Earnings Call Transcript - HNST Q1 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to The Honest Company First Quarter 2021 Earnings Conference Call. I would now like to hand the conference over to your first speaker today to Sung Kim, Vice President, Finance and Strategy. Thank you. Please go ahead.

Sung Kim, Vice President, Finance and Strategy

Thank you. Good afternoon, everyone. Thank you for joining us for our first quarter fiscal year 2021 conference call. Joining me today are Nick Vlahos, Chief Executive Officer; and Kelly Kennedy, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our earnings release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our earnings release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures, and a reconciliation of these non-GAAP to GAAP measures in today's financial results earnings release. A live broadcast of this call is also available on the Investor Relations section of our website at investor.honest.com. With that, I'll turn the call over to Nick.

Nick Vlahos, CEO

Thanks, Sung. Good afternoon, everyone. We're excited to speak with you on our first call as a public company. Honest is dedicated to providing safe, clean and effective products to consumers around the world, and becoming a public company represented a significant milestone, as it further empowered our team to drive our mission of inspiring everyone to love living consciously. I want to thank the entire Honest organization for their dedication and passion for our business and mission. Their contributions led to our successful offering and positioned us well to execute our strategy going forward. As you saw in our earnings release, we're off to a strong start with double-digit top-line growth and solid progress against our strategic initiatives. These initiatives focused on broadening awareness, introducing breakthrough product innovation, increasing our digital and retail presence, and continuing our commitment to ESG. Before I share the highlights of the quarter, for those new to the Honest story, I'll take a moment and outline what makes our company uniquely positioned to drive good growth in the near and long term. First and foremost, we're a digitally native mission-driven brand. We're a leading lifestyle brand in clean baby, beauty and personal care with top rankings across three key loyalty drivers in our product categories: better-for-you credibility, expressive brand personality, and functional excellence. Our products have garnered strong ratings and reviews across categories with industry-leading NPS scores while formulating according to our Honest standard and No List, avoiding over 2,500 chemicals and materials we chose not to use. Our brand promises to always strive to provide clean, sustainable, effective, and thoughtfully designed products for our consumers. Second, we're focused on disrupting large consumer categories. The total addressable market for our categories of Diapers and Wipes, Skin and Personal Care, and Household and Wellness is estimated to be $130 billion, with $17 billion representing the clean and natural market in those categories. Importantly, the clean and natural market is projected to grow in the high single digits through 2025, six times the rate of the conventional market, giving us a unique advantage. As we create products in our attractive consumer categories, we're focused on three key differentiators to give us a competitive advantage. Number one, we're focused on driving marketing innovation to increase consumer awareness of our products. Since inception, we've grown our brand and deepened our consumer relationships through our Content, Community, and Commerce strategy, as we educate and entertain and build long-lasting consumer connections with over 43 million followers on social media. These relationships with our consumers inform our product development and allow us to move faster to bring new and improved products to market. Number two, we have built a high-performance in-house product development team with a proven track record of bringing breakthrough, award-winning products to market. This capability has allowed us to diversify our revenue across product categories and to drive accretive innovation through our cost-ovation process. And number three, our integrated omni-channel approach drives discovery and accessibility and allows us to efficiently scale our business while making us agnostic to the channel our consumer chooses to shop. In fact, our sales are balanced with 55% transacted digitally and 45% at retail in 2020. Now let's pivot to our Q1 2021 results. Our Q1 accomplishments reflect the continued execution of our strategy against these key priorities. Number one, starting with marketing innovation, we continue to expand brand awareness and consumer touchpoints through the use of key marketing campaigns that leverage our Content, Community, and Commerce strategy. By inspiring authentic dialogue and creating lasting connections, we were able to drive 42% growth in our Skin and Personal Care business. This is a strategic focus for us as more than one-third of new honest.com consumers enter through our Skin and Personal Care products. Let me highlight one key campaign that we launched in Q1. Our morning routine campaign featured Jessica Alba, showcasing a variety of morning routines for the whole family, emphasizing the versatility of our personal care offering through multiple life stages. The content underscores the breadth of our personal care product line by utilizing a solution set – four hero personal care items: our shampoo and body wash, conditioner, basin body lotion, and conditioning detangler. We engaged our Honest community by launching a compelling and comprehensive campaign to utilize paid media and was supported by strategic influencer gifting and press features in premium publications. The campaign had a total reach of over 90 million impressions across social media, influencer, press, and paid media. According to our consumer engagement strategy, we created unique solution-oriented content, drove advocacy through our Honest community, and ultimately generated commerce through unique honest.com solution sets around the morning routine campaign. This is just one example of how we leaned into marketing innovation to drive strategic growth in the quarter through incremental marketing investment. Second, we introduced product innovation with strong consumer response. During the quarter, we introduced breakthrough innovation in Diapers and Wipes. We launched our Clean Conscious Diaper that delivers improvements in performance, sustainability, and margin. With regards to performance, our new diaper features advanced leak protection, a new wetness indicator, and product features designed for every stage of a child's development. In addition to the improved performance features, the Clean Conscious Diaper is also our most sustainable diaper yet. Our diapers continue to feature sustainably harvested, totally chlorine-free fluff pulp and a 100% plant-based backsheet. We were able to further improve the sustainability and environmental impact of this offering by moving to a more efficient diaper design that uses less material in the diaper and 100% post-consumer recycled cardboard in our diaper boxes. Finally, in addition to improved performance and sustainability, we're very proud to achieve improved margins on our diaper due to our more efficient diaper design. Early consumer and marketplace response has been strong. Over the course of the year, we expect to release a consistent cadence of new product innovation. Third, we are pleased to deliver growth across both our digital and retail channels as our integrated omni-channel strategy continues to accelerate digital and retail share of shelf. This quarter, we delivered double-digit revenue growth on top of 36% growth in Q1 2020. Our two-year stack is 48% growth. Overall, we have seen increased consumer willingness to get back into stores as consumer behavior in response to the COVID-19 pandemic changes, and have seen a channel shift and an acceleration in revenue growth within our retail channel. We're well positioned with our omni-channel strategy to capture this growth as evidenced by our retail growth in Q1 2021. Significant white space opportunities still exist to expand our on-shelf presence and the depth of our product offering with new and existing retail partners. For example, in Q1 2021, we increased both our door penetration and our assortment on beauty at Target, increasing from roughly 900 stores to over 1,200 stores with skin care and color now sitting in an integrated shelf set in the beauty aisle. In total, we added approximately 10 additional items to our core target beauty set. Before I turn it over to Kelly, I wanted to take a moment to reiterate our commitment to ESG, which has been part of our DNA since our founding. We have a deep sense of purpose and infused the ethical values of transparency, sustainability, diversity, and inclusion in all that we do. From developing products designed to be safe to working hand-in-hand with our charity partners to serve those in need to embracing diversity and inclusion, we're on a mission to create real and meaningful impact. In the first quarter, we launched several breakthrough initiatives that have deepened our commitment to offering environmentally friendly products. In addition to the launch of our Clean Conscious Diaper, we were also proud to launch our conscious cleaning essentials, a sustainable solution that seeks to reduce waste without compromising on effectiveness. According to our estimates, approximately 600 million household plastic bottles may end up in a landfill each year. As part of our effort to reduce the amount of single-use plastic thrown away each year, the Essentials collection features reusable spray-top bottles along with cleaning concentrates for bathroom, glass, and multisurface cleaning. In addition to reducing plastic waste, the lightweight concentrate plugs cut down on the amount of water shipped around the country, providing us with an opportunity to lower our carbon footprint. Consumer response has been strong, and we're inspired by the impact that simple, sustainable changes can make. Regarding social impact, we're very proud of our partnership with our charitable partner, Baby2Baby. Since inception, we have now donated over 25 million products, making an impact with individuals and families in need. As it relates to our governance efforts, in May, we're pleased to welcome James White and Susan Gentile to our Board of Directors. Mr. White brings nearly 30 years of professional experience in the CPG and retail industries, and Ms. Gentile brings more than 25 years of experience in the finance sector across industries. The background they bring to Honest will help ensure we continue to reflect the needs and wants of our consumers in the communities we serve in all that we do. With these two new additions, we are very proud of a Board that is 56% people of color and 33% women. In summary, we believe we have built the foundation for Honest to continue to grow as a leading clean and natural wellness brand. We continue to capitalize on our strong Content, Community, and Commerce platform to drive good growth across product categories and all consumer touchpoints. We are pleased with our strong start to the year and believe we are well positioned to continue to advance our strategic growth plan. Now I'd like to turn the call over to Kelly Kennedy, our Chief Financial Officer, to review our first quarter results in more detail.

Kelly Kennedy, CFO

Thank you, Nick, and welcome, everyone. I'm delighted to speak to you today and share our strong start to the fiscal year, achieving the single highest revenue quarter in the company's history, reflecting double-digit revenue growth versus the first quarter of 2020. This performance reflects the positive momentum for our Honest brand and the successful implementation of our strategic priority by our team. I'll walk you through our financial results and key drivers for the quarter. My remarks will include adjusted non-GAAP results. You can find reconciliation tables to GAAP financials in our earnings release. First quarter revenue totaled $81 million, a 12% increase over Q1 2020. As Nick highlighted, this was on top of 36% growth, which represents 2-year stack, 48% top-line growth. Now diving into the key drivers by product category. Starting with Diapers and Wipes, the category decreased 2% as we transitioned to our Clean Conscious Diaper and lapped the acceleration in Diapers and Wipes related to COVID-19 pantry loading in the first quarter of 2020. Of note, diaper growth was positive in Q1 behind our new diaper launch but was offset by a decrease in wipes as we lapped consumer stock-up behavior from Q1 2020. Based on consumption data for the last 12 weeks ending May 16, our diaper business was up 13% while the overall market declined 1%. Skin and Personal Care grew 42%, driven by sales volume from our incremental investment in digital marketing and expanded distribution with our retail partners. We invested meaningfully in marketing innovation behind our Skin and Personal Care products through some of the innovative campaigns that Nick highlighted earlier. We were also able to expand distribution points with our key retail partners, such as Target. During the first quarter, we were able to reduce our legacy beauty inventory, which puts us in a great position for the beauty relaunch launching in Q3 of 2021. Our beauty restage features tree-free packaging across the line while achieving significant margin improvement. Skin and Personal Care saw strong growth even as compared to the first quarter of 2020 when revenue grew 63% versus the first quarter of 2019. Household and Wellness grew 53% fueled by our standardization and disinfecting products that we introduced in the second half of 2020. While we were still able to see significant growth in Household and Wellness, we are starting to see households and retailers destock sanitization and disinfecting products as more consumers become vaccinated and return to their pre-COVID routine. Now turning to results by channel. Digital channel revenue increased 2% to $42.5 million. On a 2-year stack basis, growth was 25%. Retail channel revenue increased 25% to $38.6 million. Retail 2-year stacked growth was 83%. Outside retail growth was aided by a strong rebound in store traffic as vaccinated consumers increasingly returned to in-store shopping. We also benefited from expanded distribution, the sale of our existing beauty inventory as well as promotional and merchandising events with partners like Target, Whole Foods, and regional groceries. Gross profit increased $2.6 million to $28.4 million primarily due to increased revenue. As a percentage of revenue, gross margin achieved 35% for the quarter. This compares to 36% in Q1 of 2020, which benefited from the lower levels of trade spend as retailers pulled back on events during the pandemic. Overall input costs were higher in Q1 of 2021 versus Q1 of 2020, including higher transportation and freight costs. Given record levels of cost inflation, this is a focus area for us in 2021. We have a number of conservation initiatives launching in 2021, including the Clean Conscious Diaper, which launched in Q1 and our upcoming beauty restage that launches in Q3. We will continue to evaluate the input cost environment to ensure that our productivity plans are sufficient to offset current inflation levels. Total operating expenses increased $7.5 million versus Q1 of 2020, primarily driven by increased investment to support growth as well as increased cost from operating as a public company. We invested an incremental $5.5 million in marketing and R&D versus Q1 2020 as we supported the accelerated growth of our Skin and Personal Care business, the launch of our new Clean Conscious Diaper, and invested in our upcoming innovation pipeline. Adjusted EBITDA for the first quarter of 2021 was roughly breakeven. A couple of items to note on the balance sheet. We ended the quarter in a healthy position with $58 million in cash, restricted cash, and short-term investments, with no debt on our balance sheet. I just wanted to note that this is before the impact of the IPO proceeds, which will be reflected in the second quarter. As evidenced by our double-digit growth in Q1 of 2021 and our 2020 results, we continue to feel good about our strategy and growth prospects. Our consumption remains strong, and we continue to be extremely proud of our deep connection with consumers, our award-winning products, and our omni-channel approach. We believe these differentiators continue to position Honest for success, both now and into the future. We want to reinforce our long-term target: first, consistent double-digit top-line growth over the next few years; second, ongoing gross margin expansion with a path to 45% long-term; and third, improved EBITDA profitability with a long-term target of 20%. With that, I'll turn the call over to the operator to begin the Q&A portion of the call.

Operator, Operator

Our first question comes from the line of Steph Wissink from Jefferies.

Steph Wissink, Analyst

Our question is just on the business momentum. If Kelly or Nick, you could talk a little bit about what you're seeing in Q2. And then I think it would be helpful just to rationalize the lap to COVID last year in the Q2 quarter. Is there anything we should be aware of in the base from a comparability perspective?

Kelly Kennedy, CFO

Yes, thank you for the question, Steph. In the first quarter, we observed significant momentum in our business. The data from IRI shows strength in our traction function. A noteworthy trend is the shift from digital to retail as the economy begins to reopen and strengthen, which is causing some volatility for us. For instance, in Q1 2021, our retail business constituted 48% of our total business, up from 43% a year ago. While we usually experience some quarter-to-quarter volatility, this quarter we have seen benefits. Currently, we are observing that consumption is outpacing shipments, which could have a meaningful impact on this quarter. We are actively monitoring this situation as we are in the midst of our quarter. We have a major digital event planned for the end of the quarter, and there is a lot of attention on the trends emerging from this event. We always focus on long-term management, and underlying consumption remains strong. While we are not providing specific quarterly guidance, we want to highlight this trend. We will reconvene in August to share more details about the business and the outcomes of this significant event at the end of our quarter.

Steph Wissink, Analyst

Okay. That's great. And Nick, if I could just have a follow-up question on beauty and skin care. You talked a lot about Target as an illustration of the white space opportunity, but that category seems to be a real important power driver of the model. So talk a little bit about where you think you are in terms of SKU, assortment breadth, opportunity to build out those full brand experiences. Like you talked about at Target, where are you with some of your other retail partners in really harvesting that opportunity to grow that sleeve of the business?

Nick Vlahos, CEO

Yes. Thanks, Steph, for the question. I think, number one, the way we look at it is, first and foremost, we're really pleased with the strength that we're seeing within Target with this expansion we put into place. Number two, we're also, from a digital perspective, as you look at kind of skin, the personal care results and that 42% growth, when we drill down in beauty, we're seeing acceleration within that part of the business. So we're seeing it, we're seeing a nice mix between both cosmetic and the color side as well with skin starting to move, and now, as things start to open up. Here in California, I walked into a store today, and I was able to not wear my mask, and we're starting to not wear masks more and more. So we're starting to see the consumer start to gravitate more and more to our mix being both on the cosmetic as well as on the skin side. What we're seeing is from a distribution, from an assortment standpoint is in different retail. So for example, Target, Ulta.com is another example. As well as our results internationally, when we look at Douglas over the last quarter, we saw actually Douglas was about 23% growth this past quarter. We're seeing definitely the depth that we're driving around distribution on the digital as well as the physical shelf, and we're starting to see the repeat. And that's why when you see the results in Q1, that's 42%. 63% a year ago, and that's over 100-plus percent on a stack basis. So again, a lot of opportunities still, but a lot of good momentum as you look at the results coming out of Q1, and that's going to position us well when you think about the beauty restage, which is going to hit in Q3. Because just a reminder, that's going to be not only from a packaging perspective, this 100% tree-free packaging that we're thrilled about when you look at the improvements around the business; it's already doing extremely well, but also importantly, new products. We have a new daily defense collection that we're going to be introducing as well as a new lash tinted serum initiative around that from an innovation perspective. So a lot there, and then coupled with that is roughly about 800 basis points of gross margin expansion that's going to take place against that initiative.

Operator, Operator

I show our next question comes from the line of Wendy Nicholson from Citi.

Wendy Nicholson, Analyst

And actually, Kelly, I wanted to circle back and just hear a little bit more about what you were just saying in that line of questioning about how consumption is outpacing shipments, and you've got the big digital promotion coming up at the end of the month. So I'm just trying to understand, are you worried about having out of stocks? Is there a chance that you would move that promotion? Like how is everything working from a supply chain? Just wanted to really understand if there was a risk that either at the time of that promotion or at the retail level, there was a chance you couldn't fulfill demand.

Kelly Kennedy, CFO

Yes, that's a great question. I'm glad you asked for clarification, Wendy. We're currently in a solid inventory position. What we are observing is related to a shift with one of our retail partners, whose shipments do not reflect actual consumption levels. We’ve mentioned that there can be some volatility, and we notice fluctuations from quarter to quarter. Sometimes these shifts benefit us, and at other times, they do not. Right now, we are specifically seeing changes related to the balance between digital and retail sales and how one of our partners is managing their working capital. So, we are not concerned about running out of stock.

Wendy Nicholson, Analyst

Got it. Okay. And that is not a worry that, gosh, maybe they're going to cease to carry Honest Diapers or something like that. There's nothing untoward or anything we should be worried about in terms of that relationship.

Kelly Kennedy, CFO

I would say this is a highly strategic relationship. We will gain significant visibility, and we have been collaborating with them closely on this event, which we have organized in previous years. We are fully committed to this partnership and excited about it. However, it is not entirely indicative of the overall situation. Typically, we have noticed that replenishment tends to follow this event, and since the timing coincides with the end of our quarter, it's somewhat different from what we have experienced in the past.

Wendy Nicholson, Analyst

Understood. Okay. I really appreciate that clarification. That's very helpful. And then maybe for you, Nick, I had a question just about the competitive environment. Some of your competitors have announced price increases on the baby care side. And as we start to see those higher prices maybe show up on shelf over the next couple of months, do you think it impacts your pricing at all? I mean, obviously, you're more premium priced generally, but do you intend to keep the same price gap, i.e., raise your prices as well? Or do you think that's a more compelling proposition because the price gap won't be as large if you don't raise prices. Just how do you think about sort of the elasticity of demand for Honest diapers depending on what the competitive pricing environment is like?

Nick Vlahos, CEO

Thank you, Wendy. I want to address a couple of points. First, the conscious diaper we launched in Q1 really gained traction in the latter half of that quarter. We invested an additional $5 million in marketing this quarter, primarily aimed at promoting the conscious diaper initiative, as well as supporting our skin personal care businesses that have benefited significantly. This new product features the most sustainable design we've offered, marking an improvement over our previous offerings as we continue to innovate. Early signs from our market investment indicate that our share is beginning to increase. At the beginning of the quarter, our market share was around 1.2%, and it has since risen to approximately 1.4%, based on IRI and MULO data from the last 12 weeks. We're pleased to see this upward trend. Furthermore, as Kelly mentioned, the category as a whole has seen about 13% growth while the market has declined by 1%. We feel good about our position, especially given that this initiative also involved cost improvements. We didn't just enhance the product; we also achieved a better gross margin on it, which is a win for us. Regarding input costs, we're aware that some manufacturers have increased their prices, and we're actively monitoring market volatility. Currently, we have a solid plan that encompasses productivity improvements and cost innovations in both our diaper segment for the second half of the year and our beauty restage. We're closely tracking these developments. We're optimistic about the conscious diaper's market entry and the share we're starting to garner, and we see good momentum. It's crucial to keep a close watch on how inflation will affect our cost structure moving forward. We are currently well-prepared in our plans for mitigation, but we are continuing to evaluate the situation closely.

Operator, Operator

Our next question comes from the line of Laurent Grandet from Guggenheim.

Laurent Grandet, Analyst

Nick and Kelly, very good job. So I do have a really curious question about a comment you made in your release regarding this $3.4 million in personal care you sold in the quarter. Just want to understand, basically, is it on top of what you planned originally? Or is it something that was already planned? And really, when you say in exchange for future marketing and transportation credits, I mean I really like to understand this a bit more, if you can.

Nick Vlahos, CEO

Sure, I'll provide some context. This was always part of the plan. The level of innovation and the pace of new introductions from Honest has been significant. In this case, we partnered with Active International to manage legacy inventory valued at approximately $3.4 million before our Q4 restage, allowing us to sell through that inventory. The good news is that this inventory is being sold at a gross margin that exceeds what we achieved in Q1, which is positive. Additionally, we are working to move this product out of our warehouses to make room for the new products we will be introducing and to begin staging our inventory, which is beneficial. Regarding the credit component, we have marketing and transportation credits that we leverage with our current digital media partners and in-store visual merchandising vendors. As we transition this product in the market, we will apply these credits strategically with our existing vendors. This approach supports our transition plan and positions us well for the upcoming beauty restage in Q3, allowing us to enhance innovation with our 100% tree-free packaging and new items while capturing an additional incremental gross margin of approximately 800 basis points related to this initiative.

Operator, Operator

I show our next question comes from the line of Dana Telsey from Telsey Advisory Group.

Dana Telsey, Analyst

As you think about diapers and obviously, the share that you've gained and the growth in the first quarter and how you've outpaced the market is very impressive. How do you see this Clean Conscious Diaper initiative going forward? Is that a margin enhancer, too? And how are you planning wipes going forward? And then just on another note, on the beauty restage, what type of marketing investment do you make there? And does that continue through the balance of the year?

Nick Vlahos, CEO

Yes, I'll take the first one, Dana, thank you for the question. And I would say on the conscious diaper is we've kind of built out that innovation. We do this type of work when it comes to the performance and being able to address these key consumer dissatisfiers. And we've done this in a way now where we're also increasing the margin structure against that business. So it's got the right proposition for us because we talk about good growth always, which is this consistency around not just driving top line but also the margin expansion components that we want on the business. So that's rooted in the current proposition. The key for us will be, as I referenced earlier, the earlier question, will be maintaining the sufficiency within our consistent annual productivity plans, and we have 3-year productivity plans that we drive against the business to really mitigate kind of the cost environment. And that, again, is something that we're closely looking at. And then I'll let Kelly pick up on the second part of the question.

Kelly Kennedy, CFO

Yes, as we consider our marketing spend, we believe the appropriate range for us is between 14% and 17% of revenue. We have seen excellent marketing results linked to our recent innovations. We will support the upcoming beauty relaunch in the third quarter. Skin and Personal Care continue to be significant growth drivers for us, and we anticipate this will continue in the latter half of the year. Therefore, we believe this is the right level for our marketing investment. We will keep focusing on this area as we see a return that drives top-line growth. You can expect us to remain within the 14% to 17% range. Yes. I think there was a mention of this earlier. As we think about kind of looking at digital versus retail, it's helpful to look at 2-year stack as well because we want to remind everyone the COVID kind of the COVID trend that happened in Q1 was all around kind of a shift on consumer stock-up behavior, and there was kind of a growth both in retail and digital last year. In Q1 of 2020, retail grew 58% and digital grew 23%. So when you think about digital on a 2-year stack, we are seeing a significant shift versus what was happening a year ago. So the key trend that we spoke about earlier is really the shift from digital back to retail. But again, we also saw digital acceleration as well.

Nick Vlahos, CEO

Yes. I would also like to mention that for some of our major retail partners in the digital space, we observed a shift in 2020, with the percentage moving from around 20% to exceeding 30% in terms of their business activities. Additionally, there has been an increase in click-and-collect pickups in retail. This indicates that it's not just about the digital aspect but also foot traffic to stores. Our data and insights from strategic partners show that consumers are increasingly drawn to the retail side. The positive aspect is our omni-channel strategy, which allows us to cater to consumers regardless of whether they prefer shopping at honest.com, amazon.com, Target, or HEB. This positions us favorably as we adapt to where consumers choose to shop. Ultimately, consumers tend to focus on brands rather than shopping channels, and we feel we are well positioned in this landscape.

Operator, Operator

I show our next question comes from the line of Bryan Spillane from Bank of America.

Bryan Spillane, Analyst

I have two quick questions related to the channels. Firstly, I want to follow up on an earlier question regarding shipments being behind consumption. Is this issue specific to retail, or is it evident in both retail and digital? Secondly, when we consider channel agnosticism in terms of margins going forward—assuming that is true today—will the margin expansion you're anticipating over the next few years reflect that relationship? Specifically, is the margin opportunity larger in one channel compared to the other, or do you expect to remain indifferent to whether it’s digital or retail as margins increase?

Kelly Kennedy, CFO

Thank you, Bryan, for the follow-up question. The trend we mentioned earlier is specific to the digital channel. Regarding the margins, they are currently aligned, and we expect that to remain consistent over the next few years. In the long term, we believe there is an opportunity to enhance margins within the digital channel as we optimize the business and utilize our fixed costs. At present, we feel balanced between both channels, and we foresee this trend continuing. Therefore, to observe a significant difference in margin structures between digital and retail, you would need to look beyond just 1 to 2 years.

Operator, Operator

I show our next question comes from the line of Laura Champine from Loop Capital.

Laura Champine, Analyst

I wanted to talk a little bit about your international opportunity which I think management has acknowledged is very significant, but that it's longer term. How would you get started there? And what's on deck for you to do in the next couple of years in terms of international growth?

Nick Vlahos, CEO

Thank you for the question, Laura. Regarding our international business, it made up about 2% of our total business in 2020. Rather than rapidly expanding, we have taken a strategic and methodical approach. For example, we successfully introduced our brand with Douglas in Europe, where consumption trends have increased by approximately 23% in Q1. We plan to grow this business carefully, focusing on both the digital and retail aspects with partners like Douglas and also Cult Beauty in the U.K. for skin and personal care. We will continue to expand strategically in the regions we've already established, given the awareness generated by our marketing efforts, and we're starting to see repeat customers. We're still in the early stages of our international efforts and will maintain a strategic omni-channel approach through our retail partnerships. Looking ahead, we will build on the foundation and principles we established in 2020. I hope this provides some clarity.

Laura Champine, Analyst

Nick, to summarize, it seems like you plan to proceed by focusing on selecting the right partner rather than expanding geographically. While some Asian markets appear promising, your preference is to secure the right partnership first before advancing. Is that an accurate interpretation?

Nick Vlahos, CEO

Right. And I've seen a lot over the years where businesses get challenged is when they don't have the right kind of beachhead from a partnership perspective because that localization is so important, especially when you're a young brand like ours. So being very strategic, have the right alignments from a partnership perspective and a principle around really building something together because there's added value for both parties. In the examples that we've leveraged in Europe, both partners like our digital capabilities, our content, community, and home strategies, so those are enablers for them as well as the initiatives around innovation and the cadence we have around clean beauty that actually works. So when you put those things together, that's how we're going to continue to approach it as we look at Europe, number one. And then as we start talking strategically and we share a broader strategy in the future, we'll go into greater detail with other geographies.

Operator, Operator

I show our next question comes from the line of Andrea Teixeira from JPMorgan.

Andrea Teixeira, Analyst

I have a question about distribution and then a follow-up on gross margin. Regarding the distribution side, could you break down the 12% growth from the quarter? How much of that was due to distribution velocity within the same doors and/or shelf and price mix? I also need clarification on the gross margin commentary. Nick mentioned that the conscious diaper is beneficial to margins but hasn’t contributed for about half of the quarter, along with the 100 basis points benefit from restaging in Q3. Should we anticipate a larger impact on gross margin in Q2 compared to Q1, sequentially? Additionally, is the increase in mix from online to wholesale negatively affecting this? Specifically, Kelly, you mentioned that shipments are trailing consumption, especially in digital. Is that affecting a particular customer who may be emphasizing retail more? So essentially, is this shift happening where you're gaining more distribution in physical stores, and will that change because you're staging your new in-store? There are quite a few elements to consider.

Kelly Kennedy, CFO

Yes. I'll address all three points, and the first and last are interconnected. When considering the growth in Q1, it was derived from philosophy, innovation, and distribution, all of which power our growth strategy as they complement one another. You're correct in noting the shifts in consumer behavior between digital and retail, which creates some volatility as inventory levels adjust to demand changes. These two aspects are linked. As we look towards Q2, we continue to see strong demand driven by velocity in the retail channel, which currently weighs more heavily in our trends. Regarding gross margin impact, as Nick pointed out, we have a solid cost-innovation strategy in place with the launch of the Clean Conscious Diaper in Q1. The beauty restage has altered our overall margin structure, and while it is a small yet growing segment of our business, we are monitoring input costs against our cost-innovation plans. Currently, they align well, and we are optimistic about maintaining our gross margin structure. Nick mentioned earlier that we anticipate a certain level of inflation. While some areas of our business are experiencing inflation, particularly in transportation and freight, we are countering this with cost innovation. As the year progresses, we'll provide updates if situations change by August. Notably, the primary driver of our growth has been volume; we have not implemented any significant price increases and no announcements have been made yet. We are eager to explore opportunities to increase our market share as competitors raise their prices, and we will continue to assess input cost inflation while keeping future pricing adjustments as a potential option.

Operator, Operator

Our last question comes from the line of Jon Andersen from William Blair.

Jon Andersen, Analyst

Congrats on the start, Nick and Kelly. I have just a broad-based question on customer acquisition. You mentioned earlier, I think, nearly one-third of Honest users are coming in through the Skin and Personal Care, the beauty franchise. What is the right mix of kind of customer acquisition by product category as you move the business forward over the next 2 to 3 to 4 years? And how does that influence your marketing kind of tactics and innovation tactics as you move forward?

Nick Vlahos, CEO

Thank you for the question. I’d like to share some insights regarding honest.com, particularly focused on the Skin and Personal Care segment. In 2020, 34% of new consumers visiting honest.com came through Skin and Personal Care. In the first quarter, that number increased to 44%. This growth required us to adjust our investment strategy accordingly. We utilize our honest omni analytics to assess our customer acquisition efforts—specifically, identifying sources from honest.com and tracking repeat purchases through data analysis. This helps us determine how to allocate additional funds to support our strategy, whether for acquiring new customers or encouraging repeat buys of subsequent items. We have observed increased customer loyalty in the Skin and Personal Care division over the past quarter, reflected in the growth rates resulting from our omni-channel strategy. I'll let Kelly provide further details.

Kelly Kennedy, CFO

Yes. As we aim to broaden the appeal of the Honest brand, we are considering various strategies. We want to ensure balanced customer acquisition across our different products, with a particular emphasis on Skin and Personal Care. Additionally, we are closely monitoring overall metrics related to Gen Z acquisition, focusing on the balance between male and female consumers. We saw positive developments in the first quarter of 2021, with Gen Z representation growing from 9% of our customers in 2020 to 14% in 2021. This is encouraging as it indicates our brand is resonating with a wider audience. Traditionally, we have been focused on female consumers, but we are actively working to extend our appeal to male consumers through targeted campaigns. Consequently, the percentage of our male customer base increased from 18% to 20% in the first quarter of 2021 compared to the previous year. We are excited about this momentum and will continue to monitor and ensure that our appeal remains balanced as we expand our customer base.

Nick Vlahos, CEO

Very good. Well, thanks, everybody, for all the questions. On behalf of the team, I want to thank you for participating today. And we look forward to sharing our progress with you on our quarterly earnings calls going forward, and speaking with hopefully many of you at the Jefferies conference later this month. So take care, everybody. Thank you.

Kelly Kennedy, CFO

Thank you.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.