Shoals Technologies Group, Inc. (SHLS) Earnings Call Transcript & Summary

Next session is with Shoals. This is an overweight-rated stock for us. We've got Dominic Bardos, CFO. Dominic, thank you for joining.

Thanks so much, Mark. Appreciate you having us.

So we'll try and keep this open. If anybody has any questions, feel free to raise your hand. And I think we've got mics running around, it could be around that. Yes. Okay. Thank you. But with that, let's just get stuck in. So Dom, can we talk about -- just kind of start with, it's been a very active -- is an understatement active last few months or so in the space. Can we -- I want to come back to talking about tariffs and the IRA rabbit holes wherever we're going with that. Can you just kind of talk about demand and bookings kind of activity, pipeline activity that you're seeing since your last update on the 1Q call?

Sure. Well, as we said on the last call, demand in the near term has remained very strong. Projects are moving forward. You have a lot of our EPC customers, have very full slates because, as you know, but maybe perhaps some of the listeners may not, the lead times, the length of time for solar projects is relatively lengthy. And a lot of these projects have taken flight and are well underway. They've been permitted. They know their interconnection dates. And so demand has remained very strong. .

Okay. All right. Can you talk about the pain points in development today for your customers? You mentioned the EPC customers and their full slates. But I mean it's been a pretty volatile last couple of years with interconnections with supply chain, with policy uncertainty financing. Kind of where do we stand with some of that? And can you talk about your expectations anyway of some -- when these headwinds might potentially go away?

Yes. So let's set aside the regulatory environment for a minute because that's huge right now. That's created a lot of turmoil and we'll talk about that, I'm sure, here in a minute. But some of the other things are very consistent. Right now, in the solar industry, it's similar constraints that have been there, but the industry has learned to deal with them, things like labor availability for both skilled and unskilled labor in remote -- often remote locations. . The supply chain elements of large switch gear and transformer equipment and those sorts of things, it's still lengthy lead times on getting those things fulfilled, but the industry has learned how to work those into time lines. Permitting and interconnection still remain challenges. Like anything, we talked about -- I was just joking outside about getting permitting for nuclear. I imagine that's going to be a little bit harder than getting solar permitted. But those are the kinds of things that are still abounding in the industry. Recently, the, I would say, unpredictability of administrative change, either with tariffs or the regulatory policy, has introduced a new slate of issues, and I'm sure we'll talk about some of that.

Okay. Yes. So let's pivot to that. So I mean, we've got the House Bill that's been approved. We've seen the Senate Finance Committee whenever that was a week ago now. Who this could be, we could find out something today, who knows? Again, kind of going down the different rabbit holes here, but I mean kind of comparing, contrasting the House Bill versus the Senate Bill, can you just kind of talk about what you see as kind of demand trends, I guess, near term? I mean if you've got to begin construction in 60 days or begin by year-end '27 to get a partial credit. I mean just kind of -- how do you think the shape of everything looks here?

Well, I think you've caveated this well. It is very premature and everything is still in flight. Clearly, we were pleased to see some of the changes that the Senate commissions would like to put into it, which is extending and perhaps easing some of the reductions that you would see for tax credits in the IRA, the investment tax credits. But it's still early for that. So the -- I think folks are still trying to figure that out. The administration has targeted the fourth of July. We'll see how that does, if that comes through. But fundamentally, with regards to the industry, it appears that the availability of investment tax credits will be phased out, okay? I think that's a given at this point, but we have to see the timing of that. Whether or not construction on these projects can be accelerated is a difficult question, simply because if you know you have a lead time, you're not permitted yet. If you have interconnection that could be years away, it's hard to pull things forward just to safe harbor. So the definitions of what means you started -- have you started investment, have you purchased panels? Those are the sorts of things that will flesh out with the guidance here coming up in the next few weeks, we'll have a much better understanding of that. But fundamentally, folks who just kept the deal with an inflationary cost of new solar. If tax credits go away, then things will just become more expensive. There will be some offtake agreements, some power purchase agreements that will have to be renegotiated or perhaps negotiated with a different starting point. But none of that fundamentally changes demand. We still need energy. We still need electronics on the grid. And so if solar in the near term, I would say, the next few years, is still the fastest way to get things on the grid, I don't think the changes are going to be that devastating for the industry. I think the good news, I think, for Shoals is it's very much the same business for us right now. There is nothing in these things that really directly impact us. We don't participate in the 45x manufacturers credits. We'd love to. I'd love for EBOS to get credit for that and get some dollars, but we don't currently get that today. So if they do phase those things out aggressively, that's okay for us, we are still going to continue to produce EBOS. Now the timing, if folks are allowed to safe harbor and start projects earlier, like I say, there might be some challenges. If it's not permitted yet, you really don't have that in place. But other than that, we just have to wait and see over the next few weeks how everything plays out.

Got it. Okay. One of the other kind of new things with the House and the Senate Bills has been the FIAC provision. So this is the foreign entity of concern. Can you talk about that? Is that a headwind for Shoals? Is it a potential tailwind when you look at your supply chain versus your competitors?

Yes. Generally speaking, it's probably favorable for Shoals and that if there are some Chinese competitors or competitors from those countries that might face some limitations about the ability to be involved in solar projects. I think any time you can focus on domestic content. And if that can be a showpiece, if that's what the administration is after, then that should benefit Shoals. Shoals, we produce all of our EBOS solutions in the United States, just north of Nashville, Tennessee. And we're a domestic manufacturer. Now from our supply chain standpoint, not everything can be sourced in the United States. If panels have a certain proprietary connector, they have to be procured from that vendor, they may be overseas. There are certain photovoltaic components that are not just available for manufacturers in the U.S., certain fuse types and things like that. But all that is changing. So if domestic content becomes more and more of a priority, then that we'll be able to take precedence here in the United States as well. So we're excited to be a U.S.-based manufacturer. We think that if the foreign entities of concern, if there are limitations placed on it, generally speaking, that will help us. It might cause some disruptions in the industry as folks are trying to work on their own supply chains, but we are well positioned for that.

Okay. Can we talk about competition? So other EBOS technology providers, kind of status quo licensed electrician approach. Can you just kind of just for the general audience kind of talk about the pros and cons of Shoals versus other solutions? We get the question of IPC a lot lately. I know that Shoals has put out some white papers on this. Can you just kind of give us a brief overview?

Yes, sure. So Shoals is predominantly based on the electrical balance of systems, which is moving those electrons between the panels to the inverter. It's all direct current on a solar field and we manufacture those solutions on a custom basis. We design them and we work with the EPCs to maximize the efficiency of the field layout, and we build everything to spec and it's done in a factory. So we have quality control standards. We were able to test joins for voltage leakage and all those sorts of things and we shift these final solutions with plug-and-play sort of abilities. They're connectorized and you can just simply connect them in the field with minimal license and skilled electricians. Some of the competition that you mentioned, for example, insulation piercing connectors, it's IPCs that we call them. Those have to be done in the field. IPCs are fundamentally clamshell sorts of devices that have to be ratcheted down on these large trunk feeder cables, but you can't test it in the field, and they have the propensity to have a breakdown sooner than our solutions. So we have seen some developers say, we don't want IPCs on our field, simple full stop. They wanted the manufacturing solution, which we engineered to last a lifetime of the panels. And so from a competition standpoint, IPCs are there. You may have seen Ben Tech as a company that sells IPCs and Nextracker is interested in exploring that. They purchased Ben Tech. But Ben Tech has been around. They sell combiner boxes and components and then some IPCs, but they don't do the manufactured full solutions like we do. So the competitive environment hasn't changed all that much. I think the FIAC language would certainly support us if we have a Chinese competitor that we're working against right now. That is manufacturing, but that's another story altogether.

Okay. Is there a way to quantify that when you go to your customers that says, okay, well, this is our failure rate? This is what we've seen with IPCs historically, right? So that you might be -- I'm just being hypothetical here, like if an IPC is undercutting you upfront by 5%, 10%, 15%? Is there a way to kind of show the life times -- the lifetime value, the lifetime savings of your solution?

That's what we're trying to do because everything is dollars in cents in this business, as you would expect. You should expect that from me. I'm the CFO. So -- but yes, dollars and cents drive this business. And if something is going to break down sooner in the field, it's an interesting dynamic in the solar industry because the fields may be built by developers, our customers of record are actually the engineering, procurement and construction firms, not the original developer. And they only have to warranty a site for a couple of years to the developer. Developers will sell these sites. So we're working with developers to help educate them about the lifetime benefits of the Shoals solution versus an insulation piercing connector. But once again, we have to test in laboratories. We're mimicking heat and wave cycles of thermal expansion, contraction of charge and that the only time in the field will really show this happening because insulation piercing connectors have to be installed in all kinds of weather conditions. They can have dust. They can have grass. They can have rain and moisture. And all of those things are detrimental to the life of those products. So we simulate some of that in our own testing, and we'll continue to prove that out and work with our developers and prove out the business case for our solution.

Got it. Okay. So you have some very big deals. So you have the 10 gig MSA with Blattner, which I think is coming to the end of its completion, but kind of a new 12-gigawatt deal with them for the next couple of years. You've got a 12-gig deal with UGT for international projects. Can you just kind of talk about that trend? Should we expect more MSA-type deals? Maybe not that magnitude, but similar kind of structure multiyear multi-gigawatt agreements? And why? I mean, why do you think the market might be transitioning towards that?

Sure. So yes, you're exactly right. Blattner just signed us up again for another 12 gigs just last year. And so we're starting to work on that development now. It goes through '27 through the mid -- middle of 2027. The MOU and the deal with UGT in Sun Africa, their subsidiary is really exciting because that allows us to export from the United States. Many of those projects for them are actually funded by Western banks like the export-import bank, and they require domestic content. So for us, it looks very much like our domestic work, and that's a great way to be pulled around the globe. We love master supply agreements for 2 fundamental reasons. From our perspective, it really helps us predict -- have better predictability about projects that we're going to win. The timing allows us to look at how we look at our own supply chain and we can secure deals and get better deals on quantities of cabling and connectors and various things that we need, gives us some predictability about where labor is going to be deployed. It gives us confidence to invest in our facilities and growth. As you know, we've invested in the new facility. We continue to invest in a new facility right there in Tennessee. And we're going to consolidate operations, and it's going to give us even greater capacity. So we love to have the MSAs. Now from a customer perspective, it's a great deal, too, because they don't have to worry about sourcing this every single time. They know they have the quality products from Shoals. They know they can count on that, and they can worry about the other aspects of their deals. So we will expect to sign up additional EPCs with MSAs. I'd actually love to sign up some developers with MSAs to say, "Hey, we're going to Shoals Technologies Group products, we'll be spec-ed into the projects and we'll be handed off to the EPCs. We're not quite there to announce those yet, but we're working all angles there.

Is that something new targeting developers instead of the EPCs, you've been trying that for a while?

We've actually started going a little bit deeper into the developer ranks because we have seen that some of the EPCs reasons for not selecting Shoals, we believe, are shortsighted. And so the long-term benefits of our products, if it does carry a small cost premium to them on the front end, they need to understand the benefits and sometimes EPCs are only worried about it for 2 years and they just want to keep a low cost on the front end. So we have expanded our involvement with developers directly. We've gone deeper and that's an area that we're very excited to see some very good response to the Shoals products.

Okay. So going back to international. So you mentioned the UGT partnership and kind of being pulled into some of these markets. Is there also a push? Are there certain markets that you are targeting? Or is it really just kind of our -- your U.S. customers pulling you into certain international businesses?

Yes. It's -- we have a targeted approach as well, boots on the ground. We have a sales representation in Spain that handles our European side, and also in the Central American countries and Latin America countries where we won some projects such as Chile. We love Australia. Australia just had a very favorable election result, the Labor Party did very well. They are very interested in renewable energy. They're very interested in battery energy storage solutions. And so we're very excited about Australia. They have lots of land, very rectilinear. Our products work really well on large plots like that. We also announced that we have a memorandum of understanding in the Kingdom of Saudi Arabia. They want to put a lot of solar there. So we have some targeted places that we want to do some things like that. We definitely have a sales effort working on that, but we enjoy being pulled around the globe to places we normally wouldn't go with UGT. So it's great.

Okay. Can we go to the warranty issue? Can you just kind of talk about any updates there as far as potential timing, charges, resolution?

Yes. So the warranty solution that we're working through right now is progressing as we've discussed in previous time lines. The 2 elements of it are the remediation work that we're doing for customers that were impacted by the defect of wire. And that is moving as scheduled. I think there was some severe rain and flooding events this spring that delayed a couple of them being done, but we're largely on track to complete that this year. And we have, from a legal standpoint, we're in the fact discovery spaces of that litigation with Prysmian. We expect depositions and the fact discovery to be completed here in the next few months before we can really sit down and have some meaningful discussions. I'd love to be able to work that out with Prysmian, just have them resolve the issues and move on. They're a large and well-respected cable company that just had a bad series of products for us for a while.

Okay. So in the spirit of saying the word data center and seeing your stock trade up, can you talk about data centers? Well, I mean, so you mentioned at the outset, let me be serious with my question here, sorry. You mentioned at the outset that demand is very strong. And to the extent that you have visibility, right, into who the actual offtaker is, I mean is there a way to see, okay, this is -- this part of our pipeline is kind of normal replacement of natural gas, whatever this part of our pipeline has really come on because of kind of the data center angle. And you kind of talk about what you guys think is the potential magnitude of that opportunity?

Yes. So we don't directly have that visibility. We do rely on some professionals and consulting groups in the space to look at that. And I think I can't recall the exact percentage that was estimated of the demand of the energy that went on the grid last year, how much was due to data centers and artificial intelligence driving that demand. We don't expect that to wane at all in the coming years. We expect the prognosticators that have called for energy demand growth in the United States and globally to continue, largely driven by data centers. So on our core base of products, it's a fantastic place to be. We need energy in the near term. And everything else that's been talked about as potential solutions has multiple years of development lead times and cycles. Solar has a pipeline in place that can continue. So with regards to the actual data center products, we think it's been a great way. We have some lower cost and more efficient ways to move electronics using aluminum with our BLA system as an example. We could modify that to work with data centers to be the power distributor instead of large, expensive and rigid copper bus bars. But it takes someone to change. You have to work with engineers of record. So that's further out for us as a product offering, but in the meantime, we're thrilled to see that the data center providers, those that are building these out are going to work with renewable energy sources as well to get their energy needs met.

Any questions? Okay. Can you talk about gross margins going forward. So kind of obviously, you've got different products. You've got systems and you've got components that can influence kind of your gross margin on a quarterly basis. But can you talk about competition. Can you talk about, maybe like the drag from the new facility that you're building that's not fully operational yet kind of how to think about near-term margins where they go and kind of your targets over time?

Yes. So we've talked about this year in the near term being in the mid-30s to high 30s as a percentage for gross margin. And while that's a very important metric for us, and we are committed to driving that, we put dollars in the bank. And by that, I'm looking for operating profits and cash flows. So for example, there's a way that we've actually looked at our BLA product. And folks have said, "Well, we would like you to run this longer and kind of replace this feeder cable that we're buying from someone else. Can you guys run a long-tail BLA? It's fundamentally a BLA, but just much longer instead of 150 feet for 1 BLA might be 600 to 700 feet. Well, that's a new area for us. It's not really adding value to that last 500 feet of cable. So we can sell it perhaps at a lower margin. But why not? It's putting dollars in the bank, it helps us leverage. So we're very focused on maintaining a very aggressive hold on our SG&A expenses. We would like to see some of our legal expenses go down and be able to invest in some other areas of the business. But other than that, we want to put operating profit and cash flows in the bank. So we do have a target of getting back over 40% long term. We still have very attractive margins. Some of the things that we talked about. Our battery energy storage product solutions are very attractive and accretive to us on a margin basis. We want to grow that clearly. Our export business is very comparable to what we achieve domestically. We want to keep doing that. As we looked at our CC&I or the community commercial and industrial space, it's accretive margins to what we've been achieving, but they're very small parts of the business today. So it's going to take some time to ramp those. And as those ramp, that will help support where we've made deals for huge volume agreements in our core business. So we believe in the near term, I would say it's 30 -- mid-30s to upper 30s, and then we'll just go from there.

Got it. Okay. On that point, so I focus mostly on utility scale solar so far in this conversation. But can you talk about CCI, can you talk about storage, EV charging? I mean some of the other adjacent markets that you've been looking at, how to think about that kind of over the near and medium term when that really starts to scale, you think?

Yes. So we're booking revenue right now and have this year for CC&I and for BESS. We've had some international wins that we're working on. So CC&I is interesting and that there's a nice play that we get because they're accustomed to having to cobble things together on their own, and we have a solution that is plug and play, and we can help them out. So the CC&I space is really learning our product set, and we're very excited about that. And with our best products, we have some really exciting deals because a lot of solar projects are interested in battery energy storage. Australia is also another market, very interested in it because they've inverted their curves. They actually have a demand curve for utility from their grid that goes down in the peak days because everyone's got solar. So they need to be able to store it for the shoulders. Well, in the battery energy storage space, we have some very standard products, the combiners and recombiners that we can sell to EPCs. We're working with OEMs on actually skidded solutions, which are stand-alone to help drive all the electronics necessary for the storage solutions. And so as more and more projects keep BESS attached to their projects, I think it's upwards of 50% now of all the pipeline projects that you see like in Wood Mackenzie or with that. Those projects all have -- half of them have battery energy storage plans as well. So we're very excited to be in that space. That's another very good market for us. And then we'll continue to work on our OEM business who have junction boxes. First Solar has been a fantastic customer for years. We've been able to grow with them. And we think there's opportunities for other types of panels in that space as well. So like I said, I'm interested in putting dollars in cash flow in the bank. I don't necessarily need it to be the highest margin products all the time. I just want to keep growing.

Yes. Okay. Last chance. Any questions, anybody? Great. Dom, last question for me. Can you just kind of talk about, I mean, so you just said you're focused on cash in the bank, cash flow. Can you talk about capital allocation, how we should think about potential M&A, buybacks, anything else?

Sure. So yes, we've actually -- my first priority is always grow the business. So we're making the investments necessary to grow the business organically. And secondarily, we are looking at inorganic acquisition opportunities all the time. When our stock was as depressed as it has been, it was difficult to use -- look at the leverage and say, is this an accretive acquisition or not? We don't want to be stupid about capital. I am very disciplined about this. I'm going to make sure that we have the return for the shareholders. We're not going to acquire something just for the sake of making an acquisition. That said, there are multiple small companies that can either augment our product offering here domestically or could help us internationally with the footprint. So we are always looking for what we could do inorganically and then finally, I would say some of the financial things about, okay, share repurchases. We did that last year. We have an authorization remaining for the balance of this year. My cash consumption right now has been predominantly built out our new facility and handle the warranty remediation things. But that will turn right around here in short -- relatively short order and so then we'll have an opportunity to evaluate that. But like I said, my first priority is grow the business.

Okay. With that, we can wrap. Dominic, thank you so much.

Thanks so much, Mark. Really appreciate your time, and thanks for having us. Thank you.