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Hillshire Brands (NYSE:HSH)

Q1 2013 Earnings Call

November 01, 2012 8:30 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

Kenneth Goldman - JP Morgan Chase & Co, Research Division

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

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

Timothy S. Ramey - D.A. Davidson & Co., Research Division

Robert Moskow - Crédit Suisse AG, Research Division

Andrew Lazar - Barclays Capital, Research Division

Operator

Good morning, and welcome to the First Quarter Fiscal 2013 Earnings Conference Call for Hillshire Brands. [Operator Instructions] And 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.

Melissa Napier

Thanks, Wendy. Good morning, everyone, and welcome to our first quarter earnings call. Our results were released at 6:30 a.m. Central Time this morning. We also filed an 8-K to disclose some additional historical quarterly information. You can find that release and 8-K along with the slides that we'll be reviewing today posted to our website. We're expecting to file our 10-Q by the end of this week.

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. 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, and all explanations of non-GAAP financial measures are included in our release. Sean, I'll turn the call over to you.

Sean M. Connolly

Thanks, Melissa, and good morning, everyone. Maria and I are glad to be speaking with you today and sharing the results of our first quarter.

But before we get started, I know that many of you are listening from areas that have been impacted by Hurricane Sandy. Maria, Melissa and I all hope that you and your families are safe. Knowing that many of your lives have been disrupted both professionally and personally, we particularly appreciate you joining us today.

Now I'd like to make some big-picture comments about the business before diving into the results. Hillshire Brands is a focused food company, and our aim is to become the most innovative meat-centric food company in the U.S. As you know, we're a new company with an energized and experienced management team. We're clearly committed to growth and profitability through strong brands and innovation. We have a disciplined plan to create value and ultimately believe that we represent a compelling investment opportunity.

Importantly, fiscal '13 is a foundational year for us. That means we're taking foundational steps like upgrading our capabilities and team, fixing some underperforming businesses, reestablishing our commitment to advertising and rebuilding the innovation pipeline. Q1 is just the beginning of our transition year, and I am very pleased with our fast start, both with respect to the performance we delivered and the progress we're making against our overall game plan.

We had a strong Q1, particularly in our Retail segment as we drove additional volume by spending MAP more effectively and pricing more competitively in select categories. We also capitalized on declining input costs and continued to reap the benefits of our push to reduce SG&A, some of which was timing. We're definitely encouraged by our Q1 results, but expect input costs to rise as we move through the year. Clearly, we'll continue to gain more clarity on the cost picture as the year unfolds, and we'll have more to say later. No matter where it lands, our priority is to consistently build a stronger branded portfolio that can perform in any environment. Therefore, we'll continue to reinvest back in our business as we work our way through this transition year. And as you'll hear from Maria, we don't want you to extrapolate Q1's OI performance out across the remaining quarters.

Now let me spend a little time talking about our segment performances. Our Retail segment volume was up 2.3% versus last year behind Jimmy Dean's continued strong performance and Ball Park's strong summer hot dog season. This is the third consecutive quarter that we've achieved year-over-year volume increases in the Retail segment. If you recall, Easter was early last year and hit our Q3 volume instead of Q4. So if we adjusted this slide for Easter timing, we would see sequential improvement in each quarter as well.

We're happy about this accomplishment, but remember, significant price increases were taken in fiscal 2011 and carried into the first half of our fiscal 2012, which lowered our prior year volumes. So the comps are a bit easier right now. And again, we also anticipate we will see commodity inflation coming in the second half, which may put additional pressure on our volume performance. Nonetheless, we are very encouraged by these top line trends, and we haven't yet fully ramped up our brand support through MAP and innovation.

Now even though we have more MAP and innovation coming, the underlying baseline volume consumption trends on several of our businesses are already moving in the right direction. Recall this metric is a good proxy for brand vitality even in the absence of promotion, and what you see here is that the fiscal year-to-date trends are quite a bit better than the past 52 weeks.

Jimmy Dean continues to be our standout performer with very strong volume and sales growth. Our management team has stepped up to drive Jimmy Dean in a big way. We've significantly increased MAP spend, invested in better packaging, expanded support for the Delights line and have accelerated innovation. The business has responded very positively, and we see more to come.

In the end, Jimmy Dean's strong performance is a function of a commonsense equation: Produce a high-quality family of products that people want to buy, price them appropriately and invest in marketing to reinforce brand equity. Frankly, Jimmy Dean's success shows that this equation works and just reinforces our conviction in our long-term strategy of replicating the Jimmy Dean model across our other high-potential retail brands.

Several of our other core brands performed well too. Ball Park remains strong through the tail end of grilling season, although I continue to believe that the hot dog category has been too flat-footed on innovation, which is at the root of overall category sluggishness. We will do our part to change that.

Our new Ball Park Flame Grilled burgers continue to perform well in limited distribution, and Aidells delivered another strong quarter, as did State Fair. And our regional business, Gallo, is performing well as it's been refreshed and is growing distribution.

Now let's talk about lunchmeat. Recall we have 2 businesses here: Hillshire Farm and Sara Lee Deli. Both needed work. You'll also recall that we put entirely new people in place to work on these brands, and we've tasked them with turning the businesses around. I'm encouraged by the progress I'm seeing, though it's clearly early days.

On Hillshire Farm, we improved our price gaps which helped our volumes in the quarter. We also restored advertising support. And already, consumers are telling us they like the new commercial, so we expect to see market impact. One of our new spots is on air now, and the other will launch in a few weeks. We still have more work to do on Hillshire Farm, but we're getting back on track and making strides with this fantastic brand.

In the back half of the year, we'll be introducing further improvements in product quality and packaging, both on Hillshire Farm lunchmeat and Sara Lee Deli. I believe these changes are absolutely necessary to set these businesses up for future success.

On innovation more broadly, recall we have a fully dedicated new innovation team now in place. Several new items are in market now in addition to the Ball Park burgers I mentioned a minute ago. They include another Ball Park frozen entry, which is a line of sliders and snacks. Plus we had exciting news from Aidells, which is testing an entry into the hot dog category with 100% natural hot dogs. And what you see on the slide here is the pineapple paradise variety, my personal favorite.

Aidells has also launched into test an amazing line of gourmet salamis, and State Fair has begun to line extend. And of course, Jimmy Dean new items are performing extremely well like the Meat Lover’s Bowl. Overall, we're just getting warmed up when it comes to innovation.

Switching gears now to Foodservice. In the Foodservice/Other segment, the story's mixed. I'll hit the headlines, and Maria will cover it in a bit more detail. Volume and operating segment income were up, but our overall mix was unfavorable. Foodservice meat volume grew, but the commodity deflation that we've experienced hurt revenues as we passed those decreases onto our customers.

Dessert volumes continue to be affected by the industry headwinds and residual effects of disruptions from the Tarboro plant upgrades.

Now before I turn it over to Maria, let me tell you about a few things that are on the horizon. First, clearly, the input cost tailwinds that have helped us are expected to turn the other way. Second, our MAP and innovation agenda will remain a top priority as we seek to build portfolio strength. Third, we will be carefully monitoring the competitive environment, and we will vigorously defend our leading market shares as necessary. Finally, we've made huge progress building a very talented team, and our talent agenda will continue to move full steam ahead, enabled by the addition of our terrific new Chief Human Resource Officer, Mary Oleksiuk.

With that, I'll turn it over to our CFO, Maria Henry, to walk you through our financials.

Maria Henry

Thanks, Sean. Good morning, everyone. Thanks for joining us. I'm glad to see that the markets are up and running and that things are hopefully on the way to getting back to normal.

Before we dive into the numbers, let me make a few high-level comments about the quarter and how it fits in with our expectations for the remainder of the fiscal year.

As Sean just discussed, we're executing our plan, and I, too, am pleased with our progress. We had a good first quarter with strong business results that were aided by low input costs and lower SG&A expense.

You've all seen the commodity activity in the market and as expected, we have benefited from the recent deflation. We expect commodities to become inflationary in the back half of the year. Our investment in MAP and innovation will further strengthen our brand equities and build consumer preference for our products. We expect this will reduce consumer elasticity of demand over time and help us better maintain volumes when we take price in the future.

On the SG&A side, we are delivering on our cost savings program, and our teams have been doing a really good job diligently managing how we spend our money. Additionally, we benefited from some favorable timing of expenses in this quarter. We will continue to aggressively manage overhead, but our SG&A expenses will increase as we ramp up investments and as additional stranded costs start to hit our P&L. We still expect SG&A to be up versus fiscal '12 for the total year.

Now let's take a look at the quarter's financial results. As you can see on this slide, our adjusted operating income of $105 million was up 76% versus last year, and adjusted diluted EPS was up 59% to $0.51. The key drivers of our strong operating profit in the quarter were low input costs, volume growth and lower SG&A.

Our adjusted net sales grew 2% behind a 3.2% increase in volume. I note that half of the volume increase is attributed to higher commodity sales, and excluding those sales, our volume grew 1.6%.

On gross margin, we had positive price recovery with the benefit of deflationary input cost in the quarter. This was the primary driver of our 9% increase in gross profit and our higher-than-normal 30.3% gross margin rate. Our MAP spend was 4.5% of revenue. And while that's down slightly versus a high year-ago comparison, our working dollars increased, meaning the dollars that are going to productive activities that reach the consumer as opposed to nonproductive expenses like fees. And our MAP effectiveness also improved. Further, the 4.5% rate represents a material improvement over a 10-year average of 3.5%.

We continue to be very focused on the ROI we've realized from the investment that we are making in MAP, and we're pleased with the performance of our current efforts. As I discussed a moment ago, 10% lower SG&A reflects the benefit of cost savings initiatives, tight expense management and favorability of timing. As should be clear from my comments to this point, you should not extrapolate our first quarter results as a run rate as you think about the remainder of the year.

We expect input cost to turn inflationary in the second half. This may put pressure on volume growth and gross margin, both in terms of dollars and percent. Our SG&A cost will increase as investments ramp and stranded costs layer in throughout the year. Additionally, we had a number of one-time benefits in the quarter and certain variable expenses, things like medical costs, that can break either way, were also favorable in the quarter. That's something that we can't count on as we move forward.

Now let me take you through our segment results. As Sean referenced, our strong first quarter performance was led by the Retail segment. Segment sales grew 3% on volume growth of 2.3%, primarily in Jimmy Dean, Ball Park and Aidells. The 45% increase in Retail operating profit was driven by solid sales growth, as well as positive price recovery on lower input costs, and we were able to hold much of our pricing through this deflationary period.

The Foodservice/Other segment grew volume 5.3%, while sales declined 1.6%. The sales decline is a result of pass-through pricing on certain contracts and negative sales mix resulting from high-commodity turkey sales.

Within Foodservice itself, meat volume was up and bakery was down. Our Foodservice Bakery business was challenged in 2 ways. Overall out-of-home dessert consumption continues to decline, and we continue to experience the effects of the upgrades to our bakery plants related to the Food Safety Modernization Act.

The changes to our Tarboro facility that we discussed with you in the last call are substantially behind us. However, we continue to experience the residual effects on our P&L as we work to recover lost volume and work through some inefficiencies associated with the changes we just made. We're now in the process of upgrading our second bakery plant in Traverse City. We anticipate this will go much more smoothly given our learnings from Tarboro.

At the end of the day, our Foodservice business is in a strong market position. Our investments will leave us in an even stronger competitive position, helping us to weather the current cyclical softness in the space.

Moving on to Australia. Australia sales were down slightly year-over-year on a dollar basis. Excluding foreign exchange, sales declined 1%, primarily as a result of the successful execution of our plan to eliminate unprofitable retail outlets and less profitable SKUs. The segment almost doubled its adjusted operating segment income on lower input costs and the timing of MAP spend.

I'm very pleased with our cash flow for the quarter at positive $18 million. Our fiscal first quarter is particularly challenging for cash flow as we have significant use of working capital behind our seasonal inventory build and as we pay for the higher-than-usual capital purchases from the fourth quarter.

Our strong operating income and a high level of option exercises contributed to delivering positive cash flow. This puts us in a really strong cash position with $253 million of cash at the end of the quarter. Our net debt is $694 million, so we're conservatively leveraged with a very strong balance sheet.

We're currently working through our long-range planning process, which we expect to complete early in the calendar year. As part of this process, we're evaluating the best opportunities for capital deployment, and our priorities there remain consistent: Invest in our business, look to provide competitive dividends, evaluate acquisition opportunities to leverage our assets and advance our strategy for value creation. And while we have no immediate plans for share buybacks, we will consider share repurchases as an option for capital deployment. I'm pleased with the flexibility we have, and we'll have more to share as we move forward.

So I've said a lot here. Sales growth was good. We have positive price recovery in a deflationary quarter. We have a good level of MAP at 4.5% of sales, and our MAP investments are working. And we're delivering on our cost savings programs.

What does all of that mean as we look forward? It means that we're encouraged by our performance in the first quarter, but we expect year-over-year performance for the rest of the fiscal year to be more challenging, particularly in the second half. This is our transition year, and we're only one quarter into it. We've just put a lot of great people and ideas into action, but we're nowhere near done making the necessary fixes and making the necessary investments into the business to set ourselves up for long-term success. As a matter of fact, we're just getting started.

Though we posted strong results behind business traction and some favorability in the first quarter, we continue to see variability in the potential outcomes for the remainder of the year. The areas of variability we are monitoring most closely are commodity prices, competitive activity, the recovery timetable of certain businesses and the macro challenges that we see in food service. Learning from prior experience, if we're tracking to favorability for the year, we will look to dial up the investment in our business around brand building, innovation and productivity programs that will strengthen our position going into what appears to be a more challenging commodity environment in the second half and into our fiscal '14.

With only one quarter behind us, we are reaffirming our EPS guidance range given on August 9 of $1.40 to $1.55. Before I close, I also want to touch on 2 final points related to guidance. We're expecting about $140 million in adjusted D&A for the year. And on share count, if we do not repurchase any shares, the average diluted share count for the full fiscal year will be approximately 124 million to 125 million.

We'll now open the call up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Alexia Howard.

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

I guess my first question is about marketing spending. You talked a little bit about the 4.5% implying that dollars are up, but the percentage is down year-on-year. Could you talk about -- going forward, my understanding that this is a big part of your strategy and that there's going to be a big step up in innovation that I was expecting more in January of 2013, so a few months from now. Are we expected to see more of a ramp up in MAP spending and innovation as we step into the second half of the year?

Sean M. Connolly

Alexia, let me take that. A couple of things. First, in terms of our Q1 MAP, what I would focus our investors on is the absolute rate of 4.5% versus the delta versus last year. Last year was an unusually high Q1 for us in terms of MAP. So we're very happy with the rate this year. We're also very happy with our continued efforts to shift how we spend our MAP from nonworking dollars, moving nonworking dollars into working dollars. And on top of that, we're very pleased with the effectiveness of the MAP, meaning I think the quality of our marketing that we've got in the marketplace continues to get stronger as we continue to build on our learnings. With respect to how MAP will flow by quarter, don't expect the quarters to be even. The quarters are different and it has to do in part with some of the seasonality of our business. We do have a grilling season that falls into quarter 1, which is why quarter 1 has been higher historically. We also do have, with respect to innovation, we really have 2 launch windows. One is close to the start of our fiscal, the other is early in our second half. And we'll continue to use both of those launch windows. And how our advertising flows around that support of new items depends upon the new item and the rollout schedule with customers, which, frankly, has a lot to do with when customers reset their shelf. So no specificity in terms of how we're guiding to MAP spend by quarter. Just know that our fiscal '15 target remains the same, that we want our overall MAP spend as a company to be at 5% by the time we close out fiscal '15.

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

Great. And maybe just a quick follow-up question. On the food service, you mentioned unfavorable mix. I'm assuming that means a lot of price per pound product. Can you just tell us what it is that's driving that? What are the products that are growing? What are the products that maybe are higher priced but declining?

Maria Henry

Sure, Alexia. It's Maria. In our Foodservice business, when we were talking about unfavorable mix, the segment is actually Foodservice/Other, and we include our commodity sales in that segment. As you know, we're vertically integrated on turkey, and we had high amount of commodity turkey sales in the quarter. And that bumped up the volume growth in that segment, but that is at very low price and very low margin. So that's the primary driver of the unfavorable mix. The other comment that I made about Foodservice is that within Foodservice, our meat-based business grew, and our bakery-based business declined. And we have nice margins on the bakery business, so that also affected the mix.

Operator

Our next question is from Ken Goldman.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

It's JPMorgan. I'm hearing a more cautious tone on this call than perhaps what came across in the press release. I appreciate you'll have fewer one-time benefits and higher cost coming, but the release didn't make it seem like part of the reason for not raising guidance was just being conservative really in the year, right, which is understandable. So I guess I'm just trying to parse out how much of your tone on this call is because you see legitimate challenges ahead? And how much is because you just don't want to raise guidance this quickly? If there's any way to help us understand that breakdown, that would be great.

Sean M. Connolly

That's a good question. Let me try to give you my perspective on that, Ken. Clearly, we're very encouraged by the progress we're making. I don't want to dampen that message at all. But a quarter doesn't make a year, so we want to see our progress continue and get further visibility into how input costs will shake out before we consider any changes to our guidance. And this early, we'll reevaluate where we are as we get farther into the year. But being in only one quarter in, we don't view this approach as overly conservative. I think a better way to describe it is appropriately cautious.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Okay. And then can you describe what you're seeing in the hog markets right now? It seems from my perspective like we had a big liquidation and then that liquidation is more or less over at this point. I'm curious if you're agreeing with that, if that's what you're seeing. And were you surprised by the amount of the drop in hog costs during your quarter?

Maria Henry

Ken, I'll comment there. We won't comment on the specific commodities, but clearly, pork was a big driver. And let me just tell you how that flows through what we're thinking. In the first half of the fiscal year, we are seeing more favorability in terms of input cost, particularly on the meat base. And we're seeing in the second half more challenging input costs than what we had expected 3 or 4 months ago. So we were able to capitalize on the benefit of the substantially lower costs in the first quarter, and you're seeing some of that show up particularly in our gross margin. Our current view of where that will go is that we'll give back a lot of that in the second half of our fiscal year.

Operator

Our next question is from John Baumgartner.

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

Wells Fargo. Maria, on the cost savings front, are you doing anything there to accelerate some of the projects coming through this year to get ahead of the cost inflation here? And is there any update to I think the $40 million in cost saves targeted for fiscal '13? And then related, any quantification on your hedge position as we go into the second quarter here for fiscal '13?

Maria Henry

Sure. I'm very pleased with how we're managing costs, particularly on the overhead side of the business. We are absolutely on track with the $40 million of cost savings that we talked to you about for the fiscal year. As you'll recall, $10 million of that is in COGS and $30 million of it is in SG&A, and we're absolutely tracking there. And additionally, the teams have really caught on to our new cultural environment that focuses on "act like an owner", and people have been and I expect them to continue to be very diligent in managing overhead costs and making sure that everything that we spend is going toward our agenda of getting the 4% to 5% top line growth. So I'm very happy with our SG&A savings and progress there. We did talk about we have $35 million of savings yet to be identified. And to the extent that we've got some favorability and can accelerate our work on identifying the underlying productivity changes that we'll make to the infrastructure of the business, we will certainly look to do that. We are well underway in the programs to identify that $35 million. And I talked about that being in the areas of trade, supply chain and general productivity. The other part of your question was around hedging, and I'll reiterate the hedging strategy that we have that we've talked about before. We don't hedge more than 6 months out just in general. And at any given period of time, we always have exposure to the spot market. So we're never fully hedged at any point in time, and that's what allowed us to take advantage of some of the favorability that you saw in the first quarter.

Operator

Our next question is from Akshay Jagdale.

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

KeyBanc. I just wanted to follow up on 2 things, commodity costs and the comments you made on the competitive environment. So first of all, did you quantify the impact of commodity cost this quarter, as well as give us a little bit more detail in terms of the guidance? I know you just made comments before that were directional, but it would be helpful if you quantify that. And then I just have a follow-up on the competitive side.

Maria Henry

Akshay, I'll take the commodity part of your question. We are not going to quantify the specific amounts associated with commodities. What I'd direct you to is when you look at our gross margin for the quarter of 30.3% versus where the business has been running, which is about 28.5%, there's a big step-up there in gross margin. And the biggest driver of that was related to commodities, so that gives you sort of a directional view of what we're seeing in the first quarter.

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

Okay. And then just on the competitive side, I mean, what specifically -- are there any categories that you're monitoring? Because if I just look at your quarter, your sales growth performance was better than I had expected, and it looks like there's more MAP spending coming as the year goes along. So I was -- from my vantage point, I don't see anything in the quarter specifically that would make me more concerned about competition than before. So maybe I'm misreading your comments, but can you just delve into what specifically you're looking at or monitoring on the competitive side? And does that have anything to do with perhaps having to take pricing in the back half as commodities rise?

Sean M. Connolly

Akshay, let me comment on that. It kind of relates back to Ken's question earlier because I don't want to suggest that we are sitting on knowledge that says we've got some kind of unique competitive battle coming. That's not the case. What I'm suggesting is tied back to what I said previously, which is being a new company at Hillshire, we're trying to drive much more of a productive paranoia into our culture than we had in the past, which means we are always in a position where we're watching competition. We're assuming they could be aggressive. We're planning through how might we respond to that because we worked very, very hard to build our leading market shares, and we need to be aggressive. We always need to be on the lookout. So as a matter of policy, we don't comment on specific competitors. But what the point I'm trying to making here is that our culture is embracing this productive paranoia just so we can always be on our toes. And we will not do what we've done in the past, which is if competitors try to come after our business, we won't sit back on our heels and just allow our market share to be taken away.

Operator

Our next question is from Tim Ramey.

Timothy S. Ramey - D.A. Davidson & Co., Research Division

It's D.A. Davidson. I think you mentioned the performance of the Hillshire Brand in sliced meats. But unless I missed it, I didn't really hear a lot of commentary on the Sara Lee brand. Can you comment a bit on that?

Sean M. Connolly

Sure. The Sara Lee meat business, the deli business, is a bulk deli business, which means behind the glass sliced at grocer delis, and it's also a presliced business. It's a decent size business for us. As you've heard me say in the past, nothing really happened on that business for a long, long time. We've got new management on that business, and we have product quality and packaging upgrades that are currently in process and will be hitting the marketplace in the back half of the year. It is -- I'll be able to show more detail on that as we move forward. But what I've seen so far is very promising, and we continue to get very good feedback from our consumers on that line. But they're eager to see us do what our assets are capable of doing in terms of product quality and packaging.

Timothy S. Ramey - D.A. Davidson & Co., Research Division

Great. And just a question for Maria. We didn't know specific tax rates and so on quarter-by-quarter, and hopefully, that's what that 8-K is about this morning. I'm looking forward to that. But when we plug these numbers, there was a 0% tax rate last year, unless I got things wrong. In your current structure, do you anticipate having significant variability in the tax rate? Obviously, this year was pretty much right on plan. So is that just a historical artifact or should we expect more volatility in that rate?

Maria Henry

Tim, I think you've got it. It's a historical artifact. We expect roughly a 35% tax rate. And as a primarily U.S. company, our tax rate should be very stable around that 35%.

Operator

[Operator Instructions] Our next question is from Robert Moskow.

Robert Moskow - Crédit Suisse AG, Research Division

It's Credit Suisse. Just regarding the back half of the year, when I look at the hog futures curve, it's really only implying maybe 7% or 8% inflation on a year-over-year basis. When you look at May and June, that didn't seem like an onerous amount of inflation to pass through; but maybe it is sequentially, but not year-over-year. I thought the real challenge will be in the first half of fiscal '14 I guess in terms of year-over-year comparisons. So I guess here's my question. Given that it's not that much inflation to pass on, what happens if you and your competitors do it in a rational fashion and you both do it together and I'm sure there'll be some volume hit, but wouldn't that be a situation that would allow you to drop some of the upside to the bottom line?

Maria Henry

Sure, Rob. I think that, that is definitely one of the factors that we are monitoring closely, what do we think will happen with those input costs. As I mentioned a moment ago, clearly, we saw more favorability than we were anticipating several months ago in the first quarter and we think for the first half. But in the second half versus what we were thinking a few months ago, it looks like it will be significantly more inflationary. How that actually plays out will certainly impact what our economics end up being for the year. So at this point, it's just too early in the year to make the call. And we'll know more as we move forward and see how that plays out. And as you mentioned, a very important dynamic is how competitors react and therefore, how we react in terms of pricing, which will all influence how much gross margin we're able to pull out in this year.

Robert Moskow - Crédit Suisse AG, Research Division

Yes, I mean, the reason I asked it that way is that you said spot prices were down, and you and your competitors seem to hold price pretty well. That's encouraging. So it stands to reason that maybe in the back half, can you kind of give us some guidance as to what your plan is? Do you -- are you just going to wait and see or are you going to be proactive in terms of pricing with the commodities?

Sean M. Connolly

A couple thoughts, building on Maria's comments, Rob. Recall we buy a number of commodities, not just pork. And obviously, the drought last summer was an unusually significant event, and its full impact on the protein complex is still emerging. And a lot of factors play into that final outcome, including the variable of global demand. So a lot is still moving, and that's part of the reason why we want to get farther in the year before we consider changing our outlook. With respect to pricing -- future pricing, obviously, quarter 1, as you observed, was in a good place now. Now where competition goes remains to be seen. And I certainly can't comment on our future plan for pricing. But the bottom line is we need strong brands to reduce elasticities of demand over time, and that will allow us to price and do a better job of holding margins in the future if we face inflation.

Operator

Our next question is from Andrew Lazar.

Andrew Lazar - Barclays Capital, Research Division

Barclays. I was hoping you could expand a little bit on your comment during the prepared remarks around the positive price recovery despite the deflationary input cost environment. Just trying to get a sense of what exactly you meant by that. And I guess more importantly, is that a different experience than you have had or that the business has had, for the most part, in the past? And if it is, why do you think that's different? What's driving that? Is it some issue dynamic? Is it what you've done around the brands more recently? Just trying to get a better sense for that.

Maria Henry

Sorry, Andrew. The positive price recovery that we have is the calculation, what we did with price against what happened with our commodity input costs and if it was very favorable for the quarter. As you point out, it is very similar to what the company had seen historically. The timing of the change in the commodity costs, which happened very quickly, there's enough time there for the changes that we're making in our business and the investment in MAP and other investments to yet have taken and uphold to help us there. I will say that in the quarter, we had strong MAP spend behind the 3 brands that showed the most significant year-over-year growth. So strong MAP against Jimmy Dean, Ball Park and Aidells. And all 3 brands performed very, very well in the quarter. So we are seeing effectiveness on the MAP, but I think it's too soon to say that the fundamentals of how the business reacts when we've got commodities with a big deflationary effect. And I think that the same would have been true had it been an inflationary effect. But we do think as we invest in MAP and in innovation, we will be better positioned to defend against the inflationary environment that we expect to be.

Sean M. Connolly

And just building on Maria's comments, Andrew. I believe you do look at baseline consumption trends. It's one of the reasons why I put that slide in our presentation this morning is that even though it's early days, the core strength of the business, in terms of a number of our brands, particularly our big brands, clearly moving in the right direction. And that's getting the fundamentals in place, things like price gaps, getting advertising back on air, getting the right kind of merchandising. It all does kind of work in concert. With that said, let's face it, we're just getting started driving real brand strength here. So we're not declaring our work is done in terms of what we're trying to do to reduce elasticities of demand over time.

Andrew Lazar - Barclays Capital, Research Division

And I think it's probably too early to have made a lot of progress on this. But I know you've talked in the past about sort of utilization rate of the key sort of Kansas City plant in the lunchmeat side and maybe you've got a lot of different potential ideas around how to sort of how to help that process going forward, but has anything changed on that front that's notable? Or is it just it's still early?

Sean M. Connolly

I think the most critical thing in that regard is we are trying to grow our lunchmeat business and particularly, our branded lunchmeat business significantly. So we've got a bunch of things going on. We've got a rollout happening in the back half of this year. Believe me, we're not going to stop there in terms of really trying to drive branded lunchmeat growth. As I've mentioned in the past, and several of you have asked me, would we do private label growth to run more volume through that plant, and spread out fixed costs. And what I've said before is that's a bit of a slippery slope because once you go there, it's in your base. You lose a lot of leverage with customers. I'd much rather build a branded business that's larger in lunchmeat. And I'm confident, based on what I've seen so far, we can continue to make progress in that regard. But there's a lot of work happening with our supply chain team in terms of optimizing Kansas City, and that work will continue.

Operator

Our next question is from John Baumgartner.

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

Wells Fargo. Maria or Sean, any thoughts on the Australian Bakery and where that business fits in with your broader corporate structure here? Might we be seeing some sort of activity or divestiture there in the near future?

Maria Henry

John, sure. Our Australian Bakery business performed very well in the quarter. We've got a really good team that runs that business, and they're executing a strategy to improve the profitability of that business even further over time. As I mentioned, the sales being down was the result of a strategy that they're executing to really get rid of less profitable pieces of the business and manage to a higher margin business moving forward. So it's a very, very good solid business run by a very good solid management team, and we're happy with its performance in the quarter. And at this point, we're not commenting on anything else related to any areas of our portfolio.

Operator

Our final question today is from Robert Moskow.

Robert Moskow - Crédit Suisse AG, Research Division

It's Credit Suisse again. Actually for Sean, this is the second time I think you've mentioned that the hot dog category has been stagnant, and you're not satisfied with how the category has behaved. But I don't think I really remember any time in the last several years where hot dog competitors introduced a lot of innovation and really participated in category growth. It's been very commoditized. Are you expecting any kind of -- and it seems like the innovation you've launched is really outside of hot dogs. It seems to be extending into adjacent categories. So what are your expectations, Sean, for how the category is going to perform? I mean, it doesn't seem like a very innovative category by definition.

Sean M. Connolly

Well, I think your observation in terms of it doesn't seem like an innovative category is a reflection of what I was referring to, which is a lack of innovation in the category. My personal view is I refuse to accept the notion that hot dogs can't be a growth engine. It is one of America's favorite food types. There's really probably -- there are a few greater eating experiences in the summertime than a great grilled hot dog. I just think that the hot dog category is really ripe for innovation. It's one of the reasons why you see us beginning to push the envelope in that regard. So a case in point, we've recently launched an Aidells hot dog, and that's a chicken-based hot dog. It's all natural, it's nitrate-free. But like the other Aidells line, it also has inclusions, so which means it's a kind of a positive surprise. It's got pineapple in it, it's got some fruit in it. So early days on it, we'll see if it sticks. But what you should expect from us is that we're going to test the theory here in terms of what can be done with the hot dog category. It's a huge category, and we're the industry leader in it with Ball Park. So we're going to continue to push on it.

All right. I think we'll wrap it up, folks. Let me just conclude by thanking everybody again for calling in. It is not lost on us for a second what many of you are going through this week, so our thoughts will continue to be with you. But we do appreciate your time and attention today. Thanks very much.

Operator

Thank you. This does conclude today's conference. Thank you very much for joining. You may disconnect at this time.

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