Good day, ladies and gentlemen. And welcome to Enphase Energy's First Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time [Operator Instructions]. And as a reminder, this conference call may be recorded. I would now like to turn the conference over to Ms. Christina Carrabino. Ma'am, you may begin.

Good afternoon. And thank you for joining us on today's conference call to discuss Enphase Energy's first quarter 2018 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer; Bert Garcia, Chief Financial Officer; and Raghu Belur, Chief Product Officer. After the market closed today, Enphase issued a press release announcing the results for its first quarter ended March 31, 2018. During the course of this conference call, Enphase management will make forward-looking statements, including but not limited to, statements related to Enphase Energy's financial performance, market demands for its current and future products, advantages of its technology and market trends. These forward-looking statements involve significant risks and uncertainties, and Enphase Energy's actual results and the timing of events could differ materially from these expectations. For a more complete discussion of the risks and uncertainties, please see the Company's annual report on Form 10-K for the year ended December 31, 2017, which is on file with the SEC and the quarterly report on Form 10-Q for the quarter ended March 31, 2018, which will be filed with the SEC in the second quarter of 2018. Enphase Energy cautions you not to replace any undue reliance on forward-looking statements, and undertakes no duty or obligation to update any forward-looking statements as a result of new information, future events or changes in its expectations. Also, please note that financial measures used on this call are expressed on a non-GAAP basis unless otherwise noted, and have been adjusted to exclude certain charges. The Company has provided reconciliations of these non-GAAP financial measures to GAAP financial measures in its earnings release posted today, which can also be found in the Investor Relations section of its Web site. Now I'd like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy. Badri?

Good afternoon. And thanks for joining us today to discuss our first quarter of 2018 financial results. We had a decent quarter. We reported revenue of $70 million for the first quarter of 2018 at the higher end of guidance. Our non-GAAP gross margin in the first quarter was 26.5%, surpassing the higher end of guidance. Our non-GAAP operating income was $861,000. We have come a long way in the past year and are pleased to report the second consecutive quarter of positive non-GAAP operating income. As I have stated several times before, my top priority at Enphase is to build a solid financial foundation by improving operations and fortifying the balance sheet. During the first quarter, we continued to make progress on these fronts with further gross margin improvement through pricing management, supply chain optimization and IQ transition. We are making good progress on reaching our 30-20-10 target operating model by the fourth quarter of 2018. Now turning to the balance sheet. We exited the first quarter with a cash balance of $53.3 million, which included a previously announced $20 million private equity investment. Our sharpened focus on improving AR, AP and inventory management helped improve the cash conversion cycle in Q1, resulting in approximately $2.3 million of positive free cash flow. Bert will go into greater detail about our financial results later in the call. Over the past year, Enphase has transformed its culture to one of discipline and rigor supported by metrics. This focus continues to be applied broadly across all aspects of our business. One such example is ease of doing business, the way we are perceived by customers. This is measured by a popular metric called as Net Promoter Score, also called NPS, and NPS is calculated based on feedback from customer surveys on how…

Thanks, Badri. I'll provide more details related to our first quarter 2018 financial results as well as our business outlook for the second quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis unless otherwise noted. Total revenue for the first quarter of 2018 was $70 million, a decrease of 12% sequentially and an increase of 28% year-over-year. Total net revenue per DC watt increased by 8% in the fourth quarter of 2017, largely as a result of changes in product mix. We shipped approximately 180 megawatts of DC in the first quarter of 2018, a decrease in megawatts of 19% sequentially and an increase of 12% from the year-ago quarter. The megawatts shipped represented 611,000 microinverters. Approximately 67% of which were our new IQ microinverter systems. As Badri mentioned, we began shipping our IQ product in the U.S. during the first quarter. Non-inverter revenue, which includes our AC Battery storage solution, Envoy Communications Gateway and all accessories, increased as a percentage of revenue compared to our prior quarter results. Non-GAAP gross margin for the first quarter of 2018 was 26.5% compared to 24.2% for the fourth quarter. We are very pleased with the continued progress we've made expanding our gross margin. The increases reflect pricing management, supply chain optimization and the IQ transition. I'll note that we continued to be impacted by component shortages, which negatively affected our Q1 gross margin by approximately 1%. Non-GAAP operating expense was $17.7 million for the first quarter of 2018 compared to $18 million in Q4. As compared to the first quarter of 2017, we reduced non-GAAP operating expenses by 13% or $2.5 million. On a non-GAAP basis, income from operations was $861,000 compared to $1.3 million in Q4 and a loss of $12.9 million in…

[Operator Instructions] And our first question will come from the line of Philip Shen with Roth Capital Partners.

Great job on the margins, I know that's been a focus of yours for some time now, and part of that is perhaps some trade-off of volume. With the Q2 guide being slightly weaker than expected, I think the midpoint is roughly flat year-on-year growth for Q2 of this year. Do you expect that the trend flat still in Q3 and 4? I know it's still early. You don't provide official guidance, but some of the PG&E data -- or the sorry, California PG data suggested that the volumes in California for you guys were down 20-ish percent. So just kind of walk us through how you see volumes and also revenues trending as we get into Q3 and 4.

Phil, thanks for your questions. So let me tell you how we think about market share. It should be very clear to all you guys that our top priority is to build a solid financial foundation. We are focused on consistent profitability than growing market share at any cost. We are consciously walking away from empty calorie revenue like I have repeatedly said. Having said that, since we are performing great on gross margins and that is ingrained into our business or into our DNA, we are starting to work on profitable top line growth. And the 4 vectors for top line growth are IQ 7 regional expansion where the software configurability of IQ 7 helps us to be compatible to multiple regions, which was not possible before. So that adds roughly a gigawatt of new market. The IQ 7X is something that was not possible with IQ 6, where we are now addressing 96-cell modules, that was not possible before and of course, the solid color on ACM partnerships. We are partnering with a number of people. We have announced some are in the works. And we have AC modules for IQ 7, IQ 7+, IQ 7X. So we are a big believer in AC modules. That's going to propel our future. The last one, last but not the least is IQ 8 in Ensemble. In fact, we announced that we are going to introduce our grid solutions in Q4 of '18, then followed by grid-agnostic solutions in 2019. So these are the 4 growth vectors that you should think about Enphase. But again, the main message is whatever we do, we will not compromise profitable growth.

Great, that's really helpful, Badri. So given that, can you give us a sense for -- we've seen some kind of flatness on the year-on-year growth in Q2. Would you expect that acceleration from these greater revenue opportunities to kind of pick up in Q3 and 4? Or could it be sometime next year? What's your sense as to when the growth really starts to accelerate nicely?

Well, we are not going to be guiding to any numbers for Q3 or Q4, but I told you the 4 vectors. And I think they're all very tangible ones. And we have the product coming out. I'll talk a little bit about the IQ 7 transition, and let me add some color on the IQ 7 transition. So basically, Q1 '18, we started shipping IQ 7 in the U.S. We did a limited quantity of IQ 7, which was by plan as part of a controlled ramp. In fact, 8% of our shipments in Q1 '18 was IQ 7. As we proceed to Q2, that number will get better, more IQ 7 shipments. We will start introducing IQ 7 to rest of the world. We will also introduce IQ 7X. Q3 '18 will be a significant ramp for IQ 7, and we'll complete the IQ 7 transition in Q4 '18. So that gives you some sense of the time line on the IQ 7 transition. And I already told you 3 of the 4 top line growth vectors are dependent on IQ 7 transition. So that's how I'm going to answer your question.

Badri, that's super helpful. I know that you guys are targeting Q4 as the full ramp-up of IQ 7. If you can put any specific numbers around the IQ 7 mix for Q2 and 3, that would be great. But are we kind of looking at maybe 20% in Q2 and maybe 60% in Q3? Do those numbers kind of ballpark feel appropriate?

I'm not going to provide conversion numbers, Phil, but like what I told you, 8% in Q1, incremental progress in Q2, big ramp in Q3, completion in Q4.

One last one, I'll pass it on. As it relates to the AC module, is there anything you might be able to share on the 201 tariff exclusion potential? I know, based on our work, it seems like you have good shot at it. Additionally, I think SolarWorld left an opening for you guys. To what degree can you comment on timing as well as whether or not you think you might be able to get it?

Yes. So let me make some general comment on the ITC ruling. While we expect the ITC ruling, what we did not expect was the impact on AC modules. So we are working on an exception process to get exclusion on the microinverter portion of ACM. We have submitted to their exclusion request to the USTR, and we expect to hear from them by the end of June. Our overall direction as a company does not significantly change because of this tariff. Like what I said, profitable growth strategy, that doesn't change. We are working with a number of partners, some of who are affected by the tariff, some are not affected by the tariff. So we'll wait and watch, but that's our strategy.

The next question comes from the line of Eric Stine with Craig-Hallum.

It's Aaron Spychalla on for Eric Stine. Maybe first on the Q2 rev guide. Can you just talk a little bit more about the puts and the takes there? I mean, is that just primarily the controlled ramp for the IQ 7 like you're talking about? And then just maybe conservatism or depending on how the U.S. market looks, are those kind of the 2 drivers diverse? Or is there anything else there?

Yes. I mean, yes, the Q2 guidance is between $72 million and $80 million. Like what I said, it is about the IQ 7 transition, and we also talked about the 4 vectors for top line growth. So we expect to introduce IQ 7 in rest of the world. We introduced IQ 7, as you know, in the first quarter of Q1 '18 into the Americas. We now expect to introduce IQ 7 into rest of the world in Q2 of '18. And so that will be a continued ramp compared to the 8% number I told you. Then, Q3 and Q4 is where the ramps happen. Like what I said, Q3 will be a significant ramp. Q4 will complete. So some of the opportunities, top line opportunities that we are working on will start coming into play during that time along with our transition.

And then maybe second on pricing. Can you just kind of give us an update on your pricing outlook? Obviously, pricing management has been a key focus like you said and great margins this quarter. What are your thoughts kind of for the rest of the year on a year-over-year basis or something like that? And then just anything on broadly Section 201 impact as inventory moves through the channel?

Yes. I mean, I'll give you some color on pricing. So we have three levers on gross margin. The first one is pricing management. The second is supply chain optimization. The third is new product transition. So I'll talk about pricing management. Pricing has been very important to us. We hired a VP of Pricing almost a year ago. He taught us how to do pricing. So basically, our focus is value-based pricing. The way we do pricing is we look at the next best alternative. Then, we look at what value we add on top of that next best alternative. So that has taught us a lot. In addition, we are blocking and tackling on the transactional side to making sure that we are profit focused and shed away empty calories. That has been one more discipline. Also, the way we think about products is like, we think about product segmentation, how those products can be segmented from a pricing perspective in order to generate value. So basically, we have changed our game on pricing. With regarding how we model pricing, we usually model a couple of percent every quarter. And historically, for Q1 '18, for example, our pricing was flat. There has been not much change. In fact, it was up a little bit. But we model 2% erosion, price erosion quarter-on-quarter for the -- I mean for the 3 quarters in 2018.

And then maybe last for me, can you talk a little bit about the opportunity in South America following the strategic investments? Maybe just frame that out, what the opportunity looks like and how this investment helps the prospects down there, and any thoughts on timing?

This is Raghu. Latin America is, again, one of our top line growth initiatives, is when we think about regional expansion, because of the benefit of the microinverter being software defined, we are now certifying the product to be available in South America as well. So over time, we'll share with you more details about the market plan itself. But yes, we are gearing up to get our product out into that market.

And the next question comes from the line of Jeff Osborne with Cowen and Company.

Just a couple questions from my end. One is on the international expansion in the second half of the year and into 2019. How do we think about OpEx as that plays out? All the training and seminars that you folks do, is there any noticeable increase that we'll see from a P&L perspective?

So I'll go to the OpEx. We have reduced OpEx very significantly as a company. So from $108 million in 2016, we have dropped to $73 million in 2017. Our Q1 '18 non-GAAP OpEx is a little higher, 25% of revenue because primarily due to Q1 seasonality of revenue. But we do expect our long-term OpEx to be consistent with the 30-20-10 operating model, which means close to 20%. We have certain investments that we make on profitable top line growth, which we will not compromise on, and we will do them. And in addition, the most important point there is we have opened an R&D center in India, and we now have over 50 employees in India. And India is a key strategy by which we can accomplish low OpEx as well as do all the things we need.

That makes sense. I appreciate it. Just two other quick ones. One, Bert, any update on the Tennenbaum facility in terms of the ability to renegotiate the terms of that, the interest expense moving forward? And then you sort of answered it in the prior caller's question. But just in terms of the competitive environment in the second half, do you think that there's a step-function change in ASP? Or is that kind of 2-ish percent sequentially each quarter pretty consistent with what you're expecting based on your conversations with your customers?

Yes, so I think Badri answered the ASP question pretty well in terms of what our expectations are, so I don't have anything more to add to that. Respect to the Tennenbaum facility, as you know, we did do a little bit of recasting of that facility in the first quarter to push out 50% of the principal out of 2018. That was a direct result, as you can imagine, from our improving financial results. It gave us a little bit of opportunity to get creative on that and get constructive with them. As we continue to improve financially, and we do expect to continue to improve financially, we do believe it will have similar opportunities in the back half of the year to do similar constructive work with Tennenbaum, and it's definitely something that's on our radar.

And the next question comes from the line of Brad Meikle with AMPAC Research.

It's Brad Meikle, AMPAC Research. Bert, best of luck. Sorry to hear you leaving. And 2 questions. I guess, the IQ 8, is that planned for January of next year for initial shipments? Or do you have a sense on the timing of that?

So Brad, as we said, we plan to release the off-grid solutions in Q4 of '18, and it'll be followed by the grid-agnostic solutions in the first half of 2019.

And would you expect to ramp similar to the IQ 7 in terms of the slope and penetration? Or do you think you'll see still some balance of IQ 7 shipments?

Well, IQ 7 will be our bread and butter, but IQ 8 addresses a brand-new market. And once you address a brand new market, there is a cycle of learning there. I'm sure we'll go through that cycle of learning. It's difficult for us to predict ramp, but the good news is we'll have the product out there.

So thinking about the third and fourth quarter in terms of IQ 7 ramp. Obviously, the international, I guess, 20% or so of your business has not been IQ 6. So with the ramp, 200%, I guess, you see a nice margin incremental boost off that. And I guess, the question's how much are you going to pass along to customers at that point versus capture from a margin standpoint yourself.

If you see our mix of international versus North America, right, we basically had 62% and 38%, which basically means 62% is North America and 38% is rest of the world. So rest of the world is becoming a nice fraction of our business. We want that to grow more and more. And it is important to note, the rest of the world is on the fifth-generation product, and it's directly transitioning to the seventh-generation product. Okay? So that should give you some color on the gross margin.

How are the costs looking for the IQ 7 in terms of the cost reduction ramp for that?

Well, we are not going to be giving out cost numbers here. But the way we think about cost, right, our supply chain initiatives, for example, we have a multi-sourcing strategy, which means no matter what the component is, you always have multiple sources; 0-based costing approach, which means due to physics-based costing. You look at the stack-up of the product, and you calculate the cost from first principles. The third one is clear supplier selection and analysis, so basically, methodical analysis of suppliers in terms of their quality, in terms of supply chain, in terms of reliability, performance and having methodical score cards. The fourth is focus on accessories. It's not just about the microinverters, focus on accessories because that is getting to be a sizable fraction of our business. And this was previously neglected. Now we are applying a lot of focus there. The last one is overhead. No matter how the efficient company is, there is overhead, and the overhead is basically freight, service, stocking, things like RMAs, the way they are handled, things like inventory, things like variance, warranty. There is lot of hidden costs there, so we are constantly blocking and tackling that. So I think about this as a business process where we control costs in the company. And the most important part is that everybody is involved in the cost improvement. It's not just the supply chain guys. It is the CTO. It is the engineering team along with strong program management. So while I'm not answering your question directly in terms of what is the cost, I'm just giving you color on that. This is a business process we are doing methodically. We are grinding everyday and that's where costs are getting better.

The next question comes from the line of Colin Rusch with Oppenheimer.

The pace of the platform development has been fairly quick here over the recent quarters. Can you talk about expectations for whether that pace is going to continue on a multiyear basis? Or are you going to slow that down and just continue to mind the supply chain and mix to optimize the profitability of the company?

This is Raghu. So the way we think about it is the heart of our system is the ASIC, is the chip itself, the ASIC, and there's a lot of opportunity for us to continue the rapid pace of development of the ASIC in order to drive greater functions and features as well as lower our cost. Just to give you an example, if you look at our IQ 6 ASIC or IQ 7 ASIC, it has 3.8 million gates. If you look at our IQ 8 ASIC, which we mentioned came back and is fully operational, is 5 million gates, gives us huge amount of leverage in terms of cost as well as functionality. Now the other thing to take into account is, when we say platform, yes, the inverter itself may change because you're driving, the brain of the system is changing. The rest of the system, the cabling, the accessories, et cetera, we try to keep those as unchanged as possible. The advantage of that is you bring a lot of efficiencies to our installer partners. So when they get on the roof, they're installing the same exact, same cabling systems, same balance of system, but the inverters just get better and better with lower cost and better functionality.

And just to follow with that point about the data management and collection, obviously, you guys have done a couple of important upgrades on some of these inverters in various locations, and you've been working with utilities to figure out how to optimize the use of those data cases. But can you give us an update on where you're at in terms of monetizing those capabilities and what that business model can look like going forward?

That promise always exists about what can you do with the data and can you monetize it. So at this time, we are not announcing anything in terms of monetizing the data, but the data is extremely valuable. Let me speak about like in little more generality in that as our platforms change or as we progress throughout generations of inverters, the reliance on software is becoming greater and greater. So between 6 to 7 to 8, it's becoming more and more software defined, more and more software upgradable functions and more and more software capabilities are being included into the system. So in the long term, we still believe that there will be opportunity to do that. But at this time, the business plan is what we have right now.

[Operator Instructions] And our next question comes from the line of Pavel Molchanov with Raymond James.

Another trade word question but from the other kind of side's perspective. We saw headlines a few weeks ago that Huawei is essentially pulling out of the U.S. market. And I think that they have not actually sold any microinverters here, but they had talked about it. So I'm curious your thoughts are about that decision and what it might suggest about the competitive landscape.

Yes. I mean, we have been hearing about Huawei a lot in the last year. We heard that they were in Europe. Now we are hearing that they plan to be in the U.S. in Q3. And like what you said, solar is a dynamic phase. Things can change very fast. Competitive dynamics is amazing. But our strategy doesn't change. We are focused on profitable top line growth. And for us, it is the differentiation of the product that counts, and that's what I articulated in the 4 vectors of my top line growth.

Can we also get an update on how things are looking with the battery product?

Yes. I'll give you a brief update on the battery product. Basically, we are seeing a sequential uptick in AC Battery sales every quarter, and the uptick that we are seeing comes from both Europe as well as Australia. Our value proposition is pretty simple. It is the Enphase ease of installation combined with the modularity of the system. When I say modularity is it's available as 1.2 kilowatt-hour, small battery, easy to install, very easy to start small and then add on to it later. So that's why it has started selling. So we are very happy there. However, there is a lot more work to be done. On IQ 8, like what I have repeatedly said, solar plus storage is central to our strategy as we develop IQ 8. So as we come closer to Q4 of '18, when we release our off-grid solutions, we will start talking a lot more about our storage.

And the next question comes from the line of Carter Driscoll with B. Riley FBR.

Sorry to see you go, Bert. Hopefully on to new opportunities for you. The question I had was given the -- SunPower's acquisition of SolarWorld, if I recall quickly, you had a terms of working agreement on the AC module side with SolarWorld. Is the acquisition at all either a restart or more put to bed the opportunity for a module with SolarWorld and/or its new parent?

Yes, you are correct. In the last year sometime towards the end of last year, we were working with SolarWorld, and we did have an AC module ready before the thing happened at SolarWorld. We heard about the announcement from SunPower. Once we are not sure when that acquisition is going to close, et cetera. Once the acquisition closes, then I'm sure the opportunities will come. And like what I said, we are a very strong believer in AC modules, and SunPower is also a strong believer in AC modules. So I think there is lot of synergy there.

Maybe just a follow-up to that. Obviously, Panasonic's making a lot of inroads in the U.S. and has a somewhat unique position because of Tier 1. Can you talk about the timing maybe of the integration you have with their module product?

Yes. So it is a 2-phase approach. One is we are first introducing IQ 7X with discrete product, and it will go into the channel where it'll be combined with the 96-cell panel. That's the first phase. The second phase is where we are working with Panasonic in order to integrate our IQ 7X microinverter into their 330-watt HIT module. And that is more -- you know the Japanese. They are going to stress on the quality, which is the most important, right? So basically, we expect that to be available by the later part of 2018 on the full-blown ACM.

This is Raghu. Just the IQ 7X, the discrete solution, our plan is to introduce it in Q2.

Just two more quick ones for me. You just talk about IQ 8 and your inroads potentially in Latin America. I mean, how do you think of that market? I mean, obviously, it's very diverse. There's a mix of, let's say, stable grid and then something that might be a perfect solution for your to IQ 8. How do you think about approaching it? Is it take a different sales approach on country-by-country basis or a region-by-region basis? And that take any incremental spend at least vis-à-vis what you had to do in some of your more established markets? Trying to think of an SG&A spend as you try to target that market particularly as you roll out IQ 8.

Yes. Let me give you some color on IQ 8. So basically, IQ 8 is based upon a brand-new technology called as Ensemble, which was invented here at Enphase. As we said in the past, we are getting, I mean, we got the technological feasibility last quarter when the ASIC was completely functional. And once again, I'll remind you that IQ 8 consists of energy generation, energy storage, communication and software. So like, the use cases that IQ 8 addresses is enormous like what you said. It is off grid. It could be grid tied. It could be grid agnostic. So the go to market is involved, and we don't claim we have understood everything. But we are going to introduce it for the off-grid markets first, which is basically a phased introduction. In the off-grid market, the obvious places for us to attack are to go and gain market share in would be Africa and India. Africa is no-grid market, while India is weak grid market. Those are the places where we will begin. And you're right. It will involve some SG&A spending. We have comprehended that in a few places. We may enter with partners, so more to come there, but you're exactly right. We are thinking about it the way you said, and we are adopting a phased approach.

And then just the last question, a high level. Given the 62%-38%, NA-rest of the world, split you just posted, could you hit parity by year-end '18 or probably more likely in 19? And that take a mix of 7 and 8 rollout? Or that'd be based just on IQ 7 when you hit the ROW by 3Q and full ramp by 4Q, just trying to get a top-level geo mix.

Yes, there are lot more quarters between now and 2019. But if I want to be abstract about it, I'd say India is growing for us. Europe is growing. So I would be happy if we can get to something like a 50-50 sometime in 2019, 2020 time frame.

[Operator Instructions] This does conclude today's question-and-answer session. I would like to turn the call back over to CEO, Mr. Badri Kothandaraman, for closing remarks.

All right. Thank you for joining us today. Our 30-20-10 execution is going very well, and we have started working on several initiatives for profitable top line growth. We look forward to speaking with you again on our call next quarter. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude your program. You may all disconnect. Everyone, have a great day.