# Shoals Technologies Group, Inc. (SHLS) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Shoals Technologies Group, Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1831651/000183165122000008/shls-20211231.htm
Accession: 0001831651-22-000008
Filing date: 2022-03-11
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SHLS/
All MD&A years: /company/SHLS/mda/
Next year: /company/SHLS/mda/fy2022/ (FY 2022)

Item 7. 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 should be read in conjunction with our financial statements and the related notes and other financial information included in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion and analysis contain forward-looking statements that involve risks, uncertainties and assumptions. For this purpose, any statements contained in this Form 10-K 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 this Form 10-K captioned “Forward-Looking Statements” and “Risk Factors.”

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This Management’s Discussion and Analysis of Financial Condition and Results of Operations contain the presentation of Adjusted EBITDA and Adjusted Net Income, which are not presented in accordance with GAAP. Adjusted EBITDA and Adjusted Net Income are being presented because they provide the Company and readers of this Form 10-K with additional insight into our operational performance relative to earlier periods and relative to our competitors. We do not intend Adjusted EBITDA and Adjusted Net Income to be substitutes for any GAAP financial information. Readers of this Form 10-K should use Adjusted EBITDA and Adjusted Net Income only in conjunction with Net Income, the most comparable GAAP financial measure. Reconciliations of Adjusted EBITDA and Adjusted Net Income to Net Income, the most comparable GAAP measure to each, are provided in “—Non-GAAP Financial Measures.”

Overview

We are a leading provider of electrical balance of system or “EBOS” solutions for solar energy projects in the United States. 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 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 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.

We derived approximately 73% of our revenue from the sale of system solutions for the year ended December 31, 2021. For the same period, we derived substantially all of our revenue from customers in the U.S. We had $299.0 million of backlog and awarded orders, backlog of $119.3 million represents signed purchase orders or contractual minimum purchase commitments with take-or-pay provisions and awarded orders of $179.7 million are orders we are in the process of documenting a contract but for which a contract has not yet been signed, as of December 31, 2021, representing a 94% and 10% increase relative to the same date last year and September 30, 2021, respectively.

We have maintained focus on our growth strategy throughout the fourth quarter, including developments in converting customers to our combine-as-you-go system and developing products for the rapidly growing electric vehicle charging infrastructure market. We believe that eight of the top 10 solar EPCs as reported by Solar Power World Magazine use our combine-as-you-go system on a majority of their projects and we are currently in the process of transitioning an additional 11 EPCs and developers to our system. Additionally, we are currently launching four new product families for the EV charging market. The first is the power center which combines equipment needed to protect the charging equipment and transform voltage

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levels from the electric utility to those needed on the respective site. The power center provides an efficient, cost effective and aesthetically focused option versus traditional methods. The second offering focuses on quick connect solutions for chargers made by any manufacturer and any power level to connect to the Shoals system. The quick connect bases dramatically reduce the time required on site for a deployment and reduce the amount of labor required in the field. The third offering uses our Big Lead Assembly (“BLA”) technology in the EV space to connect multiple chargers to a single power center. This solution eliminates the need for homeruns from each dispenser and is above ground rated which allows wire to be run above ground rather than in underground conduit. The fourth offering is a raceway system that protects the above ground EV BLAs in walk over and drive over applications. The raceway system coupled with the EV BLA deploys much more rapidly and cost effectively than traditional methods of deployment. We introduced these first four offerings in the fourth quarter of 2021 and received our first orders for deployments. Testing and certification of the offerings and overall solution are underway and progressing.

Initial Public Offering

On January 29, 2021, we closed an IPO of 11,550,000 shares of Class A common stock at a public offering price of $25.00 per share, including shares issued pursuant to the underwriters' over-allotment option. We received $278.8 million in proceeds, net of underwriting discounts and commissions of $9.9 million, which was used to purchase 6,315,790 newly-issued membership interests (the “LLC Interests”) from Shoals Parent and 5,234,210 LLC Interests from the Founder and Class B unit holder in Shoals Parent at a price per interest equal to the IPO price of $25.00 per share.

Organizational Transactions

See Note 1 to the consolidated financial statements, included in this Annual Report on Form 10-K for more information about the above-mentioned transactions as well as the other transactions completed in connection with the IPO.

As the Organization Transactions were considered transactions between entities under common control, the consolidated financial statements for the periods prior to the IPO and Organizational Transactions have been adjusted to combine the previously separate entities for presentation purposes.

Follow On Offering

On July 16, 2021, the Company completed a follow-on offering consisting of 4,989,692 shares of Class A common stock offered by the selling shareholders and 10,402,086 shares of Class A common stock offered by the Company. Following the closing of the follow-on offering, Oaktree Power Opportunities Fund IV (Delaware) Holdings, L.P. no longer beneficially owned any shares of our common stock. The Company used the proceeds of the sale of Class A common stock to purchase an equal number of LLC Interests and Class B common stock from our Founder and management.

Acquisition of ConnectPV

On August 26, 2021, we acquired 100% of the stock of ConnectPV, for $13.8 million in cash (net of $0.8 million cash acquired) and 209,437 shares of Class A Common stock valued at $6.5 million. The acquisition was accounted for as a business combination and following the acquisition we immediately converted ConnectPV to a limited liability company and contributed the entity to Shoals Parent, LLC through a series of transactions.

Exchange of LLC Interests in Shoals Parent

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On December 7, 2021, the Company issued 7,870,042 shares of Class A common stock to our founder, executive management and certain employees in exchange for 7,870,042 LLC Interests in Shoals Parent and an equal number of Class B common stock of the Company.

Shoals Technologies Group, Inc Ownership in Shoals Parent

As of December 31, 2021, the Company owned 67.16% of Shoals Parent. The Continuing Equity Owners owned the remaining 32.84% of Shoals Parent.

Impact of COVID-19

The global health crisis caused by the novel coronavirus COVID-19 pandemic and its resurgences has and may continue to negatively impact global economic activity, which, despite progress in vaccination efforts, remains uncertain and cannot be predicted with confidence. In addition, variants of COVID-19, including Delta and Omicron, continue to emerge, the impact of which cannot be predicted at this time, and could depend on numerous factors, including vaccination rates among the population, the effectiveness of the COVID-19 vaccines against COVID-19 variants along with the response by governmental bodies and regulators. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the impact of the COVID-19 pandemic on our business.

In 2021, COVID-19 impacted our business in the following ways:

•Our ability to obtain raw material and required components from domestic and international suppliers required to manufacture our products;

•Our ability to efficiently operate our facilities and meet customer obligations due to modified employee work patterns resulting from social distancing guidelines, absence due to illness and cautionary quarantines and/or government ordered closures, or due to labor shortages;

•Our ability to secure inbound and outbound logistics to and from our facilities, with additional delays linked to international border crossings and the associated approvals and documentation and;

•Limitations on the ability of our customers to conduct their business, and resulting impacts to our customers' purchasing patterns, from social distancing guidelines, absence due to illness or government ordered closures.

Many countries around the world have continued to impose quarantines and restrictions on travel and mass gatherings to slow the spread of the virus. Accordingly, our ability to continue to operate our business may also be limited. Such events may result in a period of business, supply and manufacturing disruptions, and in reduced operations, any of which could materially affect our business, financial condition and results of operations.

A continuation or worsening of the levels of market disruption and volatility seen in the recent past could have an adverse effect on our ability to access capital, which could in the future negatively affect our liquidity. In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect our business and the value of our common stock.

We continue to monitor the impacts of COVID-19 on the global economy and on our business operations. Although we expect the vaccinations for COVID-19 will continue to improve conditions, the ultimate impact from COVID-19 on our business operations and financial results will depend on, among other things, the ultimate severity and scope of the pandemic, including the new variants of the virus, the pace at which governmental and private travel restrictions and public concerns about public gatherings will ease, the rate at

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which historically large increases in unemployment rates will decrease, if at all, and whether, and the speed with which, the economy recovers. We are not able to fully quantify the impact that these factors will have on our business, but developments related to COVID-19 may materially affect financial condition and results of operations in future periods.

Key Components of Our Results of Operations

The following discussion describes certain line items in our consolidated statements of operations.

Revenue

We generate revenue from the sale of EBOS systems and components for homerun and combine-as-you-go architectures. Our customers include EPCs, utilities, solar developers, independent power producers and solar module manufacturers. We derive the majority of our revenue from selling system solutions. When we sell a 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 system solutions can vary from one to three months whereas manufacturing typically requires a shorter time frame. Contracts for 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 products purchased by our customers. The price and volume of our products is driven by the demand for our products, 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 product costs, including purchased materials and components, 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 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, warranty costs and seasonality.

Operating Expenses

Operating expenses consist of general and administrative costs 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 52 to 99 from December 31,

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2020 to December 31, 2021, 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, bad debt expense and fees for professional services. Professional services consist of audit, legal, tax, insurance, information technology and other costs. We expect to increase our sales and marketing personnel as we expand into new geographic markets. Substantially all of our sales in 2021 were in the U.S. We currently have a sales presence in the U.S., Australia and Spain. We intend to expand our sales presence and marketing efforts to additional countries in the future. We also expect that as a result of our recent IPO, we will incur additional audit, tax, accounting, legal and other costs related to compliance with applicable securities and other regulations, as well as additional insurance, investor relations and other costs associated with being a public company.

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 customer relationships, developed technology, trade names, backlog and non-compete 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 current Senior Secured Credit Agreement and our former Senior Debt which included a revolving line of credit and term loan, which was fully repaid on October 8, 2020.

Payable Pursuant to the Tax Receivable Agreement Adjustment

Tax receivable agreement adjustment consists of changes to our effective tax rate since the initial recording of the liability related to our tax receivable agreement with our Founder and former Class A Shoals Equity Owners of Shoals Parent.

Loss on Debt Repayment

Loss on debt repayment consists of prepayment premiums and the write-off of a portion of the deferred financing costs from the prepayment of outstanding borrowings under the Term Loan Facility.

Income Tax Expense

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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. Shoals Parent is a pass-through entity for federal income tax purposes but incurs income tax in certain state jurisdictions.

Results of Operations

The following table summarizes our results of operations (dollars in thousands):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","2021 vs 2020","","2020 vs 2019"],["","","2021","","2020","","2019","","$ variance","","% variance","","$ variance","","% variance"],["Revenue","","$","213,212","","","$","175,518","","","$","144,496","","","$","37,694","","","21","%","","$","31,022","","","21","%"],["Cost of revenue","","130,567","","","108,972","","","100,284","","","21,595","","","20","%","","8,688","","","9","%"],["Gross profit","","82,645","","","66,546","","","44,212","","","16,099","","","24","%","","22,334","","","51","%"],["Operating Expenses"],["General and administrative expenses","","37,893","","","21,008","","","9,065","","","16,885","","","80","%","","11,943","","","132","%"],["Depreciation and amortization","","8,520","","","8,262","","","8,217","","","258","","","3","%","","45","","","1","%"],["Total Operating Expenses","","46,413","","","29,270","","","17,282","","","17,143","","","59","%","","11,988","","","69","%"],["Income from Operations","","36,232","","","37,276","","","26,930","","","(1,044)","","","(3)","%","","10,346","","","38","%"],["Interest expense, net","","(14,549)","","","(3,510)","","","(1,787)","","","(11,039)","","","315","%","","(1,723)","","","96","%"],["Payable pursuant to the tax receivable agreement adjustment","","(1,663)","","","\u2014","","","\u2014","","","(1,663)","","","100","%","","\u2014","","","\u2014","%"],["Loss on debt repayment","","(15,990)","","","\u2014","","","\u2014","","","(15,990)","","","100","%","","\u2014","","","\u2014","%"],["Income before income taxes","","4,030","","","33,766","","","25,143","","","(29,736)","","","(88)","%","","8,623","","","34","%"],["Income tax expense","","(86)","","","\u2014","","","\u2014","","","(86)","","","100","%","","\u2014","","","\u2014","%"],["Net income","","3,944","","","33,766","","","25,143","","","(29,822)","","","(88)","%","","8,623","","","34","%"],["Less: net income attributable to non-controlling interests","","1,596","","","\u2014","","","\u2014","","","1,596","","","100","%","","\u2014","","","\u2014","%"],["Net income attributable to Shoals Technologies Group, Inc.","","$","2,348","","","$","33,766","","","$","25,143","","","$","(31,418)","","","(93)","%","","$","8,623","","","34","%"]]
[[/GREPCENT_TABLE]]

Years Ended December 31, 2021 and 2020

Revenue

Revenue increased by $37.7 million, or 21%, for the year ended December 31, 2021 as compared to the year ended December 31, 2020, 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 increased by 30 in 2021 as compared to 2020. We believe customer recognition of the benefits of our combine-as-you-go system is resulting in increased demand for our products.

Cost of Revenue and Gross Profit

Cost of revenue increased by $21.6 million, or 20%, for the year ended December 31, 2021 as compared to the year ended December 31, 2020, primarily driven by an increase in production volumes. Gross profit as a percentage of revenue increased to 38.8% in 2021 from 37.9% in 2020 in part due to purchasing

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efficiencies from increased volumes and changes in product mix. Changes in product mix also contributed to the increase in margins as sales of system solutions for combine-as-you-go EBOS, which have higher margins than our other products, increased as a percentage of our total revenue.

Operating Expenses

General and Administrative

General and administrative expenses increased $16.9 million, or 80%, for the year ended December 31, 2021 as compared to the year ended December 31, 2020. The increase in general and administrative expenses was primarily the result of an increase in wages and related taxes of $3.6 million due to increased head counts to support our growth and public company costs, an increase in professional fees of $3.3 million related to being a public company, an increase of $2.8 million related to insurance and more specifically our directors and officers policy following our IPO, an increase of $2.3 million of acquisition related expenses for the ConnectPV acquisition, an increase of $2.1 million related to stock-based compensation and an increase of $0.6 million related to sales and marketing.

Depreciation and Amortization

Depreciation and amortization expense increased by $0.3 million, or 3%, for the year ended December 31, 2021 as compared to the year ended December 31, 2020, due to the addition of intangibles acquired in the ConnectPV acquisition.

Interest Expense

Interest expense, net increased by $11.0 million or 315%, for the year ended December 31, 2021 as compared to the year ended December 31, 2020, due to increased borrowings under our Senior Secured Credit Agreement that we entered into on November 25, 2020. We expect interest expense to increase in 2022 as a result of our higher average borrowings under the Senior Secured Credit Agreement (see description under “Debt Obligations”).

Payable Pursuant to the Tax Receivable Agreement Adjustment

Payable pursuant to the tax receivable agreement adjustment totaled $1.7 million for the year ended December 31, 2021. The adjustment resulted from an estimated increase in the Company’s blended state income tax rate.

Loss on Debt Repayment

Loss on debt repayment for the year ended December 31, 2021 consists of $11.3 million of prepayment premium and $4.7 million in write-off of a portion of the deferred financing costs related to a prepayment of $150.0 million of outstanding borrowings under the Term Loan Facility.

Income Tax Expense

Income tax expense totaled $0.1 million for the year ended December 31, 2021. The Company did not incur income tax expense prior to the Organizational Transactions, or during the year ended December 31, 2020. Our effective income tax rate was 2.1% for the year ended December 31, 2021.

Years Ended December 31, 2020 and 2019

Revenue

Revenue increased by $31.0 million, or 21%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, driven by higher sales volumes as a result of increased demand for solar

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EBOS generally and our combine-as-you-go system solutions specifically. Our total number of customers increased by 43 in 2020 as compared to 2019. We believe customer recognition of the benefits of our combine-as-you-go system is resulting in increased demand for our products.

Cost of Revenue and Gross Profit

Cost of revenue increased by $8.7 million, or 9%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, primarily driven by an increase in production volumes. Gross profit as a percentage of revenue increased from 30.6% in 2019 to 37.9% in 2020 in part due to purchasing efficiencies from increased volumes, improved material planning which reduced logistics costs, enhancements to product design that lowered manufacturing costs and other manufacturing efficiencies resulting from higher production volumes. Changes in product mix also contributed to the increase in margins as sales of system solutions for combine-as-you-go EBOS, which have higher margins than our other products, increased as a percentage of our total revenue. Our gross profit was negatively impacted in the year ended December 31, 2020 as a result of certain COVID-19 related costs totaling $2.6 million.

Operating Expenses

General and Administrative

General and administrative expenses increased $11.9 million, or 132%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase in general and administrative expenses was primarily the result of $8.3 million in equity-based compensation related to Class C units issued, an increase in professional fees of $1.5 million related to preparation for our IPO, wages and related taxes of $1.8 million related to increased head counts and year-end bonuses, insurance expense of $0.2 million, franchise and other related taxes of $0.2 million and certain COVID-19 related costs of $0.3 million, offset by a decrease in travel and trade shows of $0.7 million as a result of COVID-19.

Depreciation and Amortization

Depreciation and amortization expense increased by $0.1 million, or 1%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, due to the addition of machines and equipment to increase production.

Interest Expense

Interest expense, net increased by $1.7 million or 96%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, due to increased borrowings under our Senior Secured Credit Agreement that we entered into on November 25, 2020. We expect interest expense to increase in 2022 as a result of our higher average borrowings under the Senior Secured Credit Facility (see description under “Debt Obligations”). The $150 million prepayment we made on the Term Loan Facility in January 2021 resulted in us recording a $16.0 million loss on debt repayment in the first quarter of 2021 as a result of the write-off of financing costs and the prepayment premium.

Non-GAAP Financial Measures

Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted Earnings per Share (“EPS”)

We define Adjusted EBITDA as net income (loss) plus (i) interest expense, net, (ii) income tax expense, (iii) depreciation expense, (iv) amortization of intangibles, (v) payable pursuant to the tax receivable agreement adjustment, (vi) loss on debt repayment, (vii) equity-based compensation, (viii) acquisition-related expenses, (ix) COVID-19 expenses and (x) non-recurring and other expenses. We define Adjusted Net Income as net income (loss) plus (i) amortization of intangibles, (ii) payable pursuant to the tax receivable agreement

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adjustment, (iii) loss on debt repayment, (iv) amortization of deferred financing costs, (v) equity-based compensation, (vi) acquisition-related expenses, (vii) COVID-19 expenses and (viii) non-recurring and other 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 shares outstanding for the applicable period, which assumes the pro forma exchange of all outstanding Class B common shares for Class A common shares.

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 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 EBITDA, Adjusted Net Income and Adjusted Diluted EPS: (i) as factors in evaluating management’s performance when determining incentive compensation; (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 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; in the case of Adjusted EBITDA, does not reflect income tax expense or benefit for periods prior to the reorganization; 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 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 net income to Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS below and not rely on any single financial measure to evaluate our business.

Reconciliation of Net Income to Adjusted EBITDA (in thousands):    

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["Net income","$","3,944","","","$","33,766","","","$","25,143"],["Interest expense, net","14,549","","","3,510","","","1,787"],["Income tax expense","86","","","\u2014","","","\u2014"],["Depreciation expense","1,701","","","1,420","","","1,179"],["Amortization of intangibles","8,352","","","7,985","","","7,984"],["Payable pursuant to the TRA adjustment(a)","1,663","","","\u2014","","","\u2014"],["Loss on debt repayment","15,990","","","\u2014","","","\u2014"],["Equity-based compensation","11,286","","","8,251","","","\u2014"],["Acquisition-related expenses","2,349","","","\u2014","","","\u2014"],["COVID-19 expenses(b)","339","","","2,890","","","\u2014"],["Non-recurring and other expenses(c)","2,598","","","3,077","","","686"],["Adjusted EBITDA","$","62,857","","","$","60,899","","","$","36,779"]]
[[/GREPCENT_TABLE]]

(a)    Represents an adjustment to eliminate the remeasurement of the payable pursuant to the TRA.

(b)    Represents costs incurred as a direct impact from the COVID-19 pandemic, disinfecting and reconfiguration of facilities, medical professionals to conduct daily screenings of employees, premium pay during the pandemic to hourly workers in 2020 and direct legal costs associated with the pandemic.

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(c) Represents certain costs associated with non-recurring professional services, Oaktree’s expenses and other costs.

Reconciliation of Net Income Attributable to Shoals Technologies Group, Inc. to Adjusted Net Income (in thousands):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["Net income attributable to Shoals Technologies Group, Inc.","$","2,348","","","$","33,766","","","$","25,143"],["Net income impact from pro forma conversion of Class B common stock to Class A common stock (a)","1,596","","","\u2014","","","\u2014"],["Adjustment to the provision for income tax (b)","(456)","","","(7,327)","","","(5,456)"],["Tax effected net income","3,488","","","26,439","","","19,687"],["Amortization of intangibles","8,352","","","7,985","","","7,984"],["Amortization of deferred financing costs","1,230","","","351","","","38"],["Payable pursuant to the TRA adjustment(c)","1,663","","","\u2014","","","\u2014"],["Loss on debt repayment","15,990","","","\u2014","","","\u2014"],["Equity-based compensation","11,286","","","8,251","","","\u2014"],["Acquisition-related expenses","2,349","","","\u2014","","","\u2014"],["COVID-19 expenses (d)","339","","","2,890","","","\u2014"],["Non-recurring and other expenses (e)","2,598","","","3,077","","","686"],["Tax impact of adjustments (f)","(11,381)","","","(3,104)","","","(1,809)"],["Adjusted Net Income","$","35,914","","","$","45,889","","","$","26,586"]]
[[/GREPCENT_TABLE]]

(a)    Reflects net income to Class A common shares from pro forma exchange of corresponding shares of our Class B common shares held by our Founder and management.

(b)    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. owns 100% of the units in Shoals Parent LLC.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["Statutory U.S. Federal income tax rate","21.0","%","","21.0","%","","21.0","%"],["State and local taxes (net of federal benefit)","6.4","%","","0.7","%","","0.7","%"],["Permanent items","1.2","%","","\u2014","%","","\u2014","%"],["Effective income tax rate for Adjusted Net Income","28.6","%","","21.7","%","","21.7","%"]]
[[/GREPCENT_TABLE]]

(c)    Represents an adjustment to eliminate the remeasurement of the payable pursuant to the TRA.

(d)    Represents costs incurred as a direct impact from the COVID-19 pandemic, disinfecting and reconfiguration of facilities, medical professionals to conduct daily screenings of employees, premium pay during the pandemic to hourly workers in 2020 and direct legal costs associated with the pandemic.

(e) Represents certain costs associated with non-recurring professional services, Oaktree’s expenses and other costs.

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(f)    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):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["Diluted weighted average shares of Class A common shares outstanding, excluding Class B common shares","99,507","","","N/A (b)","","N/A (b)"],["Assumed pro forma conversion of Class B common shares to Class A common shares","67,429","","","N/A (b)","","N/A (b)"],["Adjusted diluted weighted average shares outstanding","166,936","","","N/A (b)","","N/A (b)"],["Adjusted Net Income (a)","$","35,914","","","N/A (b)","","N/A (b)"],["Adjusted Diluted EPS","$","0.22","","","N/A (b)","","N/A (b)"]]
[[/GREPCENT_TABLE]]

(a) Represents Adjusted Net Income for the full period presented.

(b) This Non-GAAP measure is not applicable for this period, as the reorganization transactions had not yet occurred.

Liquidity and Capital Resources

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","2020","","2019"],["Net cash provided by (used in) operating activities","$","(4,083)","","","$","54,082","","","$","36,182"],["Net cash used in investing activities","(17,035)","","","(3,236)","","","(1,719)"],["Net cash provided by (used in) financing activities","20,602","","","(47,855)","","","(27,489)"],["Net increase (decrease) in cash, cash equivalents and restricted cash","$","(516)","","","$","2,991","","","$","6,974"]]
[[/GREPCENT_TABLE]]

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 margins 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.

The Company (used) generated cash from operating activities of $(4.1) million, $54.1 million and $36.2 million in the years ended December 31, 2021, 2020 and 2019, respectively. As of December 31, 2021, our cash and cash equivalents were $5.0 million and we had outstanding borrowings of $252.4 million. We also had $44.9 available for additional borrowings under our $100.0 Revolving Credit Facility. From December 31, 2021 through the date of this filing, the Company, has borrowed an additional $27.5 million under the Revolving Credit Facility.

Operating Activities

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For the year ended December 31, 2021, cash used in operating activities was $4.1 million, primarily due to an increase of $8.9 million in receivables which mainly relate to unbilled accounts receivables resulting from increased revenues during December 2021 as compared to December 2020 and the timing of our billings, $17.2 million in inventory as a result of increasing our raw materials inventory to support growth and reduce the likelihood of supply chain issues from our suppliers of raw materials, a decrease in accounts payable and accrued expenses of $8.4 million, offset with operating results that included $3.9 million of net income which was reduced by $26.1 million, net of non-cash expenses.

For the year ended December 31, 2020, cash provided by operating activities was $54.1 million, primarily due to operating results that included $33.8 million of net income. An increase of $6.5 million in inventories, $1.0 million in receivables was offset by an increase in accounts payable and accrued expenses of $9.0 million.

For the year ended December 31, 2019, cash provided by operating activities was $36.2 million, primarily due to operating results that included $25.1 million of net income. An increase of $0.7 million in inventories and $1.8 million in receivables was partially offset by an increase of $3.9 million of accounts payable and accrued expenses.

Investing Activities

For the year ended December 31, 2021, net cash used in investing activities was $17.0 million, attributable to $4.1 million for the purchase of property and equipment and $12.9 million for the acquisition of ConnectPV.

For the year ended December 31, 2020, net cash used in investing activities was $3.2 million, attributable to the purchase of property and equipment.

For the year ended December 31, 2019, net cash used in investing activities was $1.7 million, attributable to the purchase of property and equipment.

Financing Activities

For the year ended December 31, 2021, net cash used in financing activities was $20.6 million, including $144.8 million of net proceeds from the IPO and $35.1 million in net borrowings under the Revolving Credit Facility, offset by $152.8 million of payments on the Term Loan Facility and $4.8 million in tax distributions to minority shareholders as required under the Shoals Parent LLC agreement.

For the year ended December 31, 2020, net cash used in financing activities was $47.9 million, including $26.3 million of payments on senior debt, a $355.8 million special distribution to members and $20.2 million in tax distributions to members, partially offset by borrowings of $370.0 million under the Senior Secured Credit Agreement, net of $11.8 million in debt discount and financing costs.

For the year ended December 31, 2019, net cash used in financing activities was $27.5 million, of which $16.0 million was payments on senior debt and $14.0 million was tax distributions to members, which was partially offset by $2.5 million of borrowings of the revolving line of credit.

Debt Obligations

For a discussion of our debt obligations see Note 8 Long-Term Debt in our consolidated financial statements.

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Surety Bonds

We provide surety bonds to various parties as required for certain transactions initiated during the ordinary course of business to guarantee our performance in accordance with contractual or legal obligations. As of December 31, 2021, the maximum potential payment obligation with regard to surety bonds was $21.8 million.

Critical Accounting Policies and Significant Management Estimates

We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the U.S. (“GAAP”). The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition

We recognize revenue from the sale of EBOS systems and components. We determine our revenue recognition through the following steps: (i) identification of the contract or contracts with a customer, (ii) identification of the performance obligations within the contract, (iii) determination of the transaction price, (iv) allocation of the transaction price to the performance obligations within the contract, and (v) recognition of revenue as the performance obligation has been satisfied.

Our contracts with customers are predominately accounted for as one performance obligation, as the majority of the obligations under the contracts relate to single projects. For each contract entered into, we determine the transaction price based on the consideration expected to be received. The transaction price identified is allocated to each distinct performance obligation to deliver a good or service based on the relative standalone selling prices. We believe that the prices negotiated with each individual customer are representative of the stand-alone selling price of the product.

We recognize revenue over time as a result of the continuous transfer of control of our product to the customer using the output method based on units manufactured. This continuous transfer of control to the customer is supported by clauses in the contracts that provide rights to payment of the transaction price associated with work performed to date on products that do not have an alternative use to us. The accounting for each contract involves a process of estimating total sales, costs, and profit for each performance obligation. Cost of revenue is recognized based on the unit of production. The amount reported as revenue is determined by adding a proportionate amount of the estimated profit to the amount reported as cost of revenue. We believe that recognizing revenue using the output method based on units manufactured best depicts the extent of transfer of control to the customer. Certain contracts contain retainage provisions. Retainage represents a contract asset for the portion of the contract price earned by us for work performed but held for payment by the customer as a form of security until we reach specified milestones. We typically bill 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

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completed. We had outstanding retainage billings of $4.8 million and $2.8 million as of December 31, 2021 and 2020, respectively.

We have elected to adopt certain practical expedients and exemptions as allowed under the new revenue recognition guidance such as (i) recording sales commissions as incurred because the amortization period is less than one year, (ii) excluding any collected sales tax amounts from the calculation of revenue, and (iii) accounting for shipping and handling activities that are incurred after the customer has obtained control of the product as fulfillment costs rather than a separate service provided to the customer for which consideration would need to be allocated.

Equity-Based Compensation

2021 Long-term Incentive Plan

The Company recognizes equity-based compensation expense based on the equity award’s grant date fair value. The determination of the fair value of equity awards issued to employees of the Company is based upon the underlying unit price and a number of factors, including comparable companies, operating and financial performance, lack of liquidity of the units and general and industry specific economic outlook, amongst other factors. The Company accounts for forfeitures as they occur. The grant date fair value of each unit is amortized on a straight-line basis over the requisite service period, including those units with graded vesting. However, the amount of equity-based compensation at any date is at least equal to the portion of the grant date fair value of the award that is vested.

Pre-IPO Class C Units

The Company accounted for equity grants to employees (Class C units) as equity-based compensation. The Class C units contained vesting provisions as defined in the agreement. Vested units did not forfeit upon termination and represented a residual interest in the Company. Equity-based compensation cost was measured at the grant date fair value and was recognized on a straight-line basis over the requisite service period, including those units with graded vesting with a corresponding credit to members’ equity (deficit). However, the amount of equity-based compensation at any date was at least equal to the portion of the grant date value of the award that was vested.

Inventory Valuation

Inventories consist of raw materials. Inventories are stated at the lower of cost or net realizable value. Cost is calculated using the weighted average cost method. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable values.

Income Taxes

We record valuation allowances against our deferred tax assets when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In making such determination, we consider all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and results of operations. We routinely evaluate the realizability of our deferred tax assets by assessing the likelihood that our deferred tax assets will be recovered based on all available positive and negative evidence. Estimating future taxable income is inherently uncertain and requires judgment. In projecting future taxable income, we consider our historical results and incorporate certain assumptions, including revenue growth and operating margins, among others. As of December 31, 2021, we had $177.0 million of deferred tax assets, net of valuation allowances of $2.0 million. We expect to realize future tax benefits related to the utilization of these assets. If we determine in the future that we will not be able to fully utilize all or part of these deferred tax assets, we would record a valuation allowance through earnings in the

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period the determination was made, which would have an adverse effect on our results of operations and earnings in future periods.

Payable Pursuant to the Tax Receivable Agreement

As described in Note 15 to the consolidated financial statements, we are a party to the TRA under which we are contractually committed to pay the TRA Owners 85% of the amount of the benefits, if any, that we are deemed to realize, as a result of certain transactions. Amounts payable under the TRA are contingent upon, among other things, (i) generation of future taxable income over the term of the TRA and (ii) future changes in tax laws. If we do not generate sufficient taxable income in the aggregate over the term of the TRA to utilize the tax benefits, then we generally would not be required to make the related TRA payments. Therefore, we will only recognize a liability for TRA payments if we determine it is probable that we will generate sufficient future taxable income over the term of the TRA to utilize the related tax benefits. Estimating future taxable income is inherently uncertain and requires judgment. In projecting future taxable income, we consider our historical results and incorporate certain assumptions, including revenue growth, and operating margins, among others. As of December 31, 2021, we recognized $156.4 million of liabilities relating to our obligations under the TRA, after concluding that it was probable that we would have sufficient future taxable income to utilize the related tax benefits. There were no transactions subject to the TRA for which we did not recognize the related liability, as we concluded that we would have sufficient future taxable income to utilize all of the related tax benefits generated by all transactions that occurred in connection with the IPO. If we determine in the future that we will not be able to fully utilize all or part of the related tax benefits, we would de-recognize the portion of the liability related to the benefits not expected to be utilized.

Additionally, we estimate the amount of TRA payments expected to be paid within the next 12 months and classify this amount as current on our consolidated balance sheet. This determination is based on our estimate of taxable income for the next fiscal year. To the extent our estimate differs from actual results, we may be required to reclassify portions of our liabilities under the TRA between current and non-current.