The Hain Celestial Group (NASDAQ:HAIN) Q3 2020 Earnings Call

0:00 Thank you. Good morning, and thank you for joining us on Hain Celestial's third quarter fiscal year 2020 earnings conference call. On the call today are Mark Schiller, President and Chief Executive Officer, and Javier Adrobo, 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 security's 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.

0:56 These refer to Hain Celestial's annual report on Form 10-K, and quarterly reports on Form 10-Q and other reports filed from time to time with the Securities and Exchange Commission. An express release issued this morning for a detailed discussion of the risks that could cause actual results to differ maturely from those expressed or implied in any forward-looking statements made today. Please note, management's remarks today will focus on non-GAAP or adjusted financial measures. A reconciliation of GAAP results and non-GAAP financial measures is available in the earnings release. As a reminder, beginning in Q1 of this year, the company changed its segment reporting to focus on North America, international, and corporate, which is the U.S., U.K., and rest of the world segments. 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. This call is being web-tapped, and an archive of it will also be available on the website. I'd also like to note that we're conducting our call today from our respective remote locations. A special maybe brief delay, cross-off, or other minor technical issues during this call. We thank you in advance for your patience and understanding, and with that, I'd like to turn the call over to Mark Schiller.

2:07 Thank you, Katie, and good morning, everyone. Let me start by saying these are very difficult and unprecedented times as we all learn to adapt to the coronavirus. My thoughts and prayers go out to those who have been negatively impacted by this pandemic, and I wish everyone safety and good health as we move toward a new normal. I appreciate that we're working in an essential industry and providing people around the world with much needed healthy products that they rely on to navigate this crisis. And I want to thank all our employees who have continued to come to work every day during this turbulent time. They've overcome numerous obstacles to produce and ship these products to stores every day and they're doing a fantastic job. On today's call, as I talk about our performance in Q3 and guidance raised for the full year, I'll give you details on the COVID pandemic, including how it's impacted our business, how we prepared for it, how we created new opportunities, and how we're setting ourselves up for the future.

3:05 Let me start with our results and outlook. I'm proud to announce that after two strong quarters with significant profit growth, we did it again in the third quarter with 24% year-over-year growth in adjusted EBITDA and an EBITDA margin which was the highest since fiscal 2018. Thank you for joining us. but it's important to note that we were on track to deliver promised improvements based on our performance in the first two and a half months of the quarter before the pandemic really changed behavior. This is further evidence that our strategy is working and we continue to deliver against our goals and guidance.

4:02 Further, we exited the third quarter with significant momentum and as we have forecasted all year, we continue to expect growth versus a year ago in gross margin dollars and percentage and adjusted EBITDA margin in dollars in the fourth quarter as well. As a result, I'm pleased to inform you that we have raised our earnings and EPS guidance for the year considerably. Now let me provide some color on both the North American and international businesses. Starting with North America, you'll recall we had embarked on a transformational journey to turn around our performance and have made significant progress to improve our margins and restore profits. The virus continued in Q3 with gross margin improving over 18% and adjusted EBITDA margin improving over 36% compared with last year.

4:52 Importantly, for the first time in the last 10 quarters, our top line in North America also grew. You're probably wondering what the impact of the virus is on these results. As I stated earlier, while our performance benefited late in March from COVID-19, we were delivering all the improved metrics on top line gross margin and adjusted EBITDA Thank you for joining us. On the negative side, we incurred increased costs to keep our employees safe in our supply chain running, like frontline crisis pay, extra sanitation, and expedited freight.

5:48 In terms of categories and brands, we saw similar improvement in both the Get Bigger and Get Better groupings of brands, but within them, individual categories varied significantly. Of our Get Bigger portfolio, T and the Celestial brand saw the biggest improvements. T is often used when one is sick for a relaxing me moment on a hectic day or for winding down at night, so it's well positioned for growth in these turbulent times. Right now, the category and brand continue to grow about 40% year over year every week. Hand sanitizers, which is a relatively small part of our personal care portfolio, also benefited greatly in this environment. With sales doubling, we've added capacity to keep up with growing demand. Outside of soaps and sanitizers, personal care categories have seen a small decrease in sales overall. As we discussed at our last earnings call, we ran a big hair care program early in the quarter that created significant growth.

6:44 We were also poised to have a record sun care season, but it's off to a slow start, given that consumers are isolating and not yet traveling. The snacks category did well in March and April, but has stabilized with low single-digit growth. as many snacking occasions like parties and lunch boxes have gone away temporarily. In the Get Better portfolio, baby food saw immediate significant stock up in March, but baby food consumption is not expandable, and as a result, orders have dropped considerably in April as consumers used up what they bought. The remainder of the Get Better brands, which include things like canned goods, almond butter, soup, and salt, have benefited from pantry loading and increased cooking from home. In almost every category, we've seen our buying rate improve.

7:29 Household penetration has also increased most significantly in tea, snacks, hand sanitizer, and some center of store categories like oils and canned goods. In terms of customers, we saw a significant increase in big box retailers during the initial surge, and our business at large grocery chains continues to show strong mid-single-digit growth in April. As consumers began isolating, we experienced a significant increase in e-commerce, Thank you for joining us. So our sales have mostly benefited from the pandemic and are expected to continue to grow modestly in Q4 when factoring out the businesses that we've exited this year.

8:26 Let me give a little more color on how the Get Bigger and Get Better segments performed within the quarter. On the Get Bigger brands, we had guided that Q3 would start to show improvement in top-line trajectory in North America where we were focused on restoring growth. For the quarter, our Get Bigger brands grew more than 10%. Again, it's important to note that our Get Bigger brands were growing high single digits before the demand surge in March, which should give you confidence that the improvement expected had in fact materialized before the crisis. Adjusted EBITDA margins for the Get Bigger brands were over 14%, something we've accomplished in five of the last six quarters. Those results are even more impressive given we increased our marketing investment by 120 basis points versus a year ago.

9:13 On the Get Better brands, we continue to focus on improved profitability. I'm pleased to report that our EBITDA dollars and margin more than doubled versus a year ago in the quarter, despite the anticipated shrinking top line. These profitability improvements and corresponding sales declines are the result of aggressive productivity initiatives, skew rationalization, reduction in low ROI spending, and a product redesign that we've been working on since Investor Day last year. In our continued simplification journey, we were also able to sell two low-margin, non-strategic businesses within the quarter, Europe's Best and CASPA. And late last week, after the quarter ended, we also sold our Rudy's business.

9:58 These businesses collectively had about $30 million in sales and EBITDA of only about $1 million, but they consumed a disproportionate share of management time and added supply chain complexity. In addition, we've also started shutting down several brands that lack scale and profitability. These brands, including DuBose, Little Bear, and Gluten-Free Grocery, had approximately collective annual revenue of $4 million and adjusted EBITDA of zero. Between the divested and discontinued brands, we've eliminated approximately 200 SKUs, 10 co-manufacturers, our only direct store delivery system, and one manufacturing site. This fits with our continuing plan to simplify the business and improve our margins and growth potential going forward.

10:46 Turning to international, we had a solid quarter with flat sales, expanding gross margin and double-digit EBITDA growth and constant currency. While most of the trends we saw in North America are similar here, there are two important differences. One, we have a scaled fruit business that makes up approximately 20% of the international sales. It has a large food service component and those sales have dropped to almost zero in late March and the trend continues in Q4. In addition, while still supplying the grocery side of the business, we have significant stranded overhead and input costs that are further impacting profit. Excluding the fruit business, about 30% of our international sales are private label. These businesses have done quite well as consumers who are concerned about their personal finances trade down to lower priced items.

11:34 Given those two factors somewhat balancing out, we're pleased that we delivered flat sales overall and strong margin expansion. It's further evidence that we have solid businesses and strong management teams behind them. One other important point that I want to draw your attention to is how we manage excess capital in the quarter. On previous calls, you'll recall that we paid down debt to lower our interest expense for the year. In March, when the stock market dropped markedly, We believe that our shares were significantly undervalued and consistent with our strategy, we utilized capital to buy back shares. We deployed approximately $60 million to acquire 2.4% of our outstanding shares at a price of about $23.60. While that purchase had minimal impact on the average share count in the quarter, you will see its impact on EPS in Q4 and beyond.

12:24 Given our strong results and outlook, let me spend a couple minutes explaining how we prepared for COVID-19 with the goal of giving you confidence that we are also well prepared for the future as this pandemic continues. From the beginning, our leadership team had a focused agenda that one, take care of our employees, and two, ensure business continuity and continued success. With regard to our employees, we ensured that they were safe and could provide for their families. We were early adopters of all recommended actions to prevent the spread of the disease and in many cases adapted them before the government directed us to do so. We've also consistently met or exceeded all government guidelines for addressing those employees who contract the virus. In addition to crisis pay for all frontline workers, we also recently established a program to help employees who suffered severe economic hardship during this crisis with free financial grants from the company to help ensure that they and their families are safe and have food on the table.

13:22 Our second priority was to ensure that we kept the company on track to deliver the plan and meet consumer and customer needs. Thank you for joining us. To meet surging demand, we consolidated shipping orders to get more product on fewer trucks, resulting in service levels in the mid-90s and significantly reduced distribution costs. In short, we were well prepared to meet the rapid increase in demand and help ensure continued strong performance as the crisis progresses.

14:14 As the situation unfolded, we also created new opportunities to drive growth and set up the future. For example, we have a small Canadian hand sanitizer business that grew exponentially. We quickly added capacity to meet demand and expand into the United States, further strengthening our relationship with key retailers. While others have been cutting their marketing, we have been increasing ours in Q3 with new advertising on some brands, impact coupons to encourage repeat purchases from new tryers, and increased market research to set ourselves up for future success. We also quickly developed scrappy innovation on some cooking brands to complement the strong pipeline on our Get Bigger brand. We are also partnering with customers in new ways to solve their issues and help them grow, resulting in stronger relationships for the future.

15:02 As we look forward, our focus has shifted to the reopening of the economy and a quest for a new normal. While we anticipate some eating occasions will migrate back out of home as economies open, we are focusing on several important trends that will help us continue to grow. These include e-commerce growth, where we have tremendous strength in relationships, New Triers for many of our new products, cash-strapped consumers seeking better value, increased cooking at home, and new consumer sentiment and values. As discussed on Investor Day, we'll also continue to assess our portfolio and recategorize brands as appropriate. While the current environment has impacted our original plans on some projects requiring some adjustments, our overall strategy and its four pillars – simplification, capability building, Cost Control and Top Line Acceleration remains intact now more than ever. We know we have much work left to do, but even more new opportunities in front of us.

15:58 Our future continues to be very bright. With that, let me turn it over to Javier, who will give you more details on our financial performance.

16:06 Thank you, Mark, and good morning, everyone. I would like to echo Mark's comments in thanking our employees who have worked tirelessly to help our company navigate through this global health crisis. I am extremely proud to work at Hain. I will focus my discussion on our financial results from continuing operations. The company is presenting the results of Tilda and the Hain pure protein businesses within this continued operation in the current and prior year period. Now on to the financials. Third quarter consolidated net sales increased 1% year-over-year to $553 million, exceeding our expectations. Turing Exchange impact on the quarter was a headwind of 100 basis points. Divestitures and skew rationalizations were an incremental headwind of about 400 basis points. When adjusting for these factors, net sales increased 6% versus the prior year period. This growth had the tailwind of the COVID-19 impact.

17:06 From a profit perspective, as we had guided, Q3 delivered year-over-year adjusted gross margin and dollar expansion, and adjusted EBITDA margin and dollar expansion. Specifically, for the third quarter, we expanded adjusted gross margin by 282 basis points, resulting in adjusted gross profit of $134 million, an increase of about 14% versus prior year. Supply chain cost reductions enabled by our productivity initiatives mainly drove the improvements. Currency impact on gross profit was a headwind of about $1 million. In terms of productivity and efficiency, we have made significant progress in the quarter as demonstrated by the meaningful improvement in gross margin.

17:53 The initial North America SKU rationalization project has been implemented and is benefiting current consolidated gross margin. As retailers place greater focus on high-velocity SKUs, we continue to evaluate our portfolio for further simplification to position ourselves for success in the current environment. In addition, distribution and warehousing costs as a percent of sales improved by about 50 basis points versus prior year. The increasing volume allowed the company to shift fuller truckloads leading to a reduction in distribution costs. SG&A as a percent of net sales was 16% up from 15.2% in the prior year period. This was largely driven by increased marketing spending of about 9% versus prior year and increased incentive compensation accruals to match our higher guidance.

18:47 Adjusted EBITDA increased to $60.7 million compared to $49.1 million in the prior year period. This represents roughly a 24% increase versus prior year. Currency impact on adjusted EBITDA was a headwind of about $1 million. Adjusted EBITDA margin of 11% represented an improvement of 200 basis points year over year We reported adjusted EPS of $0.28 based on an effective tax rate of 28.8% compared to $0.19 in Q3 last year with an effective tax rate of 28.4%. The higher tax rate was mainly driven by a higher GILTI impact than in the prior year period.

19:35 Now to provide some detail on the individual reporting segments. Let's start with our North American business. Third quarter net sales increased 1.9% year-over-year to $320 million, exceeding our expectations. Boring exchange impact on the quarter was minimal. Divestitures and few rationalizations were an incremental headwind of about 700 basis points. When adjusting for these factors, net sales increased about 9% versus the prior year period. This growth also had to tailwind to the COVID-19 impact. From a profit perspective, Q3 delivered year-over-year adjusted gross margin and dollar expansion and adjusted EBITDA margin and dollar expansion.

20:20 Specifically, for the third quarter, our North America business expanded adjusted gross margin by 350 basis points, resulting in adjusted gross profit of $84.5 million, or an increase of about 18% versus the prior year. This improvement was mostly driven by our productivity initiatives, and a number of others. year over year, driven by gross margin improvements.

21:15 We are very pleased with the progress that our North America region has accomplished thus far, but we are not finished. We have identified multiple opportunities to continue to improve our margin structure, and we plan to begin to execute them once we return to more normal operating conditions. Looking into the components of the North American portfolio, the Get Bigger brands experienced a growth in net sales of 12.7%, While COVID-19 was a clear tailwind, these brands were growing high single digits before mid-March, as Mark stated earlier. This growth primarily came from several product lines. Our personal care line, run by Alba and One Step, our Canadian hand sanitizer brand, which we also introduced in the U.S. in April under the Live Clean brand name, our snacks product line, run by Sensible Portions, as well as our tea and yogurt lines.

22:10 The adjusted EBITDA margin for these brands improved 50 basis points versus prior year, yielding a margin of 14.8%. The Get Better brands, which are being managed primarily for profit, showed a gross margin improvement of 480 basis points and an EBITDA margin improvement of 660 basis points versus prior year, yielding margins of 21% and 11% respectively. This 11% EBITDA margin on the Get Better brand is in line with our long-term guidance of 10% to 12% provided on Investor Day last winter. Now, let me shift to our international business, where results for the quarter were very consistent with our expectations.

22:56 Net sales were flat the prior year and up by 2.2% in constant currency. Foreign exchange represented a $5 million headwind. The impact of COVID-19 on performance was mixed. Our continental European business through its non-dairy product line benefited from continued high demand throughout the quarter. Our UK business experienced mixed results. On the one hand, parts of the UK portfolio such as Ella's Kitchen, Linda McCartney, and our soup business experienced healthy growth. On the other hand, our food business with large exposure to the food service channel experienced decreases in revenues. Nonetheless, adjusted gross margin and dollars and EBITDA margin and dollars were all up in the quarter versus prior year.

23:46 These results were in line with our plan. Now, let me transition to our cash flow and balance sheet. Third quarter operating cash flow improved by $29 million to $47 million, and operating free cash flow, defined as operating cash flow list topics, improved by about $25 million, Our inventory, $61 million lower than the levels at the end of June 2019, mainly driven by the sale of the Arrowhead and Sunspire businesses, reduction in the number of shipping locations in our network, and the high demand from pantry loading that took place in March. Our cash conversion cycle during the quarter decreased to 53 days compared to 61 days in the prior quarter. This is below our target of 60 days, driven by the decrease in inventory levels just mentioned.

24:50 Capital expenditures in the quarter were $18 million compared to $14 million for the prior year period. Also, as highlighted in today's earnings release and in Mark's comments, The company used $60 million to repurchase shares in March and April of 2020. That leaves us with $190 million of additional repurchases authorized under our 2017 share repurchase authorization. So, we closed the quarter on March 31st with a cash balance of $42 million, net debt of $324 million, and gross debt leverage of 3.3 times. Now, let's turn to the full year outlook. As a reminder, our guidance excludes TILVA, which contributed approximately $200 million in net sales and $26 million in adjusted EBITDA for fiscal 2019.

25:44 We now expect all profit metrics for the full year ending June 30, 2020 to be higher than the ranges we previously provided, driven by our strong business fundamentals and higher at-home food consumption. As a result, We are now raising and growing our range of full-year guidance. It is important to note that the magnitude and duration of increased demand remains uncertain and that a challenge we face is our ability to maintain the level of supply needed to keep up with the increased demand. The outlook we are providing assumes that our supply chain continues to operate with minimal disruption for the remainder of fiscal 2020. We now expect adjusted EBITDA to be in the range of $190 to $200 million, an increase of 15% to 21% as compared to adjusted EBITDA of $165 million in fiscal 2019.

26:33 In constant currency, we expect adjusted EBITDA to be in the range of $195 to $205 million, an improvement of $16 million versus the low end of the range of our earlier guidance. Adjusted EPS is expected to be 75 cents to 82 cents, with an effective tax rate of about 28%, compared to adjusted EPS of 60 cents for fiscal 2019, an increase of 25% to 37%. This forecast has the benefit of the share repurchases. In constant currency, adjusted EPS is expected to be 78 cents to 85 cents.

27:20 Our annual guidance assumes an exchange rate of $1.23 per British pound and $1.09 per euro for Q4. The full-year foreign exchange headwind on EBITDA is estimated at about $5 million compared to fiscal 2019. Interest and other expense are expected to be approximately $18 million, a decrease of about $5 million compared to the prior year, mostly driven by lower interest rates. In addition, in April 2020, The company sought to reduce future interest rate volatility and entered into several floating-to-fixed-rate swaps in U.S. dollars and cross-currency. These swaps had the added benefit of lower interest rates than the then-existing variable rate and lower than prior year rates.

28:07 Depreciation, amortization, and stock-based compensation expense are expected to range between $65 and $70 million, compared to $55 million in fiscal 2019. We expect cash flow from operations to be around $110 million consistent with the previous guidance. This represents a $70 million improvement from the prior year. We were targeting a 15-day reduction in our cash conversion cycle from 75 days to 60 days. We exceeded that target in Q3, and as a result, we now expect an increase in inventories as we seek to replenish existing levels and create some contingency in case demand surges again in the quarter. In addition, we expect capital expenditures of $60 to $65 million consistent with our earlier guidance.

28:57 As we look ahead, we believe that our business model is well-positioned for long-term growth, even with the uncertainty of how long COVID-19 will influence at-home food consumption. The ability of our teams to come together and adapt to changing conditions has become evident more than ever this quarter. We are confident in our plan and ability to further progress throughout the remainder of fiscal 2020 and beyond. I will now turn the call back to Mark.

29:26 As you can see, we've had a terrific quarter and have a positive outlook for the future. I want to thank the entire Hain team around the world for how they've performed during this transformation journey and how they've risen to help us thrive during this pandemic and what they are doing to ensure our continued success. Together, we create a scrappy entrepreneurial results-oriented culture that's delivering exceptional results, and I really appreciate all that they are doing to transform this great company. With that, let me turn it over to the operator for questions. Operator? Thank you, sir. If you would like to ask a question, please signal by pressing star 1 on the telephone keypad. If you're interested, please make sure the mute function is turned off to allow the signal to reach our equipment.

30:12 Question and answer session is restricted to one question per participant with no follow-up questions. Again, press star one to ask a question. We'll pause just a moment to allow everyone an off-sugar signal for questions. Thank you. We now take a question from the David Palmer from Evercore ISI.

30:54 Thanks, and good morning. Congrats on this margin progression that you're pulling off here. Very impressive. I wanted to ask you about the guidance implied for the fiscal fourth quarter. Obviously, it shows a little bit less growth than what you just saw from an EBITDA perspective. Does that contemplate reinvestment? And then what's the nature of that reinvestment as you prepare for fiscal 21? And I have a follow-up.

31:25 Yep. So first thing I'll tell you is obviously these are volatile times. And as we start moving toward reentering and reopening our communities, some of the in-home consumption occasions are going to gravitate back out. What exactly that means, don't know, but there will be some slowdown in the growth rate versus what we've been experiencing in the last six to eight weeks that's implied in there. But we do expect that the quarter will be up in terms of sales overall. With regard to investment, yes, there is investment in there in marketing. As I said in the prepared remarks, we believe this is a great opportunity for us to lean in and be aggressive versus kind of sit back and wait to see what happens. So we have new ad campaigns.

32:14 We have innovation coming out. We'll have some slotting fees with it if retailers take it. So there is some implied investment in those numbers.

32:22 And then just conceptually for fiscal 21, as you're thinking about those drags to your revenue from FCA rationalization and divestitures, I can imagine that the current environment Thank you.

33:00 Yeah, so we are looking at additional SKU rationalization, although it will be less than what we've been doing because we've been at this for a while. We were doing this for the last couple of years in this company, and we have taken out a huge amount of unproductive SKUs that add a lot of complexity, and that's part of why you see the margins, particularly on the Get Better brands, improving so much. With regard to divestitures, we continue to work on shedding the tail. As I said in the prepared remarks, We are evaluating the situation and some of the things that we may have been looking to sell we may change our perspective on given the surge in demand in this situation. But I would point out something that I think is pretty compelling, which is since the January of last year, we've sold about a dozen brands that had $750 million of revenue. The collective EBITDA of that $750 million of revenue was $16 million. So it was about a 2.5% EBITDA margin, $16 million. We sold those assets for $400 million, 27 times EBITDA. So we have been getting very robust prices for what we've been selling.

34:11 In many cases, we've been selling things that are losing money and getting obviously cash for them. So I think we've been doing a pretty good job of getting extremely fair value for the things that we're looking to divest. And to your point, in this environment, we will be thoughtful and choiceful about what we sell and how much we're willing to accept given that demand is up on most of the items that we sell. Great. Thank you. Thank you. We now have a question from Mr. Anthony from Simcoe. I just wanted to talk about the new customers market they've probably been able to get during this pandemic.

35:01 Exactly how were you able to market to them and specifically do you think this has opened up the opportunity to retain new customers with new products? And then just to follow up on the product and the pipeline, has the innovation moved forward during this pandemic or has there been a little bit of a slow and focus more on the current business?

35:29 Yeah, good question. So the first thing I would tell you is we've been increasing our marketing for several quarters in a row now. So we have been, as part of the turning around of the get bigger brands toward growth, We've been investing to bring the triers in before we start. So the good news is a lot of those messages were seeded in people's minds when the pandemic hit. And obviously given supply issues from many people, there was a lot of brand switching going on where people are trying new brands because potentially the one that they're used to wasn't there. So we've had some brands that have had household penetration increase by as much as 50%. So it's pretty significant in some cases. What we are doing now is marketing to those people specifically.

36:15 So we put repeat coupons in some of our products where it's easy for us to do that so that if you try it for the first time, you have incentive to come back and repeat. We are using shopper card data and digital social mobile marketing to go after the people that are most likely to be purchasers in this environment. We've changed some of our messaging to be more relevant and sensitive for the environment that we're in. So we're aggressively trying to continue to recruit people and for the people we have to make sure that they're delighted and that we start to form a relationship with them. With regard to innovation, you've heard me talk a few times on the last several calls about how we've been building the pipeline. And two of the bigger innovations that we had launched were T-Well on Celestial and the Flame in the Hot Straws on Sensible Portions.

37:08 The T-Well repeat rate is exceptionally high, but the trial is a little bit lower than we had liked before the pandemic, so we're actually going to do some downsizing to get to more of an opening price point. It was a little bit of a high-priced area for trial, but those that tried it, the repeat rate was very high, so we're very confident in that one. And on the Flaming Hot, it's already performing in the top half of the category in terms of velocity, so that one's going to be a winner as well. We have... Additional innovation coming out on yogurt and a ton of innovation coming out on tea. And right now we're trying to partner with retailers to get that onto the shelf. My expectation would be that we may have a little bit lower ACV than we initially had hoped because some of the customers are not resetting right now, and they may either postpone the resets for a year or delay the resets. But it's also an opportunity for other retailers right now who are trying to differentiate themselves from their competitors.

38:07 And so we're finding there are quite a few retailers that are very excited about innovation, want to use it to show their consumers that they are different from everybody else and that they are bringing new and exciting things to the market. So we're going forward with our innovation plan. It's some of the best stuff we've ever had, and we continue to believe that's going to be an important part of our growth going forward. Thank you, very helpful. Thank you. We now take the next question from Alexia Over from Bernstein.

38:40 Great. Good morning, everyone. Good morning. Good morning. Can I, so my first question is you mentioned the challenges that you may have in terms of keeping the supply going. Could you talk a little bit about which products that those challenges are most acute in, what the potential problems might be? I know everything's looking fine now. And then my follow-up is if you do run into challenges on being able to ramp up supply sufficiently, would you consider pulling back on promotional activity to realize higher net pricing and to what extent might that happen? Thank you.

39:24 Yep, so the first thing I would tell you is because we're a global business, we saw this pandemic coming way before, you know, the government ever said this is going to be a pandemic. And so we immediately started building inventory and creating backup sources of supply so that if something were to happen in one of our factories that we would have an alternative. And you have to also remember that we have a business that's been declining for a couple of years, so we have plenty of capacity. Thank you very much. Flexing Formulas in case certain ingredients become hard to get, etc.

40:28 I would say we're in very good shape with the exception of there's a couple of categories where we use co-manufacturers and the industry capacity is tight. So some of our products are packed in tetra-packed packaging. There's not a lot of tetra-packed capacity out there. And on baby food, as another example, there's a very limited number of manufacturers of baby formula. Those are probably the two where I say we have the most risk. But that said, we've also built inventory so that if there is a short-term outage or a short-term plant shutdown on their side, that we've got enough inventory to weather the storm. So far, our service levels have been in the mid-90s, very high relative to, I think, what others are experiencing.

41:15 Our out-of-stock levels at retail have been much lower, and so I feel pretty good about our ability to supply. With regard to this, the part of the question around promotional activity, a fair number of our competitors pulled all of their promotional spending, which alienated retailers. We have not done that as yet. If we get in a situation where we have more demand than supply. We would certainly look at something like that, but we are trying really hard to use this as an opportunity for us to partner with retailers to meet their needs. If they want to promote, we're going to promote. If they don't have the resources to change the shelf tags and don't want to promote, then fine. We're happy not to promote. So this is a great opportunity for us to become a supplier of choice, and whether it's the scrappy innovation I talked about or whether it's tailoring our programs What their specific needs are, dropping trucks specifically at stores versus in their distribution centers.

42:14 We're being incredibly flexible here and trying to further cement our relationship. So I think we're in good shape, Alexia, and I think we will be malleable depending on what the circumstance requires.

42:27 Great. Thank you very much. Thank you. We now take the next question from Mr. Michael Lowry from Fiber Sandler.

42:38 Good morning. Thank you. Good morning. Good morning. You mentioned at your investor day a little over a year ago now that you see a future steady state profile of top line growth around 3% to 6% and 13% to 16% margins. Just as you progress since then, How far away do you think that might be, and is that still your thinking, or have some portfolio moves gone differently than planned, or is there anything in the current environment that may be sticking out if you think about that any differently now?

43:14 Yeah, so you'll remember we distinguished between the Get Bigger Brands and the Get Better Brands. The Get Bigger Brands, we said it would be mid-single-digit top-line growth, and I believe around 16% EBITDA. And on the Get Better Brands, we said it would be high single-digit declines on the top line with margins in the 10 to 12 range. In this quarter, the Get Better Brands had 11% EBITDA margins, so they are already there. and they're already within the top line of what we described. To get bigger brands also grew robustly but we continue to invest in marketing. So we haven't quite hit the 16% EBITDA margin because we keep adding marketing to the equation. But we're very steady in the 14% plus EBITDA margin on those brands as well. So we're well on our way to where we said we would be in North America.

44:08 We have a little bit different circumstance in our international business given the fruit business that I talked about, given that we have 30% of our business there that's private label. The margins there will be a little bit lower. They're more than the 13% EBITDA range. But the strategy is coming to life. The margins are materializing. And, yes, there is some benefit in the short-term top-line numbers from COVID-19. But we're really confident given the trial we're seeing. Given the retailer response that we're seeing, given the huge margin expansion that we're seeing, and honestly, we have a lot more room in the middle of the P&L. We're doing some amazing things, and you can see it in the numbers that we've got. But we still have probably 80-plus percent of our trucks that we ship don't go out full.

44:58 If we can fill up trucks, which is part of what we're doing in this pandemic, if we can get standard bracket pricing in place, We can get a lot fewer trucks on the road with a lot more efficiency in our cost structure. So we've made huge improvements, but there's a lot more runway. And so I'm bullish on the top line, and I'm bullish on the middle of the P&L, and I feel confident we'll get there. Our original timeline was three years from investor day. We're halfway there in terms of time. We're about 16 months into the journey. I think the three-year journey is intact, and hopefully we'll get there a little earlier.

45:32 That's really helpful. And just to follow up on your thinking about any economic stress, just some of what you've seen in the past and how your consumer typically behaves and what some of the ways are you might be able to adapt and adjust if necessary.

45:50 Adapt to how the consumer's behaving? Oh, the recession? Gotcha. Yeah, so the first thing I would tell you is... Because we have many organic type products, non-GMO, gluten-free, et cetera, we tend to appeal to more affluent consumers. So when you hear about the massive unemployment that we're experiencing, those tend to be lower income workers and less of our target. So I think we're a little bit insulated in that regard as long as The more affluent people feel like their income is secure, the stock market's doing okay, and they're not too worried about their future. So on the one hand, I think we're relatively insulated.

46:35 The second thing I would say, at least in Europe, we've got 30% of our businesses in private labels, so we actually will be a beneficiary of those lower income consumers who trade down because it's a significant part of our business there. The third thing that I would say is we have done an exhaustive review of of all of our products here in the U.S. And where we think we have a price point that is too premium, if you will, we're looking at alternative sizes and price points. So I've said before, for example, on this call that our Garden of Eden tortilla chip business, we offer considerably more product at a higher opening price point than everybody else. So you can get four more ounces or five more ounces, but you're going to pay a dollar more for it.

47:21 If the consumer's cash strapped, they'd rather pay a dollar less. So we are already in the process of downsizing that offering and getting to a more competitive opening price point. We're doing that in a number of places. That work was already underway before the pandemic because we saw the issue and the opportunity. And so I feel like we will be pretty well positioned to compete in all of the categories that we're in, and we should be able to weather a recession relatively well. Very helpful. Thank you. Thank you. We now take the next question from . Hi. Good morning. It's . Thank you for the question.

48:07 I believe you said a majority of the margin improvement in the quarter was attributed to the many initiatives that you had in place prior to COVID-19, so maybe not as much attributed to COVID-19-related operating leverage. Is that because the quarter was only partially impacted by the pandemic? and maybe also given that you have a different co-manufacturing mix than some of your public company peers and how does the perhaps more fragmented manufacturing footprint given the history of the company's buildup over time play into that? Overall, just trying to get a sense of how should we think about that contribution split for margin improvement over the next couple of quarters which should probably see a more full COVID-19 operating leverage benefit and then just a quick follow-up on Mark's household penetration comment.

48:57 Do you have a sense of how much of that 50% increase in household penetration for some brands are new households to the category? Perhaps like some consumers are buying in different categories for at-home consumption than they were pre-COVID or is it mostly a brand change related thing? Thank you very much.

49:16 Yeah, so... Let me answer the second one first. So with regard to household penetration, I think it's a combination of new category buyers and new brand buyers. In some of the categories, people come into the category through our brands, which is interesting, particularly in snacks. The Terra Chips brand, the Sensible Fortune brand, we tend to attract new users into the category. They have a good experience, and then they stay in the category. So it depends on the category, but in some cases – We are seeing a little bit more of it be new buyers. In some cases, it's more existing buyers switching around. With regard to the first part of the question, remind me on the manufacturing side. So we have had a robust productivity set of initiatives going well before COVID.

50:05 So we were making significant improvement in the middle of the P&L beforehand. You are right that the operating leverage, the absorption benefit of producing significantly more product in our manufacturing locations really wasn't seen in the Q3 P&L because those products are in the warehouse and they're shipping in Q4, the stuff that you were making in the second half of Q3. So we will see that fixed overhead absorption benefit in Q4. There are some one-timers in here that are helping the middle of the P&L. I would be candid and tell you that in this environment, customers are relaxing some of the fines related to service because they just want product.

50:50 That's a one-time benefit. I would say certainly obsolescence. We're able to sell through everything. So if we have some things that were aging that might have aged out before, they are being sold. So our obsolescence is down a little bit because of COVID. The vast majority of the benefit is us being a more efficient operator and things like filling up trucks, which is something that we've been on a journey to do. We don't have standard bracket pricing like everybody else, but there's no incentive for people to fill up a truck. We're working on that, and we're going to make that change in F-21s. But this was an opportunity where people needed product for us to say, look, we only have so many bays in each one of our distribution centers. We've got to send you a fuller truck. You've got to consolidate all your orders because we've got so many orders. So it was a catalyst to change the behavior on the side of the manufacturers that's been very beneficial to us, and we will now make that a permanent change. and tell them, look, you have to order at least a half a truck or whatever the minimum number is that they were allowed to buy before will be raised as a result of this and that will be a permanent change that will benefit us.

51:58 So it's a balance of some benefits that we're getting naturally and some benefits that we're getting from COVID. But I want you to know there's just huge productivity. Automation has been a big part of our agenda. BMW Plus that I just mentioned has been a big part of the agenda. Getting rid of the low-margin skews that add a lot of complexity, which is resulting in less changeovers in the plant, has been a benefit. So a lot of this is our hard work. It's not just a windfall from COVID. Thank you very much for the detail. Thank you. We now take our next question from Bill Chappell from SunTrust.

52:46 Thank you for taking the question. Hope everyone's doing well. Just had a quick one on the European business. You guys noted that you saw some early trends kind of to prepare yourself in the U.S., starting early in Europe. I was wondering if you're seeing anything as part of Europe starts to come out of their post-lockdown restrictions, any early reads on Shifting Trends, factory food service business, anything on consumer G-stock that you may be able to use as you look to the U.S. business. Thank you.

53:24 Yeah, so it is early. Like us kind of sticking a toe in the water here to open society, they're doing the same there. What's interesting about Europe is it's so many different countries with so many different stances on this thing. But where they are opening, what we're seeing is they're doing it gradually. We're seeing consumers still have fear of going out in public. So just because the restaurant's open doesn't mean all of a sudden everybody's flocking to the restaurant. I think we're seeing that people want to get outside. So whether it's the beaches, whether it's the mountains, whether it's parks, the first step is for people to just get comfortable leaving their homes. But they're still eating in their homes. It's not like they've flocked back to old behaviors and those eating occasions have rapidly migrated away from the home at this point. I think with regard to opening offices, we see fits and starts.

54:22 They open. They can't figure out social distancing. They close for a week. They try and revamp and adjust. And so I think it's a trial and error process. I think everybody's doing it slowly. I think you're going to see the same thing here. When I see and hear, you know, some states in the U.S. are opening malls and movie theaters and the like, I have a feeling that they'll end up needing to take a step back if they get too aggressive there because there's still a fear of catching the virus and there's a lot to be figured out in terms of social distancing. And I think consumer psyche has changed. It's changed in Europe. It's changed here. And so I think it's going to be kind of a slow, steady... and many more.

55:35 They are in the midst of trying to bend the curve where we have bent the curve. So I think it will be a little bit slower return to normal in the UK. Can we move to the next question, sir? Yep. Okay, we now take the next question from Rebecca Sherman from Morningstar.

56:07 Good morning. Thank you for the question. So first of all, you know, I'd love to get a sense of, you know, how much the pantry stocking contributed to the quarter's growth. Can you just share with us where growth was tracking before mid-March, before the surge began?

56:27 Yeah, so as I, you know, yes. and many more. The last three weeks of the quarter certainly added some volume to what was already a business that was moving in the right direction. And you'll remember on the last earnings call, we were very clear that we were going to bend the trend on the get-bigger brand and that we were going to have a robust quarter.

57:16 In fact, it was in high single-digit growth. So we were doing that. In the case of Europe, again, it's been more of a mixed bag. In some places like fruit, we saw a huge drop in demand. and in other places like private label, we saw an increase in demand. So it's a little bit more of a mixed bag there. I would say there was in aggregate almost no benefit in total in Europe because some were favorable and some were unfavorable. But here it was definitely a few hundred basis points of improvement on the top line. What I would add, though, as we go into April, one thing that's important to note, consumption was ahead of shipments. in March. And so we have an added benefit in the fourth quarter of the shipments catching up to consumption because the demand surge was so massive in such a short period of time when that pantry-loading behavior happened that retailers couldn't keep products on the shelves. And we tend to have a little bit longer supply chain because much of our volume goes through third-party distributors.

58:15 So April was a robust month. We're off to a good start in the quarter, and our consumption continues to be steady at a much higher level than it was before the virus.

58:28 Okay, great. Thank you. And my second question is that obviously, you know, this current environment provides a great opportunity to increase trial. And I realize it's early, but, you know, do you have any initial repeat purchase data or anything to suggest that some of this benefit will be lasting?

58:47 Yeah, it's too early to give you repeat data. Our purchase cycles are, you know, tend to be 60 days, 90 days. In the case of some things like spectrum oils, it could be, you know, six months between purchases. So it's too early to tell. What I would tell you is we've seen the most robust increase in trial on snacks, on cheese has been exceptional trial, on our oils business spectrum, our soup business, Imagine Soup. and so it's early and in the case of something like soup we're coming out of the cold weather so the repeat cycle will be very long in the summer but we don't have the data yet. It's too fast for repeat purchases to be evident at this point.

59:35 Okay, thank you so much. Thank you. It looks like there are no further questions at this time so I would like to turn the call over back to you.

59:46 Yeah, let me just end by, again, thanking all of the employees here for their hard work. This has been quite the test, and I think a crisis is a good way to assess the quality of the organization and its ability to respond. I'm very proud of what we've been able to accomplish. I'm very optimistic about the future. We are well positioned. We are playing offense. We're thinking ahead versus reacting ahead. and being very proactive. So I think the future is very bright and I appreciate everybody's support and we'll talk to you later. Thank you all. Thank you. This is today's conference call. Thank you for your participation. We're now discussing lines.