DTC Business Breakdown: A Closer Look at The Honest Company

The Honest Company is a consumer packaged goods (CPG) wellness brand empowering people to live happy, healthy lives. The company touts its standards of safety and transparency, with many of its formulas developed within in-house laboratories. Honest has 2,500 chemicals and materials on its trademarked “No List,” pledging not to use these substances that could be harmful to babies and infants. 

Honest is also focused on community service via employee volunteering and partnerships with March of Dimes and Baby2Baby. 

Honest completed its IPO in May 2021, receiving $91M at $16 per share.

DTC Financial Metrics

The latest quarter was the company’s third report as a public company and saw mixed results as consumer behavior shifted throughout 2021. Total Revenue of $82.7M grew 6% YoY and 47% Yo2Y. Honest’s growth is the lowest in the Bainbridge DTC Index, primarily due to a lower digital sales mix and comparing the company against the spike in cleaning products from the 2020 pandemic period. 

The most recent quarter saw:

• Honest’s digital channel at 47% of total sales, down from 56% in the same quarter for 2020. 
• A Gross Margin of 36%, declining 170bps YoY. 
• The company’s bottom line saw a net loss of $5.1M, with some add-backs pushing adjusted EBITDA to +$1.2M.

Honest sizes it’s customer base at 4.5M households and added 450k in the last year, referring to this accomplishment as a “testament to our marketing strategy.” Selling a household the second and third item and making them “an Honest household” is the crux of the company’s retention goal. 

Growth of Product Categories

The company’s three product categories saw a wide range of growth rates as the pandemic ebbed over the late summer period. 

The key takeaway is that all three of their product categories are now experiencing slowing rates of growth, even as the overall cosmetics sector grows. The Household & Wellness category saw particularly volatile comps, spiking during Q3 2020 (+218% YoY), but now falling back to Q3 2019 levels (-71% YoY). 

A second takeaway is Diapers & Wipes remain stable at approximately two thirds of total revenue in Q3 for the last three years. The story from management focuses on growth outside of Household & Wellness running at 20%, calling out these two categories as 96% of total revenue.

Retail Channel & “Beauty Re-Stage”

Honest’s retail channel was 53% of Revenue in Q3 2021, growing 28% YoY. Their strategy is to roll out new, higher-margin beauty products across a broadening store count. Products are currently seen in 40,000 retail locations including Target and Costco with a goal to increase retail points of sale by double digit percentage growth over Q3 2020 as more stores carry the company’s Skin segment products. Walgreens will be a new key retail partner as they roll out seven new products in the Skin category. 

Digital Channel

Digital contributed 47% of revenue in Q3 2021 with growth at -11% YoY and +27% Yo2Y. The business model is among the lowest “DTC% of Revenue” in the Bainbridge DTC Index. Furthermore, the Digital category is not specifically referring to only Honest.com DTC revenue. Honest Company does not separate out Digital metrics into the company’s DTC vs. third-party eCommerce channels. 

Honest’s partnership with Amazon began in 2017, and products are prominently featured in the sustainable cleaning and diaper sections on the platform. Additionally, Honest receives $1M in annual royalty revenue from Butterblu’s operating and owning the website honestbabyclothing.com and is seeking further digital brand licensing opportunities. 

Honest’s digital marketing strategy is not clearly accentuated, but management does repeatedly share that 41% of YTD new Honest.com consumers were acquired through the Skin & Personal segment, up from 34% in the same quarter one year ago. The upcoming expansion of SKUs in the segment is meant to drive further acquisitions for their DTC digital platform. 

Gross Margin

Gross Margin in Q3 was 40bps above H1 2021 but was pressured by transportation, freight, and warehouse labor costs when compared to Q3 2020. The Conscious Clean Diaper flagship product improved total margins by 100bps as Q3 2021 was the first full quarter carrying the product. Sustainable packaging for Beauty is intended to drive 800 bps for Gross Margin in that category going forward. The company sees this range of the upper 30s as its likely long-term margin level, even as 36% lands at the bottom of the Bainbridge DTC Index.

Honest sees now as the right time to make pricing changes: In mid January 2022 Diapers will see an increase of mid to high single digits to offset higher transportation costs. Leadership believes they have the ability to make additional price increases across 35% to 45% of the portfolio in FY2022. 

DTC Marketing Spend

Marketing Spend was at 17% of total revenue in Q3, with management calling 15% their target run rate level. The incremental spend above 15% supports the company’s flagship Conscious Clean Diaper plus the Beauty product line reset as new and existing SKUs roll out to a growing retail footprint. Management calls out the potential for more sales mix from the Beauty line as a key driver of gross margin gains.

Business Predictions for 2022

The Honest Company’s management team sees continued double digit growth in the core Diapers & Wipes segment but depressed growth in Household & Wellness products. Additionally, the company is currently carrying high inventory in cleaning products, leaving them exposed to ongoing discounting in the broad cleaning products space. 

FY2021 Marketing is seen at 17% of revenue and Gross Margin at 35.0%-35.5%. Note the full year target for Gross Margin is lower than YTD Margin, driven by significant acceleration in ocean freight costs particularly in the last couple of months ($2M-$3M hit), and particularly impacting Wipes.  

Looking ahead, Honest will likely face challenges in FY2022 as price increases drive downtrading across a broad range of consumer packaged goods. The company’s target consumer may also be exposed to less federal fiscal spending directed to parents. 

The company will benefit from their well-timed expansion in Beauty & Skin products. This strategy should increase digital customer acquisitions across a different population segment and drive gross margin leverage in the P&L. As its cleaning product segment wanes, beauty will benefit from a shift back toward travel and more in-person work environments. Honest could be clearer on their marketing strategy, but the product and retail channel initiatives are communicated well and drive a compelling story of a mid-growth modern CPG company.