Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Form 10-K. This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 are not included in this Form 10-K, and can be found in the Company’s Registration Statement on Form S-1 (File No. 333-257995) filed with the Securities and Exchange Commission on July 19, 2021 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Recent Developments
CEO Transition
On November 9, 2021, by mutual agreement, the Board of Directors and Clinton Carnell, the Company’s Chief Executive Officer and member of the Board, determined that Mr. Carnell would transition out of his roles as Chief Executive Officer and as a member of the Board, in each case, effective December 31, 2021. These actions were not related to any matter regarding the Company’s financial condition, reported financial results, internal controls or disclosure controls and procedures. On January 1, 2022, Brenton L. Saunders, the Company’s Executive Chairman of the Board, assumed additional responsibilities as its interim Chief Executive Officer.
On January 20, 2022, we announced the appointment of Andrew Stanleick to serve as our President and Chief Executive Officer and as a member of the Board of Directors, effective as of February 7, 2022. In this capacity, Mr. Stanleick is serving as our principal executive officer. Upon Mr. Stanleick commencing employment as our Chief Executive Officer, Mr. Saunders, the Company’s then interim Chief Executive Officer and the Executive Chairman of the Board, ceased to serve as interim Chief Executive Officer. Mr. Saunders continues to serve as the Executive Chairman of the Board.
Warrant Redemption
In connection with Vesper’s initial public offering, the Company issued warrants to purchase 15,333,333 shares of the Company’s common stock for $11.50 per share (the “Public Warrants”). Simultaneously, with the consummation of Vesper Healthcare Acquisition Corp’s initial public offering, the Company issued 9,333,333 warrants to purchase shares of the Company’s common stock at $11.50 per share (the “Private Placement Warrants” and, together with the Public Warrants, the “Public and Private Placement Warrants”) to BLS Investor Group LLC (the “Sponsor”). On October 4, 2021, the Company issued a press release stating that it would redeem all of the Public Warrants that remained outstanding following 5:00 p.m. New York City time on November 3, 2021 (the “Redemption Date”). As of December 31, 2021, no Public Warrants were outstanding and approximately 7 million Private Placement Warrants remained outstanding .
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, 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 its Class A Common Stock is listed on the Nasdaq Capital Market under the ticker symbol “SKIN”.
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
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HydraFacial stockholders consisted of 35,501,743 newly issued shares of Class A Common Stock. The foregoing consideration paid to the HydraFacial stockholders also included 7,500,000 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. However, 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 product.
Impact of the COVID-19 Pandemic
The COVID-19 pandemic has had, and may 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 simultaneously implementing policies designed to reopen certain markets, we are working to ensure our compliance and maintain business continuity for essential operations. The majority of our customers are in the medical, (dermatologists and plastic surgeons), a/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
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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.
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, the measures we may be required to implement to contain the virus, and the resulting impact, such as 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, present material uncertainty and risk with respect to our performance and financial results. 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 incurred costs 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 and throughout 2021. We successfully managed the variable portion of our cost structure to better align with revenue, which was significantly reduced during the downturn. Additionally, all of our furloughed employees have returned to work.
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. 35% of HydraFacial’s total revenue during the fourth quarter of fiscal year 2021 came from outside the United States and Canada. Our diverse distribution channels
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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.
Regulation
It remains unclear how governmental authorities, including the 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.
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.
Year Ended December 31,
(dollars in millions) 2021 2020
Delivery Systems net sales $ 139.5 $ 53.4
Consumables net sales 120.6 65.7
Total net sales $ 260.1 $ 119.1
Gross profit $ 181.8 $ 67.2
Gross margin 69.9% 56.4%
Net loss $ (375.1) $ (29.2)
Adjusted EBITDA $ 32.7 $ 7.7
Adjusted EBITDA margin 12.6% 6.5%
Adjusted gross profit $ 192.5 $ 78.0
Adjusted gross margin 74.0% 65.5%
Adjusted net income (loss) $ 4.5 $ (12.1)
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 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
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HydraFacial’s cost of sales consists of Delivery Systems 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.
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 year ended December 31, 2021 and December 31, 2020 have been derived from the consolidated financial statements included elsewhere in this Form 10-K. Amounts and percentages may not foot due to rounding.
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Comparison of Year Ended December 31, 2021 to Year Ended December 31, 2020
Year Ended December 31,
(in millions) 2021 2020
Consolidated Statement of Operations
Net sales $ 260.1 $ 119.1
Cost of sales 78.3 51.9
Gross profit 181.8 67.2
Operating expenses
Selling and marketing 111.6 50.3
Research and development 8.2 3.4
General and administrative 98.7 30.6
Total operating expenses 218.5 84.4
Loss from operations (36.6) (17.2)
Total other expense 340.7 21.3
Loss before provision for income taxes (377.4) (38.5)
Income tax benefit (2.2) (9.3)
Net loss $ (375.1) $ (29.2)
Percentage of Net Sales
Net sales 100.0 % 100.0 %
Cost of sales 30.1 43.6
Gross profit 69.9 56.4
Operating expenses
Selling and marketing 42.9 42.3
Research and development 3.2 2.9
General and administrative 37.9 25.7
Total operating expenses 84.0 70.9
Loss from operations (14.1) (14.4)
Other expense, net 131.0 17.9
Loss before provision for income tax (145.1) (32.3)
Income tax benefit (0.9) (7.8)
Net loss (144.2) % (24.5) %
Net Sales
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
Net sales
Delivery Systems
$ 139.5 $ 53.4 $ 86.1 161.3%
Consumables 120.6 65.7 54.9 83.5%
Total net sales $ 260.1 $ 119.1 $ 141.0 118.4%
Percentage of net sales
Delivery Systems 53.6% 44.8%
Consumables 46.4% 55.2%
Total 100.0% 100.0%
Total net sales for the year ended December 31, 2021 increased $141.0 million, or 118.4%, compared to the year ended December 31, 2020. Delivery Systems sales for the year ended December 31, 2021 increased $86.1 million, or 161.3%, compared to the year ended December 31, 2020. Delivery Systems units sold for the year ended December 31, 2020 increased primarily due to continued sequential improvement in system sales, with the greatest relative year over year growth coming
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from the Asia-Pacific region. Similarly, Consumables sales for the year ended December 31, 2021 increased $54.9 million, or 83.5%, compared to the year ended December 31, 2020. The increase in Consumables sales was primarily attributable to rebounding sales volume and an increase in the number of units sold following slowdowns in relation to the COVID-19 pandemic.
Cost of Sales, Gross Profit, and Gross Margin
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
Cost of sales $ 78.3 $ 51.9 $ 26.4 50.8%
Gross profit $ 181.8 $ 67.2 $ 114.6 170.6%
Gross margin 69.9 % 56.4 %
Cost of sales increased 50.8% driven by increased sales volume and a shift in the product mix to HydraFacial Delivery Systems. Gross margin increased from 56.4% during the year ended December 31, 2020 to 69.9% during the year ended December 31, 2021 , primarily due to fixed cost leverage from higher sales volumes coupled with cost saving initiatives and margin accretion from distributor acquisitions, partially offset by higher logistics costs.
Selling and Marketing
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
Selling and marketing $ 111.6 $ 50.3 $ 61.3 121.7 %
As a percentage of net sales 42.9 % 42.3 %
Selling and marketing expense for the year ended December 31, 2021 increased $61.3 million, or 121.7%, compared to the year ended December 31, 2020. Selling and marketing expenses as a percentage of net sales has remained consistent with the increase in sales. The overall year-over-year increase was due to an increase in sales commissions of $19.4 million, which includes an increase of $1.8 million in sales commissions from international operations, compared to the year ended December 31, 2020. In addition, personnel-related expenses increased by $18.6 million, which included a $6.9 million increase from our international operations, which is primarily attributable to increased headcount. Stock-based compensation expense increased by $3.5 million, personnel-related training and certification expenses increased by $4.2 million and marketing spend increased by $4.8 million.
Research and Development
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
Research and development $ 8.2 $ 3.4 $ 4.8 140.4 %
As a percentage of net sales 3.2 % 2.9 %
Research and development expense for the year ended December 31, 2021 increased $4.8 million, or 140.4%, compared to the year ended December 31, 2020. The increase was primarily due to increased year-over-year expenses related to investments in new skincare treatment technologies of $3.4 million.
General and Administrative
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
General and administrative $ 98.7 $ 30.6 $ 68.1 222.0 %
As a percentage of net sales 37.9 % 25.7 %
General and administrative expense for the year ended December 31, 2021 increased $68.1 million, or 222.0%, compared to the year ended December 31, 2020. This increase is primarily attributable to increased transaction costs of $33.0 million related to the consummation of the Business Combination 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 year ended December 31, 2021 also drove an increase of $8.0 million in stock-based compensation which includes $1.4 million related to accelerated vesting due to the Business Combination. Personnel-related expenses increased by $10.4 million primarily due to increased headcount and higher sales.
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Other (Income) Expense, Net
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
Total other expense $ 340.7 $ 21.3 $ 319.4 1499.5 %
Other expense, net, was $340.7 million for the year ended December 31, 2021 compared to $21.3 million for the year ended December 31, 2020. The increase was primarily driven by the changes in the fair values of our Warrant liability (as defined below) and earn-out share liability of $277.3 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 Provision
Year Ended December 31, Change
(in millions) 2021 2020 Amount %
Income tax benefit $ (2.2) $ (9.3) $ 7.1 (75.9) %
Income tax benefit decreased primarily due to an increase in valuation allowance and various non-deductible expenses which include the revaluation of the warrants and contingent considerations from the business acquisitions lowering the effective tax rate of the benefit from 24.1% in December 31, 2020 to 0.6% on December 31, 2021.
Liquidity and Capital Resources
Our primary sources of capital have been funded by (i) cash flow from operating activities, (ii) net proceeds received from the consummation of the Business Combination, (iii) net proceeds received from the Notes (as defined below), and (iv) net proceeds received from the exercise of Public and Private Warrants. As of December 31, 2021, we had cash and cash equivalents of approximately $901.9 million. On September 14, 2021, we issued $750 million aggregate principal amount of our Notes. On October 4, 2021, we delivered a Notice of Redemption for all of our outstanding Public Warrants to purchase shares of our Class A Common Stock. On November 8, 2021, we announced 16.2 million Public Warrants were exercised for total cash proceeds of $185.4 million. In addition, 0.3 million of Private Placement Warrants were exercised for total cash proceeds of $3.0 million.
Our sources of liquidity and cash flows are used to fund ongoing operations, research and development projects for new products, services, and technologies, and provide ongoing support services for our providers and customers. Over the next year, we anticipate that we will use our liquidity and cash flows from our operations to fund our growth. In addition, as part of our business strategy, we occasionally evaluate potential acquisitions of businesses and products and technologies. Accordingly, a portion of our available cash may be used at any time for the acquisition of complementary products, services, or businesses. Such potential transactions may require substantial capital resources, which may require us to seek additional debt or equity financing. We cannot assure you that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, integrate acquired businesses into our current operations, or expand into new markets. Furthermore, we cannot provide assurances that additional financing will be available to us in any required time frame and on commercially reasonable terms, if at all.
We expect capital expenditures of up to $20.0 million for the year ended December 31, 2022. Based on our sources of capital (including the cash consideration received from the consummation of the Business Combination and the cash received from the issuance of the Notes), management believes that we have sufficient liquidity to satisfy our anticipated working capital requirements for our ongoing operations and obligations for at least the next twelve months. However, we will continue to evaluate our capital expenditure needs based upon factors including but not limited to 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, the continuing market acceptance of the Company’s products and services, expansion, and overall economic conditions.
If cash generated from operations is insufficient to satisfy our capital requirements, we may have to sell additional equity or debt securities or obtain expanded credit facilities to fund our operating expenses. The sale of additional equity would result in additional dilution to our stockholders. Also, 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. In the event such additional capital is needed in the future, there can be no assurance that such capital will be available to us, or,
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if available, that it will be in amounts and on terms acceptable to us. If we cannot raise additional funds when we need or want them, our operations and prospects could be negatively affected. However, if cash flows from operations become insufficient to continue operations at the current level, and if no additional capital were obtained, then management would restructure the Company in a way to preserve our business while maintaining expenses within operating cash flows.
Credit Agreement
On December 30, 2021, Edge Systems LLC, a California limited liability company (the “Borrower”) and an indirect wholly owned subsidiary of The Beauty Health Company, as borrower, entered into a Credit Agreement (the “Credit Agreement”) with Edge Systems Intermediate LLC, an indirect wholly owned subsidiary of the Company and the direct parent of the Borrower that holds the Company’s foreign and domestic operating entities, and The Hydrafacial Company Mexico Holdings, LLC, a direct wholly owned subsidiary of the Borrower that conducts the Mexican business operations, as guarantors (the “Guarantors” and, together with the Borrower, the “Loan Parties”), and JPMorgan Chase Bank, N.A., as administrative agent.
The Credit Agreement provides for a $50 million revolving credit facility with a maturity date of December 30, 2026. In addition, the Borrower has the ability from time to time to increase the revolving commitments or enter into one or more tranches of term loans up to an additional aggregate amount not to exceed $50 million, subject to receipt of lender commitments and certain conditions precedent. As of December 31, 2021, the Credit Agreement remains undrawn and there is no outstanding balance under the revolving credit facility.
Borrowings under the Credit Agreement are secured by certain collateral of the Loan Parties and are guaranteed by the Guarantors, each of whom will derive substantial benefit from the revolving credit facility. In specified circumstances, additional guarantors are required to be added. The Credit Agreement contains various restrictive covenants subject to certain exceptions, including limitations on the Borrower’s ability to incur indebtedness and certain liens, make certain investments, become liable under contingent obligations in certain circumstances, make certain restricted payments, make certain dispositions within guidelines and limits, engage in certain affiliate transactions, alter its fundamental business or make certain fundamental changes, and requirements to maintain financial covenants, including maintaining a leverage ratio of no greater than 3.00 to 1.00 and maintaining a fixed charge coverage ratio of not less than 1.15 to 1.00.
The leverage ratio also determines pricing under the Credit Agreement. At the Borrower’s option, borrowings under the revolving credit facility accrue interest at a rate equal to either LIBOR or a specified base rate plus an applicable margin. The applicable margin is linked to the leverage ratio. The margins range from 2.00% to 2.50% per annum for LIBOR loans and 1.00% to 1.50% per annum for base rate loans. The revolving credit facility is subject to a commitment fee payable on the unused revolving credit facility commitments ranging from 0.25% to 0.35%, depending on the Borrower’s leverage ratio. The Borrower is also required to pay certain fees to the administrative agent and letter of credit issuers under the revolving credit facility. During the term of the revolving credit facility, the Borrower may borrow, repay and re-borrow amounts available under the revolving credit facility, subject to voluntary reductions of the swing line, letter of credit and revolving credit commitments.
Convertible Senior Notes
On September 14, 2021, we issued $750 million aggregate principal amount of 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 Notes accrue interest at a rate of 1.25% per annum, payable semi-annually in arrears on April 1 and October 1 of each year, beginning on April 1, 2022. The Notes will mature on October 1, 2026, unless earlier repurchased, redeemed or converted. Before April 1, 2026, noteholders have the right to convert their Notes only upon the occurrence of certain events. From and after April 1, 2026, noteholders may convert their Notes at any time at their election until the close of business on the second scheduled trading day immediately before the maturity date. We will settle conversions by paying or delivering, as applicable, cash, shares of our Class A Common Stock or a combination of cash and shares of our Class A Common Stock, at our election. 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 Class A 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 $21.3 million. See Note 10 - Debt, to the Notes to Consolidated Financial Statements included elsewhere in this report.
Capped Call Transactions
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Capped call transactions cover the aggregate number of shares of our Class A 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 Consolidated Financial Statements included elsewhere in this report.
Contractual Obligations and Other Commercial Commitments
The following table discloses our material cash requirements as of December 31, 2021. In regards to future capital expenditures, we intend to use cash-on-hand and cash from operations to help satisfy future requirements.
Payments Due by Fiscal Period
(in millions) Total Less Than 1 Year 1-3 years 3-5 Years More than 5 Years
Notes and interest on the Notes (1)
$ 796.9 $ 9.4 $ 18.8 $ 768.8 $ —
Operating leases 18.1 4.1 7.3 1.9 4.8
Purchase commitments (2)
4.2 1.4 2.8 — —
Contingent consideration 0.8 0.8 — — —
Notes payable to seller (3)
2.2 — 2.2 — —
Total contractual obligations $ 822.2 $ 15.7 $ 31.1 $ 770.7 $ 4.8
_______________
(1) The Notes will mature on October 1, 2026 and are due either in cash or shares of the Company’s Class A Common Stock. From and after April 1, 2026, noteholders may convert their Notes into shares until the close of business on the second scheduled trading day immediately before the maturity date.
(2) Includes purchase commitments for software and services.
(3) The following amounts relate to amounts payable to the former owner of Ecomedic.
Cash Flows
The following table summarizes the activities from our statements of cash flows. Amounts may not foot due to rounding.
Year Ended December 31,
(in millions) 2021 2020 2019
Cash and cash equivalents at beginning of period $ 9.5 $ 7.3 $ 3.6
Operating activities:
Net loss
(375.1) (29.2) (1.6)
Non-cash adjustments 365.4 19.3 11.3
Changes in working capital (18.7) (2.6) (7.9)
Net cash flows used in operating activities (28.4) (12.4) 1.7
Net cash flows used in investing activities (37.7) (3.8) (12.5)
Net cash flows from financing activities 959.0 18.3 14.6
Net change in cash and cash equivalents 892.9 2.1 3.8
Effect of foreign currency translation (0.5) 0.2 (0.1)
Cash and cash equivalents at end of period $ 901.9 $ 9.5 $ 7.3
Operating Activities
Net cash used in operating activities of $28.4 million for the year ended December 31, 2021 was primarily due to the net loss of $375.1 million. The net loss was impacted by non-cash adjustments of $365.4 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 $18.7 million. The total increase in net operating assets and liabilities was primarily due to the increase in accounts receivable of $31.0 million and offset by an increase in accrued payroll and taxes.
Net cash used in operating activities of $12.4 million for the year ended December 31, 2020 was primarily due to the net loss of $29.2 million. The net loss was impacted by non-cash adjustments of $19.3 million primarily related to depreciation and amortization, partially offset by a decrease in net change in working capital of $2.6 million. The total increase in net operating
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assets and liabilities was primarily due to a $4.6 million increase in income tax receivables and a $0.1 million decrease in accrued payroll and other expenses offset by a $3.7 million decrease in accounts receivable.
Investing Activities
Cash used in investing activities for the year ended December 31, 2021 of $37.7 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, $11.2 million in capital expenditures and $4.4 million in capitalized software.
Cash used in investing activities for the year ended December 31, 2020 of $3.8 million was related to capital expenditures.
Financing Activities
Net cash from financing activities of $959.0 million for the year ended December 31, 2021 was primarily related to the proceeds received from the issuance of convertible senior notes and Business Combination. In addition, we received $188.4 million in proceeds for the exercise of the warrants as a result of the exercise of the redemption feature for the Public Warrants, and related to the exercise of Private Placement Warrants. 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 $18.3 million for the year ended December 31, 2020 was primarily related to proceeds from borrowings of $36.5 million, net of debt repayments and issuance costs of $16.8 million.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. In preparing the 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 consolidated financial statements include those noted below.
Revenue Recognition
Management’s Policy : 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.
Subjective Estimates and Judgements : The determination of the reduction of the transaction price for variable consideration requires that we make certain estimates and assumptions that affect the timing and amounts of revenue recognized. We estimate the variable consideration by taking into account factors such as historical information, current trends, forecasts, and availability of actual results and expectations of customer and consumer behavior.
Impact if Actual Results Differ from Estimates and Judgements : A more optimistic outlook on future demand can result in lower expected returns and reduced likelihood of price adjustments necessary to sell the product. This outlook will reduce the provision against revenue.
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Stock-Based Compensation
Management’s Policy : 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.
Subjective Estimates and Judgements : 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.
Impact if Actual Results Differ from Estimates and Judgements : If key inputs differ, the fair value of stock options and PSUs will be impacted. A higher fair value of the stock options and PSUs will result in higher share-based compensation expense over the vesting period of the grants and a lower fair value of the options will result in an understatement of share-based compensation expense over the vesting period.
Goodwill
Management’s Policy : 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 goodwill annually at the end of our fiscal year or whenever events or changes in circumstances indicate that an impairment may exist.
Subjective Estimates and Judgements : 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 the fair value of our reporting unit 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.
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, as well as our historical operating trends. Certain future events and circumstances, including deterioration of market conditions, higher cost of capital or a decline in actual and/or expected consumer consumption and demand, 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, 2021, 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 third 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.
Impact if Actual Results Differ from Estimates and Judgements : Changes in qualitative factors assessed, changes to assumptions used in the impairment test, selection and weighting of the various fair value techniques, and downturns in economic or business conditions, could have a significant adverse impact on the carrying value of goodwill and could result in impairment losses which could have a material impact on our financial condition and earnings.
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Intangible Assets
Management’s Policy : 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. If the assets have an indefinite life, these assets are assessed for impairment annually.
Subjective Estimates and Judgements : 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 and 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.
Impact if Actual Results Differ from Estimates and Judgements : Changes in qualitative factors assessed, changes to assumptions used in the impairment test, selection and weighting of the various fair value techniques, and downturns in economic or business conditions, could have a significant adverse impact on the carrying value of intangible assets and could result in impairment losses which could have a material impact on our financial condition and earnings.
Inventories
Management’s Policy : Inventories are stated at the lower of cost (determined by the first-in, first-out method) or net realizable value.
Subjective Estimates and Judgements : 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.
Impact if Actual Results Differ from Estimates and Judgements : If the assumptions around future demand for our inventory are more optimistic than actual future results, the net realizable value calculated using these assumptions may be overstated, resulting in an overstatement of the inventory balance.
Income Taxes
Management’s Policy : 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.
Subjective Estimates and Judgements : 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 December 31, 2021, we incurred cumulative pre-tax losses, and as a result, we do not rely on our 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.
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We recognized interest accrued and penalties related to unrecognized tax benefits in our income tax expense.
Impact if Actual Results Differ From Estimates and Judgments : Although management believes that the judgments and estimates used are reasonable, should actual factors and conditions differ materially from those considered by management, the actual realization of the net deferred tax asset and tax positions taken could differ materially from the amounts recorded in the financial statements. If we are not able to realize all or part of our net deferred tax asset in the future or if a tax position is overturned by a taxing authority, an adjustment to the deferred tax asset valuation allowance would be charged to income tax expense in the period such determination was made which could have a material impact on our earnings.
Warrant Liabilities
Management’s Policy : We classify the Public and Private Placement Warrants (“Warrant liabilities”) as liabilities on our 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 . The Warrant liabilities were initially recorded at fair value on the date of the Business Combination and at each reporting date thereafter. There were no Public Warrants outstanding as of December 31, 2021. The value of the Private Placement Warrants was determined at year end using the Monte Carlo simulation model. Changes in the fair value of these instruments are recognized within the Consolidated Statements of Comprehensive Loss.
Subjective Estimates and Judgements : The valuation technique requires assumptions and judgement around the inputs to be used. Specifically, there is a high degree of subjectivity and judgement in evaluating the determination of the expected share price volatility inputs used in the Monte Carlo model for the warrant derivative liability. Historical, implied, and peer group volatility levels provide a range of possible expected volatility inputs and the fair value estimates are sensitive to the expected volatility inputs.
Impact if Actual Results Differ From Estimates and Judgments : Changes around share price volatility can result in an increase or decrease in fair value which can substantially impact the outstanding liability and the change in fair value of warrant liabilities in the Consolidated Statements of Comprehensive Loss.
Convertible Senior Notes
Management’s Policy : 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.
Subjective Estimates and Judgements : The Notes required significant judgements around determining if any features of the Notes require bifurcation and whether to be treated as a free standing derivative financial instrument.
Impact if Actual Results Differ From Estimates and Judgments : If the decisions relating to the conversion option were misinterpreted it can have a material impact on the Consolidated Statement of Stockholder’s Equity.
Capped Call Transactions
Management’s Policy : We consider the freestanding capped call option contracts to 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 the 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.
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Subjective Estimates and Judgements : The capped call transactions required significant judgement on whether it would qualify as equity or as an asset or liability.
Impact if Actual Results Differ From Estimates and Judgments : If the decisions relating to the capped call transactions were misinterpreted and required classification as asset or liability, there could be a material impact on the Consolidated Balance Sheets.
Recent Accounting Pronouncements
See Note 2 of the notes to our Consolidated Financial Statements in the section titled “—Recently Issued Accounting Pronouncements” in our Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a discussion about new accounting pronouncements adopted and not yet adopted.
Known Trends or Uncertainties
We believe there are several emerging trends that may play a key role in shaping the future of the beauty health industry. Our market research demonstrated that consumers are increasingly willing to spend on high-end beauty health products. Some of the key industry trends identified by this market research are:
• Millennials/Gen Z aging : 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 experiences, such as those offered by HydraFacial.
• Influencers and social media driving purchase decisions : Social media personalities are increasingly opining and having an effect on skin care, which has gained more prominence in the age of selfies.
• Growth in disposable income : As the global economy grows, consumers have more disposable income to spend on premium products.
• Shift in spend from makeup to skin care : There appears to be an increasing movement towards treating underlying skin to make it healthy and reveal it (i.e.: “clean beauty”), as opposed to using products such as make up to cover it. Clean beauty places an emphasis on unveiling fresh, naked skin as the star, as opposed to covering it up. The HydraFacial experience not only physically cleanses skin with vortex suction, exfoliation and extraction, and removal of debris, but it also actively infuses the skin with innovative, clean ingredients to nourish and hydrate the newly cleaned skin canvas.
• Growth in multi-brand and online retailers : Multi-brand retailers and digital native brands play an important role in captivating the consumer and pushing innovation.
• Consumers shopping across mass and premium brands : Consumers appear to be willing to shop across mass and premium brands in order to allocate more money towards trending categories and products that help make them look and feel better.
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 we use to assess our operating performance. Because adjusted net income (loss), adjusted EBITDA and adjusted EBITDA margin
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facilitate 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 operating leverage.
We calculate adjusted net income (loss) 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; income tax benefit (expense); 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:
Year Ended December 31,
(in thousands)
2021 2020
Net loss $ (375,108) $ (29,175)
Adjusted to exclude the following:
Change in fair value of warrant liability
277,315 —
Change in fair value of earn-out shares liability
47,100 —
Amortization expense 13,297 11,981
Stock-based compensation expense 12,418 363
Other expense (income) 4,450 47
Management fees (1)
209 1,486
Transaction related costs (2)
34,913 4,223
Other non-recurring and one-time fees (3)
4,017 4,298
Aggregate adjustment for income taxes (14,133) (5,370)
Adjusted net income (loss) $ 4,478 $ (12,147)
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The following table reconciles our net loss to adjusted EBITDA for the periods indicated:
Year Ended December 31,
(in thousands) 2021 2020
Net loss $ (375,108) $ (29,175)
Adjusted to exclude the following:
Change in fair value of warrant liability 277,315 —
Change in fair value of earn-out shares liability 47,100 —
Depreciation and amortization expense 17,783 14,533
Stock-based compensation expense 12,418 363
Interest expense 11,777 21,275
Income tax benefit (2,242) (9,308)
Other expense (income) 4,450 47
Foreign currency (gain) loss, net 69 (21)
Management fees (1)
209 1,486
Transaction related costs (2)
34,913 4,223
Other non-recurring and one-time fees (3)
4,017 4,298
Adjusted EBITDA $ 32,701 $ 7,721
Adjusted EBITDA margin 12.6% 6.5%
____________________
(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 year ended December 31, 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 year ended December 31, 2021 such costs primarily represent recruiting fees for executive officers, severance and one-time retention awards related to the distributor acquisitions. For the year ended December 31, 2020 such costs primarily represent COVID-19 related restructuring cost of $1.2 million and $3.1 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 profitability and the ability to scale and leverage the costs of Delivery Systems and Consumables. The continued growth of Delivery Systems is expected to improve adjusted gross margin, as additional Delivery Systems sold will increase our recurring Consumables net sales, 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 they provide consistency and direct comparability with past financial performance and between fiscal periods, as the metric eliminates the effects of amortization and depreciation and 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:
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Year Ended December 31,
(in millions) 2021 2020
Net sales $ 260.1 $ 119.1
Cost of sales 78.3 51.9
Gross profit $ 181.8 $ 67.2
Gross margin 69.9% 56.4%
Adjusted to exclude the following:
Stock-based compensation expense included in cost of sales $ 0.4 $ —
Depreciation and amortization expense included in cost of sales 10.3 10.8
Adjusted gross profit $ 192.5 $ 78.0
Adjusted gross margin 74.0% 65.5%