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Ladies and gentlemen, thank you for standing by. Welcome to the Honest Company Third Quarter 2024 Earnings Call. [Operator instructions] Please be advised that today's conference is being recorded.
I would like now to turn the conference over to Allison Malkin of ICR. Please go ahead.
Good afternoon, everyone. Thank you for joining our third quarter 2024 conference call. Joining me today from the Honest Company are Chief Executive Officer, Carla Vernon; and Chief Financial Officer, Dave Loretta.
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 the call over to Carla.
Thanks, Allison. Hello, everyone, and thank you for joining us today. I'm pleased to share the details of our strong performance for the third quarter of 2024.
The continued financial improvement of Honest is due in large part to the dedication of our teams and their commitment to delivering a collection of cleanly designed and consumer-loved personal care products. Our transformation pillars of brand maximization, margin enhancement and operating discipline provide our teams with a framework that puts our product mission in balance with our financial mission.
For the third quarter of fiscal 2024, our results include 3 notable financial achievements. First, we delivered our highest quarterly revenue in the history of the Honest Company with $99 million in sales, which was an increase of 15% year-over-year. Second, we achieved a gross margin of 39%, representing an expansion of 710 basis points over the same period last year. And lastly, we generated adjusted EBITDA of $7 million, representing our fourth consecutive quarter of positive adjusted EBITDA.
With this momentum and strong performance in the third quarter, we are raising our full year 2024 guidance for both revenue and adjusted EBITDA. In addition to these strong financial measures, we're pleased that the consumption of Honest products was stronger than the competitive set of personal care categories. In this quarter, according to Circana tracked channel data, Honest portfolio grew 9% year-over-year compared to a 2% decline in the consumption for the comparable personal care sector. This serves as further evidence of the strength of the Honest brand and how we uniquely meet the needs of today's families.
Despite challenging macroeconomic factors and consumer spending pressures, we continue to see increasing interest in clean product solutions. According to Mintel, over 70% of consumers are concerned about the effects of certain chemicals in personal care products and prioritize safe for sensitive skin claims to meet the needs of their families.
Sometimes, the importance of our mission comes to life most powerfully through the personal interactions we have with the people who use Honest products. This happened for me during a photo shoot we held here at our Honest office. We wanted to feature real Honest users, so we hosted an open casting call and reached out to our community to invite them to come and be part of our campaign. It was such a beautiful and wide array of people of every age.
As the photo shoot was wrapping up, I was approached by a woman who was probably in her 20s or 30s. She wanted to tell me the story of her journey fighting and recovering from cancer. During her treatment, she tried product after product to keep her skin soft and moisturized through the brutal cancer treatment. She told me that when she discovered our hydrogel cream, which is a very lightweight moisturizer, it was the first product she found gentle enough and moisturizing enough to use without irritating her delicate skin.
She even showed me an app that she used as a frequent resource because it rates products for their clean ingredients. And there we were, our Honest products, doing what they were created to do, provides safe, efficacious personal care for whoever may need it. So it comes as no surprise to me that our hydrogel cream is growing 34% year-to-date in consumption at Amazon and yet has so much runway with only 21% ACV distribution in national retail stores.
At Honest, we are so fortunate because we often hear consumer testimonials like the one I just shared, and that inspires us every single day to deliver solutions to our community by committing to what we call the Honest standard. This standard provides our teams with an important set of formulation and design principles that make Honest products well suited to meet the moment. I'm an Honest mom now, but our products didn't exist when my own teenagers were babies.
Today, I'm so pleased that as my grandniece Kyla was born last month, her parents, the many new parents on our own Honest team and all of the parents in our extended community of Honest shoppers can rest at ease knowing that our rigorous Honest standard includes a list of over 3,000 ingredients of concern that we choose not to use in our products. We are very proud that our Honest standard is so high and is a higher standard than is required by any U.S. or European Union regulation.
It is through this standard that we meet the high expectations of Honest families and stand out in the market of personal care products. And it also helps drive the brand growth at the heart of our brand maximization transformation pillar. Our brand's strength is evident through our consumption growth of 9% nationally and 19% at Amazon. The resonance of our Honest standard can also be seen in the growth of our community and our distribution.
This quarter, our household penetration among Honest users reached 6.7%, an increase of 23 basis points versus last year. And our retail distribution grew by 4%, while sustaining strong sales momentum with velocities up 5%. Together, our performance and our alignment with growing consumer needs has made Honest the leading natural baby personal care brand in the United States. While we're confident in our top line growth, our #1 priority remains margin improvement and strengthening our financial foundation through our transformation pillars of margin enhancement and operating discipline.
On a recent visit to our Las Vegas distribution center, my team and I saw how this focus across the organization is paying off. During our visit, our supply chain and logistics teams shared how they optimized a previously cumbersome approach to our pallet management. In prior years, when our order quantities were smaller, the team would receive pallets that needed to be broken down to apply a product identity label to each case only to then reassemble the labeled cases back into partial and mixed pallets prior to shipping.
This year, in partnership with our largest retailers, the team identified a set of items that are frequently ordered in full pallet quantities. And now those pallets get labeled simply and correctly without the need to break down and reassemble them. This optimization allowed us to save on labor, order turnaround time and retail pickup speed. This process improvement demonstrates the ability of our transformation pillars to unlock the power and scale of the Honest brand and our business model.
As I close, I would like to thank our entire Honest team for their commitment to driving continued financial improvement and performance momentum for the Honest brand. I'm incredibly proud of this team and the extraordinary execution this quarter.
And with that, I will turn it over to Dave to share the financial results of our third quarter and details on our updated financial outlook.
Thank you, Carla. As noted, our third quarter results surpassed our expectations across key financial metrics, and we saw significant accomplishments toward our transformation pillars. On the top line, our 15% revenue increase was balanced across distribution and velocity gains and included shipments in support of retail and digital events.
We generated gross margin expansion, which reached a new high of 38.7%, driven by benefits across the cost structure through supply chain efficiencies and product cost savings. The execution of our transformation pillars continues to deliver efficiencies as we grow, demonstrated by our strong revenue growth, expansion in gross margin and disciplined SG&A spend leading to profitability in the quarter. And as provided in our press release issued today, we are raising our annual guidance for the second time this year, reflecting our year-to-date performance and our positive view of the business.
Let me turn to our third quarter results. As Carla noted previously, net revenue was $99 million, up 15% from the prior year third quarter, driven by strong performance across our baby products and wipes portfolios. Also noted, retail tracked channel consumption grew 9% compared to the comparative categories, which were down 2% in the same period. And at Amazon, our largest digital customer, consumption in the period was up 19%.
We advanced our brand maximization pillar with balanced revenue growth seeing increases in distribution and velocity. We continue to realize increased consumer demand across our core business offerings, which is allowing Honest to play a bigger role in consumers' daily lives. In fact, our community is purchasing our brand across multiple categories, which drove increased household penetration and spend per household in the quarter. As I mentioned, revenue also benefited from shipments to support retail events in the quarter, including our Target 10th anniversary collection and the limited edition diapers and wipes sprints at Walmart in celebration of Hispanic Heritage Month.
Additionally, we saw strong shipments in preparation for Amazon Prime Day events in July and October. During October Prime Day, our products performed incredibly well with our 720 count Clean Conscious Wipes landing in the top 100 performing deals site-wide in terms of unit volumes sold. Gross margin for the third quarter was 38.7%, a new record and expanded 710 basis points versus last year, with roughly 400 basis points related to supply chain cost reductions and 300 basis points related to product cost reductions.
As guided by our margin enhancement pillar, we are confident in our ability to profitably grow the business as we benefit from sustainable cost savings. Through our operating discipline pillar, we are also mindful and actively planning for levers that we can use in response to an ever-changing sourcing and supply chain landscape. This includes the potential for new tariffs, commodity price increases or disruptions to logistics.
Moving on to expenses. In total, operating expense increased $3 million compared to the third quarter last year, but as a percentage of revenue generated 220 basis points of leverage. Breaking this down further, SG&A as a percentage of revenue decreased 440 basis points compared to last year. Our diligence around managing expense across the organization while generating revenue growth has contributed to the majority of the strong leverage year-over-year.
That said, included in this quarter's SG&A were nonrecurring legal expense of $4.1 million. In the fourth quarter, we expect an additional $4 million to $5 million related to this nonrecurring expense. Marketing expense totaled $13 million and increased $4 million from the prior year third quarter to 13.3% of revenue versus 10.6% of revenue last year, as expected.
We continue to seek a balanced approach to gaining brand trial, building awareness and increasing household penetration. The combination of double-digit revenue growth and expansion in gross margin offset the increase in operating expenses and led to an $8 million improvement in operating income for the quarter versus an operating loss last year. In addition, adjusted EBITDA was positive $7 million compared to negative $1 million last year. This is our fourth consecutive quarter of positive adjusted EBITDA and highlights that the execution of our strategy through the transformation pillars is driving profitable growth as intended.
Turning to the balance sheet. We continue to build a strong financial foundation with quarter end cash of $53 million and no debt outstanding. Inventory at quarter end was $75 million, a decrease of $5 million from the end of the third quarter of 2023. We remain comfortable with the level of our inventory as we enter the fourth quarter and we'll maintain appropriate levels to support our expected growth. Our operating discipline pillar is driving efficiencies in our working capital usage, which led to a sequential increase of $17 million in cash flow versus the second quarter and $3 million compared to the third quarter of last year.
Turning to guidance. Given our strong performance and positive outlook, we are increasing our full year revenue and adjusted EBITDA guidance for the second time this year. First, let me share our revenue outlook. We are now raising our revenue guidance to the high single-digit percentage growth range year-over-year, which is an increase to our previous guidance for revenue in the mid- to high single-digit percentage growth range.
As you are aware, we plan our business on an annual basis, and we may experience quarterly fluctuations in growth rates due to the timing of distribution gains and shipments. Based on the current view of our order flow, we do not expect to repeat the earlier timing of shipments, which benefited Q4 of 2023.
Second, with the significant progress we're making on expanding margins and controlling costs, we now expect adjusted EBITDA in the range of $20 million to $22 million versus the previous guidance of $15 million to $18 million. This represents an improvement of over $30 million from last year. Annual gross margin is expected in the range of 37% to 38% as we benefit from savings in product costs and supply chain efficiencies.
As we look ahead, we believe we have strengthened our foundation for future growth and expect the ongoing execution of our strategy to deliver annual revenue growth, expand profit margins and generate strong cash flow, which also benefits from our asset-light business model. The investments we do make in the business are ultimately in support of expanding the availability of Honest products to all places our community shops. As a result, we believe we are well positioned to continue building on our financial gains and drive increased value for our shareholders.
And with that, I'll turn the call over to the operator.
[Operator Instructions] And the first question does come from Aaron Grey with AGP.
Nice quarter. So, first question for me, you mentioned strong consumption trends, but also talked about some shipment benefits. So curious if you could quantify how much of the shipment benefits impacted the quarter. I believe that also led to the implied softer growth for 4Q. So that would be helpful there.
Aaron, this is Dave. The consumption trend that we saw in the quarter, we're really excited about at retail level, 9% up with Amazon, 19%. And when you blend the 2 together, they do kind of resemble our revenue growth rate of 15% for that period of time. So pleased with that performance and how the team delivered it.
In terms of the incremental shipments that we did realize, and those were in line with the retail events that we had, we talked about in our second quarter, both an event at Target and an event at Walmart and then Amazon Prime Day, both the supply the July Prime Day and the October Prime Day since that was really just the first week into that next week after our third quarter ended.
So to put some context around the percentage growth rate, you could think of it as roughly 3 to 4 percentage points of our revenue growth to be attributed to supplying that inventory for those events. And the balance is really ongoing [indiscernible] in the business from a consumption standpoint and order flow.
Okay. Great. I appreciate it. Second question for me. So just as we think bigger picture, last call, you guys talked about investments to drive more growth that continues to kind of bear fruit for you guys, building a nice cash balance. So just as we look going forward and into 2025 and the holiday season, how much more confidence do you guys have to kind of keep digging deeper and pushing the lever on different marketing or investing even on the gross margin side in trade to kind of drive continued growth versus letting more of that drop down to the bottom line?
Yes, sure, Aaron. As we talked about in the second half of the year, where we did intend to increase both the marketing spend and the trade promotion investments, we're pleased with how that played out for us. As you saw in the third quarter, marketing was up [indiscernible] relative to last year and say it was a little over 13% and trade promotion as well was deeper in what we applied for that period of time. So we're comfortable with that flexibility we've got to dial up our marketing to drive the right kind of awareness and brand trial. Some of that evidence is playing out in the stats that we shared around household penetration. We're at 6.7%, which increased 23 basis points in the quarter, and I think that's a year-to-date rate.
So we're seeing the results of that brand awareness and the consumer acceptance. And so we're comfortable that we've got both the flexibility to drive velocities with some of the trade promotion dollars, but also continue to expand the brand awareness through a lot of the marketing initiatives that we employed in the third quarter. And we'll continue to do that in the remaining quarter of the year. And as we move into 2025, we'll give you some color on that period of time when we give our guidance for that period.
And the next question comes from Owen Rickert with Northland Capital Markets.
Congratulations on another great [indiscernible]. I guess, quickly, how are you viewing the dollar store end segment and what's your thoughts on the opportunity there? How penetrated are you in that space? And I guess just any more of your thoughts there would be really helpful.
Owen, nice to talk to you. Thank you for joining us. This is Carla, and thank you for asking. If you take a look at our investor presentation that's online, you will see that we have a very intentional distribution-based growth strategy underlying our overall long-range plan and our long-range growth model. And on some of those slides, we love to provide you with an update of how we're making progress against that strategy, where we currently have strength and where we see opportunity.
In this quarter, what we've communicated is our distribution growth of 4% in the quarter overall, following our stores, doors, aisles, shelves facings, distribution growth strategy. We're very pleased with the fact that as our distribution is growing, our velocities are growing at the same time. And so velocities are up 5% at the same time we've been driving distribution growth, which is just such an indicator of the excitement for the brand.
To date, we are represented in about 50,000 retail doors overall. That's a little less than half of all the retail doors available across the various retail brick-and-mortar channels that we might think of. So we do think that there is enormous runway for us to grow with regard to the opportunity and the places where this brand really makes sense to be.
Currently, we don't have any distribution in the dollar channel, which is very compelling. We know that young families shop in that channel and have the same sensitive skin needs that fit in the 70% of households that we know are very focused on the ingredient content of their products. And we look forward to not only being available in more channels than we are today, but making sure that we step our way into all the right channels that will help us continue to drive the awareness and the growth.
Great. That was very helpful. And then secondly, could you provide some more color on some of those new marketing initiatives that were discussed on the previous earnings call? What worked well in the quarter? And maybe what should we be keeping our eyes on for 4Q?
Yes. Well, I think overall, we've got just a world-class marketing team on the brand here that it has been improving the effectiveness of not only what the marketing does, but exactly where we spend it and our balance of upper, middle and lower funnel activities. So some of our marketing is used in partnership directly with our retailers. We had great strength, as Dave reported, in both Prime Days and Target Circle Week in the quarter with very strong double-digit growth rates across all of those retailers.
And you may remember that on the call, we also addressed the fact that in the most recent Amazon Prime Day, one of our boxes wipes our 720 count, wipes box was among the top 100 items across all of Prime Day, whether that's Dyson vacuum cleaners or Nike ankle socks or whatever it is you might buy our wipes boxes in the top 100 performing deals. That's because we've got a really strong sense of how to use our marketing dollars to plug into our retailer-specific tent pole items.
In addition to that, the team had several campaigns that they executed across the various forms of consumer media. We have some campaigns that are strongly aligned with our sensitive skin benefit. So we ran a campaign this quarter called the Skin to Skin Campaign. We're seeing very strong results. That campaign was actually able to feature a variety of products across our portfolio, all with one common thread that they are good and trustworthy for sensitive skin.
What you will see from us will continue to be a balance of doing both events that are really focused on amplifying our execution with our retailers, along with a complementary set of marketing activities that are really bigger, larger consumer-focused initiatives to share with people the benefits and the portfolio variety within Honest.
And the next question comes from Dara Mohsenian with Morgan Stanley.
So Carla, I was just hoping you could take a step back now that we're 3 quarters through the year. The strong consumption trends we've seen in both tracked channels and digital, how sustainable is that as we look out to 2025 and beyond? You just touched on some of the marketing success and just how you think about sustainability going forward from here? And then just a similar question on gross margins, the 37% to 38% range for the full year. Is that a sustainable level going forward? Are there any key puts and takes as you look beyond this year longer term?
Sure. Dara, it's really great to hear you today. So thank you for joining the call. To talk about consumption, I would remind everyone that the overall consumption in the MULO Track channel data was up 9% in the quarter, and that consumption was complemented by our consumption for the quarter on Amazon of 19% up year-over-year. Together, that blend is really a such strong indication of the way in which the velocities are working as well as the increased scale of household penetration.
Dave just recapped that we've grown household penetration year-to-date. We're now at 6.7% household penetration, which is an increase of 23 basis points of our household penetration. Those are great measures that really point us towards the fact that consumption has a strong underlying basis. What I also like to look at, Dara, when I try to think about the sustainability of consumption is what are some of the elements that are driving that consumption? Are we seeing it on price? Are we seeing it on units? This consumption that we've experienced and over all of the recent quarters that I've been talking to you has been really balanced and very strong.
So our consumption has driven 5% unit growth consumption increase and 4% price increase. That is not during a period where we've done price advance, so to speak, because we've actually lapped almost all of our price advances in market. That's a demonstration that people are actually buying larger basket sizes of Honest per transaction or larger items from us when they are buying transactions with Honest. Additionally that I look for is our repeat rates and our overall drivers of consumption and loyalty and our repeat has also grown in the quarter.
So all of those indicators tell me that we have consumer fundamentals that are highly aligned with the products we offer and the benefits they serve. Of course, I can't speak specifically about what consumption will do on any future basis. But I would say when I look at the indicators and the fundamental drivers of consumption, I feel very great about what that tells me about the alignment we have with our retail partners and our consumers.
Dara, I'd be happy to kind of touch on the gross margin sustainability question that you had there, too. As we see the improvement that we've made year-to-date, a little over 1,000 basis points, pretty significant with the combination of both product cost savings and supply chain fulfillment savings. Those are sustainable and they're structural.
And when we think about what's going to support kind of the level that we're at now and even longer term continuing to expand it. What we know is that we've got the right opportunity to continue to see some cost structural improvements in our product set. Our teams are continuously aggressively going after that across our sourcing network. And as we leverage with sales growth, some of the supply chain opportunity improvements will be there that sees benefit from revenue growth.
And then lastly, I'd say, as you can see where some of the highlights of our portfolio is seeing the most traction, it's in margin categories that are beneficial to the overall picture. And so over time, a mix of portfolio based on higher-margin profitability is what's also going to be part of the equation. And that's a core tenet of how we know the long-term margin expansion will play out for us. But hopefully, that supports your question.
And our next question comes from Anna Glaessgen with B. Riley Securities.
I'd love to start on the Amazon Prime Day and historically, its efficacy as a tool to reach new consumers. Or do you generally see that as existing customers who are just buying in bulk and taking advantage of the discounts and the ability to convert those new customers to DTC customers?
Anna, this is Carla. Nice to talk to you. We know from our Amazon purchase behavior that we actually track each quarter to what degree are we getting new-to-brand shoppers. And I don't know the number in this quarter specifically. But I think when we were with you all last quarter, we reported that we quadrupled new-to-brand first-time shoppers on Amazon in the quarter.
So in general, what we find with Prime Day is that Prime Day is definitely a balance of replenishment shoppers who are already very loyal and love the brand. But as our algorithm and our set of products work so powerfully in the Amazon ecosystem, we are also able to really gain new households who are doing search word, searches for maybe a product category and haven't yet decided which brands they want. And as we perform strongly, we rate higher up in those searches. And so that brings greater brand awareness and greater trial on the Amazon ecosystem.
I know some of the analysts on the call today are aware that I used to run these categories at Amazon. So I was the Vice President of Consumables categories for 2 years at Amazon. Our team not only maintains strong relationships with many of the leaders of those categories over Amazon. But as we do our business planning, we love to be highly integrated with them on making sure we deploy the right investments that unlock the ability to grow together, and we're very pleased with how that growth has gone.
And I'd like to shift to a topic that's very popular right now, assessing potential exposure to China sourcing. I believe you are limited to sourcing wipes from China, which would be roughly less than 20% of sales, but any update there would be great.
Yes. Sure, Anna. That is a topical issue these days, and we've been actually monitoring it for quite a while ourselves. You're right, our wipes portfolio is sourced in China. And so our team has been actively working with our supplier for quite a while on the topic of tariffs and really cost efficiencies. And so as we think about how -- not knowing what the level or the timing of new tariffs may come down within China, we've already been working on plans to consider diversification, working on plans around cost reductions within that product set. And so we're prepared for what the uncertainty might bring us, but we're not clear as to the timing and the level that it's going to play out along with anyone else.
Thankfully, we do have a nimble sourcing organization, and we are not heavily concentrated in that part of the world. So I think we've got a portfolio that balances across our sourcing domestically and internationally and will allow us to continue to maintain the gross margin levels that we expect and continue to build on that. So we're prepared.
And our next question comes from Laura Champine with Loop.
So the gross margin gains have been obviously substantial. How much of a lift are you getting there from the price mix benefits that you're seeing? And if you can quantify that as a percentage lift to sales in Q3 on that 15%, that would be great.
Yes. Sure, Laura. Within the quarter, and you're right, the lift was quite notable as we see our 38.7% gross margin is really an all-time high for us and tracks over last year, over 700 basis points. We don't see that, that's really letting up in terms of pricing being the driving factor there. In fact, we know that it's almost entirely made up of both the cost savings on product and fulfillment and supply chain savings that are in place for us ongoing.
The pricing that we did take in 2023, we've largely lapped all of that price increase. And so by the third quarter of this year, it was a very small amount that you could attribute to pricing or mix of higher-priced product in terms of our booked gross margin. But I think what we did call out, and Carla noted this, too, once the product is in the retailer hands and the consumers are buying it, they're buying at a higher price point and we're seeing growth on units and the average. So it's a mix factor that's out there. But in terms of our gross margin rate, it was, for the most part, all cost savings and structural improvements.
Got it. And then a quick follow-up on the tariff question. I hear you that you're preparing for it. But given that you're sourcing one of your highest growth categories out of China, we're just a little worried about the wipe side. How quickly could you shift production? And how comfortable would you be raising prices to offset any increase in cost that's tariff related?
Well, we know that there will take some time for any implemented tariffs to put into place and how that would materialize in our cost structure, just given the lead times on our inventory flow and I don't really expect it's going to be a material impact in 2025. But what we do see is that the flexibility we have on sourcing is something that we're already well underway of working on with our supplier, looking at other countries of origin, other supply locations and also actively looking at cost reductions in the wipes product itself. So that's -- I'd say, more to come, but we're actively on this topic.
Should we expect inventory to build a bit through year-end as you build safety stock there?
Well, we'll make a call on that as we get closer to the lead times necessary and if we've got any guidance on the state of implementing tariffs in certain parts of the world, but not at the risk of over-inventorying our position. I mean we'll be very prudent, but we'll also take the appropriate action to build if necessary to avoid some known costs. But today, those aren't known.
I would now like to turn the call back to Carla Vernon for closing remarks.
Thanks, everyone, for joining us today. It was a pleasure speaking with you and sharing our third quarter results. We look forward to speaking with many of you at some of our upcoming investor events. And the rest of you will see you next quarter.
This does conclude today's conference call. Thank you for participating. You may now disconnect.