Good afternoon, and welcome to Enphase Energy's Third Quarter 2023 Financial Results Conference Call. [Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Zach Freedman. Please go ahead sir.

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's third quarter 2023 results. On today's call are Badri Kothandaraman, our President and Chief Executive Officer; Mandy Yang, our Chief Financial Officer; and Raghu Belur, our Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September 30, 2023. During this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to our expected future financial performance, market trends the capabilities of our technology and products and the benefits to homeowners and installers; our operations, including manufacturing, customer service and supply and demand; anticipated growth in existing and new markets; the timing of new product introductions and regulatory and tax matters. These forward-looking statements involve significant risks and uncertainties, and our 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 our most recent Form 10-K and 10-Qs filed with the SEC. We caution you not to place any undue reliance on forward-looking statements and undertake no duty or obligation to update any forward-looking statements as a result of new information, future events or changes in 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. We have provided a reconciliation of these non-GAAP financial measures to GAAP financial measures in our earnings release furnished with the SEC on Form 8-K which can also be found in the Investor Relations section of our website. Now, I'd like to introduce Badri Kothandaraman, our President and Chief Executive Officer. Badri?

Good afternoon and thanks for joining us today to discuss our third quarter 2023 financial results. We reported quarterly revenue of $551.1 million, shipped approximately 3.9 million microinverters and 86 megawatt hours of batteries and generated free cash flow of $122 million. Approximately 86% of our Q3 microinverter shipments were IQ8. We exited the third quarter at 48% gross margin, 18% operating expense and 30% operating income, all as a percentage of revenue on a non-GAAP basis and including the IRA benefit. Mandy will go into our financials later in the call. Let's now discuss how we are servicing customers. Our worldwide NPS was 77% in Q3, compared to 74% in Q2. Our NPS in North America was 78%, compared to 77% in Q2. Our average call wait time was 1.3 minutes, compared to 1.1 minutes in Q2. We made significant progress on root cause fixes of some customer issues and expanded our field service teams globally. Let's talk about operations. In general, the overall supply environment for microinverters and batteries is quite stable right now. Let's cover microinverters specifically U.S. manufacturing. We began manufacturing at Salcomp's facility in Arlington, Texas during third quarter. We shipped approximately 531,000 microinverters to customers in Q3 from our three contract manufacturers in the U.S. Flex in South Carolina, Foxconn in Wisconsin, and Salcomp in Texas. We expect to ship approximately 1 million microinverters to customers from our U.S. manufacturing facilities in Q4. Let's talk about batteries. For IQ batteries, we have two cell pack suppliers, both of which are in China. We have a manufacturing capacity of 300 megawatt hours per quarter, positioning us well to ramp up in 2024. We are looking at bringing manufacturing of IQ batteries into the U.S. by the middle of 2024. Let's now cover the regions. Our…

Thanks, Badri, and good afternoon, everyone. I will provide more details related to our third quarter of 2023 financial results, as well as our business outlook for the fourth quarter of 2023. We have provided reconciliations of this non-GAAP-to-GAAP financial measures in our earnings release posted today, which can also be found in the IR section of our website. Total revenue for Q3 was $551.1 million. We shipped approximately 1585.6 megawatts DC of microinverters and 86.2 megawatt hours of IQ batteries in the quarter. Non-GAAP growth margin for Q3 was 48.4%, compared to 46.2% in Q2. The increase was driven by increased net IRA benefit. GAAP growth margin was 47.5% for Q3. GAAP and non-GAAP growth margin for Q3 included $14.5 million of net IRA benefit for our microinverters made in the U.S. and shipped to customers in the quarter. Non-GAAP operating expenses were $99 million for Q3, compared to $98.2 million for Q2. We are diligently managing operating expenses and will continue to do so in the coming quarters. GAAP operating expenses were $144 million for Q3, compared to $153 million for Q2. GAAP operating expenses for Q3 included $41.1 million of stock-based compensation expenses and $3.9 million of amortization for acquired intangible assets. On a non-GAAP basis, income from operations for Q3 was $167.6 million, compared to $230.5 million for Q2. On a GAAP basis, income from operations was $118 million for Q3, compared to $170.3 million for Q2. On a non-GAAP basis, net income for Q3 was $141.8 million, compared to $205.6 million for Q2. This resulted in non-GAAP diluted earnings per share of $1.02 for Q3, compared to $1.47 for Q2. GAAP net income for Q3 was $114 million, compared to a GAAP net income of $157.2 million for Q2. This resulted in GAAP diluted earnings…

[Operator Instructions] At this time, we will take our first question, which will come from Brian Lee with Goldman Sachs. Please go ahead.

Hey, guys. Good afternoon. Thanks for taking the questions. I know the environment's pretty uncertain, so appreciate the additional sort of out-quarter visibility and some of the market by market color Badri. So can I just want to ask, as you think about the framework, you said you'd under-ship in Q1 the way that you're under-shipping Q3 and Q4? Can you give us, one, a sense of how much you expect to under-ship in Q1, and then so you made the comment that this is all contingent upon sort of demand trends staying about where they're at. Can you give us a sense of what your internal expectations for demand trends are? It sounds like you don't expect them to get worse but sort of can you quantify that a bit? And then I have a follow up.

Yes, I think there are a few puts and takes. First to answer your question is, is the under shipment going to be close to $150 million in Q1? We expect it to be a little bit less than $150 million, but not too much less. That's our expectation. And second is I will talk about markets, and then it'll become clear to you. First of all, we see the non-California state stabilizing. We see that. So therefore, we aren't that much worried there. Of course, things could go a lot south during the winter, but we are already at pretty low levels, so we don't think so. California is definitely a wild card. But even if that goes down 10% more, I think we'll be fine. Because we expect Europe to recover a little more. Europe right now, for all the reasons I said, we basically are undershipping quite a bit in order to normalize inventory. And that will be the fastest to normalize. So we expect Europe revenue to come back a little bit up in Q1. Therefore, what we expect, at least, what we expect internally is that our revenues, sell-in revenues, we think will be close to what we are looking at in Q4. Of course, I don't have a crystal ball. I'm not giving you Q1 guidance. This is our expectation right now. And Q2 onwards, we think the channel inventory is going to approach normalized levels. And therefore, that normalized level, assuming the demand picture is unchanged, that normal level is what we said, roughly around $450 million to $500 million is the normal level. That assumes no change in demand from the current situation. So we expect our revenue to approach that number in the second quarter. But of course, that doesn't tell…

Yes, that's great context. I appreciate it. Just a second one here, and I'll pass it on. On the margins, gross margins, non-GAAP, it seems like you're guiding the low 40s, ex-IRA benefit. How much of that, it's down a couple hundred bips from what you've been tracking at recently. How much of that is due to pricing? How much due to mix? Maybe can you give us a sense of the margin puts and takes into year end? And then do you see anything that would put incremental pressure on the margins into next year? Thank you.

It's pretty simple. And Brian, you will understand it quickly. You can see our storage business is actually going a little bit up. Our micro inverter business is the one that is going a lot down now because of our under-shipment. And therefore, if you see the product mix issue, and microinverters have a little bit more gross margin than storage. And therefore, with this product mix, that's why we have the guidance of non-GAAP gross margin 40% to 43% for the company without IRA. With IRA, non-GAAP gross margin of 48 to 51. So in terms of pricing, I mean, we are not planning to make any broad-based pricing changes. Of course, the pricing, there is a lot of competition, but we have seen competition for the last few years since I've been here. We have a very disciplined business process. It's a pricing business process. It's called SPA, Phil Shen likes to talk about it. It's a special pricing adjustment. We have been doing that forever, and it is not new. That's one. And also in these times, of course, underloading, we have to work with our contract manufacturers to take care of underloading. But in these times, especially when you have multiple suppliers for a particular component, multi-sourcing for a component, this is the opportunity where we can drop costs a lot. So our target, I mean, any good company in these times, we should be able to drop our cost by 10% per year. And we'll be targeting that. And so we have to talk both equations, pricing and cost. And so we are quite confident in our gross margins. This is what we do. It is not new. This is what we established when I joined the company. We have a pricing team that prices based on value. We have a world-class cost team that works on costs. And it's business as usual for us in these environments.

All right, thank you, I'll pass it on.

Our next question will come from James West with Evercore ISI.

Hey, good afternoon, Badri.

Hi.

Badri, as we're going through this period of destocking and some weakness in certain markets, understanding that you've always faced competition and you have a very value-based pricing strategy, are you seeing any behavior that's by your competitors that is somewhat irrational? Or is the market overall behaving rationally, understanding that this will get out of this in a few quarters?

Well, I'll be lying if I tell you I'm not seeing something irrational. Of course, installers are very stressed, right? They do want to take advantage of the lowest cost available at a given point in time. So therefore, sometimes without understanding, they may want to switch to somebody who's offering low cost. But we usually, most of our installers are, they have a lot of experience. They're very well trained now. And they understand the importance of distributed architecture. They understand the importance of single point, no single point of failure. They understand quality. They understand customer service. And therefore, you might save a few dollars up front, but if you have a quality problem, a service call by the installer is a truck roll. You spend a lot of money in one truck roll. And if you just do one more, I mean, that's it, you have no more room there despite the low cost. So it's a penny wise pound foolish strategy to do that. And they've all realized it. And, if you actually put things in context, let us say the pricing is $3 or $3.50 for what? You look at the inverter bill of materials, probably of the order of 10%. Should you play around there? Should you take a lot of risks there? And it's their call at the end of the day. And many of them are wise to say, we're not going to make that call. So, I mean, we have a lot of robust discussions. This is the time where we are talking to customers more than ever. We have a lot of other tools at our disposal. For example, Solargraf. We do design and proposal. We can generate leads for installers at very economical rates. We can help them on permitting services, for example, sometimes even free of charge. We have a lot of tools at our disposal to reduce their soft costs. And that's critical because we have to look at everything. We cannot look at component level. We have to look at the full system level in these times. And once you start looking at that and have these discussions, usually it comes back to, we get more market share, not less. And more installers want to move to us, not less. You can see some evidence of that in the third party reports.

Okay, okay, got it. That's very helpful, Badri. Thank you. And just one quick follow up for me. You mentioned producing IQ batteries in the U.S. by middle 2024. Did you give a capacity number along with that?

No, we have not given. We will provide more details as we come close to that date.

Okay, got it. Thanks.

Yes, thank you.

Our next question will come from Eric Stein with Craig-Hallum. Please go ahead.

Hi, everyone. So just talking about California, I can appreciate talking or thinking about that as a wild card given what's going on in the market. But if I think about the expectation that that market stays flat, but then the hangover from NEM, which you said has a few quarters here left to work out, I don't want to put words in your mouth, but I mean, is it fair to say that there is some cautious optimism about California as we get into the back half of next year?

Absolutely, yes. As we get into the back half, absolutely. Meaning one is the utility rates are continuing to go up. The second is, let's assume the utility rates go up even by half the amount they are advertised, the payback, like what I said, is going to become, I mean, for a solar plus storage system is going to become the same as, almost the same as a solar only NEM 2.0 system. And, the economics are there actually today. The battery can not only provide resilience, it can help the grid during times of stress in August and September when the grid needs it the most. So it's a combination of you get resilience for yourself, you make money by providing grid services, which is incorporated into the utility rates right now. And we are well positioned to doing that. Why? Because we got great microinverters, number one. We got batteries now that can discharge at very high power, double the power of our earlier batteries. Why is that important? Because during certain hours, you have the utility paying you a lot for exporting power to the grid. And what we can do because of a high discharge rate, during those times we can maximize the power. So we can do that. So we have solar plus storage. And of course we have complete energy management software. And we couple that with our Solargraf design and proposal tool. We have everything, all the optimization at the fingertips of the homeowner. And many times he needs to do nothing. He just needs to turn on our optimization engine. It'll do the right thing for him. So we're absolutely very bullish about California towards the second half of 2024.

Got it. And maybe just sticking with California for my follow-up, with NEM, is that whole, that transition takes place being the biggest factor? I mean, what are some of the other factors that could do, that cause California to be a wildcard? What are the things that are maybe top of mind for you that could cause that market to take another leg down?

Yes, this is Raghu. And as Badri mentioned, all of the potential tailwinds that are there, remember in an environment where the demand per home is continuing to go up, people are continuing to electrify. People are buying more and more EVs, heat pumps, etcetera. And couple that with utility rates where they are and going further up, this is the right solution. Solar plus battery is the right solution. The energy management software is absolutely the right solution in order to drive your ROI and as well as reduce your payback. And to that end, what we have done as well is a lot of education into the marketplace in terms of explaining to people, what the benefits of, solar plus battery system with energy management and etcetera. And going out there and educating the market as well as providing them with a lot of tools. So in this environment where demand is going up, you have the education, you have the tools, the financials are there, the payback is very good. That's the reason why we are extremely bullish about California coming back strongly.

So to answer the question in another way, the headwinds are, headwinds that we see are if installers, aren't educated by us properly. If we don't do a good job of educating the installers, things can stall out a little bit. So it is important for us and other companies to, in this space, to make sure the installers, whatever we provide installers, the tools are very easy to use so that they can sit at the kitchen table and look at the homeowner and say, your payback is six years. And here is why your payback is six years. And explain to them very confidently. And it's not just Enphase, it is Enphase plus our competition, plus all of the energy companies. All of us have to do our job in training the, installers. And I think that is, of course, that's a piece that is not very easy to do. And you cannot have enough of it. So that's the biggest headwind that I see.

Okay, thank you.

Our next question will come from Colin Rusch with Oppenheimer. Please go ahead.

Thanks so much, guys. Can you talk a little bit about how much modulation you can do with the OpEx? As you look at investing in these incremental programs and bringing these products to market, is there some incremental cutting that you can do? Or there's going to be a regular spend increase on the R&D side?

No, I mean, we are cutting OpEx by 12% from Q3 to Q4. How are we doing that? We are on a hiring freeze, except for critical positions, for example, in sales and customer service, and to a little bit on the innovation side there. So basically, that has got a big effect on, bringing down costs. The other ones are there are a few professional expenses, like, for example, this is the time where we look at a lot of fat, cutting out a lot of fat in the company. For example, when the companies are doing well, we do hire a lot of contractors. And, we are looking at all of those, and we have taken all the necessary actions to cut that level as well. And of course, as we continue to grow, I cannot deny that there is some fat that we found we can easily cut in other areas. We're able to cut about 12%. We are always looking for further room to cut because we'd like to get back to our baseline of OpEx pretty quickly, which is 15% of sales. So, we'll give the guidance accordingly. And of course, this is a dislocation in revenue, and that is temporary, but we're very cognizant of that, and we are always going to be trying to operate close to our model, which is 15% of sales.

Excellent. And then on the component side, given the change in volumes that you guys are working through on the microinverter side, obviously you're guiding to reasonably stable gross margins here, but I'm assuming that there's going to be, some breakpoints on the components that you may run into with a negative impact. Can you just talk a little bit about how your suppliers are scaling down with you here over the next quarter or two or three, and what that might do to your COGS line?

Yes, I mean, it is a tough situation for our contract manufacturers, no question. And but we have great partners here. We have Flex, an amazing partner who helped us when we were, especially 2017, 2018, when we had some tough times, they were there right with us. Salcomp, also a great partner. So we work well together. We do have this is the time where both of us can recognize saying okay is this a short-term problem? Is this a long-term problem? Can we do things structurally? We recognize that both of us need to be profitable not just one versus the other. And we do take some necessary actions and all of those are confidential in terms of our relationships. I mean we cannot disclose the actions we are taking but our P&L always incorporates all of these. And so the message is over the next few quarters we will continue to work with them. We will give you the P&L transparently in the guidance for gross margin but we are very confident that you know we are finding the right solutions working together.

Okay thanks so much guys.

Thank you.

And our next question will come from Philip Shen with ROTH Capital. Please go ahead.

Hey guys thanks for taking my question. Badri you brought up SPA so I figured I'd jump in with a question on that. As you know our checks have come up with lower micro pricing under a bunch of SPA agreements on the order of 10%. Does that resonate with you at all or is that off base? I know you often will get something in return for some kind of price when you negotiate the SPA maybe a exclusivity or higher volume. Can you just talk through that a little bit? And then Mandy can you talk through how SPA accounting might work on your financial statements? For example do you net the SPA like the refunds against your sales? Do you have net sales or do you accrue a liability on your balance sheet? Thanks.

So SPA first of all for the others in the call, SPA stands for special pricing adjustment. It is a business process that has been forever at Enphase and it is always happening. It's business as usual. A large fraction of our business usually happens at what we call it ADLP which is the distributor list price. And you know if business happens at ADLP there is no SPA. But for a small fraction of our customers depending upon how their volumes may go up within the quarter, next quarter, depending on their forecast we do SPA. SPAs are you have a volume price curve and when the volume goes up the price comes down. And that's how it is. And that process is very active. It's always been active. It's the one I instituted six years ago when I came and the accounting for that is unchanged. Whatever it is exactly what we have done in the last six years. So you know you talk about a $10 reduction. All of those are anecdotal. They don't matter. One customer doesn't matter. It's not a trend. It is a large fraction of our customers buy at the list price. So you know I'd like you to you know if there is a broad-based pricing adjustment we will tell you. And we are telling you right now that there is no broad-based pricing adjustment from us. Yes we will continue to do SPAs. That's the way of life for us. And sometimes it is a way for us to lock market share for the next you know X amount of quarters. And we'll do that. It's business as usual. Nothing new.

So Phil to answer your accounting question. Yes we accrue for SPA rebates as our liability right. When we recognize revenue the associated future potential rebates for the current quarter should be we accrue a reduction in revenue and is the liability on our balance sheet. Same accounting process. No change.

Great. Thanks guys. Okay and then shifting gears. Appreciate that color. Thank you. I know you don't have any official guidance for 2024 but was wondering if you could talk through how you expect margin to trend by quarter in 2024. So you gave some perspective on Q1. There's under shipment there. Close to Q4. So due to product mix. So should we expect Q1 margin to be similar to Q4 because that product mix is maybe more heavily skewed to batteries again. And then due to product mix returning back in this base case to micros more micros potentially in Q2, after the undershipment in Q4 and 1, would you expect margins to return back to the pre-undershipment levels in Q2 of 2024 and back out next year? Thanks.

Yes, I mean, that's logical. It is logical. If at Q1 what you said is right, we expect similar levels. Of course, I'm not giving guidance, but I'm just giving trends. And then Q2, we expect it to, because the mix is going to change. The microinverter mix is going to be a little bit higher than the prior quarter. So we expect that logically. That's correct.

Great, okay, thanks guys. I'll pass it on.

Our next question will come from Mark Strouse with JPMorgan. Please go ahead.

Yes, thanks for taking our questions. I believe I asked this on the Q2 call as well, but just kind of given the precipitous decline in valuations across the space, I thought it's worth revisiting. So you're obviously sitting on a pile of cash. You continue to generate cash. Just curious, your latest thoughts on M&A, if that's something that you're planning on leaning into until the macro improves here?

Yes, we do take a look at a number of companies all the time, every week. I have an M&A meeting. There are a lot of companies that come. We are very careful, especially in these times, to not buy something in a hurry. We're also careful of making sure that that company is aligned, of course, in terms of strategic fit and cultural fit. The former is extremely important. The latter is practically even more important. So the areas that we usually look for are more in the energy management software, sometimes in home automation, for example, small commercial solar, any innovation in batteries. We look for these. Usually we like smaller companies, bolt-on acquisitions. That's what we have done till now. But I mean, we are looking at all kinds of companies. Please stay tuned. If we are going to move on something, it won't be without you knowing.

Okay, thanks, Badri. And then just a real quick follow-up. I apologize if I missed this, but was there an update on the small commercial product, the timing or any color there?

Yes, yes, there was. We are right now doing beta installations as we speak. The product is working great. We expect to introduce this product in this quarter, current quarter, and we expect to make some reasonable revenue out of this product in Q4.

Okay, thanks, Badri.

Our next question will come from Steve Fleishman with Wolfe Research. Please go ahead.

Yes, hi, thank you. The 150 million of undershipped [Ph] that you're talking about, could you break that out between the U.S. and Europe?

I would say approximately equal between the two.

Thank you. And then in Europe, the impact of, you mentioned two things, the weaker demand, and then also the issues with the distributors, de-stocking and the like. Could you just give some flavor of what, when you look at the weakness, you started to see what, are they about equal drivers? Is one kind of dominating the other?

Yes, actually, to tell you the truth, every country is a little bit different. Clubbing them together under macroeconomics will not do justice, but there are a few factors, let me tell you, overall thing that can be generalized. It's basically, if you rewind to last year, all distributors, installers, consumers, were a lot more aggressive due to the Ukraine crisis. The Ukraine crisis, the shortage of natural gas, caused many countries to be very aggressive, to pull in their plans for renewables. And we saw a huge spike in virtually every country in Europe. Solar plus storage, everybody started stocking up a lot. And we also profited from that. Our revenue also peaked. But then that enthusiasm is a little bit tempered right now. And because of that, what's happening is the distributors are suddenly realizing that they got more on their hands. And also, earlier, maybe a year and a half back, the product availability wasn't that high because of that increase in demand. But now, all of the suppliers have geared up, especially panels. Product availability of panels is very high. So a lot of over-inventory, particularly on the panels, has happened. That is putting pressure on the distributors because they've purchased inventory at high prices before. And now the prices have collapsed on panels. So there is some financial weakness there. But again, they are conservative now. And they want to hold as less inventory as possible. So that's kind of a macroeconomic. Now let's come to Netherlands, our biggest market. Netherlands has got a very interesting dynamic that when I went there two weeks ago, because I went there, when I heard that our demand was dropping, I got concerned. I went there. And when I looked at it, the Netherlands situation is actually not…

I guess just to wrap the topic up overall, just let's say we continue to move away from the kind of Ukraine energy crisis conditions, but we do have these markets each put in these changes. Just does your kind of expectation of Europe and kind of improving, can it be driven just by these market by market changes or do you need you need to see some kind of move up in energy prices again.

I didn't talk about energy prices, energy prices have also increased. In places like France the energy prices are also going up. So I mean energy prices are going to help us. The utility rates are increasing. And so that is definitely going to be a tailwind. But make no mistake. Despite all of this in a place like Netherlands, two gigawatts of solar in a place like France the payback is extremely good still five to six years where can you get that, even just for solar. It's going to evolve into solar plus storage with the payback up maybe seven to eight years but still very good for a 25-year product. So there is a small dislocation right now due to inventory issues due to these, but that's why we expect the ramp-up normalized -- I wouldn't say normalization, revenue recovery, a quick revenue recovery at least to some level in Europe.

Okay, thank you.

Our next question will come from Jeff Osborne with Cowen. Please go ahead.

Badri, I was just curious on your expectation for a 2Q recovery. What is your working assumption on normalized inventory in the channel? I think in the past you talked about 8 weeks to 10 weeks and assuming that is still the case, I guess, is there an argument that now that manufacturing is localized and continent by both yourself as well as competitors that -- why wouldn't that number be 5 or 6 weeks and maybe pressure would continue into Q2.

Yes. I mean, what you're saying is possible, but we don't think so. So I'll give you a quick primer on the weeks on hand. So you follow it. And I think generally, I'd like to say that everybody follows it. For example, if you have -- let's say, you start off with 100 units at the beginning of a quarter in the channel, and let us say you drain inventory at 10 weeks -- I mean 10 units a week. And you also ship into the channel at 10 units a week, okay? So you ship into the channel at 10 units a week. You drain from the channel at 10 units a week. Therefore, at the end of the quarter, you find yourself at the same 100 because 100 plus 130, which is 13 weeks, minus 130, you have 100 units at the end of the quarter. You ask yourself what is the weeks on hand. You say that is 100 divided by 10. That's 10 weeks. So remember that number, 10 weeks. Now I say, oh, my demand is suddenly dropped by, let us say, 40%. That means I have 4 units a week that is accumulating. So that means -- and assume I ship the same number of units into the channel, because I am slow in recognizing that the situation has changed. So let us say I still ship the same 130 as before. But now my dream is only 78 instead of 130. So I therefore end up with 4 units’ excess per week which is 52 units more than the last case. So now I have at the end of the quarter 152. 152, but my end customer demand is only 6 units a week. So I tell you that my weeks on hand now is 152 over 6, which is 25 weeks. So I suddenly go, my weeks on hand increases by 150% due to a 40% drop in demand. If I am -- I continue to be oblivious of -- continue to be oblivious and ship the same material into the channel. So we can blow up disproportionately right? And of course, the further the demand drops, the further your weeks on hand will go up and the converts true. So if the demand improves a little bit, the weeks on hand is going to come down fast. So we think that the distributors -- I mean, we'll look at logical things here because even a 10 to 12-week inventory will be the similar dollar number that they have had in the past. And in fact, the lesser dollar number that they've held in the past. So we think logic will prevail and -- of course, end market demand could change all of that pretty quickly. So weeks on hand is not something that you -- that is obvious. It can really change drastically by small changes in demand, which I gave you the example there.

I appreciate that. My follow-up -- and correct me if I'm wrong, but I think you're allowed to, under the IRA export U.S. manufactured goods, to international jurisdictions. Is that something you're already doing or do you intend to do in 2024?

Not doing today, but of course, will consider.

Got it. Thank you.

And our next question will come from Julien Dumoulin-Smith with Bank of America. Please go ahead.

Hey good afternoon, team. Thank you guys very much for the time. Appreciate it. I just wanted to pivot to a slightly different direction here, right? So you have a few of these exclusive deals across a number of different customers, but some larger ones, if you will. I'm curious, how do you think about how locked in those are going into the next year? And how are you think about working together realistically as partners, optimizing your value proposition while dealing and addressing with their respective needs, which are clearly and likely dynamic, especially given the backdrop in California. If you can speak to that, those dynamics? I know I'm not trying to get into the contract specifics here, but really working with them, if you will, and how you think about how locked in that portion of volumes are.

Yes. I mean, I presume you're talking about one large customer here, that's the only one we have, which is official. The -- we love our partners, right? We work very closely with them. We value their relationship a lot. And we are there -- I mean, we are at their service all the time, whether it's quality, whether it's customer experience, we value their relationship a lot. So yes, of course, we will be looking to renew all of those.

Right. Yes. Fair enough. It's difficult to [indiscernible] too much. And then just coming back to all these different contract manufacturing relationships, I know they might not be identical here, but how do you think about underutilization costs here? I mean what are the commitments like how flexible are the terms as you look at both flexing down and up the volumes through the course of the year here under these new arrangements?

Right. I did talk about it answering a prior question, and I will say the same thing here. We have great contract manufacturing partners. Flex has been great for us. They particularly helped us when we were in trouble in 2017. We are grateful there. Our relationship has been very healthy. Even during these times. And we are working together. Sometimes, we look at a problem and say, is this a short-term problem or a long-term problem. If it is going to cost them pain, we are willing to restructure. And all of those accounting are in our P&L. We report it as part of our non-GAAP and GAAP gross margin. So you should read the P&L and know that everything is there. And we view this particular situation is temporary. But we are very cognizant of the fact that under loading is a pain for our contract manufacturing. So -- and we think the right approach is to make sure both of us are profitable and share the pain. And we will be doing that.

Got it. Alright. Best of guys. We’ll speak to you soon.

Thank you.

And our next question will come from Andrew Percoco with Morgan Stanley. Please go ahead.

Hi, thanks so much for squeezing me in. So I just wanted to come back to a prior question. So it's clear that the demand backdrop is going to be a tough demand backdrop potentially for the next few quarters. Can you maybe just discuss the health of the average installer that is a recurring user of your equipment and their ability to manage through this period and transition to the TPO model? I think there's been some challenges around working capital and tax equity. So just curious what you're seeing and what you're hearing from some of those maybe repeat buyers on the smaller scale side of the installer community. Thank you.

Yes. I mean we only hear color from other industry news, but we do see some transition to the leasing model. We do see that clearly. For us, how does it affect us is we have some great partners. We have Sunnova, great partner. John Berger is a close friend of mine. Sunpower, Sunrun and other leasing partners. We do business with all of them. They're all great partners. So for us, it is -- if loan moves to lease our business, I would say there could be some product mix issues, but business is nominally not affected. We have heard anecdotes from a few industry sources that installers in California that are many long-tail installers who aren't in business any longer, but we don't have any direct data there. So I can only tell you what I know. The -- of course, I mean, it is a stressful time for them, and we are trying to help them with whatever we can, whether it leads or whether we can provide them some of the services like our Solargraf, etcetera, whether we can help them with NEM 3.0, their business. We are doing that. And that's the color that we have in general. We do business -- majority of the business we do is through distribution. And the distribution, one of the ways we would see it is in our payment, right? If we were to do direct business with all the installers, which we don't. We do business with distribution partners. So therefore, we have one level a little bit away from direct relationship with the long tail installers.

Yes, that makes sense. And the other questions -- my other questions have been answered.

Could you repeat the question -- okay?

Our next question will come from Tristan Richardson with Scotiabank. Please go ahead.

Hey good evening guys. Thank you so much. I appreciate all the commentary on 2024 and really just thinking about the commentary you made around stabilization next year. Should we think that could there be a swing factor with some of the new markets you've entered, whether that's U.K., Greece, Denmark, even India, could that be a meaningful factor that could affect sort of the timing of that stabilization or present a growth wedge above kind of that 2Q time frame you're talking about?

Absolutely. We have a lot of vectors of growth and that's a great place for us to start. But we are -- in the color I gave you, we didn't assume all of that. But we have absolutely so many countries that we are -- we were not present even a couple of quarters ago like we have introduced in batteries and microinverters, actually, batteries, for example, in Austria, in Spain, U.K., as you correctly pointed out, Sweden, Denmark, Greece. We have plans to introduce to about 15 countries in the fourth quarter. Microinverters alone, they are all new countries. So that's one vector. New geographies, very important for us. But on the flip side, there, it does take some time to establish infrastructure there. You do need to build up your installer base. You do need to train them very well because our bread and butter is our installers. Therefore, we need to train them excellently. And we need to win them one by one. And that is a process in itself. It can be as early as 3 to 6 months, but it can be over a longer time frame as well. We got several new markets in Asia that are also interesting for us, like, for example, Taiwan, Korea. Indonesia, we are there today, but we are rapidly moving into IQ8, there are a few other smaller countries in Eastern Europe that we are going after. Small commercial. That's a very big one. The small commercial in the U.S. is about 1 gigawatt. We are going to add that product this quarter. The small commercial opportunity in Europe is much bigger. It's about 10-plus gigawatts and we are figuring out that one systematically because we can service that market less than 100 kilowatts with the products we…

That’s great Badri. Appreciate all the extra comments tonight.

Thank you.

Our next question will come from Moses Sutton [Ph] with BNP Paribas. Please go ahead.

Hi Badri. Thank you for squeezing me in. I just wanted to tag on to Andrew's comment about the [indiscernible] installer. Are you seeing stress outside of the California market? Are you seeing any sellers selling distributors asking for price concessions, maybe distributors asking for concessions on terms and receivables, just curious if you could give a little more color on the health of the Tier 4?

Yes, the -- I'm just clarifying the question. You want to know the health of the business outside California. Is that correct?

Specifically for the -- for the small stores.

Specifically for the long tail, I mean -- yes, the color that I can give you is the non-California business as a poly is stabilizing right now. That's what we see. We see Q3 was 4% down from Q2. And the first 3 weeks of Q4, which is the last 3 weeks of this quarter, but also not too bad. In fact, it's a little bit up. So we think the non-California business is is pretty decent. But of course, it is still down from the high levels that we had by nearly 35%, meaning from Q4 of last year, Q4 2022, it's still down by nearly 30% to 35%. And your question is how is the health of the long tail -- it's a similar answer for us. We work with our business, if you see 80-plus percent probably, maybe 75% is the long tail there. So we see all of them down, whether there are installers going out of business. We don't get that information, but I think we don't have that data. We don't see the same trend, which is loans moving to leases. All our partners are pretty great. Sunnova, Sunpower, Sunrun, for us, it is moving from one hand to another hand like what I said. That's the color I can give you.

That's very helpful. And then just any sense on Texas and Florida, in particular. I know outside California is averaging a little better, but maybe specifically those markets?

Yes. I mean they were disproportionately down because of -- because the utility rates aren't as high compared to the increase in the interest rates. So they were worst affected, but we see many of them in Texas and California. I mean, Texas and Florida particularly moving to the lease model. We do see that like what you said. And we do see that business starting to recover.

Thank you.

And our next question will come from Joseph Osha with Guggenheim Partners. Please go ahead.

Hey thanks for fitting me in. Badri, appreciate it. Two questions. First, following on from the previous one, look, we all see Sunrun, Sunnova, Sunpower accessing ADS or whatever markets for third-party ownership. I'm curious, do you know if your long tail has found any other solutions for third-party ownership? Or when you talk about that avenue, is it basically those third companies that you're seeing? And I do have one other question.

Majority is those companies, and there are a few smaller leasing companies that are coming up, too. But 90% is those three companies.

Okay. Great. And then this is really more of a philosophical question. I know all of us on Wall Street just love to hear you talk about defending your gross margin. But given how the market is evolving, have you done some analysis and are you sure that your business couldn't perhaps generate higher bottom line earnings if you simply grew it more quickly and allow, say, a 35% gross margin. I'm just curious as to your philosophy as to why the gross margin has to stay where it is.

It is the eternal question. Can I grow faster if I drop prices, right? I mean for us, it is pricing based on value. The moment we've stopped generating value, it is over. So that's why I never look at those in conjunction pricing. I don't base it on cost. The moment you base it on cost, it's the problem. Then you forget about the value drivers. And therefore, the -- what that means is if we need to add value in both microinverters and battery and software. And that's hard to do, but that's what we do thoroughly. Innovation is -- someone said it right in Silicon Valley, innovate or die. We are that company. That's our philosophy. So we believe high quality is high volume and high price or the right prices or value.

Okay, thank you. Appreciate that.

And our next question will come from Vikram Bagri with Citigroup. Please go ahead.

Good evening everyone. Very helpful color on demand and supply dynamic in countries in Europe. Badri, you mentioned you expect to recover a bit in your calculation of $300 million of inventory reductions over the next two quarters? Is that rebound? Is that a function of Enphase entering a number of new countries in EU this year, as you mentioned, and gaining market share in existing markets, such as Germany, or the outlook for inventory reductions assumes that the base demand rebounds in first quarter. And on top of that, you gained market share in new as well as sort of like existing markets. And then if you can talk about the U.S. market also, it seems like you're looking to defend market share. You haven't seen any declines in market share so far. But if there were some, you will look to defend that.

Yes. I mean we already told you that we aren't assuming the demand picture changing from the current levels in our assumptions. And basically, I'm not here to give guidance for Q1, but I'm just giving you a general color for Q1. So all our resumptions are based on demand picture not changing in the next -- demand picture not changing from where it is today. So that's what we said in our assumptions. Then your question is on U.S. U.S. for us is -- we work with a lot of customers. We -- this is the time where our partnerships like what I said, are a lot deeper. Every one of our executives is always on the road visiting customers. Every opportunity to gain market share, we are all over it. And like what I said, we have a number of tools. Yes, of course, it's defending against competition. All competition is very important for us. We take everybody seriously. We work on our problems. We fix our problems, our customer service, you see many people in place stick to us for our quality and customer experience. Our Net Promoter Score is 78 in the U.S. We are opened 24/7, our call center. We have field service technicians who will show up in your home tomorrow if you have a problem today, right? So we have a -- if you put the total picture together, its innovation, quality and customer experience. Now we have one more fact that we have. We can give people a made-in-America products. Now we do have that many of our installers love it because they -- for example, we just had -- in Flex, we in South Carolina, President Biden and came and inaugurated that plant, and we have a lot of installers there, including not just installer partners, distribution partners. So it is very important for them. Made in America product right there in South Carolina, right there in Arlington, right? They're in Wisconsin. It is there. So we think that will help too. And we are going to -- in a similar vein, we're going to bring in our batteries as well in the U.S., and we will take advantage of the domestic content there. And so that will provide extra help to some of our leasing partners. So yes, we are always working on market share. We always take competition seriously, not just right now. This is how we do business.

Thanks Badri. And as a follow-up, I wanted to quickly follow up on the capital allocation question earlier in the call. I was wondering if your priorities have changed given where the stock price is today. I see you repurchased about $110 million in shares versus $122 million of free cash flow this quarter. Should we expect similar trend going forward, share buybacks closely following free cash flow generation in quarters?

Yes. Well, I mean we have a lot of cash like what you pointed out, $1.8 billion. We have shown that we are willing to buy back stock in a disciplined fashion. We have bought back stock in the last couple of quarters. I think we have bought back $310 million in total, $110 million in Q3 and $200 million in the prior quarter. I think this is an opportunistic time for us where we can take advantage of the stock price. So we will be opportunistic about it.

Thank you very much.

Thank you.

And our next question will come from Praneeth Satish with Wells Fargo. Please go ahead.

Thanks for squeezing me in here. Long call. I guess I wanted to ask about Tesla's new Powerwall [Ph] 3 offering and maybe what are kind of the puts and takes there comparing that against your IQ8 and 5P battery. And I guess, do you anticipate any market share changes when this product is launched next year?

This is Raghu. And Badri mentioned earlier on, look, competition is not new to us. And any company out there that's doing string inverters, we have been competing against those since the inception of the company, and we have a very, very strong value proposition against that technology, a technology that we've been fighting against since 2008. So if you think about it, if you break it down, we just produce more energy. We do maximum power point tracking on a per module basis, right, because we have -- we do power conversion right at the module itself. We are much more reliable. We don't have a single point of failure, that's a true value of the distributed architecture. So even if one of our micros or the module or to -- were to fail or get impinged on energy, the rest of the system continues to operate. String inverters on the other hand, are a very significant single point of failure of that string inverter would fail, our entire system is dead. Again, if you look at also design, installation and maintenance, we don't have string designs anymore. Like those string designs are a thing of the past, those things went away in 2012. And with us, you don't have to do any stringing, no string design, no limitation, steady, can put as much new modules or just like, installations, all plug-and-play. And maintenance, we provide you with per module information, right? And with the traditional string inverters, you're completely blind to how your modules are performing. So I think that's going backwards. And finally, and arguably one of the most important elements of it, is safety, right? You want to do -- you don't want any high-voltage DC anywhere in the system. And so with Enphase, we are…

That's very helpful. I guess, just quickly switching gears to California. I just wanted to -- you mentioned that you're educating installers about NEM 3.0, the payback is 6 years, maybe down to 5 years with some of these rate increases. You've got the Solargraf software where you're kind of automating a lot of the calculations for installers. But despite all this, and it all sounds good on paper. But despite all this, that the permits are just -- they're moving down week on week, right, in the wrong direction. So I'm just trying to understand if there's anything else you can do to simplify the process and help convert some of the leads to signed contracts? Or is it just -- is it rates? Or is it just waiting for time, waiting for just macro to improve a bit?

It start waiting, right? It's our -- we have to go out there. And we and the rest of our industry needs to get out there and continue educating our installer partners, helping our install partners, educate the homeowner, that's what it's going to take. And I think all the tools are there, everything is ready. But most importantly, the economics are there, right? It's simply getting in front of the homeowner, getting and convincing them, showing them the numbers, showing them using a tool like Solargraf and showing them what a solar install of the house would look like, the size of the battery that they would require and then showing them the payback period that it's anywhere from 5 to 7 years and getting better at utility rate continues to improve. So I think we are all doing the right things. We are getting out there and key same phase, we are getting out there and I'm sure our competition is also getting out there and educating both installers and customers and so we expect -- yes, we expect it's simply a matter of time. I think you'll see -- you'll see the California market turnaround as well.

Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to Badri Kothandaraman for any closing remarks.

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

The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.