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

Hey everyone. Our next session here is on technology leadership in solar and beyond. We're joined by Ronen Faier, CFO of SolarEdge Technologies, one of the more innovative and broadly diversified solar component providers in the space. Ronen, welcome. Thank you for being with us.

Thank you very much for having me. [indiscernible]

So I thought we just don't straight into it. It's a new year in January conference. So maybe kicking it off with some views on the outlook. I know folks are keen to hear kind of what you're what your view is for the new year. 2021, clearly solid, but a bit challenging year. Just if you look at the cadence of how things played out from the first half to the second half. Maybe walk us through Ronen your view on demand conditions here as we head into 2022, in your key geographies since you're globally diversified as well as your key end markets like resi and commercial?

Sure. So revenue where a market that is opening 2022 in a very nice position. It's a market that is demand-driven. I must say that the company I've been here for 11 years, already and the demand that we see is very strong. And one thing that really characterizes is you maintain even a country specifically is coming from almost every direction. And we cannot have many shapes and forms. Starting from the U.S., we do see, of course, a strong market in the DC market where it continues to grow driven by various reasons. One of course is the fact that solar is still very economic in most of the U.S. and even when you look at some of the proposals like NEM 3.0 that is reducing the ROI solar and certainly, solar class store is very economic, and we see a lot of demand coming from there. You also see, especially in the United States in the C&I space, the fact that migration is sustainability to company's growth. More and more companies decide that they want to be greener, they take their net zero cash of -- for 2050, they take it and they want to be ready for it. They want to improve their visibility to investors that are looking for more and more ESG and we've seen the commercial space, more companies that are agreeing to pay to set and have solar. And again, the fact that also economic decision usually helps them. Looking outside of the United States, we see various markets with various trends, I can not pursue to all of them, but I mentioned 3 or 4. By the way, 60% of our business is happening outside of the United States. So this, of course, moves labors of our business. The first one is the market line Germany. In Germany, there is a new government. The new government is where that [indiscernible] is one of their main topics. Part of was making that we would like to almost trickle the amount of installations in Germany, as they are today until the next -- the end of the decade, which means that this is like doubling what we did in the last 15 years in about 8 years from now. It's a huge market, it's a huge opportunity. But it's also a very interesting market due to the fact that there is already a solar is going to be very much battery adoption there because you need to basically -- if you go to rent store it. So this is going to be a very, very nice market. Again, it is growing and we see a lot of demand there. The last market in this very operating. We're very strong in operating for many years, continues to grow stable growth rate, it's still growing. So now it will see better percentages there. And we see a similar effect in other places like Italy, where there is a government subsidy for a solar, 5 years debt [ 110 ] of Europe investments in solar plus battery. It's a great offer. And you start to see even markets that are not very strong in solar starting to get them. So Taiwan becomes a bigger market, Thailand becomes a bigger market, Korea becomes a bigger market. And I would say that today, you won't even see one single market where solar is not growing. So in essence, if you start for 2022 based on what we see out there.

That's great. And I guess, in 2021, it wasn't a bad year for you guys, either you're on pace to grow 30% year-on-year despite a weak start to the year. I guess with all that context, is it reasonable to assume 2022 growth is going to be even better than what you saw last year? And then you mentioned a lot of the geos. Any product lines you're sort of excited about as you move into the new year, that's going to drive some incremental growth over what you saw in '21?

Well, we're that I can give percentages given the features guidance for the year at least. I think that we need to understand the dynamic something where [indiscernible]. So the first one is you mentioned the minis there in. There are 2 dynamics that have tailwinds and face wind at the same time and we need to headwind at the same time we need to [indiscernible].The first one is actually the tailwind and this is batteries. We are growing our battery injecting capability. We have signed an agreement with Samsung SDI to get 1 gigawatt hour of battery cells in 2022, which is, of course, bigger than what we had and by definition this is something that we expected to boost our revenues and to boost the adoption of solar products in other markets as well because we're in talking to people to have a battery in order to install solar. So here, we'll see a very strong tailwind, which we believe it can accelerate growth. The revenue which we will see still -- disruptions in supply chain that are heading into 2022 for -- we were not least excited when 2021 started this and people asked us, we used to say that we're not very optimistic. And actually, we turned to be a little bit more towards year-end. And now I think that we are in the same semi-pessimistic situation because we start to hear about the component shortages going to linger into 2022. And it's not just a component shortages, it's also the ability to actually mobilize products around the world, we still see very limited capacity on boats and air traffic that is limitless. And this is definitely a headwind that I don't know how it's going to change given Omicron and given some of the other factors that we see. So I think on the face of it, yes, you should see bigger growth. But I think that this year will be set year that is characterized with the lot of surprises standing on the supply chain side. And I think that this is what is going to determine the overall results much more than demand.

That's a great segue into kind of the supply side of the equation. So maybe just digging into that a bit, Ronen, COVID did cause an issue for you guys in Southeast Asia at year-end. Maybe if you could update us on that? And you sort of used the words optimistic and then semi-pessimistic. I don't want to put words in your mouth, but would you say things have actually changed for the worse relative to your expectations from a few months ago? Just kind of maybe level set us as to what you're seeing on the ground and what you're thinking about heading into the new year here.

So I'll start with Asia, and then I'll talk about again the pessimism and optimism. First of all, for us, Vietnam pace is up and running back again. As we said in the earnings call, we expected not to go back to normal at November. This was indeed the case Vietnam is actively trading. We have a lot of employees on our production line vaccinated, which brings a lot of flexibility. And I think that right now, we have a very good distribution of manufacturing where most, if not all of our manufacturing sites are where they are expected to be. We have Chinese New Year coming soon. But it was something that was expected and planned for. And on that front, we are very happy with what we see. And I think that we are where we expect it to be. The optimism or pessimism is actually related to the overall situation, which we made like it until now. You need to remember that even though you mentioned that at the beginning, we're close to a 30% growth in 2021. And this is in spite of severe component shortages that we saw especially in the mobility statement made companies actually increased production compared to last year, we are actually growing. And I think that the only changes where we see maybe less of the vision is about the ability to have the supply chain issue resolve. I would say that with that said, I think the operation we worked very close to our suppliers. We are very, very hands-on management, and we are able to solve a lot of the problems. Sometimes they can at the cost of gross margin that we guided for Q4. Sometimes they come with a little bit more time that we need to dedicate. The thing that I would say that I'm not sure if all of the supply chain issues will be resolved in 2022. But at least from where we are and where we operate today, it's exactly what we are expecting.

Clearly, no one is quite ready to claim victory around the supply chain issues. We're not out of the woods per se. So maybe on another piece, you talked about logistics, especially shipping. That was an issue for you guys. What are you seeing there? Any issues at year-end given Omicron that was clearly a month of December development. So post earnings and when people gave sort of near-term guidance updates, anything worse or any developments you're seeing with respect to that relative to what you guys were anticipating.

So we're giving that [indiscernible] organization. And that means that capacity can be achieved to do easing and sometimes to be very creative in the way that we're achieving those. But at the same time, prices are not going up. So I think that the situation is in sense unchanged. It means that still were not at the level that will allow us to get the margins immediately to where they were, if you remember in the Q3 call we said that Q4 will be bad. And we guided for this number already, but we said and we're also increasing or better situation in Q1 and coming back more normal in Q2. I think this is something that we still see. We do not see any cost, but we do not see everything working. And I think right now, I would say that stability is a good news because it clearly allows us to operate in a situation that we understand and [indiscernible].

And you touched about the implications for margins. You're clearly not where you want to be. It sounds like you get to normalize a little bit into the first and then the second quarter of this year. How do you think about it in the context of, I guess, longer-term margin targets versus just normalization? I think you're still several hundreds of basis points away from where you guys have talked about kind of that higher 30% gross margin mix. Where do you think you stand in 2022 relative to that bar if you use that as kind of the normalization level to think about?

There are 2 assets here. The first one is we put in a business like gross margin. Here, we expect that for the second half of 2022, we should be where we expect it to be for each and other business team with converters between [ 25 ] give or take 1% and batteries to be around 25% in mobility, that single digit. So in that sense, there is no change. And again, some of the changes that will help us is simply, once we're seeing logistics coming back to normal prices, which will happen, the situation now is at normal. Then we do not see any heralded there. And I think that it's important. I think the one thing that will change in our overall margin profile of the company is actually the mix because the more batteries we sell, they have about 25% margins and of course, it erodes the margin of the overall company. But here, I think that it's a good opportunity to also mention probably as management judge ourself and how can you look at our matrices. And it's been this way for many years and we continue to be, we're looking at bottom line profitability and bottom line EPS. Because if you are asking to lower more and more, we increased margin by 5%, but drop revenues by 50% or increase revenues by 100% and erode margins by 3%. I always defer the [indiscernible]. And the way that we see it is that we're optimizing operational profit of EPS. And by doing this, batteries have a good contribution because batteries have lower margin or the gross margin. But on the operating expenses, they have higher leverage because I don't need more salespeople when they go and sell it to our customers, the same salesperson to sell an inverter or the proof of the fact that the unit price of the battery is high, the R&D as portion of battery revenue from that is lower than the R&D as a proportion of inverter business. So the overall contribution to the operating bucket is not the same like solar because it is closer to where solar is. Again, especially once we have [indiscernible] that will give us our own capability. So therefore, the way that we look at it is that, yes, margins over time -- company margins will not be where they used to be a year ago or 2 years ago, but profitability and EPS shouldn't be.

That's -- I'm going to dig into the capacity a little bit here on the next few questions, but maybe I wanted to focus on in a bit on the new products, including the battery storage solutions. So maybe just for starters, how is the battery ramp going in general? I know you guys are about a quarter or 2 in. Maybe if you could level set us there. And then related to that, I know this year, you've got SDI feeding most of your capacity. You alluded to sell it too. How does that change? One, the volume opportunity for you, but also it seems like you would have cost implications. So 25% gross margin second half, you mentioned for batteries. What sort of a medium or longer term once you start to in-source and have your own sort of fixed cost structure there?

So I'll try to answer one by one. We'll get anything to the -- first of all, from an adoption point of view and without going into the quarter and we're already at the end of it. But in general, we see good adoption. Like any new product we rent, as we mentioned, in a very harshest way because it's a very complicated product plus the cost of the take is relatively large. And therefore, we are very cautious in the way that we ramp up. What issues right now from adoption is, first of all, we do learn a little bit about the manufacturing team that will fix that, always the case and we do this. But we do see that the adoption is good. And we also start to see phenomena that we have not seen before. For example, one of the things that we saw is that, we started seeing installations where the number of batteries is large, it's not one battery one installation. And this very much alludes to the fact that people would like to have resilience and they understand that maybe one battery is not enough to really have great resilience. So the adoption in good. We do have things that we need to fix and sometimes we need to do this in the do. But we do learn out of it. We do also, as I said, the overall adoption is good, and we see good adoption, especially in Italy and in Europe because it's closer to the place that we manufacture. So the time from manufacturing to actual selling batteries and storing is very close, and I think tone that we see good results for the venue. When it comes to the future, so yes indeed, the SDI gives us about 1 gigawatt hour of capacity for 2022, not all of it will be consumed in 2022 because whatever calls I get from November to the end of the year, I will not be able to make any batteries in selling in the same year. But this is definitely something that elevates our capacity and Samsung is a great partner and a great company to rely on because they know how to deliver. They're very large. In Sella 2 initial capacity is 2 gigawatt hours. So once we look into 2023, this is definitely a bigger capacity that we can have. And actually, we can increase the capacity of Sella 2 substantially if such demand is needed. So we do not see a demand issue moving into 2023 and '24. When it comes to cost, this will have a dramatic event because first of all, the bigger the capacity is, the battery is the unit cost. The fact that we're not buying from a third party that needs to cover their expenses, they have profit, of course, like in that we know how to keep the chemistry a little bit in a way that allows us to be a little bit more efficient in the way that we're utilizing the cells inside of the battery. So 25% in second or at the end of the year, gross margin is something that definitely will be improved once we move Sella 2. But on the long term, we lose prices will go down as well because once you see more capacity and the demand is satisfied then becomes a little bit more of a competitive market. And this is why we usually guides for 25% on this business for a lot longer term because even if I get the ability to reduce cost the prices follow over time. So that's about this one. And in general, again, the overall capacity that we did, it's not just related to the cells, it's also related to our ability to build batteries out of the battery cells in here, we are on track. We see that there always change a little bit. The supply will not the actual capacity will be the ability to get the right time and the right time to get the -- sorry, the right slot or ocean freight and when we see ocean freight actually quite extending, that means that sometimes you see a little bit of delay here. But from a capacity point of view, we are expected [indiscernible].

Okay. Fair enough. I think there's clearly been a lot of focus broadly for the sector on battery storage and for you guys as well as since sets a new product. I think one area where you have not seen as much focus or emphasis from the investor community, at least from our vantage point, is the utility-scale solar inverters, you guys have done very well in resi, you extended that into commercial. Now you are making inroads into utility scale. That seems to be basically new for you in 2022. What are some of the kind of reasonable expectations kind of for the scale of that end market for you? And also maybe if you can speak to profit margin levels versus other products in the solar portfolio as you layer in some utility scale end market exposure?

Sure. So first of all, by the way, just still a tender from the Analyst Day that we still plan for the end of the quarter, which I hope that will happen, and we'll extend much more there. First of all, as you mentioned, we are going to utility. Utility is a large untapped portion of the solar business that we have not yet officially touched. Why do I say officially because we already have utility installations. We have over 400 megawatts of utility installations made with the current products that are [indiscernible] by the way, the right products for it. The thing that we see there is that over time, we will be able to provide a full offering for utility. Because utility is usually, of course, inverters, modules, which we do not make. But you start to see more and more storage going into utility also given the fact that in some cases, the grid itself, they're not handled so much utility way to distribute grid usage. And by having utility installation plus battery provide much more flexibility, I believe that over time most utility installation will be solar plus [ stored ] much more than so. And here, the fact that we're already both in the battery business and utility will allow us to grow the offering and to bring a much more complete offering. The margin profile that we utility is lower compared to the residential -- the residential because of buying power and because the fact that it is more dominated by Chinese competition that was pushing in this direction. But what I can say is that our new 330-kilowatt inverter is already installed. We're going to have more installations going into 2022. And again, in slow reduction market, we will see more reduction of this. This is definitely a market for a product with lower margins than the overall product margin, but we can cross-subsidize some of this margin effect by the residential and commercial states. Over time, we do have plans and the pool of technology to develop to actually make margin profile is very attractive even in utility. And this is something that still take closer to the [ R stage ] rather than the [ D stage ], but we do have some ideas there. And we also believe that we saw it also in residential. Once you're able to provide a more broad offering to the utility, saying I'll bring you many elements and it could be the inverters, the battery sensors and maybe even grid services facilities in software and O&A capabilities, you can basically drive the margin up. And this is something that we expect to happen. So I think that in the overall market team, we'll see a little bit negative impact on margin once we go into utility, not immediately because, again, the portion will be small in the next year, but then it should improve given the fact that we have a much broader capabilities in offering there.

All makes sense. I guess just wrapping up on this part of the discussion around new products, new revenue opportunities. It seems like a number of players in this space, including yourselves, are building more diversified product portfolios. We talked about different inverters for different end markets. We've talked about battery storage. You guys clearly have other products in the mix like EV chargers and the like. Can you maybe speak to other areas where either you've got some emerging exposure or it's a key focus of kind of ramping up the portfolio as you think about broadening out into even further adjacencies?

The first way -- the first opportunity in the process, I think, by the way, that in because what we see is that solar becomes residential from a pure maximum harvesting capabilities to energy management capabilities, this is the value the bigger issue due to the fact that we do believe that the lesser of the allocation of CTG into the big NEM 3.0, which I believe it is one example of it. People will need to consume more. And therefore, [indiscernible] is a major area to make improvement. So as you mentioned, EV charger is definitely one area we already have an inverter that is a EV charger we have a stand-alone EV charger. This is something that will grow. It may come in some other places, we start to see in senior product that work very well with our inverter, for example, water heaters that allows you to basically control the time in your water -- do it at the right time in order and look in [indiscernible]. So I think what we will start to see is more and more move towards insider products of know-how to interconnect the inverter to be controlled, and we have one system that manages everything. Now by the way, I don't need to do the work to make these products. We can go today we have a connection to Google home or Alexa, and you can run the system and operate it using these devices, but I think you will be able to provide either more smart meters and we call it management units that allows you to increase the offering and to really appeal to this area of simply consuming more energy in what we're providing. This is for residential. Commercial is exactly the same but with a different emphasis. Here, the ability to connect to a battery and manage peak shaving or any other, I would call it, cost control measures is very important. We are able to do this. Then we have software as part of your ownership and maintenance scheme, which is very important. It's something that we can do. And I believe that overall, we start to connect with the EV charging to other applications in what we call migration to sustainability, come to be more sustainable, not by just installing EV but also to utilize giving energy in a better way. It's something that we can do. And again on utility, it's a more broader offering. So I think that these are the directions we already start to see, we will start to see us doing much more than the inverters and batteries.

And it seems like policy changes, although there's some uncertainty that still persists here. You mentioned NEM 3.0 in California that may further spur some adoption of these technologies. So maybe we touch on that for a bit into the new year. We have NEM 3.0 in California. We've got Build Back Better. Any other clean energy policy initiatives that might come out of the Biden administration. But just on those 2 specifically, how much exposure do you have to either? And then just any high-level thoughts on implications for your business in the near to medium term from either one of those. I think the focus clearly on kind of NEM 3.0, just given that's a very fluid situation.

By the way i think NEM 3.0 can see change, and we know that there's a lot of happening in the background in related to this. So actually, the effect from us is relatively limited. Let's do a simple math 40% of our business is happening in the United States, 60% is happening outside. Of this 40% -- and by the way, I'm talking only about solar because we have the non-solar happening outside United States. When we talk about solar, let's take the outlook is 40%, I don't know, 20% to 25% will be commercial on frequent anyway. So now we're left with let's say about 30% of our business. California is roughly 30% of these market overall. So by doing quick math, you see we're very small number by definition. So as a company, it's not the life or death situation frankly, maybe marginally unpleasant, but it also improves opportunities actually on the battery adoption because once you have a battery then, you're basically abating some of the NEM 3.0. So in a sense, we see it as marginally negative margin positive given the size of the business. So this is something that I don't think that it's very big. I know that we are being hit like other companies because of it, but I think that we will be safe as the exposure is small. B2B is a little bit different. I think that here I don't know if it can happen, but I think a part of it will happen even if it's not under a huge [ plan ], I think that this administration has a very big ambitions related to energy moving to net zero. And fortunately for us, unfortunately, maybe for others, the fact that solar should be the major part of it. If you look at some researchers, they expect that -- solar today is about 11% of the overall electricity generation around the world, it's supposed to be 38% in the end of 2050, particularly because the patterns of some share rise and sundown are very well-known unlike winds that are also changing the climate changes. So in a sense, I think that B2B can be positive for us because it is expanding the ITC, it's expanding the benefit or increasing them and encouraging battery adoption is definitely good for us. Moving to the United States. I know that there's a part of the bill that is related to local manufacturing to always be done contract manufacturers, it's going to be more expensive than bring it in other places. But if needed, we work with strong enough partners that can shift some of the manufacturing into the United States. There's a question whether exceeded because you need to have certain percentage of the overall installation to enjoy the benefit and modules and inserting relatively large. So I don't know what needs to continue. We can be flexible in this case. So I think we there can be good it will be good that different. But we need to remember one working, which is again, rest of the world. We're very strong and we're very active in Germany. So if in Germany, government would like to triple the amount of solar we will benefit dramatic condition is positive. There is a benefit now in Italy where you get in [indiscernible]. If it is going to be extended in June because it moves until the end of June, we will do that item. So here, I think that the fact that we're so much wide strength reduces the risk from adverse changes and increases all the opportunity because most of the world want more solar than yes. So that's based in the [indiscernible].

That's great. And maybe just one follow-up here. I know we're running short on time. But on the BBB not to read too much into the political TV, that's never a fruitful exercise from my experience, but I think mention was out yesterday saying that the climate agenda part of the bill, you would be a bit more supportive of than some of the other pieces he's been in a position to. So you mentioned, Ronen, in the Senate version has some manufacturing credit, specifically calling out inverters. I guess just practically speaking, would you try to exercise assuming that was an opportunity for you to monetize and get incentives from would you do that through contract manufacturing? Or would you end up becoming more of a direct manufacturer even on the inverter and optimizer side?

We need to examine it because the main 2 things are -- first of all, the U.S. is much more expensive to produce to begin with. And the second one is that our model is the CapEx slide model, meaning that we usually work with contract transactors. So it's a twofold decision because doing something directly it's not easy. Now you never own a factory here in Israel, Shellon factory, North of Israel, which has been the most stable factory that we had during COVID. It's one that we really utilize in a very good way, and we learn how to take things that we do there and deliberate the contracting the factors to make them better. So there is definitely a benefit of having your own capabilities. It's something that we need to see the equilibrium whether the complexity of doing it yourself is good enough compared to the benefit that we can get out of it. But in general, again, if needed, we know we can and we're willing to manufacture in the United States.

Yes, a high-quality problem to have if it does manifest itself. So we're going to wrap up there. I want to thank you, Ronen, for joining us and sharing your insights. I also want to wish you in SolarEdge all the best in the new year. Thank you again and bye.

Thank you very much. Stay home. Stay safe. Bye-bye.