The Hain Celestial Group, Inc. (HAIN) Earnings Call Transcript & Summary

Thanks for joining us today, everyone. It's our pleasure to have Mark Schiller, CEO from Hain; and Javier Idrovo, CFO, with us today. I love to hear more about the Hain story. I'll go through with some questions. But Mark, would you like to kick us off with some introductory remarks?

Yes, absolutely. So thank you, Michael, and thanks, everybody, for tuning in today. I hope everybody is safe and healthy during these turbulent times, and I wish you all well. Let me give you a quick summary of what we've been doing and how we're preparing for the future. Just at 30,000 feet after a number of turbulent years at Hain, I came in as CEO about 18 months ago with the mandate of really turning around the performance of the U.S. business. What I inherited was a very complex company that was more of a holding company than an operating company and really needed to make a transformation into being an operating company. We had more than 50 brands in the U.S. in 37 categories, 130 co-manufacturers, 5 sales forces, multiple ERP systems. We shipped product from 40 different locations. We were drowning in complexity. And so I focused on a couple of things. One, make sure I got the right team in place, and second, lay out a strategy to restore profitable growth. And that strategy really involved 4 key pillars: simplifying the business, building capability, controlling our costs and taking a core set of brands that had the most potential and turning them into growth businesses. What you saw in the Q3 results that we just announced, that was really the end of the first year of the journey on this strategy and we're now beginning year. Year 1 was really focused on the simplification and the capability building and cost control, and year 2 is now pivoting back toward growth for the first time. And in those Q3 results, what you saw is top line growth for the company and the first top line growth in North America since fiscal 2018. Those growth brands that I talked about, which we call the Get Bigger brands and we're managing them for profitable growth, they were up double-digit in the quarter. Our gross margins as a company were up about 300 basis points. Our EBITDA margin was up a couple of 100 basis points. And the brands that we are managing for profit in North America, which had a 0 EBITDA margin a year ago, delivered an 11% EBITDA margin in the quarter and we made more earnings in that 1 quarter on those brands than we did the entire year combined. So a lot of good things have happened in that first year. We're right at the point, the inflection point, where we're turning the business back toward growth, and the strategy has worked really well. Then, of course, COVID-19 comes into play at the very end of the last quarter for us, and it has certainly impacted our business. We've had some positives and some negatives, but a lot more positives in terms of more eating at home meal occasions, which has brought a lot more people into our franchises. We were very well-prepared for the pandemic and have been able to service the business well, which has allowed us to be opportunistic and very forward-thinking versus spending all of our energy in terms of how to get product out the door and keep the shelves full. And we've done a really solid job of keeping employees safe and informed throughout this. In the fourth quarter, where we've got 2 of the 3 months completed, we're on track to deliver the guidance that we gave with continued margin expansion and profit expansion and growth on those get bigger brands. I think in international, you'll see a little bit of a top line decline because we have a big food service business in the U.K. But in general, the strategy is working. We're on the right path, we've got the right team, and we believe we're very well set up for the future. So with that, why don't I turn it back to you, Michael.

That sounds great. So you obviously have seen quite a surge in demand recently with the greater food-at-home consumption, but also have had the improving underlying trends and really think that's an important piece of the focus for more sustainability. Can you touch on what some of the key drivers have been that have been feeding that improvement?

Yes. So a lot of the simplification that I talked about has taken a lot of cost out of the system. When you go from 5 sales forces to 1, when you go from shipping product from 40 locations down to 3. We're using the assets we have more efficiently, and it allows us to take a lot of headcount out and be a much more efficient organization, number one. Number two, the middle of the P&L, if you will, needed a lot of work. We were having problems servicing the business, and we put the right foundational elements in place to deliver product on time to our customers and reduce the fines that we were getting, to reduce the amount of old-age product that we were throwing out because we're forecasting better and doing a better job of filling up trucks, which you couldn't do when you were shipping from 40 different locations, with everything in the same [Technical Difficulty], I can now fill up a truck and much better leverage, the fixed costs in each one of those trips. So it's a combination of a lot of things, focus, prioritization, simplification has led to significant improvement in the middle of the P&L. And I would add, SKU rationalization and the elimination of uneconomic spending has also helped us, considerably the margin business.

And just on managing this unexpected and unprecedented surge in demand. How have you been able to handle that on the supply chain side? And I would assume obviously some of the simplifications, made it an easier task. But how were you prepared for that? And what have been some of the biggest challenges? And what have the results been that you've seen so far?

Yes. The good news being a global company and having a significant part of our business in Europe, they saw this coming before we did. So we were able to learn from them in terms of what was coming and how to prepare for it. So before we ever really declared this a pandemic in the middle of March, we were building inventory. We were looking for backup sources of supply. We had been making sure that we were putting procedures in place to ensure that the employees would come to work and be safe. And so when it really hit, we were very well-prepared. I'd say the first -- about 6 weeks of this, our service was impeccable. And as the surge continued obviously the replenishment of those materials became more of a challenge because you've got -- in some cases, you're ordering materials from the far east or places that are far away. So I'd say our service slipped a little bit [Audio Gap] But now we are back to having materials for everything and replenishing our businesses and have done a really good job. The other important part of that question is employee safety because you've read in the paper about lots of businesses that had to shut down, that had massive breakouts of the virus. We've been pretty lucky so far. We've been very conservative. We've exceeded all the government guidelines and done a really good job of keeping employees safe, which is critical to getting product out the door.

Absolutely. And what is the working capital impact been? And as we come into the final tail stretch of fiscal fourth quarter, what should we expect there?

Yes. So we are adding inventory at this point to make sure that we've got plenty of materials on hand, which will have some impact on working capital. But the rest of our working capital formula is about the same. The amount of capital that we're spending hasn't changed, our payables and receivables are pretty consistent where they were. I think our biggest change has been. We've worked down a lot of inventory during the surge period, and we're working that inventory back up. But Javier, I don't know if there's something you want to add there?

Yes. No, I would say that we have -- from a cash conversion cycle in the third quarter, we had a good quarter. Obviously that was driven by a lot of that inventory depletion that took place. But we went below the target that we had set out for ourselves. We want it to be at around 60 days in terms of the cash conversion cycle. We went down to 53 or so. So there will be some buildup, but still the target is 60 days or so.

Okay. Great. Back to the consumer and some of the more top line side of it. We've done some consumer survey work. There's about -- over 70% of the consumers we survey keep saying they plan to be cooking more at home and by an average of over 4 meals per week. When you look at your planning for the first -- your first fiscal half of '21 and that second calendar half of this year, how do you think about that? And what's your approach in terms of how you try to make projections ahead?

Yes. So we were in the last quarter of our fiscal year. So we're still finalizing our fiscal '21 plan that starts in July. But as you said, I think a lot of this is dependent on eating occasions at home versus eating occasions out-of-home and the consumer wallet, right? So if depending on the depth of the recession and the length of the recession as well as the number of eating occasions in or out-of-home, that's going to be, I think the 2 most critical factors in terms of how this all [Technical Difficulty] industry. Obviously by category, some categories are benefiting more than others and some categories are not faring as well. We have a big Sun Care business as an example. And when everybody was cocooning in their house, we weren't selling a lot of sunscreen. But we have other businesses like tea, where people drink tea when they're sick, they drink it for immunity, they drink it to calm themselves at the end of the day. That category has done exceptionally well. So there is differences by category. I think some of the behaviors that we've seen during the virus will continue. To your point, I think there will be more cooking at home. We think there will be more washing of the hands and concern about sanitation. So those businesses will do well. We think, tea, given the calming properties and the immunity properties, will do well. So we're really looking at it category-by-category and doing some modeling around some of the variables that I just talked about and how it's impacted the category so far and what it might look like going forward. We would expect in F'21, which starts in July, there will be -- it won't be where it is now, but there will still be more in-home eating occasions than there were pre-COVID. And you just start to do some modeling around that, make sure you've got enough contingencies built into your plan in case you were too aggressive or too conservative in your forecast.

Sounds good. One thing we've also seen spike up was, of course, e-commerce and online sales. What have you -- how has your business evolved there? And what have you done to drive both growth and profitability?

Yes. So e-commerce has always been a very significant part of our business. Amazon is one of our 5 biggest customers as an example. And we were probably growing 30% to 40% before the pandemic, and it's double that during the pandemic. So this is a very important part of our business. It has always skewed well toward millennials, toward health and wellness products so we're well-positioned. We spent a lot of time this year working on margins. We've improved our margins in e-commerce by 1,000 basis points this year, which is a huge number. So we are one of the few, I think that have cracked the code on how to make money in this channel, whereas for everyone else, it's a lot of volume, but it's not necessarily profitable volume. In our case, we're in a really good place. And we've done a lot of marketing in that channel. We understand what it takes to win there. You got to be on the front page or [indiscernible] the healthy snacking. If you're on Page 19, nobody's ever going to see you, right? So what have you got to do to be front and center? What do you have to do to create trial opportunities for your products? And now that we've seen the emergence of clicks and bricks, where people are ordering online and either going to pick it up at the store or having it delivered, there's a lot of promotional opportunities in there before they check out to say, would you like some Celestial tea, and to educate them a little bit about the products. So we're doing a lot of marketing there. We've done a lot to simplify the business and make sure that we have the right SKUs that make money for us, and some of our items are huge online. Our sensible portions, Veggie Straws, is one of the top 80 of food SKUs in the entire industry on Amazon, as an example. So we're well-positioned there for growth, and we like our odds there.

Sounds great. You touched on this at the beginning, some of the complexity that you inherited and how that's evolved. And intuitively, it's pretty clear that just that simplification and efficiency is very valuable and a margin driver. How much more upside can you find there? What's some of the key levers? And then how should we be thinking about the margin outlook ahead from here?

Yes. So at 30,000 feet, what I would tell you is the industry average is about a 35% gross margin, and we're still in the mid-to-high 20s. And our EBITDA margins are in the, call it, 10% to 12% range, 13% range, where others are in the high teens range. So we are still not -- what I would characterize as a world-class operating company. But we now have the foundation in place to continuously improve on the things that we started. There is still significant opportunity in the middle of the P&L. We have customer mix opportunity, we have brand mix opportunity. We are just at the point now where we are filling up trucks for the first time and taking a lot of trucks off the road, which will dramatically improve our D&W costs. We are rightsizing our infrastructure as we've been shedding brands and selling them off. We are reducing our infrastructure to go with it. And so we think we still have plenty of runway. I'd call us in the fourth or fifth inning of the baseball game in terms of [Technical Difficulty] you should be expecting that we will continue to expand margins next year.

That sounds great. And then on a little more near-term focus, can you help us understand some of the moving parts around the margin benefits and headwinds from the coronavirus surge, both obviously some of the operating leverage, but also some of the safety protocol costs and how do those net out? And maybe specifically, a little bit of sense -- we know your 4Q guidance and -- obviously captures that. But what, if any, spills into next year, we should bear in mind as well?

Yes. So again, we're still finalizing that plan for next year so I don't have a aligned number with the Board yet. So I'm not going to talk too much about what we're building into next year's plan. But what I would tell you is, so on the benefit side, first of all, volume cures a lot of problems in this industry because you fill up your plant, you get massive absorption benefits, none of which, by the way, we're seeing in Q3. They don't hit the P&L until you sell the product. So the stuff we were selling at the end of Q3 was product we made before the virus. So you will see that absorption benefit starting in Q4. We've certainly seen less fines, customers kind of stopped finding you for less than perfect service because everybody was just struggling to keep people in stock. We've seen less old age obsolescence because we've sold through anything that was aging because of the demand surge. And so there's been some very material benefits on the positive side. On the negative side, prices pay certainly was a cost. We have had to do expedited freight to get materials. We've had to create backup sources of supply. In case either a supplier goes down or one of our plants go down or in the case where you're not one of primary customers of a co-man, and they drop you down to the bottom of the list when the big guys that they service are asking for more and more product, we found some supply challenges on some of the smaller businesses. We had to go find alternate sources, those come at a premium. So there is definitely incremental costs as well that we've incurred. Certainly, sanitation and masks and all the employee safety measures, putting up plexiglass in the offices, you name it. There has been some cost. On the net-net, though, this has been a positive. The incremental volume and the margin flow-through on that volume has been very good. And we expect that, that will continue into the -- at least, the first half of our fiscal year. We'll see what happens if tomorrow, they come up with a vaccine and everybody just forgets what happened and it goes back to the old way. It may not continue at the same rate, but like I said, I think people are [Technical Difficulty] health and safety. They're a lot more conscious of their -- what they're eating. They're learning how to cook for the first time, and they're enjoying it. So I think there is going to be some long-term benefit from this regardless. And so you'll see that in our forecast. Certainly, in the first half of the year, we would expect some pretty robust growth before we have to overlap some of this in the second half.

Sounds good. A little bit related, your relationship with the retail trade certainly has evolved during all this. And it seems like you've had an ability to generally be keeping up with orders. And also have something like hand sanitizer that's obviously still small, but it feels like there's a goodwill twist there. How is your retail relationships evolved in all this? And what if anything does that mean for looking ahead as well?

Yes. Our relationships are getting better all the time. Prior to COVID, we were spending a lot more energy on forming strategic relationships than transactional relationships. We never really leveraged the size and scale of our portfolio to have senior-level conversations with customers and find win-win outcomes. Before, it would just be a, a retailer says, "I need you to drop the price", and we would just drop the price. Now it's, a, "I understand that you need a lower price here to be competitive, but I really need distribution over here. Can we work together to find a win-win?" And so that, combined with much better service on the business that was a very big problem when I first got here, has made us much more reliable partner to begin with. Then you take COVID and the fact that we've been able to service the business pretty well when others have struggled. The fact that we're bringing significant innovation at a time when others are cocooning and saying, "I'm just trying to get product out the door right now. I can't worry about that." And we brought something like sanitizer that people were craving, and we brought them to important strategic customers to say, "Look, we can help you here." All of those things set us up to be very successful going forward. And I'll give you an example on the sanitizer, while it is still a relatively small business. We were able to help Kroger, which is one of our -- one of the biggest customers in the United States get hand sanitizer. And in the 8 weeks that we've been in distribution there, we've sold more hand sanitizers than any other brand did in the last 52 weeks, in just an 8-week period of time. We [Technical Difficulty] $800,000 a week for our hand sanitizer at a very good margin. So opportunistic, cements our relationship with Kroger. It's also very profitable and very incremental for us. So our ability to be scrappy and nimble, which is our culture, is part of how we should navigate and win against the big guys who are going to be a little bit slower and more [Technical Difficulty]. A good example of kind of [Technical Difficulty] from idea to shipping in 4 weeks and created a whole new business that looks like it could be a very sizable business over time. And so proud of the team for doing that, but it's a good example of how you start to become a partner for a retailer if you could help them solve their problems, and this was a good example of how we did it.

That's great. From the consumer side, you've also seen some new household penetration in tea and snacks. How do you ensure that that's sticky? And what are you doing to retain those consumers?

Yes. So the good news is, we had been increasing marketing on those Get Bigger brands before the pandemic. That was part of the strategy. Instead of spending a little bit of money on 50 brands, let's concentrate it on the ones that have the most potential. And so the good news is when we got to the pandemic and people started to stock up, we were already in the consideration set because of that marketing that we were doing. Now post, people have tried, they've come into the franchise, how do we keep them? Again, marketing, we're doing a lot of digital, social, mobile, marketing, very targeted marketing. We can look at shopper card data and see who the new buyers are and send them messages. We're putting repeat coupons in the product, so that if you came in and you tried Celestial Seasonings for the first time, you've got an incentive to come back and repeat, and trying to get very kind of customized in terms of how we find the individuals that are new and give them either the right incentives or the right messages to have them come back and buy more. So, so far, so good. I think, again, some of these categories like tea, where it's good for gut health, you drink it when you're sick, you drink it when you're stressed out, the fact that we've got the right products and the right messages. The other thing I would say is, we've adjusted our messaging during this period of time as well to be more in tune with what people are feeling. And again, I think our chances are pretty darn good that we're going to retain a lot of these people.

No. That's great. On those Get Bigger brands, you gave some context in benchmarks for margins just a bit ago. But even in this last quarter, it was already 14%, even with 120 basis points of extra spending. How do we think about the margin evolution on the Get Bigger piece of the total? And how much does it drive the overall company view?

Yes. So we said over time, we think we'll get into the 17%, 18% on those businesses. We have been adding marketing for a while. So -- and we've been pretty consistent. I think 5 of the last 6 quarters the margin, the EBITDA margin, was between 14% to 15%. So we're managing in that space while we continue to add marketing. I think at some point, by this time next year, we will say we have enough marketing. We're up to almost, I think, 6% marketing on those businesses where, when I started, it was like 2%. And with the exception of Personal Care, that's a little bit more of a fashion business and needs a little bit higher spending. We've got a pretty good spending level, overall. And so the savings we're getting in the middle of the P&L will start to flow into the bottom P&L as we get toward the end of next year and into F'22. So we're confident we can get there. Again, with extra volume comes extra absorption, that's part of the equation on how we expect to get the margins there. But once those businesses started growing again, we would see the margins improve. And I think you'll start to see that in the fourth quarter and beyond as long as we continue to grow these things.

Sounds great. We have about 1 minute. Maybe here's just the last one. As you've seen this obviously unexpected boost in earnings and cash flows, any thinking -- anything -- does it do anything to change your thinking on capital allocation, you've been opportunistic with buybacks? Is that something you might still consider? How should we think about that?

Yes. I mean the headline I would give you, and then I'll let you answer it, Javier, is we've got the right balance sheet and so buying down debt, we don't really need to do that right now. It really comes down to what do you need for the business, and well, what opportunities exist outside of the business. So we look at everything. We were opportunistic in buying back shares. We're looking at acquisition targets that would be strategic and either help bulk us up in a category or give us a brand or technology that we think we can leverage. So you will see us being opportunistic as cash flow improves in terms of how we utilize it, but it's all about generating shareholder value. Javier?

I would just say that from a debt leverage perspective, we want to stay below $4 million, $4.5 million, and so we're well below that number. And so we have the ability to flex. And so it depends on the opportunities that come our ways. But if we don't have any, like Mark said, returning money to shareholders is within the consideration set.

Excellent. This is great, guys. Thank you so much, and thank you for your time.

Thank you. Appreciate it.

Thank you.

Take care, all. Stay safe.