Enphase Energy Inc (ENPH) — Q1 2019 Earnings Call Transcript

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's First Quarter of 2019 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 fourth quarter and year ended December 31, 2018. During this conference call, Enphase management will make forward-looking statements, including but not limited to, statements related to Enphase Energy's technology, products and financial performance, operations including supplier lead times and current and future market and customer demands and 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, 2018, which is on file with the SEC, and the quarterly report on Form 10-Q for the quarter ended March 31, 2018, which will be filed with the SEC in the second quarter of 2019. 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. Now, I'd like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy. Badri?

Good afternoon and thank you for joining us today to discuss our financial results for the first quarter of 2019. We had a solid quarter, reporting revenue of $100.2 million, with strong demand from all customer segments. The main challenge in meeting this demand was component shortages. We are fully booked for the second quarter just as we were for the first quarter. I will provide an update later on how we plan to address these shortages. Our non-GAAP gross margin for the first quarter was 33.5%, and our non-GAAP operating income was $11.3 million. The gross margin was negatively impacted by 280 basis points due to expedite fees associated with the component shortages, which arose from air shipments we opted for to better serve our customers. We finished the first quarter with a cash balance of $78.1 million after repaying approximately $39.5 million of our high-interest-bearing senior secured term loan, including accrued interest and fees. Additionally, we reported $16.4 million in adjusted free cash flow for the first quarter. We have emphasized improving how customers perceive working with us since the second half of 2018. Customer experience, defined by quality and service, is the foundation of our strategy. In the first quarter, we made several enhancements in our customer call center metrics and online support. For instance, our first call resolution metric improved by around 15% year-over-year, and over 50% of our customer claims were managed through our Service-on-the-Go support tool via mobile devices. We recently announced that over 2,500 homeowners have signed up for our Enphase Upgrade Program, which is geared toward those using our legacy microinverters. This program demonstrates our commitment to quality and service, and we thank the solar installers for their support. To measure customer experience, we track the net promoter score or NPS, based on survey feedback regarding how likely customers would be to recommend Enphase to others. Our NPS in North America was approximately 50% in the first quarter, slightly down from around 51% in the fourth quarter of 2018. We aim to reach a worldwide NPS of 60% or greater by the fourth quarter of 2019. Regarding tariffs, the 10% tariffs from Section 301 became effective in September 2018, affecting our microinverters and accessories. We have been sharing these cost increases with our customers, while also executing a plan to mitigate the tariffs by expanding our manufacturing agreement with Flex in Mexico beginning in the second quarter. We expect to start shipping from the Flex Mexico facility this quarter. Looking at our regional performance, our U.S. and international revenue mix for the first quarter was 78% and 22%, respectively, with strong demand across all regions, although all experienced component supply shortages. In the U.S., revenue was up 9% sequentially and 80% year-over-year, driven by positive reception of our IQ 7 product family and growth in our customer base. The revenue included shipments of IQ 7XS microinverters to SunPower. In Europe, revenue dropped 11% quarter-over-quarter but was up 2% year-over-year. This growth was hindered by component shortages, yet we managed to satisfy customer demand through channel inventories. We anticipate supply increases in the second quarter will help replenish inventories and meet growing demand in this region. Europe is a key area for expansion, particularly since IQ 7 has been well-received, especially for small systems. In the APAC region, first-quarter revenue increased by 84% sequentially but fell 54% year-over-year, following previous inventory challenges we have since addressed. We remain optimistic about future growth in this region. Meanwhile, in Latin America, revenue rose by 78% sequentially and 16% year-over-year, with steady growth in Mexico, a significant market for us. We are also collaborating with some North American customers regarding their ITC Safe Harbor opportunities. Although it’s early for volume forecasts, we expect to have more information in our next earnings call. We aim to be prepared with adequate capacity to support these opportunities. To tackle component shortages, we have signed long-term contracts for high voltage power transistors and expect enhanced supply starting as soon as this quarter, with the majority coming in the latter half of the year. We anticipate having the capacity to produce 2 million microinverters by the fourth quarter of 2019, which should help reduce lead times closer to our target of 6-8 weeks. We are focusing on four avenues for profitable top-line growth, which we have detailed in earlier calls. The first is the regional expansion of IQ 7. About 94% of our microinverter shipments in the first quarter were IQ 7, up from 84% in the previous quarter, with a goal of completing this transition by the end of Q3. The second avenue involves the introduction of high-power, high-performance products. We launched the IQ 7A family of high-power microinverters for modules up to 450 watts DC. This product is our most powerful microinverter yet, capable of delivering 366 watts AC at an average CEC efficiency of 97%. Significant volumes of IQ 7AS were shipped to SunPower in the first quarter for integration into their new AC modules. The third avenue is our AC modules. We had fewer shipments of IQ 7XS microinverters to SunPower compared to the last quarter as we worked to ensure a smooth transition to the IQ 7XS model. We expect an increase in shipments in the coming quarters. The N330E Panasonic AC modules equipped with our IQ 7XS microinverters became available in March 2019, merging Panasonic's high-efficiency HIT solar panels with our reliable microinverters. A significant driver of our top-line growth is the Ensemble “always on” Solar and Storage technology, which integrates energy generation with our grid-agnostic IQ 8 microinverter, energy storage via the Encharge battery, communication and control elements, and IoT Cloud software. We plan to introduce the Ensemble 1.0 solution by the fourth quarter of 2019, focused on residential energy storage in North America. The Encharge modular battery design will provide flexibility and scalability for installations, while the Automatic Transfer Switch enables homes to operate independently from the grid in case of outages. We anticipate further enhancements with Ensemble 2.0, which will allow for new IQ 8 PV installations and the next generation of the Automatic Transfer Switch. We aim to continuously deliver added value to our partners and customers with each new Ensemble release. We are close to completing our requirements for the off-grid IQ 8 microinverter solution and expect to ramp production soon, after a brief delay caused by software changes. We also anticipate the final milestone payment of approximately $675,000 this quarter. In summary, our priority is to increase profitability each quarter and enhance shareholder value. In the short term, we are focused on expanding and optimizing our supply chain to meet additional demand while ensuring a remarkable customer experience. In the long term, we aim to innovate our products to boost revenue potential significantly through Ensemble-based home energy management systems. With that, I will hand over the call to Eric for his review of our financial outcomes.

Thanks, Badri. I will provide more details related to our first quarter of 2019 financial results as well as our business outlook for the second 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 to GAAP financial measures in our earnings release posted today, which can also be found in the Investor Relations section of our website. Total revenue for the first quarter of 2019 was $100.2 million, an increase of 9% sequentially and an increase of 43% year-over-year. We shipped approximately 306 megawatts DC in the first quarter of 2019, an increase of 19% sequentially and an increase of 71% from the year-ago quarter. The megawatts shipped represented approximately 976,000 microinverters, approximately 94% of which were IQ 7. Both IQ 6 and IQ 7 represented 99% of Q1 microinverter shipments. I am pleased to report that since inception, we have now shipped more than 20 million microinverters globally. Non-GAAP gross margin for the first quarter of 2019 was 33.5%, compared to 30.7% for the fourth quarter. Even though we shared some of the expedite fees with our partners, component shortages continued to negatively impact our Q1 non-GAAP gross margin by approximately 280 basis points. Non-GAAP operating expenses were $22.3 million for the first quarter of 2019 compared to $19.7 million in Q4 and $17.7 million in the first quarter of 2018. As I mentioned last quarter, 2018 was our first year of SOX auditor attestation, and as a result, we incurred higher than expected expenses in internal audit plus additional consulting and advisory fees. These higher than normal expenses continued into Q1 2019. GAAP operating expenses were $26.2 million for the first quarter of 2019, compared to $23.2 million in Q4 and $20.8 million in the first quarter of 2018. The GAAP operating expenses for the first quarter included $3 million of stock-based compensation, $546,000 of amortization for acquired intangible assets, and $368,000 of restructuring expense. On a non-GAAP basis, income from operations was $11.3 million in the first quarter of 2019 compared to $8.6 million in Q4 and $861,000 in the year-ago quarter. This improvement in operating income is reflective of our continued improvements in operational excellence and continued product leadership. On a GAAP basis, income from operations was $7.1 million in the first quarter of 2019. On a non-GAAP basis, the net income for the first quarter of 2019 was $9.5 million compared to $5.1 million in Q4 and a loss of $1.3 million in the year-ago quarter. This resulted in basic earnings per share of $0.09 and diluted earnings per share of $0.08 in the first quarter of 2019, compared to basic earnings per share of $0.05 and diluted earnings per share of $0.04 in the fourth quarter of 2018. GAAP net income for the first quarter of 2019 was $2.8 million compared to $709,000 in Q4 and a loss of $5.2 million in the first quarter of 2018. This resulted in basic earnings per share of $0.03 and diluted earnings per share of $0.02 in the first quarter of 2019 compared to basic and diluted earnings per share of $0.01 in the fourth quarter of 2018. We are happy to report that this was the second quarter in the company's history that we achieved GAAP net profitability. Now turning to the balance sheet, inventory was $13 million in the first quarter of 2019 compared to $16.3 million in Q4 and $18.5 million in the year-ago quarter. We ended the quarter with 18 days of inventory on hand as of March 31, 2019, significantly below our target of 30 days and down from 23 days in the fourth quarter and also down from 32 days in the year-ago quarter. Although most of the inventory reduction was due to high demand constrained by component shortages, inventory management continues to remain one of our key cash management initiatives. We exited the first quarter of 2019 with a total cash balance of $78.1 million compared with $106.2 million in Q4. As previously discussed, we paid in full our high-interest-bearing senior secured term loan with Tennenbaum Capital Partners. The repayment included a principal amount of approximately $39.5 million plus accrued interest and fees. We generated $17.1 million in cash flow from operations and $16.4 million in adjusted free cash flow for the first quarter of 2019. Now, let's discuss our outlook for the second quarter of 2019. We expect our revenue for the second quarter of 2019 to be within a range of $115 to $125 million. Turning to margins, we expect GAAP and non-GAAP gross margin to be within a range of 32% to 35%. Note that our Q2 gross margin guidance includes a negative impact of approximately 250 to 350 basis points due to expedite fees resulting from component shortages. We expect our GAAP operating expenses to be within a range of $25 million to $27 million, including a total of approximately $4 million estimated for stock-based compensation expenses, additional restructuring and acquisition-related expenses, and amortization. We expect non-GAAP operating expenses to be within a range of $21 to $23 million. With that, I will now open the line for questions.

Thanks so much, guys. Can you talk a little bit about the operating leverage that you're seeing here? Are you expecting to hold your operating expenses flat here and see some additional leverage as you grow sales and revisit that 30-20-10 model or what can we expect going forward?

So, the framework that we are using, which is the 30-20-10 framework that we launched a year and a half ago, almost two years ago, remains in place as our baseline for operating in our business. Right? So, the operating leverage will be manifested over time. You can see that in the Q2 guidance; at the midpoint, we are already achieving some of that. By looking at the midpoint, it's about 80% of the OpEx of our revenue drive. I'll say that we continue making investments in critical areas such as sales and marketing and the investments associated with R&D for future product developments, which is part of what we do, which you see in leverage.

Okay. And then just on the battery product, can you talk a little bit about your expectations around pricing? How much that's moving around, how much visibility you have into that at this point? And then as well as the movement on LFP supply; we're certainly seeing some interesting movements in terms of cost structure there. And what are you expecting in terms of costs for acquiring those sales as you go forward and move into a little bit higher volume?

Colin, it's a little bit early, but I'll share some of our current insights. In general, if I take a look at the market pricing, the market pricing, not our pricing, for a battery system is usually ranging from $600 per kilowatt hour for the big guys, the tier 1 guys, to anywhere above $1,000 per kilowatt hour for the longer day guys. We will obviously price it appropriately taking the market dynamics into account. Regarding the cost structure of the sales, you asked, again, we are not going to break out the cost of battery cells, but we have partnered with one supplier from whom we are buying the ACB, meaning the 1.5 to 1.2 kilowatt hour battery, and they have given us extremely competitive pricing along with very high quality. We are in the process of signing an MSA with another very high-quality supplier with a great supply chain. So, those two will put us in a good position as far as both capacity and costs are concerned, and we expect to be very competitive.

Just related to SunPower, and I don't know if you're willing to break this out specifically, but I'm just curious maybe how that is trending versus your expectations. I guess what I'm getting at is, obviously a very strong top line quarter, and I'm wondering if that was a major component of the strength or if this is your underlying business. Then as we get into the back half of the year, are we going to layer SunPower's impact of the volumes on top of that?

The SunPower transition is going extremely well for us. They're a very important customer, and we will do whatever it takes to serve them well. Of course, when SunPower is ramping with the Enphase product, we had to work with them to ensure that the inventory position is right. Therefore, the numbers were a little bit lower in this quarter. But yes, we had extraordinary strength from all the customers as well. Even if we shipped less material to SunPower due to inventory reasons, we made it up with other customers. Moving forward, we should start seeing that business ramping in Q2 of '19, as we said before, so there's no change to what we were thinking.

You're making significant progress with other AC module customers. I'm curious about what the current trends are driving in terms of your existing and new AC module partners.

We started with AC modules in late 2017, and LG was the first AC module partner. We are thankful to them for that. Since then, we have learned a lot on AC modules. We have now started shipping AC modules only or the microinverters for AC modules to SunPower. We are also shipping microinverters for AC modules to Panasonic and Solaria. AC modules are a cornerstone of our innovation where we basically absorb a certain activity in the field in the factory. Because of that, we are able to reduce the installation time, improve logistics, and enhance quality. It's becoming steady growth. For example, in Europe, we are working with a couple of key module vendors to introduce AC modules. We will announce when we are ready and are also working with a few partners in APAC as well.

Maybe last one for me, and I don’t know if I missed this. Did you mention or did you give the number Q1 was constrained by on the components, and what that number looks like in Q2?

No, we have not broken out the numbers we were constrained by.

Congratulations, guys on the strong quarter and the guidance. Just the year, your strength you're seeing, I mean, is this tied to any one partner or customer? I know you're doing well in the U.S. and Latin America from a geography perspective, but what's driving some of this strength? Are you taking market share from other players? Could you just maybe give some color on the...

Actually, 18 months back, Enphase was in a very different place. The balance sheet was not in great shape, and the P&L was hurting. I think in the last 18 months, with the hard work of a lot of people, we basically turned the corner. Our balance sheet is very strong now, and we're starting to make money. A lot of customers who were kind of nervous at that time to do business with us are now coming back. Most importantly, our product innovation hasn't stopped even during the most difficult of times; we introduced IQ 6 and IQ 7. You know IQ 7 is a fantastic product - best in class in terms of the number of components, power, weight, and simplified cabling. Product innovation has really been the root cause of our success. That combined with great quality and customer service, coupled with a strong balance sheet, has led to a lot of customers coming back. The demand is broad-based and is coming from a lot of long-tail customers. We are also seeing tier 2 customers cropping up. The AC modules ramping up are another driver for growth.

Understood. Are you expecting to see this strength continue in the second half of the year as well? I'm trying to look ahead a bit. I'm not sure if you can share that information or if you have that level of visibility, but it seems likely that with Ensemble and other factors, you might be in a position to continue this trend sequentially into the fourth quarter.

Yes. It's too early, Amit, to talk about the guidance for the second half, but we feel good. We have a lot of positive things happening. Ensemble is going to get released in the fourth quarter, focusing on the residential storage market. We are excited about that, but we will take it one quarter at a time now.

Just maybe one last one, the expedite fees, now with Infineon coming online, is this now going away for us, or should we expect this to continue playing out a little bit more?

In the long term, you should always expect a little bit of expedite, which is 1% to 2%, but anything in the 3% to 4% range is egregious and needs to go away. It will probably go away early next year or maybe in the latter part of this year. Infineon is instrumental for us because we signed the contract with them; that ensures a steady stream of supply in the second half, with some starting in Q2. We expect to have some level of expedite always.

Let's try this again. Can you guys hear me okay? Oh, sincere apologies for the technical difficulties with my cell phone. But first question is on pricing, apologies if you've already talked about some of this, but we've heard that you may have raised prices by 5% on April 1. I just want to confirm that that's just for the U.S. business, and what percentage of the business does that apply to? And then looking forward, what's the outlook for pricing in general with the lack of entrance from competitors and the strength that you have now? What do you expect pricing to trend independently of tariffs as we go through the year? Thanks.

Yes, it is true. We did raise prices by 5% on April 1, correct in North America. Regarding the pricing trends, we see pricing to be stable right now. We are going to take it one quarter at a time, but right now we see pricing flat.

And I know you're not providing guidance for the back half, but I was wondering if you could provide some broad-brush strokes. So, specifically, you talked about being fully booked for Q2. Can you provide some indication about how much Q3 might be booked perhaps, talk about what the cadence of Q3 and Q4 might be?

Phil, unfortunately, I cannot break up numbers for Q3 and Q4, but I'll say the same thing I told Amit. We feel very good about our spot in terms of business. A lot of the strength is due to the long-tail tier 2 AC modules and our relationship with SunPower, typically. Historically, for the solar business, Q3 and Q4 are usually good, but you know, given the kind of business environment and conditions we are in, anything can change. We will take it one quarter at a time, but we feel good.

As for Q3 supply, how much of your U.S. demand do you think could be addressed by your Mexico facility? Are we looking at maybe 50%? I know you were starting in Q2 ramping up there but are we looking at a vast majority?

It's a little bit early, but let me tell you my line of thinking. We take all of the product qualifications seriously. The Mexico product will be treated like a new product. We will not release it until we are absolutely confident that it is as reliable and as high-quality as the China version. Therefore, we are going to not get ahead of ourselves. We are confident of getting the qualification done in this quarter. We will do a soft ramp initially, starting with a few customers and then introduce it on a broad scale. That's the perspective I can provide right now.

And one last housekeeping set of questions. Eric, this might be more for you as it relates to one-timers. You seem like a very clean quarter, but I wanted to just confirm, besides the air shipments, were there any one-timers in COGS? Were there any one-timers in revenue or in G&A?

Both exist; the only one that comes to mind for the little bit legacy of the SOX audit work that we started last year and finished with Q1 thinking, right? So, other than that on the OpEx front, it's pretty clean; rather, it is pretty straightforward.

Okay, great. Thank you, both. Congrats on the great quarter and the guide, and just development and progress in general. And I'll pass it on.

Thanks for taking my question. Just on the gross margin, can you talk about how much of the guidance includes the impact of component charges in the Q2?

Yes. As we stated in the script, the 32% to 35% gross margin guidance includes a 250 to 350 basis points impact from component charges.

Sorry for missing that earlier. And just on Safe Harbor, you indicated that we can probably expect more details in Q3, but based on your talk so far, what are customers looking for in the Safe Harbor? Is it generally the microinverters or are they looking for AC modules? Have they talked about using your warehousing capacity or anything else which we can learn on the next call with respect to this?

It's too early for us to be talking about the nature of the Safe Harbor right now. We know that our customers have a need, and right now it looks like it's going to be more of the microinverters, but we do not have the right details to share with you, and that will be available in the next three months. We'll share it with you eventually.

Thank you for your question. At the end of April, you'll have a capacity of 2 million units by Q4. You've shipped about 970 thousand so far, which means you'll have more than double the capacity in five months based on your plans. Can you provide more details about where the additional demand is coming from? How did you arrive at that number, and even if it's not bookings, is there any clarity on demand for that period, even though you're not officially guiding for it? Thank you.

So, Brad, you're right. We are planning for a 2 million unit capacity in Q4 2019. We are putting in place measures, and that's how you saw the Infineon press release, etc.; this will help us in terms of component shortages. The root cause of our profitable top line growth vectors is a clean balance sheet, a great P&L, and most importantly, our IQ 7 product. That product provides the highest quality and comes with a great PPM long-term target of 500 DPPM. This is driving strength across the board. Enphase primarily focuses on long-tail customers because we think we have a great value proposition for them. They tend to want high-quality products and customer service. The first call resolution is super important for them. We are seeing a lot of strength across long-tail and tier 2 customers as well.

Do you have a sense for what your market share would be? Let's say you were to ship all of that 2 million capacity. There are some variations in the market share numbers that you see out there. But if you got to that point, at some point in time, do you have a sense of what the market share would be?

I'm not going to speculate about market share because that involves knowing the total available market, and I don't really know what the total available market will be for the latter half. Market share is important, but for me, it’s more of an output of a lot of things. The inputs are how well we can solve customer problems, our product ease of use, and how we can innovate to serve customer problems better than the competition.

Thanks for taking the question. I want to go back to the gross margin guidance for Q2. If the supply chain loosens, as you've said, and you're also going to benefit from the final partnership payment, which I suppose carries 100% margin, why wouldn't the overall margin actually improve in Q2 versus Q1? Because you're guiding could basically flat at the midpoint.

Pavel, the embedded range of 32% to 35%; number one. Second, the increased revenue number; as I said, some of the extra supply from supply agreements is trickling down into 2019, but most in the second half of '19. Q2 will still have expedite fees of approximately 250 to 350 basis points. There is already enough gross margin guidance.

Let me also ask about warranty obligations. Given that revenue is obviously increasing and your reference was up seasonally in Q1. Work obligations actually edged down in the quarter. Can you explain how that was?

Look, I mean we are running the company with a focus on quality. This started right from when we began. We learned that customer service and product innovation are the cornerstones of our business. Our microinverters have fewer components compared to traditional products, which leads to higher quality and lower defects. We've created a business process to identify failures and continuously improve quality. Our long-term target is 500 DPPM, and we're focused on achieving that.

Just one quick one; as the battery becomes a more needle-moving revenue driver, do you plan to eventually break that out from the microinverter megawatts?

I think it's a good question. I need to debate it with my CFO, but it may not be a bad idea to eventually do that.

Badri, just on the long tail/tier 2 customers, is this a reliable channel for growth? Is this the most sustainable, or is this something that has emerged now that could grow with you guys?

We have two customers that are definitely emerging, as they are moving from tier 3 or tier 4 to tier 2 and on the way to tier 1. Yes, they’re sustainable and have a long-term relationship with us. They helped us when we were down.

Thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you again on our call next quarter.