000153097912/312022Q3FALSEhttp://fasb.org/us-gaap/2022#AccountingStandardsUpdate201602MemberP1YP1Yhttp://fasb.org/us-gaap/2022#PropertyPlantAndEquipmentAndFinanceLeaseRightOfUseAssetAfterAccumulatedDepreciationAndAmortizationhttp://fasb.org/us-gaap/2022#AccruedLiabilitiesCurrenthttp://fasb.org/us-gaap/2022#AccruedLiabilitiesCurrenthttp://fasb.org/us-gaap/2022#OtherLiabilitiesNoncurrent00015309792022-01-012022-09-3000015309792022-11-08xbrli:shares00015309792022-09-30iso4217:USD00015309792021-12-31iso4217:USDxbrli:shares00015309792022-07-012022-09-3000015309792021-07-012021-09-3000015309792021-01-012021-09-3000015309792020-12-310001530979us-gaap:CommonStockMember2020-12-310001530979us-gaap:AdditionalPaidInCapitalMember2020-12-310001530979us-gaap:RetainedEarningsMember2020-12-310001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-12-310001530979us-gaap:RetainedEarningsMember2021-01-012021-03-3100015309792021-01-012021-03-310001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-01-012021-03-310001530979us-gaap:CommonStockMember2021-01-012021-03-310001530979us-gaap:AdditionalPaidInCapitalMember2021-01-012021-03-3100015309792021-03-310001530979us-gaap:CommonStockMember2021-03-310001530979us-gaap:AdditionalPaidInCapitalMember2021-03-310001530979us-gaap:RetainedEarningsMember2021-03-310001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-03-310001530979us-gaap:RetainedEarningsMember2021-04-012021-06-3000015309792021-04-012021-06-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-04-012021-06-300001530979us-gaap:CommonStockMember2021-04-012021-06-300001530979us-gaap:AdditionalPaidInCapitalMember2021-04-012021-06-3000015309792021-06-300001530979us-gaap:CommonStockMember2021-06-300001530979us-gaap:AdditionalPaidInCapitalMember2021-06-300001530979us-gaap:RetainedEarningsMember2021-06-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-06-300001530979us-gaap:RetainedEarningsMember2021-07-012021-09-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-07-012021-09-300001530979us-gaap:CommonStockMember2021-07-012021-09-300001530979us-gaap:AdditionalPaidInCapitalMember2021-07-012021-09-3000015309792021-09-300001530979us-gaap:CommonStockMember2021-09-300001530979us-gaap:AdditionalPaidInCapitalMember2021-09-300001530979us-gaap:RetainedEarningsMember2021-09-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-09-300001530979us-gaap:CommonStockMember2021-12-310001530979us-gaap:AdditionalPaidInCapitalMember2021-12-310001530979us-gaap:RetainedEarningsMember2021-12-310001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-12-310001530979us-gaap:RetainedEarningsMember2022-01-012022-03-3100015309792022-01-012022-03-310001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-01-012022-03-310001530979us-gaap:CommonStockMember2022-01-012022-03-310001530979us-gaap:AdditionalPaidInCapitalMember2022-01-012022-03-3100015309792021-01-012021-12-310001530979srt:CumulativeEffectPeriodOfAdoptionAdjustmentMemberus-gaap:RetainedEarningsMember2021-12-310001530979srt:CumulativeEffectPeriodOfAdoptionAdjustmentMember2021-12-310001530979us-gaap:CommonStockMember2022-03-310001530979us-gaap:AdditionalPaidInCapitalMember2022-03-310001530979us-gaap:RetainedEarningsMember2022-03-310001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-03-3100015309792022-03-310001530979us-gaap:RetainedEarningsMember2022-04-012022-06-3000015309792022-04-012022-06-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-04-012022-06-300001530979us-gaap:CommonStockMember2022-04-012022-06-300001530979us-gaap:AdditionalPaidInCapitalMember2022-04-012022-06-300001530979us-gaap:CommonStockMember2022-06-300001530979us-gaap:AdditionalPaidInCapitalMember2022-06-300001530979us-gaap:RetainedEarningsMember2022-06-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-06-3000015309792022-06-300001530979us-gaap:RetainedEarningsMember2022-07-012022-09-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-07-012022-09-300001530979us-gaap:CommonStockMember2022-07-012022-09-300001530979us-gaap:AdditionalPaidInCapitalMember2022-07-012022-09-300001530979us-gaap:CommonStockMember2022-09-300001530979us-gaap:AdditionalPaidInCapitalMember2022-09-300001530979us-gaap:RetainedEarningsMember2022-09-300001530979us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-09-300001530979us-gaap:IPOMember2021-05-072021-05-0700015309792021-05-070001530979hnst:IPOSoldByCompanyMember2021-05-072021-05-070001530979hnst:IPOSoldByExistingShareholdersMember2021-05-072021-05-070001530979hnst:IPOOtherOfferingExpenseMember2021-05-072021-05-070001530979us-gaap:OverAllotmentOptionMember2021-05-072021-05-0700015309792021-05-072021-05-070001530979us-gaap:SellingGeneralAndAdministrativeExpensesMember2021-05-072021-05-070001530979us-gaap:ResearchAndDevelopmentExpenseMember2021-05-072021-05-0700015309792021-04-3000015309792021-05-0600015309792021-05-062021-05-060001530979us-gaap:RedeemableConvertiblePreferredStockMember2021-04-012021-04-30xbrli:pure0001530979us-gaap:CommonStockMember2021-04-012021-04-30hnst:segment0001530979hnst:HouseholdAndWellnessMemberhnst:SanitizationAndDisinfectingProductsMember2022-01-012022-09-300001530979hnst:HouseholdAndWellnessMemberhnst:SanitizationAndDisinfectingProductsMember2021-01-012021-12-310001530979hnst:HouseholdAndWellnessMemberhnst:SanitizationProductsMember2022-07-012022-09-300001530979us-gaap:AccountingStandardsUpdate201602Member2022-01-010001530979srt:CumulativeEffectPeriodOfAdoptionAdjustmentMemberus-gaap:AccountingStandardsUpdate201602Memberus-gaap:RetainedEarningsMember2022-01-010001530979hnst:DigitalMember2022-07-012022-09-300001530979hnst:DigitalMember2021-07-012021-09-300001530979hnst:DigitalMember2022-01-012022-09-300001530979hnst:DigitalMember2021-01-012021-09-300001530979us-gaap:RetailMember2022-07-012022-09-300001530979us-gaap:RetailMember2021-07-012021-09-300001530979us-gaap:RetailMember2022-01-012022-09-300001530979us-gaap:RetailMember2021-01-012021-09-300001530979hnst:DiapersAndWipesMember2022-07-012022-09-300001530979hnst:DiapersAndWipesMember2021-07-012021-09-300001530979hnst:DiapersAndWipesMember2022-01-012022-09-300001530979hnst:DiapersAndWipesMember2021-01-012021-09-300001530979hnst:SkinAndPersonalCareMember2022-07-012022-09-300001530979hnst:SkinAndPersonalCareMember2021-07-012021-09-300001530979hnst:SkinAndPersonalCareMember2022-01-012022-09-300001530979hnst:SkinAndPersonalCareMember2021-01-012021-09-300001530979hnst:HouseholdAndWellnessMember2022-07-012022-09-300001530979hnst:HouseholdAndWellnessMember2021-07-012021-09-300001530979hnst:HouseholdAndWellnessMember2022-01-012022-09-300001530979hnst:HouseholdAndWellnessMember2021-01-012021-09-300001530979hnst:TradeAgreementsMember2022-01-012022-09-300001530979hnst:TradeAgreementsMember2022-07-012022-09-300001530979hnst:TradeAgreementsMember2021-07-012021-09-300001530979hnst:TradeAgreementsMember2021-01-012021-09-300001530979us-gaap:CorporateBondSecuritiesMember2022-09-300001530979us-gaap:CommercialPaperMember2022-09-300001530979us-gaap:CertificatesOfDepositMember2022-09-300001530979us-gaap:USTreasuryAndGovernmentMember2022-09-300001530979us-gaap:CorporateBondSecuritiesMember2021-12-310001530979us-gaap:CertificatesOfDepositMember2021-12-310001530979us-gaap:USTreasuryAndGovernmentMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:MoneyMarketFundsMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:MoneyMarketFundsMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:MoneyMarketFundsMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:MoneyMarketFundsMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Member2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Member2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Member2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:CorporateBondSecuritiesMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:CorporateBondSecuritiesMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:CorporateBondSecuritiesMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:CorporateBondSecuritiesMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:CommercialPaperMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:CommercialPaperMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:CommercialPaperMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:CommercialPaperMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:CertificatesOfDepositMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:CertificatesOfDepositMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:CertificatesOfDepositMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:CertificatesOfDepositMember2022-09-300001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Member2022-09-300001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Member2022-09-300001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Member2022-09-300001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMember2022-09-300001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:MoneyMarketFundsMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:MoneyMarketFundsMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:MoneyMarketFundsMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:MoneyMarketFundsMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Member2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Member2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Member2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:CorporateBondSecuritiesMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:CorporateBondSecuritiesMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:CorporateBondSecuritiesMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:CorporateBondSecuritiesMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Memberus-gaap:CertificatesOfDepositMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Memberus-gaap:CertificatesOfDepositMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Memberus-gaap:CertificatesOfDepositMember2021-12-310001530979us-gaap:FairValueMeasurementsRecurringMemberus-gaap:CertificatesOfDepositMember2021-12-310001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel1Member2021-12-310001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel2Member2021-12-310001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMemberus-gaap:FairValueInputsLevel3Member2021-12-310001530979us-gaap:USTreasuryAndGovernmentMemberus-gaap:FairValueMeasurementsRecurringMember2021-12-310001530979hnst:JPMorganChaseBankMemberus-gaap:RevolvingCreditFacilityMemberhnst:A2021CreditFacilityMember2021-04-300001530979us-gaap:LetterOfCreditMemberhnst:A2021CreditFacilityMember2021-04-300001530979us-gaap:StandbyLettersOfCreditMemberhnst:A2021CreditFacilityMember2022-09-300001530979us-gaap:LondonInterbankOfferedRateLIBORMemberus-gaap:RevolvingCreditFacilityMemberhnst:A2021CreditFacilityMember2021-04-012021-04-300001530979us-gaap:RevolvingCreditFacilityMemberhnst:A2021CreditFacilityMemberus-gaap:BaseRateMember2021-04-012021-04-300001530979us-gaap:LetterOfCreditMemberhnst:A2021CreditFacilityMember2022-09-300001530979hnst:JPMorganChaseBankMemberhnst:A2021CreditFacilityMember2022-09-300001530979us-gaap:PendingLitigationMemberhnst:NevadaDepartmentOfTaxationVsTheHonestCompanyIncMember2021-06-090001530979hnst:NevadaDepartmentOfTaxationVsTheHonestCompanyIncMember2021-01-012021-12-310001530979hnst:NevadaDepartmentOfTaxationVsTheHonestCompanyIncMember2022-01-012022-09-300001530979hnst:A2021EquityIncentivePlanMember2021-04-300001530979hnst:A2021EquityIncentivePlanMember2021-04-012021-04-300001530979hnst:A2021EquityIncentivePlanMember2022-01-010001530979hnst:IncentiveStockOptionsMemberhnst:A2021EquityIncentivePlanMember2021-04-300001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:NonEmployeeDirectorsMember2021-12-310001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:OfficersAndEmployeesMember2021-12-310001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:NonEmployeeDirectorsMember2022-01-012022-09-300001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:OfficersAndEmployeesMember2022-01-012022-09-300001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:NonEmployeeDirectorsMember2022-09-300001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:OfficersAndEmployeesMember2022-09-300001530979us-gaap:RestrictedStockUnitsRSUMemberhnst:A2021EquityIncentivePlanMember2022-01-012022-09-300001530979us-gaap:RestrictedStockUnitsRSUMember2022-09-300001530979us-gaap:RestrictedStockUnitsRSUMember2022-01-012022-09-300001530979us-gaap:EmployeeStockMemberhnst:A2021EmployeeStockPurchasePlanMember2021-04-300001530979us-gaap:EmployeeStockMemberhnst:A2021EmployeeStockPurchasePlanMember2021-04-012021-04-300001530979us-gaap:EmployeeStockMemberhnst:A2021EmployeeStockPurchasePlanMember2022-01-0100015309792021-04-012021-04-300001530979us-gaap:EmployeeStockMemberhnst:A2021EmployeeStockPurchasePlanMember2022-07-012022-09-300001530979us-gaap:EmployeeStockMemberhnst:A2021EmployeeStockPurchasePlanMember2022-01-012022-09-300001530979us-gaap:EmployeeStockMemberhnst:A2021EmployeeStockPurchasePlanMember2022-09-300001530979us-gaap:EmployeeStockOptionMember2022-01-012022-09-300001530979us-gaap:SellingGeneralAndAdministrativeExpensesMember2022-07-012022-09-300001530979us-gaap:SellingGeneralAndAdministrativeExpensesMember2021-07-012021-09-300001530979us-gaap:SellingGeneralAndAdministrativeExpensesMember2022-01-012022-09-300001530979us-gaap:SellingGeneralAndAdministrativeExpensesMember2021-01-012021-09-300001530979us-gaap:ResearchAndDevelopmentExpenseMember2022-07-012022-09-300001530979us-gaap:ResearchAndDevelopmentExpenseMember2021-07-012021-09-300001530979us-gaap:ResearchAndDevelopmentExpenseMember2022-01-012022-09-300001530979us-gaap:ResearchAndDevelopmentExpenseMember2021-01-012021-09-3000015309792021-06-292021-06-290001530979us-gaap:EmployeeStockOptionMember2022-07-012022-09-300001530979us-gaap:EmployeeStockOptionMember2021-07-012021-09-300001530979us-gaap:EmployeeStockOptionMember2022-01-012022-09-300001530979us-gaap:EmployeeStockOptionMember2021-01-012021-09-300001530979us-gaap:RestrictedStockUnitsRSUMember2022-07-012022-09-300001530979us-gaap:RestrictedStockUnitsRSUMember2021-07-012021-09-300001530979us-gaap:RestrictedStockUnitsRSUMember2022-01-012022-09-300001530979us-gaap:RestrictedStockUnitsRSUMember2021-01-012021-09-300001530979us-gaap:EmployeeStockMember2022-07-012022-09-300001530979us-gaap:EmployeeStockMember2021-07-012021-09-300001530979us-gaap:EmployeeStockMember2022-01-012022-09-300001530979us-gaap:EmployeeStockMember2021-01-012021-09-300001530979hnst:SummitHouseStudiosLLCMember2021-07-012021-09-300001530979hnst:SummitHouseStudiosLLCMember2021-01-012021-09-300001530979hnst:SummitHouseStudiosLLCMember2022-01-012022-09-300001530979hnst:SummitHouseStudiosLLCMember2022-07-012022-09-300001530979srt:MinimumMember2022-09-300001530979srt:MaximumMember2022-09-300001530979srt:CumulativeEffectPeriodOfAdoptionAdjustmentMember2022-01-010001530979srt:CumulativeEffectPeriodOfAdoptionAdjustedBalanceMember2022-01-010001530979hnst:FacilityLeasesMember2021-12-310001530979hnst:WarehouseFacilityOperatingLeaseMember2021-12-31
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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 ended December 31, 2021 (the “Annual Report”), filed with the Securities and Exchange Commission (“SEC”) on March 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 65%, 26%, and 9%, respectively, of our revenue for the three months ended September 30, 2022, compared to 65%, 31%, and 4%, respectively, of our revenue for the three months ended September 30, 2021, and 65%, 29%, and 6%, respectively, of our revenue for the nine months ended September 30, 2022, compared to 63%, 32%, and 5%, respectively, of our revenue for the nine months ended September 30, 2021. 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, Amazon and Walmart in 2013, 2014, 2017 and 2022, respectively. For the three months ended September 30, 2022, we generated 40% and 60% of our revenue from our Digital and Retail channels, respectively, compared to 47% and 53%, respectively, for the three months ended September 30, 2021. For the nine months ended September 30, 2022, we generated 46% and 54% of our revenue from our Digital and Retail channels, respectively, compared to 49% and 51%, respectively, for the nine months ended September 30, 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 our Digital channel, and our Retail channel, which includes leading retailers and their websites. As of September 30, 2022, our products can be found in approximately 50,000 retail locations across the United States, Canada and Europe. Our integrated omnichannel presence provides meaningful benefits to our consumers which we believe is not easily replicated by our competitors. This distinctive business model has allowed us to efficiently scale our business while remaining agnostic as to the channel where consumers purchase our products.
Initial Public Offering
On May 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. In May 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 in January 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 and increased retail distribution, 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 in Los Angeles, California, our research and development team, including chemists, in-house toxicologists and an ecotoxicologist, 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 into more places 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.
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, club 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 customers 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 three and nine months ended September 30, 2022. We expect these elevated costs in paid advertising to continue to impact marketing efficiencies, costs and revenue in our Digital channel for the remainder of 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 customers’ websites. During the three and nine months ended September 30, 2022, we continued to see our retail consumption growth be at a higher level than our digital consumption growth 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 or broader macroeconomic conditions, such as inflation, have resulted and could in the future result in fluctuations in our operating results.
The COVID-19 pandemic caused general business disruption worldwide beginning in January 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 were temporarily closed but have 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.
The operations of our retail customers, 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, and has led to tighter inventory management by retailers, which has negatively impacted our revenue and fulfillment operations, and may continue 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. 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, which we also experienced in the second quarter of 2022. For example, due to new COVID-19 lockdown restrictions in China in the second quarter of 2022, many of the ports shut down which has negatively impacted and may in the future negatively impact our ability to timely receive shipments of our products. To the extent that additional prevention and mitigation measures are implemented in the future, or there is uncertainty about the effectiveness of these or any other measures to contain the spread of COVID-19, there has been and continues to be an adverse impact on global economic conditions and consumer confidence and spending, which has adversely affected our supply chain as well as the demand for our products and has impacted our revenue and ability to service our customer orders. 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 first quarter of 2022 resulting in a delay in the shipment and launch of our Beauty Restage products in Europe. Also, in the third quarter of 2022, some of our digital and retail customers began to reduce inventory on hand and have changed fulfillment schedules, which has negatively impacted our fulfillment operations and our revenue and is expected to continue to do so in the future.
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, respectively, that those hurdles had been met. In addition, in the third quarter of 2022, we received requests from the same two third-party manufacturers to renegotiate purchase costs due to continued increases in raw material costs. As a result, we negotiated and agreed to higher purchase prices which has negatively impacted our cost of revenue during the three and nine months ended September 30, 2022 and will continue to have a negative impact on our results of operations. Due to continued elevated input costs such as fluff pulp, we anticipate further escalation of purchase costs and cost of revenue in the fourth quarter of 2022 and in 2023. Moreover, the demand for sustainable packaging and ingredients is outpacing the supply and increasing the cost of these raw materials. For example, there is a supplier shortage or significant demand of and cost impacts to 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, surfactants, fluff pulp and other diaper raw materials and palm kernel oil. We implemented price increases that took effect in the first half of 2022 and plan to implement additional pricing increases in December 2022 and in the future as needed to offset current and future input cost inflation and have pursued productivity initiatives to offset these price increases. However, we may not be able to increase our prices or productivity sufficient to offset these costs. We continue to experience significant increasing input cost levels that have and could continue to hamper our ability to drive margin expansion. Customer demand for our products may change based on price increases.
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.
In 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 and nine months ended September 30, 2022, the Retail channel revenue continued to increase compared to our Digital channel due to expanded and new distribution, marketing efforts and strong retail consumption across product categories.
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 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 ended December 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, focusing on products with highest customer interest and developing new creative advertising to drive demand. There is no guarantee that customer demand will increase in our favor or that we will be able to successfully implement these strategies in light of rising consumer uncertainty and tighter inventory management by retailers. 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, customer returns or incur additional donation expense to reduce excess inventory. During the three months ended September 30, 2022, the Company donated $1.5 million of excess sanitization products.
Due to increasing supply chain lead times and new retail distribution, we have increased our inventory levels to ensure in-stock position to service customers and consumers. In addition, inflation in input costs including higher product costs, inbound shipping and warehouse labor has resulted in a higher dollar value of inventory. For example, in the nine months ended September 30, 2022, inventory has increased by $24.6 million. We will continue to increase inventory levels as needed to support the growth of the business and respond to the dynamic supply chain environment.
Inflation Reduction Act of 2022
On August 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022 (the “Act”), which contains provisions that will be effective on January 1, 2023, including a 15% corporate minimum tax and a 1% excise tax on stock buybacks. While we are still evaluating the impact of the Act, we do not expect any material changes on our consolidated financial position, results of operations and cash flows.
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 and their respective websites, 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 with Butterblu, LLC, or Butterblu, pursuant to which we licensed certain of our trademarks to Butterblu for the manufacture and distribution of certain baby apparel products in exchange for royalties. For the three and nine months ended September 30, 2022, we collected $0.1 million and $1.0 million, respectively, and for the three and nine months ended September 30, 2021, we collected $0.2 million and $0.7 million, respectively, in royalty revenue related to our license agreement. In August 2022, we terminated the license agreement in advance of its expiration date and entered into a supplier services agreement with Butterblu, pursuant to which Butterblu provides certain design, manufacturing, sales and marketing services to us. As part of the supplier services agreement, we acquired all of Butterblu's existing inventory of Honest baby apparel products for $5.5 million, and have agreed to purchase and own inventory for the term of the service agreement which is until December 31, 2026, unless terminated sooner. We entered into this supplier services agreement to create growth opportunities and synergies between our portfolio of products. Butterblu continues to operate and maintain our baby apparel offerings independently through the honestbabyclothing.com website. Honest Baby Clothing® sales are now reflected as revenue in our condensed consolidated statements of operations. For both the three and nine months ended September 30, 2022, we recognized $3.8 million in revenue, excluding royalty revenue, which was included in our Household and Wellness product category, and $3.0 million of associated cost of revenue. Our baby apparel offerings and our supplier services agreement with Butterblu are not currently material to our business.
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 and increased retail distribution, we have shifted the focus of our marketing spend towards supporting retail marketing programs and top of funnel marketing activities. We will continue to invest in marketing initiatives in our 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 the 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 of our foreign currency exchange gains, losses relating to transactions denominated in currencies other than the U.S. dollar and contingent gains. 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 in the United States. Our annual estimated tax rate differed from the U.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 September 30, | | For the nine months ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (In thousands) | | | | | | | |
| Revenue | $ | 84,580 | | | $ | 82,651 | | | $ | 231,792 | | | $ | 238,258 | |
| Cost of revenue | 58,963 | | | 52,892 | | | 161,984 | | | 153,177 | |
| Gross profit | 25,617 | | | 29,759 | | | 69,808 | | | 85,081 | |
| Operating expenses | | | | | | | |
Selling, general and administrative(1) | 23,491 | | | 18,568 | | | 63,068 | | | 65,356 | |
| Marketing | 12,140 | | | 13,687 | | | 38,121 | | | 41,868 | |
Research and development(1) | 1,725 | | | 2,092 | | | 5,643 | | | 6,082 | |
| Total operating expenses | 37,356 | | | 34,347 | | | 106,832 | | | 113,306 | |
| Operating loss | (11,739) | | | (4,588) | | | (37,024) | | | (28,225) | |
| Interest and other income (expense), net | (29) | | | (526) | | | 657 | | | (1,362) | |
| Loss before provision for income taxes | (11,768) | | | (5,114) | | | (36,367) | | | (29,587) | |
| Income tax provision | 20 | | | 22 | | | 60 | | | 67 | |
| Net loss | $ | (11,788) | | | $ | (5,136) | | | $ | (36,427) | | | $ | (29,654) | |
__________________________
(1) Includes stock-based compensation expense as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| (In thousands) | | | | | | | |
| Selling, general and administrative | $ | 3,852 | | | $ | 4,466 | | | $ | 10,929 | | | $ | 12,408 | |
| Research and development | 48 | | | 310 | | | 431 | | | 832 | |
| Total | $ | 3,900 | | | $ | 4,776 | | | $ | 11,360 | | | $ | 13,240 | |
The following table sets forth our condensed consolidated statements of operations data expressed as a percentage of revenue*:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | 2022 | | 2021 | |
| (as a percentage of revenue) | |
| Revenue | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of revenue | 69.7 | | 64.0 | | 69.9 | | 64.3 | |
| Gross profit | 30.3 | | 36.0 | | 30.1 | | 35.7 | |
| Operating expenses | | | | | | | | |
| Selling, general and administrative | 27.8 | | 22.5 | | 27.2 | | 27.4 | |
| Marketing | 14.4 | | 16.6 | | 16.4 | | 17.6 | |
| Research and development | 2.0 | | 2.5 | | 2.4 | | 2.6 | |
| Total operating expenses | 44.2 | | 41.6 | | 46.1 | | 47.6 | |
| Operating loss | (13.9) | | (5.6) | | (16.0) | | (11.8) | |
| Interest and other income (expense), net | — | | (0.6) | | 0.3 | | (0.6) | |
| Loss before provision for income taxes | (13.9) | | (6.2) | | (15.7) | | (12.4) | |
| Income tax provision | — | | — | | — | | — | |
| Net loss | (13.9) | % | (6.2) | % | (15.7) | % | (12.4) | % |
______________
* Amounts may not sum due to rounding.
Comparison of the Three and Nine Months Ended September 30, 2022 and 2021
Revenue | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | % change | | 2022 | | 2021 | | $ change | | % change | |
| (In thousands, except percentages) | | | | | | | | | | | | | |
| By Product Category | | | | | | | | | | | | | | | | |
| Diapers and Wipes | $ | 55,222 | | | $ | 53,847 | | | $ | 1,375 | | | 2.6 | % | $ | 150,411 | | | $ | 151,251 | | | $ | (840) | | | (0.6) | % |
| Skin and Personal Care | 21,992 | | | 25,375 | | | (3,383) | | | (13.3) | | 66,534 | | | 75,486 | | | (8,952) | | | (11.9) | |
| Household and Wellness | 7,366 | | | 3,429 | | | 3,937 | | | 114.8 | | 14,847 | | | 11,521 | | | 3,326 | | | 28.9 | |
| Total Revenue | $ | 84,580 | | | $ | 82,651 | | | $ | 1,929 | | | 2.3 | % | $ | 231,792 | | | $ | 238,258 | | | $ | (6,466) | | | (2.7) | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | % change | | 2022 | | 2021 | | $ change | | % change | |
| (In thousands, except percentages) | | | | | | | | | | | | | | | |
| By Channel | | | | | | | | | | | | | | | | |
| Digital | $ | 33,782 | | | $ | 39,114 | | | $ | (5,332) | | | (13.6) | % | $ | 105,913 | | | $ | 116,395 | | | $ | (10,482) | | | (9.0) | % |
| Retail | 50,798 | | | 43,537 | | | 7,261 | | | 16.7 | | 125,879 | | | 121,863 | | | 4,016 | | | 3.3 | |
| Total Revenue | $ | 84,580 | | | $ | 82,651 | | | $ | 1,929 | | | 2.3 | % | $ | 231,792 | | | $ | 238,258 | | | $ | (6,466) | | | (2.7) | % |
Revenue was $84.6 million for the three months ended September 30, 2022, as compared to $82.7 million for the three months ended September 30, 2021. The increase of $1.9 million, or 2.3%, was driven by a $3.9 million and $1.4 million revenue increase in Household and Wellness and Diapers and Wipes products, respectively, partially offset by a revenue decrease of $3.4 million in Skin and Personal Care. The revenue increase in Household and Wellness was primarily driven by $3.8 million in revenue from Honest Baby Clothing as a result of our transition from a license agreement to a supplier services agreement with Butterblu. The revenue increase in Diapers and Wipes was primarily driven by a $1.9 million increase in wipes revenue driven by strong consumption as consumers continued to expand alternate usage of wipes beyond diapering, as well as distribution gains, price increases and larger-size offerings, offset by a decrease in diaper revenue of $0.5 million due to $4.5 million decrease in revenue in our Digital channel, which was offset by a $3.9 million increase in revenue in our Retail channel driven by distribution gains and strong consumption trends. The Skin and Personal Care revenue decrease was primarily driven by a $5.7 million decrease in revenue due to a rotational program with a key club retailer during the three months ended September 30, 2021 that did not occur during the three months ended September 30, 2022, offset by an increase in revenue due to the launch of baby personal care products with a new retail customer, price increases and an increase in beauty product revenues due to product innovation.
We estimate that pricing actions taken in the first half of 2022 contributed $3.4 million to revenue for the three months ended September 30, 2022.
Revenue was $231.8 million for the nine months ended September 30, 2022, as compared to $238.3 million for the nine months ended September 30, 2021. The decrease of $6.5 million, or 2.7%, was primarily due to a $9.0 million decrease in revenue from Skin and Personal Care products, and a $0.8 million decrease in revenue from Diapers and Wipes, offset by a $3.3 million increase in revenue from Household and Wellness products. The revenue decrease from Skin and Personal Care was primarily driven by $4.4 million in liquidation sales in advance of our Beauty Restage to clear out legacy inventory and a decrease of $5.7 million in revenue due to a rotational program with a key club retailer that occurred during the nine months ended September 30, 2021 and did not occur during the nine months ended September 30, 2022, offset by price increases and distribution gains. The revenue decrease in Diapers and Wipes was primarily driven by a decrease in diaper revenue due to lower traffic and decreased revenue in our Digital channel as the price of digital marketing escalated and impacted our ability to cost-effectively drive traffic to our Honest.com and digital customers, offset by an increase in our wipes revenue, price increases and distribution gains. The revenue increase in Household and Wellness was primarily driven by $3.8 million in revenue from Honest Baby Clothing as a result of our transition from a license agreement to a supplier services agreement with Butterblu.
We estimate that pricing actions taken in the first half of 2022 contributed $7.4 million to revenue for the nine months ended September 30, 2022.
The increase in revenue in our Retail channel for the three months ended September 30, 2022, compared to the three months ended September 30, 2021, was primarily driven by new distribution, an increase in revenue at a key retailer driven by strong consumption supported by investments in merchandising and marketing, offset by a decrease in revenue due to a rotational program at a key club retailer that did not repeat this year. The decrease in revenue in our Digital channel for the three months ended September 30, 2022, compared to the three months ended September 30, 2021, was primarily driven by a reduction in revenue by a key digital customer due to an inventory reduction and the timing of shipments related to its national promotional event that occurred during the three months ended September 30, 2021, that did not occur during the three months ended September 30, 2022, as well as higher digital marketing costs which impacted our ability to cost-effectively drive traffic to Honest.com and digital customers.
The increase in revenue in our Retail channel for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, was primarily due to an increase in revenue across product categories related to new retail distribution gains and strong consumption growth, offset by two rotational programs (sanitization and disinfecting and baby and personal care) with a key club customer during the nine months ended September 30, 2021, that did not occur during the nine months ended September 30, 2022. The decrease in revenue in our Digital channel for the nine months ended September 30, 2022, compared to the nine months ended September 30, 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 customers.
Cost of Revenue and Gross Profit | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | % change | | 2022 | | 2021 | | $ change | | % change | |
| (In thousands, except percentages) | | | | | | | | | | | | | |
| Cost of revenue | $ | 58,963 | | | $ | 52,892 | | | $ | 6,071 | | | 11.5 | % | $ | 161,984 | | | $ | 153,177 | | | $ | 8,807 | | | 5.7 | % |
| Gross profit | $ | 25,617 | | | $ | 29,759 | | | $ | (4,142) | | | (13.9) | % | $ | 69,808 | | | $ | 85,081 | | | $ | (15,273) | | | (18.0) | % |
Cost of revenue was $59.0 million for the three months ended September 30, 2022, as compared to $52.9 million for the three months ended September 30, 2021. The increase of $6.1 million, or 11.5%, was primarily due to higher fulfillment costs, especially in transportation, freight and warehouse labor costs, product costs driven by higher revenue from Honest Baby Clothing and increased product costs for our diapers and personal care, as compared to the three months ended September 30, 2021, partially offset by cost reduction projects. Cost of revenue as a percentage of revenue increased by 572 basis points primarily due to higher input costs, along with higher trade promotion levels as compared to the three months ended September 30, 2021, partially offset by pricing increases taken in the first half of 2022 and cost reduction projects.
Cost of revenue was $162.0 million for the nine months ended September 30, 2022, as compared to $153.2 million for the nine months ended September 30, 2021. The increase of $8.8 million, or 5.7%, was primarily due to higher fulfillment costs, especially in transportation, freight and warehouse labor costs, product costs driven by higher revenue from Honest Baby Clothing and increased product costs for our diapers and personal care products, as well as rent expense related to our warehouse facility due to the derecognition of our built-to-suit lease as a result of the adoption of ASC 842 (previously recognized in interest expense). Cost of revenue as a percentage of revenue increased by 559 basis points primarily due to higher input costs, along with higher trade promotion levels as compared to the nine months ended September 30, 2021, partially offset by pricing increases taken in the first half of 2022 and cost reduction projects.
Gross profit was $25.6 million for the three months ended September 30, 2022, as compared to $29.8 million for the three months ended September 30, 2021. The decrease of $4.1 million, or 13.9%, was primarily due to higher input costs and higher expenses associated with promotional activity, partially offset by pricing increases that went into effect in 2022 and cost savings.
Gross profit was $69.8 million for the nine months ended September 30, 2022, as compared to $85.1 million for the nine months ended September 30, 2021. The decrease of $15.3 million, or 18.0%, was primarily due to the decrease in revenue in our Skin and Personal Care product category, fixed cost deleverage, higher input costs and higher expenses associated with promotional activity, partially offset by pricing increases that went into effect in 2022, favorable product mix and cost savings, including the consolidation of a distribution center.
Operating Expenses
Selling, General and Administrative Expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | % change | | 2022 | | 2021 | | $ change | | % change | |
| (In thousands, except percentages) | | | | | | | | | | | | | |
| Selling, general and administrative | $ | 23,491 | | | $ | 18,568 | | | $ | 4,923 | | | 26.5 | % | $ | 63,068 | | | $ | 65,356 | | | $ | (2,288) | | | (3.5) | % |
Selling, general and administrative expenses were $23.5 million for the three months ended September 30, 2022, as compared to $18.6 million for the three months ended September 30, 2021. The increase of $4.9 million, or 26.5%, was primarily due to $1.7 million increase in legal fees, $1.5 million increase in employee-related expenses due to higher headcount and $1.4 million increase in donation expenses.
Selling, general and administrative expenses were $63.1 million for the nine months ended September 30, 2022, as compared to $65.4 million for the nine months ended September 30, 2021. The decrease of $2.3 million, or 3.5%, was primarily due to non-recurring IPO related expenses for the nine months ended September 30, 2021 that did not occur during the nine months ended September 30, 2022, offset by an increase of $2.6 million in legal fees, a $2.1 million increase in employee-related expenses due to higher headcount, a $1.9 million increase in donation expenses and a $0.7 million increase in insurance costs related to operating as a public company. The IPO-related expenses during the nine months ended September 30, 2021 included $9.1 million in bonus payments made to certain employees, including members of management, excluding payroll taxes and
expenses, $1.9 million in stock-based compensation expense related to the vesting of performance based awards and $1.0 million in accounting expenses related to the IPO during the nine months ended September 30, 2021.
Marketing Expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | % change | | 2022 | | 2021 | | $ change | | % change | |
| (In thousands, except percentages) | | | | | | | | | | | | | |
| Marketing | $ | 12,140 | | | $ | 13,687 | | | $ | (1,547) | | | (11.3) | % | $ | 38,121 | | | $ | 41,868 | | | $ | (3,747) | | | (8.9) | % |
Marketing expenses were $12.1 million for the three months ended September 30, 2022, as compared to $13.7 million for the three months ended September 30, 2021. The decrease of $1.5 million, or 11.3%, was primarily due to a $4.2 million reduction in digital advertising, offset by a $2.0 million increase in retail marketing to support new distribution and an $0.6 million increase in public relations and influencer marketing.
Marketing expenses were $38.1 million for the nine months ended September 30, 2022, as compared to $41.9 million for the nine months ended September 30, 2021. The decrease of $3.7 million, or 8.9%, was primarily due to a $8.1 million reduction in digital advertising, offset by a $3.6 million increase in retail marketing to support new distribution and higher return shopper marketing, as well as $0.8 million increase in public relations and influencer marketing.
Research and Development Expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | % change | | 2022 | | 2021 | | $ change | | % change | |
| (In thousands, except percentages) | | | | | | | | | | | | | |
| Research and development | $ | 1,725 | | | $ | 2,092 | | | $ | (367) | | | (17.5) | % | $ | 5,643 | | | $ | 6,082 | | | $ | (439) | | | (7.2) | % |
Research and development expenses were $1.7 million for the three months ended September 30, 2022, as compared to $2.1 million for the three months ended September 30, 2021. The decrease of $0.4 million, or 17.5%, was primarily related to a $0.3 million decrease in stock-based compensation expense.
Research and development expenses were $5.6 million for the nine months ended September 30, 2022, as compared to $6.1 million for the nine months ended September 30, 2021. The decrease of $0.4 million, or 7.2%, was primarily related to a $0.4 million decrease in stock-based compensation expense.
Interest and Other Income (Expense), Net
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the three months ended September 30, | | For the nine months ended September 30, | |
| 2022 | | 2021 | | $ change | | | | 2022 | | 2021 | | $ change | | | |
| (In thousands, except percentages) | | | | | | | | | | | | | |
| Interest income (expense), net | $ | 140 | | | $ | (440) | | | $ | 580 | | | | | $ | 322 | | | $ | (1,353) | | | $ | 1,675 | | | | |
| Other income (expense), net | (169) | | | (86) | | | (83) | | | | | 335 | | | (9) | | | 344 | | | | |
| Interest and other income (expense), net | $ | (29) | | | $ | (526) | | | $ | 497 | | | | | $ | 657 | | | $ | (1,362) | | | $ | 2,019 | | | | |
Interest and other income (expense), net was net expense of $29 thousand for the three months ended September 30, 2022, as compared to net expense of $0.5 million for the three months ended September 30, 2021. The decrease of $0.5 million was primarily due to a decrease in interest expense related to the derecognition of our built-to-suit lease as a result of the adoption of ASC 842. Under the new lease accounting related to the adoption of ASC 842, all lease expense related to the built-to-suit lease is now included in the cost of revenue.
Interest and other income (expense), net was net income of $0.7 million for the nine months ended September 30, 2022, as compared to net expense of $1.4 million for the nine months ended September 30, 2021. The increase of $2.0 million was primarily due to a decrease in interest expense related to the derecognition of our built-to-suit lease as a result of the adoption of ASC 842. Under the new lease accounting related to the adoption of ASC 842, all lease expense related to the built-to-suit lease is now included in the cost of revenue. Additionally, during the nine months ended September 30, 2022, $0.7 million of other income was related to the recognition of taxes and interest to be refunded from the Nevada Department of Taxation legal settlement. Refer to Note 8 included in these condensed consolidated financial statements for more information on the legal settlement.
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 of September 30, 2022, we had $24.1 million of cash and cash equivalents and $16.7 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
In April 2021, we entered into a first lien credit agreement (the “2021 Credit Facility”), with JPMorgan 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 on April 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.
As of September 30, 2022, there were outstanding standby letters of credit of $4.8 million related to lease obligations with $30.2 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 recognize the commitment fee as incurred in interest and other income (expense), net in the condensed consolidated statements of comprehensive loss. For the three and nine months ended September 30, 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) the Wall 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 on April 30, 2026. As of September 30, 2022, there was no outstanding balance under the 2021 Credit Facility. We are required to follow certain covenants. As of September 30, 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 nine months ended September 30, |
| (In thousands) | 2022 | | 2021 |
| Net cash used in operating activities | $ | (50,669) | | | $ | (36,359) | |
| Net cash provided by (used in) investing activities | $ | 24,004 | | | $ | (28,734) | |
| Net cash (used in) provided by financing activities | $ | (39) | | | $ | 55,559 | |
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 $50.7 million for the nine months ended September 30, 2022 was primarily due to net loss of $36.4 million, non-cash adjustments of $18.2 million and a net decrease in cash related to changes in operating assets and liabilities of $32.4 million. Non-cash adjustments primarily consisted of stock-based compensation of $11.4 million, amortization of operating ROU assets of $4.6 million and depreciation and amortization of $2.0 million. Changes in cash flows related to operating assets and liabilities primarily consisted of a $24.6 million increase in inventory reflecting cost inflation, the purchase of $5.5 million of Honest Baby Clothing inventory from Butterblu and an increase in weeks of supply due to longer lead times and in advance of new distribution, a $7.1 million increase in accounts receivable due to growth in Retail channel revenue, a $5.2 million use of cash due to operating lease obligations and a $3.2 million increase in prepaid expenses and other assets, offset by a $7.6 million increase in accounts payable due to higher inventory purchases and cost inflation in the nine months ended September 30, 2022.
Net cash used in operating activities of $36.4 million for the nine months ended September 30, 2021 was primarily due to net loss of $29.7 million, non-cash adjustments of $16.6 million and a net decrease in cash related to changes in operating assets and liabilities of $23.3 million. Non-cash adjustments primarily consisted of stock-based compensation of $13.2 million and depreciation and amortization of $3.1 million. Changes in cash flows related to operating assets and liabilities primarily consisted of a $8.9 million increase in accounts receivable due to higher revenue from retail customers, a $7.6 million increase in prepaid expenses and other assets due to timing of payments, as well as the non-monetary sale of our legacy beauty inventory for future marketing and transportation credits, a $1.2 million increase in inventory due to timing of inventory purchases and a $5.8 million use of cash due to the timing of payments associated with our accounts payable and operating leasing obligations.
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.
Net cash provided by investing activities of $24.0 million for the nine months ended September 30, 2022 was primarily due to proceeds from maturities of short-term investments of $38.2 million, offset by purchases of short-term investments of $12.8 million.
Net cash used in investing activities of $28.7 million for the nine months ended September 30, 2021 was due to purchases of short-term investments of $65.3 million, offset by proceeds from the sales and maturities of short-term investments of $26.9 million and $9.9 million, respectively.
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 used in financing activities of $39 thousand for the nine months ended September 30, 2022 primarily consisted of principal payments of financing lease obligations, partially offset by proceeds from stock option exercises and the 2021 ESPP.
Net cash provided by financing activities of $55.6 million for the nine months ended September 30, 2021 primarily consisted of proceeds from our IPO of $96.5 million, net of underwriting discounts and commissions, offset by dividend payments of $35.0 million and payments of offering costs in connection with our IPO of $5.5 million.
Dividends
In April 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 of May 3, 2021, which we paid on June 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 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 September 30, | | For the nine months ended September 30, |
| (In thousands) | 2022 | | 2021 | | 2022 | | 2021 |
| Reconciliation of Net Loss to Adjusted EBITDA | | | | | | | |
| Net loss | $ | (11,788) | | | $ | (5,136) | | | $ | (36,427) | | | $ | (29,654) | |
| Interest and other (income) expense, net | 29 | | | 526 | | | (657) | | | 1,362 | |
| Income tax provision | 20 | | | 22 | | | 60 | | | 67 | |
| Depreciation and amortization | 639 | | | 1,019 | | | 2,025 | | | 3,135 | |
| Stock-based compensation | 3,900 | | | 4,776 | | | 11,360 | | | 13,240 | |
| Securities litigation expense | 1,612 | | | — | | | 2,607 | | | — | |
Related IPO and other transaction-related expenses(1) | — | | | — | | | — | | | 12,160 | |
| Payroll tax expense related to stock-based compensation | 14 | | | 123 | | | 81 | | | 135 | |
| Adjusted EBITDA | $ | (5,574) | | | $ | 1,330 | | | $ | (20,951) | | | $ | 445 | |
__________________
(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 September 30, 2022, there were no material changes to our material cash 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 and nine months ended September 30, 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
In April 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.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
The information contained under the heading “Litigation” in Note 8 to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q is incorporated by reference into this Item.
Item 1A. Risk Factors.
RISK FACTOR SUMMARY
Our business is subject to numerous risks. The following summary highlights some of the risks you should consider with respect to our business and prospects. You should carefully consider the risks and uncertainties described in our Annual Report, together with all of the other information 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. The risks and uncertainties described in our Annual Report and in this Quarterly Report on Form 10-Q are not the only ones we face. Additional risk and uncertainties that we are unaware of or that we deem immaterial may also become important factors that adversely affect our business. The realization of any of these risks and uncertainties could have a material adverse effect on our reputation, business, financial condition, results of operations, growth and future prospects as well as our ability to accomplish our strategic objectives. In that event, the market price of our common stock could decline and you could lose part or all of your investment.
Some of the more significant risks we face include the following:
• We have incurred net losses each year since our inception and we may not be able to achieve or maintain profitability in the future.
• Our growth may not be indicative of our future growth and we may not be able to effectively manage our growth or evaluate our future prospects. If we fail to effectively manage our future growth or evaluate our future prospects, our business could be adversely affected.
• Our quarterly operating results may fluctuate, which could cause our stock price to decline.
•Economic conditions, including a recession and inflationary pressures such as price increases in commodity prices, labor costs, input costs and transportation costs and their impact on consumer spending and our profit margin.
• Consolidation of retail customers, the loss of a significant retail or third-party ecommerce customer or a significant change in such customers' purchasing patterns could negatively impact our sales and ability to achieve or maintain profitability.
• Our business, including our costs and supply chain, is subject to risks associated with sourcing, manufacturing, warehousing and logistics, and the loss of any of our key suppliers or logistical service providers could negatively impact our business.
• We may not be able to compete successfully in our highly competitive market.
• If we fail to cost-effectively acquire new consumers or retain our existing consumers, our business could be adversely affected. Our sales and profit are dependent upon our ability to expand our existing consumer relationships and acquire new consumers.
• We must expend resources to maintain consumer awareness of our brand, build brand loyalty and generate interest in our products. Our marketing strategies and channels will evolve and our efforts may or may not be successful.
• Increasing scrutiny and evolving expectations from stakeholders with respect to our environmental, social and governance (ESG) practices, performance and disclosures.
• Our brand and reputation may be diminished due to real or perceived quality, safety, efficacy or environmental impact issues with our products, which could have an adverse effect on our business, financial condition, results of operations and prospects.
• Our ability to maintain our competitive position is largely dependent on the services of our senior management and other key personnel, including our founder and Chief Creative Officer, Jessica Warren and our Chief Executive Officer, Nick Vlahos.
• A disruption in our operations could have an adverse effect on our business.
• The COVID-19 pandemic has had and may continue to have an adverse effect on our business, financial condition, results of operations and prospects.
• We rely on third-party suppliers, manufacturers, retail and ecommerce customers and other vendors, and they may not continue to produce products or provide services that are consistent with our standards or applicable regulatory requirements, which could harm our brand, cause consumer dissatisfaction, and require us to find alternative suppliers of our products or services.
• Health and safety incidents or advertising inaccuracies or product mislabeling may have an adverse effect on our business by exposing us to lawsuits, product recalls or regulatory enforcement actions, increasing our operating costs and reducing demand for our product offerings.
• International trade disputes and the U.S. government’s trade policy could adversely affect our business.
• Our business may be adversely affected if we are unable to provide our consumers with a technology platform that is able to respond and adapt to rapid changes in technology.
RISK FACTORS
Other than the risk factors set forth below, there have been no material changes to the risk factors set forth in the section titled “Risk Factors” included in our Annual Report.
The COVID-19 pandemic and overall macro economic trends have had and may continue to have an adverse effect on our business, financial condition, results of operations and prospects.
In connection with the COVID-19 pandemic, governments have implemented significant measures, including closures, quarantines, travel restrictions and other social distancing directives, intended to control the spread of the virus. Companies have also taken precautions, such as requiring employees to work remotely or on a hybrid remote schedule, imposing travel restrictions and temporarily closing businesses. For example, due to new COVID-19 lockdown restrictions in China in the second quarter of 2022, many of the ports shut down which has negatively impacted and may in the future negatively impact our ability to timely receive shipments of our products. To the extent that additional prevention and mitigation measures are implemented in the future, or there is uncertainty about the effectiveness of these or any other measures to contain the spread of COVID-19, there has been and continues to be an adverse impact on global economic conditions and consumer confidence and spending, which has adversely affected our supply chain as well as the demand for our products and has impacted our revenue and ability to service our customer orders. For example, 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. While at this time we are working to manage potential disruptions to our supply chain, the fluid nature of the COVID-19 pandemic and uncertainties regarding the related economic impact, as well as overall macroeconomic trends, are likely to result in sustained market turmoil, which could also have an adverse effect on our business, financial condition, results of operations and prospects.
The impact of the COVID-19 pandemic and overall macroeconomic trends on any of our suppliers, manufacturers, retail or ecommerce customers or transportation or logistics providers has and may continue to negatively affect the price and availability of our materials and impact our supply chain. For example, there is a supplier shortage or significant demand of and cost impacts to 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, surfactants, fluff pulp and other diaper raw materials and palm kernel oil. If the disruptions caused by the COVID-19 pandemic continue for an extended period of time, our ability to meet the demands of our consumers may be materially impacted. For example, government restrictions have limited and may in the future limit the personnel available to receive or ship products at our distribution centers. In addition, the conditions caused by the COVID-19 pandemic may negatively impact collections of accounts receivable, result in reduced orders from retail or digital partners or cause some of our retail customers to go out of business, all of which could adversely affect our business, financial condition, results of operations and prospects. Also, in the third quarter of 2022, some of our digital and retail customers began to reduce inventory on hand and have changed fulfillment schedules, which has negatively impacted our fulfillment operations and our revenue and is expected to continue to do so in the future. For example, Target implemented a new inventory management system to decrease weeks of supply on hand. Additionally, Amazon is holding fewer weeks of inventory supply on hand, which could impact the consumer experience and ultimate consumption, and has and could continue to negatively impact our results of operations.
In addition, any depression or recession resulting from the COVID-19 pandemic or other factors may adversely change customer and consumer behavior and demand, including with respect to our products, which could have an adverse effect on our business, financial condition, results of operations and prospects. For example, economic conditions, including inflationary pressures such as price increases in commodity prices, labor costs, input costs and transportation costs have impacted our profit margin and could impact consumer spending decisions to choose lower priced products, particularly as a result of our price increases intended to offset these input costs. We may not be able to increase our prices or productivity sufficient to offset these costs. Our Digital channel has been negatively impacted in recent periods as consumers return to in-store shopping and our Retail channel may be impacted if governments continue to implement regional business closures, quarantines, travel restrictions and other social distancing directives to slow the spread of the COVID-19 virus. Further, to the extent our third-party ecommerce or retail customers’ operations are negatively impacted by the COVID-19 pandemic or other macroeconomic trends, our consumers may reduce demand for or spending on our products, or consumers or ecommerce or retail customers may delay payments to us or request payment or other concessions. There may also be significant reductions or volatility in consumer demand for our products due to travel restrictions or social distancing directives, as well as the temporary inability of consumers to purchase our products due to illness, quarantine or financial hardship, shifts in demand away from one or more of our products, decreased consumer confidence and spending or pantry-loading activity, any of which may negatively impact our business, including as a result of an increased difficulty in planning for operations. For example, based on macro Household and Wellness trends, consumer demand for sanitizing and disinfecting products has decelerated at a more rapid than expected rate as more consumers have become vaccinated and retailers continue to manage heavy inventories of sanitization and disinfecting products in stores. We recorded an inventory write-off of $0.8 million during the nine months ended September 30, 2022 and $5.6 million for the year ended December 31, 2021 relating to certain sanitization and disinfecting products as the amount of inventory was significantly in excess of existing demand, and we may record inventory write-offs in the future. Additionally, we may be unable to effectively modify our trade promotion and advertising activities to reflect changing consumer viewing and shopping habits due to event cancellations, reduced in-store visits and travel restrictions, among other things.
The extent of the COVID-19 pandemic’s effect on our operational and financial performance will depend on future developments, including the duration and intensity of the COVID-19 pandemic and the impact of any new variants of COVID-19, all of which are uncertain and difficult to predict considering the rapidly evolving landscape. As a result, it is not currently possible to ascertain the overall impact of the COVID-19 pandemic on our business. However, if the pandemic continues to persist as a severe worldwide health crisis, the pandemic could continue to have an adverse effect on our business, financial condition, results of operations and prospects, and may also have the effect of heightening many of the other risks described in this “Risk Factors” section.
We rely on third-party suppliers, manufacturers, retail and ecommerce customers and other vendors, and they may not continue to produce products or provide services that are consistent with our standards or applicable regulatory requirements, which could harm our brand, cause consumer dissatisfaction, and require us to find alternative suppliers of our products or services.
We do not own or operate any manufacturing facilities. We use multiple third-party suppliers and manufacturers based primarily in the United States, China and Mexico and other countries to a lesser extent, to source, manufacture and partner with us for the innovation of all of our products, including product components, under our owned brand. We engage many of our third-party suppliers and manufacturers on a purchase order basis and in some cases are not party to long-term contracts with them. The ability and willingness of these third parties to supply, manufacture and to partner in innovation of our products may be affected by raw material availability and prices, competing orders placed by other companies and the demands of those companies. Our operating results have been negatively impacted by increases in the costs of manufacturing our products, and we have no guarantees that costs will not continue to rise. 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, respectively, that those hurdles had been met. In addition, in the third quarter of 2022, we received requests from the same two third-party manufacturers to renegotiate purchase costs due to continued increases in raw material costs. As a result, we negotiated and agreed to higher purchase prices which will negatively impact our cost of goods in 2022 and we expect higher purchase prices in 2023, which will negatively impact our cost of goods in 2023, which we may not be able to offset with price increases. If we experience significant increases in demand, or need to replace a significant number of existing suppliers or manufacturers, there can be no assurance that additional supply and manufacturing capacity will be available when required on terms that are acceptable to us, or at all, or that any supplier or manufacturer will allocate sufficient capacity to us in order to meet our requirements. Furthermore, our reliance on suppliers and manufacturers outside of the United States, the number of third parties with whom we transact and the number of jurisdictions to which we sell complicates our efforts to comply with customs duties and excise taxes; any failure to comply could adversely affect our business.
In addition, quality control problems, such as the use of materials and delivery of products that do not meet our quality control standards and specifications or comply with applicable laws or regulations, could harm our brand and business or cause consumer dissatisfaction. For example, as disinfecting and sanitization products have faced supply chain challenges, decelerating market demand and aging and slower turning inventory, we have received some product quality complaints from customers and consumers that have resulted and may in the future result in additional refunds, returns, write-offs and remediation costs. Remediation costs would be significant, including the cost to rework a product to be in sellable condition or the cost to destroy a product that cannot be remediated, and while immaterial as of September 30, 2022, it could have an adverse effect on our business, financial condition and results of operations. Quality control problems could result in regulatory action, such as restrictions on importation, products of inferior quality or product stock outages or shortages, harming our sales and creating inventory write-downs for unusable products.
We have also outsourced portions of our fulfillment process, as well as certain technology-related functions, to third-party service providers. Specifically, we rely on third parties in a number of foreign countries and territories, we are dependent on third-party vendors for credit card processing, and we use third-party hosting and networking providers to host our sites. The failure of one or more of these entities to provide the expected services on a timely basis, or at all, or at the prices we expect, or the costs and disruption incurred in changing these outsourced functions to being performed under our management and direct control or that of a third party, could have an adverse effect on our business, financial condition, results of operations and prospects. We are not party to long-term contracts with some of our retail and ecommerce customers, and upon expiration of these existing agreements, we may not be able to renegotiate the terms on a commercially reasonable basis, or at all.
Further, our third-party manufacturers, suppliers and retail and ecommerce customers may:
•have economic or business interests or goals that are inconsistent with ours;
•take actions contrary to our instructions, requests, policies or objectives;
•be unable or unwilling to fulfill their obligations under relevant purchase orders or manufacturing or supply agreements, including obligations to meet our production deadlines, quality standards, pricing guidelines and product specifications, and to comply with applicable regulations, including those regarding the safety and quality of products;
•have financial difficulties;
•encounter raw material or labor shortages;
•encounter increases in raw material or labor costs which may affect our procurement costs;
•encounter difficulties with proper payment of custom duties or excise taxes;
•disclose our confidential information or intellectual property to competitors or third parties;
•engage in activities or employ practices that may harm our reputation; and
•work with, be acquired by, or come under control of, our competitors.
Our results of operations could be harmed if we are unable to accurately forecast demand for our products.
To ensure adequate inventory supply, we must forecast inventory needs and place orders with our third-party manufacturers before firm orders are placed by our consumers or our retail and third-party ecommerce customers. If we fail to accurately forecast consumer and customer demand, we may experience excess inventory levels or a shortage of products to deliver to our consumers and customers. Factors that could affect our ability to accurately forecast demand for our products include: an unanticipated increase or decrease in consumer demand for our products, in particular due to rising consumer uncertainty in the current macroeconomic environment; our failure to accurately forecast acceptance for our new products; product introductions by competitors; unanticipated changes in general market conditions or other factors, which may result in cancellations of advance orders or a reduction or increase in the rate of reorders or at-once orders placed by retailers or the timing of their orders; the impact on demand due to unseasonable weather conditions; weakening of economic conditions or consumer or customer confidence in future economic conditions, which could reduce demand for discretionary items, such as our products; and terrorism or acts of war, or the threat thereof, or political or labor instability or unrest, which could adversely affect consumer or customer confidence and spending or interrupt production and distribution of product and raw materials. For example, we periodically participate in non-recurring retail rotational programs, including a key club retailer rotational program that was not renewed in 2022, and key retailer-specific programs or other customer test programs, which might not be successful or continue long-term, including a rotational program at Costco that has not been renewed for 2023, which could make forecasting demand for products in these programs challenging. Also, in the third quarter of 2022, some of our digital and retail customers began to reduce inventory on hand and have changed fulfillment schedules, which has negatively impacted our fulfillment operations and our revenue and is expected to continue to do so in the future. For example, Target implemented a new inventory management system to decrease weeks of supply on hand. Additionally, Amazon is holding fewer weeks of inventory supply on hand, which could impact the consumer experience and ultimate consumption, and has and could continue to negatively impact our results of operations.
Inventory levels in excess of consumer or customer demand have resulted and may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices or in less preferred distribution channels, which could impair our brand image and harm our business. For example, based on macro Household and Wellness trends, consumer demand for sanitizing and disinfecting products has decelerated at a more rapid than expected rate as more consumers have become vaccinated and retailers continue to manage heavy inventories of sanitization and disinfecting products in stores. We recorded an inventory write-off of $0.8 million during the nine months ended September 30, 2022 and $5.6 million for the year ended December 31, 2021 relating to certain sanitization and disinfecting products as the amount of inventory was significantly in excess of existing demand, and we may record inventory write-offs in the future. For example, during the three months ended September 30, 2022, we donated $1.5 million of excess sanitization products. In addition, if we underestimate the demand for our products, our third-party manufacturers may not be able to produce products to meet our consumer or customer requirements, and this could result in delays in the shipment of our products and our ability to recognize revenue, lost sales, as well as damage to our reputation and retailer and distributor relationships. For example, 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.
The difficulty in forecasting demand also makes it difficult to estimate our future results of operations and financial condition from period to period. A failure to accurately predict the level of demand for our products could adversely affect our business, financial condition, results of operations and prospects.
We must expend resources to maintain consumer awareness of our brand, build brand loyalty and generate interest in our products. Our marketing strategies and channels will evolve and our efforts may or may not be successful.
In order to remain competitive and expand and keep market share for our products across our various channels, we may need to increase our marketing and advertising spending to maintain and increase consumer awareness, protect and grow our existing market share or promote new products, which could impact our operating results. Additionally, we may choose to change one of our marketing or advertising partners, which may prove to be unsuccessful. Substantial advertising and promotional expenditures may be required to maintain or improve our brand’s market position or to introduce new products to the market, and we are increasingly engaging with non-traditional media, including consumer outreach through social media and web-based channels, which may not prove successful. An increase in our marketing and advertising efforts may not maintain our current reputation or lead to increased brand awareness. Further, social media platforms frequently change the algorithms that determine the ranking and display of results of a user’s search and may make other changes to the way results are displayed, which may
negatively affect the placement of our links. Moreover, social media platforms and other digital advertising platforms have increased the costs of digital advertising which has made such marketing less cost effective and reduced the number of visits to our website and social media channels. In addition, social media platforms typically require compliance with their policies and procedures, which may be subject to change or new interpretation with limited ability to negotiate, which could negatively impact our marketing capabilities. If we are unable to maintain and promote a favorable perception of our brand and products on a cost-effective basis, our business, financial condition, results of operations and prospects could be adversely affected.
Our business, including our costs and supply chain, is subject to risks associated with sourcing, manufacturing, warehousing, distribution and logistics, and the loss of any of our key suppliers or logistical service providers could negatively impact our business.
All of the products we offer are manufactured by a limited number of third-party manufacturers, and as a result we have been and may continue to be subject to price fluctuations or demand disruptions. Our operating results have been negatively impacted by increases in the costs of manufacturing our products, and we have no guarantees that costs will not continue to rise. 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, respectively, that those hurdles had been met. In addition, in the third quarter of 2022, we received requests from the same two third-party manufacturers to renegotiate purchase costs due to continued increases in raw material costs. As a result, we negotiated and agreed to higher purchase prices which will negatively impact our cost of goods in 2022 and we expect higher purchase prices in 2023, which will negatively impact our cost of goods in 2023, which we may not be able to offset with price increases. We have also continued to experience record-high freight and shipping costs. As we expand into new categories and product types, we expect that we may not have strong purchasing power in these new areas, which could lead to higher costs than we have historically seen in our current categories. We may also be limited in our ability to pass increased costs on to consumers, which could adversely affect our operating results. Moreover, in the event of a significant disruption in the supply of the materials used in the manufacture of the products we offer, we and the vendors that we work with might not be able to locate alternative suppliers of materials of comparable quality at an acceptable price.
Products and merchandise we receive from manufacturers and suppliers may not be of sufficient quality or free from damage, or such products may be damaged during shipping, while stored in our warehouse fulfillment centers or with third-party ecommerce or retail customers or when returned by consumers. We may incur additional expenses and our brand or reputation could be harmed if customers or consumers and potential consumers believe that our products do not meet their expectations, are not properly labeled or are damaged. For example, as disinfecting and sanitization products have faced supply chain challenges, decelerating market demand and aging and slower turning inventory, the Company has received some product quality complaints from customers and consumers that have resulted or may result in additional refunds, returns, write-offs and remediation costs.
We purchase significant amounts of product supply from a limited number of suppliers with limited supply capabilities. There can be no assurance that our current suppliers will be able to accommodate our anticipated growth or continue to supply current quantities at preferential prices. An inability of our existing suppliers to provide materials in a timely or cost-effective manner could impair our growth and have an adverse effect on our business, financial condition, results of operations and prospects. For example, Valor Brands LLC (dba Ontex North America), or Ontex, which manufactures and supplies certain diaper products for us, have opened a new manufacturing facility in North Carolina and its new facility may not be able to manufacture our diapers in a timely, cost-effective manner or meet our quality standards. In addition, we do not maintain long-term supply contracts with many of our suppliers and these suppliers could discontinue selling to us at any time. However, we have a long-term supply agreement with Ontex for the manufacture and supply of certain diaper products. The current term of the supply agreement with Ontex ends on December 31, 2023. In addition, our agreement with Ontex provides that Ontex will be our exclusive supplier of diaper and training pant products so long as Ontex is able to provide us such products. Either party may terminate the agreement if the other party materially breaches the agreement and does not cure the breach within a specified notice period, or upon the other party’s insolvency. If the agreement with Ontex is terminated, is not renewed, or if Ontex becomes insolvent, ceases or significantly reduces its operations or experiences financial distress, as a result of the COVID-19 pandemic or otherwise, or if any environmental, economic or other outside factors impact their operations, our ability to procure diaper manufacturing services may be impaired, and we may not be able to obtain, or may face increased costs related to, such services. The loss of Ontex, or of any of our other significant suppliers, or the discontinuance of any preferential pricing or exclusive incentives they currently offer to us could have an adverse effect on our business, financial condition, results of operations and prospects.
We continually seek to expand our base of suppliers, especially as we identify new products that necessitate new or additional materials. We also require our new and existing suppliers to meet our ethical and business partner standards. Suppliers may also have to meet governmental and industry standards and any relevant standards required by our consumers, which may require additional investment and time on behalf of suppliers and us. If any of our key suppliers becomes insolvent, ceases or significantly reduces its operations or experiences financial distress, as a result of the COVID-19 pandemic or otherwise, if any environmental, economic or other outside factors impact their operations or if we are unable to identify or enter into distribution relationships with new suppliers or to replace the loss of any of our existing suppliers, we may experience a competitive disadvantage, our business may be disrupted and our business, financial condition, results of operations and prospects could be adversely affected.
Our principal suppliers currently provide us with certain incentives such as volume purchasing, trade discounts, cooperative advertising and market development funds. A reduction or discontinuance of these incentives would increase our costs and could reduce our ability to achieve or maintain profitability. Similarly, if one or more of our suppliers were to offer these incentives, including preferential pricing, to our competitors, our competitive advantage would be reduced, which could have an adverse effect on our business, financial condition, results of operations and prospects.
In addition, we have warehouse fulfillment centers located in Las Vegas, Nevada, Breinigsville, Pennsylvania and the Netherlands, all of which are managed by a single distribution partner, GEODIS Logistics LLC, or GEODIS. We have an agreement with GEODIS pursuant to which GEODIS provides warehousing, distribution and fulfillment services to us. Our agreement with GEODIS may be terminated for any reason by us or by GEODIS on delivery of prior written notice, and is renewable on an annual basis. If the agreement with GEODIS is terminated, is not renewed or if one fulfillment center is consolidated into another warehouse fulfillment center or if GEODIS becomes insolvent, ceases or significantly reduces its operations or experiences financial distress, as a result of the COVID-19 pandemic or otherwise, or if any environmental, economic or other outside factors impact their operations, our ability to procure warehousing, distribution and fulfillment services may be impaired, and we may not be able to obtain, or may face increased costs related to, such services and our business, financial condition, results of operations and prospects could be adversely affected. For example, we are negotiating the renewal of our agreement with GEODIS for services at our Las Vegas, Breinigsville and Netherlands fulfillment centers. If we are not successful negotiating that renewal, our business, financial condition, results of operations and prospects could be adversely affected. As part of these negotiations GEODIS may pass on increased service and inflation related costs to us, including warehouse labor cost, which would negatively impact our cost of revenue.
We are subject to international business uncertainties.
In 2021, international sales represented 2% of total revenue and part of our strategy is to accelerate growth outside of the United States. In addition, our business relies on third-party suppliers and manufacturers located in China, Mexico, and certain other foreign countries. We intend to continue to sell to consumers outside the United States and maintain our relationships in China, Mexico, and other foreign countries where we have suppliers and manufacturers. Further, we may establish additional relationships in other countries to grow our operations. The substantial up-front investment required, the lack of consumer awareness of our products in jurisdictions outside of the United States, differences in consumer preferences and trends between the United States and other jurisdictions, the risk of inadequate intellectual property protections and differences in packaging, labeling and related laws, rules and regulations are all substantial matters that need to be evaluated prior to doing business in new territories. We cannot be assured that our international efforts will be successful. International sales and increased international operations may be subject to risks such as:
•difficulties in staffing and managing foreign operations and geographically dispersed operations;
•burdens of complying with a wide variety of laws and regulations, including more stringent regulations relating to data privacy and security, particularly in the European Union;
•adverse tax effects and foreign exchange controls making it difficult to repatriate earnings and cash;
•political and economic instability;
•terrorist activities and natural disasters;
•trade restrictions;
•differing employment practices and laws and labor disruptions;
•the imposition of government controls;
•an inability to use or to obtain adequate intellectual property protection for our brand and key products;
•difficulties in enforcing contracts and legal decisions;
•tariffs and customs duties and the classifications of our goods by applicable governmental bodies;
•a legal system subject to undue influence or corruption;
•a business culture in which illegal sales practices may be prevalent;
•logistics and sourcing; and
•military conflicts.
The occurrence of any of these risks could have an adverse effect on our international business and consequently our overall business, financial condition, results of operations and prospects.
In addition, following Russia’s military invasion of Ukraine in February 2022, the United States, European Union, and other nations announced various sanctions against Russia and Belarus. The invasion of Ukraine and the retaliatory measures that have been taken, and could be taken in future, by the United States, NATO, and other countries have created global security concerns that could result in a regional conflict and otherwise have a lasting impact on regional and global economies and supply chains, any or all of which could adversely affect our business, financial condition, results of operations and prospects. For example, although we don't rely directly on Russia for oil supplies, the suppliers we do source oil from could pass on price increases to us, as a result of the overall increase in oil prices. In addition, Russia's invasion of Ukraine has impacted the availability of sunflower seed oil and its derivatives, which are used in a number of our Skin and Personal Care products, and has resulted in heightened demand for replacement ingredients, such as palm kernel oil, which have availability constraints or are subject to trade restrictions. While we believe we have supply assurances or alternate sources of supply for both sunflower seed oil, its derivatives and palm kernel oil, additional market availability constraints of these raw materials could have an adverse effect on our business, financial condition, results of operations and prospects. Additionally, Russia's military invasion has increased the cost of energy in the European Union, which has impacted the cost of raw material component parts from our European Union manufacturers, including the cost of fluff-pulp, a key ingredient in the manufacturing of our diapers. These price increases have led to additional price increase requests from our manufacturers on our diapers, which could lead to additional price increases from us and negatively impact consumer demand. We may also have to seek a raw material replacement, which could impact the timing of new innovation.
Consolidation of retail customers, the loss of a significant retail or third-party ecommerce customer or a significant change in such customer's historical purchasing patterns could negatively impact our sales and ability to achieve or maintain profitability.
Our omnichannel strategy includes selling our products through third-party ecommerce and retail customers (including their websites), which have been undergoing consolidation in recent years. This consolidation has produced larger, more sophisticated organizations with increased negotiating and buying power that are able to resist price increases, demand higher levels of marketing and promotional support, operate with lower inventories, decrease the number of brands that they carry and increase their emphasis on private label products, all of which could negatively impact our business.
We sell products to Target and Amazon under each of their standard vendor agreements. Our vendor agreements with Target and Amazon do not include a term or duration as sales under each vendor agreement are generally made on a purchase order basis. Our vendor agreement with Amazon provides that either party may terminate the agreement with 60 days’ prior written notice, provided that we are required to fulfill any purchase orders that we accept before the effective date of termination. Our vendor agreement with Target does not include any termination provisions. The loss of Target and Amazon or any other large customer, the reduction of purchasing levels or the cancellation of any business from Target and Amazon or any other large customer for an extended length of time could negatively impact our sales and ability to achieve or maintain profitability. For example, Target implemented a new inventory management system to decrease weeks of supply on hand. Additionally, Amazon is holding fewer weeks of inventory supply on hand, which could impact the consumer experience and ultimate consumption, and has and could continue to negatively impact our results of operations.
A third-party ecommerce or retail customers may take actions that affect us for reasons that we cannot always anticipate or control, such as their financial condition, changes in their business strategy or operations, the introduction of competing products or the perceived quality of our products. In the second quarter of 2021, we experienced volatility in orders from a key digital customer that reduced its inventory on-hand in consumables to free up space for other products ahead of a major promotional event. Despite operating in different channel segments, our third-party ecommerce and retail customers sometimes compete for the same consumers. Because of actual or perceived conflicts resulting from this competition, third-party ecommerce or retail customers may take actions that negatively affect us. Consequently, our financial results may fluctuate significantly from period to period based on the actions of one or more significant third-party ecommerce or retail customers.
We must successfully maintain, scale and upgrade our information technology systems, and our failure to do so could have an adverse effect on our business, financial condition, results of operations and prospects.
We have identified the need to significantly expand, scale and improve our information technology systems and personnel to support recent and expected future growth. As such, we are in the process of implementing, and will continue to invest in and implement, significant modifications and upgrades to our information technology systems and procedures, including replacing legacy systems with successor systems, making changes to legacy systems or acquiring new systems with new functionality, hiring employees with information technology expertise and building new policies, procedures, training programs and monitoring tools. These types of activities subject us to inherent costs and risks associated with replacing and changing these systems, including impairment of our ability to leverage our Retail channel or fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, the need to acquire and retain sufficiently skilled personnel to implement and operate the new systems, demands on management time, the introduction of errors or vulnerabilities and other risks and costs of delays or difficulties in transitioning to or integrating new systems into our current systems. These implementations, modifications and upgrades may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. Additionally, difficulties with implementing new technology systems, delays in our timeline for planned improvements, significant system failures, or our inability to successfully
modify our information systems to respond to changes in our business needs may cause disruptions in our business operations and could have an adverse effect on our business, financial condition, results of operations and prospects. For example, we recently replaced our order management system. If we experience any difficulties with this new system, we may encounter problems with fulfilling customer orders, which could have an adverse effect on our business.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.