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

Good morning, everybody. Thank you so much for joining us today. We are pleased and grateful to have Ronen, the CFO of SolarEdge here with us. We're going to talk about all things SolarEdge. Ronen, thank you so much for your time. We really appreciate it.

Thank you for having me. Hello. Good morning.

So I guess, Ronen, I wanted to kick off the conversation by talking about cars. Specifically, SolarEdge recently announced, it's been qualified as a Tier 1 supplier for Stellantis and the sole supplier of full electric powertrain units for the E-Ducato. We looked at the Fiat website. It looks like the original Ducato sells about 150,000 units currently. Looks like Fiat has about 20% market share. So this is obviously a big announcement for you. I was wondering if you could maybe talk about how to think about how Fiat maybe thinks about the adoption of the E-Ducato over time? Have they talked about their strategy to go from ICE to EV? Just anything you can help us to think about growth for E-Ducato over time would be great.

Sure. So first of all, as we mentioned, it's a great model to be designed in. The Ducato is the most favorable car today. LCV in Europe is a model that is running since the beginning of the '80s. And therefore, we're very happy to be on this platform. In general, this is the first electric LCV that Fiat is launching and as such, on one hand, there are expectations that this is going to be a successful model. And at the same time, there's a lot of unknown, given the fact that it's the first time that they do it. The nice thing about the LCV is that this is usually a car that goes into fleets. And therefore, fleet owners that would like to have an electrified vehicle either due to some regulations, and I'll touch those in a minute, or from any other reasons, are inclined to take this kind of a car and the Ducato is expected to be, according to Fiat, at least, to be a good car where would nominate for this kind of fleet. I think that, again, due to the fact that it's a new model and the customer acceptance is always an unknown I'm not sure that Fiat share with us or have their own internal targets that I can share, given that they are also a publicly traded company. But the sense is that if you look at what is happening in Europe, a major shift towards LCV is expected. And the reason is that over the entire continent of Europe, you see that many cities are going to limit the entrance of combustion engine vehicles into city centers over the next few years. I think that London is supposed to do it by '27, Paris by 2030, if I'm not mistaken or maybe I'm switching them, but still, these are the years in the cities. And over time, when you look at those large metropolitan areas where there is mass transportation, the majority of vehicles going into these city centers are light commercial vehicles. In addition to this, given the fact that the anxiety, a range anxiety, which is always existing when it comes to electrical vehicles does not exist in electrical LCVs then I think it makes this segment specifically in this region specifically, and this model, specifically within the region, a very good candidate for success. So therefore, while no number was shared or expectation is set, we, and I assume Stellantis Fiat are expecting to have this model as a good success. And the first step out of making eventually many of the other models into electrical as well.

That's helpful. And then I mean, maybe focusing and honing in on this specific agreement. On the last call, you talked about maybe around $100 million to $120 million of revenue associated with the business in 2021 with single digit margins. Can you maybe help us think through how to think about that revenue and gross profit trajectory as we look into 2022? Would this agreement alone be enough to drive growth into 2022 or would you need to start signing more agreements with more customers to grow e-mobility into 2022?

So by definition, we would like to sign, and we need to sign more agreements with other players because this is a major business that we're entering, and we see great future to e-mobility. In general, in this agreement specifically, and we're not -- we're relatively new to the automotive space, there are no numbers associated or quantities associated in the agreement, where we can say we have a hard number for 2022. And the reason is that the market acceptance and the customer acceptance is very crucial for this. And in general, in automotive, you do not sign an agreement with defined quantities for years. The only thing that you're signing is that you need to have certain capacity and you need to be able to ramp up if needed at a certain pace. And this is exactly what we have with Fiat. And this is something that we're ready to do if the model is going to be successful. Now when it comes to the revenues and the margins themselves, I believe that if market acceptance is good, this amount can grow both in 2021 and 2022. So there is an upside to this number in both of the next coming years when it comes to the revenues. On the margins, for this specific project, we do not expect higher margins than the single-digit that we described. And the main reason is that this agreement was seeded by SMRE, the company that we acquired prior to the acquisition. And given the fact that it was a small startup eager to win a major nomination letter with a large player, they set a price that I believe was optimistic to begin with. When you couple this with the knowledge that we acquired over time that automotive parts needs to be qualified with certain components and go through various processes that are very expensive. The thing that happened is that once we took the helm of SMRE, we basically increased the cost of the product compared to the anticipated cost by SMRE, simply due to the fact that we used all of the materials and equipment that allow us, first of all, to associate our name with it because it's very important for us to give a good quality product. And second, to make sure that we're meeting all of the warranty obligations that we have there. And this is why the margins are squeezed. Over time, you should see, I would say, high teens margins associated with the business of e-Mobility. Unfortunately, it will not be on this project. But at the same time, we're not losing money, we never sell something at the loss. And I think that here, we're loyal to this principle as well.

On the high teens gross margin target, we won't hold you to it, but can you maybe give us a guess on when you think you might get to that level?

I would assume that this is 2 to 3 years from now, and this is with the next project. Projects in e-Mobility takes a lot of time. It usually takes between 3 to 4 years to qualify into an electrical vehicle. And we currently have the funnel of projects that we are being tested in or submitting our products to. And I believe that some of them will materialize over time. I do not know yet what is the pace and how many of them will have those nomination letters, which is basically officially nomination by the automotive company. And again, given our lack of experience means that I cannot even give you that statistic saying that in 80% of the cases we're winning. So I think that the growth will come from the next project, not from this project. In an automotive project, the price is set for the entire project. And actually, all of the components are set. So we cannot do cost reduction on this project specifically because all of the vendors know that they are already designed in and we cannot replace them. It doesn't put you in a good negotiation place there. So therefore, I would assume that growth will come in the next projects. The way that we view it in SolarEdge is that we have entered into a very luxurious club of being a Tier 1 automotive player in a high-profile company, and we expect to basically get some of the fruits of this engagement, not necessarily in this project, but actually in future projects that will follow this one.

That's very helpful call, Ronen. So let's -- you since there's SolarEdge in the name, let's maybe switch gears to the solar business. So I guess maybe if we could talk about residential demand. Just curious to see -- just curious what you're seeing on demand for your product, maybe talk about residential in U.S., residential in Europe, residential in rest of the world. How -- to the extent you can share, how do you think about growth in these regions during 2021? And then a similar question for commercial as well.

Okay. So I'll start from residential. In general, we do expect to see growth in 2021. We need to remember that we saw 2020, which was a relatively different year due to COVID. And on one hand, we saw a very large success for us in residential in Europe. We were able to grow substantially there and reach a record gear in Europe despite of COVID and despite of the fact that the market did not grow substantially. This was mostly led by 2 major things. One is our new product to the German market that allows us to have a backup with a battery for 3 phase installations. In the United States, most residential installations are single phase. In Europe, many of them are 3 phase. So this is a different product than the one that you see in the United States. And this was a product that was well received in the market. The second thing was actually a success of the Polish market, which grew substantially, and we were one of the first players to go in. And it surprised us as well because you do not expect Poland to be a very strong solar country, but there is a very vibrant and strong market. And all of this was supported by a very strong presence that we still have in the Dutch market, the Belgian market and even the Italian market. But this was a year of COVID, and most of the growth came other than Poland from taking share. We do expect that in Europe, the markets themselves will go back to a growth trajectory in 2021, and we expect to benefit from this one. The U.S. market is even more interesting because 2020 was a down year in the U.S. market, which is a healthy and very strong market less, I would say, penetrated in the European market in many senses. And the expectation of very favorable regime now either under the Biden administration, maybe even extension of the ITC that we hear. Plus a year that COVID will be less present is something that drives us, and you see it also through the public companies that are our customers like Sunrun and Sunnova, they expect to have a very strong year, and we expect being their supplier to have a very strong year as well. In rest of the world, you do not see a lot of fair residential. Actually, rest of the world for us being everything other than Europe and the Americas. This is mostly Southeast Asia, and most of the installations are commercial installations where residential is not a major factor. So this is like a good segue to go to the commercial side now. And here, we also expect a very strong year. Markets that we're already present and are stronger market for us, such as Australia, Taiwan, Thailand, Vietnam, continue to grow either as markets and also our share in them is growing. India continued to grow very nicely for us. And we start to see more penetration into Japan. I think that our product is very good to Japan because of the complexity of the installations. And over time, the Japanese conservatism as we are present more and more in the market is opening towards accepting our products. At the same time, we see markets like Korea that was pretty close last year due to COVID and certification issues being open for us. And therefore, we expect a very strong growth in rest of the world. Going to Europe, we also expect to see the same growth that I described before. In residential, we expect it in commercial. Europe is a 50-50 market between residential and commercial. And now that we're emerging out of the European winter that usually stops commercial installations, we expect to see very nice growth there. The only question mark is the U.S. market. And in the U.S. market, the commercial part, which is, by the way, it's the smallest region of all regions for us in commercial, just to put everything in the right context. But the U.S. market got hit pretty severely due to COVID. A lot of the commercial installations are done on top of malls, retail stores and factories, and the economy, or I would call it, maybe the technology, but the older economy got hit a little bit during COVID here, and we do see a little bit of stagnant markets there where we are cautiously optimistic about some opening towards the second quarter when we emerged from the winter, but I think that this is still a relative question mark compared to the other regions.

That's very helpful. On the 3Q call, with respect to commercial, there was some discussion around elevated inventories. I was just wondering if you could give us an update on whether those elevated customer inventories across the world are starting to clear up whether you're seeing the benefit of the world reopening on the commercial side across all the regions.

So in Europe, this is pretty much the case already, again. And we need to understand that Europe is now emerging from winter, which is seasonally a weak quarter. But based on our discussion with our customers and expectations for orders, we do see that the inventory levels are clearing there. And in rest of the world, usually, they do not carry a lot of inventory. You see that in many cases, they simply buy the inventory for an installation and not necessarily for inventory. So there again, there is not a big problem. In the U.S., the inventory level in the channels are still relatively high not on an absolute basis, but actually on the term that we call days on hand. So the actual amount of inventory is relatively, I would say, normal, if you compare it to a normal year, but the sell-through is relatively slower. And therefore, the amount of days that these inventory is representing for the channels is relatively high. And we do not expect to see any major changes there until, I would say, the second quarter of this year when installation will pick up again.

Okay. That's very helpful. So maybe switching the discussion a little bit to batteries. On the most recent call, I think you talked about $100 million to $150 million of revenues in 2021 for your new residential product using the third-party cells. Once Kokam comes online, I think that there's an expectation for that, hopefully, to grow to $300 million, including Kokam in '22, $500 million in '23. If I recall, that $300 million in '22, $500 million in '23 was based off of a conservative $250 per kilowatt hour assumption. So just based on what you're seeing in the marketplace today on demand supply, is that -- is $250 million the right number for that blended 2 gigawatt hours? Or would it be higher? Would it be lower? Just some helpful context on where you think ASPs are for that blended guidance that you previously provided?

So in general, starting from the numbers and the prices themselves, the prices are higher than we expect. We did expect to see -- and the numbers that you're citing is the very right number from our Investor Day November 2019. Then in general, we did expect to see number of approximately $250. But right now, the prices are higher. We see Tesla selling at approximately $600, $700 per kilowatt hour. The numbers are very similar for LG. And we see some of the other peers selling it to higher numbers. So definitely, there is an upside there. Another question is how fast we're going to ramp up our activity in the Sella 2 factory, which is usually the other part relates to the quantities. I think that the numbers -- I'm not sure if I can say it's going to be -- whether it's going to be $350 million or $560 million in the year after. But I think that the potential for an upside is definitely there, which, by the way, implies also potential in the -- upside in the margins. And as long as the production will stabilize at the pace that we're expecting, then yes, there's definitely a potential for an upside there.

And just so we're on the same -- just so we're clear, the $250 was a blend of residential and commercial. And so the 2 gigawatt hours was not all assuming residential. There was a blend of residential and commercial. And you would assume commercial would be lower than what Tesla said, correct?

Yes. That's for sure. And also, by the way, the 2 gigawatt are also going to feed a lot of the -- or some of the traditional business of Kokam, which is an independent business that is going quite well. I think that there is a major unknown here and this is what is the real demand in the U.S. market right now because we know that the battery market in the U.S. is a very constrained market right now. There are not many players. We hear that some of the players right now even stopped delivering into the market. And therefore, it's very hard to see what is exactly the demand. Today, when we look at -- again, one of our peers, we talk about the tens of megawatt hours per quarter. I believe that LG and Tesla will be close to 100-megawatt hour per quarter and then within 3 or 4 quarters from now, we will come with the Sella 2 factory which will ramp up to 500-megawatt hour per quarter. And then we may find out that the request or the demand in the United States is lower than the entire capacity. The way that we are going to manage it is that we will, first of all, allocate batteries of this 500 megawatt hour to our residential storage. We believe that this is not only a good source of revenue and good margin business, it is also encouraging the sale of our inverters into the market. And therefore, this will be usually our first station. The second one will be, I assume, commercial batteries, again, lower prices and margins accordingly. And then we will send some of the other remaining quantities to the Kokam independent business that is either ESS, which is utility business in a sense that we already have such transactions coming from Kokam and to their other marine and mobility applications. So I think that we're covered if there is a downside or we're covered if the demand is not as big as we are. And if the demand is going to be higher than we expect. In this case, we have a very nice opportunity to, first of all, grow substantially the production of Sella 2 factory in Korea. This is a factory that is designed for a higher capacity. We just need to add a little bit of machinery, but all of the infrastructure is built for a higher capacity. And in addition, we still have the agreement with the current third-party supplier that can provide us also. I think we're all waiting anxiously to see what is the actual demand in the United States, which seems very strong. But I think that there will be a much more clarity once we'll see major volumes going into this market. And then we'll truly understand what is the size of the market and what is the depth of the demand.

That's great. Helpful color. Really appreciate that. And then maybe on a big picture -- from a bigger standpoint, if you could talk about the decision, what drove the decision to vertically integrate with Kokam, how do you think about -- is that a competitive advantage relative to some of what your peers are doing? And then also, when you think about just residential batteries broadly, is there any -- how should investors think about differentiation between one product versus the next product? Are they all the same? Just walk us through the vertical integration and then also differentiation between one battery versus the other battery.

So it's funny because had you asked us 4 years ago, if we will own lithium-ion chemistry company, we would tell you that most likely not. When investors used to ask us around the IPO, what areas we're looking for, we said that it was mostly UPS and e-Mobility. And we actually said, in some cases, definitely not cell manufacturing. But then as Guy, our late founder, used to say, unfortunately, life is more complex. And when we came to the design of our battery, we found that none of the major players are willing to commit to substantial megawatts or gigawatt hour of supply going to ESS because they're all concentrated on e-Mobility and electrical vehicles. And therefore, we find ourselves in a situation where we're trying to get a reliable source for batteries in, I would call it, very substantial number, and we were not able to find it. And actually, we met Kokam during one of these attempts to find ourselves a source for cells. And after meeting Kokam, in Korea, we said, actually, we have the opportunity to buy this company and secure ourselves with the right cells. So the first idea to vertically integrate was not coming from any knowledge about what we can do or how we can improve the situation, but rather than simply securing our position when it comes to cell manufacturing. But then again, we acquired Kokam, we started to work with them and our knowledge in batteries increased dramatically. And what we understood is that we can basically make by having control of the chemistry, a battery that is better suited for RSS, residential storage systems, and CSS. And the reason is that when you're designing a battery, there's like a kind of a pentagon with various qualities that you need to decide. It's like a spider web. And you can decide between the number of cycles, how many times you can charge and discharge a battery, the safety of the battery, the cost of the battery, the calendar life, how many years it is going to leave and what is what we call the C rate, how fast you can charge and discharge the battery. And by controlling those, we can basically fit the battery for the usage. Now if you look today, most of the batteries coming for residential solar, these are batteries that are based on cells that were designed for electrical vehicles. And the cells design for electrical vehicles are designed to work and to be charge and discharge for 1,500 cycles, which is lower than what the regular home would like, which is about 4,000 to 5,000 cycles. How do you get to this number with these cells? You simply discharge the battery to 20% of its capacity in order to increase the cycle life of the battery. And that means that if you want to have an effectively 10-kilowatt battery, you need to put in the box 12.5 kilowatt of battery cells. This is -- that's what called DoD, depth of discharge. By having our own cell company and all cell chemistry, we can basically now design a battery that is really designed for 4,000 cycles by changing the chemistry. And by this, we will be able to use in a battery of 10 kilowatt, really 10-kilowatt of cells. This is something that, over time, will make batteries cheaper because we do not put excess capacity into the box. It will make the batteries smaller and more compact and nobody wants to have an ugly large box in his yard. And therefore, we'll be able to do them smaller. And I believe that over time, we can even increase other qualities of the chemistry, such as the ability to drain the battery very quickly if needed, even if you have a small battery. So you can charge it, let's say, within 5 hours, but you can discharge it within one hour, if you need high backup. So this gives us now a much more, I would call it, flexible way to design our products. Where is the quality about batteries? And what is the differentiation? Actually, batteries are batteries. The electricity flowing from the batteries is the same whether you use us, Tesla, LG or any other manufacturer. I think that the biggest advantage of buying a battery from the same partner that makes the inverter is actually having a full system that was designed to work as a system. And this is related to the way that the BMS, the battery management system, is designed, the way that the inverter is designed to work with the battery and how integrated the product is. And not less important, the fact that you know that you get service from only one a supplier, and you don't need to be bounced back and forth between 2 suppliers arguing whose thought is it if something is not working.

That's great. And we're running -- we're almost out of time here with only 3 minutes. I could -- I have enough questions to last another hour, but I have to just ask one more. So again, thank you for the time. This has been a great discussion. So when we talk to investors, it's very evident that there's a lot of growth. We've talked about e-Mobility growing over time. We've talked about batteries growing over time. But one concern is that you're -- and we talk about solar growing over time, I apologize, solar, the main one. But one concern is around non-GAAP margins. So you've talked about non-GAAP operating margins for Solar being 22% to 23% as the target. You haven't really talked as much about these new businesses and what they might do to the margins. So how should investors think about long-term corporate blended margins over time? And do you have any concerns of margin degradation as more of these nonsolar businesses enter the mix over time? How should we think about that?

The way that we at SolarEdge management in thinking about margin is actually a little bit different because we think EPS. The margin for us is not a target. If I could sell, let's say, 1/10 of the revenues with 100% margin, and I get to a better EPS, I would go to a better EPS. And if I need to sell 3x more and lower the margins and get to the better EPS, this is what we will do. We believe that shareholder value is a multiplier of earnings per share. And this is what we're pushing. So we did -- when we entered those markets, we understood that these are in lower margin markets. We knew it for sure. And the thing that led us, at least, is the fact that we want to create shareholder value through providing much better profitability for every share held by our customers. And if that means that we run a business with much, much higher revenues because usually that will couple the lower margin in this industry. With a lower margin, we will do so as long as the bottom line shows growing EPS year-over-year for the benefit of our investors and the benefit of multipliers based on these EPS numbers.

Got it. That's very helpful. Well, we're just about out of time, Ronen. Thanks you so much for dialing in.

Thank you so much.

Yes, all the way from Israel. And we look to hopefully see you in-person at some point next year.

I hope as well. I think that we're not far from this point. Thank you very much, and looking forward to meet you personally.

All right. Take care.

Bye-bye.