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

Well, hi, everyone. Apologies for the late start on this one. Good morning, and thank you for joining us today. My name is Sophie Karp. I will be moderating this fireside chat. And today with us, we have J.B. Lowe with SolarEdge Technologies. J.B. thank you so much for your time. And I'd like to turn the floor over to you for some quick prepared remarks, if you have any.

Sure. Yes. I mean we are -- we did get started a little bit late, but I'll try to keep my comments brief so we can get right into the Q&A. I guess, first, SolarEdge founded in 2006 by 5 friends who got out of Israeli military around the same time. Their expertise was in power electronics. And they targeted the solar sector as an industry they wanted to get into because, number one, it was good for the planet. Number two, substantial growth outlook. And number three, it really had the potential to be disrupted through the development of new products. And so the product that these guys developed was something called the DC-optimized inverter and power optimizers. Now I don't want to get bogged down into the technical aspects of the product because we don't have the time. But essentially, the benefits of the product over competing products at the time were, number one, improve safety features, number two, the ability to maximize the energy production of each individual panel, solar panel. Number three, the ability to monitor each panel and then number four, to do this all at a lower cost than some of the competing products in the space. Now once the product was introduced to the market, it was obviously a journey to gain market acceptance, to prove that the product was superior to the legacy competition, et cetera, et cetera. But if you fast forward 10 years to the late 2010s, SolarEdge became the largest inverter company in the world by revenue, and outside of China, that actually remains the case today. So the company started in the residential space as resi was and still is the most profitable market in Solar. But given the advantages of the architecture of our system, we've been able to move into the commercial space, and we've done very well there to the point where C&I was actually more than half of our shipments last quarter. And the same advantages that we thought would get us into the C&I market, the commercial space, we're now applying to the small-scale utility market as well. We're actually taking orders for our largest inverter to date, a 330-kilowatt inverter for community solar projects in the U.S., for example. From a geographic perspective, our strategy is to be -- has always been to serve as many markets as we can. And here again, we started in the U.S. market initially, but we've since gone into the European market to the point where Europe was actually over 70% of our revenue last quarter. But we also sell into what we call the rest of world. And today, we have installations in over 125 countries. From a product perspective, we've also added to this legacy inverter plus optimizer product. We bought a battery company, for example, in South Korea in 2018 to make our own residential storage products and we're launching a commercial battery next year. We also sell EV chargers. We're rolling out a bidirectional DC EV charger later next year. We also sell load controllers, water heaters, backup interfaces and a couple of other ancillary products around the solar system. And I think importantly, on top of all of this is that we have an energy management system, which we call SolarEdge One that manages and controls the entire energy system of a home and increasingly of a commercial or industrial location. For example, the opportunity in this space, as you can imagine, is very large as more and more businesses and homes are electrified. And from our perspective, our business model SolarEdge is very strong. We put out an operating model at our Analyst Day last year that laid out a 20% to 30% top line growth target through 2027. And gross margins of 29% to 31% on a consolidated basis and operating margins of 17% to 19%, again, on a consolidated basis. And this operating model is still very much intact despite some of the recent market gyrations which I'm sure we can get into in the Q&A. So that was a more brief set of comments that I probably anticipated, but I do want to leave enough time for Q&A. So why don't we start with that?

[Operator Instructions] But J.B., this is a great segue into what was going to be my first question. SolarEdge is more diversified than a lot of its peers, right? As you mentioned, you have a variety of products is different scale of solar, you participate in the charging, EV charging et cetera. So where do you see the biggest growth opportunities coming from in the medium term and I guess, long term? So how should we think about that?

Sure. From a growth perspective, we should still see growth in every part of our business, both resi, commercial and clearly utility, which is essentially starting from 0. But the fastest-growing market for us, I would say, next year is likely to be commercial. From a growth rate perspective, utility might be higher just because it's again, going from 0, but commercial is definitely stronger in both the U.S. and in Europe. Over the residential market right now.

Okay. And so maybe speaking about your utility market a little bit more. When do you expect that to inflect?

So this is a product that we are just launching now. We're just taking orders for it now. And this is a utility product that is destined for what I would describe as the small-scale utility market. We're never going to be a product that can compete with other inverters, which are less expensive than ours in the multi gigawatt solar field in the middle of the Nevada desert, for example. We're just not going to be at a place where our product is cost competitive. But if you're talking about a utility project that is more in the hundreds of megawatts rather than gigawatt plus. This is a place that our products, we think, can be very competitive with the legacy offerings that are in the market. And the biggest reason for this is there are certain projects and areas where people are trying to put in solar that are a little bit more unique. Now as the land that is the best suitable for solar gets more and more used up, you need to push into areas and geographies that might not be ideal for solar. So for example, there's sites that have undulating terrain, or that are next to a building or that are in the middle of a forest, for example. These are areas that, with more unique characteristics, the benefits of an MLPE solution generally come to the [indiscernible] so it's the ability to separate the energy production of each individual panel. And the monitoring capabilities is actually extremely important, especially for utility customers because every minute that they have downtime or every minute that a single panel is down, this affects the operating model of their project to a significant extent. So if you can have panel-based module or panel-based monitoring capabilities, especially in terrains that are maybe a little bit more challenging, this is somewhere that our product offering really could have benefits to a system owner and this is actually -- the reason we got into this is really because this concept has already been proven in like a large scale, I guess you could call it a large-scale commercial project, for example. The example that we like to give is we have an installation in Taiwan that is 75 megawatts and it's installed with our 120-kilowatt inverter. So you can imagine that's hundreds of inverters that we put into this product. And this is because it's a little bit of a unique project, the system owner though, understood the benefits that our system could provide. Even though that we're more expensive on a CapEx level upfront for the inverters themselves. We could save him on balance of system costs. Our product allows you to use longer strings, which means you have to use less combiner boxes, you use less fuse boxes. There are certain elements on the balance of system piece that we can save money on. And then again, on the actual planning of the site itself, the fact that you don't need to necessarily do site grading to completely flat in the terrain. We have products both on the inverter side because of our MLPE product but also because of the tracker products that we actually had, we sell a tracker as well for this application. It enables a much more flexible project design that will allow you to not have to do site grading, which is, as you can imagine, the significant cost for some of these things when you're actually changing the landscape and the permitting that's involved in all of that. If you can avoid those costs, even though our inverter may be a little bit more expensive, the benefits you get, number one, from an upfront CapEx cost but also over the life of the system when you can monitor everything on a panel level, you can save on O&M costs. This has a significant improvement to the ROI that project owners can see. And this is why we're attacking this specific market on the small-scale utility side.

That's a very helpful view of that. Maybe you can talk a little bit more about batteries and energy management solutions that you guys are rolling out. A lot of your peers as well are doing that in a lot of R&D dollars and effort goes into these type of products these days. So the market is a lot more competitive than maybe market for MLPs, particularly in the U.S. I'm just curious as to what your view is longer term, is that going to end up being more concentrated market with few category winners or more fragmented markets like maybe what we see in the solar panels? So how do you see that market developing?

Yes. So I guess I would argue that outside of the U.S., the inverter market is an extremely intense. Intensely competitive market. I mean this is something that we compete against the Chinese in Europe and have done so for a decade. So the competition in the battery space is not necessarily new to us. The U.S. is a different story guest. The U.S. has become a duopoly market over time given regulations. But outside of the U.S., it is an intensely competitive market. So intensive competitive markets are something that we have handled, I would argue very well ever since the company was founded. We've carved out very nice market shares in markets that do not have regulatory barriers to Chinese entry, especially in places like Europe and the rest of the world, right? So yes, the battery market is competitive. The energy management space in general, I think, will get more competitive over time. The strategy that we are pursuing is one that -- let's start with batteries, for example. So batteries, as you said, it's a very competitive space and pricing most likely will need to come down. Just to make these things more economic, right? Because in the U.S., for example, outside of California, it's not very economic to have a battery put on your house. In Europe, it's a different story. But again, anything that can make the system generally more economic is something that will drive demand, and we think that, that needs to happen. So how do we compete on batteries? Well, number one, we have as I mentioned, we bought a battery company in 2018. We have built a 2-gigawatt hour facility in Korea to be able to serve these markets, which we actually recently expanded. So the benefits -- the question we always get is how are you going to compete on it from a cost perspective on batteries against a CATL, Samsung and LG. And from a cost perspective, that's not the idea. We're never going to compete with them on a cost perspective. What we need to compete with them on and what we can compete with them on is what does the product actually do? And how is the product actually managed within a comprehensive energy solution and energy system. So from a product perspective, 90-plus percent of batteries globally are destined for the EV market. And so they are optimized for the EV market. And there is differences within the actual chemistry of a battery that make it more optimal for use than in EV and completely different chemistries that make it more optimal for use in a residential storage system. You can imagine the different characteristics of both of those things that ED needs to be accelerated very quickly, whereas residential storage system a more steady state of energy inflow discharge. So we wanted to own the chemistry to be able to actually optimize a battery for the use that we're making for, which is residential storage. That's number one. The second piece of it is the ability to integrate a battery into a more comprehensive and holistic energy management solution system. And what we think we have a benefit is that if we make the battery if we make -- that's optimized for residential storage, if we make the battery management system, which is all the technology and software that goes on top of the battery to manage it, and we also make the inverter, and we also have an EV charger. Having all of these things made by the same company and have all these things designed to work together with all these other products is actually something that in the past, it has never really mattered before. Because no one was really worried about eking out the last percentage of energy efficiency out of your system. But once we get into an environment where let's take a home in Europe, for example, you have natural gas heating, you don't have any solar on your roof, and you have an internal combustion car. Your electricity usage is not that high. Now you're adding an EV and maybe a second EV, you are switching from natural gas heating to electric heating, and you have a solar system on your roof plus a battery. So that system just became significantly more complex, number one. But number two, it's a system that is using more than double the amount of electricity that it was using previously. So when you're talking about the actual dollar value of electricity that's coming in and out of a home has more than doubled the percentages of efficiency that you can improve actually start to make -- to mean real dollars. And so if you have a battery and a battery that's optimized for residential storage, by the way, a battery management system, an inverter and an EC charger that are all made by the same manufacturer that were all designed to work together, that is inherently a much more efficient process than if you have an EV charger for one company, an energy management system from another company, a battery from a third company and an inverter from a fourth company. Just think about trying to pair a Samsung phone with a pair of Apple AirPods. That's a 20-minute process, whereas if you have Apple AirPods in an iPhone, you open the case and it all works together. This is the same type of idea when you have very complex appliances and/or battery inverter in a home, if these things don't -- these things can all talk to each other. Anyone can make an energy management system that has a software that you can write an API and you connect to it. But if it's optimized in the proper way, it optimizes the term that I use on purpose because this is something that we focus on. If you have an assistant that is optimized in the proper way, you can save time and efficiency from all these pieces talking to each other. So let's say, the inverter has a software update. The battery -- if it's a third-party battery, you're not necessarily going to catch the software update very quickly. So it's these pieces of efficiency that I think are really going to start to become more and more important as electricity usage goes up in home and you can actually see the benefit of having a system that operates seamlessly altogether to actually save more money.

It's very helpful. [Operator Instructions] J.B. Maybe we can zoom in a little bit here and talk about the current inventory cycle and how that is developing? I know that's something you probably get asked a lot, but maybe if you can just give us some incremental color since the last time you probably spoke about this on a?

Yes. So yes, it's a very dynamic situation. If anything, what we said on the earnings call is -- was that the European distributor. Let's start with Europe because that I think is the more recent phenomenon. The situation that European distributors have in terms of having too much inventory and having too much inventory, especially on solar panels, which is the largest cost component of the solar system and thus the largest piece of inventory from a dollar perspective on their shelves. That is a real problem for them because what panel prices have done in the past 9 months is go down by 40% or even more in some cases because the Chinese are flooding the market with cheap Chinese panels. So what the distributors have in Europe is a cash flow problem because they have too much inventory of panels specifically, and that inventory is now 40% underwater. You can imagine what that's done to their working capital situation. So an environment in Europe where demand -- where underlying demand for solar is very, very strong. We're talking about 30% to 40% plus growth in 2023. And continued growth, like the data we see from our distributors is continuing to show significant growth in terms of sell-through into Europe. You have a situation where the distributors have a working capital problem. So they want to reduce ordering from OEMs like us as much as possible. So this is causing what we think is going to be a 1- to 2-quarter kind of challenge in the market from an inventory perspective as distributors, which are holding the regular amount of inventory of our product, which is around 2 to 3 months. We're regular at least prior to COVID, they want to shrink that down to 1 month. And the question is, how long is it going to take for them to actually do that? Because, again, sell-through is going out the back door at a very nice pace but they want to raise as much money as possible at the distributor level to manage their cash flow situation. So on the call, we said that this could be -- depending on seasonality, it depends if this is -- how long this is going to take. Because if it's a warm winter with no snow, you could install more -- actually install more weeks, and the problem can probably be alleviated even more. If it's a harsh winter, then it could take a little bit longer. So this is something that could go into 4Q, depending on the winter, bleed into 1Q until this inventory situation is kind of rectified but at the end of the day, 1Q is going into the spring installation season and sell-through being as strong as it is, distributor inventories are going to be depleted fairly quickly. So this is something that we think is a temporary issue, but it's one that's causing some headaches right now.

And then the U.S.?

In the U.S., it's actually a little bit of a different story because demand isn't as strong in the U.S. And so you have inventory levels that are higher, not necessarily because the inventory days levels are higher, not necessarily because the actual amount of inventories is high necessarily, but the sell-through in the U.S. market is so low that we have anywhere from 6 to 8 months of inventory in the U.S. channels versus 2 to 3 in Europe. But the U.S. distributors don't have the same working capital problem that the European distributors have. So there's not as much of a panic in the U.S. despite the fact that demand is lower here in the U.S. than it is in Europe. The distributors are sitting on -- are not sitting on inventory that has gone down by 40% price because panel prices didn't move that much here in the U.S. for various reasons. It's more of a demand issue. And demand in the U.S. has been fairly weak. And given the rise in interest rates and lower relative power prices. And it's something that -- unless we see interest rates decline or unless we see power prices go up significantly, we don't really see that changing in the U.S., and I know Ronen likes to say it will be 4 to 6 quarters of weakness in the U.S. But again, it depends on when 1 of those 2 factors changes.

If those factors going to remain where they are -- like I say, interest rates are here for longer and power price is going to ebb and flow what would be the normalized rate of growth in the U.S. in demand in your view? What should the demand look like? Is it still query demand, but like it's less right? So what's that normal demand?

Yes, it should still be growth. Because there are certain pockets in the U.S. that even with interest rates where they are and where electricity prices where they are, there are still areas in the U.S. that it's very economic to put a solar system on your house. I just put a solar system on my house on Tuesday, I had it installed. I'm getting a fairly attractive payback, not as good as what they see in Europe, but still something that's relatively attractive. I live in New York, where power prices are higher. So yes, the U.S. should be a growth market even in this interest rate. If things get a little bit better in terms of the economics, the U.S. market should grow. And from a longer-term perspective, the U.S. is going to be a very strong market because either interest rates come down, electricity prices are almost certainly going to go up. The economics should improve in the U.S. I don't know if it's going to happen in 2023 or 2024. But eventually, as more electrification comes to the U.S., electricity prices will have to go up. I mean car companies aren't going to be making ICE vehicles for much longer. You're going to have to get an EV which requires more electrification, which requires more investment in great infrastructure, which means higher power prices. So eventually, the U.S. market is going to be a very healthy market. It's going through this kind of short-term fluctuations because interest rates change so much. And the way that solar has bought in the U.S. was largely a loan market that's shifting now a little bit, but these are shifts that take time. But yes, longer term, the U.S. market should be a very nice market for solar.

We have a question from the chat. Is your long-term margin trajectory impacted by current inventory and price initiatives?

No. No. The solar market has always been one that has been very volatile. We've seen periods of over demand periods of oversupply. But generally speaking, number one, we haven't had made any movements on pricing because of current inventory situations. The only reason we move pricing is if we think we can do it in a way that will increase our EBITDA these would be margin-enhancing moves, whether it's through cost reductions or we're adding more features to our products that are actually offsetting the pricing the underlying pricing decline. But no, the current inventory situation should not change the operating model that I mentioned at all.

Any more questions from the group? This is kind of coming up on the end of our time, but maybe before we do wrap this up J.B. one quick one for you. I'm sure you guys went [indiscernible] recently. And I was just curious if you had any takeaways from there that you wanted to share maybe something about your attention or anything that was interesting?

So I was just trying to get my other camera to work. Takeaways from [indiscernible] it's basically what we said on the earnings call, just with a little bit more clarity in terms of the inventory situation in Europe. The inventory situation in Europe is the distributors are in some cases, have working capital issues, and they want our help as much as possible. And so while we're being very careful with who we do business with in Europe because there probably will be some short-term upheavals in the distributor market. At the end of the day, the underlying demand profile in Europe remains extremely strong. You're talking about 4- to 6-year paybacks for solar post-battery systems in most areas within Europe. And so this inventory issue, while it's a headache in the near term, and it's causing some cash flow problems for our customers. This is a situation that will eventually be rectified given the growth dynamics we're seeing in Europe.

We have another question from the chat which reads -- I'm going to simplify this a little bit, any competition from Tesla? And how do you view your competitive situation versus end phase? And also [indiscernible] as competitive with the solar panels you use.

Sorry, what was the second part?

[ Austrian ] were competitive with the solar panels that you use.

I'm not -- the solar panels, we're agnostic to solar panel. So I'm not sure that, that really you can put any type of solar panel you want and we can connect with that. So that's not really an issue. The competitive threat from Tesla is a question we get a lot, as you can imagine. Tesla is a very strong battery company. They have -- this is just a U.S. phenomenon, by the way. Tesla does not sell into Europe. In the U.S., the Tesla has a very good. Number one, very good battery and number two, a very good brand name. Now they're also trying to now launch an inverter product, which they actually launched over a year ago, that people are just starting to hear about it now, which is kind of interesting. The battery product has been the market leader for a little while. I think they overtook LG a few years ago. Very good battery products, we connect Tesla batteries to our product to our inverter all the time. But now they have a string inverter that they launched, like I said, over a year ago. And the question we're getting is, does that pose a significant competitive threat to you from just an inverter perspective? And the answer to that now, as of now is no because we have not seen them significantly in the market. They haven't taken any -- they've had some distributor agreements to have distributors to actually carry their products. But in terms of winning business away from us, we have not seen it yet. But it is Tesla. And Tesla has a very, very strong brand name that I do not enjoy, unfortunately. And so if installers or I guess if customers actually start requesting a Tesla inverter, I'm not sure they ever necessarily will because no one knows what an inverter is usually. The person who makes the decision on what type of an inverter you install is typically your installer. So is there a certain cohort of installers who want to carry a Tesla just to say that they carry a Tesla inverter perhaps. But from our customers so far, Tesla has not taken any market share from us to any significant degree. But again, it's a Tesla brand, and we need to be very cognizant of the fact that they are out there.

All right. And I think I had another question on chat, but you practically answered it with your remarks, and we're going to have to wrap up because we are almost out of time. Well, thank you, J.B., for joining us today. And it's a pleasure to have you and everyone on the line, please reach out to follow up with us with any additional questions you might have. Thank you.

Thanks so much, Sophie.

Thank you.