Enphase – Post Q123 takeaways

Enphase reported Q123 earnings on 4/25/23 after the market close. Enphase reported better than expected sales, gross margins and normalized eps.

· Q1 sales came in at $726m, above consensus of $720m and flat sequentially

· Non-gaap gross margins improved to 45.7%, compared to 43.8% in Q4

· Non-gaap eps was $1.37 vs $1.22 consensus

· Generated $224m in fcf and ended Q1 with $1.78b in cash and cash equivalents

For Q223, Enphase guided to the following

· Sales of between $700-750 million vs consensus of $760 million; taking the midpoint this is flat sequentially and lower than consensus

· Non-gaap gross margin 43.5%, down sequentially

The lower sequential guide, driven mainly by weaker conditions in states outside of California, has been the main driver in the price reaction. However, the price seems to have overextended to the downside.

We will review the key points we outlined in our preview.

1. Outlook for the European business

Europe continues to experience healthy growth in their core markets of Netherlands, France, Germany, Belgium, Spain, Portugal and the UK. Europe was up 21% sequentially. Non-gaap gross margins are greater than 45%. Their sell through at the end of Q1 was at an all-time high. Enphase expects Q2 to be better than Q1 and their business is growing much faster than expected. Channel inventories are also healthy. The plan to expand into new counties is on track. Their non-US business currently comprises 30% of revenue and has helped offset weakness in the US.

2. Orders US residential installer level

As we outlined in our preview, this is an important driver of the stock price for 2023. The market was looking for signs of stabilization in the US. California accounts for 20% of total revenues. Although down 9% sequentially, CA was in-line with seasonal trends supported by NEM 2.0 and installers are building 3 to 4 months backlog.

It was in the states outside of California, down 25% sequentially, that was weaker than expected. This is how Enphase described it.

“As I said earlier on this call, our sell-through of microinverters in the US was 21% lesser in Q1 compared to Q4. Our sell-through in California was only 9% lesser than Q4. There was some impact due to the weather in early Q1, but the NEM 2.0 rush in Q1 more than compensated for it.

California installers took advantage of the NEM 2.0 rush and have built up a solar backlog for the next three to four months. We believe when the stockholders aren't expanding their crews to accelerate installation, they're laser focused on their cash flow due to the high interest rate environment and are looking clarity — for clarity on the NEM 3.0 demand.

Sell-through of our batteries in California was 23% lesser in Q1 compared to Q4, as installers focused mainly on solar. We expect this trend to continue for the next three to four months. After that, we see NEM 3.0 as a net positive for California and expect strong demand to resume for solar plus storage.

Let's cover the rest of the US. The sell-through of microinverters in non-California states was 25% lesser in Q1 compared to Q4. We observed that the sell-through was even lower in states with low utility rates such as Texas, Florida and Arizona. In these states, the economics of loan financing has worsened due to rising interest rates.”

This is how Enphase described the environment installers are facing.

“Our installers, in general, are navigating three key challenges: first, the rapid increase in interest rates over last year; second is switch from selling low APR with high dealer fees, the selling market rate loans with low dealer fees; and third, the delayed payment from the loan originators or as the industry calls it, reduction of M1 payments.

Let's discuss about the second and third challenges. We see the move to high APR and low dealer fee loans as a positive for the industry. The demand for market rate loans remained strong. New capital providers who were not able to buy below market rate loans are now offering solar financing. Installers are adjusting their sales practices for a higher interest rate environment.

We are also seeing new lease providers entering the market with focus on servicing the long tail. We think capital will be available for both long-tail — for long-tail installers regardless of the mix of loan and lease.

On the reduced M1 payments, loan originators are providing less cash to installers at the time of contract signing and a greater percentage after installation. This creates a working capital challenge for the installers and is forcing them to become more efficient.

As the installers adjust to this new reality, we expect the sell-through of microinverters and batteries to incrementally improve in Q2 compared to Q1. Q2 is seasonally stronger and should help the situation even more.”

Enphase expects these conditions to improve in Q2.

“So I think it's going to be interesting to watch the situation in the next few quarters. But I think this is a resilient industry. And I believe things are only going to get better from here. Q1, as I indicated, is usually the worst quarter of the year due to seasonality. And so that — Q2 is usually a good quarter in terms of seasonality and with the adjustments installers are making in running their business, we expect things to be incrementally better.”

In terms of revenue California is the biggest at 20%. But what these comments highlight is that in aggregate other states are just as important and have their own different macro drivers both at the installer and consumer level.

On the positive side, Enphase expects pricing to remain firm.

“Question: First one's on pricing as a follow-up to a prior question. Our check suggest pricing through the US resi ecosystem is coming down rapidly. So US resi solar module pricing is down 15% to 30-plus percent. Powerwall pricing is down. Meaningfully some of your inverter peers have lowered inverter pricing. We've heard that you guys have — you may have lowered pricing as well for specific larger customers on a one-off basis. I think, Badri, you just mentioned that you don't see any drop in pricing, but can you talk — can you give us some more color on how you expect to maintain price, especially in this more difficult environment? And can you talk about price specifically in Q3 and Q4, if you expect it to hold, how does it hold? And if there is some risk, maybe talk about that risk? Thanks.

Answer: We don't see any drop in pricing. In fact, we see our gross margin sequentially up a couple of percent from Q4 to Q1. And also, I broke out the gross margins in Europe because some of you had been asking me. The gross margins in Europe are incredibly healthy. They're over 45%. The gross margin in the US is incredibly healthy.

Pricing is stable for us. Gross margin means both price as well as cost. And so we do value-based pricing, which is basically price products based upon the value they bring compared to the next best alternative like alkaline batteries, it may be increased power, increased safety. In microinverters, it may be increased quality, increased service. So that's on the pricing side.”

3. Status of US based manufacturing operations

Enphase is on track to partner with 3 different manufacturers to add inverter capacity in the US. Upon completion, the US will be almost 50% of total global capacity.

“Let's come to US manufacturing. As we discussed last quarter, the IRA, Inflation Reduction Act, will help bring back high-tech manufacturing to the US and stimulate economy through creation of new jobs. We are opening manufacturing lines with three different manufacturing partners, adding a capacity of 4.5 million microinverters per quarter, bringing our overall global capacity to 10 million microinverters per quarter as we exit 2023. We expect to begin US manufacturing with one partner in Q2 and with the remaining two in Q3.”

4. Potential earnings benefit from Inflation Reduction Act corporate tax credits

Enphase confirmed they will also deduct the IRATC from costs of sales.

“Now I'd like to discuss how the advanced manufacturing production credits from the IRA will be reported in our earnings while waiting on the implementation guidelines from the US Treasury. Based on the current guidelines, the production credit can be claimed as direct pay or in the form of tax credit. Under direct pay, the production credit will be accounted for as a reduction in cost of goods sold. And in tax credit, you will be reported in the tax expense line.”

“Incrementally we will provide us the same dollar impact to our earnings per share as the production credit is nontaxable. We expect the production credit net of any incremental costs for domestic manufacturing to be in the range of $20 to $30 per microinverter sold to customers. We expect to ship 50,000 net in USA microinverters to customers this quarter. We plan to have our US contract manufacturing facilities to be fully operational by the end of 2023. We estimate shipments to reach our US capacity of 4.5 million microinverters per quarter by the end of 2024, assuming robust demand.”

We outlined in our preview the base case for potential gross margin improvement from the IRATC. Given the timing on manufacturing capacity, we likely won’t see a gross margin uplift until the end of 2023 into 2024.

Conclusion

For Enphase, Q1 was a tale of two regions. The core markets in Europe are strong and entry into new markets is on track. On the other hand, the US is starting to feel the impact of higher interest rates as installers adjust to the changing financing economics.

Until there are signs that the US has bottomed out and is improving, this will be a headwind. Meanwhile, any hoped for uplift from the IRATC won’t be seen until the medium-term.

Enphase – Post Q123 takeaways

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