Earnings Call Transcript - SHLS Q4 2022

Operator, Operator

Good afternoon, and welcome to Shoals Technologies Group Fourth Quarter 2022 Earnings Conference Call. Today's call is being recorded, and we have allocated 1 hour for prepared remarks and Q&A. At this time, I would like to turn the conference over to Mehgan Peetz, Chief Legal Officer for Shoals Technologies Group. Thank you. You may begin.

Mehgan Peetz, Chief Legal Officer

Thank you, operator, and thank you, everyone, for joining us today. Hosting the call with me are CEO, Jason Whitaker; President, Jeff Tolnar; and CFO, Dominic Bardos. On this call, management will be making projections or other forward-looking statements based on current expectations and assumptions, which are subject to risks and uncertainties. As you listen and consider these comments, you should understand that these statements, including the guidance regarding full year 2023, are not guarantees of performance or results. Actual results could differ materially from our forward-looking statements if any of our assumptions are incorrect or because of other factors. These factors include, among other things, the risk factors described in our filings with the Securities and Exchange Commission as well as economic and market circumstances, decreased demand for our products, policy and regulatory changes, industry conditions, current macroeconomic events, supply chain disruptions and availability and price of our components and materials. Although we may indicate and believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate or incorrect and therefore, there can be no assurance that the results contemplated in the forward-looking statements will be realized. We caution that any forward-looking statement included in this discussion is made as of the date of this discussion and do not undertake any duty to update any forward-looking statements. Today's presentation also includes references to non-GAAP financial measures. You should refer to the information contained in the company's fourth quarter press release for definitional information and reconciliations of historical non-GAAP measures to the comparable financial measures. With that, let me turn the call over to Jason.

Jason Whitaker, CEO

Thank you very much, Mehgan, and good afternoon, everyone. Before I make my formal remarks, I would like to thank our employees, customers, vendors and shareholders who have each played a role in the tremendous success that Shoals has achieved over the past several years. Without your contributions and support, we would not have the company that we do today. I'll start off with some key highlights from our fourth quarter and full year results and then discuss the progress on our CEO transition. Following that, I'll turn it over to Jeff, who will provide an update on our business, growth initiatives, current market conditions and operational focus areas for this year. Dominic will then wrap up with an overview of our financial results for the fourth quarter and outlook for 2023 before we open the lines for questions. Shoals set new records for revenue, gross profit, adjusted EBITDA and adjusted net income in both the fourth quarter and full year. Compared to the prior year periods, fourth quarter and full year revenue grew 97% and 53%, respectively. The increase in revenue was driven by growing demand for solar and EV and continued share gains for our products. The strength of demand for our products is underscored by the fact that Shoals' annual revenue growth has increased each year since we've been public, despite having more than doubled revenue over the past 3 years. Versus the same period last year, fourth quarter gross margin increased more than 950 basis points to 42.7%, and adjusted EBITDA margin increased approximately 840 basis points to 31.8%. The margin expansion we achieved in the fourth quarter was the result of greater leverage on fixed costs driven by higher sales volumes and increased proportion of revenues attributable to our combine-as-you-go solution. Now turning to an update on our CEO transition. In November, Shoals announced that I will be stepping down from my role as CEO this year for health reasons. My last day with the company will be March 15. As previously announced, the company has appointed Shoals President, Jeff Tolnar, as Interim CEO. Jeff was previously SVP of EV Solutions and led the successful launch of our EV Solutions business. Prior to Shoals, Jeff held senior management positions with Fortune 100 companies and cofounded or led several startups, including Greenlots, which was acquired by Shoals. In his new role as President, Jeff is responsible for global sales, product development, engineering and operations. He and his team are accountable for ensuring the operational milestones required to achieve the company's strategic goals are met. The Board is currently working with Spencer Stuart to vet several highly qualified candidates and intends to select a permanent CEO following completion of an extensive search and vetting process. With that update, I'll turn it over to Jeff.

Jeffrey Tolnar, President

Thank you, Jason, and good afternoon, everyone. It's a pleasure to be with you all today. I'll start with a review of our performance of our core combined as-you-go solutions in the quarter then discuss the status of our new product introductions for 2023. Following that, I'll provide an update on our international expansion efforts, review conditions in our core solar and EV markets and then close with an overview of some new operational initiatives that we are implementing. System Solutions revenue grew 150% in the fourth quarter of 2022 versus the fourth quarter of 2021, reflecting strong growth in U.S. utility scale solar demand and continued share gains by our products. During the quarter, we converted 3 additional EPCs and developers to our combined as-you-go system, bringing the total number of BLA customers to 36, with an additional 14 in transition. We believe that the majority of EPCs and developers in the U.S. will be using our system in 2023. Our new wire management product line contributed to growth in the quarter. Our wire management products' attach rate to BLA has continued to grow as customers increasingly recognize that they install faster and are more reliable than conventional solutions. We recently surpassed 800 megawatts of deliveries for projects using our clips, and we expect continued growth throughout 2023. Our battery storage products also contributed to growth as we began shipments during the fourth quarter for the 1 gigawatt DC storage project awarded to Shoals in the third quarter of 2022. More solar projects are incorporating battery storage, and our sales team is actively quoting battery storage products for our solar customers. We recently added dedicated sales resources for energy storage, which we believe will help drive higher sales volumes. Our team also plans to launch an eMobility energy storage offering in the second half of this year. Our EV solutions business grew significantly in the fourth quarter as our team continued to fulfill orders received in Q3 for Q4 deliveries. The primary end uses for those orders were fleet and school bus electrification. As our EV business is still early in its evolution, growth may be uneven with outsized contribution in certain quarters and smaller contributions in others, depending on when we receive orders and ship products. Turning to our new product introductions planned for 2023. We expect to generate revenues from our new high-capacity plug-and-play wire harness and BLA 2.0 this year. UL certification of the high-capacity plug-and-play harnesses was delayed slightly, while development of the high-capacity connectors is progressing. We are now expecting prototypes to be deployed mid-2023 with UL certification and full market launch to follow later in the year. We recently began quoting our BLA 2.0 bundled solution and expect to record our first revenues in the second quarter. BLA 2.0 combines our BLA with all the components required to attach the BLA to the racking system, including wire management, support wire and tensioning systems to create a single integrated offering. This comprehensive solution further reduces the amount of installation labor required in the field and enables EPCs and developers to procure all of their EBOS components from Shoals rather than Shoals and at least one other vendor. Because BLA 2.0 includes additional components, it has a higher average selling price than BLA. We believe migrating customers to the BLA 2.0 bundle will enable us to grow revenue through both increased volume and higher ASPs. We're making progress on our international expansion with quoting volume continuing to grow, led by Latin America, Australia and EMEA activity. We are evaluating regional production of fulfillment options as quote and order volumes approach a critical mass. Notably, the 53-megawatt project we were awarded in Honduras in the third quarter of 2022 received the Renewable Energy Deal of the Year by the Export-Import Bank of the United States. Moving to an overview of solar and EV market conditions. Overall, solar market conditions are favorable, both for the industry as a whole and for Shoals specifically. We are beginning to see early benefits from the Inflation Reduction Act in the form of increasing demand for both solar and storage offerings, while funds from the 2021 infrastructure bill are generating significant demand for EV charging products. We see increasing quote volume related to on-the-go fast charging solutions, which is largely driven by the flow of infrastructure bill funds. At the same time, the combination of persistent wage inflation and the prevailing wage provision of the IRA is driving the cost of field labor higher. Rising labor costs caused our customers to seek solutions that install faster and do not require skilled labor. The environment is really ideal for our products given their demonstrated ability to reduce the number of labor hours required to install a solar project. I'll wrap up by speaking about some of the operational initiatives that we are working on. One of my jobs as President of Shoals is to ensure that we have the people, processes and systems in place to support our continued growth. We have already built an organization capable of supporting $500 million of annual revenue. Our focus now is building an organization that can support the next $500 million and take us to $1 billion a year in revenue. To do that, I'm working with our leaders to implement 3 initiatives: increasing the efficiency of our manufacturing operations, strengthening our sales infrastructure and focusing our new product development efforts. We are increasing the efficiency of our manufacturing operations by deploying production automation and carefully reviewing every step in our manufacturing process, establishing process-level KPIs and using that data to identify areas where we can increase throughput or reduce waste. We saw early dividends from our efforts when we achieved record levels of daily production in the fourth quarter. We are confident that by driving deeper automation and process efficiencies that we will be well positioned to replicate the success we have achieved in our existing plants should we decide to open new manufacturing facilities in other locations. We are strengthening our sales infrastructure in 2 key ways. First, our new CRO, Ben Macias, is building a sales operation team with systems to help us better assess when to add new sales resources and how to deploy them more efficiently. Our sales team is already delivering record revenue per account manager, but we see the potential to grow revenues even faster by adding salespeople in growing markets and specific segments. Sales operations will provide the information we need to make those decisions faster. Second, we are building a dedicated customer care organization focused on Shoals' installed and growing customer base. Their goal is not only to ensure our customers are satisfied with our products well beyond initial installation but also to identify opportunities to sell replacements or upgrades for existing installations. We are focusing our innovation and new product development by embracing agile concepts, including engineering velocity. Implementing agile principles with results-driven KPIs will improve predictability of new product development timelines while continuing to drive the innovation that Shoals is known for. I'm thrilled to be President of Shoals and very excited about our future. I'll now turn it over to Dominic, who will discuss fourth quarter 2022 financial results.

Dominic Bardos, CFO

Thanks, Jeff, and good afternoon to everyone on the call. Fourth quarter revenue grew 97% versus the prior year period to $94.7 million. The higher sales volume was primarily driven by increased demand for our solar solutions but also benefited from EV charging solutions that were launched earlier in the year. System Solutions revenue increased 150% year-over-year and represented 86% of total revenue versus 68% in the prior year period, reflecting continued market share gains for our solar combine-as-you-go system. Gross profit increased 154% to $40.4 million compared to $15.9 million in the prior year period. Gross profit as a percentage of net revenue grew more than 950 basis points to 42.7% compared to 33.1% in the prior year period driven primarily by increased leverage on fixed costs and a higher proportion of revenue from System Solutions. Fourth quarter general and administrative expenses were $14.9 million compared to $11.0 million during the same period in the prior year. The year-over-year increase in general and administrative expenses was largely driven by higher payroll expenses in connection with incentive compensation and planned new hires. Net income was $118.3 million in the fourth quarter compared to a net loss of $2.2 million in the prior year period. Net income benefited significantly from the $110.9 million noncash gain we recorded in the quarter in connection with the termination of the tax receivable agreement, or TRA, that Shoals had with Oaktree and our founder, Dean Solon. Over its life, the TRA could have required us to make more than $500 million in cash payments to Oaktree and Mr. Solon, so terminating the agreement eliminated a significant future liability for the company. Adjusted EBITDA increased 167% to $30.1 million compared to $11.3 million in the prior year period. Adjusted EBITDA margin increased by approximately 840 basis points year-over-year to 31.8%, reflecting the impact of higher gross margins, partially offset by the higher general and administrative expenses I discussed earlier. Adjusted net income grew to $25.0 million in the fourth quarter compared to $0.9 million in the prior year period. During the quarter, we generated cash from operations of $34 million, which allowed us to reduce the amount of debt outstanding under our revolver. We expect our cash generation to continue improving as investments in working capital and capital expenditures moderate, and we are no longer subject to cash distributions or restrictions associated with the TRA. As of December 31, 2022, we had $428.6 million in backlog and awarded orders, an increase of 43% year-over-year and a decrease of 9% quarter-over-quarter. The consecutive quarterly decline was the result of slower conversion of pipeline projects into awarded orders and higher-than-expected shipment volume we had in the quarter. Following the slower pace of customer activity during the holidays, our backlog and awarded orders rose to all-time record levels in the first few weeks of January. Turning now to our full year outlook. Based on current market conditions and input from our customers, we expect 2023 revenue to be in the range of $470 million to $510 million, up 44% to 56% year-over-year. We expect adjusted EBITDA to be in the range of $140 million to $155 million, and adjusted net income to be in the range of $87 million to $97 million. For the full year 2023, we are targeting gross margin in the 40% range, consistent with full year 2022, although gross margin may be higher or lower in any given quarter due to product mix in that particular period. We will continue to invest in SG&A in 2023 to position ourselves for scalable long-term growth. This will include investments in talent to support our growth initiatives as well as the continued build-out of our HR, finance and customer care teams as we scale. We anticipate SG&A will grow roughly $1 million per quarter sequentially throughout 2023, starting with a larger step-up in the first quarter due to higher stock-based compensation. As you are likely aware, we do not provide quarterly guidance. That said, I want to provide a bit more information to help set expectations around pacing in 2023. Similar to our 2022 results, we expect the majority of our revenue will be generated in the second half of 2023. For 2023, we expect that approximately 40% of our revenue, adjusted EBITDA and adjusted net income will be generated in the first half of the year, with the remaining 60% in the second half. Further, we anticipate that quarterly year-over-year revenue growth will roughly fall in line with the annual growth rate implied by our outlook. Full year 2023 interest expenses are expected to increase to $22 million to $26 million as a result of higher interest rates. And finally, we expect capital expenditures for the full year in the range of $8 million to $12 million. Now back to Jason for closing remarks.

Jason Whitaker, CEO

Thanks, Dominic. I'd like to close again by thanking all of our customers for their confidence in Shoals, our employees for enabling us to effectively serve our customers and our shareholders for their continuous support. As we move on from a record performance in 2022, we could not be more excited about the opportunity ahead. Furthermore, beyond our still growing core BLA products, we've only started to penetrate the opportunity for our new solar and EV products. With the product line building, demand is increasing as we extend our global reach. Importantly, we believe we've only started to realize the full power of the Shoals platform. I'm incredibly proud of what Shoals has accomplished over the past several years and that I will leave the company commercially, operationally and financially stronger than it has ever been. There is no question that the future is extremely bright. And with that, thank you, everyone. I appreciate your time today. We'll now open the line for questions.

Operator, Operator

The first question comes from Maheep Mandloi of Credit Suisse.

David Benjamin, Analyst

This is David Benjamin in for Maheep Mandloi. Congrats on the quarter, guys. I was wondering if there's any additional upside in the potential revenue guidance should UFLPA resolve faster than expected.

Dominic Bardos, CFO

So this is Dominic. Thanks, David. In terms of our guidance, we're very comfortable with the guidance range that we've given, in terms of our backlog, awarded orders and ability to drive that revenue number. As we've talked about before, we haven't seen a significant delay of panels and projects associated with our revenues. So we're holding firm to the guidance that we've issued today.

David Benjamin, Analyst

Okay. Great. And one more question about margins. Can you talk a little bit about the ramp-up in your manufacturing facility and talk about kind of what we could expect for long-term margins when that's fully ramped?

Dominic Bardos, CFO

Yes. So from a margin perspective, we actually guide for our production capacity that we built out ready to get about a $500 million number, as you see implied in our guidance for this year. We are looking at facilities to take us to another level and really expand further and look at geographic diversity and things like that. But what we've said and guided to, we haven't issued really long-term guidance, but we do believe a 40% gross margin is achievable, and we like having a 30% EBITDA margin. And so we'll keep that in mind as we continue to look for additional facilities.

Philip Shen, Analyst

I think you mentioned in your prepared remarks that you reached record backlog in the first few weeks of January. I was wondering if you could talk about what those bookings look like and importantly, also how you expect the bookings to trend. It seems like there was a big push in the first part of the year, and perhaps you could talk about the drivers of that activity. And ultimately, if you can even share what that record backlog number is, I think that would be fantastic.

Jeffery Tolnar, President

Phil, thanks. We won't share the specific numbers from January and February. What I think is really important to note is when you look at where we wound up the year last year, so $428 million, we had a book-to-bill of 1.3. That's consistent with prior years. And then we also had the additional shipping and outflows of product in fourth quarter. That was an upside. That was a positive. And some of the orders that we were expecting to convert from pipeline to awarded order shifted into the first couple of weeks of January. So just by having those couple of weeks, we'd be having a very different discussion about this. And that trend has also continued throughout '23 so far, 6 weeks in. So we feel very strongly about the products that we have and the market adoption of those.

Philip Shen, Analyst

Great. When you consider your guidance for the year, what percentage do you believe is covered by your current backlog? It seems like it could be as high as 85% to 90%, but I wanted to get a sense of that. Do you expect most of that backlog to be recognized this year? Additionally, could you share what percentage of that backlog might be affected by UFLPA, if any?

Dominic Bardos, CFO

Let me clarify that for you, Phil. The key point is that our guidance range takes into account the $428 million backlog as of December 31, 2022. We've previously mentioned that it usually takes about 9 to 12 months to convert awarded orders and backlog into revenue, and we don’t expect that to change. It remains consistent, though there is always a certain variability. We fully anticipate realizing that $428 million this year. There are still some orders we need to secure, and we haven't provided the exact percentage of those pending orders yet. However, we believe we can obtain some additional orders we are currently tracking. As we progress through the year, if we do not secure those orders in the next few months, our chances of integrating them into this year's revenue may diminish. At this time, we feel confident about the revenue range we've communicated. Regarding the UFLPA and the panels, as we noted in previous quarters, we haven't observed a major impact on our operations. Projects are advancing with our installations and product orders, even if there have been slight delays with panels. So far, I am not aware of any panels being denied; it seems there have just been delays. Even in Q4, we noticed more panels being released. As of now, there is no deviation from the guidance we've set, and we believe we have a clear view of all these factors, feeling very comfortable with the range we've provided.

Philip Shen, Analyst

Great. One last one here. As it relates to BLA 2.0, could you share a little bit more color in terms of what percentage of your overall BLA sales in '23 you think could be 2.0? And now that you're taking orders and so forth, can you talk about maybe the price premium that 2.0 might be getting over the original BLA?

Jeffery Tolnar, President

Yes. Thanks for the question, Phil. We're pretty excited about BLA 2.0 being launched and quoting globally at this point. As mentioned, we expect first revenues in the second quarter. Remember, the product itself is a bundled solution. So the increase in ASP will depend upon what portions of the bundle are selected by the customer base. We do expect a 10% to 20% ASP based on the portions of the kit that are taken by the customer base. And we're excited about the quoting volume even out of the gates, and we expect that to continue throughout the year.

Jason Whitaker, CEO

Phil, Jason here real quick. One thing I want to add is when you look at the BLA 2.0, kind of pointing back to a combination of what Jeff and Dominic said is, the backlog and awarded orders that we closed out at the end of 2022, it doesn't really represent what I would call BLA 2.0 because we just recently started quoting out that product, as Jeff stated, at the beginning of this year. So specifically on the question about 2023, that particular range is based upon exactly what the book looked like at the end of last year, Phil.

Jordan Levy, Analyst

Maybe just to start out by getting your thoughts on the EV solutions business and the ramp there as you move that segment through '23. I know you mentioned in your remarks, there could be some lumpiness in that segment. But I just wanted to kind of get your broad thoughts about contributions from that and also how customer demand has been trending there.

Jeffery Tolnar, President

Yes. Thanks, Jordan. That's my baby. So I'm pretty excited about that. We remain very excited about the eMobility, the EV charging business. It's been a focus area for us in the past year. We launched products last year and very excited about the uptake that we've seen. It's certainly bolstered by the 2021 infrastructure bill. If you recall, we mentioned that there's close to $7.5 billion being poured into the eMobility business itself in primarily corridor charging and school bus electrification. And we're seeing upticks in quote volumes for both of those, and we're also seeing our primary offering being adopted by the fleets, which are some of the initial evolutionary areas of electrification as well. So we feel very excited about where we're at. As mentioned, it's still early post-launch. So with any new business, any new product offering, it's going to be a bit lumpy to begin with. As we get more certainty and more predictability in our forecasting, then we may release a bit more detail.

Jordan Levy, Analyst

That's great. As a quick follow-up on the wire harness rollout, you mentioned last quarter that BLA 2.0 products were really complementary. I'm curious whether the delay in first sales for the new wire harness product has any impact on BLA 2.0.

Jeffery Tolnar, President

It really doesn't affect the wire management system is a subset of the bundle. What's nice about our wire management system is that it can be sold as a stand-alone product or as part of the bundled kit. This provides us with a lot of flexibility in our deployments.

Brett Castelli, Analyst

I want to ask about international prospects in 2023 and your thoughts on the possibility of expanding manufacturing capabilities abroad.

Jeffery Tolnar, President

Yes. We're very excited about our progress in international markets. We're seeing increasing quoting volumes in Latin America, Australia, and EMEA. This prompts us to consider the best ways to fulfill those orders and serve our customers effectively. Our growth strategy aims to reach an additional $500 million, which involves fulfilling orders in the locations where our customers are based. We're beginning to explore this further. As expected, our pipeline is expanding through quotes, which will transition into awarded orders, backlog, and eventually revenue. Timing is crucial for this process. To sum up, we're genuinely excited about our position in international markets and the areas we've discussed.

Brett Castelli, Analyst

Could you provide an update on your customer mix in the domestic solar segment? Historically, it has been heavily focused on EPC. Have you made any progress with developers specifically?

Jeffery Tolnar, President

Yes. Our primary customer base is the EPC domestically. We've got 9 of the top 10 EPCs that we're proud to call our customers and working on growing that as well. We are expanding our interface directly with developers. And one other trend that we're seeing as more and more EPCs want to lock up capacity is entering into long-term MSAs with them, gives us more certainty and order flow throughout the years.

Colin Rusch, Analyst

Could you just give us a sense of 2 things, just the overall quotation activity outside the U.S. and then the close rates that you're looking at so far in the awards that have been made?

Jeffery Tolnar, President

Yes. We haven't released the specific close rates, but what I did mention in the prepared remarks is that we're seeing quoting volumes of greater than 50% year-over-year. So the number of quotes and the volume related to those quotes continues to grow. Don't have specifics that we've released, and we have not released our close rates.

Kashy Harrison, Analyst

I was wondering if you could just provide us with an update on the progress with the EV charging business. Can you speak to receptiveness from the market? And then maybe some color on how much of the 2023 revenues is associated with the EV charging business.

Jeffery Tolnar, President

Thank you for asking. The adoption has been strong. Our primary market segments are fleet and school bus electrification. We're seeing a definite uptick in the National Electric Vehicle Infrastructure funds coming from the infrastructure bill. That would be for corridor fast charging. And the quoting volume there has greatly increased. We haven't released specific financials yet because we're waiting for them to be substantial and predictable before we do that. But overall, I'm excited to say that we're deployed in more than 15 states in the U.S. with large numbers of projects. So overall, customer demand is exceeding expectations, and we're seeing continued growth.

Dominic Bardos, CFO

Sure. One thing I've mentioned before, and reiterated last quarter, is that we had the chance to optimize several areas. I think you noticed some improvements in the fourth quarter as inventories decreased from their earlier highs this year. We’ve made significant progress with receivables and have introduced some new measures. We’ve also discussed customer deposits. We recognize that working capital investments are always necessary for a growth company, particularly as we aim to grow from $300 million to roughly $490 million or $500 million in our guidance range. However, I believe we have already tackled the majority of our inefficiencies. We’ll keep managing inventories effectively alongside sales growth and managing our Days Payable Outstanding as we adjust some vendor agreements, which we also talked about last quarter. I anticipate only modest changes here. If you analyze your models regarding Days Sales Outstanding, Days Payable Outstanding, and inventory turnover, you should observe some modest improvements across all these areas in 2023 compared to 2022. Thanks, everybody.

Operator, Operator

This concludes the question-and-answer session and today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.