Enphase Energy Inc (ENPH) — Q1 2021 Earnings Call Transcript

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's first quarter 2021 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 first quarter ended March 31, 2021. During this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to Enphase Energy's expected future financial performance; the capability of our technology and products, including availability and features; our operations, including in manufacturing and customer service; the anticipated growth in our sales and in the markets in which we operate and target; and the capabilities of our installation partners. 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, 2020, which is on file with the SEC, and quarterly report on Form 10-Q for the quarter ended March 31, 2021, which will be filed during the second quarter of 2021. 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 statement as a result of new information, future events or changes in its expectations. Also, please note that the 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 first quarter 2021 financial results. We had a good quarter. We reported revenue of $301.8 million, shipped approximately 2.45 million microinverters, achieved non-GAAP gross margin of 41.1% and generated strong free cash flow of $81.5 million. We exited the first quarter at approximately 41, 14, 27. This means 41% gross margin, 14% operating expenses and 27% operating income, all as a percentage of revenue on a non-GAAP basis. As a reminder, our baseline financial model is 35, 15, 20. Eric will go into details about our financials later in the call. Let's discuss how we are servicing customers. Our Q1 Net Promoter Score worldwide was 63% compared to 62% in Q4 and our North America Net Promoter Score was 69% compared to 68% in Q4. Our average call wait time in Q1 was more than 5 minutes as we onboarded new installers and fielded calls related to our storage systems. We are working diligently to bring wait times down under a minute. We also expect our 24/7 global customer support to help reduce wait times. The round-the-clock support is another step forward towards delivering an outstanding customer experience and will supplement the Enphase Community and training platforms. Let's talk about manufacturing. As we discussed in the last call, the semiconductor supply chain is under stress. In Q1, we experienced constraints on the supply of ASICs and AC FET drivers, which limited shipments. Our contract manufacturing facility in Mexico shipped more than 900,000 microinverters. Our contract manufacturing facility at Salcomp, India shipped nearly 500,000 microinverters. We are very pleased with the production ramp, product quality and manufacturing cost of this fully automated facility in India. Given our strong demand, we are expanding manufacturing capacity in Mexico and India further. In Mexico, we are improving operational efficiency and expect to reach quarterly capacity of 1.5 million microinverters. At our facility in Chennai, India, production is around the clock, bringing quarterly capacity to 700,000 microinverters from one manufacturing line. We have already purchased equipment for the second manufacturing line and expect to begin ramping in Q3. Looking to Q2, our shipment volumes will be constrained by semiconductor component availability. We have qualified new suppliers for our ASIC and AC FET drivers, which will result in increased shipments for Q2 compared to Q1. But the ramp from these new suppliers is slower than what we had anticipated before. We expect these component constraints to remain for the rest of the year. In terms of our Enphase Storage Systems, we shipped 42 megawatt hours in Q1, representing a sequential increase of 30% and in line with our expectations. Let's now move to the regions. The US and international revenue mix for Q1 was 82% and 18%, respectively. The US market was quite strong in Q1 despite typical seasonality. US revenue was up 14% sequentially. We achieved very good microinverter sell-through from our distribution partners. I am proud of our operations team for navigating the supply constraints and ensuring customers had continuous supply of product. With higher microinverter shipments in Q1, our channel inventory is better but still tight. With Q2 through Q4 being seasonally robust quarters, we expect the channel tightness for microinverters to continue. In Europe, we reported record Q1 revenue. Revenue increased 17% sequentially. We saw strength in the Netherlands and France while building on new markets such as Germany, Poland, and Austria. Our AC module strategy is also gaining momentum in Europe. We expect to introduce Enphase Storage Systems for the European market in the second half of 2021, first in Germany and then in Italy, adding yet another growth driver. I'm very pleased with our performance in Europe. In Australia, we had record revenue and record installer count. Q1 revenue was up 58% sequentially. The strong growth of the Enphase Installer Network or EIN and rapid market penetration of our IQ 7A product contributed to our success. In addition, we are focusing both on installer and homeowner experience, launching 24/7 customer support, conducting technical training, and collaborating on branding initiatives with installers in Australia. We expect to introduce Enphase Storage Systems to Australia also in the second half of 2021. In Latin America, Q1 revenue was down a little 33% from the prior quarter, which had benefited from large storage orders. Puerto Rico continues to be a solid market in terms of both microinverters and storage. We are also making plans to enter the Brazilian residential solar market, which is expected to be over 1 gigawatt this year. We have already hired Marco Krapels, an experienced sales leader to accelerate our entry into Brazil. Now that we have covered the region, let's discuss the overall bookings for Q2. Now once again, our customer demand for Q2 significantly exceeds the higher end of our guidance range. We remain supply constrained for Q2, as I said before. The component availability is improving but not at the rate of growth in demand. While it is very early to talk about Q3, our customer bookings are quite higher than what they would normally be at this time of the quarter. We are planning for much higher capacity in Q3 for both microinverters and storage. We're obviously pleased with the overall demand but we are cautious about the supply situation, which is not very predictable today.

Thanks, Badri, and good afternoon, everyone. I will provide more details related to our first quarter of 2021 financial results, as well as our business outlook for the second quarter of 2021. We have provided a reconciliation of these non-GAAP to GAAP financial measures in our earnings release posted today, which can also be found in the IR section of our website. Total revenue for Q1 was $301.8 million, representing an increase of 14% sequentially. We shipped approximately 830 megawatts DC of microinverter and 42 megawatt hours of storage systems in the first quarter, equivalent to 16.1 megawatts of power. Non-GAAP gross margin for Q1 was 41.1% compared to 40.2% for Q4. The increase was driven by disciplined pricing and cost management. GAAP gross margin was 40.7% for Q1. Non-GAAP operating expenses were $43.7 million for Q1 compared to $34.2 million for Q4. The sequential increase was primarily due to R&D investments, increased hiring, payroll tax associated with employee stock vesting and first-time consolidation of Sofdesk operations in late January. GAAP operating expenses were $61.6 million for Q1 compared to $42.8 million for Q4. GAAP operating expenses for Q1 included $13.9 million of stock-based compensation expenses and $4 million of acquisition expenses and amortization for acquired intangible assets. On a non-GAAP basis, income from operations was $80.2 million for Q1 compared to $72.4 million for Q4. On a GAAP basis, income from operations was $61.4 million for Q1 compared to $79.1 million for Q4. On a non-GAAP basis, net income for Q1 was $78.7 million compared to $71.3 million for Q4. This resulted in diluted earnings per share of $0.56 for Q1 compared to $0.51 per share for Q4. GAAP net income for Q1 was $31.7 million compared to GAAP net income of $73 million for Q4. GAAP diluted earnings per share was $0.22 for Q1 compared to diluted earnings per share of $0.50 for Q4. The GAAP results in the first quarter included a non-cash loss of $56.4 million on the partial settlement of convertible notes due 2024 and 2025 or approximately $0.40 on a per-share basis. Now turning to the balance sheet and the working capital front. Inventory was $34.9 million at the end of Q1 compared to $41.8 million at the end of Q4. The sequential decrease in inventory was driven by an increase in customer demand coupled with supply constraints. Days of inventory outstanding decreased to 18 days compared to 27 days in Q4. This sequential decrease was driven by the lower average inventory balance and higher shipment volumes. Our target is 30 days, but we were hampered by supply cost trends. Accounts receivable were $236.1 million at the end of Q1 compared to $182.2 million at the end of Q4. The sequential increase was due to the higher revenue in Q1 and shipments being weighted to the second half of the quarter. DSO of 56 days increased from 50 days in the prior quarter due to the timing of shipments. We exited Q1 with a total cash balance of approximately $1.5 billion compared to $679.4 million for Q4. The cash balance includes net proceeds of approximately $1.2 billion from the convertible notes issuance in May 2021, which are partially offset by $304.8 million paid in principal amounts for the partial repurchase and conversions of the convertible notes due 2024 and 2025 and $65.4 million paid for the call spread on the new convertible notes issuance. We did not make any share repurchases against our $200 million share repurchase authorization. In March, we issued green convertible notes in two tranches for total gross proceeds of approximately $1.2 billion. Both tranches have a zero coupon. The five-year tranche due 2026 raised gross proceeds of $632.5 million. With a 70% conversion premium, these notes are in the money at the share price of approximately $307. The seven-year tranche due 2028 raised gross proceeds of $575 million with a 57.5% conversion premium. This tranche is in the money at the share price of $285. Concurrent with the notes offering, we entered into a call spread overlay, which effectively increased the overall conversion price to about $398 per share. The terms of this capital raise were some of the most favorable to an issuer in history. We have a very strong cash position on a business that generates healthy free cash flow. We will invest in the business through organic and inorganic activities. We have a capex light business model, which provides for continued investment in new product development, new market entry and marketing to build our brand awareness with homeowners. On the acquisition front, we have an active pipeline and we are careful to only pursue deals with the right strategic and cultural fit, while meeting our return hurdles. In Q1, we generated $75.8 million in cash flow from operations and $81.5 million in free cash flow. Capital expenditures were $9.9 million for Q1 to increase manufacturing capacity for both microinverters and storage and costs related to enlighten software app development, corporate website development, and office space expansion.

Let's discuss the outlook for the second quarter of 2021. We expect our revenue for the quarter to be within a range of $300 million to $320 million. We expect GAAP gross margin to be within a range of 37% to 40% and non-GAAP gross margin to be within a range of 38% to 41%, which excludes stock-based compensation expenses. We expect our GAAP operating expenses to be within a range of $70 million to $73 million, including a total of approximately $17 million estimated for stock-based compensation expenses and acquisition-related expenses and amortization. We expect non-GAAP operating expenses to be within a range of $53 million to $56 million. All guidance estimates include the contribution from both Sofdesk and DIN for the entire quarter. Let me provide some additional color on a few topics. First, given the component supply constraints, we are expediting components and finished goods in Q2 to ensure customers have an adequate supply of our products. Even as component availability starts to improve this quarter, we must rush to get those components into final products into our customers’ hands. As a result, our GAAP and non-GAAP gross margin guidance incorporates a material sequential increase in expedite expense. While we expect Q2 to be the peak, logistics costs will likely remain elevated for the rest of 2021 due to the semiconductor supply chain constraints. Next, I would like to touch upon our OpEx guidance. Our non-GAAP operating expenses are increasing from Q1 to Q2 due to hiring to support our growth plans, the consolidation of acquisitions, and necessary investments in software, branding and the development of IQ 9 and IQ 10 microinverters. It is possible that our OpEx may be slightly above our 15% target at times, but we'll still expect to comfortably exceed our baseline financial model target of 20% operating income. Regarding the two acquisitions, we do have the operating expenses of those businesses, but we also include accruals for the payment of deferred cash consideration. These are cash expenses, which is why we included them in non-GAAP guidance, but there are nonrecurring in nature beyond the specific earn-out periods for each acquisition. For Q2, accruals for deferred consideration are expected to be approximately $3.5 million. With that, I will now open the line for questions.

I have a question, first and foremost, around the component and technical difficulties. So you talked about improving channel inventory in Q1, but the constraints remain. And it seems like that's weighing on shipments for both solar and storage. Can you talk about when you expect those new suppliers to really help ease the component constraints, would that be more into the back half or would that not really be until 2022? And just how much lower is that going to drive channel inventory relative to the 8-week target?

Let me clarify a few points. The constraints are specifically related to solar microinverters. We are increasing our capacity for solar microinverters and demand continues to rise, but supply is not keeping pace due to semiconductor component limitations. These limitations stem primarily from two components: the ASIC chip and the AC FET driver that operates the gate of the 600-volt transistors. We have started working with multiple suppliers for both components. Previously, we had two suppliers for AC FET drivers, and we will now increase that to three. For the ASIC chip, we were relying on one foundry, but we plan to qualify an additional foundry. However, the demand for the second quarter is extremely high, and we anticipate a similar situation in the third quarter. Despite an increase in available supply compared to the previous quarter, it remains insufficient to meet our demand on the solar side. On the storage front, we shipped 32 megawatt hours in the fourth quarter and increased that to 42 megawatt hours in the first quarter, reflecting a 30% growth. We are making significant strides in storage, especially by partnering with our long-tail installers. We have trained 1,776 installers, representing 1,035 unique companies. These installers are now engaging with us on the solar side and have started purchasing storage solutions. We also initiated weekly roundtable discussions with these installers to address their challenges. However, we recognize that storage remains a developing business for these installers. They often need to make multiple visits to each home, as it is still a new offering. The system sizing tools are not fully efficient yet, and we aim to improve this with our Sofdesk acquisition. Each installation has become a custom job, and we are trying to standardize processes, like load control, to enable full home backup rather than just partial backup. Homeowners are now more involved, leading to increased customer service demands for installers. Additionally, there are permitting delays as this product is still unfamiliar to many jurisdictions. Enphase is equipped to address these challenges, providing excellent customer service and deploying field service teams to assist installers. We've acquired a company focused on solar and storage design software and another to streamline permitting services. We have all the necessary resources to support our installers; however, this will take time. Our growth remains steady—we grew 35% from the third to the fourth quarter and 30% from the fourth quarter to the first quarter. We expect modest growth from the first to the second quarter, but we are confident we are on the right path. Moreover, expanding internationally will further stimulate demand. We are committed to supporting long-tail installers globally and will soon introduce products in Europe in the second half of the year, followed by Australia later on. We are also enhancing our marketing efforts. Last quarter, I mentioned our Chief Marketing Officer, and we plan to significantly boost our promotional and branding activities, explore various channels, and collaborate with loan providers and offer round-the-clock support. We believe these tools are essential to facilitate steady progress in storage each quarter. While this is a lengthy response, I hope it addresses your question.

Just as a follow-up question, specifically on storage. I believe you provided the guidance of 40 to 50 megawatt hours in Q2, is that right, relative to 42 megawatt hours in Q1? Can you just talk about expectations into the back half? Seemingly, I wasn't sure if there was some sort of chip constraint for the microinverters that would be using the storage, too, given the same product there. But could you just talk about expectations at the back half and perhaps bring additional suppliers and what that means for capacity into 2022?

Well, like what I said, we expect to make steady progress on storage every quarter. We gave you guidance for Q2. Q3 will be steady progress on top of that. In terms of constraints on the storage systems, it's really, yes, microinverters are also included, yes, in the storage system. Every 10 kilowatt hour battery has 12 microinverters. But in the big scheme of things, it's a small number relative to our overall demand. So we don't expect that to play a big deal there. And we are comfortable with the capacity that we have on the storage side. And like I always said, we will bring in additional suppliers in 2023. We have two suppliers today.

Maybe just big picture. Last quarter, Badri, Eric, you guys said that you sort of had visibility that the supply chain constraints, which everybody has been experiencing through the year, for you, you felt like April, you called out the month of April as being a potential having line of sight that things would start to ease around then. Now you're saying you're expecting the supply constraints on the solar side to persist through the year. So just a simple question, kind of what's changed between then and now? Did you misread the market? Or what's kind of changed between the April view and now seeing this impact through the year? And then I had a follow-up.

The situation is straightforward. Supply is quite unpredictable while demand continues to rise. We are increasing our supply each quarter and enhancing our capacity for Q3 and Q4. However, if you were to ask me how confident I am about our supply perspective today, I would say it's challenging due to the unpredictable nature of the situation. We often have to navigate around decommits. I'm collaborating directly with the CEOs of all three companies, particularly regarding the AC FET drivers. The global situation is tense, and I don't believe it solely affects us. Our architecture relies on semiconductors, so the supply is what it is. On the positive side, demand has significantly increased for Q2 and Q3, further straining the supply situation. This is a change from our previous call, and it reflects the current reality.

And so, I mean, it sounds like what you're saying is supply continues to be unpredictable, which makes sense, and then demand has actually probably gotten better. So follow up I had you is just maybe a little bit of numbers or quantification. This is the second quarter in a row where you're saying that you have bookings in excess of your guidance. You're basically undershipping demand. So maybe just a two-part question here on the quantification. Can you give us some sense of how much you are undershipping demand? Would guidance have been $10 million, $20 million, 10% higher? Just any sense on that? And then Eric also made some mention around margins. Q2, you're going to have some peak pressure from a freight cost perspective, but it doesn't get worse. What sort of margin impact is that in the quarter, 100 basis points, 200 basis points? It doesn't sound like it eases right away, but just trying to get a sense of what that is. And then just lastly, if you're seeing some of these cost increases, the tightness, are you raising prices? Are you having those negotiations or discussions with customers? And if not, given your market share position and how critical you are to your customers, why not potentially start to raise prices?

You asked me for some numbers. I'm not going to say exact numbers, but I'm going to say one thing, that the demand is higher than all the numbers that you quoted, which is the good news. The second question, what is the second question? The third question, pricing. I'm not changing pricing. The second question on gross margin. Our gross margin guidance, non-GAAP is 38 to 41. We are not going to exactly break out what we did for expedite, but it’s a big number. You expect that because when you have supply chain problems, the factories are running hand-to-mouth. The factories are running hand-to-mouth, there is no time to put product on a boat. The only way we can get product to customers is air shipments. Air shipments per unit pricing to put a microinverter on the plane are enormous. It's usually 10 times or 15 times the price that it takes to ship on the ocean as expected. And these are all not new. They are standard. So hopefully, I gave those numbers.

On the margins, Brian, regarding operations, we need to manage with expedites for a while. However, we have a predictable approach to managing our margins. In terms of cost reduction and pricing negotiations, both short and long term, I don't foresee any issues. Looking at the midpoint of our guidance, which has been stable, we just need a bit more time to address the supply challenges in the industry. Since April, as Badri mentioned, things have changed significantly. The predictability of inventory levels at contract manufacturing and supplier levels has been impacted due to a V-shaped recovery, leading to greater variability. This has made it harder for them to forecast their commitments. That's the situation we're in. Nevertheless, I feel confident about our margins; we have a profitable business, and we're focused on our objectives.

Just as a follow-up on the chip shortage. I know this was partially asked earlier, but just to put a finer point on it. Of the three companies that you're working with, Badri, are they giving you a sense for, hey, we think we can resolve this by Q1 of '22, for example, or is the situation even for them very unclear? So is this potentially a problem that could persist, for example, through a bunch of 2022?

Yes, I mean, like I said, I don't have that much visibility right now, but I do expect the supply situation to get better every quarter, especially because we have bought on a third supplier and that third supplier will eventually start ramping. So I do expect Q3 to get better. I expect Q4 to get even more better. But will that match our demand? I cannot predict it now.

So my first question is around just the rollout of IQ 8. I was just wondering how long do you think it would take or it could take to completely transition from selling majority IQ 7 to selling a majority IQ 8, a year or two years? Just some rough numbers would be great.

Yes, IQ 7 took four quarters. So IQ 8 will take a similar time. And with the supply constraints, maybe you can add one or two quarters more, four to six quarters. The reason why we are doing it is to reduce the footprint, to increase power, to increase efficiency and drop costs. I'll give you a quick example. Today, we have 4 AC high voltage FETs. They are the 600 volt FETs, 4 600 volt FETs. Then we have two AC FET gate drivers, which have faced all the shortages. Those two AC FET gate drivers are driving the four 600 volt FETs. We have four plus two, six components there. With gallium nitride, what we could do is to collapse two of those 600-volt FETs into one and we could integrate that AC gate driver also into the same package. So six discrete components will go to two discrete components. Of course, the cost of gallium nitride will be a little bit higher, but the integration capability is very powerful. If we can optimize that properly, there are massive wins for us. It will help us to increase the power of the microinverter while keeping the cost down, while keeping the footprint down while keeping the economics intact. We are working with multiple companies, and it is R&D. It's going to take us 2022 or 2023 to get an IQ 10 product, but IQ 9 will be a little bit before that; but it's R&D.

Just one from me. I think we heard from a market participant yesterday in moving to almost an exclusively bundled model for solar and storage. I think the dynamics there sound somewhat company specific, but just wanted to ask. Are you guys seeing any signs of that in your installer network? And do you guys see it as an opportunity for Enphase on the market share side for either a standalone storage product or otherwise?

I mean, that's the name of the game. Storage by itself, some people say it makes sense. But in order to have a regenerative system that can function off grid, you want solar as well. So solar plus storage is a big deal. That is precisely why we are focused on our long tail installers because they already sell in-phase microinverters for a living. Now if they start selling Enphase storage systems and more actually home energy management systems, which are solar plus storage systems that would be a big win. All our efforts are taking our Enphase Installer Network and even bigger than that, taking our long tail installers, which is much more than the Enphase Installer Network, and working really closely with them, training them properly, removing their installer pain points, and helping them with 24/7 support, and field service so that they can ramp solar plus storage with us, that's the opportunity.

When you expanded the installer network into Europe, which as one of the other questions asked about has much lower soft costs. What's the main selling point of joining that network for an installer in, for example, the Netherlands or Belgium?

First of all, the installer networks in Europe are going to be multiple of them, because Europe, you cannot generalize Europe. I think like what you said, in the Netherlands, our installer network there, they need something else versus the installer network in Germany versus the installer network in the UK versus the network in Spain versus the network in Poland. The important thing is if they can have one platform on which they can get all kinds of services, that's extremely important for them. New product availability is extremely important for them. They want to differentiate themselves from other installers. They want nothing but the best. Like that, I could go on. There are multiple services that they need. Depending upon the tier of the installer, we have three tiers, platinum installers, gold installers, and silver. The way we categorize these three tiers is pretty simple, based upon their quality and based upon how they rate on customer experience that's measured, not by us, but by the homeowners. We rate it like that and then make it attractive for platinum installers to be with us in terms of pricing, in terms of services we do. We make sure there's healthy competition there. It's a much broader strategy and we are very cautious in introducing installer networks to every region without adequate planning. So last year, we spent the entire last year introducing the installer network for the US and Australia. This year, we just started in Europe and will introduce in India as well, but a lot more to come in Europe. I hope to introduce offerings where the homeowner can take advantage of all the features we're working on. And I've discussed here how they can save on energy costs via load control and generator compatibility by using these systems more effectively. There are a lot of benefits packaged in our offerings that will be hard to compete against if we do it right. We're making sure we come to the market fully prepared. Thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you again next quarter. Bye.