Enphase Energy, Inc. (NASDAQ:ENPH) Q3 2023 Earnings Call Transcript

Enphase Energy, Inc. (NASDAQ:ENPH) Q3 2023 Earnings Call Transcript October 26, 2023

Enphase Energy, Inc. misses on earnings expectations. Reported EPS is $1.02 EPS, expectations were $1.03.

Operator: Good afternoon, and welcome to Enphase Energy’s Third Quarter 2023 Financial Results Conference Call. [Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Zach Freedman. Please go ahead sir.

Zach Freedman: Good afternoon, and thank you for joining us on today’s conference call to discuss Enphase Energy’s third quarter 2023 results. On today’s call are Badri Kothandaraman, our President and Chief Executive Officer; Mandy Yang, our Chief Financial Officer; and Raghu Belur, our Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September 30, 2023. During this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to our expected future financial performance, market trends the capabilities of our technology and products and the benefits to homeowners and installers; our operations, including manufacturing, customer service and supply and demand; anticipated growth in existing and new markets; the timing of new product introductions and regulatory and tax matters.

These forward-looking statements involve significant risks and uncertainties, and our 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 our most recent Form 10-K and 10-Qs filed with the SEC. We caution you not to place any undue reliance on forward-looking statements and undertake no duty or obligation to update any forward-looking statements as a result of new information, future events or changes in 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. We have provided a reconciliation of these non-GAAP financial measures to GAAP financial measures in our earnings release furnished with the SEC on Form 8-K which can also be found in the Investor Relations section of our website.

Now, I’d like to introduce Badri Kothandaraman, our President and Chief Executive Officer. Badri?

Badri Kothandaraman: Good afternoon and thanks for joining us today to discuss our third quarter 2023 financial results. We reported quarterly revenue of $551.1 million, shipped approximately 3.9 million microinverters and 86 megawatt hours of batteries and generated free cash flow of $122 million. Approximately 86% of our Q3 microinverter shipments were IQ8. We exited the third quarter at 48% gross margin, 18% operating expense and 30% operating income, all as a percentage of revenue on a non-GAAP basis and including the IRA benefit. Mandy will go into our financials later in the call. Let’s now discuss how we are servicing customers. Our worldwide NPS was 77% in Q3, compared to 74% in Q2. Our NPS in North America was 78%, compared to 77% in Q2.

Our average call wait time was 1.3 minutes, compared to 1.1 minutes in Q2. We made significant progress on root cause fixes of some customer issues and expanded our field service teams globally. Let’s talk about operations. In general, the overall supply environment for microinverters and batteries is quite stable right now. Let’s cover microinverters specifically U.S. manufacturing. We began manufacturing at Salcomp’s facility in Arlington, Texas during third quarter. We shipped approximately 531,000 microinverters to customers in Q3 from our three contract manufacturers in the U.S. Flex in South Carolina, Foxconn in Wisconsin, and Salcomp in Texas. We expect to ship approximately 1 million microinverters to customers from our U.S. manufacturing facilities in Q4.

Let’s talk about batteries. For IQ batteries, we have two cell pack suppliers, both of which are in China. We have a manufacturing capacity of 300 megawatt hours per quarter, positioning us well to ramp up in 2024. We are looking at bringing manufacturing of IQ batteries into the U.S. by the middle of 2024. Let’s now cover the regions. Our U.S. and international revenue mix for Q3 was 64% and 36% respectively. In the U.S., our revenue decreased 16% sequentially and 22% year-on-year. The overall sell-through of our microinverters was down 12% in Q3 compared to Q2. On the other hand, the sell-through of our IQ batteries in the U.S. was up by 34% in Q3 compared to Q2. In Europe, our revenue decreased 34% sequentially and increased 26% year-on-year at healthy gross margin.

The sell-through of our microinverters in Europe was also down 35% in Q3 compared to Q2. The sell-through of our IQ batteries in Europe was down by 14% in Q3 compared to Q2. We are now shipping IQ microinverters and batteries into many countries in Europe. We recently entered U.K., Sweden, Denmark, and Greece markets with both IQ8 microinverters and IQ batteries. Combined, these new markets represent more than 1.5 gigawatts of residential solar opportunity with countries like the U.K. having a healthy battery attach rate of 30%. I’ll provide some brief commentary on Australia. Our revenue in Australia more than doubled year-on-year. We are quite pleased with the launch of our Enphase Energy System. It is state-of-the-art, powered by IQ8 microinverters plus a third-generation battery.

Let me comment on the rest of the world. In Brazil, we launched our IQ8P microinverters, 480 watts AC, the highest power microinverters that we have. We also launched the Solargraf software platform and have good feedback from installers there. In addition, we started shipping both the 384 watts IQ8 HC and the 480 watts IQ8 P microinverters into India to support high-powered solar panels. Let’s now talk about Q4 guidance. We are guiding revenue for Q4 in the range of $300 to $350 million. This reflects approximately $150 million of channel inventory correction in the U.S. and Europe. In other words, we are under shipping to the end market demand for our products by approximately $150 million. We anticipate under shipment will continue in Q1 and expect our channel inventory to normalize in Q2.

Of course, we are conservative and are assuming the demand picture is unchanged from the current level. So what has changed since 90 days ago when we told you that the inventory levels would normalize by the end of Q3? We have seen a substantial demand reduction in Europe. We’ve also seen the U.S. market continue to fall, driven by California. When the demand falls, we think more decisive inventory correction becomes necessary. We are being conservative in our assumptions of no demand recovery until Q2 in this framework. So that explains the guidance. Despite the large reduction in Q4 guidance, we are maintaining our non-GAAP gross margin above 40% in our guidance without the IRA benefit. We aren’t making any broad-based pricing changes at this time on microinverters, and we have already made the necessary changes on batteries before.

Our pricing and operations team are doing an excellent job of managing pricing and reducing costs. Let’s discuss some market trends. I’ll give you a little more than usual color on markets. Let’s split the U.S. market by non-California states and California. For non-California states, the sell-through of our microinverters was 4% lesser in Q3 compared to Q2. We see this business starting to stabilize given the weekly sell-through trends. In California, the sell-through of our microinverters was 25% lesser in Q3 compared to Q2 due to the NEM 3.0 transition. It will take a few more quarters for our installers to fully transition to NEM 3.0 and normalize sales to NEM 2.0 levels. Utility rates are continuing to move higher in California with one California utility recently requesting a 22% rate hike, assuming that even half of that rate hike is approved by the CPUC.

The payback period for an NEM 3.0 solar plus a battery system will become close to an NEM 2.0 solar only system. So that’s good. Let me say a few words about U.S. market share before I give more color on Europe. We see stable share today for our microinverters based on both internal as well as third-party data. Competition is not new for us. We have always relied on our differentiated technology with our distributed AC architecture, product quality, and customer service to win share. And we expect this to continue. We have many tools at our disposal, such as the installer services that we have bought. We made several acquisitions over time in the last couple of years, such as the software tool for design and proposal, the permitting tools, lead management, etcetera.

We have a lot of tools at our disposal to help our installers and our partnerships go a lot deeper in the downtown. Let’s talk about Europe demand a little bit. We are facing two challenges in Europe. And the situation has dramatically changed from the last quarter, from 90 days ago. We saw a much weaker demand recovery from summer. We also see a lot of distributors facing oversupply of solar equipment, particularly panels, leading to much more aggressive destocking. Despite this temporary weakness, we think that the pullback in Europe will be temporary as the fundamentals remain strong. And we are relatively underpenetrated in the U.S. We are entering lots of new geographies with our IQ8 microinverters and batteries. So we remain very bullish about Europe.

Let me spend a few minutes discussing our three largest markets in Europe, the Netherlands, France, and Germany in detail. In Netherlands, our largest European market, our Q3 sell-through was down 40% compared to Q2. This was our first sequentially down quarter in the last two years. Installers tell us that the customers’ fear of an export penalty and confusion around ending of the net metering has caused the market pullback. I was in Netherlands two weeks ago. I visited with our leading installers. I came away confident that this pullback will be short-lived. We think that the plan for net metering will be clarified after the country’s elections in November. The payback period are continuing to be attractive in Netherlands. In addition, total system solutions which includes batteries, solar and EV chargers are going to become the norm as dynamic tariffs become more prevalent in Netherlands.

We are well positioned to take advantage of these changes. In France, our Q3 sell-through was down 34% compared to Q2, driven by seasonality. We see potential for this market to rebound very quickly. We are already seeing that as utility rates recently moved higher and are expected to increase even more in early 2024. In Germany, our Q3 sell-through was down 32% compared to Q2. We saw strong sequential growth in installer count and activations and we are continuing to gain traction there. Let’s talk about our new products, IQ batteries. Our sell-through for batteries has been steadily increasing over the last couple of quarters. We are at an inflection point for our battery business. With our IQ battery 5P, we can deliver the best power specs and the best commissioning times of any Enphase battery till date at an industry-leading 15-year warranty and at the right price point.

The battery adoption rates are on the rise globally. We are well positioned to grow battery sales throughout 2024. And we are working on entering even more countries in Europe and Asia in the next few months with our IQ battery 5P. In addition, we expect to introduce our fourth-generation battery in the middle of 2024. That will have a much reduced form factor and a reduced cost structure. As previously discussed, we have entered many new markets with the IQ8 family of microinverters. We plan to enter many more new markets in Europe and Asia in the next several months. Let’s talk about our latest microinverter for the residential segment in emerging markets. I did mention this before. This is the IQ8P microinverter, our highest power microinverter till date, 480 watts of AC power.

That can support solar panels up to 650 watts DC for Brazil, India, South Africa, Mexico, Spain, and other emerging markets. We have started shipping the product into Brazil, South Africa, and India in Q3 and are on track to start shipping in Mexico and Spain in Q4. The other variant of the IQ8P microinverter with a new three-phase cabling system is well suited for small commercial solar installations ranging from 20 to 200 kilowatts. We are doing beta installations as we speak there and we expect to release the product this quarter into the U.S. market. We are very bullish about the small commercial solar business where we believe we can add value to our business owners and installers with our quality and good customer experience. Let’s cover EV charging.

We shipped over 3,500 chargers in Q3 compared to over 6,600 chargers in Q2. We launched our IQ smart EV chargers in the U.S. just a few days ago, both U.S. and Canada, actually. The IQ EV charger is Wi-Fi enabled. It includes smart control and smart monitoring capabilities. It seamlessly integrates into our solar and battery systems to help homeowners maximize savings, for example, by directly charging from solar energy only. That’s called green charging. We are also working on developing IQ EV chargers for many countries in Europe and we expect to introduce them in the middle of 2024. Let’s now discuss our installer platform briefly. Solargraf, our cloud-based design proposal software platform, now provides M3.0 functionality for solar and battery systems in California.

We are now offering 3D and shading features and continue to make progress on our new features and functions. The software platform is now available to installers in U.S., Germany, Austria, and Brazil. We expect to make this software release as part of our standard offering to any country that we enter. Let me conclude. We are managing through a slowdown in our overall demand. In the U.S., it is due to high interest rates and M3.0. In Europe, it is due to broad macroeconomic conditions. Despite this, we are very bullish about our business long-term. We see several positive drivers that will accelerate adoption such as the 30% ITC tax credit in the U.S., rising utility rates globally, increased grid instability also globally, climate change, and of course, increasing EV adoption worldwide.

We have no doubt that these will drive meaningful solar plus battery growth. Our strategy is very clear. We manage for the long-term. We are doubling down on our relationships with our customers during these times. We are driving down installation times and investing in our customer service teams. We are also strongly investing in innovation. We are working on IQ9 and IQ10, our next two generations of microinverters, as well as the next two generations of batteries. We are also rapidly expanding worldwide with systems comprising of IQ8 microinverters, IQ batteries, IQ EV chargers, and home energy management software. We are introducing products for the small commercial and emerging residential solar markets. And we are making continuous enhancements to our installer platform in addition to driving towards world-class costs on our products.

We remain very positive about our future growth and profitability and will continue to make best-in-class home energy systems with a laser focus on innovation, quality, and customer experience. With that, I will turn the call over to Mandy for her review of her financial results. Mandy?

Mandy Yang: Thanks, Badri, and good afternoon, everyone. I will provide more details related to our third quarter of 2023 financial results, as well as our business outlook for the fourth quarter of 2023. We have provided reconciliations of this 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 Q3 was $551.1 million. We shipped approximately 1585.6 megawatts DC of microinverters and 86.2 megawatt hours of IQ batteries in the quarter. Non-GAAP growth margin for Q3 was 48.4%, compared to 46.2% in Q2. The increase was driven by increased net IRA benefit. GAAP growth margin was 47.5% for Q3. GAAP and non-GAAP growth margin for Q3 included $14.5 million of net IRA benefit for our microinverters made in the U.S. and shipped to customers in the quarter.

Non-GAAP operating expenses were $99 million for Q3, compared to $98.2 million for Q2. We are diligently managing operating expenses and will continue to do so in the coming quarters. GAAP operating expenses were $144 million for Q3, compared to $153 million for Q2. GAAP operating expenses for Q3 included $41.1 million of stock-based compensation expenses and $3.9 million of amortization for acquired intangible assets. On a non-GAAP basis, income from operations for Q3 was $167.6 million, compared to $230.5 million for Q2. On a GAAP basis, income from operations was $118 million for Q3, compared to $170.3 million for Q2. On a non-GAAP basis, net income for Q3 was $141.8 million, compared to $205.6 million for Q2. This resulted in non-GAAP diluted earnings per share of $1.02 for Q3, compared to $1.47 for Q2.

GAAP net income for Q3 was $114 million, compared to a GAAP net income of $157.2 million for Q2. This resulted in GAAP diluted earnings per share of $0.80 for Q3, compared to $1.09 for Q2. We exited Q3 with a total cash, cash equivalent and marketable securities balance of $1.78 billion, compared to $1.8 billion at the end of Q2. As part of our $1 billion share repurchase program authorized by our Board of Directors in July, 2023. We repurchased approximately 847,000 shares of Enphase common stock in Q3 at an average share price of $129.92 for $110 million. In addition, we spent approximately $8.5 million by withholding shares to cover withholding taxes for employees stock vesting in Q3. That reduced the diluted shares by approximately 59.8000 shares.

We expect to continue this anti-dilution plan. In Q3, we generated $145.9 million in cash flow from operations and $122 million in free cash flow. Despite the macroeconomic challenges, we continue to generate healthy free cash flow as a result of our strong financial discipline. Capital expenditure was $23.8 million for Q3 compared to $44 million for Q2. Capital expenditure requirements decreased as we largely completed building out our U.S. manufacturing lines. Now let’s discuss our outlook for the fourth quarter of 2023. We expected our revenue for Q4 to be within a range of $300 million to $350 million, which includes shipments of 80 to 100 megawatt hours of actual batteries. We expect GAAP gross margin to be within a range of 46% to 49% with net IRA benefit and 38% to 41% before net IRA benefit.

We expect non-GAAP gross margin to be within a range of 48% to 41% with net IRA benefit and 40% to 43% before net IRA benefit. Non-GAAP gross margin excludes stock-based compensation expenses and acquisition related amortization. We expect the net IRA benefit to be between $26 million and $28 million, an estimated shipment of 1 million units of U.S. manufactured microinverters. We expect our GAAP operating expenses to be within a range of $142 million to $146 million, including approximately $57 million estimated for stock-based compensation expenses and acquisition related expenses and amortization. We expect our non-GAAP operating expenses to be within a range of $85 million to $89 million. We are reducing our non-GAAP operating expenses by 12% in Q4 as compared to Q3, but will not compromise on investing in customer service, innovation and sales.

Moving to tax. Since we have utilized most of our net operating loss and research tax credit carry forward, we are now a significant U.S. cash taxpayer. We expect GAAP and non-GAAP annualized effective tax rate for 2023 to be at 22%, plus or minus 1% with IRA benefit. We expect the production credit net of any incremental cost for domestic manufacturing to be in the range of $26 to $28 per microinverters sold to customers in Q4. We expect to ship 1 million microinverters to customers this quarter. We now have all three of our U.S. manufacturing facilities operational. With that, I will open the line for questions.

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Q&A Session

Operator: [Operator Instructions] At this time, we will take our first question, which will come from Brian Lee with Goldman Sachs. Please go ahead.

Brian Lee: Hey, guys. Good afternoon. Thanks for taking the questions. I know the environment’s pretty uncertain, so appreciate the additional sort of out-quarter visibility and some of the market by market color Badri. So can I just want to ask, as you think about the framework, you said you’d under-ship in Q1 the way that you’re under-shipping Q3 and Q4? Can you give us, one, a sense of how much you expect to under-ship in Q1, and then so you made the comment that this is all contingent upon sort of demand trends staying about where they’re at. Can you give us a sense of what your internal expectations for demand trends are? It sounds like you don’t expect them to get worse but sort of can you quantify that a bit? And then I have a follow up.

Badri Kothandaraman: Yes, I think there are a few puts and takes. First to answer your question is, is the under shipment going to be close to $150 million in Q1? We expect it to be a little bit less than $150 million, but not too much less. That’s our expectation. And second is I will talk about markets, and then it’ll become clear to you. First of all, we see the non-California state stabilizing. We see that. So therefore, we aren’t that much worried there. Of course, things could go a lot south during the winter, but we are already at pretty low levels, so we don’t think so. California is definitely a wild card. But even if that goes down 10% more, I think we’ll be fine. Because we expect Europe to recover a little more. Europe right now, for all the reasons I said, we basically are undershipping quite a bit in order to normalize inventory.

And that will be the fastest to normalize. So we expect Europe revenue to come back a little bit up in Q1. Therefore, what we expect, at least, what we expect internally is that our revenues, sell-in revenues, we think will be close to what we are looking at in Q4. Of course, I don’t have a crystal ball. I’m not giving you Q1 guidance. This is our expectation right now. And Q2 onwards, we think the channel inventory is going to approach normalized levels. And therefore, that normalized level, assuming the demand picture is unchanged, that normal level is what we said, roughly around $450 million to $500 million is the normal level. That assumes no change in demand from the current situation. So we expect our revenue to approach that number in the second quarter.

But of course, that doesn’t tell you too much, because I’m assuming that the demand is the same at the current depressed level. One thing which I forgot to say is, in France, which is another very big market for us, we already see the sell-through rates, for example, in the first three weeks of this quarter, are already back up high, which is good. Basically, there was a utility rate hike in August. There is one more expected in February. So we think France will recover fast. Netherlands, we have some education to do. Like what I told you, there is some political uncertainty there. We think that will get cleared after Q4. So I think Q1 will be definitely better. And that’s a great market, where that market is now, in addition to solar, I think with the dynamic tariff starting to become prevalent in Netherlands, there is opportunity for battery storage in 7 million homes.

Today, just so that everybody understands, Netherlands, there is 7 to 8 million homes. Solar is there in 2.2 million homes today. And now, with this opportunity, where net metering is going to evolve into something similar to California, not exactly the same, but very similar, what’s going to happen is it opens up opportunity for solar plus storage in all 7 million homes. So I think long-term is going to be great for us. But I told you what’s going to happen in the short term.

Brian Lee: Yes, that’s great context. I appreciate it. Just a second one here, and I’ll pass it on. On the margins, gross margins, non-GAAP, it seems like you’re guiding the low 40s, ex-IRA benefit. How much of that, it’s down a couple hundred bips from what you’ve been tracking at recently. How much of that is due to pricing? How much due to mix? Maybe can you give us a sense of the margin puts and takes into year end? And then do you see anything that would put incremental pressure on the margins into next year? Thank you.

Badri Kothandaraman: It’s pretty simple. And Brian, you will understand it quickly. You can see our storage business is actually going a little bit up. Our micro inverter business is the one that is going a lot down now because of our under-shipment. And therefore, if you see the product mix issue, and microinverters have a little bit more gross margin than storage. And therefore, with this product mix, that’s why we have the guidance of non-GAAP gross margin 40% to 43% for the company without IRA. With IRA, non-GAAP gross margin of 48 to 51. So in terms of pricing, I mean, we are not planning to make any broad-based pricing changes. Of course, the pricing, there is a lot of competition, but we have seen competition for the last few years since I’ve been here.

We have a very disciplined business process. It’s a pricing business process. It’s called SPA, Phil Shen likes to talk about it. It’s a special pricing adjustment. We have been doing that forever, and it is not new. That’s one. And also in these times, of course, underloading, we have to work with our contract manufacturers to take care of underloading. But in these times, especially when you have multiple suppliers for a particular component, multi-sourcing for a component, this is the opportunity where we can drop costs a lot. So our target, I mean, any good company in these times, we should be able to drop our cost by 10% per year. And we’ll be targeting that. And so we have to talk both equations, pricing and cost. And so we are quite confident in our gross margins.

This is what we do. It is not new. This is what we established when I joined the company. We have a pricing team that prices based on value. We have a world-class cost team that works on costs. And it’s business as usual for us in these environments.

Brian Lee: All right, thank you, I’ll pass it on.

Operator: Our next question will come from James West with Evercore ISI.

James West: Hey, good afternoon, Badri.

Badri Kothandaraman: Hi.

James West: Badri, as we’re going through this period of destocking and some weakness in certain markets, understanding that you’ve always faced competition and you have a very value-based pricing strategy, are you seeing any behavior that’s by your competitors that is somewhat irrational? Or is the market overall behaving rationally, understanding that this will get out of this in a few quarters?