Enphase Energy Inc (ENPH) — Q2 2017 Earnings Call Transcript

Good afternoon and thank you for joining us on today's conference call to discuss Enphase Energy's second quarter of 2017 results. On today's call are Paul Nahi, Enphase President and Chief Executive Officer; Badri Kothandaraman, Chief Operating Officer; Bert Garcia, Chief Financial Officer; and Steve Gomo, Lead Independent Director of Enphase's Board of Directors. After the market closed today, Enphase issued a press release announcing the results for its second quarter ended June 30, 2017. During the course of this conference call, Enphase management will make forward-looking statements including but not limited to statements related to Enphase Energy's financial performance, market demand for current and future products, advantages of technology and market trend. These forward-looking statements involve significant risks and uncertainties, and Enphase Energy's actual results and the timing of events could differ materially from these expectations. For a more complete discussion of the risks and uncertainties, please see the Company's annual report on Form 10-K for the year ended December 31, 2016, which is on file with the SEC, and the quarterly report on Form 10-Q for the quarter ended June 30, 2017 which will be filed with the SEC in the third quarter of 2017. Enphase Energy cautions you not to place any undue reliance on forward-looking statements and undertakes no duty or obligation to update any forward-looking statements as a result of new information, future events, or changes in its expectations. Also, please note that certain financial measures used on this call are expressed on a non-GAAP basis unless otherwise noted, and have been adjusted to exclude certain charges. The Company has provided reconciliations of these non-GAAP financial measures to GAAP financial measures in its earnings release posted today which can also be found in the Investor Relations section of the website. Now, I'd like to introduce Paul Nahi, President and Chief Executive Officer of Enphase Energy. Paul?

Good afternoon and thank you for joining us to discuss our second quarter 2017 financial results. We reported revenue of $74.7 million for the second quarter of 2017, an increase of 36% compared to the first quarter of 2017. We shipped approximately 224 megawatts to DC, or 775,000 microinverters, which is a 39% increase in megawatts compared to the first quarter. GAAP gross margin was 18.1% and non-GAAP gross margin was 18.4%. The positive impact from the restructuring actions and optimization initiatives that we've been focusing on resulted in lower OpEx and improvements for our financial position in the second quarter. These efforts have also helped to reduce pressure on working capital. In fact, we generated $1 million of cash in the second quarter. Bert will go into greater detail about our financial results later in the call. Enphase is by far the largest microinverter company in the world; there are currently more than 661,000 Enphase systems deployed in over 100 countries. Since inception, we shipped approximately 15 million microinverters representing more than 3 gigawatts of installed generating capacity. Enphase Systems have produced approximately 9 terawatt hours of clean renewable energy. After the market close today, we announced that I'm stepping down as President and CEO of Enphase. It's been my great privilege to lead the Company for more than 10 years. From the time, Martin Fornage and Raghu Belur presented me with our concept of the microinverter to spearheading Enphase's drive to becoming the world's leading supplier of solar microinverters and energy management systems. As Enphase's founding CEO, I am incredibly proud of all of our accomplishments that helped change the face of solar, from the development of the microinverter to originating the concept of per panel monitoring. Now, with the introduction of the AC Module, Enphase accepts the change of the industry yet again. Enphase is now poised to execute on its future of sustained profitability and I’m committed to helping the Company as it transitions to a new CEO. I want to thank our customers, vendors, partners, employees, shareholders, and Board of Directors for their continued support throughout the years. It has truly been an honor to be the President and CEO of Enphase, and I wish the Company much continued success. I have no doubt that Enphase’s best days are ahead. With that, I would now like to turn the call over to Badri to provide the second quarter update on our operations, products, and markets. Badri?

Thanks, Paul. On behalf of all Enphase employees, I would like to thank you for your leadership during the past decades. As Paul mentioned, we've been working hard on restructuring actions and optimization initiatives over the past several months with the focus on lowering operating expenses and improving gross margin. As a part of our focus on operational efficiency, we introduced our 30, 20, 10 target operating model at our recent Analyst Day on June 19th. We're targeting 30% gross margin, OpEx at 20% of revenue, and operating income at 10% of revenue, all by the fourth quarter of 2018. We intend on providing you with periodic updates on our progress as we execute on these important financial metrics. We’ve been implementing new policies and procedures that will help drive gross margin improvement. We're focused on driving down costs with world-class procurement and overhead management. We’ve adopted a multiple sourcing strategy in addition to a cohesive supply strategy and are in the process of optimizing all aspects of our overhead costs including freight, service, and stocking. Moving to products, we’re pleased with the ongoing rollout of the sixth-generation IQ Microinverter System which continued to gain traction during the second quarter. The IQ 6 microinverter has been engineered to enable simpler and faster installations while continuing to provide better economics for our customers. Importantly, we believe IQ 6 is the highest quality and most reliable microinverter we've ever built. We expect to complete the transition to the IQ 6 microinverter system in the U.S. by the end of the third quarter of 2017. We're very excited by the recent launch of our Enphase Energized AC Module with LG Electronics. The product has begun shipping and is now in the channel and is available for sale. We expect demand to outstrip supply while the channel works to build up inventory. As a reminder, an AC Module is a microinverter integrated directly onto a solar panel. To accomplish this, Enphase has several patent-pending innovations that optimize product and shipping costs while maximizing performance. The AC Module creates a consolidated solution that simplifies and optimizes the entire business cycle for our installer partners from simplifying purchasing, optimizing working capital, and of course reducing installation time and effort. When compared to competitive solutions, the Enphase AC Module cuts rooftop installation time by more than half. Once installation is complete, our cloud-based monitoring software enables the owner or installer to monitor both the inverters as well as the modules, yet again simplifying operations and maintenance of the solar system. We're currently in discussions with many of the world's leading module companies and anticipate announcing additional AC Module partners soon. In fact, we're looking forward to the launch of Jinko's AC Module later this year. We believe the IQ Microinverter and our partnerships with module manufacturers will make the AC Module the default solution for rooftop solar. We're working hard to continue delivering industry-leading technology and products to our installers. In fact, our seventh-generation microinverter IQ 7 is on track for release in the first quarter of 2018. IQ 7 will further simplify the installation process and support our goal of continuous quality improvement. In addition, IQ 7's cost structure will drive increased gross margins for us. We continue to see competitive pricing for our AC battery solutions during the quarter and believe the total addressable market is developing slower than we anticipated. However, we did see an uptick in demand for the AC battery in Europe during the second quarter. While slow to develop, we expect the worldwide storage market will eventually grow as costs come down and utilities better understand how to incorporate distributed storage into the grids. Turning to our markets, the second quarter revenue in the U.S. was up 34% sequentially. Our installer acquisition strategy continued to deliver results with multiple new wins. In fact, we've added approximately 200 new installers in the last six months. In the APAC region, revenue increased 9% year-on-year. We're starting to see progress in India as we established new partnerships with distributors, installers, and module manufacturers. In Europe, revenue was up 66% sequentially and 77% year-on-year. The second quarter was a record quarter for unit shipments in the region, as we saw many new customer wins. We continue to be the market leader in France and saw our share growing both in the Netherlands and Switzerland during the fall. We also experienced significant momentum in the Latin American market during the second quarter where revenue was up sequentially and nearly doubled compared to the year-ago quarter. We remain the leader in the residential market both in Mexico and Puerto Rico with a record number of installations during the quarter. In closing, we're encouraged by our second quarter results and by what we're seeing in the third and beyond. We believe the continued ramp-up of our IQ Microinverter System and the launch of our AC Modules will help drive long-term growth with new and existing partners. We remain committed to providing our customers with the features and quality, ease and simplicity of Enphase Energy solutions while working diligently to improve gross margins and achieve sustained profitability. Now, I will turn it over to Bert for his review of our financial results.

Thanks, Badri. I will provide more details related to our second quarter 2017 financial results, as well as our business outlook for the third quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis unless otherwise noted. Total revenue for the second quarter of 2017 was $74.7 million, an increase of 36% sequentially and a decrease of 6% compared to the second quarter of 2016. Total net revenue for DC watt decreased to 2% sequentially from $0.34 to $0.33, reflecting relatively stable ASPs. On a year-over-year basis, total net revenue for DC watt decreased by 9%, directly consistent with the broad reduction in ASP. We shipped approximately 193 megawatts AC or 224 megawatts DC in the second quarter of 2017, an increase in megawatts of 39% sequentially and an increase in megawatts of 4% on a year-over-year basis. The megawatts shipped represented 775,000 microinverters, approximately 20% of which were our new IQ Microinverter Systems. We expect to complete the transition to the IQ 6 System in the U.S. by the end of Q3, 2017. Non-inverter revenue, which includes our AC battery storage solutions and all accessories, was consistent as a percentage of revenue with our prior quarter result. GAAP gross margin for the second quarter of 2017 was 18.1%. Non-GAAP gross margin was 18.4%. Non-GAAP gross margin excludes approximately $211,000 of stock-based compensation expense. As I mentioned during our last call, we anticipated seeing the full impact of recent restructuring actions reflected in our Q2 results. As expected, we saw our non-GAAP operating expenses decreased by $2.4 million sequentially and $20.2 million in Q1 to $17.8 in Q2. As compared to the year-ago quarter, we reduced non-GAAP operating expenses by $9.7 million, reflecting the cumulative impact of restructuring actions that we've taken. Non-GAAP operating expense in the second quarter of 2017 excludes $3.6 million of restructuring charges and $1.4 million of stock-based compensation expense; our GAAP operating loss narrowed by $12.8 million from a loss of $22.1 million in Q1 to a loss of $9.2 million in Q2. Our GAAP net loss was $12.1 million in Q2, resulting in a loss of $0.14 per share compared to a net loss of 23.3 million in Q1, while also showing a loss of $0.30 per share. On a non-GAAP basis, our operating loss was $4 million, representing an improvement of $8.9 million in Q1. Our non-GAAP net loss was $6.6 million, resulting in a net loss of $0.08 per share compared to a net loss of $13.6 million in Q1, or a loss of $0.18 per share. On our last few calls, we've discussed a relentless focus on improving financial performance and fueling profitability. As I just described, the restructuring actions that we've taken over the past year have significantly reduced our operating expenses, narrowed our operating losses, and created a solid foundation upon which to accelerate our timeline to sustained profitability. While we continue to focus on improving operational efficiency below the line, as Badri mentioned, much of our focus has turned to expanding margins to several supply chain optimization initiatives already underway. We believe the combination of operating expense reduction, supply chain optimization, and the transition to our new IQ platform will make it possible for us to achieve non-GAAP profitability by Q4. These initiatives will also result in improvements in working capital, placing the Company on a much-improved financial footing as we turn the corner in 2018. Now turning to the balance sheet, inventory levels were $20.8 million for the second quarter compared to $33.8 million in the first quarter and $39.3 million in the year-ago quarter. Inventory levels decreased from Q1 as we improved our working capital management and, to a lesser extent, as supply constraints created by industry-wide component shortages. We expect these shortages to impact our Q3 margins by approximately 1% to 2% as we incur expedited freight to meet near-term demand. We ended with 31 days of inventory on hand as of June 30th, down from 64 days last quarter and 55 days in the year-ago quarter. Our target inventory level is 30 days, and we've been working diligently as part of our supply chain optimization initiative to achieve this result. Our improving inventory management also helped contribute to positive cash flow results. During the second quarter, we generated approximately $1 million of cash and exited the quarter with a total cash balance of $31 million. Now let's discuss our outlook for the third quarter of 2017. We expect our revenue for the third quarter of 2017 to be within a range of $72 million to $80 million. Turning to margin, we expect GAAP and non-GAAP gross margin in Q3 to be within a range of 18% to 21%. Note that our Q3 gross margin guidance includes negative impacts of higher expedited freight resulting from some industry-wide component shortages. Non-GAAP gross margin excludes approximately $200,000 of stock-based compensation expense. We expect our GAAP operating expense for the third quarter to be within a range of $22.5 million and $24.5 million and non-GAAP operating expense to be within a range of $16.5 million to $18.5 million, excluding an estimated $1.7 million of stock-based compensation expense and approximately $4.3 million of additional restructuring expense. I'll now turn the call over to Steve Gomo, Member of our Board for some closing remarks before we open the line for questions.

Thanks, Bert. On behalf of Enphase Energy's Board of Directors, we've accepted Paul's resignation and would like to thank him for his many years of service at Enphase. Paul has led Enphase since its inception, more than a decade of hard work and many personal sacrifices. He, along with Raghu and Martin built Enphase from scratch. I think it's safe to say that without Paul Nahi, there would not be an Enphase Energy. We appreciate the leadership Paul has provided over the years, through the good times and the bad, and value his many contributions to Enphase and the solar energy industry. We also appreciate his most recent effort to stabilize the Company's financial situation. Paul is committed to a smooth transition and will continue to assist Enphase as we transition to a new leader. The Board search for Paul's replacement is underway, and significant progress has already been made. The search includes both internal and external candidates. It is our intention to name a successor by August 31, 2017. In the interim, the Board has created an Office of the CEO consisting of Badri and Bert to oversee and provide leadership for the Company's day-to-day activities. The Office of the CEO will report to the Board of Directors. We thank you for your continued support for Enphase. The Company remains committed to its decision to realize the global potential of solar technology innovation. And with that, we'll now open the lines for questions.

I'd like to start off with the AC Module. We've heard some encouraging comments out there in the field about the potential demand for the AC Module following SunPower's success with their SolarBridge. How many megawatts do you think you could sell in 2018?

So we've also heard and have been encouraged by the success that SunPower has had with their product offering. It's a bit early to project out for 2018, but all I can say is that we expect our AC shipments to grow as a percentage of our mix in Q3 and Q4, as we ramp and as we bring on additional partners. And we are equally optimistic about where we would see the AC Module placing in the marketplace in 2018 and beyond.

Okay, great. And in terms of the component shortage out there, we heard this now from a number of other players as well. Can you give us a sense for what the components are? I've heard it might be PCBs, and that they are not IGBTs, but what component are they that are in shortage?

Yes, the shortage is across a wide range of components, not necessarily restricted to one type like the PCB. The reality is there is a global shortage, and yes, I can't name something specific there.

Badri, can you talk about what the cause of the shortage is? And then how long it might take for the shortage to be resolved?

Yes, I think I will answer the question on how long. I have no visibility right now. We expect Q4 to be similar, and only time will tell. Regarding the cause of the shortages, it is likely due to the industry-wide actions, with some consumer devices ramping up; some of these components are quite short. So that's the insight I have.

I think the broad perspective is that we've heard this from other players in the industry, and the consensus is that the component shortages will likely persist into the second half of 2018. But as Badri mentioned, it’s a little too early to tell. We're all watching it very closely and paying attention.

Okay great. One more, if I may on storage. You mentioned Badri in your comments that worldwide storage will eventually grow. You guys have some experience now in Australia and elsewhere. Given the experience, when do you expect to see potential reflection on the upside of demand? And perhaps you can talk about what needs to be done for demand to be realized?

So, I think the most prudent thing we can say about the storage market is that it's fiercely competitive. There are a significant number of players in the Australian market alone. Several factors will drive demand in these markets, certainly price stability, as the pricing environment has been somewhat fluid causing near-term uncertainty among consumers. And as costs come down, I believe it will be easier for the industry to recognize the long-term value from engaging in that market.

Thanks very much, and one last comment here: Paul, it was great working with you and best of luck to you in your next steps.

Thank you very much. I enjoyed it as well.

Thanks, Paul, for your support through the years and good luck with your next endeavor. First question I have on IQ 6. Just quickly, I think you mentioned that you expect the U.S. to be fully transitioned to IQ 6 by 3Q, excluding the factor of component shortage. Are you already producing IQ 6 at your target cost? Or should we expect more incremental cost savings beyond this quarter?

I think the short answer there is we have hit our target cost on IQ 6. But bear in mind, just like every generation of product that we've ever introduced, the initial cost of any product will overtime come down. IQ 6 may not be terribly different, with the exception that its lifecycle will be relatively short—about 12 months. So that price drop is reflected in the next version of the IQ, which is the IQ 7. We have put a lot of effort into both IQ 6 and IQ 7, and I think the cost trajectory of those products will follow a similar pattern as products in the past.

Okay, great. That's helpful information. On the guidance, I wanted to ask about the Q3 guidance. It sounds like you had some strong results and that the U.S. has seen some pickup as well. So, I'm wondering what's driving the guidance to be flat or have more moderate sequential growth in Q3? Could you give some insight on that?

While our Q3 guidance reflects holding share in a flat time, it's important to note that it reflects our focus on profitable growth, consistent with our 30, 20, 10 operating model. Additionally, our Q3 revenue is impacted by component shortages in the market dynamics associated with our transition to the new products—IQ 6 and ACM.

Historically, seasonally, Q3 should be a stronger quarter than Q2, right? Do you see this year being different?

You're right; historically we've seen a small uptick in seasonality. But, as Badri mentioned, we see a relatively flat total addressable market in 2017, and so we're not expecting a significant seasonal increase in Q3 relative to Q2.

Last question, to clarify: if this environment continues, pricing seems okay but demand is somewhat flat. You guys have some incremental cost savings as you ramp for IQ 6, right? Can you help me understand how you get to the non-GAAP breakeven number that you're talking about? Maybe walk us through some numbers if you can?

What you're asking is what's driving margin expansion. At the end of the day, when you look at our work below the line, we get to profitability and non-GAAP breakeven through margin expansion. The primary drivers for margin expansion in 2017 will be the transition to IQ as well as the supply chain optimization efforts that Badri mentioned. Q2 only had about 20% of shipments classified as IQ, and as we progress into Q3, we will see more positive margins resulting from these transitional and optimization efforts.

Can you talk a little bit about the demand dynamics and the warranty dynamics in Europe? Obviously, with this licensing agreement with Flextronics, can you discuss if there has been pushback from customers and what they need to see to continue the growth they're experiencing right now?

Yes, without a doubt, we've seen some competitive dynamics, and it's been a focus for us. I don't think anyone is surprised that these dynamics have played a part in our guidance and financial results over the last couple of quarters. That said, I believe that through the restructuring and optimization work we've done, we will determine our success, and we are confident in our ability to deliver. Our 30, 20, 10 target operating model is an expression of that confidence.

Great. And obviously, it's nice to see the restructuring activity flow through the P&L. As you've gone through that process, do you see opportunities for more cost savings? Or are you going to wait for the new CEO to come in and assess the situation? How should we think about potential for operating leverage as we progress into the remaining quarters of this year and into 2018?

Yes, as I've mentioned, we continue to critically evaluate opportunities for cost optimization and margin expansion. We remain committed to this process, and while it may seem prudent to wait for a new CEO, the work is already in progress, and it would be difficult to pause our ongoing efforts.

We also mentioned in the Analyst Day on June 19th that our long-term target was $15 million a quarter, and that's a Q4 '18 target for us.

Just two quick questions from me. I was wondering if you could give us an update on the lines of credit you have, and how much facility you have left available and what was drawn against the cash balance?

We actually don’t have a revolver anymore; we settled that back in Q1. All we have now is a term debt facility that is fully drawn at $50 million.

How is the plan to work that down?

Our priority is executing on our plan and generating cash. We believe that as we deliver on our strategy, we will improve the economics of that term facility and, ultimately, look to lessen that burden.

Make sense. I did have a question on Paul's resignation. I enjoyed working with Paul and share similar sentiments to others on this call. However, I'm confused from a Board perspective. First one, when did he resign? Why from a board perspective would you agree to hire someone by August 31st? It seems like you should take time to find the right person, especially if you're considering internal and external candidates; typically, companies don’t find people in a couple of weeks.

We've had discussions with Paul now for some time. I can't go into the exact dates, but the Board got the process underway earlier. We have a robust set of candidates, it does take time to find the right person, and there is no guarantee that we'll meet the August 31st deadline as expected. However, we believe we can pull it off given the candidates we have; they are highly qualified.

Maybe we could just look at the fourth quarter a little bit. I wanted to clarify; the thought process is that your goal of operating income in Q4 is due to margins and OpEx. Is there any impact you're thinking about from the overall market top-line growth? And if so, what gives you confidence that you'll see that?

As mentioned, we see a relatively flat TAM in the balance of 2017. Our confidence stems from our focus on cost containment and margin expansion through ongoing supply chain initiatives and the strength of the IQ product transition.

Got it. And maybe the last one for me: at the Analyst Day, I know you were talking about launching IQ 7, and you mentioned it would cater to certain markets like Italy, Germany, and South East Asia. Can you remind me if that is driven by cost, features, or how should I think about that?

We plan to introduce IQ 7 in Q1 of '18, starting in North America and following it up globally. This product helps us fill gaps in markets like Germany. Availability in markets like these is indeed related to regulatory requirements and competitive pricing, allowing us to be competitive.

A direct answer to your question, the reason we feel that IQ 7 will allow us to expand into new geographies is that it supports the regulatory requirements of those regions. We're now able to serve places like Germany, which our current product does not qualify for. Additionally, it offers the right cost to be competitive in these markets, including South East Asia, Latin America, and Europe, now that one SKU can cater to all.

Kind of a two-part question, but focusing on the battery product. It seems like the market for residential storage is quite fragmented. Number one, do you agree it is due for a shakeout? Secondly, how do you differentiate your product versus the plethora of other residential storage solutions that are available?

Yes, we agree that the market is fragmented, and there may be some consolidation ahead. We're aware of several competitors already exiting the market. In respect to differentiation, our product is known for its modularity and ease of installation. Furthermore, we use the most stable and safest chemistry available, which resonates with consumers and installers alike, and Enphase stands firmly behind our products.

Another key point is the integration of solar and storage functioning as an energy management system. Our tightly coupled offerings, along with our monitoring software, distinguish us in the marketplace. This cohesive offering wouldn’t be feasible in a fragmented case where one company supplies the inverter, another the storage, etc. Our strength lies in our integrated energy management solutions.

First, on the Q3 gross margin guidance, what kind of pricing assumptions are you making for Q3? I think you mentioned flat pricing in Q2. I just wanted to confirm if that’s still the case? What are you seeing for Q3? And then secondly, what percentage of your current revenues is coming from the storage segment?

We don't usually breakout revenue from the storage solutions right now. Regarding pricing, we expect a 10% AC erosion year-over-year for 2017, which we're still comfortable with as an outlook for the year.

Okay, fair enough. That's tough to call. So in terms of the IQ 6 mix impact on margins, can you talk about what kind of margin improvement you assume from the transition to IQ 6? I think you've mentioned a 20% erosion so far going to 100% by the end of Q3?

I won’t be able to give you an explicit number tied directly to the IQ transition itself, but we're seeing a combination of factors driving margin expansion. The transition to IQ will definitely play a crucial role, and we expect to see those improvements start to show in Q3 as we move deeper into this transitioning phase.

Three questions. First is, what would have been the gross margin you are projecting in the third quarter without the legacy product's price protection impact? The other two questions are, what's the mix of IQ 6 that you have seen domestically? And in the third quarter, what does that ramp up to in the fourth quarter?

Okay, I'll answer the second question. 20% of our worldwide shipments for Q2 '17 were IQ, and we expect to transition to 100% by the end of Q3 '17.

To restate your first question, if we had not shipped any legacy products and did not provide price protection in Q3, what would our margins look like? The answer is meaningful, but I am not able to share an exact number.

Right, but essentially the way the price protection works is if a new product is 15% less than a previous generation's product, that benefits the distributors and traction on the new product.

Exactly, and it's fair to say that our Q3 results would have been better margin-wise had we been fully transitioned to IQ without providing price protection against previous generation products.

Thanks, Bert. If you look at Q4 and the first quarter, where do margins feel like they're going? If they are a bit higher without the price protection in Q3, and with the phase two of IQ 6 and IQ 7 rolling out, how should I think about the direction of margins?

While I can't provide specifics, we expect margins to generally improve as we transition to IQ and see the benefits of supply chain optimization initiatives. Our goal is to reach 30% margins by Q4 of '18 as part of our operating model. So, while the margin trajectory will not be a straight line, we anticipate an upward trend.

It's clear you have a presence in India, Latin America, and Europe now, but do you see more opportunity in one of these markets than the others in the near term?

Each of those markets is important to us. I wouldn't say we're focusing on one over the other. They all represent great growth opportunities. Latin America is developing quickly and we see significant potential there. India is also a tremendous opportunity for us, and we're focused there as well.

Thank you very much, operator, and thank you for joining us today. We do look forward to speaking with you again on our next call next quarter.