The Honest Company, Inc.

ladies and gentlemen thank you for standing by and welcome to the honest company's first quarter 2024 earnings call at this time our participants are on 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 to hand the conference call over to miss elizabeth bugart senior director in best relations at the honest company please go ahead

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.

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 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.

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 10Q, 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 and 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.

And thank you. As a reminder to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by. We've compiled the Q&A roster, and we ask that you limit yourself to one question and one follow-up. Again, that's one question and one follow-up. And bear with me one moment for our first question. And our first question comes from Dara Mosinian from Morgan Stanley. Your line is now open.

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 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 or trade-down impacts on your business? And perhaps give us an update for how things are trending so far in Q2. Thanks.

Hi, Dara. Dave here. Thanks for the question. And, you know... Certainly, we're pleased with the first quarter 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, you know, leaning towards The mid-side of that range is where we're gaining confidence, and the next couple quarters really will give us a clear road map there. So we'll come back at the next quarter to update any changes we've got.

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.

Great. 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 to go forward over the next few quarters here? Thanks.

Yeah, certainly. You know, 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 YEARS RIGHT OFF DUE TO THE TRANSFORMATION INITIATIVE. 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, that 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, you know, sequentially, you know, more tougher with the comps. But we're comfortable in the range that we're at.

Great. That's helpful. Thank you.

And thank you. And one moment for our next question. And our next question comes from Dana Telsey from Telsey Group. Your line is now open.

Hi. Good morning. Good afternoon, everyone. As 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 go forward, What lever on the gross margin does that play going forward as compared to what happened this quarter? Thank you.

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 products. 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 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 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.

Thank you.

And thank you. And one moment for our next question. And our next question comes from Laura Champagne from Loop. Your line is now open.

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, adjusting to the loss making?

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, you know, they are really, you know, becoming grounded in the business model success. So, you know, I'd say the guidance that we've given is, you know, the justity of the top, you know, low to mid single digit millions still gives us room to see improvement each quarter. And And at this stage, with so much balance of the year in front of us, we're going to keep working through all of our plans and trying to replicate and execute as best as we can. 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.

Let me try to rephrase in a way that's a little less guidance and 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?

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 expertises 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, you know, 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.

Understood. Thank you so much.

And thank you. And one moment for our next question. And our next question comes from Andrea Teixeira from JP Morgan. Your line is now open.

Thank you, operator, and good afternoon, Carla, Dave, and Elizabeth. So I just wanted to, well, first shout out, 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, 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 investments you may need to make as you get more distribution or 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 is there any short-term impact to adjusted EBITDA that offset the strong start of the year? Thank you.

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. Oh, my, sorry, my kids are texting. They always get through the do not disturb. Let me move my phone off the table. Sorry about that. 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 at getting into Walmart, as we saw that those gains happen in 2023, there is 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 Walmarts, while some of our inventory was at 100% of the Walmarts. 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 at 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.

And Carly, if I can sneak in just one comment on that. So obviously you've done amazing at both clicks and breaks. It says here track channel consumption was up seven. Wondering if you can help us with the non-tracked. And since you grew sales by three, it kind of implies there was a 400 basis points headwind to your revenue. Is that any stocking? And if so, is that over?

Yeah, Andrew, let me just address that last point on the revenue side, the 3% growth over prior year. You know, 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, you know, 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 track 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, of fixed overhead and capital expenses. And the flow through in particular on revenue down the bottom line was quite notable once the structural changes in the product costs 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 in expenses uh, flexible in future periods that can, uh, that we can drive some of the momentum and keep it going through the, to the balance of the year. So maintaining that flexibility on, on those two fronts is something that we, that we want to keep in front of us and, um, and we'll use, uh, in the right moments to really, uh, keep that top line momentum. Hopefully that, that helps. And I think that the question around the NIL, um, As we shared, there's a transition plan, but any cost to kind of make adjustments 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's sort of been in motion over the last 12 months anyway. So it is a big impact on the product and assortment.

Great. Thank you very much. I'll pass it on. Very helpful.

And thank you. And one moment for our next question. And our next question comes from Aaron Gray from Alliance Global Partners. Your line is now open.

hi good evening and thank you for the questions so uh first question for me is one uh you know come off the back of the last one and just to get you know better color in terms of you know how you're thinking about you know letting some of the um you know top kind of flow through the bottom especially in the back half we're looking for more top line growth uh you kind of touched on there dave in terms of you know 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 that exists today. Just in terms of how you think about that would be helpful. Thanks.

Yeah, 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 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, you know, aspect to the model that we see going forward. But, again, fits within the guidance that we've given and even leaning towards 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.

Okay, great. Thanks for that. And second question for me. Just in terms of some of the 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.

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 am so pleased with the fact that we, you know, we have Kate Barton as our chief growth officer and Jonathan Maley 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, 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 A-B testing and different versions. And some of the updates are going to be really fantastic. One of them that we've been talking about a lot is making sure that you know what's inside the box 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 skincare, beauty, beauty care product lines.

Okay, great. Thanks for the call, and I'll go ahead and jump back in the queue.

And thank you. And one moment for our next question. And our next question comes from Ryan Mayers from Lake Street Capital Markets. Your line is now open.

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.

We're jumping all over each other to answer that. You know, 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 is a really high traction way to grow. So we have a lot of indicators that make us feel good about that.

Okay, that's helpful. Thank you for taking my question.

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

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.

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