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

Hey, everyone. This is Colin Rusch. I lead Oppenheimer's Sustainable Growth and Resource Optimization Practice. I'm very pleased to be joined by Ronen Faier, the CFO of SolarEdge. He's been doing this for way too long. So congratulations on surviving my friend.

Thank you so much.

Yes. So we want to get through a bunch of material here, and I'm apologize to the late start everybody. But Ronen, can you talk a little bit about the demand fundamentals that you're seeing right now? And let's start with Europe and then go to the U.S., because I know that's been a deep concern.

Yes, definitely. So first of all, happy to be here, as always. And we two do it for a very long time. So I appreciate you getting older with me. With regards to the demand picture that we see, I think that there's a little bit of disconnect between what we see in the channels to demand picture that we see. And I think that it's a good way to start because what we continue to see in Europe is a very strong demand, where the underlying demand for our products, in particular, in solar in general, is very strong. We do see a period where everyone thought or at least everyone in the industry thought in the beginning of the year, the Europe is going to grow this year by maybe 50% or 60% given the high electricity prices, the war in Ukraine and a lot of concerns about the electricity availability. Situation in reality was that actually the winter was not so bad. And at the same time, electricity prices were able to go down a little bit due to the fact that other gas sources were found. But the result is that instead of growing 50%, 60%, Europe is growing only 30% to 40% year-over-year. It depends on the country, of course. Europe is made out of many countries. And therefore, we still see very strong underlying demand for -- last quarter, for example, we get from our channels and distributors what we call point-of-sale data, is showing how much we're selling out of the channels. We're talking about record high numbers that we haven't seen before. That in some cases, even for our products are close to 100% just compared to about a quarter ago. So the underlying demand is very strong, although not as strong as everyone thought. And I guess we will talk about channels in the next questions. When we move from Europe to the United States, we see a little bit of a different picture because in the U.S., the combination of high interest rates, the market that is very much concentrated towards loans. And the fact that the electricity prices did not go up so much created a situation where we see a demand for a market that is either not growing or maybe even declining. And as such, we do see that the underlying demand, for example, in the first half of the year is actually smaller than the demand that we saw in the second half of last year. And we do not see any drivers like in Europe where electricity prices are still high and interest rates are low to actually change the situation for at least the upcoming quarters. So we see a very different picture, very strong Europe, very moderate to slow U.S. And rest of the world is many countries, but I would say that it's mixed, in some cases, we see European, in some cases, we see kind of U.S. similar policies. I would say that it's mostly mix. I'm not sure that there is 1 single direction that I can point out to.

Okay. That's incredibly helpful. I think as we think about this, the underlying demand, the sell-through is one piece of it. The second thing is around how people are managing working capital, right? And that's obviously been a big change. So, can you talk a little bit about what you're seeing on that, particularly as component availability improves and it kind of move towards just-in-time delivery on a bunch of these elements.

Sure. So I think that's a real story at least for us, what we see in Europe right now. And we need to understand that we see a little bit of 2 contradicting phenomenon. On one hand, in Europe, we see demand that is still strong but a little bit smaller than everyone expected to see. But at the same time, we do see the product availability has improved dramatically over the last few months. And by the way, not just for us, it's mostly for solar modules. The situation just in, let's say, Q4 2022 was that a very severe demand or shortage of supply to weak demand created a situation where every distributor laid their hands on whatever piece of equipment that they could get. It means that on modules, a lot of distributors went into either purchase agreements that are over longer term at relevant -- relatively higher prices. When it comes to inverters, sometimes some of the players needed to take Chinese inverters that are usually not selling outside of China, simply in order to fulfill demand. And the result was that everyone was stocking knowing that first of all, they're going to see very strong demand, and they will not see sufficient supply. Somewhere in April, May, the situation changed because, again, the milder winter changed a little bit the demand picture and the fact that the U.S. is not growing created, at least for module situation, where modules are coming to Europe where the demand is still there. And at the same time, component availability for companies like us or some of our competitors gets a little bit better and therefore, you saw a much more stable supply. And the result was that now there are a lot of products in the channel, and at the same time, supply for new product is very short. But the main issue is actually the story of the modules because some of the Chinese module manufacturers that needs to make their factory work on all the time because they have very high fixed costs are continuing to ship products into Europe, but now they are reducing prices substantially. And we see a situation where the majority, if not all of the distributors across Europe are holding very large amount of modules that were purchased in prices that are sometimes double than the prices that they pay today for new modules, and at the same time, there is a constant flow of modules going into Europe. And since modules are usually the most expensive part of the installation, what we see is that now, everyone, as you mentioned before, is much more conscious to working capital. So the first thing that they do is that they try sometimes to pay a little bit later or to ask for extended terms. The second thing the distributors are doing is since they can rely better on our supply right now instead of holding 3 months or sometimes even 4 months of inventory, let's say, at the end of Q4 -- at the end of Q2, we saw in average 2 months of inventory of our product in the channel. And now they're even sometimes reduced to 5 or 4 weeks. And this creates a situation or on one hand, you see amazing demand. But at the same time, since the inventory is still being cleared from the channel going to lower levels, the orders to us or other companies is not happening. The one last thing that you see here is also that you see a little bit of smaller shrinking portfolio sizes in some of the distributors. And therefore, you see that some of the Chinese companies that sold inverter into the channels, maybe they still have a little bit of residual inverters there. But once the distributors are getting enough supply for the known product, they're actually getting rid of this inventory. And only then they start ordering from fewer amount of inverter makers in order to make sure that they are holding 3 or 4 inverter companies in their portfolio.

That's super helpful. And this is maybe a question around some of the history because you've gone through a number of cycles, right, whether it's with subsidy changes in certain regions, migration from demand from this region to that region. I guess as you look across kind of some of the historical analogies that you've seen in this industry. This feels different to me a little bit in terms of the volume of working capital and folks getting down to -- the 4 or 5 weeks is not much inventory to be dealing with in terms of doing that. Is there another time where you've seen this happen? And if so, how did it play out afterwards? Because it feels a little bit like people are getting a little more aggressive on the working capital at this point to me.

First of all agree with you, and I would say that we haven't seen anything like it before. I think that the 2 new characteristics of the phenomenon that we see right now is, first of all, the speed in which everything happened. I would say that if you asked me 6 weeks ago, we saw a little bit of a different picture. It seems that the speed of the happening, especially once module prices started to drop significantly. And this is the last 3 weeks something that moved the entire market into a real fear of, what I'm going to do with so much inventory at high prices that are holding. This is something to change very dramatically. So we've never seen such a big move from oversupply, over demand to an extreme oversupply. And we need to remember that we used to see, as you mentioned before, for example, policy changes in the past that changes market characteristics. But usually, these policy changes happen with enough notice that everyone got ready for it. And now everyone was taken by surprise, first of all, by the lower growth still, by the way, 30% to 40% growth, but also how fast the availability of products are there. So I think that these are the differences. The similarities for us at least. And as you mentioned, I've seen at least 3 cycles like this is that we need to be very careful as a company when selling into this kind of a market because when everything is growing, usually the distributor's working capital is based on vendors credit. I give them credit of, let's say, 60 days. They collect after 30 days, and they use this money in order to pay me while increasing the volumes. Usually, once we start to see a deceleration, either the customers are not able to pay on time or at all. Then the distributors are going into cash distress and may sometimes even go bankrupt. And therefore, it not only requires you to sell a little bit more because of the dynamic, but also if you are prudent management, trying to make sure that you're not writing off your debts later on, you need to be much more selective in the inventories that you send even when you have orders coming in.

And how is that playing out for you right now? Like how much more protection do you feel like you need? And how are you managing pricing around some of those dynamics to make sure that you don't end up with a working capital issue and you're not extending too much credit, but also if you're providing those sort of working capital arrangements to folks, you have to get paid for it in some capacity, right? And so to understand, how you balance all of that out?

Sure. So I'll start maybe by saying that in general, the interesting thing is that we do not see pricing pressure. And it is coming both from the fact that on one hand, we're considered as a premium product and most of the price wars that you see among inverters will be among the more commoditized products like the string inverters, mostly Chinese in the channels. But actually, another phenomenon that we see and we hear a lot about it is that the pricing pressure on us is smaller because once the inverter is down by 50% and -- sorry, the module price goes down by 50%, and this is the most expensive part. Let's say that it's down $0.17. Nobody is really pushing on inverter pricing to go down $0.01 or $0.02 per watt. So this is one thing that we see around pricing. Around arrangement with customers. Again, it's a very customer specific, and it's very, I'd say, region specific in service side, because in general, we usually sell to very large distributors. And we don't work with the smaller customers. So the fear of bankruptcy may be a little bit lower for our -- in our case. But what we do here is that we keep a very constant discussions with our distributors, try to understand what is the real problem that they have, and then trying to help them with the real problems. For example, in some cases, yes, we extended terms. And you can see it in our DSO that went up from 114 days which already reflects something that happened before into 126 days. That's exactly the case. In some cases, by the way, we find that we're charging interest on lower payment term -- slower payment terms because today, there is a cost of money and you not want to find myself being a bank. And in some cases, we are trying to help our distributors, for example, if they have local inventory issues by expediting other products. For example, we know that some of them sometimes have more batteries. And if they have more batteries, the only way to help them really get working capital is to expedite the shipment of inverters so they can actually sell the batteries together with a inverter. Every inverter in Germany or 80% of them are going up with 2 batteries where the cost is -- of the batteries is about 4x or 5x cost of the inverter. So I think it's a combination of understanding what is the reason for the cash shortages, trying to accommodate a little bit while not being a bank because we're not financing companies. And also find, I would call it, kind of a tailored solution for our customers to make sure that eventually, we help them with really -- is painful for them.

Okay. That's super helpful. And I guess talking about competition, right? You started to address it a little bit. There's a lot of discussion around Tesla getting into the market and string inverters at low cost with the different brands coming into the market, some of the other elements of other optimizers in the market. I guess what can you say about the competitive dynamics, whether it's from China or Tesla or other folks? And what you're seeing and hearing from your customers at this point?

So I think there's again clear distinction between the U.S. and Europe in that case. I'm starting from the U.S. because I think that the Tesla offering is mostly concentrated in this market and here, first of all, everyone talks about the competition in inverters. I must say that the Tesla competition is very much pronounced on batteries actually because Tesla is the only company that can really enjoy today the IRA 45X5x credits related to batteries because they have manufacturing in U.S. So I think that in batteries, we do see the competition of Tesla very pronounced. They're very active selling batteries, prices are going down, which we expect it to happen, but they can actually do it much faster than anyone else. And I think that we do see -- I'm not sure if I'm happy or not, but we see a lot of SolarEdge inverters installed with Tesla batteries. So we're happy about the inverters. We're not as happy as missing the batteries, especially that we believe that our DC architecture is very much fitting those kind of installations, but that's a fact. On the inverter side, we see it a little bit less. One reason being that we're usually selling to the larger -- further we have the higher portion of our sales going to TPOs. And in TPOs, usually, they have buckets. They have the MLP bucket, the string bucket. So I think the Tesla is mostly displacing product on the string. I'd assume that Tesla is going a little bit more to the long tail installers rather than the large ones because stickiness because of the monitoring, but also because for a small installer, that's a way to be differentiated to say that he's selling Tesla. It's a new weapon that they usually didn't have before. And therefore, since we're not very strong there, we do not see a lot of impact happening there. And when it comes to, of course, let's not forget Enphase, which is an amazingly good competitor in the United States. I think the here the dynamics are, us virtually the same as they were. They're a smart, aggressive company with a great product. We're smart, aggressive with equally or better products. But here, I think it's more of a dynamic that relates to our starters. In Europe, it's a little bit of a different situation because in Europe, first of all, there is no need for MLP on the rooftop. So by definition, they built in duopoly that existed in the U.S. does not exist and competition was always Chinese versus European versus MLP. And what we hear from our customers is that they have 2 kinds of offering. The first one is what they call premium. Premium will be always MLP. In most cases, it's us alone. In the Netherlands, it will be us and Enphase. In France, it will Enphase and us. Of course, we do see that they have premium offering. And then they have the economy product offering, which will usually be comprised of 1 European via SMA or maybe Fronius and 2 or 3 Chinese. So the first thing that we see is that most of the competition around invertors is actually happening there, happening among themselves. And what we see is that, first of all, there is a shrinkage in the number of companies or this tier that are -- they're known like Chinese, we see much more fierce competition between the components -- the companies themselves in this year. And we see very less pressure going to us. I'm not sure that we are completely immune if the prices will go down dramatically in the economy tier, maybe the premium will have to go down, but this is not something that we see right now. And I think that when we talk to our customers, and this is the lesson that we learned in the intersolar trade show in Germany is that they still very much appreciate the additional capabilities, technological capabilities that we have related especially to the varying tariffs and the dynamic tariffs that we see in Europe. So in full honesty, it's always been a more competitive market than it is in the U.S., but we feel that here actually the competition is not strengthening for us at least, and it's most happening in the other layers. But we need to make sure that we're not sleeping while something has changes. But right now, we don't see a major change there.

Okay. That's incredibly helpful. I guess the next set of questions is really around the energy storage product, right? You mentioned Tesla being very competitive in the U.S. Certainly, we're seeing more and more markets that batteries just make sense because of some of the restrictions as well as just the energy prices. I guess, how can you characterize and tell us what the right buckets are to think about the different end markets in terms of what's driving the sale of the batteries and how you guys think about those targeted end markets and the different tiers of places where those batteries are getting sold.

Sure. So first of all, again, it's an economic discussion. Most people -- years ago, people used to buy a battery in order to make sure that they have a backup in case of wildfires or storms. This is not the case anymore. In the majority of the geographies to which we're selling other than in South Africa, the main driver is economy. And that means that the price of battery together coupled with price of energy, coupled with regulations that are not allowing to push electricity to the grid are determining what's going to be the situation. . What we see today is that with the exception of California, with NEM3.0 not yet playing a very big part of it, the U.S. is not a very interesting battery market because prices are too high, electricity prices are too low and other than California, you can push electricity to the grid in reasonable prices. There is a marginal effect that can actually increase a little bit the ROI, but it's not as big. In Europe, it's sometimes impossible to be profitable on the system without a battery because in Germany, for example, you're not allowed to push electricity to the grid in most cases. And because of the dynamic tariff changes, you play with the battery as a tool to stabilize your demand and supply. So while in the U.S., we see today in attachment rate of low single digit, in Germany, we see 60%, 70% attachment rates for our batteries -- to our inverters. Places like U.K., Austria, Switzerland, we see high 50s. Italy there was this whole story about policy that changed, but we saw a very nice attach rate. This was mostly economics. Now another question that comes and I think it relates to your second half. When you look at other markets and how do we approach them. We need to understand that the battery market is also very competitive because the batteries are mostly are commoditized in many senses. Electrons are all born the same. And here, we have a major technological difference, which is the DC coupled battery. In the interest of time, I won't tell too much about it, everyone can learn about it, in YouTube or something but the idea is that, you can actually get more than 10% more energy by using our technology by saving some conversions. And this is something that very well resonate. So we see, for example, that in Europe, in Germany, for example, we compete well against BYD batteries or against names that you don't even know Chinese batteries simply because of the fact that the technological advantage is clear that the installers know how to sell it, and we work on it. For the U.S., we're working on it right now for California. We're explaining to installers how to sell the battery solution and everything around it, and this is the sales pitch. So I think that for us, the way to sell batteries into a market is to understand the market dynamics and to see what are the technological advantages that we have compared to the other smaller, cheaper or different batteries that allows us to grow so much. And lastly, by the way, we're an open garden. If you want to take our inverter and install it with any other batteries, we're open for this. You'll decide whatever is good for you.

And so I guess you mentioned having an estimator tool that you're working with, with some of those installers, you're potentially rolling that out. How important is the software ecosystem around the sales process for you guys in terms of being able to move product into the channel?

It's incredibly important, and this is why we put a lot of effort for digitization because, first of all, many people that put our system on the rooftop do not know what is going to be the result eventually. There are so many changing factors and so much lack of knowledge. Then sometimes even by the way, the installers themselves don't know how to explain. So what we actually did over the last few years is that we developed our own software tools that allow salespeople and that allow installers or TPOs to go to the kitchen table and to very easily exercise what are the results of putting SolarEdge, either by doing very quick design using our designer tool, which is very much equivalent to PVCs or Aurora. By the way, this reduces cost also for the installer, so they're encouraged by to use our products. And then also help to sharpen a little bit the dilemmas. For example, in California if you have a battery that you can manage the energy flow that you can sell to the utility in September after sundown, this is where you make the money or not. You can have a lot of scenarios that you can play with. And I think that as the sales become a little bit more economic in a sense, it's more about what is ROI, the ability to be very sharp embodies what are the needles that are moving and to provide a software that is designated to actually show how to best design the system is something that's very important, and this is why we put a huge amount of effort in building these tools. And by the way, later on, building installation tools for the installers to make the installation much faster because it's also important for cost for them. And then, by the way, how to make sure that when you're comparing what you expected to what the result is how you can basically see if you get what you wanted and what do you need to refine here. It's a huge effort, and it's the biggest one that we do right now.

Excellent. I want to shift gears a little bit on to the manufacturing side. So both on U.S. manufacturing with your CMs, but also sell it to. So why don't we start with the U.S. in terms of how you're ramping up capacity, how you expect that to play out and balancing the global footprint of resources that you have to serve your different end markets. So would love to -- you've provided some guidance around units for the balance of this year, but I want to think about that not only those units, but the decision-making around how to scale up and at what cadence?

Sure. So the first one, by the way, is related to clarity. We do not have yet clarity whether our optimizers will get additional $0.045 under 45X or not. And this is something that's very important. And therefore, as a company, the first thing that we decided to do is to go on the fastest time to market, which means to make inverters with the contract manufacturers because we know that contract manufacturer will do it the quickest plus we're getting for sure, the $0.065. And this is what we actually did. We started manufacturing with the contract manufacturers first boards are actually coming out of the SMT machines by the end of Q3, we will ship immaterial amount of inverters and as we said, at least 30,000 inverters in Q4, and this is an amount that is going to grow in the next year. Now comes how do or where do we move from here? And here, the idea is very simple. Once we get the clarification whether optimizers can be made in the U.S., we intend to build our own factory because we want eventually to serve all of the U.S. market from the U.S., and we expect that the U.S. market will go back to growth. And eventually making product yourself and [ building at ] Sella 1 is cheaper and more productive than doing it with anyone else. So the decision-making was, first of all, start with the CM, get the clarifications already we're in the final selection of sites to manufacture our products. We already have a design team that is starting to work on this. We've already ordered machines in order to fit this. And once we have the clarification, we decide, do we build an inverter factory, the inverter and optimize our factory and we move very quickly to make sure that by the end of '24, we already have products coming out from this new factory. So this is on the U.S. What we're also doing is that we're looking now at our entire footprint around the world, and we say, what do we need to optimize? Today, we do Hungary, China, Vietnam, Israel, U.S., Mexico. So we need to decide what products we need to do, where to do them and at what pace. And by the way, how to build excess capacity because in the past, we're always chasing with capacity, now it's the first time that we actually have the ability to have a little bit of spare capacity. So this is with regards to optimizers and inverters.

And then on Sella 2, could you give us an update on where you're at with that in terms of equipment, ramp-up yields, cadence of throughput and how to think about how that carries forward over the next several quarters?

Sure. So first of all, factory is up and running, we ship products to customers from Sella 2. A chemistry or battery factory is something is -- it's very much different than regular assembly factory. And this is something that we learned over time because not only that you need to have the process, you need to actually master various elements within the process. It's like baking a cake. You get the recipe, doing it in ovens will yield different cases. So you need to learn how your oven is baking in this sense. And this is what we actually do. So in Sella 1 we started ramping up late last year. By the way, we already started to ship late last year products to customers. In the first quarter, we simply worked with the recipe, and we very much refined it, higher temperature, a little bit lower, this pressure, that pressure this how fast the battery and anode and cathode, [ reels ] are moving. We've done this. This was not in Q1. This is the time where yield was the lower meaning that we threw a lot of material, and we had a lot of cost. In the second quarter, what we started to do, we have stabilized process. Now we started making the sales. So we started to, first of all, build capacity for sales, then are sold to other customers outside of our solar industry. And we also started to make the cells that will go into our RSS battery. It's a different form factor. And in addition, we moved from first shift to second shift and then third shift. So by the end of this year, we should be at the run rate of about 1.7 gigawatts, which is after yield of machinery, what you can get out of a 2-gigawatt factory. We are increasing it already to a larger number. It's a very small investment because the building is already there. And I believe that at least for the next 2 to 2.5 years, the entire capacity that we will need can come from Sella 2, not only on the solar side but also on the other businesses that we're building that are yielding a nice amount of sales.

Excellent. I want to be a little attentive to time. We've just got a couple of minutes left here. Can you just talk about some of the key areas of investment on the R&D side? You guys have always been a astute with where you're spending your money in that effort. So I just want to get a sense of what you're spending time on?

Sure. So 4 major areas. First one -- first, we are related to solar. First one, next generation, fourth generation inverter already being tested in our labs. Fifth generation optimizer already being designed and built in our labs. And of course, the idea is to come with every product being able to be at a higher power capacity, lower cost in order to reduce cost per watt. That's the first thing. Second thing is always cost reduction. It's the first time after 3 years that we do not need to work on the time on changing components. We can do cost reductions. So that's the second area. Third area around solar is actually more products that are related to our bidirectional EV charger, our second-generation battery. So all of [ the invertor ] ancillary product that eventually make the solar at home, which is the total offering that we have. At the same time, we have all of the areas that are not just solar, they're all connected by the way, to energy. So this will be, first of all, our trackers. Again, they're not part of the large amount of revenues right now, but we are developing trackers for various applications. It's a company that we acquired about a year -- 2 years ago, very nicely growing. We do a lot of work there. Second is on software. As we mentioned before, selling tools, designing tools, connectivity tools and a lot of what we call energy management tools to be able to connect to other elements. The next one is actually in our companies like Hark, where we acquired and now we're taking their tools that were developed for smaller scale and make them bigger for other scales. So I think that it's a multiple strings that are moving from core products, ancillary products, cost reduction and the future because in order to sell more inverters 2 years from now, you need to make more software today.

Okay. I want to sneak one last one in here. We may run a little bit over. But can you just -- you generate a lot of cash. Can you talk about where you're going to spend it? Obviously, you've got a big cash balance, you could buy back stock in other areas. Just if you could go quickly through your priorities for cash deployment?

Sure. So first of all, by the way, just to be transparent, last quarter, we didn't generate cash, but you're right, the general that we to create cash general from our business. And that, by the way, this is something that will increase much more into the second quarter because some of the extended terms of inventory billing will go in. Here, our first priority still remains on organic growth. I think that as long as we know how to generate more shareholder value by increasing our portfolio of products, making them much more sophisticated and be faster to market with some products that we know that all the industry is going to that's the most important part that we see today. And this is where we will put the majority of our efforts. We're not yet in a position that we feel that we do not, who want to do with the money, and therefore, we need to return it to the investors because that means that we do not know where growth and some of the growth engines are. So we're not there yet. I would say that maybe we're not acquiring companies as quickly as we would like to. We're pretty cautious on making these movements. But I think that this is something that will grow over time. And I will say that we will need to be intellectually honest, asking once in a while do we still believe that we know how to generate this value by more acquisitions? Or is it something that we maybe hoped for, but we're not able to do. And therefore, maybe something like returning capital is the right way to look at it. Right now, I must say that based on the pipeline that we see and based on the [indiscernible] that we have on our strategy side, I don't see a share purchasing happening in the very near future.

Excellent. Well, Ronen, thank you for your patience with the late start. Thanks, everybody, for tuning in.

Always a pleasure to be in. Thank you.

Yes, it's always a pleasure, my friend. Thank you so much. We'll talk to everyone soon. Take care.

Thank you for listening in everyone. Bye-bye.

Thanks. Bye-bye.