The Honest Company, Inc. (NASDAQ:HNST) Q4 2022 Earnings Call Transcript

The Honest Company, Inc. (NASDAQ:HNST) Q4 2022 Earnings Call Transcript March 16, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to The Honest Company’s Fourth Quarter 2022 Earnings Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Mr. Steve Austenfeld, Vice President, Investor Relations at Honest Company. Please go ahead, sir.

Steve Austenfeld: 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 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 will turn it over to Carla.

Carla Vernon: Thanks, Steve. Good morning, everyone and thanks for joining us today. I am 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 2 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 first hand 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 of partners, I have 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 brands 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 and 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 omnichannel business model.

Since joining Honest, I have had the opportunity to meet with some of our key retail and manufacturing partners. I have spent time in stores with my team seeing the many ways that The Honest brand comes to life. And most importantly, I have 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 am thrilled to support our team, our consumers, and our many partners in the next stage of Honest journey. Kelly, I will turn it over to you to review the financials.

Kelly Kennedy: 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 in tracked 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. Strong consumption gains in Diapers and Wipes were offset by declining traffic and subscriptions in our digital channel.

Shipments 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 space and it speaks to the minimalist trend in skin care. 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 offering. 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 channel. Digital channel revenue declined 14% as shipments lag 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 platform, 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 margin. 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 have 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 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 plan. We shifted our marketing investment from lower funnel digital tactics, the 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 goal of being positive for the quarter due to the margin pressure we experienced related to the standardization product inventory reserve as well an escalated transportation and warehousing costs. Turning to the balance sheet. We ended the fourth quarter with $150 million in cash, cash equivalents and short-term investments with no debt. This reflected $50 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.

Carla Vernon: 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.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Laura Champine with Loop Capital. Your line is open.

Laura Champine: Thanks for taking my questions. It’s for Carla, and it’s sort of a longer-term question. So since the IPO, the digital business has not had the kind of growth trajectory that we had been hoping for. Can you talk a little bit about, given your background in this particular channel, what the action steps are for ones to turn that business around?

Carla Vernon: Hi, Laura, it’s lovely to meet you. Thank you for that question. Yes, absolutely. One of the things that I am excited to be bringing to Honest is the experience I had at Amazon. At Amazon, as the Vice President of Consumables Categories, I have responsibility for the digital store fronts for all of the categories that you might consider center-store categories, and so many of those were categories that Honest participates in. In addition to being responsible for the storefronts, my team and I were also responsible for innovation about how to bring brands to life better on those storefronts. That experience is going to pull directly into what we do here at Honest and how the digital team and I collaborate on what we need to do in order to make sure that our honest.com storefront continues to meet today’s expectations of the digital shopper and that has everything to do with things from being efficient in the experience of the storefront really making sure you maximize the storefront so that the consumer transactions are clear, efficient and fast and so that we can really customize what we show to customers on the store front so that when they are shopping, it’s an experience that’s highly relevant for them.

In addition to that, our digital business is also brought to life through some of our strongest retail partnerships, right? So as we continue to grow with our retail partners, we want to make sure that Honest is effectively being brought to life in the digital mediums that they are continuing to grow and invest in.

Laura Champine: Great. Thank you.

Operator: Thank you. Our next question comes from the line of Dana Telsey with Telsey Group. Your line is open.

Dana Telsey: Good morning. Good afternoon, everyone, whichever it is. Nice to meet you, Carla. As you think about the margin improvement roadmap, how do you think about it given in the vein of the guidance of this upcoming fiscal year and what it could look like going forward? And as you think of the expanded retail portfolio that you have now of distribution, how are you thinking about pricing? How you’re thinking about margins and revenue as we move forward? Thank you.

Carla Vernon: Thank you, Dana. Good to meet you as well. The first and most important thing for me to make sure I emphasize and get across is, we are not satisfied with what we have delivered thus far on margin and on profit. And so our team is squarely focused on making sure we have discipline and rigor with what are the most important things to continue to fix and optimize about our portfolio and how we operate so that we quickly improve our margin footprint of our business. That really is brought to life through a number of things that we will do and that we will continue to assess as we develop that margin roadmap. Margin is important for us to address on a pricing level, as you’ve said. So I think what I’m going to do is allow Kelly to get in more detail with you about our plans for pricing, but it is also imperative that we work on cost out and cost savings projects.