Hain Celestial Group Inc Q3 FY2023 Earnings Call

Greetings and welcome to The Hain Celestial Third Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. I am pleased to introduce your host, Alexis Tessier, Head of Investor Relations. Thank you. You may begin.

Good morning, and thank you for joining us on Hain Celestial's Third Quarter Fiscal Year 2023 Earnings Conference Call. On the call today are Wendy Davidson, President and Chief Executive Officer; and Chris Bellairs, Executive Vice President and Chief Financial Officer. During the course of the 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. These statements are based on management's current expectations and involve risks and uncertainties that could cause actual events to differ materially from 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 as well as 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 presentation inclusive of additional supplemental financial information, which is 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 results to non-GAAP financial measures are available in the earnings release and the slide presentation accompanying this call. This call is being webcast, and an archive will be made available on the website. And now I'd like to turn it over to Wendy.

Thank you, Alexis, and welcome. We're excited to have you on board as our new Head of Investor Relations for Hain Celestial. Good morning, everyone, and thank you for joining the call today. This is my first full quarter with Hain Celestial. In the past four months, I've had the opportunity to visit many of our locations across North America and the U.K. to explore our operations and connect with our local teams. I've learned about the market potential of our brands and the growth potential in our categories. I conducted a robust review of our current performance and outlook with the teams. And while the third quarter and end of year results will fall below our initial expectations, we understand the key drivers and are taking the necessary actions to address them. Importantly, despite these results, I remain confident that we have a strong portfolio. And as I look ahead, I expect to see continued growth opportunities within our key categories and stabilization in some of our more challenged categories. Looking back at our Q3 performance, top line came in weaker than expected, down nearly 6% year-on-year on an adjusted basis. However, we did see several category and brand bright spots across both North America and international. In North America, two of our largest brands, Greek Gods and Earth's Best, both grew by double digits. Unfortunately, these highlights were eclipsed by softness in the snacks, tea, and personal care categories. Within Snacks, the primary driver of our weaker-than-expected top line results in the quarter was Sensible Portions. The Sensible Portions brand has been trending up double digits fiscal year-to-date, but trends slowed within the quarter due to competitive spending in brand building and promotion. As you will recall, in 2022, we pulled back on brand building, given supply chain impacts on service levels. With the supply chain challenges largely behind us, we are now just beginning to reinvest in brand building, in innovation, and in-store promotions and are confident in the long-term growth outlook for this brand. The recovery in service levels supported a strong quarter for the Terra Chips brand, growing dollar consumption by 17% and gaining share. The ParmCrisps brand performance was down year-over-year as expected as it was impacted by a significant loss of distribution, resulting in an impairment, which Chris will discuss in detail later. Recent dollar consumption data indicates we have seen an inflection point and a return to growth in many of our categories. In particular, in tea, Celestial Seasonings is growing dollar consumption by 8% and gaining share. Greek Gods Yogurt continues to perform very well. In the latest 12 weeks, the brand's dollar consumption grew by 21%, gaining share, reflecting double-digit growth in velocities. Earth Best dollar consumption grew by 4% despite cycling the year ago formula surge and industry-wide supply issues. Excluding formula, the brand grew dollar consumption by 13% with velocities up double digits. First Best Snacks dollar consumption was up nearly 50%, driven by growth in total distribution and strong velocity. Overall, Hain snack dollar consumption grew by 2.5% in the quarter, driven by Terra Chips and Sensible Portions. Total distribution for the overall snacks portfolio was up 8%, reflecting continued distribution gains and new margin-accretive channels, such as convenience and drug stores. This is an important part of our future growth strategy. Our Personal Care brand portfolio has been challenged, and we have taken significant steps to stabilize and return the business to profitable growth. In the most recent quarter, we brought in new leadership to turn around the strategy for the business and look forward to sharing more on this in the future. More recent data shows Alba Botanica dollar consumption is improving, and we have a strong sun season planned with robust merchandising, advertising, and earned media to support the promotion of the Alba mineral line. While North America performance was challenged, international continues to stabilize and improve, primarily in the better-for-you snacking business in the U.K., led by Hartley's and in the nondairy business in Europe. In the U.K., our dollar consumption growth accelerated, and we gained share in several categories with fresh soup consumption dollar consumption up 18%, gaining two share points in the quarter and four points in the latest four weeks and our better-for-you ingredients such as jams and marmalade, dollar consumption growth in the quarter. Now, I'd like to spend a few minutes talking about our fiscal '23 year-over-year projections as it sets the stage for the more strategic conversation as to where our longer-term growth will come from. I'll start with North America. Our overall snacks portfolio for fiscal year '23 is projected to grow high single digits year-over-year with the exception of ParmCrisps and tenders. While we have seen a slowdown in the second half, it has been driven by the pullback in marketing and brand building spend in the prior year as well as customer programs that were not repeated this year. We are addressing this with reinvestment support within the quarter, as mentioned on the last call, and we anticipate seeing the benefits begin to materialize in the back half of this calendar year. I'm pleased to report that we have programs in place for a significant increase in distribution on some of our key brands with some of our major customers for the next year. The Earth's Best business, despite lapping the demand surge last year and ongoing supply challenges in formula, is projected to be up high single digits. We are very excited about our Earth Best business, which continues to resonate with consumers and is demonstrating strong growth in total distribution and velocity. The recently launched Good Food Made Fun brand campaign is delivering above expectations in driving brand awareness and preference. Our Greek Gods brand is projected to finish with mid-teens year-over-year growth and we are excited going forward because of the service level recovery from a year ago and the strong unit growth in response to the reinvestment in media and promotions. Our tea business is projected to finish down high single digits due in part to the pullback in marketing and brand building support and the overall category weakness as it lapped a pandemic-related demand surge in the prior year. As a leading brand in the category, Celestial Seasonings was impacted as well. To counter this impact and return the brand to growth, we activated media with our Magic in Your Mug campaign in quarter 3 and continue to engage with our retail partners on optimizing the assortment and shelf sets. We are beginning to see recovery in the brand returning to growth in the most recent weeks, and the outlook includes new innovation launches and improved distribution at some of our largest customers as we head into fiscal '24. Turning now to international. The international segment performed broadly in line with our expectations while also improving sequentially across all key metrics. Our business continues to strengthen due to the stabilizing macro environment, our participation in both branded and private label as consumers seek out value, execution of our planned pricing, distribution gains, and improving service. We're encouraged by the stabilization and improvement in the better-for-you snacking business in the U.K., led by pricing and velocities and in the non-dairy beverage business in Europe. The meat-free category is beginning to reset from the accelerated category growth in the past two years and the entrance of new players. We're beginning to see stabilization with private label and meat-free returning to growth. In addition, we continue to see improvements in the efficiency initiatives underway across our business. Despite significant inflationary headwinds and the combination of price actions, operational cost management, and robust productivity programs prevented significant margin erosion while protecting core distribution. I will now turn the call over to Chris to share greater detail around the quarter and to discuss our full-year guidance. After which, I will share some of the actions we are already taking to drive towards successful outcomes.

Thanks, Wendy, and good morning, everyone. Third quarter consolidated net sales decreased 9.5% versus the prior year period to $455.2 million, inclusive of a $17 million impact from foreign exchange. On an adjusted basis, consolidated net sales decreased 5.8% in the quarter. Adjusted gross margin was 21.4% in the third quarter, a decrease of approximately 160 basis points versus the prior year period, driven by greater pricing and productivity more than offset by inflation, increased plant deleverage resulting from a lower volume, as well as negative mix. Adjusted EBITDA on a constant currency basis was $39.3 million versus $58.7 million in the prior year period. This came up short of our guidance, largely due to the top line softness in the quarter, accompanied by negative mix and increased trade spend, including the impact of foreign exchange. Q3 adjusted EBITDA was $37.3 million. Total SG&A came in at 16.5% of net sales for the quarter. Net income for the quarter was a loss of $115.7 million or negative $1.29 per diluted share compared to $24.5 million or $0.27 per diluted share in the prior year period. The loss was primarily related to a noncash impairment of ParmCrisps and intangible assets. Due to the underperformance of the brands, we conducted a quantitative analysis, which resulted in an impairment totaling $156 million, resulting in an impact of $117 million after tax. Adjusted EPS was $0.08 versus $0.33 in the prior year period. Increased interest expense accounted for approximately $0.10 of the year-over-year decline as rising rates as well as a higher outstanding debt balance translated into an incremental $10.2 million in interest expense compared to the prior year quarter. Now turning to our individual reporting segments. In North America, reported net sales decreased 12% to $286.6 million in the third quarter. Adjusted net sales decreased by 10.8% versus the prior year period. The year-on-year decline was a function of previously discussed lost customer promotional programs, baby formula declines as we lapped the prior year demand surge for the category as well as softer-than-expected results mainly in snacks and tea. As Wendy mentioned, the slowdown in the growth for snacks was largely a function of a pullback in marketing and brand building support and continued challenges with ParmCrisps. While the tea category continued to show softness, and we underperformed versus the category. Q3 adjusted gross margin in North America was 21.9% and a 180-basis point decrease versus the prior year period. Our margin performance reflects inflation, unfavorable volume and mix, and increased trade, partially offset by pricing and productivity. While our supply chain performance has greatly improved versus the prior year, the lower volume additionally drove plant deleverage. Adjusted EBITDA at constant currency in North America was $27.4 million, a $9.9 million or 26.5% decrease versus the prior year period. North America's adjusted EBITDA margin was 9.5% on a constant currency basis, a 200 basis point decrease from the prior year period. In our international business, reported net sales declined 4.9% to $168.6 million in the third quarter. When adjusted for the impact of foreign exchange of $15 million, net sales increased 3.5% compared to the prior year period, representing a 670 basis point sequential improvement from the last quarter. Our year-over-year increase for international adjusted net sales reflects an 8.6% increase in the U.K., offset by an 8.4% decline in Continental Europe. The U.K. increase was driven by strong jams, marmalade, and soup performance and a continued benefit from the ongoing shift to our private label due to our diverse offerings. The year-over-year rate of decline for Continental Europe moderated once again on the back of further improvement in the non-dairy beverage category performance, new customer acquisition, and private label mix shift within the category, where we have a meaningful presence. International adjusted gross margin was 20.6%, up approximately 160 basis points sequentially on recent pricing actions, productivity, and positive mix. On a year-over-year basis, adjusted gross margin compression continues to moderate meaningfully with the rate of decline less than half of what we experienced in Q2. Inflation remains elevated; however, we are seeing signs of stabilization, and recent energy subsidies are providing relief as well. International adjusted EBITDA at constant currency was $23.1 million, a 12.6% decrease from the prior year period. As a percentage of net sales, on a constant currency basis, adjusted EBITDA was 12.6%, down 230 basis points versus the prior year period, yet up 140 basis points compared to the second quarter, demonstrating continued improvement. Shifting to cash flow and the balance sheet. Third quarter operating cash flow was $29 million versus $31.2 million a year ago. The lower operating cash resulted from a reduction in net income and use of cash for net working capital. As we anticipate generating incremental positive cash flow in the balance of our fiscal year, we would expect the resulting cash to be used to pay down debt. CapEx was $7.4 million in the quarter, approximately $1.4 million higher than Q3 2022. Finally, we ended the quarter with cash on hand of $44 million and net debt of $813 million, translating into a leverage ratio of 4.6x as calculated under our amended credit agreement. Consistent with our stated priority for cash, we have reduced net debt by $40 million since the end of the first quarter of fiscal 2023. In light of our Q3 results and updated expectations for the fourth quarter, we are revising our full year outlook for both adjusted net sales and adjusted EBITDA on a constant currency basis as follows: adjusted net sales decline to be minus 4% to minus 3%. Adjusted EBITDA decline to be minus 15% to minus 13%. For the fourth quarter, we now expect on a consolidated basis, adjusted net sales to be down low single digits versus the prior year period. Adjusted gross margins to be up year-over-year and sequentially, as we continue to benefit from our pricing actions and recognize a ramp in savings for our productivity agenda and supply chain improvements. Adjusted EBITDA at constant currency is expected to be approximately $40 million to $44 million, driven by lower sales volume and increased brand building and organizational capability investments in the quarter, abating supply chain disruptions, plateauing inflationary pressure, and greater benefits realized from planned pricing actions as well as increased productivity. Turning to our segment outlook. For North America in the fourth quarter, we expect adjusted net sales to decline versus the prior year period, but at a lower rate than Q3. We expect to realize continued top line softness in ParmCrisps and Personal Care, while the ramp-up in our brand building investments takes hold. We do expect to see Sensible Portions return to growth in the high single digits though ParmCrisps continues to decline versus the prior year, creating a material drag on North American top line results. North America adjusted gross margins are expected to show improvement when compared to the prior year period. Lastly, constant currency adjusted EBITDA is projected to decline versus the third quarter and when compared to the prior year period as we continue to accelerate brand-building investments, which will support our future growth while limiting EBITDA growth in the near term. For international, we expect adjusted net sales to deliver growth versus the prior year but at a slower pace compared to the third quarter due to new pricing actions, net of elasticities as consumers shift between brand and private label. Our diversified portfolio as a significant supplier in both the brand and private label space provides sustained opportunities for growth. There will be continuous improvements in adjusted gross margins, both versus the third quarter and the prior year period as we benefit from increased pricing and productivity, offset by challenges due to stranded overhead and mix impacts. Lastly, adjusted EBITDA on a constant currency basis is expected to grow both versus the third quarter and the prior year period, with margins improving over 500 basis points versus the fourth quarter of 2022.

Thank you, Chris. While the rest of the year is not where we would like, our detailed review of the business has me optimistic about the future, and I'm focused on setting the company up for future success. We have already started to invest behind our brands and are in the active stages of our strategy assessment and development. I continue to have confidence in the future potential of our brands and our portfolio and our ability to return to profitable growth. Although our starting point is lower than previously believed and we have work to do to transform the business, we have already made progress building capabilities to drive operating improvements and efficiencies. I'll share a few examples. We're working to simplify and globalize our organizational structure to drive both efficiency and effectiveness. In February, we implemented our new global leadership structure and will be driving alignment and synergies across the organization. We've enhanced our international commercial resources to improve distribution and in-market performance. We've simplified our end-to-end supply chain under a global center of excellence. We have a number of productivity projects underway with a focus on cash flow and balance sheet improvements through improved forecasting and inventory reduction. We're optimizing our office footprint and leveraging a more robust hub-and-spoke model to better enable our hybrid working model. As a result, we exited our headquarter lease in Lake Success and are in the process of finalizing a smaller workspace more closely aligned to our needs and future vision. We are focused on culture and talent, as you can see by the changes we've made to our leadership team. As I mentioned in the last earnings call, we have begun a strategic review of the Hain 3.0 strategy. The process to confirm our where-to-play choices and clearly define the how-to-win building blocks is well underway and progressing as expected. While the company simplified its portfolio of brands over the last few years to categories with tremendous potential, we have yet to leverage our scale and our reach to enable the investment in capabilities and brand building necessary to generate sustained performance. We are committed to building a clear path to predictable, achievable, and sustainable top and bottom-line growth. And we see an opportunity for Hain to blend aspects of traditional CPG growth models with those of smaller disruptive brands to enable the growth of our Better-for-You portfolio, while harnessing the power of our operational scale. You've heard me refer to this as outsmalling the big and out-bigging the small. We have several core assets to leverage to achieve our potential, including a strong portfolio of brands, two-thirds of which are number one or number two in their categories, we're in attractive categories and geographies with better-for-you tailwinds and a committed organization that is aligned to our purpose to inspire healthier living. The key to unlocking more value for our shareholders is based on a few core tenets, taking a consumer-centric approach to driving growth, executing with commercial and operational excellence, expanding our reach to be where the consumer is shopping, generating the fuel needed within the organization to invest for growth, and building a high-performance growth mindset culture. Importantly, we will work to balance the pacing and sequencing of investments needed in capabilities, categories, and brands with the growth in margin to deliver performance. As we work to pivot the company from shaping the portfolio to accelerated growth, our efforts will center on clarifying our focus with a balance between short-term urgency and long-term capability. And as we live our company purpose to inspire healthier living, we are committed to grow our people, grow our brands, grow our business and grow our impact. These tenets will underpin our strategy and our long-term growth framework, which we look forward to sharing early fall at our Investor Day. Now I'd like to turn it back to the operator to open the line for questions.

Our first question comes from Andrew Lazar with Barclays.

Great. Wendy, you mentioned balancing the pacing and sequencing of reinvestment spending. I'm trying to understand if you believe that the lower 23 base could allow Hain to grow profitability at a more normal rate in fiscal '24. Or should we expect that profitability will still likely be somewhat muted in '24, considering the reinvestments needed and the time it typically takes for the business to respond to those reinvestments? Essentially, is '24 likely to be more of a transition year?

Thank you for the question. I know there were some inquiries during the last conference call regarding my comments on reinvesting in the brand, so let me clarify for 2023 and provide some insights on what that means for the long term. In 2023, we mentioned a reduction in spending from 2022. We didn't allocate much for marketing or promotions in the first or second quarters of 2023, which means we concentrated our spending later in the year. Our marketing expenditures for this year are about the same as last year, slightly below what we indicated for the entire fiscal year of 2022, but they are backloaded into fiscal 2023. Year-on-year, you'll see this relatively flat. However, we have started to observe positive market responses to our new campaign initiatives and some distribution improvements. Our strategy with this pacing and prioritization is to invest as we see results rather than commit funds upfront with expectations of returns six months later. This approach should allow us to maintain our margins while funding future growth. We are confident about our productivity pipeline, and this year we achieved more than we initially planned. Unfortunately, it was used to offset losses in the plants due to reduced volume. We will continue to manage this balance as we move into next year. I hope this provides some clarity.

Our next question comes from Ken Goldman with JP Morgan.

Wendy, I understand you were involved in the acquisition of ParmCrisps and Thinsters, but today Hain reported a write-down of over half the purchase price. It wasn't too long ago. Looking back, hindsight is always clear. In your opinion, what do you think went wrong, if anything, with Hain? Was it merely bad timing with private labels gaining market share as prices increased? I’m trying to understand what you see in Hain’s internal processes for future M&A, so that the next deal, whenever it happens, can be more successful than the recent one.

Ken, it's always difficult to reflect on past decisions, but we've spent considerable time reviewing the assumptions behind the acquisition and what has occurred since. I can share that we feel confident about our move into the better-for-you snacking category, particularly in high protein. The consumer trends supported that direction. However, we may have misjudged a couple of aspects. One is our dependence on keto as a diet related to ParmCrisps and the subsequent downturn in the keto category, which created consumer challenges we did not fully foresee at the time of the acquisition. The second issue is customer and channel concentration; we had anticipated that channel expansion would progress more quickly than the risks associated with concentration, but it turned out to be the opposite. What is evident now is a recognition of the brand’s current position. Nonetheless, aside from where we're recalibrating ParmCrisps, our outlook and growth outside of the customer concentration has been positive, so we remain optimistic about the brand's future. We are simply establishing a new foundation instead of expecting a rebound from the previous customer concentration. I hope this clarifies things.

No, that's very helpful. And then I wanted to ask a quick follow-up. You mentioned that you're starting to see some brands react nicely to some reinvestments, which is great to hear. How do we think about what to look for in terms of the data that we get in terms of syndicated information? What I'm asking for is, should we really expect to see some kind of uptick or acceleration in consumption or at least visible consumption? Or is it a case where, hey, maybe that doesn't measure quite enough of Hain's U.S. business to be meaningful?

Yes. I would mention a few observations from the syndicated data. In North America during the third quarter, there was a year-on-year decline in some categories and brands within Personal Care, particularly in "that's how we roll." These data points are evident. You will also notice growth in Terra and Sensible across measured channels. It's important to consider the total distribution points, as we've seen improvements in brands that are responding to reinvestment by increasing their distribution and assortment in the market. Additionally, examining the velocities will reveal how consumers and shoppers are reacting to investments in in-aisle activation. You can observe some recovery, especially in food, drug, mass, and to a lesser extent in convenience.

Our next question comes from Michael Lavery with Piper Sandler.

I wanted to revisit the spending aspect briefly. I know you touched on it, but you mentioned in the release that you've started reinvesting. Given the timing in the year and the usual budgeting cycles, could you clarify if there are some unexpected adjustments and increased spending? Is it accurate to think that with the fiscal '24 budget starting July 1, the situation might look different? I would like to understand more about the ongoing investments versus a comprehensive plan for the spending you believe is necessary for the upcoming year.

Thank you for your question. I believe we currently have enough resources within our profit and loss statement to support investments in our targeted categories and brands. In fiscal 2023, we shifted from minimal spending in the first half of the year to concentrating our investments in the latter half. This change involves not only the amount spent but also the quality of those investments. We've reassessed our marketing expenditures, focusing more on effective marketing and media rather than ineffective ones. Similarly, we are applying this approach to our shopper programs and trade activations, prioritizing active trade investments that enhance distribution and boost the performance of our key brands and categories. As we've previously discussed in our investor meeting a few months ago, our expansion into higher growth channels tends to be more profitable. Therefore, the way we allocate our current funds and where we pursue growth will enable us to sustain our investments in the future.

That's helpful. I have a follow-up on ParmCrisps. The discrepancy between what we observe in the scanner data and the shipment numbers appears to be significantly related to distribution loss. Can you provide insight into the timing? Should we anticipate three more quarters of this when considering the North America top line?

Yes, that's exactly the way to think about it, Michael. As we got into this year, we had an okay first quarter on ParmCrisps, and then things turned more challenging. So as you say, we're a couple of quarters into that as we sit here today and a couple of more quarters to go.

Our next question comes from Matt Smith with Stifel.

I wanted to ask about the increased level of investment in the second half of the year. I understand some of that is due to the timing compared to last year. Looking at the gross margin performance for the quarter, pricing and productivity did not sufficiently counteract inflation in the third quarter. So as we consider margins moving forward with this higher level of investment, do you anticipate that pricing and productivity will contribute more, allowing us to offset inflation and expand margins? Or is inflation expected to decrease, leading to less inflation in the future? Some clarification on this would be appreciated.

I will begin and then let Chris provide some additional insights. When comparing the third quarter to the previous year, the pricing strategies we implemented were generally adequate to handle the inflation we experienced. However, we faced some challenges because, while the elasticities were below one, we still encountered some impacts on volume, which affected our plants. As Chris pointed out earlier, this resulted in some deleverage, leading to additional costs that needed to be managed. Consequently, our productivity was used up rather than serving as a tool to drive business growth, which was our initial aim. Looking ahead, although raw material inflation may ease somewhat in energy costs, we still anticipate elevated labor rates, which you've likely heard from others as well. These will act as offsets, but we believe that as volumes begin to recover, the impact from price elasticity will lessen, allowing us to utilize our productivity pipeline for growth.

So Matt, a couple of data points. First, recall we did see the good gross margin progression in the first half of the year. So second quarter better than first quarter. And then I'd characterize the third quarter gross margin as being a little bit of an anomaly. There were some nonworking trade things that hit in the third quarter. We had negative mix that we didn't anticipate as the tea business was a little softer than was our original guidance. So the gross margin that you saw in the third quarter, a bit lower than we would have expected, of course. And then we do see a pretty nice recovery in gross margin in the fourth quarter. So yes, I mean, I think at the end of the day, the gross margin progression will step back up again, and so you'll see that as a very healthy opportunity for us to offset the investment increases that we're going to make.

Our next question comes from Jon Andersen with William Blair.

When you talked about shifting strategies toward reaccelerating profitable growth from portfolio simplification, I'm curious if you're also evaluating the portfolio as a whole. Are there broader decisions being made regarding core and noncore businesses, and is there potential for future restructuring on a category or brand level?

You bet. So we're approaching the strategy work like everybody probably does where you begin with where we play and specifically where we have a right to win and what it will take to bring that to life. I like the categories that we're in, and I like the geographies that we're in. Both offer opportunities for upside without the need for incremental acquisitions to be able to fuel the growth. That said, we're not set up to fully realize the potential of what we could do in those categories. And that's the work that we're undertaking is looking at how do we leverage our reach and scale to be able to get our fair share in the higher growth parts of the better-for-you categories. How have we invested behind the things that customers and channels would expect us to have around insights and consumer focus. How robust is our innovation pipeline? Are we able to leverage innovation across our markets so that we're not doing those in isolation? I think in the past, Hain was structured largely by brand, by category and didn't allow you to leverage synergies or scale and reach. That's where we're really looking is less about overall company portfolio shaping and much more around operating model and organizational shaping that I believe can unlock efficiencies we can then invest behind growth.

That's helpful. And you mentioned a number of changes that you've already made from, I guess, the new global leadership structure to see some commercial resource enhancements in the international business and I think a global COE for supply chain. Just in aggregate, what are your expectations regarding productivity, say, on an annual basis? It seems like that's going to be a key part of, to your point, providing the fuel for the reinvestment that you're planning to do in demand generation activities. So I think historically, Hain has talked about maybe $50 million a year in productivity. Are you willing or able at this point to kind of give us some context around that?

Yes, absolutely. I would say that, that $50 million number is about right for what you would expect in ongoing run rate productivity that can offset inflation offset cost impacts, those things. What we're actually looking at over the next couple of years that we'll roll out in Investor Day this fall is probably much more of a large-scale end-to-end restructure that will help us unlock some bigger buckets inside the P&L that will enable us to get to a margin structure that can sustain continuous investment behind the brands. What we've found, if you look back over the last couple of years is some of our brands had no investment and some had very little or it was episodic. We need, in some of our categories, to have more of an always-on sustained support. But to do that, we need to make sure that we are sweating the middle of the P&L, so to speak, so that we're able to free up that kind of fuel, both to pay down debt, but also to be able to reinvest back in the foundations of the company.

Our next question comes from Alexia Howard with Bernstein.

Can you share the strategy for reducing leverage? With the recent downgrade in guidance, it appears that leverage will be significantly above 4x, likely at the higher end of the 4% to 5% range. How soon do you expect to begin improving that as we enter fiscal '24? I assume that repaying debt is currently the primary focus for cash usage.

Indeed, as we've said on this call on the last call, Alexia remains our priority. And you saw in my prepared remarks the progress that we have made since earlier this year. So the plan is twofold. We're going to continue to focus on EBITDA growth, and that helps a part of the calculation, and then we're going to continue to focus on net debt reductions, both through free cash flow and through continuing to improve our working capital position. We've identified opportunities within working capital. We've got work plans in place today to take significant amounts of inventory out of the system, and that, of course, will go directly to reducing net debt. And so, as I've said before, my forecast has always been that leverage was going to peak in the third quarter of this year. And then as we get into more favorable overlap on the EBITDA side of the calculation and continue to reduce net debt, we will begin to see leverage come down over the next several quarters.

And let me add a little bit of color around that. As we looked at some of the investments that we've made around our operating model, I think we mentioned in the last call that we've made some investments around end-to-end forecast and forecast management. But last year, we had significant supply chain issues and service level problems. We went into this year with a focus on fixed service level first, fixed inventory later, and that's part of what you're seeing in that working capital number is we're sitting on more inventory than we're comfortable, but we wanted to make sure that we were assuring supply in the marketplace so we could recover from the service levels of a year ago. And actually, in the recent data that we've seen from IRI, we actually have top-tier service levels across our categories and our channels of focus. So we're delivering on our customers' expectations. That allows us to now focus on demand forecast models and reducing both raw and pack but also finished goods inventories so we can get that working capital down. And as Chris said, we've got active work teams focused against that now.

Great. And maybe as a follow-on question to that. One theory is that because you have smaller brands and you're more sort of focused in the higher end that the supply chain and service level disruptions hit you guys harder than companies with bigger brands, etc. Are you through a lot of that service level and supply chain disruption? What sort of inning are we in, in terms of getting back to normal? Is that all pretty much now behind us at this point?

Yes. It's pretty well stabilized. We still have a couple of hot pockets that we're working on. I guess is the way I would say we've talked about this before, I think, industry-wide around formula. In the baby category continues to be a challenge for everyone in the space. And there's a few areas where we want to make sure that we've got redundant suppliers of packaging materials and redundant contingency production locations to assure supply without some dependency on a few. So some of that work is still in play, but it's not affecting our service levels other than really on the formula side.

Our next question comes from Anthony Vendetti with Maxim Group.

Yes. I was just wondering, Wendy, if you could talk a little bit about pricing. With the lower sales, do you think some of the pricing in this environment finally started to catch up? And then on the gross margin side, was that just increased input costs supply chain costs? Or was it just a result of lower sales, trying to cover the same fixed cost?

Yes, I'll begin by discussing pricing, and then Chris will address the margin question in more detail, as it relates to our mix. Regarding pricing, we believe we have implemented the appropriate amount of price increases to address what appears to be more permanent inflation rather than temporary. Our goal is to avoid setting prices so high that we end up needing to lower them later. We're confident in our current pricing strategy. Historically, before my tenure, we've highlighted that Hain operates in categories where consumers are willing to spend. Additionally, we often occupy the premium segment of those categories but serve as the entry price point for those seeking healthier alternatives to traditional products. This positions us advantageously in the market. The team has been strategic and considerate in determining how much to raise prices, ensuring we take just enough to cover costs without risking future challenges in maintaining those price points.

So Anthony, on the gross margin question. The shape of the curve is actually consistent with our original plan. We did expect that the third quarter would step down a little bit from the second quarter in our original plan for the year. Now, it stepped down a little bit more than what we had anticipated and largely due to three reasons. I think you named two of them. So there was lower volume, which led to some plant deleverage across the system. There was negative mix, as I mentioned earlier. And then the third one, and I think I mentioned this earlier to an earlier question as well, were some nonworking trade items that hit in the third quarter that we don't expect to repeat going forward. So all of those things conspired to drive gross margin in the third quarter, a little lower than what we expected. And then consequently, we do see it recovering pretty nicely in the fourth quarter.

It appears there are no further questions at this time. I would now like to turn the floor back over to Wendy Davidson for concluding comments.

I want to thank you all again for joining us today to review our third quarter performance and updated fiscal year outlook. In these first few months, I've seen firsthand the capabilities of our supply chain and the attention to quality, service, and safety. The strength and potential of our brands, the passion of our people, and the opportunity for scale in our business is impressive and exciting. I'd like to thank the entire Hain team for their energy and their engagement, and I look forward to seeing and speaking with many of you in the coming weeks and the Investor Day in the fall. Take care.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.