The Honest Company, Inc. (NASDAQ:HNST) Q1 2024 Earnings Call Transcript

The Honest Company, Inc. (NASDAQ:HNST) Q1 2024 Earnings Call Transcript May 8, 2024

The Honest Company, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by. Welcome to The Honest Company’s First Quarter 2024 Earnings Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the conference over to, Ms. Elizabeth Bouquard, Senior Director, Investor Relations at The Honest Company. Please go ahead.

Elizabeth Bouquard: Good afternoon, everyone and thank you for joining our first 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.

Carla Vernon: Thanks, Elizabeth. Good afternoon, everyone, and thank you for joining us today. As we kick off the first 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 eight 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 1300 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 brand, 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.

Dave Loretta: 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 1275 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 cost, logistics and fulfillment. As a reminder, the sizable gross margin improvement includes certain onetime 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.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Dara Mohsenian from Morgan Stanley Dara Mohsenian. Your line is now open.

Dara Mohsenian: Hey, guys. 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? 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, trade down impacts on your business? And perhaps give us an update for how things are trending so far in Q2? Thanks.

Dave Loretta: Hi, Dara, Dave here. Thanks for the question. And certainly we’re pleased with the first results. We’re off to a strong start this year, both pleased with the top line, but even the margin expansion was all kind of elements working together as we brought forward. So pleased with that. Now looking at the balance of the year, certainly we want to be a little bit cautious from any uncertainties out there and it’s early. It is really just a function of it’s early in the year and we’re cautiously confident that the range is the appropriate range. As I did highlight in my prepared remarks, leaning towards the mid side of that range is where we’re gaining confidence and the next couple of quarters really will give us a clear roadmap there. But I am so we’ll come back at the next quarter to update any changes we’ve got.

Carla Vernon: Hi, Dara. This is Carla. It’s good to hear your voice. Thank you for joining our call. Your question for me was really what am I seeing in the landscape of the categories we play in? Do I feel like there’s indicators from any of the external trends or consumer indicators that concern me. And I will say that, the results you’re seeing are driven by uniformly strong consumption for us across our category portfolio. The real confidence builder for us in the quarter is that if you look at the way our growth shaped up, we were able to actually grow year-over-year on a combination of unit volume and pricing as Dave covered in his remarks. So I think what that really shows us is that the Honest brand is very strong and resonant even in these times, because the benefits we offer for clean, personal care and baby have such a meaning and our brand is such a demonstrated leader in this area.

On top of really strong execution by the team knowing how we need to deploy the way we support the brand is working very well for us.

Dara Mohsenian: 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? Thanks.

Dave Loretta: Yes. Certainly. As you said, the gross margin drivers were a big element of what we saw 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 management on product 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, our 35% related to a pretty healthy increase 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: Our next question comes from Dana Telsey from Telsey Advisory. Your line is now open.

Dana Telsey: Hi. Good afternoon, everyone. Carla, as you think about the distribution channels in your categories, what changes are you seeing in distribution channels? What changes are you seeing in orders? And then as you think about pricing go forward, what lever on the gross margin does that play going forward as compared to what happened this quarter? Thank you.

Carla Vernon: Hi, 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 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 by 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 aisles. 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 effective 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 is being 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: Our next question comes from Laura Champine from – Loop Capital. Your line is now open.

Laura Champine: Thanks for taking my question. It’s a follow-up, and congratulations on especially the EBITDA performance. It does seem like a lot of the improvements you’ve made on profitability are structural. So if you were to turn to a negative EBITDA in next quarter or some quarter this year, what would be the most likely drivers of that downturn? Would it take sales decline? And what would need to happen for you to get back into EBITDA adjust the EBITDA loss making?

Dave Loretta: Hi, Laura. Thanks for the shout out on the progress on EBITDA. We’re happy with that and we know that it’s kind of a function of executing well across the team on a number of those fronts. So structurally they are really becoming grounded in the business model success. So I’d say the guidance that we’ve given is on adjusted EBITDA low to mid-single digit millions still gives us room to see improvement each quarter. And at this stage with so much balance of the year in front of us, we’re just we’re going to keep working through all of our plans and trying to replicate and execute as fast as we can. So I don’t I think that’s the confidence that we’ve got, but I’ll kind of leave it at that point and have us sort of reflect on that.

Laura Champine: Let me try to rephrase in a way that’s a little less guidance and CFO oriented and get a bigger picture for you. 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: Hi, Laura. So good to hear you. Well, I’m going to be honest with you that we’ve been on this really consistent path of improving ourselves quarter-by-quarter. And that strength in performance is really based on our team coming together well over the last year. We brought people with great expertise, but intentionally a variety of experiences and expertise. And I’m so proud of how we’ve been executing. And so as we look ahead, I really think we’re even continuing to have the discipline internally to make sure that we understand how to deliver on this plan and how to be nimble in the event of change. However, I would say the things that we don’t control, I really — I can’t kind of even predict or comment on the things we don’t control.

What I do know is that the plan we have articulated and reconfirming our guidance for the year is something we feel strong about because of what we know we have in front of us and what we see as our drivers. So I think we all have to be on the lookout for consumer macroeconomic trends or any kind of unpredictability that would probably not only affect us, but would affect others in our sector and our segment. What is within our control, I think the reason we’re reporting we feel confident is because we really like how we’re executing.

Laura Champine: Understood. Thank you so much.

Operator: Our next question comes from Andrea Teixeira from J. P. Morgan. Your line is now open.

Andrea Teixeira: Thank you, operator, and good afternoon, Carla, Dave and Elizabeth. So I hope I just wanted to well, for a shoutout, hope you’re all well and congrats on the performance. Following up on Dana’s question on distribution, I was wondering if you can give us a phasing of the comps of extra distribution extra — the additional distribution you got last year and into this year? And if at all we should be mindful of the lapping of those gains? Or are you seeing velocity and innovation offset that? And if you can also comment on what you’re making, Dave, you said about being conservative at this point. Are there any reinvestments you may need to make as you get more distribution? Or perhaps incorporating the changes in the likeness agreement with Jessica Alba or incorporating any of these charges?

I understand that it would be positive for margins long term, but if you — is there any short term impact to adjusted EBITDA that offset the strong start of the year? Thank you.

Carla Vernon: Great. I think we have a divide and conquer here. Let me start by talking about how our distribution has been kind of our glide path there. And I know you’re asking about investments. I would love Dave to talk to you about how we’re feeling about investments and what we think we’re going to want to do there. And so what I would say about distribution and I think it’s something we’ve discussed on our previous quarters. We’re very successful. As you guys know the shape of our portfolio is very strongly balanced as a combination of brick and mortar and digital. And we are so pleased with the way we’ve been able to deliver growth. And so we’re very balanced digitally and brick and mortar. But brick and mortar is really the distribution that you see show up when you see these big distribution changes for us.

And it is also where we are less distributed relative to our competition. And so while much of that distribution was actually new in 2022 for us in a big tranche getting into Walmart, As we saw that those gains happen in 2023, there was a little bit more of a uniform glide path. But I would say that distribution when you’re doing it in a brick-and-mortar context across as many categories as we have can have periods where there will be strong one-time gains and then we want to see ourselves settle in and drive velocities from there. So it’s always going to be a mix. It’s not going to be the same rhythm in any given time period. But we know that we’ve got an enormous runway for growth on being in more doors. Remember, we only got some of our inventory at 50% of the Walmart, while some of our inventory was at 100% of the Walmart.

We also know that even on our hero items, some of them have distribution as low as 20% and 30% ACV individually. So we also know that while we are in some retailers, we are looking to get stronger shoulders, if you will, across the board and that that’s going to come at different time periods with the different resets. So it might occasionally be a little bit lumpy. But overall on a year by year basis, we like the outlook.

Andrea Teixeira: And Carla, if I can sneak in just one comment on that. So obviously, you’ve done amazing both clicks and bricks. It says here tracked channel consumption was up 7%. Wondering if you can help us with the non-tracked. And since you grew sales by 3%, so it kind of implies there was a 400 basis points headwind to your revenue. Is that any destocking or and if so is that over?

Dave Loretta: Yes. Andrea, let me just address that last point on the revenue side, the 3% growth over prior year. We still as we called out last quarter, there was some shift in order flow into the fourth quarter that accelerated that period’s net revenue, which was 10% up. Normally those orders would have been in the first quarter. So that sort of helps bridge any difference in what you would expect within the tracked channel progress. But let me kind of revisit the EBITDA and the flexibility that we’ve got there. And this is really the benefit of the business model that we’re building here is, it’s flexible in its nature. We’re not encumbered with a lot of fixed overhead and capital expenses. And the flow through in particular on revenue down to bottom line was quite notable, once the structural changes in the product cost and the fulfillment and logistics costs are now, really working well.

But I’ll also say part of the EBITDA benefit and the gross margin benefit this quarter was trade promotions were lighter than we would normally have them in the quarters and that helps flow through gross revenue to net revenue. So we will see trade promotion activity and marketing investment and expenses flexible in future periods that can that we can drive some of the momentum and keep it going through the balance of the year. So maintaining that flexibility on those two fronts is something that we want to keep in front of us and we’ll use in the right moments to really keep that top line momentum. Hopefully that helps. And I think the question around the NIL, as we shared there’s a transition plan, but any cost to kind of make adjustments to under that separation agreement are fully factored into our outlook.

We don’t expect any incremental beyond our outlook plans for expenses to make that transition. And frankly, the transition sort of been in motion over the last 12 months anyway. So it is a big impact on the product and assortment.

Andrea Teixeira: Great. Thank you very much. I’ll pass it on. Very helpful.

Operator: Our next question comes from Aaron Grey from Alliance Global Partners. Your line is now open.

Aaron Grey: Hi, good evening and thank you for the questions. So first question for me is I want to come 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 top line flow through the bottom, especially in the back half, we’re looking for more top line growth. You kind of touched on it 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 that 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. Thanks.

Dave Loretta: 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 that 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: Okay, great. Thanks for that. And same question for 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? Thank you.

Carla Vernon: I love this question. So thank you for asking and it’s really great to hear from you, Aaron. So appreciate that. We packaging is really an important part of our brand maximization pillar. And I’m so pleased with the fact that we — we have Kate Barton as our Chief Growth Officer and Jonathan Mayle as our Head of Sales. And between the two of them, they’ve been really collaborating strongly on how we update and upgrade our packaging as a key piece of our marketing pillars. That uniform packaging update is something that we want to be making sure is strong across our portfolio. And over the last year, the team has been working diligently to iterate on the packaging to conduct both quantitative and in store physical in person qualitative analysis with several rounds.

Because I would say from those of us that are alumni of some of these great CPGs that we are in, we understand the power of packaging as your lead marketing vehicle, for especially for a brand like ours. As well as the importance of getting it right. So I would say that I’m able to talk about it because we have done some of these packaging tests now actually physically in our top brick and mortar retail stores with AB testing in different versions. And some of the updates are gonna be really fantastic. One of them that we’ve been talking about a lot is making sure that you know what’s inside the boxes from here forward. That’s been a key area. There’s a very exciting execution that will be introduced into the market and I see it’s going to make a big difference in making the products more shoppable for consumers, especially in our skin care beauty, beauty care product lines.

Aaron Grey: Okay, great. Thanks for the color. I’ll go and jump back in the queue.

Operator: Our next question comes from Ryan Meyers from Lake Street Capital Markets. Your line is now open.

Ryan Meyers: Hey, guys. Thanks for taking my questions. 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: 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 at 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: Thank you and I’m showing no further questions. I would now like to turn the call over to Carla for closing remarks.

Carla Vernon: 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 Closing Remarks].