SkinHealth Systems Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Statements This Quarterly Report contains “forward looking statements” within the meaning of the “safe harbor” provisions of the United States Private Securities Litigation Reform Act of 1995. When used in this Quarterly Report, the words “estimates,” “projected,” “expects,” “anticipates,” “forecasts,” “plans,” “intends,” “believes,” “seeks,” “may,” “will,” “should,” “future,” “propose” and variations of these words or similar expressions (or the negative versions of such words or expressions) are intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance, conditions or results, and involve a number of known and unknown risks, uncertainties, assumptions and other important factors, many of which are outside The Beauty Health Company’s control, that could cause actual results or outcomes to differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled Risk Factors of this filing. Important factors, among others, that may affect actual results or outcomes include the inability to recognize the anticipated benefits of the Business Combination; costs related to the Business Combination; the inability to maintain the listing of The Beauty Health Company’s shares on Nasdaq; The Beauty Health Company’s availability of cash for debt service and exposure to risk of default under debt obligations; The Beauty Health Company’s ability to manage growth; The Beauty Health Company’s ability to execute its business plan; potential litigation involving The Beauty Health Company; changes in applicable laws or regulations; the possibility that The Beauty Health Company may be adversely affected by other economic, business, and/or competitive factors; and the impact of the continuing COVID-19 pandemic on our business. The Beauty Health Company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. Unless the context otherwise requires, references to “ HydraFacial ”, “ we ”, “ us ”, and “ our ” in this section are intended to mean the business and operations of The Beauty Health Company and its consolidated subsidiaries. Overview Founded in 1997, HydraFacial is a category-creating beauty health company. Its offerings in skin care and scalp health occupy a position at the intersection of medical aesthetics and traditional skin and personal care products. HydraFacial treatments are convenient, affordable, personalized and have demonstrated effectiveness. HydraFacial distributes its products in 87 countries through multiple channels including day spas, hotels, dermatologists, plastic surgeons and beauty retail. HydraFacial’s business model has two predominant revenue streams: Delivery Systems (as defined below) and Consumables (as defined below). Delivery Systems are purchased up-front. Consumable single- and multi-use serums, tips and boosters or “Consumables” to provide treatments using our Delivery Systems are purchased on a recurring basis. The expansion of the number of Delivery Systems installed, or “install base,” increases the foundation for future revenue by creating a larger base to drive consumable sales. We believe that as the install base grows and Delivery Systems become more productive, recurring revenue will grow to become a larger share of the business. HydraFacial has more than tripled Net Sales from $48 million for the year ended December 31, 2016 to $166 million for the year ended December 31, 2019, growing its footprint both in the US and internationally. Net sales decreased in 2020 as a result of COVID-19 restrictions, but have rebounded since the onset of the pandemic, as Net sales increased $33.5 million, or 97.2%, for the three months ended September 30, 2021 when compared with the Net sales for the three months ended September 30, 2020. For the nine months ended September 30, 2021 compared to September 30, 2020, Net sales increased $101.0 million, or 124.3%. Financial metrics we use to track our goals include revenue growth, Adjusted gross profit and Adjusted EBITDA. For a definition of Key Performance Indicators (“ KPIs ”) see the section titled “ —Key Operational and Business Metrics ”. 30 Table of Contents Recent Developments Convertible Senior Notes On September 14, 2021, we issued $750 million aggregate principal amount of our 1.25% Convertible Senior Notes due 2026 (the “ Notes”) in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. The Notes were issued pursuant to, and are governed by, an indenture, dated as of September 14, 2021, between the Company and U.S. Bank National Association, as trustee. The initial conversion rate is 31.4859 shares of Class A Common Stock per $1,000 principal amount of Notes, which represents an initial conversion price of approximately $31.76 per share of common stock. We used $90.2 million of the net proceeds from the sale of the Notes to fund the cost of entering into capped call transactions. The net proceeds from the issuance of the Notes were approximately $638.7 million, net of capped call transaction costs of $90.2 million and debt issuance costs totaling $21.1 million. See Note 9 - Debt, to the Notes to Condensed Consolidated Financial Statements included elsewhere in this report. Capped Call Transactions Capped call transactions cover the aggregate number of shares of our common stock that will initially underlie the Notes, and generally reduce potential dilution to our common stock upon any conversion of Notes and/or offset any cash payments we may make in excess of the principal amount of the converted Notes, as the case may be, with such reduction and/or offset subject to a cap, based on the cap price of the capped call transactions. See Note 2 - Summary of Significant Accounting Policies, to the Notes to Condensed Consolidated Financial Statements included elsewhere in this report. Impact of the COVID-19 Pandemic The COVID-19 pandemic has had, and we expect will continue to have adverse impacts on our business. As government authorities around the world continue to implement significant measures intended to control the spread of the virus and institute restrictions on commercial operations, while at the same time implementing multi-step policies with the goal of re-opening certain markets, we are working to ensure our compliance while also maintaining business continuity for essential operations in our facilities. The COVID-19 pandemic caused us to experience several adverse impacts primarily in the first and second quarters of fiscal year 2020, including extended sales cycles to close new orders for our products, delays in shipping and installing orders due to closed facilities and travel limitations and delays and failures in collecting accounts receivable. The rapid development and uncertainty of the impacts of the COVID-19 pandemic precludes any prediction as to the ultimate adverse impact of the COVID-19 pandemic on our business. However, the COVID-19 pandemic, and the measures taken to contain it, present material uncertainty and risk with respect to our performance and financial results. In particular, closure of providers, restrictions on performing personal services, consumer perceptions about the safety of HydraFacial’s services, disruption in the supply chain of raw materials and components, and inefficiencies in the manufacturing of products due to social distancing and hygiene protocols. Disruptions in the capital markets as a result of the COVID-19 pandemic may also adversely affect our business if these impacts continue for a prolonged period and we need additional liquidity. During the year ended December 31, 2020, we took and may continue to take, actions to mitigate the impact of the COVID-19 pandemic on our cash flow and results of operations and financial condition. Starting in April 2020, after the government mandated shutdowns, we experienced a significant decline in sales during the second quarter of 2020, and took certain corrective measures. HydraFacial furloughed a majority of its workforce and went through a restructuring process, which included the write-off of certain product lines, and costs incurred for assistance provided by third-party consultants to assist in managing the downturn. Subsequent to the downturn experienced during the second quarter of 2020, our revenues increased, and we returned to having positive Adjusted EBITDA in the latter half of 2020. This trend continued into the third quarter of 2021. We successfully managed the variable portion of our cost structure to better align with revenue, which was significantly reduced during the downturn. Additionally, nearly all of our furloughed employees have returned to work. Business Combination and Public Company Costs On May 4, 2021, HydraFacial consummated the previously announced Business Combination pursuant to that certain Merger Agreement, dated December 8, 2020 with Vesper Healthcare Acquisition Corp. (“Vesper"), pursuant to which Vesper acquired, directly or indirectly, 100% of the stock of HydraFacial and its subsidiaries. Upon closing, the combined entity was renamed The Beauty Health Company and trades on the Nasdaq Capital Market under the ticker symbol “SKIN”. 31 Table of Contents Pursuant to the terms of the Merger Agreement, the aggregate merger consideration paid to the HydraFacial stockholders in connection with the Business Combination was approximately $975.0 million less HydraFacial’s net indebtedness as of the Closing Date, transaction expenses, and net working capital relative to a target. In connection with the transaction, all of HydraFacial’s existing debt under its credit facilities were repaid and the note receivable from its stockholder was settled. The merger consideration included both cash consideration and consideration in the form of newly issued Class A Common Stock. The aggregate cash consideration paid to the former HydraFacial stockholders at the Closing was approximately $368.0 million, consisting of the Vesper’s cash and cash equivalents as of the closing of the Business Combination including proceeds of $350.0 million from Vesper’s Private Placement of an aggregate of 35,000,000 shares of Class A Common Stock, and approximately $433.0 million of cash available to Vesper from the Trust Account that held the proceeds from Vesper’s initial public offering after giving effect to income and franchise taxes payable in respect of interest income earned in the Trust Account), and redemptions that were elected by Vesper’s public stockholders, minus approximately $224.0 million used to repay HydraFacial’s outstanding indebtedness at the Closing, minus approximately $94.0 million of transaction expenses of HydraFacial and Vesper, minus $100.0 million. The remainder of the consideration paid to the HydraFacial stockholders consisted of 35,501,743 newly issued shares of Class A Common Stock. The foregoing consideration paid to the HydraFacial stockholders may be further increased by amounts payable as earn-out shares of Class A Common Stock pursuant to the terms of the Merger Agreement. Notwithstanding the legal form of the Business Combination pursuant to the Merger Agreement, the Business Combination was accounted for as a reverse recapitalization in accordance with GAAP. Under this method of accounting, Vesper was treated as the “acquired” company for financial reporting purposes. This determination was primarily based on the following: • HydraFacial’s existing shareholders were expected to have the largest minority interest of the voting power in the combined entity under the minimum and maximum redemption scenarios; • HydraFacial’s operations prior to the acquisition comprise the only ongoing operations of the combined entity; • HydraFacial senior management were retained and compose the majority of the senior management of the combined entity; • HydraFacial’s relative valuation and results of operations compared to Vesper; and • pursuant to the Investor Rights Agreement, HydraFacial was given the right to designate certain initial members of the board of directors of the post-combination company immediately after giving effect to the transactions. Consideration was given to the fact that Vesper paid a purchase price consisting of a combination of cash and equity consideration and its shareholders would have significant voting power. However, based on the aforementioned factors of management, board representation, largest minority shareholder, and the continuation of the HydraFacial business as well as size it was determined that accounting for the Business Combination as a reverse recapitalization was appropriate. Accordingly, for accounting purposes, the financial statements of the combined entity will represent a continuation of the financial statements of HydraFacial with the acquisition being treated as the equivalent of HydraFacial issuing stock for the net assets of Vesper, accompanied by a recapitalization. The net assets of Vesper were stated at historical cost, with no goodwill or other intangible assets recorded. Following the consummation of the Business Combination, we became an SEC-registered and NASDAQ-listed company, which required us to hire additional staff and implement procedures and processes to address public company regulatory requirements and customary practices. We have incurred and expect to incur additional annual expenses for, among other things, directors’ and officers’ liability insurance, director fees and additional internal and external accounting, legal and administrative resources and fees. Factors Affecting Our Performance Market Trends HydraFacial is a pioneer in the attractive and growing beauty-health industry and there are several emerging market trends that we believe will play a key role in shaping the future of this industry. Recent growth in the skincare industry has been driven by an emphasis on skincare rather than cosmetics and HydraFacial is poised to capture a larger share of wallet from consumers. Further, HydraFacial’s market research conducted in 2019 demonstrated that consumers are increasingly willing to spend on high-end beauty health products. To the extent disposable income grows, we expect impacts of this trend to be amplified. We believe these favorable market trends will continue and strengthen going forward. 32 Table of Contents Demographics HydraFacial benefits from a large, young and diverse customer base and the ability to serve a large percentage of the population given that HydraFacial’s patented technology addresses all skin, regardless of type, age or gender. At the intersection of the medical and consumer retail markets, the large potential customer base should provide significant upside to drive top-line growth. HydraFacial over indexes with males, significantly increasing the Total Addressable Market (TAM) compared to peers and the mix of male customers is growing at two times the rate of female customers. HydraFacial customers are young; approximately 50% of HydraFacial customers are Millennials, and approximately 30% of HydraFacial’s beauty retail customers are under the age of 24. As the Millennial and Gen Z consumers age, they appear to be taking skincare more seriously and willing to invest in premium treatments, such as those offered by HydraFacial. Marketing Effective marketing is vital to our ability to drive growth. We plan to further our successful demand-generating activities through educational campaigns that focus on our brand, values, and quality, as well as enhancing our digitally integrated media campaigns. Innovation Our strategy involves innovating our current product offering while also diversifying into attractive adjacent categories where we can leverage our strengths, capabilities and community. We intend to maintain investment in research and development to stay at the forefront of cutting-edge technology. Technology Our investments in technology enhance the HydraFacial experience for consumers while capturing valuable and leverageable data. As we expand our capabilities, we hope to enable the world’s largest skin health database. We believe this data will allow us to drive habituation by enhancing personalization, access, trend identification and consumer education. Geographic Expansion HydraFacial’s recent growth has been driven in part by our international strategy. 34% of HydraFacial’s total revenue during the third quarter of fiscal year 2021 came from outside the United States and Canada. Our diverse distribution channels create a significant opportunity within our existing retail and wholesale channels, as well as new locations abroad. We plan to expand our global footprint, building out our team and infrastructure for further penetration across Asia, Europe and Latin America. Key Operational and Business Metrics In addition to the measures presented in our consolidated financial statements, we use the following key operational and business metrics to evaluate our business, measure our performance, develop financial forecasts, and make strategic decisions. Amounts and percentages may not foot due to rounding. Three Months Ended September 30, Nine Months Ended September 30, (dollars in millions) 2021 2020 2021 2020 Delivery Systems net sales $ 36.2 $ 15.9 $ 96.8 $ 36.0 Consumables net sales 32.0 18.6 85.4 45.2 Total net sales $ 68.1 $ 34.6 $ 182.2 $ 81.2 Consolidated gross profit $ 46.1 $ 21.0 $ 125.1 $ 44.2 Consolidated gross margin 67.6% 60.6% 68.6% 54.4% Net loss $ (215.1) $ (2.2) $ (357.8) $ (21.7) Adjusted EBITDA $ 5.8 $ 7.6 $ 24.2 $ 4.2 Adjusted EBITDA margin 8.5% 21.9% 13.3% 5.1% Adjusted gross profit $ 48.7 $ 23.6 $ 133.0 $ 52.4 Adjusted gross margin 71.5% 68.3% 73.0% 64.5% Adjusted net income (loss) $ 2.5 $ 0.9 $ 2.8 $ (10.3) 33 Table of Contents Adjusted Net Income (Loss), Adjusted EBITDA (Loss) and Adjusted EBITDA Margin Adjusted net income (loss), Adjusted EBITDA (loss) and Adjusted EBITDA margin are key performance measures that our management uses to assess our operating performance. See the section titled “ Non-GAAP Financial Measures—adjusted net income (loss), adjusted EBITDA (loss) and adjusted EBITDA margin ” for information regarding our use of Adjusted net income (loss) and adjusted EBITDA and reconciliations of Adjusted net income (loss) and Adjusted EBITDA to net loss. Adjusted Gross Profit and Adjusted Gross Margin We use Adjusted gross profit and Adjusted gross margin to measure our profitability and ability to scale and leverage the costs of our Delivery Systems and Consumables sales. See the section titled “ Non-GAAP Financial Measures—adjusted gross profit and adjusted gross margin ” for information regarding our use of Adjusted gross profit and a reconciliation of Adjusted gross profit to gross profit. Components of our Results of Operations Net Sales Net sales consists of the sale of products to retail and wholesale customers through e-commerce and distributor sales. HydraFacial generates revenue through manufacturing and selling HydraFacial and Perk Delivery Systems (“ Delivery Systems ”). In conjunction with the sale of Delivery Systems, HydraFacial also sells its serum solutions and consumables (collectively “ Consumables ”). Consumables are sold solely and exclusively by HydraFacial and are available for purchase separately from the purchase of Delivery Systems. For both Delivery Systems and Consumables, revenue is recognized upon transfer of control to the customer, which generally takes place at the point of shipment. Cost of Sales HydraFacial’s cost of sales consists of Delivery System and Consumables product costs, including the cost of materials, labor costs, overhead, depreciation and amortization of developed technology, shipping and handling costs, and the costs associated with excess and obsolete inventory. As we launch new products and expand our presence internationally, we expect to incur higher cost of sales as a percentage of net sales because we have not yet achieved economies of scale with these items. Selling and Marketing Selling and marketing expense consists of personnel-related expenses, sales commissions, travel costs, training and advertising expenses incurred in connection with the sale of our products. We intend to continue to invest in our sales and marketing capabilities in the future and expect this expense to increase in absolute dollars in future periods as we release new products, grow our global footprint, and drive consumer demand in the ecosystem. Selling and marketing expense as a percentage of net sales may fluctuate from period to period based on net sales and the timing of our investments in our sales and marketing functions as these investments may vary in scope and scale over future periods. Research and Development Research and development expense primarily consists of personnel-related expenses, tooling and prototype materials, technology investments, and other expenses incurred in connection with the development of new products and internal technologies. We expect our research and development expenses to vary from period to period as a percentage of net sales, as HydraFacial plans to continue to innovate and invest in new technologies and to enhance existing technologies to fuel future growth as a category creator. General and Administrative General and administrative expenses include personnel-related expenses, professional fees, credit card and wire fees and facilities-related costs primarily for our executive, finance, accounting, legal, human resources, and IT functions. General and administrative expense also includes fees for professional services principally comprising legal, audit, tax and accounting services and insurance. We expect to continue to incur additional general and administrative expenses as a result of operating as a public company, including expenses related to compliance and reporting obligations of public companies, and increased costs for insurance, investor relations expenses and professional services. In addition, we expect to continue to incur additional IT expenses as we scale HydraFacial and enhance our ecommerce, digital and data utilization capabilities. As a result, we expect that our general and administrative expenses will increase in absolute dollars in future periods and vary from period to period as a percentage of net sales. 34 Table of Contents Other Income (Expense), Net Other income (expense) consists of the change in fair value of both the public and private placement warrants and earn-out shares liability, interest expense, deferred financing write-off costs and prepayment penalties related to the repayment of our long-term debt, foreign currency transaction gains and losses and investment income. Foreign currency transaction gains and losses are generated by settlements of intercompany balances and invoices denominated in other currencies other than the reporting currency. We expect other income (expense) to increase in absolute dollars as we grow internationally and obtain additional financing. Other income (expense) as a percentage of revenue will fluctuate period to period along with interest rates, exchange rates and other factors not related to normal business operations. Income Tax Provision (Benefit) The provision for income taxes consists primarily of income taxes related to federal, state and foreign jurisdictions in which we conduct business. Results of Operations The following tables set forth our consolidated results of operations in dollars and as a percentage of net sales for the periods presented. The period-to-period comparisons of our historical results are not necessarily indicative of the results that may be expected in the future. The results of operations data for the three and nine months ended September 30, 2021 and September 30, 2020 have been derived from the interim condensed consolidated financial statements included elsewhere in this Form 10-Q. Amounts and percentages may not foot due to rounding. Comparison of Three Months Ended September 30, 2021 to Three Months Ended September 30, 2020 Three Months Ended September 30, (in millions) 2021 % of Net Sales 2020 % of Net Sales Net sales $ 68.1 100.0 % $ 34.6 100.0 % Cost of sales 22.1 32.4 % 13.6 39.4 Gross profit 46.1 67.6 % 21.0 60.6 Operating expenses Selling and marketing 30.5 44.7 10.5 30.5 Research and development 1.9 2.8 0.6 1.7 General and administrative 19.2 28.2 7.1 20.4 Total operating expenses 51.5 75.6 18.2 52.6 Income (loss) from operations (5.5) (8.0) 2.8 8.1 Other expense, net 210.8 309.4 5.6 16.2 Loss before provision for income tax (216.3) (317.4) (2.8) (8.1) Income tax benefit (1.1) (1.7) (0.6) (1.7) Net loss $ (215.1) (315.7) % $ (2.2) (6.4) % Net Sales Three Months Ended September 30, Change (in millions) 2021 2020 Amount % Net sales Delivery Systems $ 36.2 $ 15.9 $ 20.3 127.2% Consumables 32.0 18.6 13.4 71.5% Total net sales $ 68.1 $ 34.6 $ 33.5 97.2% Percentage of net sales Delivery Systems 53.1% 46.1% Consumables 46.9% 53.9% Total 100.0% 100.0% 35 Table of Contents Total net sales for the three months ended September 30, 2021 increased $33.5 million, or 97.2%, compared to the three months ended September 30, 2020. Delivery System sales for the three months ended September 30, 2021 increased $20.3 million, or 127.2%, compared to the three months ended September 30, 2020. Delivery Systems units sold for the three months ended September 30, 2021 increased primarily due to strong trends in the U.S. and Mexico as markets reopened and consumer demand accelerated, as well as continued strength in China and Australia despite partial closures due to the Delta variant. Similarly, Consumables sales for the three months ended September 30, 2021 increased $13.4 million, or 71.5%, compared to the three months ended September 30, 2020. The increase in Consumables sales was primarily attributable to rebounding sales volume following the COVID-19 pandemic, as domestic and international stay-at-home orders were lifted and commercial operations were allowed to resume with social distancing restrictions during the three months ended September 30, 2021. Cost of Sales, Gross Profit, and Gross Margin Three Months Ended September 30, Change (in millions) 2021 2020 Amount % Cost of sales $ 22.1 $ 13.6 $ 8.5 62.3% Gross profit $ 46.1 $ 21.0 $ 25.1 119.9% Gross margin 67.6 % 60.6 % Cost of sales increased 62.3% driven by increased sales volume and a shift in the product mix to HydraFacial Delivery Systems. Gross margin increased from 60.6% during the three months ended September 30, 2020 to 67.6% during the three months ended September 30, 2021. The improvement in gross profit was due to fixed cost leverage from higher sales, improved average selling prices for Delivery Systems, as well as cost savings initiatives. Operating Expenses Sales and Marketing Three Months Ended September 30, Change (in millions) 2021 2020 Amount % Selling and marketing $ 30.5 $ 10.5 $ 20.0 188.9 % As a percentage of net sales 44.7 % 30.5 % Selling and marketing expense for the three months ended September 30, 2021 increased $20.0 million , or 188.9%, compared to the three months ended September 30, 2020. The overall increase as a percentage of net sales was driven by higher sales commissions of $5.2 million, which included $0.3 million in sales commissions from international operations, primarily attributable to the overall increase in sales. Personnel-related expenses increased by $6.8 million, which included a $2.3 million increase from our international operations, primarily attributable to increased headcount, and stock-based compensation expense of $1.1 million. In addition, personnel-related training expenses increased by $1.4 million and marketing spend increased by $1.4 million as we moved forward with marketing programs after COVID-19 restrictions were lifted and markets reopened. Research and Development Three Months Ended September 30, Change (in millions) 2021 2020 Amount % Research and development $ 1.9 $ 0.6 $ 1.3 225.8 % As a percentage of net sales 2.8 % 1.7 % Research and development expense for the three months ended September 30, 2021 increased $1.3 million , or 225.8%, compared to the three months ended September 30, 2020. The increase was due to increased expenses related to investments in new skincare treatment technologies of $1.0 million. 36 Table of Contents General and Administrative Three Months Ended September 30, Change (in millions) 2021 2020 Amount % General and administrative $ 19.2 $ 7.1 $ 12.1 172.2 % As a percentage of net sales 28.2 % 20.4 % General and administrative expense for the three months ended September 30, 2021 increased $12.1 million, or 172.2%, compared to the three months ended September 30, 2020. Stock-based compensation expense increased by $3.9 million and personnel-related expenses increased by $1.3 million primarily due to increased headcount and higher sales. We incurred additional public company costs, which included directors’ and officers’ liability insurance, Sarbanes-Oxley Act compliance and additional audit and tax related services of $1.7 million, increased legal fees of $1.2 million, and one-time transaction costs of $0.9 million. Other (Income) Expense, Net and Income Tax Provision Three Months Ended September 30, Change (in millions) 2021 2020 Amount % Other expense, net $ 210.8 $ 5.6 $ 205.2 3670.0 % Income tax benefit $ (1.1) $ (0.6) $ (0.5) 90.4 % Other expense, net, was $210.8 million for the three months ended September 30, 2021 compared to $5.6 million for the three months ended September 30, 2020. The increase was primarily driven by the changes in the fair values of the Warrant liability and Earn-out Shares liability of $199.3 million and $10.6 million, respectively. Comparison of Nine Months Ended September 30, 2021 to Nine Months Ended September 30, 2020 Nine Months Ended September 30, (in millions) 2021 % of Net Sales 2020 % of Net Sales Net sales $ 182.2 100.0 % $ 81.2 100.0 % Cost of sales 57.1 31.4 37.1 45.6 Gross profit 125.1 68.6 44.2 54.4 Operating expenses Selling and marketing 74.5 40.9 34.4 42.4 Research and development 6.3 3.5 2.5 3.1 General and administrative 73.6 40.4 19.7 24.2 Total operating expenses 154.5 84.8 56.6 69.7 Loss from operations (29.4) (16.2) (12.5) (15.4) Other expense, net 331.7 182.0 15.5 19.1 Loss before provision for income tax (361.1) (198.2) (27.9) (34.4) Income tax benefit (3.3) (1.8) (6.3) (7.7) Net loss $ (357.8) (196.4) % $ (21.7) (26.7) % Net Sales Nine Months Ended September 30, Change (in millions) 2021 2020 Amount % Net sales Delivery Systems $ 96.8 $ 36.0 $ 60.8 169.0% Consumables 85.4 45.2 40.2 88.8% Total net sales $ 182.2 $ 81.2 $ 101.0 124.3% Percentage of net sales Delivery Systems 53.1% 44.3% Consumables 46.9% 55.7% Total 100.0% 100.0% 37 Table of Contents Total net sales for the nine months ended September 30, 2021 increased $101.0 million, or 124.3%, compared to the nine months ended September 30, 2020. Delivery System sales for the nine months ended September 30, 2020 increased $60.8 million, or 169.0%, compared to the nine months ended September 30, 2020. Delivery Systems units sold for the nine months ended September 30, 2020 increased primarily due to both increased consumer demand and continued strength in the Asia-Pacific region. Similarly, Consumables sales for the nine months ended September 30, 2021 increased $40.2 million, or 88.8%, compared to the nine months ended September 30, 2020. The increase in Consumables sales was primarily attributable to rebounding sales volume following the COVID-19 pandemic. Cost of Sales, Gross Profit, and Gross Margin Nine Months Ended September 30, Change (in millions) 2021 2020 Amount % Cost of sales $ 57.1 $ 37.1 $ 20.0 54.2% Gross profit $ 125.1 $ 44.2 $ 80.9 183.2% Gross margin 68.6 % 54.4 % Cost of sales increased 54.2% driven by increased sales volume and a shift in the product mix to HydraFacial Delivery Systems. Gross margin increased from 54.4% during the nine months ended September 30, 2021 to 68.6% during the nine months ended September 30, 2020, primarily due to fixed cost leverage from higher sales volumes coupled with cost saving initiatives, partially offset by higher logistics costs. Sales and Marketing Nine Months Ended September 30, Change (in millions) 2021 2020 Amount % Selling and marketing $ 74.5 $ 34.4 $ 40.1 116.5 % As a percentage of net sales 40.9 % 42.4 % Selling and marketing expense for the nine months ended September 30, 2021 increased $40.1 million, or 116.5%, compared to the nine months ended September 30, 2020. The overall decrease as a percentage of net sales was due to higher sales commissions of $14.8 million, which included $1.3 million in sales commissions from international operations, primarily attributable to overall increases in sales. Personnel-related expenses increased by $14.5 million, which included a $3.9 million increase from our international operations, primarily attributable to increased headcount, and stock-based compensation expense of $1.4 million. In addition, personnel-related training and certification expenses increased by $3.0 million and increased marketing spend of $2.7 million. Research and Development Nine Months Ended September 30, Change (in millions) 2021 2020 Amount % Research and development $ 6.3 $ 2.5 $ 3.8 147.9 % As a percentage of net sales 3.5 % 4.3 % Research and development expense for the nine months ended September 30, 2021 increased $3.8 million, or 147.9%, compared to the nine months ended September 30, 2020. The increase was due to increased expenses related to investments in new skincare treatment technologies of $3.5 million. 38 Table of Contents General and Administrative Nine Months Ended September 30, Change (in millions) 2021 2020 Amount % General and administrative $ 73.6 $ 19.7 $ 53.9 274.6 % As a percentage of net sales 40.4 % 24.3 % General and administrative expense for the nine months ended September 30, 2021 increased $53.9 million, or 274.6%, compared to the nine months ended September 30, 2020. Transaction costs increased by $32.3 million related to the consummation of the Business Combination, primarily consisting of $21.0 million paid to the former owner of HydraFacial as well as professional fees for financial advisory, legal and accounting services. The consummation of the Business Combination during the nine months ended September 30, 2021 also drove an increase of $6.7 million in stock-based compensation which includes $1.4 million in related to the accelerated vesting due to Business Combination. Personnel-related expenses increased by $5.8 million primarily due to increased headcount and higher sales. Other (Income) Expense, Net and Income Tax Provision Nine Months Ended September 30, Change (in millions) 2021 2020 Amount % Other expense, net $ 331.7 $ 15.5 $ 316.2 2043.8 % Income tax benefit $ (3.3) $ (6.3) $ 3.0 (47.2) % Other expense, net, was $331.7 million for the nine months ended September 30, 2021 compared to $15.5 million for the nine months ended September 30, 2020. The increase was primarily driven by the changes in the fair values of our Warrant liability and Earn-out Share liability of $271.3 million and $47.1 million, respectively. In connection with the consummation of the Business Combination, we repaid all long-term borrowings and incurred a total of $4.3 million in prepayment penalties and deferred financing cost write-offs. Income tax benefit decreased primarily due to an increase in valuation allowance and various non-deductible expenses. Liquidity and Capital Resources Our operations have been funded primarily through cash flow from operating activities and net proceeds received from the consummation of the Business Combination. As of September 30, 2021, we had cash and cash equivalents of approximately $718.6 million. On September 14, 2021, we issued $750 million aggregate principal amount of our 1.25% Notes due 2026. We believe our existing cash and cash equivalent balances (including the cash consideration received from the consummation of the Business Combination and the cash received from the issuance of the Notes) and cash flow from operations will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, potential acquisitions, the timing and amount of spending on research and development, growth in sales and marketing activities, the timing of new product launches, timing and investments needed for international expansion, expansion and overall economic conditions. We expect capital expenditures of up to $15.0 million for the year ended December 31, 2021. We anticipate using cash from the Business Combination, cash from the issuance of the Notes and cash generated through the normal course of operations to fund these items. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of additional debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations. There can be no assurances that we will be able to raise additional capital. The inability to raise capital would adversely affect our ability to achieve our business objectives. Subsequent to September 30, 2021, on October 4, 2021, we delivered a Notice of Redemption for all of our outstanding public warrants to purchase shares of BeautyHealth's Class A common stock. On November 8, 2021, BeautyHealth announced 16,123,235 public warrants were exercised for total cash proceeds of $185.4 million. 39 Table of Contents Convertible Senior Notes On September 14, 2021, we issued $750 million aggregate principal amount of our 1.25% Notes due 2026. The net proceeds from the issuance of the Notes were approximately $638.7 million, net of capped call transaction costs of $90.2 million and debt issuance costs totaling $21.1 million. See Note 9 - Debt, to the Notes to Condensed Consolidated Financial Statements included elsewhere in this report. Cash Flows The following table summarizes the activities from our statements of cash flows. Amounts may not foot due to rounding. Nine Months Ended September 30, (in millions) 2021 2020 Cash and cash equivalents at beginning of period $ 9.5 $ 7.3 Operating activities: Net loss (357.8) (21.7) Non-cash adjustments 343.5 16.8 Changes in working capital (17.4) (7.2) Net cash flows used in operating activities (31.6) (12.0) Net cash flows used in investing activities (29.2) (2.7) Net cash flows from financing activities 770.8 19.2 Net change in cash and cash equivalents 710.0 4.5 Effect of foreign currency translation (0.8) 0.1 Cash and cash equivalents at end of period $ 718.6 $ 11.8 Operating Activities Net cash used in operating activities of $31.6 million for the nine months ended September 30, 2021 was primarily due to the net loss of $357.8 million. The net loss was impacted by non-cash adjustments of $343.5 million, primarily related to fair value adjustments to Earn-out shares liability and Warrant liabilities, partially offset by a decrease in net change in working capital of $17.4 million. The total increase in net operating assets and liabilities was primarily due to the increase in accounts receivable of $17.3 million and offset by an increase in accrued payroll and taxes. Net cash used in operating activities of $12.0 million for the nine months ended September 30, 2020 was primarily due to the net loss of $21.7 million. The net loss was impacted by non-cash adjustments of $16.8 million primarily related to depreciation and amortization, partially offset by a decrease in net change in working capital of $7.2 million. The total increase in net operating assets and liabilities was primarily due to a $5.1 million increase in income tax receivables and a $1.8 million decrease in accrued payroll and other expenses offset by a $4.1 million decrease in accounts receivable Investing activities Cash used in investing activities for the nine months ended September 30, 2021 of $29.2 million was primarily related to our business acquisitions of distributors in Australia, Germany, Mexico and France with cash paid of $22.9 million, net of cash acquired, $4.9 million in capital expenditures and $2.2 million in capitalized software. Cash used in investing activities for the nine months ended September 30, 2020 of $2.7 million was primarily related to capital expenditures. Financing activities Net cash from financing activities of $770.8 million for the nine months ended September 30, 2021 was primarily related to the proceeds received from the issuance of convertible senior notes and Business Combination. The proceeds were offset by the payoff of long-term debt of $225.5 million and proceeds from our issuance of convertible senior notes. Net cash from financing activities of $19.2 million for the nine months ended September 30, 2020 was primarily related to proceeds from borrowings of $36.5 million, net of debt repayments and issuance costs of $16.4 million. 40 Table of Contents Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP. In preparing the condensed consolidated financial statements, we make estimates and judgments that affect the reported amounts of assets, liabilities, stockholders’ equity/deficit, revenue, expenses, and related disclosures. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Because of the uncertainty inherent in these matters, actual results may differ from these estimates and could differ based upon other assumptions or conditions. The critical accounting policies that reflect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements include those noted below. Revenue Recognition We elected to adopt the new revenue recognition standard using the full retrospective method as of January 1, 2019. The adoption of the new standard did not have a significant effect on earnings or on the timing of our transactions and, therefore, the effect of applying the new guidance was not material. As such, there were no adjustments to the prior periods. In accordance with ASU 2014-09, we determine the amount of revenue to be recognized through application of the following steps: • Identify the customer contract; • Identify the performance obligations in the contract; • Determine the transaction price; • Allocate the transaction price to the performance obligations in the contract; and • Recognize revenue as the performance obligations are satisfied. Stock-Based Compensation We measure and recognize compensation expenses for stock options, RSUs, and PSUs to employees on a straight-line basis over the vesting period based on their grant date fair values. We estimate the fair value of stock options on the date of grant using the Black-Scholes option pricing model and the fair value of PSUs on the date of grant using a Monte Carlo simulation. The fair value of the RSUs is based on the closing price of our common stock on the grant date. Goodwill Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the assets acquired and liabilities assumed. Goodwill is not amortized but is evaluated for impairment annually or more frequently if indicators of impairment are present or changes in circumstances suggest that impairment may exist. We have one reporting unit and management evaluates the carrying value of HydraFacial’s goodwill annually at the end of its fiscal year or whenever events or changes in circumstances indicate that an impairment may exist. When testing goodwill for impairment, we have the option of first performing a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as the basis to determine if it is necessary to perform a quantitative goodwill impairment test. In performing our qualitative assessment, we consider the extent to which unfavorable events or circumstances identified, such as changes in economic conditions, industry and market conditions or company specific events, could affect the comparison of the reporting unit’s fair value with its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we are required to perform a quantitative impairment test. Quantitative impairment testing for goodwill is based upon the fair value of a reporting unit as compared to its carrying value. Under a quantitative impairment test, we will make certain judgments and assumptions in allocating assets and liabilities to determine carrying values for our reporting unit. The impairment loss recognized would be the difference between a reporting unit’s carrying value and fair value in an amount not to exceed the carrying value of the reporting unit’s goodwill. Testing goodwill for impairment requires us to estimate fair values of reporting units using significant estimates and assumptions. The assumptions made will impact the outcome and ultimate results of the testing. We will use industry accepted valuation models and set criteria that are reviewed and approved by various levels of management and, in certain instances, we will engage independent third-party valuation specialists for advice. 41 Table of Contents The key estimates and factors used in the valuation models would include revenue growth rates and profit margins based on our internal forecasts, our specific weighted average cost of capital used to discount future cash flows, and comparable market multiples for the industry segment, when applicable, as well as our historical operating trends. Certain future events and circumstances, including deterioration of market conditions, higher cost of capital, a decline in actual and expected consumer consumption and demands, could result in changes to these assumptions and judgments. A revision of these assumptions could cause the fair values of the reporting units to fall below their respective carrying values, resulting in a non-cash impairment charge. Such charge could have a material effect on the consolidated financial statements. We performed a qualitative assessment as of December 31, 2020, based on which we determined that there is no indication of goodwill impairment. During the second quarter of 2020, our business was substantially impacted by the COVID-19 pandemic, which subsequently recovered and returned to having positive Adjusted EBITDA during the 3rd quarter of 2020. We evaluated our goodwill for impairment during the second quarter of 2020, and as a result of that assessment, concluded that our goodwill was not impaired. Intangible Assets Intangible assets are composed of developed technology, customer relationships and trademarks. At initial recognition, intangible assets acquired in a business combination are recognized at their fair value as of the date of acquisition. Following initial recognition, intangible assets are carried at cost less accumulated amortization and impairment losses, if any, and are amortized on a straight-line basis over the estimated useful life of the asset. We assess the impairment of intangible assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If necessary, we will use an industry accepted valuation model to estimate the fair value of the intangible assets. The fair value calculation requires significant judgments in determining both the assets’ estimated cash flows potentially the appropriate discount and royalty rates applied to those cash flows to determine fair value. Variations in economic conditions or a change in general consumer demands, operating results estimates or the application of alternative assumptions could produce significantly different results. If these assumptions differ materially from future results, we may record impairment charges in the future. Inventories Inventories are stated at the lower of cost (determined by the first-in, first-out method) or net realizable value. Obsolete inventory or inventory in excess of management’s estimated usage is written-down to its estimated net realizable value. Inherent in the net realizable value are management’s estimates related to economic trends, future demand for products, and technological obsolescence of our products. Income Taxes We use the asset-and-liability method for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the consolidated financial statement carrying amounts and tax bases of assets and liabilities and operating loss and tax credit carryforwards and are measured using the enacted tax rates that are expected to be in effect when the differences reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to an amount that, in the opinion of management, is more likely than not to be realized. Significant judgement is required to determine if a valuation allowance is needed. As of September 30, 2021, HydraFacial had incurred cumulative pre-tax losses, and as a result, does not rely on its projections as a source of income that would give us the ability to realize our deferred tax assets. In order to determine the realizability of our deferred income tax assets, we have pointed to the reversal of our taxable temporary differences as a source of income that will result in the realization of our deferred income tax assets. During the year ended December 31, 2020, and due to the pre-tax loss recorded, we began to accrue for a valuation allowance for the portion of deferred income tax assets that will not be realized through the reversal of taxable temporary differences. Our policy for accounting for uncertainty in income taxes requires the evaluation of tax positions taken or expected to be taken in the course of the preparation of tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax expense in the current year. Reevaluation of tax positions considers factors such as changes in facts or circumstances, changes in or interpretations of tax law, effectively settled issues under audit or expiration of statute of limitation and new audit activity. We recognized interest accrued and penalties related to unrecognized tax benefits in our income tax expense. 42 Table of Contents Warrant Liabilities We classify the Public and Private Placement Warrants (“Warrant liabilities”) as liabilities on our Condensed Consolidated Balance Sheets as these instruments are precluded from being indexed to our own stock given the terms allow for a settlement adjustment that does not meet the scope of the fixed-for-fixed exception in ASC 815, Derivatives and Hedging . In certain events outside of our control, the Public Warrant and Private Placement Warrant holders are entitled to receive cash while in certain scenarios the holders of the common stock are not entitled to receive cash or may receive less than 100% of any proceeds in cash, which precludes these instruments from being classified within equity pursuant to ASC 815-40. The Warrant liabilities were initially recorded at fair value on the date of the Business Combination and are subsequently adjusted to fair value at each subsequent reporting date. Changes in the fair value of these instruments are recognized within change in fair value of warrant liabilities in the Condensed Consolidated Statements of Comprehensive Loss. Earn-out Shares Liability We consider Earn-out Shares liability as contingent consideration, which is measured at its acquisition-date fair value and included as part of the consideration transferred in a business combination. Contingent consideration that is classified as a liability in accordance with the requirements under ASC 480, Distinguishing Liabilities from Equity, is remeasured at subsequent reporting dates, with the corresponding gain or loss recognized in profit or loss. With the closing of the four distributor acquisitions in Australia, France, Germany and Mexico, the 7.5 million Earn-out Shares were earned and subsequently issued on July 15, 2021. Convertible Senior Notes We consider the Notes in “Long-term liabilities” at face value net of issuance costs in accordance with ASC 470-20, Debt with Conversion and Other Options and Derivatives and Hedging—Contracts in Entity's Own Equity (“ASU 2020-06”). If any of the conditions to the convertibility of the Notes is satisfied, or the Notes become due within one year, we may be required under applicable accounting standards to reclassify the liability carrying value of the Notes as a current, rather than a long-term, liability. Capped Call Transactions We consider the freestanding capped call option contracts qualify as equity under the accounting guidance on indexation and equity classification, and recognized the contract by recording an entry to “Additional paid-in capital” (“APIC”) in stockholders’ equity in its condensed consolidated balance sheet. We also determined that the capped call option contracts meet the definition of a derivative under ASC Topic 815, Derivatives and Hedging but are not required to be accounted for as a derivative as they meet the scope exception outlined in ASC 815. Instead the capped call options are recorded in APIC and not remeasured. Recent Accounting Pronouncements See Note 2 of the notes to our Condensed Consolidated Financial Statements in the section titled “—Recently Issued Accounting Pronouncements” in our Note 2 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for a discussion about new accounting pronouncements adopted and not yet adopted. Off Balance Sheet Arrangements None Known Trends or Uncertainties We operate in the beauty health industry, which is highly competitive and changes rapidly. Our operating results could be significantly affected by our ability to develop new products and find new distribution channels for new and existing products. The majority of our customers are in the medical, (dermatologists and plastic surgeons), esthetician, and beauty retail industry. During economic downturns, we have seen consolidations in such industries. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous factors we cannot reliably predict, including the duration and scope of the pandemic; businesses and individuals' actions in response to the pandemic; and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending as well as customers' ability to pay for our products and services on an ongoing basis. As a result, our growth rate could be affected by consolidation and downsizing in the medical, esthetician, and beauty retail industry. 43 Table of Contents Furthermore, it remains unclear how governmental authorities, including the Food and Drug Administration (“FDA”), will regulate the products that we sell, and in the case of the FDA, whether and when it will propose or implement new or additional regulations. Unforeseen regulatory obstacles or compliance costs may hinder our business in both the short and long-term as well. Non-GAAP Financial Measures In addition to our results determined in accordance with accounting principles generally accepted in the United States of America (GAAP), management utilizes certain non-GAAP performance measures, Adjusted net income (loss), Adjusted EBITDA (loss), Adjusted EBITDA margin, Adjusted gross profit, and Adjusted gross margin, for purposes of evaluating our ongoing operations and for internal planning and forecasting purposes. We believe that these non-GAAP operating measures, when reviewed collectively with our GAAP financial information, provide useful supplemental information to investors in assessing our operating performance. Adjusted Net Income (Loss), Adjusted EBITDA and Adjusted EBITDA Margin Adjusted net income (loss), Adjusted EBITDA and Adjusted EBITDA margin are key performance measures that management uses to assess its operating performance. Because Adjusted net income (loss), Adjusted EBITDA and Adjusted EBITDA margin facilitates internal comparisons of our historical operating performance on a more consistent basis, we use these measures for business planning purposes. We also believe this information will be useful for investors to facilitate comparisons of our operating performance and better identify trends in our business. We expect Adjusted EBITDA margin to increase over the long-term as we continue to scale our business and achieve greater leverage in our operating expenses. We calculate Adjusted net income as Net income (loss) adjusted to exclude: change in fair value of Public and Private Placement Warrants, change in fair value of Earn-out Shares liability, Other expense (income), net; amortization expense; stock-based compensation expense; management fees incurred from our historical private equity owners; one-time or non-recurring items such as transaction costs (including transactions costs with respect to the Business Combination); restructuring costs (including those associated with COVID-19) and the aggregate adjustment for income taxes for the tax effect of the adjustments described above. We calculate Adjusted EBITDA as Net income (loss) adjusted to exclude: change in fair value of Public and Private Placement Warrants, change in fair value of Earn-out Shares liability, Other expense (income), net; Interest expense; Provision for income taxes; depreciation and amortization expense; stock-based compensation expense; foreign currency gain/loss; management fees incurred from our historical private equity owners; one-time or non-recurring items such as transaction costs (including transactions costs with respect to the Business Combination); and restructuring costs (including those associated with COVID-19). The following table reconciles our Net loss to Adjusted net income (loss) for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, Unaudited (in thousands) 2021 2020 2021 2020 Net loss $ (215,145) $ (2,214) $ (357,797) $ (21,682) Adjusted to exclude the following: Change in fair value of warrant liability 199,306 — 271,333 — Change in fair value of earn-out shares liability 10,575 — 47,100 — Amortization expense 3,521 3,068 9,373 9,468 Stock-based compensation expense 5,082 76 8,624 326 Other expense (income) (24) (23) 4,290 (84) Management fees (1) — 217 209 953 Transaction related costs (2) 1,156 204 32,313 1,011 Other non-recurring and one-time fees (3) 452 569 590 3,334 Aggregate adjustment for income taxes (2,437) (992) (13,252) (3,620) Adjusted net income (loss) $ 2,486 $ 905 $ 2,783 $ (10,294) 44 Table of Contents The following table reconciles our net loss to Adjusted EBITDA for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, Unaudited (in thousands) 2021 2020 2021 2020 Net loss $ (215,145) $ (2,214) $ (357,797) $ (21,682) Adjusted to exclude the following: Change in fair value of warrant liability 199,306 — 271,333 — Change in fair value of earn-out shares liability 10,575 — 47,100 — Depreciation and amortization expense 4,566 3,704 11,904 11,007 Stock-based compensation expense 5,082 76 8,624 326 Interest expense 530 5,629 8,289 15,447 Income tax benefit (1,129) (593) (3,305) (6,260) Other expense (income) (24) (23) 4,290 (84) Foreign currency (gain) loss, net 431 (14) 663 108 Management fees (1) — 217 209 953 Transaction related costs (2) 1,156 204 32,313 1,011 Other non-recurring and one-time fees (3) 452 569 590 3,334 Adjusted EBITDA $ 5,800 $ 7,555 $ 24,213 $ 4,160 Adjusted EBITDA margin 8.5% 21.9% 13.3% 5.1% ____________________ (1) Represents quarterly management fees paid to the majority shareholder of HydraFacial based on a pre-determined formula. Following the Business Combination, these fees are no longer paid. (2) For the nine months ended September 30, 2021 such amount primarily represents direct costs incurred with the Business Combination, including $21.0 million paid to the former owner of HydraFacial, and to prepare HydraFacial to be marketed for sale by HydraFacial’s shareholders in previous periods . (3) For the three and nine months ended September 30, 2021 such costs primarily represent one-time retention awards related to the distributor acquisitions. For the three and nine months ended September 30, 2020, respectively, such costs primarily represent COVID-19 related restructuring cost of $0.2 million and $2.3 million including write-off of expired Consumables, discontinued product lines, human capital and cash management consultants, and, to a lesser extent, costs associated with a former warehouse and assembly facility during the transition period. Adjusted Gross Profit and Adjusted Gross Margin We use Adjusted gross profit and Adjusted gross margin to measure our profitability and ability to scale and leverage the costs of our Delivery Systems and Consumables sales. The continued growth of our Delivery Systems installed will allow us to improve our Adjusted gross margin, as additional Delivery System units sold will increase our recurring Consumables revenue, which has higher margins. We believe Adjusted gross profit and Adjusted gross margin are useful measures to us and to our investors to assist in evaluating our operating performance because it provides consistency and direct comparability with our past financial performance and between fiscal periods, as the metric eliminates the effects of amortization and depreciation as well as stock-based compensation expense, which are non-cash expenses that may fluctuate for reasons unrelated to overall continuing operating performance. Adjusted gross margin has been and will continue to be affected by a variety of factors, including the product mix, geographic mix, direct vs. indirect mix, the average selling price on Delivery Systems, and new product launches. We expect our Adjusted gross margin to fluctuate over time depending on the factors described above. The following table reconciles Gross profit to Adjusted gross profit for the periods indicated. Amounts and percentages may not foot due to rounding. 45 Table of Contents Three Months Ended September 30, Nine Months Ended September 30, (in millions) 2021 2020 2021 2020 Net sales $ 68.1 $ 34.6 $ 182.2 $ 81.2 Cost of sales 22.1 13.6 57.1 37.1 Gross profit $ 46.1 $ 21.0 $ 125.1 $ 44.2 Gross margin 67.6% 60.6% 68.6% 54.4% Adjusted to exclude the following: Stock-based compensation expense included in cost of sales $ 0.1 $ — $ 0.2 $ — Depreciation and amortization expense included in cost of sales 2.6 2.7 7.7 8.2 Adjusted gross profit $ 48.7 $ 23.6 $ 133.0 $ 52.4 Adjusted gross margin 71.5% 68.3% 73.0% 64.5%