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 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 condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q, in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2022 and June 30, 2022 filed with the U.S. Securities and Exchange Commission (SEC) on May 10, 2022 and August 9, 2022, respectively, and also with our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC on March 1, 2022. 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. Company Overview The Beauty Health Company is a global category-creating company focused on delivering beauty health experiences that help consumers reinvent their relationship with their skin, bodies and self-confidence. Our flagship brand, Hydrafacial, created the category of hydradermabrasion by using a patented Vortex-Fusion Delivery System to cleanse, extract, and hydrate the skin with proprietary solutions and serums. Hydrafacial provides a non-invasive and approachable skincare experience. Together, with our powerful community of aestheticians, consumers and partners, we are personalizing skin care solutions for all ages, genders, skin tones, and skin types. 27 Table of Contents Recent Developments; Factors Affecting Our Performance We remain attentive to economic and geopolitical conditions that may materially impact our business. We continue to explore and implement risk mitigation strategies in the face of these unfolding conditions and remain agile in adopting to changing circumstances. Such conditions have or may have global implications which may impact the future performance of our business in unpredictable ways. Impact of the COVID-19 Pandemic The COVID-19 pandemic continues to disrupt business for us, our providers, and other companies with which we do business. Although many markets have recently shown encouraging signs of emergence from the pandemic, other markets and regions where we conduct business, particularly in China, have enacted sporadic and/or zero-tolerance COVID-19 policies leading to prolonged store closures and travel restrictions within those markets and regions. Although we had strong performance during windows of re-opening, these COVID-related restrictions continued to negatively impact consumer traffic for our providers. We anticipate that COVID-19 will continue to cause intermittent store closures and supply chain challenges. We are mindful that these trends may continue to impact the pace of recovery, and that such recovery may be non-linear until COVID-19 containment measures are discontinued across all regions and normal consumer traffic resumes on a consistent basis. We currently expect that in the short term, any easing of containment measures and recovery of the impacted sectors of the economy will be gradual and uneven, as regions face resurgence of COVID-19 and related uncertainties. As a result, we anticipate that consumer spending habits and consumer confidence will continue to shift, causing future sales and volume trends to be non-linear. Furthermore, the extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous factors we cannot reliably predict, including but not limited to the duration and scope of the pandemic; businesses and individuals’ actions in response to the pandemic; government actions to certain pandemic impacts; and the impact on economic activity including the possibility of further financial market instability. Inflation During the three months ended September 30, 2022, we experienced the impact of inflation primarily on an increase in raw materials, shipping costs, and labor costs. We currently anticipate the impact of inflation to continue into the fourth quarter of 2022. To offset these trends, we plan to implement a range of mitigation strategies which could include price increases on our Delivery Systems and consumables, and/or accepting revenue in either U.S. dollar and/or local currency, as applicable. However, such measures may not fully offset the impact to our operating performance. After the resumption of more typical business conditions, the economics of developing, producing, launching, supporting and discontinuing products will continue to impact the timing of our sales and operating performance each period. Foreign Exchange Rates Our operations outside of the United States account for a portion of our revenues and expenses. As a result, a portion of our total revenue and expenses are denominated in currencies other than the U.S. dollar. Recently, exchange rates between these currencies and the U.S. dollar have fluctuated significantly and may continue to do so in the future. Fluctuations in foreign exchange rates may have a significant impact on our operating results. During the three months ended September 30, 2022, fluctuations in the U.S. dollar relative to certain other foreign currencies – such as the Chinese Renminbi, British pound, Euro and, Australian dollar – reduced our reported revenue and expenses, principally related to net sales, cost of sales, controllable fixed costs, and advertising and promotional costs. Global Supply Chain Challenges During the three months ended September 30, 2022, we experienced global supply chain challenges resulting from industry-wide component and/or raw material shortages and transportation delays. These challenges have negatively impacted order fill rates for our Delivery Systems and consumables, particularly in certain European and Asian countries. We continue to take steps to improve order fill rates and mitigate the impact of these constraints by working closely with our suppliers to ensure the availability of components and/or raw materials such as procuring components with longer lead times than typical. We expect these challenges to continue through the remainder of the fiscal year 2022. 28 Table of Contents Regulation It remains unclear how governmental authorities, including the Food and Drug Administration (“FDA”) and foreign government authorities, 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. The uncertainty around the timing, speed, and duration of the recovery from the adverse impacts of the COVID-19 pandemic, including the impacts on our business of the ongoing restrictions in China, and the other macroeconomic challenges we are facing, will continue to affect our ability to grow sales profitably. We believe we can, to some extent, offset the impact of more ordinary challenges by continually developing and pursuing a diversified strategy with multiple engines of growth and by accelerating initiatives focused on areas of strength, discipline, and agility. As the current situation continues to progress, if economic and social conditions or the degree of uncertainty or volatility worsen, or the adverse conditions previously described are further prolonged, there could be a further negative effect on consumer confidence, demand, spending and willingness or ability to travel and, as a result, on our business. We are continuing to monitor these and other risks that may affect our business. 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) 2022 2021 2022 2021 Delivery Systems net sales $ 49.1 $ 36.2 $ 155.5 $ 96.8 Consumables net sales 39.7 32.0 112.2 85.4 Total net sales $ 88.8 $ 68.1 $ 267.7 $ 182.2 Gross profit $ 61.6 $ 46.1 $ 185.2 $ 125.1 Gross margin 69.3% 67.6% 69.2% 68.6% Net income (loss) $ 0.1 $ (215.1) $ 40.6 $ (357.8) Adjusted net income (loss) $ 8.0 $ 2.5 $ 1.7 $ 2.8 Adjusted EBITDA $ 16.5 $ 5.8 $ 31.4 $ 24.2 Adjusted EBITDA margin 18.6% 8.5% 11.7% 13.3% Adjusted gross profit $ 66.6 $ 48.7 $ 196.3 $ 133.0 Adjusted gross margin 75.1% 71.5% 73.3% 73.0% 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. Comparison of Three Months Ended September 30, 2022 to Three Months Ended September 30, 2021 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 29 Table of Contents may be expected in the future. The results of operations data for the three and nine months ended September 30, 2022 and September 30, 2021 have been derived from the condensed consolidated financial statements included elsewhere in this Form 10-Q. Amounts and percentages may not foot due to rounding. Three Months Ended September 30, (in millions) 2022 % of Net Sales 2021 % of Net Sales Net sales $ 88.8 100.0 % $ 68.1 100.0 % Cost of sales 27.2 30.7 % 22.1 32.4 Gross profit 61.6 69.3 % 46.1 67.6 Operating expenses Selling and marketing 39.8 44.8 30.5 44.7 Research and development 2.2 2.4 1.9 2.8 General and administrative 23.8 26.8 19.2 28.2 Total operating expenses 65.7 74.0 51.5 75.6 Income (loss) from operations (4.1) (4.7) (5.5) (8.0) Other (income) expense, net (3.5) (3.9) 210.8 309.4 Income (loss) before provision for income tax (0.7) (0.8) (216.3) (317.4) Income tax expense (benefit) (0.8) (0.9) (1.1) (1.7) Net income (loss) $ 0.1 0.1 % $ (215.1) (315.7) % Net Sales Three Months Ended September 30, Change (in millions) 2022 2021 Amount % Net sales Delivery Systems $ 49.1 $ 36.2 $ 12.9 35.7% Consumables 39.7 32.0 7.7 24.2% Total net sales $ 88.8 $ 68.1 $ 20.7 30.3% Percentage of net sales Delivery Systems 55.3% 53.1% Consumables 44.7% 46.9% Total 100.0% 100.0% Total net sales for the three months ended September 30, 2022 increased $20.7 million, or 30.3%, compared to the three months ended September 30, 2021. Delivery System sales for the three months ended September 30, 2022 increased $12.9 million, or 35.7%, compared to the three months ended September 30, 2021. Net sales for the three months ended September 30, 2022 increased primarily due to strength in Delivery Systems sales. There were 1,860 Delivery Systems units sold for the three months ended September 30, 2022. Delivery Systems units sold for the three months ended September 30, 2022 increased primarily due to the strong demand for the Company’s new Syndeo delivery system. Consumables sales for the three months ended September 30, 2022 increased $7.7 million, or 24.2%, compared to the three months ended September 30, 2021. The increase in Consumables sales was primarily attributable to increased placements of delivery systems and the adjoining consumption of consumables during the three months ended September 30, 2022. Cost of Sales, Gross Profit, and Gross Margin Three Months Ended September 30, Change (in millions) 2022 2021 Amount % Cost of sales $ 27.2 $ 22.1 $ 5.1 23.3% Gross profit $ 61.6 $ 46.1 $ 15.5 33.6% Gross margin 69.3 % 67.6 % Cost of sales increased $5.1 million driven by and in conjunction with increased sales volume in delivery systems and consumables. Gross margin increased from 67.6% during the three months ended September 30, 2021 to 69.3% during the three 30 Table of Contents months ended September 30, 2022, primarily due to fixed cost leverage associated with higher volume and stronger realized delivery systems pricing. The improvement in adjusted gross margin was driven by fixed cost leverage associated with higher volume and stronger realized delivery systems pricing, and a one-time write-off primarily related to the discontinued Glow & Go pilot program, partly offset by headwinds from global supply chain challenges, inflationary pressures and foreign exchange rates. Operating Expenses Sales and Marketing Three Months Ended September 30, Change (in millions) 2022 2021 Amount % Selling and marketing $ 39.8 $ 30.5 $ 9.3 30.6 % As a percentage of net sales 44.8 % 44.7 % Selling and marketing expense for the three months ended September 30, 2022 increased $9.3 million , or 30.6%, compared to the three months ended September 30, 2021. The increase was driven by an increase in personnel-related expenses of $1.1 million resulting from an increase in headcount and commissions, and an increase in s tock-based compensation expense of $2.5 million. The increase in selling and marketing expense was partially offset by a $2.6 million reduction in the accrual for estimated bonus expenses, which were originally accrued at 200% of target amounts. In addition, travel expenses increased by $1.5 million and marketing spend increased by $2.8 million due primarily to the investments in Americas and EMEA in key tradeshows and other marketing programs. Research and Development Three Months Ended September 30, Change (in millions) 2022 2021 Amount % Research and development $ 2.2 $ 1.9 $ 0.3 15.3 % As a percentage of net sales 2.4 % 2.8 % Research and development expense for the three months ended September 30, 2022 increased $0.3 million , or 15.3%, compared to the three months ended September 30, 2021. The increase was primarily due to increased spend in personnel of $0.3 million and certain product write-offs during the period. General and Administrative Three Months Ended September 30, Change (in millions) 2022 2021 Amount % General and administrative $ 23.8 $ 19.2 $ 4.6 23.9 % As a percentage of net sales 26.8 % 28.2 % General and administrative expense for the three months ended September 30, 2022 increased $4.6 million, or 23.9%, compared to the three months ended September 30, 2021. This increase is primarily attributable to an increase of $0.3 million in stock-based compensation and $2.6 million in recruiting and other professional fees. The increase in general and administrative expense was partially offset by a $2.9 million reduction in the accrual for estimated bonus expenses, which were originally accrued at 200% of target amounts. Other (Income) Expense, Net and Income Tax (Benefit) Expense Three Months Ended September 30, Change (in millions) 2022 2021 Amount % Other (income) expense, net $ (3.5) $ 210.8 $ (214.3) (101.6) % Income tax (benefit) expense $ (0.8) $ (1.1) $ 0.3 (27.3) % Other income, net was $3.5 million for the three months ended September 30, 2022 compared to other expense of $210.8 million for the three months ended September 30, 2021. The change was primarily driven by the changes in the fair values of our warrants and earn-out shares issued on July 15, 2021. During the three months ended September 30, 2022 the Company recognized other income of $4.3 million due to the change in the fair value of the warrant liabilities compared to an expense of $199.3 million for the three months ended September 30, 2021. In addition, during the three months ended September 30, 2021 the Company recognized a $10.6 million expense for the change in the fair value of the earn-out shares liability. 31 Table of Contents Comparison of Nine Months Ended September 30, 2022 to Nine Months Ended September 30, 2021 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, 2022 and September 30, 2021 have been derived from the condensed consolidated financial statements included elsewhere in this Form 10-Q. Amounts and percentages may not foot due to rounding. Nine Months Ended September 30, (in millions) 2022 % of Net Sales 2021 % of Net Sales Net sales $ 267.7 100.0 % $ 182.2 100.0 % Cost of sales 82.6 30.8 57.1 31.4 Gross profit 185.2 69.2 125.1 68.6 Operating expenses Selling and marketing 121.1 45.2 74.5 40.9 Research and development 7.0 2.6 6.3 3.5 General and administrative 77.6 29.0 73.6 40.4 Total operating expenses 205.7 76.8 154.5 84.8 Loss from operations (20.5) (7.7) (29.4) (16.2) Other (income) expense, net (63.0) (23.5) 331.7 182.0 Income (loss) before provision for income tax 42.4 15.9 (361.1) (198.2) Income tax expense (benefit) 1.9 0.7 (3.3) (1.8) Net income (loss) $ 40.6 15.2 % $ (357.8) (196.4) % Net Sales Nine Months Ended September 30, Change (in millions) 2022 2021 Amount % Net sales Delivery Systems $ 155.5 $ 96.8 $ 58.7 60.7% Consumables 112.2 85.4 26.8 31.4% Total net sales $ 267.7 $ 182.2 $ 85.5 47.0% Percentage of net sales Delivery Systems 58.1% 53.1% Consumables 41.9% 46.9% Total 100.0% 100.0% Total net sales for the nine months ended September 30, 2022 increased $85.5 million, or 47.0%, compared to the nine months ended September 30, 2021. Delivery Systems sales for the nine months ended September 30, 2022 increased $58.7 million, or 60.7%, compared to the nine months ended September 30, 2021. Net sales for the nine months ended September 30, 2021 increased primarily due to strength in Delivery Systems sales. Consumables sales for the nine months ended September 30, 2022 increased $26.8 million, or 31.4%, compared to the nine months ended September 30, 2021. The increase in Consumables sales was primarily attributable to increased placements of delivery systems and the adjoining consumption of consumables during the nine months ended September 30, 2022. Cost of Sales, Gross Profit, and Gross Margin Nine Months Ended September 30, Change (in millions) 2022 2021 Amount % Cost of sales $ 82.6 $ 57.1 $ 25.5 44.5% Gross profit $ 185.2 $ 125.1 $ 60.1 48.1% Gross margin 69.2 % 68.6 % 32 Table of Contents Gross margin improved to 69.2% during the nine months ended September 30, 2022, driven by fixed cost leverage associated with higher volume and stronger realized delivery systems pricing, and a one-time write-off primarily related to the discontinued Glow & Go pilot program, partly offset by headwinds from global supply chain challenges, inflationary pressures and foreign exchange rates. Selling and Marketing Nine Months Ended September 30, Change (in millions) 2022 2021 Amount % Selling and marketing $ 121.1 $ 74.5 $ 46.6 62.4 % As a percentage of net sales 45.2 % 40.9 % Selling and marketing expense for the nine months ended September 30, 2022 increased $46.6 million, or 62.4%, compared to the nine months ended September 30, 2021. Compared to the nine months ended September 30, 2021 the year-over-year increase was due to an increase in sales commissions of $4.1 million, an increase in personnel-related expenses of $12.8 million, and an increase of stock-based compensation expense of $7.0 million. The increase in personnel-related expenses was partially offset by a $2.6 million reduction in the accrual for estimated bonus expenses, which were originally accrued at 200% of target amounts. Personnel-related training and travel expenses increased by $6.1 million due to the launch of Syndeo and advertising/promotional spend increased by $10.5 million due to investments in Americas and EMEA in key tradeshows and other marketing programs. Research and Development Nine Months Ended September 30, Change (in millions) 2022 2021 Amount % Research and development $ 7.0 $ 6.3 $ 0.7 10.7 % As a percentage of net sales 2.6 % 3.5 % Research and development expense for the nine months ended September 30, 2022 increased $0.7 million, or 10.7%, compared to the nine months ended September 30, 2021. The increase was primarily due to additional personnel-related expense which increased by $2.3 million year-over-year. There were additional investments into our data infrastructure which increased by $1.2 million, offset by a $3.5 million decrease in Syndeo research and development expenses. General and Administrative Nine Months Ended September 30, Change (in millions) 2022 2021 Amount % General and administrative $ 77.6 $ 73.6 $ 4.0 5.4 % As a percentage of net sales 29.0 % 40.4 % General and administrative expense for the nine months ended September 30, 2022 increased $4.0 million, or 5.4%, compared to the nine months ended September 30, 2021. This increase is primarily attributable to an increase of $5.1 million in stock-based compensation, $5.6 million in personnel-related expenses, $7.7 million in recruiting and other professional fees, $2.7 million in legal fees, and $1.4 million in director and officer insurance, partially offset by a decrease in transaction costs of $28.4 million related to the consummation of the Business Combination. The increase in personnel-related expenses was partially offset by a $2.9 million reduction in the accrual for estimated bonus expenses, which were originally accrued at 200% of target amounts. Other (Income) Expense, Net and Income Tax Provision Nine Months Ended September 30, Change (in millions) 2022 2021 Amount % Other (income) expense, net $ (63.0) $ 331.7 $ (394.7) (119.0) % Income tax expense (benefit) $ 1.9 $ (3.3) $ 5.2 (156.6) % Other income, net, was $63.0 million for the nine months ended September 30, 2022 compared to other expense of $331.7 million for the nine months ended September 30, 2021. The change was primarily driven by the changes in the fair values of our warrant liabilities and earn-out share liabilities which were issued on July 15, 2021. During the nine months ended 33 Table of Contents September 30, 2022, the Company recognized other income of $71.5 million due to the change in the fair value of the warrant liabilities versus a $271.3 million expense for nine months ended September 30, 2021. In addition, during the nine months ended September 30, 2021 the Company recognized a $47.1 million expense for the change in the fair value of the earn-out shares liability. 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 Placement Warrants. As of September 30, 2022 , we had cash and cash equivalents of approximately $684.2 million. A revolving credit facility of $50 million is also available as a source of capital. As of September 30, 2022, the revolving credit facility remains undrawn and there is no outstanding balance thereunder. Our operating cash flows result primarily from cash received from sales of delivery systems and consumables, offset primarily by cash payments made for products and services, employee compensation, payment processing and related transaction costs, operating leases, marketing expenses, and interest payments on our long-term obligations. Cash received from our customers and other activities generally corresponds to our net sales. 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 ending 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, 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, Hydrafacial LLC, a California limited liability company f.k.a. Edge Systems LLC (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. 34 Table of Contents 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 September 30, 2022, 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. As of September 30, 2022 the Company’s unused commitment rate was 0.25%. 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 the Condensed Consolidated Financial Statements included elsewhere in this report. Capped Call Transactions 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 As of September 30, 2022, our material contractual obligations are approximately $37.5 million in interest-only payments related to the Notes, the Notes of $750 million, and $16.4 million in lease obligations. Known Trends or Uncertainties 35 Table of Contents The majority of our customers are in the medical, (dermatologists and plastic surgeons), aesthetician, and beauty retail industry. Although we have not seen any significant reduction in revenues to date due to consolidations, we have seen some consolidation in our industry during economic downturns. These consolidations have not had a negative effect on our total sales; however, should consolidations and downsizing in the industry continue to occur, those events could adversely impact our revenues and earnings going forward. Furthermore, during the nine months ended September 2022, we have experienced global supply chain disruptions and a significant inflationary impact, including higher interest rates and capital costs, increased shipping costs, supply shortages, increased costs of labor and strengthened U.S. dollar. In particular, we have seen increased costs associated with our global operations in foreign countries as a result of weakening exchange rates, as our international sales are primarily denominated in the local currency of such foreign country. Also, as a result of the invasion of Ukraine by Russia, we stopped selling and shipping products into our distributor in Russia, which has negatively impacted our overall net sales in the EMEA region. These impacts have created headwinds for our products and profits that we expect to continue through the remainder of the year. In addition, the extent to which the uncertainty around the timing, speed and recovery from the adverse impacts of the COVID-19 pandemic impacts our business going forward will depend on numerous factors we cannot reliably predict, including further governmental actions in the countries in which we operate, such as China’s ongoing zero COVID policy, and the other macro challenges we are facing, as well as the impact of any governmental actions on the economy, 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, if economic and social conditions or the degree of uncertainty or volatility worsen, or the adverse conditions previously described are further prolonged, our growth rate could be affected by consolidation and downsizing in the medical, esthetician, and beauty retail industry. We are continuing to monitor these and other risks that may affect our business so that we can respond appropriately. Off-Balance Sheet Arrangements We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial condition or results of operations. 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) 2022 2021 Cash and cash equivalents at beginning of period $ 901.9 $ 9.5 Operating activities: Net income (loss) 40.6 (357.8) Non-cash adjustments (20.7) 343.5 Changes in working capital (121.1) (17.4) Net cash flows (used in) provided by operating activities (101.2) (31.6) Net cash flows (used in) provided by investing activities (16.0) (29.2) Net cash flows (used in) provided by financing activities (102.8) 770.8 Net change in cash and cash equivalents (220.0) 710.0 Effect of foreign currency translation 2.3 (0.8) Cash and cash equivalents at end of period $ 684.2 $ 718.6 Operating Activities Net cash used in operating activities of $101.2 million for the nine months ended September 30, 2022 was primarily due to investment in inventory in relation to the global launch of Syndeo Delivery Systems, combined with a corresponding shift in the average collection period of receivables related to increased payment plan participation on delivery systems globally, as well as continued investments globally in people and systems to fuel future growth. The net income of $40.6 million was driven by 36 Table of Contents non-cash adjustments of $20.7 million, with the largest adjustment being the fair value adjustment to warrant liabilities. The decrease in working capital of $121.1 million was primarily due to the increase in accounts receivable of $40.6 million and the increase in inventory of $69.3 million. Net cash used in operating activities of $31.6 million for the nine months ended September 30, 2021 was primarily due to an increase in accounts receivable of $17.3 million. The net loss of $357.8 million was driven by non-cash adjustments of $343.5 million, primarily related to fair value adjustments to earn-out shares and warrant liabilities, and a decrease in working capital of $17.4 million. Investing Activities Cash used in investing activities for the nine months ended September 30, 2022 of $16.0 million was primarily related to $9.9 million in capital expenditures for property and equipment, $1.5 million in capital expenditures for the asset acquisition of Mxt and related developed technology, and $4.7 million in capitalized software. 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. Financing Activities There was $102.8 million used in financing activities for the nine months ended September 30, 2022 of which $100.0 million was used in relation to the accelerated stock repurchase and $2.8 million in relation to the distributor acquisitions of Wigmore and Sidermica. The Company did not withdraw from the line of credit and there were no transactions related to the warrants during the nine months ended September 30, 2022. Net cash from financing activities of $770.8 million for the nine months ended September 30, 2021 was primarily related to proceeds received from the issuance of convertible senior notes and the Business Combination. The proceeds were offset by the payoff of long-term debt of $225.5 million and costs from our issuance of convertible senior notes. 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. There has been no change to our critical accounting policies as included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. Recent Accounting Pronouncements See Note 2 of the notes to our Condensed Consolidated Financial Statements in the section titled “Summary of Significant Accounting Policies” in our Note 2 to our condensed 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. 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. 37 Table of Contents 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 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 income (loss) to adjusted net income (loss) and adjusted EBITDA for the periods indicated: Three months ended September 30, Nine months ended September 30, Unaudited (in thousands) 2022 2021 2022 2021 Net income (loss) $ 131 $ (215,145) $ 40,569 $ (357,797) Adjusted to exclude the following: Change in fair value of warrant liability (4,284) 199,306 (71,521) 271,333 Change in fair value of earn-out shares liability — 10,575 — 47,100 Amortization expense 3,937 3,521 11,588 9,373 Loss on disposal of assets 4,697 — 4,697 — Stock-based compensation expense 7,449 5,082 20,876 8,624 Other (income) expense (2,509) (24) (3,230) 4,290 Management fees (1) — — — 209 Transaction related costs (2) — 1,156 3,025 32,313 Other non-recurring and one-time fees (3) 2,595 452 6,452 590 Aggregate adjustment for income taxes (4,021) (2,437) (10,744) (13,252) Adjusted net income (loss) $ 7,995 $ 2,486 $ 1,713 $ 2,783 Depreciation expense 2,001 1,028 5,269 2,446 Interest expense 3,380 530 9,997 8,289 Foreign currency (gain) loss, net (38) 431 1,800 663 Remaining benefit for income taxes 3,200 1,325 $ 12,614 $ 10,032 Adjusted EBITDA $ 16,538 $ 5,800 $ 31,393 $ 24,213 Adjusted EBITDA margin 18.6% 8.5% 11.7% 13.3% ___________________ (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, 2022, such amounts primarily represent direct costs incurred in relation to potential acquisitions. For the three months ended September 30, 2021, such amounts primarily represent direct costs incurred in relation to 38 Table of Contents potential acquisitions. For the nine months ended September 30, 2021, such amounts primarily represent direct costs incurred in relation to potential acquisitions, direct costs incurred with the Business Combination and to prepare Hydrafacial to be marketed for sale by Hydrafacial’s shareholders in previous periods . (3) For the three months ended September 30, 2022, such costs primarily represent a write-off related to the discontinued Glow & Go pilot program. For the nine months ended September 30, 2022, such costs include the re-organization severance, other personnel costs related to executive recruiting, executive severance, a loss on fixed asset and Glow & Go-related write-offs and a CEO sign-on bonus . 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: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Net sales $ 88,792 $ 68,147 $ 267,743 $ 182,197 Cost of sales 27,217 22,072 82,577 57,131 Gross profit $ 61,575 $ 46,075 $ 185,166 $ 125,066 Gross margin 69.3 % 67.6 % 69.2 % 68.6 % Adjusted to exclude the following: Write-off of discontinued product (1) $ 2,048 $ — $ 2,048 $ — Stock-based compensation expense included in cost of sales 191 70 624 222 Depreciation and amortization expense included in cost of sales 2,833 2,589 8,457 7,747 Adjusted gross profit $ 66,647 $ 48,734 $ 196,295 $ 133,035 Adjusted gross margin 75.1 % 71.5 % 73.3 % 73.0 % ___________________ (1) Represents a one-time write-off primarily related to the discontinued Glow & Go pilot program.