Last Monday, I finished what I had planned to do in this series. Wednesday, I reviewed Enphase’s earnings. On that post Wednesday, I promised to use the numbers from Enphase’s earnings to help people understand the Way to Wealth Formula. Before I do that, I want to say that Brian Tracy coined that phrase. Brian published 2 books: The Way to Wealth and The Way to Wealth Workbook. Both are fantastic and I highly recommend them.
What I wanted to cover today was the announcement on Wednesday that Enphase was adjusting its pricing and therefore can expect lowered Gross Margins. They also “adjusted” Operating Expenses and I want to take a look at how this runs through a set of numbers based on what they do and show the impact. In case you don’t know Enphase, they are a publicly traded Solar Power Company that focuses on power conversion and storage. They are relatively young as a company and have been really successful. Recently the stock has had issues, culminating in problems last quarter and going forward. Note, all the information I use here is public and available on the Internet.
In a typical quarter, Enphase has about (and I plan on using nice round numbers where I can) $100M in Revenue. Traditionally, they have had Gross Margins (GM) in the 30% range. This means that 70% of the money goes for Cost of Goods Sold (COGS). In real money this equates to $70M in COGS and $30M in GM.
Now let’s change the pricing. Enphase announced that Gross Margins would be in the mid-20s. I will use 25% as the number for my calculations. However, I am going to hold COGS constant in this exercise. This means I am recalculating if they sell the same number of units built at the same cost. We know that GM will be 25% and COGS is thus 75%. If that $70M is COGS (from the earlier calculation), this means that revenue is now $93.3M. Let’s get back to GM and see that it is only $23.3M. That means a 5% Price Reduction leads in a drop of $7M in GM. This is a drop in excess in 20%.
Wait, why is that such a bigger percentage change? The reason is that a Price Reduction without a Cost Reduction flows dollar for dollar into a reduction in profits. That is why the company will attempt to compensate with a reduction in Operating Expenses (OPEX). According to filings, this reduction in OPEX will be about 7%. Enphase was run as just about a break even company. This means that OPEX spent just about every dollar that GM gave. So, let’s call OPEX $30M. A 7% reduction is $2.1M or a new OPEX of just about $28M – I will use $27M to account for my rounding of numbers.
This implies that Enphase, in its new model, should expect to lose between $3.5M and $4M per quarter (GM of $23.3M and OPEX of $27M). What can they do? Either sell more stuff or cut costs more. How much stuff will they need to sell? Well, they need to generate $3.5M in GM that means that implies an new Revenue Number of $14M or a total Revenue of about $107M. This is about a 15% increase. Not a huge stretch, but that is just to get back to where they are today.
All of these factors of Prices and Costs factor into each business everyday. The kind of “What-If” scenarios are easy to do and something a Business Owner should be comfortable doing.
Have a great week!
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