Shoals Technologies Group, Inc. (NASDAQ:SHLS) Q3 2023 Earnings Call Transcript

Shoals Technologies Group, Inc. (NASDAQ:SHLS) Q3 2023 Earnings Call Transcript November 7, 2023

Shoals Technologies Group, Inc. misses on earnings expectations. Reported EPS is $-0.13598 EPS, expectations were $0.16.

Operator: Good afternoon. And welcome to Shoals Technologies Group Third Quarter 2023 Earnings Conference Call. Today’s call is being recorded and we have allocated one 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. Please go ahead.

Mehgan Peetz: Thank you, operator. And thank you everyone for joining us today. Hosting the call with me are CEO, Brandon Moss; 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, including economic, market and industry conditions, defects or performance problems in our products or their parts, including those related wire inflation shrinkback matter, failure to accurately estimate the potential losses related to such matter and failure to recover those losses from the manufacturer, decrease demand for our products, policy and regulatory changes, 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 — 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 Shoals CEO, Brandon Moss.

Brandon Moss: Thank you very much, Mehgan, and good afternoon, everyone. I will start today’s call with some key highlights from the third quarter. I will follow with an overview of business conditions, our investment in production capacity and an update regarding the wire insulation shrinkback warranty investigation and remediation. I will wrap up with some of my initial takeaways, one quarter into the job before I turn it over to Dominic, who will provide more detail on our financial results. Shoals had another great quarter delivering record revenue, adjusted EBITDA and adjusted net income. I would like to thank the management team and associates for their strong execution in delivering these record results. Compared to prior year, third quarter revenue grew 48% to a $134.2 million.

Revenue was slightly impacted by lower production yields early in the quarter as we ramped up our third Tennessee facility, which has already added 15 gigawatts of new capacity to our 2022 base of 20 gigawatts, bringing total capacity to approximately 35 gigawatts. I also want to thank our commercial team for delivering yet another record for backlog and awarded orders. Backlog and awarded orders were up 34% year-over-year and 16% sequentially to $633.3 million. We added over $228 million in orders during the quarter. We are also pleased to see emerging strength in our international business, which now represents more than 10% of our backlog and awarded orders. Moving now to the solar market landscape. The domestic utility scale solar market is currently experiencing slower growth as a result of higher interest rates, lingering uncertainty about the IRA, supply chain constraints and interconnection complications.

Though we expect Shoals’ growth rate to decline from the extremely high levels of the last few years, we believe that our domestic utility scale business will continue growing in at attractive rate. We still see potential to partner with large EPCs, converting them to the Shoals solution and growing our penetration of current customers. Shoals has historically targeted large utility scale projects that are approximately 75 megawatts and up, but we see an attractive opportunity to apply our industry leading value proposition to smaller projects. Additionally, we are in the early stages penetrating adjacent product markets to grow wallet share in the solar space. Turning now to international. We are targeting specific higher growth markets within Europe, Africa, Latin America and Australia.

These markets combined are more than double the US market and according to industry data are growing at a 9% CAGR through 2026. In recent quarters, we announced major project wins in Australia, Latin America, and we expect growth to continue as international EPCs understand the value proposition of our entire product suite. As I mentioned earlier, more than 10% of our backlog and awarded orders is now attributable to our international business. In our EV charging business, we announced at the end of October that we will deploy our Fuel by Shoals e-mobility solution for the U.S. Department of the Air Force, supporting an EV charging-as-a-service pilot project to be provided by Leidos, a Fortune 500 science and technology leader. This project will support the Air Force’s climate action plan to achieve a 100% carbon free electricity by 2030 and net zero emissions at Air Force facilities by 2046.

Shoals is proud to partner with the Air Force as they work towards reaching their emissions targets. Although it’s early days in our e-mobility business, we are excited about our innovative above ground EV charging infrastructure solution, which minimizes construction costs and accelerates EV charging deployments. Turning now to an update on production capacity. Shoals has a strong operational team that continues to execute and support our commercial growth. The team has been focused on increasing capacity in 2023 to meet our strong demand. Since January, we have installed almost a 100 new machines, hired over 200 operators and added 225,000 square feet to our manufacturing footprint. As I mentioned at the start of the call, we completed the ramp up of third Tennessee facility in Q3.

This facility increases our capacity by 15 gigawatts or 75% year-over-year. This brings Shoals total capacity to 35 gigawatts with the ability to scale to 42 gigawatts. With this added capacity, we estimate Shoals conserve growing demand well into 2025, further enhanced production efficiency and maintain our attractive margins. I would like to take some time now to discuss where we stand on our investigation and remediation of the wire insulation shrinkback warranty issue. On October 31st, we filed a complaint to recover for damages caused by defective wire that Prysmian Cables and Systems USA, LLC sold to Shoals between 2020 and approximately 2022. Shoals has already expended millions of dollars in identification, repair and replacement of defective wire and is seeking full recovery from Prysmian for those, as well as future expenses related to the issue.

Because of the pending litigation, we’re limited to what we can discuss publicly. Based on our continuing analysis of information available as of today, the updated estimated range for potential loss related to wire exhibiting insulation shrinkback is $59.7 million at the low end and $184.9 million at the high end. Dominic will provide more granularity on the breakdown when he reviews our financial results. Based on our own investigation and third party testing, we determined that unacceptable amounts of insulation shrinkback were occurring on Prysmian wire purchased from 2020 through 2022. The range of damages we are seeking reflects potential costs of remedial measures, including wire and labor at the approximately 300 sites that include at least one harness made with defective Prysmian wire sold during this period.

This represents about 30% of the total amount of Shoals harnesses manufactured in the same timeframe. Shoals is committed to quality. Based on the information we have gathered to date, it is apparent that this installation shrinkback issue is unique to the defective Prysmian wire and not from any other wire suppliers. As we work to remedy the Prysmian defective wire issue, our top priority is taking care of our customers, which we are doing by leveraging our strongest assets, our people and our technology. Identifying the effective wire is time consuming because of the size of solar fields, which can be as large as four square miles but we’re focused on working as efficiently as possible. We want to emphasize that our underlying business remains very strong and we expect it to continue to flourish through the resolution of this issue.

Now I’ll take a moment to provide a brief update on the patent infringement complaints filed by Shoals with the ITC in May of this year. The evidentiary hearing is scheduled for March of 2024. And as we’ve emphasized in prior quarters, we’ll continue to vigorously defend and protect our intellectual property. I’ll now wrap by highlighting some of my initial takeaways and why I’m so excited about Shoals. In the first quarter of my tenure as CEO, I’m focused on refining our company strategy, continuing to build our organizational capacity and implementing a more robust operating model to sustain our strong execution. Shoals solutions continue to have an industry leading value proposition, particularly in the current environment where there’s a shortage of licensed electricians.

A recent third party study stated that utility scale solar installation workforce decreased by 18% from 2021 to 2022. Conventional EBOS systems are expensive and time consuming to install, and most of the work must be done by licensed electricians who continue to be in short supply. Our system reduces both material and labor costs. Additionally, our products are constructed in a quality controlled manufacturing environment and are built to last, providing value to owners and power providers versus traditional methods that have a high failure rate, such as field assembly and the use of devices like insulation piercing connectors. We believe we have ample room to grow in our core domestic solar market with large EPC partners and with a new focus on smaller projects.

I’m also confident in our ability to accelerate growth in adjacent product markets and internationally. Shoals is an innovation leader with strong product development capability. We have been successful in growing share due to our ability to innovate better solutions and with our domestic manufacturing footprint in the US, we are well positioned to capitalize in the US federal legislation that provides tax and other incentives for onshore manufacturing. Shoals will focus on markets that support global electrification that are impacted by skilled labor needs and supply chain constraints. Our core competency of engineering quality prefabricated plug and play solutions at scale aligns well with market needs. By delivering these prefabricated solutions, we expect to continue to generate strong margins and we are moving up our gross margin target, which Dominic will cover in greater detail.

I’ll now turn it over to Dominic, who will discuss third quarter 2023 financial results.

Dominic Bardos: Thanks, Brandon. And good afternoon to everyone on the call. Third quarter revenues grew 48% to $134.2 million, driven by higher production volumes as a result of increased domestic demand for solar EBOS. Gross profit was $14.2 million compared to $36 million in the prior year period. Gross profit as a percentage of net revenue decreased to 10.5% from 39.7% in the prior year period, driven by $50.2 million of wire insulation shrinkback warranty expense recorded in the period. The significant warranty expense was partially offset by improved pricing, slightly lower raw materials input costs, increased leverage on fixed costs and efficiencies gained in operations. We have not booked any offsetting recovery from Prysmian.

The liability and related expenses for addressing Prysmian’s defective wire is based on our continued analysis of information available as of today. Based on this analysis, as Brandon noted earlier, we have an updated range of the potential loss related to the defective Prysmian wire, which is $59.7 million at the low end represented in our financial statements through September 30, 2023 and $184.9 million at the high end. As no amount within the range of loss is more likely than any other, as of September 30, 2023. Our liability balance, broken down between current and long term liabilities on the face of our balance sheet, remains $56.6 million. As Brandon noted, the range of potential loss reflects cost of remediation, including Shoals manufacturing expenses and field installation labor.

Because the complaint was filed on October 31st before our third quarter 10-Q, we used the amount of damages that had been accrued and was publicly available at the time of the filing of the amount of damages being sought as management, as well as our Board continued assessing and refining the updated range of losses to be accrued for the third quarter. That accrued amount as of our second quarter was not less than $9.3 million. The amount of damages we are seeking may be amended from time to time as the litigation proceeds and additional or different information becomes known. In the ordinary course of litigation, we will be required to make initial disclosures in which we will include the most current higher estimate of damages. To provide additional insight into our recurring gross margin performance, we have introduced additional non-GAAP metrics this quarter.

Adjusted gross profit and adjusted gross profit percentage are non-GAAP metrics that remove the wire insulation shrinkback expenses from our GAAP cost of goods sold. Reconciliations of adjusted gross profit, and adjusted gross profit percentage are provided in our press release and 10-Q filing. Our adjusted gross profit for the quarter was $64.4 million, reflecting a 48% adjusted gross profit percentage. Year-to-date, our adjusted gross profit percentage 48.7% excludes the cost of expenses of remediation of Prysmian’s defective wire in both the second and third quarter. For clarity, our normal non-GAAP metrics of adjusted EBITDA and adjusted net income also add back the wire insulation shrinkback expenses from our cost of goods sold, as well as the wire insulation shrinkback litigation expenses from the SG&A section of the income statement.

Once again, reconciliations may be found in our press release and 10-Q filing. Third quarter general and administrative expenses were $22.6 million compared to $13.9 million during the same period in the prior year. The year-over-year increase in general and administrative expenses was primarily related to higher non-cash stock based compensation, legal fees related to the patent infringement and Prysmian defective wire complaints and planned increases in payroll expense due to higher headcount supporting growth. Net loss was $9.8 million in the third quarter compared to net income of $12.8 million in the prior year period. Adjusted EBITDA increased 81% to $48 million compared to $26.6 million in the prior period. Adjusted EBITDA margin increased 649 basis points year-over-year to 35.8%, reflecting the impact of higher adjusted gross profit achieved this quarter.

Adjusted net income grew 101% to $33.4 million in the third quarter compared to $16.6 million in the prior year period. Once again, both adjusted EBITDA and adjusted net income add back the defective wire warranty expenses. During the quarter, we generated cash from operations of $27.7 million. In the quarter, we used excess cash to fully pay down the revolver. As I have stated on multiple calls, we will continue to prioritize investment in the business and driving shareholder value. As of September 30, 2023, we had $633.3 million in backlog and awarded orders, an increase of 34% year-over-year as the company added over $220 million of orders in the period. It’s important to note that some international orders have longer lead times than domestic orders and we are booking jobs that extend beyond our historical revenue cycle of nine to 13 months to realize revenue from awarded orders.

Approximately 15% of our backlog and awarded orders have delivery dates beyond 2024. Turning now to our full year outlook. Based on current market conditions and visibility into anticipated fourth quarter production, we are narrowing our outlook for revenue and raising our outlook for adjusted EBITDA and adjusted net income. Our outlook for interest expense and capital expenditures remain unchanged. For the year ending December 31, 2023, we expect revenues to be in a range of $485 million to $495 million, adjusted EBITDA to be in a range of a $165 million to $175 million, adjusted net income to be in the range of $110 million to $120 million, interest expense to be in the range of $22 million to $26 million and capital expenditures for the full year in the range of $8 million to $12 million.

Before I turn it back over to Brandon for closing remarks, I want to note that our long term target for adjusted gross profit percentage is in the range of 40% to 45%, which we believe we can sustain going forward by managing price, operational efficiencies and operating leverage. With that, I’ll now turn it back over to Brandon for closing remarks.

Brandon Moss: Thanks Dominic. I would like to close by thanking all of our customers for the confidence in Shoals, our employees for enabling us to effectively serve our customers and our shareholders for their continuous support. I’m incredibly excited about the opportunities Shoals has ahead. Shoals continue to have an industry leading value proposition in the EBOS space with great opportunity for continued growth in the domestic solar market. Our strategic focus on international expansion positions us to capitalize on higher growth international markets that will enable sustained growth in the coming years. Additionally, our world-class team with its strong product development capability will allow Shoals to keep building on its leading position by developing innovative products in both core and adjacent markets.

With our asset light business model that has industry leading margins and significant cash flow generation, I’m incredibly optimistic about what we can achieve in the coming quarters and could not be more excited about the opportunity ahead. And with that, thank you everyone. I appreciate your time today, and we will now open the line for questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from Brian Lee from Goldman Sachs.

Brian Lee: Thanks for some of the additional disclosure here on some of the hot topics as well. I had a couple questions I guess regarding that, maybe first off on the warranty. If I look at the cash flow statement, it looks like all of these close to $60 million you’ve represented are non-cash as of today. Can you give us a sense of how that potentially turns into more of a cash impact as you continuously remediate how many quarters it might show up over and then whether it’s OpEx or COGS? Just any sense of — I know you’re booking this as a liability, but sort of what is the ultimate potential cash impact you’re anticipating and over what timeframe based on the fact that you’re already kind of into the remediation process? Maybe have an early look into that and then I have a follow-up.

Dominic Bardos: Let me start by saying on the face of our balance sheet, in our liabilities and stockholders equity section, we’ve tried our breakdown and estimated the warranty liability between current portion, which would be within the next 12 months and the long term portion of the warranty expense, which would be greater than 12 months out. We do believe the remediation will take multiple quarters and therefore we’ve tried to estimate that. So in our balance sheet, we’ve currently got 17 million of current liability expense. As you noted, most of it was a non-cash charge this quarter. $17 million that we have on the balance sheet is the current portion with $39 million as the long term portion of the warranty expense. And as you can imagine, the vast majority of that expense is going to be related to COGS.

It’s really the manufacturing, it’s the remediation, it’s the labor to install these things in the field. So that’s where the warranty expenses manifest. And there will be some expenses associated with litigation that clearly would happen during this timeframe as well. But I can’t — that’s the clarification I can provide, it’s on the face of the balance sheet, it’s in my press release and our Q as well.

Brian Lee: And then I guess on the demand backdrop, you guys noted there’s a little bit of a slowdown you’re seeing US domestic, if I heard you correctly. But this $220 million plus of bookings, you printed in the quarter it’s one of your best quarterly bookings metrics you’ve posted. So just trying to reconcile your commentary with kind of the results here. Is there sort of a precursor to bookings starting to slow as we move into year end Q4? Or are you just kind of throwing caution to the wind but you’re offsetting some of that through either market share gain or international and non-solar expansion or both? Just trying to understand kind of where Shoals fits into that dynamic of the high level commentary around US domestic maybe [selling] a bit. Thank you, guys.

Brandon Moss: I’ll jump in on that one, I appreciate the question. Look, you pointed it out. First and foremost, we’re excited about the quarter in terms of the booking we’ve seen. Our quote volume is up 69% and as you noted $220 million of bookings in the quarter gave us a record at 633.3 of total backlog and awarded orders. I think really the thing to point out 10% of our backlog and awarded orders is international business. Some of that international business is pushed out into 2025. Our total backlog and awarded orders that is for 2025 delivery is about 15%. So look, we’re seeing the same choppiness that everybody’s seeing in the marketplace that I indicated in my prepared remarks. There’s some fear about interest rates, obviously, interconnections, complexities, still some lingering supply chain issues.

We are not seeing overwhelmingly big changes and product push outs. I mean, in this business, things move quarter-to-quarter. But there’s nothing we’re really seeing of significance there. I think that the major thing is the forward-looking bookings into 2025. And then look this business has executed great the last couple years, we’ve grown at a 50% plus CAGR since IPO. It’s impossible for a company to do that on into perpetuity. We continue to feel very good about the marketplace and our ability to compete. And our goal is to outpace the market growth and we’ll continue to do that as a company. So it’s a great question. Thank you.

Operator: Your next question comes from Philip Shen from ROTH MKM.

Philip Shen: I wanted to follow up on some of the warranty questions. Specifically, how confident are you that the $185 million could be the high end of the range, is there potential that it could go beyond that. Are you still buying the Prysmian wire? And then from — I think, you were alluding to most of this would be a cash expense over time, it’s on cash now. But over time, does become more cash and then maybe the what the mix of cash is there? And ultimately how do you expect to pay for it? My guess is it comes out of your cash flow in the coming quarters. Just curious if you could give a little bit more color in terms of the source of how you pay for it as well. Thanks.

Mehgan Peetz: So the first questions that I can answer are that we are no longer buying the Prysmian wire, that is in our complaint that has been filed. So feel free to check there for some additional details. And then as far as the further financial questions, I will hand it over to Dominic.