The Honest Company, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to the Honors Company's fourth quarter 2022 earnings call. At this time, all participants are in 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 now like to hand the conference over to Mr. Steve Austin-Feldt, Vice President Investor at the Honors Company. Please go ahead, sir.

Good morning, everyone. Thank you for joining our fourth quarter and full year 2022 conference call. Joining me today are Carla Vernon, Chief Executive Officer, and Kelly Kennedy, our Chief Financial Officer. Before we start, I would like to remind you that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our earnings release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our earnings release issued today as well as our SEC filings for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events, except as required by law. Also, during this call, we will discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in the financial results section of today's earnings release. A live broadcast of this call is also available on the investor relations section of our website at investors.honest.com. With that, I'll turn it over to Carla.

Thanks, Steve. Good morning, everyone, and thanks for joining us today. I'm glad to be speaking with you as the new CEO of The Honest Company, and I look forward to meeting many of you in the months ahead. Before starting at Honest a little over two months ago, I was the vice president of consumables categories at the leading e-commerce retailer in the United States, which gave me the opportunity to get to know the categories that Honest participates in. I also oversaw the supply chain and digital storefront innovation for those categories. In that role, I got a firsthand view of how strongly the Honest brand performs with the consumers we serve and the key operational elements of running a high-performing e-commerce business. In that retailer-vendor partnership, I also had the opportunity to get to know several of our key leaders, including our founder, Jessica Alba. Since that early beginning as partners, I've been impressed with the quality of Honest products, the strength of the brand, and the Honest mission to make purpose-driven consumer products designed for all people. My work leading categories in e-commerce builds nicely on another set of experiences that have helped me hit the ground running here at Honest. As a division president at a leading CPG company, I have more than two decades of experience building and growing some of America's most classic brands. In that role, I also ran a portfolio of sustainability-driven founder-built businesses, giving me a deep understanding for the important financial, operational, and consumer drivers required to have a strong brand portfolio. My degree in ecology and career in sustainability allowed me to build the triple bottom line ESG business principles of sustainability, strong culture, and profitability into mission-driven brand business models, much like Honest. When Honest was launched 11 years ago, it disrupted and modernized many categories by bringing a new standard of product design to categories ranging from baby, beauty, and personal care to household and wellness. Our standards for clean and highly efficacious products have allowed Honest to lead innovation in our categories and drive growth for our partners. Our origin as a company built in the Gen Z era has poised us to be relevant, relatable, and available to a broad cross-section of consumers through a truly omni-channel business model. Since joining Honest, I've had the opportunity to meet with some of our key retail and manufacturing partners. I've spent time in stores with my team, seeing the many ways that the Honest brand comes to life, and most importantly, I've had the opportunity to talk with Honest's consumers and employees about what attracts them to Honest. And time and time again, the answer is grounded in the values embedded in the brand and the company. These early touch points, along with the strength of our mission and our products, gives me the confidence that we have a great future ahead. I firmly believe that Honest is a powerful brand that resonates with an ever-diversifying consumer base. However, as I noted in the earnings release, we are not satisfied with the revenue and margin results. We do not believe they reflect the strength and potential of the honest brand. In 2023, we will be relentlessly focused on taking actions and defining a strategy to set us up to be a stronger, more profitable company in 2024 and beyond. I'm thrilled to support our team, our consumers, and our many partners in the next stage of Honest's journey. Kelly, I'll turn it over to you to review the financials. Thank you, Carla, and welcome, everyone. We were pleased with revenue in the quarter, which came in slightly ahead of expectations. but faced continuing cost pressures, which impacted margins. Starting with the top line, fourth quarter revenue was up 2% versus a year ago, driven by strong performance in retail, reflecting healthy consumption and distribution increases, as well as pricing actions taken in 2022, partially offset by continuing softness in the digital channel. Honest consumption in the fourth quarter was up 15%. Based on these results, it is clear the Honest brand continues to resonate with consumers. Honest is gaining market share and track channels as our growth continues to outpace the categories where we compete. Our unit velocities remain healthy following 2022 price increases as both volume and pricing are supporting our top-line growth. Turning to key drivers by product category. First, diapers and wipes. Our diapers and wipes business represented approximately 60% of revenue this quarter and was up 1%. Wipes consumption was up 24% and diapers consumption was up 23%, outpacing category growth by over 15 percentage points. Growth reflected the benefit of price increases, retail distribution expansion, and increased assortment. Wipes also benefited from expanded usage around the home beyond diapering. We continue to innovate in this category and now can announce that 94% of our baby wipes portfolio are home compostable. Drawn consumption gains in diapers and wipes were offset by declining traffic and subscriptions in our digital channel. Chipments with a key digital customer also lagged consumption as they reduced fourth quarter purchases. Skin and personal care, which represented nearly 30% of total revenue this quarter, declined 13% year over year. Revenue was impacted by the reduced shipments we mentioned by our key digital customer. We continue to innovate our beauty and skin care portfolio with the Q1 launch of our new daily green juice antioxidant super serum. This serum was developed with Gen Z and the Latino consumer in mind. With easy-to-understand ingredients such as kale, lemon, carrot, goji green tea, and apple, it is inspired by the feeling of a fresh, moisturized face, and it speaks to the minimalist trends in skincare. Our household and wellness business represented just over 10% of revenue this quarter and doubled year over year, driven by honest baby clothing. We continue to anticipate solid growth on this business in 2023, as our bedding, towels, blankets, and seasonal pajamas nicely complement our current baby care offerings. In Q4, Honest Family Pajamas was on Oprah's Favorite Things list in 2022 for a second year in a row. Now turning to results by channel. Revenue in Q4 was split, 57% retail and 43% digital, reflecting recent retail distribution wins as well as softness in the digital channels. Digital channel revenue declined 14% as shipments lagged consumption at our largest digital customer. And in light of increased cost of digital marketing, we shifted marketing spend to higher return opportunities to support retail expansion. Despite these near-term headwinds, we are continuing to improve our digital platforms, including faster checkout and site speed, as well as expanding the Build Your Own Bundle program to include a broad cross-section of products, which drives larger basket sizes. Now turning to retail, where revenue increased 18%, reflecting strong traffic and consumption at our largest customer, distribution expansion, assortment gains, and strong in-store execution. In 2022, we increased placements from 43,000 retail locations to over 50,000. As a result, ACV increased from 49% to 72%. Key distribution wins during the year included the launch into over 2,500 Walmart stores and the addition of Publix, Ulta, and additional assortment at Kroger. At Target, our largest customer, we achieved 20 consecutive quarters of year-over-year consumption growth. We are very pleased that Honest has become the number one baby personal care brand at Target. Now turning to gross margins. Gross margin was 27.5% in the fourth quarter of 2022 compared to 30% in the fourth quarter of 2021. This reflects approximately 800 basis points of higher supply chain costs offset by 550 basis points of positive impact from pricing, cost savings, and favorable mix. We've continued to experience a post-COVID slowdown in our standardization business, which resulted in an approximate $2 million non-cash inventory reserve in the quarter in line with Q4 2021. Turning to operating costs and profitability. Operating expenses increased $3 million this quarter, but were lower than a year ago if we exclude a $6 million CEO transition expense and $1 million in security litigation expense. Marketing spend was 12% of sales in line with plans. We shifted our marketing investment from lower funnel digital tactics to higher return retail marketing levers, where we believe we can cost effectively reach our consumers and support new distribution. Adjusted EBITDA for the fourth quarter of 2022 was negative 1.6 million, a nearly $4 million improvement from Q3 and $2 million favorable to Q4 of 2021. We fell short of our goals being positive for the quarter, due to the margin pressure we experienced related to the standardization product inventory reserve, as well as escalated transportation and warehousing costs. Turning to the balance sheet, we ended the fourth quarter with $15 million in cash, cash equivalents, and short-term investments with no debt. This reflected $15 million in inventory purchases in advance of increased supplier prices in early 2023. Over 2023, we expect to sell down inventory to more normalized levels, generating approximately $20 million in cash. In January, we entered into a new $35 million asset-based credit facility that provides us with more financial flexibility. We have the ability to request up to $70 million to support future growth investments. Now turning to 2023, as Carla highlighted, We stand on the foundation of a strong brand, but we have significant work to do, and we've already gotten started. For example, we recently communicated new pricing actions in 2023 to reflect our premium positioning, and we've initiated robust cost savings programs as well. Prior to introducing our improved margin improvement roadmap, our full year 2023 revenue and adjusted EBITDA would be in line with our fiscal year 2022 results. With that, let me turn it back to Carla before we open it up for questions. Thanks, Kelly. I want to reinforce that we are not satisfied. So now our focus is on marrying the quality of our product and our premium positioning to our pricing strategy, along with advancing cost savings initiatives and improving our margin structure. We plan to address our business challenges head on in 2023, and put Honest back on a path to profitability with meaningful benefits expected in 2024. Despite the current challenges, we are confident. Our distribution is healthy, our market shares are growing, and the Honest brand is strong. With that, I will turn the call over to the operator, and we look forward to answering your questions.