The Honest Company, Inc. (NASDAQ:HNST) Q1 2023 Earnings Call Transcript May 9, 2023

The Honest Company, Inc. misses on earnings expectations. Reported EPS is $-0.2 EPS, expectations were $-0.13.

Operator: Good day, and thank you for standing by. Welcome to The Honest Company First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session [Operator Instructions]. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Austenfeld. Please go ahead.

Steve Austenfeld: Good morning, everyone. Thank you for joining our first quarter 2023 conference call. Joining me today are Carla Vernon, Chief Executive Officer; and Kelly Kennedy, our Chief Financial Officer. Before we start, I’d 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 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 Web site at investors.honest.com.

With that, I will turn the call over to Carla.

Carla Vernon: Thanks, Steve. Good morning, everyone and thanks for joining us today. Last quarter, I indicated that we were not satisfied with the recent performance of our business. I also assured you that we can and will drive shareholder value by bringing greater discipline to our cost structure and operating approach. It was also my first opportunity to share my confidence in the fundamental strength and growth potential of the Honest brand. With decades of experience as a CPG Brand Builder and more recent experience as a digital retailer, I was drawn to the company because of the quality of the product, the demonstrated strength across a broad set of categories and the way the modern mission of the clean and sustainable product design has taken a strong place in consumers’ homes and lives.

And now with my first 100 days behind me, my conviction about the growth potential of the Honest brand and the opportunity to transform our business model remains strong. The strength of our portfolio is reflected in the Q1 revenue growth we announced today, which exceeded our expectations. As a result, we are now raising our revenue outlook for the year. Over the last year, we’ve successfully executed our plan to expand retail distribution and drive greater growth in physical channels. And while we are pleased with the roll of growth from the retail channel, our Q1 revenue performance was balanced evenly across retail and digital channels with both growing over 20%, illustrating the strength of our omnichannel approach. While we are pleased with our top line performance, as I emphasized with you last quarter, we are relentlessly focused on improving our cost structure and margin performance.

I’m pleased to announce the launch of our transformation initiative in Q1, which will drive long term profitability and sustained shareholder value. This transformation initiative encompasses three pillars; brand maximization, margin enhancement and operating discipline. The workstreams across these pillars are expected to improve our margin structure, drive focus on the most productive areas of our business, reduce working capital, deliver greater impact of brand building investments and improve executional excellence across the enterprise. While some of this work builds on ongoing work streams, I’m pleased to share that in recent months our team has redoubled our efforts to identify a more robust set of strategies and initiatives to accelerate our path to achieve sustainable, profitable growth.

Kelly, I’ll turn it over to you to review the financials, including further details on our transformation initiative.

Kelly Kennedy: Thank you, Carla, and welcome everyone. Our performance in the quarter reflected strong top line results, as well as continued cost inflation and costs associated with our transformation initiatives. Starting first with revenue performance. First quarter revenue was $83 million, which was up 21% versus a year ago with comparable growth rates in both our digital and retail channels. Growth in the quarter was driven by healthy consumption trends, expanded distribution, prior year pricing actions and healthy orders from a key digital retailer. Honest consumption in track channels, which now represents roughly half of our revenue, was up 30% in the first quarter with half reflecting organic growth and half coming from incremental distribution.

Honest is gaining market share as our growth continues to outpace the categories where we compete. For example, in our largest category, diapers and wipes, Honest consumption growth in Q1 was over 40%, significantly outpacing the overall category growth of 7%. Reflecting on price increases taken in 2022, we are pleased to see consistent volume growth indicating the value of our brands and resiliency of our consumers. As we are poised to take additional pricing actions in 2023, we are confident in our ability to achieve price premiums that are aligned with our premium brands. Turning to key drivers by product category, first, diapers and wipes. Our diapers and wipes business represented nearly 65% of our revenue this quarter and was up 23% with consumption significantly outpacing the category.

Growth reflected the benefit of price increases, retail distribution expansion and increased assortment. In particular, we’ve seen growth in wipes as we have capitalized on uses beyond diapering, with recent campaigns focused on multiple uses in the household. Skin and personal care, which represented over 25% of total revenue this quarter, increased 7% due to retail consumption gain, a more focused assortment on best selling [hero] items and innovation, including Daily Green Juice Antioxidant Super Serum, which launched in the first quarter. We’re seeing particular strength in our beauty business with consumption up double digits, driven by over 20% growth at Target. Our household and wellness business represented nearly 10% of revenue this quarter and increased 81% due to the benefit of integrating the baby clothing business.

Now turning to results by channel. Digital channel revenue increased 22% while retail increased to 21%. Revenue in Q1 was equally split 50% retail and 50% digital, reflecting recent retail distribution wins, robust track channel consumption, as well as strong purchases by our key digital retailers. Some highlights included: continued strong performance at Target, our largest customer, where we saw all time record consumption during the quarter; continued strength at Walmart behind new distribution secured last year, which we believe is highly incremental to our existing business; and double-digit point of sales growth across diapers, wipes and beauty items at our key digital retail customer. Before I cover the rest of the income statement, I want to share further details on our transformation initiatives recognizing its impact on reported results in the first quarter, as well as key actions we’re taking to drive margin expansion through the three key pillars of our transformation initiative; brands maximization, margin enhancement, and operating discipline.

First, to drive brand maximization, we plan to leverage the strength of the Honest brand to deliver growth through new innovation and focus on core items. Specifically, we will grow distribution and drive higher velocities of margin and creative products in our portfolio. Something as simple as elevating the benefit, claims and imagery of our products in our marketing and packaging can make an impact quickly and drive revenue growth within our existing products. Another critical component of our brand maximization strategy is pricing. We’re taking significant pricing actions in 2023 to return to historical premiums that align with our brand positioning. Results of recent pricing actions indicate that consumers believe our value proposition is strong.

The second pillar in our transformation initiative is margin enhancement. We’ve taken decisive actions this quarter to transform our cost structure. From a portfolio standpoint, we are aligning our focus where we can lead and win, including two immediate actions that can drive improved margins and profitability. First, we will focus on North America where we have scale and the ability to most cost efficiently drive growth. This impacts our international business where we are exiting Asia and Europe. This decision will reduce complexity, inventory levels and associated costs, and give us greater focus on how we deploy our resources. We are also exiting portions of the household category as we contract [standardization] line in the face of waning demand and look for opportunities to rationalize SKUs across the portfolio to drive higher margin and meaningfully reduce inventory.

Costs associated with these structural changes are reflected in today’s earnings release. Exiting SKUs is likely to impact offerings at certain retailers, which has been reflected in our revenue outlook 2023 beginning in the second quarter. We are currently executing multiple supply chain and sourcing projects to reduce the landed cost of our products. Areas of focus include, contract manufacturing strategies, reduced shipping and logistics costs and product cost optimization. The third pillar of our initiative is operating discipline. This includes tightly managing our SG&A expenses and aligning our talent, resources and skills to reflect the prioritization of higher margin opportunities and the exit of select low priority businesses and products.

And our operating discipline will extend beyond the P&L to ensure we’re aggressively managing working capital, including the reduction of inventory, thereby reducing warehousing and fulfillment costs and generating cash we can invest to drive the business. In total, we anticipate the transformation initiative to incur $10 million to $15 million in costs with the majority being noncash. In the first quarter, we recognized $7 million of costs, which reflected noncash charges related to inventory and prepaid write-offs. Initiative costs impacted multiple parts of our income statement, including revenue, cost or revenue, SG&A and also resulted in restructuring charges, which are reflected within operating expenses. We anticipate our transformation initiatives will generate an estimated $15 million to $20 million in annualized benefit starting in late 2023 as we monetize pricing, cost savings and reduce operating expenses.

Returning back to our Q1 financial results, gross margin was 24% in the first quarter of 2023 compared to 30% in the first quarter of 2022. This included nearly 400 basis points of transformation initiative costs, including reserving for inventory related to exiting our international business, portions of our sanitizing business and from SKU rationalization as we pivot to higher margin parts of our portfolio. Excluding the charges related to our transformation initiative, our gross margin would have been 28%. Gross margin was also impacted by approximately 400 basis points of higher supply chain costs due in part to short term inefficiencies driven by elevated levels of inventory. These costs are expected to sequentially improve throughout the year as inventory levels come down.

Gross margin also reflected over 200 basis points of benefit from pricing and cost savings. Turning to operating costs and profitability. Operating expenses increased $4 million in the first quarter of 2023 compared to the first quarter of 2022. Operating expenses included $6 million of nonrecurring expenses, including $4 million in restructuring and other transformation initiative related expenses, $1 million in CEO transition costs and $1 million in legal fees related to securities litigation expense. Marketing spend was 12% of sales, reflecting higher returns associated with greater support for our retail expansion. Adjusted EBITDA for the first quarter of 2023 was negative $10 million, including $6 million in costs related to the transformation initiative.

Excluding the charges we recorded for the transformation initiatives, our adjusted EBITDA would have been negative $5 million. Turning to the balance sheet. We ended the quarter with $12 million in cash, cash equivalents and short term investments with no debt. Excluding items that we don’t anticipate occurring again in 2023, such as CEO transition costs that were accrued in 2022 and paid in the first quarter, operating cash flow was positive in the first quarter. As mentioned earlier, the transformation initiative costs in the quarter were predominantly noncash. As we committed to last quarter, we made significant progress to reduce our inventory balance, which decreased by $17 million in the quarter. We now anticipate exceeding our initial goal of $20 million inventory reduction and continue to believe it will offset our operating loss for the year.

As we mentioned in our March call, we entered into a $35 million asset based credit facility in January to provide liquidity for future growth investments. We’ve not borrowed on this line to date and plan to aggressively manage working capital as we implement our transformation initiative and drive to profitability. Now turning to our outlook for 2023. Following strong consumption trends in the first quarter, we are increasing our full year 2023 revenue outlook to be up low single digits versus full year 2022. The company’s full year 2023 revenue outlook reflects continued positive track channel consumption combined with the benefit of midyear pricing actions, offset by lower revenue related to the exit of low margin and low priority product line beginning in the second quarter and comparing against significant new distribution in the second half of 2022.

Adjusted EBITDA is expected to be in the range of negative $25 million to negative $30 million, including $7 million to $10 million in costs and charges related to the transformation initiative that will impact adjusted EBITDA. With that, let me turn it back to Carla before we open it up for questions.

Carla Vernon: Happy to take it over from here. As Kelly indicated, in 2023, we will be relentlessly focused on delivering the goals of our transformation initiative. This foundation of improved brand maximization, margin enhancement and operational discipline will set the path for more profitable growth in 2024 and beyond. Later this year, I will present the long term strategic roadmap that will guide our ongoing growth. As we redefine our growth path, I’m pleased to announce that Kate Barton has joined the Honest management team in the new role of Chief Growth Officer. Kate brings a strong track record of brand building, innovation and business management skills. Most recently, Kate was the Chief Brand Officer at an omnichannel founder-built lifestyle brand, and she also has a history of driving growth of both high profile global beauty brands and category leading food brands that you can read about in our press release issued earlier today.

Kate’s signature combination of heart and horsepower make her the perfect leader to inspire the loyalty and imagination of our discerning and passionate Honest consumers. With that, I’ll turn the call over to the operator and we look forward to answering your questions.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Laura Champine from Loop Capital.

Operator: [Operator Instructions] Our next question comes from the line of Andrea Teixeira from JP Morgan.

Operator: Our next question comes line of Jon Andersen from William Blair.

Operator: Thank you [Operator Instructions]. And I’m not showing any further questions in the queue. I would now like to turn the conference back to Carla for any closing remarks.

Carla Vernon: Wonderful. Thank you again everyone for joining us and your interest and support for The Honest Company. We look forward to speaking with you next quarter.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.