FIGS, Inc. (FIGS) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Part I, Item 1A. “Risk Factors” and other factors set forth in other parts of this Annual Report on Form 10-K. A discussion of the year ended December 31, 2020 compared to the year ended December 31, 2019 has been reported previously in our final prospectus dated September 15, 2021, filed with the SEC on September 17, 2021 pursuant to Rule 424(b) of the Securities Act (the “Prospectus”), under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Overview
Our mission is to celebrate, empower and serve those who serve others.
We are a founder-led, direct-to-consumer healthcare apparel and lifestyle brand that seeks to celebrate, empower and serve current and future generations of healthcare professionals. We are committed to helping this growing, global community of professionals, whom we refer to as Awesome Humans, look, feel and perform at their best—24/7, 365 days a year. We create technically advanced apparel and products that feature an unmatched combination of comfort, durability, function and style, all at an affordable price. In doing so, we have redefined what scrubs are—giving rise to our tag-line: why wear scrubs, when you can #wearFIGS?
We have revolutionized the large and fragmented healthcare apparel market. We branded a previously unbranded industry and de-commoditized a previously commoditized product—elevating scrubs and creating premium products for healthcare professionals. Most importantly, we built a community and lifestyle around a profession. As a result, we have become the industry’s category-defining healthcare apparel and lifestyle brand.
We generate revenue by selling technically advanced apparel for the modern healthcare professional. Our offerings include scrubwear, as well as lifestyle apparel and other non-scrub offerings, such as lab coats, underscrubs, outerwear, loungewear, compression socks, footwear and masks. We design all of our products in-house, leverage third-party suppliers and manufacturers to produce our raw materials and finished products, and utilize shallow initial buys and data-driven repurchasing decisions to test new products. We directly and actively manage every step of our product development and production process to ensure that our extremely high quality standards are met. We also have a highly efficient merchandising model—due to the non-discretionary, replenishment nature of healthcare apparel, we maintain low inventory risk driven by a high volume of repeat purchases and a focus on our core scrubs offerings. We primarily market and sell our products through our digital platform, consisting of our website and mobile app, to a rapidly growing community of loyal customers.
At December 31, 2021, we had approximately 1.9 million active customers. Our customers come to us through word of mouth referrals, as well as through our data-driven brand and performance marketing efforts. See the section titled “Key Operating Metrics and Non-GAAP Financial Measures” for a definition of active customers.
In the year ended December 31, 2021, we had the following results compared to the comparable periods in 2020:
o
Expanded our community of active customers by 46.0% from approximately 1.3 million at December 31, 2020 to approximately 1.9 million at December 31, 2021;
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Net revenues increased from $263.1 million to $419.6 million in the year ended December 31, 2021, representing 59.5% year-over-year growth;
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Gross margin decreased 0.5 percentage points from 72.3% to 71.8% in the year ended December 31, 2021;
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Net operating income decreased from $57.9 million to $11.0 million in the year ended December 31, 2021;
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Adjusted EBITDA increased from $69.1 million to $105.2 million in the year ended December 31, 2021, representing an Adjusted EBITDA Margin of 25.1%;
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Cash flow from operations increased from $21.7 million to $66.4 million in the year ended December 31, 2021; and
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Free cash flow increased from $19.5 million to $63.7 million in the year ended December 31, 2021.
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See the section titled “Key Operating Metrics and Non-GAAP Financial Measures” for information regarding Adjusted EBITDA, Adjusted EBITDA Margin and free cash flow, including a reconciliation to the most directly comparable financial measures prepared in accordance with U.S. GAAP.
COVID-19 Update
We believe the COVID-19 pandemic has accelerated the awareness of the FIGS brand and a shift in purchasing decisions that will continue to drive future growth; however, there can be no assurance that these trends will continue.
The ongoing COVID-19 pandemic has continued to negatively impact global supply chains and cause challenges to logistics, including causing ocean freight delays, reliability and capacity issues, port congestion, increased ocean and air freight rates and labor shortages. Certain of our ocean freight providers, as well as some of our suppliers and manufacturers, particularly those operating in Vietnam, have experienced delays and shutdowns, and could experience delays and shutdowns again in the future due to the COVID-19 pandemic.
As we seek to timely and cost effectively fulfill orders and ship products to our customers, we have been able to continue to produce our products without significant disruptions and have taken successful measures to mitigate these macroeconomic challenges to which we are not immune. For example, to meet our customers’ expectations, we have from time to time shipped goods earlier when possible and adjusted shipments to alternate origin and destination ports to avoid delays. We have also from time to time used faster but more expensive air freight in the quarter and year ended December 31, 2021, which increased our cost of goods sold.
Our replenishment-driven model has also been a key part of our ability to navigate these challenges. Nearly 90% of our production utilizes our main scrubwear fabric technology FIONx and almost half of our revenue is generated by our core scrubwear styles in core colors, which are in demand year-round. As a result, we have been able to produce our raw materials and finished products farther in advance and hold greater inventory without significant risk of obsolescence or exposure to seasonality.
We believe we have managed effectively through COVID-19 logistical challenges. We nevertheless expect we will continue to contend with elevated ocean and air freight rates, unpredictable ocean transit times and other COVID-19 related logistical challenges. The COVID-19 pandemic may also continue to adversely affect workforces, supply chains, economies and financial markets globally, potentially leading to an economic downturn and a reduction in consumer spending or an inability for our suppliers, vendors or other parties with whom we do business to meet their contractual obligations, any of which could negatively impact our business and results of operations.
Initial Public Offering
On June 1, 2021, we completed our initial public offering (“IPO”) by issuing 4,636,364 shares of our Class A common stock at a price to the public of $22.00 per share, resulting in net proceeds to us of $95.1 million, after deducting the underwriting discount and commissions of $6.1 million and deferred offering expenses of $0.8 million, net of reimbursements. The Company incurred a total of $8.7 million of expenses, before reimbursements, in connection with the IPO.
Follow-on Offering
On September 20, 2021, we completed a follow-on offering (the “Follow-on Offering”) in which Tulco, LLC, the Company’s majority stockholder, and our co-founders and co-Chief Executive Officers, as selling stockholders, sold an aggregate of 10,254,992 shares of the Company’s Class A common stock in a registered public offering at a price to the public of $40.25 per share. We did not sell any shares of Class A common stock in the Follow-on Offering and did not receive any of the proceeds from the sale of shares by the selling stockholders.
In connection with the Follow-on Offering, 1,468,324 shares of the Company’s Class B common stock were converted at a 1:1 ratio into shares of the Company’s Class A common stock.
Key Factors Affecting Our Performance
We believe that our performance and future success depend on a number of factors that present significant opportunities for us. These factors also pose risks and challenges, including those discussed in Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K for the year ended December 31, 2021.
Brand Awareness and Loyalty
Our ability to promote and maintain brand awareness and loyalty is critical to our success. We have a significant opportunity to continue to grow our brand awareness and loyalty through word of mouth, brand marketing and performance marketing. We have made significant investments to strengthen the FIGS brand through our marketing strategy, which includes brand marketing
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campaigns across platforms, including email, digital, display, site, direct-mail, commercials, social media and Ambassadors, as well as performance marketing efforts, including retargeting, paid search and product listing advertisements, paid social media advertisements, search engine optimization, personalized email and mobile push notifications through our app. We plan to continue to invest in our brand and performance marketing to help drive our future growth.
Net Revenues per Active Customer
We believe the growth in our net revenues per active customer demonstrates our increasing value proposition for our customer base. We calculate net revenues per active customer as the total net revenues for a specified time period divided by the number of active customers during that same time period. Through our differentiated core products, limited edition color and style releases and lifestyle apparel and other non-scrub products, we have repeatedly drawn customers back to our digital platform and increased our net revenues per active customer. As we continue to expand our products to fully outfit the medical professional, we believe we have a significant opportunity to continue to expand our share of both the uniform and lifestyle wardrobe of our customers and increase our net revenues per active customer over time. Our future growth will depend in part on our ability to continue to increase our net revenues per active customer.
Customer Acquisition Cost
Our business performance depends in part on our continued ability to cost-effectively acquire new customers. We define customer acquisition cost (“CAC”), as performance and brand marketing expense attributable to both new customer acquisition and repeat customer retention in a period divided by the customers acquired during that same period. Our strategic investments in performance marketing, such as retargeting, paid search and product listing advertisements, paid social media advertisements, search engine optimization, personalized email and mobile push notifications through our app, compounded with strong brand awareness driven largely through word of mouth, have led to significant improvements in CAC.
Customer Retention and Engagement
Our continued success depends in part on our ability to retain, and drive repeat purchases from, our existing customers. We monitor retention across our entire customer base. Our goal is to attract and convert visitors into active customers and foster relationships that drive repeat purchases. As of December 31, 2021, we had approximately 1.9 million active customers, up from approximately 1.3 million active customers as of December 31, 2020. Over the last four years, we have consistently increased the percentage of net revenues from repeat customers while also continuing to increase the number of new customers acquired. These newly acquired customers frequently make one or more repeat purchase in the same year, which is supplemented by the embedded growth from prior-year cohorts’ customers who continue to purchase from us.
The increasing share of our net revenues from customers who have made a previous purchase with us in a prior year reflects our customer loyalty and the net revenues retention behavior we see in our cohorts. We believe the increasing contribution from repeat customers is reflective of our ability to engage and retain our customers through our differentiated product offerings, community-driven brand and customized customer experience. This cohort behavior demonstrates our ability to not only retain customers, but also to increase our customers’ spend as they place orders more frequently.
Components of our Results of Operations
Net Revenues
Net revenues consist of sales of healthcare apparel, footwear and other products primarily through our digital platform. We recognize product sales at the time control is transferred to the customer, which is when the product is shipped to the customer. Net revenues represent the sale of these items and shipping revenue, net of estimated returns and discounts. Net revenues are primarily driven by the growth in the number of active customers, the frequency with which customers purchase and the average order value.
Cost of Goods Sold
Cost of goods sold consists principally of the cost of purchased merchandise and includes import duties and other taxes, freight-in, defective merchandise returned by customers, inventory write-offs and other miscellaneous shrinkage. Our cost of goods sold has and may continue to fluctuate with the cost of the raw materials used in our products and freight costs.
Gross Profit and Gross Margin
We define gross profit as net revenues less cost of goods sold. Gross margin is gross profit expressed as a percentage of net revenues. Our gross margin has fluctuated historically and may continue to fluctuate from period to period based on a number of factors, including the timing and mix of the product offerings we sell as well as our ability to reduce costs, in any given period.
Operating Expenses
Our operating expenses consist of selling, marketing and general and administrative expenses.
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Selling
Selling expenses represent the costs incurred for fulfillment, selling and distribution. Fulfillment expenses consist of costs incurred in operating and staffing a third-party fulfillment center, including costs associated with inspecting and warehousing inventories and picking, packaging and preparing customer orders for shipment. Selling and distribution expenses consist primarily of shipping and other transportation costs incurred delivering merchandise to customers and from customers returning merchandise, merchant processing fees and packaging. We expect fulfillment, selling and distribution costs to increase in absolute dollars as we increase our net revenues.
Marketing
Marketing expenses consist primarily of online performance marketing costs, such as retargeting, paid search and product listing advertisements, paid social media advertisements, search engine optimization, personalized email and mobile push notifications through our app. Marketing expenses also include our spend on brand marketing channels, including billboards, podcasts, commercials, photo and video shoot development, expenses associated with our Ambassador Program and other forms of online and offline marketing. We expect our marketing expenses to increase in absolute dollars as we continue to grow our business.
General and Administrative
General and administrative expenses consist primarily of employee-related costs, including salaries, bonuses, benefits, stock-based compensation, other related costs and other general overhead, including certain third-party consulting and contractor expenses, certain facilities costs, software expenses, legal expenses and recruiting fees. We expect our general and administrative expenses to increase in absolute dollars as we continue to grow our business. We also anticipate that we will continue to incur significant additional legal, accounting, insurance, investor relations and other expenses to support our operations as a public company, including costs associated with our compliance with the Sarbanes-Oxley Act.
Other Income (Loss), Net
Other income (loss), net consists of interest income or expense associated with our Follow-on Offering, debt financing arrangements, amortization of debt issuance costs and interest income earned on investments, as well as gain or loss on foreign currency, primarily driven by payment to vendors for amounts not denominated in U.S. dollars.
Provision for Income Taxes
Our provision for income taxes consists of an estimate of federal and state income taxes based on enacted federal and state tax rates, as adjusted for allowable credits, deductions and uncertain tax positions.
Seasonality
Unlike the traditional apparel industry, the healthcare apparel industry is generally not seasonal in nature. However, due to our continued strong sequential growth, as well as our decision to conduct select promotions during the holiday season, we historically have generated a higher proportion of net revenues, and incurred higher selling and marketing expenses, during the fourth quarter of the year compared to other quarters, and we expect these trends to continue.
Results of Operations
Year Ended December 31, 2021, Compared to Year Ended December 31, 2020
The following table sets forth information comparing the components of our results of operations for the periods indicated and our results of operations as a percentage of net revenues for the periods presented.
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| Year ended December 31, | Year ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| (in thousands) | (as a percentage of net revenues) | |||||||||||||||
| Net revenues | $ | 419,591 | $ | 263,112 | 100.0 | % | 100.0 | % | ||||||||
| Cost of goods sold | 118,370 | 72,888 | 28.2 | 27.7 | ||||||||||||
| Gross profit | 301,221 | 190,224 | 71.8 | 72.3 | ||||||||||||
| Operating expenses | ||||||||||||||||
| Selling | 81,923 | 51,896 | 19.5 | 19.7 | ||||||||||||
| Marketing | 58,713 | 38,852 | 14.0 | 14.8 | ||||||||||||
| General and administrative(1) | 149,602 | 41,536 | 35.7 | 15.8 | ||||||||||||
| Total operating expenses | 290,238 | 132,284 | 69.2 | 50.3 | ||||||||||||
| Net income from operations | 10,983 | 57,940 | 2.6 | 22.0 | ||||||||||||
| Other income (loss), net | (1,124 | ) | 136 | (0.3 | ) | 0.1 | ||||||||||
| Net income before provision for income taxes | 9,859 | 58,076 | 2.3 | 22.1 | ||||||||||||
| Provision for income taxes | 19,415 | 8,318 | 4.6 | 3.2 | ||||||||||||
| Net income (loss) and comprehensive income (loss) | $ | (9,556 | ) | $ | 49,758 | (2.3 | )% | 18.9 | % |
(1)
Includes stock-based compensation expense of $81.1 million and $8.7 million for the year ended December 31, 2021 and 2020, respectively.
Net Revenues
| Year ended December 31, | Change | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % | ||||||||||
| (in thousands) | ||||||||||||
| Net revenues | $ | 419,591 | $ | 263,112 | 59.5 | % |
Net revenues increased by $156.5 million, or 59.5%, for the year ended December 31, 2021, compared to the prior year. The increase in net revenues was primarily driven by an increase in orders as a result of new customer acquisition coupled with strong retention of existing customers. Our average order value also increased from $94 to $105 which contributed to the increase in net revenues.
Cost of Goods Sold
| Year ended December 31, | Change | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % | ||||||||||
| (in thousands) | ||||||||||||
| Cost of goods sold | $ | 118,370 | $ | 72,888 | 62.4 | % | ||||||
| Gross profit | 301,221 | 190,224 | 58.4 | % | ||||||||
| Gross margin | 71.8 | % | 72.3 | % | (0.5 | )% |
Cost of goods sold increased by $45.5 million, or 62.4%, for the year ended December 31, 2021, compared to the prior year. This increase was primarily driven by an increase in the total number of orders in the fourth quarter of 2021 as compared to the same period in 2020.
Gross profit increased by $111.0 million, or 58.4%, for the year ended December 31, 2021, compared to the prior year, primarily due to the increase in the total number of orders.
Gross margin decreased 0.5 percentage points for the year ended December 31, 2021, compared to the prior year. The decrease in gross margin was primarily related to an increase in freight-in due to the utilization of more expensive air freight and increased ocean freight rates, partially offset by lower discounts and a decrease in returns.
Operating Expenses
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| Year ended December 31, | Change | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % | ||||||||||
| (in thousands) | ||||||||||||
| Operating expenses: | ||||||||||||
| Selling | $ | 81,923 | $ | 51,896 | 57.9 | % | ||||||
| Marketing | 58,713 | 38,852 | 51.1 | % | ||||||||
| General and administrative | 149,602 | 41,536 | 260.2 | % | ||||||||
| Total operating expenses | 290,238 | 132,284 | 119.4 | % |
Operating expenses increased by $158.0 million, or 119.4%, for the year ended December 31, 2021, compared to the prior year and, as a percentage of net revenues, increased by 18.9 percentage points, primarily driven by increases in general and administrative expense as described below.
Selling expense increased by $30.0 million, or 57.9%, for the year ended December 31, 2021, compared to the prior year and, as a percentage of net revenues, decreased by 0.2 percentage points. The decrease in selling expense as a percentage of net revenues was primarily due to leverage in shipping as a result of an increase in average order value.
Marketing expense increased by $19.9 million, or 51.1%, for the year ended December 31, 2021, compared to the prior year and, as a percentage of net revenues, decreased by 0.8 percentage points. The decrease in marketing expense as a percentage of net revenues was primarily due to leverage in performance marketing driven by strong retention of existing customers.
General and administrative expense increased by $108.1 million, or 260.2%, for the year ended December 31, 2021, compared to the prior year and, as a percentage of net revenues, increased by 19.9 percentage points. The increase in general and administrative expense as a percentage of net revenues was primarily due to an increase in stock-based compensation expense in connection with the IPO and to a lesser extent, higher investment in human capital.
Other Income (Loss), Net
| Year ended December 31, | Change | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % | ||||||||||
| (in thousands) | ||||||||||||
| Other income (loss), net | $ | (1,124 | ) | $ | 136 | (926 | )% |
Other income (loss), net decreased for the year ended December 31, 2021, compared to the prior year, primarily related to expenses associated with the Follow-on Offering.
Provision for Income Taxes
| Year ended December 31, | Change | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % | ||||||||||
| (in thousands) | ||||||||||||
| Provision for income taxes | $ | 19,415 | $ | 8,318 | 133.4 | % |
Provision for income taxes increased by $11.1 million, or 133.4%, for the year ended December 31, 2021, compared to the prior year, primarily due to an increase in non-deductible items including stock-based compensation expense.
Key Operating Metrics and Non-GAAP Financial Measures
We report our financial results in accordance with U.S. GAAP. In addition to the measures presented in our 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. We believe the non-GAAP financial measures, Adjusted EBITDA, Adjusted EBITDA Margin and free cash flow, are useful in evaluating our performance. Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with U.S. GAAP.
Active Customers, Net Revenues per Active Customer, and Average Order Value
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The number of active customers is an important indicator of our growth as it reflects the reach of our digital platform, our brand awareness and overall value proposition. We define an active customer as a unique customer account that has made at least one purchase in the preceding 12-month period. In any particular period, we determine our number of active customers by counting the total number of customers who have made at least one purchase in the preceding 12-month period, measured from the last date of such period.
| As of December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||
| (in thousands) | |||||||
| Active customers | 1,872 | 1,300 |
We believe the growth in our net revenues per active customer demonstrates our increasing value proposition for our customer base. We define net revenues per active customer as the sum of total net revenues in the preceding twelve month period divided by the current period active customers.
| Year ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||
| Net revenues per active customer | $ | 224 | $ | 202 |
We define average order value (“AOV”) as the sum of the total net revenues in a given period divided by the total orders placed in that period. Total orders are the summation of all completed individual purchase transactions in a given period. We believe our relatively high average order value demonstrates the premium nature of our product. As we expand into and increase our presence in additional product categories and price points as well as expand internationally, AOV may fluctuate.
| Year ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||
| Average order value | $ | 105 | $ | 94 |
Adjusted EBITDA and Adjusted EBITDA Margin
We calculate Adjusted EBITDA as net income adjusted to exclude: other income (loss), net; gain/loss on disposal of assets; provision for income taxes; depreciation and amortization expense; stock-based compensation and related expense; transaction costs; and expenses related to non-ordinary course disputes. Adjusted EBITDA Margin is calculated by dividing Adjusted EBITDA by net revenues.
Management believes that excluding certain non-cash items and items that may vary substantially in frequency and magnitude period-to-period from net income provides useful supplemental measures that assist in evaluating our ability to generate earnings, provide consistency and comparability with our past financial performance and facilitate period-to-period comparisons of our core operating results as well as the results of our peer companies.
There are several limitations related to the use of Adjusted EBITDA and Adjusted EBITDA Margin as analytical tools, including:
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other companies may calculate Adjusted EBITDA and Adjusted EBITDA Margin differently, which reduces their usefulness as a comparative measure;
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Adjusted EBITDA and Adjusted EBITDA Margin do not reflect other income (loss), net;
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Adjusted EBITDA and Adjusted EBITDA Margin do not reflect any gain or loss on disposal of assets;
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Adjusted EBITDA and Adjusted EBITDA Margin do not reflect our tax provision, which reduces cash available to us;
•
Adjusted EBITDA and Adjusted EBITDA Margin do not reflect recurring, non-cash expenses of depreciation and amortization of property and equipment and, although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
•
Adjusted EBITDA and Adjusted EBITDA Margin do not reflect the impact of stock-based compensation expense;
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Adjusted EBITDA and Adjusted EBITDA Margin do not reflect transaction costs; and
•
Adjusted EBITDA and Adjusted EBITDA Margin do not reflect expenses related to non-ordinary course disputes.
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The following table reflects a reconciliation of Adjusted EBITDA to net income, the most directly comparable financial measure prepared in accordance with U.S. GAAP:
| Year ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||||
| (in thousands, except margin) | ||||||||
| Net income (loss) | $ | (9,556 | ) | $ | 49,758 | |||
| Add (deduct): | ||||||||
| Other income (loss), net | 1,124 | (136 | ) | |||||
| Gain/loss on disposal | — | 2 | ||||||
| Provision for income taxes | 19,415 | 8,318 | ||||||
| Depreciation and amortization expense(1) | 1,424 | 946 | ||||||
| Stock-based compensation and related expense(2) | 83,516 | 8,713 | ||||||
| Transaction costs | 1,139 | 296 | ||||||
| Expenses related to non-ordinary course disputes(3) | 8,183 | 1,197 | ||||||
| Adjusted EBITDA | $ | 105,245 | $ | 69,094 | ||||
| Adjusted EBITDA Margin | 25.1 | % | 26.3 | % |
(1)
Excludes amortization of debt issuance costs included in “Other income (loss), net.”
(2)
Includes stock-based compensation expense and payroll taxes related to equity award activity.
(3)
Represents legal fees incurred in connection with the litigation claims described in the section titled “Legal Proceedings” appearing in this Annual Report on Form 10-K.
Free Cash Flow
We calculate free cash flow as net cash provided by operating activities reduced by capital expenditures, including purchases of property and equipment and capitalized software development costs. Management believes free cash flow is a useful measure of liquidity and an additional basis for assessing our ability to generate cash. There are limitations related to the use of free cash flow as an analytical tool, including: other companies may calculate free cash flow differently, which reduces its usefulness as a comparative measure; and free cash flow does reflect our future contractual commitments and it does not represent the total residual cash flow for a given period.
The following table presents a reconciliation of free cash flow to net cash provided by operating activities, the most directly comparable financial measure calculated in accordance with U.S. GAAP.
| Year ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||||
| (in thousands) | ||||||||
| Net cash provided by operating activities | $ | 66,437 | $ | 21,748 | ||||
| Less: capital expenditures | (2,712 | ) | (2,262 | ) | ||||
| Free cash flow | $ | 63,725 | $ | 19,486 |
Liquidity and Capital Resources
As of December 31, 2021 and 2020, we had $195.4 million and $58.1 million of cash and cash equivalents, respectively. Since inception, we have financed operations primarily through cash flow from operating activities and the sale of our capital stock.
In December 2020, we entered into a credit agreement with J.P. Morgan Chase Bank, N.A., providing for a revolving credit facility in an initial amount of up to $50.0 million (the “2020 Facility”). On September 7, 2021, we terminated the 2020 Facility. As of December 31, 2021, letters of credit with an aggregate face amount of $1.9 million remained outstanding under the 2020 Facility but our reimbursement obligations were secured by cash collateral pledged by us to JPMorgan Chase Bank, N.A. in the amount of approximately $2.1 million or 105% of the amounts outstanding.
In September 2021, we entered into a credit agreement with Bank of America, N.A. providing for a revolving credit facility in an amount of up to $100.0 million (the “2021 Facility”). The 2021 Facility will mature in September 2026. As of December 31, 2021, we had letters of credit aggregating to $2.5 million outstanding under the 2021 Facility and available borrowings of $97.5 million. As of December 31, 2021, we had no outstanding borrowings under the 2021 Facility.
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See Note 8 to our audited financial statements included elsewhere in this Annual Report on Form 10-K for more information regarding the 2021 Facility.
Our cash requirements have primarily been for working capital and capital expenditures. We believe that existing cash and cash equivalents, cash flows from operations, and available borrowings under our 2021 Facility, if needed, will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months.
Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of international expansion efforts and other growth initiatives, the expansion of our marketing activities and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of additional debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations. There can be no assurances that we will be able to raise additional capital when needed or on terms acceptable to us. The inability to raise capital if needed would adversely affect our ability to achieve our business objectives.
Historical Cash Flows
The following table summarizes our cash flows for the periods presented:
| Year ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||||
| (in thousands) | ||||||||
| Net cash provided by operating activities | $ | 66,437 | $ | 21,748 | ||||
| Net cash used in investing activities | (2,712 | ) | (2,262 | ) | ||||
| Net cash provided by financing activities | 75,572 | 294 | ||||||
| Net increase in cash, cash equivalents, and restricted cash | $ | 139,297 | $ | 19,780 |
Operating Activities
Cash provided by operating activities consist primarily of net income adjusted for certain items including depreciation and amortization, stock-based compensation expense and the effect of changes in operating assets and liabilities.
Net cash provided by operating activities increased by $44.7 million for the year ended December 31, 2021, compared to the same period last year. We saw an increase in cash provided from operating activities as a result of improvements in net income, excluding the impact of non-cash adjustments of $75.7 million. In addition, we saw an increase in cash provided as a result of a net change in operating assets and liabilities of $28.3 million driven by higher accrued expense balances from the timing of payments during the period, lower accounts receivable balances from the timing of collections during the period, and higher income tax payable balances from the timing of tax payments during the period.
Investing Activities
Cash used in investing activities relates to capital expenditures and other investing activities.
Cash used in investing activities of $2.7 million for the year ended December 31, 2021 increased by $0.5 million as compared to the same period last year.
Capital expenditures during the year ended December 31, 2021 and 2020 were primarily related to capitalized software development costs, purchases of machinery and equipment, and purchases of computer equipment.
Financing Activities
Cash provided by financing activities consists primarily of proceeds and payments related to transactions involving our common stock, borrowings, and fees associated with our existing line of credit.
Cash provided by financing activities was $75.6 million for the year ended December 31, 2021, which was attributable to proceeds from our IPO of $95.9 million, capital contributions of $1.3 million and proceeds from stock option exercises of $0.9 million, partially offset by tax payments related to net share settlements on restricted stock units of $21.6 million.
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Cash flows from financing activities for the year ended December 31, 2020 were not material.
Contractual Obligations and Commitments
Our most significant contractual obligations relate to purchase commitments on inventory and operating lease obligations on our facilities. See Note 10 to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K for a description of our contractual obligations and commitments.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and judgments that affect the amounts reported in those financial statements and accompanying notes. Although we believe that the estimates we use are reasonable, due to the inherent uncertainty involved in making those estimates, actual results reported in future periods could differ from those estimates. We believe that the following accounting policies involve a high degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of our operations. See Note 2 to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K for a description of our other significant accounting policies.
Revenue Recognition
Our primary source of revenues is from sales of healthcare apparel, footwear and other products primarily through our digital platform.
We determine revenue recognition through the following steps in accordance with Topic 606, which we adopted effective January 1, 2018:
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identification of the contract, or contracts, with a customer;
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identification of the performance obligations in the contract;
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determination of the transaction price;
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allocation of the transaction price to the performance obligations in the contract; and
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recognition of revenue when, or as, we satisfy a performance obligation.
Revenue is recognized upon shipment when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Our revenue is reported net of sales returns and discounts. We estimate our liability for product returns based on historical return trends and an evaluation of current economic and market conditions. We record the expected customer refund liability as a reduction to revenue, and the expected inventory right of recovery as a reduction of cost of goods sold. If actual return costs differ from previous estimates, the amount of the liability and corresponding revenue are adjusted in the period in which such costs occur.
Stock-Based Compensation
We have granted stock-based awards consisting primarily of stock options and RSUs to employees and consultants. We measure and recognize stock-based compensation expense for all stock option awards granted to employees and non-employees based on their estimated fair values as of the grant date using the Black-Scholes option-pricing model. Our use of the Black-Scholes option-pricing model to estimate the fair value of stock options granted requires the input of various assumptions which are as follows:
Risk-free interest rate—determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award.
Expected volatility— we derive our volatility from the average historical stock volatilities of several peer public companies over a period equivalent to the expected term of the awards. We expect to continue to do so until such time as we have adequate historical data regarding the volatility of our own traded stock price.
Expected dividend yield—we have not paid, and do not currently anticipate paying, cash dividends on our common stock; therefore, the expected dividend yield is assumed to be zero.
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Expected term—the expected term of stock options granted to employees has been determined utilizing the “simplified” method for awards that qualify as “plain-vanilla” options, which calculates the expected term as the average of the time-to-vesting and the contractual life of options.
Fair value of common stock—the fair value of our common stock is the closing stock price of our Class A common stock as reported on the New York Stock Exchange.
For employee and non-employee options, we recognize compensation expense based on the grant date fair value of the award over the requisite service period, which is generally the vesting period of the respective award based on the grant date fair value of the award. We account for forfeitures as they occur.
We measure the fair value of restricted stock units (“RSUs”) granted to employees based on the fair value of our Class A common stock on the grant date. Our RSU grants vest upon the satisfaction of either a service condition or both a service condition and a performance condition. The service condition is generally satisfied ratably over four years. The performance condition related to our outstanding performance-based awards was satisfied in connection with the IPO.
Inventory
Inventories are stated at the lower of cost and net realizable value. Cost is determined using an average cost method. Cost of inventory includes import duties and other taxes and transport and handling costs. We write down inventory where it appears that the carrying cost of the inventory may not be recovered through subsequent sale of the inventory. We analyze the quantity of inventory on hand, the quantity sold in the past year, the anticipated sales volume, the expected sales price and the cost of making the sale when evaluating the value of our inventory. If the sales volume or sales price of specific products declines, additional write-downs may be required.
Income Taxes
We are subject to income taxes in the United States. We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized and the charge is recorded to earnings.
Significant judgment is required in determining our uncertain tax positions. We continuously review issues raised in connection with all ongoing examinations and open tax years to evaluate the adequacy of our tax liabilities. We evaluate uncertain tax positions under a two-step approach. The first step is to evaluate the uncertain tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon examination based on its technical merits. The second step is, for those positions that meet the recognition criteria, to measure the largest amount of benefit that is more likely than not of being realized. We believe our recorded tax liabilities are adequate to cover all open tax years based on our assessment. This assessment relies on estimates and assumptions and involves significant judgments about future events. To the extent that our view as to the outcome of these matters changes, we will adjust income tax expense in the period in which such determination is made. We classify interest and penalties related to income taxes as income tax expense.
Loss Contingencies
We may be involved in legal proceedings, claims and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business resulting in loss contingencies. We accrue for loss contingencies when losses become probable and are reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. We do not accrue for contingent losses that, in our judgment, are considered to be reasonably possible, but not probable; however, we disclose the range of such reasonably possible losses. Loss contingencies considered remote are generally not disclosed.
Recent Accounting Pronouncements
Refer to Note 2 to our financial statements appearing elsewhere in this Annual Report on Form 10-K for a discussion of accounting pronouncements recently adopted and recently issued accounting pronouncements not yet adopted and their potential impact to our financial statements.
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