☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2023
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number: 001-39942
Shoals Technologies Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware
85-3774438
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1400 Shoals Way
Portland
Tennessee
37148
(Address of principal executive offices)
(Zip Code)
(Registrant’s telephone number, including area code)
(615)
451-1400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock, $0.00001 Par Value
SHLS
Nasdaq Global Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
As of October 31, 2023, the registrant had 170,057,495 shares of Class A common stock and no shares of Class B common stock issued and outstanding.
This report contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include information concerning our possible or assumed future results of operations; business strategies; technology developments; financing and investment plans; warranty, litigation and liability accruals and estimates of loss or gains; litigation strategy and expected benefits or results from the current intellectual property and wire insulation shrinkback litigation; competitive position; industry and regulatory environment; potential growth opportunities, including international growth, production and capacity at our plants; and the effects of competition. Forward-looking statements include statements that are not historical facts and can be identified by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “will,” “would” or similar expressions and the negatives of those terms.
Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Given these uncertainties, you should not place undue reliance on forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this report. You should read this report with the understanding that our actual future results may be materially different from what we expect.
Important factors that could cause actual results to differ materially from expectations are included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part I and Item 1A “Risk Factors” of Part II, as well as Part I Item 1A “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2022.
Except as required by law, we assume no obligation to update these forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. Some of the key factors that could cause actual results to differ from our expectations include the following:
•if demand for solar energy projects does not continue to grow or grows at a slower rate than we anticipate, we may not be able to achieve our anticipated level of growth and our business will suffer;
•defects or performance problems in our products or their parts, including those related to the wire insulation shrinkback matter, could result in loss of customers, reputational damage and decreased revenue, and may have a material adverse effect on our business, financial condition and results of operations;
•if we fail to accurately estimate the potential losses related to the wire insulation shrinkback warranty liability, our financial results could be materially adversely impacted;
•if we fail to recover the costs and expenses incurred by us in connection with the identification, repair and replacement of the defective Prysmian wire, our financial results, business and prospects could be materially adversely impacted;
•our industry has historically been cyclical and experienced periodic downturns;
•current macroeconomic events, including high inflation, rise in interest rates and potential recession could impact our business and financial results;
•the interruption of the flow of components and materials from international vendors has and may continue to disrupt our supply chain, including as a result of the imposition of additional duties, tariffs and other charges on imports and exports;
•if we fail to retain our key personnel and attract additional qualified personnel, we are unable to execute a smooth transition and successfully integrate our new Chief Executive Officer, or we or our suppliers face disputes with labor unions, we may not be able to achieve our anticipated level of growth and our business could suffer;
•our products are primarily manufactured and shipped from our production facilities in Tennessee, and any damage or disruption at these facilities may harm our business;
•if we fail to, or incur significant costs in order to, obtain, maintain, protect, defend or enforce our intellectual property and other proprietary rights, including those that are subject to the complaints we filed with the ITC and two District Courts, our business and results of operations could be materially harmed;
•acquisitions, joint ventures and/or investments and the failure to integrate acquired businesses, could disrupt our business and/or dilute or adversely affect the price of our Class A common stock;
•we may experience delays, disruptions or quality control problems in our manufacturing operations in part due to vendor concentration;
•our future growth in the electrical vehicle (“EV”) charging market is highly dependent on the demand for, and consumers’ willingness to adopt, EVs;
•a significant drop in the price of electricity sold may harm our business, financial condition, results of operations and prospects;
•a further increase in interest rates, or a reduction in the availability of tax incentives or project debt capital in the global financial markets could make it difficult for end customers to finance the cost of a solar energy system and could reduce the demand for our products;
•our results of operations may fluctuate from quarter to quarter, which could make our future performance difficult to predict and could cause our results of operations for a particular period to fall below expectations, resulting in a decline in the price of our Class A common stock;
•compromises, interruptions or shutdowns of our information technology systems, including those managed by third parties, whether intentional or inadvertent, could lead to delays in our business operations and, if significant or extreme, affect our results of operations;
•our indebtedness could adversely affect our financial flexibility and our competitive position;
•our indebtedness may restrict our current and future operations, which could adversely affect our ability to respond to changes in our business and to manage our operations;
•developments in alternative technologies may have a material adverse effect on demand for our offerings;
•existing electric utility industry, renewable energy and solar energy policies and regulations, and any subsequent changes, may present technical, regulatory and economic barriers to the purchase and use of solar energy systems that may significantly reduce demand for our products or harm our ability to compete;
•changes in the U.S. trade environment, including the imposition of import tariffs and antidumping and countervailing duties, could adversely affect the amount or timing of our revenue, results of operations or cash flows;
•future sales of our Class A common stock, or the perception that such sales may occur, could depress our Class A common stock price;
•provisions in our certificate of incorporation and our bylaws may have the effect of delaying or preventing a change of control or changes in our management;
•our certificate of incorporation also provides that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees; and
•if we fail to maintain effective internal controls over financial reporting, we may be unable to accurately or timely report our financial condition or results of operations, which may adversely affect our business.
Preferred stock, $0.00001 par value - 5,000,000 shares authorized; none issued and outstanding as of September 30, 2023 and December 31, 2022
—
—
Class A common stock, $0.00001 par value - 1,000,000,000 shares authorized; 170,054,787and 137,904,663 shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively
2
1
Class B common stock, $0.00001 par value - 195,000,000 shares authorized; none and 31,419,913 shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively
—
1
Additional paid-in capital
466,768
256,894
Accumulated earnings
57,870
34,478
Total stockholders’ equity attributable to Shoals Technologies Group, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Organization and Business
Shoals Technologies Group, Inc. (the “Company”) was formed as a Delaware corporation on November 4, 2020 for the purpose of facilitating an initial public offering (“IPO”) and other related organizational transactions to carry on the business of Shoals Parent LLC and its subsidiaries (“Shoals Parent”). Shoals Parent LLC is a Delaware limited liability company formed on May 9, 2017. The IPO and related reorganization transactions that occurred on January 29, 2021 resulted in the Company becoming the sole managing member of Shoals Parent, with the Company having sole voting power in and control of the management of Shoals Parent. On July 1, 2023, the Company contributed 100% of its membership interests (“LLC Interests”) in Shoals Parent LLC to its wholly-owned subsidiary Shoals Intermediate Parent, Inc. (“Shoals Intermediate”). As of September 30, 2023 the Company, including Shoals Intermediate, owned 100% of Shoals Parent. Following the contribution, Shoals Parent became a disregarded single member limited liability company, eliminating the Company’s umbrella-partnership C corporation structure (“Up-C structure”).
The Company is headquartered in Portland, Tennessee and is a manufacturer of electrical balance of systems (“EBOS”) solutions and components for solar, battery storage and electric vehicle charging applications, selling to customers primarily in the United States as well as internationally. Shoals Parent, through its wholly-owned subsidiaries, Shoals Intermediate Holdings LLC (“Shoals Intermediate Holdings”) and Shoals Holdings LLC (“Holdings”) owns five other subsidiaries through which it conducts substantially all operations: Shoals Technologies, LLC, Shoals Technologies Group, LLC, Solon, LLC (collectively “Shoals”), Shoals International, LLC and Shoals Connect LLC. Shoals Parent acquired Shoals on May 25, 2017.
Secondary Offering
On March 10, 2023, selling stockholders, which consisted of certain entities controlled by Dean Solon, our founder (the “Founder”), completed a secondary offering consisting of 24,501,650 shares of Class A common stock. Following the closing of the secondary offering, the Founder no longer owned any shares of our Class B common stock or LLC Interests. The Company did not receive any proceeds from the sale of shares of our Class A common stock by the selling stockholders in this offering.
Shoals Technologies Group, Inc. Ownership of Shoals Parent
In March 2023, following the secondary offering described above, all Continuing Equity Owners (as defined in Note 12 - Stockholders’ Equity), exchanged all the LLC Interests and corresponding shares of Class B common stock of the Company beneficially owned by them into shares of Class A common stock of the Company. As a result, upon effectiveness of such exchanges, and prior to the July 1, 2023 contribution described above, all of the LLC Interests in Shoals Parent were held by the Company, no other holders own LLC Interests and no Class B common stock is outstanding.
2. Summary of Significant Accounting Policies
Basis of Accounting and Presentation
The condensed consolidated financial statements have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
Notes to Condensed Consolidated Financial Statements (Unaudited)
The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current period presentation.
Non-Controlling Interests
The non-controlling interests on the condensed consolidated statements of operations represented a portion of earnings or loss attributable to the economic interests in the Company’s subsidiary, Shoals Parent, formerly held by the Continuing Equity Owners (as defined in Note 12 - Stockholders’ Equity). Non-controlling interests on the condensed consolidated balance sheets represented the portion of net assets of the Company attributable to the Continuing Equity Owners, based on the portion of the LLC Interests owned by such unit holders. As of September 30, 2023, the Company, along with a wholly-owned subsidiary, Shoals Intermediate, owned 100% of Shoals Parent.
Unaudited Interim Financial Information
The accompanying condensed consolidated balance sheets as of September 30, 2023 and December 31, 2022, the condensed consolidated statements of operations, changes in stockholders’ equity (deficit) and cash flows for the three and nine months ended September 30, 2023 and 2022 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the audited annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2023 and the results of its operations and its cash flows for the three and nine months ended September 30, 2023 and 2022. The financial data and other information disclosed in these notes related to the three and nine months ended September 30, 2023 and 2022 are also unaudited. The results for the three and nine months ended September 30, 2023 are not necessarily indicative of results to be expected for the year ending December 31, 2023, any other interim periods, or any future year or period. The balance sheet as of December 31, 2022 included herein was derived from the audited financial statements as of that date. Certain disclosures have been condensed or omitted from the interim condensed consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates. Significant estimates include revenue recognition, allowance for credit losses, useful lives of property, plant and equipment and other intangible assets, impairment of long-lived assets, allowance for obsolete or slow moving inventory, valuation allowance on deferred tax assets, equity-based compensation expense and warranty liability.
Trends and Uncertainties
In 2022 and to a lesser extent during the first three quarters of 2023, significant levels of inflation resulted in increased energy prices, freight premiums, and other operating costs. As a result of inflation, during 2022 and the first three quarters of 2023, the Federal Reserve increased interest rates. Such increased interest rates have resulted in higher interest rates associated with our Senior Secured Credit Agreement, as defined in
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 8 - Long-Term Debt. The Federal Reserve may continue raising interest rates, and any such additional increases will have a corresponding increase in the interest rates charged under our Senior Secured Credit Agreement. The eventual implications of higher government deficits and debt, tighter monetary policy, and potentially higher long-term interest rates may drive a higher cost of capital during our forecast period.
In 2022 and to a lesser extent during the first three quarters of 2023, as a consequence of macroeconomic events, our ability to obtain raw materials required to manufacture our components and system solutions from domestic and international suppliers, as well as our ability to secure inbound logistics to and from our facilities, were impacted, with additional delays linked to international border crossings and the associated approvals and documentation. The Company does not directly source a significant amount of raw materials from Europe. However, the ongoing conflict in Ukraine has reduced the availability of certain materials that can be sourced in Europe and, as a result, increased global logistics costs for the procurement of some inputs and materials used in our products. We expect these trends to persist throughout the year. In addition, changes over the last few years in the international relations and tariff regimes between the U.S. and China in response to various political issues and heightened uncertainty regarding China-Taiwan relations could significantly adversely impact the availability of parts and components to us, and, correspondingly, our ability to produce our components at targeted levels, although we did not experience such negative effects during the first three quarters of 2023. We are continuously monitoring the situation of our supply chain and evaluating our procurement strategy and supply chain to reduce any negative impact on our business, financial condition, and results of operations.
In response to supply chain constraints, in 2022 we increased certain raw materials inventory, partly to limit the potential impact of supply chain issues of raw materials in the near term. During the first three quarters of 2023, we continued to monitor and optimize our inventory levels.
As of September 30, 2023, other than increased interest expense, we did not experience material adverse effects on our financial results from the events and trends discussed above.
Restricted Cash
Restricted cash is included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the condensed consolidated statements of cash flows. Restricted cash is restricted as to withdrawal or use. Prior to the termination of the Tax Receivable Agreement (“TRA”), tax distributions paid by Shoals Parent to the Company were restricted under the limited liability company agreement (“LLC Agreement”) for future payments under the TRA and totaled $20.4 million as of September 30, 2022. There was no restricted cash as of September 30, 2023.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Customer Concentrations
The Company had the following revenue concentrations representing approximately 10% or more of revenue for the nine months ended September 30, 2023 and 2022 and related accounts receivable concentrations as of September 30, 2023 and December 31, 2022:
2023
2022
Revenue %
Accounts Receivable %
Revenue %
Accounts Receivable %
Customer A
34.1
%
41.3
%
9.0
%
8.4
%
Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company follows a fair value hierarchy which requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs may be used to measure fair value, as follows:
•Level 1 – Quoted prices in active markets for identical assets or liabilities.
•Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•Level 3 – Unobservable inputs that are supported by little or no market activity that are significant to the fair value of the assets or liabilities.
The fair values of the Company’s cash and cash equivalents, accounts receivable, and accounts payable approximate their carrying values due to their short maturities. The carrying value of the Company’s long-term debt approximates fair value and is considered level 2, as it is based on current market rates at which the Company could borrow funds with similar terms.
Recent Accounting Pronouncements
Adopted
In October 2021, the FASB issued Accounting Standard Update (“ASU”) No. 2021-08, Business Combinations (Topic 805) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. This ASU requires that contract assets and contract liabilities acquired in a business combination be recognized and measured in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. This guidance is effective for fiscal years beginning after December 15, 2022, including interim periods within that fiscal year. The adoption of this standard on January 1, 2023 did not have an impact on the Company’s condensed consolidated financial statements.
Not Yet Adopted
Management does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the Company’s condensed consolidated financial statements.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Accounts receivable, net consists of the following (in thousands):
September 30, 2023
December 31, 2022
Accounts receivable
$
109,645
$
51,061
Less: allowance for credit losses
(759)
(486)
Accounts receivable, net
$
108,886
$
50,575
4. Inventory
Inventory, net consists of the following (in thousands):
September 30, 2023
December 31, 2022
Raw materials
$
64,105
$
73,970
Work in process
2,699
1,023
Finished goods
592
785
Allowance for obsolete or slow-moving inventory
(6,435)
(2,924)
Inventory, net
$
60,961
$
72,854
5. Property, Plant and Equipment
Property, plant, and equipment, net consists of the following (in thousands):
Estimated Useful Lives (Years)
September 30, 2023
December 31, 2022
Land
N/A
$
840
$
840
Building and land improvements
5-40
11,975
9,031
Machinery and equipment
3-5
16,379
12,371
Furniture and fixtures
3-7
2,336
1,787
Vehicles
5
125
125
31,655
24,154
Less: accumulated depreciation
(8,866)
(7,284)
Property, plant and equipment, net
$
22,789
$
16,870
Depreciation expense for the three months ended September 30, 2023 and 2022 was $0.7 million and $0.5 million, respectively. During the three months ended September 30, 2023 and 2022, $0.5 million and $0.4 million, respectively, of depreciation expense was allocated to cost of revenue and $0.2 million and $0.1 million, respectively, of depreciation expense was allocated to operating expenses.
Depreciation expense for the nine months ended September 30, 2023 and 2022 was $1.7 million and $1.4 million, respectively. During the nine months ended September 30, 2023 and 2022, $1.2 million and $1.1 million, respectively, of depreciation expense was allocated to cost of revenue and $0.5 million and $0.3 million, respectively, of depreciation expense was allocated to operating expenses.
Notes to Condensed Consolidated Financial Statements (Unaudited)
6. Goodwill and Other Intangible Assets
Goodwill
Goodwill relates to the acquisition of Shoals and ConnectPV, Inc. There were no changes in the carrying amount of goodwill during the nine months ended September 30, 2023. Goodwill totaled $69.9 million as of September 30, 2023 and December 31, 2022.
Other Intangible Assets
Other intangible assets, net consists of the following (in thousands):
Estimated Useful Lives (Years)
September 30, 2023
December 31, 2022
Amortizable:
Costs:
Customer relationships
13
$
53,100
$
53,100
Developed technology
13
34,600
34,600
Trade names
13
11,900
11,900
Backlog
1
600
600
Noncompete agreements
5
2,000
2,000
Total amortizable intangibles
102,200
102,200
Accumulated amortization:
Customer relationships
26,124
22,925
Developed technology
16,856
14,860
Trade names
6,056
5,230
Backlog
600
600
Noncompete agreements
2,000
2,000
Total accumulated amortization
51,636
45,615
Total other intangible assets, net
$
50,564
$
56,585
Amortization expense related to intangible assets amounted to $2.0 million and $2.1 million for the three months ended September 30, 2023 and 2022, respectively, and $6.0 million and $6.6 million for the nine months ended September 30, 2023 and 2022, respectively.
7. Accrued Expenses and Other
Accrued expenses and other consists of the following (in thousands):
Notes to Condensed Consolidated Financial Statements (Unaudited)
General Warranty
The Company offers an assurance type warranty for its products against manufacturer defects which does not contain a service element. For these assurance type warranties, a provision for estimated future costs related to warranty expense is recorded when they are probable and reasonably estimable. As of September 30, 2023 and December 31, 2022 our estimated general warranty liability was approximately zero and $0.1 million, respectively. The Company recorded total warranty expense related to general warranty matters of $0.2 million and $0.6 million for the three and nine months ended September 30, 2023, respectively, and zero for the three and nine months ended September 30, 2022.
Wire Insulation Shrinkback Warranty
The Company has been notified by certain customers that a subset of wire harnesses used in its EBOS solutions is presenting unacceptable levels of pull back of wire insulation at connection points (“wire insulation shrinkback”). Based upon the Company’s ongoing assessment, the Company currently believes the wire insulation shrinkback is related to defective red wire manufactured by Prysmian. Based on the Company’s continued analysis of information available as of the date of this Quarterly Report, which includes better visibility into the scope of affected sites and potential solutions, including identification, repair and replacement of harnesses, the Company has determined that a potential range of loss was both probable and reasonably estimable and has updated its estimate of potential losses from the estimate provided in the previous quarter. However, as no amount within the current range of loss appears to be a better estimate than any other amount, the Company has recorded a warranty liability and related expense representing the low end of the range of potential loss of $59.7 million. The high-end of the range of potential loss is $184.9 million, which is $125.2 million higher than the amount we recorded. As of September 30, 2023, our recorded warranty liability related to this matter was $56.6 million.
The estimated range is based on several assumptions, and as additional information becomes available, the Company may increase or decrease its estimated warranty liability from its current estimate, and such increase or decrease may be material. The Company does not maintain insurance for product warranty and has commenced a lawsuit against Prysmian, as discussed in more detail under Wire Insulation Shrinkback Litigation section of Note 14 - Commitments and Contingencies. Because the lawsuit against Prysmian is ongoing, potential recovery from Prysmian is not considered probable as defined in ASC 450, and has not been considered in our estimate of the warranty liability as of September 30, 2023.
The Company recorded total warranty expense related to this matter of $50.2 million and $59.1 million for the three and nine months ended September 30, 2023, respectively, and zero for the three and nine months ended September 30, 2022.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Warranty liability, which includes both general warranty and wire insulation shrinkback warranty, consists of the following (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
Warranty liability, beginning of period
$
9,634
$
60
$
560
$
60
Warranty expense
50,421
—
59,723
—
Payments
(3,441)
—
(3,669)
—
Warranty liability, end of period
56,614
60
56,614
60
Less: current portion
17,254
60
17,254
60
Warranty liability, less current portion
$
39,360
$
—
$
39,360
$
—
9. Long-Term Debt
Long-term debt consists of the following (in thousands):
September 30, 2023
December 31, 2022
Term Loan Facility
$
193,750
$
195,250
Revolving Credit Facility
—
48,000
Less: deferred financing costs
(3,370)
(4,187)
Total debt, net of deferred financing costs
190,380
239,063
Less: current portion
(2,000)
(2,000)
Long-term debt, net current portion
$
188,380
$
237,063
Senior Secured Credit Agreement
Holdings has a senior secured credit agreement (as amended, the “Senior Secured Credit Agreement”), consisting of (i) a $350.0 million senior secured six-year term loan facility (the “Term Loan Facility”) and (ii) a $150.0 million revolving credit facility (the “Revolving Credit Facility”).
As of September 30, 2023, interest rates on the Term Loan Facility were SOFR plus 5.75%, or 11.27%, and on the Revolving Credit Facility, SOFR plus 3.25%. As of September 30, 2023, there were $193.8 million outstanding under the Term Loan Facility, no borrowings outstanding under the Revolving Credit Facility, letters of credit of $0.6 million, and $149.4 million of availability under the Revolving Credit Facility.
The Senior Secured Credit Agreement contains affirmative and negative covenants, including covenants that restrict the Company’s incurrence of indebtedness, incurrence of liens, dispositions, investments, acquisitions, restricted payments, and transactions with affiliates. The Senior Secured Credit Agreement also includes customary events of default, including the occurrence of a change of control.
The Revolving Credit Facility also includes a consolidated leverage ratio financial covenant that is tested on the last day of each fiscal quarter. To remain in compliance with the financial covenant, Shoals Intermediate Holdings’ consolidated leverage ratio, as of the last day of any quarter, cannot be greater than 6.50 to 1.00. As of September 30, 2023, the Company was in compliance with all the required covenants.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Basic EPS of Class A common stock is computed by dividing net income (loss) attributable to the Company by the weighted average number of shares of Class A common stock outstanding during the period. Diluted EPS of Class A common stock is computed similarly to basic EPS except the weighted average shares outstanding are increased to include additional shares from the exchange of Class B common stock under the if-converted method and the assumed exercise of any common stock equivalents using the treasury stock method, if dilutive. The Company’s restricted and performance stock units are considered common stock equivalents for this purpose.
Basic and diluted EPS of Class A common stock have been computed as follows (in thousands, except per share amounts):
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
Numerator:
Net income (loss) attributable to Shoals Technologies Group, Inc. - basic
$
(9,828)
$
7,958
$
23,392
$
15,000
Reallocation of net income attributable to non-controlling interests from the assumed exchange of Class B common stock
—
—
—
—
Net income (loss) attributable to Shoals Technologies Group, Inc. - diluted
$
(9,828)
$
7,958
$
23,392
$
15,000
Denominator:
Weighted average shares of Class A common stock outstanding - basic
169,965
112,975
162,173
112,561
Effect of dilutive securities:
Restricted / performance stock units
—
609
438
255
Class B common stock
—
—
—
—
Weighted average shares of Class A common stock outstanding - diluted
169,965
113,584
162,611
112,816
Earnings (loss) per share of Class A common stock - basic
$
(0.06)
$
0.07
$
0.14
$
0.13
Earnings (loss) per share of Class A common stock - diluted
$
(0.06)
$
0.07
$
0.14
$
0.13
For the nine months ended September 30, 2023 and three and nine months ended September 30, 2022, the reallocation of net income attributable to non-controlling interests from the assumed exchange of Class B common stock has been excluded along with the dilutive effect of Class B common stock to the weighted average shares of Class A common stock outstanding – dilutive, as they were antidilutive. For the three months ended September 30, 2023 there were no shares of Class B common stock outstanding and the assumed exercise of any restricted and performance stock units has been excluded as they were antidilutive .
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Shoals Technologies Group, Inc. 2021 Long-Term incentive Plan (the “2021 Incentive Plan”) became effective on January 26, 2021. The 2021 Incentive Plan authorized 8,768,124 new shares, subject to adjustment pursuant to the 2021 Incentive Plan.
Restricted Stock Units
During the nine months ended September 30, 2023, the Company granted 392,672 restricted stock units (“RSUs") to certain employees, officers and directors of the Company. The RSUs have grant date fair values ranging from $18.12 to $28.26 per unit and generally vest ratably over 3 years, except director grants which vest over 1 year.
Activity under the 2021 Incentive Plan for RSUs was as follows:
Nine Months Ended September 30, 2023
Restricted Stock Units
Weighted Average Price
Outstanding, December 31, 2022
1,736,975
$
22.34
Granted
392,672
$
25.25
Vested
(823,736)
$
20.99
Forfeited
(74,178)
$
22.88
Outstanding, September 30, 2023
1,231,733
$
24.14
Performance Stock Units
During the nine months ended September 30, 2023, the Company granted an aggregate of 205,585 Performance Stock Units ("PSUs") to certain executives. The PSUs cliff vest after 3 years upon meeting certain revenue and gross profit percentage targets and contain certain modifiers which could increase or decrease the ultimate number of shares of Class A common stock issued to the executives. The PSUs were valued using the market value of the Class A common stock on the grant date ranging from $26.55 to $28.26.
Activity under the 2021 Incentive Plan for PSUs was as follows:
Nine Months Ended September 30, 2023
Performance Stock Units
Weighted Average Price
Outstanding, December 31, 2022
256,305
$
11.89
Granted
205,585
$
27.75
Vested
(67,101)
$
11.86
Forfeited
(101,323)
$
13.08
Outstanding, September 30, 2023
293,466
$
22.59
The Company recognized equity-based compensation of $5.1 million and $4.0 million for the three months ended September 30, 2023 and 2022, respectively, and $17.1 million and $11.9 million for the nine months ended September 30, 2023 and 2022, respectively. As of September 30, 2023, the Company had $27.7 million of unrecognized compensation costs which is expected to be recognized over a period of 1.7 years.
Notes to Condensed Consolidated Financial Statements (Unaudited)
12. Stockholders’ Equity
Shoals Parent Ownership
Prior to July 1, 2023, the Company was the sole managing member of Shoals Parent and had the sole voting power in, and controlled the management of Shoals Parent. As of September 30, 2023, the Company owned 100% of Shoals Parent. Prior to the Company owning 100% of Shoals Parent, the remaining interest in Shoals Parent, was held by direct or indirect holders of LLC Interests and our Class B common stock, including the Founder and certain current and former executive officers, employees and their respective permitted transferees (collectively, the “Continuing Equity Owners”), who could exchange at each of their respective options, in whole or in part, from time to time, their LLC Interests (along with an equal number of shares of Class B common stock (which shares were then immediately canceled)) for cash or newly issued shares of our Class A common stock. Accordingly, the Company consolidated the financial results of Shoals Parent and reported non-controlling interests in its condensed consolidated financial statements. In accordance with the LLC Agreement, Shoals Parent made cash distributions to its members in an amount sufficient to cover the members’ tax liabilities, if any, with respect to each member’s share of Shoals Parent taxable earnings. The payment of these cash distributions by Shoals Parent to Continuing Equity Owners was recorded as distributions to holders of LLC Interests in the accompanying condensed consolidated statements of stockholders’ equity (deficit) and condensed consolidated statements of cash flows.
Common Stock Economic and Voting Rights
Holders of Class A common stock and Class B common stock (if any shares are outstanding) are entitled to one vote per share and, except as otherwise required, vote together as a single class on all matters on which stockholders generally are entitled to vote. Holders of Class B common stock (if any shares are outstanding) are not entitled to receive dividends and will not be entitled to receive any distributions upon the liquidation, dissolution or winding up of the Company. Shares of Class B common stock were only issuable to the extent necessary to maintain the one-to-one ratio between the number of LLC Interests held by the Continuing Equity Owners and the number of shares of Class B common stock held by the Continuing Equity Owners. As of September 30, 2023, there were no shares of Class B common stock nor LLC Interests outstanding, and no shares of Class B common stock are currently issuable. Shares of Class B common stock were transferable only together with an equal number of LLC Interests.
13. Non-Controlling Interests
Effective July 1, 2023, the Company owned 100% of Shoals Parent. The following table summarizes the effects of the changes in ownership in Shoals Parent on equity:
Notes to Condensed Consolidated Financial Statements (Unaudited)
Nine months ended September 30,
2023
2022
Net income attributable to non-controlling interests
$
2,687
$
9,711
Transfers to non-controlling interests:
Increase as a result of activity under equity-based compensation plan
687
4,257
Decrease from tax distributions to non-controlling interests
(2,628)
(7,762)
Reallocation of non-controlling interests
(10,361)
107
Change from net income attributable to non-controlling interests and transfers to non-controlling interests
$
(9,615)
$
6,313
Issuance of Additional LLC Interests
Under the LLC Agreement, the Company was required to cause Shoals Parent to issue additional LLC Interests to the Company when the Company issued additional shares of Class A common stock. Other than as it relates to the issuance of Class A common stock in connection with an equity incentive program, the Company contributed to Shoals Parent net proceeds and property, if any, received by the Company with respect to the issuance of such additional shares of Class A common stock. The Company caused Shoals Parent to issue a number of LLC Interests equal to the number of shares of Class A common stock issued such that, at all times, the number of LLC Interests held by the Company was equal to the number of outstanding shares of Class A common stock. During the nine months ended September 30, 2023 and 2022, the Company caused Shoals Parent to issue to the Company a total of 601,518 and 480,116 LLC Interests, respectively, for the vesting of awards granted under the 2021 Incentive Plan. On July 1, 2023, the Company contributed 100% of its LLC Interests in Shoals Parent LLC to its wholly-owned subsidiary, Shoals Intermediate. Following the contribution, Shoals Parent LLC became a disregarded single member limited liability company, eliminating the Up-C structure.
Distributions for Taxes
As a limited liability company (treated as a partnership for income tax purposes), Shoals Parent does not incur significant federal, state or local income taxes, as these taxes are primarily the obligations of its members. As authorized by the LLC Agreement, Shoals Parent was required to distribute cash, to the extent that Shoals Parent had cash available, on a pro rata basis, to its members to the extent necessary to cover the members’ tax liabilities, if any, with respect to each member’s share of Shoals Parent taxable earnings. Shoals Parent made such tax distributions to its members quarterly, based on the single highest marginal tax rate applicable to its members applied to projected year-to-date taxable income. During the nine months ended September 30, 2023 and 2022, tax distributions to non-controlling LLC Interests holders were $2.6 million and $7.8 million, respectively.
14. Commitments and Contingencies
Litigation
The Company is from time to time subject to legal proceedings and claims, which arise in the normal course of its business. In the opinion of management and legal counsel, except as disclosed below, the amount of losses or gains that may be sustained, if any, would not have a material effect on the financial position, results of operations or cash flows of the Company.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Intellectual Property Litigation
On May 4, 2023, the Company filed a patent infringement complaint with the U.S. International Trade Commission (“ITC”) against Hikam America, Inc., a corporation based in Chula, California, and its related foreign entities (together, “Hikam”), and Voltage LLC, a limited liability company based in Chapel Hill, North Carolina, and its related foreign entities (together, “Voltage”). The complaint primarily requests that the ITC (i) investigate unlawful imports of certain photovoltaic connectors and components that the Company alleges infringe on two valid and enforceable patents owned by the Company related to improved connectors for solar panel arrays and (ii) issue a limited exclusion order and a cease and desist order against the Hikam respondents and the Voltage respondents to bar them from importing, marketing, distributing, selling, offering for sale, licensing, advertising, transferring, or otherwise using the infringing photovoltaic connectors and components in and into the United States. On July 18, 2023, the Company filed an amended complaint with the ITC, adding allegations that the Voltage respondents also infringe a third, recently-issued patent owned by the Company. Also on May 4, 2023, the Company filed complaints against the Hikam defendants in the U.S. District Court for the Southern District of California, and against the Voltage defendants in the U.S. District Court for the Middle District of North Carolina on the same subject matter. On June 28, 2023, the Company filed an amended complaint in the U.S. District Court for the Middle District of North Carolina against the Voltage respondents alleging that they also infringe on a third, recently-issued patent owned by the Company. These complaints seek injunctive relief and damages for reasonable royalty and lost profits. The District Court actions have been stayed pending the final disposition of the ITC investigation. An evidentiary hearing in the ITC investigation has been scheduled for March 18 through 22, 2024. The ITC has set a target date for completion of the investigation of November 12, 2024. The Company intends to vigorously pursue these actions. However, at this stage, the Company is unable to predict the outcome or impact on its business and financial results. The Company is accounting for this matter as a gain contingency, and will record any such gain in future periods if and when the contingency is resolved, in accordance with ASC 450 Contingencies.
Wire Insulation Shrinkback Litigation
On October 31, 2023, the Company filed a complaint in the U.S. District Court for the Middle District of Tennessee, Nashville Division, against Prysmian Cables and Systems USA, LLC (“Prysmian”). The complaint alleges damages caused by defective red wire Prysmian sold the Company between 2020 through approximately 2022. The defective red wire has presented unacceptable levels of wire insulation shrinkback. The complaint includes, among other causes of action, product liability, breach of contract, breach of warranty, indemnity, and negligence claims. The Company seeks compensatory and punitive damages, recovery of all costs and expenses incurred by the Company in connection with the identification, repair and replacement of the defective wire, and other legal and equitable relief. The Company intends to vigorously pursue this action, and as the Company continues to assess this matter, it may, from time to time, amend, update or supplement the complaint to, among other things, increase the damages sought for various purposes, including in accordance with increases to the Company’s estimated warranty liability and related expenses related to this matter. At this stage, the Company is unable to predict the outcome of this litigation or the impact on its business and financial results. The Company is accounting for this matter as a gain contingency, and will record any such gain in future periods if and when the contingency is resolved, in accordance with ASC 450 Contingencies.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company provides surety bonds to various parties as required for certain transactions initiated during the ordinary course of business to guarantee the Company’s performance in accordance with contractual or legal obligations. As of September 30, 2023, the maximum potential payment obligation with regard to surety bonds was $31.6 million.
15. Income Taxes
In August 2022, the U.S. President signed into law the Inflation Reduction Act of 2022 (the “IRA”), which revised U.S. tax law by, among other things, including a new corporate alternative minimum tax (the “CAMT”) of 15% on certain large corporations, imposing a 1% excise tax on stock buybacks, and providing incentives to address climate change, including the introduction of advanced manufacturing production tax credits. The provisions of the IRA are generally effective for tax years beginning after 2022. Given the complexities of the IRA, including recently issued guidance and regulations from the Internal Revenue Service and U.S. Treasury Department, we will continue to monitor these developments and evaluate the potential future impact to our results of operations.
The Company is taxed as a subchapter C corporation and is subject to federal and state income taxes. The Company’s sole material asset is Shoals Parent, which is a limited liability company that was taxed as a partnership for U.S. federal and certain state and local income tax purposes. Shoals Parent’s net taxable income and related tax credits, if any, were passed through to its members and included in the member’s tax returns.
On July 1, 2023, the Company contributed 100% of its LLC Interests in Shoals Parent LLC to its wholly-owned subsidiary, Shoals Intermediate. Following the contribution, Shoals Parent LLC became a disregarded single member limited liability company, eliminating the Up-C structure. The contribution resulted in a $5.1 million income tax benefit during the nine months ended September 30, 2023 and a corresponding increase to the deferred tax asset as of September 30, 2023.
Shoals Parent is subject to and reports an entity level tax in various states. The income tax burden on the earnings taxed to the non-controlling interest holders was not reported by the Company in its condensed consolidated financial statements under U.S. GAAP. As a result, the Company’s effective tax rate can differ materially from the statutory rate, depending on the ownership percentage of the non-controlling interests. The Company’s effective income tax rate for the nine months ended September 30, 2023 and 2022, was 9.3% and 18.2%, respectively.
In calculating the provision for interim income taxes, in accordance with ASC Topic 740, an estimated annual effective tax rate is applied to year-to-date ordinary income. At the end of each interim period, the Company estimates the effective tax rate expected to be applicable for the full fiscal year.
For annual periods, the Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. In assessing the realizability of deferred tax assets, management considers whether it is more-likely-than-not that the deferred tax assets will be realized. Deferred tax assets and liabilities are calculated by applying existing tax laws and the rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the year of the enacted rate change.
The Company accounts for uncertainty in income taxes using a recognition and measurement threshold for tax positions taken or expected to be taken in a tax return, which are subject to examination by federal and
Notes to Condensed Consolidated Financial Statements (Unaudited)
state taxing authorities. The tax benefit from an uncertain tax position is recognized when it is more likely than not that the position will be sustained upon examination by taxing authorities based on technical merits of the position. The amount of the tax benefit recognized is the largest amount of the benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The effective tax rate and the tax basis of assets and liabilities reflect management’s estimates of the ultimate outcome of various tax uncertainties. The Company recognizes penalties and interest related to uncertain tax positions within the provision (benefit) for income taxes line in the accompanying condensed consolidated statements of operations. As of the quarter ended September 30, 2023, the Company has recorded $1.0 million of gross unrecognized tax benefits inclusive of interest and penalties, all of which, if recognized, would favorably impact the effective tax rate. The Company recognizes penalties and interest related to uncertain tax positions within the income tax expense line in the accompanying condensed consolidated statements of operations.
The Company files U.S. federal and certain state income tax returns. The income tax returns of the Company are subject to examination by U.S. federal and state taxing authorities for various time periods, depending on those jurisdictions’ rules, generally after the income tax returns are filed.
16. Revenue Recognition
Disaggregation of revenue
Based on Topic 606 provisions, the Company disaggregates its revenue from contracts with customers based on product type. Revenue by product type is disaggregated between system solutions and components. System solutions are contracts under which the Company provides multiple products typically in connection with the design and specification of an entire EBOS system. Components represents sales of individual components.
The following table presents the Company’s revenue disaggregated by product type (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
System solutions
$
99,461
$
69,486
$
292,822
$
173,136
Components
34,748
21,337
65,681
59,153
Total revenue
$
134,209
$
90,823
$
358,503
$
232,289
Contract Balances
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), retainage (contract assets), and deferred revenue (contract liabilities) on the condensed consolidated balance sheets, recorded on a contract-by-contract basis at the end of each reporting period.
The Company’s contract balances consist of the following (in thousands):
Notes to Condensed Consolidated Financial Statements (Unaudited)
(*)
September 30, 2023
December 31, 2022
Billed accounts receivable
Accounts receivable, net
$
104,138
$
48,571
Retainage
Accounts receivable, net
$
4,748
$
2,004
Unbilled receivables
Unbilled receivables
$
28,506
$
16,713
Deferred revenue
Deferred revenue
$
27,025
$
23,259
(*) Location on the condensed consolidated balance sheets.
The majority of the Company’s contract amounts are billed as work progresses in accordance with agreed-upon contractual terms, which generally coincide with the shipment of one or more phases of the project. Billing sometimes occurs subsequent to revenue recognition, resulting in unbilled receivables. The changes in unbilled receivables relate to fluctuations in the timing of billings for the Company’s revenue recognized over time. As of December 31, 2021, billed accounts receivable and unbilled receivables were $26.7 million and $13.5 million, respectively.
Certain contracts contain retainage provisions. Retainage represents a contract asset for the portion of the contract price earned by the Company for work performed but held for payment by the customer as a form of security until the Company obtains specified milestones. The Company typically bills retainage amounts as work is performed. Retainage provisions are not considered a significant financing component because they are intended to protect the customer in the event that some or all of the obligations under the contract are not completed. The changes in retainage relate to fluctuations in the timing of retainage billings and achievement of specified milestones. As of December 31, 2021, retainage was $4.8 million.
The Company also receives deferred revenue in the form of customer deposits. The customer deposits are short term as the related performance obligations are typically fulfilled within 12 months. The changes in deferred revenue relate to fluctuations in the timing of customer deposits and completion of performance obligations. During the three and nine months ended September 30, 2023, $2.3 million and $20.8 million, respectively, of deferred revenue recorded as of December 31, 2022 was recognized in revenue. As of December 31, 2021, deferred revenue was $1.8 million and during the three and nine months ended September 30, 2022, $0.4 million and $1.7 million, respectively, of deferred revenue recorded as of December 31, 2021, was recognized in revenue.
17. Related Party Transactions
As part of the LLC Agreement we were required to pay tax distributions to the non-controlling interest holders, some of which were considered related parties at the time of distribution. See Note 13 - Non-Controlling Interests.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our consolidated financial statements and the related notes and other financial information included in our Annual Report on Form 10-K for the year ended December 31, 2022 (“2022 Form 10-K”) and this Quarterly Report on Form 10-Q. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. For this purpose, any statements contained in this Form 10-Q that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “estimate” or “continue” or comparable terminology are intended to identify forward-looking statements. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under the sections of our 2022 Form 10-K and this Form 10-Q captioned “Forward-Looking Statements” and “Risk Factors”.
This MD&A contains the presentation of Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings per Share, which are not presented in accordance with generally accepted accounting principles in the U.S. (“GAAP”). Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings per Share are being presented because management believes they provide investors and readers of this Form 10-Q with additional insight into the Company’s operational performance relative to earlier periods and relative to its competitors. We do not intend Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings per Share to be substitutes for any GAAP financial information. Readers of this Form 10-Q should use Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings per Share only in conjunction with Gross Profit, Net Income (Loss), and Net Income (Loss) Attributable to Shoals Technologies Group, Inc., the most closely comparable GAAP financial measures, as applicable. Reconciliations of Adjusted Gross Profit, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings per Share to the respective most closely comparable GAAP measure, as well as a calculation of Adjusted Gross Profit Percentage and Adjusted Diluted Weighted Average Shares Outstanding, are provided below, in “—Non-GAAP Financial Measures.”
Overview
We are a leading provider of electrical balance of systems (“EBOS”) solutions and components for solar, battery storage and electrical vehicle (“EV”) charging applications, selling to customers primarily in the United States as well as internationally. EBOS encompasses all of the components that are necessary to carry the electric current produced by solar panels to an inverter and ultimately to the power grid. EBOS components are mission-critical products that have a high consequence of failure, including lost revenue, equipment damage, fire damage, and even serious injury or death. As a result, we believe customers prioritize reliability and safety over price when selecting EBOS solutions.
EBOS components that we produce include cable assemblies, inline fuses, combiners, disconnects, recombiners, wireless monitoring systems, junction boxes, transition enclosures and splice boxes. We derive the majority of our revenue from selling “system solutions” which are complete EBOS systems that include several of our products, many of which are customized for the customer’s project. We believe our system solutions are unique in our industry because they integrate design and engineering support, proprietary components and innovative installation methods into a single offering that would otherwise be challenging for a customer to obtain from a single provider or at all.
We sell our solar products principally to engineering, procurement and construction firms (“EPCs”) that build solar energy projects. However, given the mission-critical nature of EBOS, the decision to use our products typically involves input from both the EPC and the owner of the solar energy project. The custom nature of our system solutions and the long development cycle for solar energy projects typically gives us 12
25
months or more of lead time to quote, engineer, produce and ship each order we receive, and we do not stock large amounts of finished goods.
Throughout the first three quarters of 2023, we have maintained focus on our growth strategy, including converting customers to our combine-as-you-go system. We believe that as of September 30, 2023, 13 of the top 15 and 15 of the top 25 solar EPCs, as reported by Solar Power World Magazine, use our combine-as-you-go system on their projects. As of the date of this report, we are in the process of transitioning an additional 15 EPCs and developers to our system.
We derived 81.7% of our revenue from the sale of system solutions for the nine months ended September 30, 2023. For the same period, we derived substantially all of our revenue from customers in the U.S. As of September 30, 2023, we had $633.3 million of backlog and awarded orders, backlog of $267.3 million represents signed purchase orders or contractual minimum purchase commitments with take-or-pay provisions and awarded orders of $366.0 million are orders we are in the process of documenting a contract for but for which a contract has not yet been signed. As of September 30, 2023, backlog and awarded orders increased by 34% relative to the same date last year and increased by 16% relative to June 30, 2023.
Secondary Offering
On March 10, 2023, selling stockholders, which consisted of certain entities controlled by Dean Solon, our founder (the “Founder”) completed a secondary offering consisting of 24,501,650 shares of Class A common stock. Following the closing of the secondary offering, the Founder no longer owned any shares of our Class B common stock or membership interests in Shoals Parent (“LLC Interests”). The Company did not receive any proceeds from the sale of shares of our Class A common stock by the selling stockholders in this offering.
Exchange of LLC Interests and Contributions
In March 2023, certain Continuing Equity Owners (as defined in Note 12 - Stockholders’ Equity), including the Founder, exchanged an aggregate of 31,419,913 LLC Interests together with an equal number of shares of Class B common stock for 31,419,913 newly-issued shares of Class A common stock. As a result, upon effectiveness of such exchanges, all of the LLC Interests in Shoals Parent were held by the Company, no other holders owned LLC Interests and no Class B common stock is outstanding.
On July 1, 2023, the Company contributed 100% of its LLC Interests of Shoals Parent LLC to Shoals Intermediate Parent, Inc. Following the contribution, Shoals Parent LLC became a disregarded single member limited liability company, eliminating the umbrella-partnership C corporation structure (“Up-C structure”).
Effective July 1, 2023, the Company owned 100% of Shoals Parent together with its wholly-owned subsidiary, Shoals Intermediate Parent, Inc. (“Shoals Intermediate”).
Trends and Uncertainties
In 2022 and to a lesser extent during the first three quarters of 2023, significant levels of inflation resulted in increased energy prices, freight premiums, and other operating costs. As a result of inflation, during 2022 and the first three quarters of 2023, the Federal Reserve increased interest rates. Such increased interest rates have resulted in higher interest rates associated with our Senior Secured Credit Agreement, as defined in Note 8 - Long-Term Debt. The Federal Reserve may continue raising interest rates, and any such additional increases will have a corresponding increase in the interest rates charged under our Senior Secured Credit Agreement. The eventual implications of higher government deficits and debt, tighter monetary policy, and potentially higher long-term interest rates may drive a higher cost of capital during our forecast period.
In 2022 and to a lesser extent during the first three quarters of 2023, as a consequence of macroeconomic events, our ability to obtain raw materials required to manufacture our components and system solutions from domestic and international suppliers, as well as our ability to secure inbound logistics to and from our facilities, were impacted, with additional delays linked to international border crossings and the
26
associated approvals and documentation. The Company does not directly source a significant amount of raw materials from Europe. However, the ongoing conflict in Ukraine has reduced the availability of certain materials that can be sourced in Europe and, as a result, increased global logistics costs for the procurement of some inputs and materials used in our products. We expect these trends to persist throughout the year. In addition, changes over the last few years in the international relations and tariff regimes between the U.S. and China in response to various political issues and heightened uncertainty regarding China-Taiwan relations could significantly adversely impact the availability of parts and components to us, and, correspondingly, our ability to produce our components at targeted levels, although we did not experience such negative effects during the first three quarters of 2023. We are continuously monitoring the situation of our supply chain and evaluating our procurement strategy and supply chain to reduce any negative impact on our business, financial condition, and results of operations.
In response to supply chain constraints, in 2022 we increased certain raw materials inventory, partly to limit the potential impact of supply chain issues of raw materials in the near term. During the first three quarters of 2023, we continued to monitor and optimize our inventory levels.
As of September 30, 2023, other than increased interest expense, we did not experience material adverse effects on our financial results from the events and trends discussed above.
Key Components of Our Results of Operations
The following discussion describes certain line items in our condensed consolidated statements of operations.
Revenue
We generate revenue from the sale of EBOS systems and components for homerun and combine-as-you-go architectures, battery storage and EV charging infrastructure. Our customers include EPCs, utilities, solar developers, independent power producers, solar module manufacturers and charge point operators. We derive the majority of our revenue from selling solar system solutions. When we sell a solar system solution, we enter into a contract with our customers covering the price, specifications, delivery dates and warranty for the products being purchased, among other things. Our contractual delivery period for solar system solutions can vary from one to three months whereas manufacturing typically requires a shorter time frame. Contracts for solar system solutions can range in value from several hundred thousand to several million dollars.
Our revenue is affected by changes in the price, volume and mix of solar system solutions and components purchased by our customers. The price and volume of our system solutions and components is driven by the demand for our solar system solutions and components, changes in product mix between homerun and combine-as-you-go EBOS, geographic mix of our customers, strength of competitors’ product offerings, and availability of government incentives to the end-users of our products.
Our revenue growth is dependent on continued growth in the amount of solar energy projects constructed each year and our ability to increase our share of demand in the geographies where we currently compete and plan to compete in the future, as well as our ability to continue to develop and commercialize new and innovative products that address the changing technology and performance requirements of our customers.
Cost of Revenue and Gross Profit
Cost of revenue consists primarily of system solutions and components costs, including purchased raw materials, as well as costs related to shipping, customer support, product warranty, personnel and depreciation of manufacturing and testing equipment. Personnel costs in cost of revenue include both direct labor costs as well as costs attributable to any individuals whose activities relate to the transformation of raw materials or component parts into finished goods or the transportation of materials to the customer. Our product costs are affected by the underlying cost of raw materials, including copper and aluminum; component costs, including fuses, resin, enclosures, and cable; technological innovation; economies of scale resulting in lower component
27
costs; and improvements in production processes and automation. We do not currently hedge against changes in the price of raw materials. Some of these costs, primarily indirect personnel and depreciation of manufacturing and testing equipment, are not directly affected by sales volume. Gross profit may vary from year to year and is primarily affected by our sales volume, product prices, product costs, product mix, customer mix, geographical mix, shipping method and warranty expense.
Operating Expenses
Operating expenses consist of general and administrative expenses as well as depreciation and amortization expense. Personnel-related costs are the most significant component of our operating expenses and include salaries, equity-based compensation, benefits, payroll taxes and commissions. The number of full-time employees in our general and administrative departments increased from 103 to 139 from September 30, 2022 to September 30, 2023, and we expect to hire new employees in the future to support our growth. The timing of these additional hires could materially affect our operating expenses in any particular period, both in absolute dollars and as a percentage of revenue. We expect to invest in additional resources to support our growth, which will increase our operating expenses.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries, equity-based compensation expense, employee benefits and payroll taxes related to our executives, and our sales, finance, human resources, information technology, engineering and legal organizations, travel expenses, facilities costs, marketing expenses, insurance, bad debt expense and fees for professional services. Professional services consist of audit, tax, accounting, legal, internal controls, information technology, investor relations and other costs. We expect to increase our sales and marketing personnel as we expand into new geographic markets. Substantially all of our sales are currently in the U.S. We currently have a sales presence in the U.S., Asia-Pacific, Europe, Latin America, and Africa. We intend to grow our sales presence and marketing efforts in current geographic markets and expand to additional countries in the future.
Depreciation
Depreciation in our operating expenses consists of costs associated with property, plant and equipment (“PP&E”) not used in manufacturing our products. We expect that as we increase both our revenue and the number of our general and administrative personnel, we will invest in additional PP&E to support our growth resulting in additional depreciation expense.
Amortization
Amortization of intangibles consists of amortization of customer relationships, developed technology, trade names, backlog and noncompete agreements over their expected period of use.
Non-operating Expenses
Interest Expense
Interest expense consists of interest and other charges paid in connection with our Senior Secured Credit Agreement.
Income Tax Benefit (Expense)
Shoals Technologies Group, Inc. is subject to U.S. federal and state income tax in multiple jurisdictions with respect to our allocable share of any net taxable income of Shoals Parent. Prior to the July 1, 2023, contribution described in Note 15 - Income Taxes, Shoals Parent was a pass-through entity for federal income tax purposes but incurred income tax in certain state jurisdictions. Following the contribution, Shoals Parent became a disregarded single member limited liability company, eliminating the Up-C structure.
28
Results of Operations
The following table summarizes our results of operations (dollars in thousands):
Three Months Ended September 30,
Increase / (Decrease)
Nine Months Ended September 30,
Increase / (Decrease)
2023
2022
2023
2022
Revenue
$
134,209
$
90,823
$
43,386
48
%
$
358,503
$
232,289
$
126,214
54
%
Cost of revenue
120,059
54,776
65,283
119
%
245,579
141,357
104,222
74
%
Gross profit
14,150
36,047
(21,897)
(61)
%
112,924
90,932
21,992
24
%
Operating expenses
General and administrative expenses
22,551
13,853
8,698
63
%
59,266
41,037
18,229
44
%
Depreciation and amortization
2,170
2,229
(59)
(3)
%
6,493
6,939
(446)
(6)
%
Total operating expenses
24,721
16,082
8,639
54
%
65,759
47,976
17,783
37
%
Income (loss) from operations
(10,571)
19,965
(30,536)
(153)
%
47,165
42,956
4,209
10
%
Interest expense, net
(5,899)
(4,754)
1,145
24
%
(18,400)
(12,760)
5,640
44
%
Income (loss) before income taxes
(16,470)
15,211
(31,681)
(208)
%
28,765
30,196
(1,431)
(5)
%
Income tax benefit (expense)
6,642
(2,452)
(9,094)
(371)
%
(2,686)
(5,485)
(2,799)
(51)
%
Net income (loss)
(9,828)
12,759
(22,587)
(177)
%
26,079
24,711
1,368
6
%
Less: net income attributable to non-controlling interests
—
4,801
(4,801)
(100)
%
2,687
9,711
(7,024)
(72)
%
Net income (loss) attributable to Shoals Technologies Group, Inc.
$
(9,828)
$
7,958
$
(17,786)
(223)
%
$
23,392
$
15,000
$
8,392
56
%
Comparison of the Three Months Ended September 30, 2023 and 2022
Revenue
Revenue increased by $43.4 million, or 48%, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022, driven by higher sales volumes as a result of increased demand for solar EBOS generally and our combine-as-you-go system solutions specifically. Our total number of customers along with the number of combine-as-you-go system solutions projects increased during the three months ended September 30, 2023, as compared to the same period in 2022. We believe expanding customer recognition of the benefits of our combine-as-you-go system solutions is continuing to result in increased demand for our products.
Cost of Revenue and Gross Profit
Cost of revenue increased by $65.3 million, or 119%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022, driven by $50.2 million of wire insulation shrinkback warranty expense recorded during three months ended September 30, 2023, compared to none recorded during the same period during 2022. The remaining increase is driven by the increase in revenue. Gross profit as a percentage of revenue was 39.7% during the three months ended September 30, 2022, and 10.5% during three months ended September 30, 2023. The decrease in gross profit as a percentage of revenue was driven by the increase in recorded wire insulation shrinkback warranty expense and was offset by slightly lower raw materials input costs, increased leverage on fixed costs, and efficiencies gained in operations.
29
Operating Expenses
General and Administrative
General and administrative expenses increased $8.7 million, or 63%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The increase in general and administrative expenses was the result of an increase in wages and related taxes of $3.4 million due to increased employee headcount to support our growth initiatives, as well as an increase in professional fees of $3.0 million primarily related to legal fees incurred in connection with the ongoing patent infringement and wire insulation shrinkback litigation, an increase of $1.0 million related to equity-based compensation, and an increase of $0.8 million in expense related to travel and trade shows.
Depreciation and Amortization
Depreciation and amortization expenses decreased $0.1 million, or 3%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The decrease in depreciation and amortization was due to definite lived intangible assets that became fully amortized during 2022.
Interest Expense
Interest expense, net increased by $1.1 million or 24%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022, which was due to increased borrowing rates. During 2022 and the first three quarters of 2023, the Federal Reserve increased interest rates resulting in higher interest rates associated with our Senior Secured Credit Agreement. Any additional increases in interest rates by the Federal Reserve would have a corresponding increase in the interest rates charged under our Senior Secured Credit Agreement. This increase in interest expense was offset by a decrease in the weighted average outstanding balance of the Revolving Credit Facility and Term Loan Facility during the three months ended September 30, 2023, compared to the three months ended September 30, 2022.
Income tax benefit (expense)
Income tax benefit totaled $6.6 million for the three months ended September 30, 2023, as compared to income tax expense of $2.5 million for the three months ended September 30, 2022. Our effective income tax rate for the three months ended September 30, 2023 and 2022 was 40.3% and 16.1%, respectively. The 2023 increase in our effective income tax rate for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022 was due to an income tax benefit of $5.1 million recorded in connection with termination of the Up-C structure on July 1, 2023, as discussed in more detail in Note 15 - Income Taxes, and a reduction in permanent differences as a result of net income attributable to non-controlling interests.
Comparison of the Nine Months Ended September 30, 2023 and 2022
Revenue
Revenue increased by $126.2 million, or 54%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022, driven by higher sales volumes as a result of increased demand for solar EBOS generally and our combine-as-you-go system solutions specifically. Our total number of customers along with the number of combine-as-you-go system solutions projects increased during the nine months ended September 30, 2023 as compared to the same period in 2022. We believe expanding customer recognition of the benefits of our combine-as-you-go system solutions is continuing to result in increased demand for our products.
30
Cost of Revenue and Gross Profit
Cost of revenue increased by $104.2 million, or 74%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022, driven by $59.1 million of wire insulation shrinkback warranty expense recorded during nine months ended September 30, 2023, compared to none recorded during the same period during 2022. The remaining increase is driven by the increase in revenue. Gross profit as a percentage of revenue was from 39.1% during the nine months ended September 30, 2022, and 31.5% during the nine months ended September 30, 2023. The decrease in gross profit as a percentage of revenue was driven by the increase in wire insulation shrinkback warranty expense and was offset by a higher portion of overall revenue coming from the Company’s combine-as-you-go system solutions, which carry higher margins than the Company’s other products, slightly lower raw materials input costs, increased leverage on fixed costs, and efficiencies gained in operations.
Operating Expenses
General and Administrative
General and administrative expenses increased $18.2 million, or 44%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase in general and administrative expenses was the result of an increase in wages and related taxes of $7.6 million due to increased employee headcount to support our growth, as well as an increase in equity-based compensation of $4.6 million related to termination of our former CEO for disability and an increase in employee headcount, and an increase in professional fees of $4.1 million primarily related to legal fees incurred in connection with the ongoing patent infringement and wire insulation shrinkback litigation.
Depreciation and Amortization
Depreciation and amortization expense decreased by $0.4 million, or 6%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022, due to definite lived intangible assets that became fully amortized during 2022.
Interest Expense
Interest expense, net increased by $5.6 million or 44%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022, which was due to increased borrowing rates. During 2022 and the first three quarters of 2023, the Federal Reserve increased interest rates resulting in higher interest rates associated with our Senior Secured Credit Agreement. Any additional increases in interest rates by the Federal Reserve would have a corresponding increase in the interest rates charged under our Senior Secured Credit Agreement. This increase in interest expense was offset by a decrease in the weighted average outstanding balance of the Revolving Credit Facility and Term Loan Facility during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022.
Income tax benefit (expense)
Income tax expense was $2.7 million for the nine months ended September 30, 2023 as compared to income tax expense of $5.5 million for the nine months ended September 30, 2022. Our effective income tax rate for the nine months ended September 30, 2023 and 2022 was 9.3% and 18.2%, respectively. The decrease in the effective tax rate was due to an income tax benefit of $5.1 million recorded in connection with termination of the Up-C structure on July 1, 2023, as discussed in more detail in Note 15 - Income Taxes. This decrease was offset by an increase due to a reduction in permanent differences as a result of net income attributable to non-controlling interests.
Non-GAAP Financial Measures
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Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings per Share (“EPS”)
We define Adjusted Gross Profit as gross profit plus wire insulation shrinkback expenses. We define Adjusted Gross Profit Percentage as Adjusted Gross Profit divided by revenue. We define Adjusted EBITDA as net income (loss) plus (i) interest expense, net, (ii) income tax benefit (expense), (iii) depreciation expense, (iv) amortization of intangibles, (v) equity-based compensation, (vi) acquisition-related expenses, (vii) wire insulation shrinkback expenses, and (viii) wire insulation shrinkback litigation expenses. We define Adjusted Net Income as net income (loss) attributable to Shoals Technologies Group, Inc. plus (i) net income impact from assumed exchange of Class B common stock to Class A common stock as of the beginning of the earliest period presented, (ii) amortization of intangibles, (iii) amortization of deferred financing costs, (iv) equity-based compensation, (v) acquisition-related expenses, (vi) wire insulation shrinkback expenses, and (vii) wire insulation shrinkback litigation expenses, all net of applicable income taxes. We define Adjusted Diluted EPS as Adjusted Net Income divided by the diluted weighted average shares of Class A common stock outstanding for the applicable period, which assumes the exchange of all outstanding Class B common stock for Class A common stock as of the beginning of the earliest period presented.
Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS are intended as supplemental measures of performance that are neither required by, nor presented in accordance with, GAAP. We present Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS because we believe they assist investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS: (i) as factors in evaluating management’s performance when determining incentive compensation, as applicable; (ii) to evaluate the effectiveness of our business strategies; and (iii) because our credit agreement uses measures similar to Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS to measure our compliance with certain covenants.
Among other limitations, Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments; do not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations; and may be calculated by other companies in our industry differently than we do or not at all, which may limit their usefulness as comparative measures.
Because of these limitations, Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS should not be considered in isolation or as substitutes for performance measures calculated in accordance with GAAP. You should review the reconciliation of gross profit to Adjusted Gross Profit and Adjusted Gross Profit Percentage, net income (loss) to Adjusted EBITDA, and net income (loss) attributable to Shoals Technologies Group, Inc. to Adjusted Net Income and Adjusted Diluted EPS below and not rely on any single financial measure to evaluate our business.
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Reconciliation of Gross Profit to Adjusted Gross Profit and Adjusted Gross Profit Percentage (in thousands):
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
Revenue
$
134,209
$
90,823
$
358,503
$
232,289
Cost of revenue
120,059
54,776
245,579
141,357
Gross profit
14,150
36,047
112,924
90,932
Wire insulation shrinkback expenses(a)
50,211
—
61,705
—
Adjusted gross profit
$
64,361
$
36,047
$
174,629
$
90,932
Adjusted gross profit percentage
48.0%
39.7%
48.7%
39.1%
Reconciliation of Net Income (Loss) to Adjusted EBITDA (in thousands):
(a) For the three months ended September 30, 2023 represents, (i) $50.2 million wire insulation shrinkback warranty expenses related to the identification, repair and replacement of a subset of wire harnesses presenting unacceptable levels of wire insulation shrinkback. For the nine months ended September 30, 2023 represents, (i) $59.1 million wire insulation shrinkback warranty expenses related to the identification, repair and replacement of a subset of wire harnesses presenting unacceptable levels of wire insulation shrinkback, including $8.9 million recorded during the six months ended June 30, 2023, and (ii) $2.6 million of inventory write-downs of the defective red wire. We consider expenses incurred in connection with the identification, repair and replacement of the impacted wire harnesses as well as the write-down of related inventory distinct from normal, ongoing service identification, repair and replacement expenses that would be reflected under ongoing warranty expenses within the operation of our business and normal write-downs of inventory, which we do not exclude from our non-GAAP measures. In the future, we also intend to exclude from our non-GAAP measures the benefit of liability releases, if any. We believe excluding expenses from these discrete liability events provides investors with a better view of the operating performance of our business and allows for comparability through periods. See Note 14 - Commitments and Contingencies, in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for more information.
(b) For the three and nine months ended September 30, 2023 represents $0.6 million of expenses incurred in connection with the lawsuit initiated by the Company against the supplier of the defective red wire. We consider this litigation distinct from ordinary course legal matters given the expected magnitude of the expenses, the nature of the allegations in the Company’s complaint, the amount of damages sought, and the impact of the matter underlying the litigation on the Company’s financial results. In the future, we also intend to exclude from our non-GAAP measures the benefit of recovery, if any. We believe excluding expenses from these discrete litigation events provides investors with a better view of the operating performance of our business and allows for comparability through periods. See Note 14 - Commitments and Contingencies, in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for more information.
(c) Reflects net income to Class A common stock from assumed exchange of corresponding shares of our Class B common stock held by the Founder and management. There were no shares of Class B common stock outstanding during the three months ended September 30, 2023.
(d) Shoals Technologies Group, Inc. is subject to U.S. Federal income taxes, in addition to state and local taxes with respect to its allocable share of any net taxable income of Shoals Parent LLC. The adjustment to the provision for income tax reflects the effective tax rates below, assuming Shoals Technologies Group, Inc. owned 100% of the units in Shoals Parent LLC for all periods presented.
34
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
Statutory U.S. Federal income tax rate
21.0
%
21.0
%
21.0
%
21.0
%
Permanent adjustments
1.8
%
0.1
%
1.4
%
0.1
%
State and local taxes (net of federal benefit)
3.3
%
2.5
%
3.2
%
2.5
%
Effective income tax rate for Adjusted Net Income
26.1
%
23.6
%
25.6
%
23.6
%
(e) Represents the estimated tax impact of all Adjusted Net Income add-backs, excluding those which represent permanent differences between book versus tax.
Reconciliation of Diluted Weighted Average Shares Outstanding to Adjusted Diluted Weighted Average Shares Outstanding (in thousands, except per share):
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
Diluted weighted average shares of Class A common stock outstanding, excluding Class B common stock
170,365
113,584
162,611
112,816
Assumed exchange of Class B common stock to Class A common stock
—
54,253
7,619
54,579
Adjusted diluted weighted average shares outstanding
170,365
167,837
170,230
167,395
Adjusted Net Income
$
33,353
$
16,567
$
89,873
$
37,369
Adjusted Diluted EPS
$
0.20
$
0.10
$
0.53
$
0.22
Liquidity and Capital Resources
Nine Months Ended September 30,
2023
2022
Net cash provided by operating activities
$
65,508
$
5,014
Net cash used in investing activities
(7,911)
(2,896)
Net cash provided by (used in) financing activities
(57,139)
19,941
Net increase in cash, cash equivalents and restricted cash
$
458
$
22,059
We finance our operations primarily with operating cash flows and short and long-term borrowings. Our ability to generate positive cash flow from operations is dependent on the strength of our gross profits as well as our ability to quickly turn our working capital. Based on our past performance and current expectations, we believe that operating cash flows and availability under our Revolving Credit Facility will be sufficient to meet our near and long-term future cash needs.
We generated cash from operating activities of $65.5 million during the nine months ended September 30, 2023, as compared to cash provided by operating activities of $5.0 million during the nine months ended September 30, 2022. As of September 30, 2023, our cash and cash equivalents were $9.2 million, an increase from $8.8 million as of December 31, 2022. As of September 30, 2023 we had outstanding borrowings of $193.8 million, a decrease from $243.3 million as of December 31, 2022. As of September 30, 2023, we also had $149.4 million available for additional borrowings under our $150.0 million Revolving Credit Facility.
35
Operating Activities
For the nine months ended September 30, 2023, cash provided by operating activities was $65.5 million, primarily due to operating results that included $26.1 million of net income, which included $92.0 million of non-cash expense, along with an increase of $10.7 million in accounts payable and accrued expenses, a decrease of $8.3 million in inventory, and an increase of $3.8 million in deferred revenue. These cash inflows were offset by an increase in accounts receivable and unbilled receivables of $70.4 million and cash outflows of $3.7 million related to the warranty liability.
Investing Activities
For the nine months ended September 30, 2023, net cash used in investing activities was $7.9 million, which was primarily attributable to the purchase of property and equipment.
Financing Activities
For the nine months ended September 30, 2023, net cash used in financing activities was $57.1 million, primarily due to $3.9 million in taxes related to net share settled equity awards, $48.0 million in net payments on the Revolving Credit Facility, $1.5 million in principal payments on the Term Loan Facility, and $2.6 million in distributions to our non-controlling interest holders.
Debt Obligations
For a discussion of our debt obligations see Note 9 - Long-Term Debt in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Surety Bonds
For a discussion of our surety bond obligations see Note 14 - Commitments and Contingencies in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Product Warranty
For a discussion of our product warranties see Note 14 - Commitments and Contingencies in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Critical Accounting Policies and Accounting Estimates
Except as set forth below, as of September 30, 2023, there were no significant changes in the application of our critical accounting policies or estimation procedures from those presented in our 2022 Form 10-K.
Product Warranty
General Warranty
The Company offers an assurance type warranty for its products against manufacturer defects and does not contain a service element. For these assurance type warranties, a provision for estimated future costs related to warranty expense is recorded when they are probable and reasonably estimable. This provision is based on historical information on the nature, frequency and average cost of claims for each product line. When little or no experience exists for an immature product line, the estimate is based on comparable product lines. Specific reserves are established once an issue is identified with the amounts for such reserves based on the estimated cost of correction. These estimates are re-evaluated on an ongoing basis using best-available information and revisions to estimates are made as necessary. These estimates are inherently uncertain given our relatively short history of sales, and actual results that differ from our assumptions and judgments could have a material adverse effect on our business, financial condition and results of operations.
36
Wire Insulation Shrinkback Warranty
The Company has been notified by certain customers that a subset of wire harnesses used in its EBOS solutions is presenting unacceptable levels of wire insulation shrinkback. Based upon the Company’s ongoing assessment, the Company currently believes the wire insulation shrinkback is related to defective red wire manufactured by Prysmian. Based on the Company’s continued analysis of information available as of the date of this Quarterly Report, which includes better visibility into the scope of affected sites and potential solutions, including identification, repair and replacement of harnesses, the Company has determined that a potential range of loss was both probable and reasonably estimable and has updated its estimate of potential losses from the $9.3 million estimate provided in the previous quarter. However, as no amount within the current range of loss appears to be a better estimate than any other amount, the Company has recorded a warranty liability and related expense representing the low end of the range of potential loss of $59.7 million. The high-end of the range of potential loss is $184.9 million, which is $125.2 million higher than the amount we recorded. As of September 30, 2023, the Company recorded a warranty liability of $56.6 million related to this matter. The Company recorded total warranty expense related to this matter of $50.2 million and $59.1 million for the three and nine months ended September 30, 2023, respectively, and zero for the three and nine months ended September 30, 2022.
The estimated range is based on several assumptions, including with respect to the magnitude of engineering, procurement and construction firms’ (“EPCs”) labor cost to identify and perform the repair and replacement of impacted harnesses, estimated failure rates, materials replacement cost, planned remediation method, inspection costs, and other various assumptions. These assumptions are highly subjective and require significant management judgment. As a result, these assumptions could prove to be materially different from our current estimate, causing us to incur substantial unanticipated expense to identify. repair or replace the defective wire or to compensate customers. As additional information becomes available, the Company may increase or decrease its estimated warranty liability and related expense from its current estimate, and such increase or decrease may be material.
As of September 30, 2023, a 10% increase in EPC labor costs, failure rate, materials replacement cost, and inspection costs would result in an increase of the low end of the range of potential losses of $2.8 million, $0.9 million, $1.6 million, and $0.5 million, respectively. A 10% increase in EPC labor costs, materials replacement cost, and inspection costs would result in an increase of the high end of the range of potential loss of $11.0 million, $5.2 million, and $0.5 million, respectively. Additionally, changes to the planned remediation method could also have a material impact on the warranty liability.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes with respect to our market risk disclosed in our 2022 Form 10-K.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
37
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2023, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There were no changes to our internal control over financial reporting that occurred during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be involved in litigation relating to claims that arise out of our operations and businesses and that cover a wide range of matters, including, among others, intellectual property matters, contract and employment claims, personal injury claims, product liability claims and warranty claims. Except as described under Litigation in Note 14 - Commitments and Contingencies, there are no claims or proceedings to which we are party that we believe would have a material adverse effect on our business, financial condition, results of operations or cash flows. However, the results of any current or future litigation cannot be predicted with certainty, and regardless of the outcome, we may incur significant costs and experience a diversion of management resources as a result of litigation.
Item 1A. Risk Factors
Except as set forth below, there have been no material changes with respect to our risk factors disclosed in our 2022 Form 10-K.
Defects or performance problems in our products or their parts, including those related to the wire insulation shrinkback matter, could result in loss of customers, reputational damage and decreased revenue, and may have a material adverse effect on our business, financial condition and results of operations.
EBOS components, including cable assemblies, inline fuses, combiners, disconnects, recombiners, wireless monitoring systems, junction boxes, transition enclosures, splice boxes, conventional homerun EBOS system solutions and combine-as-you-go EBOS system solutions, whether manufactured by us or third party suppliers, are products and systems that have a high consequence of failure, including equipment damage, fire damage, and even serious injury or death because of the high voltages involved and potential for fire. Further, a fault in the wiring of an EBOS system, whether as a result of product malfunctions, defects or improper installation, may cause electrical failures in solar energy projects. Faults typically occur when natural thermal expansion and contraction occurs at a point where two wires have been joined, loosening the insulation, and allowing moisture into the joint. Faults can result in lost production for customers, damage to the equipment, fire and injury or death depending on their severity and whether people are onsite.
Although we conduct quality assessments on our products and these products have stringent quality requirements, they may contain undetected errors or defects, especially when first introduced or when new generations are released. Errors, defects, product failures, destructions or poor performance can arise due to design flaws, defects in raw materials or components or manufacturing difficulties, which can affect both the quality and the yield of the product. Any actual or perceived errors, defects or poor performance in our products could result in the replacement or recall of our products, shipment delays, rejection of our products, damage to our reputation, lost revenue, diversion of our engineering personnel from our product development efforts and
38
increases in customer service and support costs, all of which could have a material adverse effect on our business, financial condition and results of operations.
Furthermore, defective components may give rise to warranty, indemnity or product liability claims against us that exceed any revenue or profit we receive from the affected products. Our limited warranties cover defects in materials and workmanship of our products under normal use and service conditions. As a result, we bear the risk of warranty claims long after we have sold products and recognized revenue. While we accrue reserves for warranty claims, our estimated warranty expense for previously sold products may change to the extent future products are not compatible with earlier generation products under warranty.
The Company has been notified by certain customers that a subset of wire harnesses used in its EBOS solutions is presenting unacceptable levels of wire insulation shrinkback. Based upon the Company’s ongoing assessment, the Company currently believes the wire insulation shrinkback is related to defective red wire manufactured by Prysmian. Based on the Company’s continued analysis of information available as of the date of this Quarterly Report, which includes better visibility into the scope of affected sites and potential solutions, including identification, repair and replacement of harnesses, the Company has determined that a potential range of loss was both probable and reasonably estimable and has updated its estimate of potential losses from the estimate provided in the previous quarter. However, as no amount within the current range of loss appears to be a better estimate than any other amount, the Company has recorded a warranty liability and related expense representing the low end of the range of potential loss of $59.7 million. The high-end of the range of potential loss is $184.9 million, which is $125.2 million higher than the amount we recorded. As of September 30, 2023, we recorded a warranty liability of $56.6 million related to this matter. The estimated range is based on several assumptions, and as additional information becomes available, the Company may increase or decrease its estimated warranty liability from its current estimate, and such increase or decrease may be material. The Company recorded total warranty expense related to this matter of $50.2 million and $59.1 million for the three and nine months ended September 30, 2023, respectively, and zero for the three and nine months ended September 30, 2022. The Company does not maintain insurance for product warranty and has commenced a lawsuit against Prysmian, as discussed in more detail under Litigation in Note 14 - Commitments and Contingencies in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Because the lawsuit against Prysmian is ongoing, potential recovery from Prysmian is not considered probable as defined in ASC 450, and has not been considered in our estimate of the warranty liability as of September 30, 2023.
Our warranty liability for this matter is based on a number of assumptions, including with respect to the magnitude of engineering, procurement and construction firms’ (“EPCs”) labor cost to perform the repair and replacement of impacted harnesses, estimated failure rates, materials replacement cost, planned remediation method, and other various assumptions. We do not have a long history of making assumptions relating to warranties. As a result, these assumptions could prove to be materially different from our current estimate, causing us to incur substantial unanticipated expense to identify, repair or replace the defective wire or to compensate customers. As additional information becomes available, the Company may increase or decrease its estimated warranty liability from its current estimate, and such increase or decrease may be material. Our failure to accurately estimate this liability could result in unexpected volatility and have a material adverse effect on, our financial condition.
In addition, results of the litigation we have commenced against Prysmian are inherently uncertain and we cannot guarantee the outcome of that litigation. Litigation can be expensive and time consuming and will divert the efforts of our management and other personnel, which could harm our business, whether or not such litigation results in a determination favorable to us. If we fail to recover the costs and expenses incurred by us in connection with the identification, repair and replacement of the defective Prysmian wire, our financial results, business and prospects could be materially adversely impacted. Our actual loss in this matter is uncertain and may have a material adverse effect on our business, financial condition and results of operations.
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If one of our products, including those that contain the defective red wires mentioned above, causes injury to someone or causes property damage, including as a result of product malfunctions, defects or improper installation, we could also be exposed to product liability claims. We could incur significant costs and liabilities if we are sued and if damages are awarded against us. Further, any product liability claim we face, including those related to the wires mentioned above, could be expensive to defend and could divert management’s attention. The successful assertion of a product liability claim against us, including those related to the defective wire harnesses mentioned above, could result in potentially significant monetary damages, penalties or fines; subject us to adverse publicity; damage our reputation and competitive position; and adversely affect sales of our products. In addition, product liability claims, injuries, defects or other problems experienced by other companies in the solar industry could lead to unfavorable market conditions for the industry as a whole and may have an adverse effect on our ability to attract new customers, thus harming our growth and financial performance.
If we fail to, or incur significant costs in order to, obtain, maintain, protect, defend or enforce our intellectual property and other proprietary rights, our business and results of operations could be materially harmed.
Our success depends to a significant degree on our ability to protect our intellectual property and other proprietary rights. We rely on a combination of patent, trademark, copyright, trade secret and unfair competition laws, as well as confidentiality and license agreements and other contractual provisions, to establish and protect our intellectual property and other proprietary rights. Such means may afford only limited protection of our intellectual property and may not (i) prevent our competitors from duplicating our processes or technology; (ii) prevent our competitors from gaining access to our proprietary information and technology; or (iii) permit us to gain or maintain a competitive advantage.
We generally seek or apply for patent protection as and if we deem appropriate, based on then-current facts and circumstances. We have applied for patents in the U.S., some of which have been issued. We cannot guarantee that any of our pending patent applications or other applications for intellectual property registrations will be issued or granted or that our existing and future intellectual property rights will be sufficiently broad to protect our proprietary technology. While a presumption of validity exists with respect to U.S. patents issued to us, there can be no assurance that any of our patents, patent applications, or other intellectual property rights will not be, in whole or in part, opposed, contested, challenged, invalidated, circumvented, designed around, or rendered unenforceable. Any such impairment or other failure to obtain sufficient intellectual property protection could impede our ability to market our products, negatively affect our competitive position and harm our business and operating results, including by forcing us to, among other things, rebrand or redesign our affected products. Moreover, our patents and patent applications may only cover particular aspects of our products, and competitors and other third parties may be able to circumvent or design around our patents, or develop and obtain patent protection for more effective technologies, designs or methods. There can be no assurance that third parties will not create new products or methods that achieve similar or better results without infringing upon patents we own. If these developments occur, they could have an adverse effect on our sales or market position.
In countries where we have not applied for patent protection or trademark or other intellectual property registration or where effective patent, trademark, trade secret, and other intellectual property laws and judicial systems may not be available to the same extent as in the U.S., we may be at greater risk that our proprietary rights will be circumvented, misappropriated, infringed, or otherwise violated.
We rely heavily on trade secrets and nondisclosure agreements to protect our unpatented know-how, technology, and other proprietary information, and to maintain our competitive position, which we seek to protect, in part, by entering into nondisclosure and confidentiality agreements with parties who have access to them, such as our employees, consultants, and other third parties. However, we cannot guarantee that we
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have entered into such agreements with each party that has or may have had access to our proprietary information, know-how and trade secrets. Moreover, no assurance can be given that these agreements will be effective in controlling access to, distribution, use, misuse, misappropriation, or disclosure of our proprietary information, know-how and trade secrets, or in preventing our competitors from independently developing technologies that are substantially equivalent or superior to ours.
The registered or unregistered trademarks or trade names that we own may be challenged, infringed, circumvented, declared generic, lapsed or determined to be infringing on or dilutive of other marks. We may not be able to protect our rights in these trademarks and trade names, which we need in order to build name recognition. In addition, third parties may file for registration of trademarks similar or identical to our trademarks, thereby impeding our ability to build brand identity and possibly leading to market confusion. If we are unable to establish name recognition based on our trademarks and trade names, we may not be able to compete effectively.
We have and may in the future need to initiate infringement claims or litigation in order to protect or enforce our intellectual property rights. As disclosed under Litigation in Note 14 - Commitments and Contingencies in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, on May 4, 2023, we filed patent infringement complaints with the ITC and with the U.S. District Courts against each of Hikam and Voltage seeking to ban the importing, marketing, distributing, selling, offering for sale, licensing, advertising, transferring, or otherwise using the infringing photovoltaic connectors and components in and into the United States in a manner that we allege infringes on the Company’s enforceable patents. On June 28, 2023 and July 18, 2023, we filed an amended complaint with the ITC and the U.S. District Court for the Middle District of North Carolina, respectively, against the Voltage respondents alleging that they also infringe on a third, recently issued patent owned by the Company. The District Court actions have been stayed pending the final disposition of the ITC investigation. An evidentiary hearing in the ITC investigation has been scheduled for March 18 through 22, 2024. The ITC has set a target date for completion of the investigation of November 12, 2024. We intend to vigorously pursue these actions, however, at this stage, we are unable to predict the outcome or impact on our business. Litigation, whether we are a plaintiff or a defendant, can be expensive and time consuming and may divert the efforts of our management and other personnel, which could harm our business, whether or not such litigation results in a determination favorable to us. Enforcing our intellectual property rights in all countries throughout the world may be prohibitively expensive, and we may choose to forgo such activities in some jurisdictions. Litigation, including the complaints discussed above, also puts our patents or other intellectual property at risk of being invalidated or interpreted narrowly and our patent applications or applications for other intellectual property registrations at risk of not issuing. If we are unsuccessful with respect to the patent infringement complaints against Hikam and Voltage, the alleged counterfeit products may continue to be imported and sold in the United States. In such case, we could lose potential revenue to the defendants as well as other parties who may sell similar products. Additionally, any enforcement of our patents or other intellectual property may provoke third parties to assert counterclaims against us. Any of the foregoing could have a material adverse effect on our business, financial condition, results of operations and prospects.
If we fail to retain our key personnel and attract additional qualified personnel, or successfully integrate our new Chief Executive Officer, or we or our suppliers face disputes with labor unions, we may not be able to achieve our anticipated level of growth and our business could suffer.
Our future success and ability to implement our business strategy depends, in part, on our ability to attract and retain key personnel, and on the continued contributions of members of our senior management team and key technical personnel, each of whom would be difficult to replace. All of our employees, including our senior management, are free to terminate their employment relationships with us at any time. Competition for highly skilled individuals with technical expertise is extremely intense, and we face challenges in identifying,
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hiring and retaining qualified personnel in many areas of our business. Since we became a public company, there have been changes in our executive management team resulting from the hiring or departure of executives. As previously announced, our Board of Directors appointed Brandon Moss as our Chief Executive Officer effective July 17, 2023. Even though Mr. Moss has had a long and successful career managing and scaling businesses for long-term growth, joining the Company from Southwire Company, one of North America’s largest wire and cable developers, manufacturers and suppliers, failure to execute a smooth transition could affect the execution of our business strategy.
Integrating new employees, such as our new Chief Executive Officer, into our team could prove disruptive to our operations, require substantial resources and management attention and ultimately prove unsuccessful. An inability to attract and retain senior management, our inability to effectively provide for the succession of senior management, and our inability to attract and retain other key or qualified personnel could limit or delay our strategic efforts, which could have a material adverse effect on our business, financial condition, results of operations and prospects.
In addition, although none of our employees are currently represented by a labor union and our relations with our employees have been good to date, the increased frequency of union activity coupled with the constricted labor market may contribute to efforts by our employees to belong to a union, which may result in higher employee costs, operational restrictions and increased risk of disruption to operations. We may also directly and indirectly depend upon other companies with unionized work forces, such as suppliers and trucking and freight companies, and work stoppages or strikes organized by such unions could have a material adverse impact on our business, prospects, financial condition, results of operations, and cash flows.
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
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* Filed herewith.
** Furnished herewith.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
