Enphase Energy, Inc. (ENPH) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Enphase Energy's Fourth 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 is being recorded. I would now like to introduce your host for today's conference 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 fourth quarter and year-end 2018 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer; Eric Branderiz, Chief Financial Officer; and Raghu Belur, Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its fourth quarter and year ended December 31, 2018. During this conference call, Enphase management will make forward-looking statements, including but not limited to, statements related to Enphase Energy's technology, products and financial performance, operations including supply and lead times and current and future market and customer demands and 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 quarterly report on Form 10-Q for the quarter ended September 30, 2018, which is on file with the SEC, and the annual report on Form 10-K for they ended December 31, 2018, which will be filed with the SEC in the first quarter of 2019. Enphase Energy cautions you not to place 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 a reconciliation 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 website. 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 fourth quarter and full year 2018 financial results. We had a solid quarter, we reported revenue of $92.3 million. We had strong customer demand as our financial strength and robust balance sheet reaffirmed customer confidence. Our biggest challenge in Q4 was meetings this additional demand due to component shortages that constrained our revenue. We are fully booked for Q1 2019, just as we saw in Q4 2018. I will provide an update later in the call on our plans to mitigate component shortages. Our non-GAAP gross margin in the fourth quarter was 30.7% and the Non-GAAP operating income was $8.6 million. Our gross margin was negatively impacted by 4.3% due to expedite fees related to component shortages. The expedite fees were in the form of air shipments that we chose to make in order to service our customers. We exited the fourth quarter with a cash balance of $106.2 million net of a $10 million final payment to SunPower. The strong cash balance also enabled us to completely repay on January 28, 2019, our high interest bearing senior secured term loan of approximately $39.5 million plus accrued interest and fees. Now let's talk about 30-20-10 our target financial model. We introduced 30-20-10 at our Analyst Day in June of 2017 and committed to meeting the model in Q4 of 2018. The 30-20-10 stands for 30% gross margin, 20% operating expense and 10% operating income. We made significant progress towards making that model reality as we exited 2018. Eric will go into greater detail about our financial results later on the call. An important focus items that we discussed in the past few quarters is ease of doing business. How customers perceive us. Quality and customer service are the cornerstones of our strategy and our objective is to deliver exceptional customer experience. Our business processes are maturing, and we are prioritizing customer experience to be number one in all aspects of our business. During Q4,we made several improvements in our call center and online support, particularly in Europe and Asia Pacific. We also rolled out our Enphase Upgrade Program, the service program for early adopters of our legacy micro inverters and announced that over 1,000 homeowners have joined the program. The key metric we use to measure customer experience is the net promoter score or NPS, this metric is calculated based on feedback from customer surveys on how likely customers or partners will recommend Enphase to a friend or colleague. Our NPS in North America was approximately 51% in Q4, and our target is to achieve a worldwide NPS of 60% or higher in 2019. Now let's talk about the 301 tariffs that became effective in September of 2018 impacting Enphase microinverters and accessories. As we discussed last quarter, we are mitigating the existing 10% 301 tariffs by sharing the cost increases with our customers and expanding our manufacturing agreement with Flex in Mexico starting in Q2 of 2019.This additional line in Mexico is expected to help Enphase better service our North American customers by cutting down cycle times and streamlining inventory at a similar manufacturing costs currently with Flex in China. Now turning to our regions, our U.S. and international mix for Q4 was 77% and 23% respectively. All of our regions were impacted by component shortages in Q4. Our fourth quarter revenue in the U.S. was up 38% sequentially and up 29% year-on-year due to strong customer demand across the board. Note that the U.S. revenue includes volume shipments of our IQ 7XS microinverters to SunPower as we previously planned. In Europe, revenue was down 2% sequentially, but up 27% year-on-year. The megawatts shipments were up 26% sequentially and up 31% year-on-year setting a new record for Europe. Note that the Q3 2018 revenue for Europe included a $3.3 million of milestone achievement from a partner on IQ8. We are encouraged by the growth outlook in the new build and social housing sectors in Europe. In APAC our revenue was down 61% sequentially and down 74% year-on-year. As we previously mentioned, the region had built up significant channel inventory over time and we took this opportunity to bring the inventory down. We recently appointed Wilf Johnston as our new General Manager for the region and we believe his years of international executive management experience will help strengthen our APAC business. In Latin America fourth quarter revenue was down 41% sequentially and down 14% year-on-year, unfortunately component shortages significantly impacted our Q4 sales to this region as well. Now that we are financially stable a large portion of our time is spent on profitable top line growth. We plan to achieve this growth through differentiated products and services. Our four levers for profitably top line growth remain IQ7 regional expansion, high power and high performance products, AC modules and Ensemble Solar and Storage technology. The first lever for profitable top line growth is IQ7 regional expansion. Approximately 84% of our microinverter shipments in Q4 were IQ7, up from 78% in Q3. As I mentioned earlier, component shortages constrained our revenue in Q4. We have been working with our customers and partners to manage these shortages and we are thankful for their efforts and patience. The additional capacity based on an investment we made with one of our suppliers earlier in 2018 is now online. This has allowed us to increase our micro inverter supply for Q1 2019, but with the growth we have seen our lead times are still around 13 to 15 weeks. We have recently signed two new long-term contracts for additional high voltage transistors. This additional supply is expected to become available in the second half of this year, which we believe will help improve our microinverter lead times to six to eight weeks. The second lever for profitable top line growth is releasing high power and high performance new products. The IQ7XS product addresses 96-cell PV modules up to 400 watt DC and with its 97.5% CEC efficiency is ideal for integration into high power modules like SunPower and Panasonic. In addition, we shipped limited quantities of our new product IQ7A, which addresses up to 450 watt DC modules. The third lever for profitable top line growth is AC modules. We had volume shipments of our IQ7XS microinverters to SunPower in the fourth quarter and as previously announced, we expect a continuation of the ramp in 2019. In addition, we are making steady progress with module partners such as Solaria and Panasonic, and ramping Enphase Energized AC modules. These integrated systems allow installers to be more competitive through improved logistics, reduced installation time, faster inspection and training. Since their release in October of 2017 Enphase Energized ACMs from our module partners have been adopted by about 420 installers in the U.S. as of today. Finally, a major catalyst for our profitable top line growth in the long-term is our Ensemble solar and storage technology. The IQ8 system is based on our grid agnostic always on technology called Ensemble. This system has four components, energy generation which is accomplished with the grid agnostic micro inverter IQ8, energy storage which is achieved by Encharge battery with capacities of 3.3, 10 kilowatt hour, 13.2 kilowatt hour, communication and control called Enpower which consists of the automatic transfer switch and the combiner box with the Envoy gateway. The fourth and final component is Enlighten, which is the IoT cloud software. We are working hard on each of these four components of the IQ8 system. There are over 100 engineers working on the project across multiple time zones. However, given the high complexity of the technology in terms of hardware and software, we are running a little bit late. We believe in making right decisions for the long-term and getting the customer experience right. Therefore we now anticipate introducing Ensemble in a phased manner starting in the fourth quarter of 2019. Let me remind you that there are two major market segments Ensemble technology addresses. One is the pure off grid segment and the other is a grid agnostic segment. We just talked about the grid agnostic solution being delayed to the fourth quarter of 2019. However, the pure off-grid microinverter solution is on track. We shipped limited quantities to our partner on IQ8 during the fourth quarter of 2018 and we expect to ramp production in the first half of 2019. We also expect the final milestone revenue from this partner in the first quarter of 2019. In summary, we are encouraged by our progress in 2018. Our top priorities remain providing superior customer experience and focusing on our four profitable top line growth factors. I would like to thank our employees for their hard work and our customers, partners and shareholders for their strong support. With that, I will turn the call over to Eric for his review of our financial results. Eric?

Thanks, Badri. I will provide more details related to our fourth quarter and full year 2018 financial results, as well as our business outlook for the fourth quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis, unless otherwise noted. We have provided reconciliations of these non-GAAP financial measures in our earnings release posted today, which also can be found in the Investor Relations section of our website. Total revenue for the fourth quarter of 2018 was $92.3 million, an increase of 18% sequentially, and an increase of 16% year-over-year. We shipped approximately 257 megawatts DC in the fourth quarter of 2018, an increase in megawatts of 25% sequentially, and an increase of 16% from the year-ago quarter. The megawatts shipped represented about 820,000 microinverters, approximately 84% of which was IQ7. Both IQ6 and IQ7 represented 91% of Q4 microinverter shipments. Non-inverter revenue, which includes our AC Battery Storage Solution, Envoy Communications Gateway, combiner box and accessories increased as a percentage of revenue compared with the prior quarter. Total revenue for 2018 was $316.2 million, up 10% from 2017. In 2018, we shipped approximately 2.8 million microinverters, representing 972 megawatt DC, a 13% year-over-year increasing in megawatts shipped. Non-GAAP gross margin for the fourth quarter of 2018 was 30.7%, compared to 32.8% for the third quarter. Note that Q3 2018 non-GAAP gross margin including a $3.3 million milestone achievement from a partner on IQ8. Even though we shared some of the expedite fees with our partners, component shortages negatively impacted our Q4 gross margin by approximately 4.3%. Non-GAAP operating expenses were $19.7 million for the fourth quarter of 2018, compared to $18.6 million in Q3 and $18 million in the fourth quarter of 2017. 2018 was our first year of SOX compliance efforts and as a result we incurred higher than expected expenses in internal audit plus additional consulting and advisory fees. These higher than normal expenses will also continue into Q1 2019. Non-GAAP operating expenses for 2018 were $75 million, compared to $72.8 million in 2017. GAAP operating expenses were $23.2 million for the fourth quarter of 2018, compared to $25.6 million in Q3, and $21.1 million in the fourth quarter of 2017. GAAP operating expenses for the fourth quarter included $1.5 million of the stock-based compensation expenses, $1.5 million of restructuring expenses, and approximately $400,000 [later changed by the company to $500, 000] of acquisition related expenses and amortization. GAAP operating expenses for 2018 were $92.8 million, compared to $95.4 million in 2017. On a non-GAAP basis income from operations was $8.6 million in the fourth quarter of 2018, compared to $7 million in Q3 and $1.3 million in the year ago quarter. This improvement in operating income is reflective of our improved operational excellence and continued product leadership. On a non-GAAP basis, net income for the fourth quarter of 2018 was $5.1 million, compared to $4.6 million in Q3 and $683,000 in the year ago quarter. This resulted in basic earnings per share of $0.05 and diluted earnings per share of $0.04 in the fourth quarter of 2018, compared to basic and diluted earnings per share of $0.01 in the year ago quarter. GAAP net income for the fourth quarter of 2018 was $709,000. We are happy to report that this was the first quarter in the company's history that we reported GAAP net profitability. Now turning to the balance sheet. Inventory was $16.3 million in the fourth quarter of 2018, compared to $17.9 million in Q3, and $26 million in a year ago quarter. We ended at 23 days of inventory on hand as of December 31, 2018 significantly below our target of about 30 days and down from 31 days in the third quarter, and also down from 39 days in the year ago quarter. Although most of the inventory reduction was due to high demand constrained by component shortages, inventory management continues to remain one of our key cash management initiatives. We exited the fourth quarter of 2018 with a total cash balance of $106.2 million compared to $116.2 million in Q3. The Q4 balance includes the final payment to SunPower of $10 million for the acquisition of its microinverter business. We also generated $1.9 million in cash flow from operations and $4.1 million in adjusted free cash flow. The $1.9 million in cash flow from operations in Q4 would have been $5.9 million as we allocated $4 million out of the $10 million payment to SunPower in operating cash flow for the acquired customer relationship acquisition related intangibles. As Badri mentioned, on January 28, 2018 we repaid in full our high interest bearing senior secured term loan with Tennenbaum Capital Partners an indirect wholly owned subsidiary of BlackRock Inc. The repayment included a principal amount of approximately $39.5 million plus accrued interest and fees. The repayment also terminated the liens of all Enphase’s assets, providing greater operating flexibility going forward. Now let's discuss our outlook for the first quarter of 2019. We expect our revenue for the first quarter of 2019 to be within a range of $90 million to $95 million. Turning to margins, we expect GAAP and non-GAAP gross margin to be within that range of 31% to 34%. Note that our Q1 gross margin guidance includes a negative impact of approximately 2% to 3% due to expedite fees, resulting from component shortages. We expect our GAAP operating expenses to be within a range of $25 million to $26 million, including a total of approximately $4.5 million estimated for stock-based compensation expenses, additional restructuring expenses and acquisition related expenses and amortization. We expect non-GAAP operating expenses to be within a range of $20.5 million to $21.5 million. With that, I will now open the line for questions.

[Operator Instructions] And our first question comes from Brad Meikle with Williams Trading. Your line is now open.

Hi. Thanks for the question. Could you add a little more color in terms of your visibility into second quarter and the second half the year from a demand standpoint. And also areas you're ramping, it sounds like you prioritize the ramp of the IQ7 and to alleviate the shortages and catch up with customer demand. Can you comment on how much more capacity you'll have as you go into the second and third quarter? Thanks.

Yes, Brad, thanks for the question. As you know, we are not going to provide guidance beyond a quarter and we guided $90 million to $95 million of revenue for Q1 of 2019. Having said that, we are unlocking three of the four top line growth vectors that I said. The first one was the IQ7 regional expansion, the second is the AC modules and the third is the high performance, high power products so I'll take each of them. In the first one obviously our balance sheet has significantly improved. We are very financially stable we have great cash in our cash balance. So customers are coming back to us. In addition, we pride ourselves on offering the highest quality end customer experience. So, with all of this our demand has started to increase and what we did was we recognized this sometime last year and we basically we worked with one of our suppliers to increase our 600 volt transistor supply, which is a key component in our microinverters. And we did that early in 2018 we locked some capacity down and that capacity is coming on in Q1 2019. In fact, it is online right now. But having said that, as we unlock more of our top line growth vectors, we found that that is not enough. We found that in the fourth quarter that we had to scramble for more capacity and I personally went down and talk to the CEOs of these companies and we were able to get two additional long-term contracts done. The result is that from middle of 2019, meaning from the second half of 2019 the incremental supply will turn on and we will start to service customers a lot better. The answer to your question is Q1 2019 will be better than Q4 of 2018, Q2 1019 will be better than Q1 of 2019 and Q3 and Q4 will be a lot more comfortable for us.

Thanks, Badri. I guess just to ask in other way. I think you’ve said in the past that the new power MOFSET line could be 60% of your output, when ramped. And I'm not sure exactly how long it takes to ramp, but that really implies close to doubling of capacity depending on how your existing contracts sort of look, but is that the right way to think about that?

Well, I mean, yes that is the right way to think about it. The -- let me let me say this. In the second half of the year we will be in a very comfortable spot in terms of our supply. Supply -- I hope supply will not be a major problem in the second half.

And are you sold out through the second quarter at this point as well?

We’re not going to talk about the second quarter, Brad the -- we are sold out for the first quarter though.

Okay, thanks. And just last question, could you speak to the battery ramp and we've heard of some high attach rates in California of 25% plus and, obviously you make probably eight times as much on a storage installation with your customers. So could you comment on what you're seeing from customers that you're talking about in terms of storage attachment and what that could mean for the business. Thanks very much.

Yes, we’re extremely excited about storage, as I said in the prior quarter, storagerepresents a significant opportunity for us to increase the revenue potential for home from $2,000 to $10,000. And a key part of Ensemble is Encharge, Encharge is going to have capacities of 3.3 kilowatt hour, 10 kilowatt hour, 13.2 kilowatt hour it is going to have us see over two charging rate, it is going to have LSP chemistry, which is going to be very safe for residential applications. It is, I mean, most importantly, it’s going to use IQ8 and the same IQ8 microinverter. So we are furiously working on Encharge, having said that like what it has it is a little bit delayed to the fourth quarter of 2019. But we are extremely optimistic about our prospects in storage and yes I’ll leave at that.

Thanks. I'll get back in the queue.

Thank you. And our next question comes from Carter Driscoll with B. Riley FBR. Your line is now open.

Good afternoon gentlemen. I mean you just talk about your assessment of the opportunity for Ensemble and the grid-tied versus not necessarily having being grid-tied and the delay of when you're going to ramp the second portion of that market just trying to get a sense of relative market opportunity.

Right, so Ensemble is designed to service two markets, one is grid agnostic market segment and the other is the off-grid market segment. Come to the off-grid market segment where we are on track. We started sampling the product to our lead customer in the fourth quarter of 2018 and we are expecting to ship significant quality to them in the first quarter of 2019. So what I’ll say is this, I mean, if you look at of -- if you look at the countries, where the off-grid technology is going to play a major part is going to be places like India and Africa. India and Africa are places where you will see, of course the PV and storage systems are not going to be that big, they've got to be small. But imagine a hot -- having one or two AC modules or one or two modules with microinverters. And so that will be just perfect for the architecture of a microinverter. It's still too early for us to assess, to talk about volumes and talk about ramps, but we're excited that our product is there, our product is sampling. We have a strong partner and we will talk about in the coming quarters progress. So, that's on the off-grid -- pure off-grid microinverter. On the grid agnostic one it gets more exciting, the grid agnostic one obviously there's a lot of cases. We service somebody, who wants to be completely good independent. We service somebody who wants to be totally dependent on the grid, but just wants backup as a peace of mind. So Ensemble technology that can do whatever the customer wants. That's why, we call it as grid agnostic and Ensemble complex. It has got four components, which is the micro, the battery, the automatic transfer switch, and the combiner and cloud. Having working all of these together seamlessly in terms of hardware and software is something that we have been challenged with. And I think that's why we are experiencing the delay, but the way I think about it is two big opportunities on the Ensemble side is one is the storage, which is Encharge, which takes our revenue per home from $2,000 to $10,000. And the other is even if there is not much storage attachment, what would people want grid agnostic solar or a grid-tied solar. I mean, we think that most people would want a grid-agnostic solar they've given a choice. So once again, we are extremely excited about the technology, we're extremely excited about Ensemble. But we did not want to get ahead of ourselves. Right now we are basically having our heads to the table, we are focused on execution and we are focus on getting this product out in the fourth quarter of 2019.

Okay. Maybe just another one in, maybe talk about the percentage shipped to AC modules and the form factor or a range. Where you have been 4Q and where you think it could go by say year-end 2019?

Well, we’re not going to break out the percentage shipments. But AC modules have been increasing slowly and steadily. And it starts with customers like SunPower, which is all AC modules are the microinverters IQ7Xs that we shipped to SunPower is in their Equinox AC modules. In addition, partners like Solaria or all gaining a lot of traction in their market. Solaria has got a 355 watt AC module, they use their IQ7 plus microinverter, which is a 295 watt AC output. So basically a DC/AC ratio 1.2 there. And Solaria value proposition is it's effective module is aesthetic and that's why everybody likes it that's that. And earlier in the year, we announced our partnership with Panasonic that's slowly getting to be a reality and we'll announce when we are ready there. So basically these are our very strong partners and in addition we have a few more that we are working on in the international regions, which we’ll announce when we are ready.

Maybe just last one for me. To get to the high and low end of your margin guidance for 1Q. Can you just talked about the factors is it some combination and mix. Obviously what you've done in -- potentially in terms of sharing the tariff impact. Maybe just talk about those factors the more important ones to get to the 300 bps delta?

Yes. I mean, look we are already sharing the tariff costs with our customers. We did that effective in Q4 of 2018, which is what we said we were. So we're doing that our -- really the puts and takes on gross margin. The 4.3% really comes from air shipping our microinverter. So that we provide customer service. And so I didn't -- to tell you the truth, I prioritize customer service in Q4. And therefore we spent a lot of money air shipping product. Yes, now a few of our customers are also willing to pay for air ships. So that basically offset us a little bit, but even after that we still had a gross margin hit of 4.3% as we said. And now in Q1 of 2019 with the supply situation a little bit better. We are not going to be spending so much money, but still is a significant 2% to 3% in terms of air shipments is still significant. And that's really accounted in the guidance of 31% to 34%.

Sorry, if I may just sneak the last one. Just talk about the competitive environment from existing and then maybe the new entrants what you're seeing both last quarter and what you expect in 2019?

I mean, the competitive environment remains pretty -- I mean, pretty much the same there is not much change of course we're all talking about Huawei. We do not see them that much in the residential space right now, but of course they are a formidable competitor we are watching the space. But let me remind you that our product is unique, our product is differentiated it's a micro inverter and we focus on the differentiation through innovation. So we'll be prepared to meet competition.

Appreciate taking all my questions. I’ll go back in queue guys. Thank you.

Thank you. And our next question comes from Eric Stine with Craig-Hallum. Your line is now open.

Hi, everyone. Maybe just wanted start with SunPower and I might have missed this, but did you break out the percentage of your revenues in fourth quarter there? And then just curious, if you could talk about the ramp, I know it's still early, but the ramp? And maybe how it's progressing versus your expectations when you made the acquisition a couple months ago?

Yes, we're not going to make on the percentage of SunPower revenue. But I'll tell you what, I mean, it is -- the ramp is very much in line with our expectation. I expected volume shipments beginning Q4 of 2018 and we are exactly at that point where we had volume shipments to SunPower on our IQ7X microinverters in Q4, of 2018. I expect Q1 2019 to be a ramp, nice ramp. And I expect us to be done by Q2 of 2019 as I previously communicated.

Okay. And I guess you touched on this on your answer to previous questions. But, I'm just curious with SunPower with some of the traction you're getting with some of your other AC module partners. Just curious what you're seeing from the rest of the market? I mean what that's doing in terms of interest people coming to you looking for their own solution, anything along those lines would be helpful.

Yes, I mean, if you really see it an AC module is actually perfect when you see that the modules are going to higher and higher power. Because we can easily scale our microinverters. So, it’s actually advantageous for us in terms of gross margin as well. And, having said that, SunPower is the biggest. And then people like Solaria, for example, like I will reemphasize that again, it's a 355 watt AC module. And it is a really neat module, 72 cell modules and very high aesthetic black on black and it really looks nice. So those are the kinds of partnerships we are actually getting and we're getting many such partnerships across the world. Like for example, Europe, yes, Europe there are couple of partnerships which we're working on. We cannot allow them yet, but they are making rapid progress.

Got it. So may be last one for, Eric, just on the OpEx you mentioned that in fourth quarter you had some professional fees and some other stocks related items that ran a little hotter than you thought. And the guide for first quarter, I mean, it sounds like it's going to persist maybe beyond first quarter, maybe a way to think about OpEx at a more normalized level.

Yes, I think that as we -- when we think about OpEx for 2019 except for the qualification from Q4 and Q1 we should thinking in terms of a model, the financial operating model that we set out price, which is cash generating so the $0.24 number is still relevant. It may go up a little bit may go down. It's the whole model of the 30-20-10 that we basically live by and double-digit earning principle outside this unique specific circumstances, right.

Okay, thanks for that.

Thank you. And our next question comes from Jeff Osborne with Cowen and Company. Your line is now open.

Excellent. Maybe just following up on Eric's question, Eric is there a way you can quantify what the OpEx increase was in Q4 for SOX in professional fees or will that be broken out in the 10-K?

Yes, it will be broken out in 10-K, you actually can see that as well I believe in the table of the press release, right. And for the most part you can see there the stock component 1.5, another portion associated with the restructure fees. So everything is neatly easy to follow there compared with prior quarter and then you can take it into a following impact.

Got it. And then, I think Badri had in his prepared remarks a comment about the last -- if I heard you right Badri the last milestone payment would be showing up in Q1 from your partner for IQ8. Can you confirm; A, confirm that? Then B, is there a way to think about what the magnitude of that payment is?

Yes, confirmed, yes, it will be Q1 of 2019 and it will be under $1 million.

Okay. I just noticed you didn't break that out when you were talking about the puts and takes on the gross margin side, but if it's under $1 million, is that the last of the -- if that's the last of the payments? Or is there any additional payments in the future?

That's the last of the payments.

Got it. And then another question on SunPower, I know you can't break out specifics, but is there a way you can talk about what your level of engagement is with their channel, their dealer network? Is that something that you have more than half of their channel has been exposed to the product? Or is that still an uphill battle over the next six months for you to penetrate that channel?

No, I mean, it's not an uphill battle, but it is not for us to penetrate the channel. SunPower has -- is going to exclusively use end phase microinverters and therefore it is in SunPower's best interest to promote these microinverters and the future microinverters to their dealer network. So, our job is a little bit easier there, because SunPower is taking all -- I mean, is making all the efforts to make sure that everybody is trained, the dealer network is trained. And of course, we are helping them every step of the way.

Got it, that makes sense. The last question I had was on the component side, two part question one is an IQ8, does that use more or less of the 600 volt transistors? I know it's a slightly different form factor and more cost optimized, but I wasn't sure if it's more intensive on the transistor side in particularly?

The IQ8 uses the same for high voltage transistors.

Got it. And then as part of these now, I guess, three contracts you have in supply, is there any notable cash payments upfront, that would be disclosed in the 10-K, as that's published or how did the mechanics of these work? And the second part of that question would be, what are the general duration of these types of contracts? Just any events so the auto industry or some other industry comes back and these components continue to have a problem later in the year and in 2020?

Yes, we have two arrangements that we have on top of the one that we existing before, is one of the two that are new that Badri set out is actually a continuation of the existing one with some prepaid arrangement similar to what we had before. The other one is with another one, with has a take-or-pay that is very short timeframe, right? So probably I wouldn't think beyond 18 months to 2 years right, which gives us enough runway to get the problem resolved. But at the same time doesn’t committee company on our structure pricing arrangement on a take-or-pay for the long-term.

Got it, that’s very helpful, Eric. I appreciate it.

Thank you. And our next question comes from Amit Dayal with HC Wainwright. Your line is now open.

Thank you and good evening guys. Most of my questions have been asked. Maybe just on the leverage of the business, now that we're seeing some revenue ramp coming through, what is the opportunity over here, should we expect operating costs to sort of normalize at these levels? Or should these expected to increase with the ramping revenues?

Right now you should think about the OpEx as our long-term model is 20% of revenue, we are not going to deviate from that. We incurred restructuring expenses to make sure we have the right people in the right places. So we are very confident that we can meet that. That's not an issue. So we are -- while we ramp revenue we will control OpEx at 20% of sales.

Got it. So the 30-20-10 no update to that maybe in the next few quarters?

Look, I mean, the 30-20-10 is more and more looking like 32-22-10. So the -- I mean what you should be looking at is the 30-20-10 spirit is what is the 10% operating income. So as long as that is met numbers will fluctuate a little bit. Having said that we feel good about are profitable top line growth vectors. We feel good that even if Ensemble is late we feel that the other three vectors are actually kicking in and more than compensating for that. And so we feel really good about that, but still we’re not going to guide more than one quarter out. And we know this is a solar industry anything can happen overnight. We know if the government sneezes on this a little bit, things can go south. So we’re not going to be update more right now.

Right. And in the context of pretty strong sort of guide for the first quarter relative to the fourth quarter, Ensemble -- should we expect Ensemble to really contribute anything meaningful this year? Or should that be pushed out in terms of expectations for 2020?

Well, look, I think, when we introduce the product in the fourth quarter, obviously that will be only the ramp, right. There won't be much significant revenue from Ensemble in 2019.

Got it. Yes, that’s all I have guys, I’ll follow-up offline. Thank you.

Thank you. And our next question comes from Colin Rusch with Oppenheimer. Your line is now open.

Thanks so much guys. It looks like you increase the working capital a little bit here with AR getting up to almost 78 days for the quarter. Can you talk a little bit about what happened there and what your expectation is for working capital needs as you go into the first part of 2019?

Yes, I'll take the first part and Badri, can probably cover the business aspects of it, Colin. But if you think about it the fifth supply component some shortages right, it has created challenges on our linearity right. So what you see is significant amount of shipments taking place sometimes on even an expedited costing basis on air shipping towards the end of the quarter. And that has been aggravated since Q3. And so now I believe we are turning a corner right in which you can see receivables with day sales outstanding of 70 basis, right and at the same time that compensate with the payable side, which we have a lot of purchases of inventory taking place towards the end of the quarter. So with that being said, you end up with a super low levels of inventories on the working capital front, maybe a little bit below our comfort level for operational flexibility now at 23 days with a total cash conversion cycle of 24 days of working capital in the corner, right. So we believe the linearity challenges being starting to get resolved in Q1 and pretty much gone by the end of Q2, we are in good shape to normalize the business back again and if are seeing receivables, payables getting to our own internal target.

And as you go into 2019 so you're expecting that 10/1 should be a source of cash and your expectations for March and June?

I didn't quite follow your question. Say that again.

You should be generating a bit of cash from the working capital as you go into March and June, or you feel like you're going to consume that as you ramp up.

It's just needs [ph] cash a little bit. We feel confident about our cash generating capabilities based on our financial operating model that we have right 30-20-10 or like Badri reported 32-22-10. That model is a cash generating model. And we don't see all the things that we took into account. I believe, we're going to continue going forward into the year by resolving the linearity challenges and increasing our cash cover.

Okay, that's helpful. And then you broke out international and domestic sales. As you look into the 2019 how is that shifting at all? And is there a price component that you're going to see a benefit or any sort of headwinds on -- from mix on a geographic basis?

Look, I mean, it's still going to heavily be skewed towards North America, because of SunPower. Having said that, we are really excited about Europe, we had the highest megawatt shipments like what we noted, really excited about the social housing boom in Netherlands and we have very strong distribution partnerships in France. And once the component shortages are resolved, we hope to break into other regions like start ramping in Germany, start ramping in Austria. Those are the places, we would like to start ramping. And then if you look at Australia and the Asia Pacific, Australia and New Zealand, et cetera. There we really took this opportunity with the component shortages in order to correct our inventory, correct the inventory in the channel. We did that before we brought on a general manager and his expertise, he is a solar guide, he understands storage as well. And we really want him to grow the battery business there. And then the last one is India, we’re not talking about India much, but with the off-grid product starting to come, the pure off-grid product, I'm really excited about the prospects in India as well. There are some niche applications that I am not going to talk about right now. But as our pure off-grid product rolls out in the first half of the year and as Ensemble turns on, there are exciting prospects there as well.

Okay. Thanks so much, guys.

Thank you. And our next question comes from Philip Shen of ROTH Capital Partners. Your line is now open.

Thanks for the questions guys. I have follow-up on the last question there by Colin. I think we're seeing some really nice growth internationally, is there a situation where you can see the international growth rate actually being faster than the U.S.? Or do you kind of look at it in that way at all? And if so, do you see potential for getting to an international versus U.S. mix of call it 60-40 even 50-50 someday in the near call medium-term two to three years out?

Yes, I mean, that's our goal to obviously get to parity in terms of U.S. versus Europe versus Asia to get to something like 33-33-33. But having said that, the U.S. business is the strongest at this point in time, especially with SunPower, especially with our financial stability with the long tail of customers coming back because of our product quality, because of our customer experience. U.S. is really firing on all cylinders right now. And I think, 2019 is going to be about the U.S.. And -- but I'm optimistic that 2021 time frame we can start being more balanced in terms of all the deals.

Great. That makes a lot of sense. And we're even starting to hear about some really aggressive growth rates for the overall U.S. market. I think people going to think about 15% year-over-year growth. But I'm hearing now a 20% -- maybe even 25% or 30% growth in the U.S. as a market overall. Are you guys seeing any of that? And then let's put your internal supply constraints or component shortages aside, when you look at the U.S. market, is there any validation or a potential you think that the overall U.S. market can actually grow 25% year-over-year in 2019 versus 2018? Let me let me specify that for residential and if you want to speak to commercial feel free.

Yes, I mean, I'm going to talk on the residential space. And yes, I mean, look, what I said in the last conference call is that we could not ship more than $10 million of demand. And in the -- I said that in the Q3 conference call, and that number is a little bit higher for Q4. So basically, yes, there is a lot of demand out there and we are seeing a lot of demand because of our financial stability because of our strong balance sheet. Because IQ7 is the latest and greatest product that we have, our customer experience, our high quality. And so demand is strong and it is also probably the middle at this point in time and I expect the next two quarters like that, but I'm optimistic about Q3 and Q4.

Great. On -- following up on that thought there, Badri, can you talk about Q1, and your official guide is $90 million to $95 million. I know you're sold out. I know you had internal constraints, but how much revenue do you think you're leaving on the table as it relates to Q1 specifically?

So Phil, we are not going to break that out. I broke that out in Q3, because just to make sure that our top-line is starting to break out. Now, we are not going to get into the habit of breaking that out. But I’ll just tell you this, I mean, we feel really good, the demand is strong and what we feel bad is we are not -- I mean, we're still not servicing customers well in terms of deliveries, and we need to fix that. That's what I'm working on day and night. That's what our top priority is to not be internally focused, but to be focused on what customers want. And we need to do a lot more work there.

Great. One last one for me on the competitive dynamics in Europe. I know we were just talking about Huawei more skewed to the U.S. but in Europe, they have been selling their products for some time. Can you talk about whether or not you're running into them at all as it relates to installers and customers is their storage product getting, like are you competing with them you think or do you feel like the demand -- overall market demand is so strong it's really not an issue. Would love to get your thoughts on that in Europe. Thanks.

Hey Phil, this is Raghu. Yes, we definitely see them in the market in Europe. We are competing with a very effectively, of course, in the markets that we are more active in Holland and Netherlands and in France and couple of other countries in that region. So we do run into them. But we clearly have been very effective there and doing well, given that in Q4, we had the highest megawatts shipped ever in Europe, both in terms of megawatts actually as well in terms of units. So I think it is -- Badri mentioned this earlier on, it's because we have a really well differentiated product, we do microinverters, we are string with or without optimizer, right. So I think the fact that it's a microinverter that is the highest performance and very high quality and reliability as well as the customer experiences itself including customer support in the work that we have done is what I think separating us from all the other string players that are out there, which obviously there's more than just Huawei. The other thing also is and we touched upon this earlier on the ACM, AC module is going to be very interesting in Europe. We are now actively engaged with a few partners that we’ll announce when we are ready and there is clear value to the -- value generation when installers have installed AC modules both in terms of the savings both on the logistics side as well as the installation time and quality of installation, training, inspection, et cetera. So all in all, we feel pretty -- we feel very good about Europe and it's shown in the numbers right like I said we did record numbers in Q4.

Great, thanks Raghu and Badri. I'll pass it on.

Thank you. [Operator Instructions] Our next question comes from Pavel Molchanov with Raymond James. Your line is now open.

Thank you for taking the question guys. Given the deleveraging that you've recently accomplished with a debt pay down and the cash flow that you'll likely generate in 2019. I'm curious if you're becoming more open to acquisition opportunities above and beyond what you've purchased from SunPower. I know that hasn't historically been the Enphase business model to do M&A but any changes on that front?

Yes. So, the conversation about the strategic target is accretive short impact acquisitions similar to something like SunPower on different parts of the spaces more in line with the complimentary to assemble our position in the commercial sector are always part of the discussion here, right. The success on how we integrated paid for and we studying harvesting the benefit associated with the SunPower transaction put a high bar in terms of what we are trying to achieve, right. And we have cash, we feel very comfortable, but we want to be very careful on how we are going to go about spending it and targeting, trust me, Pavel, I mean, there will not be kind of big diversion to what we are trying to do for 2019 strategy or potentially decisions that we eventually will need to have a payback that extends beyond 18 months or maybe 2 years right. So that's kind of how we are seeing it.

Okay. And can we get a quick update on the tariff exemption process with relation to the AC modules? I know that's been kind of a work in progress for a while.

Yes you can get an update and the update is that we have not heard back.

I can understand how that can be. All right, thanks guys.

Thank you. And our next question comes from Brad Meikle with Williams Trading. Your line is now open

Thanks. Just a follow-up. So you've spoken about one power MOFSET line that's running, another one that's coming up and as well as a couple of contracts I think from a supplier standpoint. So obviously implies a lot more demand out there and a lot more supply. Can you speak to your level of confidence that the demand is there and what -- I know you are not guiding on the second half, but just kind of what your demand visibility is for the second half? And just as part of the capacity ramp up also I wanted to know what portion you expect of U.S. demand to be from Guadalajara in the second and third quarter? Thank you.

So Brad, so like what I -- I mean you already know we're not going to be talking about specific demand in the beyond Q1. But, having said that, our objective is to basically make sure we take all supply related problems off the table. That's what we would like to do. That is why I went and did in the last couple of months I went and take these additional two long term contracts. And you know, Guadalajara coming on is an interesting dynamic it doesn't change anything on the supply scenario. But it does one thing with the stream line inventory and cycle time to all our customers, which we think is important especially as we service the U.S. So if we do a good job in ramping, the Flex Mexico there's no reason why we cannot ship almost all of the North American demand from Mexico. Time will tell in terms of the quality of their plant, et cetera which we will have to see, but we are working towards that.

Thank you. And just last question is I guess solarquotes.com at EU and Australia reported of solar edge threatening to sue some of the customers around the failure rates being higher I guess unexpected in that region we've heard about it in the U.S. as well. Can you speak to whether you think that Enphase will benefit from market share shift away as a result. And just broadly speaking, what your feeling is in terms of your potential for market share again.

So Brad, we’re not going to comment on the competition what their strategies, et cetera but like, I sound like a broken record what -- where we really our core strength are the product quality, superior customer experience, that is what we do, ease of use, high quality, high customer service. And so we will continue to offer that to customers. And if they pick us we are more than happy we need to solve this component shortages, we can start servicing them right.

Thank you.

Thank you. [Operator instructions] I am not showing any further questions at this time. I would now like to turn the call back over Badri Kothandaraman for any further remarks.

Yes, thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you once again on our call next quarter.

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