# Celsius Holdings, Inc. (CELH) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Celsius Holdings, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1341766/000095017023005612/celh-20221231.htm
Accession: 0000950170-23-005612
Filing date: 2023-03-01
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/CELH/
All MD&A years: /company/CELH/mda/
Previous year: /company/CELH/mda/fy2021/ (FY 2021)
Next year: /company/CELH/mda/fy2023/ (FY 2023)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion in conjunction with the audited financial statements and the corresponding notes included elsewhere in this information statement. This Item 7 contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risk, uncertainties, and other factors that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. Please refer to “Item 1A. Risk Factors” for a discussion of the uncertainties, risks and assumptions associated with these statements.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Annual Report on Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. A detailed discussion of 2021 items and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

Executive Summary/Items Affecting Reported Results

The COVID-19 pandemic has presented and continues to present a substantial public health and economic challenge around the world and is affecting our communities and business operations, as well as the global economy and financial markets. The human and economic consequences of the COVID-19 pandemic as well as the measures taken or that may be taken in the future by governments, businesses (including the Company and our suppliers, distributors, co-packers and other service providers) and the public at large to limit new variants could directly and indirectly impact our business and results of operations. See "Part I. Item 1A - Risk Factors." In spite of the global pandemic, we have worked together with our employees, distributors, co-packers and suppliers around the world to deliver another record year in net sales.

Pepsi Transaction and Distribution Agreement

On August 1, 2022, the Company issued 1,466,666 shares of non-voting Series A Preferred stock to Pepsi. On an as-converted basis the Series A held by Pepsi accounts for approximately 8.5% of the Company’s outstanding Common Stock, both on the date of issuance and as of December 31, 2022. Also, as discussed Note 14, the Purchase Agreement granted Pepsi the right to designate a nominee for election to the Company’s nine-member board of directors, so long as Pepsi meets certain ownership requirements with respect to the Company’s stock. During the year ended December 31, 2022, a Pepsi executive was nominated by Pepsi and elected to the Company’s board of directors.

Also, on August 1, 2022, the Company entered into a Distribution Agreement with Pepsi relating to the sale and distribution of certain of the Company’s beverage products in existing channels and distribution methods in the United States, excluding certain existing customer accounts, sales channels, Puerto Rico and the U.S. Virgin Islands. Under the Distribution Agreement, the Company granted Pepsi the right to sell and distribute its existing beverage products in existing channels and distribution methods and future beverage products that are added from time to time as licensed products under the Distribution Agreement in defined territories.

Distribution and Supply Chain

In 2022 and 2021, the Company, as well as the international beverage sector, experienced a number of supply chain challenges which adversely impacted our operations in the form of longer transportation lead times as well as increased ingredient and other input costs, including aluminum, shipping and freight, labor, co-packing fees, and secondary packaging materials, which resulted in increased costs of revenues and increased operating costs. The Company has successfully managed through these challenges, none of which, have impacted the Company's ability to expand its footprint across the U.S.

Results of Operations

Year ended December 31, 2022 compared to year ended December 31, 2021

Revenue

For the year ended December 31, 2022, revenue was approximately $653.6 million, an increase of $339.3 million or 108% from $314.3 million for the year ended December 31, 2021. This growth was as a result of an increase in North America in 2022, of $344.4 million or 126% from 2021. Asia revenues (which primarily consist of royalty revenues from our China licensee) for the year ended December 31, 2022 had an increase of $1.1 million when compared to the year ended December 31, 2021. Other international markets had an increase of $0.8 million or 129% for 2022, when compared to 2021. This was offset by a decrease in Europe revenues in 2022, of $7.0 million or 18% from 2021.

The total increase in revenue from 2021 to 2022 was largely attributable to increases in sales volume, as opposed to increases in product pricing. The primary factors behind the increase in North America's sales volume were related to continued strong triple-digit growth in traditional distribution channels, combined with an increase in and optimization of our products’ presence in world class retailers. Additionally, the continued expansion of our DSD network and our transition to the Pepsi distribution network in the fourth quarter, resulted in significant growth of our distributor revenues when compared to the prior year period.

The following table sets forth the amount of revenues by category and changes therein for the years ended December 31, 2022 and December 31, 2021:

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Gross profit

For the year ended December 31, 2022, gross profit increased by $142.7 million or 111% to $270.9 million, from $128.2 million for the year ended December 31, 2021. Gross profit margins increased to 41.4% for the year ended December 31, 2022 from 40.8% for the year ended December 31, 2021. The increase in gross profit dollars is related to increases in sales volumes, while the increase in gross profit margins from 2021 to 2022 is mainly related to our ability to leverage the increased volumes associated with our significant growth as well as increased pricing and improved processes and freight lanes, offset in part by increases in raw material costs (including high priced aluminum cans that were significantly depleted throughout 2022). The increase in gross profit dollars, includes $339.3 million related to purchase and volume increases, which was offset in part by increases in costs of $196.6 million.

Sales and marketing expenses

Sales and marketing expenses for the year ended December 31, 2022 were $352.8 million, an increase of $278.0 million or 372% from $74.7 million for the year ended December 31, 2021. We increased incremental marketing investment activities of $48.4 million from the 2021 period in comparison to 2022. Additionally, employee costs increased by $8.3 million from the 2021 year ago period as we continued to invest in this area in order to have the proper infrastructure to support our growth. Similarly, we experienced increases in other sales expense in the amount of $196.3 million mainly related to termination fees and trade-marketing activities to support our continued expansion of our DSD network. Lastly, storage and distribution as well as broker costs accounted for the remainder of the increase in this area in the amount of $25.0 million when compared to the prior year period, mainly related to the increase in business volume.

General and administrative expenses

General and administrative expenses for the year ended December 31, 2022 were $75.9 million, an increase of $18.4 million or 32% from $57.5 million for the year ended December 31, 2021. Employee costs for the year ended December 31, 2022 reflect an increase of $5.2 million or 67%, as investments in this area were also required to properly support our higher business volume and commercial and operational areas of the business. Administrative expenses amounted to $37.0 million or an increase of $26.0 million or approximately 237%, when compared to the prior year period. This variance is mainly related to an increase in audit costs, legal expenses, insurance costs and office rent. Depreciation, amortization and impairment had an increase of $3.0 million when compared to the prior year due to investments in operational equipment (e.g., coolers) and the impairment of the Func Food brand name. The increased expenses were offset by a lower stock option expense in 2022, which was $20.7 million, a decrease of $15.8 million from the prior year period. This change in stock option expense was mainly attributable to the revaluation of certain share-based payment awards that were modified during 2021. Management deems it very important to motivate employees by providing them ownership in the business in order to promote over performance which translates into the continued success of our business based on key performance attributes.

Other Income/(expense)

Total net other income for the year ended December 31, 2022, was $5.1 million which reflects an increase of $5.1 million when compared to net total other income of $31.0 thousand for the year ended December 31, 2021. The variance of $5.1 million is mainly related to interest income related to our money market accounts.

Income tax (expense)/benefit

An income tax expense of $34.6 million was obtained during the 2022 year, primarily due to the tax impact of the $282.5 million Series A Preferred Stock fair value adjustment which will be expensed over twenty years for book purposes. As this expense is non-deductible for tax purposes, the Company recorded a $72.1 million deferred tax liability in 2022 deferred tax expense. The effective income tax rate for the twelve months ending December 31, 2022 was also impacted by disallowed stock-based compensation expense, state and local income taxes and the release of certain state income tax reserves. An income tax benefit of approximately $8.0 million was obtained during the 2021 year, mainly related to the release of our U.S. valuation allowance and windfall benefits on stock-based compensation awards.

Net (loss)/income attributed to common stockholders

Net loss attributed to common stockholders for the year ended December 31, 2022, was $198.8 million or a loss of $2.63 per share based on a weighted average of 75,649 shares outstanding. In comparison, for the year ended December 31, 2021 the Company had net income attributed to common stockholders of $3.9 million with a weighted average of 73,781 shares outstanding and a dilutive weighted average of 77,689 shares outstanding, with a $0.05 per share for each.

Liquidity and Capital Resources

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General

As of December 31, 2022, and December 31, 2021, we had unrestricted cash of $614.2 million and $16.3 million, respectively, and working capital of $756.7 million and $169.2 million, respectively.

We believe that cash available from operations, including our cash resources, will be sufficient for our working capital needs, including purchase commitments for raw materials and inventory, increases in accounts receivable and other assets, purchases of capital assets, and equipment, for the next twelve (12) months, with respect to our current operating plan. Please refer to "Risk Factors" in Part 1, item 1A, for these and other factors that may have a material effect on our operations. Our primary sources of cash included cash from operations, and proceeds from the issuance of Series A convertible preferred shares. These sources of cash are available to fund cash outflows that have both a short and long-term component.

Purchases of inventories, increases in accounts receivable and other assets, equipment (including coolers), advances for our distributors, co-packers, payments of accounts payable, and income taxes payable are expected to remain our principal recurring use of cash.

In addition to cash flow from operations, our primary sources of working capital have been the proceeds from private placements including a private placement of 1,466,666 shares of Series A Preferred as part of our strategic transaction with Pepsi at a price of $375 per share, completed in August of 2022.

Cash flows provided by (used in) operating activities

Cash flows provided by operating activities totaled $108.2 million in 2022, which compares to $96.6 million net cash used by operating activities for the year ended December 31, 2021. The $204.8 million increase in cash generation was driven by continued growth in the operations of the Company as well as timing of cash receipts and payments associated with the Pepsi transition. The use of cash in 2021was primarily driven by higher inventory levels in order to properly service the demand for our products and to mitigate inefficiencies of the global supply chain.

Cash flows (used in) provided by investing activities

Cash flows used in investing activities totaled $5.7 million in 2022, which compares to cash used in investing activities of $1.3 million for the year ended December 31, 2021. The change in the cash used in investing activities when compared to the 2021 period was primarily due to the investment of approximately $8.3 million mainly pertaining to equipment which was partially offset by note receivable payments from our China licensee of approximately $2.6 million.

Cash flows provided by financing activities

Cash flows provided by financing activities totaled $534.1 million for 2022, representing a $462.7 million increase from $71.4 million in 2021. The increase of cash provided by financing activities is mainly related to the net proceeds of $542 million from the issuance of Series A convertible preferred shares related to Pepsi, net of issuance costs. Net proceeds were received from a public offering in June 2021 for approximately $67.8 million.

Off Balance Sheet Arrangements

As of December 31, 2022 and 2021, we had no off-balance sheet arrangements.

Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with U.S. GAAP. In connection with the preparation of our consolidated financial statements, we are required to make judgments and estimates that significantly affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. Our estimates are based on historical experience, current trends and various other assumptions we believe to be relevant under the circumstances. We review the underlying factors used in our estimates regularly, including reviewing the significant accounting policies impacting the estimates, to ensure compliance with U.S. GAAP. However, due to the uncertainty inherent in our estimates, actual results may be materially different. We have identified the accounting estimates below as critical to understanding and evaluating the financial results reported in our consolidated financial statements.

For a complete description of our significant accounting policies and recent accounting pronouncements, see Item 8 Financial Statements and Supplementary Data, Note 2. Basis of Presentation and Summary of Significant Accounting Policies.

Promotional (Billbacks) Allowance

The Company’s billbacks are calculated based on various programs with distributors and retail customers, and accruals are established at the time of initial product sale for the Company’s anticipated liabilities. These accruals are based on agreed upon terms as well as the Company’s historical experience with similar programs and require management’s judgment with respect to estimating consumer participation and/or distributor and retail customer performance levels. Differences between such estimated expenses and actual expenses for promotional and other allowance costs have historically been insignificant and are recognized in earnings in the period such differences are determined. Promotional and other allowances primarily include consideration given to distributors or retail customers, including, but not limited to, the following: (i) discounts granted off list prices to support price promotions to end consumers by retailers; (ii) reimbursements given to distributors for agreed portions of their promotional spend with retailers, including slotting, shelf space allowances, and other fees for both new and existing products; (iii) agreed share of fees given to distributors and/or directly to retailers for advertising, in-store marketing, and promotional activities; (iv) agreed share of slotting, shelf space allowances, and other fees given directly to retailers, club stores and/or wholesalers; (v) incentives given to distributors and/or retailers for achieving or exceeding certain predetermined volumes goals; (vi) discounted products; (vii) contractual fees given to distributors related to sales made by the Company directly to certain customers that fall within the distributors’ sales territories; and (viii) contractual fees given to distributors for items sold below defined pricing targets. The promotional programs are of varying durations, typically ranging from one week to one year based on the

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agreed-upon terms. The nature of such programs is determined on a per retail customer or distributor basis, and in certain instances, the same program is set for multiple customers or distributors. The billback fees are recorded as a reduction to net sales in the period the underlying sale occurs.

Total promotional expenditures included as a reduction to revenue were $158.5 million for the year ended December 31, 2022, and accrued promotional allowances were $36.0 million as of December 31, 2022.

Revenue Recognition

The Company recognizes revenue in accordance with ASC Topic 606 Revenue from Contracts with Customers. The Company recognizes revenue when performance obligations under the terms of a contract with the customer are satisfied. Product sales occur once control or title is transferred based on the commercial terms. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods. Product sales are

recorded net of variable consideration, such as provisions for returns, discounts and allowances. Such provisions are calculated using historical averages and adjusted for any expected changes due to current business conditions. Consideration given to customers for cooperative advertising is recognized as a reduction of revenue except to the extent that there is a distinct good or service, in which case the expense is classified as selling or marketing expense. The amount of consideration the Company receives and revenue the Company recognizes varies with changes in customer incentives the Company offers to its customers and their customers. Additionally, for any agreements which are one year or less, the practical expedient under ASC 340-40-25-4 is applied to expense contract acquisition costs when incurred if the amortization period of the contract asset would have otherwise been recognized in one year or less. Sales taxes and other similar taxes are excluded from revenue. Management believes that adequate provision has been made for cash discounts, returns and spoilage based on the Company’s historical experience.

Goodwill and Intangible Assets Valuation

We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at least annually or when an interim triggering event occurs that would indicate impairment may have taken place. We evaluate our other definite-lived intangible assets for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Judgments and assumptions are required in such impairment evaluations. During the third quarter of 2022, we entered into a long term distribution agreement with Pepsi. The addition of the Pepsi distribution network has shifted the Company's focus to the US market and as a consequence it was determined that impairment indicators for the Func Foods brands indefinite intangible asset were present. The Company no longer anticipates focusing on the expansion of Func Food branded products and the Company plans to focus on Celsius branded products. As a result of the strategic shift, which the Company considered a triggering event, the Company quantitatively tested the Func Foods brand name for impairment utilizing the relief from royalty method to determine fair value. As a result of the quantitative assessment, the Company recorded an impairment charge of $2.5 million which is presented within General and Administrative expenses on the Consolidated Statements of Operations and Comprehensive (Loss) Income.

Our annual impairment evaluation of goodwill involves qualitative aspects, including comparing our single reporting unit's fair value to its respective carrying value. Some of the qualitative aspects evaluated included macro-economic conditions, industry and market considerations, cost factors regarding our raw materials and operations and overall financial performance of our business.

We use the income approach to determine the fair value of our definite-lived customer relationships intangible asset. In accordance with FASB ASC 350, intangible assets with indefinite lives are not amortized but instead are measured for impairment at least annually, or when events indicate that an impairment exists. The Company calculates impairment as the excess of the carrying value of its indefinite-lived assets over their estimated fair value. If the carrying value exceeds the estimate of fair value a write-down is recorded. The Company amortizes its trademarks with finite useful lives over their respective useful lives.

Changes in economic and operating conditions impacting these assumptions could result in goodwill and intangible assets impaired in future periods. Additionally, disruptions to our business such as prolonged recessionary periods or unexpected significant declines in operating results could result in impairment of goodwill and other intangible assets in future periods.

Changes in the factors used in our fair value estimates, including the impacts of the cost inflation or other margin erosion, and discount rates used, could have a significant impact on the fair values of the reporting unit and indefinite-lived intangible assets.