# Shoals Technologies Group, Inc. (SHLS) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Shoals Technologies Group, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1831651/000183165124000011/shls-20231231.htm
Accession: 0001831651-24-000011
Filing date: 2024-02-28
Report date: 2023-12-31
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/
Previous year: /company/SHLS/mda/fy2022/ (FY 2022)
Next year: /company/SHLS/mda/fy2024/ (FY 2024)

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 (“MD&A”) should be read in conjunction with our consolidated 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 contains 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”. Management’s discussion and analysis relating to the fiscal year ended December 31, 2022 and the applicable year-to-year comparisons to the fiscal year ended December 31, 2021 are not included in this Annual Report on Form 10-K but can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

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-K with additional insight into our operational performance relative to earlier periods and relative to our competitors. We do not intend Adjusted Gross Profit, Adjusted Gross Profit Percentage, Adjusted EBITDA,

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Adjusted Net Income, and Adjusted Diluted Earnings per Share to be substitutes for any GAAP financial information. Readers of this Form 10-K 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, and Net Income 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 EBOS solutions and components for solar, battery storage and 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 generally 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, splice boxes and battery energy storage system (“BESS”) cabinets. 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 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.

Throughout fiscal year 2023, we have maintained focus on our growth strategy and continued strengthening our leadership position in the industry. We believe that as of December 31, 2023, we have worked with 13 of the top 15 solar EPCs, per Wood Mackenzie data from 2019-2023, and 11 of those EPCs used our combine-as-you-go system on their projects.

We derived 81.5% of our revenue from the sale of system solutions for the year ended December 31, 2023. For the same period, we derived substantially all of our revenue from customers in the U.S. As of December 31, 2023, we had $631.3 million of backlog and awarded orders. Backlog of $205.8 million represents signed purchase orders or contractual minimum purchase commitments with take-or-pay provisions and awarded orders of $425.5 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 December 31, 2023, we believe approximately $205.8 million of backlog and $250.0 million of awarded orders have delivery dates in 2024. The remaining $175.5 million have planned delivery dates beyond 2024. Additionally, we believe more than 13% of our December 31, 2023 backlog and awarded orders relate to international projects. As of December 31, 2023, backlog and awarded orders increased by 47% relative to December 31, 2022 and decreased by 0.3% relative to September 30, 2023.

Elimination of Up-C Structure and Entity Simplification

In 2023, following a secondary offering of shares of Class A common stock by certain selling shareholders, all the holders of LLC Interests exchanged all the LLC Interests and corresponding shares of

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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, all of the LLC Interests in Shoals Parent LLC were held by the Company, no other holders owned LLC Interests and no Class B common stock was or is outstanding.

On July 1, 2023, the Company contributed 100% of its LLC Interests to Shoals Intermediate Parent, a wholly-owned subsidiary of the Company. Following the contribution, Shoals Parent LLC became a disregarded single member limited liability company, eliminating the Company’s Up-C structure.

Following the elimination of the Up-C structure, effective December 31, 2023, the Company consummated an internal reorganization transaction whereby certain of the Company’s wholly-owned subsidiaries merged with and into other subsidiaries. As part of this reorganization, Shoals Parent LLC merged with and into Shoals Intermediate Parent, with Shoals Intermediate Parent as the surviving corporation.

Trends and Uncertainties

During 2023 and 2022, significant levels of inflation resulted in increased energy prices, freight premiums, and other operating costs. These increases are expected to persist into 2024. As a result of inflation, during 2023 and 2022, the Federal Reserve increased interest rates. Such increased interest rates have resulted in higher interest rates associated with our Senior Secured Credit Agreement. The Federal Reserve may continue raising interest rates as long as high inflation persists, 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 forecasted period.

In 2022 and to a lesser extent during 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 Russia-Ukraine war 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 into 2024. 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 2023. We are continuously monitoring the condition of our supply chain and evaluating our procurement strategy 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 2023, we continued to monitor and reduce our inventory levels.

In 2023, the domestic utility scale solar market experienced slowing growth as a result of the costs of project financing, lingering uncertainty about the application of the Inflation Reduction Act of 2022 to solar projects, supply chain constraints and interconnection complications. We expect these trends to persist in 2024. However, even though we expect our growth rate to decline from the very high levels of the last few years, we believe that our domestic utility scale business will continue growing at an attractive rate.

As of December 31, 2023, other than increased interest expense, we did not experience material adverse effects on our financial results from the events and trends discussed above.

Recent Developments

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On February 21, 2024, we announced our intention to expand and consolidate our existing manufacturing and distribution operations into a new, more than 600,000 square foot facility in Portland, Tennessee over the next five years. On February 7, 2024, we entered into a lease agreement for the new facility.

Separately, in February 2024, we announced the closing of our Poway, California facility as a result of a strategic assessment aimed at enhancing overall production and performance and at allowing for greater efficiency throughout our operations. The closure is expected to be completed in May 2024.

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, battery storage, EV charging infrastructure, and O&M offerings. 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 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

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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 115 to 149 from December 31, 2022 to December 31, 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.

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.

Payable Pursuant to the Tax Receivable Agreement Adjustment

Tax Receivable Agreement (“TRA”) adjustment consists of changes to our tax rate since the initial recording of the liability related to the TRA.

Gain on Termination of Tax Receivable Agreement

Gain on termination of TRA is related to the early termination and settlement of the TRA, as discussed in Note 18 - Payable Pursuant to the Tax Receivable Agreement of the consolidated financial statements. The TRA was terminated in December 2022.

Income Tax Expense

Shoals Technologies Group, Inc. is subject to U.S. federal and state income tax in multiple jurisdictions. Prior to the July 1, 2023 contribution described in Note 17 - Income Taxes, Shoals Parent LLC was a pass-through entity for federal income tax purposes but incurred income tax in certain state jurisdictions. On July 1, 2023, the Company contributed 100% of its LLC Interests in Shoals Parent LLC to its wholly-owned subsidiary, Shoals Intermediate Parent, and following the contribution, Shoals Parent LLC became a disregarded single member limited liability company, eliminating the Up-C structure.

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Results of Operations

Set forth below is a comparison of the results of operations and changes in financial condition for the years ended December 31, 2023 and 2022.

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

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2023 vs 2022"],["","2023","","2022","","$ variance","","% variance"],["Revenue","$","488,939","","","$","326,940","","","$","161,999","","","50","%"],["Cost of revenue","320,635","","","195,629","","","125,006","","","64","%"],["Gross profit","168,304","","","131,311","","","36,993","","","28","%"],["Operating expenses"],["General and administrative expenses","80,719","","","55,908","","","24,811","","","44","%"],["Depreciation and amortization","8,550","","","9,073","","","(523)","","","(6)","%"],["Total operating expenses","89,269","","","64,981","","","24,288","","","37","%"],["Income from operations","79,035","","","66,330","","","12,705","","","19","%"],["Interest expense, net","(24,100)","","","(18,538)","","","5,562","","","30","%"],["Payable pursuant to the tax receivable agreement adjustment","\u2014","","","(6,675)","","","(6,675)","","","(100)","%"],["Gain on termination of tax receivable agreement","\u2014","","","110,883","","","110,883","","","(100)","%"],["Income before income taxes","54,935","","","152,000","","","(97,065)","","","(64)","%"],["Income tax expense","(12,274)","","","(8,987)","","","3,287","","","37","%"],["Net income","42,661","","","143,013","","","(100,352)","","","(70)","%"],["Less: net income attributable to non-controlling interests","2,687","","","15,402","","","(12,715)","","","(83)","%"],["Net income attributable to Shoals Technologies Group, Inc.","$","39,974","","","$","127,611","","","$","(87,637)","","","(69)","%"]]
[[/GREPCENT_TABLE]]

Comparison of the years ended December 31, 2023 and 2022

Revenue

Revenue increased by $162.0 million, or 50%, for the year ended December 31, 2023 as compared to the year ended December 31, 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 year ended December 31, 2023 as compared to the year ended December 31, 2022. We believe expanding customer recognition of the benefits of our combine-as-you-go system solutions resulted in increased demand for our products.

Cost of Revenue and Gross Profit

Cost of revenue increased by $125.0 million, or 64%, for the year ended December 31, 2023 as compared to the year ended December 31, 2022, driven by $61.7 million of wire insulation shrinkback expense recorded during the year ended December 31, 2023. The remaining increase is driven by the increase in revenue. Gross profit as a percentage of revenue was 34.4% and 40.2%, respectively, during the years ended December 31, 2023 and 2022. The decrease in gross profit as a percentage of revenue was driven by the increase in wire insulation shrinkback expense and was offset by a higher portion of overall revenue coming from our combine-as-you-go system solutions, which carry higher margins than our other products, slightly lower raw materials input costs, increased leverage on fixed costs, and efficiencies gained in operations.

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Operating Expenses

General and Administrative

General and administrative expenses increased $24.8 million, or 44%, for the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase in general and administrative expenses was the result of an increase in wages, benefits and related taxes of $9.9 million due to increased employee headcount to support our growth, as well as an increase in equity-based compensation of $4.1 million related to termination of our former CEO for disability and an increase in employee headcount, and an increase in professional fees of $7.3 million, related to a $3.3 million increase in legal fees incurred in connection with the ongoing patent infringement litigation, a $1.3 million increase in legal fees related to wire insulation shrinkback litigation, and $2.7 million of other miscellaneous professional services.

Depreciation and Amortization

Depreciation and amortization expense decreased by $0.5 million, or 6%, for the year ended December 31, 2023 as compared to the year ended December 31, 2022, due to definite lived intangible assets that became fully amortized during 2022 and 2023.

Interest Expense

Interest expense, net increased by $5.6 million or 30%, for the year ended December 31, 2023 as compared to the year ended December 31, 2022, due to increased borrowing rates. During 2022 and 2023, the Federal Reserve increased interest rates resulting in higher interest rates associated with our Senior Secured Credit Agreement. The 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 year ended December 31, 2023 compared to the year ended December 31, 2022.

Payable Pursuant to the Tax Receivable Agreement Adjustment

Payable pursuant to the TRA adjustment decreased $6.7 million or 100% for the year ended December 31, 2023 as compared to the year ended December 31, 2022, due to termination and settlement of the TRA on December 6, 2022.

Gain on Termination of Tax Receivable Agreement

Gain on termination of TRA for the year ended December 31, 2022 totaled $110.9 million, which is equal to the difference between the carrying value of the payable pursuant to the TRA recorded as of the date of amendment to the TRA, which permitted its termination, net of related fees. There was no gain on termination of TRA for the year ended December 31, 2023.

Income Tax Expense

Income tax expense was $12.3 million for the year ended December 31, 2023 as compared to income tax expense of $9.0 million for the year ended December 31, 2022. Our effective income tax rate for the year ended December 31, 2023 and 2022 was 22.3% and 5.9%, respectively. The increase in the effective income tax rate was due to a reduction in permanent differences as a result of net income attributable to non-controlling interests, as well as the gain on termination of TRA recorded during 2022, and an increase in the valuation allowance during 2023 compared to a decrease in the valuation allowance during 2022. These increases were offset by a decrease related to the elimination of the Up-C structure on July 1, 2023, as discussed in more detail in 17 - Income Taxes.

Non-GAAP Financial Measures

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

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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 plus (i) interest expense, net, (ii) income tax expense, (iii) depreciation expense, (iv) amortization of intangibles, (v) payable pursuant to the TRA adjustment, (vi) gain on termination of TRA, (vii) loss on debt repayment, (viii) equity-based compensation, (ix) acquisition-related expenses, (x) COVID-19 expenses, (xi) non-recurring and other expenses, (xii), wire insulation shrinkback expenses, and (xiii) wire insulation shrinkback litigation expenses. We define Adjusted Net Income as net income 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) adjustment to the provision for income tax, (iii) amortization of intangibles, (iv) amortization of deferred financing costs, (v) payable pursuant to the TRA adjustment, (vi) gain on termination of TRA, (vii) loss on debt repayment, (viii) equity-based compensation, (ix) acquisition-related expenses, (x) COVID-19 expenses, (xi) non-recurring and other expenses, (xii) wire insulation shrinkback expenses, and (xiii) 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):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Revenue","$","488,939","","","$","326,940","","","$","213,212"],["Cost of revenue","320,635","","","195,629","","","130,567"],["Gross profit","$","168,304","","","$","131,311","","","$","82,645"],["Gross profit percentage","34.4%","","40.2%","","38.8%"],["Wire insulation shrinkback expenses (a)","$","61,705","","","$","\u2014","","","$","\u2014"],["Adjusted gross profit","$","230,009","","","$","131,311","","","$","82,645"],["Adjusted gross profit percentage","47.0%","","40.2%","","38.8%"]]
[[/GREPCENT_TABLE]]

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

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Net income","$","42,661","","","$","143,013","","","$","3,944"],["Interest expense, net","24,100","","","18,538","","","14,549"],["Income tax expense","12,274","","","8,987","","","86"],["Depreciation expense","2,612","","","1,858","","","1,701"],["Amortization of intangibles","7,917","","","8,651","","","8,352"],["Payable pursuant to the TRA adjustment (b)","\u2014","","","6,675","","","1,663"],["Gain on termination of TRA","\u2014","","","(110,883)","","","\u2014"],["Loss on debt repayment","\u2014","","","\u2014","","","15,990"],["Equity-based compensation","20,862","","","16,108","","","11,286"],["Acquisition-related expenses","\u2014","","","42","","","2,349"],["COVID-19 expenses (c)","\u2014","","","\u2014","","","339"],["Non-recurring and other expenses (d)","\u2014","","","\u2014","","","2,598"],["Wire insulation shrinkback expenses (a)","61,705","","","\u2014","","","\u2014"],["Wire insulation shrinkback litigation expenses (e)","1,260","","","\u2014","","","\u2014"],["Adjusted EBITDA","$","173,391","","","$","92,989","","","$","62,857"]]
[[/GREPCENT_TABLE]]

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

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Net income attributable to Shoals Technologies Group, Inc.","$","39,974","","","$","127,611","","","$","2,348"],["Net income impact from assumed exchange of Class B common stock to Class A common stock (f)","2,687","","","15,402","","","1,596"],["Adjustment to the provision for income tax (g)","(653)","","","(3,726)","","","(456)"],["Tax effected net income","42,008","","","139,287","","","3,488"],["Amortization of intangibles","7,917","","","8,651","","","8,352"],["Amortization of deferred financing costs","2,165","","","1,365","","","1,230"],["Payable pursuant to the TRA adjustment (b)","\u2014","","","6,675","","","1,663"],["Gain on termination of TRA","\u2014","","","(110,883)","","","\u2014"],["Loss on debt repayment","\u2014","","","\u2014","","","15,990"],["Equity-based compensation","20,862","","","16,108","","","11,286"],["Acquisition-related expenses","\u2014","","","42","","","2,349"],["COVID-19 expenses (c)","\u2014","","","\u2014","","","339"],["Non-recurring and other expenses (d)","\u2014","","","\u2014","","","2,598"],["Wire insulation shrinkback expenses (a)","61,705","","","\u2014","","","\u2014"],["Wire insulation shrinkback litigation expenses (e)","1,260","","","\u2014","","","\u2014"],["Tax impact of adjustments (h)","(24,604)","","","1,158","","","(11,381)"],["Adjusted Net Income","$","111,313","","","$","62,403","","","$","35,914"]]
[[/GREPCENT_TABLE]]

(a) For the year ended December 31, 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, 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 9 - Warranty Liability, in our consolidated financial statements included in this Annual Report on Form 10-K for more information.

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

(c)    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 and direct legal costs associated with the pandemic.

(d)    Represents certain costs associated with non-recurring professional services, our prior private equity owners’ expenses and other costs.

(e)    For the year ended December 31, 2023 represents $1.3 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

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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 16 - Commitments and Contingencies, in our consolidated financial statements included in this Annual Report on Form 10-K for more information.

(f)    Reflects net income to Class A common stock from assumed exchange of corresponding shares of our Class B common stock held by our founder and management.

(g)    Shoals Technologies Group, Inc. is subject to U.S. Federal income taxes, in addition to state and local taxes. 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 prior to March 10, 2023.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Statutory U.S. Federal income tax rate","21.0","%","","21.0","%","","21.0","%"],["Permanent adjustments","1.9","%","","0.2","%","","1.2","%"],["State and local taxes (net of federal benefit)","3.3","%","","3.0","%","","6.4","%"],["Effective income tax rate for Adjusted Net Income","26.2","%","","24.2","%","","28.6","%"]]
[[/GREPCENT_TABLE]]

(h)    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,"],["","2023","","2022","","2021"],["Diluted weighted average shares of Class A common stock outstanding, excluding Class B common stock","164,504","","","114,803","","","99,507"],["Assumed exchange of Class B common stock to Class A common stock","5,698","","","52,828","","","67,429"],["Adjusted diluted weighted average shares outstanding","170,202","","","167,631","","","166,936"],["Adjusted Net Income","$","111,313","","","$","62,403","","","$","35,914"],["Adjusted Diluted EPS","$","0.65","","","$","0.37","","","$","0.22"]]
[[/GREPCENT_TABLE]]

Liquidity and Capital Resources

We finance our operations primarily with operating cash flows and current 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 $92.0 million during the year ended December 31, 2023, as compared to cash provided by (used in) operating activities of $39.5 million and $(4.1) million, respectively, during the years ended December 31, 2022 and 2021. As of December 31, 2023, our cash and cash

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equivalents were $22.7 million, an increase from $8.8 million as of December 31, 2022. As of December 31, 2023 we had outstanding borrowings of $183.8 million, a decrease from $243.3 million as of December 31, 2022. As of December 31, 2023 we also had $109.7 million available for additional borrowings under our $150.0 million Revolving Credit Facility.

On December 27, 2023 and January 19, 2024 we used proceeds from the Revolving Credit Facility and cash on hand to make $50.0 million and $100.0 million, respectively, voluntary prepayments of outstanding borrowings under the Term Loan Facility. Following the January prepayment, we had outstanding borrowings of $168.8 million and $24.7 million available for additional borrowings under our Revolving Credit Facility.

In 2023, we also used approximately $4.7 million of cash to pay for expenses related to the identification, repair and replacement of the wire harnesses impacted in connection with the wire insulation shrinkback matter. We expect to continue spending significant amounts of cash in connection thereof. For more information, see Note 9 - Warranty Liability in our consolidated financial statements.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Net cash provided by (used in) operating activities","$","91,955","","","$","39,455","","","$","(4,083)"],["Net cash used in investing activities","(10,847)","","","(3,657)","","","(17,035)"],["Net cash provided by (used in) financing activities","(67,167)","","","(36,589)","","","20,602"],["Net increase (decrease) in cash, cash equivalents and restricted cash","$","13,941","","","$","(791)","","","$","(516)"]]
[[/GREPCENT_TABLE]]

Operating Activities

For the year ended December 31, 2023, cash provided by operating activities was $92.0 million, due to operating results that included $42.7 million of net income, which included $109.8 million of non-cash expense, along with an increase of $9.6 million in accounts payable and accrued expenses and other, and a decrease of $15.0 million in inventory. These cash inflows were partially offset by an increase of $80.3 million in accounts receivable and unbilled receivables, which is primarily driven by an increase in revenues, $5.2 million cash outflow related to warranty liability and a decrease of $1.0 million in deferred revenue.

For the year ended December 31, 2022, cash provided by operating activities was $39.5 million, due to operating results that included $143.0 million of net income, which included $65.6 million of non-cash income, an increase of $21.4 million in deferred revenue, and an increase of $10.7 million in accrued expenses and other. These cash inflows were partially offset by an increase in inventory of $36.9 million as a result of increasing our raw materials inventory to support growth and reduce the likelihood of supply chain issues from our raw materials suppliers, an increase of $22.4 million in accounts receivable and unbilled receivables, which is primarily driven by an increase in revenues, and a decrease of $11.0 million in accounts payable.

Investing Activities

For the year ended December 31, 2023, net cash used in investing activities was $10.8 million, of which $10.6 million was attributable to the purchase of property and equipment.

For the year ended December 31, 2022, net cash used in investing activities was $3.7 million, of which $3.2 million was attributable to the purchase of property and equipment.

Financing Activities

For the year ended December 31, 2023, net cash used in financing activities was $67.2 million, due to $51.5 million in payments on the Term Loan, $8.0 million in net payments on the Revolving Credit Facility, $2.6 million in distributions to our non-controlling interest holders and $3.9 million in taxes related to net share settled equity awards.

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For the year ended December 31, 2022, net cash used in financing activities was $36.6 million, primarily due to $58.0 million paid to terminate the TRA, as discussed in Note 18 of the consolidated financial statements, plus related fees of $1.9 million, $2.0 million in payments on the Term Loan, $7.1 million in net payments on the Revolving Credit Facility, $7.8 million in distributions to our non-controlling interest holders, $1.5 million of offering costs, and $1.3 million in taxes related to net share settled equity awards. These cash outflows are partially offset by $42.9 million received in connection with the issuance of Class A common stock sold in follow-on offering, net of underwriting discounts and commissions.

A discussion and analysis covering historical cash flows for the year ended December 31, 2021 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

Debt Obligations

For a discussion of our debt obligations see Note 10 - Long-Term Debt in our consolidated financial statements included in this Annual Report on Form 10-K.

Surety Bonds

For a discussion of our surety bond obligations see Note 16 - Commitments and Contingencies in our consolidated financial statements included in this Annual Report on Form 10-K.

Product Warranty

For a discussion of our product warranties see Note 9 - Warranty Liability in our consolidated financial statements included in this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with 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 primarily 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 right to payment of the transaction price associated with work performed to date on products that do not have an alternative use. We believe that recognizing revenue using the output method based on units manufactured best depicts the extent of transfer of control to the customer. If revenue were recognized at a point in time rather than over time, then for the year ended December 31, 2023, net income would be $17.1 million lower, and EPS - basic and diluted would decrease by $0.10.

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In certain instances the promised goods do have an alternative use. In these instances we recognize revenue when the customer obtains control of the product. Contracts of this nature typically include customer acceptance clauses, which results in revenue recognition occurring upon customer acceptance.

Depending on the size of project, the manufacturing process generally takes from less than one week to four months to complete production. The accounting for each contract involves a judgmental 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 have elected to adopt certain practical expedients and exemptions as allowed under the 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.

Payable Pursuant to the Tax Receivable Agreement

As discussed in Note 18 to the consolidated financial statements, we were party to a TRA, dated January 29, 2021, under which we were contractually committed to pay the TRA Owners 85% of the amount of the tax benefits, if any, that we were deemed to realize, as a result of certain transactions. Amounts payable under the TRA were contingent upon, among other things, (i) generation of future taxable income over the term of the TRA and (ii) future changes in tax laws.

On November 29, 2022, the Company entered into an amendment to the TRA (the “TRA Amendment”), pursuant to which the parties thereto agreed to grant the Company a right to terminate the TRA until December 31, 2022 (the “TRA Termination Right”) in exchange for a termination consideration of $58.0 million payable in cash (the “TRA Termination Consideration”). The Company exercised its TRA Termination Right, and the TRA was terminated on December 6, 2022.

As of the effective date of the TRA Amendment, we concluded it was probable that the expected payments related to the payable pursuant to the TRA had changed. As a result of this change, the Company remeasured the payable pursuant to the TRA to $58.0 million. We analyzed the relevant accounting guidance and considered the nature of the TRA termination and the involved parties in order to determine if the transaction should be recorded as a gain in the Consolidated Statement of Operations or as a stockholder contribution. Ultimately, we determined that, despite the involvement of the Company’s founder, the transaction was performed at arm's length, both parties received the same payment based upon ownership percentage, and therefore, the gain should be recorded in the Consolidated Statement of Operations as of the effective date of the TRA Amendment. If the transaction had been accounted for as a stockholder contribution rather than a gain in the Consolidated Statement of Operations, then for the year ended December 31, 2022 net income would have been $110.9 million lower, EPS - basic would have decreased by $0.96 and EPS - diluted would have decreased by $0.70.

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 closing market price of the Company's common stock on the day prior to the grant date. Equity-based compensation expense related to performance stock units is recognized if it is probable that the performance conditions will be satisfied. 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

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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.

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, 2023, we had $468.2 million of deferred tax assets, net of a $1.0 million valuation allowance related to land and other non-amortizable intangibles. Other than the valuation allowance related to land and other non-amortizable intangibles, 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 increase our valuation allowance through earnings in the period the determination was made, which would have an adverse effect on our results of operations and earnings in future periods.

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.

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. As of December 31, 2023, based on the Company’s continued analysis, which included better visibility into the scope of affected sites and potential solutions, including identification, repair and replacement of harnesses, the Company determined that a potential range of loss was both probable and reasonably estimable and updated its estimate of potential losses from previously provided estimates. Based on the Company’s continued analysis of information available as of the date of this Annual Report, the estimate of potential losses remains unchanged from the estimate provided as of September 30, 2023. 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 have recorded. As of December 31, 2023, the Company recorded a warranty liability of $54.9 million related to this matter. The Company recorded total warranty expense related to this matter of $59.2 million and $0.5 million, respectively, during years ended December 31, 2023 and 2022.

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The estimated range is based on several assumptions, including the potential magnitude of EPC’s 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 has become available or becomes available, the Company has increased and may continue to increase or decrease its estimated warranty liability and related expense from its current estimate, and such increase or decrease may be material.

As of December 31, 2023, a 10% increase in harness installation costs, failure rate, materials replacement cost, and inspection costs would have resulted in an increase of the low end of the range of potential losses of $2.4 million, $1.2 million, $1.4 million, and $0.6 million, respectively. A 10% increase in harness installation costs and materials replacement cost would have resulted in an increase of the high end of the range of potential loss of $12.0 million and $5.8 million, respectively. Additionally, changes to the planned remediation method could also have a material impact on the warranty liability.