Enphase Energy, Inc. (ENPH) FY 2022 MD&A

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

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto included in this Annual Report on Form 10-K.

Business Overview and 2022 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. As of December 31, 2022, we have shipped approximately 58 million microinverters, and over 3.0 million Enphase residential and commercial systems have been deployed in more than 145 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, original equipment manufacturers (“OEMs”) and strategic partners. Our OEMs 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.

In March 2022, we paid approximately $26.1 million in cash for the acquisition of SolarLeadFactory, a privately-held company. SolarLeadFactory provides high quality leads to solar installers.

In October 2022, we paid approximately $34.9 million in cash for the acquisition of GreenCom, a privately-held company. GreenCom provides Internet of Things (IoT) software solutions for customers to connect and manage a wide range of distributed energy devices within the home.

Further details on the above acquisition 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.

Global Events Affecting our Business and Operations

Supply Chain Constraints. Due to increased demand across a range of industries, the global supply chain and the semiconductor industry experienced significant disruptions in second half of 2021 and during 2022. We have seen supply chain challenges, including component shortages, which have, in certain cases, caused delays in critical components and inventory, longer lead times, and have resulted in increased costs.

We believe these supply chain challenges will persist in 2023 and expect that the extended lead times and elevated supply chain costs we have experienced will continue for the reasonably foreseeable future. It is unclear when the supply environment will become less volatile and what impacts the supply environment will have on our business and results of operations in future periods. In addition, the impact of inflation on the price of components, raw materials and labor has increased, although in the near term we have not seen our gross margin impacted by inflation as we increased prices for our product offerings in the second half of 2021 and in 2022 as well.

Throughout 2022, overall reliability of supply improved, and the majority of our suppliers were able to deliver components by their promised lead times, although such times had, in many cases, been extended. We continue to work to mitigate the effects of supply chain constraints and the impacts of inflation. In the event we are unable to mitigate the impact of delays in and/or price increases for raw materials, electronic components and freight, the manufacturing and installation of our products could be delayed, which would adversely impact our cash flows and results of operations, including revenue and gross margin. We continue to focus on a range of initiatives that seek to optimize our operations, improve our resiliency, and drive cost reductions. We seek to balance these goals through our sourcing and supply chain strategy, outsourcing and our use of lower cost geographies. Our efforts also include process optimization initiatives designed to drive improved efficiencies in our sourcing, production, logistics and fulfillment.

COVID-19 Pandemic. The impact of the COVID-19 pandemic and countermeasures taken to contain its spread remain dynamic. We continue to monitor the situation and actively assess further implications for our business, supply chain, fulfillment operations and overall demand. We continue to take meaningful precautions in accordance with relevant guidelines to protect the health and safety of our employees. The extent of the continuing impact of COVID-19 on our operational and financial performance will depend on various developments, including the duration and spread of the virus and its variants, impact on our end-customers’ spending, volume of sales,

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impact on our partners, suppliers and employees, and actions that may be taken by governmental authorities. If the COVID-19 pandemic or its adverse effects become more severe or prevalent or are prolonged in the locations where we, our customers, suppliers or manufacturers conduct business, or we experience more pronounced disruptions in our business or operations, or in economic activity and demand for our products and services generally, our business and results of operations in future periods could be materially adversely affected. 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.

Russia and Ukraine Conflict. In February 2022, armed conflict escalated between Russia and Ukraine. The United States and certain other countries have imposed sanctions on Russia and could impose further sanctions, which could damage or disrupt international commerce and the global economy. While we do not have sales or operations in Russia or Ukraine, it is possible that the conflict or actions taken in response, could adversely affect some of our markets and suppliers, the broader economic and financial markets, or costs and availability of components and materials, or cause further supply chain disruptions.

Inflation Reduction Act of 2022. In August 2022, the IRA was enacted, which includes extension of the ITC as well as an AMPTC to incentivize clean energy component sourcing and production, including for the production of solar related components, battery cells and battery packs. The IRA provides for an AMPTC on microinverters of 11 cents per alternating current watt basis. The AMPTC for each component, including on microinverters, decreases by 25% each year beginning in 2030 and ending after 2032. Under the IRA, the ITC was extended until 2032 to allow a qualifying homeowner to deduct 30% of the cost of installing residential solar systems from their U.S. federal income taxes, thereby returning a material portion of the purchase price of the residential solar system to homeowners. Under the terms of the current extension, the ITC will remain at 30% through the end of 2032, reduce to 26% for 2033, reduce to 22% for 2034, and further reduce to 0.0% after the end of 2034 for residential solar systems, unless it is extended before that time. We believe the enactment of the IRA is favorable to our overall business worldwide; however, we are continuing to evaluate the overall impact and applicability of the IRA to our results of operations going forward, including the revisions to the U.S. Internal Revenue Code, which includes a 15% corporate minimum income tax and a 1% excise tax on corporate stock repurchases in tax years beginning after December 31, 2022.

In December 2022, the California’s Public Utilities Commission approved and voted for NEM 3.0, which will be in effect starting April 15, 2023. The new policy reduces the compensation earned by solar customers selling extra energy to the grid by a substantial amount. The average export rate in California is expected to be approximately $0.05/kWh to $0.08/kWh when effected compared to current average of $0.25/kWh to $0.35/kWh. NEM 3.0 in California may reduce demand for solar PV systems, including our future inverter sales.

Components of Consolidated Statements of Operations

Net Revenues

Revenues

We generate revenue from sales of our solutions, which include microinverter and related accessories, an IQ Gateway, the cloud-based Enlighten monitoring service, storage solutions, EV charging solutions, design, proposal, permitting and lead generation services, as well as a platform matching cleantech asset owners to a local and on-demand workforce of service providers, 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 support personnel and logistics costs, freight costs, inventory write-downs, hosting services costs related to our Enlighten service offering, lead acquisition costs, design and proposal services, depreciation and amortization of manufacturing test equipment, amortization of capitalized software development costs related to our Enlighten service offering and

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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.

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 United States, 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 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 United States, Canada, Mexico, Europe, Australia, New Zealand, India, Brazil, the Philippines, Thailand, 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 2022 to reorganize our global workforce, consolidate facilities and eliminate non-core projects. Under this restructuring, costs included in restructuring primarily consisted of employee severance and one-time benefits, workforce reorganization charges and non-cash charges related to impairment of property and equipment.

Other Income (Expense), Net

Other income (expense), net primarily consists of interest income on our cash, cash equivalents and marketable securities, amortization of discount or premium on purchase of cash equivalents and marketable securities, gains or losses upon conversion of foreign currency transactions into U.S. dollars, interest expense, fees under our convertible notes, 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.

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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 United States because we have sold the majority of our products to customers in the United States. As we have expanded the sale of products to customers outside the United States, 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.

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 69%, or $948.8 million, for the year ended December 31, 2022, as compared to the same period in 2021, driven primarily by a 47% increase in microinverter units volume shipped and a 103% increase in Enphase IQ Battery Megawatt-hour (“MWh”) shipped. For the year ended December 31, 2022, consumer demand increased and component supply improved as we sold approximately 15.4 million microinverter units, as compared to approximately 10.4 million units for the year ended December 31, 2021. For the year ended December 31, 2022, we also increased shipments of our Enphase IQ Batteries to customers in the United States and Europe to 508.5 MWh as compared to 251.0 MWh shipped in the same period in 2021. The average selling price of our microinverter products increased by 11% for the year ended December 31, 2022, which resulted in approximately $133.0 million increase in revenue, as compared to the same period in 2021, primarily driven by a favorable product mix as we sold more IQ8 microinverters relative to IQ7 microinverters for the year ended December 31, 2022, and we increased prices for our product offerings in the second half of 2021 and in 2022 to partially offset the impact of higher logistics costs and component costs from global supply chain pricing pressures.

Cost of Revenues and Gross Margin

Cost of revenues increased by 64%, or $528.6 million, for the year ended December 31, 2022, as compared to the same period in 2021, primarily due to higher volume of microinverter units sold, higher Enphase IQ Battery MWh shipped, and higher shipping and warranty costs associated with the higher volume of sales globally. The increase was also due to $6.3 million higher amortization of developed technology and $5.7 million higher stock-based compensation.

Gross margin increased by 1.7 percentage points for the year ended December 31, 2022, as compared to the same period in 2021. The increase was primarily due to an increase in average selling prices driven by a favorable product mix, as we sold more IQ8 microinverters relative to IQ7 microinverters for the year ended December 31, 2022, and price increases to our products in the second half of 2021 and in 2022, as well as cost management efforts such as reduction of freight costs. This increase was partially offset by unfavorable impact of 1.5 percentage points from currency fluctuations in the euro relative to the U.S. dollar when we convert the current year euro denominated revenue into the U.S. dollar using the comparable prior period’s average currency exchange rate and 0.3 percentage points from higher amortization of developed technology and 0.2 percentage points from higher stock-based compensation.

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Research and Development

Research and development expense increased by 60%, or $63.3 million, for the year ended December 31, 2022, as compared to the same period in 2021. The increase was primarily due to $55.1 million of higher personnel-related expenses and $8.2 million of 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 a 51% growth in headcount from hiring and retention programs for employees in New Zealand, India and the United States, which increased 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 for our products.

Sales and Marketing

Sales and marketing expense increased by 67%, or $86.1 million, for the year ended December 31, 2022, as compared to the same period in 2021. The increase was primarily due to $81.1 million of higher personnel-related expenses from a 90% growth in headcount as a result of our efforts to improve customer experience, to provide 24/7 support along with a field service desk for installers and Enphase system owners globally, and to support our business growth in the United States and international expansion in Europe. In addition, annual retention programs for employees also resulted in the increase in total compensation costs, including stock-based compensation. The increase in sales and marketing expense for the year ended December 31, 2022, as compared to the same period in 2021, was also attributable to $8.9 million of higher amortization costs related to intangible assets acquired through business combinations and $8.4 million of higher professional services and facility costs to support our business growth. This increase was partially offset by a decrease of $12.3 million in the advertising costs and marketing expenses.

General and Administrative

General and administrative expense increased by 35%, or $35.9 million, for the year ended December 31, 2022, as compared to the same period in 2021. The increase was primarily due to $23.5 million of higher personnel-related expenses from a 33% growth in headcount increasing total compensation costs, including stock-based compensation and post business combination employment-related expense, $7.7 million of investments in technological infrastructure and other operational and facilities costs to support scalability of our business growth, and $4.7 million of higher legal and professional services.

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Restructuring Charges

**    Not meaningful

During the year ended December 31, 2022, we implemented restructuring actions to reorganize our global workforce, consolidate facilities and eliminate non-core projects. We expect to complete our restructuring activities in 2023. Restructuring charges for the year ended December 31, 2022 primarily included $2.4 million of one-time termination benefits and other employee-related expenses and impairment of property and equipment, net. We had no restructuring charges for the year ended December 31, 2021.

Other Income (Expense), Net

**    Not meaningful

Interest income of $13.7 million for the year ended December 31, 2022 increased, as compared to $0.7 million in the same period in 2021, primarily due to an increase in interest rates and a higher average cash, cash equivalents and marketable securities balance for the year ended December 31, 2022, as compared to the same period in 2021.

Cash interest expense

Cash interest expense for the year ended December 31, 2022 and 2021 totaled $1.2 million and $0.7 million, respectively. Cash interest expense for the year ended December 31, 2022 primarily included $1.0 million in interest incurred with the Notes due 2025 and Notes due 2023, $0.1 million of bank charges and $0.1 million accretion of interest expense on contingent consideration for an acquisition. Cash interest expense for the year ended December 31, 2021 primarily included $0.5 million in coupon interest incurred with the Notes due 2025, Notes due 2024 and Notes due 2023 and $0.2 million accretion of interest expense on contingent consideration for an acquisition.

Non-cash interest expense

Non-cash interest expense of $8.2 million for the year ended December 31, 2022 primarily related to $8.2 million for the debt discount amortization with the Notes due 2025 and amortization of debt issuance costs with the Notes due 2023, Notes due 2025, Notes due 2026 and Notes due 2028. 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 the Notes due 2024, Notes due 2025, Notes due 2026 and Notes due 2028 and less than $0.1 million related to the amortization of debt issuance costs associated with the Notes due 2023.

Other expense, net of $0.4 million for the year ended December 31, 2022 primarily related to $0.9 million net loss due to foreign currency denominated monetary assets and liabilities and a $0.3 million impairment of a note receivable, partially offset by a $0.7 million non-cash net gain related to a change in the fair value of debt securities and $0.1 million in interest income. Other income, net of $6.1 million for the year ended December 31, 2021 primarily related to a $6.6 million cash gain related to a settlement of debt securities and a $3.0 million non-cash gain related to a change in the fair value of debt securities, partially offset by a $3.5 million net loss related to a foreign currency exchange and remeasurement.

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Loss on partial settlement of convertible notes recorded for the year ended December 31, 2021 primarily related to the $37.5 million non-cash inducement loss incurred on the repurchase of the Notes due 2025, $9.5 million non-cash loss on the partial settlement of $217.8 million aggregate principal amount of the Notes due 2025 and $9.6 million non-cash loss on the partial settlement of $88.1 million aggregate principal amount of the Notes due 2024. We did not have any such loss in the year ended December 31, 2022.

Income Tax Benefit (Provision)

The income tax provision of $54.7 million for the year ended December 31, 2022 was primarily related to higher tax expense in the United States and foreign jurisdictions that are more profitable in 2022, partially offset by the tax deduction from employee stock-based compensation.

The income tax benefit of $24.5 million for the year ended December 31, 2021 was primarily related to a higher tax deduction from employee stock-based compensation, partially offset by a higher tax expense in foreign jurisdictions that were profitable in 2021.

Liquidity and Capital Resources

Sources of Liquidity

As of December 31, 2022, we had $1,626.1 million in net working capital, including cash, cash equivalents and marketable securities of $1,612.8 million, of which approximately $1,578.3 million were held in the United States. Our cash, cash equivalents and marketable securities primarily consist of U.S. treasuries, money market mutual funds, 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 United States to be accessible and have provided for the estimated U.S. income tax liability associated with our foreign earnings.

Our cash, cash equivalents and marketable securities increased by $596.2 million for the year ended December 31, 2022, as compared to the same period in 2021, primarily due to cash generated from operations, partially offset by cash used to fund acquisitions, make investments in private companies, and make payments of withholding taxes related to net share settlement of equity awards.

Total carrying amount of debt increased by $252.7 million for the year ended December 31, 2022, as compared to the same period in 2021, primarily due to adoption of ASU 2020-06 as of January 1, 2022, partially offset by repayment of the Notes due 2024 and partial repayment of the Notes due 2025.

We had net operating loss carryforwards for California income tax purposes of approximately $10.4 million, as well as federal tax credit carryforwards and state research credit carryforwards of approximately $7.0 million and $18.0 million, respectively, as of December 31, 2022. We have utilized all of our federal net operating loss carryforwards and expect our cash paid for taxes in the United States will substantially increase in 2023.

We expect that our principal short-term (over the next 12 months) and long-term cash needs related to our operations will be used to fund working capital, strategic investment, acquisitions, payment of withholding taxes for net share settlement of equity awards and purchase of property and equipment, such as production lines at our contract manufacturing partners. We plan to fund any cash requirements from our existing cash, cash equivalents and marketable securities on hand, and cash generated from operations. We anticipate that access to the debt market will be more limited compared to prior years as interest rates have increased and are expected to continue to rise. Our ability to obtain debt or any other additional financing that we may choose to, or need to, obtain will

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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.

Repurchase of Common Stock. In May 2021, our board of directors authorized a share repurchase program (the “2021 Repurchase Program”) pursuant to which we may repurchase up to an additional $500.0 million of our common stock. The repurchases will be funded from available working capital and 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. As of December 31, 2022, we have approximately $200.0 million remaining for repurchase of shares under the 2021 Repurchase Program. The IRA enacted in August 2022 includes a 1% excise tax on corporate stock repurchases in tax years beginning after December 31, 2022; in consideration of any further stock repurchases, we intend to evaluate the impact of the IRA’s 1% excise tax on corporate stock repurchases in tax years beginning after December 31, 2022.

Convertible Notes. In August 2018, we issued $65.0 million aggregate principal amount of 4.0% Notes due 2023 of which $5.0 million aggregate principal amount remained outstanding as of December 31, 2022. The Notes due 2023 mature on August 1, 2023 with interest payable semi-annually on February 1 and August 1 of each year. In March 2020, we issued $320.0 million aggregate principal amount of 0.25% Notes due 2025 of which $102.2 million remained outstanding as of December 31, 2022. The Notes due 2025 mature on March 1, 2025 with interest payable semi-annually on March 1 and September 1 of each year. In March 2021, we issued $632.5 million and $575.0 million in aggregate principal amount of 0% Notes due 2026 and 0% Notes due 2028, respectively. Upon conversion of the Notes due 2025, Notes due 2026 and Notes due 2028, we will pay cash equal to the aggregate principal amount of the Notes of such series to be converted, and, at our election, will pay or deliver cash and/or shares of our common stock for the amount of our conversion obligation in excess of the aggregate principal amount of the Notes of such series. The sale price condition for the Notes due 2025 was met during the quarter ended December 31, 2022, and, as a result, holders may convert their Notes due 2025 at any time during the quarter ending March 31, 2023. If all of the holders of the Notes due 2025 converted their Notes due 2025 during this period, we would be obligated to settle the $102.2 million principal amount of the Notes due 2025 due in cash. We believe that our cash provided by operating activities, our existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs should the holders choose to convert their Notes due 2025 during the quarter ending March 31, 2023 or upon settlement of the Notes due 2023 on its maturity on August 1, 2023. As of December 31, 2022, substantially all of our Notes remained outstanding. Refer to Note 12. “Debt,” in Part II, Item 8 of this Annual Report on Form 10-K for more information on our outstanding notes.

Operating Leases. We have entered into various non-cancelable operating leases primarily for our facilities with original lease periods expiring through the year 2032, with the most significant leases relating to our offices in Petaluma, California and Bengaluru, India. As of December 31, 2022, we have total operating lease obligations of $29.0 million recorded on our consolidated balance sheet.

Other Material Cash Requirements. As of December 31, 2022, we have open purchase obligations of $589.3 million 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 Flows. The following table summarizes our cash flows for the periods presented:

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Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the continued effects of COVID-19, the ongoing conflict in Ukraine, new regulations and other risk factors discussed in Part I, Item IA, Risk Factors of 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 working capital and capital expenditures for at least the next 12 months and thereafter for the foreseeable future, including our ability to make payments on our outstanding debt.

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 the COVID-19 pandemic, inflation, increase in interest rates and the ongoing conflict in Ukraine. 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.

Cash Flows from Operating Activities

Cash flows from operating activities consisted of our net income adjusted for certain non-cash reconciling items, such as stock-based compensation expense, non-cash interest expense, change in the fair value of debt securities, deferred income taxes, depreciation and amortization, asset impairment, and changes in our operating assets and liabilities. Net cash provided by operating activities increased by $392.8 million for the year ended December 31, 2022, as compared to the same period in 2021, 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.

Cash Flows from Investing Activities

For the year ended December 31, 2022, net cash used in investing activities of $371.9 million was primarily from the purchase of $907.4 million of marketable securities, $62.2 million net cash used to acquire GreenCom, SolarLeadFactory and ClipperCreek, $46.4 million used in purchases of test and assembly equipment to expand our supply capacity, related facility improvements and information technology enhancements, including capitalized costs related to internal-use software and $16.0 million used to invest in private companies, partially offset by $660.1 million sale and maturities of marketable securities.

For the year ended December 31, 2021, net cash used in investing activities of $1,219.5 million was primarily from the purchase of $935.0 million of marketable securities, $58.0 million from the investment in a debt security, $235.7 million, net cash used to acquire ClipperCreek, 365 Pronto, Sofdesk and DIN Engineer Service LLP’s solar design services business, and $52.3 million used in purchases of test and assembly equipment to expand our supply capacity, related facility improvements and information technology enhancements, including capitalized costs related to internal-use software, partially offset by approximately $35.0 million maturities of marketable securities and $26.6 million of settlement of our investment in a private company.

Cash Flows from Financing Activities

For the year ended December 31, 2022, net cash used by financing activities of approximately $17.1 million was primarily from the payment of $27.5 million in employee withholding taxes related to net share settlement of equity awards, partially offset by $10.4 million net proceeds from employee stock option exercises and purchases under our employee stock purchase plan.

For the year ended December 31, 2021, net cash provided by financing activities of approximately $309.4 million was primarily from $1,188.4 million in net proceeds from the issuance of the Notes due 2028 and Notes due 2026, $220.8 million from the sale of warrants related to the Notes due 2028 and Notes due 2026 and approximately $7.5 million in 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 $88.1 million in aggregate principal amount of the Notes due 2024 and $217.8 million in aggregate principal amount of the Notes due 2025, $500.0 million paid to repurchase shares of our common stock under our repurchase programs approved by our board of directors, the payment of $29.1 million in employee withholding taxes related to net share settlement of equity awards, and $1.7 million of repayment on the 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 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 and the conflict in Ukraine. 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 IQ Gateway, the cloud-based Enlighten monitoring service, storage solutions, EV charging solutions, design, proposal, permitting and lead generation 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, storage solutions, EV charging solutions, design, proposal, permitting and lead generation 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, permitting and lead generation 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 IQ 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 6.5 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 3 to 12 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 the IQ Gateway, 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 recognize 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 the sale of monitoring hardware and services are capitalized and amortized over the period of the associated revenue.

Refer to 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 the Notes due 2025. Concurrently with the issuance of the 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 the 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 the 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 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, 2022 and 2021, we do not have any convertible note derivatives. Refer to Note 12. “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

Our warranty accrual provides for the replacement of microinverter units, AC Battery storage solutions and IQ Gateway that fail during the product’s warranty term. The warranty term related to microinverter units is 15 years for first and second generation microinverters and up to 25 years for subsequent generation microinverters. The warranty term for AC Battery storage solutions and IQ Gateway is 10 years and 5 years, respectively. 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 and returned for replacement over time (i.e., return rate); and (2) 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 Return Rates — Our Quality and Reliability department has primary responsibility to determine the estimated return rates for each generation of product. To establish initial return rate estimates for each generation of product, our quality engineers use a combination of industry standard Mean Time Between Failure estimates for individual components contained in that generation of product, third-party data collected on similar equipment deployed in outdoor environments similar to those in which our product are installed, and rigorous long term reliability and accelerated life cycle testing which simulates the service life of the product 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 product 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.

As the vast majority of our microinverters have been sold to end users for residential applications, we believe that warranty return rates will be affected by changes over time in residential home ownership because we expect that subsequent homeowners are less likely to file return 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 products; (2) the estimated cost to ship replacement products 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 products over long periods of time (typically between 5 to 25 years, depending on the product and the generation of that 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 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 return 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.

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

Our warranty obligations related to products 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 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 products 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.

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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 return 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. Refer to 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. Refer to Note 13. “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.

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.

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We operate in various tax jurisdictions and are 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.