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

All right. Well, thanks, everybody, for joining us today for Morgan Stanley's 2021 Sustainable Futures Conference. I'm Stephen Byrd. I cover clean energy and utilities here at Morgan Stanley. I'm really thrilled to be joined by Ronen Faier from SolarEdge. We're a big fan of SolarEdge. Before we get into the content, though, a couple of housekeeping items. I'm going to read a disclosure. And also just wanted to highlight, if you do want to ask any questions of Ronen or have me asked questions to Ronen, feel free to use the online portal. If you're watching this online, you can simply -- you can find the box where you can submit a question, I'll be sure to get to your questions, or feel free to e-mail me directly live, if you'd like as well, whatever is easiest for you. So let me read the disclosure and then we'll get into the content. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Okay. So we've done housekeep. Ronen, thank you so much for being with us.

Good evening. Hi.

Well, great. Well, there's a lot of directions we can go with SolarEdge. You're involved in many different verticals. And I wanted to actually kind of talk about those global opportunities, Ronen, in terms of one, solar; two, energy management; and three, e-mobility. SolarEdge is involved in this, better than I, in all of these areas. And I wonder if you can talk about the opportunities that you see for SolarEdge in these markets, how they may evolve. As economics improve and as decarbonization policies evolve, what's the opportunity set in these different verticals for SolarEdge?

So first of all, I do believe that there is a very nice and large opportunity in each of the markets, but I think that the more exciting opportunity is by having all of them. If you start holistically, we see how the world is moving towards more sustainable and more green energy. And you see it in many directions. And I think that the beautiful thing is that today, we're actually engaged in all of them. Many people would like to have contribution to the sustainable economy due to the fact that they're actually using EV. It doesn't really help a lot if you're using a lot of fossil fuel that you're burning in order to make sure that you can actually mobilize your car. And at the same time, if you're utilizing a solar system to generate energy, but you're not really consuming it, sometimes you're not getting all of the benefits of the energy that you're producing. And I think that the fact that we're able to tie together, first of all, the production side through our solar systems, the storage, which we did not mention as a market by itself, but the lithium-ion battery and the battery market by itself is a very large opportunity. So the ability to have the means to store seamlessly this energy and to utilize it using a lot of software in a way that will best utilize this energy in your home. And later on, use your energy into an EV, where we are providing today the full powertrain to these kind of EVs, allows us to be in all of the value chain from the generation up to the storage and consumption of energy. All of these markets are expected to grow. We see an evident growth, of course, in solar, the market is growing everywhere. In the United States, in Europe, we do see post-COVID policies that are encouraging this kind of growth. We saw the summit a few weeks ago in the United States, where you saw a commitment for a net zero energy by various years by various countries. This is, of course, something that pushes our business and the solar capabilities. And of course, the fact that prices are going down or costs are going down when you are producing modules, inverters or batteries is something that helps a lot. When you look at the EV or the e-mobility market, many people talk about the component shortages right now from the angle of how problematic it is for the industry, but I think that we all neglect to understand that this is coming due to the fact that the e-mobility market is growing very quickly. And when you're playing in this fast-growing industry, I think that the opportunity is large and just to capture our opportunity in it, we're focused on the LCV market, light commercial vehicle. This is a market that is expected to be only for full drivetrains, what we are providing to be a $30 billion market by 2030. And this is from almost nothing today. So I think that all of these areas are connected to each other. I think that all of them are going to experience growth based on the global trends that we see. And I think that opportunity lies for us simply due to the fact that we're present in all of these vectors and we know how to play in all of them.

That's a great start. I mean, it strikes me that these different verticals require sort of cutting-edge power electronics, power management, SolarEdge is a leader. And I guess a related point, we are fairly obsessed with the integrated home idea and then at SolarEdge, you have a great graphic that shows how that integrated home might work. I wonder, could we dig a little bit further into that? Could you talk a little bit further about your vision of the integrated home? And importantly, how do -- what SolarEdge's role to achieve that?

I think that in order to fully understand it, I think that we need to look into the future a little bit and what are the trends that are happening in the industry. And looking into California right now is a very interesting showcase. There's a lot of debate of whether net metering should continue. And if yes, at what rate. And net metering basically means that you generate electricity, you sell it to the utility and then the utility is sent to you by the end of the day. You see that there is a heated discussion of whether utilities should actually buy this electricity due to the fact that it puts a lot of the load on the other costs of electricity like transmissions on those that don't have solar systems. Some may even claim that it is destabilizing the grid because now the utilities don't know how to forecast how much electricity will come. And therefore, our belief was and it still is that over time, utilities and maybe states following these utilities will be less and less inclined to absorb this energy. And therefore, the key of being really able to have all of the benefits of a solar system is not just to produce more, but it's actually to utilize in the best way. Now when we think about how can we use the excess electricity, always people thinking, first of all, about batteries. But I think that this should be the second stage because battery is a very good way to store energy, but it's a very expensive. And again, since the theme of this conference is sustainability, the issue of recycling batteries is going to pop up at a certain point of time. Batteries are not very environmentally friendly as well. And therefore, our belief has always been that the best way to utilize energy is, first of all, to better utilize it in your home and better consume it and then only store the residual and then only sell what's left if you can sell to the utility. And the suite of products that we provide today or develop is supporting all of it. Of course, everything starts with the generation itself. So today, we have our power optimizers and inverters. They allow a much more efficient production of energy due to the fact that we know how to overcome a partial shading or other design issues. And we know how to generate a lot of electricity. Once this electricity is getting into the inverter or getting harvested, here comes the bigger layer or the more important layer that most people do not know, and this is the very strong software layer that we have underlying our product. And this software layer that is all included in our My SolarEdge application is the ability to analyze the energy needs of your home, to be able to connect to other devices that are consuming energies and to efficiently use all of these areas. So if you're now in the United States and it's noon, you would like to heat your water, which is, by the way, one of the biggest consumptions other than heating and cooling, you would like to heat your water at noon and leave them hot until the evening in order to utilize the cheap electricity that you generated. And by the way, heating water is always the cheapest storage that you can find. If you have an AC unit or HVAC unit that is connected to the system, preheat or precool your home at noon when you generate the electricity and then just maintain it at the right level, this is much more energy smart than doing it in the evening. And if you have to run a pull pump, a dishwasher or a washing machine that is, again, using warm or heat, do everything when you generate this electricity. The software layer that we built is able to analyze, to recommend and to help to do all of these. And of course, all of these applications will get better over time because we're getting more and more connected. Today, we already have interoperability with Google Home and Alexa. But over time, of course, you need to be connected to all of the system and we work on this ecosystem. Once you satisfy all of those, actually, your energy consumption in the evening when you do not generate PV falls dramatically because now you need lights for keep the water hot or your house cool or warm, and you need to have lightning and TV, but this is where a very efficient battery system allows you to utilize the energy. So today, we have all of those elements. But even before those elements, there's another, I would call it, topology advantage that we have and we take advantage of. And this is the fact that we are utilizing what's called the DC-coupled solution when it comes to the battery. And it's very important to explain this because some people think that it's only an issue of how do you do things, but do not really understand the real power of it. Most homes in the United States, outside of the United States that install solar system on the rooftop, install DC capacity, modules capacity that is bigger than the inverter capacity. And the reason is that they want collect as much as possible energy in the morning or in the evening when you do not have the sun at the right angle to produce as much energy as you can. This is called over DC. When you have an AC-coupled system, all of this over DC capacity is lost because your output is always dependent on the size of the inverter. So if I have 12-kilowatt modules on my home in Israel, and I have 8-kilowatt inverter, I can only utilize 8-kilowatt inverter. Under our technology and our topology, we can put the battery at the DC side. So now it means that when we do not have power or even when we have a grid present, we can take all of these 12-kilowatt hour that I'm producing at noon to take 4-kilowatt hour to charge my battery while still using all of the inverter capacity to take energy out. I'm simply getting much more energy out of this system. So the combination of harvesting that is better than string inverters. The fact that we know how to utilize the energy at the right time to reduce the consumption in times when there is no PV. And how do we know to store everything but use the storage in the most efficient way that utilize the energy in the most efficient way, provides us, I believe, a very nice advantage when you look at a future where you really want to be zero energy in your home. And that means that you produce everything that you consume and you consume everything that you're actually able to produce.

Well, on hearing you describe the integrated home, you addressed a lot of misconceptions, it does strike me that everything you just walked through is far from a commodity. It's integrated software, I think -- and you're right that software, I think, is often overlooked. As a part of what you're doing, the capabilities you have on storage is overlooked. Storage is often thought of as a commodity product. I think you highlighted a number of reasons why that's not the case. I'm going to continue on the integrated home a little bit further just because we -- as I mentioned, we are fairly obsessed with it. You have a -- you work with Sunrun quite a bit. It's an important customer for you. We're excited to see the agreement between Sunrun and Ford relating to the lightning. How do you see sort of -- can you talk more about EVs within the home and sort of integration within the integrated home, how that might work?

Of course, and -- but I will also highlight some of the challenges because they also appear. In general, we said for a very long time that actually an EV is a battery on wheels. And that means that once you have an EV and you have, I don't know, 50 kilowatts of battery on your EV, you basically now have the way to store energy and you can manage it. The issue is that we need to understand that in order to really utilize EV as part of this game, especially when it comes to energy storage for non-EV utilization, and when it comes to, by the way, the ability to sometimes play a little bit of I would call it, exchange game where you're maybe charging the battery a little bit more and then you utilize it in the evening in order to change the structure of your payments. We need to, first of all, take into account that today, EVs are under warranty by the EV makers and the battery makers. And the battery warranty is very much related to the cycle times that you charge it and discharge it. And basically, if you do not utilize the battery in the way that the EV maker warranted it, you actually may lose it. So I think first of all, we need to understand that there is a challenge that needs to be looked at. The EV cannot be just a battery because it reduces its value as an EV. And also, of course, you need to see what's going to happen if you want to have a full battery when you want to drive and how do you manage it. But in general, I think that the direction is right. And if you look at EV for simple storage for day-to-day usage, this may not be the case. But if you look at EV as a means of actually backup when you have a wildfire in California, and you want to make sure that you have product, I think that this is a very nice idea once you know how to tie all of the ends related to how the EV is used. So I think that this is the first time that I said I was equally excited due to the fact that it was the first time that what we say for many years is becoming real. And I think that this will be something that Sunrun, that is a really innovative company, and companies like Sunrun will develop over time. But I think that it just shows also how strong the connection is and it just shows how over time everything will be related, your EV, your solar and your heating water device in as one system.

Those are great points. The -- as we think about EVs as an effective battery, I think you raised a really important point. And the distinction between sort of constantly using an EV as some kind of home management system versus basically an insurance policy for really catastrophic power outage, for example. I think that's a nice distinction, an important one. Yes, we're certainly -- I'd love to see how these different technologies are clearly becoming much more related to each other. That's really exciting. I wanted to shift gears maybe a little bit and just talk about -- we tend to focus on E endlessly. When we think about ESG, it's always E, and that's fantastic. But as on the governance and social fronts or just other things where you can -- just touch on Scope 1, 2 and 3 emissions, if you'd like, but why don't we try to broaden it out away from the typical topics. Any other sort of priorities you have on those other elements of ESG?

So yes, and I think that there's always a challenge of how not to make it a fluff discussion. ESG becomes a very important theme, especially when it comes to investment thesis. And in many cases, you see all -- you see companies that put the right words in order to satisfy those who wants to check the box. But I think that the interesting journey is actually behind of the words. And I want to give you one example that we are, as a company, very much thinking of and debating of and try to accelerate. One of the issues that we are like other companies trying to promote, of course, is gender equality and to have a gender equality in the participation of the labor in the company. And when we're looking today at least where our R&D is done into power engineering class in university, out of 40 students, you will usually find 5 women and 35 men. And the big question is, how can you really create equality in the number of men and women employed in the power engineering department if this is the situation to begin with? And while declaring that you want to get to equal number of people, that's great, but the question is, how do you really make it happen? And these are some of the questions that we're trying to address as a company. We're trying to address how do we, first of all, make sure that we have more participation of both genders in, first of all, study. And the way that we look at it, for example, is that when Guy Sella, our founder, died out of cancer, we basically, together with a very, I would call it, respected institute -- academic institute in Israel, started a funds program and scholarship program for people. Using these kind of tools to advance women's participation in those studies is very important. Some of the issues related to how do we give a little bit of classes of school, the exposure into what we do and expose both men and women, kids and girls and boys to what we do and make them curious and make this accessible to them is very important. So therefore, the way that we're looking is not just how to report, but actually how do we actually make an impact in order to influence this. Some areas are obvious. When you talk about bookkeepers or CPAs, it's relatively easy to make this equalization. But I think that we need to look into the other areas, and these are the areas that we put a lot of effort. Another effort that we're putting and of course, it is going back, and I apologize, to the E part, but it is also looking at our products and how can we use less earth products into our products by moving -- using technology into HD Wave, we were able to decrease substantially the amount of copper and aluminum that we're using. This is something that is not coming from the regular areas of how to save a little bit more energy, but it's how to go deep down into what are the sources of needing resources and how to reduce those. So I think that what we try today is to have a holistic view of all of the elements, and we built a team starting from top management and Board of Directors down to the employees level to tackle some of these areas that we highlighted in our reports. So it's gender equality, it's human rights among our subcontractors. How do we make sure that in China, your employees and your subcontractors are treating their employees well and how do you build a program to look at this and make sure that you audit them frequently. I think that these are the areas that we put more effort. Less on the reporting, which we will try to do as elaborate, but actually more of how do we influence that the reporting 5 years from now, 7 years from now can really get better results.

That's a great overview.

There's a lot to talk about it, but I think that these are the areas that are most important for us, at least to make sure that we're driving this change rather than just reporting it and giving more clarity to it.

Yes, I love the tangible focus. And it's a great point about gender diversity, if you don't have enough women students in various technical fields, then it's going to be challenging to achieve the ultimate end result. So it's a great point. I had a question here from an investor just on growth, Ronen, and back to your core business. And the question relates to sort of growth rates for residential demand versus commercial and industrial. And the question essentially is, do you expect C&I to grow faster than residential and in which regions? I wonder if you could sort of talk about your expectations for growth.

Of course. The positive side is that we see growth everywhere right now. So all of these areas are growing. But I think that the distinction that the person who raised the question is making is very important because every region is behaving a little bit differently. I think that if you go market by market, residential solar is growing very quickly in the United States. But I think that this year, even though starting from a relatively low base, a lot of growth will come from commercial that was hit dramatically due to COVID. And I think that returning to the normal levels of pre-COVID will require high growth rate in this sector. And we see good signs of this growth based on point-of-sale data that we're getting from our distributors. On utility, we see a lot of growth in the United States, a lot of growth projected for the next 2 to 3 years where you see also, by the way, a lot of growth in the demand for solar-plus-storage because storage becomes almost an accompanying part of most utility installations. So here, I think that you are supposed to be seeing relatively large growth. I would say that utility, then commercial, though from a lower base, and then residential will show -- this will be the order of growth. When you go to outside of the United States, I think that you see very similar growth rates of residential and commercial in Europe. The market was exposed to COVID in this effect. It's a healthy market. It used to be a healthy market, and the growth is there. It is not necessarily our growth because we take some share today in some of those areas, and therefore, we're growing faster than the market, but you overall see a growing market in all segments. I'm not sure that I can distinct which is growing the faster. When you look at everything that happens outside of the United States and Europe, here, it's actually mostly C&I and utility. And in the developing countries, in Southeast Asia, in Latin America, I think that you see high double-digit growth of C&I. You see very strong growth of utility. You see residential being relatively small. And I'm not sure that even the size is noticeable compared to the other regions. So it's a very healthy market with very healthy growth, mostly on C&I outside of U.S. and Europe. In U.S., strong growth in all of them. And in Europe, to a lesser extent, equal growth, but I think smaller than the other 2 regions, both in residential and commercial.

That's really helpful. We often will get questions that are focused on the U.S. market. It's really helpful to get that global perspective. I try to remind folks about SolarEdge is sort of global footprint. It's a big world out there. A lot of areas for growth. Ronen, another question I've received just relates to availability of components, cost of raw materials. This comes up all the time with investors. SolarEdge has been, I think you've been quite thoughtful in preparing for situations where there may be shortages. Would you mind just elaborate on your position there?

Sure, of course. So before I even start, I would say that it's not easy for us as well. The component shortages and actually, everywhere that you look today on your supply chain, you see hurdles. You see hurdles in components. You see hurdles in shipping. You see hurdles in the time that it takes the Rotterdam port to have ships being distributed into the landlines. And you see problems with getting empty containers from the United States into China back. So it's everywhere. I think that we're in a little bit of a less exposed situation due to 3, I would call it, pillars that our operational mode is built on. The first one is the fact that it's the third time that I, at least in SolarEdge over my 10.5 years there, experienced component shortages. And the same apply for Zvi, our CEO. Zvi is coming from the NAND and the flash industry semiconductor. He had seen the cycle before, so did I. It is something that we're well aware of. And as such, the first thing that we did is that we understood that when you have component shortages, diversification of your vendors help you a lot because it gives you a lot of flexibility. In 2018 and '19, we saw another component shortages. And one of the things that we did was to develop alternate sources for our components and alternate, I would call it, modifications to our product. We paid for this, by the way, by higher failures that we saw because we saw many new products with higher failure rate at the beginning of the life cycle. But what we enjoy today is the fact that in most of our critical components, we know how to have more than 1 supplier, and therefore, we know how to leverage better between 2 suppliers. The second area is our close proximity to our contract manufacturers. We use contract manufacturing but we have people present, employed on the sites of those contract manufacturers, and they're embedded to everything, from there, I would call it, quality checks when -- in the entry of components, up to the level of logistic and supply chain. We go over the MRP plans. We go over the POs that are being placed. We're able, due to this, to sense things that are happening in the market way before they start. And actually, we sense these component shortages a few quarters ago, and we were able to start preparing for this. So this gives us a lot of ability to be very close to the sub-vendors of our contract manufacturers and to react very fast. And the last thing that we did is that we identified that the contract manufacturers are most limited on working capital. That means that in some cases, they are trying to minimize their inventory and to work on what's called based of just-in-time kind of manufacturing. That means that they hold very little inventory out there and when shortages happen and shortage is sometimes just delay in deliveries, they're not able to have components. What we did over the last few years is that we developed a methodology in which we buy and we store critical component safety stock with our contract manufacturers. And therefore, when shortages come, we have enough buffer stock to smoothen some of these elements. So all of these are helping us. And as Zvi said in the last call, I think that our operating plan that is assuming growth this year is in a comfortable position, even in light of the shortages that we see right now. The only question is, of course, if we see much growth beyond this, how much we can get out of it, but of course, we'll work as hard as possible to do it. And this also, I think, a true and assuming that this is not something that will be solved quickly. On the other area that is related to the material prices that you've mentioned, it is somehow reflected in our gross margin target for the next quarter that is lower than the one that we had before. Actually, it's still on the higher range of our long-term target, but we see prices soaring everywhere. The cost of copper is about 2.5x compared to where it was before. Aluminum prices are the same. We were able to stop some of these trends with our subcontractors and vendors, but it cannot hold forever. And therefore, we do see some increases that are happening, and this is again embedded into our projection. So I think that what we will see is that the shortages will continue for a relatively long time. We do expect that this will impair a little bit cost reduction activities that we can have or at least will not let us use the full potential. But at the same time, I hope that with no bad surprises, we will be able to cross this one while still meeting our internal goals.

That's a really thorough overview of the situation and it does strike me to your point that if these issues persist into '22, which it does look like many of the issues will, I think that's going to put just more stresses and strains on everybody across the entire supply chain. We can't really deny that. That's an issue we're all going to have to wrestle with.

I fully agree. And what you see, by the way, is that actually, it's becoming a self-fulfilling prophecy due to the fact that now that you see that there is component shortages, you increase artificially your demand, so you will be able to get -- even if you get allocated amount, it's growing. So you see it's kind of a vicious circle until more capacity is in place. And we assume, as you are, that this is something that will continue in 2022 as well.

Very good. Well, I think we have time for one last question here. I wanted to go back to your relationship with your suppliers. You mentioned, Ronen, earlier, sort of thinking about human rights and ensuring that you've sort of auditing and understand the ESG characteristics of your suppliers. Could you just add a little bit more how you approach that, how you ensure you're avoiding human rights issues?

Sure. So first of all, it's work in process, but it starts with the fact that we decided deliberately to work with American contract manufacturers that adhere to higher standards than some of the other peers around the world to begin with. And therefore, when you work with Flex, when you work with Jabil that have very elaborated rules, you know that they're auditing their subcontractors, they do everything that they can themselves. And we have a very good common language when we talk to them about these issues in a way that really allows us to feel comfortable that they are meeting our supplier code of conduct that they are signing on. I think that usually, the bigger problem is on those sub-vendors that are supplying those contract manufacturers, some of which we contract directly and we simply sell the components to our subcontractors. And here, the main issue is, first of all, to make them aware of the fact that we are demanding this by having a code of conduct. And this is also elaborating on human rights and making sure that they sign and they understand. The second area is the fact that our quality and reliability people are meeting all the time and visiting all of these sites to do quality checks. We are now developing an audit plan of how do we meet as many of these players and how do we make sure that human rights are kept. And then we will need to develop, which we didn't do so far. But again, it's a journey what should be the, I would call it, a response to the various scenarios that we will see there from no violations to clear violations and what are the, I would call it, sticks and carrots that we can hold against those suppliers. So I think that it's a journey that starts by identifying, elaborating with them and then auditing and later on simply complying with this.

Excellent. That's great to hear. I think we're right up at the end of the time. I want to thank, Ronen Faier, from SolarEdge. It's just a fantastic discussion. Thanks all very much for taking part. Thank you, Ronen.

Thank you very much. Bye-bye. All the best.