Honest Company, Inc. Q2 FY2024 Earnings Call

Good afternoon, everyone and thank you for joining our second quarter 2024 conference call. Joining me today are Carla Vernon, our Chief Executive Officer; Dave Loretta, our Chief Financial Officer. Before we start, I would like to remind you that we will make certain statements today that are forward-looking within the meaning of the Federal Securities Laws, including statements about the outlook of our business and other matters referenced in our earnings release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our earnings release issued today as well as our SEC filings for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events, except as required by law. Also during this call, we will discuss non-GAAP financial measures which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in the financial results section of today's earnings release. A live broadcast of this call is also available on the Investor Relations section of our website at investors.honest.com. With that, I'll turn it over to Carla.

Thanks, Elizabeth. Good afternoon, everyone, and thank you for joining us today. As we exit the first half of 2024, I'm pleased to share that we achieved another quarter of improved financial results on both the top and bottom line, exceeding our expectations. This strong performance is evidence of our team's commitment to strengthening the financial foundation of the Honest Company, while also accelerating the growth momentum of the Honest brand. Our achievements in the second quarter illustrate that our transformation pillars of brand maximization, margin enhancement, and operating discipline are driving improved performance and a stronger financial foundation. In the quarter, our results included four notable financial achievements. First, we delivered the highest quarterly revenue in the history of The Honest Company with $93 million in sales, which was an increase of 10% year-over-year. Second, we achieved a gross margin of 38%, representing more than 1100 basis points of growth year-over-year. Third, we improved our profitability by achieving positive adjusted EBITDA of $8 million which is our third consecutive quarter of delivering positive adjusted EBITDA, and finally, in Q2, we saw our fifth consecutive quarter of positive cash flow. This strong performance and momentum for the first half of the year gives us confidence to increase our full year guidance for both revenue and adjusted EBITDA. Our success this quarter was broad-based across our portfolio and business model. In particular, the Honest brand is performing notably well in our baby personal care categories as the appeal of our clean and sustainably designed lotions, body washes, and bath products continues to grow. According to the National Center for Health Statistics, the presence of skin allergies among children has nearly doubled since 1997. Also, estimates by KBV Research, as outlined in our investor presentation earlier this year, indicate that the market for sensitive skin care products is expected to be $80 billion by 2030, which is nearly double the market size today. These consumer trend indicators are well aligned with the high standards that Honest delivers in our clean and gentle products. For example, our newly relaunched fragrance-free sensitive skin collection not only fits these important trends, but its performance in the quarter is a great example of our brand maximization pillar. We doubled the revenue of our sensitive Skin collection year-over-year by expanding these items into all Target stores, and our Sensitive Skin Shampoo Plus body wash has become one of our top five selling baby items on Amazon this year. In addition to our clean product benefits, our community looks to Honest for our approach to sustainable design. The early success of our new milk carton style refills for our bubble bath and shampoo plus body wash products are proving to be a great solution in reducing the plastic footprint of our most loyal community members. These 32-ounce refills use 89% less plastic when swapped with three of our 10-ounce size bottles and the milk carton style packaging allows them to be easy to pour. Having recently launched in Target and on Amazon, these new refills are off to a strong start. For anyone who loves a good hot bubble bath, with these refills by your side, we give you permission to enjoy the bubbliest of spa moments as much as you want. Another key driver of our success this quarter is the strong alignment we have across our retailer partnerships. As you know, the Honest brand is a little over 13 years old this year, and we are celebrating the 10th anniversary of our original launch into Target stores. In fact, if you visit a Target store over the next two months, you'll see a festive collection of limited edition diapers and wipes featuring whimsical red and white prints. To bring this partnership to life, our community of content creators has been finding adorable ways to bring Honest's 10th Target birthday to life with trend-setting baby birthday parties full of these limited edition wipes and diapers along with matching decorations and party treats. We hope you'll check out our Honest social media channels on TikTok, Instagram, and Pinterest to be part of the birthday fun. Overall, our second quarter results are evidence that our transformation pillars are creating a stronger financial foundation and that we are well poised to advance our strategy to be in all the places that our community shops with the hero products they love in the formats they want. And now I'll turn it over to Dave to share the financial results of our second quarter and details on our updated financial outlook.

Thank you, and welcome, everyone. We are pleased to report our second quarter results reflecting strong growth momentum that accelerated as the quarter progressed and landed ahead of our expectations. Shipments to our key retail customers were driven by positive consumption trends, inventory builds in preparation for several notable retailer events, and expansion of key hero items into more doors. The actions we took over the last year to address product and supply chain costs and adjusting to a more strategic approach with our trade promotion dollars have continued to support an expanded gross margin reaching a new high of 38% for the company. The benefits we are realizing from all aspects of our transformation pillars continue to materialize and improve financial results that are approaching operating income profitability and have strengthened our foundation to support growth. With the first half of 2024 outpacing our initial guidance on the top and bottom line, we are providing an update to our full year outlook, which I will touch on shortly, but first, I'll review the details of our second quarter results. Net revenue for the second quarter was $93 million, up 10% driven by distribution gains and strong consumption growth in tracked channels. In particular, baby apparel, wipes, and baby personal care are growing market share. Our tracked channel data was up high single digits in the quarter driven by expanded product assortment in baby personal care and wipes, including new flushable wipes and incremental pack size configurations. We're leaning into what is working across our baby portfolio to offer more options on our best-selling innovations and expanding shelf space with our newer large scale customer Walmart. This year, we have increased our wipes category footprint in our Walmart assortment, including launching our new toddler flushable wipes in a subset of Walmart stores and offering larger pack sizes on shelf. In addition, I mentioned revenue growth driven by notable retailer events. This includes limited edition diapers and wipe prints in Walmart stores in celebration of Hispanic Heritage Month beginning this month and extending through October. Also, our annual focus on Amazon Prime Day in July drove a healthy growth in shipments in the second quarter. During the two-day event, our unit volume on Amazon increased over 30% driven by baby personal care and wipes, and our skincare assortment doubled in volume compared to last year. Gross margin for the second quarter was 38%, reaching a new high and expanding over 1100 basis points versus last year. Of this improvement, roughly 500 basis points is attributable to price increases and trade spending efficiencies, 400 basis points is due to product and supply chain cost savings, and 200 basis points is due to mix of higher margin products and sales channels. We began adjusting prices in early 2023 on our diaper assortment and enter 2024 with a lower cost structure that will continue through most of the year. In mid-2023, we raised prices on baby personal care, cosmetics, and skincare, which we have now largely lapped midway through Q3. Our sales teams continue to strike a good balance between pricing and trade promotion investments tailored by customer and product growth objectives. We expect to continue to maintain spending flexibility and trade promotions through the balance of the year to drive category and hero item performance as needed. Cost savings initiatives within our supply chain are in full effect and support a sustainable benefit to margins. However, we continue to monitor certain transportation and shipping costs for volatility that may emerge as global activity ramps up in the back half of the year. Our actions that have impacted our portfolio's profitability as guided by our margin enhancement pillar continue to realize a healthy flow through of unit volume growth to gross profit growth. Operating expenses overall increased $3 million compared to the second quarter last year, but realized 30 basis points of improvement as a percentage of revenue. Included in this quarter's SG&A expense of $26 million was a one-time accelerated restricted stock grant expense related to our previously disclosed separation agreement with Honest Founder. Absent this expense, our SG&A would have been $19 million for the quarter. Marketing expense in the quarter of $11 million increased $2 million versus last year and reflects the commitment to brand building that is integral to our brand maximization pillar. We continue to seek a balanced approach to marketing investments through upper funnel awareness driving spend and mid to lower funnel spend to drive digital conversion, drive trial, and accelerate retail velocities. Adjusted EBITDA for the second quarter was positive $8 million compared to negative $4 million last year. This is our third consecutive quarter of positive adjusted EBITDA and further demonstrates our ability to generate consistent profitable growth, which is a key tenant of our strategic growth objective. Turning to the balance sheet. We ended the quarter with $37 million in cash, an increase of $19 million versus last year. We continue to operate with disciplined management of our balance sheet by driving revenue growth year-to-date of 7% on lower working capital excluding cash over the same time. We also have no debt outstanding and no expected needs to draw on our line of credit. Overall, our second quarter financial results support our continued confidence in our long-term strategic plan and our updated outlook for 2024. Due to the strong momentum and financial results achieved in the first half, we are raising our full year financial outlook for both revenue and adjusted EBITDA. This includes full year revenue to be up mid to high-single digit percentage growth over prior year. Previously, we expected revenue to be up low to mid-single digit percentage growth. The updated revenue outlook reflects continued distribution gains and strength across our baby products and wipes portfolio as we continue to make investments in growing the business. We expect revenue growth in the second half of the year to be similar to growth of 7% achieved in the first half of the year. While we are pleased with our overall growth momentum to date, keep in mind that our largest category diapers is experiencing competitive activity and overall softening category trends. We'll continue to monitor closely and react to any changes needed to support our business for the long term. We are also raising our outlook for adjusted EBITDA for the full year. We now expect adjusted EBITDA to be in the $15 million to $18 million range. Previously, our guidance called for adjusted EBITDA to be in the positive low single digit to mid-single digit millions range. This updated adjusted EBITDA outlook reflects our higher revenue outlook for the full year, structural cost savings and marketing investments that we have plans to increase relative to the first half. The combination of the strength of our team's execution with a focus on operating discipline and healthy first half results gives us confidence in raising our full year financial outlook. We remain focused on executing our plan with the goal of building long-term shareholder value through a stronger and more scaled honest brand and company.

Hi, good evening. Thank you for the questions and congratulations on the strong quarter there. First question for me, just in terms of Walmart, you highlighted the continued progress you have with the retailer there, with toddler flushable wipes and some limited edition prints as well. Just wondering if you could provide some additional commentary, maybe in terms of how it's progressing, some more data points on permanent shelf space and SKUs that you'll be planning to have available at Walmart? Because I know you've been having the initiative to move from the NCAPPS to the NIO there. Thank you.

Hi, Aaron. This is Carla. Great to hear from you, and thank you. Yes, we are so pleased with how well the execution came together in this quarter, resulting in strong revenue, record revenue, 10% growth. Walmart plays a very important role in that growth and we are pleased with our consumption growth at Walmart for this quarter is in the mid-teens at around 16% year-over-year versus the previous quarter. That is a result of both really excellent performance of the expanded distribution and portfolio that we have at Walmart that we've been building together over time as well as the velocity really taking hold on the items that have been there. As you heard Dave talk about in the recorded remarks, right now we're in the beginnings of an execution of something that is unique to Walmart, which is our celebration of Hispanic Heritage Month, which is a 12-week end cap execution, which will take us through mid-October, and along with that, we are always in conversation with Walmart against the strategy that we articulated in our Investor Presentation around expanding availability. At Walmart, we really believe we have an ability to expand both some of the items into more doors at Walmart as well as certain new items that are not in Walmart yet. A great example that we executed that you can see that was shipped in Q2 is our toddler flushable wipes. That's a great example of how even though we are already in Walmart doors, there is so much more opportunity to drive our distribution-based strategy by the types of items, the quantity of items, and the number of aisles that we find ourselves in.

Thank you. Yeah. Hi, Aaron. Dave here. I can help with those questions. We certainly are pleased with how well the organization executed on the transformation pillars driving the strong bottom line results and the progress we made this quarter was a function of certainly revenue growth and the expansion of the margin which contributed to those bottom line results. Expense management was also a key contributor to the bottom line results, seeing some leverage there. So as we look to the back part of the year and our guidance of $15 million to $18 million a couple of functions that you can think about in looking at that. First, our gross margin rate of 38% in Q2 is likely a high watermark in the near term. We're comfortable within a 36% to 38% still reflecting that upper end potential, but somewhere in the middle there is how we're thinking about gross margin and one of the key factors that we're looking at in gross margin in the back half of the year is preserving some flexibility around trade promotion spend. That was one element of particular efficiency in the first half of the year. As we look in the back half, we know that we need to maintain flexibility there and drive and have that flexibility on trade promotion dollars similar to what we had last year in the back half of the year. So I'd expect that plays into a bit of the adjusted EBITDA margin rate question you've got. And then on marketing as well, we increased the amount of spend in this second quarter as we kind of indicated we were thinking of doing from our last call and it proved to be a good outcome for us. So we'll see marketing in the back half of the year likely tick up. If you think about first half marketing as a percent of sales at around 11.5%, we'll likely see that closer up 50 to 100 basis points, so in the back half of the year. So that's another area that we're focused on using as a lever to continue to drive the momentum of the brand, brand awareness and also drive conversion, and it sets us up well as we head into 2025. So those are key aspects of the modeling that hopefully provides some clarity there.

Thanks for taking my question. It's a lot about the how. So the tracked channel consumption outperforming the category this much seemed a little counterintuitive given that the macro pressure has caused trade down in a lot of categories. So I wanted to get a better sense of, first of all, just to confirm that baby products and wipes include strong performance for diapers and then to get a sense of how much of this outperformance came from e-commerce compared to brick and mortar?

Hi, Laura. Why don't I give that a start? And, Dave, if I've missed anything, feel free to layer on for me. Thank you. Good to hear your voice today. Our performance is one of the reasons I feel so pleased with the results is what you're seeing in the 10% growth that we demonstrated in revenue is really quite broad-based across the portfolio. In the remarks, I know we highlighted the strength of our baby personal care category as well as our wipes category. We know we still continue to have a stronger role in the portfolio than in previous years, and for diapers overall, I would say, we know that the diaper category has, as you said, some macroeconomic dynamics and category dynamics that have it be a rather muted category relative to other categories in our portfolio, but we did hold share and grew 2% in diaper consumption this quarter. So we feel that diapers are playing the role as intended in our overall plan and is reflected as we look at the numbers that Dave talked to you about for the remainder of the year at about that 7% growth rate.

Yes. Hi, Laura. Our channel mix continues to be balanced with digital being largely through Amazon. That continues to be our primary digital channel for us. Consumption in the quarter was up high teens, which we're happy with and as we prepared ourselves for Amazon Prime Day, there were some nice shipments out of the quarter to support that event with the two-day event actually seeing some unit volume growth of a little over 30%. So, we're pleased with that digital growth and finding it to be the right balance for us and we expect that going forward.

Thank you, Laura. You know I would love to answer an Amazon question. Overall, what I think you are seeing works so well in our execution is how our transformation pillars are all coming together as a collective to deliver the strategy that we really have always had envisioned. What is helping our Amazon growth is, first of all, our products are very well suited and aligned for the broad base of Amazon shoppers. The Honest brand has been one that has performed well at Amazon for a long time and continues to do so because what we have is what consumers are looking for. That's why we grew 18% in consumption at Amazon in the quarter. It is also very important to have an effective supply chain strategy with Amazon in advance of something big like Prime Day or holiday. Our teams work very well in alignment with their supply chain teams to make sure we are prepared with shipments in advance of the execution, because you do need to have shipments in order to make sure that you continue to perform well on page searches and on page views. We also continue to make sure we bring our new products forward on Amazon. So we know that Amazon has that infinite shelf, doesn’t have the same physical limitations as the other retailers of brick and mortar; but Amazon, it's just as exciting when we bring something like our milk carton style gable top refills, those 32-ounce refills. When we launch those and are able to bring them to life both on Amazon and brick and mortar, that kind of new product introduction also drives growth rate for us in the e-commerce channel.

Hi, Carla. Hi, Dave. Congrats on the stellar quarter there. I just have a quick question in terms of subscriptions. Is there anything to call out there? Are subscriptions continuing to become a bigger part of the picture and are they growing in some of the other segments maybe besides diapers and wipes? Thank you.

Oh, and it's so great to hear from you. This is Carla. I'm also gonna introduce that with us on the call is our Chief Growth Officer, Kate Barton. Kate manages all the portfolios individually. I will just start this to say, I love that you asked that question. I don't know if you know, but I used to work at Amazon running these categories and so when we think of subscription here at Honest, we know that while Honest was a pioneer in the subscription business through our own honest.com channel, we also have a very strong Amazon subscribe and save subscription business. That's not something we break out separately in our numbers. I don't know if Kate wants to build any nuance to that of how we're working with Amazon, but subscription is very important to the way a digital shopper shops today and we're in a great position there.

Hi. It's nice to meet you. As Carla said, I'm Kate Barton, Chief Growth Officer. To answer your question, our subscription model business on our own honest.com site, continues to be a robust part of that business. It's diapers and wipes subscription which conveniently packages them together, and it will continue to be, ongoing a part of our honest.com strategy for the rest of the year. All of our sales on honest.com are subscription. We actually have our whole portfolio on honest.com where you can buy our adult skincare products as well as some of our baby personal care, and so what we try to do is keep it consumer first, and ensure that the options that we see consumers asking for are available.

Great. Thank you. Very, very helpful. And then quickly as a follow-up, obviously some increased marketing spend this quarter and going forward, but in terms of that marketing strategy, what channels are succeeding? And is there anything to call out maybe for the remainder of the year in terms of that marketing strategy?

Wonderful. I'll take that one as well. In our investor presentation, we actually showcased some of the improvements that we've made in our marketing model and some of the improved ads that we've had quarter-over-quarter. We have an incredible team that works cohesively across paid, owned, and earned to have a full funnel modern approach. We are a company of innovators, and we will continue to innovate and stay modern as the marketing landscape evolves, but we are very pleased with the results that we're seeing in our consumption and how consumer to inform messaging as we feature our hero products and really feature what's unique and special about the Honest brand. We're excited about our Q3 campaign that's launching right now and so, we just continue to use that as a lever for growth as we're finding it to be very effective and efficient.

Hi. Good afternoon, everyone, and, congratulations on a great quarter. Carla, as you were approaching, I think it's a year and a half on the job, significant progress on the turnaround, particularly over the last several quarters, but, clearly, it didn't happen overnight. As you look ahead, how do you think about sort of what the next phase for Honest is going to be? And then a little bit more concretely, how are you thinking about driving household penetration in your existing categories? Clearly, you've made a lot of progress, but there's a lot of white space ahead.

Thank you, Eric. It's wonderful to hear from you. I appreciate the recognition of our year and a half milestone. I believe our strong results reflect a team effort, and as I look forward, I'm focusing on the operating discipline mindset we've discussed before, which is a key part of our third transformation pillar. Internally, we refer to it as our people mindset. We aim to operate with focus, executional excellence, and alignment. Our strategy is designed to be sustainable for the long term, anchored in the availability of our strong hero portfolio while continuing to enhance it. However, we are still in the early stages regarding availability. For instance, while our overall portfolio has 85% ACV availability, each individual item tends to be lower. Take our Lavender Bubble Bath, a beloved SKU among our core demographic; it's currently available in only 35% of retailers, even though we know it performs well. We've launched the gable top refill, which reflects our confidence in where we're headed. While you mentioned the next phase, I feel we've only recently shared our current phase with you, and it's functioning well. There's significant opportunity for us to grow by entering new retail accounts and expanding into aisles where we currently don't have a presence. For example, the Dollar Channel is a high-growth segment where we still need to establish a stronger presence. Additionally, we are innovating for new consumer needs, as evidenced by our recent introduction of toddler flushable wipes, which we know are in demand among potty training families. There's much more potential for us to expand our hero products, including their formats, options, and locations. This will be a consistent theme in our updates, highlighting how our strong partnerships with retailers are contributing to our success.

Kate Barton here. I'll take that one. I will say first and foremost that our results of 10% growth in the quarter really articulate and represent the strength of the Honest brand and within that growth, we see our competitive set not just in the natural category, but also within conventional. We are actually now the number one baby personal care brand in Target, and that is over all segments of baby personal care, and so as we think about the consumer demand behind our products, I think that represents relevance of the brand and the relevance of sensitive skin and clean options and that's something that we don't think will go away over time and even in the macroeconomic times that we find ourselves, we still see that to be a very relevant consumer need that we are meeting. So we are absolutely watching the macroeconomic environment and that is factored into our guidance for the year to go, but we also are very confident in our brand positioning, and the part that makes our brand and our products different and special.

Thank you so much to everyone who joined us today for the call. We really appreciate that and we look forward to joining you next quarter with updated results.