly guidance, I will say that the unusual nature of fiscal '13, with significant commodities and SG&A favorability in the first half and the unusual items in the fourth quarter that we've discussed on this call, will make for exaggerated quarterly year-over-year comparisons as we go through fiscal '14.

With that, let me open it up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Ken Zaslow.

Kenneth B. Zaslow - BMO Capital Markets U.S.

Bank of Montréal. Just thinking about big picture, thinking about 2015. You talk about like this is -- the unusual situation with commodities going up and down. Do you guys think about what type of input costs and competition that you need to get to 2015? Or does that become less relevant as you become more into the packaged food and get your marketing spending where it needs to be? Can you put that in a framework for us?

Sean M. Connolly

Yes, I think the key is that we're not changing our midterm outlook at all. Our plan remains intact. We're looking to get sales growing 4% to 5% and to get to a double-digit OI margin. And that the actions we're taking on the business and the organization are aimed at delivering just that, because we've got a great branded portfolio, and we'll continue to be unwavering in our efforts to get its potential unleashed and really take cost out. In any given window, margins could be temporarily inflated or depressed, but we're focused on delivering, really, the 200 basis points of underlying OI margin expansion off our starting point from a year or so ago. And the way we'll get there is stronger brands and cost efficiency.

Kenneth B. Zaslow - BMO Capital Markets U.S.

So the inflation just doesn't make as big of a deal in 2015? Or do you have specific assumptions for that year, I guess, is what I'm trying to get at?

Sean M. Connolly

Well, the way I think about that, Ken, is, look, inflation happens, so does deflation. We can't control that, obviously, but what we can control is the strength of our brands. We can control our cost structure, and we can also innovate our portfolio in ways that make it less impacted by swings in meat costs. Jimmy Dean breakfast sandwiches are a great example of this, where only a fraction of the weight of the product is meat, while meat plays the key role as hero ingredient. So from -- really from day 1, it's been our plan to put the 200 basis points of underlying OI margin into this business through both stronger brands and cost efficiency, and we're making very good progress in that regard and we'll continue to march on.

Operator

Our next question, Robert Moskow.

Robert Moskow - Crédit Suisse AG, Research Division

It's Crédit Suisse. I guess, what I -- if I look at what my model was for fiscal '14 back a year ago, I did have a higher EPS estimate than what you're guiding to. And I think the bigger driver is the sales, like the sales came in lower than I thought this year, maybe some of it from divestitures. But as you look to next year, Sean, you're saying it's going to be a more difficult operating environment. Can you elaborate a little bit more on that? Are you seeing the need to lower prices in certain categories? That certainly happened in the fourth quarter. Are you seeing more of this risk of inventory de-loading? And are you seeing a weaker consumer than what you had expected?

Sean M. Connolly

Well, clearly, from my remarks earlier, the year will be tipped to the back half, but we fully expect to build both top and bottom line momentum as the year unfolds and to complete this year with solid growth momentum. Clearly, the first half will be a bit lighter as we complete our lunchmeat recovery and we bear the net sales impact of more competitive pricing in some categories. But nevertheless, we view those as near-term situations and we've got a robust innovation agenda coming in, in the back half of the year, and we're very confident we will be building momentum through the year and close out the year in a good position.

Robert Moskow - Crédit Suisse AG, Research Division

Sean, if commodities are going a little bit higher in -- especially in pork in the near term, why do you think the competition is getting more intense? Why do you think that the promotional activity is going up?

Sean M. Connolly

Well, it depends upon the category. So where -- in some of our categories, we've seen -- it's been a fairly competitive environment. And usually, in a lot of cases, that's because they're very attractive categories. So frozen breakfast sandwiches, as an example, last year, we saw a lot of activity there in terms of competitive entrants, and we really doubled down to protect our leading market share. And because Jimmy Dean's probably farthest along in our portfolio in terms of brand building and innovation, the response we got, both in terms of growing our business and defending our market leadership position, was just outstanding. Corn dogs is another category that's very interesting because it's snack-able, it's convenient, it tastes great. So when you see categories like that, it's not unusual at all that you'll get competitors interested in it, especially where there's a limited number of entrants, as had been the case previously in corn dogs. I think lunchmeat is a bit of a unique animal in that the category overall, as I've said before, needs innovation because people love sandwiches, but it's been stagnant for the better part of the decade. We were well on our way to stimulating the category with innovation, and we had actually had our lunchmeat business growing nicely in terms of net sales performance by the time we got out of quarter 2, then we ran into the issue we've talked about extensively around our package transition. And what that's done there is that really creates a void for competitors to see that we can't merchandise fully because we didn't have the product fulfillment in place, and they jumped in and filled those merchandising voids and really looked to take an opportunity to steal away some market share in the short term. So that's more -- I would describe that one as more of an acute issue where people saw opportunity and they dialed it up. And now that we've got our ability to get lunchmeat in the market fully in place, we've got to make sure we get our market share back and get that business back to growth.

Robert Moskow - Crédit Suisse AG, Research Division

Sean, you're not seeing any issues in the macro that would make you reconsider the 4% to 5% sales growth? You think you can grow at that pace even though the macro is changing a bit?

Sean M. Connolly

Yes. The growth rates that we've put out before are not changing. Our outlook, overall, is not changing. And keep in mind, again, we've got market-leading brands that not only have potential to grow within the categories where they're already established by being refreshed, but they also have the potential to extend into adjacent spaces. We've done that exceedingly well with Jimmy Dean. We're beginning to do that with Ball Park, with frozen Flame Grilled Burgers. And we've got opportunities with our other brands as well. For example, this -- the back half of this last year, we launched Aidells into these gourmet chicken meatball initiatives that we've got out there that are just fantastic. So given the size of our company relative to some of the food giants, we think that kind of growth rate off of our base is absolutely achievable.

Operator

Next question, Kenneth Goldman.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

JPMorgan. Sean, I wanted to ask about the lunchmeat packaging issue, not the production problem, but the lid color. Because for a long time, clear packaging was being held up by you as sort of the flagship example of how Hillshire would drive growth via innovation, and it didn't work out, right? I'm not saying this is a big deal, right? It's just the color of a lid. But I guess, I'm curious, does this call into any question, on your end, some of the other innovation plans you have now and whether they'll work? And I'm curious maybe which lessons your team has learned from this experience and maybe which changes you've made internally to perhaps make sure this mistake doesn't happen again?

Sean M. Connolly

Yes, absolutely. I mean, as I mentioned in my remarks, what you see in this case was that there was a disconnect between what consumers were saying in research and what they were doing in practice, and that is not the first time that has happened in the world of branded packaged goods or market research. I think the key point I want to stress is that I am incredibly pleased with the progress we've made on innovation overall. So significant progress on innovation. I feel great about where we are. But all that said, you never bat 1,000 when it comes to innovation. I've said that before as well. I think the key is to learn fast and course correct fast when you see something is off. And in this case, we fixed the manufacturing challenges. We did get our lines running better than ever. The meat is layering beautifully into the package. Service is back to normal. But we also used common sense, and we acknowledged that the consumer couldn't fully articulate what this red lid was doing for them in terms of really creating pop on the shelf. So we made a quick decision. We mobilized and we got a solution into market in less than 10 weeks, which is way better than we've done previously. So I think the bottom line here is we're well on our way with innovation overall. We're well on our way back with Hillshire Farm lunchmeat overall, and we've got big plans for Hillshire Farm lunchmeat in the future.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

I think a quick follow-up. Maria, looking over guidance for the year, can you talk about which line items have the most flexibility to come in better or even worse than your current expectation? I'm asking because you've beaten the Street each of the last 4 quarters. Just trying to get a sense of where you might be conservative today.

Maria Henry

Sure. I think a couple of comments around our earnings outlook for fiscal '14. If I think about what are the most variable items in -- what drives our outlook on the earnings guide, there's really -- there's really 2 things: The first is input costs, and the second would be how competitive dynamics play out throughout the year, including how much price we can take against the rising input costs that we see. In the near term, for fiscal '14, we have 2 things happening at the same time. We have increasing input costs and we have the intensified competitive environment in a couple of the spots that Sean has been talking about. So where we typically look to price recover against inflationary input costs over time, here in the beginning of the fiscal year, we've got rising input costs and we've got some pricing actions that may go the other way based on what the competitive environment is. And those are the biggest factors that give variability to exactly where we expect to land the year. As I went through in my prepared comments, I went through all the details of what the assumptions are in our outlook for '14, the cost programs are completely underway. We have full line of sight to them. I'm 100% confident we'll deliver against the objectives. On the productivity side of the house that we have, it's really the more market-driven external factors that introduce variability.

Operator

Next question, Ken Perkins.

Kenneth Perkins - Morningstar Inc., Research Division

It's Morningstar. I just wanted to touch on the competition for State Fair a little bit more. I know you've worked to instill a culture of productive paranoia, but I'm just wondering if you can speak to sort of the opportunities that you think may be left open to the new competitors and if -- what levers you think you can pull to regain your footing, whether it's just all price or the mix or the innovation. If can you talk about that, that would be great.

Sean M. Connolly

Well, I think it's a 2-step process, Ken, and the first step is to defend the market share in the business we own today. And what we see now with a more competitive environment, with more company on the shelf near by us and price gaps that we didn't have to deal with before, we've got to make sure that we're priced competitively and that we're promoting competitively because as we do that with the market-leading brand that's well established in the category with the quality product we've got, we will see a response. But beyond that, the State Fair brand equity is really about all family leaning toward kid-convenient, fun food enjoyment. And that means that State Fair does not have to be limited to being a corn dog. It's got innovation potential in corn dogs and beyond corn dogs. Currently, we have a corn dog on a stick business. We've got a mini snack business. We think there's potential beyond that. So the second piece of it is really about bringing that innovation pipeline to life and getting these products into the marketplace over the next couple of years.

Operator

Next question, Ann Gurkin.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Davenport. I want to ask you a follow-up question on the pricing and where you think you may need to adjust pricing across your portfolio. If you could just go through that again, and then, if you could also address how we should think about Jimmy Dean, as we come off a very strong performance this year?

Sean M. Connolly

Well, let me take the Jimmy Dean piece and then I'll hand it off to Maria to talk a little bit about pricing. Jimmy Dean is a fantastic $1 billion brand. It's growing robustly, top line and bottom line, and it is nowhere near being done. If you look at breakfast sandwiches as an example, it's a category that I've described as very youthful. It's only 30% household penetration. And if you saw the article in the Journal this week on the importance of getting more calories and more protein into the breakfast day-part in terms of what it does for weight management, we think there's a long way to go there in terms of additional growth, and that means additional innovation and we'll support it with additional investment. So Jimmy Dean will continue to ride that horse for some time to come.

Maria Henry

And on pricing, Ann, we talked about 2 areas in particular where we see intensified competitive dynamics in the near term. We talked about lunchmeat and how we see our position coming out of the packaging change and our focus on defending that great piece of our franchise. And the other area we've been talking about is corn dogs where we've got some price gap issues to a very aggressive competitor in that space. Outside of that, with inflationary input costs, we do look to recover input costs through pricing over time and so you would expect that to continue in terms of how we manage our pricing strategy.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

And have you put price changes into the marketplace for deli and corn dogs?

Maria Henry

We have put some pricing changes into the market at the end of the fourth quarter, and we are -- we continue to work through our pricing tactics on the lunchmeat side to coincide with the packaging change that is going out into the market.

Sean M. Connolly

Typically, when you were talking, Ann, about competitive flareups and price adjustments for those purposes, you tend not to see shelf prices change. You tend to see promoted prices get a little bit more competitive, reflecting what we believe is a temporary nature of those kinds of moves.

Operator

Next question, Jason English.

Jason English - Goldman Sachs Group Inc., Research Division

Goldman Sachs. Sean, first question, MAP spend ramped substantially this year. As we look into next year, I know you said higher, can you give us a sense of how meaningful it may tick up?

Sean M. Connolly

I think Maria hit the nail on the head. Total marketing spend will increase year-on-year. That encompasses MAP, innovation investments, trade spend and new item -- new innovation slotting expenses. And frankly, that total basket of activities reflects how much we've got going on with respect to brand building and innovation. On MAP specifically, we don't guide to an annual number other than to say that for the midterm guidance through fiscal '15, coming out of fiscal '15, we expect to be at a rate of 5% that year. And as I said from the beginning when we got started coming out of F '12, don't straight-line it there because within any given quarter or, frankly, with any given year, it depends upon a number of things where we are. It could depend upon seasonalities, the grilling season. It could depend upon competitive dynamics, do we need to get more promotional in the short term? And it could depend upon how much innovation is in the marketplace requiring support to generate awareness. So the MAP line will move around. I think the bottom line is we're going to be supporting our brands meaningfully and we'll support it with MAP meaningfully. And as we spend MAP versus last year and even the year before, we're making big progress in getting more efficient in terms of really making sure that the percentage of the total MAP dollars that we've got are maximum working dollars versus nonworking dollars. And by working dollars, I mean things like media running a commercial as opposed to agency fees, commercial production fees, things like that, where we're pushing hard on efficiency so we can get nonworking MAP spend down.

Jason English - Goldman Sachs Group Inc., Research Division

And coming back real quick on the pricing question, just to make sure I understand this. On lunchmeat, it's not just a factor of maybe raising list prices and dealing some back, but it sounds like there's an, at least in the near term, an inability to even raise list prices? And then on corn dogs, we're talking about rolling back in the face of inflation. Do I have it right?

Sean M. Connolly

Well, I think what I -- my comment to Ann was really that, in categories like this where it's more of a competitive flareup, what you tend to see is promoted pricing get more aggressive and -- because in the case of lunchmeat, as an example, the other players in the category have gotten much more promotional as we kind of stepped out of promotion but -- because we were working to get our product fulfillment back. So we've got to get competitive in terms of promoted volume price points and promotional activity overall in both of those categories near term.

Jason English - Goldman Sachs Group Inc., Research Division

And that constrains your ability to raise list prices? Is that right?

Sean M. Connolly

Yes. Well, I think this year is a bit more pressured in the near term, because we've got to keep prices competitive in certain categories. And when there's a benign competitive environment, you've got position amidst inflation to take prices up more in certain categories than you do in the very near term.

Operator

Next question, Alexia Howard.

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Yes, it's Sanford Bernstein. So you mentioned the M&A activity a couple of times in the prepared remarks. Just wanted to get your latest thinking on the criteria that you're thinking about, maybe in terms of the scale of the acquisitions that you're thinking about, bolt-on or transformational? Would you be focused on meat-centric companies or thinking beyond meat? Premium price like Aidells or more mainstream? And maybe a little bit about the financial criteria, especially how long you'd be willing to wait before a deal becomes accretive?

Maria Henry

Alexia, thanks for the question. On M&A, we think it's a great opportunity for us to create shareholder value because we have great assets and capabilities that can be leveraged. Specifically, what we're looking for in acquisitions are acquisitions that align with our strategy and that have smart financials. And by that, I mean, that they have attractive top line growth trends, they are accretive to our margin structure and EPS, and obviously, looking for opportunities where we can structure deals that create shareholder value, meaning that we can get them at a price that we think is reasonable with what we can do with them. As you know, with acquisitions, we don't control the availability of them, and therefore, we don't control the timing of when we might do something. In terms of size, we see attractive assets in the market on the very small end of the scale. We see assets that are similar to size to Aidells, which was a great acquisition for us a couple of years ago. But we also see attractive assets on the higher end of the scale, and that's one of the reasons why we set the capital allocation coming into this year where we did. We want to maintain flexibility with our balance sheet and to go into a levered situation to be able to move very quickly if an attractive asset becomes available that can add to our portfolio and give us an opportunity to really accelerate the shareholder value creation objective that we've got.

Operator

Next question, John Baumgartner.

John J. Baumgartner - Wells Fargo Securities, LLC, Research Division

Wells Fargo. Sean, just more of a conceptual, bigger picture question. In terms of the Foodservice business, can you talk a bit to the opportunity there for protein growth going forward within the convenience channel? I mean, it seems as though you're getting some benefit there in your numbers this past quarter. How are you visualizing the rate at which retailers move towards greater adoption of some of these fresh programs in their stores going forward?

Sean M. Connolly

So you're talking about within the retailer and grocery-type environment, but you're talking about the deli type of operation, which, as many people know, is more of a foodservice-type operation? I just want to make sure I understand your question, John.

John J. Baumgartner - Wells Fargo Securities, LLC, Research Division

The convenience -- the convenience outlet, I guess, more specifically, and some of the opportunities there for fresh product?

Sean M. Connolly

Yes, okay. So well, let's face it, consumers spend half of their dollars on food away from home, so the market is enormous in terms of food sales away from home. And consumers are also incredibly pressed for time. And so the convenience channel, in particular, is a very strategic channel and that you've got a lot of our shopper base who are going in there, they're buying food, they're buying beverages and they -- that channel in particular tends to skew toward men and men tend to skew toward protein. So it's an attractive space. The Jimmy Dean equity is a good example, it has very good equity in that space as does Ball Park, as does Hillshire Farm. So Foodservice, there's not a food company I know of, of our scale or larger that doesn't have a meaningful foodservice division, we'll continue to have one. But it's -- the whole channel is in a bit of a cyclical malaise right now, and I think in that type of environment, our goal is to win share through innovation and better service. And if we do that, we will be better positioned to emerge in even stronger growth as the cycle turns. So right now in Foodservice, the environment is challenged. We are gaining share in a lot of channels and a lot of categories in a difficult environment, and we think that's the right way to play it as we're working through this.

Operator

Our last question is Christine McCracken.

Christine McCracken - Cleveland Research Company

Cleveland Research. Just really briefly, you mentioned in your prepared comments that you were seeing a bit of a shift back, I think, to bulk deli and some of your competitors have made similar comments. I'm just curious, what do you think is behind that move? Do you think any of it could be in any way related to the challenges you've had on some of your lunchmeat items? Or do you think it's more of a cost issue? Maybe if you could elaborate on that a little.

Sean M. Connolly

Sure. Let me make sure that I was clear in my comments earlier. I was not referring to any shift to the bulk deli. What I was referring to is in our deli meat business in the deli section of the store, which is under the Sara Lee brand, the bulk of our business there is in bulk, meaning behind-the-glass service deli, sliced deli, and that business had been a chronic decliner and it's almost stable now as we've refreshed that product quality to outstanding product quality. So that's really what I was referring to there. Certainly, there is some interaction between the deli section and the sliced mainstream lunchmeat section, but it is not the 1:1 dynamic, the way some might lead you to believe. Lunchmeat sandwiches are simple meals overall, meaning that the consumer has a consideration set of a number of diverse options. And the common thread between those options is that they all tend to be convenient, they all tend to be satisfying and they all tend to be day-part-specific. So in the case of deli meat, we're really talking about lunch. And the way to win in that broader set is to offer a relevant benefit so that the perceived value of our offering is elevated. So when you see switching out of a category, it's usually because the category needs to be refreshed, and lunchmeat, including the deli, would clearly benefit, in my opinion, from increased innovation and that's exactly what we intend to do.

Christine McCracken - Cleveland Research Company

All right. But you are seeing more stable trends in that deli category? And that is -- I mean, it's been a few years now of declines. So do you think that's like a shift out of Foodservice? Is that the more expensive alternative? Or what do you think is behind that?

Sean M. Connolly

I think that the point I was trying to make a minute ago is there's tremendous -- there's always switching between convenient, simple meals in different parts of the store and what people -- consumers tend to switch out of are categories that have become dull and they haven't been refreshed. And one they tend to switch into are categories that have been innovated. They're exciting. They're relevant. They're provocative. And the deli section certainly has had some of that innovation and some of that excitement brought back to it, and we've begun to contribute to that with our Sara Lee innovations. I think we can do more.

Christine McCracken - Cleveland Research Company

Just real quickly on turkey. You'd mentioned that you expected a little bit of a decline, I guess, in sales there. Is that just a reflection of the volume cuts that the industry's made? Or is there something more to that?

Maria Henry

Well, as you know, that we are -- we're vertically integrated on turkey. And so what I was referring to is what we consider commodity meat sales. And as we're vertically integrated, sometimes, we have more turkey than our internal demand requires and then we sell that on the market. In fiscal '13, we had an unusually high level of sales of our commodity turkey. I expect that, that will be significantly lower in fiscal '14, and that's what I was referring to.

Operator

We do have an additional question. We have Akshay Jagdale.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

This is Akshay from KeyBanc. And I just -- sorry, I jumped on from another earnings call. So if I missed this, I'm sorry. But did you talk about the expectations for commodity costs overall? Or if not, can you give us an update on where you see them headed in '14 and how does the decline, recent decline, in grain prices sort of play through? Obviously, there's a delay from that happening and it getting to the protein level and then reaching you. But can you put that a little bit into context and help us understand just longer-term, broader picture, like, how that might flow through your P&L?

Maria Henry

Sure, Akshay. Let me make a couple of comments on commodities. We do see commodities being inflationary for the entirety of fiscal '14. We see them being acutely inflationary here in the near term, particularly in the first quarter and even the first half. So that's how we think about it. In terms of what happens with grain prices and corn in particular, we do expect that, that will flow through the cycle. Not exactly sure when or how -- to what extent that will end up giving us some relief from what we're seeing today. But for fiscal '14, we are assuming in the outlook that I provided that we will have inflation on the commodity side through the entire year.

Sean M. Connolly

But I think if you look at last year, Akshay, to your point, when there's a significant event in the grains market, there's usually a ripple-on effect. Last year was the worse drought in 70 years. Who knows? We'll see how the summer unfolds. Some people think we're going to have the largest harvest ever. So too early to tell, but we'll be monitoring it so we can report out in terms of the ripple effect.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

And the near-term inflation that you alluded to, does that have anything to do with the recent significant rise in sort of sow prices, which is the result of a disease issue, which is temporary and should subside? I mean, so pork, obviously, is a big deal. Chicken, we know there is inflation and it's been strong, and beef, sort of being inflationary for a while. But is the sort of near term driven, in any way, by the increase in sow prices recently?

Maria Henry

Yes, yes, it is. And your other comments are right on. While we don't break out the specifics of our commodity basket, you guys know that sows are clearly an impact on us and that's been a big mover as of late. And both beef and packaging costs are also up, and clearly, we use both of those in the products that we sell.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

And just one last one on innovation and just competitive dynamics. I think Kraft had said that the lunchmeat category is pretty competitive. But I'd like to focus just on innovation. It seems like some of the larger players, Hormel included, are pretty focused, and yourselves, are focused on innovation. It seems like the timing, I mean, of it is such that a lot of it is yet to hit. We're seeing sort of REV, mac [ph] wraps being launched by Hormel, and Kraft talked about a bunch of innovation coming on and you guys also have some slated for later. How -- can you just characterize like sort of the innovation environment for the lunchmeat and just meats, in general -- meat snacks, in general, now versus what it's been over the last few years? I mean, is it at an elevated level versus the last 3 years? And do you expect that to continue? I mean, I'm just trying to get a sense of how positive or neutral or negative were you thinking about just innovation in general for the categories you're in?

Sean M. Connolly

Well, innovation, I think good companies believe in innovation. They believe in the power of innovation. Everybody wins when there's innovation. The consumer wins because they get better products. Manufacturers win because they drive better sales, hopefully, better margins. So I think sophisticated food -- branded food manufacturers want to be innovators, and we certainly want to count ourselves near the top of that list over time because innovation is central to our vision, it's central to our game plan. We had a very good year in terms of fiscal '13 moving the needle on innovation. We've got a big year in terms of innovation for fiscal '14 coming in the back half of the year. And we've got exciting stuff planned further out for fiscal '15. So I'd really rather not comment in terms of competitive innovations, but I'll focus the attention on our unwavering commitment to innovation. And we'll be in a position to talk more about what we've got coming at some of the industry conferences as the year unfolds.

Operator

Our final question is from Robert Moskow.

Robert Moskow - Crédit Suisse AG, Research Division

Could you just comment on the nature of the inventory reset that you have in the press release? Is it a permanent reset? And why did it take place?

Maria Henry

Rob, it is a onetime reset. If you think about it from the customer perspective, they're managing their inventory. They decided to run at a lower fundamental inventory level. They reset that. It's onetime. We've seen ordering patterns restore to normal, so that was onetime and it ran through the -- our numbers in the fourth quarter.

Melissa Napier

So on behalf of Sean and Maria, I'd like to thank you all for joining us this morning, and Investor Relations will be happy to take any follow-up questions that you may have. Have a great day.

Operator

Thank you for your participation. That does conclude today's conference. You may now disconnect.

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