The Hain Celestial Group, Inc. (HAIN) Q2 2019 Earnings Report, Transcript and Summary

Greetings and welcome to The Hain Celestial Group Second Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded. I will now turn the call over to Katie Turner for opening remarks.

Thank you. Good morning. We appreciate you joining us on Hain Celestial Second Quarter Fiscal Year 2019 Earnings Conference Call. On the call today are Mark Schiller, President and Chief Executive Officer; James Langrock, Executive Vice President and Chief Financial Officer. During the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and involve risks and uncertainties that could differ materially from actual events than those described in these forward-looking statements. Please refer to Hain Celestial's Annual Report on Form 10-K and other reports filed from time to time with the Securities and Exchange Commission and its press release issued this morning for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. A reconciliation of GAAP results to non-GAAP financial measures is available in the earnings release and the presentation, all of which are posted on Hain Celestial's website at www.hain.com under Investor Relations. This conference call is being webcast and an archive will be available on the website. It’s now my pleasure to turn the call over to Mark Schiller

Thank you Katie and good morning everyone. You'll recall that my first earnings call in November was my third day as CEO. At that time, I committed to provide all our stakeholders with a clear and credible view of our current situation and future direction and to deliver consistent operational and financial results. To that end, as we report earning's today, my goal is to level set expectations on the reality of where we really are, this will deliver on my promise of clarity and credibility. In late November at Investor Day, I'll share with you the details go forward plan to deliver the goal of consistency. Today's news on our current performance is truly disappointing. It's where we are starting our transformational journey. We have issues that need fixing and we have decisions that need unwinding. For example we have a long-tail of unprofitable and low velocity SKUs resulting from launching too many new line extensions that really didn't add growth to the specific brands or categories. As a result they didn't earn their space on the shelf and we lost considerable distribution and faced more distribution losses going forward. We've made some uneconomic investments and pricing decisions in pursuit of volume at any cost. We've also introduced complexity into our supply chain without understanding its full cost. As a result, we've lost profit in the United States and are lowering our outlook for fiscal 2019. The good news is that, these issues are largely self-inflicted and our recovery is predominantly within our control. When I reflect on where we are as a company and the future ahead, I believe that we have great businesses with great potential. I'm optimistic about our future and our path to achieving it. Outside the U.S., we have good businesses with strong operators in place who've consistently delivered value and have efficiently and effectively managed our evolving marketplace. Inside the United States, we have a core set of high-margin health and wellness brands with mainstream potential competing in high-growth categories. We've building a world-class team who will fix the challenges we see before us and know how to write them. We're simplifying our organization and reallocating resources towards the strongest potential opportunities to maximize shareholder return. We're creating an operating model focused on cross functional decision-making that maximizes financial returns. We're taking a systematic approach in moving aggressively from a focus on volume growth at any cost to a focus on growth that is both profitable and sustainable for us and our customers, from buying our way on the shelf to earning our way off the shelf through increased consumption from complexity being an output of decisions made to complexity being an input into decision-making and avoiding it unless it drives tremendous economic value. From growth, driven largely by M&A to a focus of primarily organic growth through growth marketing and great execution. We're starting to undo poor uneconomic decisions and build-in operational discipline. In just a few short months, we've lowered our inventory significantly, reduced our cost to serve and improved our service levels. We're attacking uneconomic trade investments and reassessing our distribution costs. As a result of these actions that we've already taken, we're experiencing sequential improvement in our Q2 results relative to Q1. We expect to see continued improvement in the second half versus the first half as these initiatives in Project Terra savings materialize. Going forward, we will address the long tail of unprofitable SKUs, we envision a smaller more focused company with higher margins and profits. That's a fundamentally different approach for Hain. In the past, we added tremendous complexity and drain profit in pursuit of growth at any cost. Going forward, we will be smaller, less complex and more efficient resulting in higher margins and profits. As you'll hear at Investor Day, we're segmenting our portfolio of brands into four main categories: Mainstream growth, sustainable contributors, incubation and profit maximization. We'll use these category designations to focus more resources for people in dollars against the brands and SKUs that drive better growth with better profitability. We're already seeing great progress here brands like Terra, Sensible Portions, Garden of Eatin', Greek Gods, Dream and Live Clean are all seeing mid single-digit velocity growth when you exclude the distribution losses. That reaffirms as we shrink to a core set of high velocity and high-margin SKUs we have great potential to grow. To achieve this potential, we'll need to direct our -- redirect our investment choices, optimize our assortment to a smaller more profitable set of brands and SKUs and simplify our supply chain. You can expect us to eliminate uneconomic decisions and double down on strategies that drive our P&L. These actions will occur with our retail partners when they do their category resets over the course of the coming year. So in short, our transformation to build a consistent and sustainable performance in the U.S. has already started. While we're unsatisfied with our performance, we remain optimistic and excited about our future. I look forward to sharing more details on our business transformation at our Investor Day in a few weeks. And I'm confident that you'll find the plan to be both compelling and credible. With that brief overview, let me turn it over to James, who'll provide more detail on our Q2 performance and fiscal 2019 guidance. James?

Thank you, Mark, and good morning, everyone. As a reminder, the results of operations, financial position and cash flows related to the Hain Pure Protein segment are presented as a discontinued operation for the current and prior periods. We continue to make substantial progress and expect to complete the divestiture in the coming months. Today, I will focus my discussion on our financial results from continuing operations unless otherwise noted. In the second quarter, consolidated net sales decreased 5% to $584 million, or a 4% decrease on a constant-currency basis. When adjusted for constant currency acquisitions, divestitures and certain other items net sales would have decreased 1%. Adjusted gross profit was $118.6 million or 20.3%, a 240 basis points decline year-over-year. This decline was due to higher trade and promotional investments and increased freight and commodity costs in the U.S. partially offset by $16 million of Project Terra savings. SG&A as a percentage of net sales was 15.2%, up from 14.7% in the prior-year period. The decrease in SG&A in absolute dollars resulted from $5 million of Project Terra savings, partially offset by marketing investments in our international businesses. Adjusted EBITDA was down 34% to $44.9 million from $67.7 million in the prior-year period. Reported adjusted EPS of $0.14 based on the effective tax rate of 29.1% compared to $0.32 in Q2 last year based on effective tax rate of 23.1%. I'll now provide you with key financial results to each of our business segments. For the U.S. net sales decreased 4%, or 1% when adjusted for SKU rationalization. This resulted from distributional losses and increased trade investments. U.S. adjusted gross margin for Q2 was 20.1%, a significant improvement of 150 basis points from 18.6% in Q1. As we expected, our service levels and personal care improved throughout the quarter, and we continue to see further improvement in January. We also benefited from Project Terra cost savings, although freight and input costs still remain elevated and planned trade spend increased 20% year-over-year. As Mark mentioned, we have a plan to eliminate uneconomic investments to improve our margin structure. U.S. SG&A was down 3% compared to the prior-year period, primarily related to timing of marketing spend and Project Terra savings. And U.S. adjusted operating income decreased to $13.4 million from $31 million. In the U.K. net sales decreased 5% to $225.3 million, over the prior-year period, or 1% on an adjusted basis, which was generally in line with our expectations. Adjusted gross profit increased $1.5 million and our gross margin increased 170 basis points driven by Project Terra cost savings, partially offset by higher input costs and commodity inflation and increased labor cost. U.K. adjusted operating income increased at an impressive 11% to $18.1 million from the prior-year period in line with our expectations. Net sales for the Rest of the World decreased 8% to $99.7 million over the prior-year period, or down 3% adjusted for acquisitions divestitures and certain other items including SKU rationalization with Europe up 3%, Canada down 7%, and Hain Ventures formerly known as Cultivate, down 14%. In Canada, we experienced some lost points of distribution due to pricing and increased competition from private label in our low-margin branded frozen fruit business. This was partially offset by strength in the plant-based and T categories. Rest of the World adjusted gross profit decreased $3.5 million to $22.5 million and adjusted gross margin decreased 150 basis points. Adjusted operating income was $9.3 million a $2.1 million decrease over the prior-year period with 120 basis point decrease in adjusted operating margin. This was in line with our expectations. Now turning to our cash flow and balance sheet. For the three months ended December 31, 2018 operating cash flow was $17.2 million and capital expenditures were $19 million. While operating free cash flow was slightly negative, it marked a significant improvement from the first quarter. Going forward, we continued to expect a sequential improvement in our operating free cash flow as we further improve our cash conversion cycle. As of December 31, our cash balance was $38 million and net debt was $690 million. Inventory decreased $12 million sequentially from Q1, reflecting better forecasting and an improvement in service to our customers in the United States. Importantly, beginning in January our inventory in the U.S. has dropped to year-ago levels and is $25 million less than our peak inventory levels in August. Our bank leverage ratio was 3.97 times as of December 31 compared to 3.32 times in fiscal 2018. On February 5, the company amended its credit agreement, whereby the allowable consolidated leverage increased to no more than 4 times as of December 31 and will increase to no more than 3.75 times in both Q3 and Q4 2019. Similar to the last three quarters Hain Pure Protein results are noted as a discontinued operation for reporting purposes and are not part of earnings from continuing operations. In the second quarter, Hain Pure Protein net sales were $147 million, a decrease of 7% compared to the prior-year period. We recorded a $54.9 million pretax non-cash impairment charge, primarily associated with Plainville Farms, our Turkey business, as well as unfavorable market conditions that continued to negatively impact the Hain Pure Protein reportable segment. Now I'll provide an update on Project Terra, the compressive global plan that we have been aggressively working on to reduce cost and complexity, as well as driving more profitable sales growth. We have made significant progress on Project Terra and saved $21 million of costs in the quarter which was in line with our expectations. The fiscal 2019 we continued to expect our Project Terra savings to build quarter-over-quarter as we progressed throughout the year. However, we expect that our total savings will be at the lower end of our anticipated $90 million to $115 million as certain savings are taking longer to materialize, based on the complexities in the U.S. business. For example, we have made a proactive decision to continue to invest in trade and fund more competitive pricing points. Some of our distribution our warehouse optimization efforts are taking longer than we anticipated. That being said, we are updating our fiscal 2019 guidance and now expect reported net sales from continuing operations in the range of $2.32 billion to $2.35 billion, a decrease of approximately 4% to 6% as compared to fiscal year 2018. We're down approximately 2.5% to 4% on a constant-currency basis. As Mark mentioned in the U.S. we have a long tail of unprofitable and low velocity SKUs result in considerable distribution losses that will impact sales going forward. We expect adjusted EBITDA of $185 million to $200 million. This reflects Project Terra savings and productivity at the lower end of our $90 million to $115 million range. We expect adjusted earnings per share in the range of $0.60 to $0.70. We expect our effective tax rate for fiscal 2019 to be 27% to 28%. Interests and other expenses are expected to be approximately $35 million with depreciation amortization and stock-based compensation expense of approximately $70 million. Based on fiscal 2019 EBITDA and working capital expectations, we anticipate cash flow from operations of $75 million to $90 million and we expect capital expenditures of $70 million to $80 million. We are making investments in manufacturing in our higher growth businesses to meet demand. Our cash flow guidance includes $30 million of associated charges related to the CEO succession agreement and $45 million of costs we expect to incur to implement certain Project Terra initiatives and other related items. As a reminder, our guidance is provided on a non-GAAP or adjusted basis from continuing operations, excluding the impact of any future acquisitions, divestitures and other non-recurring items, which we will continue to identify with our future financial results. With that, I will turn the call back to Mark.

Thank you, James. As I said earlier, we're not pleased with these results and are working systematically to restore profitable growth in the U.S. while continuing our profit momentum in our international businesses. While the transformation has begun, there's a lot of work ahead. We're energized and excited about the opportunities, we have to drive continuous improvement and my team and I have been through similar situations during previous roles, which gives us high confidence in our ability to execute Hain Celestial's business transformation and create value for all our stockholders. Hain Celestial has started implementing a new strategic plan focused on simplification, capability building, cost reduction and mainstream growth. These core four strategies will make Hain a much more disciplined and successful company and one that will generate meaningful financial improvements going forward. While I know you all want to hear more about our new strategic direction today is about earnings and balance of the year guidance. We look forward to providing you with more details at our upcoming Investor Day on February 27. With that said, we're now happy to take any of your questions. And I'll turn it back to the operator. Thank you.

Thank you. We will now be conducting a question-and-answer session. In the interest of time, we ask that you please limit yourself to one question, one follow-up and rejoin the queue for any additional. [Operator Instructions] Our first question comes from the line of Ken Goldman with JPMorgan. Please proceed with your question.

Hi. Thank you Good morning.

Good morning.

Mark you talked about similar situations you faced in previous roles. Can you elaborate a little bit on what that means to you so that we can get I know you don't want to talk specific numbers today we'll get those in a few weeks I imagine, but just trying to get a little bit of a sense for what you see at Hain it's similar to some of your particular experiences in the past so a little more color there I think might help guide people in direction you may be looking for?

Sure. So what I would say is first and foremost this is an organization that has tremendous complexity and one where we're treating all brands, customers, opportunities the same and as a result of that we take the limited resources that we have and we fragment them over too many initiatives that really at the end of the day don't add up to the kind of value that we need to create. So what we spent a lot of time doing and what I've done in the past in a similar situation is identifying the roles of the brand which ones have the most growth potential, which ones have the most profit potential, which ones should be managed for profit, which ones do we need to incubate to better understand their potential and resourcing them appropriately so that we get the right kind of return. If we can put more resources against fewer things that have higher potential we will have a much greater outcome at the end of the day. An example, I would give you is, we have a core maybe 200 SKUs that make up a huge percentage of our sales and yet we only have distribution on those SKUs in less than 50% of the ACV. Why is that the case? Because we've launched so many additional SKUs in pursuit of growth at any cost that we traded out good SKUs for lower velocity and lower margin SKUs. And so what we need to do is go back and unwind some of those decisions and put more focus against that core set of SKUs that will really drive both velocity and profit for us and for the retailer. And I use that as an example, but there's lots of other examples like that where we've spread the peanut butter too thin, have not had good economic lenses on the decisions that we've made and as a result we've eroded profit in pursuit of growth at any cost. So really -- it's a long answer to your question, but it's about focus, it's about disciplined decision-making, it's about cross-functional decision-making and making sure that you're putting the vast majority of your resources against fewer bigger opportunities that will have a better outcome.

That's helpful. And a quick follow-up from me. I may have missed it, but did you provide an update in your prepared remarks on the divestiture process for Hain Pure Protein?

Yes. This is James. Ken, so where we expect to have the entire business sold over the next few months. We have active buyers and some preliminary term sheets, process is taking a bit longer than we expected, but we've made significant progress on the process. We also would slowed down a little bit as we originally anticipated selling HPP in its entirety and now expect multiple transactions, so again, we're progressing nicely. However, at this point, it's an ongoing process, so I’ll leave my comments at where we are so, but again, the process is moving along.

Thanks so much.

Thank you. Our next question comes from the line of Alexia Howard with Bernstein. Please proceed with your question.

Good morning, everyone.

Good morning.

Good morning.

Just listening to the prepared remarks, it sounded as though investments in pricing and promotional activity, basically, I guess, payment on trades seem to be the major driver of the guide down from previous guidance. Is that the case or am I misinterpreting that? And how can you be confident that the retailers won't be just coming back and asking for more of those kind of concessions over time? How can you be confident with the strength of your retailer relationships? Thank you.

Yes. Let me take a shot at that, Alexia. So I would say that guide down is a function of two things. One, investment in trade and the other is some issues within our supply chain. With regard to the trade investments back to the comment, I made about pursuing growth at any cost, we made some significant investments in high-volume initiatives that were low to no profit at the end of the day. So what we did was we artificially inflated the volume, eroded the margins and eroded the profit in the process. So we're going to strip those kinds of investments out of the algorithm going forward. We're also looking at what other investments we've made in trade and the ones that are uneconomic, we will pull out. That said, as we pull out some of the trade, we will reinvest some of the trade back in the assortment optimization, as I was just talking about on Ken's question. We have an opportunity to optimize the assortment that we have in store and sometimes that comes with a cost, you may have to pay nuisance fees, you may have to help lead down the inventory of the existing items in the warehouse before they can put the new ones in place, but when we exit all of this, we'll end up with a better assortment on shelf, which is bother higher velocity and higher-margin for us. So it really is a series of what I would call uneconomic decisions that were in pursuit of growth. Growth at any cost without really understanding the financial implications of them and we're unwinding many of those as we go forward.

And then on the retailer relationships?

The retailer relationships are actually quite good. I mean, we are important in the sense that we have a very broad portfolio of health and wellness brands. We are viewed as a go-to company for both strategic thought partnering as well as insights around where the consumer is going. And so, I'd say, we have good relationships. I think our opportunity is to better leverage the size and strength of our portfolio, to be more partnering when it comes to retail execution. We tend to sell one brand at a time to one buyer at a time and have not fully leveraged the size and scale of the portfolio to our best advantage. But from a retailer standpoint, they view us as a critical partner, a leader in this space, one who has a breadth across the portfolio that gives us kind of knowledge and scope that they can't get from anybody else. So the relationships are good.

Thank you very much. I'll pass it on.

Thank you. Our next question comes from the line of Andrew Lazar with Barclays. Please proceed with your question.

Good morning, everybody.

Good morning, Andrew.

Hi. Two things for me. First, there's been, I think, a decent slog of SKU rationalization that's gone on at Hain over the last couple of years, but to your comments seems like there's quite a bit more that you've identified that makes sense to do. Is there anyway, I guess, you can put some quantification around the sort of magnitude or level of SKU rationalization? Whether it's a certain percentage of the portfolio around SKU that need to come out, just to give us some perspective on that. And then, the second part would be, as you now sort of embrace some of these new strategies going forward, you're already halfway through, obviously, of this fiscal year. It's going to be, obviously, a while before you think about fiscal 2020 and whatnot. But I mean, is it sensible to assume that some of these strategies obviously go through the course of the year, obviously bleeding into, one would think, at least part of fiscal 2020? As we just think about I guess the ramp, or how things can accelerate or not from this new 2019 base?

Yes. Happy to answer that. So let me start with the SKU rat. The good news in the SKU rationalization is, we are seeing improved velocities on the remaining SKUs that are left on the shelf, which is good news, right? And I gave you six or seven brands in my opening remarks where we're seeing mid to high single digit velocity growth on the remaining SKUs. I think part of the problem there is, we've just over-proliferated the line. So, as an example, if you have Sleepytime tea, how many flavors of Sleepytime tea before you just start taking your existing volume and fragmenting it over a lot more SKUs. So in eliminating some of those SKUs, a lot of that volume will flow back to the remaining SKUs, which we're seeing. The SKU rat was about 4% of our TDP losses, but only about 2% of our volume. So we are getting rid of the unproductive SKUs and seeing a lot of that volume flowing back to the core, that's the good news. Now with regard to what's left going forward, I would tell you, we still have somewhere around 35% of our SKUs sitting in the bottom quartile of the category on velocity. So obviously 25% would be fair share, we've got maybe 35%. So we've got more in the tale that needs to be rationalized. That said, we have a lot of opportunity on those core SKUs that I've mentioned, that are very high velocity and very high margin and yet are not ubiquitous in terms of distribution. I think of that core 150 to 200 SKUs only 20% of them have more than 50% ACV distribution. So, just think of the magnitude of the upside, if we could move that 10 or 20 points on each of those 200 SKUs, it's worth hundreds of millions of dollars of potential upside. So, part of this is going to be about SKU optimization, part of it is going to be about rationalizing more of the tail so that we get to a place where less than 25% of our SKUs have velocities in the bottom quartile. And there is a difference between what we're calling the mainstream growth brands and the profit maximization brands because there are some brands that have -- that are just over-proliferated where we have too many SKUs that don't make money and we're either going to price those SKUs, we're going to cost-reduce those SKUs or we're going to eliminate those SKUs. So, there will be a fairly meaningful rationalization of the tail on the brands that we're just not making a lot of money on. So, I think going forward what does that all mean for F 2020? What you're going to see is continued shrinking of the topline as we grow the middle of the P&L and the bottom-line. So, a lot of things that we're doing in the middle of the P&L, Andrew, around supply chain, closing warehouses, getting the mixing centers open, and getting the right pricing architecture around customer pickups getting our service up so that the fines are reduced and that we're selling more of the high-volume high-velocity items that middle of the P&L will continue to improve sequentially. And as we take out uneconomic SKUs, we'll see margins and profit grow as well, but it will come at the expense of some continued rationalization on the topline for the foreseeable future.

Got it. Thanks very much for that perspective.

Thank you. Our next question comes from the line of Scott Mushkin with Wolfe Research. Please proceed with your question.

Hey guys. Thanks for taking my question. So, -- and I'm sure maybe I'm just getting old and getting confused, I'm just trying to understand a little bit better some of the things that were said vis-à-vis the spending that you're doing, the velocity pickup in some of the faster-turning items, and then the plans going forward to maybe curtail that. And I'm just trying to understand is that true and should we expect even the places where we're seeing the velocity pickup, should we expect that to come down as you pull back the spend?

So, the -- in the places where the velocity is improving, we would expect those velocities to continue to be robust, but they're offset by rationalization of the tail that is today more than offsetting the velocity improvements on the things that are getting better. We've got 55 brands. At the end of the day, we're not going to grow 55 brands. So, there's a core set of brands and categories and I've talked about this before, Tea, Personal Care, Snacks, Yogurt, those are high-velocity high-margin high-growth categories where we are well-positioned to succeed. And in those categories, we're going to put a disproportional investment in marketing and in innovation to capitalize on the full potential of those brands and categories. Meanwhile, we have many other brands and categories that are in either the disadvantaged brands, they're too small for them to make a material difference in our P&L or they're underwater in terms of their financial performance either at brand level or SKU level. That part we're going to continue to rationalize aggressively, price aggressively, take costs out aggressively, so that those brands will be a lot smaller but we'll make more money on them than we do today. And you'll see that when we get to Investor Day at the end of the month. That tail will shrink considerably from where it is today, whether we shed assets, close down assets, reduce SKUs, price SKUs, cost-reduce etcetera. We are very aggressively going after profit maximization on that tail because we just don't see the long-term potential there that we do on some of categories and brands that I just mentioned. So longer term where does this algorithm settle out? You are going to have a core set of brands that are going to be nice-growing brands in mid-single-digit territory and you're going to have a much smaller tail. And that's how we're going to get to an algorithm that's going to be perpetuating and very attractive going forward.

I mean that totally makes sense and I appreciate the further clarity because I know we've talked about this a couple of times. I guess, what I was getting at a little bit was, just the comments that you made about growth at any cost that you were probably spending way too much money into the trade and that would pull back and I was just trying to square that with the volume, the volume comments you made with some of the faster turning as we moved forward into the year last two quarters. If you pull that back, should we see even some of the core items that you're focused on in the future, should we see that even pull back?

Yes. The things that are growing nicely, we're going to continue to invest in and those are going to continue to grow nicely. But when I say uneconomic investments, its trade investments and things that don't make money. Its repacking things for a specific customer that adds significant cost and takes something that would've otherwise made money and makes it unprofitable. It's in and out SKUs that are very small volume and very small margin that you just have to lap next year. It's a lot of those kind of growth at any cost initiatives that really drain resources, drain focus and drain profit that we're going to suck out of the P&L as rapidly as we possibly can. The part that's growing and the part that those categories that I mentioned that have the most potential, we're actually adding resources to those things. We're adding people, we're adding innovation resources, we're adding marketing dollars, so that we keep that part of the P&L growing robustly. And again some of those are 40 and 50 margin businesses in a company that doesn't have those kinds of margins overall. There are pieces and pockets that are very, very attractive financially and we are in a very good place relative to our competitive environment. So that's where we're going to double down that should continue to get better. But the tail, which is very long and it's a lot of brands, that's what's going to shrink and that will impact the total top line growth of the company.

And also Scott, this is James. Just to be aware that the -- in the back half of the year from a trade rate perspective, sequentially that will be improving on some of the actions that we're taking, but we're still going to be investing behind the high-velocity SKUs.

I got it. Perfect. Great clarification. Thank you.

Thank you.

Thank you. Our next question comes from the line of Akshay Jagdale with Jefferies. Please proceed with your question.

Good morning. Thanks. Thanks for the question. So my first question is just around the timing of the turnaround on the top line, right? So, obviously, you've lowered this year's expectations materially and then you're saying we should expect continue to see top line declines in aggregate in 2020. I mean any idea you can give us on like when this would -- when in aggregate we might start to grow? Do you have that visibility at the moment, is the first question. And maybe give us some color on like $200 million or so is what your sales guidance is reduced by. I mean that doesn't sound like its all tail, right? There's got to be some big brand-related initiatives that weren't profitable. Maybe an example or two would be useful.

Yes. So on the timing of the top line, a lot of it is going to be dependent on how fast we can rationalize the tail. And again, some of that's in our control and some of that isn't. What's in our control obviously is we can discontinue SKUs over time and do that in collaboration with our retail partners and their reset timing. We can take pricing. We can cost-reduce. If we want to exit brands, that isn't totally within our control. So some of the pace at which the declines go away is going to be related to how fast we can address the tail. What we do have visibility to and what I think we can start showing you going forward is on that core set of brands we should start seeing those brands turning into growth brands over time. Now to your point, there are still some uneconomic SKUs within those brands. There are some pieces and parts that we're going to need to rationalize. I'll give you an example on the baby business. We're in wipes, and we're in diapers, and we're in formula, and we're in pouches and we're in jars. We're in dozens of segments not all of those are economical. Earth's Best is a great brand and one that we think has good potential for the long haul. But there are some pieces that have to get rationalized. So the next -- foreseeable future the next 12 months is going to be about continuing to rationalize to a smaller more efficient set of SKUs and segments and brands, but we should start to see faster progress on those growth brands and you may see actually accelerated declines on the tail as we make much bolder economic decisions to really rationalize the financial performance of those businesses and get the most out of them. So that's why in aggregate it will probably be declining for a while, but there will be a bifurcation between the growth brands and the tail brands over time.

Got it. And then the question about the middle of the P&L, you're expecting that obviously in the back half to sequentially get better I'm guessing. That will continue -- that trend will continue into 2020. But is -- my question there is related to what's in the company's control right and that's a core competency, obviously of yours and the team you're bringing for it. So, whether it's SKU rationalization for margin improvement, whether it's the Project Terra-type stuff, mix management all of those. Why hasn't that worked so far, right? Because there was a Project Terra in place and it cut SKUs to the tune of 800 basis points over two years, but that never transferred into margins. So I'm just curious as to how quickly you can change that, but maybe the answer lies in sort of what is already in place.

Yes. It's a great question. So what I would tell you is most of the issues in the middle of the P&L are self-inflicted. Some are related to service challenges due to us not being able to service the Personal Care business and having to go to the outside to copackers and things that raise costs. Some of it is related to I'll call it silo decision-making. An example would be we went out and bought a lot of baby food in anticipation of big volume to come that didn't come. It's now sitting in outside warehousing that's costing us millions of dollars. We got to get rid of that product, but we're not going to fire-sell it, because has a long shelf life. As that product goes away we will shut down the outside warehousing that added cost. So silo decision-making is a contributor. And then I would say that we've made some decisions that have actually added cost to the P&L without fully understanding the implications of those decisions. All of that said everything I just mentioned is self-inflected and controllable, right? So what we have been doing in the last 90 days since I've gotten here is we are spending a lot of time understanding what's draining the P&L, putting plans in place to address them, and systematically taking out those costs over time. We will get out of these distribution centers that are uneconomic. We will get out of this inventory on babies that is costing us significant warehousing. We will get to better supply chain performance in terms of service, which will reduce customer fines for not being -- delivering product on time and getting us to lower cost as we move out of co-man. So its hard work, it will take some time but it's all self-inflicted and it's all within our control. So I'm very optimistic that you'll see the cost in the middle of the P&L come down over time as well.

Great. I’ll get back in line. Thank you.

Thank you.

Thank you. Our next question comes from the line of Amit Sharma with BMO Capital Markets. Please proceed with your question.

HI, good morning, everyone.

Good morning.

James, just a quick question on the guidance. Clearly very large cut more than what we were expecting, but it still implies a bit of acceleration in the back half. How do you feel about that like what's driving that? And then Mark a bigger question for you. Getting your message is very clear that the top line needs to restructure, right? And that needs to come down and we get that. Can you also just talk about the margins, right? You're talking about a lot of this self-inflicted wounds and that normally means that you'll have to add capacity from a management perspective or talent. How do you think about your margin structure and especially as you market behind these brands too? I mean, obviously, 5% operating margin in U.S. is not sufficient. But what's the right ballpark? Should we think about traditional packaged food margins? Or are there structural headwinds that prevent you from getting there from a margin profile?

Sure.

I'll start first. So on the back half from a gross profit and EBITDA margin; we're going to see improvement from the first half to the second half. I just mentioned earlier we're going to see improvement in the trade rates, Project Terra cost savings are more in the back half than they are on the front half. We've talked about the removal of uneconomic growth activities that we're taking out. So we will see that improve in the back half. As it relates to the top line, clearly as we mentioned in the U.S. with the unprofitable and low-velocity SKUs that that will continue to be down in the back half of the year. The U.K. will be on a full year basis, will be flat on a constant currency basis. In the U.K. there's some competition around private label in certain of our categories that's putting a little pressure on the top line and we are exiting some unprofitable private label SKUs in the U.K. as well, but the profitability in the U.K. was up in Q2 on a year-over-year basis very nicely, and we'll continue to see that improvement in the back half. Similar with the rest of the world we'll see continued improvement in the back half from a gross margin standpoint and an EBITDA. So, very confident in the back half guidance and the improvement in the profitability.

And with regard to margin, first of all the fact that we had fairly significant margin improvement in the second quarter versus the first quarter should give us all confidence that there is plenty to go get. What I would tell you with regard to your question about structure, we do have some structural disadvantages versus the CPG average. We have a large percentage of our volume that goes through distributors who take a markup and we have a large percentage of our volume that is co-packed. We have more than 125 co-packers who are all taking margin as well versus a company that is more fully integrated and doing self-manufacturing. So I don't anticipate that we're going to get to the CPG average margins overall, but there is a huge gap between where we are and the CPG average. And we can create tremendous shareholder value from where we are by fixing the P&L in the middle as we were talking about by focusing on these core sets of brands and categories that are high-margin businesses, most of which are self-manufactured by the way that takes out that middleman cost. And so really it's about from where we are, how much value can we create. And the answer is a lot. But I don't expect that we're going to be in mid-30s gross margin business like the CPG average because of some of the structural barriers we've got relative to some of our competitors. Q – Amit Sharma: And Mark that doesn't change even when you restructure your portfolio and become a much more concentrated portfolio versus -- you anticipate that these headwinds or structural headwinds will still be in place? A – Mark Schiller: Well I think it depends again on how fast we rationalize the tail. If it all disappeared tomorrow and we were just in those core set of categories, we would have very attractive margins. We would have -- we would not have as many of the structural issues that I mentioned because most of those are self-manufactured as an example. We would still have the distributor markup because we do a significant percentage of our business in the natural channel. But those are very attractive businesses. We have 50 margin businesses in some of those categories which are as good as it gets in CPG food. But that implies that we get out of all of those tail brands which is 40 brands. That's probably not a realistic outcome. So it's going to be about how quickly we can rationalize that tail. And look there are some pieces within that tail that are not going to be super-high margin, but they're going to be very steady annuities if you will that turn out cash that we can reinvest back in the growth. So I expect that it's going to get significantly better. It's hard to put a number down because again that tail is very large and it's going to take some time for us to work our way down on that tail. But again, I think you're going to see significant sequential improvement over time. Q – Amit Sharma: Got it, thank you so much. A – Mark Schiller: Thank you.

Thank you. Our next question comes from the line of Michael Lavery with Piper Jaffray. Please proceed with your question. Q – Michael Lavery: Good morning, thank you. Two quick ones, just follow-ups basically, you touched on moving out of co-manufacturing with I think it was Akshay's question, could you just give us a sense of how much more CapEx -- should we expect a pretty significant uptick in CapEx related to all that or is it more modest tweaks around the edges? Can you consolidate co-manufacturers? Is it more bringing it in-house? Just a little peek under the tent there. And then on the segment outlook, you've touched on some of the SKU rationalizations in U.S. and the U.K. and different things that hit, but can you -- various markets, but can you give us some sense of -- is there geographic disparity and how to think about the outlook for the rest of the year? And is there any Brexit impact we should have in mind either stockpiling or negative consumer sentiment or anything else. A – Mark Schiller: Yes. Let me take part of it and then James you can talk about Brexit. As we think about globally where the most value can get created, it's in the United States. Most of the erosion has been in the United States, actually all of the erosion has been in the United States and undoing some of those uneconomic decisions and getting back to kind of a core set of SKUs will move us back toward where we've been historically in terms of profit in the United States. So the large emphasis is going to be on investment in those core sets of categories in the U.S. That said there are other businesses around the world that are also attractive. The Ella’s baby business in the U.K., we've got a plant-based meat substitute business in the U.K. and Canada that are very attractive that have potential here in the U.S. So, there are pockets of the rest of the world if you will that are investment-grade that we'll continue to invest in as we have. We don't spend a lot of time on these calls talking about it because those have been very stable, consistent contributors and we expect that they will continue to be. But really the opportunity that is the largest both in terms of dollars and profit fits in the U.S. on that core set of brands that I mentioned. So that's where we're going to focus our energy. With regard to co-packers, I think as we start to rationalize brands and SKUs in the tail, the amount of co-packing that we do will come down substantially, which will greatly simplify our supply chain, it will also greatly simplify our selling profits. If I’m a salesman and I have to go sell 55 brands, if we can cut that to 30 brands that I have to go sell and my job becomes a lot easier, and I can have much more strategic conversations with our retail partners. So I don't anticipate a ton of co-packed volumes to come internally other than in Personal Care where we had to move stuff externally because of our service problems. Over time we'll move that back internally. But I don't think that the CapEx dollars that we've been spending is going to change materially from where we've been. With that why don't – James, why don't you talk about Brexit a little bit?

So, Brexit, so the U.K. is an important business for us and we have very strong team in the U.K. and they're well equipped to deal with the situation. And as you get more -- we need to get more information on the final terms of Brexit, but the teams are assessing all the potential scenarios and contingency planning based on the various potential outcomes, which we mentioned is going a little low potentially on inventory or setting up warehouses in Europe. So again we are working through that and again we're continuously planning on the ultimate outcome. Due to the uncertainty at the moment we have not included any potential impact of Brexit in our guidance and as we get closer to it, we'll update everyone on what potential impact it has on our numbers in the U.K. business.

Okay, thank you very much. That’s helpful.

Thank you.

Thank you. Our next question comes from the line of John Baumgartner with Wells Fargo. Please proceed with your question.

Thanks, good morning. Thanks for the question. Mark, I'd like to stick with the topic of the structural issues because when you consider the larger multinationals that are getting into the NNO space with I guess far greater resources to spend, the private label set growing in NNO and then also the start-ups out there in the shelf-stable NNO space. It just feels like it's the nature of this natural food segment where price points have to be lower to be more competitive or maybe it requires more trade promo just to run in place. I mean, how do you think about Hain being squeezed comparatively from both ends from that perspective? What are your thoughts there?

Yeah, it's a great question. There's no doubt that there -- we call them ankle biters. There's a lot of new entrants that nip away your heels and you've got the big multinationals who are approaching health and wellness from a much more mainstream perspective. Our advantage versus the big guys is authenticity and credibility as health and wellness brands first as opposed to mainstream brands. There's – I'm not going to mention names, but we've seen examples of big guys who try and take their brand and get into gluten-free or get into organic and find they don't have the supply chain to deal with it, and then they've to have recalls and there's the credibility gap with the consumer on some of those brands trying to jump into health and wellness. So I think we have authenticity on our side. We have history on our side. We have the fact that we start in the natural channel in many cases and migrate to the mainstream channels as an advantage. And then I would also say, given our size and our DNA, we should be a lot scrappier and nimble and more opportunistic in terms of saying yes to the needs of customers than some of the big guys, and again going back to my last company that was one of our key points of differences. We became a go to for the retailers, because while the big guys are still deciding whether they want to do it or not and going through their bureaucracy, we're already half way through our execution. So I do think we have an advantage versus the big guys in that regard. Versus the little guys, we have scale, right? We have more dollars to spend. We have more CapEx to spend. We have more marketing. And so we ought to be able to meet – to beat the little guys and frankly I'm not ashamed to go find a good idea at Expo West and mainstream it before they ever could get the resources mustered to do it and do it with brands that already have decent household penetration versus starting from scratch in your garage. So I think there's advantages to being an ankle biter, there's advantages to being a big. But there's also advantages to being where we are. And again, I go back to those mid-single to high single digit velocity growth numbers in those core sets of brands and categories shows me that the consumer finds our brands to be relevant and is voting with their dollars to say this is – these are brands that I want to have in my pantry. So I'm cognizant of it, I'm not overly worried about it. I think we're well positioned and – not with every brand, not in every segment, but in those core set of brands that I talked about I think we're very well positioned for the future.

Great. Thanks Mark. Appreciate that. And just a follow-up on the pressure HPP, I think over the last 18 months we've heard about headwinds from seasonality, input costs, new manufacturing ramp but the fundamentals don't seem to getting any better. So can you just walk through I guess the fundamentals there in real-time in terms of changes in distribution points what's happening at the operating line? Because it feels like the performance is not helping with the sale of a business there. So any color there would be appreciated.

So the real issue on the HPP, you got the three businesses you have Empire Kosher, you got FreeBird which is the chicken business and while there's pressure in that segment they're performing well. It's the Turkey business, the Plainville Farms that has been more challenged business and a lot of that has to do with the pricing and the oversupply of Turkey. So that's been putting a lot of pressure on the P&L around Plainville Farms. And as I mentioned, we were kind of going into this process thinking that we would sell the entire business in one transaction, but with some of the challenges in the Turkey side, it's probably multiple transactions now that we're looking at again. So that's what's really driving the HPP results is the Turkey business.

Great. Thanks, James. Thanks for clarity there.

Thank you. Our next question comes from the line of Rob Dickerson with Deutsche Bank. Please proceed with your question.

Great. Thank you so much. So just in terms of cash, I don't know – if you've laid out what CFO could be this year and then also CapEx and I think you then said subsequent to past Q&A that, it doesn't seem like CapEx really, hopefully wouldn’t -- will it be changing that much going forward. Even though -- but it seems like there's a little bit more gross correction maybe in this year. And then obviously a lot of questions on ATP and then this -- the other questions I would assume given a simplification focus just around potential divestment right? I mean you rationalize the SKUs, but while you're actually in this whole process obviously you both sat in the room and discuss which ones, can we potentially divest? So I'm just curious broadly speaking, when you think about free cash flow and then where that allocation could go, maybe not like tomorrow, but it's got to be -- let's say next year or 2021 what have you, given you're not extremely levered right and given the simplification process I would think that there would be -- there should be some excess cash coming in. So if you were to have additional flexibility on the cash side and maybe this is just kind of a boilerplate response you give me. But I'm curious like how do you and Mark and the board really think about the ability to allocate maybe in a more shareholder-friendly basis, the excess cash going forward? Thanks.

So as we generate excess cash, clearly from a capital allocation standpoint, we would look at the options of share buyback. Depending where our leverage ratio is and where our interest rates are, you de-lever, go forward. But clearly as we generate free cash flow we look at the capital allocation and one of there options would be to share buyback. And you talk about CapEx this year, just want to remind everyone that it's a little elevated this year because we have the -- we're building the new Personal Care facility this year and then -- and in the U.K. we've had a -- consolidating some of the soup factories. So CapEx this year is a little more elevated than it has been in the past with those two big investments. But clearly as you generate free cash flow we would use the -- from a capital allocation standpoint, we'd figure out what we're doing. The stock share buyback would be one of the options.

Yes. I think debt reduction would be an option and returning it to shareholders would be an option and acquisitions would be an option. At the end of day, once we decide on the core set of brands and we've got this company operating efficiently and effectively there is some opportunity to do M&A as well to create some value. So I think we have lots of choices. Our job right now is to get the cash flow up. I think you've seen in things like reducing our inventory $25 million just over the last 100 days says that, we are focused on it, ROIC. We're focused on making sure that whatever we're spending we're getting maximum return on. But as we've talked about given the financial performance of the business, given HPP which has drained some cash, we've got to get that stuff fixed and get the cash flow up before we can make those choices.

Okay perfect. And then just in terms of the Investor Day forthcoming, realize you're not giving any incremental data or intel around that. But just obviously a lot of questions there around timing and how all this plays out and what do you think the relevance of the upside potential of all these actions may be? Is it fair to think that historically, Hain kind of gave us annual guidance really versus this longer-term kind of target with the restructuring play margin expansion what have you. Is it something obviously discussed internally? It is something that we should expect to kind of see when we get to the Investor Day? Or is it still we're just really focused on 2019, the next six months?

Yes. You know what, you're going to see on Investor Day is an algorithm that we are striving towards that we think we can deliver on a consistent basis. But as I've said a couple of times on the call, the pace at which we get there is going to be dependent on how fast we deal with the tail and how fast we get growth on the things we'd grow. So we actually have an algorithm for each of the four buckets that I mentioned; the mainstream growth brands, the sustainable contributor brands, the incubation brands and the profit maximization brands. And it's going to be the combination of those four buckets that's going to pull together what the algorithm is ultimately going to be each year. What we will show you is, as our plans play out in each of those four buckets, what kind of algorithm we expect to end up with. The pace of getting there, again, is going to be dependent on, in particular, how fast we deal with the tail.

Okay. And then just last quick question. A bit sensitive in nature, I realize, but always interesting to hear. The stock price not going to do well today, not doing well today, for obvious reasons. The opportunity is really still substantial, which is why you joined, Mark. I'm just curious, is there potential for other kind of executive appointments that we should expect over time? And especially, I would think, it would be not easy per se, but not entirely challenging to attract new talent, given the upside in the equity side? Thanks.

Yes. I mean, look, we are continuously evaluating our organization. We are looking at the top 50 employees and saying do we have the right people in the right chairs. In some cases, we have significant jobs that are vacant. Right now, we don't have a Head of Supply Chain as an example, where that's being managed with Alix Partners, who's doing a fine job, but we need to get a head of supply chain. We've made a couple of key hires, as you know. We'll talk about, hopefully, some more on the 27th when we're with you. But, yes, we are looking at the management team and what do we need to deliver against this opportunity. And I think what we're finding is, people are seeing where we are and agreeing that we're at the bottom and that there's opportunity to grow significantly and create significant personal wealth as being part of Hain going forward. So, I think, we will continue to attract talent and it will be important to us on this journey.

Perfect. See you on the 27.

Very good. Thank you.

Thank you. We have reached the end of our question-and-answer session. I would like to turn the call back over to Katie Turner for any closing remarks.

Thanks, Michelle. Thanks everyone for your participation and your questions today. We look forward to speaking with you again on February 27 at Hain Celestial's Investor Day. Have a great day.

Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.