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Good day, and thank you for standing by. Welcome to The Honest Company First 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 [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Austenfeld. Please go ahead.

Good morning, everyone. Thank you for joining our first quarter 2023 conference call. Joining me today are Carla Vernon, Chief Executive Officer; and Kelly Kennedy, our Chief Financial Officer. Before we start, I'd 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 Web site at investors.honest.com. With that, I will turn the call over to Carla.

Thanks, Steve. Good morning, everyone and thanks for joining us today. Last quarter, I indicated that we were not satisfied with the recent performance of our business. I also assured you that we can and will drive shareholder value by bringing greater discipline to our cost structure and operating approach. It was also my first opportunity to share my confidence in the fundamental strength and growth potential of the Honest brand. With decades of experience as a CPG Brand Builder and more recent experience as a digital retailer, I was drawn to the company because of the quality of the product, the demonstrated strength across a broad set of categories and the way the modern mission of the clean and sustainable product design has taken a strong place in consumers' homes and lives. And now with my first 100 days behind me, my conviction about the growth potential of the Honest brand and the opportunity to transform our business model remains strong. The strength of our portfolio is reflected in the Q1 revenue growth we announced today, which exceeded our expectations. As a result, we are now raising our revenue outlook for the year. Over the last year, we've successfully executed our plan to expand retail distribution and drive greater growth in physical channels. And while we are pleased with the roll of growth from the retail channel, our Q1 revenue performance was balanced evenly across retail and digital channels with both growing over 20%, illustrating the strength of our omnichannel approach. While we are pleased with our top line performance, as I emphasized with you last quarter, we are relentlessly focused on improving our cost structure and margin performance. I'm pleased to announce the launch of our transformation initiative in Q1, which will drive long term profitability and sustained shareholder value. This transformation initiative encompasses three pillars; brand maximization, margin enhancement and operating discipline. The workstreams across these pillars are expected to improve our margin structure, drive focus on the most productive areas of our business, reduce working capital, deliver greater impact of brand building investments and improve executional excellence across the enterprise. While some of this work builds on ongoing work streams, I'm pleased to share that in recent months our team has redoubled our efforts to identify a more robust set of strategies and initiatives to accelerate our path to achieve sustainable, profitable growth. Kelly, I'll turn it over to you to review the financials, including further details on our transformation initiative.

Thank you, Carla, and welcome everyone. Our performance in the quarter reflected strong top line results, as well as continued cost inflation and costs associated with our transformation initiatives. Starting first with revenue performance. First quarter revenue was $83 million, which was up 21% versus a year ago with comparable growth rates in both our digital and retail channels. Growth in the quarter was driven by healthy consumption trends, expanded distribution, prior year pricing actions and healthy orders from a key digital retailer. Honest consumption in track channels, which now represents roughly half of our revenue, was up 30% in the first quarter with half reflecting organic growth and half coming from incremental distribution. Honest is gaining market share as our growth continues to outpace the categories where we compete. For example, in our largest category, diapers and wipes, Honest consumption growth in Q1 was over 40%, significantly outpacing the overall category growth of 7%. Reflecting on price increases taken in 2022, we are pleased to see consistent volume growth indicating the value of our brands and resiliency of our consumers. As we are poised to take additional pricing actions in 2023, we are confident in our ability to achieve price premiums that are aligned with our premium brands. Turning to key drivers by product category, first, diapers and wipes. Our diapers and wipes business represented nearly 65% of our revenue this quarter and was up 23% with consumption significantly outpacing the category. Growth reflected the benefit of price increases, retail distribution expansion and increased assortment. In particular, we've seen growth in wipes as we have capitalized on uses beyond diapering, with recent campaigns focused on multiple uses in the household. Skin and personal care, which represented over 25% of total revenue this quarter, increased 7% due to retail consumption gain, a more focused assortment on best selling [hero] items and innovation, including Daily Green Juice Antioxidant Super Serum, which launched in the first quarter. We're seeing particular strength in our beauty business with consumption up double digits, driven by over 20% growth at Target. Our household and wellness business represented nearly 10% of revenue this quarter and increased 81% due to the benefit of integrating the baby clothing business. Now turning to results by channel. Digital channel revenue increased 22% while retail increased to 21%. Revenue in Q1 was equally split 50% retail and 50% digital, reflecting recent retail distribution wins, robust track channel consumption, as well as strong purchases by our key digital retailers. Some highlights included: continued strong performance at Target, our largest customer, where we saw all time record consumption during the quarter; continued strength at Walmart behind new distribution secured last year, which we believe is highly incremental to our existing business; and double-digit point of sales growth across diapers, wipes and beauty items at our key digital retail customer. Before I cover the rest of the income statement, I want to share further details on our transformation initiatives recognizing its impact on reported results in the first quarter, as well as key actions we're taking to drive margin expansion through the three key pillars of our transformation initiative; brands maximization, margin enhancement, and operating discipline. First, to drive brand maximization, we plan to leverage the strength of the Honest brand to deliver growth through new innovation and focus on core items. Specifically, we will grow distribution and drive higher velocities of margin and creative products in our portfolio. Something as simple as elevating the benefit, claims and imagery of our products in our marketing and packaging can make an impact quickly and drive revenue growth within our existing products. Another critical component of our brand maximization strategy is pricing. We're taking significant pricing actions in 2023 to return to historical premiums that align with our brand positioning. Results of recent pricing actions indicate that consumers believe our value proposition is strong. The second pillar in our transformation initiative is margin enhancement. We've taken decisive actions this quarter to transform our cost structure. From a portfolio standpoint, we are aligning our focus where we can lead and win, including two immediate actions that can drive improved margins and profitability. First, we will focus on North America where we have scale and the ability to most cost efficiently drive growth. This impacts our international business where we are exiting Asia and Europe. This decision will reduce complexity, inventory levels and associated costs, and give us greater focus on how we deploy our resources. We are also exiting portions of the household category as we contract [standardization] line in the face of waning demand and look for opportunities to rationalize SKUs across the portfolio to drive higher margin and meaningfully reduce inventory. Costs associated with these structural changes are reflected in today's earnings release. Exiting SKUs is likely to impact offerings at certain retailers, which has been reflected in our revenue outlook 2023 beginning in the second quarter. We are currently executing multiple supply chain and sourcing projects to reduce the landed cost of our products. Areas of focus include, contract manufacturing strategies, reduced shipping and logistics costs and product cost optimization. The third pillar of our initiative is operating discipline. This includes tightly managing our SG&A expenses and aligning our talent, resources and skills to reflect the prioritization of higher margin opportunities and the exit of select low priority businesses and products. And our operating discipline will extend beyond the P&L to ensure we're aggressively managing working capital, including the reduction of inventory, thereby reducing warehousing and fulfillment costs and generating cash we can invest to drive the business. In total, we anticipate the transformation initiative to incur $10 million to $15 million in costs with the majority being noncash. In the first quarter, we recognized $7 million of costs, which reflected noncash charges related to inventory and prepaid write-offs. Initiative costs impacted multiple parts of our income statement, including revenue, cost or revenue, SG&A and also resulted in restructuring charges, which are reflected within operating expenses. We anticipate our transformation initiatives will generate an estimated $15 million to $20 million in annualized benefit starting in late 2023 as we monetize pricing, cost savings and reduce operating expenses. Returning back to our Q1 financial results, gross margin was 24% in the first quarter of 2023 compared to 30% in the first quarter of 2022. This included nearly 400 basis points of transformation initiative costs, including reserving for inventory related to exiting our international business, portions of our sanitizing business and from SKU rationalization as we pivot to higher margin parts of our portfolio. Excluding the charges related to our transformation initiative, our gross margin would have been 28%. Gross margin was also impacted by approximately 400 basis points of higher supply chain costs due in part to short term inefficiencies driven by elevated levels of inventory. These costs are expected to sequentially improve throughout the year as inventory levels come down. Gross margin also reflected over 200 basis points of benefit from pricing and cost savings. Turning to operating costs and profitability. Operating expenses increased $4 million in the first quarter of 2023 compared to the first quarter of 2022. Operating expenses included $6 million of nonrecurring expenses, including $4 million in restructuring and other transformation initiative related expenses, $1 million in CEO transition costs and $1 million in legal fees related to securities litigation expense. Marketing spend was 12% of sales, reflecting higher returns associated with greater support for our retail expansion. Adjusted EBITDA for the first quarter of 2023 was negative $10 million, including $6 million in costs related to the transformation initiative. Excluding the charges we recorded for the transformation initiatives, our adjusted EBITDA would have been negative $5 million. Turning to the balance sheet. We ended the quarter with $12 million in cash, cash equivalents and short term investments with no debt. Excluding items that we don't anticipate occurring again in 2023, such as CEO transition costs that were accrued in 2022 and paid in the first quarter, operating cash flow was positive in the first quarter. As mentioned earlier, the transformation initiative costs in the quarter were predominantly noncash. As we committed to last quarter, we made significant progress to reduce our inventory balance, which decreased by $17 million in the quarter. We now anticipate exceeding our initial goal of $20 million inventory reduction and continue to believe it will offset our operating loss for the year. As we mentioned in our March call, we entered into a $35 million asset based credit facility in January to provide liquidity for future growth investments. We've not borrowed on this line to date and plan to aggressively manage working capital as we implement our transformation initiative and drive to profitability. Now turning to our outlook for 2023. Following strong consumption trends in the first quarter, we are increasing our full year 2023 revenue outlook to be up low single digits versus full year 2022. The company's full year 2023 revenue outlook reflects continued positive track channel consumption combined with the benefit of midyear pricing actions, offset by lower revenue related to the exit of low margin and low priority product line beginning in the second quarter and comparing against significant new distribution in the second half of 2022. Adjusted EBITDA is expected to be in the range of negative $25 million to negative $30 million, including $7 million to $10 million in costs and charges related to the transformation initiative that will impact adjusted EBITDA. With that, let me turn it back to Carla before we open it up for questions.

Happy to take it over from here. As Kelly indicated, in 2023, we will be relentlessly focused on delivering the goals of our transformation initiative. This foundation of improved brand maximization, margin enhancement and operational discipline will set the path for more profitable growth in 2024 and beyond. Later this year, I will present the long term strategic roadmap that will guide our ongoing growth. As we redefine our growth path, I'm pleased to announce that Kate Barton has joined the Honest management team in the new role of Chief Growth Officer. Kate brings a strong track record of brand building, innovation and business management skills. Most recently, Kate was the Chief Brand Officer at an omnichannel founder-built lifestyle brand, and she also has a history of driving growth of both high profile global beauty brands and category leading food brands that you can read about in our press release issued earlier today. Kate's signature combination of heart and horsepower make her the perfect leader to inspire the loyalty and imagination of our discerning and passionate Honest consumers. With that, I'll turn the call over to the operator and we look forward to answering your questions.

[Operator Instructions] Our first question comes from the line of Laura Champine from Loop Capital.

It's a two parter related to the outlook. First part, on the revenue guide, it doesn't seem as if you've passed through the full amount of the Q1 beat. So I'm wondering whether you expect some retrenchment from a key digital customer in Q2 after this strong Q1? Second question is on the adjusted EBITDA guide. I'm a little confused on which costs from the transformation initiative stay in that number and which ones you'll pull out? So just looking for some more clarification on the guidance.

Happy to start maybe with the revenue question first, Laura. Certainly, we see great and strong underlying consumption as we highlighted that consumption, which is roughly 30% is half organic and half from new distribution as we move into the back half of the year. Of course, you know that we'll be up against the pipeline filled new distribution in the back half. So as we think about just growth, certainly the 21% growth in Q1 reflects -- we're up against a low quarter a year ago. We have, as we move into the back half, significant pricing that's going in that we've taken a kind of a thoughtful and conservative approach on what the elasticities will be against that pricing action. And then we also, as we move into Q2 and foward, we have pulled out revenue associated with the SKU rationalization, the exit of international and product lines that we're not moving forward with, which were a drag on margin and allow us to reallocate those resources towards kind of the future growth and really driving accretive growth in the future. But those are the main reasons if you think about kind of the back half coming off of Q1, we're tending to be kind of thoughtful about what we think that revenue outlook will be for the balance of the year. And certainly, we did take up the outlook. But as you mentioned, some of that, certainly, as we go into the back half of the year. And as we announced the transformation initiative, we hadn't yet reflected the new revenue coming out. So that's predominantly the reason. Specific to your question, we had great results in the digital channel. In Q1, we saw consumption in line with shipments from our key digital partner. We are not anticipating. We think that the inventory levels are the right levels to support that business. But we're not anticipating any further exhale or inhale in the back half of the year. As it moves to just the question on adjusted EBITDA, certainly with the transformation initiative, that $10 million to $15 million is actually going to be across the P&L. And so we wanted to make sure that the range of adjusted EBITDA, which is $25 million to $30 million, you need to back out $7 million to $10 million, which excludes the restructuring component, which is already taken out of adjusted EBITDA. So we anticipate the restructuring component to be $3 million to $5 million. And the restructuring is really going to be around exit costs, for example, termination fees or contracts, liabilities that we had as we kind of moved away in our SKU, so that would cover the severance or headcount, contract termination fees and then also prepaid write offs go into restructuring. Separate from that, anything inventory related is predominantly noncash in nature. These would be reserved and write off of inventory that we won't be going forward with and those continue to go through cost of revenue and will impact adjusted EBITDA. So you need to exclude $7 million to $10 million, which is predominantly inventory reserves that were taken in costs, will be taken in cost of revenue. If you back that out, you'll notice that adjusted EBITDA is a slight improvement. Of course, we took up our revenue outlook. And so it is not what -- it is a slight improvement versus what we were talking about in the fourth quarter.

[Operator Instructions] Our next question comes from the line of Andrea Teixeira from JP Morgan.

Just to basically come in and ask on the transformation process. What is the bridge for sales and margins of those products have been excluded and also the regions? I mean, just to give us perspective on how you're thinking of the underlying business as we move forward to a new Honest company, like how we should be thinking of -- and I understand that obviously, you have some work to be done on the underlying itself. Just to see like how it's the recurrent or underlying growth patterns and marching for as you progress beyond 2023?

I’ll start and Kelly you can jump in. When you think about kind of the transformation initiative, we talked about there being kind of three big buckets that we’re focused on, and the first is really around brand maximization. And this is driving pricing and getting back to our pricing premium historically, and also really focusing on our core and margin enhancing products into which we can support with marketing that are packaging and really driving better performance. So that's really around way of maximization. The margin expansion really is the area that generated the cost for the business, which was $7 million in Q1 and we anticipate some additional costs coming later in the year. And I would break that into kind of three components. The first is really product exits and international. And as we think about kind of getting through that product, those were margin drags overall on the business. And more importantly, as we think about the complexity of that piece of the business, whether it be international or some of these other category and lower volume, lower margin products, getting out of those allows us to, one, focus, but also less drag and get out of some of the complexity that we see within those and focus more on core where we think there's a higher return. We also did do a fee rationalization across all of our categories. So that touched every part of our portfolio, which is just something that company has not done in many years and we thought it was the right thing for the business. And then the last piece really to think about the transformation initiatives around cost savings initiatives as we move into lower cost, there are some costs that we incur as we kind of move in to new packaging, cost savings that we can generate, that we’ll also take. So as you think about the revenue impact, we're not breaking down specifically the impact. But these were smaller parts of our business we have this close, international being a small percentage of our business. And the other product exits predominantly will be areas that are not going to be a significant impact on revenue as we think about going forward, but really allowing us to get the margin and cost structure of our business in the right place.

I'll just build a couple of additional themes, because I know that at the heart of your question, you were asking about the underlying base of the business, and really reasons to believe about where we are going in terms of growing our margins and driving value creation in the portfolio. So Kelly did a great job of explaining the bridge. I want to make sure couple themes just come out loud and clear, which is, first and foremost, one of the things we have done is we've redoubled our efforts to drive discipline in how we operationalize our approach here on the team is we've found that there are opportunities to improve the cost structure of items in our existing portfolio. And so that is really wonderful, because that's something in the near term we can really begin to address is expanding the margins of the things we like that we already have. Additionally, we also believe there's great growth opportunities in some of our best items. Our distribution levels are very small against some of our most productive and highest velocity items that will remain items in our core. So we have an opportunity to really drive growth. Often I love to talk about the Pareto principle, which is that it's really true for many CPG portfolios that the top items drive the majority of the revenue and the majority of the productivity of the portfolio. And so making sure that we have a mindfulness to our top items as we drive our growth roadmap going forward is going to be important, and we like what we see there with that opportunity. And then lastly, as I said, I will be back later in the year to talk about my growth strategy. That growth strategy is where you're going to also hear more about, in addition to the importance of the core, reimagining the mix of our portfolio so that we understand the role of enhancing margins by enhancing the mix in categories we are in where we know we can lead and win and categories where we see opportunities to drive that leadership and innovation that those categories need.

And just to be super clear, when you say you're going to come back on the top line growth, and I think we all appreciate in CPG that you're being focused on the 80/20 rule and basically drive home kind of the highest level of growth and return of the products and focus. But is that also given that we are all kind of burned by the rebase? Is that basically it in terms of rebasing, should we tell investors like how much visibility do you have into the planograms of the large retailers, obviously, you come from one of them, on your key retail partner? Like to make sure that you have that visibility to the extent the selling and sell out converge, that you were seeing some sort of confidence on the new number that there was not going to be any further rebase at this point at least on the margin front?

I think -- let me make sure I'm understanding your question, Andrea. If you're talking about whether we think that consumption momentum we're seeing at our current 30% overall consumption track channel along with our top-line growth of 21%, if we think that the underlying fundamentals will remain fundamentally strong in that regard, or if we expect surprises, if that's the nature of it, is that it?

Yes, thank you Carla for making sure -- and I know there's a lot in there. I think number one is more the 20 to 30 negative, is that 25 to 30, sorry, and adjusted 18 to 20 EBITDA or EBITDAs range. Is that pretty much embedding some conservatism and that you don't need to come back when you come up back with your top line growth, strategy, that it's going to be more upside, what do you have so far rather than downside? So in other words, this is the number one part of the question. And then number two is, on that vein, how much visibility do you have into the balance of the year?

I'm going to start just by really grounding us philosophically, I'm going to have Kelly really hit on some of the specific building blocks. But philosophically, I hope what I'm conveying is that it's very -- we have great confidence in our ability to continue to have a glide path towards margin expansion, profit creation, value creation, that we think is very evident already in the early things we're identifying as we do our transformation initiative. In addition to the transformation initiative, our growth strategy project lives on top of that and that growth strategy is designed specifically to continue to strengthen the places that we already liked, that are margin accretive in our portfolio but small and have an opportunity to grow, and then really continue to move in that direction of that glide path. So I feel very confident that because of the amount of growth we see before us, that even if there are bumps in the road, the glide path we're on is one towards greater value creation and margin expansion. I'm going to let Kelly answer you about any specific structural building blocks.

And I think I think this is what you're getting is, Andrea, is that as we think about implementing that growth plan, there will be investments we need to make. And that is absolutely the beauty of an asset light model is there can be advantages and disadvantages of not owning your own manufacturing, but it allows us to quickly get into new products and expand and invest in innovation. And those investments are predominantly around resources, which we talked about and are contemplated within our transformation initiative, within the SG&A, with the headcount changes, we've realigned the headcount in the business away from the areas that we're getting out of towards the areas that we're going to be investing in, including innovation. The other piece is that it’s predominantly a working capital investments that we'll need to make at the time we launch those. And as you can imagine that growth plan is predominantly not 2023, it's really driving growth in 2024 and forward. And so those working capital investments that we need to take we’ll be able to utilize liquidity available in our etiologies, and that we have kind of the -- to make investments in 2024 and then going forward as we move on our path to profitability, be able to self fund on those investments going forward. In terms of visibility, I do think in your question, there the expenses that we will incur around the transformation initiative, which is the entire foundation of growth, we have contemplated any costs that we anticipate for 2023 within the numbers we've provided. So that is sufficient, the ranges that we’ve given to cover the activities that will also cover that growth.

Our next question comes line of Jon Andersen from William Blair.

I was going to take one more kind of stab at the prior question, just so I'm clear on it. The guidance for the year, at this point, as I understand it takes the sales guidance, takes into account the kind of the pruning, let's say, work in terms of SKU, key exits, international, some of the household. And what can come later in the year then, Carla, would be the strategy to -- that lays on top of that, there wouldn't be a further reset of kind of the sales outlook or reset, it would be more of an opportunity to enhance the top line growth outlook relative to where we sit today. Is that fair?

I think that's a really great way to capture what we’ve communicated. Thank you.

Okay, I appreciate that. Thank you. I did want to ask on pricing, a lot of companies are, not pricing as much this year, I guess, as they did last. And it sounds like you've done the homework to determine that the brand and the elasticities are such that a price increase makes sense. Could you provide a little bit more detail around what kind of level of price scene are we talking about on what part of the portfolio? And again, maybe why what evidence you have that you're really confident that that you won't see greater elasticities going forward on that?

Yes, happy to speak to the pricing and Carla, if you can speak a little, maybe to the brand component of it. When we looked at the data, Jon, and we talked about this in our last call, we really felt that we left some money on the table, but not by not taking pricing as quickly. And the one thing we were really pleased to see, and you can see in the recent consumption data, ending 3/31 and even the next round of basically track channel's data that has coming out is that we continue to grow predominantly by volume and pricing as we highlighted earlier. We taken only about half the pricing versus kind of the competitive products. And we've actually depressed the premium to where we would like to be. So as we think about the pricing we're taking, which is in -- the timing is kind of scaled out over the course of the year, but it will cover roughly half of our revenue base and it's mid to high single digit. And so it also is across our product categories. And so it will be, in some cases, taking additional pricing atop of pricing that we've already taken in 2022. And I don't know, Carla, if you want to…

Yes, I’ll just talk about why we feel that this is not only the right thing to do, but why we feel good about the way we're estimating the impacts going forward. A few factors for me. One is, the Honest brand has typically had that 15% price premium to our key branded players that are often the share leaders in the category. That pricing relationship is one that's true for us across many of our categories, and our retail partners know that, they understand that that is related to the premium of the product, the quality of the inputs in our product, and really what our brand stands for in all of the categories we are in. And so in the conversations we've been having with our retailers, they understand this pricing strategy. And so far, we are finding that we're getting agreement and alignment on the return of our 15% approximate price premium. The other thing that we see is, we've been growing across every category that we are in. So we have a lot of reason to believe, in addition to seeing the 30% consumption growth for the quarter, we have a lot of reason to believe that our brand is, as we see, gaining market share is strong with the consumers that we serve. It is important though that we have a pricing structure that matches the brand and premium and that allows us to continue to deliver that shareholder value and invest in the brand and invest in the differentiated benefits that we deliver. So we have every signal to believe that this is going to really be accepted in the market and fit with the retail strategies in our categories.

Thank you [Operator Instructions]. And I'm not showing any further questions in the queue. I would now like to turn the conference back to Carla for any closing remarks.

Wonderful. Thank you again everyone for joining us and your interest and support for The Honest Company. We look forward to speaking with you next quarter.