The Honest pany(HNST) - 2023 Q4 - Annual Report

Special Note Regarding Forward-Looking Statements This report contains forward-looking statements subject to substantial risks and uncertainties that could cause actual results to differ materially from expectations - This report contains forward-looking statements that involve substantial risks and uncertainties, which could cause actual results to differ materially from expectations. These statements are identified by words like 'anticipate,' 'believe,' 'expect,' 'intend,' 'may,' 'plan,' 'potential,' 'predict,' 'project,' 'should,' 'target,' 'will,' or 'would'[14] - Key forward-looking statements include expectations regarding revenue, costs, operating expenses, gross margin, adjusted EBITDA, the Transformation Initiative's impacts and benefits, profitability, ability to offset inflation, execution of long-term growth strategy, and management of macroeconomic factors[15] Risk Factors Summary Investing in the company's common stock involves substantial risks, including growth management, operating result fluctuations, and strategic execution challenges - Investing in the company's common stock involves substantial risks, including the inability to manage future growth, quarterly operating result fluctuations, failure to achieve long-term strategy, customer consolidation, intense market competition, challenges in consumer acquisition and retention, and dependence on information technology[19] - Other significant risks include adverse effects from pandemics and macroeconomic trends, potential long-term adverse effects from cost-reduction initiatives (like the Transformation Initiative), the need to maintain brand awareness, risks related to product quality/safety, reliance on key personnel (including founder Jessica Warren and CEO Carla Vernón), a history of net losses, and operational disruptions[19] Part I Item 1. Business The Honest Company is a personal care company focused on clean and sustainably-designed products, operating an omnichannel model across Diapers and Wipes, Skin and Personal Care, and Household and Wellness categories Overview Of Business The Honest Company, launched in 2012, is an omnichannel personal care brand committed to clean and sustainably-designed products through Digital and Retail channels - The Honest Company is a personal care company committed to creating clean- and sustainably-designed products, launched in 2012. It operates as an omnichannel brand, offering products through both Retail and Digital channels[21] Our Products and Product Categories The company offers products across Diapers and Wipes, Skin and Personal Care, and Household and Wellness categories, emphasizing clean and naturally-derived ingredients 2023 Revenue Contribution by Product Category | Product Category | 2023 Revenue Contribution | | :--------------- | :------------------------ | | Diapers and Wipes | 63% | | Skin and Personal Care | 26% | | Household and Wellness | 11% | - The company's product categories include Diapers and Wipes (primary components: plant-based fluff pulp), Skin and Personal Care (clean and safe ingredients, many naturally-derived), and Household and Wellness (baby clothing with organic cotton, vitamins, sanitizing wipes)[24] Our Integrated Omnichannel Presence The company leverages an integrated omnichannel strategy, expanding product accessibility through Digital and Retail channels, including key partnerships and significant ACV growth - The company has an integrated omnichannel presence, expanding product accessibility across Digital and Retail channels, including partnerships with Target (2014), Amazon (2017), and Walmart (2022)[24] 2023 Revenue by Channel | Channel | 2023 Revenue Contribution | | :------ | :------------------------ | | Digital | 49% | | Retail | 51% | - The Digital channel includes Honest.com (19% of 2023 revenue) and third-party pureplay e-commerce sites like Amazon. The Retail channel includes brick-and-mortar stores and their websites, with products in approximately 51,000 locations across the U.S. and Canada as of December 31, 2023[24][25] - For the 13 weeks ended December 31, 2023, the company's All-commodity volume (ACV) in national multi-outlet stores was approximately 83 points, up from 72 points in the prior year, primarily due to new distribution and growth at a key retailer[25] Our Growth Strategy The company's growth strategy focuses on purpose-driven branding, expanding the 'Honest Standard' to new categories, and executing a Transformation Initiative for margin enhancement and operating discipline - The core marketing strategy focuses on building a purpose-driven brand through social media, influencer networks, and strategic paid media, aiming to bring the 'Honest Standard' to new products and categories[26][27] 2023 Revenue Contribution by Key Retailers | Retailer | 2023 Total Revenue Contribution | | :------- | :------------------------------ | | Target | 31% | | Amazon | 30% | | Walmart | 7% | - In 2023, the company executed a broad-based Transformation Initiative with pillars of Brand Maximization, Margin Enhancement, and Operating Discipline. This included cost savings, reduced marketing spend on low-return campaigns, emphasizing best-selling items, exiting Asian, European, and parts of the sanitization business, and implementing price increases[28] - For fiscal year 2024, the company expects to improve operating results by expanding gross margin, leveraging operating expenses, and generating positive Adjusted EBITDA. Beyond 2024, it anticipates 4% to 6% annual revenue growth and continued Adjusted EBITDA margin expansion[30] Supply Chain and Operations The company manages a global supply chain with third-party manufacturers and a two-warehouse distribution network, prioritizing quality, clean ingredients, and sustainability - The company manages a global supply chain with third-party suppliers and manufacturers in the U.S., Mexico, and China, focusing on quality, cGMPs, clean ingredients, sustainability, and design. Key raw materials include plant-based fluff pulp for diapers and plant-based substrate for wipes[31][32] - The distribution network includes two warehouses in Nevada and Pennsylvania, operated by NFI and GEODIS Logistics LLC, respectively, with capabilities for retail and direct-to-consumer (DTC) fulfillment[33] Competition The company operates in highly competitive and evolving markets, facing established CPG players and emerging DTC brands based on product attributes and direct consumer relationships - The company operates in highly competitive and rapidly evolving markets, facing significant competition from established CPG players and emerging DTC brands[34] - Competition is based on product attributes such as clean formulation, sustainability, effectiveness, design, and the ability to establish direct consumer relationships through digital channels[35] - Key competitors include Kimberly-Clark (Huggies), Procter & Gamble (Pampers), Kenvue (Johnson's Baby), The Clorox Company (Burt's Bees), Unilever (Shea Moisture, Seventh Generation), LVMH, Estée Lauder, L'Oréal, and Pacifica Beauty[38] Our Industry The company operates in an industry with growing demand for clean products, positioning it to gain market share from legacy brands by focusing on health, wellness, and social impact 2023 Product-Level Revenue Growth vs. Industry Growth | Product Category | Honest Product Growth (52 weeks ended Dec 31, 2023) | Industry Growth (52 weeks ended Dec 31, 2023) | | :--------------- | :-------------------------------------------------- | :-------------------------------------------- | | Wipes | 39% | 6% | | Diapers | 23% | 4% | | Baby Personal Care | 19% | 3% | - The company believes the demand for clean products will continue to grow, positioning it to gain market share from legacy brands that use conventional ingredients, given consumers' increasing focus on health, wellness, waste reduction, and social impact[37] Our Purpose-Driven Organization The company's mission is to challenge industry norms through 'The Honest Standard,' driving its ESG strategy, product quality, diversity, community impact, and environmental mindfulness - The company's mission is to challenge ingredients, ideals, and industries to help people protect what they love, guided by 'The Honest Standard' for quality across ingredients, ideals, and industries, which also drives its ESG strategy[40] - The company maintains a NO List™ of over 3,500 prohibited chemicals, rigorously tests products, prioritizes naturally-derived ingredients, and holds certifications from organizations like USDA, National Eczema Association, and EWG Verified™[43][44][45] - As of December 31, 2023, people of color represented over half of the workforce, and women represented approximately 65% of the workforce and 60% of leadership, reflecting a commitment to diversity and inclusion[49] - The company supports community impact through partnerships with charities like Baby2Baby (donating over 30 million essentials since 2012) and March of Dimes (donating over $0.7 million in 2023)[52] - Environmental mindfulness is integrated into product development and packaging, using FSC-certified, 100% recycled cardboard for shipping, and aiming for a 42% reduction in scope 1 and 2 emissions by 2030[55][56] Government Regulation The company's products are subject to extensive federal, state, local, and foreign regulations, including CPSC, EPA, FTC, and FDA, covering ingredients, labeling, advertising, and data privacy - The company's products are subject to extensive regulation by various federal, state, local, and foreign authorities, including the CPSC, EPA, FTC, and FDA, covering ingredients, labeling, advertising, manufacturing, and safety[57][58] - The Modernization of Cosmetics Regulation Act (MoCRA), enacted in December 2022, expanded the FDA's authority over cosmetics, requiring facility registration, adverse event reporting, cGMPs, and safety substantiation, with registration/listing enforcement delayed until July 1, 2024[58] - The FTC regulates advertising and product claims, including endorsements and testimonials, requiring clear disclosures of material connections with influencers to prevent deceptive practices[65][66] - The company is subject to evolving data privacy and security laws, including GDPR and CCPA, which impose significant compliance obligations, transparency requirements, and potential penalties for non-compliance[67][68][69] Trademarks and Other Intellectual Property The company protects its intellectual property through trademarks, domain names, copyrights, trade secrets, and patents, reinforced by confidentiality agreements - The company protects its intellectual property through trademarks ('Honest,' 'The Honest Co.'), domain names, copyrights, trade secrets, and one issued U.S. patent expiring in April 2037[70][71] - Confidentiality agreements with employees, consultants, contractors, and business partners are used to protect proprietary technology and intellectual property[72] Available Information The company's SEC filings and other important information are publicly available free of charge on its investor relations website - The company's SEC filings (10-K, 10-Q, 8-K) and other important information, including press releases, are available free of charge on its investor relations website: investors.honest.com[73] Item 1A. Risk Factors The company faces a high degree of risk across various aspects of its business, including growth management, operating result fluctuations, intense competition, and the ability to cost-effectively acquire and retain consumers Risks Related to Our Business, Our Brand, Our Products and Our Industry The company faces risks from managing future growth, fluctuating operating results, intense competition, consumer acquisition/retention, macroeconomic trends, and the success of its Transformation Initiative - The company's past growth may not indicate future growth, and effective management of future expansion requires significant resources and successful execution of strategies like increasing brand awareness, effective marketing, product pricing, distribution expansion, and continuous innovation[77][78] - Quarterly operating results may fluctuate due to consumer demand, inflationary pressures on costs (transportation, labor, raw materials), marketing effectiveness, supply chain disruptions, and competitive developments, potentially causing stock price declines[83][85] - The company's long-term strategy, including the Transformation Initiative, requires investments that may incur short-term costs without immediate sales, and there's no assurance of realizing anticipated benefits, potentially impacting profitability[87] - Consolidation of retail customers or the loss of significant partners (Target, Amazon, Walmart, which accounted for 31%, 30%, and 7% of 2023 revenue, respectively) could negatively impact sales and profitability[88][89] - The company faces intense competition from larger CPG players and emerging natural brands with greater resources, potentially leading to price pressure, increased marketing spend, or loss of market share[94][95][96] - Failure to cost-effectively acquire new consumers or retain existing ones, especially with price increases (mid-single digit across two-thirds of the portfolio in 2023) and shifts in marketing spend, could adversely affect sales and profitability[100][101][102] - Macroeconomic trends, such as inflation, rising interest rates, and potential recession, can negatively impact consumer discretionary spending and the company's business, as seen with the exit of low-margin cleaning and sanitization products post-COVID-19[105][106] - The Transformation Initiative, while designed to improve margins and cost structure, carries risks of not realizing anticipated savings, increased costs, loss of institutional knowledge, and adverse effects on employee morale and retention[107][109] - Ineffective inventory management can lead to obsolescence, write-downs (e.g., $4.3 million in 2022 for sanitization products), shortages, or discounted sales, impacting gross margins and brand image[110][111] - Failure to introduce new, appealing products or recoup substantial marketing expenditures for new launches could hinder growth and profitability[113][114] - Maintaining consumer awareness and brand loyalty requires significant and evolving marketing efforts, and shifts in strategy (e.g., reducing digital media spend due to higher costs) may not always be successful and could impact operating results[115][116] - The brand and reputation are vulnerable to real or perceived quality, safety, efficacy, or environmental impact issues, which could lead to recalls, lawsuits, and diminished consumer trust, especially given its positioning as a 'clean' product purveyor[120][121][122][124] - Economic downturns or shifts in consumer preferences away from premium 'clean' products could limit demand, particularly as birthrates decline in developed countries like the U.S.[125][126][127] - The company's competitive position heavily relies on its senior management, including founder Jessica Warren (whose likeness agreement is under discussion) and CEO Carla Vernón; loss of these key personnel could adversely affect the business[130][131][132][133] - The company has a history of net losses ($39.2 million in 2023, $49.0 million in 2022, $38.7 million in 2021) and may not achieve or maintain profitability in the future, as investments and expenses may outpace revenue growth[139][127] - Reliance on independent third-party certifications (e.g., USDA Organic, EWG Verified) means loss of these certifications could harm market position and brand reputation[144] Risks Related to Our Dependence on Third Parties The company's reliance on limited third-party manufacturers, distribution partners, and shipping vendors exposes it to supply disruptions, cost increases, quality control issues, and operational impairments - The company relies on a limited number of third-party manufacturers for all products (e.g., one supplier for diapers, one for most wipes), making it vulnerable to price fluctuations, supply disruptions, and quality control issues[174][176][182] - Increased manufacturing and transportation costs have negatively impacted operating results, and while price increases have been implemented, they may not fully offset these costs or could reduce consumer demand[174] - The company's distribution network relies on partners NFI (Nevada) and GEODIS (Pennsylvania); termination or non-renewal of these agreements, or operational disruptions, could impair services and increase costs[181] - Failure of third-party suppliers, manufacturers, or retail/e-commerce customers to comply with ethical practices, quality standards, or regulations could harm the brand, lead to consumer dissatisfaction, and expose the company to litigation or enforcement actions[182][187] - Ineffective management or expansion of warehouse fulfillment centers by the company or its distribution partners could lead to excess/insufficient capacity, increased costs, or delays in order fulfillment, damaging reputation and consumer relationships[188][191][192] - Reliance on major vendors for shipping (DTC and inbound domestic freight) exposes the company to risks from performance problems, price increases, and external factors like weather or trade disputes, potentially impacting delivery and consumer satisfaction[193] - Risks related to online payment methods, including third-party processing, credit card fraud, and compliance with PCI-DSS, could lead to fines, higher fees, loss of payment acceptance, and reputational damage[194][197][198] Risks Related to Legal and Governmental Regulation The company is subject to extensive and evolving legal and governmental regulations, including product safety, advertising, data privacy, and ESG, which can lead to litigation, fines, and reputational harm - Product safety incidents, advertising inaccuracies, or mislabeling can lead to lawsuits (e.g., past class actions for sunscreen effectiveness, 'natural' claims, plant-based wipes), product recalls, regulatory enforcement, increased operating costs, and reduced demand[199][201][205] - The company is subject to extensive governmental regulation by agencies like FDA, CPSC, USDA, FTC, and EPA, with non-compliance potentially resulting in fines, sanctions, recalls, or operational changes[208][209] - Evolving regulations, such as MoCRA for cosmetics, revised FTC Endorsement Guides, and Green Guides, can increase compliance costs, restrict marketing, and place the company at a competitive disadvantage[214][215] - Failure of third-party partners to comply with product safety, environmental, or other laws can disrupt supply, harm reputation, and lead to lawsuits or regulatory actions[216] - The company faces heightened risk of consumer class action litigation and regulatory enforcement actions regarding product marketing and labeling claims, which can result in significant liabilities, reformulation requirements, and reputational damage[218][219] - Increasing scrutiny and evolving expectations regarding ESG practices, performance, and disclosures from stakeholders can impact reputation, increase costs, and affect access to capital[224][225][228] - Stringent and changing data privacy and security laws (e.g., GDPR, CCPA, TCPA) and contractual obligations pose significant compliance burdens, risk of regulatory investigations, litigation, fines, and reputational harm, especially with evolving targeted advertising regulations[232][234][236][240][244][247] - Evolving government regulation of the Internet and e-commerce, including automatic renewal laws, could impede growth, increase costs, and lead to legal actions if the company fails to comply[249] - Developments in labor and employment law, including potential unionizing efforts or changes in wage and hour rules, could increase costs and adversely affect business operations[251][252] Risks Related to Our Intellectual Property and Information Technology The company's dependence on IT systems and intellectual property exposes it to cybersecurity threats, infringement claims, and operational disruptions if these assets are not adequately protected or managed - The company is highly dependent on information technology systems and data processing, making it vulnerable to cybersecurity threats like cyber-attacks, ransomware, and data breaches, which could lead to regulatory actions, litigation, fines, operational disruptions, and reputational harm[253][254][255][260] - Reliance on third-party service providers for critical IT functions (e.g., cloud infrastructure, payment processing) introduces additional cybersecurity risks, as their security incidents could adversely affect the company[257] - Failure to adequately obtain, maintain, protect, and enforce intellectual property rights (trademarks, patents, trade secrets) could allow competitors to gain an advantage, lead to costly litigation, or require expensive licensing agreements[264][265][267][268] - Loss of registered trademarks could enable competitors to compete more effectively, cause consumer confusion, and negatively impact brand perception[270][271] - Failure to comply with obligations under existing license agreements (e.g., with Jessica Warren) or inability to license critical third-party IP on reasonable terms could inhibit product commercialization and adversely impact business[272][273] - Claims of intellectual property infringement from third parties could result in substantial damages, injunctions, and diversion of management's attention and resources[274] - Reliance on SaaS technologies from third parties (e.g., Salesforce) for critical business functions means unavailability or issues with these services could disrupt operations and increase expenses[275][277] - Failure to successfully maintain, scale, and upgrade information technology systems, including replacing legacy systems, could lead to operational disruptions, increased costs, and impaired ability to fulfill orders[278] Risks Related to Conducting Business Internationally International business activities expose the company to risks from anti-bribery laws, export controls, trade disputes, currency fluctuations, and political instability, potentially impacting costs and operations - International business activities are subject to the U.S. Foreign Corrupt Practices Act (FCPA) and similar anti-bribery laws, as well as export controls, trade sanctions, and import laws, with violations potentially leading to severe fines, penalties, and reputational harm[279][280][281] - International trade disputes and U.S. government trade policies, including tariffs, could increase product costs, impact gross margins, and limit the ability to offer products, adversely affecting the business[282][283][284][285] - Fluctuations in currency exchange rates (Canadian Dollar, Euro, British Pound) can negatively affect financial condition and results of operations by impacting costs of materials, manufacturing, and transportation[286] - International business uncertainties include compliance with diverse laws, adverse tax effects, political/economic instability, trade restrictions, and difficulties in intellectual property protection and contract enforcement[287][288] Risks Related to Ownership of Our Common Stock Ownership of common stock carries risks including price volatility, delisting, anti-takeover provisions, forum selection clauses, lack of dividends, and potential dilution from future stock sales - The market price of the common stock has been highly volatile and declined substantially since the IPO, influenced by financial performance, competitive announcements, regulatory changes, and sales of common stock[291] - Failure to maintain Nasdaq listing standards, such as the minimum $1.00 bid price requirement, could lead to delisting, adversely impacting liquidity and stock price[292][293][294] - Anti-takeover provisions in charter documents and Delaware law could make company acquisition more difficult and limit stockholders' ability to replace management, potentially reducing the market price of common stock[295][297][299][300] - The company's amended and restated certificate of incorporation designates Delaware's Court of Chancery and federal district courts as exclusive forums for certain disputes, potentially limiting stockholders' choice of judicial forum[301][302] - The company does not intend to pay dividends for the foreseeable future (except for a $35.0 million dividend in 2021), meaning returns depend solely on stock price appreciation, which may not occur[305] - An active public trading market for common stock may not be sustained, impairing the ability to sell shares at a reasonable price and affecting the company's ability to raise capital or make acquisitions[306] - Principal stockholders (directors, executive officers, and >5% holders) collectively own approximately 40.2% of outstanding capital stock, giving them substantial control over corporate matters and potentially influencing decisions in their own best interests[307] - Future sales of a substantial number of common stock shares, or the perception of such sales, could depress the market price and impair the ability to raise additional equity capital[308] - Issuance of additional capital stock for financings, acquisitions, or equity incentive plans will dilute existing stockholders' ownership interests and could cause the per-share value to decline[309] - As an 'emerging growth company,' the company benefits from reduced reporting and disclosure requirements, but this may make its common stock less attractive to some investors and potentially increase stock price volatility[312][313][315] - Operating as a public company incurs increased costs (legal, accounting, insurance) and requires substantial management time for compliance with regulations like Sarbanes-Oxley Act Section 404, with potential adverse effects if internal controls are not effective[316][318][320] Item 1B. Unresolved Staff Comments The company has no unresolved staff comments from the SEC - There are no unresolved staff comments[321] Item 1C. Cybersecurity The company maintains an Enterprise Risk Management Program and a Cybersecurity Program, overseen by the Audit Committee and managed by the Vice President of Technology and a dedicated team Risk management and strategy The company implements information security processes to identify, assess, and manage cybersecurity risks to critical systems and data, integrating them into its Enterprise Risk Management Program - The company has implemented information security processes to identify, assess, and manage material cybersecurity risks to its critical systems and data, including intellectual property and customer information[322] - The Information Security function, overseen by the Vice President of Technology, administers an Enterprise Risk Management Program that monitors threats, conducts vulnerability assessments, and uses manual/automated tools[323] - Measures include an incident response plan, risk assessments, data encryption, network security controls, access controls, physical security, system monitoring, employee training, penetration testing, and cybersecurity insurance[324] - Cybersecurity risk is integrated into the overall Enterprise Risk Management Program, with annual security risk assessments against the NIST Cybersecurity Framework 2.0[325] - Third-party service providers are used to assist with risk identification, assessment, and management, with a vendor management program in place to address associated cybersecurity risks[326] Governance The Audit Committee oversees cybersecurity risk management, while management, including the CFO and VP of Technology, implements processes, approves budgets, and responds to incidents - The board of directors, through the Audit Committee, oversees the company's cybersecurity risk management processes and financial reporting of cybersecurity risks and incidents[327] - Company management, including the Vice President of Technology (15+ years experience) and IT Systems and Cyber Security Manager (8+ years experience), implements and maintains risk assessment and management processes[328] - The CFO and Vice President of Technology are responsible for hiring personnel, integrating cybersecurity into strategy, approving budgets, preparing for incidents, and reviewing security reports[329] - Cybersecurity incident response processes escalate incidents to management, including the CFO and VP of Technology, and certain incidents are reported to the board of directors[330][331] Item 2. Properties The company leases its corporate headquarters in Los Angeles (46,518 sq ft, expiring Feb 2027) and a warehouse/distribution facility in Las Vegas (570,810 sq ft, expiring Dec 2027) - The company leases its corporate headquarters in Los Angeles (46,518 sq ft, lease expires Feb 2027) and a warehouse and distribution facility in Las Vegas (570,810 sq ft, lease expires Dec 2027)[332] - Distribution partners, NFI and GEODIS, operate the Las Vegas and Breinigsville, Pennsylvania facilities, respectively, totaling approximately 930,000 square feet for DTC and retail order fulfillment[332] Item 3. Legal Proceedings The company is involved in various legal proceedings, including a Prop 65 lawsuit and securities class actions, but does not anticipate a material adverse effect on its financial position - The company is subject to various legal proceedings, including a Prop 65 lawsuit alleging lead in Diaper Rash Cream (filed Oct 2021) and multiple federal and state securities class action and derivative complaints related to its IPO (filed Sept 2021 onwards)[334][585][586][588] - A putative class action complaint regarding 'plant-based' claims on certain wipes products (filed Aug 2022) has reached a notice of settlement on an individual, non-class basis as of Feb 2024[589] - The company does not believe the ultimate resolution of current legal matters will have a material adverse effect on its financial position, results of operations, or cash flows[334][590] Item 4. Mine Safety Disclosures This item is not applicable to the company - This item is not applicable[335] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on Nasdaq under 'HNST,' with approximately 108 holders of record, and it does not anticipate paying future cash dividends - The company's common stock (HNST) began trading on Nasdaq Global Select Market on May 5, 2021[338] - As of March 4, 2024, there were approximately 108 holders of record for the common stock[339] - A cash dividend of $35.0 million was paid on June 29, 2021. However, the company does not anticipate declaring or paying any cash dividends in the foreseeable future, with future decisions at the board's discretion and subject to 2023 Credit Facility restrictions[340][427] Item 6. [ Reserved ] This item is reserved and contains no information - This item is reserved[345] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The Honest Company reported a 9.8% revenue increase to $344.4 million in 2023, driven by Diapers and Wipes and Household and Wellness, while its Transformation Initiative aims for $15.0 million to $20.0 million in annualized Adjusted EBITDA benefits Overview The Honest Company is a personal care company focused on clean and sustainably-designed products, operating an omnichannel brand across Digital and Retail channels, with products in approximately 51,000 North American retail locations - The Honest Company is a personal care company focused on clean and sustainably-designed products, operating an omnichannel brand across Digital and Retail channels[348][351] 2023 vs. 2022 Revenue Contribution by Product Category | Product Category | 2023 Revenue Contribution | 2022 Revenue Contribution | | :--------------- | :------------------------ | :------------------------ | | Diapers and Wipes | 63% | 64% | | Skin and Personal Care | 26% | 28% | | Household and Wellness | 11% | 8% | 2023 vs. 2022 Revenue Contribution by Channel | Channel | 2023 Revenue Contribution | 2022 Revenue Contribution | | :------ | :------------------------ | :------------------------ | | Digital | 49% | 45% | | Retail | 51% | 55% | - As of December 31, 2023, products are available in approximately 51,000 retail locations across the United States and Canada. The company plans to focus on North American customers and is reducing its portfolio in Europe[351] Initial Public Offering The company completed its IPO on May 7, 2021, selling 6,451,613 shares at $16.00 per share, generating approximately $91.0 million in net proceeds and converting preferred stock to common stock - The company completed its IPO on May 7, 2021, selling 6,451,613 shares of common stock at $16.00 per share, generating approximately $91.0 million in net proceeds after deducting underwriting discounts and offering expenses[354] - Upon IPO completion, $9.5 million in cash bonuses were paid to employees, and 49,100,928 shares of redeemable convertible preferred stock were converted into 49,649,023 shares of common stock[484][486] Transformation Initiative The 2023 Transformation Initiative focused on Brand Maximization, Margin Enhancement, and Operating Discipline, including cost savings and business exits, with expected annualized Adjusted EBITDA benefits of $15.0 million to $20.0 million - In 2023, the company executed a broad-based Transformation Initiative focused on Brand Maximization, Margin Enhancement, and Operating Discipline[355][358] - The initiative included delivering supply chain cost savings, reducing marketing spend on low-return campaigns, emphasizing best-selling items, exiting Asian, European, and parts of the sanitization business, and implementing price increases[28][360] Transformation Initiative Costs (2023) | Cost Type | Amount (in thousands) | | :-------------------- | :-------------------- | | Reduction in Net Revenue | $339 |\n| Cost of Revenue | $3,842 |\n| Restructuring Costs | $2,205 |\n| Other Costs | $4,411 |\n| Total | $10,797 | - The Transformation Initiative is expected to result in annualized benefits to Adjusted EBITDA in the range of $15.0 million to $20.0 million beginning in 2024, with benefits already seen in late 2023[359] - Restructuring costs of $2.2 million in 2023 primarily included employee-related costs ($1.1 million), contract termination costs ($0.9 million), and asset-related costs ($0.2 million), with the restructuring element substantially completed by December 31, 2023[359][407][642] Key Factors Affecting Our Performance Performance is influenced by brand awareness, innovation, omnichannel strategy, operational efficiency, macroeconomic trends, and effective inventory management, including reserves and write-downs - Growth depends on increasing brand awareness, maintaining trustworthiness, and effectively communicating product value as clean, sustainable, and effective[365] - Continued innovation through in-house R&D, focusing on clean ingredients and green technology, is crucial for attracting and retaining consumers[366] - The company prioritizes growth in Skin and Personal Care due to its attractive margin characteristics and aims to expand into new adjacent product categories[367] - Executing the omnichannel strategy involves leveraging digital platforms for direct consumer connection and expanding retail partnerships to broaden reach and enhance margins[370] - Operational and marketing efficiency is improved by optimizing marketing spend, shifting focus to retail support, and leveraging proprietary data for consumer insights[371][372] - Macroeconomic trends, including inflationary pressures and geopolitical events, have increased product and transportation costs, hampering margin expansion, despite cost-savings programs and price increases[373][374][375][378] - Inventory management includes reserves for excess and obsolete inventory, with a $3.4 million write-down in 2023 related to international product exits and SKU rationalization, and $3.1 million in donations for low-margin household products[380] - The Inflation Reduction Act of 2022 is not expected to have a material impact on the company's financial position, results of operations, or cash flows[382] Components of Results of Operations Results of operations are driven by revenue from Digital and Retail channels, cost of revenue, gross profit, operating expenses (SG&A, marketing, R&D), interest income/expense, and income tax provision - Revenue is generated from product sales through Digital (Honest.com, third-party e-commerce) and Retail channels (brick-and-mortar, their websites), recognized net of returns, discounts, and taxes[383] - Cost of revenue includes merchandise purchase price, shipping, freight, duties, packaging, credit card fees, and warehouse fulfillment costs (including rent, depreciation, labor, inventory reserves)[386] - Gross profit is revenue minus cost of revenue; gross margin can fluctuate due to commodity/manufacturing costs, transportation rates, promotions, product mix, and sales channels[387] - Operating expenses comprise selling, general and administrative (personnel, technology, professional fees, facility costs, depreciation), marketing (branding, advertising, PR), and research and development (personnel, new product development, quality enhancement)[388][389][390][391] - Interest and other income (expense), net, includes interest on investments, fees from the 2023 Credit Facility, foreign currency exchange gains/losses, and contingent gains[392][394] - Income tax provision is affected by federal and state income taxes, with a full valuation allowance maintained against deferred tax assets due to cumulative losses[395] Results of Operations In 2023, revenue increased by 9.8% to $344.4 million, gross profit rose to $100.5 million, and net loss improved to $(39.2) million, resulting in a basic and diluted net loss per share of $(0.42) Consolidated Statements of Comprehensive Loss (2023 vs. 2022) | Metric (in thousands) | 2023 | 2022 | Change ($) | Change (%) | | :-------------------- | :---------- | :---------- | :---------- | :---------- | | Revenue | $344,365 | $313,651 | $30,714 | 9.8% | | Cost of revenue | $243,833 | $221,336 | $22,497 | 10.2% | | Gross profit | $100,532 | $92,315 | $8,217 | 8.9% | | Operating expenses | $139,441 | $142,095 | $(2,654) | (1.9%) | | Operating loss | $(38,909) | $(49,780) | $10,871 | (21.8%) | | Net loss | $(39,238) | $(49,019) | $9,781 | (20.0%) | Revenue by Product Category (2023 vs. 2022) | Product Category (in thousands) | 2023 | 2022 | Change ($) | Change (%) | | :------------------------------ | :---------- | :---------- | :---------- | :--------- | | Diapers and Wipes | $218,263 | $200,429 | $17,834 | 8.9% | | Skin and Personal Care | $88,104 | $89,316 | $(1,212) | (1.4%) | | Household and Wellness | $37,998 | $23,906 | $14,092 | 58.9% | | Total Revenue | $344,365| $313,651| $30,714 | 9.8% | Revenue by Channel (2023 vs. 2022) | Channel (in thousands) | 2023 | 2022 | Change ($) | Change (%) | | :--------------------- | :---------- | :---------- | :---------- | :--------- | | Digital | $169,015 | $141,403 | $27,612 | 19.5% | | Retail | $175,350 | $172,248 | $3,102 | 1.8% | | Total Revenue | $344,365| $313,651| $30,714 | 9.8% | - The 9.8% revenue increase in 2023 was primarily driven by Diapers and Wipes (+$17.8 million, 8.9%) due to a key digital partner and Retail channel growth, and Household and Wellness (+$14.1 million, 58.9%) from Honest Baby Clothing, partially offset by a decrease in Skin and Personal Care (-$1.2 million, -1.4%) due to exiting low-margin channels and a customer bankruptcy[398][399] - Pricing increases in 2022 and 2023 contributed an estimated $11.4 million to 2023 revenue[400] - Digital channel revenue increased by 19.5% (+$27.6 million) primarily due to a key digital customer, while Honest.com revenue decreased by $13.0 million due to lower digital marketing spend. Retail channel revenue increased by 1.8% (+$3.1 million) from key retailers, partially offset by exiting low-margin channels and customer bankruptcies[398][401] - Cost of revenue increased by 10.2% to $243.8 million in 2023, primarily due to the 9.8% revenue increase, $15.7 million higher product costs (including transportation), and $3.8 million related to the Transformation Initiative. Gross margin decreased slightly from 29.4% to 29.2%[402] - Gross profit increased by 8.9% to $100.5 million, mainly from price increases (+$9.7 million) and reduced trade spending (+$4.4 million), partially offset by higher product costs and Transformation Initiative costs[403] - Selling, general and administrative expenses increased by 8.3% to $94.6 million, driven by higher service fees for Honest Baby Clothing, increased donation expense (Transformation Initiative), employee-related expenses, and legal fees[404] - Marketing expenses decreased by 23.7% to $36.4 million, primarily due to reductions in retail marketing, digital advertising, public relations, and product sample distribution[405] - Restructuring expenses were $2.2 million in 2023, comprising employee-related costs, contract termination costs, and asset-related costs as part of the Transformation Initiative[407] - Research and development expenses decreased by 11.2% to $6.2 million, reflecting resource realignment under the Transformation Initiative[408] - Interest and other income (expense), net, shifted from a net income of $0.9 million in 2022 to a net expense of $0.3 million in 2023, primarily due to a $0.7 million refund in 2022 and the write-off of debt issuance costs in 2023[409] Liquidity and Capital Resources As of December 31, 2023, the company had $32.8 million in cash and a $35.0 million revolving credit facility, with operating cash flow significantly improving to $19.4 million - As of December 31, 2023, the company had $32.8 million in cash and cash equivalents, an increase from $9.5 million in 2022[410][473] - The company believes existing cash and cash generated from operations will be sufficient to meet short-term projected operations for the next 12 months[410] - In January 2023, the company entered into a $35.0 million revolving credit facility (2023 Credit Facility) maturing April 30, 2026, with $17.7 million available to be drawn as of December 31, 2023, and no outstanding balance[411][413] - The 2023 Credit Facility includes covenants, such as maintaining a minimum total fixed charge coverage ratio, with which the company was in compliance as of December 31, 2023[416] Cash Flows Summary (2023 vs. 2022) | Cash Flow Activity (in thousands) | 2023 | 2022 | | :-------------------------------- | :---------- | :---------- | | Operating Activities | $19,353 | $(76,275) | | Investing Activities | $3,835 | $34,963 | | Financing Activities | $122 | $38 | - Net cash provided by operating activities was $19.4 million in 2023, a significant improvement from $76.3 million used in 2022, primarily due to a $42.2 million decrease in inventory and an $8.0 million decrease in prepaid expenses[420][421] - Net cash provided by investing activities was $3.8 million in 2023, mainly from maturities of short-term investments, compared to $35.0 million in 2022[423][424] - Net cash provided by financing activities was $122 thousand in 2023, primarily from the Employee Stock Purchase Plan (ESPP), similar to $38.4 thousand in 2022[425][426] Non-GAAP Financial Measure Adjusted EBITDA is a non-GAAP measure used by management to evaluate operating performance, calculated by excluding specific non-cash and non-recurring items from net income (loss) - Adjusted EBITDA is a non-GAAP financial measure used by management to evaluate operating performance, assess business health, determine incentive compensation, and for internal planning[428][430] - Adjusted EBITDA is calculated by excluding interest and other (income) expense, income tax provision, depreciation and amortization, stock-based compensation expense (including payroll tax), litigation and settlement fees, CEO and CFO transition expenses, and restructuring expenses from net income (loss)[429] Reconciliation of Net Loss to Adjusted EBITDA (2023 vs. 2022) | Metric (in thousands) | 2023 | 2022 | | :-------------------------------- | :---------- | :---------- | | Net loss | $(39,238) | $(49,019) | | Interest and other (income) expense, net | $254 | $(871) | | Income tax provision | $75 | $110 | | Depreciation and amortization | $2,740 | $2,753 | | Stock-based compensation | $15,804 | $15,078 | | Securities litigation expense | $4,703 | $3,583 | | CEO and CFO transition expense | $2,075 | $5,766 | | Restructuring costs | $2,205 | $0 | | Payroll tax expense related to stock-based compensation | $140 | $89 | | Adjusted EBITDA | $(11,242)| $(22,511)| Material Cash Requirements The company has unconditional purchase commitments for software, advertising, and other services, in addition to lease obligations for its facilities - The company has unconditional purchase commitments for software service subscriptions, advertising services, and other services, in addition to lease obligations for facilities[435] Recent Accounting Pronouncements The company adopted ASU No. 2016-13 in 2023 with no material impact, and other recently issued ASUs are not expected to have a material effect - The company adopted ASU No. 2016-13 (Financial Instruments Credit Losses) effective January 1, 2023, with no material impact on financial statements[553] - Recently issued ASUs not yet adopted include ASU 2023-07 (Segment Reporting) and ASU 2023-09 (Income Taxes), neither of which are expected to have a material impact[554][555] Critical Accounting Estimates Critical accounting estimates involve significant judgment for inventory valuation, sales returns, doubtful accounts, investments, long-lived assets, leases, deferred taxes, and stock-based compensation - Critical accounting estimates involve significant judgment and complexity, including valuation of inventories, sales returns and allowances, allowances for doubtful accounts, valuation of short-term investments, useful lives of long-lived assets, incremental borrowing rates for leases, valuation allowances for deferred tax assets, accruals, and stock-based compensation[437][492] - Revenue recognition follows ASC 606, identifying contracts, performance obligations, transaction price, allocation, and recognizing revenue upon transfer of control, with shipping and handling costs recorded as fulfillment costs[439][441][536] - Sales returns and allowances are estimated using the expected value method based on historical data, demand assumptions, and future business initiatives, recorded as a reduction in revenue[445][540] - Inventories are stated at the lower of cost or estimated net realizable value, with reductions for excess and obsolete inventory based on future demand and sales prices[449][502] - Stock-based compensation expense is recognized based on the grant-date fair value of awards over the service period, using valuation models and subjective assumptions like expected volatility and term[452][521][530] - Income taxes are accounted for using an asset and liability approach, with deferred tax assets and liabilities determined by temporary differences and a valuation allowance provided when realization is not more likely than not[454][455][516][517] - As an 'emerging growth company,' the company has elected to delay adoption of new or revised accounting standards until they apply to private companies, which may affect comparability with other public companies[457][552] Item 7A. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, the registrant is not required to provide quantitative and qualitative disclosures about market risk - As a smaller reporting company, the registrant is not required to provide information on quantitative and qualitative disclosures about market risk[458] Item 8. Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for The Honest Company, Inc. for 2023, 2022, and 2021, including the Independent Auditor's Report, Balance Sheets, Statements of Comprehensive Loss, Equity, Cash Flows, and detailed Notes Report of Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP issued an unqualified opinion on the consolidated financial statements, affirming fair presentation in conformity with GAAP, noting a change in accounting principle for leases - PricewaterhouseCoopers LLP, the independent registered public accounting firm, issued an unqualified opinion, stating that the consolidated financial statements for the periods ended December 31, 2023, 2022, and 2021, present fairly, in all material respects, the financial position, results of operations, and cash flows in conformity with GAAP[465] - The report notes a change in accounting principle for leases in fiscal year 2022, as discussed in Note 2[466] - The company is not required to have, nor was the auditor engaged to perform, an audit of its internal control over financial reporting[468] Consolidated Balance Sheets As of December 31, 2023, cash and cash equivalents increased to $32.8 million, while total assets decreased to $201.6 million and total liabilities decreased to $78.5 million, reflecting disciplined inventory management Consolidated Balance Sheet Highlights (in thousands) | Item | December 31, 2023 | December 31, 2022 | | :------------------------ | :---------------- | :---------------- | | Assets | | | | Cash and cash equivalents | $32,827 | $9,517 | | Total current assets | $157,772 | $189,147 | | Total assets | $201,621 | $240,599 | | Liabilities | | | | Total current liabilities | $56,710 | $63,580 | | Total liabilities | $78,482 | $94,239 | | Stockholders' Equity | | | | Total stockholders' equity| $123,139 | $146,360 | - Cash and cash equivalents significantly increased from $9.5 million in 2022 to $32.8 million in 2023. Total assets decreased from $240.6 million to $201.6 million, and total liabilities decreased from $94.2 million to $78.5 million[473] - Inventories decreased from $115.7 million in 2022 to $73.5 million in 2023, reflecting disciplined inventory management[473] Consolidated Statements of Comprehensive Loss In 2023, revenue increased by 9.8% to $344.4 million, gross profit rose to $100.5 million, and net loss improved to $(39.2) million, resulting in a basic and diluted net loss per share of $(0.42) Consolidated Statements of Comprehensive Loss (in thousands) | Metric | 2023 | 2022 | 2021 | | :------------------------ | :---------- | :---------- | :---------- | | Revenue | $344,365 | $313,651 | $318,639 | | Cost of revenue | $243,833 | $221,336 | $209,467 | | Gross profit | $100,532 | $92,315 | $109,172 | | Total operating expenses | $139,441 | $142,095 | $145,998 | | Operating loss | $(38,909) | $(49,780) | $(36,826) | | Net loss | $(39,238) | $(49,019) | $(38,679) | | Basic and diluted net loss per share | $(0.42) | $(0.53) | $(0.43) | - Revenue increased by 9.8% from $313.7 million in 2022 to $344.4 million in 2023. Gross profit increased by 8.9% to $100.5 million[475] - Net loss improved from $(49.0) million in 2022 to $(39.2) million in 2023. Basic and diluted net loss per share improved from $(0.53) in 2022 to $(0.42) in 2023[475] Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) Total stockholders' equity decreased to $123.1 million in 2023 due to the net loss, while additional paid-in capital increased from stock-based compensation and ESPP proceeds - Total stockholders' equity decreased from $146.4 million at December 31, 2022, to $123.1 million at December 31, 2023, primarily due to the net loss incurred during the year[477] - Additional paid-in capital increased by $15.9 million in 2023, mainly from stock-based compensation ($15.8 million) and ESPP proceeds ($0.2 million)[477] - Accumulated deficit increased from $(439.8) million in 2022 to $(479.1) million in 2023, reflecting the net loss[477] Consolidated Statements of Cash Flows Net cash provided by operating activities significantly improved to $19.4 million in 2023, primarily due to a $42.2 million decrease in inventory