Good day, ladies and gentlemen, and welcome to the Enphase Energy Second Quarter 2019 Financial Results Conference Call. [Operator Instructions]. As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Ms. Christina Carrabino. You may begin.

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's Second Quarter 2019 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 second quarter ended June 30, 2019. During this conference call, Enphase management will make forward-looking statements including, but not limited to, statements related to Enphase Energy's financial performance, and the capabilities and performance of its technology and products, operations including service capacity and supply and current and future market and customer demands and trends for its services and products. These forward-looking statements involve significant risks and uncertainties, and Enphase Energy's actual results and the timing of events is different 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, 2018, which is on file with the SEC and the quarterly report on Form 10-Q for the quarter ended June 30, 2019, which will be filed with the SEC in the third 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 Second Quarter 2019 Financial Results. We had a pretty strong quarter. We reported revenue of $134.1 million, reflecting the strong demand from our customers across the board. While the demand continued to outstrip available supply in Q2, we were able to increase capacity to better support our customers. I will provide a supply update later in the call. Our non-GAAP gross margin in the second quarter was 34.1% and our non-GAAP operating income was $23.2 million. Our gross margin was negatively impacted by 330 basis points due to expedite fees related to component shortages. The expedite fees were in the form of air shipments made to service our customers.We continued to make a lot of progress in strengthening our balance sheet. We exited the second quarter with a cash balance of $206 million, which included net proceeds of approximately $115.5 million associated with the issuance of convertible senior notes due 2024 and the repurchase and exchange of certain convertible notes due 2023.We exited Q2 with approximately 34-17-17. This means 34% gross margin, 17% operating expense and 17% operating income, all approximate non-GAAP numbers -- percentage. The most obvious question is whether we are going to reset our target financial base model, given that we're doing a lot better than 30-20-10. It is certainly a possibility that we will consider a new model in the future, but we would like a few more quarters of solid execution under our belt. Eric will go into greater detail about our financial results later in the call.Let's now talk about ease of doing business, how customers perceive us. Our Net Promoter Score in Q2 was 53% in North America. However, our call wait times were a little bit higher than what we wanted.…

Thanks, Badri. I will provide more details related to our second quarter of 2019 financial results as well as our business outlook for the third 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 reconciliation of these non-GAAP to GAAP financial measures in our earnings release posted today, which can also be found in the Investor Relations section of our website.Total revenue for the second quarter of 2019 was $134.1 million, an increase of 34% sequentially and an increase of 77% year-over-year. We shipped approximately 416 megawatts DC in the second quarter of 2019, an increase in megawatts of 36% sequentially and an increase of 105% from the year-ago quarter. The megawatts shipped represent 1.283 million microinverters, approximately 98% of which was IQ 7. Both IQ 6 and IQ 7 represented almost 100% of the Q2 microinverter shipments.Non-GAAP gross margin for the second quarter of 2019 was 34.1% compared to 33.5% for the first quarter. Component shortages continue to negatively impact our Q2 non-GAAP gross margin by approximately 330 basis points.Non-GAAP operating expenses were $22.5 million for the second quarter of 2019, compared to $22.3 million in Q1 and $19 million in the second quarter of 2018. GAAP operating expenses were $27.9 million for the second quarter of 2019, compared to $26.2 million in Q1 and $23.3 million in the second quarter of 2018. GAAP operating expenses for the second quarter included $4.2 million of stock-based compensation expenses, $546,000 of amortization expenses for acquired intangible assets and $631,000 of restructuring expense.On a non-GAAP basis, income from operation was $23.2 million in the second quarter of 2019, compared to $11.3 million in Q1 and $4.1 million in the year-ago quarter. This increasing operating income is reflective of…

[Operator Instructions]. And our first question comes from Colin Rusch with Oppenheimer.

Can you talk a little bit about the preparedness of the supply chain to support the elevated levels of revenue that you're seeing? Certainly, I think a lot of us are trying to figure out what the real ceiling is here.

Yes. We have been talking about component shortages in the last few quarters. And what we have done as we have qualified multiple suppliers, especially for the high-voltage FETs, we have signed a bunch of contracts. And we have been increasing our microinverter output quarter-on-quarter. If you notice, Q1 was approximately 980,000 microinverters, Q2 is about 1.28 million microinverters. And we expect roughly -- if you look at the midpoint of guidance, we expect around 1.7 to 1.8 million microinverters in Q3. And we are really comfortable with that. And also we are on track to do couple of million microinverters in terms of supply, we will be ready for couple of million microinverters in Q4. So basically, in terms of high-voltage transistors, I think we expect to be largely in good shape as we exit 2019.

Okay. And then just in terms of pricing power with your customers. How much do you have right now? Is it a situation where you guys could actually raise prices here or in the last couple of quarters and sustain that into 2020? Or are you just trying to move as much volume as you can right now?

Well, I mean, we have already increased pricing on customers because of the tariffs. The customers are actually absorbing the pricing today. And in general, other than that the pricing environment is largely stable.

And our next question comes from Eric Stine with Craig-Hallum.

Maybe I'd just like to talk about SunPower a little bit. You said that you will be fully transitioned there and ramped there. Maybe just -- maybe if you can quantify what your expectation is for the 3Q contribution. And just looking at your Q2 number, I mean it does seem like that's trending well ahead of what your initial expectation was. So maybe just talk about how that's playing into the guidance and certainly as a big part of the rest of your overall business?

We did the SunPower transaction last year. We announced the transaction in June, we closed the acquisition in August of 2018. We said we would, by and large, be done by the second quarter of 2019. And that is the case. We are done with the SunPower acquisition, meaning we are done with the ramp. Basically, we also said we will do roughly about $60 million to $70 million of annualized run rate when the business ramps. So everything revenue we did in Q2 is completely consistent with that. So SunPower was largely on track, things are going well. If SunPower does well, we do well and that's all we can say right now.

Yes, no, I got it. Okay, maybe I don't know if this is a number you've ever disclosed, but I'm just curious what percentage of your mix would be AC modules. And just obviously, that's a big component of the traction that you're getting. And wondering if that is something that's attracting other people, other potential partners for that in the market.

Yes. To tell you on the AC modules is not a hockey stick growth, it is steady -- slow and steady growth. And of course, the biggest customers there are SunPower and then, we have Panasonic started ramping couple of quarters ago. And Solaria is also ramping right now. And then, we are working with a couple of people -- couple of module customers in Europe to provide some differentiator AC module solutions. I would say, the pickup is kind of steady. And to date, about 400 or 500 installers have tried AC modules. It's not that they are going to switch to AC modules forever, but they have at least tried AC modules, and in our experience, once you try AC modules, usually you stick to that. Right now it's slow and steady.

Okay, but it's fair to see we should see -- or it's very possible we see more partners for you in that area?

Yes. I mean we are always in the process of adding partners if and when it makes sense. And that will be the case going forward.

Okay. Last one for me. Just on the component shortages you mentioned that you expect that to be pretty much taken care of by the end of the year, but I also know expedited shipping is -- can be just a part of the business. What would you expect a more normal number to be rather than the 300 basis points it was this quarter?

Yes. Normal [indiscernible] net as usual I would say expedite should be between 1 and 2, 1% and 2%, basically between 100 and 200 basis points. Component shortages, like what I said, we're largely out of the woods on high-voltage FETs, but think about it like this. The microinverter uses 300 components. So we are always constantly monitoring the supply chain on -- we are looking a few quarters ahead and making sure that we are completely out of the woods in general.

And our next question comes from Philip Shen with Roth Capital Partners.

Congrats on the results, nice quarter. Wanted to ask about your units here, you talked about the 1.7 to 1.8 in Q3. And obviously $2 million in Q4 units. Is it possible to -- that Mexico could come in better-than-expected as we get into 2020? Is there potential for that facility to be able to ship closer to 2.5 million or maybe even 3 million units?

Yes, look, I mean we are only going to talk about right now our numbers for Q4 '19, but as a management team, what we do, we look at the next 6 quarters and we look at it on a monthly basis and then we are going to constantly look at our capacity. So the capacity is now a monthly process versus a one-time event. So of course, we gave you specific numbers for Q4 '19, but that doesn't mean we are not going to increase that number. So that number will continuously increase as far as demand also accumulates at the same level. And we are in a great position to do so because we have the [indiscernible] factory, Flextronics has done an amazing job there. And also, we have a capital light approach. All we need to do is to add the textures. So the capital investment is quite light. Of course, there is a lead time for it that's usually a quarter. So as long as we have reasonable notification, which we have with a six quarter forecasting methodology, there is no reason why we won't have -- why we cannot ramp up.

Great. And then to what degree are you considering alternative geographies for capacity as well. So beyond China and Mexico. Is there anything there that you guys might be able to share?

Yes. We are not going to share in detail, but I'll tell you one thing that we have always talked about multi-sourcing. In all aspects of our business. And that is truly everywhere. So you can count on us to deploy the strategy wherever it makes sense in -- I'll leave it at that.

Fantastic. As it relates to safe harbor, Eric, I know you guys talked about $6 million to $10 million in Q3. We've heard in our checks that there are some meaningful safe harbor deals brewing. So $6 million to $10 million seems a little bit modest, but it is earlier in the year. As you ramp up to Q4, what percentage of your shipments in Q4 could actually be safe harbor?

We are not going to be talking about Q4 at this point right now, we have great visibility, but good visibility of Q3. We don't yet know about Q4, we'll talk about it when we're ready in the next earnings call.

Great, Badri. And this is a very quick set of housekeeping questions. Can you share what the impact of the tariff was on the margin in terms of basis points or maybe even dollars? And then, in terms of megawatts, any chance you guys could share how many megawatts was actually shipped in the U.S. or delivered in the U.S. in Q2? And if you think you guys are actually taking share from your peer at this point?

Well, I'll have Eric comment on the basis points if he's ready, but in terms of the megawatts, we said the rough split up in geographies we said 70 -- remember we said 74% in the U.S. and 26% outside the U.S. So you should think about the overall megawatts from that ratio.

Great, Badri. Eric, any thoughts on the tariffs impact on the margin?

Well, Phil we will not break it out, but you know the tariff percentage, as you know, we actually increased prices to cover 100% or a portion of it, I guess, of the cost, right. So we are sharing that cost with our customers, right. And so with that being said, we shouldn't be concerned about the breakout. It's all covered about -- through the price increase.

Our next question comes from Brad Meikle with Williams Research.

Wow, great revenue growth...

Brad?

You are growing a lot faster than the market. And then also last call you said you were sold out in Q2 at the time of the call. Are you sold out in Q3?

Yes, we are fully booked for Q3. Yes, at this point in time.

And how do you make sense of the amount of -- obviously, there was a discount to the amount of business you were doing because of the bankability issue and there's a lot of catch-up. How do you interpret the amount of obvious market share that you're taking now?

Yes, it's basically comes back to the four things that always talk about. One is the bankability that you said and our balance sheet is pretty strong. And you guys know a lot about it. Our cash balance today is $206 million. Second is our product quality. Our target is to be at an annual DPPM of 500. We are not there today, but we are well on our way there. That's two. Number three is customer experience. Although we did go a little bit higher on rate times, we are really committed as the management team. In fact, in every executive staff meeting Tuesday, the first thing I review is the customer service calls, the sample of them to understand what kind of problems customers are having. So we are laser focused as management team on customer service. And the last one is innovation. I believe customers want to stick with us because of products like Ensemble.Of course, we haven't executed well on Ensemble. It's been delayed a little bit, so that's why we didn't talk about it much. But we're laser focused on getting Ensemble 1.0, which is the residential -- with the focus on residential storage, we are laser focus on getting the product out in the fourth quarter of 2019. So we are heads down there. So these are the four things. And I think I would like to think these are the ones that cause the customers to come back and the demand overall comes from long tail customers, those are the broad base of customers, they in particular, the long tail of customers really is suited -- is the right -- are the right customers base for us because of the focus on quality and customer experience; they just don't have the time to deal with quality issues, or they don't have the time to keep calling us again. So it's really that's the place where we service well. So Brad, these are the factors. And I'm not sure that I answered you enough.

Just one other question would be, can you talk about the Mexico ramp? I think on July 1; you have a press release saying that the volumes were finally ramping out of Mexico. And you said in the past that Q1 of next year would be 100% Mexico. So should we just assume it's a linear ramp to that January level?

Yes, let me tell you a few things in the Mexico ramp. Basically, we are a couple of months behind what I expected. And it's really for us transferring the process steps using copy exact methodology. Basically it didn't go great. Two of the 230 process steps had issues. We quickly got on it, and the nice thing is we were able to get all of the signals in line in terms of reliability, monitors as well as we were able to do audit. So of course, that total is a little bit behind, that's why we started shipping only on July 1. And having said that, in this quarter, we will probably -- my team is looking at me, but we will probably do somewhere around a couple of hundred thousand units in Q3 of '19. And in two or three quarters from now, we expect the years to stabilize. We expect to have enough manpower to running all ships, but we are really laser focus on quality. We would like to ramp at the right levels, have a controlled ramp. So I'm looking for the next 90 days. Can we execute and do 200,000 units in Q3? That's what I'm looking at.

Just last small one was, can you tell us the total megawatts shipped in the U.S. in Q2?

Well, we already disclosed the megawatts for the quarter being 416 megawatts DC, so we talked about 74% being domestic. So you can probably do the math.

Yes, 74% of 416, that is roughly 312, around that.

Our next question comes from Jeff Osborne with Cowen & Company.

Congratulations from me on the strong results. A couple questions of mine. I was wondering if you could just flesh out the share gains. Are you seeing any noticeable trends, Badri, on sort of the larger Top 5 installers in North America? Or is it more the longer tail of folks buying through distribution. Any noticeable commentary you have there would be helpful.

Yes. We are not going to give out any market share numbers because we don't look at the business like that. Basically, we are laser focused on customer experience, we are laser focused on our quality. And at the end of the day, profitable top line growth is what we are looking at. Having said that, we have 100% of the SunPower business. The North American demand is ramping quite nicely across the board and our long tail of customers is probably the place where we basically are gaining some share. And Europe is also, if you see the Europe numbers are also not too shabby either. The places that we are doing well are actually Netherlands and France. And I was just in Europe to do a bunch of review meetings there and it does turn out that Netherlands is the fastest growing country in Europe. So I think we are in the right places there. And these basically contribute to overall share.

That's helpful and while you're meandering around the world, any commentary you have on the new leadership in Australia or Asia-Pacific more broadly?

We put the new leadership in place a couple of quarters ago. I'm going to be in Australia pretty soon. We are going to do a similar kind of exercise that what we did in Europe, but I think Australia, we need to rebuild our organization first. I think the Australian market is a very interesting market, both in terms of solar plus storage and it is not a small market. And so we are going to work on it.

Makes sense. I had two other quick ones here. One, could you just give any sense of indication -- you mentioned fully booked for Q3. And demand constraint or supply constraint, sorry, for Q2. Any sense of what that excess demand was in 2Q, that you couldn't meet or did that just slip into Q3? I'm just trying to get a sense of are people walking away from you because your lead times are too long?

We are not going to break out the specific numbers, but we have had this situation of the last three quarters, people have not walked away, and as I mentioned, we are fully booked for Q3. And we still have a lot more days left in Q3.

Makes sense. And then just the last one I had is just around the fourth pillar of your strategy around services and I'm an Enphase customer myself. I just received an e-mail today asking me to enroll in your program, but can you just talk about your attempt at services in getting the consumer engaged. And how do you bridge the border of stepping on the toes of the installer versus going straight to the customer in bringing them awareness of Ensemble and getting them on the 5,000 person waiting list to upgrade. If I click on that link in my own e-mail that I received today, does my installer receive an indication that I'm interested in doing that? Or can you just walk us through how that works? How you monetize that?

First of all, I'm going to say this is pretty nascent. And we are basically starting to scratch the surface. And I think you should -- if you are thinking that we are going around the installers, you should scratch that. We can never, ever go around the installers. The installers are a conduit for us. And basically, it is like what can we do in order to better service the customers. Here we are talking about the legacy product upgrade program. These customers bought the first two generations of Enphase products from us, now it's obviously been time. We would like to give them the option of purchasing an IQ 7 system and maybe also purchasing an Encharge system when it is available. So therefore, in a sense we basically generate the demand. And we essentially pass on the demand to our installers -- our network of installers who basically service it for us. So it is a win-win situation for both of us and not excluding the installers. So that's just scratching the surface. Of course there's a lot more things that we can start doing, understanding the consumption, providing homeowners a bunch of tools to enable that and we'll start talking a lot more about those down the line.

Our next question comes from Maheep Mandloi from Crédit Suisse.

Congratulations on the quarter. Just trying to dig more on the market share and thanks for the comments earlier, but can you just talk about how much of the growth in Q2 or even Q3 is driven by gaining market share versus overall growth, just trying to understand like your thoughts on the North American market business?

It's the same answer that I gave Jeff. We are not going to give out any numbers in market share, but the reasons why we are gaining market share, I believe, is basically along the lines of our core competence is essentially the focus on providing the highest quality, the highest customer experience and basically, products like Ensemble showed innovation in our product innovation capability. We think customers would like to stick to somebody who has an innovation road map like Ensemble. So those are the broad strokes and, of course, the healthy balance sheet always helps.

Got it. Second, you said you're fully booked in Q3, but how does the bookings look beyond Q3 or how should we think about that. And as part of that question, like, how do you think of the international mix in 2020 or kind of like a long-term target. Can you give an update on that?

Yes, we're not going to be breaking out numbers on Q4 bookings, it's just too early right now, it's not -- we are not going to give guidance. In terms of international mix, obviously with the SunPower acquisition, international mix is skewed a little bit towards North America. Right now we are approximately 75-25 and in the past has given numbers if possible, 50-50 would be nice. 50 North America and 50 rest of the world would be nice in a couple of years. And ultimately, something that is balance between APAC, Europe and North America would be actually perfect, but that's a little bit beyond doubt -- beyond that.

And just last question on Ensemble, could you just talk about like delay we now expect in Q4. And would we see some initial presentations to dealers, so could you just talk about like their initial feedback from dealers and U.S. rather markets?

Yes, Ensemble 1.0 is expected to basically release in Q4 of '19 and particularly we entered toward residential storage. And we haven't started any alpha or beta demonstration yet. In the next three months, we expect to obviously start doing those two with a few installers. But right now, we are laser focused on the development, we are heads down. It's all about execution.

Our next question comes from Amit Dayal with H.C. Wainwright.

Most of my questions have been asked. Just looking at IQ 8, is this more of a 2020 driver now largely?

No, it's not. If you see our Ensemble 1.0, we are talking about high-capacity residential storage for North America. If you see the Encharge, the Encharge battery system, it has got battery cells, it has got battery management system, software, the controller, battery controllers plus. Every 3.3 kilowatt hour system has got four IQ 8s. That IQ 8 is nothing but our grid forming microinverter. That's how we put together a battery system. So IQ 8 will be inside our battery. And that will be the first product that we will be releasing, that's what we call Ensemble 1.0. That will work with IQ 6 and IQ 7 installed base on the PV side. That's what we're going to release in the fourth quarter of 2019. And of course, Ensemble 2.0 is what we are talking about IQ 8 PV, which is IQ 8 on the roof, the IQ 8 solar system, that could be available in 2020.

Okay, understood. So as we move into more of a home energy management solutions company, how should we think about -- and this is more longer term obviously, but the shift in margins. How much of these services could be SaaS-type offerings? Or are they still going to be one-time sale. Can you provide any color on -- think about this?

Good question. These are more -- I think we will have a detailed discussion of these in the Analyst Day. The way we are thinking about it is storage alone -- like what I've said multiple times, the revenue potential for storage will take us from $2,000 per home, which is a pure microinverter play to over $10,000 per home. And then, consumption and services obviously add on a little bit more there. So basically, it will help us on the revenue side and on the gross margin side, no matter what business we take, we already established a floor. We are never going to take a business that is not 30% gross margin. And so our gross margin targets this quarter in terms of guidance or the midpoint of gross margin would be 34.5. Gross margin would be around that number.

Understood. And on the OpEx site, from just your ramping on the revenues on the OpEx. Are we at a stable level of these current levels? Or do we expect some ramp obviously from a marketing point of view, it may be some increases, but generally should we expect leverage to now really start kicking in?

Yes. So you remember that we -- this is Eric. I don't know if you remember we had the big realignment of resources around the world, where we did double structure activity moving a functional [indiscernible], we created a new headquarter in Fremont establishing a center of excellence in India, plus additional R&D resources in New Zealand, right? Four of those are part of the bigger strategy on how we are going to be able to scale and we are going to have operating leverage, right? So from a expand point of view, operating leverage at the corporate level on G&A is probably already somewhat reflective of the guidance, right? So if you look at the guidance, we are at 14% OpEx as a revenue, right? Now in terms of sales and marketing and R&D, remember we are an innovation company, right? So our focus on investing on new products and product development and digital platform work and all that kind of stuff that Badri mentioned as part of our strategy and we'll have that probably in R&D part of that kind of [indiscernible] OpEx as well the same results of marketing growing regionally. Yes, we developed Europe, I think Badri mentioned Asia-Pacific We may need boots on the ground, a sales force there. We are going to roll out formation as well, right, in those depreciation associated with those technologies or licenses will also hit OpEx, right, in many cases. So I think that we have a healthy operating leverage, already will trigger on the guidance. You should also think about how those R&D investments will materialize over time, right.

Our next question comes from Pavel Molchanov from Raymond James.

On power storage. So sounds like Q4 is when you expect that to become, kind of, financially needle moving in the sales mix for the first time. Is that fair to say?

No, Q4 '19 will not be needle moving. Q4 '19 will be the introduction and then obviously, there will be a ramp. And I would say needle moving will be in 2020.

Okay. And when you talk about margin structure, 30% your long-term target, you're obviously a little above that now. Before the introduction of the storage product, is storage, all else being equal, likely to move that up or down, given the different competitive dynamics in the battery market as compared to microinverters?

Storage will always be at our corporate gross margin. And the reason I say that is, of course, if you -- this is not a commodity product, right? This is where we are going to differentiate Ensemble from the rest of the fact is the unique features that we are going to be offering. The flexibility, the scalability, the modularity and then, eventually, the Ensemble will work with our IQ 8 on the road. In addition, that is a bunch of software that we can introduce in order to enhance the customer experience. So you should not think about it as what you're thinking just on the battery cell site. It will fall in line with our corporate gross margin.

Our next question comes from a follow-up from Bradford Meikle with Williams Research.

I have a quick follow-up. How much do you think the market share gains is driven by the lower failure rates in our surveys of installers, we increasingly been hearing of high 5%, 10% failure rates at SolarEdge. And I'm not sure what yours are exactly, but I think they are probably 90% less than that. How much do you think that's a driver of the unit growth?

That we are not going to comment on that.

Okay. Well, in Storage, just to get a sense for how quickly it could grow. I know you're in touch with a lot of your existing installed base. Have you asked that installed base what their interest is in storage or do you know what percentage roughly might have said that they would be interested?

Yes, of course, these are surveys that are not comprehensive, but usually, people get excited when you ask them such questions and then they change their mind when it comes time to cut the check. So we'll see, we are very close to launching this product. So we are heads down launching this product right now. We will look at both new installers as well as the -- our existing [indiscernible], but we are obviously excited.

[Operator Instructions]. And I'm showing no further questions at this time. I'd like to turn the call back to Badri Kothandaraman for any closing remarks.

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

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