Enphase Energy Inc (ENPH) — Q3 2018 Earnings Call Transcript

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's third quarter 2018 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer; Eric Branderiz, Chief Financial Officer; and Raghu Belur, Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September 30, 2018. During this conference call, Enphase management will make forward-looking statements, including but not limited to, statements related to Enphase Energy's financial performance, market demands for its current and future products, advantages of its technology, and market trends. 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, 2017, which is on file with the SEC, and the quarterly report on Form 10-Q for the quarter, and nine months ended September 30, 2018, which will be filed with the SEC in the fourth quarter of 2018. 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 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 a reconciliation 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 its website.

Good afternoon, and thanks for joining us today to discuss our third quarter of 2018 financial results. We reported revenue of $78 million for the third quarter. Customers continue to appreciate our differentiated products, quality, and service initiatives. Our strong balance sheet was instrumental in driving increased customer demand. Our biggest challenge in Q3 was meeting this additional demand. We experienced supply shortages that constrained our revenue by more than $10 million. For Q4, we are seeing strong demand and are fully booked already. We expect to be supply constrained in Q4 as well. Our non-GAAP gross margin in the third quarter was 32.8%, and our non-GAAP operating income was $7 million. We are pleased to report the fourth consecutive quarter of positive non-GAAP operating income. We have also made a lot of progress on transforming our balance sheet and improving the company's operations. We exited the third quarter with a cash balance of $116.2 million. Next, I will talk about 30-20-10. We introduced the concept of a 30-20-10 target financial model at our Analyst Day in June 2017, with a commitment to meeting it in Q4 of 2018. 30-20-10 stands for 30% gross margin, 20% operating expense, and 10% operating income. We have now reported five consecutive quarters of improved financial performance and are very close to realizing 30-20-10. Eric will go into greater detail about our financial results later in the call. An important focus item that we have discussed over the past few quarters is ease of doing business, how customers perceive us. Quality and customer service are the cornerstones of our top line growth, and our objective is to deliver exceptional customer experience. Our business processes are maturing, and we are prioritizing customer experience as number one in all aspects of our business, be it in product development or operations. During Q3, we continued to make several improvements in our customer contact center metrics and online support. Our Service-on-the-Go has now enabled the majority of customer claims to be handled through self-service via mobile devices. A key customer experience metric we introduced last quarter was Net Promoter Score or NPS. This metric is calculated based on feedback from customer surveys on how likely customers are to recommend Enphase to a friend or colleague. Our customer service NPS was over 50% in Q3, versus 40% in Q2. We have made significant improvement with our customer service in the last four quarters, making it easier to do business with Enphase. Our target is to achieve an NPS of 60% or higher in 2019. Let's now talk about tariffs. We all know about the 201 tariffs on solar cells and modules. Many of our AC module partners are building factories in the U.S. to counter the tariffs. Also, we all know SunPower recently obtained an exemption from the 201 tariff. In summary, we see the barriers on AC module seem to be easing up, and their production is beginning to ramp. Let's now move on to 301 tariffs, which became effective late September, and their impact on Enphase microinverters and accessories. We expect to mitigate the 301 tariffs by sharing the cost increases with our customers and expanding our manufacturing agreement with Flex to include Mexico. Starting in Q2 of 2019, Flex will begin delivering Enphase products produced in Mexico to the U.S. market. This additional line in Mexico will help Enphase not only to mitigate the tariffs, but also better serve our North American customers by cutting down cycle times and streamlining inventory at a similar manufacturing cost as China. Now, turning to our markets, our U.S. and international mix for Q3 was 65% and 35% respectively. Third quarter revenue in the U.S. was up 1% sequentially, and down 4% year-on-year. We ramped IQ7 shipments to our U.S. customers during the quarter, along with IQ7X, our microinverter compatible with 96-cell modules. In Europe, revenue was up 9% sequentially and 31% year-on-year. We entered the German and Austrian solar markets in Q2 with IQ7, and continue to develop the customer relationships in Q3. We maintained our market share lead in France, and were flat in Benelux and Switzerland compared to Q2. In APAC, the revenue was down 7% sequentially and up 18% year-on-year. The revenue decrease was due to channel inventory on our legacy microinverters. We expect to bleed out the excess inventory in the fourth quarter, and we also expanded our partnership with BayWa to distribute IQ7 microinverters across Southeast Asia. In Latin America, the third quarter revenue was up 33% sequentially and down 38% year-on-year. We experienced steady growth in Mexico during the quarter. Now that we are financially stable, a large portion of my time is spent on profitable top line growth. We plan to achieve this growth through differentiated products. Our four levers for profitable top line growth remain IQ7 regional expansion, high-power and high-performance products, AC modules, and Ensemble solar and storage technology. Of course, quality and customer experience remain cornerstones of this top line growth. The first lever for profitable top line growth is IQ7 regional expansion. We had a significant IQ7 ramp in Q3, and we expect to complete the transition in Q4. Approximately 78% of our microinverter shipments in Q3 were IQ7, up from 22% in Q2. As I mentioned earlier, we experienced supply shortages on high-voltage transistors in Q3. We expect this situation to continue in the fourth quarter, and have made appropriate investments to alleviate the majority of the constraints in early 2019. The second lever for profitable top line growth is releasing high-power high-performance products. As you know, IQ7X is the highest power and highest efficiency variant of our seventh generation family of microinverters. The IQ7X product addresses 96-cell PV modules up to 400 watt DC, and with its 95% CEC efficiency is ideal for integration into AC modules. We plan to introduce a new product in the first quarter of 2019, IQ7A, which is even higher power than IQ7X, to address up to 450 watt DC modules. The benefit of our architecture is that it enables higher value to customers at a lower incremental cost for us, thus improving our gross margins. The third lever for profitable top line growth is AC Modules or ACMs. Last week, we announced a strategic partnership with LONGi to develop Enphase energized LONGi ACMs based on IQ7. We expect these ACMs to be available in the U.S. starting in the fourth quarter of 2018. Enphase is now the exclusive model-level power electron supplier for SunPower's residential business in the U.S., and we anticipate volume shipments of IQ7X microinverters in the fourth quarter, and an acceleration of ramp throughout 2019. We expect to add $60 million to $70 million of annualized revenue from this acquisition in the second half of 2019 at 33% to 35% non-GAAP gross margins. Both SunPower and LONGi joined leading module manufacturers such as Panasonic, Solaria, and LG, in developing Enphase Energized AC Modules. These integrated systems allow installers to be more competitive through capital management, reduced labor costs, and improved SKU management with accelerated design and installation. Since their release to installers in October of 2017, Enphase Energized ACMs from our module partners have been adapted by 330 installers in the U.S. Finally, a big catalyst for our profitable top line growth is on Ensemble solar and storage technology. The IQ8 system based upon our grid agnostic always-on technology called Ensemble. This system has four components: energy generation, which is the grid agnostic microinverter; energy storage which is the Encharge battery with capacities of 3.3 kilowatt hour, 10 kilowatt hour, and 13.2 kilowatt hour; communication and control, which consists of the automatic transfer switch that provides fine grain load control; and the combiner box circuitry; and the fourth component is Enlighten which is the IoT cloud software. The IQ system with its sophisticated software capabilities can address use cases ranging from grid-tied to off-grid and any possible hybrid configuration in between. In addition, the grid agnostic feature of the microinverter can be turned on and off through software remotely. This is just one of the many software configurable options in the IQ8 system enabling a future service business within our install base. Consequently, the Ensemble technology enables Enphase to transition from a pure-play microinverter solar company to a complete energy management systems company, bringing about a substantial growth opportunity for us. We expect our revenue potential to increase from approximately $2,000 per home selling pure microinverter systems to over $10,000 per home selling complete energy management systems with Ensemble solar and storage technology. We anticipate introducing the grid agnostic IQ8 systems to customers in the first half of 2019, and realize meaningful revenue by Q4 2019, while still adhering to 30-20-10. We also expect to release the pure off-grid microinverter solution in Q4 of 2018 in limited quantities as we previously discussed. We have completed the necessary safety certification and the off-grid product is currently being field tested. In summary, our top priority is to improve profitability quarter-on-quarter, creating shareholder value. In the near term, our focus is to optimize the supply chain to meet additional demand, unlocking our growth vectors, and providing outstanding customer experience. In the next few years, Ensemble represents the transformative opportunities for Enphase to increase our revenue manifold by providing a complete home energy management system. With that, I will turn the call over to Eric for his review of our financial results. Eric?

Thanks, Badri. I will provide more details related to our third quarter 2018 financial results as well as our business outlook for the fourth quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis, unless otherwise noted. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings release posted today, which also can be found in the Investor Relations section of our website. Total revenue for the third quarter of 2018 was $78 million, an increase of 3% sequentially, and an increase of 1% year-over-year. We shipped approximately 204 megawatts DC in the third quarter of 2018, an increase in megawatts of 1% sequentially, and a decrease of 12% from the year-ago quarter. The megawatts shipped represented about 665,000 microinverters, approximately 78% of which were IQ7. Non-inverter revenue, which includes our AC Battery Storage Solution and Envoy Communications Gateway and accessories increased as a percentage of revenue compared to our prior quarter. Non-GAAP gross margin for the third quarter of 2018 was 32.8%, compared to 30.5% for the second quarter. We are pleased with the continued progress that we have made expanding our gross margins. The increases reflect the targeted initiatives of our pricing management, transition to IQ7, and the $3.3 million milestone achievement from an IQ8 partner. We continue to be impacted by component shortages, which negatively affected our Q3 gross margin by approximately 2% due to expedite fees. Non-GAAP operating expenses were $18.6 million for the third quarter of 2018, compared to $19 million in Q2 and $16.9 million for the third quarter in 2017. GAAP operating expenses were $25.6 million for the third quarter of 2018, compared to $23.3 million in Q2, and $22.4 million for the third quarter of 2017. GAAP operating expenses for the third quarter included $3.7 million of stock-based compensation expenses, $2.6 million of restructuring expenses, and approximately $700,000 of acquisition-related expenses and amortization. On a non-GAAP basis, income from operations was $7 million, compared to $4.1 million in Q2, and a loss of $102,000 in the year-ago quarter. This improvement in operating income for the year-ago quarter is reflective of our hard work and underscores our commitment of establishing a solid financial foundation. On a non-GAAP basis, net income was $4.6 million, resulting in basic earnings per share of $0.05 and diluted earnings per share of $0.04. Now turning to the balance sheet, inventory levels were $17.9 million for the third quarter, compared to $17.5 million in the second quarter, and $25.3 million in the year-ago quarter. We ended at 30 days of inventory on hand as of September 30, up from 30 days last quarter, and down from 38 days in the year-ago quarter. Inventory management remains one of our key cash management initiatives in 2018. We exited the quarter with a total cash balance of $116.2 million, compared to $58.5 million in Q2. The Q3 balance includes both net proceeds of approximately $62.7 million from a convertible debt offering and a payment to SunPower of $50 million. We generated $6.8 million in cash flows from operations, as well as approximately $11.9 million in positive adjusted free cash flow. The $6.8 million in cash from operations in Q3 would have been $12.8 million as we allocated $6 million out of the $50 million payment to SunPower in operating cash flow for the acquired customer relationship intangible. Now, let's discuss our outlook for the fourth quarter of 2018. We expect our revenue for the fourth quarter of 2018 to be within our range of $80 million to $90 million. Turning to margins, we expect GAAP and non-GAAP gross margin to be within a range of 31% to 34%. Note that our Q4 gross margin guidance includes approximately 2% of higher expedite fees, resulting from industry-wide component shortages. We expect our GAAP operating expenses to be within a range of $25 million to $28 million, including a total of approximately $7.2 million or $50 million in stock-based compensation expenses, additional restructuring expenses, and acquisition-related expenses, and amortization. We expect non-GAAP operating expenses to be a range of $18.5 million to $20.5 million. With that, I will now open the line for questions.

Thanks so much, guys. Can we break down that $10,000 per home opportunity? How much of that is energy storage and Ensemble? And then could you break it down between what's hardware and what's actually software and service type revenue?

Yes, Colin. Currently, we offer a microinverter system that averages around $100. This comprises a microinverter, the Envoy, the Combiner Box, the Cable, and typically includes 20 microinverters per home, totaling about $2,000 per home. When we incorporate the home energy management system powered by Ensemble, it adds additional storage and an automatic transfer switch along with our usual Combiner Box and software. For an 8 to 10 kilowatt-hour system, the storage would amount to $8,000, including the storage and ATS. However, this is just the beginning, as the software component, such as grid-agnostic service capability, will also be available as software, with the potential for an annual software fee delivered through our IoT system via the cloud. So you're correct—it starts at around $10,000, and we anticipate further growth.

Okay. And then, just on the component shortage, obviously you guys are working through the issues on this, but how can we expect that to start flowing through over the next several quarters in terms of your ability to actually serve the revenue or the opportunity that you think you have in front of you with your customers?

I mean, just stepping back and looking at it, the supply shortage is on the high-voltage transistors. These are the 600-volt transistors. They are complicated devices to make. The people who usually make this, I'm talking about the general suppliers who make it are a handful. They are basically STMicroelectronics, Infineon, Alpha & Omega Semiconductor, On Semi, Toshiba, these are the usual suspects. We have done our homework. We have three of these five suppliers on our AVL today. Despite that, those guys are facing unprecedented demand due to EV charging. So their demand exceeds the supply that they have. We recognized this problem about six to eight months ago. I invested money, creating a dedicated line for us to create capacity, and that line is coming on board in January of 2019. So I expect the majority of my supply problems to be gone in Q1 of 2019.

Okay. Thanks so much, guys. I'll hop into queue.

Thank you for the question. To clarify, is the line you mentioned specifically the power MOFSET line, or can you elaborate on the overall scope of the shortages and the capacity you are adding? Thank you.

We experienced a loss of $10 million in demand in Q3. Currently, we are fully booked for Q4 based on the guidance I provided, and it's only early November. This indicates that demand is exceeding our supply capabilities. Regarding our supplier investment, I won't share too many details, but we are transitioning to this supplier as our preferred choice, and they have assured us of their capacity. They are well-respected and reliable, and together with our other two existing sources, we believe we will meet the available demand. I anticipate resolving the supply issues by Q1 of 2019.

Could you provide more details on whether the issue is generally a shortage in the specialty memory sector, or if it primarily concerns power MOFSETs, capacitors, and passive components?

Yes. I mean, look, the power MOFSETs 600 volts is by far the biggest shortage. Yes, there are problems on MLCCs, everybody knows that, but we have been able to resolve that through spot buys. It's not pretty. It affects our gross margins by a couple of percent, as Eric said, but we are getting by there with the shortage of MLCCs, but the high-voltage transistor FET is an esoteric device. It's made only by the five suppliers I said, and therefore that's a little bit more complex, and like what I said, we believe we have put in the right actions six to eight months ago, and the capacity is coming onboard now. It is at the right time, and I think this should be behind us soon.

Okay, thanks. On a separate topic, can you talk about your being sold out for Q4, what's your visibility into the first quarter at this point, and could you share some thoughts generally on 2019 revenue growth and opportunities that you're looking at? Thanks.

We typically do not provide guidance beyond one quarter, but I can share some insights on 2019. Our four key areas for profitable growth are gaining traction. The IQ7 is becoming popular, and our strong balance sheet is attracting customers back to us, particularly with the SunPower transaction, which is expected to add approximately $60 million to $70 million in annualized revenue in the second half of 2019. We also have additional partnerships on the AC modules. Furthermore, we are launching high-power and high-performance products that offer high gross margins. The most exciting development is Ensemble. While new product development can be quite challenging and timelines are hard to predict, if we continue on our current path, our revenue per home is set to significantly increase, which could be transformative for Enphase.