Earnings Call Transcript - SHLS Q3 2021

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; CFO, Philip Garton; and SVP of EE Solutions, Jeff Tolnar. 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 uncertainty. As you listen and consider these comments, you should understand that these statements, including the guidance regarding the fourth quarter of 2021 and the first quarter of 2022, 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, industry conditions, company performance and financial results, the COVID-19 pandemic, supply chain disruptions, availability and price of our components and materials, project cancellations, decreased demand for our products, and our policy and regulatory changes. 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 we 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 third 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. I'll start off with some highlights from the quarter, provide an overview of our acquisition of ConnectPV, and I'll wrap up with a progress report on our new EV business. Phil will then provide the financial details for the quarter and then turn it back over to me for an update on our outlook for the fourth and first quarters of 2022. During the third quarter, we continued to successfully convert customers to BLA. We now have four times as many customers using our system as we did at the time of our IPO earlier this year, and we don't see our market share gains diminishing. As of the end of the third quarter, we had 12 additional customers transitioning to our system. I couldn't be more pleased with customer conversion and the number of new customer prospects coming into our sales flow. We have a lot more growth ahead of us. And we also made good progress during the quarter outside of our BLA with new products for solar. As of the end of the quarter, we were sold out of our new wire management solution, and we're currently manufacturing our first large order of our new IV curve benchmarking product. Both of these products have gross margins at or above our overall system solution margins, so we're very excited about their growth. The gains we are seeing in BLA as well as the ramp of our new products for solar was reflected in our record backlog and awarded orders of $270.7 million at the end of September. To put that number in perspective, we now have over 30% more backlog in awarded orders than we generated in revenues over the past 12 months. During the third quarter, we also completed our first acquisition, ConnectPV. ConnectPV is a California-based provider of solar and storage EBOS products. The acquisition accomplishes several things for Shoals. First, ConnectPV is a leader in EBOS for utility-scale battery energy storage systems, and their product line and expertise significantly strengthens our offerings for this rapidly growing market segment. ConnectPV was one of the first companies to introduce specialized EBOS for battery storage, and their products have been specified for some of the largest stand-alone storage projects in the U.S. We're very excited about what we can do with our products, leveraging our customer relationships and manufacturing cost structure. I should also mention that ConnectPV has very strong expertise in AC solutions, which is another area we see an opportunity to introduce new products. Second, ConnectPV sells solar EBOS offerings to customers that we did not historically have relationships with. Making ConnectPV part of Shoals will allow us to convert these customers to our system more rapidly and accelerate our market share gains. Third, ConnectPV has excellent engineering talent that will help support our growth. The company's historical business model was to focus on more challenging projects, where a significant amount of customization was required. They are skilled at designing and specifying products. Having their engineers on the West Coast with our engineering team in Tennessee adds to our capability with two teams across time zones. We have more hours in the day to work with customers. The purchase price for ConnectPV was a combination of cash and stock and was not material to our financials. We expect the transaction to be accretive to our 2022 earnings per share. Now turning to our EV business. During the third quarter, we deployed our full EV solution set, skidded charging stations, quad charger, Raceway and EV-BLA at a demonstration site outside of our headquarters. We are using the site to showcase our products for prospective customers. We've begun taking orders from customers and, to date, have received orders from a charging network operator, a large investor-owned utility, and an EPC for one or more of our EV charging products. We expect to begin shipping products to our customers during the fourth quarter. The first public charging station to use our solution will be installed at the end of this year, and we expect that if it performs well, it could become the basis for the rollout of hundreds of more stations using our equipment. We remain very focused on the EV charging opportunity and are excited about the prospect of creating a significant business in EV to complement our core solar business. I will now turn it over to Phil, who will discuss our third quarter financial results.

Philip Garton, CFO

Thank you, Jason. For the third quarter, revenues increased 14% versus the prior year period to $59.8 million driven by an increase in revenue from solar components, as well as an increase in demand for solar EBOS generally and our combined to-go system solutions specifically. The strength in components revenue during the quarter was consistent with the expected change in mix driven by the addition of a significant number of new customers we typically start with component purchases. Sales of System Solutions represented 65% of total revenue versus 70% in the prior year period. The acquisition of ConnectPV closed on August 26 and its contribution during the quarter was immaterial. Prices across our product lines during the third quarter were comparable to the prior year. Gross margin in the third quarter was 36.4% compared to 39.3% in the prior year period due to a higher mix of component sales, which have lower margins than System Solutions as well as the impact of ConnectPV during the quarter. Gross margins on Components and System Solution products were in line with prior periods. ConnectPV's historical gross margins are lower than Shoals' historical gross margins primarily due to the higher prices they pay for components used in their products. This results from their smaller size relative to Shoals. Excluding the impact of ConnectPV, gross margins would have been higher in the quarter. We expect to bring ConnectPV's margins in line with Shoals' average gross margin as we migrate them to our suppliers. Third quarter general and administrative expenses were $10 million compared to $3.5 million in the prior year period. This increase was primarily a result of higher stock-based compensation, acquisition-related expenses for ConnectPV, planned increased payroll expense due to higher headcount to support our growth and product initiatives, new public company costs, and nonrecurring public offering expenses. Adjusted EBITDA for the third quarter was $16.9 million compared to $19.9 million in the prior year period. Adjusted net income was $11.6 million in the third quarter compared to $15.4 million in the prior year period. Please see the adjusted EBITDA and adjusted net income reconciliation tables in our third quarter press release for a bridge to our GAAP results. As of September 30, 2021, we had backlog and awarded orders of $270.7 million, an increase of 101% year-over-year and 35% versus June 30, 2021. The increase in backlog and awarded orders reflects continued robust demand for Shoals' products from our customers.

Jason Whitaker, CEO

Thanks, Phil. Now I'll provide an update on the current market environment in solar and how it is impacting our near-term results. The key challenge to our growth is the current supply chain environment. Our business model has effectively insulated us from most of the margin pressure that many of our peers are experiencing as a result of rising commodity prices, and the form factor of our products has limited the impact of shipping and logistics shortages on our business. But unfortunately, our customers still have to contend with these issues as they progress their projects. The result is very fluid delivery schedules with customers making frequent changes to both the product specifications and when they want the product on site. Recently, some of our projects have been delayed to accommodate design updates as a result of panel changes or because other materials or components needed are not available. In both cases, the impact to us is the delay where we can produce and ship product, which will have the effect of shifting revenues that we expected to recognize in the fourth quarter of this year into the first quarter of next. While it is not our practice to provide quarterly guidance, we felt it was important to quantify for our shareholders the impact on our results of the changes that our customers have made, which is why we're providing our outlook for the next two quarters. Phil will take you through the numbers, but before I turn to him, I'd like to make three final points. First, this is truly a timing issue. We have not had a single order canceled. And candidly, our primary focus right now is making sure we have the capacity to deliver on the tremendous demand that we're seeing across our business. Second, we're not seeing any pressure on our margins. Our lower gross profit margin in Q3 is solely related to mix. We expected it and talked about it on our last call. I feel very good about our ability to continue to expand our margins based upon the order book we have in hand today. Third, this is a temporary situation. We have seen an extraordinary amount of disruption in the global supply chains, but it is clear to us that the market is slowly beginning to normalize. Suppliers are adapting, customers are adapting, and logistics providers are adapting. This won't last forever. And now I'll turn it back to Phil to talk about the specifics of what we see for Q4 and Q1.

Philip Garton, CFO

Based on what we are seeing in the market and feedback from our customers, we currently expect fourth quarter revenues to be in the range of $40 million to $50 million. We expect adjusted EBITDA to be in the range of $11 million to $15 million and adjusted net income to be in the range of $3 million to $7 million. As for the first quarter of 2022, we expect revenues to be in the range of $71 million to $76 million. We expect adjusted EBITDA to be in the range of $22 million to $24 million and adjusted net income to be in the range of $14 million to $17 million. While the mix of component sales is expected to remain high in the fourth quarter, which will reduce our gross margin in the quarter, we expect that to reverse in the first quarter of 2022, consistent with our outlook for adjusted EBITDA. Jason, back to you.

Jason Whitaker, CEO

I'd like to close by thanking all of our customers for their commitment to Shoals, our employees for their contributions to our company's success, and our shareholders for their continuous support. With that, thank you, everyone, and I appreciate your time today. I'd like to ask the operator to open the line for questions.

Operator, Operator

Our first question today comes from Brian Lee from Goldman Sachs.

Brian Lee, Analyst

I appreciate the additional guidance here. I guess one of the questions I had was more around the gross margins. I know you had telegraphed that in 3Q, the margins would have a mix impact. Can you kind of talk to what you're seeing on the cost side and supply chain issues outside of mix and whether or not any of that is impacting the view for gross margins in 4Q and into 1Q? And then I had a follow-up.

Jason Whitaker, CEO

Brian, this is Jason speaking. Good to talk to you again. I'll take that question. So when you look at the margin profile, first and foremost, it is strictly a function of the mix shift in product. And as we talked about before, especially when you look at the success that our sales team has had in converting over customers to our full system BLA, when those customers are in the process of converting, going from prospects to transition, it's not uncommon for those initial product offerings to ultimately fall into that component category while we're working with them to transition over.

Brian Lee, Analyst

Okay, fair enough. So it's all mix-related. And then I think you mentioned ConnectPV, it's immaterial here in the near term, but it did impact margins in the quarter. Your margins would have been higher if you had not made that acquisition. Any sense of what that magnitude of impact was on a basis point basis? And then is there going to be some ConnectPV margin headwind in the next couple of quarters? When do we start to see that maybe become more in line with the corporate average as you're targeting?

Philip Garton, CFO

Brian, it was approximately 100 basis points. We are in the process of transitioning to our own suppliers from those that are currently much higher in cost. This will have a bit of an impact in the fourth quarter and into the first quarter. However, the overall sales are not significant, and we are quickly integrating them into Shoals' manufacturing process. Therefore, we hope to mitigate the impact completely as we move through the first quarter.

Brian Lee, Analyst

Okay, fair enough. And then maybe last one for me and I'll pass it on. On the timing here of the revenue. I know you're saying, Jason and Phil, that you haven't seen any orders be canceled, and I know that the Q1 guidance is supposed to give us some sense of what's slipping from the end of this year into the early part of next year. It would seem that there's still maybe $10 million or $15 million of revenue that isn't getting captured across the two quarters that maybe we had been anticipating. So is all of the Q4 pushout being captured in Q1? Or are we going to see some of that slip into the quarters following it? And just how would you kind of characterize your ability to capture the risk of additional project slippage as we move through the next several quarters, not just into the early part of '22?

Jason Whitaker, CEO

Yes. No problem, Brian. So looking at where we are, first of all, I'd like to point out that customer demand is very strong. When you go back and look at our prepared remarks, quoting activity and average project size were up over 140% and 170%, respectively. When you consider our backlog and awarded orders, up over 100% and 70% related to year-end 2020. There's a lot of opportunity ahead. But when you look at Q4 and rolling into Q1, we have a uniquely high level of demand booked for Q1, even aside from the Q4 pushouts. So we're extremely comfortable with our particular forecast, and we've actually included potential for incremental industry headwinds in those particular numbers.

Operator, Operator

Our next question comes from Colin Rusch from Oppenheimer.

Colin Rusch, Analyst

With wage inflation at the labor level on these projects and in your own inflation, have you guys looked at where your relative value is in terms of labor savings and your pricing strategy here? Is there an opportunity for you to start increasing some prices as you displace more high-cost labor?

Jason Whitaker, CEO

Yes, that's a great question, Colin, especially when you consider our full system solution offering abroad. One of the key aspects is being able to provide real value with our offering in the form of savings on labor, not only the classification of labor, but the amount of labor. So we're constantly evaluating that. But keep in mind, when you look at where we are right now, we're really focusing on growth. So from a project perspective, we're keeping our pricing in line from that particular standpoint.

Colin Rusch, Analyst

All right. And then just in terms of some of the smaller elements of the design that you guys have, can you talk a little bit about the potential to diversify suppliers with some of these coatings or on the wires or some of the clip systems? Certainly, we're seeing shortages of basic materials, not just in metals, but all over the supply chain, but I just want to understand how you're resilient to hit your full supply chain to serve a global customer base.

Jason Whitaker, CEO

Yes, Colin, great question. We have a vast approved vendor list that we operate from, and one of the things that we're constantly doing is we're constantly adding to that particular list itself. To be able to make sure that if something were to happen with one particular supplier, we could immediately pivot to another. That is something that we've been working on since day one many years ago, and we continue to build that over time.

Operator, Operator

Our next question comes from Kashy Harrison from Simmons Energy.

Kashy Harrison, Analyst

Jason, you indicated that you expect delivery schedules to eventually normalize. And in your prepared remarks, you said you're actually already seeing supply chains beginning to adjust. Can you go into maybe a little bit more detail on what you mean by that? Where are you seeing improvements in the supply chain? And then when do you expect things to maybe get a little bit closer back to normal?

Jason Whitaker, CEO

That's a great question. So it's definitely hard to predict the exact timing. But when you take a look at the raw material inputs that come into our facilities, we are starting to see those normalize. Based on, again, the approved vendor lists we've built up, we're actually utilizing and going out and supporting more of those particular vendors with additional orders to be able to derisk the supply chain itself. But I think the key thing is working closely with your vendors themselves to make sure they understand what the actual expectations are so that they can make their changes based upon any of the inputs from a logistics perspective. If it takes, let's just say, five days longer to get somewhere, be able to make those changes accordingly so that you can counteract that and actually receive the material when you need it so that ultimately, we can make our commitments to our customers.

Kashy Harrison, Analyst

And what about from your customers' perspective? Are you seeing them now able to get more components than before? Have they started to readjust? Or was that statement more in reference to inputs into your manufacturing capabilities?

Jason Whitaker, CEO

Yes. It's really hard to speak to all the exact items from a customer perspective. We were mainly just speaking more to our particular inputs in general.

Kashy Harrison, Analyst

Got it. Makes sense. And then my next question, the backlog increased 35% quarter-over-quarter. And the implied bookings and growth — the implied growth in bookings was quite pronounced. Is the increase just coming from these customers that you've been able to add? Or is there something else going on that's driving such a meaningful increase quarter-over-quarter on bookings and backlog? And then how should we think about converting that backlog into revenue over the next several quarters or in the next several years?

Jason Whitaker, CEO

That's a great question. When you take a look as well as supporting customers that we've been working with, but also as we begin to win more of that particular pipeline from those customers, that also is very accretive to our backlog and awarded orders. When you look at the timing of our particular backlog and awarded orders, it's very similar to what we've talked about in the past. You're looking at roughly — give or take — some particular projects may actually extend further than that, but that's a good rough average of how our backlog looks.

Operator, Operator

Our next question comes from Mark Strouse from JPMorgan.

Mark Strouse, Analyst

Jason, can you just comment about how widely distributed the project timing issues are? Are these just a handful of larger projects causing this near-term air bubble? Or is it a broader issue?

Jason Whitaker, CEO

There are actually several projects, larger projects that are out there. A good example here, Mark, is when you take a look at a particular panel manufacturer. Let's say that one of our customers shifts from panel manufacturer A to panel manufacturer B. It's the same form factor, same power levels. Just a simple shift like that could ultimately put us into a redesign that could cause project delays if for no other reason than the connector type itself because we have to actually follow the connectors that are included with the panels themselves. A large portion of what we're seeing, it's a group of several projects that are out there, and a few of them are fairly large projects.

Mark Strouse, Analyst

Okay. And can you remind me what's the contract language regarding who's responsible for the expenses associated with those change orders? If you've already produced product and it's ready to go out the door and then you get a last-minute change, is the customer bearing that cost?

Jason Whitaker, CEO

Yes, that's correct. When you look at a couple of different things to point out, whenever there is a change on a particular project, the change orders associated with that, the customer is responsible for that. One other thing I also want to point out based on a margin perspective is if, for example, that change itself requires additional raw material inputs, like copper, that change order will also be reflected based on the current COMEX price, not the COMEX price that was actually utilized at the initial receipt of the deal.

Operator, Operator

Our next question comes from Philip Shen from ROTH Capital Partners.

Philip Shen, Analyst

The first one is on 2022. I know you haven't provided official guidance, but I think back to your view of 2022 revenue and EBITDA from your IPO and then think about it now. We've seen an accelerating growth offset in part by these project delays and change orders. As you think about the delta between what you saw 1.5 years ago versus what you see now, are you incrementally more positive on your 2022 outlook or incrementally more concerned?

Jason Whitaker, CEO

Yes, that's a great question, Phil. So I can't specifically talk about the 2022 outlook in general. We're only offering up information for Q4 and Q1, as you know. But one thing that I can tell you is I have never been more excited about what we've been able to accomplish, specifically in solar as well as other areas I have been to date. You can see that as a direct reflection when you look at the number of customers that we've converted over, the number of prospects that we've added in, and obviously, the demand that we're getting as you can see reflected in our backlog and awarded orders and the number of projects that we're quoting.

Philip Shen, Analyst

Okay, great. And then as it relates to the upcoming reconciliation bill, with the prevailing wage requirements to hit the 30% ITC, when you think about the change potentially in the labor pool for your customers, some have said that you might be able to help reduce the labor because you've reduced the labor in the field. There might be more demand for your products and so forth, but I want to understand if you have a view on how that new potential requirement in the ITC for 30% may impact your business.

Jason Whitaker, CEO

Yes, Phil. So when you look at the prevailing wage requirement based upon the extension or the current ITC, it definitely helps. When you look at labor itself and the cost profile of labor, whether it is general labor or licensed electrician in a prevailing wage, non-prevailing wage, anything that we can do to change that classification down significantly provides value to our customers themselves. I think in that particular case, it will provide additional value.

Philip Shen, Analyst

Okay, great. And then one last one, if I may. As it relates to ConnectPV, I've done a few checks on the company, and it seems like they may also offer traditional EBOS. One part of their offering might be more labor-intensive than your offering. I was wondering if you might be able to give us a little bit more color on the rationale beyond just energy storage. Is part of it, for example, to acquire a customer base or is there something else that we might be missing that might be useful to understand?

Jason Whitaker, CEO

No, that's a good question. When you look at the overlap, the traditional EBOS offering that we manufacture that they also manufacture, there is overlap there. That's definitely not where the value is between the company. The value really comes from a lot of other synergies when you look at the teams they've assimilated. They have a lot of respect in the actual industry that we serve. They have phenomenal products from an energy storage perspective. As we talked about in our prepared remarks, there are also customers that they serve that we don't. So being able to merge the teams together to continue to support the industry both from a PV and a storage perspective with the combined product offerings that we have will definitely support value for our organization.

Operator, Operator

Our next question comes from Joseph Osha from JMP Securities.

Joseph Osha, Analyst

Just for the record, I'm with Guggenheim now. A couple of questions. First, I know you said that the run rate on ConnectPV was de minimis. But are you able to give us some sense of how much the Q1 outlook reflects their contribution from that company? Or should we not be thinking that way?

Jason Whitaker, CEO

Well, I think, first of all, great question. I want to further reiterate, just like we've talked about, I'm very excited about the combined forces of ConnectPV and Shoals. If you take a look at the forward outlook, we've already begun integrating our operations together so that we can leverage our collective capacity with the distant orders that we have. But if you take a look at the contribution to guidance, it was definitely immaterial.

Joseph Osha, Analyst

Okay, great. And then secondly, your comment about people respecting you is really, really interesting. So I've kind of got two sub-questions. The first I would think, and Colin kind of alluded to this, if you're looking to take costs out, are you seeing people come back to you and say, hey, we want to do a complete BLA as opposed to just a component sale in an effort to get some of that maybe get some of the labor cost out? And then the second question is on the panel front; if people are doing that, I would think that, that ultimately is going to push projects. So when you're seeing people talk about subbing panel suppliers out, I assume that also is going to be pushing the project by a quarter or two.

Jason Whitaker, CEO

Yes. Great questions. Maybe I'll take these in reverse order. When you talk about the panel supply itself, when you look at timing, obviously, the timing when there is a potential delay varies depending on what that delay looks like. If a customer is actually making a module change and they're going from one technology to another, that delay could be further out. For some entities, a panel change doesn't have any delay because the product offering just rolls right in. It's hard to quantify the exact delay depending on the changes made. When you look specifically at BLA itself, you're spot on. That is the exact proposition the BLA brings when you look at the savings we get. Customers reported an average of 40% savings on labor, which is remarkable when you look at the product itself.

Operator, Operator

Next question comes from Moses Sutton from Barclays.

Moses Sutton, Analyst

Just going back to ConnectPV and the margins. If I heard correctly, there was about a 100 basis point impact on this quarter's margin from Connect PV, but also minimal sales. Is there something in there that affected COGS from ConnectPV? Are they at negative margins? How do we sort of bridge those two points?

Philip Garton, CFO

Yes, this is Philip. No, they are not at negative margins. They contributed positively to the bottom line, though minimally. Their cost structure is just different than ours, and a lot of their work is subcontracted out. We're working to bring that in-house, and there were minimal margins. We're transitioning them to our much better cost structure, and we expect their products to contribute approximately our margins moving forward. So it will be accretive to the business.

Moses Sutton, Analyst

Got it. Got it. And I think it was mentioned that some stock was issued. How much stock was issued to ConnectPV?

Jason Whitaker, CEO

It was 209,437 shares.

Moses Sutton, Analyst

Perfect, perfect. And then just one last one for me. The mix shift to components from systems affecting 3Q and 4Q, anything that was specifically discrete in there? Other than the effect of some of the EPC transitions and some of the mix that's bought initially, is there perhaps one big contract and are you just thinking it's extended for more than a quarter? So just trying to get a sense of how that sort of happened and then how we shift back to a greater percentage from systems.

Jason Whitaker, CEO

No, that's a great question. Again, kind of pointing out the mix shift in Q3 was something that we saw and talked about on our last call. We see that mix shift continuing into Q4. It's not necessarily just a contribution from one particular project. There were a small handful of projects that did shift out that actually took that higher margin contribution with it from a BLA perspective.

Operator, Operator

And ladies and gentlemen, that will conclude today's question-and-answer session. I would now like to turn the conference call back over to Shoals' CEO, Jason Whitaker, for closing remarks.

Jason Whitaker, CEO

I appreciate everybody's time today and look forward to having future conversations. Thank you very much.

Operator, Operator

Ladies and gentlemen, that does conclude today's conference call and presentation. We thank you very much for joining. You may now disconnect your lines.