SolarEdge Technologies, Inc. (SEDG) Earnings Call Transcript & Summary

Good day, everyone. Thank you for joining us at the Barclays CEO Energy and Power Conference. With us today for this session is SolarEdge. We have CFO, Ronen Faier. He's joining us all the way from Israel, I believe. Ronen, I'm going to pass to you the floor first. Maybe you give a brief overview of SolarEdge, and then we'll jump right into Q&A.

Sure. Thank you very much for hosting me. And I guess, hello from this sunny Tel Aviv, Mediterranean is just out there. So SolarEdge, we are a company that was founded by the end of 2006 that developed a new architecture for PV inverter architecture that's called DC optimized solution. Our architecture allows to have solar systems producing more energy to be easily designed to monitor the production of each and every module and good to comply with most of the safety regulations out of the box. We started saying in 2010, we became, 3 years ago, the largest inverter company worldwide on a revenue level, selling in about 40 countries, installed in 133 countries. We're the market leader in the residential U.S. market and a large player in the other markets. The company actually evolves since there. We also went into 3 new categories that came through acquisitions. One was a entrance into the UPS, uninterruptible power supply systems market with an acquisition that was done 2 years ago to the lithium-ion battery by acquiring a Korean company named Kokam in 2018. And finally, to the EV motor drive market by acquiring an Italian company at the beginning of 2019. Fun company, growing company and interesting, I wanted to be a CFO of.

Very helpful background. Let's jump into inverter specifically. The core market there. Resi and commercial, international, U.S., both of them, this is sort of like a 4 -- you can look at that in sort of 4 separate categories in some sense. Commercial has reached about 50% more even in 2Q, international has grown to such a high level. What's driving your acceleration even in this -- in the commercial market, which you sort of pushed into second after residential? Is it more small-scale commercial, greater need for MLPE? Maybe you could sort of discuss for us how you've successfully expanded from resi to both distribute -- all distributed?

So as a player in the fair market, first of all, we aim at all segments of the market being residential, commercial and utility. The first products that we released to the markets were residential products in 2010, only in 2013, we started to ship commercial products. And since then, we're growing the, what we call, basic unit chassis, which is the size of the basic inverter. Today, we have importers that are getting up to 120-kilowatt per inverter. And of course, all of them are coming with an optimizer. I think that the reason for our growth, especially in 2020, is divided to 2 main areas. The first one is actually COVID. In the United States, which is our largest market today as a single country, residential is much more widespread. And usually, we used to be in a position where at least annually, more than 50% of our revenues are coming outside of the -- from the United States. Due to COVID, we see a shift to more sales outside of the United States. Last quarter, it was close to 60%. And actually, those are markets that are characterized with higher ratio of commercial. For example, if you go to Taiwan, India, you won't even find a residential market. And if you go to Europe, usually, you'll see 50-50. So the first reason for our growth in the commercial ratio is simply going worldwide. The second one, we're going with more shift of our revenues worldwide rather than in U.S. The second one is actually the continuous evolution of our inverters. Just like 3 years ago, our biggest inverter was 33-kilowatt inverter. Today, we have inverters that are up to the size of 120 kilowatts. And by the end of this year, we will present an inverter with greater capacity of -- than 300 kilowatts. The ability to make larger inverters reduces the cost per watt of the system enjoying economies of scale. And that does make us very competitive to the inverters that you see out there. So tomorrow morning, if you go to the field, and you'll see an installation of 1 megawatt on the rooftop, where it's us or a string inverter, in many situations, our product could be cheaper at the overall installation cost, easier to install. And in some markets, maybe it would be a little bit cheaper, but it would be competitive enough to justify the addition of the optimizer. So I think that this combination of right products that are competitive in price and can justify the premium or products that are simply sold more outside of the United States is the reason for this growth.

Great. No, that's very helpful color. And looking at the international strategies, more crowded space, whether it's resi or commercial, you already sort of hinted at this, wherein there are instances where you're even cheaper based on the specific architecture, size of the inverter. Are you also finding that you need to compete on price? Is it really just a technological advantage that makes you win? You've been gaining share in a lot of the European markets in particular. Maybe you can give a little color there.

So I think it's a combination of both. In general, we always say that we sell at premium. By definition, since our solution involves both having inverters and optimizers, usually, the price will be slightly higher. The question is whether we can justify the additional premium with the technological features that are good enough in order to cover it. And I think that in most cases, this is indeed the fact. Outside of the United States, we do not see other MLP solution other than us. Therefore, a short time, there was also Huawei, there's a small company called Tigo, but the overall offering that we gave that allows a really easy installation, very flexible one at a system that is relatively simple to install, provided a unique, I think, situation, in our case, where you need to make a decision on whether to use MLP or not. Sometimes the whole different -- let's say, difference on a residential home, where the cost is about $12,000, it's only about $150 to have SolarEdge or Chinese inverters. So it's very easy to justify this premium. And I think that, in general, we never compete on the price only. We will never be cheaper than European strings. We will never be cheaper, of course, from Chinese strings, but I think that our technology and our road map allows us to really be able to harvest a little bit of higher cost due to the offering that we did.

That's great. That's very helpful. And you could easily see that in the markets that you're expanding into. If I look at U.S. specifically, what are you -- first of all, any status quo update on the post-COVID recovery time line, channel inventories? You get those questions every earnings call, any update there?

So I think it's very similar to what we saw with some improvement. In general, the U.S. markets are not yet at the level of installations that were there prior to COVID. And we're tracking on a weekly basis, the installations worldwide on a country basis, region basis and even on a megawatt basis, and we can see how it is compared to 2019. While in Europe and rest of the world, we do see evidence that installation rate is above 2019 and in some places, high -- more -- higher above this number. In the U.S., we're still below this number, while we do see gradual improvement. The combination of this improvement that you see, again, not yet in pre-COVID levels, but the fact that you do see that the rate of revenues went down for us, actually means that, yes, you do see that the inventories in the channels that were not very high to begin with if you see a normal market, but when you see installation rate at the very low levels, is starting to clear up. And I think that we're getting towards healthier situation in the channels themselves. With that said, again, this is not the pre-COVID market, unfortunately. And I'm not sure when will be the plan that we're back to pre-COVID.

Right, right. I'm still sitting at home. So this is one of those indicators. It's really hard, but any market, whether it's commercial, residential, international, U.S., any commentary you can give on thoughts on 2021 and beyond. How do you think the market is going to evolve? It's really hard. This is not a high-visibility market distributor generation, but any thoughts.

So putting COVID aside, because every change in the situation of the pandemic, either finding a vaccine or a worsening situation, of course, control everything, I think that there is a clear distinction between the U.S. and the non-U.S. Outside of the U.S. today, the situation is that in many of the -- our markets, at least, this is not a policy-driven market, even those new deal -- new green deals -- transactions that you hear about. Actually, none of them is really implemented other than one in Italy called Ecobonus. And all of them is taking a very big change. But still, you do see that even within COVID, the situation is that the market continues to grow, and we do not expect any changes. We do not see any market where regulatory changes are going to change it, and we do not see, other than, again, economic disruptions, something that can stop it. The U.S., I think, is very interesting actually due to the presidential campaigns and the post-elections results, because here there are 3 scenarios. One is -- the first scenario is what's going to happen with ITC towards the end of 2020? Is it going to be extended or not? This is something that will very much affect 2019 and, of course, going to affect 2020. Then based on the results of the presidential campaign, there are going to be again the expectations. If, for example, Trump wins and there is going to be no extensions of the ITC, we should see a huge 2021 because the drop in ITC in 2022 for residential is going to be dramatic. If Biden wins and he's going to extend the ITC, I think that you're going to see a regular year of growth, again, putting COVID aside. So I think that the only factor here that can affect 2021 dramatically is the result of the elections in the U.S. Outside of the U.S., I think that it's supposed to be a continued growth year.

That's a very helpful answer. And it sort of reflects what happened in 2016 with the extension, right? We got that big...

Exactly. The extension brought big surge in this year. And then by the way, you saw a little bit of -- less of a good year or the year after, simply because of it. It's simply psychology. People felt that there is nothing to be hurry about and, therefore, to install. I think that the situation is a bit different today because the industry is much bigger, much more money are dependent on it. And therefore, extension of the ITC, I do not believe that it will drop the market, while again, if it will not be extended, 2021 is going to be very dramatically growth year.

Great. Great. And one last one on the market. Is U.S. commercial lagging U.S. residential in the recovery? This is...

I believe so. It seems -- it is what we see right now. And yes, this is the case.

Great. Great. Great. I mean not great, but makes sense. Moving to technology. The technology -- you sort of touched on this, the mode that you have around your technology. You mentioned one of the other smaller optimizer solutions. There's even -- there's Huawei who may have copied your solution. I think that might be your contention. Let me just phrase the question as I get it from investors all the time. What stops foreign competitors, old and new, from commoditizing the inverter similar to the panel? And to preview that answer, might it be the holistic solution, it's the software, it's the percent of the install that is the inverter and how you work with the installer, the -- you could really add to that. How do you think of that technological mode and also the differences from the panel side of the market, which has had lots of challenges?

So I think it's a 3-layered answer. The first one is IP. We have today close to 500 patents and patent applications around our technology, starting from the very basic level of the technology and architecture going through very small points on how exactly do we move packages of data on the power line itself. And it's a very wide patent portfolio. By the way, just as -- by means of anecdote, when GE came to us in 2008, they said, we believe that this is the right way to go. We cannot over bypass your patents. And therefore, we would like to be an investor in SolarEdge. They were investor in SolarEdge prior to our IPO. And in 2012 to '14, ABB or Power-One tried to make an optimizer and they stopped because I believe that it was relatively hard to do and the patents were there. So I think that we have a very strong IP. The second issue is actually the technological level. We're doing this for the last 14 years. And whoever goes into the market tomorrow morning needs to start summer. Now if they're respectful of IP, they need to go much longer way to get to our fourth generation optimizer and our third generation inverter, and this is without stepping on our patents. It's a very, very heavy task. It's going to be very expensive one. And if you're a small startup, no VC would like to actually finance this. So the barrier of entry is going to be years of development and tens if not hundreds of millions of dollars of investments that you need to do on the technology itself just to get to where we are. The last level would be actually continued innovation. We continue to present year after year new products and basically living to the say that in technology, you're not good as your last technology, but as your next technology, and that means that we're always pushing to be more innovating -- innovative than all the packs. So the combination of those allows us to be very successful there. A year ago or actually 3 years ago, Huawei, one of the large players in the market, tried to enter the market. They came with a product that we believe infringed our patents. We sued them in Germany. This is something that's still ongoing. But at the same time, the product did not succeed even in places that are -- where we didn't sue Huawei because it was not good enough. And I believe that if and when they come with the second generation, I assume that they will be a little bit better. But at the same time, we also moved forward. So it's always kind of a race where you need to be a little bit faster than your competition.

It's very interesting. And not to belabor the one in Huawei, but I've heard at least that there's somewhat success in Australia. I don't have data, but maybe it's not even such a relevant point. Any...

No, no. They are successful in Australia. We need to differentiate in Huawei between residential and commercial and utility. Huawei today is the third largest inverter company in the world, where the vast majority is coming from commercial and utility. They have pretty good inverters. It's not SMA, maybe, but it's pretty good for what you pay for. And therefore, they're very successful. Australia has been very open to Chinese brands for a very long time, and they're successful. At least in the residential space today, Huawei is not a player in Australia or in the other places as well.

Very helpful. And thoughts on the architecture. So you've clearly settled what seems like the right successful formula residential, it's a 1:1 optimizer per panel; commercial, 2:1. I guess utility will be 3.1 or even 4:1 maybe as you scale. There's a competitor out there that has a solution that they think is similar enough and it zones the roof. It has a 4:1 almost for residential. In theory, you could just do that. There's reasons you didn't. So any thoughts on how you settled on the architecture on the roof? And if you reopen that equation at any point?

So it's a decision that can be made technologically. The thing is that we look at it, first of all, commercially and second from the benefit to the customer. When you look at the overall LCOE, levelized cost of energy, for a residential home, we believe that we can provide very good results even on a one-to-one basis. Because usually, in residential, you see more shading. And you see less of, let's say, good maintenance of the system. And therefore, the ability to optimize each and every module is actually bearing fruits over the long term, where at least in commercial and utility, you usually see a much more robust maintenance program that maybe it makes us to optimize a cluster of modules and not just one of them. So while by definition, we can change this equation. I think that commercially, of course, we don't want because we make more profit if we are doing this, but other than this, I think that, again, it all comes down to whether you can justify the premium that you're charging for simply doing this. And at least until now, our growth shows that we're able to do it. One day, we'll see that there is a -- that we're not growing where someone starts to take a lot of share. We need to rethink this strategy. Right now, this doesn't seem to be a case.

Yes. That makes sense. If I shift to the margin profile, sort of the target model, yours is a bit more complicated because you are in so many markets, and you use commercial, residential and international, U.S. How should we think of the mix shifting over time? I think people struggled, analysts like me, we struggled in the last few quarters to figure out how to land on that mix. Any numbers you can give, you still think it blends above 30% over the longer period? Any thoughts there?

So first of all, as you mentioned, our margins are mixing so many more elements than some of our competition, given the fact that we're both U.S. and international, we are large commercial. We do have single installation of 27 megawatts, for example. And therefore, the international, non-international, commercial, residential pushes or brings a lot of volatility into the mix itself. But we believe that we can be at the 36%, give or take 1%, in solar over the longer term. This takes into account, first of all, I would say, more traditional allocation of the mix between the U.S. and non-U.S. What you see, for example, in the last 2 quarters is simply that the U.S. is missing substantially in our mix. And since the competition in the U.S. makes us and our competitor there almost a de facto duopoly due to the safety regulations, the prices are a little bit higher compared to Europe. But once you don't have this, I would say, volume in your mix, you go and you're shifting towards the areas where, first of all, you see much more Chinese, much more string inverters, and again, much more commercial where our offering suite is much younger in age compared to the residential. And therefore, cost reduction was not done yet to the full extent or to the place where it is today in residential. But once you play with everything, and again, when we look and we model 3, 4 years ahead, we believe that we're able -- with a non-COVID world, with the right mix of geographical sales, we're able to balance everything around 36%, give or take 1% on solar. On the nonsolar business, by the way, it's completely different, but these are different industries.

Yes. Yes. No, no, that's a very, very helpful, comprehensive answer. And on the COGS side, in particular, we had almost no impact when you really think about it on margin from different volume changes, let's say, due to COVID. So is it fair to say that it's almost all variable near 100%? Air shipments being the only thing that's affected you at times at a wide range and maybe have to set up, you let me know?

No, it's not. And it's not as only is variable, but there are many, many, many moving parts that at least are hard for me to say is the effect of each and every one. The fact is that, yes, air shipment went down dramatically. We were suffering around 550 basis points in Q4 2019. This number came to almost 0 in the second half of due to the fact that we can ship a lot. We didn't see across the board prices going up due to the volume decrease. It's a combination of us being very vigorous on fighting everyone on raising prices on one hand. And also the fact that we're a large enough portion of their business, where everyone understand that once COVID goes away, if the pendulum goes to their favor -- in their favor now, it will go back in our favor, and we prefer this kind of equilibrium where prices are not going up. At the same time, again, we're able to continue and do cost reduction. We're not able to realize it so quickly as before because now we have more inventories, and it takes time to clear those and enjoy the cost reductions. But I think that, in general, this air shipment, logistic costs and cost reductions plus maybe very little moves in the overall manufacturing prices are balancing in a way that the effect that you see today is mostly coming from the shift in the geographical mix and nothing else.

Great, great, great. And this is sort of already implied in your sort of view on margins long term, but just speaking about ASP stability, whether it's a modeling question or just in general how you think of the philosophy going forward. Do you put 8%, 10% ASP erosion over time on a global basis is, of course, that's on an annual basis? What are your thoughts on what the right number is? Maybe there is no right number, but what's conservative at least?