The Honest Company, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparisons are with the three months ended March 31, 2022 unless noted. The company sells baby, personal care, household and wellness products through digital and retail channels.
Financial performance
| Metric | Q1 2023 | Q1 2022 |
|---|---|---|
| Revenue | $83.4 million | $68.7 million |
| Gross profit / margin | $20.2 million / 24.2% | $20.6 million / 30.0% |
| Operating loss | $(18.7) million | $(14.5) million |
| Net loss | $(18.9) million | $(14.6) million |
| Adjusted EBITDA, non-GAAP | $(10.3) million | $(10.3) million |
| Net cash used in operating activities | $(2.8) million | $(14.7) million |
Revenue increased 21.3%. Digital revenue rose 22.0% to $41.8 million and retail revenue rose 20.6% to $41.6 million; each represented about half of sales. Diapers and Wipes revenue grew 22.6% to $53.1 million, Skin and Personal Care rose 7.2% to $22.8 million, and Household and Wellness rose 80.6% to $7.5 million.
Gross margin contracted 5.8 percentage points. Cost of revenue rose 31.4%, faster than sales, reflecting higher fulfillment and input costs and $2.7 million of inventory reserves related to the Transformation Initiative. Price increases and more efficient trade spending partly offset these pressures. Net loss widened by $4.2 million; adjusted EBITDA was essentially unchanged.
Liquidity and balance sheet
At March 31, 2023, cash and cash equivalents were $9.2 million and short-term investments were $2.7 million, down from a combined $15.2 million at year-end 2022. Inventory fell to $98.5 million from $115.7 million. Operating cash use improved year over year, aided chiefly by a $17.2 million inventory reduction and lower prepaid expenses; the company still reported a quarterly net loss.
Total liabilities were $82.2 million, including $55.6 million of operating lease liabilities. The company reported no borrowings under its new $35 million revolving credit facility; $4.8 million of letters of credit were outstanding and $18.3 million was available to draw at quarter-end. The facility is secured by substantially all company and certain subsidiary assets, includes financial covenants, and matures April 30, 2026. The company reported compliance with its covenants.
Changes, outlook and risks
- Revenue growth included $11.0 million of higher sales to a key digital customer, which the company attributed to restocking versus prior-year destocking, and $4.8 million of Honest Baby Clothing revenue following a change in its arrangement with Butterblu. Honest.com revenue declined $3.8 million, which management attributed partly to lower digital marketing spend and site traffic.
- Management began a broad Transformation Initiative focused on higher-margin growth, cost reduction, North America and operating discipline. It expects 2023 initiative costs of approximately $10 million to $15 million, annualized benefits of $15 million to $20 million beginning to appear in late 2023, and cash costs of $4 million to $7 million. Restructuring is expected to be substantially complete by December 31, 2023. The company cautions that additional costs may arise and anticipated savings may not be achieved.
- Initiative-related costs recognized in Q1 totaled $7.0 million across operating expenses, revenue reductions, cost of revenue and restructuring. The company recorded $1.4 million of restructuring expense and earmarked $2.4 million of donations, primarily related to liquidation of low-margin household products.
- Management said existing cash, investments and available credit were expected to meet projected short-term operations for the next 12 months from issuance of the statements, assuming planned inventory reduction, working-capital management and initiative benefits. Continued losses, cash needs and access to future financing remain risks.
- Key risks include inflation and fulfillment costs, consumer demand and retailer order patterns, inventory liquidation, execution of the Transformation Initiative, and the company’s history of losses. The company is also renegotiating founder Jessica Warren’s likeness agreement; its termination or revised terms could adversely affect the business.
- Pending matters include securities and derivative litigation, a California Prop 65 matter, and a consumer class action concerning plant-based claims for certain wipes. The company says outcomes and potential losses cannot currently be estimated. On May 1, 2023, after quarter-end, a court granted the securities class-certification motion in part and limited the certified class.
- The company reported its disclosure controls were effective at the reasonable-assurance level and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether sales growth persists after separating underlying demand from the key digital customer’s restocking and Honest Baby Clothing revenue.
- Whether gross margin recovers despite inflation, fulfillment costs, product exits and inventory rationalization.
- Actual Transformation Initiative costs, cash requirements, timing and realized annualized benefits versus management’s estimates.
- Cash burn, inventory reduction and borrowing-base availability under the revolving facility, including ongoing covenant compliance.
- Developments in the disclosed litigation and the renegotiation of the founder’s likeness agreement.