Q4 2023 Honest Company Inc Earnings Call

Participants

Elizabeth Bouquard; IR; Honest Company Inc

Carla Vernon; Chief Executive Officer; Honest Company Inc

David Loretta; Chief Financial Officer; Honest Company Inc

Aaron Grey; Analyst; Alliance Global Partners

Shabana Chaudhry; Analyst; JPM

Laura Champine; Analyst; Loop Capital

Dana Telsey; Analyst; Telsey Advisory Group

Dara Mohsenian; Analyst; Morgan Stanley

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the honest Company's fourth quarter 2023 earnings call. At this time, all participants are in a listen only mode after the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your host, Ms. Elizabeth Burkart, Senior Director, Investor Relations at the artist company.
Please go ahead.

Elizabeth Bouquard

Good afternoon, everyone, and thank you for joining our fourth quarter 2023 conference call. Joining me today are Carla Vernon, our Chief Executive Officer, Dave Loretta, our Chief Financial Officer, and Keith Martin, our Chief Growth 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 dot Onex.com.
With that, I'll turn it over to Carla.

Carla Vernon

Thanks, Elizabeth. Good afternoon, everyone, and thank you for joining us today. On today's call, we hope to achieve several objectives. First, we're excited to share our successful results for the fourth quarter and details on key financial milestones that leave us strengthened as we close out 2023. Second, we'll share our outlook for 2024. And third, we will provide our new long-range financial algorithm and a strategic update detailing the differentiated attributes of our company and key drivers for our long-term growth. To complement our discussion today, please find our new investor presentation available on honest, Investor Relations website.
As I round the corner on my 1st year as CEO of the Honest Company. I'm extremely proud of the results we will share today, but I must acknowledge that 2023 has been a year of tremendous change. As I mentioned when I was with you a year ago, we were not satisfied with our past results. We were a company in need of a transformation and our teams quickly went into action to define our transformation initiative and a new operating mindset. As a result of these efforts, we strengthened our business performance, our team culture and our financial results. These 2023 improvements include expanding our gross margins by 900, 30 basis points since Q1, doubling our cash position year over year and achieving a major milestone in the fourth quarter. By delivering positive adjusted EBITDA and positive net income. We expanded margins and achieved our profitability goal while also driving double-digit top line growth in the quarter. But among our most meaningful accomplishments this year is the way our honest team collaborated to drive focus, clarity and alignment on our ambitious business goals. So I want to take a moment to thank our entire Onex team for the remarkable ways that they strengthened our culture and delivered and even exceeded their commitments this year.
Our transformation initiative pillars of brand maximization margin enhancement and operating discipline have each contributed meaningfully to our business model improvements. We exited 2023 with growth in both units and dollar sales, strong marketing efficiency, a healthier balance sheet and a clear path to ongoing profitability. And our brand continues to grow in relevance and scale as shown by the growth of our household penetration, which has now crossed the threshold of 5%. I'm confident that with our stronger foundation, growing consumer residents and a clear vision of the future, we will continue to advance on its mission as a personal care company that courageously challenges, ingredients, ideals and industries through the power of our brand, our team and our honest standard. And now I'll turn it over to Dave to share the financial details of our strong fourth quarter and our 2024 outlook.

David Loretta

Thank you, Carla, and welcome, everyone. Our team's work over the last 12 months has helped us to build a strong financial foundation. We achieved 10% revenue growth both for the fourth quarter and full year 2023, while also expanding gross margins and reducing operating expenses. We mark 2023 as a significant turnaround period for the Company. And we expect the improving financial trends to continue in 2024 and beyond, as we will share today, in our strategic update, but first, let me dive deeper into the fourth quarter results. This quarter, we delivered a record high revenue of $90 million, up 10%, driven by strong results in the digital channel, including robust consumption at Amazon price increases implemented across the portfolio over the course of 2023 and increased volume growth due to both greater velocity and distribution gains by product category. Our Diapers and Wipes revenue increased 15% in the fourth quarter, driven by new distribution price increases and strong sales momentum in wipes, whilst growth was especially strong in the quarter through increased velocity, larger pack sizes and innovation, including on our new flushable wipes.
Next, our Skin and Personal Care revenue declined 6% in the quarter due to exiting distribution and low margin channels. This was partially offset by strong consumption growth in baby personal care. In fact, we remain the number-one natural baby personal care brand at Target and Walmart as we continue to grow our breadth of products in the baby category.
And finally, our Household and Wellness revenue increased 28% in the fourth quarter reflecting strong performance of the baby clothing business.
Turning to results by channel. In the fourth quarter, digital revenue increased 28%, driven by meaningful growth with Amazon. Our Amazon business has benefited from high return marketing and improved supply chain planning. Retail revenue decreased 3% due to exiting distribution and low margin channels, partially offset by continued benefit from distribution into new retail outlets.
Our gross margin in the fourth quarter was 34%, up 930 basis points from the first quarter of 2023 and 600 basis points from the fourth quarter of last year due to improvements from cost savings and pricing. This represents our highest quarterly gross margin in over two years.
Operating expenses decreased $6 million in the fourth quarter compared to last year, reflecting higher marketing efficiency and lower SG&A expenses. Adjusted EBITDA for the fourth quarter was positive $4 million, which surpassed our original guidance. This also resulted in positive operating income for the quarter, marking the first time achieving this as a public company.
Turning to the balance sheet, we ended the quarter with $33 million in cash, more than doubling our cash position of $15 million at the end of 2022. We also achieved positive operating cash flow for the third consecutive quarter. Our cash position improved from continued discipline in managing working capital, including significant reductions in inventory. For 2023, inventory was reduced by 36% or $42 million, while also supporting 10% revenue growth. Our balance sheet remains strong with zero debt outstanding. Overall, these results strengthen our confidence in the strategic direction we are sharing today with that, let's turn to our annual outlook for 2024. Our full year 2024 financial outlook includes low to mid single digit percentage revenue growth and positive adjusted EBITDA in the low single digit to mid-single digit millions range. We are expecting a softer first half of the year compared to an improved second half due to retailer ordering patterns and exiting distribution and low margin channels. We expect higher revenue growth in the back half of the year due to timing of our distribution gains and new product innovation launches. Our adjusted EBITDA outlook includes operating margin expansion, derived from improved gross margin and operating expense leverage. Our transformation pillars will continue to enable our profitable growth. We envision 2024 as a year of continued strengthening of our financial foundation in order to accelerate strategic growth in 2025 and beyond.
And now I will turn the discussion back over to Karla to share our vision for Honest's next chapter.

Carla Vernon

Thank you for the comprehensive overview of the team's great work in 2023, and I look ahead at 2024. Now I'm pleased to share our updated vision for the company. We believe Onex is truly a consumer products company built for modern times. Now that we have an improved financial foundation, we are in a great position to further unleash the distinctive elements. Of the honest brand honest, was born out of a desire to bring a higher standard for clean ingredients and sustainable design to baby and personal care products. And to this day, we hold every product we sell to the honest standard. This standard is a set of guiding principles that puts our mission into action. The honest standard is the compass that guides how we deliver on consumers' expectations. At honest, our standard always begins with clean ingredients. As we noted in our investor presentation, the market for sensitive skin care products is expected to be $80 billion by 2030, which is nearly double today's $41 billion market. Additionally, the presence of skin allergies in children has nearly doubled since 1997. This is why our entire portfolio distinguishes itself by eliminating more than 35 hundred chemicals and materials of concern from our products. Our own honest standard is a more strict benchmark than the restrictions dictated by either EU or U.S. regulations. But our success goes beyond our approach to ingredients. We are reshaping and revolutionizing categories in other ways. For example, we revolutionized baby care with our approach to seasonal fashion inspired diaper prints, matching baby apparel, baby gifting and inspiring wellness rituals that take baby bath time to a whole new level in the most recent period of Cercon data honest ranks as the number one natural brand in baby care with the successful launch of our plant-based flushable wipes and the great success of our IQstream lengthening mascara, which is Amazon's leading Climate Pledge friendly mascara. We have seen that the honest brand is as meaningful to adults for products that they use themselves. With this evidence, we are confident that honest, meets a broad set of needs that are growing in demand. This was the cornerstone of the comprehensive strategic research we performed to define the business landscape and market opportunities. We studied the needs and preferences of thousands of consumers and hosted personal conversations with people who use honest products and people who do not through the assessment of consumer needs and the available opportunity. We have crafted a clear vision of how to continue growing the power of the honest brand by scaling distribution, introducing strong innovation, entering new categories and our continued leadership as a modern brand builder. We will do this while maintaining our disciplined financial and operating mindset to share more detail on this growth vision and our long-range algorithm. I will now turn it back over to Dave.

David Loretta

Thanks, Carla. We believe the key principles that underpin our long term plan for profitable scalable growth include three key elements distribution to expand availability, modern brand building to drive velocities and cost management to ensure profitable growth. First, within distribution, we will maximize the extensive distribution opportunities available to us. These opportunities are multifaceted and include distribution through new retail partnerships and growth at our current retailers. We have a long-standing retail partnership with Target recently expanding our shelf space in baby toiletries, and we see opportunity for further in store expansion with Target and other current retailers. We also see a runway for expansion with our new retailers, including Walmart, we have shown an ability to grow distribution, but still remain underpenetrated relative to the competition. For example, we have an opportunity to expand in more channels with large retailer segments, including club discount, drug and grocery and more beauty is specialty retailers. In addition to expanding distribution through new stores and doors, we have an opportunity to expand aisles and shelf facings with current retailers. In fact, in most categories honest, has less than half the number of SKUs on shelf than leading competitors. Another distribution opportunity is growing. Our best-selling Hero items, which we believe are underpenetrated. One example is our top-rated hydrogel moisturizing cream, which has less than 20% ACV. We are also focused on bringing new product innovation to the baby aisle and beyond innovation. Within our core and adjacent categories, we'll support our objective of increased availability. As Karla mentioned, consumer research indicates that we have a large opportunity to take the honest brand into new categories within the personal care universe, the market opportunity in Personal Care is significantly larger than the baby aisle and natural personal care is expected to grow faster than the broader personal care category.
The second key driver of growth will be improved velocities, supported by our modern brand-building approach to accelerate our velocities and penetration. We'll be focused on a marketing strategy with best in class brand building. This will include clear consumer targeting differentiated messaging and modern ways of connecting our marketing effectiveness will be more tailored by activating cutting edge paid media, revitalizing our creative images and leveraging our content creators to amplify key campaigns. We have already started to see benefits of these enhancement enhancements by quadrupling the number of new households that are new to our brand at Amazon in Q4.
Third, driver of profitable growth is an ongoing focus on cost management. We will build on the progress we made in 2023 on improving the financial results, we remain committed to expanding gross margins through cost savings and improved mix of our portfolio. Similarly, we will continue to improve the efficiency of our operating structure, with benefits from reducing non-strategic spend and gaining leverage across fixed costs as we scale these actions, which began with the new leadership team will put us on a path to sustainable positive operating margins and the bottom line that grows faster than the top line. This brings us to introducing our new long-term financial algorithm, which includes expected revenue growth of 4% to 6% annually and continue adjusted EBITDA margin expansion. This long-term financial view is grounded in our updated strategic plan as well as our transformation pillars of brand maximization, margin enhancement and operating discipline. Together, these frameworks set the building blocks for long-term value creation. I encourage you to review our updated investor presentation that outlines the strategic vision in more detail.
In closing, we remain confident that we can continue to build on the stabilizing results from last year and realize our profitable growth goals as a leading modern CPG company.
And now I'll turn the call over to the operator.

Question and Answer Session

Operator

(Operator Instructions) Aaron Grey, Alliance Global Partners.

Aaron Grey

Hi, good evening here.
A nice quarter here, and thank you for the question. Tom, just in terms of the top line, Digital had a nice quarter, it looks like some of the Amazon investments, pay dividends, you pointed to a number of levers driving growth going forward. So as we look to 2024 and your long-term sales guidance, how should we think about how to leverage our pulled more so in the near term versus the long term?
I just think about between channels of brick and mortar distribution in digital? And then can you also provide any color on how much more of a lever you believe those for pricing to be both? Thank you.

David Loretta

Yes, hi, Aaron. This is Dave. Here from me. As you know, we are looking at the future with a balanced model that that does reflect some of the success that you just saw in the fourth quarter. And digital was a strong driver for us, and that was a lot of growth that we got from Amazon, which which continues to have some some big opportunity for us. So as I talked about, the long term growth opportunity between with distribution being a big component of top line that will that will be a blend of balance, a continued balance of brick and mortar distribution and the digital channel with larger that being Amazon.
So I outlined in the U.S. investor presentation, which you can see the elements of how we see that distribution playing out between entering new stores, increasing the number of locations within those stores and even shelf and facing opportunities. And it's really about maximizing those opportunities that we see driving the growth for us in 2024 and beyond.
And in terms of I think you said, leveraging leveraging the potential for the brand beyond at that period of time, we're going to look at our long range model. And as I shared, it's a balance between driving top line growth, but bottom line growth faster than the top line. And we think that gives us a lot of advantages to to set us up have a strong foundation in the future.

Aaron Grey

Okay, great. Thanks for that color. Really appreciate it.
A second quick one for me, just based on the EBITDA guidance and the current run rate, it implies there might be some investments you plan to make behind the brand to drive growth for the year. So any color in terms of no planned uptick in investment, you might have been easier to drive innovation and build brand awareness or otherwise would be greatly appreciated.

David Loretta

Yes, I think we're really proud with the fourth quarter results. It was a strong revenue period, $90 million. And what what it really illustrates is the power of the model that allows incremental revenue to drop to the bottom line in that period.
Now I'd say looking forward, we do we do have clear sight on positive adjusted EBITDA for the full year, but I wouldn't paint it as a straight line. There will be some periods and I would particularly call it out a soft first half of the year from the top line. But there are investments that we are going to maintain in terms of flexibility in this model to continue to drive demand for marketing. And we're expecting investments in R&D to help drive the innovation side. And we're just going to be you're going to maintain flexibility to get through periods that might have consumer pressures and be able to maintain that top line momentum so I would say that the full year outlook that we provided on adjusted EBITDA is something that we're confident in and can weather through any conditions that we might see what do we face.

Aaron Grey

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

Operator

[Shabana Chaudhry], JPM.

Shabana Chaudhry

Hi. Congrats on the quarter and thank you for taking our question. And so a big focus is on distribution gains. So if you can please give us what you had of tremendous retail distribution gains on second half of 22 onwards. Can you please give us a sense of what your current shelf space looks like? And when do you expect how much more distribution space you're expecting and what kind of timeframe?
And as a part of that question. We believe Walmart started doing resets in the summer. Are you getting getting any additional space from there? And I have another question. Thank you.

Carla Vernon

Savannah, it's Carla. Thank you so much for joining the call today and thank you for the question. It's great to hear your voice. I'd love to take that question about distribution and really make sure we put that in the context of the journey we've been on and the journey we're going, as you can see in the investor presentation on Page 13 now, excuse me, page 13. It's farther in the document. There is a slide that talks about the fact that we thought about a 12% or 13% CAGR in distribution and total points of distribution for the year since 2019 or so. I think that really reflects that. But in the most recent period for this year, we grew distribution at a 6% rate, a lot of that was driven by Walmart, not exclusively. So however, we have been getting into other retail stores and doors. When we look at our portfolio overall, we know that the opportunity is that even though we've now got quite a large presence in big mega change, let your targets and your Walmart. In many instances, we do not have all of our categories or all of our portfolio in distribution there. For example, when we look at our presence on shelf, even in our diaper category, we only have about 20% of the shelf presence of the key competitor in that category. That same ratio is about the same for us in wipes and in skin facial skin care. So even when we are in Ohio. We know that we are under face at versus what our opportunity really is. We have great conversations going on with our retailers. We have a really very clear line of sight to how we will plan to unlock. As Dave said, new banners, new doors within the banners, new files and broader distribution will come back in the coming quarters to give you the exact add-up of those numbers.

Shabana Chaudhry

Thank you for the color on that. And I just quickly wanted to touch base and then track channel data. I believe from the previous quarter, you had mentioned you were expecting something in the track channel data to remain pretty high, double digit or so. And but then most recently, it's showing like about mid-single low of high single digits. If you could please comment on that and how you see as you gain distribution to your point, how quickly can we see an uptick in the track channel data as well? Thank you.

Carla Vernon

I'll start. I'll start us off and then Dave, if I miss anything, please.
Let me know. As you know, very well, 2023 was the year, we got the benefit of going from 50% ACV overall to about an 80% ACV for the brand. As a total, what we found are what we find ourselves lapping in some of those instances is either timing for retailers, timing shifts to retailers or pipeline build behind some of the new distribution we've gotten. I don't remember the second part of the question.

David Loretta

No, the current track channel in the high single digits, which is more a reflection of what we're seeing in the consumer consumer spend area with those tracked channels that that are part of that channel, which is about 50% of our overall business.

Carla Vernon

Yes, yes, we feel good about what we feel really good about is that we're growing on both dollars and units for overall, which as you've been watching what's happening in the consumer products space, that is such a great indicator for us and our consumer really values not only the distinctiveness of the brand, but that when they're making these choices about which brands best serve their needs, even as we have delivered price advances over the last year, year and a half, our consumers are actually still growing with us on top of the additional distribution, we're still able to demonstrate velocity growth.

Shabana Chaudhry

Thank you so much. I'll pass it on.

Operator

(Operator Instructions) Laura Champine, Loop.

Laura Champine

Thanks and congratulations on achieving profitability faster than we were expecting. And I wanted to ask about free cash flow, which also beat our expectations in the quarter and the year. A lot of that came from an inventory drawdown, though is that have repeatable events? Or should we expect in free cash flow flattish or even a little bit worse than 2024?

David Loretta

Yes, hi, Laura.Certainly the cash flow gains in 23, we're pretty pronounced and it was that opportunity to rightsize the inventory there. It generated, as well as I'll say that fourth quarter strong earnings earnings results that that just flowed through on to land on our cash balance of $33 million. '24, I do not expect we will have that kind of a cash flow gain and over the course of the year. We do think the inventory levels that are better right-size to the demand in front of us. And so we'll keep managing that to eke out what we can, but we don't expect free cash flow to be to be positive. The ending cash balance of $33 million and where we're at today will certainly cover any additional needs through the balance of the year. But I do want to call out in 2024, we have on some costs related to legal expenses of the cases that are already reported on. And those are those are hard costs and cash cash flow items that we will have a 2024 that would impact our ability to see positive cash flow. So it will be very flat to slightly down, but not much not the kind of positive cash flow that we generated 23.

Laura Champine

Got it. So that will impact cash, but obviously not the adjusted EBITDA outlook that you provided today Correct?

David Loretta

That's correct. That would be an add back. And so but it is a cash outflow kind of.

Operator

Dana Telsey, Telsey Advisory

Dana Telsey

Thank you. Good afternoon, everyone. as you think about 2024 and the guidance you gave versus the first half and the second half of the year, given the more tougher comparisons on the top line in the second half of the year. What do you see as the drivers of growth in the second half?
Is it distribution? Is it something with the categories with new launches? How how you're thinking about it. And then as you think about the adjusted EBITDA as we go through the year, any puts and takes, we should be mindful of. Thank you.

Carla Vernon

I think what Dana is great to hear you. Thanks for joining us today. This is Karla. I think we will take those in two parts. Let me start out by talking about how we think about our overall growth road map. I would say this all still fits within the context of and you can see in our investor presentation on page 9, we really articulate our journey over the course of a few years, right. And so 2023 was absolutely defined as a transformation year for us. We I think we've been really candid about that and hard at work and proud of those results. We still believe in 2024, there are some activities that we want to continue in the vein of our three pillars, our brand maximization pillar, our margin enhancement pillar and our operating discipline pillar. And as we do that, that will mean that we're still really helping to drive a very strong and stable foundation of our core portfolio. We I've talked to you before about our real strong belief in the pro rata principle in any CPG company and that every CPG brand you look at has this sort of stable of core items that really really make or break the portfolio?
We call those our hero items. We really only defined that strategy as a beginning strategy in 2023.
As we look at those Hero items, I know that my that our Chief Growth Officer, Kate, who's here today, is absolutely reflecting on where are the growth opportunities you might also in this slide, and we've talked to you before, many of our hero items are very well under distributed, even though we know that they are so popular, for example, are extremely exciting. Mascara can never stop talking about it. I'm having a great last day when I choose to put on my primary and then my extreme lengthening, and that's the bad that the consumer loves that also, right? It's the number one timing, Climate Pledge friendly mascara in all of Amazon and yet its distribution remains less than half of all stores that we play in. So we do believe that distribution in all of its forms, it is going to be a very rewarding journey for us not only this year, not only next year, but a company like ours has a long runway for growth on distribution and that some of those distribution efforts will be against new items and some of those distribution efforts will be against Hero items. We believe those are both levers we have to play in balance. So I think that the answer is you will see some of all of that from us because there's actually so much opportunity.

David Loretta

Yes, I can touch on the adjusted EBITDA question, Tom, you know, there will be some puts and takes across the year. We're comfortable that the model is set up to deliver on a full year basis, the positive outcome that we've articulated, but in the very near term, some of the revenue pressures that that relate to inventory that was orders that were pulled into our fourth quarter will impact our first quarter. And so we want to call out that first quarter in particular will be a little more muted on the top line, and that would impact the bottom line opportunity for us. But but we do see the top line progressing and a positive way going through the balance of the year as Carla articulated those back half of the year opportunities. And really this is a reflection of setting up this. This model that we see developing our bottom line results growing faster than the top line. It's going to be a consistent gross margin expansion opportunity through it for us across the periods and an expense leverage as well. That will help get us to that adjusted EBITDA positive level.

Operator

Dara Mohsenian, Morgan Stanley.

Dara Mohsenian

Hey, good afternoon, guys. So can we talk about the long-term EBITDA margin potential and what you guys are thinking looking out three to five years, obviously made some nice progress in 2023. But what do you think is a reasonable level looking out long term? And how do you think about the pace of improvement over the next few years?

David Loretta

And are, you know the algorithm that that we think is the best way to express the opportunity as Scott obviously, a function of the progress that we've made that we've demonstrated in 23 on the model that we believe is best to allow revenue gains to kind of flow through at a faster pace to the bottom line. And but it is what it's also balanced with what we think is things that are out of our control. The uncertainty of the macro environment pressures from the consumer that we might face. And and so we think that this model allows us to weather through any of those those periods that we might encounter those and it gives us the flexibility to be strategic over time with with that growth in the bottom line. And I think it's safe to say that it continually expanding margin from an adjusted EBITDA standpoint is what we're comfortable expressing at this time, given that we're still in the early stages of a transformation journey. And then as time goes through, I think you'll see that we can kind of deliver behind that.

Dara Mohsenian

Okay. But maybe a more specific question leaving 2024. Are there big opportunities left from a cost perspective as you think about maximizing profit and driving longer-term profitability? And how do you think about that from a cost perspective after 2024?

David Loretta

And yes, I believe we definitely see continued cost savings opportunities beyond 2024 both within our supply chain, our cost structure of that products, we bring to market and maintaining a real vigilance on expense control pumps. So those are those are going to be aspects of opportunity beyond 2024. And I'll say we always benchmarked ourselves against other CPG companies out there and use use the opportunity that we see in those best, the best in class companies as guidance for us is what we can we can get to as well.

Dara Mohsenian

Great. Thanks.

Operator

Thank you. I'm showing no further questions at this time, I'd like to turn the call back over to Carla for any closing remarks.

Carla Vernon

Well, on behalf of the entire ICE team or as we like to call them our butterfly family. We are so thankful that you dialed in today to join us for our fourth quarter and full year results. And we look forward to talking to you next time. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect and have a great day.