Hain Celestial Group Inc Q2 FY2021 Earnings Call

Greetings, and welcome to the Hain Celestial Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Anna Kate Heller of Investor Relations. Thank you. You may begin.

Thank you. Good morning, and thank you for joining us on Hain Celestial's Second Quarter Fiscal Year 2021 Earnings Conference Call. On the call today are Mark Schiller, President and Chief Executive Officer; and Javier Idrovo, 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 include expectations and assumptions regarding the company's future operations and financial performance, including expectations and assumptions related to the impact of the COVID-19 pandemic. 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, Quarterly Reports on Form 10-Q 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. The company has also prepared a few presentation slides and additional supplemental financial information which are posted on Hain Celestial's website under the Investor Relations heading. Please note, management's remarks today will focus on non-GAAP or adjusted financial measures. Reconciliations of GAAP to both to non-GAAP financial measures are available in the earnings release and a slide presentation accompanying this call. As a reminder, beginning in Q1 of fiscal year 2020, the company changed its segment reporting to focus on North America, International and Corporate, which had previously been reported as the US, UK and Rest of World segment. This call is being webcast and an archive of it will also be available on the website. I'd also like to note that we are conducting our call today from our respective remote locations. As such, there may be brief delays, crosstalks or other minor technical issues during this call. We thank you in advance for your patience and understanding. And now, I'd like to turn the call over to Mark Schiller.

Thank you, Anna Kate, and good morning. I hope everyone is safe and doing well in these turbulent times. On today's call, I'll give some color on our strong second quarter results and explain how we continue to position ourselves for sustainable profitable long-term growth. Let me start with the Q2 results. On our last earnings call, I stated for the second quarter, we expected continued mid single-digit top line growth after adjusting for divestitures and discontinued brands, several hundred basis points of margin improvement and adjusted EBITDA growth comparable to the 25% we delivered in the second half of fiscal 2020. I'm pleased to report that we have met or exceeded all of these projections and again delivered another very strong quarter. For the fourth straight quarter, sales growth was up over 5% in constant currency excluding divestitures and discontinued brands. For the sixth straight quarter, gross margin was up more than 200 basis points. And for the fourth straight quarter, adjusted EBITDA margin was also up more than 200 basis points. Adjusted EBITDA dollars was up 38% in the quarter versus last year, while investing 15% more dollars in marketing. That's the fifth straight quarter of double-digit adjusted EBITDA dollar growth. Both North America and International delivered strong sales, profit and margin expansion, further demonstrating that our strategy is working across the globe and we have considerable momentum. If we reflect back on the financial targets we laid out on Investor Day 2 years ago, we are already delivering at or near the three-year growth and margin targets, one year ahead of schedule, and we are doing it while increasing our marketing investment. When we started our transformation two years ago, we said that we would begin by showing immediate progress on margins with lower sales, as we eliminated unprofitable brands, SKUs and low ROI investments. The result would be a smaller, more profitable company that was ready to grow again. As you know, we have delivered and exceeded on those expectations. We also said that in order to restore sustainable profit growth, there were four things that we needed to focus on. First, we needed to be a more reliable supplier to our customers. This meant making it easier to do business with Hain, which we've done by simplifying our sales force and supply chain to deliver improved service. I'm pleased to report that our service levels have been strong for some time now and we've distinguished ourselves in this area throughout the pandemic. Second, we needed to provide the right sizes and price points to make our products more affordable and competitive by channel. We achieved this by doing things like downsizing and lowering the price on many offerings to be more competitive in the grocery channel, creating the right multipacks for e-commerce and the club consumer and creating trial sizes to get our snacks on the front end of the store near the cash register. Third, we needed to improve our marketing and focus our dollars on the Get Bigger brands, which have the most growth potential. To accomplish this, we've consolidated marketing partners, revamped all our campaigns, refocused our spending on the channels that show the most potential like e-commerce, and reallocated dollars from the Get Better brands to Get Bigger brands. And lastly, we needed to provide breakthrough innovation that would be margin accretive and attract incremental consumers and drive eating occasions for our brands and categories. We've done that with products like Sensible Portions, Screamin' Hot Veggie Straws that brought young males into healthier snacking. Celestial Seasonings Tea with new category benefits like energy, probiotics, melatonin, and gut health and new formats like K-Cups and trial packs. While this work is ongoing, the results so far have been terrific. Starting before the pandemic and continuing for the last year, we've seen strong sales growth across the Get Bigger portfolio and there are clear indications that those trends are accelerating. In the most recent quarter, the Get Bigger brands, which represent two-thirds of the sales in North America, grew more than 10% for the fourth straight quarter. We've gained market share again in snacks behind the continued strength of Sensible Portions, restored growth on Garden of Eatin' and stabilized performance on Terra. Recon Yogurt again grew double digits and gained significant market share, key health share and measured channels while growing almost 20% overall. And Personal Care continued its double-digit top-line growth with particular strength in unmeasured channels. In the most recent four weeks, the Get Bigger brands have shown strong momentum with volume growth and share gains accelerating. Household penetration and buying rate grew close to 10% in the second quarter. That's the third straight quarter of growth as we continue to see new households trying our Get Bigger brands and repeating at a high rate. ACV distribution on the core Get Bigger brands grew last quarter and average items per store grew by more than 10%. In fact, 11 of our 13 biggest brands in the U.S. gained distribution last quarter, demonstrating the breadth of strength across our portfolio. Shelf space gains are largely being driven by our innovation, which has delivered strong velocities and high incrementality to our categories. As customers begin resetting their shelves again starting with snacks and baby later this quarter, we expect to see our space continue to grow materially. Importantly we also have more innovation coming. We just launched Sensible Portions of Veggie Puffs, which are so far turning fast as our Veggie Straws and again highly incremental. We also have more tea, yogurt and personal care launches happening next quarter. So we expect to see TDP growth be a significant driver of growth as the pandemic wanes. From the investments needed to profitably drive the sustainable growth, we also needed to continue eliminating complexity and cost from the organization. That journey continues and there are quite a few sizable initiatives underway. First as you know, we've been optimizing our portfolio by exiting businesses and SKUs that have limited potential within Hain and add unnecessary complexity. Last quarter I told you we were in the process of selling our fruit business. And in early January, we were able to successfully complete that transaction. This $140 million food service-oriented business, which had been declining 25% to 35% during the pandemic, was very complex and delivered no profit. By selling it, we not only continue to simplify and focus our company, we also will see our go-forward company-wide gross margins expand by about 150 basis points and our EBITDA margins expand by roughly 100 basis points. In the last 20 months, we have now sold or shut down 17 non-strategic businesses, which had collective sales in excess of $900 million but less than $15 million of EBITDA. In doing so, we've generated $430 million in proceeds, which equates to about 30 times the EBITDA. We've used that money to reduce our debt to under two times and buy back some stock. Second, as we've discussed previously, we are currently executing our simplified pricing model, which encourages retailers to order in bigger quantities and fill up trucks. This will increase our capacity by freeing up dock doors in our DCs, reducing administrative work for Hain and our customers and reducing costs. In addition this will also improve our carbon footprint as consolidating orders means fewer trucks on the road. In Q2, we began implementation of this simplified pricing model and have seen some terrific results. The average order size increased by almost 50% and costs have come down materially. As we rolled this out to the rest of the customers in the current quarter, we expect to see continued material savings for both Hain and our customers. Third, in both North America and International, we built a robust productivity capability and process and have identified almost $150 million of additional cost savings initiatives that will bear fruit starting this year and continuing over the next several years. One of the biggest focus areas on the productivity list is optimizing our manufacturing footprint. In Q2, we made the decision to consolidate our Terra and Sensible Portions snack plants in North America, and expect that project to be completed before year-end. In doing so, we will be investing in significant automation further simplifying our operations and reducing costs. In the UK, we're also simplifying our manufacturing operations and have taken steps to consolidate our soup manufacturing locations, rightsizing our remaining facilities and repatriating some of our co-manufactured volumes to drive absorption and efficiency. While there are many more initiatives underway, hopefully these few examples give you confidence in our ability to drive continued margin expansion. We've built an accountable productivity capability and culture. We have the right team and tools. And importantly, we have a robust pipeline of projects to drive further improvement over the next several years. In summary, Q2 was another strong quarter for Hain and I'm very proud of the strong results the team has delivered in the quarter, and the profitable growth momentum of the business. Our transformation plan is clearly working, and we continue to believe, there is significant upside both in North America and our International business. With that, let me now turn it over to Javier, who will give you more color on our recent results.

Thank you, Mark, and good morning everyone. There are five key aspects of the second quarter financial information that I want to highlight in today's call, that demonstrate continued strong performance from the execution of our transformation plan. First, we delivered strong topline growth versus prior year for the fourth consecutive quarter, with adjusted revenue growth that was balanced across North America and International. Second, our growth was supported by significant continued margin expansion. Third, we're generating much stronger cash flows. Fourth, our balance sheet remains strong with excellent capital allocation flexibility. And finally, our business is well-positioned for continued success. So let's drill into each of these aspects, starting with the topline. Keep in mind; I will focus my discussion on our financial results from continuing operations. Second quarter consolidated net sales increased 4% year-over-year to $528 million, modestly above internal expectations. Foreign exchange benefited second quarter net sales by around 200 basis points, while divestitures and brand discontinuations reduced net sales by 360 basis points. After adjusting to exclude these factors, net sales increased close to 6% versus the prior year period, consistent with the previously provided guidance of mid-single-digit topline growth on an adjusted basis. As mentioned during our last call, we were anticipating some of the third quarter volume to move into the second quarter, particularly as retailers built inventory, largely in anticipation of potential disruptions from Brexit and the impending UK lockdown. This sales shift from Q3 to Q2 did materialize during the quarter. On profitability. For the second quarter, adjusted gross profit increased 20% versus the prior year period to $134 million. Currency impact on gross profit was a tailwind of about $2 million. Gross margin improved roughly 330 basis points, driven by a reduction in low trade ROI trade investments, our significant supply chain productivity initiatives, improved product mix from our SKU rationalization efforts and better overhead absorption in our plants. Distribution and warehousing costs as a percentage of sales improved versus the prior year period, due to the consolidation of shipping locations and improved utilization of trucks, contributing to improved gross margin despite higher freight costs in the US. SG&A came in at 16.2% of net sales, similar to the prior year period. The positive impacts to SG&A were driven by lower broker commissions, reduced headcount, as we consolidated our North American operations into one business unit and reduced travel. These improvements allowed us to increase marketing spending to support our North America Get Bigger brands and our UK Hain Daniels business. Our marketing support for the North America Get Bigger brands was close to 7% of net sales in Q2. Second quarter adjusted EBITDA increased to $62 million compared to $45 million in the prior year period, representing a 38% increase versus Q2 last year. Currency impact on adjusted EBITDA was a tailwind of $1.6 million. Adjusted EBITDA margin of close to 12% represented a significant improvement of about 290 basis points year-over-year, driven by gross margin improvements while increasing marketing spending. Our adjusted EPS of $0.34 was double the prior year period of $0.17. We benefited from an adjusted effective tax rate of 24% compared to 27.8% in the prior year period. The lower tax rate was mainly driven by the company's ability to claim deductions and foreign tax credits on foreign taxable income. Now to provide some detail on the individual reporting segments, where both regions contributed with strong adjusted top line growth, profit growth, and profit margin improvement. Starting with our North American business. On the top line, second quarter net sales increased 5.5% versus the prior year period after adjusting for currency movements, divestitures and brand discontinuations. Without these adjustments, net sales increased close to 1% year-over-year to $283 million. Foreign exchange impact on the quarter was a small tailwind of 20 basis points. From a profitability perspective, Q2 results were strong, as we delivered year-over-year adjusted gross margin and dollar expansion and adjusted EBITDA margin and dollar expansion. Specifically, our North America business expanded adjusted gross margin by close to 380 basis points, resulting in adjusted gross profit of $81 million, or an increase of 16% versus Q2 last year. This improvement was driven by a reduction from low ROI trade investments and lower supply chain costs as a result of our SKU rationalization effort, productivity initiatives and efficiencies in our supply chain system. Adjusted EBITDA increased to $40 million, a 31% increase. Currency impact on adjusted EBITDA was minimal. Adjusted EBITDA margin of 14% represented an improvement of about 330 basis points versus the prior year period, driven by gross margin improvement. Looking into the components of the North American portfolio. The Get Bigger brands, which represent two-thirds of the North American net sales delivered sustained strong net sales growth of about 11% versus the prior year period. That's the fourth straight quarter of double-digit top line growth. Notable brand growth call-outs include Celestial Teas, Sensible Portions, and Garden of Eatin' Snacks, Greek Gods and a number of our Personal Care brands. Adjusted EBITDA margins for the Get Bigger brands improved close to 100 basis points compared to Q2 last year, yielding a margin of 15%. We achieved this improvement in profitability, notwithstanding stronger investment in marketing activity to support innovation launches and core products as well as an increased investment in e-commerce. The Get Better brands, which I will remind you are being managed primarily for profit showed a net sales decrease versus the prior year period of about 3% after adjusting for currency movements, brand discontinuations and divestitures. The Get Better brands, consistent with our portfolio role continued to show very robust adjusted profit and margin improvement. Specifically, adjusted EBITDA grew by more than 70% with an improvement in EBITDA margin of more than 600 basis points, yielding a margin slightly north of 12%. This level of profitability is at the high end of our long-term target of 10% to 12% for the Get Better brands. Now let me shift to our International business, where performance for the quarter was a key contributor to the results of the total company. Net sales versus prior year increased close to 9% on a reported basis and north of 6% after adjusting for currency movement and divestitures. Foreign exchange increased sales by 430 basis points while divestitures reduced sales by 190 basis points. Net sales growth was driven by the strength of our non-dairy brands, such as Joya and Natumi in Europe, most of our Hain Daniels business, including our leading market share Linda McCartney and Hartley's brands in the UK, as well as our Ella's UK business. Our fruit business was a drag on growth due to its food service exposure. Net sales versus one year ago for our international segment excluding the food business increased by close to 14% in constant currency after adjusting for divestitures. To note, the international Q2 growth was helped by a volume shift from Q3 to Q2 driven by customers' inventory building, largely to avoid disruptions from Brexit. As previously communicated, we have successfully divested our food business as of mid-January. As a result, it will be adjusted out of our results for the balance of the fiscal year. Given the adoption of the North American playbook in our international business, adjusted gross margin in dollars and adjusted EBITDA margin in dollars were all up considerably in the quarter versus the prior year period. Adjusted gross margin improved by more than 300 basis points versus the prior year period, driven by a reduction in lower ROI trade investments and lower supply chain costs as a result of productivity initiatives and efficiencies in our supply chain system that were implemented in our Hain Daniels and Continental European businesses. Adjusted EBITDA grew by 28% versus the prior year period to $38 million, supported by an adjusted EBITDA margin improvement of close to 200 basis points, resulting in an EBITDA margin slightly higher than 13%, driven by higher adjusted gross margin. Excluding fruit, the remaining international business delivered an EBITDA margin of close to 16%, up 150 basis points versus year ago. This level of profitability for the international business excluding fruit is consistent with the long-term target of 15% to 17% announced two years ago. In Q2, due to the classification of our food business as an asset held for sale, and agree to final purchase price, the company recorded an additional non-cash impairment charge of about $24 million. Our UK food business had trailing 12-month net sales of about $138 million with about negative $4 million in adjusted EBITDA. Shifting to cash flow and balance sheet, Q2 operating cash flow improved by $43 million to $64 million, and operating free cash flow, defined as operating cash flow minus CapEx, was $46 million close to a $42 million improvement from the prior year period. These improvements resulted primarily from stronger earnings and better working capital management. At the end of Q2, our inventory was $312 million, $19 million higher than the levels at the end of September 2020. This was an intentional inventory deal to ensure high levels of customer service while avoiding supply disruptions due to COVID lockdowns and Brexit challenges. That said, we expect inventory levels to decrease throughout the second half of fiscal 2021. Our Q2 inventory and other working capital account usage resulted in a 55-day cash conversion cycle that was slightly higher than the prior quarter by one day, but below our target of 60 days due to improvements in accounts payable days. Cash on hand at the end of the quarter was $61 million including the cash in our food business while net debt stood at $234 million and gross debt leverage was only 1.5 times. Our balance sheet is the strongest it has been in years. And as a result, we have significant capital allocation flexibility. Given our healthy balance sheet, as well as our expectations to continue to generate strong free cash flow, we remain well positioned to both reinvest in the business and return value to shareholders. Consistent with our capital allocation principles and pursuant to the repurchase program authorized by the Board in 2017, during the quarter, we bought back $29.7 million of our shares at an average price of $32.15, leaving us with about $118 million of additional repurchases remaining under our 2017 program. Looking ahead, given our strong Q2 performance and confidence in managing the controllable aspects of the business, we are reaffirming our fiscal 2021 outlook that calls for gross margin and adjusted EBITDA margin expansion as well as strong double-digit adjusted EBITDA and operating free cash flow growth. As we move into the third quarter, we expect to continue to deliver strong gross margin and EBITDA margin improvement as well as adjusted EBITDA growth near 10%. As Mark mentioned, the business is performing exceptionally well and has tangible top line momentum. That said, the reported top line results for Q3 will be impacted by the following: the divestitures the company carried out including fruit; the Brexit volume pull forward that was mentioned earlier and discussed on the last earnings call; and the lapping of a Personal Care club program that we expected to occur later this calendar year. Excluding these factors, we expect top line strength that should be evident in the syndicated data. As part of the second half outlook, we have assumed the following: foreign exchange translation will continue to be a tailwind versus prior year, cost of goods inflation of around 2% which is been more than offset by our productivity initiatives; capital expenditures between 4% and 5% of net sales, an increase over prior year to drive multiple productivity projects and to carry out projects that weren't delayed from last year due to COVID-19; an adjusted effective tax rate between 24% and 25%. In summary, the momentum illustrated in the prior three quarters has continued into fiscal Q2. We exceeded expectations both on the top and bottom-line and we continue to believe that we are well-positioned to deliver continued strong earnings growth and margin expansion for the balance of the fiscal year.

As you can see we had another very strong quarter. While Javier just outlined some timing headwinds that will impact the topline in Q3, we expect continued improvement in our business fundamentals and anticipate continued robust margin and profit expansion. On behalf of the Board of Directors and management team, I want to thank the global team at Hain Celestial. Our number one priority is keeping employees safe and I'm proud of the way the team has done so while continuing to execute in this dynamic operating environment, especially given the robust surge in demand that we've seen. With that, let me turn the call over to the operator for questions.

Thank you. We will now be conducting a question-and-answer session. Our first questions come from the line of Ken Goldman with JPMorgan. Please proceed with your question.

Good morning everyone. I wanted to inquire about your gross margin guidance for the third quarter. You mentioned a strong improvement year-on-year. The market is expecting about a 150 basis point increase compared to the same period last year. While this would be the smallest rise in some time, it also follows a tough comparison. I would like to delve a bit deeper into this and ask if the 150 basis point improvement aligns with your rough estimates for the third quarter. Any quantitative insights you could provide would be appreciated.

Yes. Mark, if you would like to add your thoughts.

No, go ahead.

I think the expectation for the quarter will be higher on a gross margin basis.

Perfect. Regarding your follow-up, I believe you had previously projected 2% COGS inflation for the year, and today you mentioned maintaining that forecast for the latter half of the year. Several companies have mentioned rising freight costs, and there has been an increase in prices for corn, soybeans, and other raw materials. I understand your COGS portfolio is quite different from that of a traditional food company. I wanted to inquire if the 2% figure is relatively lower than others because you've secured many key items at fixed prices, or if your commodity prices, even on a spot basis, are simply not increasing as much as the industry overall. I'm trying to gauge if you anticipate a price spike in fiscal 2022 or something similar.

I'll take that Mark and then you can add some comment. Yes. So, we have five months left in the year. And so we have good visibility as to what we think our basket of different raw materials and the finished goods is going to be for the rest of the year. So, we feel pretty comfortable about that 2% number. You're absolutely right on the freight cost increases. We have seen double-digit inflation throughout the year and we expect that to continue through the second half of our fiscal year but that's embedded within our assumptions of that overall 2%. And then on your second point, yes, you're absolutely right. Our basket of ingredients is slightly different than the average CPG. So, we're not as impacted by some of the inflationary backdrop that you could say is impacting some of our competitors.

Okay. Thank you, Javier.

Our next questions come from the line of Alexia Howard with Bernstein. Please proceed with your question.

Good morning, everyone.

Good morning.

Good morning, Alexia.

Hi. So my first question is really around the numbers coming through better-than-expected relative to your guidance that you provided last quarter. So for example, on the EBITDA line I'm focusing on, you came in at 38% growth year-on-year versus the 25% you guided to last quarter. What surprised you in a positive way? And then as I think about the 10% you're guiding to for the third quarter, what are the puts and takes there? What could go better or perhaps worse than expected? And then I have a follow-up.

Yes, in Q2, our execution was very strong with both service and promotional activities. We anticipated a bit more price competition, which helped us capture a greater share of merchandising events, aimed at bringing more customers into the franchise. This was a positive outcome, and we are continuing to perform exceptionally well on our productivity initiatives. The projects we have are yielding the savings we expected and even more. In fact, in Q2, we faced a freight headwind that was larger than anticipated, yet we still achieved 38% EBITDA growth and covered those additional costs, highlighting our strong execution. Looking ahead to Q3, we are affected by the COVID overlap and the surge in March, which poses challenges. There are also timing issues related to international volume shifting from Q3 to Q2 due to Brexit preparations and delays in a personal care program in the club channel because of COVID, which has pushed back their merchandising efforts. These factors impact EBITDA as they are tied to associated revenue. Despite these timing adjustments and the surge overlap, there is significant momentum in the business, as reflected in the syndicated data. We are acquiring TDPs at a high rate, gaining market share, and attracting new households while maintaining a strong productivity agenda. We are confident that you will still see the 100 basis points of margin improvement we discussed in the last call, along with the double-digit EBITDA growth. Overall, we are optimistic about our ability to navigate through these challenges and hope to deliver another strong quarter with potential upside.

Great. And then as a quick follow-up. The number of brands that you've divested recently, how many have you left with? I think you started with 55. The last I heard you were down to 37. It sounds as though the core is really the 12th or 13th biggest, most strong brands across the portfolio. Where are you in that divestment process? And I'll pass it on.

Yes. So we continue to reshape the portfolio with the same criteria that we had on Investor Day. The things that we think have mainstream potential, that have leading market share, that are responsive to marketing and innovation those are brands that we're going to invest in for growth and we continue to do so. We've done a good job of shrinking the tail. But I would still tell you that outside of those 13 brands in North America, there are still more in the tail that we would for the right opportunity look at exiting. And we have a few in international as well. So I wouldn't say that we're finished. But importantly, I would also say we're now pivoting towards conversations around acquisitions and trying to bulk up in the categories that we prioritize. And in some cases like in Europe where we have a very strong non-dairy business and a very strong meat-free business, there's potential to acquire capacity so that we can continue to grow at the rate that we have been. So it's going to be more balanced going forward. You'll see some more divestitures, but hopefully you'll also see some acquisitions as we move through the next couple of years.

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

Hi, Mark and Javier.

Hey! Andrew.

Good morning.

First of all, Mark, it's clear that Hain has been making significant progress in terms of margins related to the company's long-term objectives. On the revenue side, there have been numerous variables to consider. If we evaluate the portfolio as it currently stands, excluding the announced divestitures and taking into account the next few quarters affected by factors like COVID comparisons, what growth rate do you believe the portfolio is currently achieving? Additionally, how does this compare to the long-term target of 5% to 7% for growth under the Get Bigger strategy, and the target of minus 5% to minus 10% for the Get Better strategy? I'm trying to understand, excluding all the various factors and year-over-year changes, where you see the portfolio positioned now and whether there is further potential for growth from its current state.

Yes. So if you look at the last three quarters, and you take out all the divestitures and all that noise, the entire portfolio including international has been growing mid-single digit, about 5%. The Get Bigger brands have been growing around 10%. International has been growing around 10%. The Get Better brands have been flat to slightly declining, although to your point the long-term guidance we gave was minus 5% to minus 10%, on those Get Better brands. So, the business has been performing in line with what the long-term guidance has been. Now the question of course is, how much of that is COVID? And how much of that is driven by, the things that we are creating? And the reason I'm bullish going forward is, because if you go back to Investor Day, our main thesis on the Get Bigger brands was always that they had mainstream potential. And that we were going to be able to drive distribution and trial, in the mainstream channels where we were very underdeveloped. We've got significant presence in the natural channel with many number one and number two share brands, but we were underdeveloped in the mainstream channels. And what you're starting to see right now in the data is, double-digit growth in terms of distribution points on those Get Bigger brands, three straight quarters of very significant household penetration growth, innovation that is working that's very incremental to the categories and we just need these categories to reset. And so as we start going through the calendar year 2021, and customers start resetting their shelves again, starting with snacks and baby food at the end of this quarter and into the beginning of April, you're going to see us pick up significant space. And that's the gift that keeps on giving. If you're bringing in things that are turning and that have earned their space, that's going to be very incremental in terms of our growth rate. So I think as COVID wanes, you'll see, the distribution gains and the incrementality of that space, bringing in new consumers that will offset any losses that we have, coming from the waning of the pandemic. So we feel pretty good about, where we are. We feel really good about, the momentum we have on the core business. And it's just a matter of us getting through the pandemic, and seeing where we are on the other side. But all the signs are very positive right now, in terms of momentum on the business.

Okay. Thank you for that. You mentioned that marketing as a percentage of sales for the Get Bigger brands is currently at 7%. Could you clarify what that percentage was when you first defined the Get Bigger segment? Do you believe 7% is an appropriate figure, or is there potential for it to increase sustainably?

Yes. So we were in the 2% to 3% range, when we started this journey. And we have been adding marketing for, I think, four or five straight quarters. And we also redeployed some of the marketing from the Get Better brands to Get Bigger brands. But we are around 7%. I think that's generally a good number, with the exception of Personal Care that tends to have a little bit higher spending levels. So we will look to increase in Personal Care, as we start to build that mainstream distribution that I just talked about. We're still very dominant in the natural channel, but not as penetrated in the grocery channel. And you don't see it in the syndicated data, the strength in that business that you see in the other ones, because it's largely a non-measured channel and natural channel business. So, as Personal Care starts to get that distribution and we're seeing it now although, in the last I think six weeks is up about 4% on distribution, as an example. And we have a lot of innovation coming. That will be the catalyst for us to increase the spending there, because we'll have enough of a footprint nationally to be able to make more meaningful investments there. But the rest of the business I think we're about where we need to be.

Great. Thank you so much.

Yes.

Thank you. Our next questions come from the line of David Palmer with Evercore ISI. Please proceed with your question.

Thank you, and congratulations on the progress made this year. Following up on those questions, I’d like to discuss your targets in more detail. With the challenges posed by COVID, it can sometimes be clearer to focus on longer-term goals rather than the more volatile quarterly comparisons. You mentioned that you are nearing the higher end of your targets for improved EBITDA margins. For the "Get Bigger" initiative, after accounting for marketing reinvestment and COVID-related expenses, you are in the mid-teens. I imagine that your Personal Care division has the potential for higher margins, although it may be impacted by COVID. Are you considering that reaching the upper end of the 13% to 16% EBITDA margin target for fiscal 2023 is quite achievable? I have a brief follow-up after that.

Yes. I think you're spot on. Right now, we are delivering at the mid-end of the three-year guidance at the end of year two. And we expect that we are going to continue to see margin expansion into F2022 and beyond. I mentioned in my comments that we have about $150 million worth of productivity initiatives in North America and International that we're working on that will more than offset inflationary costs and wage increases and other costs coming our way. Plus, we'll also have the unwinding of some of the costs related to COVID. The cost of keeping employees safe and quarantining them and the like. And so we expect that margins are going to continue to expand. And I would again remind you that we are at the low end of the industry in terms of where our margins are even with the 500 basis points of improvements that we've made. So there's more to go. We're not running out of ideas. And I think between the momentum that we're starting to see on the top line and the continued momentum in the middle of the P&L, I would expect that this is going to be a meaningful growth company going forward.

And just speaking more directly to the things the gives and takes with regard to margins as you lap this COVID period, I think post-vaccine and herd immunity. As we get into that zone, how do you think about the legacy of this year in terms of margin? And what I'm thinking about is you might have had some tailwinds some of your at-home products but you have some headwinds with some of perhaps the personal care your COVID-related costs. So I'm wondering, do you feel like you've maybe COVID has given you a boost this year in your margin targets? Or is it a net neutral? Thanks.

Yes. It's a great question because the direct costs are easy to calculate. The indirect costs that are hard. So for example, we have amazing innovation. And because customers haven't reset, we haven't gotten it in full distribution. That's a headwind that is clearly caused by COVID that I can't put a dollar value to. But look there are some tailwinds there. We do have some absorption that's come with higher volume. We do have some competitive opportunities that have materialized, because we've serviced our business better than others. And we've been promoting at times when others have not that have allowed us to get more merchandising and more consumers into our franchise. But at the same time, the headwinds are meaningful. And just even in this quarter, this Personal Care program that we mentioned that was very sizable last year, because of COVID it's not going to happen until later in the year because the customers are behind on their merchandising. So I think in Q3, it's definitely a headwind between the March surge, the timing on the Personal Care program and the pull forward of volume into Q2. COVID is definitely a headwind in Q3. I think it was probably a little bit of a tailwind in the first half, but not nearly as much as it was when the pandemic started March through June last year.

Thank you.

Thank you. Our next questions come from the line of Rob Dickerson with Jefferies. Please proceed with your question.

Great. Thank you so much.

Hi, Rob.

Hey, Mark. I wanted to discuss pricing. It seems like your cost inflation is better than others, but I've heard you mention before your plans to optimize pricing across different sizes, pack types, and channels. People still appear to be somewhat less price-sensitive during the pandemic. I think I heard you say today that there might be slightly less price competition than you expected a few months ago. Could you share your thoughts on the price competition in your categories? And do you see a need to increase list pricing, aside from the optimization and mix efforts? I have a follow-up as well. Thanks.

Yes. So on the list pricing, I think with the freight cost surge that everybody is seeing including us and some of the commodity inflation, we'll see whether others start taking list price increases or not. But we've been spending a lot of our time and energy again making these products ready for mainstream channels. And what I mean by that is, we've done a lot of downsizing a lot of trial sizes. And so when you look at the syndicated data you see that our prices are actually flat or down where others have been going up. That's all with intent. And it's all in the spirit of getting us the distribution and the trial and the channels that we think are going to be a big part of our growth going forward. We do have dry powder there. As I said when we built the plan, we put aside some money for pricing if needed because we don't want to be late to the party and miss out on all the opportunity if all of a sudden everybody starts dropping prices. But I think given the pressure that everyone is seeing on the cost side. I think the promotional environment is going to be a lot more subdued than it might be when you come into the overlap of the pandemic. There's cost increases that people are incurring at a higher rate than us. It's going to be hard for them to absorb those costs and drop their prices too. So I think if anything we'll see prices continue to go up and we will opportunistically look for ways to do that. But the good news is we have enough productivity to offset the vast majority of the cost increases that we're seeing anyway and that's why you see such robust margin expansion.

All right. Yes, that sounds great. I just want to quickly discuss cash flow allocation. Current leverage is obviously manageable. They recently sold some fruit and there are discussions around divestment opportunities. Bottom line, are you generating substantial free cash flow from the divestment? You're buying back a bit of stock, but not a lot. I heard you mention today that you might be starting to focus more on acquisitions, potentially more in Europe than in the US. So, as we consider future cash allocation, are you indicating that instead of possibly paying a dividend, you are focusing more on enhancing capacity and capability in some of the core brands that will remain after the divestments in Europe, without necessarily leaning more into yogurt in the US? That's it. Thanks.

Yes. So let me take a quick shot, and then I'll let Javier talk about our capital allocation. We continue to reshape the portfolio. You mentioned Earth's Best. What I would tell you is we're not going to comment on specific rumors and I wouldn't be distracted by them. If there's something that we are actively trying to sell we will tell you. We did with fruit. We did with HPP. The fact that there's some rumors swirling around things in our portfolio we get contacted all the time and there's interest and lots of things that we have. We would be more interested in selling off the tail outside of those core 13 brands that I mentioned. And as we generate more proceeds we have some optionality. And why not let Javier talk about how we've been deploying our capital and how we think about it going forward.

On the capital allocation front, we evaluate where the company can achieve the highest risk-adjusted returns among various options, including internal and external investments. External investments typically relate to mergers and acquisitions, and we also consider share repurchases and dividends. Share repurchases are assessed with the same perspective as our overall investments. We aim to allocate our capital to its most effective use. If we believe our share price is lower than its intrinsic value, we aim to purchase shares. Currently, this perspective guides our capital allocation. If we identify opportunities after assessing internal investments and M&A activities, and our shares are priced adequately, we might contemplate a one-time dividend, but I do not believe we are at that point. For the foreseeable future, particularly in the near term, I do not think we will consider a permanent dividend. These will be the options we evaluate moving forward.

And just one point I would add, Rob, to your comment on international acquisitions. We're looking at acquisitions in North America as well. So it's around bulking up in the categories that we think have the most growth potential and where we have a significant presence that would be the leadership brands here in North America, as well as the categories that I mentioned internally internationally.

All right. Great. Thanks so much. Appreciate it.

Thank you. Our next questions come from the line of Michael Lavery of Piper Sandler. Please proceed with your question.

Good morning. Thank you.

Good morning.

I wanted to just swing the pendulum back a little bit the other way from David's question to just the rest of the year, or even third quarter. And, obviously, you gave pretty specific color on EBITDA and gross margin. But just curious, thinking about the top line, how much should we expect maybe that to be up or not? Is it all driven by margin? I know you've got the tough comps and some of the Brexit pull forward. But just maybe some color on what you're thinking as you plan internally around where the top line lands?

The reported number will be negative primarily due to nearly 1,000 basis points of overlap from divestitures that need to be adjusted, reflecting businesses we no longer operate. Additionally, the Brexit and U.K. lockdown effects, combined with the timing of the club program, contribute another 500 to 700 basis points of downward pressure on revenue. This means we are looking at a total impact of 1,500 to 1,600 basis points before assessing the business performance against these timing and divestiture factors. It's important to note that we recently sold the fruit business for $140 million, which is a significant adjustment alongside previous sales over the past nine months. The top line will appear materially different when factoring in these timing-related elements. However, the underlying health of the business is improving, as evidenced by syndicated data. It’s essential not to be misled by these timing issues, as the actual data reflects the business's health. We are continuing to gain market share in categories like tea, snacks, and yogurt, and we've stabilized brands such as Garden of Eatin' and Terra, which had faced challenges. We've also seen significant growth in household penetration and TDP expansion. If we exclude these factors, the business remains very healthy, with strong growth observed in Europe. Nonetheless, the reported number will be negative, which is why we are highlighting this situation so that stakeholders can adjust their models accordingly.

No. That's helpful. I'm sorry, I meant to specify organic growth. You mentioned some of the underlying drivers. Would organic revenue growth, then, be at least around flat or perhaps slightly up?

Excluding the timing issues, it would be in the mid-single-digit range. For the last three quarters, we've been experiencing an organic growth rate of 5% to 6%. However, Brexit timing and the club program will reduce that by 500 to 700 basis points. As a result, it will be slightly negative to flat when adjusting for divestitures. Still, we expect to be back in the mid-single digits over time.

Okay, great. Really helpful. Just a quick follow-up. You mentioned some uncertainties that prevent you from providing more specific guidance. There are certainly the U.K. lockdowns and some mobility uncertainties that are not yet resolved. Is there anything else contributing to that? Have you resolved any absenteeism issues, or is that still an uncertainty? What are some key factors that would prevent you from being more specific about the outlook?

Brexit has been signed, but it was handled without transparency, leaving businesses to decipher the implications afterward. We're experiencing some delays at the border and an increase in paperwork, leading to manageable costs, though we are still navigating through these issues. Regarding COVID, its impact could swing either way, but currently, it’s more favorable in Europe due to strict lockdowns. Countries like Germany are unlikely to fully vaccinate their population until fall, suggesting that challenges will persist there. Freight costs are rising quickly, and obtaining goods from China is proving difficult due to port backlogs. Fortunately, we anticipated the lockdown and stocked up on packaging and raw materials from China, positioning ourselves well for the upcoming demand. However, if freight costs and delays continue, they could become obstacles. Many factors are beyond our control, but we are optimistic about the aspects we can influence, including execution, customer relationships, service, and innovation, all of which are positive and driving momentum. So far, we've managed to counterbalance some of the macro challenges that could hinder our progress. We remain hopeful, but there is still considerable volatility. The pace at which vaccines are rolled out and changes in consumer behavior remain uncertain, and clarity will come once we navigate through these issues. However, I anticipate some uncertainty will linger over the next six months.

Very helpful. Thank you very much.

Thank you. Our next questions come from the line of Bill Chappell with Truist Securities. Please proceed with your question.

Thanks. Good morning.

Good morning, Bill.

Good morning.

Good morning. I have two questions that are related. I'm trying to understand your expectations for category growth, rather than just focusing on the turnaround you're experiencing. I believe the conditions for this spring are more favorable than what you anticipated last July and August when you provided guidance. With more people working from home and schools still operating virtually, I think about the upcoming fall, which is your fiscal 2022. You might expect the categories to decline as we move back toward normalcy. Would you say that’s how you're viewing the situation? Are you considering this merely a postponement of the decline, or do you genuinely believe that the categories will continue to grow permanently after we get past the initial spike in growth?

Yes. So the first thing, I would tell you is, we look at subcategories within the category. So, for example, in snacks, we share ourselves against natural snacks not all snacks. We do that because that's where we have the highest interaction indices. And consumers who have made a decision to buy something organic are not as likely to buy something that's not organic as an example. So, if you go back pre-pandemic, the natural categories that we're in that cater toward health and wellness, we're growing mid single-digit, high single-digit in some cases. And given that this has been a health and wellness crisis, given that we think the return to normal behavior is going to be a long tail, because to your point, I'm not sure anybody is going back to the office five days a week. I think you will still have some level of working from home and other behavior changes that are going to not have this be a light switch where all of a sudden everybody is vaccinated and we just go back to the way it used to be. So I would expect that these categories will continue to be growth categories even overlapping what we've seen. Now it will be a little choppy as we get through the fourth quarter. We saw a 50% surge in tea in the fourth quarter last year. That will be difficult to overlap. But in general, I think, when you get to the back of this you're talking about categories that are going to grow because that's where the consumer is heading. You're talking about e-commerce that is going to be here to stay, which over indexes on healthy products. We're talking about consumer behavior changes both lifestyle changes as well as where they work and how they travel and all that that are going to lead to more in-home mealtime occasions and pre-pandemic. And so we feel like we're still in the right part of the market and that part of the market is going to grow in F2022. Again, it will be a little choppy as we get through the next six months but we expect that we'll be able to lap this and still see growth in the categories that we compete in.

I appreciate that. Regarding your market share gains, you mentioned they have occurred despite not being able to launch new products and innovate. I'm trying to understand if most of your gains are due to your ability to serve clients while smaller competitors have struggled. Will the situation change as they start to recover? They also haven't launched new products. Do you anticipate shifts in the competitive landscape over the coming months?

Yes. I mean, there's a couple of things that, I think, have led to us gaining share. Number one, we service the business really well as you said. And for a company that historically had not serviced well the fact that we went from below average to above average as the pandemic hit has been a feather in our cap with retailers in terms of them looking at us as a real player and partner that they want to work with, number one. Number two, we did launch a bunch of innovation. We just didn't get it in ubiquitous distribution because of the pandemic. And where we have launched it the data is so compelling that when you take it to other retailers and say, let me show you how energy tea is 80%, 90% incremental to the category and how it's turning in the top half of the category and velocity you've got to have this thing on your shelf. So I think we've got proof points in our innovation that others don't have because they didn't launch anything at all in many cases. And so I think that's a second tailwind for us. And then the third is we've done a really good job with our marketing dollars bringing new people into the franchise. And so our franchisers are much bigger than they were before and we're not just bringing them in for one occasion and then they leave. We're finding that those that have come in are becoming repeat purchasers and are staying with us. And our three-plus purchase group of consumers continues to grow every quarter because we're turning these people into loyalists. So I think we're very well-positioned to do better than the rest and continue to grow share, but there's no question that the competition is going to be different as the pandemic wanes. Some of it will be on pricing. Some of it will be on innovations. But again, I think it feels like because we've been leaning in we're one step ahead of people and we intend to stay one step ahead with our customers and be the partner of choice. And so we're pretty bullish and optimistic on our ability to continue to grow share.

Great. Thanks so much for the color.

I appreciate everybody's time and engagement today. I know we ran a little bit long. We had some technical difficulties at the beginning and started a bit late. But hopefully you get a sense that the things that we're doing are working. You see it in the results. And hopefully, we give you confidence in the future and the trajectory of the business. And I'll leave it at that. Thank you, guys and we look forward to the one-on-one conversations throughout the day. Thanks.

Thank you.

Thank you. That does conclude today's call. We appreciate your participation. You may disconnect.