Shoals Technologies Group, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our financial statements and the related notes and other financial information included in our Annual Report on Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K”) and this Quarterly Report on Form 10-Q. In addition to historical financial information, the following discussion and analysis contain forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under the sections of our 10-K and this Form 10-Q captioned “Special Note Regarding Forward-Looking Statements” and “Risk Factors”. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contain the presentation of Adjusted EBITDA and Adjusted Net Income, which are not presented in accordance with GAAP. Adjusted EBITDA and Adjusted Net Income are being presented because they provide the Company and readers of this Form 10-Q with additional insight into our operational performance relative to earlier periods and relative to our competitors. We do not intend Adjusted EBITDA and Adjusted Net Income to be substitutes for any GAAP financial information. Readers of this Form 10-Q should use Adjusted EBITDA and Adjusted Net Income only in conjunction with Net Income, the most comparable GAAP financial measure. Reconciliations of Adjusted EBITDA and Adjusted Net Income to Net Income, the most comparable GAAP measure to each, are provided in “—Non-GAAP Financial Measures.” Overview We are a leading provider of electrical balance of system or “EBOS” solutions for solar energy projects in the United States. EBOS encompasses all of the components that are necessary to carry the electric current produced by solar panels to an inverter and ultimately to the power grid. EBOS components are mission-critical products that have a high consequence of failure, including lost revenue, equipment damage, fire damage, and even serious injury or death. As a result, we believe customers prioritize reliability and safety over price when selecting EBOS solutions. EBOS components that we produce include cable assemblies, inline fuses, combiners, disconnects, recombiners, wireless monitoring systems, junction boxes, transition enclosures and splice boxes. We derive the majority of our revenue from selling “system solutions” which are complete EBOS systems that include several of our products, many of which are customized for the customer’s project. We believe our system solutions are unique in our industry because they integrate design and engineering support, proprietary components and innovative installation methods into a single offering that would otherwise be challenging for a customer to obtain from a single provider or at all. We sell our products principally to engineering, procurement and construction firms ("EPCs”) that build solar energy projects. However, given the mission critical nature of EBOS, the decision to use our products typically involves input from both the EPC and the owner of the solar energy project. The custom nature of our system solutions and the long development cycle for solar energy projects typically gives us 12 months or more of lead time to quote, engineer, produce and ship each order we receive, and we do not stock large amounts of finished goods. We derived approximately 73% of our revenue from the sale of system solutions for the three months ended March 31, 2021. For the same period, we derived substantially all of our revenue from customers in the U.S. We had $180.6 million of backlog and awarded orders as of March 31, 2021, representing a 42% and 15% increase relative to the same date last year and December 31, 2020, respectively. 19 We have maintained focus on our growth strategy throughout the quarter including developments in converting customers to our combine-as-you-go system and developing products for the rapidly growing electric vehicle charging infrastructure market. We believe that eight of the top 10 solar EPCs as reported by Solar Power World Magazine use our combine-as-you-go system on a majority of their projects and we are currently in the process of transitioning an additional 11 EPCs and developers to our system. Additionally, we are currently developing four new product families for the EV charging market: skid solutions that package the key components required for an EV charging station in the factory with the objective of reducing the amount of labor required in the field; raceways that allow wire to be run above ground rather than in underground conduit; EV-BLA that eliminates homeruns from each dispenser and offers benefits similar to our solar BLA, including a 75% reduction in wire runs; and quad chargers that are prefabricated dispensers with four charge points. We expect to introduce our first offerings for this rapidly growing market in the fourth quarter of 2021. Initial Public Offering On January 29, 2021, the Company closed an IPO of 11,550,000 shares of Class A common stock at a public offering price of $25.00 per share, including shares issued pursuant to the underwriters' over-allotment option. The Company received $278.8 million in proceeds, net of underwriting discounts and commissions, which was used to purchase 6,315,790 LLC Interests from Shoals Parent and 5,234,210 LLC Interests from the founder and Class B unit holder in Shoals Parent at a price per interest equal to the IPO price of $25.00 per share. Subsequent to the IPO and related organizational transactions that occurred in connection with the IPO, the Company is the sole managing member of, and has a 56.14% economic interest in, Shoals Parent. Organizational Transactions In connection with the IPO, the Company and Shoals Parent completed the Organizational Transactions. Following the completion of the Organizational Transactions, the Company owns 56.14% of Shoals Parent. The Continuing Equity Owners own the remaining 43.86% of Shoals Parent. As the Organization Transactions are considered transactions between entities under common control, the condensed consolidated financial statements for the periods prior to the IPO and Organizational Transactions have been adjusted to combine the previously separate entities for presentation purposes. See Note 1 to the condensed consolidated financial statements of Shoals, included in this Quarterly Report on Form 10-Q for more information about the above-mentioned transactions as well as the other transactions completed in connection with the IPO. Impact of COVID-19 In December 2019, a novel strain of coronavirus, SARS-CoV-2, which causes coronavirus disease, or COVID-19, surfaced in Wuhan, China. Since then, COVID-19 has spread to multiple countries, including the United States. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. To date, the Company has maintained uninterrupted business operations with normal turnaround times for its delivery of solar EBOS solutions and components. The Company has implemented adjustments to its operations designed to keep employees safe and comply with federal, state and local guidelines, including those regarding social distancing. For the three months ended March 31, 2021, the Company incurred $0.1 million in COVID-19 related costs (disinfecting and reconfiguration of facilities, medical professionals to conduct daily screening of employees and direct legal costs associated with the pandemic) which is included in general and administrative expenses in the accompanying condensed consolidated financial statements. The extent to which COVID-19 may further impact the Company’s business, results of operations, financial condition and 20 cash flows will depend on future developments, which are highly uncertain and cannot be predicted with confidence. In response to COVID-19, the United States government has passed legislation and taken other actions to provide financial relief to companies and other organizations affected by the pandemic. Key Components of Our Results of Operations The following discussion describes certain line items in our condensed consolidated statements of operations. Revenue We generate revenue from the sale of EBOS systems and components for homerun and combine-as-you-go architectures. Our customers include EPCs, utilities, solar developers, independent power producers and solar module manufacturers. We derive the majority of our revenue from selling system solutions. When we sell a system solution, we enter into a contract with our customers covering the price, specifications, delivery dates and warranty for the products being purchased, among other things. Our contractual delivery period for system solutions can vary from one to three months whereas manufacturing typically requires a shorter time frame. Contracts for system solutions can range in value from several hundred thousand to several million dollars. Our revenue is affected by changes in the price, volume and mix of products purchased by our customers. The price and volume of our products is driven by the demand for our products, changes in product mix between homerun and combine-as-you-go EBOS, geographic mix of our customers, strength of competitors’ product offerings, and availability of government incentives to the end-users of our products. Our revenue growth is dependent on continued growth in the amount of solar energy projects constructed each year and our ability to increase our share of demand in the geographies where we currently compete and plan to compete in the future as well as our ability to continue to develop and commercialize new and innovative products that address the changing technology and performance requirements of our customers. Cost of Revenue and Gross Profit Cost of revenue consists primarily of product costs, including purchased materials and components, as well as costs related to shipping, customer support, product warranty, personnel and depreciation of manufacturing and testing equipment. Personnel costs in cost of revenue include both direct labor costs as well as costs attributable to any individuals whose activities relate to the transformation of raw materials or component parts into finished goods or the transportation of materials to the customer. Our product costs are affected by the underlying cost of raw materials, including copper and aluminum; component costs, including fuses, resin, enclosures, and cable; technological innovation; economies of scale resulting in lower component costs; and improvements in production processes and automation. We do not currently hedge against changes in the price of raw materials. Some of these costs, primarily personnel and depreciation of manufacturing and testing equipment, are not directly affected by sales volume. Gross profit may vary from year to year and is primarily affected by our sales volume, product prices, product costs, product mix, customer mix, geographical mix, shipping method, warranty costs and seasonality. Operating Expenses Operating expenses consist of general and administrative costs as well as depreciation and amortization expense. Personnel-related costs are the most significant component of our operating expenses and include salaries, equity-based compensation, benefits, payroll taxes and commissions. The number of full-time employees in our general and administrative departments increased from 44 to 57 from March 31, 2020 to March 31, 2021, and we expect to hire new employees in the future to support our growth. The timing of these 21 additional hires could materially affect our operating expenses in any particular period, both in absolute dollars and as a percentage of revenue. We expect to invest in additional resources to support our growth which will increase our operating expenses. General and Administrative Expenses General and administrative expenses consist primarily of salaries, equity-based compensation expense, employee benefits and payroll taxes related to our executives, and our sales, finance, human resources, information technology, engineering and legal organizations, travel expenses, facilities costs, marketing expenses, bad debt expense and fees for professional services. Professional services consist of audit, legal, tax, insurance, information technology and other costs. We expect to increase our sales and marketing personnel as we expand into new geographic markets. The majority of our sales in 2020 were in the U.S. We currently have a sales presence in the U.S., Australia and Spain. We intend to expand our sales presence and marketing efforts to additional countries in the future. We also expect that as a result of our recent IPO, we will incur additional audit, tax, accounting, legal and other costs related to compliance with applicable securities and other regulations, as well as additional insurance, investor relations and other costs associated with being a public company. Depreciation Depreciation in our operating expenses consists of costs associated with property, plant and equipment (“PP&E”) not used in manufacturing our products. We expect that as we increase both our revenue and the number of our general and administrative personnel, we will invest in additional PP&E to support our growth resulting in additional depreciation expense. Amortization Amortization of intangibles consists of customer relationships, developed technology, trade names and non-compete agreements over their expected period of use. Non-operating Expenses Interest Expense Interest expense consists of interest and other charges paid in connection with our current Senior Secured Credit Agreement (as defined below) and our former Senior Debt which included a revolving line of credit and term loan, which was fully repaid on October 8, 2020. Loss on Debt Repayment Loss on debt repayment consists of prepayment premiums and the write-off off a portion of the deferred financing costs from the prepayment of outstanding borrowings under the Term Loan Facility. Income Tax Expense Shoals Technologies Group, Inc. is subject to U.S. federal and state income tax in multiple jurisdictions with respect to our allocable share of any net taxable income of Shoals Parent. Shoals Parent is a pass-through entity for federal income tax purposes but incurs income tax in certain state jurisdictions. 22 Results of Operations The following table summarizes our results of operations (dollars in thousands): Three Months Ended March 31, Increase / (Decrease) 2021 2020 Revenue $ 45,604 $ 40,740 $ 4,864 12 % Cost of revenue 26,830 26,554 276 1 % Gross profit 18,774 14,186 4,588 32 % Operating Expenses General and administrative expenses 6,816 2,558 4,258 166 % Depreciation and amortization 2,068 2,061 7 — % Total Operating Expenses 8,884 4,619 4,265 92 % Income from Operations 9,890 9,567 323 3 % Interest expense, net (3,709) (272) (3,437) 1264 % Loss on debt repayment (15,990) — (15,990) 100 % Income (loss) before income taxes (9,809) 9,295 (19,104) (206) % Income tax benefit 1,475 — 1,475 100 % Net income (loss) (8,334) 9,295 (17,629) (190) % Less: net loss attributable to non-controlling interests (5,475) — (5,475) 100 % Net income (loss) attributable to Shoals Technologies Group, Inc. $ (2,859) $ 9,295 $ (12,154) (131) % Non-GAAP Financial Measures Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS We define Adjusted EBITDA as net income (loss) plus (i) interest expense, (ii) income taxes, (iii) depreciation expense, (iv) amortization of intangibles, (v) loss on debt repayment, (vi) equity-based compensation, (vii) COVID-19 expenses and (viii) non-recurring and other expenses. We define Adjusted Net Income as net income (loss) plus (i) amortization of intangibles, (ii) loss on debt repayment, (iii) amortization of deferred financing costs, (iv) equity-based compensation, (v) COVID-19 expenses and (vi) non-recurring and other expenses, all net of applicable income taxes. We define Adjusted Diluted EPS as Adjusted Net Income divided by the diluted weighted average shares of Class A common shares outstanding for the applicable period, which assumes the pro forma exchange of all outstanding Class B common shares for Class A common shares. Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS are intended as supplemental measures of performance that are neither required by, nor presented in accordance with, GAAP. We present Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS because we believe they assist investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS: (i) as factors in evaluating management’s performance when determining incentive compensation; (ii) to evaluate the effectiveness of our business strategies; and (iii) because our credit agreement uses measures similar to Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS to measure our compliance with certain covenants. Among other limitations, Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments; do 23 not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations; in the case of Adjusted EBITDA, does not reflect income tax expense or benefit for periods prior to the reorganization; and may be calculated by other companies in our industry differently than we do or not at all, which may limit their usefulness as comparative measures. Because of these limitations, Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS should not be considered in isolation or as substitutes for performance measures calculated in accordance with GAAP. You should review the reconciliation of net income to Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted EPS below and not rely on any single financial measure to evaluate our business. Reconciliation of Net Income (Loss) to Adjusted EBITDA (in thousands): Three Months Ended March 31, 2021 2020 Net income (loss) $ (8,334) $ 9,295 Interest expense 3,709 272 Income tax benefit (1,475) — Depreciation expense 405 326 Amortization of intangibles 1,996 1,996 Loss on debt repayment 15,990 — Equity-based compensation 1,392 — COVID-19 expenses (a) 55 — Non-recurring and other expenses (b) 339 182 Adjusted EBITDA $ 14,077 $ 12,071 (a) Represents costs incurred as a direct impact from the COVID-19 pandemic, disinfecting and reconfiguration of facilities, medical professionals to conduct daily screenings of employees, premium pay during the pandemic to hourly workers and direct legal costs associated with the pandemic. (b) Represents certain costs associated with non-recurring professional services, Oaktree’s expenses and other costs. Reconciliation of Net Income (Loss) Attributable to Shoals Technologies Group, Inc. to Adjusted Net Income (in thousands): 24 Three Months Ended March 31, 2021 2020 Net income (loss) attributable to Shoals Technologies Group, Inc. $ (2,859) $ 9,295 Net income (loss) impact from pro forma conversion of Class B common stock to Class A common stock (a) (5,475) — Adjustment to the provision for income tax (b) 1,134 (2,077) Tax effected net income (loss) (7,200) 7,218 Amortization of intangibles 1,996 1,996 Amortization of deferred financing costs 370 9 Loss on debt repayment 15,990 — Equity-based compensation 1,392 — COVID-19 expenses (c) 55 — Non-recurring and other expenses (d) 339 182 Tax impact of adjustments (e) (4,171) (475) Adjusted Net Income $ 8,771 $ 8,930 (a) Reflects net income (loss) to Class A common shares from pro forma exchange of corresponding shares of our Class B common shares held by our founder and management. (b) Shoals Technologies Group, Inc. will be subject to U.S. Federal income taxes, in addition to state and local taxes with respect to its allocable share of any net taxable income of Shoals Parent LLC. The adjustment to the provision for income tax reflects the effective tax rates below, assuming Shoals Technologies Group, Inc. owns 100% of the units in Shoals Parent LLC. Three Months Ended March 31, 2021 2020 Statutory U.S. Federal income tax rate 19.8 % 21.0 % State and local taxes (net of federal benefit) 0.9 % 0.7 % Effective income tax rate for Adjusted Net Income 20.7 % 21.7 % (c) Represents costs incurred as a direct impact from the COVID-19 pandemic, disinfecting and reconfiguration of facilities, medical professionals to conduct daily screenings of employees, premium pay during the pandemic to hourly workers and direct legal costs associated with the pandemic. (d) Represents certain costs associated with non-recurring professional services, Oaktree’s expenses and other costs. (e) Represents the estimated tax impact of all Adjusted Net Income add-backs, excluding those which represent permanent differences between book versus tax. Reconciliation of Diluted Weighted Average Shares Outstanding to Adjusted Diluted Weighted Average Shares Outstanding (in thousands, except per share): 25 Three Months Ended March 31, 2021 2020 Diluted weighted average shares of Class A common shares outstanding 93,540 N/A (b) Assumed pro forma conversion of Class B common shares to Class A common shares 73,067 N/A (b) Adjusted diluted weighted average shares outstanding 166,607 N/A (b) Adjusted Net Income (a) $ 8,771 N/A (b) Adjusted Diluted EPS $ 0.05 N/A (b) (a) Represents Adjusted Net Income for the full period presented. (b) This Non-GAAP measure is not applicable for this period, as the reorganization transactions had not yet occurred. Comparison of the Three Months Ended March 31, 2021 and 2020 Revenue Revenue increased by $4.9 million, or 12%, for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020, driven by an increase in demand for solar EBOS generally and our combine-as-you-go system solutions specifically. Our total number of customers increased in 2021 as compared to 2020. We believe customer recognition of the benefits of our combine-as-you-go system is resulting in increased demand for our products. Cost of Revenue and Gross Profit Cost of revenue increased by $0.3 million, or 1%, for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020, primarily driven by an increase in production volumes. Gross profit as a percentage of revenue increased from 35% in 2020 to 41% in 2021 in part due to purchasing efficiencies from increased volumes, improved material planning which reduced logistics costs, enhancements to product design that lowered manufacturing costs and other manufacturing efficiencies resulting from higher production volumes. Changes in product mix also contributed to the increase in margin as sales of system solutions for combine-as-you-go EBOS, which have higher margin than our other products, increased as a percentage of our total revenue. Operating Expenses General and Administrative General and administrative expenses increased $4.3 million, or 166%, for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The increase in general and administrative expenses was primarily the result of $1.4 million in equity-based compensation related to restricted stock units issued in connection with our IPO, an increase in professional fees of $0.8 million related to preparation for our IPO, wages and related taxes of $1.2 million related to increased head count and year-end bonuses, insurance expense of $0.6 million, franchise and other related taxes of $0.3 million and certain COVID-19 related costs of $0.1 million, offset by a decrease in travel and trade shows of $0.2 million as a result of COVID-19. 26 Depreciation and Amortization There was no significant change in depreciation and amortization expense during the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. Interest Expense Interest expense, net increased by $3.4 million or 1264%, for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020, due to increased borrowings and related deferred financing costs under our Senior Secured Credit Facility entered into on November 25, 2020. We expect interest expense to increase in 2021 as a result of our higher average borrowings under the Senior Secured Credit Facility (see description under “Debt Obligations”). Loss on Debt Repayment Loss on debt repayment for the three months ended March 31, 2021 consists of $11.3 million of prepayment premium and $4.7 million in write-off off a portion of the deferred financing costs related to a prepayment of $150.0 million of outstanding borrowings under the Term Loan Facility. Income Tax Benefit Income tax benefit totaled $1.5 million for the three months ended March 31, 2021. The Company did not incur income tax expense prior to the Organizational Transactions, or during the three months ended March 31, 2020. Liquidity and Capital Resources Three Months Ended March 31, 2021 2020 Net cash provided by (used in) operating activities $ (17,779) $ 17,938 Net cash used in investing activities (863) (795) Net cash provided by financing activities 12,796 22,911 Net increase (decrease) in cash and cash equivalents $ (5,846) $ 40,054 We finance our operations primarily with operating cash flows and short and long-term borrowings. Our ability to generate positive cash flow from operations is dependent on the strength of our gross margins as well as our ability to quickly turn our working capital. Based on our past performance and current expectations, we believe that operating cash flows and availability under our Revolving Credit Facility will be sufficient to meet our near term future cash needs. We used cash from operating activities of $17.8 million in the three months ended March 31, 2021 as compared to cash generated from operating activities of $17.9 million for the three months ended March 31, 2020. As of March 31, 2021, our cash and cash equivalents were $4.2 million and we had outstanding borrowings of $238.1 million. We also had $61.0 million available for additional borrowings under our $100.0 million Revolving Credit Facility. Operating Activities For the three months ended March 31, 2021, cash used in operating activities was $17.8 million, primarily due to operating results that included $8.3 million of net loss, reflecting an increase of $6.0 million in 27 inventory, $7.3 million in receivables, $3.5 million in other current assets, and a decrease in accounts payable and accrued expenses of $2.2 million. For the three months ended March 31, 2020, cash provided by operating activities was $17.9 million, primarily due to operating results that included $9.3 million of net income, reflecting a decrease of $6.4 million in receivables, a decrease in $3.1 million in accounts payable and accrued expenses partially offset by $3.1 million increase in inventory. Investing Activities For the three months ended March 31, 2021, net cash used in investing activities was $0.9 million, attributable to the purchase of property and equipment. For the three months ended March 31, 2020, net cash used in investing activities was $0.8 million, attributable to the purchase of property and equipment. Financing Activities For the three months ended March 31, 2021, net cash provided by financing activities was $12.8 million, including $145.6 million in net proceeds from the IPO and $19.0 million in borrowings under the Revolving Credit Facility offset by $150.1 million of payments on term loan facility. For the three months ended March 31, 2020, net cash provided by financing activities was $22.9 million. We received proceeds from our senior debt – revolving credit facility of $24.0 million which was offset by payments to our members for tax distributions of $0.2 million and payments on our senior debt-term loan of $0.9 million. From time to time, we may seek to retire or purchase the Company’s outstanding debt or equity securities through cash purchases and/or exchanges for other debt or equity securities in open market purchases, privately negotiated transactions, or otherwise, and may be made pursuant to Rule 10b5-1 or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, the Company’s liquidity requirements, contractual restrictions and other factors. Debt Obligations Senior Secured Credit Agreement On November 25, 2020 Shoals Holdings, entered into that certain credit agreement with the lenders party thereto from time to time and Wilmington Trust, National Association, as administrative agent and collateral agent (the “Senior Secured Credit Agreement”), consisting of (i) a $350.0 million senior secured six-year term loan facility (the “Term Loan Facility”), (ii) a $30.0 million senior secured delayed draw term loan facility, which matures concurrently with the six-year Term Loan Facility (the “Delayed Draw Term Loan Facility”) and (iii) an uncommitted super senior first out revolving credit facility (the “Revolving Credit Facility”). The proceeds of the Term Loan Facility and a $10.0 million draw under the Delayed Draw Term Loan Facility were used to (i) make certain distributions from Shoals Holdings to Shoals Intermediate Holdings and from there to certain of our direct or indirect equity holders, (ii) pay transaction expenses, (iii) repay and terminate all outstanding commitments under the Senior Debt (as defined herein) and (iv) finance working capital and general corporate purposes. An additional $10.0 million draw under the Delayed Draw Term Loan Facility funded on December 14, 2020. In December 2020, Shoals Holdings entered into two amendments to the Senior Secured Credit Agreement in order to obtain a $100.0 million increase (the “Revolver Upsize”) to the Revolving Credit Facility 28 and modify the terms of the interest rate and prepayment premium. As part of the first amendment we repaid and terminated all outstanding commitments under the Delayed Draw Term Loan Facility. As of March 31, 2021, interest rates on the Term Loan facility and the Revolving credit facility were 4.25% and 3.75%, respectively and we had $61.0 million of availability under the Revolving Credit Facility. The Senior Secured Credit Agreement contains affirmative and negative covenants, including covenants that restrict our incurrence of indebtedness, incurrence of liens, dispositions, investments, acquisitions, restricted payments, and transactions with affiliates. The Senior Secured Credit Agreement also includes customary events of default, including the occurrence of a change of control. As of March 31, 2021, we were in compliance with all the required covenants. Senior Debt Intermediate and subsidiaries were party to the Senior Debt Agreement under which Holdings and its subsidiaries were borrowers and Intermediate was a guarantor. The Senior Debt was collateralized by all of the assets of the guarantor and borrowers. The amended agreement provided a term loan of $35 million and a revolving line of credit of $25 million. On October 8, 2020, we paid the outstanding amount due on the term loan and settled all obligations with respect to the Senior Debt. The Senior Debt provided for an interest rate to equal the Base Rate plus margin. The Base Rate charged was the highest rate of three defined methods as follows: 1) Federal Funds Rate plus 0.5%, 2) Fifth Third Bank N.A. Rate or 3) LIBOR Rate plus 1%. The Base Rate ranged from 1% to 2.5% depending on the EBITDA Rate calculation as defined in the Senior Debt (the “EBITDA Rate calculation”) for the Federal Funds Rate. The Base Rate for the LIBOR Rate ranged from 2% to 3.5% depending on the EBITDA Rate calculation. Surety Bonds We provide surety bonds to various parties as required for certain transactions initiated during the ordinary course of business to guarantee our performance in accordance with contractual or legal obligations. As of March 31, 2021, the maximum potential payment obligation with regard to surety bonds was $11.8 million. Critical Accounting Policies and Significant Management Estimates Income Taxes We record valuation allowances against our deferred tax assets when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In making such determination, we consider all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and results of operation. We routinely evaluate the realizability of our deferred tax assets by assessing the likelihood that our deferred tax assets will be recovered based on all available positive and negative evidence. Estimating future taxable income is inherently uncertain and requires judgment. In projecting future taxable income, we consider our historical results and incorporate certain assumptions, including revenue growth, and operating margins, among others. As of March 31, 2021, we had $48.5 million of deferred tax assets, net of valuation allowances. We expect to realize future tax benefits related to the utilization of these assets. If we determine in the future that we will not be able to fully utilize all or part of these deferred tax assets, we would record a valuation allowance through earnings in the period the determination was made, which would have an adverse effect on our results of operations and earnings in future periods. 29 Liabilities Under Tax Receivable Agreement As described in Note 14 to the condensed consolidated financial statements, we are a party to the TRA under which we are contractually committed to pay the TRA Owners 85% of the amount of any tax benefits that we actually realize, or in some cases are deemed to realize, as a result of certain transactions. Amounts payable under the TRA are contingent upon, among other things, (i) generation of future taxable income over the term of the TRA and (ii) future changes in tax laws. If we do not generate sufficient taxable income in the aggregate over the term of the TRA to utilize the tax benefits, then we would not be required to make the related TRA payments. Therefore, we will only recognize a liability for TRA payments if we determine it is probable that we will generate sufficient future taxable income over the term of the TRA to utilize the related tax benefits. Estimating future taxable income is inherently uncertain and requires judgment. In projecting future taxable income, we consider our historical results and incorporate certain assumptions, including revenue growth, and operating margins, among others. As of March 31, 2021, we recognized $41.7 million of liabilities relating to our obligations under the TRA, after concluding that it was probable that we would have sufficient future taxable income to utilize the related tax benefits. There were no transactions subject to the TRA for which we did not recognize the related liability, as we concluded that we would have sufficient future taxable income to utilize all of the related tax benefits generated by all transactions that occurred in connection with the IPO. If we determine in the future that we will not be able to fully utilize all or part of the related tax benefits, we would de-recognize the portion of the liability related the benefits not expected to be utilized. Additionally, we estimate the amount of TRA payments expected to be paid within the next 12 months and classify this amount as current on our condensed consolidated balance sheets. This determination is based on our estimate of taxable income for the next fiscal year. To the extent our estimate differs from actual results, we may be required to reclassify portions of our liabilities under the TRA between current and non-current. As of March 31, 2021, there were no other significant changes in the application of our critical accounting policies or estimation procedures from those presented in our Annual Report on Form 10-K for the year ended December 31, 2020. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes with respect to our market risk disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.