Earnings Call Transcript - HNST Q3 2024

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Honest Company Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would like now to turn the conference over to Allison Malkin of ICR. Please go ahead.

Allison Malkin, ICR

Good afternoon everyone. Thank you for joining our third quarter 2024 conference call. Joining me today from the Honest Company, our Chief Executive Officer Carla Vernon, and Chief Financial Officer, Dave Loretta. 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 the call over to Carla.

Carla Vernon, CEO

Thanks, Allison. Hello everyone, and thank you for joining us today. I'm pleased to share the details of our strong performance for the third quarter of 2024. The continued financial improvement of Honest is due in large part to the dedication of our teams and their commitment to delivering a collection of cleanly designed and consumer-loved personal care products. Our transformation pillars of brand maximization, margin enhancement, and operating discipline provide our teams with a framework that balances our product mission with our financial mission. For the third quarter of fiscal 2024, our results include three notable financial achievements. First, we delivered our highest quarterly revenue in the history of the Honest Company with $99 million in sales, which represents a 15% year-over-year increase. Second, we achieved a gross margin of 39%, representing an expansion of 710 basis points over the same period last year. And lastly, we generated adjusted EBITDA of $7 million, marking our fourth consecutive quarter of positive adjusted EBITDA. With this momentum and strong performance in the third quarter, we are raising our full year 2024 guidance for both revenue and adjusted EBITDA. Moreover, we are pleased that the consumption of Honest products was stronger than the competitive set of personal care categories. In this quarter, according to Circana tracked channel data, Honest's portfolio grew 9% year-over-year, compared to a 2% decline in consumption from the comparable personal care sector. This further evidences the strength of the Honest brand and how we uniquely meet the needs of today's families. Despite challenging macroeconomic factors and consumer spending pressures, we continue to see increasing interest in clean product solutions. According to Mintel, over 70% of consumers are concerned about the effects of certain chemicals in personal care products and prioritize safe for sensitive skin claims to meet their families' needs. Sometimes the importance of our mission comes to life most powerfully through the personal interactions we have with people who use Honest products. This happened for me during a photo shoot at our Honest office. We wanted to feature real Honest users, so we hosted an open casting call and reached out to our community to invite them to be part of our campaign. A beautiful and diverse array of people of every age attended. As the photo shoot wrapped up, a woman in her 20s or 30s approached me to share her story of fighting and recovering from cancer. During her treatment, she tried various products to keep her skin soft and moisturized through brutal cancer therapy. She told me that when she discovered our Hydrogel Cream, which is a lightweight moisturizer, it was the first product gentle and moisturizing enough not to irritate her delicate skin. She even showed me an app she used that rates products for their clean ingredients. Our Honest products are doing what they were created to do: provide safe, efficacious personal care for those in need. So it's no surprise that our Hydrogel Cream is growing 34% year-to-date in consumption at Amazon, and yet it has so much potential with only 21% ACV distribution in national retail stores. At Honest, we are lucky to often hear customer testimonials like the one I just shared, which inspires us every day to deliver solutions to our community by committing to what we call the Honest standard. This standard provides our teams with an important set of formulation and design principles that make Honest products well-suited to meet the moment. Today, I’m an Honest mom, but our products didn’t exist when my teenagers were babies. Now, I’m pleased that my grandniece Kyla, born last month, her parents, many new parents on our Honest team, and all the parents in our community can rest assured that our rigorous Honest standard includes a list of over 3,000 ingredients of concern that we choose not to use in our products. We pride ourselves on having a higher standard than required by any U.S. or European Union regulations. This standard helps us meet the high expectations of Honest families, stand out in the personal care product market, and drive the brand growth that is at the heart of our brand maximization transformation pillar. Our brand's strength is evident through our 9% national consumption growth and 19% growth on Amazon. The resonance of our Honest standard can be seen in our community growth and distribution. This quarter, our household penetration among Honest users reached 6.7%, an increase of 23 basis points versus last year, while our retail distribution grew by 4%, maintaining strong sales momentum that reflects a 5% sales velocity increase. Together, our performance and alignment with growing consumer needs have made Honest the leading natural baby personal care brand in the United States. While we are confident in our top-line growth, our number one priority remains margin improvement and strengthening our financial foundation through our transformation pillars of margin enhancement and operating discipline. During a recent visit to our Las Vegas distribution center, my team and I saw how this focus is paying off across the organization. Our supply chain and logistics teams shared how they optimized a previously cumbersome approach to pallet management. In prior years, when our order quantities were smaller, the team received pallets that needed to be broken down to apply a product identity label to each case, only to reassemble the labeled cases back into partial and mixed pallets prior to shipping. This year, in partnership with our largest retailers, the team identified items frequently ordered in full pallet quantities. Now, those pallets get labeled simply and correctly, without needing breakdown and reassembly. This optimization allowed us to save on labor, order turnaround time, and retail pickup speed. This process improvement demonstrates the ability of our transformation pillars to unlock the power and scale of the Honest brand and our business model. As I close, I thank our entire Honest team for their commitment to driving continued financial improvement and performance momentum for the Honest brand. I’m so proud of this team and the extraordinary execution this quarter. Now, I will turn it over to Dave to share the financial results of our third quarter and details on our updated financial outlook.

Dave Loretta, CFO

Thank you, Carla. As noted, our third quarter results surpassed our expectations across key financial metrics, and we saw significant accomplishments toward our transformation pillars. On the top line, our 15% revenue increase was balanced across distribution and velocity gains and included shipments in support of retail and digital events. We generated gross margin expansion, which reached a new high of 38.7%, driven by benefits across the cost structure through supply chain efficiencies and product cost savings. The execution of our transformation pillars continues to deliver efficiencies as we grow, as demonstrated by our strong revenue growth, gross margin expansion, and disciplined SG&A spending leading to profitability in the quarter. As provided in our press release issued today, we are raising our annual guidance for the second time this year, reflecting our year-to-date performance and our positive view of the business. Let me turn to our third quarter results. As Carla noted previously, net revenue was $99 million, up 15% from the prior year third quarter, driven by strong performance across our baby products and wipes portfolios. Also noted, retail tracked channel consumption grew 9% compared to the comparative categories, which were down 2% in the same period. At Amazon, our largest digital customer, consumption in the period was up 19%. We advanced our brand maximization pillar with balanced revenue growth, seeing increases in distribution and velocity. We continue to realize increased consumer demand across our core business offerings, allowing Honest to play a bigger role in consumers' daily lives. In fact, our community is purchasing our brand across multiple categories, which drove increased household penetration and spend per household in the quarter. Revenue also benefited from shipments to support retail events in the quarter, including our target 10th anniversary collection and limited edition diapers and wipes in celebration of Hispanic Heritage Month. Additionally, we saw strong shipments in preparation for Amazon Prime Day events in July and October. During October Prime Day, our products performed incredibly well, with our 720-count clean conscious wipes landing in the Top 100 product performance deals sitewide in terms of unit volume sold. Gross margin for the third quarter was 38.7%, a new record, and expanded 710 basis points versus last year, with roughly 400 basis points related to supply chain cost reductions and 300 basis points related to product cost reductions. As guided by our margin enhancement pillar, we are confident in our ability to profitably grow the business as we benefit from sustainable cost savings. Through our operating discipline pillar, we are mindful and actively planning for levers we can use in response to an ever-changing sourcing and supply chain landscape, including the potential for new tariffs, commodity price increases, or disruptions to logistics. Moving on to expenses, Total operating expense increased $3 million compared to the third quarter last year, but as a percentage of revenue generated 220 basis points of leverage. Breaking this down further, SG&A as a percentage of revenue decreased 440 basis points compared to last year. Our diligence around managing expenses across the organization while generating revenue growth has contributed to the majority of this strong leverage year-over-year. That said, included in this quarter's SG&A were non-recurring legal expenses of $4.1 million. In the fourth quarter, we expect an additional $4 million to $5 million related to this non-recurring expense. Marketing expense totaled $13 million, an increase of $4 million from the prior year third quarter, reaching 13.3% of revenue versus 10.6% of revenue last year. As expected, we continue to seek a balanced approach to gaining brand trial, building awareness, and increasing household penetration. The combination of double-digit revenue growth and expansion in gross margin offset the increase in operating expenses, leading to an $8 million improvement in operating income for the quarter versus an operating loss last year. In addition, adjusted EBITDA was positive $7 million compared to negative $1 million last year. This is our fourth consecutive quarter of positive adjusted EBITDA and highlights that the execution of our strategy through the transformation pillars is driving profitable growth as intended. Turning to the balance sheet, we continue to build a strong financial foundation with quarter-end cash of $53 million and no debt outstanding. Inventory at quarter-end was $75 million, a decrease of $5 million from the end of the third quarter of 2023. We remain comfortable with our inventory levels as we enter the fourth quarter and will maintain appropriate levels to support our expected growth. Our operating discipline pillar is driving efficiencies in our working capital usage, which led to a sequential increase of $17 million in cash flow versus the second quarter and an increase of $3 million compared to the third quarter of last year. Turning to guidance, given our strong performance and positive outlook, we are increasing our full-year revenue and adjusted EBITDA guidance for the second time this year. Our revenue guidance is now set to the high single-digit percentage growth range year-over-year, which is an increase from our previous guidance for revenue in the mid-to-high single-digit percentage growth range. As you are aware, we plan our business on an annual basis and may experience quarterly fluctuations in growth rates due to the timing of distribution gains and shipments. Based on the current view of our order flow, we do not expect to repeat the earlier timing of shipments which benefited Q4 of 2023. Second, with the significant progress we're making on expanding margins and controlling costs, we expect adjusted EBITDA in the range of $20 million to $22 million compared to the previous guidance of $15 million to $18 million. This represents an improvement of over $30 million from last year. Annual gross margin is expected in the range of 37% to 38% as we benefit from savings in product costs and supply chain efficiencies. Looking ahead, we believe we have strengthened our foundation for future growth and expect the ongoing execution of our strategy to deliver annual revenue growth, expand profit margins, and generate strong cash flow, all benefiting from our asset-light business model. The investments we make aim to expand the availability of Honest products to all places our community shops. As a result, we are well-positioned to continue building on our financial gains and drive increased value for our shareholders. And with that, I'll turn the call back to the operator. Thank you.

Operator, Operator

And please stand by for our first question. The first question comes from Aaron Grey with AGP. Your line is now open. Good evening.

Aaron Grey, Analyst

Good evening. Thank you for the questions and a nice quarter there. So, first question for me. You mentioned strong consumption trends, but also talked about some shipment benefits. So curious if you could quantify how much of the shipment benefits impacted the quarter. I believe that also led to the implied softer growth for Q4, so that would be helpful there? Thank you.

Dave Loretta, CFO

Yes. Hi Aaron, this is Dave. The consumption trend that we saw in the quarter we're really excited about at the retail level, 9% up with Amazon at 19%. Blending the two together resembles our revenue growth rate of 15% for that period. We are pleased with that performance and how the team delivered it in terms of the incremental shipments that we did realize, and those were in line with the retail events. We talked about in our second quarter, both an event at Target and an event at Walmart and then Amazon Prime Day, both to supply for the July Prime Day and the October Prime Day since that was really just the first week into that following week after our third quarter ended. To put some context around the percentage growth rate, you could think of it as roughly 3 to 4 percentage points of our revenue growth attributed to supplying that inventory for those events. The balance is really ongoing momentum from a consumption standpoint and order flow.

Aaron Grey, Analyst

Okay, great. Thank you for that. I appreciate it. Second question for me. As we think bigger picture, last call, you guys talked about investments to drive more growth that continue to bear fruit for you guys, building a nice cash balance. So, looking forward into 2025 and the holiday season, how much more confidence do you guys have to keep pushing the lever on different marketing or investing in gross margins to drive continued growth versus allowing more of that to drop down to the bottom line? Thanks.

Dave Loretta, CFO

Yes, sure. Aaron, as we talked about in the second half of the year, we intended to increase both marketing spend and trade promotion investments, and we’re pleased with how that played out for us. As you saw in the third quarter, marketing was up in dollars relative to last year and sales a little over 13%. We also applied deeper trade promotions during that period. So we're comfortable with the flexibility we've got to dial up our marketing to drive awareness and brand trial. Some of that evidence is reflected in the stats shared around household penetration, which is at 6.7%, an increase of 23 basis points year-to-date. We are seeing the results of that brand awareness and consumer acceptance. We’re confident that we have both the flexibility to drive velocities with some of our trade promotion dollars and continue to expand brand awareness through marketing initiatives employed in the third quarter. We'll continue to do that in the remaining quarter of the year, and as we move into 2025, we’ll provide you with more color on that period during our guidance for that timeframe.

Operator, Operator

And the next question comes from Owen Rickert with Northland Capital Markets. Your line is open.

Owen Rickert, Analyst

Hi, Carla, hi, Dave. Congrats on another great print. I guess quickly, how are you viewing the Dollar Store end segment and what's your thoughts on the opportunity there? How penetrated are you in that space? Any insights would be really helpful.

Carla Vernon, CEO

Hi Owen. Nice to talk to you. Thank you for joining us. If you take a look at our investor presentation that's online, you will see that we have a very intentional distribution-based growth strategy underlying our long-range plan and growth model. In this quarter, we've communicated our distribution growth of 4%, following our stores, doors, aisles, and shelves distribution growth strategy. We're pleased with the fact that as our distribution grows, our velocities are growing at the same time, with velocities up 5%. We currently represent about 50,000 retail doors overall, which is less than half of all retail doors available across various brick-and-mortar channels. We see enormous runway to continue growing and believe our brand fits into the Dollar Store channel as young families shop there and have the same sensitive skin needs that align with 70% of households focused on ingredient content. We look forward to being available in more channels to drive awareness and growth.

Owen Rickert, Analyst

Great. Thanks, Carla. That was very helpful. Secondly, could you provide some more insight into new marketing initiatives discussed on the previous earnings call? What worked well in the quarter, and what should we keep an eye on for Q4?

Carla Vernon, CEO

Yes. Overall, we've got a world-class marketing team that has been enhancing the effectiveness of our marketing spend and balancing upper, middle, and lower funnel activities. Some of our marketing is used in partnership with our retailers. We had strong performance during both Prime Days and Target Circle Week in the quarter with double-digit growth rates across those events. I’d like to highlight that during the last Amazon Prime Day, our 720-count wipes box was among the top 100 items across all of Prime Day. We have a strong sense of how to use our marketing dollars effectively to plug into our retailer-specific tentpole items. Additionally, we ran a campaign this quarter called the Skin to Skin campaign, which was able to feature a variety of products across our portfolio, all with a common thread that they are good and trustworthy for sensitive skin. You will continue to see a balance of events aimed at amplifying our retail execution alongside larger consumer-focused marketing initiatives to showcase the benefits and variety within Honest.

Operator, Operator

And the next question comes from Dara Mohsenian with Morgan Stanley. Your line is open.

Dara Mohsenian, Analyst

Hi, good afternoon guys.

Dave Loretta, CFO

Hi, Dara.

Dara Mohsenian, Analyst

So Carla, I was just hoping you could take a step back now, three quarters through the year. The strong consumption trends we've seen in both direct channels and digital. How sustainable is that as we look out to 2025 and beyond? You just touched on some of the marketing success and how you think about sustainability going forward from here? Similar question on gross margins, specifically the 37% to 38% range for the full year. Is that sustainable moving forward? Any key puts and takes as you look beyond this year longer-term? Thanks.

Carla Vernon, CEO

Sure. Dara, it's great to hear you today. To talk about consumption, I would remind everyone that the overall consumption in the MULO tracked channel data was up 9% in the quarter, complemented by our 19% consumption growth on Amazon. Together, this strong measurement indicates the progress of velocities and increased household penetration. We’re now at 6.7% household penetration, showing a 23-basis point increase year-to-date, which indicates a solid driver of consumption from our retail partners and consumers. When considering sustainability, I assess what elements are driving that consumption. Our consumption has been balanced, with a 5% unit growth and a 4% price growth. This indicates that consumers are not just attracted by increased pricing, but buying larger baskets of Honest products in transactions. Our repeat rates for customers have also shown growth in the quarter. While I can't speak specifically about future consumption, I feel confident about the indicators and fundamentals we see. Regarding gross margins, the improvement we achieved year-to-date was a little over 1,000 basis points and is quite significant. They are sustainable and structural. We see opportunities for continued cost structure improvements in our product set across our sourcing network and through leveraging supply chain efficiencies as sales grow. Additionally, growth in margin categories will also play a significant role in our long-term margin outlook.

Dave Loretta, CFO

Dara, I'd like to touch on the gross margin sustainability question. We've seen significant improvement this year, and the combination of product cost savings and supply chain fulfillment savings is expected to continue. We’re currently engaged in diversifying our sourcing and actively exploring cost reductions within our product line, including wipes, to maintain our gross margin stability. Therefore, while we need to stay cautious about any developments affecting our cost structure, we’re prepared to address changes efficiently.

Operator, Operator

And our next question comes from Anna Glaessgen with B. Riley Securities. Your line is open.

Anna Glaessgen, Analyst

Hi, good afternoon. Thanks for taking my questions. I'd love to start on Amazon Prime Day and historically its efficacy as a tool to reach new consumers. Do you generally see that as existing customers buying in bulk to take advantage of discounts or do you see it as an opportunity to convert new customers to DTC customers? Thank you.

Carla Vernon, CEO

Anna, this is Carla. Nice to talk to you. We know from our Amazon purchase behavior that we track each quarter to assess how many new-to-brand shoppers we gain. I don’t have the specific numbers for this quarter, but from the last quarter, we reported that we quadrupled new-to-brand first-time shoppers on Amazon. Generally, Prime Day features both replenishment shoppers who are loyal to the brand and also allows us to capture new households searching for product categories without applying specific brand loyalty. Since we perform strongly, we rank higher in those searches, increasing our brand awareness and trial among new customers. Our team actively works with Amazon to deploy the right investments that unlock mutual growth, and we’re pleased with how that growth has unfolded.

Anna Glaessgen, Analyst

Great, thanks for that color, Carla. I’d like to shift to assessing potential exposure to China sourcing. I believe you are limited to sourcing wipes from China, which is roughly less than 20% of sales, but any update there would be great.

Dave Loretta, CFO

Yes, Anna. That is indeed a topical issue we've been monitoring. You're correct that our wipes portfolio is sourced from China. Our team is actively working with our suppliers to address tariffs and identify cost efficiencies. We’re prepared for potential uncertainties regarding new tariffs, but are not concentrated heavily in that region. Our portfolio balances sourcing domestically and internationally, enabling us to maintain expected gross margin levels. We are committed to proactively addressing sourcing challenges.

Operator, Operator

And our next question comes from Laura Champine with Loop. Your line is open.

Laura Champine, Analyst

Thanks for taking my question. The gross margin gains have been substantial. How much of a lift are you getting there from the price mix benefits that you’re seeing? If you can quantify that as a percentage lift to sales in Q3 on that 15%, that would be great. Thanks.

Dave Loretta, CFO

Yes, Laura. You’re right, the 38.7% gross margin is an all-time high for us, expanded over 700 basis points. However, that increase is primarily due to cost savings rather than pricing. The pricing adjustments we made in 2023 have lapped, and by Q3, the contribution to gross margins from pricing was minimal. The significant margin rate increase is due to cost-saving measures.

Laura Champine, Analyst

Got it. A quick follow-up on the tariff question. I understand you’re preparing for it, but given that you’re sourcing one of your highest growth categories out of China, we’re concerned about the wipe side. How quickly could you shift production? And how comfortable would you be with raising prices to offset any tariff-related cost increases?

Dave Loretta, CFO

We don’t anticipate significant impact in 2025 from any tariff implications, as lead times on our inventory flow mitigate immediate effects. Our sourcing flexibility allows for diversifying suppliers and locations. Rest assured, we are addressing this topic actively, but we must remain prudent regarding inventory and cost decisions.

Operator, Operator

I would now like to turn the call back to Carla Vernon for closing remarks.

Carla Vernon, CEO

Thanks everyone for joining us today. It was a pleasure speaking with you and sharing our third quarter results. We look forward to speaking with many of you at some of our upcoming investor events. The rest of you will see you next quarter.

Operator, Operator

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