The Hillshire Brands' (HSH) CEO Sean Connolly on Q3 2014 Results - Earnings Call Transcript

| About: Hillshire Brands (HSH)

The Hillshire Brands (NYSE:HSH)

Q3 2014 Earnings Call

May 06, 2014 10:30 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

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

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

Farha Aslam - Stephens Inc., Research Division

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Robert Dickerson - Consumer Edge Research, LLC

Rachel Nabatian

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

Jason English - Goldman Sachs Group Inc., Research Division

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

Andrew Lazar - Barclays Capital, Research Division

Gregory Hessler - BofA Merrill Lynch, Research Division

Operator

Good morning, and welcome to the Third Quarter Fiscal '14 Earnings Conference Call for Hillshire Brands. [Operator Instructions] This call is being recorded. If you have any objections, please 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, and good morning, everyone. Our results were released at 6:30 a.m. Central Time this morning. That release and the slides that we'll be reviewing today are posted on our website under the Investor Relations section, and we expect to file our 10-Q later today.

Sean Connolly, our CEO; and Maria Henry, our CFO, will provide their perspectives on the performance of the business during the quarter and discuss our outlook for the rest of fiscal 2014. We'll take your questions after management's prepared remarks conclude. [Operator Instructions]

I'd now like to refer you to the forward-looking statement displayed and remind you that during today's call, we may make forward-looking statements about future operations, financial performance and business conditions. And our actual results may differ from those expressed or implied in these statements. Explanations of non-GAAP financial measures, that we may also refer to, 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. We've been looking forward to this call as we have a number of positive things to update you on. Before we jump into the quarterly details, I think it's worth spending a minute on the big picture, which is really all about building a different kind of food company, one that is simultaneously lean and innovative and focused on doing what's necessary to sustain strong value creation over time.

Roughly 2 years ago, we hosted many of you in New York at our inaugural Investor Day where we outlined our investment thesis, which basically asserted that this is a terrific branded portfolio and if we could become leaner with stronger skills, we can reinvest in demand drivers and deliver better sales growth and better margins. And when you include smart balance sheet management, it would all add up to total strong shareholder returns that were excellent. Well, here we are 2 years in, and the progress we've made in strengthening our brands and reducing costs is unmistakable. Our disciplined approach to brand-building and innovation is clearly having the desired effect. And underlying much of our progress is the work we've done to improve our capabilities in key areas like innovation, pricing analytics, marketing and partnering with our customers.

Fueling our growth agenda is our relentless cost and productivity program, which will continue to contribute into the years ahead. All in all, the evidence is clear. We are well positioned to continue to deliver strong returns to our shareholders. And the strength of our results is evident. This quarter, our sales were up 3.4%, a number that we estimate comes closer to 5% when you factor in the Easter timing shift to Q4. And our operating margins have been quite strong despite an input cost environment that has been acutely inflationary and has worsened continuously over the past few months.

A number of factors have contributed to our profit improvement. The first is the fact that our brands have performed well despite higher prices. Second, our cost containment has been excellent, both in our base productivity program and in our additional belt-tightening. Finally, we did benefit from some onetime favorability in corporate expenses. The net of that is a very solid story. And as you likely saw in our CAGNY materials, our innovation pipeline has never been stronger, and many of the items we showed at CAGNY are shipping as we speak. We are also beginning to leverage our strong balance sheet for additional value creation, and our focus here is on smart acquisitions, which we clearly expect to do more of. Overall for the year, we now expect sales to be up in the low single-digits and for EPS to be at the high end of our previous range.

Now while I always welcome a good quarter, what's more important to me is the longer-term view of our performance, specifically how have we done since spin? And here again, the progress is excellent. Our sales growth has become progressively stronger, and our EPS growth is approaching 30% since we began this journey. And importantly, our margins have improved despite the cost environment that we've had to navigate. This year, through the first 3 quarters, our OI margin has averaged 10.3%. And since spin, it has averaged 9.7%. So excellent progress here against one of our top priorities, margin expansion.

Now getting back to Q3. Our consumption trends have been positive overall. And as you can see in this chart showing the multi-outlet IRI data, still strong. Continued strong performance on Jimmy Dean, Hillshire lunchmeat, Ball Park, Aidells and Gallo. You can also see here that the business that is most tied to sow costs, which is Jimmy Dean fresh sausage at the top of the page, softened a bit, which is due to much higher prices. Now I want to point out that the Hillshire Farm Smoked Sausage line looks a bit worse than reality, and that's tied to the Easter shift to Q4. Overall, this data reflects that our brand-building efforts are helping us to do a better job holding volumes in the face of pricing than we've done historically, and clearly, we're pleased with the way consumers have stuck with our brands.

Sticking with the theme of our brands, there are 4 businesses I want to comment briefly on this morning. The first is our power hitter, Jimmy Dean. Here, we continue to see very strong performance in frozen protein breakfast, particularly on Delights, which is a business that has delivered explosive growth since we got behind it with MAP spend and innovation a couple years ago. Despite a number of new competitors over the past few years, Jimmy Dean's sales, profit and market share growth remained very strong. On Hillshire Farm, I am pleased to report that we have our lunchmeat business more than fully back on track and at the highest volume shares we've seen since pre-spin. A big part of this success is the terrific advertising we've been running, which highlights the brand's quality and craftsmanship.

Moving to Aidells. Here, momentum continues, both in smoked sausage and in our new meatball line, driven by our proprietary product-sampling capability. And finally, a word on Golden Island jerky. The integration here has been seamless and is nearing completion. As I've said before, Golden Island gives us a great entry point into the attractive jerky category. Our priority now is on expanding production capacity to meet the strong demand we have for this extraordinary product. We will have more to report on our future jerky plans at a later date.

In Q3, we began rolling out a robust slate of new products. You see a number of those new items here. Our customer response has been very positive, and as we reach scale on distribution, we will be in a position to back these innovations with marketing support. For those of you who have already broken out your grills, I implore you to go buy the new Hillshire Farm American Craft sausages. I recommend you try the Jalapeno & Cheddar variety. You can thank me later.

Now fueling our growth drivers is our ongoing cost savings program. And recall here, we're talking about unlocking efficiencies in existing spend through discrete work streams around revenue management, supply chain and support processes. This effort is also helping us to improve our capabilities in key areas so we can sustain the higher level of efficiency and effectiveness. We delivered the $40 million we signed up for in fiscal '13 and are well on our way to achieve the remaining $105 million we're after. Our supply chain team, as an example, is doing an excellent job. You'll recall we have just announced plans to close our Florence, Alabama plant, which is a project that will deliver strong returns. And the team's work to minimize customer service disruptions on our turkey products following a fire at our Storm Lake facility has been exceptional.

Now a few words on Van's. Van's is a great business, and I'm thrilled to have it as part of our company. The acquisition lined up nicely with our criteria. It's a strong brand that's growing. It's margin-accretive. It offers a compelling consumer benefit, in this case, real health and wellness credentials. Further, it helps us expand our presence in frozen breakfast and provides new opportunities in the center store. And I view the fact that it further diversifies our COGS base as a real positive. I should also point out that the Van's team is very talented, and we look forward to welcoming them to Hillshire. So overall, a great fit and a business with a ton of runway.

And before I turn it over to Maria, a few comments on the months ahead. Clearly, we will continue to face acute inflation near term and are currently communicating additional pricing actions that will phase in early next fiscal year. While we will continue to keep the belt tight on costs and support our brands with MAP and innovation, we do expect base volumes and margins to be pressured in Q4. In the case of volumes, it's largely tied to the much higher price points on our Jimmy Dean roll sausage business where shelf prices have been up over 15% and promoted prices have been up around 20%. In the case of margins, much higher COGS tied to PEDV are at the root of it.

Now if our performance wasn't already ahead of our expectations, this unusually acute inflation may have caused us to back off some of the merchandising we have planned for the upcoming grilling season. But the fact is our performance of the business is even better than what we expected, and that gives us the ability to maintain our grilling season merchandising support on our businesses and still deliver our plan.

And given the higher price points the consumer will see in the market going forward, we believe that merchandising support is critical to maintaining brand vitality going into next fiscal year. So when you add it all up, we expect full year sales now to be up in the low single-digits, with EPS at the high end of the previous range. And finally, while we're thrilled with the Golden Island and Van's acquisitions, we expect to do more.

With that, Maria, over to you.

Maria Henry

Thanks, Sean. Good morning, everyone, and thanks for joining us. As you just heard, we delivered strong financial results for the third quarter. Our business is performing well as we effectively manage significant input cost inflation with pricing actions and cost measures. Beyond that, our structured productivity program remains well on track, and we benefited from some favorable items such as mark-to-market and insurance true-ups in the quarter. That said, the inflationary pressure that we are experiencing has become more acute since our last earnings call, and I'll talk more about that in just a moment. The bottom line is that despite the challenging environment, our core business is strong, and we continue to have balance sheet firepower to deliver additional shareholder value.

Going to the numbers. Our adjusted diluted EPS of $0.46 was up 31.4% on net sales growth of 3.4%. This sales growth was mainly driven by pricing, which we took to offset higher input costs, and also by favorable mix in both of our segments. Pricing and mix offset a 3.2% decline in volume in the quarter. Gross profit dollars increased 3% as we were able to hold our gross margin rates flat to last year at 29.6% through a combination of pricing and productivity actions.

Our third quarter MAP investment was $40 million or 4.2% of our net sales. That's up slightly from last year's third quarter. We continue to gain efficiencies in our MAP spend above our original expectations, and we're pleased with the return that we're seeing on our investment in this area. Our adjusted SG&A, excluding MAP, was down versus the third quarter of fiscal '13 on tight cost management and some expense timing in the segment. Additionally, corporate expenses were unusually low at $5 million for the quarter. Lower corporate expense was the result of lower spending and the favorable expense items that I mentioned just a moment ago. Year-to-date, our sales were up 2.1%, but our gross profit was down $22 million with a 140 basis-point decline in gross profit rates as the input cost inflation that we experienced was not fully offset by pricing. Our adjusted operating income is up 3.9% as our cost programs and SG&A favorability offset our gross margin decline.

Now let's take a look at the segments. Our Retail segment sales were up 3.2% as the benefit of price and mix offset a 2.7% decline in volume. The volume decline in Retail was driven by Jimmy Dean roll sausage. As Sean said earlier, that's the business that's most impacted by sow costs, and therefore, it's where we price the most. On the positive side, our Jimmy Dean frozen business, Hillshire Farm lunchmeat and Aidells businesses were all very strong contributors this quarter. Operating income was up 19.9% in the Retail segment as sales growth, continued cost management and some timing favorability more than offset higher input costs.

In our Foodservice/Other segment, third quarter sales grew 4%. You'll recall, much of our Foodservice business has pass-through price contracts. So with higher inflation comes higher pricing. This increased pricing and favorable mix offset a 4.1% volume decline for the quarter. That volume decline was the result of lower commodity meat sales. Excluding those commodity meat sales, volume was effectively flat to last year, and sales growth was 5.3%. Operating segment income increased 9.6%, reflecting commodity-driven pricing actions, favorable mix and continued cost management. Overall, our team has performed well, given the challenges in the segment, and they continue to focus their efforts on the growth channels within Foodservice.

Before I move on to cash, let me give you some additional color on movements in our input costs. We purchase over $1 billion of meat annually. What you see on this slide is the unhedged spot prices for our meat input basket. As you know, we have a hedging strategy in place where we generally hedge up to 6 months out for a portion of our commodities. This inflation does not match what is flowing through our P&L, but it does give you a good idea of what we're dealing with in the commodity meat market.

You can clearly see that what we've been working through is significant cost increases, which have been primarily driven by the outbreak of PEDV. This has driven up the price of pork and sow. We originally planned for some of this increase, but not to this extent. Our input costs are up well over $100 million versus what we expected to be facing when we set our plan and provided guidance for fiscal '14. About 3/4 of the increase versus our plan is the result of higher inflation in pork and sow.

The inflation caused by PEDV has been rapid and acute, but it will also be a transitory. And we fully expect that the market will revert to more historical norms once we're past this situation. However, we don't know exactly when that will happen. As I've discussed, we've been able to offset much of the increase that you see here through pricing and cost management. But since the last time we spoke in January, the curve has steepened, and we expect that our fourth quarter margins will be pressured.

Moving on to cash. We closed the quarter with $389 million of cash and short-term investments. We will use some of this cash to pay for the Van's acquisition that we expect to close in the fourth quarter. The underlying cash flow of the business continues to be strong. Our year-to-date adjusted EBITDA margin was 13.6%, and we remain well positioned to execute the growth agenda that we've outlined.

Our capital allocation plan hasn't changed. Our first priority continues to be investing in our business. Our investments in brand-building, innovation, capability development and efficiency programs are targeted at creating long-term sustainable growth and profitability. And to date, we're very pleased with what we're seeing from our investments in these areas. In the quarter, we advanced our M&A agenda with the announcement of the acquisition of Van's for $165 million. We did not repurchase any shares during the quarter. On a year-to-date basis, we've repurchased $30 million worth of shares against our target to repurchase $200 million by the end of fiscal '15. We intend to pay off our 0 coupon notes for $105 million when they come due at the end of June, which, because of our fiscal calendar, will actually fall into fiscal '15. And finally, we continue to pursue M&A opportunities to drive additional value.

With 1 quarter left in the fiscal year, we are refining our fiscal '14 guidance. We now expect sales growth to be in the low single-digits for the fiscal year. As you saw in the consumption trend, we have solid momentum on many of our businesses. We have the benefit of recently launched innovations, and of course, we have the volume pricing dynamic that we've been discussing. We expect EPS for fiscal 2014 to be at the high end of our previous range. This incorporates our sales estimate and our expectation that input cost inflation will pressure our gross margins in the fourth quarter. Additionally, we now expect corporate expenses, excluding significant items and mark-to-market adjustments, to be between $40 million and $45 million for the year.

So let me close here by saying that overall, I'm very pleased with our business performance, both in the quarter and on a year-to-date basis. So with that, I'll open it up for Q&A. Operator, if you could please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Alexia Howard of Sanford Bernstein.

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

Can I ask about the remaining cost-cutting opportunities? You've obviously achieved quite a lot since the spin. How much is left at this point? And what kind of costs do you still have to get at?

Maria Henry

Sure, Alexia. We have $105 million of the remaining cost and productivity benefits that we expect to deliver. As you'll recall, we had $145 million. We delivered $40 million last year. We're realizing a lot of that in fiscal '14. The majority of the $105 million will come in '14 and '15. A little bit of it goes into fiscal '16. So those are the cost reductions and productivity gains that we expect to achieve from our structured cost program that we announced last year. In addition to that, because we've been seeing really significant pressure on the input cost side of our business, we've tightened our belt in our spending in fiscal '14, and you're seeing some of that favorability from those near-term actions show up in our fiscal '14 P&L. You see some of that on the segment SG&A line, as well as in the corporate area. Now the timing of that will vary. It depends on the business situation that we're in. But I think the key focus area is that, that fundamental core productivity program that we announced is well on track, and I have a very high degree of confidence that we'll get the whole $105 million that we signed up for.

Operator

Next question, John Baumgartner of Wells Fargo.

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

Sean, in terms of M&A, just wondering if you can maybe just frame the environment here in terms of what you're seeing come across your desk in terms of target areas. Are you looking more towards protein? Can we see more center store acquisitions? Could M&A help your Foodservice margins? Just how are you thinking about M&A going forward?

Sean M. Connolly

Well, it's a question we often get, John, and I think we're not going to give you the list of our prospects, obviously. But what I would say is we always tend to favor good brands. We tend to favor brands that are complementary to our portfolio, as you've seen us do some of that in the past. We also look for things like margin accretion benefits. So as we've said before, we're open to smaller things that make sense, we're open to larger things that make sense. The key is that we will look at it all in a highly disciplined fashion and make sure that before we pull the trigger on anything, that it's a good deal for our shareholders.

Operator

Next question is Farha Aslam of Stephens.

Farha Aslam - Stephens Inc., Research Division

Question regarding your MAP targets. I believe your targets are sort of 5% of sales. Do you still anticipate hitting those in 2015, given the cost inflation we're seeing in the pricing actions you're taking? Or should we think that now a more 2016 target?

Sean M. Connolly

We have not changed anything with respect to our midterm targets and we certainly view MAP as an area that drives the business, both top and bottom line, as opposed to a tax on the bottom line. We're very disciplined in making sure that the MAP we spend is a high ROI MAP. So as you could see within our business, when you get under the hood, the businesses that perform the best and have the highest margin structures in our company are also those that are farthest along in terms of what I call being MAP-ready. So we view MAP as a positive driver to the top and bottom line, and hopefully, our investors know by now that we are highly committed to MAP spend as one of the best levers to drive sustainable results for the long term through healthy brands.

Farha Aslam - Stephens Inc., Research Division

So we should still expect it to be sort of 5% of sales for next year?

Sean M. Connolly

Yes, we've not changed anything. And to the degree we have any update at all on our fiscal '15 outlook, what we'll do here is what we do every year in August. So August is the conference call where we will provide our specific guidance for the following year, and that's when we'll be back with our specific targets in a few months.

Operator

Our next question is Ken Goldman of JPMorgan Chase.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Sean, your implied guidance for 4Q, obviously, much lighter than what the Street was forecasting on cost. I guess given that this inflation, unless there's a sudden cure for PEDV, won't go away for a few quarters, doesn't this suggest that, I guess, the first half of fiscal '15 will be under a lot of margin pressure, too? Right, so I know you don't want to give official guidance, but any help you can give us regarding the magnitude of pressure we should think about 1H margins, I guess, being under would be pretty helpful.

Sean M. Connolly

Well, I think with respect to next year, as I just pointed out to Farha, as we always do, we'll issue guidance on our August call. Until then, we don't have an update. But clearly, the challenging near-term cost environment is driven by the PEDV issue, but this issue is rare. It's acute, and it's transitory. So there's likely to be a reversal, especially when considering that aside from the virus, the fundamentals for pork are very strong. So we're working through that forecast as we speak, and we'll share our best perspective on how it nets out in August. With respect to kind of what you're implying, Ken, on the lumpiness from half to half, that's a concept that we dealt with before. And frankly, it's just kind of is what it is because at the end of the day, inflation happens and deflation happens. So there may be short-term windows where our margins are temporarily inflated or deflated. We can't fully control that. But what we can control is the health of our brands for the long haul, and that is our focus. And really, to get the real full picture here on this, you really need to go back to when we started and look at last year because when we got going after 2 years of significant commodity inflation, last year in fiscal '13, we benefited from deflation. And recall, we reinvested some of that benefit behind our brands and advancing our cost-efficiency program. And we did that in anticipation of a return to commodity inflation in fiscal '14, which is exactly what's unfolded to a greater degree than we planned. I think the key point is given the way our brands have held up so far this year, I'm sure glad that we reinvested back in our brands when we had the deflation in fiscal '13 because that's a central piece of how we run this business for moving the centerline of our profitability north over time, and that's what we've been doing.

Operator

Next question is Rob Dickerson, Consumer Edge Research.

Robert Dickerson - Consumer Edge Research, LLC

Just a quick, easy question on corporate expense. I know you said you still have some of the cost-saving opportunity coming through. That said though, I mean, now, guidance for the year is $40 million, $45 million. Last year, I think you came in around $40 million. So I'm just wondering, again, I know you're not going to give guidance for next year, but that said, I mean, is the $40 million now fairly -- is that fair? Is the run rate going forward in corporate?

Maria Henry

I think that the run rate, normalized run rate of corporate is higher than that. What I have said historically is that I would expect a level of corporate expense of around $60 million. That was our guidance coming into the year. There's been 2 things on our corporate expenses this year. One of them is that we've tightened our belt on expenses and on investments that aren't directly tied to growth, and so that lowered our corporate number for fiscal '14. The other thing is that we have had expense favorability, and that is on items that can kind of go either way in any given quarter or in any given year. Items like insurance, legal expenses, those types of items that can be up or down. So I think that the $40 million to $45 million that we expect to have on the P&L in fiscal '14 is low. I think that a more normalized level of corporate expense would be closer to the $60 million.

Operator

And next question is Robert Moskow of Credit Suisse.

Rachel Nabatian

It's Rachel Nabatian in for Rob Moskow. So it seems like things have certainly turned around for lunchmeat, and I know you mentioned advertising helping out. But have you also removed promotion at this point? And if you have, how are you ensuring that the demand is sticky post that?

Sean M. Connolly

I think that notion is too extreme. Lunchmeat is a business. It's a category that's always going to have a pretty stable balance between what moves off the shelf and what moves on promotion. And certainly, as we learned last year when we had some supply challenges, you cannot walk away from promotion in the lunchmeat category. That would not be a good business decision. So going forward, we anticipate that we will have a balance of strong base volumes and a competitive promotional profile. But what you shouldn't expect from us is that we will be leading the category in terms of price base competition. That's not the way we play the game. That is not the way we think you build a relationship between a consumer and a brand. We think the better way to do it is through innovation and advertising. And recall on lunchmeat, part of our strategy, as well, that we shared at CAGNY is to really expand the way we go to market in the category. Historically, we've kind of been a one-trick pony with a mainstream lunchmeat, but we see distinct opportunities in the value tier and then in the premium natural tier. So we announced previously at CAGNY that we've got 2 great initiatives that will be coming out next year with our Hillshire Farm, Farm Classics line, as well as our Hillshire Farm Naturals line. And when you wrap those around our core red lid line, we think we've got excellent outlook on lunchmeat.

Operator

Our next question is Akshay Jagdale, KeyBanc Capital Markets.

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

Just wanted to ask about the relationship between pricing and cost. We really appreciate the extra color on the commodities. But can you give us a sense of if the price versus cost relationship was a positive this quarter? I mean, it -- I'm just trying to get a read into for next quarter. Your guidance obviously implies lower margins. I'm trying to figure out whether it's on the SG&A line or a gross margin line. It seems like it's a little bit of both. But if you could give us a little bit more color on price versus cost and what's flowing through this quarter in terms of the inflation versus mix, that would be very helpful.

Maria Henry

Akshay, it's Maria. I'll provide some additional color there on -- first, let me take pricing. We said on our last call that we were putting pricing into the market during the second quarter. So we put that in more toward the end of the second quarter. So if you think about this quarter, we've got the benefit of that pricing showing up in our numbers. Sean commented in his comments earlier that given where the input cost inflation is going, we expect to take more price. That price won't be in the market yet in the fourth quarter. And when I showed you the commodity curve in my slides, you see that we have acute inflation that will be running through the fourth quarter. The timing of how the pricing actions line up with the inflation that runs through the P&L is the big driver of the margins on a quarter-to-quarter basis. So in the third quarter, we had that benefit of the pricing that we took at the end of the second quarter. In the fourth quarter, we'll still have that pricing in the market. We'll have higher input costs, which you can see from the curve that I shared with you, and that's why I'm talking about a squeeze in terms of the gross margin for the fourth quarter. Now as you know, we intend to price against the inflation that we see coming into the P&L. So we will do that, and over time, we expect that we'll fully recover the inflation that we're seeing. But any quarter -- in any given quarterly period, you might have a dynamic where you've got some new pricing with a commodity curve slope in the quarter where you get some benefit, the following quarter that those commodity costs kind of overtake that. So it's a little lumpy on the quarters. But over time, we expect that, that will fully recover.

Operator

Next question, Jason English of Goldman Sachs.

Jason English - Goldman Sachs Group Inc., Research Division

Maria, I want to pick up a little bit where you just left off. Talking about more pricing coming, everything kind of washing out over the course of time. In the near term, can you enlighten us a little bit more on what you see in the competitive dynamics, whether or not any of your competitors in sausage have started to follow and close that gap with Jimmy Dean? And then also, KRFT made some comments last week, I guess, around taking 10% pricing across 50% of its Oscar Mayer portfolio. Have you followed? Or did you lead? Or do you have a similar type of pricing rolling through your lunchmeat portfolio on to come?

Sean M. Connolly

Jason, it's Sean. I'm going to field this one primarily because I'm not going to comment on any of our specific competitors' pricing actions and what our response is to that for obvious reasons. I think the key point here is a principle-based one, which is when we experience inflation, we expect to do our best to recover it with pricing. And we started taking price earlier in the year. We expanded it to other items as we move through the year, and we still do have spots within the portfolio that we've yet to price, and that's the part where we will be -- we are currently communicating new pricing that will fold in next year. So the way we think about it, the decision to price, first and foremost, is a principle-based one that we follow in order to protect our margins at all times. Now obviously, we need to be responsive should we see specific dynamics occur with any given category. And of course, we will do that. As also as I've said before, we work too hard to build our market shares. And if we see somebody get irrational short term and we've got to take additional action to defend it, we'll do that because that's the right thing to do for the long haul. What I will say, generically speaking right now, is I don't see extreme irrational behavior in the marketplace today. What I see is fairly rational. Obviously, I hope that continues because that's -- I think that's the best thing overall, but we'll have to continue to monitor it.

Operator

[Operator Instructions] Next question is Ken Zaslow, Bank of Montreal.

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

I find in acquisitions, one of the greatest values is the distribution opportunities. Can you talk about what distribution opportunity is for Van's and Golden Island? Can these brands become part of the core 4, or whatever you -- those bigger brands? How do you see them developing? And how long do you think it will take to develop?

Sean M. Connolly

Well, there are unique things that have to happen for each of them to fulfill their potential. But big picture, I think they're both great brands. Van's is clearly much farther along than Golden Island, but they're both great brands with a ton of runway. With respect to Golden Island, the issue there right now that we're working on is not one of seeking out distribution. We have people calling us wanting to carry the product. It is an extremely unique process. That's one of the reasons why we bought the company. So we're in the process of scaling that up and adding new capacity in. And as we do that, we will surgically seek out distribution in the places that really build the brand the most effectively for the long haul. Van's is much farther along, clearly, in the frozen section. Distribution is pretty solid there. We see incremental opportunities, obviously. That's a big piece of it. But one of the other things I really like about Van's is the extendibility into other categories, and that's not an uncommon thing when you're dealing with a health and wellness equity. One of the analogies I often point to is when Safeway created the O Organics brand and the Eating Right brands. They were successfully able to take those trademarks into a number of healthy categories where they went up against incumbent brands who had market-leading positions but really didn't have a lot of credentials in the health and wellness area. And what we've seen through our analysis is that when you've got a brand that can have those credentials and deliver on the promise of great taste, you can gain a lot of market share and do so profitably. And that's exactly what we expect to do with Van's.

Operator

Next question, Andrew Lazar of Barclays.

Andrew Lazar - Barclays Capital, Research Division

Sean, you talked about some of the historical -- the current elasticities on volume have been better than some of the historical numbers would show. And I'm trying to get a sense. Do you think that holds for the overall category, as well? Or do you think the category has shown sort of similar rates of elasticity, but because of the investment you've done, the Hillshire numbers look quite a bit better. And then secondly, it's probably too early, but any early read on some of these new products that you're launching? It's obviously an impressive array of activity. I'm trying to get a sense of if there's some early read on which ones you think look like they'll be more impressive for you or less so.

Sean M. Connolly

Yes. Okay. Good questions. On the first piece of it, in terms of category elasticities relative to brand elasticities, one of the things I look for there is, is it a mature category or is it a young category that's just inherently going to be growing for a period of years. So in a category, let's pick breakfast sandwiches as an example. As I've shown you all many times, that's a young category. It's only at about 35% household penetration. I see no reason why it shouldn't be at 60% household penetration. So even in a higher pricing environment, I think that's a category that's going to continue to grow, and I think it's inherently insulated with lower elasticities at both the category level and, certainly, when you're dealing with Jimmy Dean, far and away the #1 brand at the brand level. I think it's a different story when you're talking about mature categories that, let's say, are flattish. So if you look at hot dogs as an example of a category where I have said there hasn't been enough innovation historically, the category itself volumetrically is somewhat flattish. But within that, you're going to see brands with very different elasticities. And I think the -- if we could run a correlation, you would see that those companies that are investing behind innovating those brands and backing them with good MAP support and brand-building investments are going to see lower elasticities. And those who don't are going to see the product behave in a more commoditized way, and that is the fundamental premise of why we run the company the way we do. With regard to the second part of your question on new innovations, I think the headlines are that it's early days, but what I'm seeing is encouraging. I'll give you a couple of examples. We just launched this American Craft sausage, which is a fantastic pre-cooked grilling sausage, the one I implored you guys to go out and buy for your grills. It's early days, but sales are outpacing our original estimates. And that's due not to distribution, it's due to velocity. So that's a good sign. We haven't even been marketing that one yet. We have another new initiative called Park's Finest, which is our entry into the super-premium tier of the hot dog category. And that one we launched it, we got it on shelf, and then as soon as we achieved the threshold distribution, that is one where we've already begun running a specific commercial featuring Park's Finest advertising within the context of our normal Ball Park advertising. And when you look at the data in terms of what elasticities have done since we turned the advertising on, it's a vivid inflection point. And that's typical because with new items, it's much easier to get trial once you create awareness, and that's what those marketing investments do in the early days, they drive awareness.

Operator

Next question, Greg Hessler of Bank of America.

Gregory Hessler - BofA Merrill Lynch, Research Division

There was a -- you guys had some commentary at CAGNY where you said based on the credit rating and leverage, that you wouldn't anticipate really de-leveraging or paying down debt. So with the 0 coupons that are maturing this summer and the $165 million acquisition, should we expect you to be back in the debt-to-capital markets in the near term?

Maria Henry

Well, that will depend on a number of factors. The $105 million that's coming due just makes sense to go ahead and take that out at the end of June. We have talked about the fact that we are very active in the M&A space, and so depending on the size of the acquisition and depending on the timing of when we execute it will depend if we'll be into the debt markets to get it done or not.

Gregory Hessler - BofA Merrill Lynch, Research Division

Okay. And then just one follow-up. On M&A, I mean, if we're sort of looking out a year or 2, just kind of a longer-term view, what do you think is the right level of leverage to run the business at?

Maria Henry

Well, if I look across the space at what do I think is kind of normal leverage for our space, it's probably 2 -- it looks like 2.5x, maybe a little bit more than that is the more normalized level for CPG food. Clearly, right now, we have -- we're in a position where we've got a very low level of leverage. We've talked about the fact that we have no issue with going into the debt markets to take on acquisitions that make financial sense and that we believe will create long-term shareholder value. So we'll see how that plays out and what we're able to get done.

Operator

Next question, Ken Goldman of JPMorgan Chase.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

I have a couple of follow-ups. Maria, there were some public speculation you were looking at Michael Foods. I won't ask if you were bidding for that asset specifically, but I am curious, right, the bidding process is over. Is that the kind of business you'd be interested in? Again, very generally, a company not necessarily with the greatest, most well-known brands, but very strong category trends in an area of protein you're currently not playing in. Would that have made sense from a very general perspective? Or is it just a question you can't answer?

Maria Henry

Well, I'm -- as you know, Ken, I won't comment specifically on Michael Foods, and I understand you're not asking me to do that. What I would say...

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Well, I kind of am. I think I'm kind of am, but I'm trying to ask in a roundabout way.

Maria Henry

But you kind of know my response. But let me bring you back to what we said about M&A and how we think about it. I think the first point is that we follow a very disciplined approach to how we think about M&A and how we evaluate potential targets in the market. But as we think about M&A, we're a branded food company. We look for strong brands to bring into our portfolio that we'll be able to leverage our capabilities to grow and to maximize the value of those brands as part of Hillshire Brands. We look at opportunities that would be able to leverage the kind of the core assets and capabilities of our company, whether that is through synergies on the cost side or whether that is through leveraging our growth attributes, which would be things like our strong sales force and our strong relationship with customers, looking to leverage our marketing capabilities, looking to leverage our knowhow on the capabilities that we've built in revenue management, managing trade, et cetera. But overall, we look for something that's a strategic fit and that also makes sense financially. And there, we're looking at things that are margin-accretive and have attractive long-term growth prospects. So yes, those criteria haven't changed. A lot of different things that are in the market available or could be available, and we put it through that filter to make sure that we are very disciplined before we bring anything on.

Sean M. Connolly

And then just one bit of additional color on that, too. Because we always get the question and that I think is a hangover from before we were named and we were affectionately called MeatCo, I think we always get the question, would you consider things that are not meat-centric? And my answer to that has consistently been, of course. We go to market in a number of different places. We like good brands. And just look at what we did with Van's. We think it is a perfect complement to what we do, and I rather like the notion that it continues to diversify our COGS base.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Yes, but Sean, I mean, that makes sense for a Van's, which is frozen breakfast, which you're already in. I mean, does it make sense for something like marinara sauce, right? I mean, I think something like that could be financially accretive, but strategically, it sort of gets you into something that I don't know how many people would look at that as necessarily a -- and I'm just using that as an example, as a strategic fit for the company at the time. Does that make sense?

Sean M. Connolly

Well, so far, Ken, you hit Michael's and you hit Ragu. I know I can keep going here, but we're not going to comment on specific market opportunities.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

No, I'm not really -- I'm really asking because people -- there are some investors in your stock who want to make sure that you stay more of a pure play, right? And if you go into something that's a little far afield from frozen breakfast. I mean, waffles makes some sense, right? Forget tomato sauce. I mean, anything else beyond frozen breakfast that doesn't necessarily make sense might take you away from that pure play. And I just think people are wanting to know a little bit more deeply about how you think about that, that's all.

Sean M. Connolly

Well, I think even the language of pure play is a bit of a holdover. What we're really interested in is value creation. And what you've got to ask yourself is what is the relative value creation of your so-called pure-play model versus good brands, great cash flows and the ability to sustain top and bottom line performance over time and do it in a consistent way. And I think that is really what we're focused on. So as we look at things, we'll look at it in a very clear-eyed, analytical way around what does it do to complement the existing enterprise as you know it today, and does it improve our ability to deliver returns to our shareholders and do it in a way that is more consistent and consistently less volatile than we've done historically. And that is exactly the way we look at it.

Operator

Our final question comes from Rob Dickerson, Consumer Edge Research.

Robert Dickerson - Consumer Edge Research, LLC

This will be quick again. So Sean, not to beat the horse a little bit on M&A, but I thought you'd be a good person to ask. I mean, considering the purchase of Van's, which is owned by Catterton, private equity, and all the M&A activity that we've seen in the food space, I mean, people do point, as we just heard, to the larger deals. But it seemed like where we are in the health and wellness food cycle, where the investment cycle is on the private side, are you seeing more deals come to you from private equity, from private investment that are smaller deals with brand expansion potential relative to some of these larger, underperforming sort of weaker brands per se?

Sean M. Connolly

Well, I think there's certainly a ton of small start-up companies with high growth trajectories out there. But I think one of the simplest ways to look at it is look at our existing portfolio. And I think it shows you what we're comfortable doing as operators. We are quite comfortable running these smaller high-growth businesses like Aidells, like Van's, like a Golden Island.

Robert Dickerson - Consumer Edge Research, LLC

Like Applegate or something like that?

Sean M. Connolly

Well, now you're piling on Ken's approach here. But in addition to that, I would say we're equally comfortable, in fact, our foundational capabilities are in running large established brands and helping revitalize them to get more performance out of the top line and the bottom line. So it's not as if one fits us, our model, better than the other. We are equally comfortable with both approaches.

Robert Dickerson - Consumer Edge Research, LLC

Okay. And I think you pointed to this earlier but you are still comfortable, out of the gate at least, upfront with an acquisition of being around 3.5x levered?

Maria Henry

Yes, we are. We have an eye toward maintaining investment grade. I've been asked the question numerous times around would we go further than that, and we would as long as we saw our way back to investment grade in relatively near-term order. So that's kind of how we think about it. We remain open to it. As Sean said, as long as what we're doing is fundamentally improving our position to deliver long-term shareholder returns, then we're open to doing it.

Sean M. Connolly

So with that, I'm going to conclude our call today with a couple of closing thoughts. Clearly, I'm pleased with the quarter, but what I'm most pleased by is the strong progress our team has made to build a winner for the long haul. As I've said before, we've always had great brands, but now our improved capabilities are enabling us to unlock the potential of this portfolio. And I think that bodes well for the returns we can continue to generate in the future. So between our core business momentum and our plans to utilize our balance sheet for additional value creation, we are confident that we will deliver strong returns for a long time to come. With that, we'll sign off and wish you all a great day. So long.

Operator

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

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