Enphase Energy Inc (NASDAQ:ENPH) is a financially troubled company competing in the fast growing but fiercely competitive microinverter systems, storage battery, and micro-grid space. As discussed in an article titled "Enphase Is in Financial Trouble" published May 15th, ENPH was down to approximately $19.95 million of cash (net of restricted cash) at March 31st. ENPH had raised approximately $50.6 million in debt and equity capital during Q1, but it suffered a very large cash flow from operations loss of $24.5 million and incurred capex of $3.5 million during the quarter.
On June 16th, there was an article published on SA about ENPH's upcoming analyst day on June 19th. The article studiously avoided all mention of ENPH's current financial predicament while breathlessly touting the prospects of its new products and predicting significant expansion in gross margins. The article failed to mention that ENPH will likely run out of cash by early Q3 barring a significant capital raise. Such a capital raise, if it was to occur, would be highly dilutive to the current shareholders. For convenience I have included a model of estimated Q2 cash flows below.
Cash is the life blood of troubled companies. When a company is bleeding cash and needs to constantly raise capital, the existing shareholders suffer. The debt and equity capital that was raised by ENPH during the first quarter was quite costly. Now burdened by $50 million of debt and blocked from raising more (see discussion on coverage ratio restrictions below), the next round of equity capital raised will likely have terms that look more like a vulture venture capital raise.
Strategic vision and new products will only be meaningful within the context of a financial forecast that includes raising significant new capital at ENPH. If the Analyst Day presentation does not include a detailed financial forecast by product and include reasonable predictions of revenue and margin that provide a road map to cash flow breakeven by year end 2017, then avoid the stock. If the Analyst Day presentation does not include a detailed financing plan that contemplates raising $25 to $35 million of non-debt capital during Q3, avoid the stock.
If, by some miracle, the Analyst Day presentation includes a detailed financial plan that passes the smell test and includes a plan to raise $25 to $35 million in non-debt capital, then do not front run the financing. Any new significant capital raise will be dilutive to current small shareholders so wait until after the next capital raise is executed so that you know the impact of the financing. Companies that are bleeding cash and in risk of failing have very little leverage in negotiations with vulture investors. Don't hope for good financing terms. Wait to see what the terms and their impact on the stock actually are. Be patient.
ENPH has been in financial trouble for quite some time. If its current products and future products are so great, why have no strategic buyers come forward? Why is no one banging on ENPH's door? As a former M&A banker, I guarantee that members of my brotherhood have been flogging the company to potential strategic buyers (i.e., entities that own competing businesses or that are looking to expand into related verticals). Why have there been no takers? Reasons that strategic buyers would not step up for a business like this include:
- the assets do not fit into their growth plan
- the addressable market is too small or the expected margins are too low
- the assets are inferior
- the price of getting a deal done exceeds the value of the assets
Some of those reasons are acceptable and should not trouble an individual investor, but others are red flashing lights. If ENPH is able to complete a significant capital raise and has a financial plan that provides a road map to cash flow breakeven, then be skeptical that it can achieve the plan. Wait for ENPH to demonstrate that it can hit a financial forecast milestone. It has not for a while. Desperate managements will push the envelope on projections so be skeptical about this Analyst Day presentation. Wait for ENPH to prove the viability of its business model before jumping in.
I am reproducing the cash flow roll forward from my prior article for review. I will update it, if necessary, after the Analyst Day presentation on Monday.
Cash Roll Forward to June 30th, 2017
|Enphase Energy Inc.|
|Cash Roll Forward|
|Q2 Cash Earnings||(millions)|
|Gross Margin Percentage||15%||15%||15%|
|Non GAAP Operating Expenses||$18.0||$18.0||$18.0|
|Q2 Restructuring Expenses||$3.2||$3.2||$3.2|
|Q1 Restructuring Expenses|
|Accrued, Not Incurred||$1.5||$1.5||$1.5|
|Cash Interest Expense||$1.3||$1.3||$1.3|
|Cash Earnings (Loss)||$(14.3)||$(13.5)||$(12.8)|
|Working Capital Change||$-||$-||$-|
|Increase in Warranty Payments||$0.43||$0.43||$0.43|
|Cash Flow Q2||$(18.20)||$(17.45)||$(16.70)|
|Cash @ March 31st||$29.95||$29.95||$29.95|
|Restricted Cash Balance per Term Loans||$(10.00)||$(10.00)||$(10.00)|
|Cash Available @ June 30th||$1.76||$2.51||$3.26|
|Loan Fees Due July 2017||$0.88||$0.88||$0.88|
|Cash Available Post Loan Fees||$0.88||$1.63||$2.38|
|Gross Margin Sensitivity||1%||$0.65||$0.70||$0.75|
ENPH is estimating revenues between $72 million and $80 million and gross margins of 17% to 20% for Q2. The company began rolling out a new product late Q1, but I am skeptical that ENPH will be able to achieve its revenue targets and increase its gross margin from approximately 12.9% to the high teens when ASPs are declining in the market. I have used a revenue range of $65 million to $75 million and a gross margin of 15%. A gross margin sensitivity of 1% is provided at the bottom of the table.
Non-GAAP operating expenses of $18 million are from ENPH's business outlook in its earnings release. I believe this is aggressively low so I have not adjusted for non cash items of $1.5 million.
Q2 restructuring expenses of $3.2 million are from the earnings release and are assumed to be accrued and expended during the quarter. Q1 restructuring expenses that were accrued but not expended during Q1 are from Footnote 6 of the 10-Q and are assumed expended during Q2.
Cash interest expense is the face amount of the $50 million in term loans and assumes a 10.5% annual interest rate. It does not include the amortization of issuance costs.
Capex is based on the runrate for the prior two quarters.
Despite a revenue increase, I am assuming that any accounts receivable increase is offset by increases in accounts payable or drawdowns in inventory.
Current warranty obligations jumped $1.73 million from Q4 2016 to Q1 2017 meaning that cash outlays to satisfy warranty claims will increase more than $430k per quarter going forward. It also begs the question of why near-term warranty claims spiked.
The restricted cash equals the minimum $10 million cash balance required under a maintenance covenant in the term loans. I have used the term "restricted cash" in the table to make it clear it is not available to ENPH to fund operations. See Footnote 7 of the 10-Q.
Although it is not due until July, ENPH has a significant fee payment due to the term loan lenders immediately after the end of Q2 and it is reflected in the table.
Assuming a high case of $75 million in revenue (almost the midpoint of management projections), cash available after loan fees is only $2.4 million. At the Q2 projected burn rate, ENPH would run out of cash during the second week of July. If ENPH is unable to attain the $75 million revenue target, the liquidity noose will be even tighter at June 30th.
The term loans coverage ratio requires cash, accounts receivable, and inventory to equal 1.5x the face value of the debt. This will inhibit ENPH's ability to issue debt based on the Q2 projected cash burn, so its funding alternatives are limited to the issuance of privately placed common stock or convertible preferred stock. ENPH did use an At-the-market equity issuance program during Q1 but its current equity needs are likely too pressing to pursue this route.
At a current equity market value of $77.6 million, ENPH would need to dilute its existing shareholders by at least 40% to raise the $25 million (before issuance fees and expenses) it would need to survive the third quarter since private placement common equity purchasers would be looking for a significant discount to market. If ENPH goes the convertible preferred route, it would structurally subordinate the common stock holders. Please note that ENPH has almost doubled its share count in the last 12 months because it has a business model that has not worked to date.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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