The Hain Celestial Group, Inc. (HAIN) Q3 2019 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to The Hain Celestial Group Third Quarter Fiscal Year 2019 Earnings Conference Call. As a reminder, all participants are in a listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Katie Turner for opening remarks. Please go ahead.

Thank you. Good morning. And thank you for joining us on Hain Celestial's third 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 and 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 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, which is posted on Hain Celestial's website at www.hain.com under Investor Relations. This call is being webcast and an archive of it will also be available on the website. And now I'd like to turn the call over to Mark Schiller.

Thank you, Katie, and good morning, everyone. I look forward today to providing an update on the early progress we've made during our fiscal third quarter against the transformational strategic plan we outlined at Investor Day in late February. At Hain Celestial, we remain committed to providing all our stakeholders with a clear incredible view of our business and future direction and to delivering consistent operational and financial results. To that end, we are encouraged to report that, as expected, our third quarter financial results demonstrate sequential improvements in our performance in many key areas of our business and we remain on track to achieve our fiscal year outlook. We're pleased with our early results -- while pleased with our early results, it's important to understand that there is still significant work to be done to return our business to acceptable levels of growth and profitability. Our current performance remains below our historical highs in the US, but we believe that we have the right strategy and the right team to generate consistent profitable growth and deliver value to our shareholders. To summarize our Q3 results, our team executed well in key areas of our business, generating operational improvements in the US and internationally. This executional improvement drove significant sequential improvement in consolidated adjusted gross margin, adjusted EBITDA margin and adjusted EBITDA in Q3 compared to Q1 and Q2 of this fiscal year. For example, Q3 adjusted gross margin improved 260 basis points from Q1 and 130 basis points from Q2. Adjusted EBITDA margin increased 320 basis points from Q1 and 160 basis points from Q2 with solid improvements in both US and international businesses. These results represent the second consecutive quarter of sequential improvement. Now to provide a little bit more color, I'll start with the US business. At our Investor Day, we laid out a clear strategy to transform the financial performance in the US, anchored in the following key strategies; simplify the portfolio and organization; strengthen core capabilities; reinvigorate profitable top line growth in a core set of brands, and expand margins and cash flow. I'm pleased to report that in Q3, we made good progress on all of these strategic objectives. In terms of the first one, simplifying the organization, we told you that we are going to aggressively pursue margin enhancement in our profit maximization brands. These are the low margin, non-strategic brands that add considerable complexity with minimal benefit to our P&L. When we don't have a clear path to profitability or believe the brands may have more value to someone else, we also stated that we would consider selling them. To that end, last week we completed the divestiture of the WestSoy Tofu business and this week reached a definitive agreement to sell the remaining Hain Pure Protein brand. Both of these businesses were low-margin and low growth with minimal potential to be accretive to our portfolio. In addition to simplifying the portfolio, these divestitures should also improve our balance sheet as we generate cash from these transactions and reduce operating losses. Our team is also in the process of formalizing our SKU optimization effort that is expected to address over 90% of the low-margin SKUs in the US and Canada by eliminating. cost-reducing and pricing SKUs that don't make meaningful profit. Overall, we plan to eliminate approximately 350 SKUs, reduce the number of co-manufacturers by 20 to 25, and improve our margin profile by more than 150 basis points over time in both the US and Canada. Next, our second strategy, strengthening our core capabilities, we are finalizing a restructuring in North America -- of the North America business to create centers of excellence, reduce layers, increase spans of control, and refocus resources. While we expect there will be some modest savings going forward, the primary driver of these changes are efficiency and effectiveness. While these actions will entail a restructuring charge, we don't expect this to impact our ability to achieve fiscal ‘19 guidance. Instead, it will help set up F ‘20 to support the future sustainable growth of our business. You may have also noticed that we've been busy adding executive talent to our organization to bolster our core capabilities. We've hired six senior executives on the leadership team since I started in November. Most recently, we've added an SVP of R&D who I've worked with previously and a Chief Supply Chain Officer who had been working with Hain as a consultant for several months. Both of these leaders bring significant functional expertise and have already brought meaningful process improvements in innovation, distribution and warehousing, inventory management, and service. We also have a new President of North America starting in a couple of weeks who would be responsible for overseeing marketing in the US and creating synergies between our US and Canadian businesses. In summary, we're building a world-class team with core skill sets that are well aligned with our transformation journey. Our third strategy of reinvigorating profitable top line growth, on this one, I wanted to provide you with an update on our recent progress. You'll recall that we expected to see year-over-year revenue declines in fiscal '20 -- into fiscal 2020, partly due to lapping distribution losses and partly due to the elimination of uneconomic investments, pricing and SKU rationalization. That said, we promised better visibility into the performance of our investment brands, which we dub to get bigger brands with velocity improvements as a leading indicator of future performance. While our total distribution points are still down due to last year's SKU reduction and this year's elimination of uneconomic activities, velocities on the get bigger brands were up 8% in the third quarter compared to 6% in the second quarter. Importantly, we've delivered this velocity growth while expanding margin on the get bigger brands. We've also begun the journey of reallocating resources to these get bigger brands with the goal of creating category-growing innovation and equity-driving marketing program. While in the early stages, we are tightening processes, partnering with experts, and are starting to build the foundation for consistent growth. For the get better brands, where we're primarily focused on simplification and expansion of profit, our velocities were also up 1% versus year ago in the quarter. This represents the first quarter of velocity improvement in the last two years on this collection of brands and suggests that we are doing a good job eliminating the lowest velocity programs and SKUs from our assortment. The result is that the remaining SKUs are faster turning and more likely to hold their shelf space in the store over time. Our fourth objective to expand margins and cash flow, as I mentioned earlier, we expanded our sequential performance in adjusted gross margin and adjusted EBITDA margins in each quarter of the fiscal year. In the US, adjusted gross margin was up 310 basis points from Q2 and 450 basis points from Q1. We made significant reductions in uneconomic trade and we did it -- and while it did impact our net sales, we expected this and set that expectation on Investor Day. When looking at profitability in the US, our adjusted EBITDA margin was up 300 basis points from Q2 and 510 basis points from Q1. Our team has been delivering significant progress in the middle of the P&L. For example, distribution and warehousing costs have dropped almost 200 basis points compared to the first half of the fiscal year and service levels have improved to 97% for the first time in two years, while inventory has dropped $25 million versus the prior-year period. Our get bigger brands generated adjusted EBITDA margin expansion of 190 basis points from Q2 to 16.6%, which is in line with our long-term guidance, and our get better brands' adjusted EBITDA expanded 430 basis points from Q2 as we aggressively take out uneconomic investment. Now, let me shift to our international business where we've delivered consistent performance. In the third quarter, our international business represented 56% of the total company net sales and 78% of the operating profit. We achieved modest growth in constant currency net sales and sequential adjusted EBITDA margin improvement. From a brand perspective, Tilda, Ella's Kitchen, plant-based Yves and Linda McCartney brands fueled our results and our European business was also quite strong. As expected, EBITDA was down slightly versus the same period last year, but this was timing-driven and we expect strong growth in Q4. While James will discuss our performance and outlook in more detail, for Q4, we expect continued sequential improvement in overall adjusted gross margin and adjusted EBITDA margin, and we are reaffirming our guidance for the year. That said, as we discussed on Investor Day, we expect some softening of the top line in the US as we lap last year's price increase, the buy-in for the personal care in the club channel and cut some uneconomic trade program. We'll also see some top line softness in parts of our international business as we aggressively eliminate low-margin promotion. Despite this, we remain confident that we continue to generate improvements in profitability heading into Q4. In summary, our results are showing signs that the business transformation is starting to work. We're demonstrating our ability to reduce uneconomic activity and stabilize and cost-reduce areas of our supply chain, resulting in better gross margins and EBITDA margins. As forecasted , this will come with some softness in the top line through the balance of this year and much of next year, but we're running this business with much greater discipline around a very clear strategy. That said, it's important to understand that we still have lots of significant work left to be done to turn our business to acceptable levels of growth and profitability in line with our commitment to deliver consistency. Many issues are complex and will take more time. Many capabilities need to still be developed and enhanced like pricing and forecasting. There is a culture change that's still getting embedded. There's areas of improvement that need to be addressed like cash flow and ROIC. So while we are very pleased with our Q3 performance and our trajectory, we have a long road ahead before we can declare victory. That said, we remain optimistic about our future and our path to achieving it. Our confidence gets stronger every day and we look forward to driving continued improvement throughout our company. With that brief overview, let me turn it over to James who will provide more detail on our Q3 financials and fiscal ‘19 guide. James?

Thank you, Mark, and good morning, everyone. As a reminder, the results of operation, 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 are pleased to have entered into a definitive agreement yesterday, May 8th, with the sale of the remaining Hain Pure Protein businesses, including the Empire Kosher and FreeBird brands for $80 million subject to adjustments. The transaction is expected to close before the end of our fiscal year. In addition, as Mark mentioned, we are pleased to have completed the sale of WestSoy Tofu last week as we focus on our get bigger and get better brand strategies for sustainable long-term growth. Today, I will focus my discussion on our financial results from continuing operations unless otherwise noted. At our Investor Day, we discussed our long-term strategy and also reiterated that in the near term, net sales will continue to be down year-over-year as we aggressively eliminate uneconomic investments and take pricing on low-margin brands and SKUs. As these changes are made, we expect profitability and margins to improve sequentially every quarter this year. In line with our expectations, third quarter consolidated net sales decreased 5% to $599.8 million or a 2% decrease on a constant currency basis. When adjusted for constant currency, acquisitions, divestitures, and certain other items, net sales would have been flat with Q3 last year. Adjusted gross profit was $129.4 million or 21.6%, a 140 basis point decline year-over-year. Declines were driven by higher, but improving trade and supply chain costs in the US and commodity inflation, partially offset by Project Terra savings. Compared with Q2 of this year, our gross margin performance improved 130 basis points, in line with the expectations we set on the last earnings call. SG&A as a percentage of net sales was 15.1%, up from 14.2% in the prior-year period, but flat in absolute dollars. As stated on Investor Day, we continue to optimize our organizational structure and align our team with our long-term strategic objectives for sustainable growth. Adjusted EBITDA was $55.5 million compared with $73.4 million in the prior year period. Adjusted EBITDA margin improved 160 basis points on a sequential basis from Q2, driven by both the US and our international business. This represents the second consecutive quarter of sequential profit margin improvement. We reported adjusted EPS of $0.21 based on an effective tax rate of 27% compared to $0.37 in Q3 last year based on an effective tax rate of 21.6% and an improvement from EPS of $0.14 in Q2. I'll now provide you with key financial results in each of our business segments. As Mark mentioned, we made good progress in Q3 on our strategic objectives to drive sustainable improvements in our US business. For the US, net sales increased 5% or 2% when adjusted for the SKU rationalization. While we've gained incremental planned distribution in the mass channel, we are still working through distribution losses as we eliminate uneconomic trade investments, take pricing on low margin SKUs and better manage product and customer mix. However, we are pleased with the year-over-year velocity growth for both our get bigger and get better brands. U.S. adjusted gross margin for Q3 was 23.3%, a significant improvement of 320 basis points from 20.1% in Q2. The sequential improvement was driven by a reduction in distribution and warehousing costs as our mixing center is now generating the operational improvements we planned. Margins also benefited from the elimination of uneconomic trade activities and Project Terra cost savings such as co-manufacturing and procurement savings and factory efficiencies. US SG&A was 15.1% as a percentage of net sales compared to 12.8% in Q3 last year, primarily related to increased marketing expenses. Adjusted EBITDA as a percentage of net sales increased to 9.6%, an increase of 300 basis points from Q2 2019 as we continued to deliver on our key metric of improved sequential profitability. For Q3 in our US business, the get bigger brands represented roughly 55% of sales and 90% of profit and the get better brands represented 45% of sales and 10% of profit. Our international business continued to perform in line with our expectations for the third quarter. Adjusted EBITDA margins improved sequentially for the second consecutive quarter, improving 80 basis points from Q2 of this fiscal year and flat versus the prior year. We continue to be pleased with the quality and stability of the international business profitability and its future potential. In the UK, net sales decreased 5% to $127.2 million over the prior year period. However, on an adjusted basis, the UK increased 3% driven by strong growth at Tilda and Ella's Kitchen and flat net sales at Hain Daniels. Adjusted gross margin decreased 60 basis points year-over-year and down 20 basis points from Q2. This was primarily the result of commodity inflation being offset by Project Terra savings within Hain Daniels primarily related to our soup manufacturing consolidation. UK adjusted EBITDA as a percentage of net sales improved 60 basis points from Q2 and 350 basis points compared to Q1, which was in line with our expectations. Net sales for the rest of world decreased 6% to $106.1 million over the prior year period or increased 1% on an adjusted basis with Europe increasing 4% and Canada increasing 2%, partially offset by Hain Ventures, formerly known as Cultivate, down 14%. Rest of world adjusted gross margin decreased 120 basis points year-over-year and was down 50 basis points from Q2. This was primarily the result of supply chain inefficiencies that we have identified and are addressing in Canada. That said, shifting to operating expenses, our team has done a good job controlling expenses in the business and we have also generated an improvement in Hain Ventures as we eliminate uneconomic trade activities and reduce SG&A. Rest of world adjusted EBITDA as a percentage of net sales was 13.6%, an increase of 40 basis points compared to the prior-year period, and 120 basis points from Q2 this year. Now, turning to our cash flow and balance sheet. For the three months ended March 31, 2019, operating cash flow was $13.1 million and capital expenditures were $14.4 million. Cash flow from operations was less than we expected due to the timing of payments and forward inventory buys in the UK to mitigate any potential Brexit related supply disruptions. Going forward, we continue to expect a sequential improvement in our operating free cash flow generation, particularly in Q4, as we further improve our cash conversion cycle and expect continued improvement in our profitability. Over time, we plan to use our increased cash flow to delever our balance sheet, provide returns to shareholders, and pursue profitable M&A. As of March 31st, our cash balance was $27.6 million and net debt was $724 million. Inventory decreased $8 million sequentially from Q2, reflecting better forecasting and an improvement in service to our customers in the US, partially offset by strategic forward inventory buys in the UK. Importantly, beginning in January, our inventory in the US has dropped to year-ago levels and is $35 million less than our peak inventory levels in August. Our bank leverage ratio was 3.83 times as of March 31st compared to 3.32 times in fiscal 2018. On May 8th, the company amended its credit agreement whereby the allowable consolidated leverage was increased to no more than 5 times as of March 31st through December 31st, 2019. Similar to the last three quarters, Hain Pure Protein's results are noted as discontinued operations for reporting purposes and are not part of our earnings from continuing operations. As I mentioned, we are pleased to have signed a definitive agreement for the sale of the remaining Hain Pure Protein business including Empire and FreeBird brands. Now, I'll provide an update on Project Terra. We made significant progress on Project Terra and saved $27 million of costs in the quarter and $62 million year-to-date, which is in line with our expectations. For fiscal 2019, we continue to expect total savings to be approximately $90 million. That being said, for fiscal 2019, we expect reported net sales from continuing operations at the lower end of our $2.32 billion to $2.35 billion guidance range, a decrease of approximately 4% to 6% as compared to fiscal year 2018 or down approximately 2.5% to 4% on a constant currency basis. As Mark mentioned, in the US, we have a long tail of unprofitable, low velocity SKUs resulting in considerable distribution losses. As a result, we are aggressively removing uneconomic trade and finalizing our SKU optimization efforts, including pricing actions, which will impact our net sales for the next several quarters. We expect all these actions to result in us delivering toward the lower end of our sales guidance range for the year, but we are reaffirming our adjusted EBITDA guidance of $185 million to $200 million and also anticipate another quarter of sequential profitability improvement in the fourth quarter. Adjusted earnings per diluted share is anticipated to be in the range of $0.60 to $0.70 with an effective tax rate for fiscal 2019 to be between 27% to 28%. Interest and other expense are expected to be approximately $35 million with depreciation, amortization, stock-based compensation expense of approximately $70 million. Based on fiscal 2019 EBITDA and working capital expectations, we anticipate cash flow from operations to be at the low end of our $75 million to $90 million range due to timing of payments and forward inventory buys in the UK to mitigate any potential Brexit related supply disruptions. 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 and productivity investments to improve margins. Our cash flow guidance includes $35 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. So this excludes 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’ll turn the call back to Mark.

Thank you, James. In summary, we're developing a compelling transformation plan for our business and are in the early days of bringing it to life. We have confidence that our strategy of simplification, capability building, reinvigorating top-line growth, and focusing on margin expansion is going to deliver significant shareholder value over time. We are starting to see evidence of a meaningful improvement and are pleased with our third quarter performance. This initial progress is very much in line with our expectations and guidance as we build toward our long-term algorithm. At the same time, we know we have much work ahead to achieve the goals we outlined on Investor Day in February. Like all transformations, it will take time and require significant changes in our culture, processes, and capabilities. Our team is excited to continue this journey and remains committed to delivering strong consistent results for all our stakeholders. With that said, we're happy to take your questions. Let me turn it back to the operator.

Thank you. [Operator Instructions] The first question comes from Ken Goldman with JP Morgan. Please go ahead.

I wanted to follow up on the comments made at the end about guiding to the lower end of the sales range for the year. I picked up a little bit in there about investments in pricing, maybe some SKU rat. Can you just give us a little bit more color on what the major driver is? And I understand it's not affecting your EBITDA, but just a little bit more help there would be useful, I think. Thanks.

So, as we said at Investor Day, we are going to aggressively pull out uneconomic activity, we're going to do take pricing, we're going to SKU rationalization, and we said that the pace at which our sales changes is going to be directly related to how quickly and aggressively we can make some of those changes in the uneconomic activity. I think what you saw in Q3 is that we are making progress at a very rapid pace. And so the more we pull out, the lower the short-term revenue is going to be. And I think as we look at what we did in Q3 and look at what we have coming in Q4, that's really the driver of the sales being a little bit softer. As we pull out some of this activity, we are losing some of the distribution that was in that bottom quartile that I've talked about before where we had a disproportionate number of our SKUs with velocities in the lowest quartile. So we have been losing some distribution as a result of the decisions that we've made, but you see very rapid margin expansion going along with that, which is part of what we were counting on. As we pull costs out, we're going to shrink the size of the tail, the sales will be lower, the profits will be higher, and I think that's what you're going to see in Q4. So, really long story short, Ken, it's uneconomic investments, it's distribution losses related to pulling back on things that we know didn't make any money, they could be customized SKUs for retailers, they could be SKUs that are in one retailer that we either said you have to accept a significant price increase or we are going to discontinue the item, and so that's really the driver of the acceleration in the top line erosion. We expect that to be very short-term in nature as we pull these activities out. You only pull them out once and they're gone. And so that would mean that we might get to stabilization on the top line faster in F ‘20 than we thought on Investor Day as well.

Thank you for that. And then at your Investor Day, I think you highlighted that compensation for managers has really shifted toward shareholder returns as the key metric. It seems that they -- obviously the stock is up over 30%. So I realize you have a wide EPS guidance range, but I'm just curious to what extent this range includes maybe a little bit of higher compensation expense than you expected at your Investor Day or is it just too early to be modeling that internally?

Yes. No, the change is not related to compensation expense. You got to remember, we had an initial plan way back when this fiscal year started that we are far off of that plan. So there is not going to be robust rewards this year for our overall earnings relative to what we originally said as our guidance. We do have some compensation expense accrued given the performance that we've been delivering, but it's not impacting our P&L in F ‘19 at all.

The next question comes from Scott Mushkin with Wolfe Research.

Yes. This is actually Evan. I'm on for Scott right now. Thanks for taking my question. So just a general one for now. Have you seen any noticeable headwinds or tailwinds coming up as you move into the fourth quarter from a US industry perspective? Any changes in competition?

Nothing material. I mean, it is always intense, it's always competitive. There is definitely a lot of interest in health and wellness from both the retailers and competition, but I wouldn't say that we have seen anything externally that's dramatically impacting our performance. I think our -- both our woes and our victories are more internally driven at this point and we don't anticipate significant change in the near term.

Okay, thanks. That's helpful. And then my next question. On your second quarter call, you mentioned 35% of your SKUs were on the bottom quartile in terms of velocity and you wanted to get that down to 25%. How has that been progressing? Is it on track with your expectations?

Yes, great question. So what we have done is broken our portfolio into get bigger and get better, as we've talked about. The get bigger brands now have less than 25% in that bottom quartile, which is really good, that would suggest that we're going to have a relatively stable distribution base going forward. The get better brands are the ones that have the higher percentage of SKUs in the bottom quartile. That's why when we get to the SKU rationalization discussion that will come before the end of the quarter that the vast majority of the SKUs that we're taking out, almost all of them are in that get better bucket. They're not turning and they're not high margin. In some cases, it may be SKUs that we have in one retailer that will never generate economic return for us and won't justify us trying to expand them because they don't turn well. So our expectation as we go through the SKU rationalization on the get better brands is that the amount of low velocity items will shrink back down toward the 25% number, but the vast majority of the issue still is in those low-margin get better brands.

The next question comes from Amit Sharma with BMO Capital Markets.

Mark, in light of what your commentary was on the sales guidance for next year, and granted, those are good reasons, the question is, can we move even faster, and not just from a SKU perspective, but from a brand perspective, right? You still have, what, 35, 40 brands and other than the five in the get bigger, all of them are in the bucket that you are actively trying to reduce. So the question really is that the pace of brand divestitures, is that internally driven or is it due to lack of maybe real interest from interested parties there?

Yes. So it's a great question. As you know, when you're considering divesting something and it's not totally in your control, you have to have buyers with the right valuations. But as we said on Investor Day, we're not waiting around for people to come and buy these businesses. We are going to improve their margins. We are going to do all the things that we've said and you saw in the third quarter very dramatic improvement in the adjusted EBITDA margin of those businesses. I think it was about 400 basis points. So we are aggressively running those businesses as though we are going to keep them for the long haul and make them as economic as they possibly can be within our algorithm. That said, like the WestSoy business, if there is an interested buyer and they want to move quickly, we are a for-profit public company and we are open for business. So as people come and approach us, we will have the right conversations and we'll move as swiftly as both parties are able. There's nothing on our side holding us up from doing any transactions. But like I said, they take time and we're not going to wait around. We're going to continue to make improvements in terms of the profitability of those businesses.

Great. And then just one more. If you look at the operating profit in the US, right, a pretty dramatic sequential improvement, almost 300 basis points. Two things there. A, is there any seasonality that's helping you at least from a quarterly margin perspective? And if not, then is this the right run rate because if you think about this long SKU tails which you're continuing to rationalize, are these type of opportunities or opportunities of this magnitude available to you as we look to 2020 as well?

So with regard to the seasonality part of the question, we're not really impacted at all by Easter, but we do have some seasonality for soup and tea and brands that are stronger over the winter months. Tea is one of our higher margin businesses. So as we get into the summer months, tea will be a smaller percentage of our mix, which will impact our overall margins a little bit. So there -- may be slightly inflated because of seasonality, but we're very proud of the run rate and the improvements that we've made. And there is still significant runway to be made. With the middle of the P&L and supply chain, we're just getting started on making some of the changes that need to happen. You remember, as we get into next year, we're going to overlap the mixing center debacle that we had early in the year that cost us significant money in F ‘19. We're also going to do SKU rationalization, as I mentioned, and restructuring which is going to free up some money in the P&L. So there is runway ahead of us. There's a lot of hard work, but there is definitely more to come over time. So we're pleased with the progress we've made, but we think you'll continue to see that sequentially as we move into F ‘20 .

The next question comes from Rob Dickerson with Deutsche Bank.

Mark -- hey, how are you? Mark, at your Investor Day, you pointed to the distribution expansion potential, right, on a number of your get bigger brands, right? It's all about increasing ACV and maybe, as an example, taking something like Greek Gods from the West Coast to the East Coast. So I'm just curious maybe it'd be helpful to provide just some color around conversations you've had over the past couple of months so far regarding such distribution opportunity on those get bigger brands because I feel like especially today, but you -- so you said on the call well, you come in a little, maybe at the lower end of that guide this year, that should be taken negatively given you're just really just rationalizing SKUs and improving the profitability piece, but also, let's make sure we kind of give you a fair up so to speak in being able to speak about the potential and the probability that those get bigger brands actually can expand distribution as you get through next year or '21, what have you. Thanks.

Yes. Great question and I appreciate the opportunity. There were three primary drivers to how we're going to increase the sales of the get bigger brands. One is around distribution expansion of those core high margin, high velocity items. The other two were around marketing and innovation. And the innovation obviously would take a little bit more time because you got to build the pipeline and commercialize the new items and then wait for the category resets. The marketing, we'll start to see taking place in F ‘20. But with regard to the question on distribution, we have started to have those conversations with retailers and they are very receptive. We've had some pretty big wins in a number of customers that are coming when their categories reset. So I do expect we're going to start to see momentum on those get bigger brands from a distribution standpoint. And the other thing I would tell you is, to date we have not been willing to spend slotting dollars to make those distribution points materialize because we're late in the fiscal year and we didn't want to take the expense in the short run. So we're having the conversation. And then as we get into F ‘20 and build our plan, we will build in the slotting dollars needed for some of the retailers who just won't take it unless you're willing to write a check to get the space. So the interest is high, the conversations are positive. We have some very good signs of progress in non-slotted customers who have said, yeah, absolutely I see what you're talking about, we only have these top items in 20% of our ACV, or we don't have them at all or they're authorized, but they're not in the stores, they'll get you retail force to cut them in. We're making that kind of progress and we will start to see that momentum turn as we move into F ‘20.

And then just with respect to kind of the executive bench so to speak, we've seen in the quarter, over the past month or so, we've seen you announce hiring new Head of R&D, Supply Chain. I think today you called out the North American marketing as well. How do you feel at this point just with respect to additional hires going forward? Do you feel like the bench at this point is fairly built out or are there holes that you still expect to fill?

So I'm very pleased with the team that we've built. To make six major hires in six months on my direct staff, I feel great about. They all bring different skills and different backgrounds and the good news is that several of them, I've worked with previously. So we can hit the ground running versus the time to take to fill each other out. That said, we are building new capabilities as we go through this organizational restructuring. So we were over-staffed in some areas and we had significant gaps in capability in other areas. So as we go through this restructuring, we do plan on hiring expertise in some of the areas that I talked about. Pricing would be a good example; project management, the complex linkage between functions and -- on complex projects is just not a strength of this company. We're stronger in functional silos than we are cross-functionally. So having somebody lead those efforts, as an example, will be important. They won't all necessarily be people that are going to be on my leadership team, but they will be senior leaders in the company who will make a big difference in terms of us changing the outcome of the organization. So you won't hear necessarily as much news as you've seen in the last six months on my team, but you will see other people joining who bring skills and capabilities that we don't currently have.

Okay, great. And then very quickly, just on HPP, selling price just seemed to be OK all things considered, but obviously go-forward guidance didn't factor anything on the HPP side. You get $80 million cash inflow at least pre-tax. I'm just curious given kind of prior CFO and CapEx guidance for ' 19, and now with a little bit extra cash coming in, it sounds like there is a tremendous amount of cash. Is it fair to say that that cash will just probably sit there for increased financial flexibility or should we actually expect to see some accelerated deleverage?

The plan would be to use that to pay down debt to delever the balance sheet. That was the plan with the $80 million cash.

The next question comes from Alexia Howard with Bernstein.

Okay. So two quick ones from me. Firstly, the mixed incentive problem that obviously you've really had earlier in the year, I think one of the issues was that you needed to actually negotiate with the retailers to get pricing increase to cover the incremental freight costs that you were taking on. How easy was it to -- or has it been easy and have you succeeded in getting the price point passed on to the retailers? That's my first question. And then the second one is really around when does the SKU rationalization really complete? Because obviously on a year-on-year basis, the impact will be felt for another year beyond that. So I'm just wondering whether you have a hard stop for when that process will be finished. Thank you and I'll pass it on.

So, on the first question, there is -- I would say there is fairly significant activity going on around pricing. Just some of the basic tenets of how the industry operates, we don't have in our pricing models. Bracket pricing, robust pickup allowances et cetera are all being kind of analyzed for continued evaluation. That said, we were able to go back to retailers to explain that we were driving more miles and they were driving less miles and that we were going to need to pass on some of those costs, and we've done that. But there is more work to be done around pricing and that is one of the key priorities for next year that we will some time likely in the second quarter have a robust rethinking of our pricing structure across our enterprise and have a number of conversations with retailers around that. It's just -- it needs more structure than it has today and we are leaving money on the table and so we're working through that as we speak. With regard to the SKU rationalization, one of the things I would point out, which I've said on previous calls, for many years, we were focused on growth. And so the last SKU rationalization exercise was really not about addressing low profit SKUs. It was about addressing low growth SKUs. And so we've eliminated a bunch of SKUs that were a drag on growth, but some of those were profitable. So we actually took some profit out of the business on the last SKU rationalization. It improved margins, they were lower margin businesses, but they were profitable businesses and so part of the earnings drag this year is the fact that we eliminated profitable SKUs. The new SKU rationalization is exclusively focused on profit. We are taking out SKUs that don't make money and so 90% of the SKUs that lose money will be either addressed through SKU rationalization or pricing, and I'm giving both options because, in some cases, these may be important to retailers and we're going to give them the option of either have to take a -- make it up a 20% price increase, a significant price increase or we are going to discontinue the item and let them decide. If they want to take a 20% price increase, we may choose not to discontinue something because now it's a very profitable SKU. So that work is under way. We're in the final throes of figuring all of that out and there will be some restructuring cost that comes with both the org redesign and the SKU rationalization. We'll come back before the end of this quarter with an announcement on exactly what that looks like, but our hope is that because we're addressing a different issue, that this is going to be much more accretive to the P&L. Going forward, after we get through this next SKU rationalization, my hope would be that our innovation can replace low-margin SKUs going forward and that we don't have to do a SKU rationalization every year, but -- so our expectation would be that we're taking care of the vast majority of the problem in the upcoming rationalization.

The next question comes from Anthony Vendetti with Maxim Group.

Thanks. Just a quick question on the restatement of prior results in revenue. What was the -- what was driving that, for like 3Q, fiscal 3Q ‘18?

That wasn't a restatement. That would just be the HPP coming out of continuing operations and going into discontinued operations.

Okay. Great, great. And then if you could talk a little bit about the Whole Foods, Amazon relationship, I know they're two separate relationships, but can you talk a little bit about, Mark, how that's proceeding as Amazon continues to make changes at Whole Foods?

Yes, absolutely. So both of those are important partners and meaningful parts of our business. Amazon is bringing interesting dynamics to Whole Foods in terms of assortment management, in terms of really looking at their portfolio differently than they have historically. And the good news is we are -- we believe we are the biggest supplier to Whole Foods. So we have a very strong partnering relationship with them. And as we are looking at SKU rationalization and as they are looking at assortment optimization, it is a perfect opportunity for us to sit together and say, let's compare our lists, are we both thinking about the same SKUs or different SKUs. We actually had a very robust discussion with them in March on this very subject. And we're pretty much in lockstep in terms of what they think they need to do and what we think we need to do, which is terrific. It also gives us the opportunity to do the -- put those high velocity, high-margin SKUs into all their stores where they may not be. So our relationship with them is very strong. I think they are becoming more sophisticated in terms of how they manage their inventories and their assortment, and because we're such an important supplier to both of them, we have a very prominent seat at the table in all these decisions they're making and we are collaborating in terms of how we make it a win-win for both parties.

Okay, great. And then just a little more color on the SKU rationalization. It sounds like if that accelerates at a more rapid pace than you originally thought, that's why you'll be at the lower end of sales guidance. You've talked about at the Investor Day, this is a 12, 24-month process. You said the early innings. Are you still thinking it's a -- up to 24-month process, or based on the progress you've made so far, you could see that moving down to less than 24 months?

So, what I said on earnings day is the rate of progress is going to be largely driven by how fast we rationalize the tail. And we've got a lot of work left to do to rationalize the tail both through SKU rat or through divestitures or through closures or the like. So what I would tell you is we are making very good progress on the things that we control, whether that's pricing, whether that's assortment, SKU optimization, but there -- as I said on the earnings call earlier today, there are still some areas where we got a lot of work to do; forecasting, we don't have a robust S&OP process; pricing, I've made a couple of mentions of pricing; innovation, we're in the very early stages of rebuilding our innovation pipeline and commercializing. So some of the things that are important building blocks on this journey are going to take more time, but we are making very good progress on the things that we've started, probably faster progress than we would have anticipated, which is great, but I don't want to mislead anybody. There is a lot of heavy lifting left to do. And I don't want to comment on the timetable. We're going to go as fast as we possibly can. We're going to need some help from people outside the organization with regard to some of these brands. HPP is a good example. It took us a year to sell HPP. We wanted to sell it faster. So some of these things aren't totally in our control, but we're making good progress on the things that we do control.

The next question comes from Eric Larson with Buckingham Research Group.

Thank you, everyone. A couple of really quick questions. Now with the divestiture of HPP kind of behind you, are there any stranded costs here, or was that -- were you able to take care of that as you put that operation into discontinued ops?

There was -- the HPP was very stand-alone. So there was really no stranded costs when we divested it.

Okay. I figured that was the case. So the second question here is, can you give us an idea, as you -- we talk -- I think you talked a little bit about this, there was a Q&A question at your Investor Day, but as you eliminate SKUs, you can reduce significantly the complexity of your manufacturing operation, your co-packing complex et cetera. So as you rationalize SKUs, is there a relatively immediate impact on elimination of co-packers? Is it a one or a two quarter lag? Does it depend on the contracts with those? I mean, so how does the cost benefits, how does they accrue as you take these SKUs out?

So, back at Investor Day, we said that our objective or our goal anyway over time is to cut the number of co-mans in half from 130 to call it 50 to 60. This coming SKU rationalization will take out about 20 to 25, and to your question, we -- for those that we are not contractually obligated to do something else, we will just immediately stop manufacturing with them. Now we have to be cognizant of raw materials that we're sitting on, we have to be cognizant of customer reset timing because the category may not reset till next March, and so we may have to produce a little bit more. So it's really going to depend by what they make and what contract we have with them, but there is nothing keeping us from getting out of these 25 co-mans over time. The other thing that I would also mention, which is important to this journey, is the benefit of the SKU rationalization. You'll only see part of the benefit next year because, again, category resets happen throughout the year. So just because we are announcing that we are going to discontinue a SKU, it may not -- we may not stop selling it for seven, eight, nine, 10 months from now, depending, again, on when the customers reset the category. So the full impact of the SKU rationalization will be felt in F ‘21. We'll get a partial impact, things that -- where the categories reset in the first quarter will get much of the full impact. Things that reset later will get less of the full impact. So you'll see some -- and that's why we keep talking about gradual improvements in our performance. That's a good example of why some of this happens gradually and it's not just a light switch where you make a change and you instantaneously see the benefit. But over the course of the year, we will see a gradual decrease in sales as those things exit and a gradual increase in margins as those are all low-margin or money-losing SKUs.

The next question comes from Bill Chappell with SunTrust.

Just kind of going back to those maybe competitive, but also the retail response to the SKU rationalization and just trying to understand when you go to a retailer and say, I'd like to remove 25% of the SKUs, sometimes they say why don't you take the other 25% with you. And so is that coming into play? Do you have enough of innovation to kind of fill that spot right now, or is it going to result in kind of near-term share losses or maybe greater share losses than just the SKU rationalization before things kind of pick back up? I'm just trying to understand both what you're seeing right now and then kind of the cadence of how it builds back over the next few quarters.

So we have only -- we're still finalizing the SKU rationalization list. So we've really only had the conversation with the biggest retailers so that they know what's coming beforehand. So I can't fully answer what the impact of the conversations will be when we have it with everyone. We have to finalize the list and then we will go out with that list. But our intent is to replace those SKUs with those higher-velocity, higher-margin SKUs. So we have 200 core ones that we talked about, but even within a brand, pick any brand you want, there are high-margin SKUs and low-margin SKUs. There is high-velocity SKUs and low-velocity SKUs. So our intent would be to replace the SKUs with better SKUs in our portfolio. That said, the retailer has a say, and as I said before on the get better brands, we still have a disproportionate amount of SKUs that sit in the bottom quartile. So in some cases, we will be a net loser of space because we don't justify the space that we have. When -- on brands where we are less than 25% of our SKUs sitting in the bottom quartile, we do justify the space we have. So if we have a couple of SKUs that aren't productive, we ought to be able to replace them with higher-margin SKUs as our -- we have enough SKUs in the portfolio that are performing in the top three quartiles. So, we do have a plan on how to replace them. Where we have innovation, we will certainly look to put in, in that innovation. We talked at Investor Day about some of the innovation we have. We will definitely look to put our innovation in where appropriate. And my expectation at the end of the day, particularly on the get better brands, is there will be some reduction in distribution because of the amount of SKUs in the bottom quartile. But remember again, these are money-losing SKUs. So it's addition by subtraction in terms of our P&L and it eliminates a lot of complexity. So the financial benefit should be good regardless, but hopefully we can replace as much of that as possible with better turning SKUs.

Got it. And then just particularly on baby, where does that category stand in the U.S. with all the changes in, moving in, moving out? I mean, do you feel like post the spring reset, your -- it's a more stable place or is that still kind of -- I know that's where there's probably the most competition of some of your categories with everybody coming in with an organic product and buying for shelf space and pricing. So just trying to understand where that stands.

Yes. So our baby business is pretty stable, but you'll remember at Investor Day that we said that it is a very low-margin business for us. So we are -- part of our SKU rationalization is going to be to shrink the size of the baby business and get out of some of the uneconomic skews. In third quarter, we had 6% pricing that we took on our baby portfolio, and so we are already starting to dramatically change the financial performance of that business, but I do expect that business will get smaller, not because of what competition is doing, because of what we're doing to improve the margins and try and move that into our get bigger bucket with brands that we want to invest in. It's just, we've got to get significant margin expansion to be able to do that. So it's really not -- it's not a competitive issue. It's the strategic intent on our part to transform the economics of that business.

Thank you. The next question will come from Steve Strycula with UBS.

So, two-part question, and congratulations on your sequential profit improvement. One point of clarification, you mentioned Brexit, I think one or two times on the call. Just so I'm clear, how do I think about what happened in Q1, a lot of CPG companies sold in product in Q1 ahead of the March 29th deadline. Is there anything that we should be mindful of between Q1 and Q2 or are they pretty even? That's my first question.

So, I'll turn it over to you in a sec, James. I would just say, one, we've built inventory because we weren't sure if there was going to be hard Brexit at the end of the quarter and we want to make sure that there was no supply disruption. So part of the impact on cash flow and the cash conversion cycle is we did intentionally increase inventory, but we did not push inventory into retailers. So in fact, what we're finding is retailers are getting more conservative as we go -- as they're struggling with the uncertainties of Brexit, they're reluctant to do anything transformational at this point because they're not sure which way things are going to go. So the good news is you have inventory there, we're set for a while. The good news also is that Brexit got kicked down the road away. So it will be business as usual in the short term, but we don't expect any significant kind of flow of sales between one quarter and the other. You'll actually see inventory probably starting to come down in the second quarter as we worked out some of that inventory that we've built up for.

Okay. And then I appreciate that there is a lot of moving pieces that are happening now as you go through the SKU rationalization and shift to profitability focus, all good things, but we just came out of a planogram cycle or at least some significant planograms were determined for some large retailers. How does this shape how investors should think about the US trends which people monitor pretty closely? Nielsen, as we think forward over the next few quarters, since we're supposed to be focusing more on EBITDA than necessarily total gross sales. That'd be question one. And then the follow-up before I wrap up would be, Mark, do you still think that EBITDA dollars should kind of grow next year? I think that's what you said directionally at the Analyst Day. Thank you.

So, the answer to the second question first is EBITDA dollars will grow next year. We are confident in that fact. With regard to category resets and retailers, we are having robust discussions with them on pricing, on SKU rationalization, on innovation et cetera, and because we are such a big player in health and wellness, we are very important to each other. The good news about Hain and one of the questions that I've gotten asked many times is, is our portfolio advantaged or disadvantaged. I think we are well advantaged because of the breadth of offerings that we have. If you're a retailer and you want to be a player in health and wellness, we're the first guys you're going to call because we're in 37 different categories, I believe. And so, there is not a lot of win-lose conversations. It's really about how do we win together. We've had very senior top to tops, which is the other thing that we're doing differently. We're managing the portfolio as a portfolio and taking a lot of conversations above the buyer level to have more strategic conversations with senior management around, you want to be a winner in health and wellness, we want to be a winner, how do we work together to do that. So I'm optimistic that our relationships are strong as they've ever been, that our interests are aligned, and that retailers see the value of our portfolio and that over time as we get through all this uneconomic activity and the things that we've talked about that you're going to see a very robust business at the end of the day.

This concludes the question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Great. Thank you all. I appreciate your time. And we're available over the next couple of days to answer questions as you have them. So, I appreciate it. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating. And have a pleasant day.