Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Risk Factors” and our audited consolidated financial statements and the related notes to those statements included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions.
Our discussion and analysis of the year ended December 31, 2022 compared to the year ended December 31, 2021 is included herein. Our discussion and analysis of the year ended December 31, 2021 compared to the year ended December 31, 2020 can be found in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 30, 2022.
Overview
We own and operate premium brands with ingenious products that we market and deliver through our direct-to-consumer (“DTC”) platform and wholesale partnerships. We aim to help our customers enjoy good moments that create lasting memories. We consistently deliver innovative, high-quality products that are loved by our customers and revolutionize the outdoor experience, build community and help everyday people reconnect with what matters most.
Key performance indicators used by management to monitor the health of the business include customer volume and growth by year with 3.8 million total customers as of December 31, 2022, an increase of 34.7% from December 31, 2021, total email subscriptions and growth by year with 5.6 million email subscribers as of December 31, 2022, an increase of 33.1% from December 31, 2021 and our repeat purchase rate of 42.0% in 2022. We are deliberate in keeping the customer at the center of what we do in order to drive solid customer lifetime value that we believe will result in long-term financial value to the Company.
Our net sales increased from $403.7 million for the year ended December 31, 2021 to $517.6 million for the year ended December 31, 2022, representing a growth rate of 28.2%, including the effect of acquisitions. Our revenue growth was driven by greater demand in both the DTC and wholesale sales channels, with the growth in wholesale outpacing the growth in DTC. During 2022 and 2021, DTC sales were 81.8% and 88.1% of net sales, respectively, and wholesale sales were 18.2% and 11.9% of net sales, respectively.
Our net income decreased to a net loss of $7.6 million for the year ended December 31, 2022 from net income of $56.5 million for the year ended December 31, 2021. The net loss for the year ended December 31, 2022 was primarily due to $30.6 million of impairment charges recorded during the second quarter of 2022, coupled with higher selling, general and administrative costs compared to the corresponding period as a result of investments in long-term strategic initiatives, costs associated with being a public company and headcount. Additionally, marketing and distribution expenses increased along with the increases in net sales.
Outlook
We continue to focus on our long-term growth strategies, including product innovation, channel and category expansion, strategic acquisitions, and investments in information technology to drive efficiencies. As the macroeconomy continues to face uncertainty around inflation and rising interest rates, consumer behavior is unknown. Our business is not immune to the impacts resulting from decreased discretionary spending. However, we believe we are prepared to mitigate these pressures and quickly adjust our short-term strategies as necessary throughout 2023 to ensure financial health without jeopardizing our long-term growth expectations.
Key Factors Affecting Our Financial Condition and Results of Operations
We believe that our performance and future success depend on a number of factors that present significant opportunities for us, but also pose risks and challenges, including those discussed in Part I, Item 1A, Risk Factors, and included elsewhere in this Annual Report on Form 10-K.
During 2022, demand for our products remained healthy; however, we were minimally impacted by global economic conditions including supply chain disruptions, inflation and rising interest rates. In 2022, some of our factories in China closed periodically due to COVID-19, which did temporarily delay the delivery of the Solo Stove Pi. Our other products were insignificantly impacted due to our strong inventory position. Freight rates were, in general, higher in 2022 than the prior year, which put pressure on gross margin in 2022. However, we saw spot rates decrease in the second half of 2022, and we opportunistically used the spot rates if they were lower than our contracted rates. We re-negotiate contracted freight rates early in the year on an annual basis and expect to take advantage of lower freight rates in the second half of 2023.
Although we have been able to navigate inflationary pressures through December 31, 2022, we expect the volatility we experienced in 2022 to continue to impact the Company in 2023. We have not historically raised the prices of our products and have mitigated inflationary pressures through cost management. We believe consumers will continue to feel the strain of higher inflation, thereby impacting their spending. We expect to continue to monitor inflation and consider strategies to minimize the impact. As interest rates rose during 2022, we mitigated the impact via strategic
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repayments of borrowings on our Revolving Credit Facility. We expect to continue to monitor interest rates and balance our working capital needs with the cost of debt.
If current macroeconomic pressures persist or worsen, our business may continue to be adversely impacted.
Components of Our Results of Operations
Net Sales
Net sales are comprised of DTC and wholesale channel sales to retail partners. Net sales in both channels reflect the impact of partial shipments, product returns, and discounts for certain sales programs or promotions.
Our net sales have historically included a seasonal component. In the DTC channel, our historical net sales tend to be highest in our second and fourth quarters, while our wholesale channel has generated higher sales in the first and third quarters. Additionally, we expect variance in the results of operations throughout the year relative to the timing of new product launches.
Gross Profit and Cost of Goods Sold
Gross profit reflects net sales less cost of goods sold, which primarily includes the purchase cost of our products from our third-party manufacturers, inbound freight and duties, product quality testing and inspection costs and depreciation on molds and equipment that we own.
Selling, General, & Administrative Expenses
Selling, general and administrative (“SG&A”) expenses consist primarily of marketing costs, equity-based compensation expense and benefits costs, costs of our warehousing and logistics operations, costs of operating on third-party DTC marketplaces, professional fees and services, costs of shipping product to our customers, and general corporate expenses.
Depreciation and Amortization Expenses
Depreciation and amortization expenses consist of depreciation of property, plant and equipment and amortization of definite-lived intangible assets.
Impairment Charges
Impairment charges consist of impairments recorded to definite-lived intangible assets and goodwill.
Other Operating Expenses
Other operating expenses include certain costs incurred for the initial public offering, acquisition-related expenses, business optimization and expansion expenses and management transition costs.
Interest Expense, Net
Interest expense, net consists primarily of interest on our Revolving Credit Facility and Term Loan.
Income Taxes
Income taxes represents federal, state, and local income taxes on the Company's allocable share of taxable income of Holdings, as well as Oru's, ISLE’s and Chubbies' federal, state and foreign tax expense related to international subsidiaries. We are the sole managing member of Holdings, and as a result, consolidate the financial results of Holdings. Holdings is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, Holdings is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by Holdings is passed through to and included in the taxable income or loss of its members, including us, on a pro rata basis. We are subject to U.S. federal income taxes, in addition to state and local income taxes with respect to our allocable share of any taxable income or loss of Holdings, as well as any stand-alone income or loss generated by Solo Brands, Inc.
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Results of Operations
Year Ended December 31, 2022 Compared to Year Ended December 31, 2021
Net Sales
Year Ended December 31, Change
The increase in net sales for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily driven by a 47.0% increase in total orders as a result of $93.6 million of activity related to acquisitions and 8.8% organic growth in total orders. Partially offsetting the increase in total orders for the year ended December 31, 2022, average order value decreased 10.5% compared to the corresponding period, primarily due to the product offerings of the Chubbies acquisition, which occurred in the third quarter of 2021. Demand improved in both the DTC and wholesale sales channels as a result of continued market penetration.
Cost of Goods Sold and Gross Profit
Year Ended December 31, Change
Gross margin (Gross profit as a % of net sales) 61.5 % 64.1 % (2.7) %
The increase in cost of goods sold for the year ended December 31, 2022 compared to the year ended December 31, 2021 included $35.6 million of activity related to the businesses acquired in 2021, for which the comparative periods did not include such activity for the full period. Additionally, cost of goods sold increased due to greater net sales as well as higher inbound freight costs.
The increase in gross profit for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to acquisition activity. Gross margin decreased for the year ended December 31, 2022 compared to the year ended December 31, 2021 due to the gross margin profile of the businesses acquired in 2021 and the shift in sales channel mix with greater growth in wholesale sales, which typically have lower gross margins than DTC sales.
Selling, General, and Administrative Expenses
Year Ended December 31, Change
The increase in SG&A for the year ended December 31, 2022 compared to the year ended December 31, 2021, included $43.7 million, or a 7.3% increase as a percent of net sales, related to the businesses acquired in 2021, which did not include activity for the full comparative period. The remaining increase in SG&A was driven by $39.8 million of fixed cost increases, or a 6.5% increase as a percent of net sales, and $15.9 million of variable cost increases, or a 3.0% decrease as a percent of net sales.
The fixed cost increases for the year ended December 31, 2022 compared to the year ended December 31, 2021 were primarily due to $26.3 million in employee costs as a result of an $10.4 million increase in equity-based compensation, a $0.9 million increase in severance and increased headcount; $3.8 million in professional services costs and $3.2 million in insurance as a result of being a public company; $4.4 million in rent and $1.9 million in investments in information technology. The variable cost increases for the year ended December 31, 2022 compared to the year ended December 31, 2021 were primarily due to $6.1 million in distribution costs, $6.1 million in marketing spend and $1.8 million in supplies.
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Depreciation and Amortization Expenses
Year Ended December 31, Change
The increase in amortization for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily related to increases in definite-lived intangible assets as result of acquisition activity in 2021, and the increase in depreciation for the same comparative periods was primarily related to a new global headquarters facility completed in the fourth quarter of 2021.
Impairment Charges
During the year ended December 31, 2022, impairment charges of $30.6 million were recorded, of which $27.9 million related to goodwill and $2.7 million related to trademark intangibles. For more information, see Note 8, Goodwill, and Note 7, Intangible Assets, net in Item 8 of this Annual Report.
Other Operating Expenses
Year Ended December 31, Change
Other operating expenses decreased for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to a $7.9 million decrease in acquisition-related expenses as a result of lower acquisition activity during 2022 and a $1.8 million decrease in business optimization expenses as a result of non-recurring warehouse and headquarters transition costs primarily incurred in the fourth quarter of 2021, partially offset by $0.7 million of management transition costs incurred during 2022.
Interest Expense, Net
Year Ended December 31, Change
Interest expense, net decreased for the year ended December 31, 2022 compared to the year ended December 31, 2021 due to a lower average debt balance.
Income Taxes
Year Ended December 31, Change
Income tax expense decreased for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to the decrease in pre-tax net income predominantly resulting from goodwill and intangible asset impairment recognized in the second quarter of 2022 and a change in tax rates driven by a reduction in the blended state tax rate applied to our deferred tax liability, offset by the decrease in income attributable to non-controlling interests that reduces the tax benefit applicable to the controlling interest for 2022 and an increase in current state income taxes.
Liquidity and Capital Resources
Historically, our cash requirements have principally been for working capital purposes. We expect these needs to continue as we develop and grow our business. We fund our working capital, primarily inventory, from cash flows from operating activities, cash on hand, and borrowings under our Revolving Credit Facility.
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Current Liquidity
As of December 31, 2022, we had a cash balance of $23.3 million, working capital (excluding cash) of $104.8 million, and $330.0 million of borrowings available under the Revolving Credit Facility.
Revolving Credit Facility and Term Loan
On May 12, 2021, we entered into a credit agreement with JPMorgan Chase Bank, N.A., the Lenders and L/C Issuers party thereto (each as defined therein) and the other parties thereto (as subsequently amended on June 2, 2021, and September 1, 2021, the “Revolving Credit Facility”). As so amended, the Revolving Credit Facility allows us to borrow up to $350.0 million of revolving loans, including the ability to issue up to $20.0 million in letters of credit. While our issuance of letters of credit does not increase our borrowings outstanding under the Revolving Credit Facility, it does reduce the amounts available under the Revolving Credit Facility. The Revolving Credit Facility matures on May 12, 2026 and bears interest at a rate equal to the base rate as defined in the agreement plus an applicable margin, which as of December 31, 2022, was based on LIBOR. Interest is due on the last business day of each March, June, September and December. Principal under the Revolving Credit Facility is not due until maturity. As of December 31, 2022, we had $20.0 million in outstanding borrowings and $330.0 million available for future borrowings on the Revolving Credit Facility.
In addition to the above, the amendment on September 1, 2021 included a provision to borrow up to $100.0 million under a term loan (the “Term Loan”). The proceeds from the Term Loan were used to fund the Chubbies acquisition. The Term Loan matures on September 1, 2026 and bears interest at a rate equal to the base rate as defined in the agreement plus an applicable margin, which as of December 31, 2022, was based on LIBOR.. We were required to make quarterly principal payments on the Term Loan beginning on December 31, 2021. At December 31, 2022, we had $96.3 million outstanding on the Term Loan. All required principal payments were made on time and with available cash through the year ended December 31, 2022. Interest payments are due on a quarterly basis under the Term Loan, with the same due dates as noted for the Revolving Credit Facility above.
The recent changes in our working capital requirements generally reflect the growth in our business. Although we cannot predict with certainty all of our particular short-term cash uses or the timing or amount of cash requirements, we believe that our available cash on hand, along with amounts available under our Revolving Credit Facility will be sufficient to satisfy our liquidity requirements for at least the next twelve months. However, the continued growth of our business, including our expansion into international markets, may significantly increase our expenses (including our capital expenditures) and cash requirements. Furthermore, we will continue to seek possible brand and mission consistent acquisition opportunities that would require additional capital. In addition, the amount of our future product sales is difficult to predict, and actual sales may not be in line with our forecasts. As a result, we may be required to seek additional funds in the future from issuances of equity or debt, obtaining additional credit facilities, or loans from other sources.
Other Terms of the Revolving Credit Facility
We may request incremental term loans, incremental equivalent debt, or revolving commitment increases (we refer to each as an Incremental Increase) in amounts such that, after giving pro forma effect to such Incremental Increase, our total secured net leverage ratio (as defined in the Revolving Credit Facility) would not exceed the then-applicable cap under the Revolving Credit Facility. In the event that any lenders fund any of the Incremental Increases, the terms and provisions of each Incremental Increase, including the interest rate, shall be determined by us and the lenders, but in no event shall the terms and provisions, when taken as a whole and subject to certain exceptions, of the applicable Incremental Increase, be more favorable to any lender providing any portion of such Incremental Increase than the terms and provisions of the loans provided under the Revolving Credit Facility unless such terms and conditions reflect market terms and conditions at the time of incurrence or issuance thereof as determined by us in good faith.
The Revolving Credit Facility is (a) jointly and severally guaranteed by the Guarantors (as defined in the Revolving Credit Facility) and any future subsidiaries that execute a joinder to the guaranty and related collateral agreements and (b) secured by a first priority lien on substantially all of our and the Guarantors’ assets, subject to certain customary exceptions.
The Revolving Credit Facility requires us to comply with certain financial ratios, including:
•at the end of each fiscal quarter, a total net leverage ratio (as defined in the Revolving Credit Facility) for the four quarters then ended of not more than: 4.00 to 1.00 for each quarter ended in 2022 and through June 30, 2023; 3.75 to 1.00 for each quarter ending June 30, 2023 through March 31, 2024; and 3.50 to 1.00 for each quarter ending June 30, 2024 or thereafter;
•at the end of each fiscal quarter, an interest coverage ratio (as defined in the Revolving Credit Facility) for the four quarters then ended of not less than 3.00 to 1.00.
In addition, the Revolving Credit Facility contains customary financial and non-financial covenants limiting, among other things, mergers and acquisitions; investments, loans, and advances; affiliate transactions; changes to capital structure and the business; additional indebtedness; additional liens; the payment of dividends; and the sale of assets, in each case, subject to certain customary exceptions. The Revolving Credit Facility contains customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, defaults under other material debt, events of bankruptcy and insolvency, failure of any guaranty or security document supporting the Revolving Credit Facility to be in full force and effect, and a change of control of our business. We were in compliance with all covenants under the Revolving Credit Facility as of December 31, 2022.
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Cash Flows
Year Ended December 31,
Cash flows provided by (used in):
Operating activities
The $42.6 million increase in cash provided by operating activities period over period, as shown in the table above, was due to a $59.2 million decline in cash usage from changes in operating assets and liabilities (“working capital”), partially offset by greater cash usage of $16.6 million from changes in net income (loss) after non-cash adjustments, predominantly due to increases in SG&A. The decrease in cash used by working capital was primarily due to:
•a $21.3 million increase in cash provided by changes in deferred revenue, primarily driven by shipments that were backordered in 2020 shipping in 2021;
•an $18.5 million decrease in cash used by changes in inventory due to a higher inventory balance at the beginning of 2022 than the prior year, resulting in fewer inventory purchases in 2022, as well as a reduction in replenishment of inventory exiting the year; and
•a $9.1 million decrease in cash used by changes in accounts receivable as a result of improved collection efforts.
Investing activities
The $133.9 million decrease in cash used in investing activities, as shown in the table above, was due to a $132.5 million decrease in acquisition activity in the current period compared to the prior period. Additionally, cash usage for capital expenditures decreased by $1.4 million, primarily due to reduced equipment purchases for factory and warehouse build outs.
Financing activities
The $170.0 million increase in cash used in financing activities, as shown in the table above, was primarily due to a $234.6 million decrease in cash provided by Class A common stock issuance and a $68.3 million decrease in cash provided by net debt activities, partially offset by a $100.0 million increase in cash as a result of a decrease in payments for contingent consideration and a $33.2 million increase in cash as a result of decreases in distributions to non-controlling interests.
Contractual Obligations
Our material cash commitments from known contractual and other obligations primarily consist of obligations for long-term debt and related interest, leases for properties and equipment and purchase obligations as part of normal operations. See Note 10, Long-Term Debt, in Item 8 of this Annual Report for more information regarding scheduled maturities of our long-term debt. See Note 11, Leases, in Item 8 of this Annual Report for additional information on leases. Interest payable on our long-term debt is expected to be $5.7 million due in the twelve months following December 31, 2022 and $11.5 million due thereafter.
As of December 31, 2022, we had a non-cancelable agreement to purchase $8.4 million of advertising services, of which 50% is due in 2023 and the remainder is due in 2024. This purchase obligation includes all enforceable, legally binding agreements to purchase goods or services that specify all significant terms, regardless of the duration of the agreement, and exclude agreements with variable terms for which we are unable to estimate the minimum amounts.
Subsequent to December 31, 2022, we entered into a non-cancelable agreement to purchase $10.8 million of advertising services, of which 50% is due in 2023 and the remainder is due in 2024.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the consolidated financial statements, we make estimates and judgments that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosure of contingent assets and liabilities. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Because of the uncertainty inherent in these matters, actual results may differ from these estimates and could differ based upon other assumptions or conditions.
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See Note 2, Significant Accounting Policies, to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for more information about our significant accounting policies, including our critical accounting policies. The critical accounting estimates that reflect our more significant judgments and estimates used in the preparation of our consolidated financial statements include those noted below. Within the context of these critical accounting estimates, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.
Revenue Recognition
We primarily engage in direct-to-consumer transactions, which are comprised of product sales directly from our brands’ websites, through Amazon, and from our retail locations. We also sell products via business-to-business transactions, which are comprised of sales to retailers, including where possession of our products is taken and sold by the retailer in-store or online.
There are no significant extended payment terms with our customers. Payment is due at the time of sale for our direct-to-consumer transactions. Our business-to-business customers’ payment terms vary depending on the contract with each retailer, but the most common is net 30 or net 60 days.
Revenue is recognized for the amount of consideration to which we expect to be entitled in exchange for transferring promised goods to a customer. The consideration promised in a contract with a customer includes fixed and variable amounts. The fixed amount of consideration is the standalone selling price of the goods sold. Variable considerations, including cash discounts and rebates, are deducted from gross sales in determining net sales. Variable considerations also include the portion of goods that are expected to be returned and refunded. Any consideration received (or receivable) that we expect to refund to the customer is recognized as a refund liability. Our refund liability is based on historical experience and trends. The actual amount of customer returns and refunds may differ from our estimates. Net sales include shipping costs charged to the customer and is recorded net of sales taxes collected from customers, which are remitted to government authorities.
Income Taxes
In determining the provision for income taxes for financial statement purposes, we make estimates and judgments which affect our evaluation of the carrying value of our deferred tax assets as well as our calculation of certain tax liabilities. We evaluate the carrying value of our deferred tax assets on a quarterly basis. In completing this evaluation, we consider all available positive and negative evidence. Such evidence includes historical operating results, the existence of cumulative earnings and losses in the most recent fiscal years, taxable income in prior carryback year(s) if permitted under the tax law, expectations for future pre-tax operating income, the time period over which our temporary differences will reverse, and the implementation of feasible and prudent tax planning strategies. 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 projected revenue growth, and operating margins, among others. Deferred tax assets are reduced by a valuation allowance if, based on the weight of this evidence, it is more likely than not that all or a portion of the recorded deferred tax assets will not be realized in future periods.
We have recorded a valuation allowance against the capital loss resulting from the portion of the basis difference in our investments in Holdings, Oru, and Chubbies, that will only reverse upon the eventual sale of our interest in Holdings, Oru, and Chubbies, as well as certain state tax losses and foreign losses that are not expected to be utilized prior to expiration. As of December 31, 2022, we had $2.5 million of deferred tax assets, net of $26.9 million of valuation allowances. We expect to realize future tax benefits related to the utilization of these assets. However, since future financial results may differ from previous estimates, periodic adjustments to our valuation allowances may be necessary. 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 period the determination was made, which would have an adverse effect on our results of operations and earnings in future periods.
Goodwill
Goodwill is determined based upon the excess enterprise value over the estimated fair value of assets and liabilities assumed at acquisition date and is recorded at its estimated fair value at the date of acquisition. See Note 8, Goodwill, for further details regarding our goodwill balance and accumulated impairment losses.
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In the second quarter of 2022, we identified triggering events indicating the fair value of one or more of the reporting units more likely than not did not exceed their carrying values. The triggering events included: (1) adverse equity market conditions resulting in a sustained decline in our stock price subsequent to the issuance of our first quarter 2022 results on Form 10-Q and (2) weakened demand for the ISLE reporting unit’s products resulting in a lower near-term forecast of future operating results. As a result, we performed an interim quantitative goodwill impairment test for all of our reporting units and recorded a $27.9 million goodwill impairment charge related to the ISLE reporting unit, which has $1.7 million of remaining goodwill after the impairment. The results of the interim quantitative test did not result in a goodwill impairment for the other reporting units. As determined by the results of our interim test, the fair value of the remaining reporting units exceeded their carrying values by greater than 10%. The impairment charge was recorded to impairment charges on the consolidated statements of operations and comprehensive income (loss).
We estimated the fair value of the reporting units using a weighting of fair values derived from the income and market approaches, where comparable market data was available. Under the income approach, we determined the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections were based on management’s estimates of revenue growth rates and operating margins, considering industry and market conditions, and management’s estimates of working capital requirements. The discount rate for each reporting unit was based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of each reporting unit and its estimated cash flows. Under the market approach, we utilized a combination of methods, including estimates of fair value based on: (1) market multiples of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics as the reporting unit and (2) pricing multiples derived from recent merger and acquisition transactions of comparable publicly-traded companies. A 100 basis point change in the weighted average cost of capital, with all other factors remaining stagnant, would not have resulted in an impairment charge for the reporting units that were not impaired as a result of the analysis performed in the second quarter of 2022.
As of December 31, 2022, we have goodwill of $382.7 million, of which $289.1 million relates to one reporting unit. For our annual goodwill impairment tests in the fourth quarters of 2022 and 2021, we performed a qualitative assessment to determine whether the fair value of goodwill was more likely than not less than the carrying value for each reporting unit. Due to the triggering events identified in the second quarter of 2022 and the subsequent quantitative impairment test performed at that time that resulted in the recognition of $27.9 million of impairment charges to goodwill, the non-persistent nature of the triggering events in the second half of 2022 and the qualitative assessment performed as of October 1, 2022, we do not believe that it is more likely than not that the carrying value of our reporting units exceed their fair values as of the annual goodwill impairment test dates. There were no impairment charges recognized in 2021.
The future occurrence of a potential indicator of impairment could include matters such as: a decrease in expected net earnings, a further decline in equity market conditions, a decline in comparable market multiples, a continued and sustained decline in our common stock price, a significant adverse change in legal factors or the general business climate, an adverse action or assessment by a regulator, and a significant downturn in demand for products offered by us. In the event of significant adverse changes of the nature described above, it may be necessary for us to recognize a non-cash impairment of goodwill, which could have a material adverse effect on our consolidated business, results of operations and financial condition.
Intangible Assets
Intangible assets are comprised of brands, trademarks, customer relationships, developed technology and patents and are recorded at their estimated fair values at the date of acquisition. Acquired definite-lived intangible assets subject to amortization are amortized using the straight-line method over the estimated useful lives of the assets. See Note 7, Intangible Assets, net in Item 8 of this Annual Report, for further details regarding intangible asset balances and related accumulated amortization and impairment losses.
We evaluate the carrying value of definite-lived intangible assets whenever a change in circumstances indicates that the net carrying value may not be recoverable from the undiscounted future cash flows from operations. Events or circumstances that could trigger an impairment review of a long-lived asset or asset group include, but are not limited to: (i) a significant decrease in the market price of the asset, (ii) a significant adverse change in the extent or manner that the asset is used or in its physical condition, (iii) a significant adverse change in legal factors or in the business climate that could affect the value of the asset, (iv) an accumulation of costs significantly in excess of original expectation for the acquisition or construction of the asset, (v) a current period operating or cash flow loss combined with a history of operating or cash flow losses or a forecast of continuing losses associated with the use of the asset and (vi) a more-likely-than-not expectation that the asset will be sold or disposed of significantly before the end of its previously estimated useful life. If an impairment exists, the net carrying values are reduced to fair values. The estimates of undiscounted future cash flows used during an impairment review of a long-lived asset or asset group require judgments and assumptions of future cash flows that are expected to arise as a direct result of the use and eventual disposition of the asset or asset group. If these assets were for sale, our estimates of their values could be significantly different because of market conditions, specific transaction terms and a buyer's perspective on future cash flows.
As a result of the identification of triggering events to perform an interim quantitative goodwill impairment test in the second quarter of 2022, we first considered the extent to which the adverse events and circumstances identified could affect the reporting units’ carrying amounts. We observed weakened paddleboard sales resulting in a lower near-term forecast of future operating results, which constituted a triggering event for one of our held and used long-lived asset groups primarily consisting of the ISLE trademark. We reviewed the undiscounted future cash flows for the identified long-lived asset group, and the results of the analysis indicated the carrying amount for the long-lived asset group was not expected to be recovered. The fair value of the trademark intangible was estimated using the relief-from-royalty method under the income approach, based on the following significant assumptions: management’s estimates of future net sales for the long-lived asset group, the royalty rate and the weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the long-lived asset group, and we recorded a $2.7 million impairment charge. This impairment charge was recorded to impairment charges on the consolidated statements of operations and comprehensive income (loss). There were no impairment charges recognized in 2021.
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Inventory
Inventories are comprised primarily of finished goods and are recorded at the lower of cost or net realizable value. Cost is determined using average costing that approximates actual cost on a first-in, first-out (FIFO) method. Net realizable value is estimated based on our assumptions about market conditions and historically has remained above cost. As a result, we have not recorded any write-downs to inventory below cost, except as it relates to obsolete or slow-moving inventory. Based on our review of inventories, obsolete or slow-moving inventories were not material as of December 31, 2022. If actual market conditions are less favorable than those projected by management, additional write-downs may be required. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold to customers, resulting in lower cost of sales and higher income from operations than expected in that period.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, see “Recently Adopted Accounting Pronouncements” and “Recently Issued Accounting Standards—Not Yet Adopted” in Note 2, Significant Accounting Policies, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
JOBS Act
We currently qualify as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Accordingly, we are provided the option to adopt new or revised accounting guidance either (i) within the same periods as those otherwise applicable to non-emerging growth companies or (ii) within the same time periods as private companies. We have elected to adopt new or revised accounting guidance within the same time period as private companies, unless management determines it is preferable to take advantage of early adoption provisions offered within the applicable guidance. Our utilization of these transition periods may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the transition periods afforded under the JOBS Act.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates.
Interest Rate Risk
In order to maintain liquidity and fund business operations, we have a long-term credit facility and separate term loan that bear variable interest rates based on prime, federal funds, or LIBOR plus an applicable margin based on our total net leverage ratio. As of December 31, 2022, we had indebtedness of $20.0 million and $96.3 million under our Revolving Credit Facility and Term Loan, respectively. The nature and amount of our long-term debt can be expected to vary as a result of future business requirements, market conditions, and other factors. We may elect to enter into interest rate swap contracts to reduce the impact associated with interest rate fluctuations, but as of December 31, 2022, we have not entered into any such contracts. A 100 bps increase in LIBOR would increase our interest expense by approximately $1.2 million in any given year.
Inflation Risk
Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and SG&A expenses as a percentage of net sales, if the selling prices of our products do not increase with these increased costs.
Commodity Price Risk
The primary raw materials and components used by our contract manufacturing partners include stainless steel and aluminum. We believe these materials are readily available from multiple vendors. We have, and may continue to, negotiate prices with suppliers of these products on behalf of our third-party contract manufacturers in order to leverage the cumulative impact of our volume. We do not, however, source significant amounts of these products directly. Certain of these products use petroleum or natural gas as inputs. However, we do not believe there is a significant direct correlation between petroleum or natural gas prices and the costs of our products.
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Foreign Currency Risk
Our international sales are primarily denominated in U.S. dollars. During 2022 and 2021, net sales in international markets accounted for 7.1% and 6.7% of our consolidated revenues, respectively. Therefore, we do not believe exposure to foreign currency fluctuations has had material impact on our net sales. A portion of our operating expenses are incurred outside the Unites States and are denominated in foreign currencies, which are also subject to fluctuations due to changes in foreign currency exchange rates. In addition, our suppliers may incur many costs, including labor costs, in other currencies. To the extent that exchange rates move unfavorably for our suppliers, they may seek to pass these additional costs on to us, which could have a material impact on our gross margin. In addition, a strengthening of the U.S. dollar may increase the cost of our products to our customers outside of the United States. Our operating results and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates. However, we believe that the exposure to foreign currency fluctuations from operating expenses is not material at this time.
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Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm - PCAOB Firm ID: 42 44
Consolidated Balance Sheets 45
Consolidated Statements of Operations and Comprehensive Income (Loss) 46
Consolidated Statements of Cash Flows 47
Consolidated Statements of Equity 49
Notes to Consolidated Financial Statements
Note 1 - Organization and Description of Business 53
Note 2 - Significant Accounting Policies 54
Note 3 - Revenue 59
Note 4 - Acquisitions 60
Note 5 - Inventory 62
Note 6 - Property and Equipment, net 62
Note 7 - Intangible Assets, net 63
Note 8 - Goodwill 64
Note 9 - Accrued Expenses and Other Current Liabilities 64
Note 10 - Long-Term Debt 65
Note 12 - Equity-Based Compensation 66
Note 13 - Income Taxes 71
Note 14 - Commitments and Contingencies 74
Note 15 - Fair Value Measurements 74
Note 17 - Net Income (Loss) Per Share 75
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Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Solo Brands, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Solo Brands, Inc. (the Company) as of December 31, 2022 and 2021, the related consolidated statements of operations and comprehensive income (loss), cash flows and equity for each of the two years in the period ended December 31, 2022, and for the period from October 9, 2020 to December 31, 2020 (Successor), January 1, 2020 to October 8, 2020 of Solo Brands, LLC, formerly Frontline Advance, LLC (Intermediate Successor), and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years ended December 31, 2022, and for the periods from October 9, 2020 to December 31, 2020 (Successor) and January 1, 2020 to October 8, 2020 (Intermediate Successor), in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2021.
Dallas, Texas
March 9, 2023
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SOLO BRANDS, INC.
Consolidated Balance Sheets
ASSETS
Current assets
Prepaid expenses and other current assets 12,639 9,889
Non-current assets
LIABILITIES AND EQUITY
Current liabilities
Accrued expenses and other current liabilities(1) 43,377 30,264
Current portion of long-term debt 5,000 3,125
Non-current liabilities
Commitments and contingencies (Note 14)
Equity
Retained earnings (accumulated deficit) 5,746 10,691
Accumulated other comprehensive income (loss) (499) 6
Treasury stock (35) —
Equity attributable to the controlling interest 363,426 360,879
Equity attributable to non-controlling interests 211,571 213,292
(1) Amounts in accounts payable as of December 31, 2021 have been reclassified to accrued expenses and other current liabilities as of December 31, 2022 in order to maintain comparability of the financial statements. See Note 9, Accrued Expenses and Other Current Liabilities for further information.
See Notes to Consolidated Financial Statements
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SOLO BRANDS, INC.
Consolidated Statements of Operations and Comprehensive Income (Loss)
SUCCESSOR INTERMEDIATE SUCCESSOR
(In thousands, except per share data) 2022 2021
Operating expenses
Impairment charges 30,589 — — —
Non-operating expenses
Net income (loss) attributable to Solo Brands, Inc. $ (4,945) $ 10,691 $ — $ —
Other comprehensive income (loss)
Foreign currency translation, net of tax (827) 5 — —
Less: net income earned prior to the Reorganization Transactions — 37,963 — —
Comprehensive income (loss) attributable to Solo Brands, Inc. (5,450) 10,696 — —
Income (loss) per Class A common stock
Weighted-average Class A common stock outstanding
* Refer to Note 17, Net Income (Loss) Per Share for further details of the reason income (loss) per share is not presented for the Successor period from October 9, 2020 through December 31, 2020, and the Intermediate Successor period from January 1, 2020 through October 8, 2020.
See Notes to Consolidated Financial Statements
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SOLO BRANDS, INC.
Consolidated Statements of Cash Flows
SUCCESSOR INTERMEDIATE SUCCESSOR
CASH FLOWS FROM OPERATING ACTIVITIES:
Impairment charges 30,589 — — —
Operating lease right-of-use assets expense 6,889 — — —
Changes in accounts receivable reserves 1,293 77 35 2
Loss on disposal of property and equipment 66 187 — —
Non-cash interest expense — 1,652 — —
Change in fair value of contingent consideration — — 19,073 —
Changes in assets and liabilities
Other non-current assets and liabilities (6,359) 653 13 (16)
Prepaid expenses and other current assets (2,802) (8,134) (118) (68)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of property and equipment — 64 — —
CASH FLOWS FROM FINANCING ACTIVITIES:
Debt issuance costs paid — (4,234) — —
Payment of contingent consideration — (100,000) — (2,080)
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Contributions from members before Reorganization Transactions — 250 — 700
Payments of initial public offering costs — (5,594) — —
Distributions to non-controlling interests (8,304) (2,256) — —
Taxes paid related to net share settlement of equity awards (35) — — —
Stock issued under employee stock purchase plan 422 — — —
Effect of exchange rate changes on cash (646) 5 — —
Cash and cash equivalents balance, beginning of period 25,101 32,753 — 5,025
SUPPLEMENTAL DISCLOSURES:
Cash income taxes paid $ 13,190 $ 8 $ — $ —
SUPPLEMENTAL NONCASH INVESTING AND FINANCING DISCLOSURES:
Non-cash issuance of Class B units - ISLE $ — $ 16,494 $ — $ —
Non-cash issuance of Class B units - Chubbies $ — $ 29,075 $ — $ —
Non-cash acquisition of Class B units $ — $ — $ 4,749 $ —
See Notes to Consolidated Financial Statements
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SOLO BRANDS, INC.
Consolidated Statements of Equity
(In thousands) Class A Common Stock Class B Common Stock
Tax distributions to non-controlling interests — — — — — — — — (7,859) (7,859)
Other comprehensive income (loss) — — — — — — (505) — (322) (827)
Employee stock purchase plan 103 — — — 422 — — — — 422
See Notes to Consolidated Financial Statements
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SOLO BRANDS, INC.
Consolidated Statements of Equity
Member tax distributions — — — — — (31,503) — (1,660) — — — — — (33,163)
Contributions — — — — — — 60 250 — — — — — 250
Noncontrolling interest in Oru — — — — — — — — — — — — 15,320 15,320
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See Notes to Consolidated Financial Statements
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SOLO BRANDS, INC.
Consolidated Statements of Equity
(In thousands) Class A-1 Class A-2
(In thousands) Class A Class B
Balance at October 9, 2020 — $ — — $ — $ — $ —
Net income (loss) — — — — (8,318) (8,318)
See Notes to Consolidated Financial Statements
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SOLO BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – Organization and Description of Business
Description of Business
Solo Brands, Inc. (“Company” or “Solo Brands”), through a wholly-owned subsidiary, Solo Stove Holdings, LLC (“Holdings”), operates four premium brands—Solo Stove, Oru Kayak (“Oru”), ISLE Paddle Boards (“ISLE”), and Chubbies apparel. Solo Stove offers portable, low-smoke fire pits, grills, and camping stoves for backyard and outdoor use in different sizes, fire pit bundles, gear kits, stoves, cookware, dinnerware, and a variety of clothing and accessories. Oru offers a flagship line of lightweight, foldable kayaks. ISLE produces high-quality stand-up paddle boards with colorful designs that are engineered to accommodate every skill level, style, and interest. Chubbies is a fun-loving, premium apparel brand that offers well-fitted comfortable clothing with unique style. Solo Brands distributes its products through individual brand websites and other partners across North America, Europe and Australia.
Organization
Solo Brands, Inc. was incorporated in Delaware on June 23, 2021 for the purpose of facilitating an initial public offering and other related transactions in order to carry on the Company’s business. On October 28, 2021, Solo Brands, Inc. completed its initial public offering of 14,838,708 shares of Class A common stock.
In connection with the IPO, the organizational structure was converted to an umbrella partnership-C-Corporation with Solo Brands, Inc. having a controlling equity interest in Holdings. The Reorganization Transactions were accounted for as a transaction between entities under common control. As the sole managing member, Solo Brands, Inc. operates and controls all of the business and affairs and, through Holdings and its subsidiaries, conducts the business. Solo Brands, Inc. consolidates Holdings in its consolidated financial statements and reports a non-controlling interest related to the common units held by the Continuing LLC Owners on its audited consolidated financial statements.
Holdings was formed as a single-member limited liability company in the state of Delaware on October 6, 2020. Through a wholly-owned subsidiary, pursuant to the securities purchase agreement (the “2020 Agreement”) dated October 9, 2020, Holdings acquired 100% percent of the outstanding units of Solo Brands, LLC (previously Frontline Advance, LLC dba Solo Stove).
While operating as a limited liability company from 2011 to 2019, Solo Brands, LLC had two owners, or the Founders, which together owned 100% of the outstanding membership interest. Pursuant to the membership interest purchase agreement (“the 2019 Agreement”) dated September 24, 2019, SS Acquisitions, Inc. (which was majority-owned by Bertram Capital) acquired 66.74% of the total Class A-1 and Class A-2 units of Solo Brands, LLC from the Founders. The remaining interests were retained by the Founders and other employees who acquired interest as part of the 2019 Agreement.
For all periods, the operations of the Company are conducted through Solo Brands, LLC. As a result of the 2020 Agreement, Solo Brands, LLC became a wholly-owned subsidiary of Holdings. In exchange, Holdings issued Class A and B units, through which Summit Partners Growth Equity Funds, Summit Partners Subordinated Debt Funds, and Summit Investors X Funds (collectively, the “Summit Partners”) acquired an effective 58.82% percent of Holdings. The remaining units were retained by the Founders, SS Acquisitions, Inc., and other employees (collectively, the “Continuing LLC Owners”).
Basis of Presentation
The period January 1, 2020 through October 8, 2020 is referred to as “Intermediate Successor.” The Intermediate Successor period reflects the costs and activities as well as the recognition of assets and liabilities at their fair values pursuant to the election of push-down accounting as of the consummation of the 2019 Agreement. Prior to the formation of Holdings, equity represents interest in Solo Brands, LLC.
The period October 9, 2020 through December 31, 2022 is referred to as “Successor.” The Successor period reflects the costs and activities as well as the recognition of assets and liabilities of the Company at their fair values pursuant to the election of push-down accounting as of the consummation of the 2020 Agreement. Due to the application of acquisition accounting, the election of push-down accounting, and the conforming of significant accounting policies, the results of the consolidated financial statements for Intermediate Successor and Successor periods are not comparable. Subsequent to the formation of the Successor and through the date of the Reorganization Transactions, equity represents interest in Holdings. Subsequent to the Reorganization Transactions, equity represents interest in Solo Brands, Inc. and the Continuing LLC Owners’ interest in Holdings. However, the operations of the Company during this period were conducted through Solo Brands, LLC.
The consolidated financial statements contained herein have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and the rules of the U.S. Securities and Exchange Commission (“SEC”). The consolidated financial statements include those of our wholly-owned subsidiaries. Intercompany balances and transactions are eliminated in consolidation. Certain prior period amounts have been conformed to the current period’s presentation.
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NOTE 2 – Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses during the reporting period and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Estimates and assumptions about future events and their effects cannot be made with certainty. Estimates may change as new events occur when additional information becomes available and if our operating environment changes. Actual results could differ from our estimates.
Concentrations of Credit Risk
The Company extends trade credit to its business-to-business customers on terms that generally are practiced in the industry. The Company periodically performs credit analyses and monitors the financial condition of its customers to reduce credit risk. The Company performs ongoing credit evaluations of its customers, but generally does not require collateral to support accounts receivable. Accounts receivable mostly consist of amounts due from our business-to-business customers.
For the year ended December 31, 2022, Costco accounts for 42.5% of the Company’s total outstanding accounts receivable. For the year ended December 31, 2021, Bed Bath and Beyond, Ace Hardware, and Dick’s Sporting Goods accounted for 21.0%, 19.0%, and 13.0%, respectively, of the Company’s total outstanding accounts receivable. There are no other significant concentrations of receivables that represent a significant credit risk.
In the Successor periods for the years ended December 31, 2022 and December 31, 2021, in the Successor period for October 9, 2020 through December 31, 2020, and in the Intermediate Successor period for January 1, 2020 through October 8, 2020, no single customer accounted for more than 10% of total net sales.
The Company is exposed to risk due to the concentration of business activity with certain third-party manufacturers of our products. The majority of the camp stoves and fire pits are currently made in China by one manufacturer, with additional manufacturing and available capacity between two separate manufacturers in China. Further, limited manufacturing occurs in India and Vietnam. The majority of the kayaks and kayak accessories were made by two manufacturers in Mexico for the majority of 2022, but are currently made by one manufacturer in Mexico. The majority of the stand up paddle boards and paddle board accessories are currently made in China between a number of manufacturers, with an additional manufacturer in Vietnam. The majority of the casual wear, sportwear, swimwear, outerwear, loungewear, and other accessories are currently made in Vietnam between a variety of manufacturers, with additional manufacturers in India, China, and the United States.
Segment Information
The Company’s Chief Executive Officer, as the chief operating decision-maker, organizes the Company, manages resource allocations, and measures performance on the basis of one operating segment. We report the Company’s operations as a single reportable segment and manage the business as a single-brand outdoor consumer products business. This is supported by the operational structure of the Company, which includes marketing, distribution, information technology, accounting and finance, human resources, payroll and legal functions focused on the entire product suite rather than individual product categories. The chief operating decision maker does not regularly review financial information for individual product categories, sales channels, or geographic regions that would allow decisions to be made about the allocation of resources or performance.
Fair Value Measurements
Accounting standards require certain assets and liabilities to be reported at fair value in the consolidated financial statements and provide a framework for establishing that fair value. The framework for determining fair value is based on a hierarchy that prioritizes the inputs and valuation techniques used to measure fair value.
Fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets or liabilities in active markets and other inputs, such as interest rates and yield curves, that are observable at commonly quoted intervals.
Fair values determined by Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability. These Level 3 fair value measurements are based primarily on management’s own estimates using pricing
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models, discounted cash flow methodologies, or similar techniques taking into account the characteristics of the asset or liability.
In instances whereby inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
The Company’s financial instruments consist primarily of cash, accounts receivable, accounts payable, and bank indebtedness. The carrying amount of cash, accounts receivable, and accounts payable, approximates fair value due to the short-term maturity of these instruments.
Cash and Cash Equivalents
The Company considers all investments with an original maturity of three months or less when purchased to be cash equivalents. The Company continually monitors its position with, and the credit quality of, the financial institutions with which it invests. The Company has maintained bank balances in excess of federally insured limits. We have not historically experienced any losses in such accounts.
Accounts Receivable, net
Accounts receivables consists of amounts due to the Company from retailers and direct-to-corporate customers. Accounts receivable are recorded at invoiced amounts, less contractual allowances for trade terms, sales incentive programs, and discounts. The Company maintains an allowance for doubtful accounts for estimated losses that will result from the inability of customers to make required payments. The allowance is determined based on a review of specific customer accounts where the collection is doubtful, as well as an assessment of the collectability of total receivables considering the aging of balances, historical and anticipated trends, and other factors. All accounts are subject to an ongoing review of ultimate collectability. Receivables are written off against the allowance when it is probable the amounts will not be recovered.
Bad debt expense is recorded to selling, general, & administrative expenses on the consolidated statements of operations and comprehensive income (loss). Bad debt expense for the Successor years ended December 31, 2022 and December 31, 2021 was $1.3 million and $0.3 million, respectively. Bad debt expense was nominal for the Successor period from October 9, 2020 through December 31, 2020 and for the Intermediate Successor period from January 1, 2020 through October 8, 2020.
Inventory
Inventories are comprised primarily of finished goods and are recorded at the lower of cost or net realizable value. Cost is determined using average costing that approximates actual cost on a first-in, first-out (FIFO) method. Obsolete or slow-moving inventory is written down to estimated net realizable value.
Property and Equipment, net
Property and equipment acquired through acquisitions (as described in Note 4, Acquisitions) are recorded at estimated fair value as of that date. Property and equipment acquired subsequent to acquisitions are recorded at cost, net of accumulated depreciation. Costs of maintenance and repairs are charged to expense when incurred. When property and equipment are sold or disposed of, the cost and related accumulated depreciation is written off, and a gain or loss, if applicable, is recorded. The Company reviews property and equipment for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Property and equipment are depreciated on a straight-line method over their estimated useful lives. The useful lives for property and equipment are as follows:
Useful Life
Computers, software, and other equipment 3 Years
Machinery 5 Years
Leasehold improvements Shorter of lease term or 5 Years
Furniture and fixtures 5 Years
Goodwill
Goodwill is determined based upon the excess enterprise value over the estimated fair value of assets and liabilities assumed and is recorded at its estimated fair value at the date of acquisition. The Company reviews goodwill at the reporting unit level, which is one level below the operating segment, for impairment annually on October 1st of each fiscal year and on an interim basis whenever events or changes in circumstances indicate the fair value of such assets may be below their carrying value.
Intangible Assets
Intangible assets are comprised of brands, trademarks, developed technology, customer relationships and patents and are recorded at their estimated fair values at the date of acquisition. Acquired definite-lived intangible assets subject to amortization are amortized using the straight-line method over the estimated useful lives of the assets.
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In addition, external legal costs incurred in the defense of our trademarks and patents are capitalized when we believe that the future economic benefit of the intangible asset will be increased, and a successful defense is probable. In the event of a successful defense, the settlements received are netted against the external legal costs that were capitalized. Capitalized trademark and patent defense costs are amortized over the remaining useful life of the asset. Where the defense of the trademark or patent maintains rather than increases the expected future economic benefits from the asset, the costs would generally be expensed as incurred. The external legal costs incurred and settlements received may not occur in the same period.
The useful lives for intangible assets subject to amortization are as follows:
Useful Life
Brand 15 Years
Trademarks 5-15 Years
Customer relationships 6-15 Years
Developed technology 6 Years
Patents 8 Years
Debt Issuance Costs
Debt issuance costs incurred by the Company in connection with obtaining debt are recorded on the balance sheet as a direct deduction from the carrying value of the associated debt liability. The costs are amortized on a straight-line basis over the term of the related debt and reported as a component of interest expense, net.
Leases
The Company leases space for warehouses, stores and corporate space under operating leases expiring at various times through 2029. The Company accounts for leases in accordance with Accounting Standards Codification (“ASC”) No. 842, Leases. The Company determines if an arrangement is a lease at inception of a contract if the terms state the Company has the right to direct the use of, and obtain substantially all the economic benefits from, a specific asset identified in the contract. The right-of-use (“ROU”) assets represent the Company's right to use the underlying assets for the lease term, and the lease liabilities represent the obligation to make lease payments arising from the leases. The Company records its ROU assets in other non-current assets, its current lease liabilities in accrued expenses and other current liabilities and its non-current lease liabilities in other non-current liabilities. ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments to be made over the lease term. Certain of the Company's lease agreements contain options to extend the lease. The Company evaluates these options on a lease-by-lease basis, and if the Company determines it is reasonably certain to be exercised, the lease term includes the extension. The Company uses its incremental borrowing rate at lease commencement to determine the present value of lease payments, and lease expense is recognized on a straight-line basis over the lease term. The incremental borrowing rate is the rate of interest the Company could borrow on a collateralized basis over a similar term with similar payments. The Company does not record leases with an initial term of twelve months or less (“short-term leases”).
Certain of the Company's lease agreements include payments for certain variable costs not determinable upon lease commencement, including common area maintenance, utilities, property taxes and inflation adjustments, as well as fixed payments for non-lease components, including common area maintenance. These variable and fixed lease payments are recognized in selling, general and administrative expenses, but are not included in the ROU asset or lease liability balances. The Company's lease agreements do not contain any material residual value guarantees, restrictions or covenants.
Revenue Recognition
The Company primarily engages in direct-to-consumer transactions, which are comprised of product sales directly from the Company’s website, and business-to-business transactions, or wholesale, which are comprised of product sales to retailers, including where possession of the Company’s products is taken and sold by the retailer in-store or online.
For the Company’s direct-to-consumer and wholesale transactions, performance obligations are satisfied at the point of shipment. To determine the point in time at which a customer obtains control of a promised asset and the Company satisfies a performance obligation, the Company considered the following:
a.The Company has a present right to payment for the asset
b.The customer has legal title to the asset
c.The Company has transferred physical possession of the asset
d.The customer has the significant risks and rewards of ownership of the asset
e.The customer has accepted the asset.
There are no significant extended payment terms with our customers. Payment is due at the time of sale on our website for our direct-to-consumer transactions. Business-to-business customers’ payment terms vary depending on the contract with each retailer, but the most common is net 30 or net 60 days.
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Revenue is recognized for the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods to a customer. The consideration promised in a contract with a customer includes fixed and variable amounts. The fixed amount of consideration is the stand-alone selling price of the goods sold. Variable considerations, including cash discounts and rebates, are deducted from gross sales in determining net sales. Variable considerations also include the portion of goods that are expected to be returned and refunded. Any consideration received (or receivable) that the Company expects to refund to the customer is recognized as a refund liability. Our refund liability is based on historical experience and trends. Net sales include shipping costs charged to the customer and are recorded net of taxes collected from customers, which are remitted to government authorities.
Sales Returns and Allowances
Sales returns are recorded when the customer makes a return of a purchased product or when the customer agrees to keep a purchased product in return for a reduction in the selling price. The allowance for sales returns is established based on historical return rates and the Company’s analysis of macroeconomic conditions.
Contract Balances
Contract liabilities are recorded when the customer pays consideration, or the Company has a right to an amount of consideration that is unconditional before the transfer of a good to the customer and thus represents the Company’s obligation to transfer the good to the customer at a future date. The Company’s primary contract liabilities are from its direct-to-consumer channel and represent payments received in advance from the Company’s customers for its products.
Cost of Goods Sold
Cost of goods sold includes the purchase price of merchandise sold to customers and inbound shipping and handling costs. Cost of goods sold also includes depreciation on molds and equipment that we own, allocated overhead and direct and indirect labor for warehouse personnel.
Shipping and Handling Costs
Costs associated with the shipping and handling of customer sales are expensed when the product ships to the customer. These costs are included in selling, general, & administrative expenses on the consolidated statements of operations and comprehensive income (loss).
Advertising Expense
Advertising costs are expensed as incurred. These costs are included in selling, general, & administrative expenses on the consolidated statements of operations and comprehensive income (loss).
Advertising expense for the Successor years ended December 31, 2022 and December 31, 2021 was $93.4 million and $74.5 million, respectively, $9.4 million for the Successor period from October 9, 2020 through December 31, 2020 and $8.4 million for the Intermediate Successor period from January 1, 2020 through October 8, 2020.
Research and Development Expense
Research and development costs consist of costs related to new product development, continued evolution of current products, tools and supplies related to new and current products and prototyping and testing. These costs are expensed as incurred and included in selling, general, & administrative expenses on the consolidated statements of operations and comprehensive income (loss).
Research and development expense for the Successor years ended December 31, 2022 and December 31, 2021 was $1.1 million and $0.3 million, respectively. Research and development expense was nominal for the Successor period from October 9, 2020 through December 31, 2020 and for the Intermediate Successor period from January 1, 2020 through October 8, 2020.
Other Operating Expenses
Other operating expenses consist primarily of business optimization, business expansion, transaction-related, management transition and merger and acquisition expenses.
Income Taxes
The Company accounts for income taxes pursuant to the asset and liability method which requires the recognition of deferred income tax assets and liabilities related to the expected future tax consequences arising from temporary differences between the carrying values and tax bases of assets and liabilities based on enacted statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Any effects of changes in income tax rates or laws are included in income tax expense (benefit) on the consolidated statements of operations and comprehensive income (loss) in the period of enactment. A valuation allowance is recognized if the Company determines it is more likely than not that all or a portion of a deferred tax asset will not be recognized. In making such determination, the Company considers all available evidence, including
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scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent and expected future results of operations.
As a result of the Reorganization Transactions, Solo Brands, Inc. became the sole managing member of Holdings, which is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, Holdings is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by Holdings is passed through to and included in the taxable income or loss of its members, including Solo Brands, Inc. following the Reorganization Transactions, on a pro rata basis. Solo Brands, Inc. is subject to U.S. federal income taxes, in addition to state and local income taxes with respect to its allocable share of any taxable income of Holdings following the Reorganization Transactions. The Company is also subject to taxes in foreign jurisdictions.
Oru Kayak, Inc. and Chubbies, Inc., wholly owned subsidiaries of Holdings, are subject to federal and state income taxes on corporate earnings and accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
In accordance with authoritative guidance on accounting for and disclosure of uncertainty in tax positions, the Company follows a more likely than not measurement methodology to reflect the financial statement impact of uncertain tax positions taken or expected to be taken in a tax return. For tax positions meeting the more-likely-than-not threshold, the tax liability recognized in the consolidated financial statements is reduced by the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement with the relevant taxing authority.
The Company files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. In the normal course of business, the Company is subject to examination by federal, state, and local jurisdictions, where applicable. If such examinations result in changes to income or loss, the tax liability of the Company could be changed accordingly.
Warranty
The Company warrants its products against manufacturing defects and will replace all products sold by an authorized retailer that are deemed defective. The Company does not warranty its products against normal wear or misuse. Historically, warranty claims have been nominal, and the Company does not expect large warranty claims in the future. These costs are included in selling, general, & administrative expenses on the consolidated statements of operations and comprehensive income (loss).
Income (Loss) Per Share
In the Successor periods following the IPO, basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of Class A common stock outstanding during the period. Diluted earnings per share assumes conversion of potentially dilutive securities such as stock options, restricted stock units, and performance stock units.
Equity-Based Compensation
The Company recognizes equity-based compensation expense for employees and non-employees based on the grant-date fair value of the award. Certain awards contain service and performance vesting conditions. The grant date fair values of restricted stock awards that contain service vesting conditions and performance stock awards that contain a performance target are estimated based on the fair value of the underlying shares on the grant date. The Company uses a Black-Scholes option-pricing model to calculate the fair value of stock options. This model requires various judgmental assumptions including volatility, the risk free rate, and expected term. For awards with market vesting conditions, the fair value is estimated using a Monte Carlo simulation model, which incorporates the likelihood of achieving the market condition. For service-based awards and performance-based awards that are considered probable of vesting, compensation cost is recognized on a straight-line basis over the requisite service period. Equity-based compensation expense is recorded in the selling, general and administrative expense line item on the consolidated statements of operations and other comprehensive income (loss).
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Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), and has modified the standard thereafter, which supersedes the lease requirements in ASC 840. The ASU requires lessees to recognize a right-of-use asset and related lease liability for all leases, with a limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the consolidated statement of operations and comprehensive income (loss). Prior to this new standard, leases were classified as either capital or operating, with only capital leases recognized on the consolidated balance sheets. The Company did not have any capital leases prior to or upon adoption of ASU 2016-02. The Company adopted this standard on January 1, 2022 using the modified retrospective transition approach. Upon adoption of ASU 2016-02, the Company recorded the following amounts associated with operating leases in its consolidated balance sheet at January 1, 2022: $24.9 million of ROU assets in other non-current assets, $4.1 million of lease liabilities in accrued expenses and other current liabilities and $21.4 million of lease liabilities in other non-current liabilities. There was no impact to the opening balance of retained earnings as a result of implementing ASU 2016-02. The Company elected the package of three practical expedients available under the ASU, which allows entities to carryforward accounting conclusions under previous GAAP by not reassessing the following: (a) whether a contract is or contains a lease, (b) lease classification or (c) determination of initial direct costs. Additionally, the Company implemented appropriate changes to internal processes and controls to support recognition, subsequent measurement and disclosures.
Recently Issued Accounting Pronouncements - Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments. The ASU includes changes to the accounting and measurement of financial assets, including the Company’s accounts receivable, by requiring the Company to recognize an allowance for all expected losses over the life of the financial asset at origination. This is different from the current practice, where an allowance is not recognized until the losses are considered probable. In November 2019, the FASB issued ASU 2019-10, deferring the effective date of ASU 2016-13 to annual periods beginning after December 15, 2022. Upon adoption on January 1, 2023, the ASU will be applied using a modified retrospective transition method to the beginning of the earliest period presented. Although early adoption is permitted, the Company has chosen not to early adopt. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, an update that provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions effected by reference rate reform if certain criteria are met. The optional guidance is provided to ease the potential burden of accounting for reference rate reform. The guidance was effective as of March 12, 2020. In December 2022, the FASB issued ASU 2022-06, deferring the date through which Topic 848 is available for contract modifications to December 31, 2024. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The ASU requires that an acquirer recognize and measure contract assets and liabilities acquired in a business combination in accordance with ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance is effective for annual periods beginning after December 15, 2023, including interim periods therein, with early adoption permitted. The guidance will be applied prospectively to acquisitions occurring on or after the effective date. The Company will continue to evaluate the impact of this guidance, which will depend on the contract assets and liabilities acquired in future business combinations.
NOTE 3 – Revenue
The following table disaggregates our net sales by channel:
SUCCESSOR SUCCESSOR SUCCESSOR INTERMEDIATE SUCCESSOR
Net sales by channel
Total sales returns and allowances were $14.8 million and $11.6 million for the Successor years ended December 31, 2022 and 2021, respectively, $4.7 million in the Successor period from October 9, 2020 through December 31, 2020, and $3.0 million in the Intermediate Successor period from January 1, 2020 through October 8, 2020. These amounts are included in net sales on the consolidated statements of operations and comprehensive income (loss).
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NOTE 4 – Acquisitions
The following transactions were accounted for under the acquisition method of accounting for business combinations.
Oru Kayak, Inc.
On May 3, 2021, Solo Brands, LLC acquired 60% of the voting equity interests in Oru Kayak, Inc. (“Oru”) for total cash consideration of $25.4 million. Additionally, the Company had the option to purchase the remaining 40% upon a liquidity event, which it did on September 8, 2021 in exchange for 9.3 million Class B Units of Holdings. The exercise price of the option was equal to Oru’s last twelve months adjusted EBITDA times a predetermined multiple. The Company acquired Oru to increase its brand and market share in the overall outdoor activities industry, as Oru manufactures, markets, and sells kayak boats and kayak accessories.
The excess enterprise value of Oru over the estimated fair value of assets and liabilities assumed was recorded as goodwill. Goodwill was recorded to reflect the excess purchase consideration over net assets acquired, which represents the value that is expected from expanding the Company’s product offerings and other synergies. Factors that contributed to the recognition of goodwill included the expected future revenue growth of Oru. None of the goodwill recognized was expected to be deductible for tax purposes. A working capital settlement of $0.2 million was paid during the first quarter of 2022 and purchase accounting has been finalized.
The following table summarizes the fair values of the assets acquired and liabilities assumed by the Company at the acquisition date:
Accounts receivable 357
Property and equipment 436
Prepaid expenses and other assets 902
Accounts payable and accrued liabilities (4,119)
Deferred revenue (746)
Deferred tax liability (6,247)
Total identifiable net assets 22,176
Noncontrolling interest (15,320)
Less: cash acquired (6,307)
Total, net of cash acquired $ 19,330
Net sales of Oru included in the Company’s consolidated statements of operations and comprehensive income (loss) since the acquisition date for the Successor years ended December 31, 2022 and December 31, 2021 were $28.2 million and $19.9 million, respectively, and net income for the same periods was $2.8 million and $2.8 million, respectively.
International Surf Ventures, LLC
On August 2, 2021, Solo Brands, LLC acquired 100% of the voting equity interests in International Surf Ventures, LLC (“ISLE”) for total consideration of cash paid of $24.8 million and Class B units of $16.5 million. The Company acquired ISLE to increase its brand and market share in the overall outdoor activities industry, as ISLE manufactures, markets, and sells stand up paddle boards and paddle board accessories.
The excess enterprise value of ISLE over the estimated fair value of assets and liabilities assumed was recorded as goodwill. Goodwill was recorded to reflect the excess purchase consideration over net assets acquired, which represents the value that is expected from expanding the Company’s product offerings and other synergies. Factors that contributed to the recognition of goodwill included the expected future revenue growth of ISLE. None of the goodwill recognized was expected to be deductible for tax purposes. Purchase accounting has been finalized.
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The following table summarizes the fair values of the assets acquired and liabilities assumed by the Company at the acquisition date:
Accounts receivable 107
Property and equipment 110
Prepaid expenses and other assets 60
Intangible assets 4,121
Accounts payable and accrued liabilities (4,697)
Total identifiable net assets 11,772
Less: fair value of class B units (16,494)
Less: cash acquired (3,085)
Total, net of cash acquired $ 21,757
Net sales of ISLE included in the Company’s consolidated statements of operations and comprehensive income (loss) since the acquisition date for the Successor years ended December 31, 2022 and December 31, 2021 were $17.8 million and $5.4 million, respectively, and net loss for the same periods was $33.8 million and $7.1 million, respectively.
Chubbies, Inc.
On September 1, 2021, Solo Brands, LLC acquired 100% of the voting equity interests in Chubbies, Inc. (“Chubbies”) for total consideration of cash paid of $100.4 million and Class B units of $29.1 million. The Company acquired Chubbies to increase its brand and market share in the overall outdoor activities industry, as Chubbies sells casual wear, sportwear, swimwear, outerwear, loungewear, and other accessories.
The excess enterprise value of Chubbies over the estimated fair value of assets and liabilities assumed was recorded as goodwill. Goodwill was recorded to reflect the excess purchase consideration over net assets acquired, which represents the value that is expected from expanding the Company’s product offerings and other synergies. Factors that contributed to the recognition of goodwill included the expected future revenue growth of Chubbies. None of the goodwill recognized was expected to be deductible for tax purposes. A working capital settlement of $0.6 million was paid during the first quarter of 2022 and purchase accounting has been finalized.
The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed by the Company at the acquisition date:
Accounts receivable 1,962
Property and equipment 401
Prepaid expenses and other assets 893
Accounts payable and accrued liabilities (15,011)
Deferred revenue (392)
Deferred tax liability (12,095)
Other non-current liabilities (12)
Total identifiable net assets 56,942
Less: cash acquired (7,990)
Less: fair value of class B units (29,075)
Total, net of cash acquired $ 92,995
Net sales of Chubbies included in the Company’s consolidated statements of operations and comprehensive income (loss) since the acquisition date for the Successor years ended December 31, 2022 and December 31, 2021 were $89.3 million and $16.4 million, respectively. Net income for the 2022 period was $0.1 million, and net loss for the 2021 period was $8.1 million.
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The table below summarizes the aggregate amount of net sales and net loss for Oru, ISLE and Chubbies for the years ended December 31, 2022 and 2021. The amounts for the year ended December 31, 2021 are unaudited pro-forma amounts reflecting the amounts of net sales and net loss as if the acquisitions had occurred as of January 1, 2021.
Successor
Year Ended December 31,
(Actuals) (Pro-Forma) (Unaudited)
Net sales
Net loss
Pro-forma net sales, if combined with the net sales of Solo Brands, Inc., for the Successor period ended December 31, 2021 would have been $483.3 million and pro-forma net income, if combined with the net income of Solo Brands, Inc., would have been $48.5 million.
NOTE 5 – Inventory
Inventory consisted of the following:
Fair value write-up — 7,813
NOTE 6 – Property and Equipment, net
Property and equipment, net consisted of the following:
Computer, software, and other equipment 2,003 3,032
Construction in progress 67 166
Accumulated depreciation (4,266) (750)
Depreciation expense was $3.6 million and $0.8 million for the Successor years ended December 31, 2022 and 2021, respectively. Depreciation expense was nominal in the Successor period from October 9, 2020 through December 31, 2020 and in the Intermediate Successor period from January 1, 2020 through October 8, 2020.
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NOTE 7 – Intangible Assets, net
Intangible assets, net consisted of the following:
Gross carrying value
Accumulated amortization and impairments
(1) Includes impairment of trademark discussed below.
In the second quarter of 2022, as a result of the Company’s identification of triggering events to perform an interim quantitative goodwill impairment test (see Note 7, Goodwill for more information), the Company first considered the extent to which the adverse events and circumstances identified could affect the reporting units’ carrying amounts. The Company observed weakened paddleboard sales resulting in a lower near-term forecast of future operating results, which constituted a triggering event for one of the Company’s held and used long-lived asset groups primarily consisting of a trademark intangible asset. The Company reviewed the undiscounted future cash flows for the identified long-lived asset group, and the results of the analysis indicated the carrying amount for the long-lived asset group was not expected to be recovered. The Company estimated the fair value of the trademark intangible using the relief-from-royalty method under the income approach, based on the following significant assumptions: management’s estimates of future net sales for the long-lived asset group, the royalty rate and the weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the long-lived asset group. The fair value was then compared to the carrying value of the long-lived asset group, and the Company recorded a $2.7 million impairment charge to the trademark intangible asset at June 30, 2022. This impairment charge was recorded to impairment charges on the consolidated statements of operations and comprehensive income (loss). As a result of this impairment charge, the Company also reassessed the useful life of this trademark and revised it from fifteen years to five years. This change does not have a material impact to amortization expense in any future year.
Amortization expense was $21.0 million and $17.5 million for the Successor years ended December 31, 2022 and 2021, respectively. Amortization expense was $3.2 million in the Successor period from October 9, 2020 through December 31, 2020 and $2.3 million in the Intermediate Successor period from January 1, 2020 through October 8, 2020.
Estimated amortization expense for the next five years was as follows:
Years ending December 31, Amount
Total future amortization expense $ 234,632
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NOTE 8 – Goodwill
The carrying value of goodwill was as follows:
Accumulated impairment losses (27,901)
In the second quarter of 2022, the Company identified triggering events indicating the fair value of one or more of the Company’s reporting units more likely than not did not exceed their carrying values. The triggering events included: (1) adverse equity market conditions resulting in a sustained decline in the Company’s stock price subsequent to the Company’s issuance of its first quarter 2022 results on Form 10-Q and (2) weakened demand for the ISLE reporting unit’s products resulting in a lower near-term forecast of future operating results. As a result, the Company performed an interim quantitative goodwill impairment test for all of its reporting units and recorded a $27.9 million goodwill impairment charge related to its ISLE reporting unit, which has $1.7 million of remaining goodwill after the impairment. The results of the interim quantitative test did not result in a goodwill impairment for the Company’s other reporting units. The impairment charge was recorded to impairment charges on the consolidated statements of operations and comprehensive income (loss).
The Company estimated the fair value of its reporting units using a weighting of fair values derived from the income and market approaches, where comparable market data was available. Under the income approach, the Company determined the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections were based on management’s estimates of revenue growth rates and operating margins, considering industry and market conditions, and management’s estimates of working capital requirements. The discount rate for each reporting unit was based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of each reporting unit and its estimated cash flows. Under the market approach, the Company utilized a combination of methods, including estimates of fair value based on: (1) market multiples of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics as the reporting unit and (2) pricing multiples derived from recent merger and acquisition transactions of comparable publicly-traded companies.
The Company completed its annual goodwill impairment test as of October 1, 2022. The Company qualitatively assessed whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. This assessment was made based on relevant information, including applicable facts and circumstances, known as of the goodwill impairment assessment date. Due to the triggering events identified in the second quarter of 2022 and the subsequent quantitative impairment test performed at that time, the non-persistent nature of the triggering events in the second half of 2022 and the qualitative assessment performed as of October 1, 2022, the Company does not believe that it is more likely than not that the carrying value of its reporting units exceed their fair values. For 2021, the annual goodwill impairment analysis did not result in impairment charges at any of the Company’s reporting units.
NOTE 9 – Accrued Expenses and Other Current Liabilities
Significant accrued expenses and other current liabilities were as follows:
Accrued expenses and other current liabilities $ 43,377 $ 30,264
(1) $2.1 million in accounts payable for inventory-in-transit as of December 31, 2021 has been reclassified to accrued expenses and other current liabilities as of December 31, 2022 in order to maintain comparability of the financial statements.
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NOTE 10 – Long-Term Debt
Long-term debt consisted of the following:
Unamortized debt issuance costs (2,867) (3,727)
Less current portion of long-term debt 5,000 3,125
Interest expense related to long-term debt was $6.3 million and $10.1 million for the Successor years ended December 31, 2022 and 2021, respectively. Interest expense was $1.5 million in the Successor period from October 9, 2020 through December 31, 2020 and $1.7 million in the Intermediate Successor period from January 1, 2020 through October 8, 2020.
Revolving Credit Facility and Term Loan
On May 12, 2021, the Company entered into a credit agreement with a bank (the “Revolving Credit Facility”). Under the terms of this agreement, the Company may borrow up to $200 million under a revolving credit facility. On June 2, 2021, and on September 1, 2021, the Company entered into amendments to the Revolving Credit Facility, which resulted in an increase in the maximum amount available under the Revolving Credit Facility to $350 million. Under the terms of the Revolving Credit Facility, the Company has access to certain swing line loans and up to $20.0 million in letters of credit. The Revolving Credit Facility matures on May 12, 2026 and bears interest at a rate equal to the base rate as defined in the agreement plus an applicable margin, which as of December 31, 2022, was based on LIBOR. Interest is due, at a minimum, on a quarterly basis, with principal not due until maturity under the Revolving Credit Facility.
In addition to the above, the amendment on September 1, 2021 included a provision for the Company to borrow up to $100.0 million under a term loan (the “Term Loan”). The proceeds from the Term Loan were used to fund the Chubbies acquisition (see Note 4 for information on the acquisition). The Term Loan matures on September 1, 2026 and bears interest at a rate equal to a base rate defined in the agreement plus an applicable margin, which as of December 31, 2022 was based on LIBOR. The Company was required to make quarterly principal payments on the Term Loan beginning on December 31, 2021. The Company was in compliance with all covenants under all credit arrangements as of December 31, 2022.
Subordinated Debt - Related Party
On October 9, 2020, the Company entered into notes payable agreements (the “Subordinated Debt”) with certain Class A unitholders for $30.0 million that were subordinate to the Senior Debt Facility described below. The notes bore interest at 12% per annum and required quarterly interest payments, with principal due one year following the maturity of the Senior Debt Facility. In November 2021, the Company used the IPO and underwriters option proceeds to repay in full the Subordinated Debt.
Senior Debt Facility
The Company voluntarily repaid in full the principal amount and $1.0 million of accrued interest outstanding under the Senior Debt Facility on May 31, 2021, using proceeds from the Revolving Credit Facility described above. The Company wrote off $1.5 million of debt issuance costs associated with the Senior Debt Facility during the year ended December 31, 2021.
As of December 31, 2022, the future maturities of principal amounts of our total debt obligations, excluding lease obligations (see Note 11 for future maturities of lease obligations), for the next five years and in total, consists of the following:
Years Ending December 31, Amount
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NOTE 11 – Leases
The following table presents the components of the total leased assets and lease liabilities and their classification in the Company's consolidated balance sheets:
Classification in Consolidated Balance Sheets December 31, 2022
Operating lease right-of-use assets Other non-current assets $ 34,259
Long-term operating lease liabilities Other non-current liabilities 29,133
Total operating lease liabilities $ 36,022
The components of lease expense were as follows:
Year Ended December 31,
Operating lease right-of-use expense $ 6,890
Variable and short-term lease expense 1,446
Total lease expense $ 8,336
The weighted average remaining lease term and discount rate are presented in the following table:
Weighted average remaining lease term (years) 5.05
Weighted average discount rate 2.66 %
Cash flow and other information related to leases is included in the following table:
Year Ended December 31,
Right of use assets obtained in exchange for lease obligations 14,797
Future maturities of lease liabilities at December 31, 2022 are presented in the following table:
Years Ending December 31, Operating Leases
Total lease payments 38,982
Less: imputed interest 2,960
Present value of lease liabilities $ 36,022
NOTE 12 – Equity-Based Compensation
Fair Value Considerations
Determining the fair value of awards requires judgment. The Monte Carlo simulation and Black-Scholes models were used to estimate the fair value of awards that have service, performance and/or market vesting conditions. The assumptions used in these models require the input of subjective assumptions as follows:
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Fair value—The fair value of the common stock underlying the incentive units was determined by the Company’s board of directors (the “Board”). Because there was no public market for the incentive units, the Company’s Board determined the common stock fair value at the incentive unit grant date by considering several objective and subjective factors, including the price paid for its common and preferred stock, actual and forecasted operating and financial performance, market conditions and performance of comparable publicly traded companies, developments and milestones within the Company, the rights, preferences, and privileges of its common and preferred stock, and the likelihood of achieving a liquidity event. The fair value of the common stock underlying stock options, restricted stock units and performance stock units was determined by the closing stock price on the New York Stock Exchange.
Expected volatility—Expected volatility was based on historical volatilities of a publicly-traded peer group based on weekly price observations over a period equivalent to the expected term of the award.
Expected term—For awards with only service vesting conditions, the expected term was determined using the simplified method, which estimates the expected term using the contractual life of the award and the vesting period. For awards with performance or market conditions, the term was estimated in consideration of the time period expected to achieve the performance or market condition, the contractual term of the award, and estimates of future exercise behavior.
Risk-free interest rate—The risk-free interest rate was based on the U.S. Treasury yield of treasury bonds with a maturity that approximates the expected term of the award.
Expected dividend yield—The dividend yield was based on the Company’s expectations of dividend payouts. The Company has never declared or paid any cash dividends on its common stock, and the Company does not anticipate paying any cash dividends in the foreseeable future.
DLOM estimate—The discounts for lack of marketability were used to help calculate the value of closely held and restricted shares. A valuation discount exists between a share that is publicly traded, and thus has a market, and the market for privately held stock, which often has little, if any, marketplace.
Forfeiture rate—The Company recognizes forfeitures as they occur instead of estimating forfeitures based on historical activity.
Summary of Equity-Based Compensation
The table below summarizes equity-based compensation expense recognized by award type:
SUCCESSOR INTERMEDIATE SUCCESSOR
Restricted stock units 3,626 553 — —
Performance stock units 628 — — —
Employee stock purchases 71 — — —
Total equity-based compensation $ 18,598 $ 7,329 $ — $ —
The following table summarizes the Company’s total unrecognized equity-based compensation as of December 31, 2022:
Unrecognized Equity-Based Compensation
Restricted stock units 15,301
Performance stock units 4,371
Total unrecognized equity-based compensation $ 35,405
Excess tax benefits (detriments) related to equity-based compensation were $(1.6) million in 2022, with no corresponding amount in 2021.
Incentive Units
Prior to the IPO, certain employees of the Company purchased incentive units in Solo Stove Holdings, LLC for $0.000001 per unit. The majority of the incentive units were issued in December 2020 with additional issuances in January and March 2021. The Company used the Monte Carlo simulation model to determine the fair value of the incentive units. Each incentive award consists of service-based units (representing one-third (1/3) of the number of incentive units) and performance-based units (representing two-thirds (2/3) of the number of incentive units).
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The incentive units with a service condition are scheduled to vest over four years with 25% vesting on the one-year anniversary of the grant date and the remaining 75% of such service-based units vesting in substantially equal monthly installments over the following three years, subject to the employee’s continued employment through each applicable vesting date. Additionally, the vesting of the service-based units will accelerate upon the occurrence of a sale transaction prior to the employee’s termination of employment. The IPO did not meet the definition of a sale transaction per the incentive unit agreement. Therefore, the vesting of the service-based units did not accelerate upon the IPO, nor did the vesting schedule change.
There were 27.6 million incentive units outstanding immediately before the Reorganization Transactions. After the Reorganization Transactions, the 27.6 million incentive units converted into 3.4 million common units in Holdings. The 3.4 million common units consist of service-based units representing one-third (1/3) of the common units and performance-based units representing two-thirds (2/3) of the common units.
In connection with the IPO, 0.9 million of the 2.3 million performance-based common units vested with the remaining 1.4 million unvested performance-based common units being canceled. Associated with these vested units, the Company recognized $3.3 million of stock compensation expense during the fourth quarter of fiscal year 2021.
At IPO, the 1.4 million performance-based incentive units that did not vest were replaced with service-based common units in Holdings that vest over two years, with 50% of units vesting after one year and 50% vesting in four quarterly installments in the following year, subject to the employee’s continued employment with the Company through the applicable vesting date. If Summit Partners sells all of its equity interests in the Company or if the investment return to Summit equals or exceeds 4.0x on a per-share basis for four consecutive quarters, and in each case the employee remains employed with the Company on such date, then all unvested service-based common units that were previously performance-based incentive units will vest. For accounting purposes, these awards were considered new awards with an estimated fair value of $25.8 million. Pursuant to the Stockholders Agreement, dated October 27, 2021 by and among the Company and the stockholders party thereto, holders of common units cannot exercise vested service-based common units until such time as Summit Partners and its affiliates cease to own any of the shares of Holdings common stock owned by them at IPO, Summit Partners does a follow-on registered offering in which case holders can perform an equivalent transaction, or the Stockholders Agreement is otherwise terminated in accordance with its terms.
The grant date fair value of each incentive unit incorporates a range of assumptions for inputs as follows:
Expected term (years) 4.0
Expected stock price volatility 36.0 %
Risk-free interest rate 0.3 %
Expected dividend yield —
DLOM estimate 16.0 %
Weighted average fair value at grant date $ 0.25
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A summary of the incentive and common units is as follows for the periods indicated (in thousands, except per share data):
Granted prior to Reorganization Transactions 3,730 — 0.45 1,663
Forfeited/cancelled prior to Reorganization Transactions (723) — 0.25 (183)
Effect of Reorganization Transactions(1) (27,558) 3,408 — —
Grant of replacement awards in connection with the IPO(3) — 1,359 18.95 25,754
Vested in connection with the IPO(4) — (913) 1.47 (1,342)