Enphase Energy, Inc. (ENPH) FY 2021 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements reflecting our current expectations and involves risks and uncertainties. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential” or “continue” or the negative of these terms or other comparable terminology. Such statements, include but are not limited to statements regarding our expectations as to future financial performance, expense levels, liquidity sources, the capabilities and performance of our technology and products and planned changes, timing of new product releases, our business strategies, including anticipated trends, growth and developments in markets in which we target, the anticipated market adoption of our current and future products, performance in operations, including component supply management, product quality and customer service, risks related to the ongoing COVID-19 pandemic and the anticipated benefits and risks relating to our recent acquisitions. Our actual results and the timing of events may differ materially from those discussed in our forward-looking statements as a result of various factors, including those discussed below and those discussed in the section entitled “Risk Factors” included in Part I, Item 1A of this Annual Report on Form 10-K.

Business Overview and 2021 Highlights

We are a global energy technology company. We deliver smart, easy-to-use solutions that manage solar generation, storage and communication on one platform. We revolutionized the solar industry with our microinverter technology and we produce a fully integrated solar-plus-storage solution. To date, we have shipped more than 42 million microinverters, and approximately 1.9 million Enphase residential and commercial systems have been deployed in more than 130 countries.

We sell primarily to solar distributors who combine our products with others, including solar modules products and racking systems, and resell to installers in each target region. In addition to our solar distributors, we sell directly to select large installers, OEM and strategic partners. Our OEM customers include solar module manufacturers who integrate our microinverters with their solar module products and resell to both distributors and installers. Strategic partners include providers of solar financing solutions. We also sell certain products and services to homeowners primarily in support of our warranty services and legacy product upgrade programs via our online store.

Safe Harbor Prepayments

The Renewable Energy and Job Creation Act of 2008 provided a 30% federal tax credit for residential and commercial solar installations through December 31, 2019, which was reduced to a tax credit of 26% for any solar energy system that began construction during 2020 through December 31, 2022, and 22% thereafter to December 31, 2023 before being reduced to 10% for commercial installations and 0% for residential installations beginning on January 1, 2024. As a result, several of our customers explored opportunities to purchase products in 2019 to take advantage of safe harbor guidance from the IRS published in June 2018, allowing them to preserve the historical 30% investment tax credit for solar equipment purchased in 2019 for solar projects that are completed after December 31, 2019. Safe harbor prepayments from customers in the fourth quarter of 2019 resulted in $44.5 million of revenue recognized in the first quarter of 2020 when we delivered the product. There was no safe harbor revenue recognized in the years ended December 31, 2021 in comparison.

Acquisitions

On January 25, 2021, we completed the acquisition of Sofdesk Inc. (“Sofdesk”), a privately-held company. Sofdesk provides design tools and services software for residential solar installers and roofing companies and will enhance our digital transformation efforts. As part of the purchase price, we (i) paid approximately $32.0 million in cash on January 25, 2021 and (ii) paid approximately $3.7 million of contingent consideration payable in the first quarter of 2022, of which we recorded a liability of approximately $3.5 million representing the fair value of the contingent consideration on the date acquisition. In addition to the purchase price, we paid approximately $3.7 million in the first quarter of 2022, as the continued employment condition of key employees of Sofdesk was deemed completed.

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On March 31, 2021, we completed the acquisition of DIN Engineering Services LLP’s (“DIN”) solar design services business. DIN’s solar design services business provides outsourced proposal drawings and permit plan sets for residential solar installers in North America and will enhance our digital transformation effort. As part of the purchase price, we paid approximately $24.8 million in cash. In addition to the purchase price paid, we are obligated to pay up to (i) approximately $5.0 million in equal monthly installments over the course of one year following the acquisition date; and (ii) approximately $5.0 million payable in one year following the acquisition date subject to achievement of certain revenue, operational and employment targets.

On December 13, 2021, we completed the acquisition of 365 Pronto, Inc. (“365 Pronto”), a privately-held company. 365 Pronto provides an online platform for clean technology installation and service landscape by matching asset owners with an on-demand qualified workforce in the U.S. As part of the purchase price, we paid approximately $69.9 million in cash on December 13, 2021. In addition to the purchase price paid, we are obligated to pay up to approximately $11.0 million in shares of our common stock in 2023 subject to achievement of certain revenue, operational and employment targets.

On December 31, 2021, we completed the acquisition of ClipperCreek, Inc. (“ClipperCreek”), a privately-held company. ClipperCreek offers electric vehicle (“EV”) charging solutions for residential and commercial customers in the U.S. As part of the purchase price, we paid approximately $113.1 million in cash on December 31, 2021. [In addition to the purchase price paid, we are obligated to issue up to approximately $40.0 million in shares of our common stock payable in the first quarter of 2023, subject to achievement of certain revenue, operational and employment targets

Further details on business acquisitions may be found in Note 6. “Business Combinations,” in the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

Convertible Notes

On March 1, 2021, we issued an aggregate principal amount of $1.15 billion of convertible senior notes comprised of $575.0 million of our 0.0% convertible senior notes due 2026 (the “Notes due 2026”) and $575.0 million of our 0.0% convertible senior notes due 2028 (the “Notes due 2028”). In addition, on March 12, 2021, we issued $57.5 million aggregate principal amount of the Notes due 2026 in connection with the initial purchasers’ full exercise of the over-allotment option to purchase additional Notes due 2026. The Notes due 2026 and Notes due 2028 will not bear regular interest, and the principal amount of the Notes due 2026 and Notes due 2028 will not accrete. The Notes due 2026 and the Notes due 2028 are general unsecured obligations and the Notes due 2026 and Notes due 2028 are governed by relevant indentures entered by and between us and U.S. Bank National Association, as trustee. The Notes due 2026 will mature on March 1, 2026 and Notes due 2028 will mature on March 1, 2028, unless earlier repurchased by us or converted at the option of the holders. Further information relating to the Notes due 2026 and Notes due 2028 may be found in Note 13. “Debt,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

During the period ended December 31, 2021, $88.1 million in aggregate principal amount of our 1.0% convertible senior notes due 2024 (the “Notes due 2024”) were converted or repurchased by us, and the principal amount of the converted and repurchased Notes due 2024 was repaid in cash. Of the $88.1 million in aggregate principal amount, $25.5 million in aggregate principal amount was repurchased pursuant to separately- and privately-negotiated exchange agreements entered into in March 2021 with certain holders of Notes due 2024 concurrently with the offering of the Notes due 2026 and the Notes due 2028. In connection with such conversions or repurchases, during the year ended December 31, 2021, we also issued 3.8 million shares of our common stock to the holders of the converted and repurchased Notes due 2024 with an aggregate fair value of $669.5 million, representing the conversion value in excess of the principal amount of the Notes due 2024, which were fully offset by shares received from the settlements of the associated note hedging arrangements. Following the conversions and repurchases summarized above, Notes due 2024 are no longer outstanding.

During the first quarter of 2021, concurrently with the offering of the Notes due 2026 and the Notes due 2028, we entered into separately- and privately-negotiated transactions to repurchase approximately $217.7 million in aggregate principal amount of our 0.25% convertible senior notes due 2025 (the “Notes due 2025”). The principal amount (and for certain holders the conversion value in excess of the principal amount) of the repurchased Notes due 2025 was repaid in cash. We also issued approximately 1.7 million shares of our common stock to the holders of the repurchased notes with an aggregate fair value of $302.7 million, representing the conversion value in excess of the principal amount of the Notes due 2025, which were fully offset by shares received from the settlements of the associated note hedging arrangements.

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Repurchases of Common Stock

In April 2020, our board of directors authorized the repurchase of up to $200.0 million of our common stock, exclusive of brokerage commissions, under the 2020 Repurchase Program. During the second quarter of 2021, we repurchased and subsequently retired approximately 1.7 million shares of common stock from the open market at an average cost of $117.47 per share for a total of $200.0 million. In May 2021, our board of directors authorized the 2021 Repurchase Program, pursuant to which we may repurchase up to an aggregate of $500.0 million of our common stock. During the fourth quarter of 2021, we repurchased and subsequently retired approximately 1.5 million shares of common stock from the open market at an average cost of $196.98 per share for a total of $300.0 million. As of December 31, 2021, we have approximately $200.0 million remaining for repurchase of shares under the 2021 Repurchase Program. Purchases may be completed from time to time in the open market or through structured repurchase agreements with third parties. The program may be discontinued or amended at any time and expires on May 13, 2024. Such purchases are expected to continue through May 2024 unless otherwise extended or shortened by our board of directors.

COVID-19 Update

We are actively monitoring, evaluating, and responding to developments relating to COVID-19 pandemic, which has resulted in, and is expected to continue to result in substantial manufacturing or supply chain problems, disruptions in local and global economies, volatility in the global financial markets, overall reductions in demand, delays in payment, restrictions on the shipment of our products, or other ramifications. The extent of the impact of COVID-19 on our operational and financial performance will depend on developments, including the duration and spread of the virus and its variants, impact on our end-customers’ spending, volume of sales, impact on our partners, suppliers, and employees and actions that may be taken by governmental authorities. The global supply chain and the semiconductor industry are experiencing challenges. We have seen supply chain challenges and logistics constraints increase, including component shortages, which have, in certain cases, caused delays in critical components and inventory and have resulted in increased costs. We continue to work to minimize the effects from supply chain constraints. Given the dynamic nature of these circumstances, the full impact of COVID-19 and other macroeconomic factors on our ongoing business, results of operations and overall financial performance cannot be reasonably estimated at this time. Further information relating to the risks and uncertainties related to the ongoing COVID-19 pandemic may be found in Part I, Item 1A “Risk Factors” of this Annual Report on Form 10-K.

Components of Consolidated Statements of Operations

Net Revenues

We primarily generate net revenues from sales of our microinverter solutions and related accessories, which include our storage systems, our Envoy communications gateway, Enlighten cloud-based monitoring service, design and proposal services, and proposal and permitting services to distributors, large installers, original equipment manufacturers (“OEMs”) and strategic partners.

Our revenue is affected by changes in the volume and average selling prices of our solutions and related accessories, supply and demand, sales incentives, and competitive product offerings. Our revenue growth is dependent on our ability to compete effectively in the marketplace by remaining cost competitive, developing and introducing new products that meet the changing technology and performance requirements of our customers, the diversification and expansion of our revenue base, and our ability to market our products in a manner that increases awareness for microinverter technology and differentiates us in the marketplace.

Cost of Revenues and Gross Profit

Cost of revenues is comprised primarily of product costs, warranty, manufacturing personnel and logistics costs, freight costs, inventory write-downs, hosting services costs related to the Company’s Enlighten service offering and design and proposal services, depreciation and amortization of manufacturing test equipment, amortization of capitalized software development costs related to the Company’s Enlighten service offering and design and proposal services, and employee-related expenses associated with proposal and permitting services and design and proposal service customer support. Our product costs are impacted by technological innovations, such as advances in semiconductor integration and new product introductions, economies of scale resulting in lower component costs, and improvements in production processes and automation. Certain costs, primarily personnel and depreciation and amortization of test equipment, are not directly affected by sales volume.

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We outsource our manufacturing to third-party contract manufacturers and generally negotiate product pricing with them on a quarterly basis. We believe our contract manufacturing partners have sufficient production capacity to meet the anticipated demand for our products for the foreseeable future. However, shortages in the supply of certain key raw materials could adversely affect our ability to meet customer demand for our products. We contract with third parties, including one of our contract manufacturers, to serve as our logistics providers by warehousing and delivering our products in the U.S., Europe and Asia.

Gross profit may vary from quarter to quarter and is primarily affected by our average selling prices, product cost, product mix, customer mix, tariff refunds, warranty costs and sales volume fluctuations resulting from seasonality.

Operating Expenses

Operating expenses consist of research and development, sales and marketing, general and administrative and restructuring expenses. Personnel-related costs are the most significant component of each of these expense categories other than restructuring expense and include salaries, benefits, payroll taxes, sales commissions, incentive compensation, post-combination expense and stock-based compensation.

Research and development expense include personnel-related expenses, third-party design and development costs, testing and evaluation costs, depreciation expense and other indirect costs. Research and development employees are primarily engaged in the design and development of power electronics, semiconductors, powerline communications, networking and software functionality, and storage. We devote substantial resources to research and development programs that focus on enhancements to, and cost efficiencies in, our existing products and timely development of new products that utilize technological innovation to drive down product costs, improve functionality, and enhance reliability. We intend to continue to invest appropriate resources in our research and development efforts because we believe they are critical to maintaining our competitive position.

Sales and marketing expense include personnel-related expenses, travel, trade shows, marketing, customer support and other indirect costs. We expect to continue to make the necessary investments to enable us to execute our strategy to increase our market penetration geographically and enter into new markets by expanding our customer base of distributors, large installers, OEMs and strategic partners. We currently offer solutions targeting the residential and commercial markets in the U.S., Canada, Mexico, Europe, Australia, New Zealand, India, Brazil, South Africa, and certain other Central American and Asian markets. We expect to continue to expand the geographic reach of our product offerings and explore new sales channels in addressable markets in the future.

General and administrative expense include personnel-related expenses for our executive, finance, human resources, information technology and legal organizations, facilities costs, and fees for professional services. Fees for professional services consist primarily of outside legal, accounting and information technology consulting costs.

Restructuring charges are the net charges resulting from restructuring initiatives implemented in 2018 through 2019 (the “2018 Plan”) to improve operational performance and reduce overall operating expenses. Under the 2018 Plan, costs included in restructuring primarily consisted of employee severance and one-time benefits, workforce reorganization charges, non-cash charges related to impairment of property and equipment, and the establishment of lease loss reserves. See Note 12. “Restructuring,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

Other Expense, Net

Other expense, net primarily consists of interest expense, fees under our convertible notes and term loans, changes in fair value of contingent consideration, non-cash interest expense related to the accretion of debt discount and amortization of deferred financing costs, non-cash charges recognized for loss on partial settlement of convertible notes and the change in fair value of our convertible notes embedded derivative and warrants. Other expense, net also includes interest income on our cash, cash equivalents and marketable securities, amortization of discount or premium on purchase of cash equivalents and marketable securities, accrued interest on marketable securities, tariffs previously paid and approved for refund, and gains or losses upon conversion of foreign currency transactions into U.S. dollars.

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Income Tax Benefit (Provision)

We are subject to income taxes in the countries where we sell our products. Historically, we have primarily been subject to taxation in the U.S. because we have sold the majority of our products to customers in the U.S. As we have expanded the sale of products to customers outside the U.S., we have become subject to taxation based on the foreign statutory rates in the countries where these sales took place. As sales in foreign jurisdictions increase in the future, our effective tax rate may fluctuate accordingly. We regularly assess the ability to realize deferred tax assets based on the weight of all available evidence, including such factors as the history of recent earnings and expected future taxable income on a jurisdiction by jurisdiction basis. During the fourth quarter of fiscal year 2019, after considering these factors, we determined that the positive evidence overcame any negative evidence, primarily due to cumulative income in recent years, and the expectation of sustained profitability in future periods and concluded that it was more likely than not that the US federal and state deferred tax assets were realizable. As a result, we released the valuation allowance against all of the U.S. federal and state deferred tax assets during the fourth quarter of fiscal year 2019.

Summary Consolidated Statements of Operations

The following table sets forth a summary of our consolidated statements of operations for the periods presented (in thousands):

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Results of Operations

Net Revenues

Net revenues increased by 78% or $607.6 million for the year ended December 31, 2021, as compared to the same period in 2020, driven primarily by a 53% increase in microinverter units volume shipped and a 351% increase in Enphase IQ Battery storage systems MWh shipped. In the year ended December 31, 2021, consumer demand improved from the same period in 2020 as we sold approximately 10.4 million microinverter units in the year ended December 31, 2021, as compared to approximately 6.8 million units in the year ended December 31, 2020. We also increased shipments of our Enphase IQ Battery storage systems to customers in the U.S. and Europe from 56 MWh in 2020 to 251 MWh in 2021 with over 1,300 installers now deploying our Enphase IQ Battery storage systems in the U.S. Business growth in the U.S. and international regions resulted in a 74% and 100%, respectively, increase in net revenues in the year ended December 31, 2021, as compared to the same period in 2020. The increase in net revenues is also due to favorable product mix as we sold more IQ7+™ microinverters relative to IQ7™ microinverters, and we made initial shipments of our IQ8TM solar microinverters in the fourth quarter of 2021. The average selling price of our microinverter products increased in the year ended December 31, 2021, as compared to the same period in 2020, primarily driven by customer mix and we increased prices to partially offset the impact of higher expedited freight costs and component costs.

Cost of Revenues and Gross Margin

Cost of revenues increased by 93% or $399.2 million in the year ended December 31, 2021, as compared to the same period in 2020, primarily due to higher volume of microinverter units sold, higher shipments of our Enphase IQ Battery storage systems, higher expedited freight costs as a result of the COVID-19 pandemic globally in combination with semiconductor supply constraints, higher costs of certain components experiencing supply constraints, $8.5 million higher warranty expense based on continuing analysis of field performance data and diagnostic root-cause failure analysis primarily relating to our prior generation products as well as higher costs of certain components experiencing supply constraints, and $38.9 million in refunds approved for tariffs previously paid on certain microinverter products and recorded as a reduction to our cost of revenues in the year ended December 31, 2020.

Gross margin decreased by 4.6 percentage points for the year ended December 31, 2021, as compared to the same period in 2020. The decrease in gross margin was primarily attributable to the $38.9 million in refunds approved for tariffs in the year ended December 31, 2020 mentioned above, higher expedited freight costs and increased component costs due to global supply constraints in the year ended December 31, 2021, partially offset by the increase in average selling price due to changes in product, customer mix and price increases, as well as cost management efforts, including the transition of our contract manufacturing from China to Mexico and India to mitigate tariffs.

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Research and Development

Research and development expense increased by 89% or $49.6 million in the year ended December 31, 2021, as compared to the same period in 2020. The increase was due to $41.9 million of higher personnel-related expenses and $7.7 million of outside consulting services and equipment expense associated with our investment in the development, introduction and qualification of new product innovation. The increase in personnel-related expenses was primarily due to hiring and retention programs for employees in New Zealand, India and the U.S. as well as onboarded employees through our recent acquisitions, increasing total compensation costs, including stock-based compensation. The amount of research and development expenses may fluctuate from period to period due to the differing levels and stages of development activity.

Sales and Marketing

Sales and marketing expense increased by 144% or $76.0 million in the year ended December 31, 2021, as compared to the same period in 2020. The increase was primarily due to $52.0 million of higher personnel-related expenses primarily due to hiring employees as a result of our efforts to improve customer experience, to provide 24/7 support along with field service desk for installers, and Enphase system owners globally, and to support our business growth in the U.S. and international expansion in Europe as well as retention programs for employees increasing total compensation costs, including stock-based compensation. The increase in sales and marketing expense in the year ended December 31, 2021, as compared to the year ended December 31, 2020 is also attributable to $24.0 million for a combination of higher advertising costs, marketing expenses, professional services associated with our product launch and facility costs to enable business growth.

General and Administrative

General and administrative expense increased by 105% or $53.4 million in the year ended December 31, 2021, as compared to the same period in 2020. The increase was primarily due to $35.5 million of higher personnel-related expenses primarily due to hiring and retention programs for employees increasing total compensation costs, including stock-based compensation and post business combination employment-related expense, $4.9 million of acquisition related costs, $7.8 million of investments in technological infrastructure and other operational and facilities costs to support scalability of our business growth and $5.2 million of higher legal and professional services.

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Other Income (Expense), Net

Interest income of $0.7 million for the year ended December 31, 2021 decreased, as compared to $2.2 million for the year ended December 31, 2020, primarily due to significant decline in interest rates earned on cash, cash equivalents and marketable securities, and approximately $0.6 million accrued interest on refunds for tariffs previously paid from September 24, 2018 to March 31, 2020 for certain microinverters that qualify for the Tariff Exclusion that was recognized in 2020, partially offset by a higher average cash, cash equivalents and marketable securities earning interest in the year ended December 31, 2021, compared to the same period in 2020.

Cash interest expense

Cash interest expense for the year ended December 31, 2021 and 2020 totaled $0.7 million and $2.2 million, respectively. Cash interest expense in the year ended December 31, 2021 primarily includes $0.5 million coupon interest incurred with the Notes due 2025, the Notes due 2024 and Notes due 2023 and $0.2 million accretion of interest expense on contingent consideration for an acquisition. Cash interest expense in the year ended December 31, 2020 primarily includes $2.1 million coupon interest incurred with the Notes due 2025, Notes due 2024 and Notes due 2023.

Non-cash interest expense

Non-cash interest expense of $44.4 million for the year ended December 31, 2021 primarily relates to $44.3 million for the debt discount and amortization of debt issuance costs with our Notes due 2024, Notes due 2025, Notes due 2026 and Notes due 2028 and less than $0.1 million relates to the amortization of debt issuance costs associated with Notes due 2023.

Non-cash interest expense of $18.8 million for the year ended December 31, 2020 primarily includes $18.3 million related to the accretion of the debt discount and amortization of debt issuance cost incurred associated with the Notes due 2025 and Notes due 2024, and less than $0.1 million related to the amortization of debt issuance costs associated with Notes due 2023, and $0.5 million related to long-term financing receivable recorded as debt.

Other (expense) income, net of $6.1 million income for the year ended December 31, 2021 relates to a $6.6 million cash gain related to a settlement of debt securities and $3.0 million non-cash gain related to change in the fair value of debt securities, partially offset by a $3.5 million net loss related to foreign currency exchange and remeasurement. Other (expense) income, net of $0.8 million expense for the year ended December 31, 2020, relates to the net loss from foreign currency exchange and remeasurement.

Loss on partial settlement of convertible notes recorded in the year ended December 31, 2021 primarily relates to the $9.6 million non-cash loss on partial settlement of $88.1 million aggregate principal amount of the Notes due 2024, $9.5 million non-cash loss on partial settlement of $217.8 million aggregate principal amount of the Notes due 2025 and $37.5 million non-cash inducement loss incurred on repurchase of Notes due 2025. See Note 13. “Debt,” of the notes to consolidated financial statements included in Part I, Item 8 of this Annual Report on Form 10-K for additional information.

Change in fair value of derivatives associated with issuance of Notes due 2025 of $44.3 million for the year ended December 31, 2020 primarily includes the charge recognized for the change in fair value of our convertible notes embedded derivative and warrants of $47.6 million and $24.7 million, respectively. This charge is partially offset by a gain recognized for the change in fair value of our convertible notes hedge of $28.0 million. We did not have any derivatives transactions during the year ended December 31, 2021.

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Income Tax Benefit

The income tax benefit of $24.5 million for the year ended December 31, 2021 increased, compared to the income tax benefit of $14.6 million for the same period in 2020, both calculated using the annualized effective tax rate method, primarily due to higher tax deduction from employee stock-based compensation, partially offset by higher projected tax expense in U.S. and foreign jurisdictions that are more profitable in 2021 compared to 2020.

Liquidity and Capital Resources

Sources of Liquidity

As of December 31, 2021, we had $1.0 billion in working capital, including cash, cash equivalents and marketable securities of $1.0 billion, of which approximately $1.0 billion were held in the U.S. Our cash, cash equivalents and marketable securities primarily consist of U.S. government money market mutual funds, U.S. Treasuries, Corporate notes and bonds and both interest-bearing and non-interest-bearing deposits, with the remainder held in various foreign subsidiaries. We consider amounts held outside the U.S. to be accessible and have provided for the estimated U.S. income tax liability associated with our foreign earnings.

We believe we have sufficient sources of funding to meet our business requirements for the next 12 months and in the longer term. Our cash, cash equivalents and marketable securities increased by $337.3 million in the year ended December 31, 2021 primarily due to cash generated from operations and issuance of Notes due 2026 and Notes due 2028, partially offset by acquisitions, the repurchase of common stocks, purchases of property and equipment, repayment of Notes due 2024 and partial repayment of Notes due 2025.

Total carrying amount of debt increased by $706.8 million, primarily due to issuance of an aggregate principal amount of $632.5 million of Notes due 2026 and aggregate principal amount of $575.0 million of Notes due 2028 during the year ended December 31, 2021, partially offset by $217.7 million in aggregate principal amount of Notes due 2025 repurchased and repaid in cash, and settlement of remaining $88.1 million in aggregate principal amount of Notes due 2024.

We expect that our principal short-term (over the next 12 months) and long-term needs for cash relating to our operations will be to fund operating activities and working capital, acquisitions, and purchase of property and equipment, such as production lines at our contract manufacturing partners.

We plan to fund such cash requirements from our existing cash, cash equivalents and marketable securities on hand, and cash generated from operations. We anticipate that our future capital needs from the debt market will be more limited compared to prior years. Our ability to obtain this or any additional financing that we may choose to, or need to, obtain will depend on, among other things, our development efforts, business plans, operating performance and the condition of the capital markets at the time we seek financing.

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Repurchase of Common Stock. During the second quarter of 2021, we repurchased and subsequently retired 1.7 million shares of our common stock for an aggregate amount of $200.0 million. In May 2021, our board of directors authorized the repurchase of up to an additional $500.0 million of our common stock. During the fourth quarter of 2021, we repurchased and subsequently retired approximately 1.5 million shares of common stock from the open market at an average cost of $196.98 per share for a total of $300.0 million. As of December 31, 2021, we have approximately $200.0 million remaining for repurchase of shares under the 2021 Repurchase Program. The repurchases may be executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. Such purchases are expected to continue through May 2024 unless otherwise extended or shortened by our board of directors. See Note 15. “Stockholders’ Equity,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

Contractual Obligations

The following table summarizes material cash requirements from known outstanding contractual obligations as of December 31, 2021:

(1)See Note 14. “Commitment and Contingencies” of the notes to consolidated financial statement for further details regarding leases. As of December 31, 2021, the Company has additional operating lease for real estate that have not yet commenced of $5.6 million which have not been included above.

(2)See Note 13. “Debt,” of the notes to consolidated financial statements for further details regarding debt.

(3)Purchase obligations include amounts related to component inventory that our primary contract manufacturers procure on our behalf in accordance with our production forecast as well as other inventory related purchase commitments. The timing of purchases in future periods could differ materially from estimates presented above due to fluctuations in demand requirements related to varying sales levels as well as changes in economic conditions.

Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the effects of COVID-19 and other risk factors discussed in the section entitled “Risk Factors” included in this Annual Report on Form 10-K. We believe that our cash flow from operations with existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for at least the next 12 months and thereafter for the foreseeable future. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products, the costs to acquire or invest in complementary businesses and technologies, the costs to ensure access to adequate manufacturing capacity, the continuing market acceptance of our products and macroeconomic events such as the impacts from COVID-19. We may also choose to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition may be adversely affected.

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Cash Flows. The following table summarizes our cash flows for the periods presented:

Cash Flows from Operating Activities

Cash flows from operating activities consist of our net income adjusted for certain non-cash reconciling items, such as stock-based compensation expense, change in the fair value of investments, deferred income taxes, loss on conversion of Notes due 2024 and Notes due 2025, depreciation and amortization, adjustment to reclass cash gain on settlement of debt securities to investing activities and changes in our operating assets and liabilities. Net cash provided by operating activities increased by approximately $135.7 million for the year ended December 31, 2021 compared to the same period in 2020, primarily due to an increase in our gross profit as a result of increased revenue, partially offset by higher operating expenses as we continue to invest in the long-term growth of our business and also by $15.7 million deemed cash repayment attributable to accreted debt discount as an amount paid for settlement of approximately $88.1 million and approximately $217.8 million in aggregate principal amount of the Notes due 2024 and Notes due 2025, respectively.

Cash Flows from Investing Activities

For the year ended December 31, 2021, net cash used in investing activities was primarily from approximately $935.0 million used in purchases of marketable securities, $235.7 million, net of cash acquired from the acquisition of ClipperCreek, 365 Pronto, Sofdesk and DIN’s solar design services business, $58.0 million from investment in debt securities of private companies, and $52.3 million used in purchases of test and assembly equipment to expand our supply capacity, related facility improvements and information technology enhancements and capitalized costs related to internal-use software. Net cash used in investing activities during the year ended December 31, 2021 was partially offset by $35.0 million maturities of marketable securities and $26.6 million settlement of our investment in a private company.

For the year ended December 31, 2020, net cash used in investing activities was approximately $20.6 million, primarily from purchases of test and assembly equipment to expand our supply capacity, related facility improvements and information technology enhancements and capitalized costs related to internal-use software and $5.0 million payment related to the equity investment in a private company.

Cash Flows from Financing Activities

For the year ended December 31, 2021, net cash provided by financing activities of approximately $309.4 million was primarily from approximately $1,188.4 million net proceeds from the issuance of our Notes due 2028 and Notes due 2026, $220.8 million from sale of warrants related to the Notes due 2028 and Notes due 2026, and $7.5 million net proceeds from employee stock option exercises, partially offset by $286.2 million purchase of convertible note hedge related to the Notes due 2028 and Notes due 2026, $290.2 million cash paid to settle both approximately $88.1 million in aggregate principal amount of the Notes due 2024 and approximately $217.8 million in aggregate principal amount of the Notes due 2025, $500.0 million paid to repurchase our common stock under repurchase programs approved by our board of directors, $29.1 million payment of employee withholding taxes related to net share settlement of equity awards, and $1.7 million of repayment on sale of long-term financing receivables.

For the year ended December 31, 2020 net cash provided by financing activities of approximately $191.7 million was primarily from approximately $312.4 million net proceeds from the issuance of our Notes due 2025, $71.6 million from sale of warrants related to our Notes due 2025, $8.4 million net proceeds from employee stock option exercises and issuance of common stock under our employee stock incentive program, partially offset by $89.1 million purchase of convertible note bond hedge related to our Notes due 2025, $68.3 million payment of employee withholding taxes related to net share settlement of equity awards, $40.7 million settlement of $43.9 million in aggregate principal amount of the Notes due 2024 and $2.6 million of repayment on sale of long-term financing receivables.

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Critical Accounting Estimates

The preparation of our consolidated financial statements and related notes requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, fair value of acquired intangible assets and goodwill, useful lives of acquired intangible assets and related disclosure of contingent assets and liabilities. The Securities and Exchange Commission ("SEC") has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments. Based on this definition, we have identified the critical accounting policies and judgments addressed below.

We have based our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to risks and uncertainties, including uncertainty in the current economic environment due to the global impact of COVID-19. As of the date of issuance of these financial statements, we are not aware of any specific event or circumstance that would require us to update our estimates, judgments or revise the carrying value of our assets or liabilities. For a description of our significant accounting policies, see Note 2. “Summary of Significant Accounting Policies,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

We generate revenue from sales of our solutions, which include microinverter units and related accessories, an Envoy communications gateway, the cloud-based Enlighten monitoring service, storage solutions, Electric Vehicle (“EV”) charging solutions beginning in the first quarter of 2022, design, proposal and permitting services, as well as a platform matching cleantech asset owners to a local and on-demand workforce of service providers, to distributors, large installers, OEMs and strategic partners.

Revenues are recognized when control of the promised goods or services are transferred to our customers in an amount that reflects the consideration that is expected to be received in exchange for those goods or services. We generate all of our revenues from contracts with our customers. A description of principal activities from which we generate revenues are follows.

•Products Delivered at a Point in Time. We sell our products and professional services to customers in accordance with the terms of the related customer contracts. We generate revenues from sales of our solutions, which include microinverter units and related accessories, an Envoy communications gateway and Enlighten service, communications accessories, storage solutions, EV charging solutions beginning in the first quarter of 2022, design, proposal and permitting services, as well as a platform matching cleantech asset owners to a local and on-demand workforce of service providers to distributors, large installers, OEMs and strategic partners. Microinverter units, microinverter accessories, storage and EV solutions, design proposal and permitting services, as well as completed work orders on our platform matching cleantech asset owners to a local and on-demand workforce of service providers, are delivered to customers at a point in time, and we recognize revenue for these products or professional services when we transfer control of the product or professional services to the customer, which is generally upon product shipment or service delivery, respectively.

•Products Delivered Over Time. The sale of an Envoy communications gateway includes our Enlighten cloud-based monitoring service. The full consideration for these products represents a single performance obligation and is deferred at the sale date and recognized over the estimated service period of 6 years. We also sell certain communication accessories that contain a service performance obligation to be delivered over time. The revenue from these products is recognized over the related service period, which is typically 5 or 12 years. The subscription services revenue generated from each customer’s subscription to our design and proposal service is recognized on a ratable basis over the contract term beginning on the date that our service is made available to the customer. The subscription contracts are generally three to twelve months in length and billed in advance.

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When we sell a product with more than one performance obligation, such as our IQ Combiner which includes both hardware and Envoy, the total consideration is allocated to these performance obligations based on their relative standalone selling prices.

We record certain contra revenue promotions as variable consideration and recognizes these promotions at the time the related revenue is recorded.

We record upfront contract acquisition costs, such as sales commissions, to be capitalized and amortized over the estimated life of the asset. For contracts that have a duration of less than one year, we follow the Topic 606 practical expedient and expense these costs when incurred. Commissions related to our sale of monitoring hardware and service are capitalized and amortized over the period of the associated revenue.

See Note 3. “Revenue Recognition,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to revenue recognition.

Inventory

Inventory is valued at the lower of cost or market. Market is current replacement cost (by purchase or by reproduction, dependent on the type of inventory). In cases where market exceeds net realizable value (i.e., estimated selling price less reasonably predictable costs of completion and disposal), inventories are stated at net realizable value. Market is not considered to be less than net realizable value reduced by an allowance for an approximately normal profit margin. We determine cost on a first-in first-out basis. Certain factors could affect the realizable value of its inventory, including customer demand and market conditions. Management assesses the valuation on a quarterly basis and writes down the value for any excess and obsolete inventory based upon expected demand, anticipated sales price, effect of new product introductions, product obsolescence, customer concentrations, product merchantability and other factors. Inventory write-downs are equal to the difference between the cost of inventories and market.

Fair Value of Financial Instruments

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying amounts of our cash, cash equivalents and restricted cash, accounts receivable, accounts payable and accrued liabilities approximate fair value because of the short maturity of those instruments. Equity investments with readily determinable fair value are carried at fair value based on quoted market prices or estimated based on market conditions and risks existing at each balance sheet date. Equity investments without readily determinable fair value are measured at cost less impairment, and are adjusted for observable price changes in orderly transactions for an identical or similar investment of the same issuer.

Convertible Note Derivatives

In March 2020, we issued $320.0 million aggregate principal amount of Notes due 2025. Concurrently with the issuance of Notes due 2025, we entered into privately-negotiated convertible note hedge and warrant transactions which in combination are intended to reduce the potential dilution from the conversion of the Notes due 2025. We could not elect to issue the shares of common stock upon settlement of Notes due 2025 or convertible note hedge or warrant transactions due to insufficient authorized share capital. As a result, the embedded conversion option and warrants were accounted for as a derivative liabilities and convertible notes hedge as derivative asset and a gain (or loss) was reported in other expense, net in our consolidated statement of operations to the extent the valuation changed from the date of issuance of Notes due 2025. On May 20, 2020, at our annual meeting of stockholders, the stockholders approved an amendment to its certificate of incorporation to increase the number of authorized shares of our common stock. As a result, we are now be able to settle the Notes due 2025, convertible notes hedge and warrants through payment or delivery, as the case may be, of cash, shares of its common stock or a combination thereof, at our election. Accordingly, on May 20, 2020, the embedded derivative liability, convertible notes hedge and warrants liability were remeasured at a fair value and were then reclassified to additional paid-in-capital in our condensed consolidated balance sheet in the second quarter of 2020 and are no longer remeasured as long as they continue to meet the conditions for equity classification. As of December 31, 2020, we do not have any convertible note derivatives. See Note 13. “Debt,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

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Warranty Obligations

Microinverters and Other Products Sold Through December 31, 2013

Our warranty accrual provides for the replacement of microinverter units or other products that fail during the product’s warranty term (15 years for first and second generation microinverters and up to 25 years for subsequent generation microinverters). On a quarterly basis, we employ a consistent, systematic and rational methodology to assess the adequacy of our warranty liability. This assessment includes updating all key estimates and assumptions for each generation of product, based on historical results, trends and the most current data available as of the filing date. The key estimates and assumptions used in the warranty liability are thoroughly reviewed by management on a quarterly basis. The key estimates used by us to estimate our warranty liability are: (1) the number of units expected to fail over time (i.e., failure rate); (2) the number of failed units expected to result in warranty claims over time (i.e., claim rate); and (3) the per unit cost of replacement units, including outbound shipping and limited labor costs, expected to be incurred to replace failed units over time (i.e., replacement cost).

Estimated Failure Rates — Our Quality and Reliability department has primary responsibility to determine the estimated failure rates for each generation of microinverter. To establish initial failure rate estimates for each generation of microinverter, our quality engineers use a combination of industry standard Mean Time Between Failure (“MTBF”) estimates for individual components contained in that generation of microinverters, third party data collected on similar equipment deployed in outdoor environments similar to those in which our microinverters are installed, and rigorous long term reliability and accelerated life cycle testing which simulates the service life of the microinverter in a short period of time. As units are deployed into operating environments, we continue to monitor product performance through our Enlighten monitoring platform. It typically takes three to nine months between the date of sale and date of end-user installation. Consequently, our ability to monitor actual failures of units sold similarly lags by three to nine months. When a microinverter fails and is returned, we perform diagnostic root cause failure analysis to understand and isolate the underlying mechanism(s) causing the failure. We then use the results of this analysis (combined with the actual, cumulative performance data collected on those units prior to failure through Enlighten) to draw conclusions with respect to how or if the identified failure mechanism(s) will impact the remaining units deployed in the installed base.

Estimated Claim Rates — Warranty claim rate estimates are based upon observed historical trends and assumptions with respect to expected customer behavior over the warranty period. As the vast majority of our microinverters have been sold to end users for residential applications, we believe that warranty claim rates will be affected by changes over time in residential home ownership because we expect that subsequent homeowners are less likely to file claims than the homeowners who originally purchase the microinverters.

Estimated Replacement Costs — Three factors are considered in our analysis of estimated replacement cost: (1) the estimated cost of replacement microinverters; (2) the estimated cost to ship replacement microinverters to end users; and (3) the estimated labor reimbursement expected to be paid to third party installers performing replacement services for the end user. Because our warranty provides for the replacement of defective microinverters over long periods of time (typically between 15 and 25 years, depending on the generation of product purchased), the estimated per unit cost of current and future product generations is considered in the estimated replacement cost. Estimated costs to ship replacement units are based on observable, market-based shipping costs paid by us to third party freight carriers. We have a separate program that allows third-party installers to claim fixed-dollar reimbursements for labor costs they incur to replace failed microinverter units for a limited time from the date of original installation. Included in our estimated replacement cost is an analysis of the number of fixed-dollar labor reimbursements expected to be claimed by third party installers over the limited offering period.

In addition to the key estimates noted above, we also compare actual warranty results to expected results and evaluate any significant differences. We may make additional adjustments to the warranty provision based on performance trends or other qualitative factors. If actual failure rates, claim rates, or replacement costs differ from our estimates in future periods, changes to these estimates may be required, resulting in increases or decreases in our warranty obligations. Such increases or decreases could be material.

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Fair Value Option for Microinverters and Other Products Sold Since January 1, 2014

Our warranty obligations related to microinverters sold since January 1, 2014 provide us the right, but not the requirement, to assign our warranty obligations to a third-party. Under Accounting Standards Codification (“ASC 825”), “Financial Instruments” (also referred to as the “fair value option”), an entity may choose to elect the fair value option for such warranties at the time it first recognizes the eligible item. We made an irrevocable election to account for all eligible warranty obligations associated with microinverters sold since January 1, 2014 at fair value. This election was made to reflect the underlying economics of the time value of money for an obligation that will be settled over an extended period of up to 25 years.

We estimate the fair value of warranty obligations by calculating the warranty obligations in the same manner as for sales prior to January 1, 2014 and applying an expected present value technique to that result. The expected present value technique, an income approach, converts future amounts into a single current discounted amount. In addition to the key estimates of failure rates, claim rates and replacement costs, we used certain inputs that are unobservable and significant to the overall fair value measurement. Such additional assumptions included compensation comprised of a profit element and risk premium required of a market participant to assume the obligation and a discount rate based on our credit-adjusted risk-free rate. See Note 11. “Fair Value Measurements,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

Commitments and Contingencies

In the normal course of business, we are subject to loss contingencies and loss recoveries, such as legal proceedings and claims arising out of our business as well as tariff refunds. An accrual for a loss contingency or loss recovery is recognized when it is probable and the amount of loss or recovery can be reasonably estimated. See Note 14. “Commitments and Contingencies,” of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

Business Combinations

Assets acquired and liabilities assumed as part of a business acquisition are generally recorded at their fair value at the date of acquisition. The excess of purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Determining fair value of identifiable assets, particularly intangibles, and liabilities acquired also requires the Company to make estimates, which are based on all available information and in some cases assumptions with respect to the timing and amount of future revenues and expenses associated with an asset. Accounting for business acquisitions requires the Company to make judgments as to whether a purchase transaction is a multiple element contract, meaning that it includes other transaction components. This judgment and determination affect the amount of consideration paid that is allocable to assets and liabilities acquired in the business purchase transaction.

Intangible Assets

Intangible assets include patents and other purchased intangible assets. Intangible assets with finite lives are amortized on a straight-line basis, with estimated useful lives ranging from 5 to 9 years. Indefinite-lived intangible assets are tested for impairment annually and are also tested for impairment between annual tests if an event occurs or circumstances change that would indicate that the carrying amount may be impaired. Intangible assets with finite lives are tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable. An impairment loss is recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows used in determining the fair value of the asset. The amount of the impairment loss to be recorded is calculated by the excess of the asset’s carrying value over its fair value. Fair value is generally determined using a discounted cash flow analysis. There was no impairment of intangible assets in any of the years presented.

Income Taxes

We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax bases of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes. In estimating future tax consequences, generally all expected future events other than enactments or changes in the tax law or rates are considered. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.

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We assess the realizability of the deferred tax assets to determine release of valuation allowance as necessary. In the event we determine that it is more likely than not that we would be able to realize deferred tax assets in the future in excess of our net recorded amount, an adjustment to the valuation allowance for the deferred tax asset would increase income in the period such determination was made. Likewise, should it be determined that additional amounts of the net deferred tax asset will not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance will be charged to income in the period such determination is made.

We operate in various tax jurisdictions and is subject to audit by various tax authorities. We follow accounting for uncertainty in income taxes which requires that the tax effects of a position be recognized only if it is “more likely than not” to be sustained based solely on its technical merits as of the reporting date. We consider many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.