You should read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and related notes as disclosed in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 (the "Annual Report"), filed with theSecurities and Exchange Commission ("SEC") onMarch 28, 2022 . This discussion, particularly information with respect to our future results of operations or financial condition, business strategy and plans, and objectives of management for future operations, includes forward-looking statements that involve risks and uncertainties as described under the heading "Special Note Regarding Forward-Looking Statements" in this Quarterly Report on Form 10-Q.
Overview
The Honest Company, Inc. ("Honest" and, together with its consolidated subsidiaries, the "Company," "we," "us" and "our") is a digitally-native, mission-driven brand focused on leading the clean lifestyle movement, creating a community for conscious consumers and seeking to disrupt multiple consumer product categories. Our commitment to our core values, continual innovation and engaging our community has differentiated and elevated our brand and our products. Since our launch in 2012, we have been dedicated to developing clean, sustainable, effective and thoughtfully-designed products. By doing so with transparency, we have cultivated deep trust around what matters most to our consumers: their health, their families and their homes. We are an omnichannel brand, ensuring our products are available wherever our consumers shop. Our differentiated platform positions us for continued growth through our trusted brand, award-winning multi-category product offerings, deep digital-first connection with consumers and omnichannel accessibility. Our integrated multi-category product architecture is intentionally designed to serve our consumers every day, at every age and through every life stage, no matter where they are on their journey. Our three product categories are Diapers and Wipes, Skin and Personal Care, and Household and Wellness, which represented 63%, 31%, and 6%, respectively, of our revenue for the three months endedMarch 31, 2022 , compared to 62%, 32%, and 6%, respectively, of our revenue for the three months endedMarch 31, 2021 . We refer to Diapers and Wipes and Skin and Personal Care as our "core" product categories. At the center of our product ecosystem are our diapers, which are a strategic consumer acquisition tool that acts as an entry point for our portfolio, as new parents often go on to purchase products from our other categories for their everyday family needs. Our integrated multi-category product architecture is designed to drive loyalty, increase our consumer wallet share and generate attractive consumer lifetime value. We believe that our consumers are modern, aspirational, conscious and style-forward and that they seek out high quality, effective and thoughtfully-designed products. We believe that they are passionate about living a conscious life and are enthusiastic ambassadors for brands they trust. As purpose-driven consumers, they transcend any one demographic, spanning gender, age, geography, ethnicity and household income. Honest consumers are often young, mobile-centric and digitally-inclined. We build relationships with these consumers through a disruptive digital marketing strategy that engages them with "snackable" digital content (short-form, easily digestible content), immerses them in our brand values, and inspires them to join the Honest community. Our direct connection with our community enables us to understand what consumers' needs are and inspires our product innovation pipeline, generating a significant competitive advantage over more traditional consumer packaged goods, or CPG, peers. Our omnichannel approach seeks to meet consumers wherever they want to shop, balancing deep consumer connection with broad convenience and accessibility. Since our launch, we have built a well-integrated omnichannel presence by expanding our retail accessibility across both Digital and Retail channels, including the launch of strategic partnerships with Costco, Target and Amazon in 2013, 2014 and 2017, respectively. For the three months endedMarch 31, 2022 , we generated 50% and 50% of our revenue from our Digital and Retail channels, respectively, compared to 52% and 48%, respectively, for the three months endedMarch 31, 2021 . We maintain direct relationships with our consumers via our flagship digital platform, Honest.com, which allows us to influence brand experience and better understand consumer preferences and behavior. We increase accessibility of our products to more consumers through both the third-party pureplay ecommerce sites that, with Honest.com, comprise the rest of our Digital channel, and our Retail channel, which includes leading retailers and their websites. As ofMarch 31, 2022 , our products can be found in approximately 43,000 retail locations acrossthe United States ,Canada andEurope . This distinctive business model has allowed us to efficiently scale our business while remaining agnostic as to the channel where consumers purchase our products. Our integrated omnichannel presence provides meaningful benefits to our consumers which we believe is not easily replicated by our competitors. 22 --------------------------------------------------------------------------------
Initial Public Offering
OnMay 7, 2021 , we completed our initial public offering ("IPO") of 25,807,000 shares of our common stock at a stock price of$16.00 per share, resulting in aggregate net proceeds to us of approximately$91.0 million , after deducting the underwriting discount and commissions of$6.7 million and offering expenses of$5.5 million . We sold 6,451,613 shares and certain existing stockholders sold an aggregate of 19,355,387 shares. We granted the underwriters an option for a period of 30 days to purchase up to an additional 3,871,050 shares of common stock from the selling stockholders at$16.00 per share less the underwriting discounts and commissions. InMay 2021 , the underwriters fully exercised the option to purchase these additional shares from the selling stockholders. We did not receive any proceeds from the sale of shares of our common stock by the selling stockholders.
Key Factors Affecting Our Performance
We believe that the growth of our business and our future success are dependent on many factors. While each of these factors presents significant opportunities for us, they also pose important challenges that we must successfully address to enable us to sustain the growth of our business and improve our operations while staying true to our mission, including those discussed below and in the section of this Quarterly Report on Form 10-Q titled "Risk Factors."
Ability to Grow Our Brand Awareness
Our brand is integral to the growth of our business and is essential to our ability to engage and stay connected with the growing clean lifestyle consumer. Honest is still unknown to many consumers, with unaided brand awareness of 29% among diaper buyers according to our consumer research conducted inJanuary 2022 . In order to increase share of wallet of existing conscious consumers and to attract new consumers, our brand has to maintain its trustworthiness and authenticity. Our ability to attract new consumers will depend, among other things, on our ability to successfully produce products that are free of defects and communicate the value of those products as clean, sustainable and effective, the efficacy of our marketing efforts and the offerings of our competitors. Beyond preserving the integrity of our brand, our performance will depend on our ability to augment our reach and increase the number of consumers aware of Honest and our product portfolio. Given higher costs of digital marketing we have and expect to continue to shift the focus of our marketing spend towards supporting retail marketing programs and to make changes in our domestic and global marketing initiatives to increase brand awareness. We believe our brand strength will enable us to continue to expand across categories and channels, allowing us to deepen relationships with consumers and expand our access to global markets. Our performance depends significantly on factors that may affect the level and pattern of consumer spending in the product categories in which we operate. Continued Innovation Research, development and innovation are core elements underpinning our growth strategy. Through our in-house research and development laboratories, we are able to access the latest advancements in clean ingredients and continue to innovate in the clean conscious lifestyle space. Based inLos Angeles, California , our research and development team, including chemists and an in-house toxicologist, develops innovative clean products based on the latest green technology. At Honest, product innovation never stops. The improvement of existing products and the introduction of new products have been, and continue to be, integral to our growth. We have made significant investments in our product development capabilities and plan to continue to do so in the future. We believe our rigorous approach to product innovation has helped redefine and grow the clean and natural product categories in which we operate. Our continued focus on research and development will be central to attracting and retaining consumers in the future. Our ability to successfully develop, market and sell new products will depend on a variety of factors, including our continued investment in innovation, integrated business planning processes and capabilities. We use connectivity to our community of consumers to provide lifestyle insights that power innovation across categories. We use innovation to support our growth objectives across our portfolio, as highlighted in the three core pillars of our Innovation Framework: that we bring product innovation that 1) feeds and nurtures our core values, 2) expands within our existing product categories, and 3) grows into new potential product categories adjacent to existing categories that fit with our value proposition to the consumer. We continue to innovate in each of our product categories in areas such as breakthrough new product formulations, innovative packaging, costovation (defined below) and marketing strategy, with a focus on driving "big bets" across potential product adjacencies where we have: 1) permission to play with consumers, 2) relevant domain expertise, and 3) the opportunity to expand across a broader consumer demographic within an existing Honest home. We are also focused on building a portfolio of products in complementary categories through our Innovation Strategy and the momentum created by our Digital Strategy. We are building an Honest community with the goal of creating a more holistic clean, conscious home for consumers and customers alike. We strive for continuous improvement in our existing products' safety, sustainability, efficacy and design profile while achieving better performance often at lower cost, which we refer to as costovation. 23 --------------------------------------------------------------------------------
Continued Product Category Growth
Our product mix is a driver of our financial performance given our focus on accretive product launches and innovation to increase product margins. Even though our growth strategy aims to boost sales across all categories, we intend to prioritize growth in Skin and Personal Care given its attractive margin characteristics and leverage our brand equity and consumer insights to extend into new adjacent product categories. Since we launched our Innovation Strategy, we have enhanced our product portfolio by strategically discontinuing certain products and making calculated extensions within our three product categories. These product changes have contributed to our revenue and margin growth.
Continued Execution of Omnichannel Strategy
The continued execution of our omnichannel strategy impacts our financial performance. We intend to continue leveraging our marketing strategy to drive increased consumer traffic to our flagship digital platform, Honest.com, as it is a valuable tool for creating direct connections with our consumers, influencing brand experience and understanding consumer preference and behavior. Our partnerships with leading third-party retail platforms and national retailers have broadened our consumer reach, raised our brand awareness and enhanced our margins through operating leverage. We will continue to pursue partnerships with a wide variety of retailers, including online retailers, big-box retailers, grocery stores, drugstores and specialty retailers. Our ability to execute this strategy will depend on a number of factors, such as competitive dynamics and retailers' satisfaction with the sales and profitability of our products, channel shifts of their customers, and their own supply chain, order timing, and inventory needs, which may fluctuate from period to period.
Operational and Marketing Efficiency
To grow our business, we intend to continue to improve our operational and marketing efficiency, which includes attracting new consumers, increasing community engagement and improving fulfillment and distribution operations. We invest significant resources in marketing and content generation, use a variety of brand and performance marketing channels and work continuously to improve brand exposure at our retail partners to acquire new consumers. It is important to maintain reasonable costs for these marketing efforts relative to the revenue we expect to derive from our consumers. We leverage our proprietary Honest Omni-Analytics to generate valuable consumer insights that guide our omnichannel strategy and inform our marketing spend optimization. Our future success depends in part on our ability to effectively attract consumers on a cost-efficient basis and achieve efficiencies in our operations. Our paid advertising includes search engine marketing, display, paid social media and product placement and traditional advertising, such as direct mail, television, radio and magazine advertising. Paid advertising costs significantly increased industry-wide in 2021, which negatively impacted our ability to cost-effectively drive traffic to Honest.com and contributed to the decline in Digital revenue in 2021 and for the quarter endedMarch 31, 2022 . We expect these elevated costs in paid advertising to continue to impact marketing efficiencies, costs and revenue in our Digital channel in 2022.
Overall Macro Trends
We have strategically positioned ourselves to benefit from several macro trends related to changes in consumer behavior. We believe consumers' increasing interest in a conscious lifestyle has contributed to higher demand for our products. Further, the rise in digital shopping has complemented our flagship digital platform, Honest.com, our presence with third-party ecommerce players and our Retail partners' websites. During the three months endedMarch 31, 2022 , we continue to see the shift from Digital to Retail as more consumers chose to return to in-store shopping. Changes in macro-level consumer spending trends, including as a result of the COVID-19 pandemic, have resulted and could in the future result in fluctuations in our operating results. The COVID-19 pandemic caused general business disruption worldwide beginning inJanuary 2020 . The full extent to which the COVID-19 pandemic will directly or indirectly impact our cash flow, business, financial condition, results of operations and prospects will depend on future developments that are uncertain.
Business Operations
As a result of the COVID-19 pandemic, our headquarters was temporarily closed
but has since reopened in a hybrid capacity. During the pandemic we implemented
travel restrictions and social distancing measures, including replacing many
in-person meetings with virtual interactions, as well as other precautions for
the safety of our employees, many of which we have continued into 2022. These
actions represented a significant change in how we operate our business, but we
believe that we successfully navigated this transition. We will continue to take
actions as may be required or recommended by government or health authorities or
as we determine are in the best interests of our employees and business partners
in light of the pandemic.
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The operations of our retail partners, manufacturers and suppliers have also
been impacted by the COVID-19 pandemic. While the duration and extent of the
COVID-19 pandemic depends on future developments that cannot be accurately
predicted at this time, it has already had an adverse effect on the global
economy and the ultimate societal and economic impact of the COVID-19 pandemic
remains unknown. In particular, the conditions caused by this pandemic may
negatively impact collections of accounts receivable and reduce expected
spending from new consumers, all of which could adversely affect our business,
financial condition, results of operations and prospects in the future.
Prolonged unfavorable economic conditions, including as a result of COVID-19 or
similar outbreaks, and any resulting recession or slowed economic growth, may
have an adverse effect on our sales and profitability.
Supply Chain Disruptions
We have experienced some impacts on our inventory availability and delivery capacity since the COVID-19 outbreak, which to date has not significantly impacted our ability to service our consumers and retail and third-party ecommerce customers; however, the out-of-stock inventory due to supply chain disruptions has been significant on several key items, particularly in our Skin and Personal Care and Diapers and Wipes product categories. In the fourth quarter of 2021, we experienced lower than expected inventory receipts due largely to global supply chain delays, including a delay in receiving shipments from overseas. We have taken measures to bolster key aspects of our supply chain, such as ensuring sufficient inventory to support our continued growth, new distribution and longer lead times. As a result of the COVID-19 pandemic and other macroeconomic trends, we and our distribution partners have experienced some disruptions to the operations of our fulfillment centers, including a nationwide truck driver shortage. For example, during the fourth quarter of 2021, some employees at our warehouse facilities were ill with COVID-19 and/or following quarantine protocols, which coupled with the nationwide truck driver shortage, negatively impacted our and our distribution partner's ability to fulfill orders in a timely manner and had a negative impact on our results of operations. In addition, an international freight forwarder partner experienced a cyber attack during the three months endedMarch 31, 2022 resulting in a delay in the shipment and launch of our Beauty Restage products inEurope . We continue to work with our existing manufacturing, logistics and other supply chain partners to ensure our ability to service our consumers and retail and third-party ecommerce customers. We have experienced and anticipate continued increases in commodity prices, labor costs, input costs and transportation costs in 2022. For example, some of our contracts with third-party manufacturers have clauses that trigger good faith renegotiation of purchase costs in the case of significant raw material cost escalation. In the fourth quarter of 2021, we were informed by two third-party manufacturers in our Diapers and Wipes and Skin and Personal Care categories that those hurdles had been met. As a result, we negotiated and agreed to higher purchase prices which has negatively impacted our cost of goods during the three months endedMarch 31, 2022 and will continue to have a negative impact on our results of operations through the rest of 2022. We implemented price increases that take effect in 2022 and have pursued productivity initiatives to offset these price increases, but continue to experience significant input cost levels that has and could continue to hamper our ability to drive margin expansion. The demand for sustainable packaging and ingredients is outpacing the supply of these raw materials. For example, there is a supplier shortage of various raw materials used in manufacturing and distributing our products, including tree-free paper, post-consumer recycled plastic resin, post-consumer recycled cardboard shipping cartons for our Honest.com shipments and palm kernel oil.
Consumer Preferences
We believe that during 2020, COVID-19 drove a demand shift towards our Digital channel as consumers shifted to online shopping amid the pandemic. Given our digitally-native brand and strong digital penetration, we believe we benefited from this trend. Additionally, in 2020 we benefited from increasing consumer and customer demand for sanitization and disinfecting products, which drove revenue growth in our Household and Wellness product category. In 2021, we saw a significant decline in consumer demand for sanitization and disinfecting products as consumers returned to pre-COVID routines. In addition, retailers continue to manage heavy inventories of these products in stores and warehouse facilities. Toward the end of 2021, we began to see increased consumer willingness to return to in-store shopping as the economy reopened and more of the population became vaccinated, driving revenue growth within our Retail channel, specifically within our Diapers and Wipes and Skin and Personal Care product categories in 2021. During the three months endedMarch 31, 2022 , the mix of revenue across channels became more balanced between Retail and Digital.
Inventory
Inventory is reflected at net realizable value which includes a reserve for
excess inventory. We estimate reserve requirements based on current and
forecasted demand, including the ability to liquidate excess inventory and
estimated liquidation
25 -------------------------------------------------------------------------------- value. For example, given the significant decline in consumer demand for sanitizing and disinfecting products, we recorded an inventory write-down of$5.6 million during the year endedDecember 31, 2021 relating to certain sanitization and disinfecting products as the amount of inventory was significantly in excess of existing and projected demand. Management is implementing various strategies to address this reduction in demand and the related impact on gross margin, including higher markdowns and promotions to clear through inventory, liquidation efforts, investing in new product ideas and developing new creative advertising. There is no guarantee that customer demand will increase in our favor or that we will be able to successfully implement these strategies. Depending on future consumer behavior in relation to changes in the COVID-19 pandemic and related aging of inventory, among other factors, we may incur additional inventory write-downs and customer returns.
Components of Results of Operations
Revenue
We generate revenue through the sale of our products through Digital and Retail channels in the following product categories: Diapers and Wipes, Skin and Personal Care, and Household and Wellness. The Digital channel includes direct sales to the consumer through our website and sales to third-party ecommerce customers, who resell our products through their own online platforms. The Retail channel includes sales to traditional brick and mortar retailers, who may also resell our products through their own online platforms. Our revenue is recognized net of allowances for returns, discounts, credits and any taxes collected from consumers. In 2019 we entered into a license agreement withButterblu, LLC , or Butterblu, pursuant to which we license certain of our trademarks to Butterblu for the manufacture and distribution of certain baby apparel products in exchange for royalties. Butterblu operates and maintains our baby apparel offerings independently through the honestbabyclothing.com website. Our baby apparel offerings and our license agreement with Butterblu are not currently material to our business. For the three months endedMarch 31, 2022 and 2021, we collected$0.4 million and$0.2 million , respectively, in royalty revenue related to our license agreement. Cost of Revenue Cost of revenue includes the purchase price of merchandise sold to customers, inbound and outbound shipping and handling costs, freight and duties, shipping and packaging supplies, credit card processing fees and warehouse fulfillment costs incurred in operating and staffing warehouses, including rent. Cost of revenue also includes depreciation and amortization for warehouse fulfillment facilities and equipment, allocated overhead and direct and indirect labor for warehouse personnel. Gross Profit and Gross Margin Gross profit represents revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin may in the future fluctuate from period to period based on a number of factors, including the mix of products we sell, the channel through which we sell our products, the innovation initiatives we undertake in each product category, the promotional environment in the marketplace, manufacturing costs, commodity prices and transportation rates, among other factors.
Operating Expenses
Our operating expenses consist of selling, general and administrative, marketing
and research and development expenses.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of personnel
costs, principally for our selling and administrative functions. These include
personnel-related expenses, including salaries, bonuses, benefits and
stock-based compensation expense. Selling, general and administrative expenses
also include technology expenses, professional fees, facility costs, including
insurance, utilities and rent relating to our headquarters, third-party product
development and marketing costs, depreciation and amortization and overhead
costs. We expect our general and administrative expenses to increase in absolute
dollars as we continue to grow our business and organizational capabilities.
Since our IPO, we have also incurred additional costs for employees and
third-party professional fees related to operating as a public company and costs
to comply with the rules and regulations applicable to companies listed on a
national securities exchange, costs related to compliance and reporting
obligations, and increased expenses for insurance, investor relations and
professional services.
Marketing
Marketing expenses include costs related to our branding initiatives, retail
customer marketing activities, point of purchase displays, targeted online
advertising through sponsored search, display advertising, email and influencer
marketing campaigns, market research, content production and other public
relations and promotional initiatives. Given higher costs in digital marketing,
we expect to shift the focus of our marketing spend towards supporting retail
marketing programs and top of
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funnel marketing activities. We will continue to invest in marketing initiatives
in our core product categories and hero products with key retailers, as well as
expand brand awareness, introduce new product innovation across multiple product
categories and implement new marketing strategies in the United States and
abroad. As we expand our distribution in existing international markets and
launch new products, we expect to make marketing investments to build brand
awareness, drive trial and set foundation for future revenue growth in global
markets.
Research and Development
Research and development expenses consist primarily of personnel-related
expenses for our research and development team. Research and development
expenses also include costs incurred for the development of new products,
improvement in the quality of existing products and the development and
implementation of new technologies to enhance the quality and value of products.
This includes the expense related to claims and clinical trials as well as
formulation and packaging testing. Research and development expenses also
include allocated depreciation and amortization and overhead costs. We expect
research and development expenses to increase in absolute dollars as we invest
in the enhancement of our product offerings through innovation and the
introduction of new adjacent product categories.
Interest and Other Income (Expense), Net
Interest income consists primarily of interest income earned on our short-term investments and our cash and cash equivalents balances. Prior to the adoption of Financial Accounting Standards Board Accounting Standard Update No 2016-02, Leases (Topic 842), interest expense consisted primarily of the portion of rent payments recognized as imputed interest expense under build-to-suit accounting associated with our leasing arrangements. Other income (expense), net consists primarily of our foreign currency exchange gains and losses relating to transactions denominated in currencies other than theU.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in both the volume of foreign currency transactions and foreign currency exchange rates.
Income Tax Provision
We are subject to federal and state income taxes inthe United States . Our annual estimated tax rate differed from theU.S. federal statutory rate of 21% primarily as a result of a valuation allowance against deferred tax assets, stock-based compensation, state taxes, nondeductible executive compensation and other permanent differences. We maintain a full valuation allowance for our federal and state deferred tax assets, including net operating loss carryforwards, as we have concluded that it is not more likely than not that the deferred tax assets will be realized.
Results of Operations
The following table sets forth our condensed consolidated statements of
operations data for each of the periods indicated:
For the three months ended March 31,
2022 2021
(In thousands)
Revenue $ 68,719 $ 81,032
Cost of revenue 48,092 52,651
Gross profit 20,627 28,381
Operating expenses
Selling, general and administrative(1) 19,611 16,697
Marketing 13,465 14,173
Research and development(1) 2,096 1,646
Total operating expenses 35,172 32,516
Operating loss (14,545) (4,135)
Interest and other income (expense), net (61) (327)
Loss before provision for income taxes (14,606) (4,462)
Income tax provision 20 22
Net loss $ (14,626) $ (4,484)
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(1) Includes stock-based compensation expense as follows:
For the three months ended March 31,
2022 2021
(In thousands)
Selling, general and administrative $ 3,370 $ 1,748
Research and development 178 90
Total $ 3,548 $ 1,838
The following table sets forth our condensed consolidated statements of
operations data expressed as a percentage of revenue*:
For the three months ended March 31,
2022 2021
(as a percentage of revenue)
Revenue 100.0 % 100.0 %
Cost of revenue 70.0 65.0
Gross profit 30.0 35.0
Operating expenses
Selling, general and administrative 28.5 20.6
Marketing 19.6 17.5
Research and development 3.1 2.0
Total operating expenses 51.2 40.1
Operating loss (21.2) (5.1)
Interest and other income (expense), net (0.1)
(0.4)
Loss before provision for income taxes (21.3) (5.5) Income tax provision - - Net loss (21.3) % (5.5) %
* Amounts may not sum due to rounding.
Comparison of the Three Months Ended
Revenue
For the three months ended March 31,
2022 2021 $ change % change
(In thousands, except percentages)
By Product Category
Diapers and Wipes $ 43,289 $ 49,574 $ (6,285) (12.7) %
Skin and Personal Care 21,266 26,245 (4,979) (19.0)
Household and Wellness 4,164 5,213 (1,049) (20.1)
Total Revenue $ 68,719 $ 81,032 $ (12,313) (15.2) %
For the three months ended March 31,
2022 2021 $ change % change
(In thousands, except percentages)
By Channel
Digital $ 34,260 $ 42,461 $ (8,201) (19.3) %
Retail 34,459 38,571 (4,112) (10.7)
Total Revenue $ 68,719 $ 81,032 $ (12,313) (15.2) %
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-------------------------------------------------------------------------------- Revenue was$68.7 million for the three months endedMarch 31, 2022 , as compared to$81.0 million for the three months endedMarch 31, 2021 . The decrease of$12.3 million , or 15.2%, was driven by a$6.3 million ,$5.0 million and$1.0 million revenue decline in Diapers and Wipes, Skin and Personal Care and Household and Wellness products, respectively. The revenue decrease in Diapers and Wipes was primarily driven by a$4.9 million decrease in diaper revenue and$1.4 million decrease in wipes revenue due to lower traffic and revenue in our Digital channel partially as the price of digital marketing escalated and impacted our ability to cost-effectively drive traffic to our digital platforms. Our wipes revenue was also impacted by supply chain constraints and out-of-stock inventory related to port closures and delays. The revenue decrease in Skin and Personal Care was primarily driven by$3.4 million in liquidation sales in advance of our Beauty Restage to clear out legacy inventory during the three months endedMarch 31, 2021 that did not occur during the three months endedMarch 31, 2022 . Skin and Personal Care was also impacted by a$1.1 million decrease in beauty product sales in our Digital channel due to lower digital traffic, increased marketing costs due to the higher price of digital marketing and certain product out-of-stocks driven by supply chain constraints. The Household and Wellness revenue decrease was primarily driven by a decrease in overall consumer demand for sanitization and disinfecting products. The reduction in revenue in our Retail channel for the three months endedMarch 31, 2022 , compared to the three months endedMarch 31, 2021 , was primarily due to$3.4 million in liquidation sales in advance of our Beauty Restage to clear out legacy inventory, as well as a decrease of$1.4 million in revenue from a sanitizing and disinfecting rotational program with a key retail partner during the three months endedMarch 31, 2021 that did not occur during the three months endedMarch 31, 2022 , partially offset by an increase of$1.1 million in revenue with a key retailer driven by strong in-store traffic and expanded store and SKU count. The reduction in revenue in our Digital channel for the three months endedMarch 31, 2022 , compared to the three months endedMarch 31, 2021 , was primarily due to consumers returning to in-store shopping and higher digital marketing costs which impacted the ability to cost-effectively drive traffic to Honest.com and digital partners.
Cost of Revenue and Gross Profit
For the three months ended March 31,
2022 2021 $ change % change
(In thousands, except percentages)
Cost of revenue $ 48,092 $ 52,651 $ (4,559) (8.7) %
Gross profit $ 20,627 $ 28,381 $ (7,754) (27.3) %
Cost of revenue was $48.1 million for the three months ended March 31, 2022 , as
compared to $52.7 million for the three months ended March 31, 2021 . The
decrease of $4.6 million , or 8.7%, was primarily due to lower sales revenue,
resulting in fixed cost deleverage; higher input, transportation, freight and
warehouse labor costs; and higher trade promotions as compared to the first
quarter of 2021. Cost of revenue as a percentage of revenue increased by 501
basis points primarily due to higher input costs, especially in transportation,
freight and warehouse labor costs, along with higher trade promotions as
compared to the three months ended March 31, 2021 .
Gross profit was $20.6 million for the three months ended March 31, 2022 , as
compared to $28.4 million for the three months ended March 31, 2021 . The
decrease of $7.8 million , or 27.3%, was primarily due to the decrease in revenue
in our three product categories, fixed cost deleverage and higher input costs,
partially offset by pricing increases that went into effect in 2022, favorable
product mix and cost savings.
Operating Expenses
Selling, General and Administrative Expenses
For
the three months ended
2022 2021 $ change % change
(In thousands, except percentages)
Selling, general and administrative $ 19,611 $ 16,697 $ 2,914 17.5 %
Selling, general and administrative expenses were $19.6 million for the three
months ended March 31, 2022 as compared to $16.7 million for the three months
ended March 31, 2021 . The increase of $2.9 million , or 17.5%, was primarily due
to an increase of $1.6 million in stock-based compensation expense and $0.9
million increase in costs related to insurance for operating as a public
company.
Marketing Expenses
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For the three months ended March 31,
2022 2021 $ change % change
(In thousands, except percentages)
Marketing $ 13,465 $ 14,173 $ (708) (5.0) %
Marketing expenses were $13.5 million for the three months ended March 31, 2022 ,
as compared to $14.2 million for the three months ended March 31, 2021 . The
decrease of $0.7 million , or 5.0%, was primarily due to a higher level of spend
in the three months ended March 31, 2021 to support the launch of our Clean
Conscious Diapers, and reflected a shift to trade promotions in support of
retail distribution and merchandising.
Research and Development Expenses
For the three months ended
2022 2021 $ change % change
(In thousands, except percentages)
Research and development $ 2,096 $ 1,646 $ 450 27.3 %
Research and development expenses were $2.1 million for the three months ended
March 31, 2022 , as compared to $1.6 million for the three months ended March 31,
2021 . The increase of $0.5 million , or 27.3%, was primarily related to our 2022
strategic product plan.
Interest and Other Income (Expense), Net
For the three months ended
2022 2021 $ change % change
(In thousands, except percentages)
Interest and other income (expense), net $ (61) $ (327) $ 266 -81.3 %
Interest and other income (expense), net was net expense of $0.1 million for the
three months ended March 31, 2022 , as compared to net expense of $0.3 million
for the three months ended March 31, 2021 . The decrease of $0.3 million , or
81.3%, was primarily due to a decrease in interest expense related to the
derecognition of our built-to-suit lease. Under the new lease accounting related
to the adoption of ASC 842, all lease expense related to the built-to-suite
lease is now included in the cost of revenue.
Liquidity and Capital Resources
We have incurred net losses and net cash outflows from operating activities since our inception. Prior to our IPO, our available liquidity and operations were financed primarily through the sale of redeemable convertible preferred stock, equity securities and to a lesser extent, debt financing. Upon the closing of our IPO, we received net proceeds of approximately$91.1 million , after deducting underwriting discounts and commissions of$6.7 million and offering expenses of$5.4 million . As ofMarch 31, 2022 , we had$44.7 million of cash and cash equivalents and$33.4 million of short-term investments. Although we are dependent on our ability to generate sufficient cash flow from operations or raise capital to achieve our business objectives, we believe our existing cash, cash equivalents, and short-term investments will be sufficient to meet our short-term and long-term working capital and capital expenditure needs. Future capital requirements will depend on many factors, including our rate of revenue growth, gross margin and the level of expenditures in all areas of the Company. To the extent that existing capital resources and sales growth are not sufficient to fund future activities, we will need to raise capital through additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. Failure to raise additional capital, if and when needed, could have a material adverse effect on our financial position, results of operations, and cash flows.
2021 Credit Facility
InApril 2021 , we entered into a first lien credit agreement (the "2021 Credit Facility"), withJPMorgan Chase Bank, N.A ., as administrative agent and lender, and the other lenders party thereto, which provides for a$35.0 million revolving credit facility that matures onApril 30, 2026 . The 2021 Credit Facility includes a subfacility that provides for the issuance of letters of credit in an amount of up to$10.0 million at any time outstanding, which reduces the amount available under the 2021 Credit Facility. 30 -------------------------------------------------------------------------------- As ofMarch 31, 2022 , there were outstanding standby letters of credit of$6.3 million related to lease obligations with$28.7 million available to be drawn upon. The 2021 Credit Facility is subject to customary fees for loan facilities of this type, including a commitment fee based on the average daily undrawn portion of the revolving credit facility. We expensed the commitment fee and included it in interest and other expense, net in the condensed consolidated statements of comprehensive loss. For the three months endedMarch 31, 2022 , the commitment fee incurred was immaterial. The interest rate applicable to the 2021 Credit Facility is, at our option, either (a) the LIBOR (or a replacement rate established in accordance with the terms of the 2021 Credit Facility) (subject to a 0.00% LIBOR floor), plus a margin of 1.50% or (b) the CB floating rate minus a margin of 0.50%. The CB floating rate is the higher of (a) theWall Street Journal prime rate and (b)(i) 2.50% plus (ii) the adjusted LIBOR rate for a one-month interest period. The 2021 Credit Facility will terminate and borrowings thereunder, if any, will be due onApril 30, 2026 . As ofMarch 31, 2022 , there was no outstanding balance under the 2021 Credit Facility. We are required to follow certain covenants. As ofMarch 31, 2022 , we are in compliance with the net leverage ratio covenant.
Refer to Note 6 included in these condensed consolidated financial statements
for more information on the 2021 Credit Facility.
Cash Flows
The following table summarizes our cash flows for the periods presented:
For the three months ended March 31,
(In thousands) 2022 2021
Net cash used in operating activities $ (14,702) $ (11,964)
Net cash provided by investing activities $ 8,609 $ 21,786
Net cash provided by (used in) financing activities $ 45 $ (1,382)
Operating Activities
Our largest source of operating cash is from the sales of our products through
Digital and Retail channels to our consumers and customers. Our primary uses of
cash from operating activities are for cost of revenue expenses, selling,
general and administrative expenses, marketing expenses and research and
development expenses. We have generated negative cash flows from operating
activities and have supplemented working capital requirements through net
proceeds from the sale and maturity of short-term investments.
Net cash used in operating activities of $14.7 million for the three months
ended March 31, 2022 was primarily due to net loss of $14.6 million , non-cash
adjustments of $5.9 million and a net decrease in cash related to changes in
operating assets and liabilities of $6.0 million . Non-cash adjustments primarily
consisted of stock-based compensation of $3.5 million , amortization of operating
ROU assets of $1.6 million and depreciation and amortization of $0.7 million .
Changes in cash flows related to operating assets and liabilities primarily
consisted of a $7.7 million increase in inventory due to timing of inventory
purchases, a $1.6 million use of cash due to the timing of payments associated
with our accounts payable and a $1.5 million use of cash due to operating
leasing obligations, offset by a $3.0 million decrease in prepaid expenses and
other assets due to timing of payments and a $1.8 million decrease in accounts
receivable due to lower revenue in the three months ended March 31, 2022 .
Net cash used in operating activities of $12.0 million for the three months
ended March 31, 2021 was primarily due to net loss of $4.5 million , non-cash
adjustments of $3.0 million and a net decrease in cash related to changes in
operating assets and liabilities of $10.5 million . Non-cash adjustments
primarily consisted of stock-based compensation of $1.8 million and depreciation
and amortization of $1.1 million . Changes in cash flows related to operating
assets and liabilities primarily consisted of a $5.6 million use of cash due to
the timing of payments associated with our accounts payable and operating
leasing obligations and $1.0 million use of cash due to timing of payments on
prepaid expenses and other assets, as well as the non-monetary sale of our
legacy beauty inventory for future marketing and transportation credits. These
uses of cash were partially offset by $4.9 million increase in accounts
receivable due to increase in sales from retail customers and a $0.9 million
reduction in inventory due to timing of inventory purchases.
Investing Activities
Our primary source of investing cash is the sale and maturity of short-term
investments and our primary use of investing cash is the purchase of short-term
investments and property and equipment.
31 -------------------------------------------------------------------------------- Net cash used in investing activities of$8.6 million for the three months endedMarch 31, 2022 was primarily due to maturities of short-term investments of$8.8 million . Net cash provided by investing activities of$21.8 million for the three months endedMarch 31, 2021 was due to proceeds from the sales and maturities of short-term investments of$13.6 million and$8.5 million , respectively, net of purchases of short-term investments of$0.3 million and purchases of property and equipment of$0.1 million . Financing Activities
Our financing activities primarily consisted of proceeds from sales of
securities, payment of offering costs, proceeds from stock option award
exercises and principal payments of financing lease obligations.
Net cash provided by financing activities of$45 thousand for the three months endedMarch 31, 2022 primarily consisted of proceeds from stock option exercises, partially offset by principal payments of financing lease obligations and taxes paid related to net share settlement of equity awards. Net cash used in financing activities of$1.4 million for the three months endedMarch 31, 2021 primarily consisted of payments of deferred offering costs in connection with our IPO of$1.1 million and principal payments of financing lease obligations of$0.3 million .
Dividends
InApril 2021 , our board of directors declared a cash dividend of$35.0 million to the holders of record of our common stock and our redeemable convertible preferred stock as ofMay 3, 2021 , which we paid onJune 29, 2021 (the "2021 Dividend"). Other than the 2021 Dividend, we have not declared or paid cash dividends on our capital stock, and we do not anticipate declaring or paying any cash dividends other than the 2021 Dividend in the foreseeable future. Any future determination regarding the declaration and payment of dividends, if any, will be at the discretion of our board of directors and will depend on then-existing conditions, including our financial condition, operating results, contractual restrictions (including any restrictions in our then-existing debt arrangements), capital requirements, business prospects and other factors our board of directors may deem relevant. The 2021 Credit Facility contains restrictions on our ability to pay dividends.
Non-GAAP Financial Measure
We prepare and present our condensed consolidated financial statements in
accordance with GAAP. However, management believes that adjusted EBITDA, a
non-GAAP financial measure, provides investors with additional useful
information in evaluating our performance.
We calculate adjusted EBITDA as net income (loss), adjusted to exclude:
(1) interest and other (income) expense, net; (2) income tax provision;
(3) depreciation and amortization; (4) stock-based compensation expense,
including payroll tax; (5) the IPO bonuses in the second quarter of 2021,
including associated payroll taxes and expenses, and third-party costs
associated with our IPO in 2021; and (6) in certain periods, litigation and
settlement fees associated with certain non-ordinary course litigation.
Adjusted EBITDA is a financial measure that is not required by, or presented in
accordance with GAAP. We believe that adjusted EBITDA, when taken together with
our financial results presented in accordance with GAAP, provides meaningful
supplemental information regarding our operating performance and facilitates
internal comparisons of our historical operating performance on a more
consistent basis by excluding certain items that may not be indicative of our
business, results of operations or outlook. In particular, we believe that the
use of adjusted EBITDA is helpful to our investors as it is a measure used by
management in assessing the health of our business, determining incentive
compensation and evaluating our operating performance, as well as for internal
planning and forecasting purposes.
Adjusted EBITDA is presented for supplemental informational purposes only, has
limitations as an analytical tool and should not be considered in isolation or
as a substitute for financial information presented in accordance with GAAP.
Some of the limitations of adjusted EBITDA include that (1) it does not reflect
capital commitments to be paid in the future; (2) although depreciation and
amortization are non-cash charges, the underlying assets may need to be replaced
and adjusted EBITDA does not reflect these capital expenditures; (3) it does not
consider the impact of stock-based compensation expense; (4) it does not reflect
other non-operating expenses, including interest expense; (5) it does not
include the IPO bonuses, including associated payroll taxes and expenses, or
third-party costs associated with the preparation of the IPO; (6) it does not
reflect tax payments that may represent a reduction in cash available to us; and
(7) does not include certain non-ordinary cash expenses that we do not believe
are representative of our business on a steady-state basis. In addition, our use
of adjusted EBITDA may not be comparable to similarly titled measures of other
companies because they may not calculate adjusted EBITDA in the same manner,
limiting its
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usefulness as a comparative measure. Because of these limitations, when
evaluating our performance, you should consider adjusted EBITDA alongside other
financial measures, including our net income (loss) and other results stated in
accordance with GAAP.
The following table presents a reconciliation of net income (loss), the most
directly comparable financial measure stated in accordance with GAAP, to
adjusted EBITDA, for each of the periods presented:
For the three months ended March 31,
(In thousands) 2022 2021
Reconciliation of Net Loss to Adjusted EBITDA
Net loss $ (14,626) $ (4,484)
Interest and other (income) expense, net 61 327
Income tax provision 20 22
Depreciation and amortization 720 1,090
Stock-based compensation 3,548 1,838
Related IPO and other transaction-related expenses(1) - 1,075
Payroll tax expense related to stock-based compensation 13 -
Adjusted EBITDA $ (10,264) $ (132)
__________________
(1) Includes IPO-related costs, including transaction-related third-party
expenses, which are generally incremental costs incurred associated with the
preparation of the IPO.
Material Cash Requirements
As of
requirements from those described under “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” in our Annual Report.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q are prepared in accordance with GAAP. The preparation of condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our critical accounting estimates are described under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" in our Annual Report and the notes to the audited consolidated financial statements appearing in our Annual Report. During the three months endedMarch 31, 2022 , there were no material changes to our critical accounting estimates from those discussed in our Annual Report. Refer to Note 2 and 13 to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a discussion of the adoption of ASC 842 and related policy changes.
Recent Accounting Pronouncements
Refer to Note 2 to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a discussion of recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted.
Emerging Growth Company Status
InApril 2012 , the JOBS Act was enacted. Section 107(b) of the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to take advantage of the extended transition period to comply with new or revised accounting standards and to adopt certain of the reduced disclosure requirements available to emerging growth companies. As a result of the accounting standards election, we are not subject to the same implementation timing for new or revised accounting standards as other public companies that are not emerging growth companies which may make comparison of our financials to those of other public companies more difficult. 33
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