Honest Company, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. The company sells clean lifestyle products through Digital and Retail channels in Diapers and Wipes, Skin and Personal Care, and Household and Wellness. Results below are unaudited; dollar amounts are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $84.6 | $82.7 | $231.8 | $238.3 |
| Gross profit / margin | $25.6 / 30.3% | $29.8 / 36.0% | $69.8 / 30.1% | $85.1 / 35.7% |
| Operating loss | $(11.7) | $(4.6) | $(37.0) | $(28.2) |
| Net loss | $(11.8) | $(5.1) | $(36.4) | $(29.7) |
| Adjusted EBITDA, non-GAAP | $(5.6) | $1.3 | $(21.0) | $0.4 |
Q3 diluted loss per share was $0.13 versus $0.06; nine-month diluted loss per share was $0.40 versus $0.33. Adjusted EBITDA is a non-GAAP measure and should be considered alongside GAAP results.
- Revenue mix: Q3 Digital revenue fell 13.6% to $33.8; Retail rose 16.7% to $50.8. Nine-month Digital revenue declined 9.0% to $105.9; Retail increased 3.3% to $125.9.
- Category trends: Q3 Diapers and Wipes revenue increased 2.6% to $55.2; Skin and Personal Care declined 13.3% to $22.0; Household and Wellness increased 114.8% to $7.4. Nine-month changes were -0.6%, -11.9%, and +28.9%, respectively.
- Cash flow: Cash used in operating activities was $50.7 for the first nine months, compared with $36.4 a year earlier. Cash and cash equivalents were $24.1 at September 30, down from $50.8 at year-end 2021; short-term investments were $16.7, down from $42.4.
- Balance sheet: Current assets were $194.4 and current liabilities $61.5. Inventory rose to $100.3 from $75.7 at year-end. Total assets were $248.4 and stockholders’ equity $155.1.
- Debt and liquidity: No amount was drawn on the $35.0 revolving credit facility; $30.2 was available after $4.8 of standby letters of credit. The company reported compliance with its leverage covenant. Operating and finance lease liabilities totaled $39.5; these are lease obligations, not borrowings under the revolver.
Changes versus the comparable period
- Q3 revenue grew 2.3%, but nine-month revenue declined 2.7%. Q3 growth included $3.8 of Honest Baby Clothing sales following a change from a licensing arrangement to a supplier services agreement with Butterblu. The company purchased $5.5 of apparel inventory under that arrangement.
- Gross margin fell 5.7 percentage points in Q3 and 5.6 points year to date. Management attributed pressure chiefly to higher input, freight, transportation and warehouse labor costs and increased trade promotions; price increases and cost-reduction efforts partly offset the impact.
- Operating losses widened in Q3 and for the nine-month period. Q3 SG&A rose 26.5%, including higher legal, employee-related and donation expenses. Nine-month SG&A and marketing were lower than the prior year, partly reflecting the absence of prior-year IPO-related costs and lower digital advertising.
- Operating cash use increased by $14.3 year over year. Inventory growth was a major use of cash, alongside higher receivables and lease payments.
Outlook, commentary, risks and unusual items
- Outlook: No quantified revenue, earnings or margin guidance is provided in this filing. Management said existing cash, cash equivalents and short-term investments should meet short- and long-term working-capital and capital-expenditure needs, while noting that future needs depend on business performance and that additional financing could be required if resources and sales growth are insufficient.
- Costs and pricing: Management expects elevated input costs and higher manufacturer purchase prices to pressure cost of revenue in Q4 2022 and 2023. Price increases took effect in the first half of 2022; further increases were planned for December 2022 and as needed. The company cautioned that pricing or productivity may not fully offset inflation and could affect demand.
- Demand, customers and supply chain: Retail growth was offset by lower Digital revenue, including higher digital-advertising costs, consumers returning to stores and customer inventory reductions or shipment timing. Supply disruptions and out-of-stocks affected key products. Retailers’ tighter inventory management and the non-renewal of certain rotational programs create forecasting and sales risks.
- Inventory and unusual items: The company recorded a $0.8 inventory write-down for sanitizing and disinfecting products during the first nine months and donated $1.5 of excess products in Q3. Separately, it recognized $0.7 of other income for an anticipated Nevada tax and interest refund after an appeal overturned the state’s deficiency notice. Q3 adjusted EBITDA included $1.6 of securities-litigation expense.
- Accounting change: Adoption of lease accounting standard ASC 842 in January 2022 recognized operating lease right-of-use assets and corresponding liabilities; management said adoption did not materially affect the statements of operations or cash flows.
- Legal contingencies: Pending matters include a Prop 65 claim concerning Diaper Rash Cream, securities class and derivative litigation related to the IPO, and a putative class action concerning plant-based claims on certain wipes. The company says outcomes are uncertain and it cannot estimate probable losses or ranges for these matters.
- Other risks: Inflation, consumer spending uncertainty, dependence on third-party suppliers and manufacturers, customer concentration and purchasing patterns, product quality and demand forecasting are highlighted risks. Management reported disclosure controls were effective as of September 30, 2022.
Investor verification points
- Track whether price increases and cost-reduction measures stabilize gross margin as manufacturer and freight costs rise.
- Assess whether Retail growth can offset continued Digital weakness, retailer inventory reductions and the loss or non-renewal of promotional programs.
- Monitor inventory levels, cash burn and the company’s ability to convert inventory into sales without further write-downs, markdowns or donations.
- Review liquidity against operating cash use: management expects current resources to be sufficient, but the company continues to incur losses and use operating cash.
- Follow developments and potential financial exposure in the listed product-claims and securities-related litigation; loss estimates are not provided.
- Confirm the impact of the Butterblu arrangement, including ongoing inventory commitments and whether apparel sales become material.