Earnings Call Transcript - HNST Q1 2025

Operator, Operator

Ladies and gentlemen, thank you for standing by. And welcome to The Honest Company’s First Quarter 2025 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference call over to Ms. Elizabeth Bouquard, Senior Director, Investor Relations at The Honest Company. Please go ahead.

Elizabeth Bouquard, Senior Director, Investor Relations

Good afternoon, everyone. Thank you for joining our first quarter 2025 conference call. Joining me today are Carla Vernon, our Chief Executive Officer; and Dave Loretta, our Chief Financial Officer. Before we start, I would like to remind you 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 earnings release issued today, as well as our SEC filings 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, except as required by law. Also, during this call, we will 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 the financial results section of our earnings release today. A live broadcast of this call is also available on our Investor Relations section of our website at investors.honest.com. And with that, I’ll turn the call over to Carla.

Carla Vernon, CEO

Thanks, Elizabeth. Good afternoon, everyone, and thank you for joining us today. As I begin today’s remarks, I’d like to take a moment to share some important updates to our recent announcement of Dave Loretta’s planned retirement from his role as the Chief Financial Officer of The Honest Company. Most importantly, I want to recognize Dave for his incredible partnership. Thanks to Dave’s leadership, we have an exceptional finance team in place, a stronger financial foundation, and are well-positioned for the future. Dave, thank you for playing such a critical role in the transformation of Honest, and congratulations on the considerable success you have had at Honest and across your career. Earlier today, we announced the appointment of Curtiss Bruce as The Honest Company’s next Chief Financial Officer. Curtiss is an accomplished financial leader with deep expertise across some of the most respected consumer brands, including Hain Celestial, Keurig Dr. Pepper, The Kellogg Company, and Kraft Heinz. Across his career, Curtiss has led a blend of both emerging businesses, as well as some of the food industry’s most iconic $1 billion brands. His passion for consumer-loved brands, combined with a track record of driving growth and transformation, make him the right leader to help guide Honest into the next chapter. Curtiss’ June 2nd start date will include ample transition time with Dave to allow for a smooth handoff. Again, I want to extend my sincere thanks and congratulations to Dave for all he has done to drive our strong results. For today’s call, there are three messages I want to share with you. First, we delivered solid results for the first quarter of the year with double-digit revenue growth, gross margin expansion, and positive operating income. Second, our transformation pillars of brand maximization, margin enhancement, and operating discipline are enabling us to successfully navigate this dynamic environment. With a healthy balance sheet and growing consumer demand for our cleanly formulated and sustainably designed products, we remain confident that our long-term growth strategy leaves us well-positioned to scale The Honest brand. And third, as we continue to adapt to the evolving market conditions and manage the impact of economic headwinds, we are reaffirming our 2025 financial outlook. For the first quarter, our teams continued to strengthen the business model and in-market performance of The Honest Company. We delivered growth across our key financial measures, including revenue of $97 million, which was 13% growth year-over-year. Our gross margin grew 170 basis points to 39%. Additionally, we delivered positive net income of $3 million and adjusted EBITDA margin of 7%, representing our sixth consecutive quarter of positive adjusted EBITDA. We are particularly proud of these results amid the dynamic environment of both cost and consumer demand uncertainty. The strength of these results is grounded in our transformation pillars, which were designed for their enduring ability to guide us through both short- and long-term periods. Our first foundational pillar, brand maximization, is inspired by the growth vision we have for The Honest brand across our trusted portfolio of baby and personal care products. Our portfolio of cleanly formulated, sustainably designed products continues to meet everyday essential consumer needs, especially for those with sensitive skin. With consumption growth of 8% in the quarter, The Honest brand continues to deliver growth that outpaces the growth of our competitive categories, which declined 1% in the same period. Our growth underscores our focus on bringing new shoppers into The Honest portfolio, as demonstrated by the increases in our household penetration to 7.3%, a growth of 55 basis points versus the prior year. Two bright spots in our brand maximization performance for the quarter are our wipes portfolio and our baby personal care collection. Both of these businesses benefit from the growing interest in products that are effective, safe for a broad range of uses, and gentle on sensitive skin. For many consumers, products that work well for sensitive skin aren’t just preferences; they have become essential. Because of our rigorous product standards, our community has come to trust our commitment to having products that meet their most sensitive skin needs. The Honest standard is our set of guiding principles that contains our no list. The no list defines 3,500 ingredients of concern that we choose not to use in our products. As evidenced by increases in our household penetration, our buy rate, which grew 8%, and our repeat usage, which grew more than 200 basis points, our Honest products are more than essential; they’re beloved by our community. We know that the sensitive skin segment is expected to double to $80 billion by 2030, and skin allergies among children have increased 100% since 1997. In fact, this quarter, our sensitive skin portfolio grew 35% year-over-year, benefiting from the launch of our larger sizes of sensitive skin shampoo and body wash, and sensitive skin conditioning detangler. In addition to our sensitive skin portfolio growth, across our wipes portfolio, we delivered consumption growth of over 40% this quarter. Our successful growth in wipes is driven by distribution gains, expanded size offerings, in-store merchandising, and consumer-driven design improvements. We have seen increasing demand for our 288 count wipes package, which more than doubled in distribution over the past two years. This size provides great value to our most loyal users, and we see that the more wipes consumers have in their homes, the more ways they find to use them. As a digitally native brand with a strong omnichannel strategy, we believe in the power and scale of being represented both in-store and online. In March, our sanitizing wipes launched for the first time on Walmart.com, and our pocket and purse-friendly sanitizing sprays have been added to the on-the-go travel section at Target stores nationally. We also continue to expand the availability of Honest wipes into new aisles of the store, including the potty training aisle. Our toddler flushable wipes are the perfect solution for those moments when messes meet milestones. With the addition of pop-out displays called jump shelves, our toddler flushable wipes are conveniently placed for when parents are shopping for potty training essentials. For our Honest community, it is also important that our products come to life beautifully in their homes. Our recently launched adult flushable wipes now come in a new pattern we call gold gilded wings, and it’s gorgeous. They make the perfect finishing touch to give bathrooms and powder rooms an elevated style. Our community has come to love the combination we bring of gentle products that work beautifully and have a style to match. As a result, Honest is now the leading natural wipes brand nationally, surpassing the category’s previous leader. As I mentioned, as consumers seek out clean solutions for their essential needs, we continue to see our consumption outpace our competitive categories. However, along with a modest slowdown in the categories in which we compete, we observed some headwinds in our own momentum as we exited the quarter. Most notably, we saw these headwinds in our diaper portfolio. This is mainly attributable to an expected diaper distribution change that took place at a key retailer in Q1. We also recognize that a regular cadence of technology improvements is vital in the diaper category. That’s why we continuously monitor consumer feedback and understand the needs for innovation. Our diaper research confirmed that while we perform well in key areas, including our cleanly formulated materials that are gentle on baby and our signature prints, there were key technical features identified for improvement. After extensive development work and technical research, I’m pleased to share that our team of diaper engineers has developed our best-built diaper yet. In fact, I recently had the chance to visit our diaper manufacturing headquarters and saw firsthand how we were able to achieve such great results in our newest diaper. I had the pleasure of performing the absorbency test myself. As I poured the blue liquid onto the new and improved core of our diaper, the liquid was absorbed within seconds, leaving the surface practically dry to the touch. Our new and improved diaper, which has recently started shipping into stores and online, guarantees up to 100% leak protection with comfort dry technology and was thoughtfully designed to protect delicate skin. It also features a plant-based liner designed to be gentle on baby’s skin, a breathable outer layer that helps reduce the risk of irritation, fastener tab improvements for an irritation-free fit, and softer materials that make the diaper soft to a parent’s touch. With these improvements, we are proud to bring our best diaper ever to the littlest members of our Honest community. The second pillar we focus on after brand maximization is margin enhancement. In Q1, with a gross margin of 39% and expansion of 170 basis points, we continue to grow the bottom line faster than the top line through cost savings and changes to product mix. Just as we are closely watching the consumer environment, we are also watching and managing the cost environment, particularly related to tariffs. Based on currently announced tariffs, our greatest exposure is related to our imports from China. However, even with the additional tariff-related headwinds that were subsequent to our Q4 earnings call, our disciplined execution and progress on our margin enhancement pillar enable us to reaffirm our financial outlook today. As we shared in Q4 earnings, our Honest teams are not new to managing the impact of tariffs on a global supply chain and on our financial model. We’ve been managing tariffs in portions of our portfolio across several administrations. We have a comprehensive approach in place and a strong, experienced, cross-functional team that we lovingly call the Tariff Tacklers. This team oversees a three-prong strategy to drive our tariff mitigation efforts. These prongs include; first, building an annual plan that is agile in the face of tariffs; second, implementing an inventory management strategy to delay tariff impact; and third, working closely with our internal teams and external partners to drive additional cost savings and spending optimization. The high-frequency cadence and collaborative approach of our Tariff Tackler team allows them to continuously evaluate and prepare short- and long-term levers. Because of our three-prong strategy, our team acted quickly to increase inventory on hand, allowing us to delay the impact of incremental tariffs to the back half of the year. The addition of senior supply chain leadership to our management team, coupled with our strong history of collaboration with our suppliers, has enabled us to identify cost savings we can address together and helped us accelerate the timing on some cost savings initiatives. And guided by the third prong, we optimized our investment spending to reduce waste, drive higher returns, and amplify our highest strategic priorities. Our operating discipline pillar is our third and final transformation pillar. Operating discipline underscores our focus on building a culture of executional excellence. In the first quarter, we launched two improvements to our operating approach to better enable our teams to execute with excellence. Modeled after the practices of best-in-class consumer products companies, our business teams are operating with an improved cross-functional model which drives process rigor and ensures that we are aligned to deliver our priorities. We also implemented an integrated process that drives continuous improvement across forecast accuracy, inventory management, and customer service levels. As a result, we are able to drive a more efficient cost structure and deliver orders reliably on time and in full for our retail partners. We believe that this focus on forecast accuracy and supply reliability will be critical for our business, our retail partners, and our Honest community in this period of volatility. As I bring my remarks to a close, I’m pleased that our disciplined approach to transforming The Honest brand has allowed us to continue to outperform our categories with revenue up 13%, consumption up 8%, all while delivering increasingly profitable volume growth with net income of $3 million and our sixth consecutive quarter of positive adjusted EBITDA. We remain cautiously confident in our business as we navigate the evolving economic landscape and maintain a disciplined approach to managing the impact of tariffs. My belief in this company, our extraordinary team, and our trusted product is as strong today, if not stronger, as it was the day I joined Honest. In times like these, our resilience shines, as does our belief in continuing to invest to build a strong and scaled Honest brand. And now I will turn it over to Dave to share the financial results of our first quarter and more details on our 2025 financial outlook.

Dave Loretta, CFO

Thank you, Carla, and welcome everyone. Our team’s hard work to start the year has been instrumental in advancing our strategic objectives and building a stronger financial foundation. The progress we’ve made across our transformation pillars has led to strong topline growth and improved profitability this quarter. Now let me dive deeper into the first quarter results. This quarter, we delivered revenue of $97 million, up 13%, driven by strong performance across our wipes and baby personal care portfolio. As a reminder, we shared during our fourth quarter earnings call that we expected our revenue growth in the first quarter would be higher than our full year revenue growth outlook due to the comparable period from last year. In addition, in the first quarter, we saw retailer inventory builds, with shipments growing 5 percentage points faster than retail track channel consumption. We now expect this retailer inventory build to reverse in the second quarter. We also expect to continue to face headwinds in our diaper business in Q2 as we execute the full rollout of our new and improved diaper across the remainder of the year. We expect that the combination of these factors will lead to a first half of the year growth rate within the range of our annual revenue outlook. Our gross margin in the first quarter was 39%, up 170 basis points versus last year, primarily driven by supply chain cost savings and a mix of higher margin products, offset by a $3 million one-time inventory adjustment related to the strategic diaper renovation that Carla shared earlier. The adjustment to existing diaper inventory will allow for an accelerated transition in the market to the new diaper renovation and support a stronger launch with full marketing investment behind it. As the underlying gross margin performance suggests, we continue to make progress on expanding our portfolio’s profit potential through efficiencies and cost savings in the supply chain. One notable cost savings example is the reorganization of our Las Vegas warehouse layout that reduces the time spent on inbound handling and staging high volume inventory for more efficient outbound fulfillment. The less time our teams spend on reconfiguring the inventory for receiving, the more efficient and cost-effective our operations will be. Next, turning to operating expenses. We increased operating expenses by $2 million versus last year. However, on a rate basis, operating expenses decreased 230 basis points as a percentage of revenue. Within operating expenses, the drivers of change include; first, SG&A expenses that decreased $1 million compared to last year and decreased 440 basis points as a percentage of revenue; and second, marketing expenses that increased $3 million to 13% of revenue. As we continue to focus on our overall cost structure, we remain committed to investing in brand building and driving growth partially funded by the SG&A expense savings. I’m particularly proud to share that we delivered positive net income this quarter. The combination of strong revenue growth, gross margin expansion, operating expense leverage, and interest income earned on our cash led to positive net income of $3 million, up $5 million from last year. We remain committed to sustained net income growth over the long-term and this quarter is a continued evidence of our progress against that commitment. Adjusted EBITDA for the first quarter was $7 million, compared to $3 million from the prior year first quarter. Our adjusted EBITDA as a percentage of revenue improved from 3% in the prior year first quarter to 7% in this quarter. These results are in line with our long-term algorithm of adjusted EBITDA margin expansion. Turning to the balance sheet, we ended the quarter with $73 million in cash and no debt outstanding. Our cash position continues to benefit from a capital-light business model and diligent management of working capital. Our strong financial footing provides greater flexibility in our growth model and allows us to invest in the business in support of expanding availability of Honest products and in navigating the current environment. Our free cash flow for the first quarter was negative $3 million, driven primarily by an intentional inventory build as part of our tariff mitigation plan. Overall, our first quarter financial results and the ongoing commitment to transformation pillars give us continued confidence in our 2025 financial outlook. Therefore, we are reaffirming our full year 2025 financial outlook that includes net revenue growth of 4% to 6% year-over-year and adjusted EBITDA to be in the range of $27 million to $30 million. This outlook includes the impact of the tariffs announced this year. As Carla detailed, we have a comprehensive approach and strong experience in place to manage these tariffs, both in the short- and long-term. Our focus on managing tariffs includes three prongs. First, we built our 2025 plans to be agile in anticipation of some degree of impact, and we are adjusting our spend across the business to offset the expected impact. Second, our teams are leveraging inventory management actions to delay the impact in 2025 and accelerate supply chain cost savings. And third, with a strong and longstanding relationship with our suppliers, we are partnering to mitigate the remaining tariff exposure. Our exposure under the current slate of tariffs comes largely from our sourcing of wipes in China. Our diapers are USMCA-compliant goods from Mexico and are currently exempt from the latest tariffs. Overall, the current tariff policies have a roughly 1.5 percentage points net impact on gross margin in 2025, which we plan to offset with incremental cost savings and efficiencies. These tariffs are part of a dynamic macroeconomic environment. Outside of the specific impact of tariffs, we recognize there is uncertainty with broader consumer sentiment and potential changes in shopping behavior that our outlook does not include. We continue to play the long game behind our transformation pillars. We remain committed to investment in marketing and innovation through our brand maximization pillar, as we also drive efficiencies to offset the cost headwinds through our margin enhancement pillar. I want to thank our team for the strong results in the first quarter and their continued execution against our transformation pillars, enabling us to successfully navigate this dynamic environment and reaffirm our 2025 financial outlook today. Before we open the call for questions, I’d like to take a moment to express my sincere gratitude, as this will be my final earnings call as CFO of The Honest Company. It’s been an honor to be part of such an exceptional team, guiding Honest through a period of remarkable transformation. The progress we’ve made is a testament to the extraordinary talent, relentless commitment, and collaborative spirit of this incredible team. I believe The Honest brand is still in the early stages of unlocking its full potential with so much more opportunity ahead, and I remain confident in the company’s future and its ability to expand The Honest brand. I look forward to working with Curtiss to ensure a seamless transition, and I leave this role deeply proud of what we’ve accomplished and grateful for Carla’s leadership and support. Thank you for joining our call today and now I’ll turn the call back to the Operator.

Operator, Operator

Thank you. Please standby for our first question. And our first question comes from the line of Aaron Grey with Alliance Global Partners.

Aaron Grey, Analyst

Hi. Good evening. Thank you very much for the questions. Congrats on the quarter, and Dave, thanks for your time, and best of luck in your future endeavors. So, first question for me, just on the sales for the quarter, came ahead of our expectations there. It sounds like there was some shipping impact that you called out there, so just if you could help to quantify that. For the 1H guidance you gave, so you said 1H, I think, will be up 4% to 6%. That implies 2Q will be flat to down 4% on my math, so just if you could help us to maybe quantify the shipping timing impact that you had in 1Q and how much of that reverses in 2Q versus the remainder of the year. I think that’d be helpful. Thank you.

Carla Vernon, CEO

Hi, Aaron. It’s Carla. Good to be here with you. Let me start by framing this up. Dave, feel free to jump in if you have anything to add. We appreciate your input. We mentioned that in the first quarter, we experienced some pull-forward of shipments, which we believe has been beneficial for managing our tariff strategy this year. The shipments that were pulled forward are primarily due to Amazon, and we anticipate that these shipments will taper off as we move into the second half. Overall, when we assess the first half of the year, we feel that we're aligned with our guidance model because of this mix.

Aaron Grey, Analyst

Okay. All right. Great. Thank you for that. You gave great color on the gross margin.

Dave Loretta, CFO

Aaron.

Aaron Grey, Analyst

Sorry. Go ahead, Dave.

Dave Loretta, CFO

Sorry, Aaron. Maybe I could just tack on to that, too, a little bit, because I think what we want to make sure is clear on the first half, 4% to 6%. We did, in last year’s second quarter, have the benefit of the retailer events that drove some incremental volume. And last year, if you recall, it was 10% growth rate in the second quarter. So, that does provide a bit of a comp that we’re not going to have the ability to get over. So, to quantify, really, the benefit of that pull-forward, it’s 5 percentage points, which is roughly the difference between our revenue of 13% and our consumption growth of 8% in the first quarter, as that shifts between quarters and then coming off that comp of last year’s special retailer event.

Aaron Grey, Analyst

Okay. Great. That’s really helpful, there. Appreciate it. Second question for me, just on the marketing side. Maybe if you could speak to some of the plans you have for marketing for 2025 and how we should think about marketing as a percentage of sales. Last year, we did see an uptake in marketing, which translated to some nice accelerated sales growth. So, curious to how you plan your spending for the year, what you’re seeing as the best ROI opportunities as you look at macro and micro marketing initiatives? Thank you.

Carla Vernon, CEO

Thanks, Aaron. So, we believe so strongly in our opportunity to build The Honest brand. The performance in the first quarter, as it really even follows the strong performance last fiscal year, is extremely encouraging and is one of the reasons why we try to make it clear that we intend to continue our investment in both innovation, marketing, and brand building. So, with our revenue up 13% in the first quarter, with 8% growth on consumption, what was so compelling about that consumption growth that we saw is that it was driven by units. This was not consumption growth driven by pricing in the quarters, driven by units. And it’s driven by really strong consumer fundamentals that don’t always come along together at the same time. So, our ability to increase our household penetration to our highest level of 7.3%, a basis point expansion of 55%, while dollars per transaction at the same time and growing consumer loyalty gives us a great indication that as we manage the business model and have been able to find efficiencies from our margin enhancement pillar, we are able to protect for continued strong investment behind marketing. You saw that our investment in the first quarter in marketing was very strong and represented an increase in an investment in the brand while SG&A levels pulled down. And so, as we go into the remainder of the year, one of the things I talked about in the remarks was the importance of this new and improved diaper. We intend to support that diaper launch. Additionally, we are launching our wipes business into new retailers and into new aisles. And so, we will continue to protect the investment to drive awareness of the new stores that we are in, as well as to continue to drive trial and awareness.

Aaron Grey, Analyst

Great color there. Really appreciate that, Carla. And I’ll go ahead and jump back into the queue. Thank you.

Operator, Operator

Thank you. And our next question comes from the line of Anna with B. Riley Securities.

Anna Glaessgen, Analyst

Good afternoon. Thanks for taking my question. I guess I’d like to start with unpacking the deceleration you noted exiting the quarter and into 2Q. I guess what data do you have? Is there anything to suggest that 1Q consumption benefited from a pull-forward and that in 2Q the categories are decelerating as well or is it more specific to you guys? I’m just unpacking maybe trends by category.

Carla Vernon, CEO

Sure. Anna, this is Carla. Nice to speak with you. So, let me start by, I just got a chance to share the really strong consumption numbers that we saw in the first quarter and how that was driven by strong consumer fundamentals. It’s important to help unpack as we talk about the deceleration, we’re really in a tale of two cities. And so, if I really take a look at the sort of deconstructed consumption information for the first quarter, in the Target channel for us, that is really where those decelerations were fairly isolated, and they were even more specifically isolated to our diaper performance in Target for the first quarter. So, in Target for the first quarter, our consumption was down 4%. When we look at our performance in the rest of the market, you compare that down 4% in Target to strong double-digit growth for our performance in the market, almost at 20% consumption growth for our portfolio at ex Target. That’s very compelling for us. We know that as we look at the deceleration of the diaper business in Target, we think that there are a couple of factors that are important to note. One, the category as a whole, the diaper category remains to be under pressure, and this quarter, we saw that it was declining at a modest rate broadly for the diaper category. We also indicated in our remarks that there has been a change to our diaper selection at Target, and we have removed our gendered prints from that retailer. And so, we expect that as we continue to watch the distribution losses from the gendered prints flow through the year, that we will continue to see some consumption losses associated with those distribution losses across the quarter. But we remain very confident that the natural product market, when you look at the performance of natural products versus conventional, again, it’s that tale of two cities. We’re seeing strong growth in natural products overall, which is really one of the reasons why we’ve seen our own strength in the natural product category, whether that is now being the number one natural wipes brand nationally or our strength in our baby personal care business that we see both in broadly in the market, being the number one natural baby personal care brand, as well as being the number one baby personal care brand at Target overall. Lots of green shoots and things that make us confident, but we do have to work our way through some of these changes in distribution.

Anna Glaessgen, Analyst

Great. Thanks, Carla. That’s super helpful. I guess, double-clicking on one of your comments, you spoke to continued strength in natural. Now, one question we get from investors a lot is the willingness to continue to pay up for natural products in the face of continued macro uncertainties. It seems that at this point, you haven’t seen meaningful trade down in your categories. Is that fair?

Carla Vernon, CEO

I like to emphasize that we should concentrate on our performance compared to our categories. For this quarter, we maintained our growth in consumption, surpassing our competitive categories. Just as a reminder, our own consumption increased by 8% this quarter, while our competitors saw a decline of 1% during the same timeframe. We have observed a slight slowdown in our business. When we finished Q4, and based on our revised data reporting from MULO to MULO+, which better captures the growth from Amazon, we found that our fourth quarter consumption experienced approximately 11% growth. This is an increase from the 8% growth in the first quarter, reflecting a 3% change. As we forecast consumer behavior, there remains considerable uncertainty. We will keep monitoring our performance, but we recognize that our products meet essential needs. We are observing that households no longer view sensitive skin products as optional as they address their family’s necessities. We maintain a cautious sense of confidence, and our projections indicate that our consumption figures will land in the mid-single digits for the remainder of the year.

Anna Glaessgen, Analyst

Great. Thanks so much, Carla.

Operator, Operator

Thank you. Our next question comes from the line of Andrea Lisher with JPMorgan.

Andrea Lisher, Analyst

Thank you, Operator, and good afternoon. Congratulations to both Dave and Curtiss on the new positions. Dave, I appreciate your guidance in analyzing and selecting numbers that aid the company. I have a demand-related question for you, Carla, regarding distribution and the product portfolio, followed by a query about tariffs. Regarding distribution and product portfolio, is the growth in units primarily driven by velocity, or is it due to distribution gains, or a combination of both? Looking ahead, when do you anticipate reaching a plateau, or do you have further expansion plans? It would be great to hear how the spring resets have performed for you and if there’s more to expect in the fall. As you reflect on your portion of the portfolio, could you provide more details on your plans? You have an extensive product portfolio catering to families, but you've also expanded into areas like prenatal vitamins. Given the slowdown in the vitamins and VMS sector, do you believe this is still a category you want to pursue, and do you feel you have a competitive advantage there? Apologies for the lengthy question list, but I will return to the topic of tariffs shortly. Thank you.

Carla Vernon, CEO

Andrea, first of all, I’m stepping in, but I want to just echo your thanks to Dave. I know Dave wants to get a chance to make sure that he thanks you for your continued partnership. Let me start with your question about distribution and give you an update there. So the unit growth that I mentioned, when you compare that to exactly how it happened, it’s extremely compelling. For the quarter, while you will see that our total points of distribution actually declined in the quarter, if you remember, the distribution strategy we’re executing is actually a hero distribution strategy. That means that as we continue to remodel our business, do some mixed shifting, we know that there might be some distribution points that go away, but all distribution points are not equal for us. So let me make sure that I frame that a little bit more specifically. We think that there are about 90,000 relevant doors we could be in. Today, we are still in less than half of those doors. I know this has been a conversation we’ve been talking about for a long time, but I want to assure you that we’re still at very early days on actually executing getting into the doors. And then if you remember from our investor presentation, we say that it is a door strategy, but that it’s also a number of stores strategy, it is a breadth of aisle strategy, and then it is a breadth of item strategy. So there are quite a lot of layers of depth in there. We are in less than half of the available stores today. But what was so important as we exited last fiscal year, although we brought SG&A numbers down, we greatly shifted where our people are supporting our strategy. So we really ramped up on sales and distribution and customer-facing support. And we’re seeing the fruits of that in the quarter. So, I wanted to just emphasize that we’ve seen some really strong distribution growth in the quarter in the grocery and drug channel. In the grocery and drug channel, we’ve increased 12,000 points of distribution in the quarter and some of that is by getting into aisles we hadn’t been in. I will give you just a couple of examples. We are now the only diaper brand in Sprout stores nationwide. That’s a first for us. We got in at Whole Foods in a broader way in the baby personal care set. You can imagine how important Whole Foods is for us and making sure our baby personal care items are there. Then lastly, I don’t want to forget about the importance of online volume, because online volume is not counted in points of distribution, but we can see by the strength of our performance at Amazon, online volume is going to be an important place to make sure we expand our set and we have all of our products available. That’s why gaining sensitive skin wipes, excuse me, why gain the sanitizing wipes in Walmart.com this quarter is such a big deal and such a great example. There are many consumers who don’t have access to shopping in a physical Walmart but will order from Walmart.com online. So feeling really good about where our distribution will go, but that might mean that at times like at Target, we are seeing some of our less efficient distribution coming out while we focus on heroes. The other thing I wanted to say was that our velocities are up all the while. So you asked about that growth. Remember, I did say dollars per transaction are up for us. So the more that we continue to grow space and continue to sell people larger sizes, more items in their basket, the better that will be for us in the long run. I like to just step over to the question about the vitamin really quickly and say that our vitamin portfolio is something that really we have narrowed down to specify the vitamins we think that are the most aligned with our prenatal and our mama care strategy. We really have two, a prenatal and a postnatal vitamin. They play most strongly in the online channel.

Andrea Lisher, Analyst

Thank you for the comprehensive data. Regarding tariffs, I understand you manage your inventory and I'm curious about the impact, particularly in China. Are you suggesting that you will face some challenges in the second half, but your cost initiatives and strategies will help mitigate those? Then, looking ahead to next year, will you experience the impact from the first half as you lap the inventory? Can you clarify your assumptions regarding the 90-day and the 125 days, particularly concerning the 20 plus the 20?

Dave Loretta, CFO

Yes. Hi, Andrea. Let me address the tariff questions. To start, you touched on some key aspects of our three-pronged strategy and how we began tackling this issue early on. When we presented our outlook at the beginning of the year, we had already considered tariffs based on the information available at the time, which included potential tariffs on Mexico where our diapers are produced. Now that risk has been removed, we are concentrating primarily on China, where our wipes are manufactured. We are currently factoring in the existing tariff rates from China, noting that there isn't a 90-day waiting period for these tariffs. By proactively building a wipes inventory, we are gaining valuable lead time to manage through our existing inventory that’s tariff-free. This approach will take us into the third quarter, where we expect to see the effects of the tariffs reflected in our cost of goods around mid-third quarter and into the fourth quarter. Additionally, it's worth reiterating that our starting point for gross margin is relatively healthy, thanks to our focus on margin enhancement over the past two years and our three-pronged mitigation strategy, which includes collaborating with our suppliers to help offset some of these impacts. To illustrate that in our first quarter, I referenced a charge, an adjustment to diaper inventory of almost $3 million. If that were to be removed in the first quarter, our base gross margin levels are clearly a little over 41%. And so I think what we’re seeing now, and that’s just for one quarter, but we’re seeing the ability for us to manage some of the tariff impact, which isn’t new to us, but manage it within this framework as we’ve been building our profit profile of the portfolio over this time. And that’s giving us the confidence that as we look into next year, if there’s still an environment where we’re facing tariffs at whatever level they might be, that we’ve got the flexibility and we’ve got the business model to weather through that. As a reminder, our sourcing is with partnerships. We are a capital-light model. And so we operate with a variable cost model in that, and it gives us a lot of maneuverability and flexibility as we look forward.

Andrea Lisher, Analyst

So if I interpreted that in the way, like if it comes to fruition and you have until basically call it like mid-third quarter, the fall, right? So if by then things are still in place, the tariffs are still in place, are you able to negotiate with those suppliers to either have them move their production elsewhere, where let’s say, Mexico, where you have your adopted production with a third-party or you’re going to say, listen, you’re going to have to absorb part of it or you’re thinking there’s still a much cheaper place to make the diapers, they don’t have flexibility or you do have the flexibility, or you have started to look around as possibilities in other places, including with your suppliers in Mexico or in Canada or other places where you have reciprocity or USMCA. Is that the way to think? I mean, in other words, you’re not going to pass these cost increases through if it comes to that.

Carla Vernon, CEO

Andrea, I think what I want to make sure that I establish is, as we’ve modeled it out for the year with about a 1.5%, 1-percentage-point tariff impact for the year, which we think begins again at around the mid-point of Q3 and going into Q4. The ability for us to stay on model for the year really still lives in the fact that we’re actually not new at all to being prepared for this moment and how we deal with tariffs. We’ve been dealing with tariffs and talking with our suppliers about ways to improve our supply chain and our partnership for several administrations, which means that our solution set of having a reliable sourcing supply has already been an ongoing conversation and strategy we were having as we entered this time. As we consider the solutions for the upcoming year, I want to emphasize that we are firmly grounded in our approach. We will evaluate a wide range of factors and opportunities. Our ongoing margin enhancement initiative has been robust, positioning us to maintain a strong balance sheet with ample cash reserves, while ensuring that we grow our bottom line at a faster pace than our top line. This work is ongoing. We will also implement our three-pronged tariff mitigation strategy, which I like to think of as an accordion-style model for our investment spending. This is one area of focus as we strive for greater efficiency. We're learning continuously and have enhanced our supply chain expertise by adding a supply chain executive to my team. This allows us to engage more effectively with our supply partners about various options. I'm looking forward to discussing our next steps in the upcoming quarter, and we will adapt our approach if necessary based on thorough analysis to meet our guidance.

Andrea Lisher, Analyst

Very good. Thank you very much. I’ll pass it on.

Operator, Operator

Thank you. Our next question comes from the line of Dana Telsey with Telsey Advisory Group.

Dana Telsey, Analyst

Hi, good afternoon, everyone. Dave, best of luck in your retirement. I have a question regarding both the near-term and long-term outlook. Carla mentioned a modest deceleration in the business. Is this trend observed across all customer types and categories? What have you experienced, and how does the promotional environment look? Additionally, in the long-term, considering the supply chain mitigation strategies you've implemented, do you foresee any margin opportunities arising from the improved efficiencies in the business, despite the current headwinds? Thank you.

Carla Vernon, CEO

Thank you for the question, Dana. It’s great to be here today. We are noticing a slowdown in the business, but it appears to be primarily tied to one customer this quarter. When I assess our performance at Target, we see consumption down 4%, compared to nearly 20% growth in the rest of the market. This consumption growth has stayed fairly stable recently. It’s important to note that the diaper distribution losses at Target will likely impact us for the rest of the year. We need to address these changes and simplify that aspect. Additionally, the category is still facing some pressure. There were also a few specific events we executed last year that we won’t be repeating this year. For instance, we had a Target-specific anniversary celebration last year in the third quarter, and some revenue from preparing inventory for shipping was recognized in the second quarter. We won’t replicate that this year. Similarly, we had a Latino-focused event for Walmart last year, which is another event we will not be repeating. These are factors that we anticipate will influence our numbers. Despite this, we are also growing our distribution, continuing to build our brand and market effectively, and launching improvements such as our best diaper ever, larger sizes, and expanded designs for our flushable wipes. I believe we are implementing smarter and more balanced strategies, but there are challenges we need to navigate.

Dave Loretta, CFO

Yeah. Hi, Dana. I’d say the question around the long-term opportunities, we don’t think we’re done finding the opportunities to expand margin. I mean, that is a core tenet of our long-term algorithm. We do believe that supply chain is one of the areas that’s going to materialize there. The tariff environment and the current challenges is something that is giving us even further focus on this area of the business. But I’ll also add, when we look at the beauty of the portfolio and how it’s evolved, we are with a portfolio that’s got a profit potential that’s greater than we’ve had before. The mix of our products at margin levels that are higher in the channels that we’re selling through of a higher margin will continue to evolve and allow us to see margin expansion over the long-term.

Owen Richard, Analyst

Hi, Carla. Hi, Dave. Thank you for taking my question. I’ll try to keep it quick here, but how do you plan to balance promotional intensity in both the retail and digital channels, just as you continue to push for margin expansion? And then secondly, how far along are you in the process of pushing more of your digital consumers towards Amazon and other partners and away from the DTC website?

Carla Vernon, CEO

Hi, Owen. Carla here. Hope you’re well. The way we think about our channel strategy is, while we work to make sure we’ve got the right strategy to meet every consumer and we do great joint business planning with the retailers to make sure we’ve got our investment approach right. We do not try to push a consumer to any particular channel. And we’ve learned that as we’ve been omnichannel operators since our beginning, and we’ve tried it a number of ways, we realize the best thing for us is to make sure we’ve got the right selection and the maximum selection for whenever someone wants to be buying an Honest product. And Owen, what I can tell you that you can actually see evidenced in our results this quarter is that distribution, whether it’s online distribution, which doesn’t get counted in points or physical in-store distribution, is extremely incremental. When you get into a new store, into a new channel, and into a new aisle, you really have the opportunity to pull in a new consumer. That’s why in a quarter where you actually saw us go modestly backwards in distribution points, you actually saw all of our growth drivers get stronger because we got our distribution more broad meant we reached more homes. So that is something that we plan to continue. And as we work our way towards shifting our own honest.com model, I want to remind everyone that the honest.com channel will remain available, it will remain active for our consumers who land there and want to execute a transaction, and for our consumers if they want to gain information. It’s just that we’re getting out of the fulfillment and shipping component of that business. So we don’t really expect that to be a dramatically different experience.

Operator, Operator

Now I’m showing no further questions. So, with that, I’ll hand the call back over to CEO, Carla Vernon for any closing remarks.

Carla Vernon, CEO

Well, this is a quarter where the most important thing I can do is absolutely thank Dave for the impact he’s had in his tenure. The results are so evident, Dave. We just absolutely commend the role you’ve played in driving our strategy of topline growth and bottomline margin expansion while strengthening the team. You are evidence of the transformation pillars in action. So thankful. We are excited for you all to meet Curtiss when we are on our next call and look forward to joining you next quarter. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, this does conclude today’s program, and you may now disconnect.