Hain Celestial Group, Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2016 (the first quarter of fiscal 2017), compared with the three months ended September 30, 2015. The filing was submitted June 22, 2017, after a delay. Although the request metadata identifies “2015 Q3,” the filing itself covers September 2016.
Business context
Hain Celestial markets organic and natural food, beverage, and personal-care products in more than 80 countries. Its fiscal 2017 strategy included reorganizing U.S. platforms under Project Terra, launching Cultivate Ventures to develop smaller brands and concepts, and pursuing cost savings over three years, with some savings intended for reinvestment in brands.
Financial results
Amounts below are in millions of U.S. dollars, except per-share data. The 2015 comparison reflects revisions to previously reported figures.
| Metric | Q1 FY2017 | Q1 FY2016, revised | Change |
|---|---|---|---|
| Net sales | $681.5 | $667.7 | +2.1%; +6.5% at constant currency |
| Gross profit / margin | $109.9 / 16.1% | $137.9 / 20.6% | Margin down 450 basis points |
| Operating income / margin | $13.8 / 2.0% | $54.3 / 8.1% | Down 74.7% |
| Net income | $8.6 | $29.2 | Down 70.5% |
| Diluted EPS | $0.08 | $0.28 | Down $0.20 |
| Adjusted EBITDA | $45.6 | $76.9 | Down 40.7% |
| Operating cash flow | $12.4 | $5.8 | Up $6.6 |
| Operating free cash flow | $(2.1) | $(13.7) | Improved $11.6 |
Reported sales growth included a $29.5 million adverse foreign-exchange impact. Orchard House contributed approximately $46 million of current-quarter sales. Sales were also affected by U.S. customer inventory realignment and product rationalization, and increased trade spending and competitive pricing.
Profitability fell sharply. Management cited U.S. pricing and customer mix, Orchard House margin dilution, higher U.K. production and input costs, purchases in non-functional currencies, and start-up costs at the new FreeBird facility. Prior-year poultry supply shortages had supported HPPC volumes and pricing. Current-quarter accounting review costs were $6.0 million. The effective tax rate was 8.3%, versus 31.4%, helped by earnings mix and a U.K. statutory tax-rate reduction.
Liquidity, debt, and balance sheet
At September 30, 2016, cash was $113.5 million, total debt was $851.4 million (including $23.5 million current), and working capital was $544.3 million. Cash declined $14.5 million during the quarter. The $1.0 billion revolving credit facility had $820.2 million drawn, $3.9 million of letters of credit, and $176.0 million available. The company said cash, expected operating cash flows, and facility availability were sufficient for ordinary working capital, expected fiscal 2017 capital spending of approximately $70 million, and other needs for at least 12 months. It was deemed in covenant compliance under limited waivers and extensions related to delayed financial reporting. Approximately 75.8% of cash was held outside the U.S.; repatriation could incur significant U.S. taxes.
Operating cash flow improved mainly because less cash was used in working capital, while investing cash outflow was lower than the prior year, which included Mona acquisition and facility/equipment spending. Financing cash flow reflected net debt repayments and contingent consideration payments.
Material changes and unusual items
- U.S. sales declined 8.9% and operating income declined 46.8%; U.K. sales rose 23.6%, including Orchard House, but operating income fell 53.8%. HPPC recorded a $1.0 million operating loss; Rest of World sales and operating income increased.
- The company identified additional concessions to certain U.S. distributors and reviewed whether related revenue was recorded in the correct period. It revised prior-period financial statements for errors it deemed individually immaterial; it said a cumulative correction would have materially affected fiscal 2016 results. The 2015 quarter’s revised net sales were $19.5 million lower and net income $2.1 million lower than originally reported.
- The Audit Committee’s independent review found no evidence of intentional wrongdoing. Management concluded the financial statements were fairly stated in all material respects under U.S. GAAP, while acknowledging material weaknesses in internal controls.
- Goodwill and indefinite-lived intangible impairment charges were recorded in fiscal 2016; none were recorded in this quarter. Foreign-currency translation reduced other comprehensive income by $31.7 million.
Outlook, controls, and risks
No specific sales or earnings guidance is provided. Management expected approximately $70 million of fiscal 2017 capital spending and described planned cost savings over the next three fiscal years. The filing cautions that first-quarter results are not necessarily indicative of the full year and notes seasonal fluctuations.
Disclosure controls were ineffective at September 30, 2016 because of material weaknesses involving the control environment and revenue recognition, including controls over concessions, side agreements, supporting documentation, and trade-promotion timing and classification. Remediation included finance hires, contract and revenue-review controls, training, an internal audit function reporting to the Audit Committee, and a planned global contract-management system.
The company disclosed securities and derivative lawsuits and an ongoing SEC investigation; the SEC issued a subpoena for documents in January 2017, and Hain said it intended to cooperate. The company stated that ordinary-course claims were not expected to have a material adverse effect, but the filing does not provide a clear estimate of potential losses from the securities matters or investigation. Other risks include competition, consumer preferences, input costs and ingredient availability, international exposure, acquisitions, litigation, and continued remediation of reporting controls.
Important facts for investors to verify
- Whether revenue concessions and trade-promotion accounting were consistently documented, recorded in the correct period, and covered by effective controls.
- Progress and independent validation of remediation of the material weaknesses, and the reliability of subsequent filings.
- Whether gross-margin pressure, U.S. sales declines, Orchard House costs, and FreeBird start-up losses improve or persist.
- Debt covenant status after the reporting waivers, revolver availability, and cash needs, including the location and potential tax cost of foreign-held cash.
- Developments and potential financial exposure from the SEC investigation and shareholder litigation.
- Basis and comparability of adjusted EBITDA and constant-currency measures, and the assumptions underlying the stated liquidity and capital-spending outlook.