Earnings Call Transcript - HNST Q1 2024

Operator, Operator

Thank you all for joining us today for The Honest Company's First Quarter 2024 Earnings Call. Please note that this conference is being recorded. I will now turn the call over to Ms. Elizabeth Bouquard, Senior Director of Investor Relations at The Honest Company. Please proceed.

Elizabeth Bouquard, Senior Director, Investor Relations

Good afternoon, everyone. Thank you for joining our first quarter 2024 conference call. Joining me today are Carla Vernon, our Chief Executive Officer; and 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. And with that, I'll turn it over to Carla.

Carla Vernon, CEO

Thanks, Elizabeth. Good afternoon, everyone, and thank you for joining us today. As we kick off the first quarter of 2024, I'm pleased to share that we achieved another quarter of improved financial results and solid growth momentum. As you recall, during our last earnings call in March, I shared several new achievements and announcements. These included key financial milestones we achieved as a management team in 2023, a new long-range financial algorithm and an updated strategic plan detailing our key drivers for long-term growth. We also reiterated our new operating mindset focused on our transformation pillars. These pillars, brand maximization, margin enhancement and operating discipline, are deeply rooted in our enterprise practices, and they will remain an enduring strategic component of building a stronger financial foundation and unleashing the full potential of the Honest brand. These pillars have enabled us to strengthen our business performance, our operating culture and our financial results. This quarter's notable financial achievements include delivering a second consecutive quarter of positive adjusted EBITDA and reaching revenue growth in line with our outlook, marking our eighth consecutive quarter of positive year-over-year revenue growth. We also achieved a gross margin of 37%, which is a record high for our time as a public company and is an improvement of nearly 1,300 basis points year-over-year. In addition to these financial highlights, our brand continues to grow in the number of homes and people we are reaching. Our last 52-week household penetration is 6%, which is up 18 basis points year-over-year. As we begin on the path of executing our long-range strategic plan, our growth with new consumers and new households is delivered through a blend of increasing availability, maximizing our Hero products and delivering meaningful new product innovation. Our wipes portfolio is emblematic of the strategic building blocks that will drive our long-range growth strategy. Our wipes business grew 44% in consumption in 2023. We're pleased this growth was driven by a combination of strong performance across our core items and successful innovation launches, including flushable wipes. Our early indicators of our successful launch into flushable wipes underscore an important principle of our long-range strategic growth plan. We continue to see that the Honest brand can successfully travel across consumer age groups, usage occasions and even parts of the home. As I look out to 2024 and beyond, I continue to remain confident in our ability to further amplify the distinctive elements of the Honest brand and meet the growing consumer demand for a higher standard of clean ingredients in baby and personal care products. With a clear vision for the future, we will continue to advance and scale Honest's trusted products and our business model through the power of our brands, our team and our Honest standard. And now I will turn it over to Dave to share the financial details of our first quarter and outlook.

David Loretta, CFO

Thank you, and welcome, everyone. As Carla noted, we are off to a solid start in the first quarter, giving us confidence in our newly articulated strategy moving forward. We have continued to make progress on improving profitability while maintaining revenue growth. The significant expansion in operating margin is the result of two drivers. One, meaningful improvement in gross margin of 37% this quarter. And two, diligent management of operating expenses, which leveraged 810 basis points over Q1 of last year. We remain confident in delivering the stated results for 2024 and executing our long-term strategy with a clear focus on building a stronger financial foundation. Before I dive into financial results, however, I wanted to address the changes we made in our revenue reporting structure. We have transitioned away from our prior disaggregated revenue categories and channels to align our reporting structure with how we operate the business and what impacts the timing of our cash flows. We will continue to provide the percentage of revenue from honest.com in our 10-Q, given the difference in cash flow timing versus our third-party channels. Now let me dive deeper into our first quarter results. This quarter, through our brand maximization pillar, we delivered revenue of $86 million, up 3% driven by distribution gains and strong velocities across a number of key products, specifically baby apparel, wipes and baby personal care. We continue to grow the Honest brand through balanced revenue growth of unit volume and pricing. Notably, our total Honest company ACV, or all commodity volume, increased to 85% versus 78% a year ago. Our baby business demonstrated strength across two key areas this quarter: baby apparel and baby personal care. First, our baby apparel business has emerged as a key growth driver as a result of distribution expansion in brick-and-mortar stores, along with consumption growth of 41% at our leading online retail customer. Second, we are pleased with the growth of our baby personal care portfolio that has now become the leading baby personal care brand in our largest brick-and-mortar retail customer. Turning to our second pillar of margin enhancement. Gross margin in the first quarter was 37%, up 1,275 basis points from last year and up 350 basis points sequentially. Key gross margin drivers included product and supply chain cost savings, pricing and trade promotion efficiency. With our continuous improvement mindset, we realized savings across product costs, logistics and fulfillment. As a reminder, the sizable gross margin improvement includes certain one-time inventory write-offs related to the transformation initiative in 2023 that amounted to roughly 400 basis points. The remainder of gross margin improvement included approximately 600 basis points in cost savings, mostly as a result of renegotiated product and logistics contracts, and 275 basis points in pricing. Operating expenses decreased $6 million in the first quarter compared to last year, reflecting lower SG&A expenses and improved marketing efficiency. SG&A as a percentage of revenue declined 500 basis points compared to last year as we remain focused on ongoing expense management. Our operating discipline pillar represents our commitment to generating improved bottom line results and continued strengthening of our balance sheet. Adjusted EBITDA for the first quarter was positive $3 million compared to negative $10 million last year. This is our second consecutive quarter of reporting positive adjusted EBITDA and supports our path to profitability as we have now achieved positive adjusted EBITDA on a trailing 12-month basis. On the balance sheet, we ended the quarter with $34 million in cash, an increase of $22 million versus last year, and zero debt outstanding. This represents our fourth consecutive quarter of positive operating cash flow. Our cash position continues to benefit from a capital-light business model and diligent management of working capital. Overall, our first quarter financial results support our continued confidence in our long-term strategic plan and our outlook for 2024. Therefore, we are reaffirming our full year 2024 financial outlook that includes net revenue growth of low to mid-single-digit percentage and positive adjusted EBITDA in the low single-digit to mid-single-digit millions range. The combination of the strength of our team, our focus on operating discipline and healthy Q1 results give us growing confidence in the mid-single-digit portion of our range in both revenue and adjusted EBITDA. We will continue to closely monitor and react to any changes in the macroeconomic or consumer environment. We are pleased that these three transformation pillars provide us a clear framework for defining and measuring our growth roadmap. Along with our strategic growth plan, they define and guide our building blocks for growth and our operating approach. Together, they enable us to deliver improved financial results and long-term shareholder value creation through a stronger and more scaled Honest brand and company. And with that, I will turn the call over to the operator.

Operator, Operator

And our first question comes from Dara Mohsenian from Morgan Stanley.

Dara Mohsenian, Analyst

First, just a clarity question. Why maintain full year guidance given the Q1 upside to some extent that applies to revenues, but particularly EBITDA given the strong profitability in Q1? Is that just conservatism? Is it early in the year? Or is there something about Q1 that comes out of the balance of the year? And then, Carla, maybe just given an uncertain consumer environment, can you discuss if you think you're seeing any impact on consumption for your products from any consumer pressure or trade-down impacts on your business? And perhaps give us an update for how things are trending so far in Q2.

David Loretta, CFO

Dara, this is Dave here. Thanks for the question. We are certainly pleased with the first quarter results. We’ve made a strong start this year, and we're happy with both the revenue and the margin expansion, which is a result of several factors working in unison. As we look ahead for the rest of the year, we want to approach uncertainties with caution. It’s still early in the year, and we are carefully optimistic that the current range is appropriate. I mentioned in my prepared remarks that we’re gaining confidence leaning towards the middle of that range. The next couple of quarters will provide us with a clearer direction. We will return next quarter to update any changes we may have.

Carla Vernon, CEO

Dara, this is Carla. It's great to hear from you. Thank you for being on our call. Your question was about what I'm observing in our categories and whether any external trends or consumer indicators are concerning to me. I want to emphasize that our results are propelled by consistently strong consumption across our entire category portfolio. A significant confidence booster for us this quarter is that we've managed to achieve year-over-year growth through a combination of unit volume and pricing, as mentioned by Dave. This illustrates that the Honest brand is robust and resonates well, even during challenging times, because the benefits we provide in clean personal care and baby products are substantial, and our brand has a proven leadership position in this sector. Additionally, our team's strong execution and effective support for the brand are working excellently for us.

Dara Mohsenian, Analyst

Great. And then, Dave, if I can slip in one follow-up. Just the gross margins were obviously very strong in the quarter, well above what the street expected. It sounded like most of the drivers you mentioned year-over-year were more sustainable. So maybe can you just talk about that gross margin line and how sustainable the Q1 level is as you think about the go-forward over the next few quarters here?

David Loretta, CFO

Yes, certainly. As you said, gross margin drivers were a big element of what we saw. It is the improvement this quarter. And we did call out that improvement over last year benefited from the prior year's write-off due to the transformation initiatives, so roughly 400 basis points benefit there. But the remaining amount is a function of cost, cost management on products, fulfillment, logistics and the benefit of pricing. And so if you think about our outlook and driving earnings growth, it will come from a combination of increased revenue, but also the expansion of gross margin. And Q4 are 35% related to a pretty healthy increase and in Q1, 37%. So we're comfortable within this range and see that that's where for the balance of the year, we'll still see meaningful improvement over the prior year, which gets sequentially more tougher with the comps, but we're comfortable in the range that we're at.

Operator, Operator

And our next question comes from Dana Telsey from Telsey Group.

Dana Telsey, Analyst

Carla, as you think about the distribution channels and your categories, what changes are you seeing in distribution channels? What changes are you seeing in orders? And then as you think about pricing going forward, what lever on the gross margin does that play going forward as compared to what happened this quarter?

Carla Vernon, CEO

Dana, nice to be with you today. Thanks for joining the call. So as far as distribution, as you pointed out, distribution is such an important part of our overall roadmap for growth. We articulated in our recent investor presentation in these three pillars: brand maximization, margin enhancement and operating discipline. And that distribution piece really lives for us in that brand maximization pillar. And it's actually been a very strong driver for us. As you may recall, we moved from 78 ACV into the mid-80s this year. And our distribution growth in the quarter, we also grew 9% within the quarter in distribution. So we're very pleased at the early stages of really delivering on our overall distribution strategy, which internally we have this shorthand, we call it our faces, places and spaces strategy because there is so much fundamental growth for us available on distribution. That distribution is actually driven not only by getting into a new door, but by increasing the product offerings available in our Hero portfolio. So, for example, this year we executed a couple of really strong sizing strategy launches. We launched our gable-top refills for our very top selling baby personal care, body wash and shampoo line. We also launched a large size of our healing ointment. By being able to bring our Hero items forward in larger sizes, we're really able to bring distribution on proven hits to our retail channels and our current aisle. So we're very pleased about the early days in which we're executing our distribution strategy. We continue to expect that to be a leading driver of our scaling of the Honest brand. You know us about pricing. We have seen our pricing be affected in market that we put in place over the last year, which broadly was across almost all of our categories. As I just said, for the last 12 weeks, our growth is really nicely balanced between unit growth and dollar growth. So we feel comfortable that our pricing has been accepted. And then where pricing plays a role in the future will be something we will always consider based on what we're seeing in our relationship with the categories where we serve a role as a premium brand and what we see as the sort of consumer macroeconomics.

Operator, Operator

And our next question comes from Laura Champine from Loop.

Laura Champine, Analyst

It's a follow-up. Congratulations on the EBITDA performance. It seems that the improvements you've made in profitability are mostly structural. If you were to experience a negative EBITDA in the next quarter or any quarter this year, what would likely cause that decline? Would it require a drop in sales? What would need to occur for you to return to an EBITDA loss?

David Loretta, CFO

Thank you, Laura, for acknowledging our progress on EBITDA. We are pleased with the results, which reflect our team's successful execution in several areas. Our business model is becoming more solid, and the guidance we've provided for adjusted EBITDA in the low to mid-single-digit millions suggests that we have room for improvement each quarter. With a significant part of the year still ahead, we will continue to work on our strategies and strive for the best execution possible. I think that's where our confidence lies, and I’ll leave it at that for now.

Laura Champine, Analyst

Let me try to rephrase in a way that's a little less guidance than CFO-oriented and get a bigger picture view. Maybe, Carla, if you think about your business, what are the risks that you're watching out for right now, especially that might impact your profitability?

Carla Vernon, CEO

Laura, it's great to hear from you. I want to be straightforward; we've been consistently improving our performance each quarter. This positive trend is a result of our team effectively collaborating over the past year. We've assembled a group with diverse skills and expertise, and I’m proud of our execution. As we look to the future, I believe we are maintaining the internal discipline needed to follow through on our plan and adapt to any changes. However, there are external factors beyond our control that I cannot predict or comment on. What I can say is that the plan we've laid out and our guidance for the year are grounded in our confidence in what lies ahead and our identified drivers. We need to stay vigilant about consumer macroeconomic trends or any unpredictability that could impact not only us but others in our industry. The reason we feel assured in our reporting is our strong execution.

Operator, Operator

And our next question comes from Andrea Teixeira from JPMorgan.

Andrea Teixeira, Analyst

I hope you’re all well and congratulations on the performance. Following up on Dana's question about distribution, could you provide a timeline of the additional distribution gained last year and this year? Should we be cautious about the impact of those gains? Are you seeing that velocity and innovation are balancing it out? Additionally, could you address the comments Dave made about being conservative at this time? Are there any reinvestments needed as you expand distribution or related to changes in the likeness agreement with Jessica Alba or any associated costs? I understand this would be beneficial for margins in the long term, but is there any short-term impact on adjusted EBITDA that might counterbalance the strong start to the year?

Carla Vernon, CEO

I believe we have a strategy to address this effectively. I'll begin by discussing how our distribution efforts have shaped our progress. I recognize your interest in investments, and I'd like Dave to elaborate on our perspective regarding investments and our future plans in that area. Regarding distribution, as we've mentioned in previous quarters, we've been quite successful. Our portfolio is well-balanced between brick-and-mortar and digital channels, and we are pleased with our growth. However, brick-and-mortar is where we see significant changes in our distribution. This area is where we lag behind our competitors. In 2022, we made considerable strides by entering Walmart, and as these gains materialized in 2023, our progress has been more steady. Distribution in brick-and-mortar involves different categories and can lead to substantial one-time gains, after which we aim to maintain stable velocities. The rhythm of distribution will vary over time, but we recognize there's vast potential for growth as we enter more retail outlets. Currently, we have only reached 50% distribution of our inventory at Walmart, with some items even lower at 20% to 30% ACV. While we are established with several retailers, we are focused on expanding our presence across the board, which will occur at different times due to various resets, potentially resulting in uneven distribution. Nevertheless, we are optimistic about our long-term outlook.

Andrea Teixeira, Analyst

Carla, I would like to make one comment on that. You've achieved impressive results in both online and physical sales. The report mentions that tracked channel consumption increased by 7%. Could you clarify the situation with the non-tracked channels? Since your sales only grew by 3%, it suggests that there is a 400 basis point challenge impacting your revenue. Is there any destocking occurring, and if so, has it concluded?

David Loretta, CFO

Yes. Andrea, I want to address the last point regarding the 3% growth over the prior year. As mentioned last quarter, there was a shift in order flow into the fourth quarter which resulted in a 10% increase in that period's net revenue. Typically, those orders would have fallen in the first quarter, which accounts for some variations in our tracked channel progress. Now, regarding EBITDA and the flexibility we have, our business model is inherently flexible. We aren't burdened with significant fixed overhead and capital expenses. The revenue flow-through to the bottom line was quite significant, especially after recent structural adjustments in product costs and fulfillment and logistics expenses. Additionally, part of this quarter's EBITDA and gross margin improvement can be attributed to reduced trade promotions compared to what we usually see, allowing more gross revenue to translate into net revenue. In the future, we expect to have flexible trade promotion activities and marketing investments that can maintain our momentum throughout the year. It’s important for us to keep this flexibility in mind and leverage it at the right time to sustain our top-line growth. Regarding the NIL question, as we've discussed, there's a transition plan in place, and any costs associated with adjustments under the separation agreements have already been incorporated into our outlook. We don't anticipate any additional expenses beyond what we've planned for this transition, which has been in progress for the past year anyway, so it shouldn't significantly affect our product and assortment.

Operator, Operator

And our next question comes from Aaron Grey from Alliance Global Partners.

Aaron Grey, Analyst

So first question from me is I just want to go off the back of the last one. And just to get better color in terms of how you're thinking about letting some of the, you know, top line flow through the bottom, especially in the back half, we're looking for more top line growth. You kind of touched around there, Dave, in terms of having that lever in terms of trade promotion and marketing. So is it fair to think that maybe you kind of push that lever a little bit more on the marketing and trade in the back half to drive growth longer term rather than let it flow through the bottom line versus letting it flow through maybe coming at the higher end of where guidance is today? Just in terms of how you think about that would be helpful.

David Loretta, CFO

Yes. I mean we've got marketing plans in place today, but there's also a lot of flexibility because so much of what we do spend in the media content side is digital, and that's short term. And so we have the ability to kind of dial it up and dial it down based on return on ad spend. And we like having that flexibility during different periods of events that we've got planned with retail partners and to drive in our digital channels with our online retailers. So it will be a flexible aspect to the model we see going forward. But again, fits within the guidance that we've given and even leaning towards the kind of the mid side of that guidance, as I shared on my remarks. So pleased with the progress we're making to execute at this stage.

Aaron Grey, Analyst

Okay. Great. And second question from me. Just in terms of some other issues you have in terms of packaging specifically. Can you give us any updates in terms of some expectations there? Have you guys done any types of pilots or what we could think in terms of some changes on packaging for some of your SKUs going forward?

Carla Vernon, CEO

Thank you for your question, Aaron. It's great to hear from you. I appreciate it. Packaging plays a significant role in our brand maximization strategy. I’m very pleased with the collaboration between Kate Barton, our Chief Growth Officer, and Jonathan Maley, our Head of Sales, as they focus on updating our packaging, which is essential to our marketing strategy. We aim to ensure that our packaging is consistent across our portfolio. Over the past year, the team has been diligently iterating on the packaging, conducting both quantitative analysis and in-store qualitative tests. As former members of some leading consumer packaged goods companies, we recognize the importance of packaging as a primary marketing tool, especially for a brand like ours, and getting it right is crucial. We've conducted physical packaging tests in our top retail stores, testing different versions. We have some exciting updates planned, particularly regarding transparency about the product inside the packaging. This new execution will significantly enhance product visibility and make our beauty care products more appealing to consumers.

Operator, Operator

And our next question comes from Ryan Meyers from Lake Street Capital Markets.

Ryan Meyers, Analyst

Congrats on another solid quarter. Just wondering if there's any way that you can quantify new customers that you were able to add during the quarter?

Carla Vernon, CEO

We're jumping all over each other to answer that. There's a few ways we think about that. One of them is really recounted in my remarks. So as I was talking about the success in the quarter, especially the revenue growth that we've seen, that's really driven by expansion with distribution and expansion by our buyer base. The household penetration information that I shared, you may recall in the script, I indicated that this quarter, our household penetration was up 18 basis points. Also if you look to our investor presentation that is on our website, we published the new investor presentation last fiscal quarter at investors.honest.com. There's some information there that talks about looking at some of the new household growth, specifically in our leading digital retailer. Really pleased. Last quarter, we reported that we quadrupled the new-to-brand household users on Amazon for Honest and as a former Amazon alum myself, I can tell you that pulling new people into your order pattern is a really high traction way to grow. So we have a lot of indicators that make us feel good about that.

Operator, Operator

And thank you. And I am showing no further questions. I would now like to turn the call over to Carla for closing remarks.

Carla Vernon, CEO

Everybody, thank you so much for joining in and being with us today. It was a pleasure being with you. We look forward to speaking with you next quarter and can't wait to reconnect. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.