Enphase Energy Inc

NASDAQ:ENPH

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Enphase Energy Fourth Quarter 2019 Financial Results Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Adam Hinckley. Please go ahead, sir.

[Adam Hinckley, Investor Relations]

Good afternoon and thank you for joining us on today’s conference call to discuss Enphase Energy’s fourth quarter 2019 results. I am the Head of Investor Relations for Enphase Energy and I am pleased to be hosting my first earnings call for the company. 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 ended December 31, 2019. During this conference call, Enphase management will make forward-looking statements including, but not limited to statements related to Enphase Energy’s expected financial performance, technology, new products, operations and sales and marketing. These forward-looking statements involve significant risks and uncertainties and Enphase Energy’s actual results and the timing of events could differ materially from these expectations. For a more complete discussion of the risks and uncertainties, please see the company’s annual report on Form 10-K for the year ended December 31, 2018 which is on file with the SEC and the annual report on Form 10-K for the year ended December 31, 2019 which will be filed with the SEC in the first quarter of 2020.

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 would like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy. Badri?

[Badri Kothandaraman, President and Chief Executive Officer]

Good afternoon and thanks for joining us today to discuss our fourth quarter 2019 financial results. We had a good quarter. We reported revenue of $210 million and shipped approximately 2.1 million microinverters. Demand was strong for our microinverter products in Q4. We are pleased with the preorders for our Encharge battery utilizing our Ensemble energy management technology and have started training installers to support the upcoming product launch.

We exited the fourth quarter at approximately 37, 12, 25. This means 37% gross margin, 12% operating expenses and 25% operating income, all as a percentage of revenue on a non-GAAP basis. As a reminder, we introduced our new baseline financial model of 35, 15, 20 at our Analyst Day in December. The baseline model represents the minimum financial performance we expect to achieve over the next 18 to 24 months while demonstrating meaningful top line growth. Eric will go into greater detail about our finances later in the call.

Let’s now talk about ease of doing business, how customers perceive us. Our Q4 net promoter score was 56% in North America compared to 54% in Q3. Our average call rate time is slightly over a minute and we are working on several self-service initiatives to reduce call volumes. We recently opened our online Enphase 2 with the objective of providing even better customer experience. Our target is to exit 2020 with an NPS score greater than 65, a number that’s considered very good in our industry.

Let’s talk about the impact of the coronavirus. Our thoughts and prayers are with the people of China as they fight the virus. Our priority is to ensure the well-being of our teams as well as our partners in China. Our contract manufacturing facility – partner facility in China is steadily ramping back up following the Chinese New Year. The component supply chain is also ramping. We are seeing some indications that the outbound logistics from China is constrained.

Now, coming to the first quarter, we are fully booked for the first quarter to the midpoint of guidance. In addition with nearly 7 weeks into the quarter, our shipments have been 100% linear to our revenue guidance. While we remain cautious and are watching the impact of the virus carefully, we do not see a big impact to the first quarter revenue guidance at this point. Depending on the situation with the outbound logistics, we may have to expedite some product through air ships from China and we are getting prepared for that. We have already factored that in our revenue as well as gross margin guidance to the extent we know.

Now is a good time to talk about how Mexico is doing. We are very happy that Mexico is running well and provides us a good backup to service global demand in the event of supply disruptions elsewhere. We manufactured more than 0.5 million IQ 7 microinverters in Mexico during Q4. Our current run-rate in Mexico is a little over 50,000 units a week. We previously stated our target is to double the capacity to 1 million microinverters per quarter by Q4 of 2020 and we are making very good progress towards that goal. I would like to acknowledge the hard work of numerous people both on our team plus the Flex team in order to make this happen.

Next, let’s talk about safe harbor. The revenue related to safe harbor shipments was $36.4 million in Q4, an increase from $8 million in Q3. For Q1, we plan to recognize the revenue of $44.5 million for ITC safe harbor shipments. I would like to highlight that only a very small number of our customers engage in safe harbor activity and that each of these customers has an ongoing relationship with Enphase beyond safe harbor sales. These shipments are not nearly one-time purchases and growing share in their portfolio beyond safe harbor is an area of opportunity for Enphase.

Let’s talk a little bit more about Q1. We all know Q1 is our seasonally soft quarter for the solar industry with double-digit percentage declines in revenue and it is worthwhile for us to look at how we are doing and our base business is doing with respect to the industry. For example, if we include safe harbor revenue from our midpoint of Q1 ‘20 guidance of $205 million our base revenue only drops by 8%, which is a pretty good result considering the typical seasonality.

Although we will provide formal guidance for the second quarter of 2020 in our April earnings call, I would like to provide some color today. There will obviously be no safe harbor sales in Q2. Our bookings for Q2 look pretty healthy right now considering where we are. We expect a nice uptick in our base business for Q2 commensurate with the industry seasonality. We also expect Q2 to benefit from a full quarter of Encharge battery sales. As I said before, the preorders for Encharge remain very healthy and our installer training is already underway. Obviously, whatever we are seeing with respect to Q2 is based on our current understanding of the coronavirus situation.

Let’s move on to the regions. The U.S. and international mix for Q4 was 92% and 8% respectively, excluding safe harbor revenue. The result is an obvious indication of strength of our North American business. Our U.S. mix as a percentage is probably going to remain high for a few more quarters with the introduction of Ensemble in North America. Nevertheless, we are putting a lot of effort to grow our international business. You heard some updates on the Analyst Day and I am going to expand a little bit more on that now.

On Europe, we are making excellent progress. We are doing a few things that are different from before. We are pulling out all stops in order to bolster our sales force in both internal transfers and new hires. Some of those are already in place right now. We have made several offers and expect to have increased headcount in place in Netherlands, Belgium, France, Germany and Spain by early March. While relationships with the distributors are very important to us, we are placing extraordinary emphasis on winning the long-tail installers by focusing on quality and customer experience. We are doing this by increasing our installer training significantly in Europe and tracking installer visit metrics diligently. Our 2020 goal is to double the 2019 European sales, which was approximately $68 million. Aside from our focus on the long-tail installers, our key initiatives in the region are social housing, ACM partnerships and providing differentiated solutions, such as integrated improved solar with Kraton, which we announced last week.

Let’s now talk about Asia-Pacific and Latin America. Both Asia-Pacific and Latin America are small-sized business in our similar sized businesses and quite small. Our businesses in APAC, is mainly in Australia. Just to remind you, we hired a General Manager for that region in early 2019. We had the right team in place along with the focus and the right metrics there. We are seeing very encouraging sell-through to the installers. In addition, you recently saw a press release where we partnered with the installers to support the Australian PV industry to introduce rapid shutdown as a requirement. On top of this, Enphase’s AC architecture means there is no high voltage DC on the roof, thereby providing increased fire safety. With these initiatives, we expect this region to grow nicely in 2020.

We will discuss products next. We had volume shipments of IQ 7A, our highest power product, a 349 watt AC for SunPower as well as other customers in the fourth quarter. IQ 7A like what I said is our highest power microinverter for the residential space and fares very well with the high efficiency modules up to 450-watt DC in both 60 and 72-cell configuration.

We are going to talk about AC module partners next. We continued to make steady progress with our AC module partners, including SunPower, Panasonic, Solaria to mention a few. We are working to bring in a few more module partners both in the U.S. as well as in Europe. Enphase energized ACMs from our module partners have now been adopted by more than 740 installers in the U.S. as of this date. By the way, some of these ACMs are also available for both installers and homeowners to purchase directly from the Enphase online store.

Next topic is our Encharge battery that uses Ensemble energy management technology. The shipments for the Encharge battery are expected to begin in March of 2020. We have already started training installers. We are expecting to ramp trainings a lot over the next few months. The feedback has been really positive with very high NPS scores. The installers clearly see Encharge as a safe, reliable and powerful option for the homeowners. However, they feel the biggest value for the homeowners is that for the first time ever, they can easily generate energy, store energy and control energy in a single system all completely designed by Enphase. That is the power of Ensemble. In the coming months, we will be expanding the training program beyond our Fremont headquarters to include many of our partner sites in order to increase our training throughput significantly.

In summary, we are very happy with our performance in 2019 across all fronts. We talked about our three pillars of differentiation at the Analyst Day: semiconductor, software and Ensemble. This combined with operational excellence and our scalable business model is helping us win new customers. As we highlighted in the Analyst Day, our immediate growth driver is the Encharge battery, followed by the IQ 8 solar microinverters on the roof, then by IQ 8D for the small commercial space, and finally, Ensemble and above for the India off-grid markets.

With that, I will turn the call over to Eric for his review of our financial results. Eric?

[Eric Branderiz, Chief Financial Officer]

Thanks, Badri. I will provide more details related to our fourth quarter of 2019 financial results as well as our business outlook for the first quarter of 2020. We have provided reconciliations of 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 fourth quarter of 2019 was $210 million, including approximately $36.4 million of safe harbor revenue. Total revenue for the fourth quarter of 2019 increased 17% sequentially and increased 128% year-over-year. We shipped approximately 677 megawatts DC in the fourth quarter of 2019, an increase in megawatts DC of 16% sequentially. The megawatts shipped represented approximately 2.1 million microinverters.

Non-GAAP gross margin for the fourth quarter of 2019 was 37.3% compared to 36.2% for the third quarter of 2019. Expedite fees are now normalized within our expected range and therefore did not have an abnormal impact in gross margin. Our component supply is stable and as a result we will no longer quantify this expense if it is within the normal course of business.

Non-GAAP operating expenses were $26.1 million for the fourth quarter of 2019 compared to $25 million for the third quarter of 2019. GAAP operating expenses were $33.4 million for the fourth quarter of 2019 compared to $31 million for the third quarter of 2019 and GAAP operating expenses for the fourth quarter of 2019 included $5.6 million of the stock-based compensation expenses, $545,000 of amortization expenses for acquiring intangible assts and $1.1 million of restructuring expenses. Our restructuring program was completed at the end of 2019 and at this time, we do not anticipate any further or future expenses related to restructuring.

On a non-GAAP basis, income from operations was $52.3 million for the fourth quarter of 2019 compared to $40.2 million for the third quarter of 2019. On a GAAP basis, income from operations was $44.4 million for the fourth quarter of 2019. This increase in operating income is reflective of the strong demand of our products and our focus on cost reduction on expense management. On a non-GAAP basis, net income for the fourth quarter of 2019 was $52 million compared to $39.5 million for the third quarter of 2019. This resulted in diluted earnings per share of $0.39 for the fourth quarter of 2019 compared to $0.30 for the third quarter of 2019.

GAAP net income for the fourth quarter of 2019 was $116.7 million compared to $31.1 million for the third quarter of 2019. This resulted in diluted earnings per share of $0.88 for the fourth quarter of 2019 compared to $0.23 for the third quarter of 2019. GAAP earnings per share for the fourth quarter of 2019 includes a $0.54 non-cash benefits from the release of our valuation allowance against deferred tax assets that we highlighted on the Q3 2019 earnings call. I will address taxes shortly. The strong financial results for the fourth quarter of 2019, represents a fifth consecutive quarter of cash generation and GAAP profitability. I’d also like to highlight the significant milestone of achieving the first full year of GAAP profitability in the company’s history.

Now, turning to the balance sheet, inventory was $32.1 million at the end of Q4 2019 compared to $30.2 million at the end of Q3 2019. We exited the fourth quarter of 2019 with a total cash balance of $296.1 million, including restricted cash compared to $230 million for third quarter of 2019 and $106.2 million for the fourth quarter of 2018. The restricted cash balance related to first quarter 2020 safe harbor deliveries. We expect that restriction to be lifted at the end of April 2020 and for all cash to be restricted by then. The cash balance benefited from prepayments of $49.9 million for safe harbor deliveries in Q1 2020, of which $5.4 million related to products with deferred revenue component, such as Envoy and Enlighten. Revenue from these products is deferred and recognized as revenue over the respective useful life. As a result, our safe harbor revenue guidance of $44.5 million for the first quarter of 2020 differs from the prepayments we have received. We generated $102.3 million in cash flow from operations and $94.9 million in adjusted free cash flow for the fourth quarter of 2019. For calendar year 2019, we generated $124.3 million of adjusted free cash flow. Capital expenditures were $7.4 million for Q4 2019 mainly to ramp up our microinverter supply capacity in Mexico and Encharge battery capacity in China.

Now, let’s discuss our outlook for the first quarter of 2020. We expect our revenue for the fourth quarter of 2020 to be within a range of $200 million to $210 million, including $44.5 million of revenue for ITC safe harbor shipments. Turning to margins, we expect GAAP and non-GAAP gross margin to be within the range of 36% to 39%. We expect our GAAP operating expenses to be within the range of $35 million to $37 million, including approximately $7 million estimated for stock-based compensation expenses and acquisition-related amortization. We expect non-GAAP operating expenses to be within a range of $28 million to $30 million. The sequential increase is primarily related to greater spending on R&D to support new products as well as increasing sales headcount in Europe. In general, our operating expenses are expected to be in line or lower than our baseline financial model of 15% of revenue.

Before wrapping up, let me address taxes. During the fourth quarter, we released our valuation allowance against deferred tax assets based on our recent history of profitability that is forecast to persist. This will result on a GAAP tax benefit. We will now be subject to a 26% to 28% GAAP tax rate in 2020, inclusive of federal, state and introduction of taxes. Cash taxes are expected to deviate materially from GAAP taxes as we have federal net operating loss carry-forwards of $147.4 million, federal reserve credits of $12.4 million, and state net operating loss carry-forwards of $97.6 million and state research credits of $11.3 million. Until we fully utilize these NOLs and research credit, most of the cash taxes will only relate to income from international operations, which represents the minority of our business.

With that, I will now open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Brian Lee with Goldman Sachs. You may proceed with your question.

[Brian Lee, Goldman Sachs]

Hey, guys. Thanks for the questions and congrats on the strong quarter. I guess maybe first question on the Q1 guidance, the safe harbor revenue, appreciate all the granularity of providing around the dollar figures, can you also give us a sense of what the customer mix looks like, I know in Q4, you had specific called out the one customer, SunRun, is it the same customer in Q1, is it a totally different customer in Q1 and if it’s a different customer, are there multiple customers? That will be the first question I have.

[Badri Kothandaraman, President and Chief Executive Officer]

It is a different customer. In fact, there are multiple customers, yes, for the safe harbor, long-term $44.5 million.

[Brian Lee, Goldman Sachs]

Okay. And Badri, it’s safe to assume that our Tier 1 installers, as you mentioned during your prepared remarks, there is only a handful of data due to the safe harbor?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes.

[Brian Lee, Goldman Sachs]

Okay, fair enough. That’s helpful. And then I guess if I – I don’t want you to – I don’t want to corner you into give any more guidance than you are willing to provide, but you did try to provide us a little bit of sense around Q2. So when I look back at the Q2 revenue trends historically, there has been about an average of 30% give or take sequential revenue growth and also a similar range for volumes if I look back to the model, dating all the way back to the 2010s. I know a lot has changed over the period, but is that the type of seasonality we should expect in Q2 this year as well based on your incumbents around healthy bookings and seasonality on core revenues, again, assuming no safe harbor and then no incremental coronavirus impact being the base cases, just wondering if that’s sort of the read we should be taking away from your comments? Thanks.

[Badri Kothandaraman, President and Chief Executive Officer]

Yes. I mean, that’s a good question. As you correctly said, Q2 is quite seasonally strong whether the number is 20% or 30%, it’s hard for us to say at this point in time, but in general, we expect to outperform the industry seasonality.

[Brian Lee, Goldman Sachs]

Alright. And then maybe last one if I could squeeze it in, just around the Encharge, it’s encouraging to hear you guys are on schedule for the shipments in Q1, one of your peers who also has a new product in the market. Just last week, Generac announced that they are raising their target for shipments by 50% versus there original view, any thoughts around kind of the market makeup as you are seeing early traction of preorders and also to March and just in the context of your 5% attach rate, is there potentially some upside as you move through the year given how the market is developing? Thanks guys.

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, I mean, look we are extremely excited by our product. In fact, Encharge is running well at all three of our houses, my house, Eric’s house, Raghu’s house, we are all running. In fact, I went off-grid this morning for about 8 hours. So we are really happy with the performance of Enchage so far. And of course it’s time for us to bring to the market. Ours – if you really step back and think about it, why installers like that solution a lot and this is what the installers told us is really it’s the all in one solar and storage system, seamless experience for the homeowner, one number to call, very high quality, very high customer experience, safe AC architecture, all controlled by Ensemble energy management technology. That’s our value proposition. And we are sticking to our value proposition, there is obviously a lot of competition, lot of noise in the market, but I think our value proposition is quite difficult to compete against. So, we will – many people are coming, we will see them in the marketplace, that’s all I can say right now.

[Brian Lee, Goldman Sachs]

Okay. Thanks guys.

[Operator]

Thank you. Our next question comes from Mark Strouse at JPMorgan. You may proceed with your question.

[Mark Strouse, JPMorgan]

Yes, thank you very much for taking our questions. Badri, I just wanted to go back to the comment that you made about the impact from coronavirus and what’s included and what’s not? I believe you said it’s possible there could be some expedited shipping fees, is that included or excluded from the 36% to 39% guidance that you have given?

[Badri Kothandaraman, President and Chief Executive Officer]

We have already included that in the guidance we gave you.

[Mark Strouse, JPMorgan]

Okay, thank you. And then you have been talking about expedited shipping fees for several quarters now, excluding the wildcard from coronavirus, can you just give an update there? Are you tracking expectations having your capacity be above expected demand?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, I mean, look we used to have expedite charges of more than 200 basis points before. That situation has changed. We are now normalized with respect to expedite it’s really in the noise. Of course, due to coronavirus, we have planned little bit more than usual, but that’s already factored in the guidance and going forward if the situation normalizes with respect to coronavirus we will – expedite is going to become nice. It’s not going to be significant for us.

[Mark Strouse, JPMorgan]

Okay, thank you. And then just one quick follow-up for Eric starting next quarter, with the Encharge starting to ship in March, how should we think about any metrics that you are going to give around those shipments – or those revenue beginning in 1Q?

[Eric Branderiz, Chief Financial Officer]

Yes. So we are considering the possibility that starting in Q3 we may start providing breakouts on revenue. We haven’t made the final decision yet. There are external reporting considerations, but we understand that when this becomes meaningful part of our ramp, it will create a little bit of a problem for you folks to be able to model and we are very sensitive to that and we will address it when we have more visibility into how that will workout for external reporting.

[Mark Strouse, JPMorgan]

Okay, very helpful. Thank you.

[Badri Kothandaraman, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. Our next question comes from ` from Credit Suisse. You may proceed with your question.

[Maheep Mandloi, Credit Suisse]

Hi, good evening. Thanks for taking the questions and congratulations on the strong quarter. Maybe just on the other product launches just mentioned on the Analyst Day the IQ 8 and IQ 8D could you probably just talk about how you are thinking about the rollout of those products, specifically given the supply chain disturbances in China if any?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, I mean for those, basically we are thinking about the second half of the year, it’s the rough order would be the IQ 8 microinverters on the roof would be the first followed by the commercial microinverters followed by the Ensemble in a box.

[Maheep Mandloi, Credit Suisse]

Got it, thanks. And just probably going back to the Encharge, could you just talk about like how much do you – should we expect from Encharge in Q1 specifically or is mostly a Q2 number?

[Badri Kothandaraman, President and Chief Executive Officer]

We’ll have small shipments of Encharge in Q2 – I mean in Q1, but nothing significant in terms of revenue. Q2 will have one full quarter of Encharge and we expect that to be nice.

[Maheep Mandloi, Credit Suisse]

Got it. And just lastly on taxes, I just wanted to make sure we understood that correctly, so from a tax perspective it’s minimal cash taxes and like a standard GAAP tax rate in line with the U.S. corporate tax rate, is that a fair statement?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, you got it. Think about $59 million of cash savings for the monetization of the NOL and tax credits, right. That’s for my cash. And for P&L, we give you all the data to be able to morrow on a non-GAAP basis. When those are exhausted, we flip GAAP and non-GAAP will be the same.

[Maheep Mandloi, Credit Suisse]

Got it, right. Thanks for taking your questions.

[Badri Kothandaraman, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. Our next question comes from Colin Rusch with Oppenheimer. You may proceed with your question.

[Colin Rusch, Oppenheimer]

Thanks so much. Can you guys talk a little bit about the growth in Europe, how effective you have been in being able to build out the sales team and how much of the 1Q guide is especially come out of non-North American sales?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, I mean, we don’t really breakout the exact numbers for Europe, but I did give you some color this time, on the total revenue for 2019 was $68 million. Our plan is to double it in 2020 to go to $136 million. And like what I told you, we have not been happy with our progress in Europe, but that has changed. Now, we are actually doing very well. We have hired already bunch of sales guys in place. We have internal transfers from the U.S. already in place, they have already started. And so in terms of headcount, approximately 5 sales people was the number we had in 2019 and that number will triple as we get towards March and April. So we are tripling our sales headcount in Europe. We are focusing on the right regions. Our sales guy in Germany already started. He is driving the collaboration with Kraton. We have already hired the guys for Spain. And we are doubling down on Netherlands, our most important area. We are also going to double down on France, where we have a very high market share already. Yes, I mean it’s a good story right now. We are very confident that we are going to make progress. We are very confident of start seeing an uptick in revenue as early as Q1.

[Colin Rusch, Oppenheimer]

Great. And then as you think about the battery supply chain and your cost structure there, how should we think about the cadence of cost reduction, I am assuming that you are going to go through a series of costs as you get to higher volumes, but just trying to get a sense of what the order of magnitude is on that and how quickly we might get to some of those cost breaks?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, like what I told you guys in the Analyst Day, cost reduction is embedded in our DNA, that’s what I call as operational excellence. We look at all kinds of costs. If I look at microinverter costs, I look at the transformer costs, defect costs, the connector costs, for example, the connector yes I can talk about that for hours. So we have a DC connector in our microinverter. Today, we have an adapter cable that converts the connection from the panel into a proprietary connector on the microinverter. We are going to eliminate that adapter cable by building what is called as an MC4 light connector on the microinverter. That alone will save us roughly $2 to $3, but that’s going to take some time. It’s going to take some time. It’s going to be done over multiple quarters. That is just an example of one. We are focusing on transformers. We are focusing on the – always on sourcing the right AC effects. We are always working on combinations where we can integrate more components into out ASIC. So that’s on the microinverter. On the accessories, gateway is an entire exercise. Our Envoy is – we are spending a lot about trying to take cost out of the Envoy, the same effort on the cable and we will apply the same diligence to Encharge going forward. So, that’s why you see our gross margins kinds of sequentially going up. If you see the Q4 number or Q3 number was 36%, Q4 ‘19 we did around 37%, we are guiding 36% to 39% for Q1. So, we are getting more and more executing well on the cost deduction.

[Colin Rusch, Oppenheimer]

I will take the rest of it offline. Thanks guys.

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, thank you.

[Eric Branderiz, Chief Financial Officer]

Thank you.

[Operator]

Thank you. Our next question comes from Jeff Osborne with Cowen & Company. You may proceed with our question.

[Jeff Osborne, Cowen & Company]

Hey, good afternoon. Just a couple of questions of my end, I was wondering if – I know I’ve asked you this in the past, Badri, but if you just confirm that with Encharge, the launch of that margin profile would be consistent with the corporate average or how do we – I think Colin was trying to ask about that as well, is the initial phases of the launch pressuring margins in Q2 and Q3 and then as you say cost out will come back to the targeted range?

[Badri Kothandaraman, President and Chief Executive Officer]

No, it’s not going to compress our margins it’s going to be right in line with our model.

[Jeff Osborne, Cowen & Company]

Great. That’s great to hear. And then can you just talk about IQ 8 introduction for solar-only deployments, is that still targeted for Q2, Q3? So right now, it’s in the Encharge solution, but how do we think about it, somebody doesn’t want storage, when will that be available?

[Badri Kothandaraman, President and Chief Executive Officer]

So, as I said, it’s in the second half of 2020 and yes, it’s almost ready. And basically you rightly pointed out it’s already available inside the Encharge, but of course we have to do a lot more work with lot of flavors on IQ 8, which is IQ 8, IQ 8+, the IQ 8X, the IQ 8A and then the real effort is to make sure that the gateway talks to the same language as IQ 8 and ensuring that we do all the due diligence on quality on the various flavors. So, we might do it, earlier things go better, but for now I am just – I am not giving a quarter, but I am saying generically second half of 2020.

[Jeff Osborne, Cowen & Company]

Got it. And the last one I had either for yourself, Badri or Eric, just how do we think about the second half as your Mexico capacity ramps up to the million a quarter target and what the implications are for pricing as you sort of reverse the higher prices that you had experienced in 2019, because of the tariff fully recognized and it doesn’t impact the gross margins, but just it would be important for modeling as we think about ASPs per watt?

[Eric Branderiz, Chief Financial Officer]

Like what I said, our – if you think about gross margin, gross margin is a combination of pricing and cost. We are continuously improving our cost in terms of pricing. We know right now the pricing environment is very stable, but of course, we always model 1% to 2% price reductions every quarter, that’s what we do.

[Jeff Osborne, Cowen & Company]

Got it. Thank you.

[Eric Branderiz, Chief Financial Officer]

Thank you.

[Badri Kothandaraman, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. Our next question comes from Philip Shen with ROTH Capital Partners. You may proceed with your question.

[Philip Shen, ROTH Capital Partners]

Hey, guys. Thanks for the questions. First one is on the coronavirus situation, I was just wondering if you could give us a little bit more color on what’s happening on the ground there in their facility? So specifically, what kind of capacity utilization have you been running through this tough time and then how do you expect that to trend in the coming weeks? And then what kind of potential impact do you think you could see in Q2? And then finally, you source any critical components from Hubei Province specially?

[Badri Kothandaraman, President and Chief Executive Officer]

Thanks. So just to give you a quick thing, we make all our microinverters at Flex for young [ph], that’s about 12 hours drive from Wuhan. We have done our homework in terms of the raw materials, the supplier of the raw materials etcetera. Most of our raw material suppliers are in Suzhou and Hangzhou which are also a little bit away from Wuhan. From our diligence checks, our raw materials aren’t, they aren’t affected. And so if I were to think about the entire situation in terms of priority, I would think the following: number one is labor, is labor back in full force or not, the labor in our Flex factory is roughly about, because of the reduced labor our throughput is roughly 50% of the full capacity which is still pretty good for us and then the second priority or the second constraint that we think about is logistics we hear that the outbound logistics from China is getting difficult and so we are always watching our we are paying attention to that the third is a raw materials that you pointed out which we have done the homework we think we are good there. The fourth is obviously we are doing this conference call so late 7 weeks into the quarter if the revenue guidance for the quarter is X we have already shipped 7 over 13X right now that is what I mean by I am at 100% lane we have already shipped that revenue 7 over 13 multiplied by X is what we have shipped the last one is what god he is doing over a 50,000 units a week and of course what depends on the raw material from China and so there is always risk there but we feel pretty good about that guidance right now we have factored all of this situation in both revenue as well as gross margin guidance and considering that we one of the data point is we are fully booked to the guidance that we gave you we are fully booked we are 100% linear we have done the homework in terms of raw materials we are paying extraordinary attention to logistics and so at this time we feel pretty good that if that situation materially changes because there is something that we don’t know we will come back to you but that’s what we know now.

[Philip Shen, ROTH Capital Partners]

Okay. Thanks Badri. But as it relates to Q2 I know you have not provided official guidance you talked to Brian about seasonality kind of being in lines is slightly better than historical or something like that what is the risk to Q2 obviously you have already shipped for Q1 so the question is what is your view on how lets say the current situation remains at this level 50% of full capacity how does that impact what you can deliver on Q2?

[Badri Kothandaraman, President and Chief Executive Officer]

In the current situation I mean the situation remains the same we will be I don’t think will be in and I don’t think we will have a problem for Q2 if it remains the same the reason is of course we are making good progress in Mexico that is starting to take the burden more and more we are keeping a close eye on the raw material so all things being equal if it were exactly the same in a few days from now and Q2 beginning I am still pretty optimistic about Q2 but you don’t realize that things can change by the day so that’s all I can tell you right now.

[Philip Shen, ROTH Capital Partners]

Okay, great. That’s really helpful. Thanks. Shifting gears to pricing I know you talked about that briefly but historically you guys have talked about as you shipped away from China and from Mexico that you test long that pricing to customers earlier probably a few months ago you are talking about may be a price cut starting April 1st to pass it on to customers seems like our recent checks with customers that you are not necessarily getting you have not been actively talking about that what is your view on a potential for price reduction and at what point of time would you expect that to possibly happen?

[Badri Kothandaraman, President and Chief Executive Officer]

Right. Yes, so we are clear when the supply chain right now is in turbulence due to the coronavirus. Other suppliers are thinking about raising the prices we are not we basically value our customers this time we think that they have already taken a lot of burden on the tariffs so we are not planning to raise prices and it is not prudent for us to also drop prices without understanding the situation on the supply chain due to the virus. So if things stabilize, we will do exactly what I said, which is basically depending upon the percentage of manufacturing in [indiscernible] versus China for North American shipments we will basically reduce prices to that level. And that will happen sometime in Q3 if the situation gets stable in terms of the coronavirus. If not, we got to wait and watch.

[Operator]

Thank you. Our next question comes from Brad Meikle with Williams Trading. You may proceed with your question.

[Brad Meikle, Williams Trading]

Hi, guys. Thanks for the question. So your U.S. business grew 137% year-over-year in 2019, so can you give us some detail in terms of the level of inventories in the channel today versus a year ago? So we can understand how much market share has changed that is because other checks are indicating that SolarEdge inventories are higher in the channel than they were a year ago? I know you get POS data on your inventory in the channel, so can you add any color on that please? Thanks.

[Badri Kothandaraman, President and Chief Executive Officer]

Yes. We think the reasonable level of inventory to have is usually 8 to 10 weeks and we tried to maintain our channel inventory between 8 to 10 weeks like what I pointed out the last earnings call. But what you said is right we have grown a lot in the last year. Mainly the growth is because of our IQ 7 product, fantastic product it’s due to quality, due to customer experience. We have made a lot of announcements with Tier 1s. We have made a lot of announcement with the long-tail installers. We recently signed up Petersen-Dean and SunRun as well. Things look good there. But as long as we don’t take our eye off the ball in terms of customer experience, I believe we will continue to take shift.

[Brad Meikle, Williams Trading]

Can you quantify though what that market share is today in U.S. residential versus a year ago?

[Badri Kothandaraman, President and Chief Executive Officer]

So, Brad, I mean, we don’t really track – we don’t really think market share. We control the inputs, but we don’t really track the output. So it would be – I don’t know the number and I am not going to that I am not standing by, okay?

[Brad Meikle, Williams Trading]

Thanks. I mean, it’s obviously a big number given that the market is growing at 25% and you grew at 137% without much inventory growth, so what about storage, can you add anymore color on the beta installs, however many 500 to 800 that have been done, what your feedback has been from the customers, have you gotten follow-on orders? It sounds like April is when production volumes really start off. Can you give us a sense for, I know there is a day and a half training required for an installer? Can you give us some level of understanding what the ramp up might be? I know it’s a new business, but what is the theme like at this point?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes. Just to get our terminology straight, right now, we are doing what are called as alpha. Alphas are basically near and dear people is what we are doing and like what I said to Eric’s house, my house, or Raghu’s house are all running full Ensemble. And that’s what we have done. So we are giving feedback to the team. There aren’t any major issues. There are always minor in our teething issues that are there in this. And now coming to the second thing is the training, the training of installers. We have trained all our beta installers. So they are our – what we call as the ambassadors that we claimed in the first round. So we obtained about 70 installer personnel and 32 installation companies. These farm our beta network and that essentially in the first week of March they will start installing – pardon, the second week of March, they will start installing beta systems. Ad we are going to get further feedback from that. By that time our compliance will also be done. And so we will be in a very good position in order to ship the product. But in terms of the performance of the product, we are actually exercising it. Like in my house like yes, like what I said this morning I was off-grid for about 6 hours. And everything goes finally, didn’t even – someone has flipped my app to go from on-grid to off-grid, so we can enter it through the app and they were doing a test in my house and I didn’t even know that I was off-grid. That’s a big deal. If I can make that customer experience seamless, it’s all going to be that. We can make that customer experience seamless, I think so there is a lot of upside here.

[Operator]

Thank you. Our next question comes from Jeffrey Campbell from Tuohy Brothers. You may proceed with your question.

[Jeffrey Campbell, Tuohy Brothers]

Good afternoon and congratulations on the strong quarter. Badri, at the Analyst Day, it was said that other than possibly the price that DC cannot compete with Enphase, and that's what I have me thinking about the IQ 8D and the and the small commercial solar I was thinking even with higher unit ASP IQ 8D reduction in components should see system costs come down relative to the IQ 7, so is it fair to think of it that way and could the IQ 8D be the first Enphase macro that will benefit from quality service and cost competitiveness?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes but it is not because of the reason you said our architecture is a scalable architecture fully resonant architecture so we are able to what we told you in the analyst day is that the power density for our product is 50% higher for IQ 8D than IQ 8 which means we are able to pack a lot more power not more power in the same form factor and of course that translates into cost and of course we are going to be competitive but we do not price on cost we price on value what is the differentiation with respect to our next best alternative we will have to look at what is in the competition and what value are we specifically providing is it higher quality is it better customer experience is it better installation less labor all of those factors need to be looked at and then we will price our products.

[Jeffrey Campbell, Tuohy Brothers]

Okay well, that’s very helpful And then I also want to ask about the Kraton partnership that that you sent a press release on out recently it looks like it’s a large operation there is 8 factories but I have no sense of how large the client on retail market is or Kratons place in that market so some color there would be helpful and I also wondered if the installer relationships that Enphase will build through Kraton can go beyond claytie installation?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes the idea is very neat right. If you basically have in-roof solar, and you do it for new homes you would think that it can it basically can catch on like wildfire right but this is an entirely brand new market we have not seen it kick off I expect that it will be a slow and steady growth because we are introducing it in a matured country like Germany. Germany is very strict on quality is very strict on customer experience they would not ramp something as fast it is going to be in a measured way but the advantages are very, very clear it is an AC roof basically standardizes everything and it will reduce the cost of an installation it by definition the modules are built in the factory including the microinverters quality is going to be very high and it is all in all a good experience for the installer so the installers obviously they want it but at this point it is too early for us to talk about the wrap.

[Operator]

Thank you. Our next question comes from Eric Stine with Craig-Hallum. You may proceed with your question.

[Eric Stine, Craig-Hallum]

Hi everyone. Few quick questions here. The end maybe just on Tier 1 customers, I know a couple of years back you took the action to kind of step away there and late last year picked up sun run these new safe harbor customers that you referenced just curious what kind of contribution you expect from those customers as they come back in 2020 is it meaningful in 2020 and more of a 2021 or do you expect that it could impact 2020 nicely?

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, we did the safe harbor with SunRun in Q4 and we are doing safe harbor in Q1 with the couple of customers who are not new who are our existing customers the answer to your question is we expect them to use a lot of the safe harbor material but that does not mean that they would not place additional orders in the quarters of course the orders will be in the reduced magnitude but I think they will still be tightened that is what I think.

[Eric Stine, Craig-Hallum]

Okay, got it. And maybe last one for me just I know it is early here in the new year, but the new home mandate in California, whether you are starting to see an impact or how may be your view has changed or starting to become more clear and then just curious and do you have in mind kind of a share of that markets since you're partnered with SunPower and the Peterson and Dean relationship?

[Badri Kothandaraman, President and Chief Executive Officer]

I mean it is one way here I have to rely on our partners like SunPower like Peterson and Dean like Lennar homes, these are our partners. They are our front-end to the homeowners to the home builders and so we expect it really well because of our partnership with SunPower here and partnership with Peterson Dean and like our imagine a house being fitted with like for example in the case of Peterson just imagine a house being fitted with an all in one solar and storage system with beautiful in charge in the Enphase solar system that is going to be an amazing customer experience for them.

[Eric Stine, Craig-Hallum]

Got it. So this is I mean still thinks I mean it has not changed either way you still think it is a big opportunity and may be still too early to tell the magnitude?

[Badri Kothandaraman, President and Chief Executive Officer]

Absolutely. I mean it is a nice opportunity for us we are ideally placed because many of these will be small systems and if these small systems the whole point of micro inverters is I can build small systems very easily whole point of Encharge is I can do modularity flexibility very easily I can do 3.3 kilowatt or 6.6, 9.9 or 10 kilowatt hour and I can add chunks later depending upon the customer need for example Raghu has got a 10 kilowatt hour system he wants to add two more 3.3 I have a 16.8 kilo watt hour system Eric has got a 20 kilo watt hour system so each of us are different and the modularity really helps us to fine tune exactly what we want.

[Eric Stine, Craig-Hallum]

Got it. Thanks.

[Badri Kothandaraman, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. [Operator Instructions] Our next question comes from Sameer Joshi with HC Wainwright. You may proceed with your question.

[Sameer Joshi, HC Wainwright]

Yes good afternoon. Thanks for taking my questions. What are the products that are being pushed in Europe are they IQ 7 and 7+ based or are you pushing for IQ 8 as well there?

[Badri Kothandaraman, President and Chief Executive Officer]

Most of Europe right now today is 72 cell modules I believe and so that’s basically IQ 7+ and IQ 7 are the predominant cells in Europe.

[Sameer Joshi, HC Wainwright]

Okay. Coming to the safe harbor sales, are the gross margins similar the gross margin profile similar for a safe harbor versus non safe harbor sales?

[Badri Kothandaraman, President and Chief Executive Officer]

Since we are actually shipping to Tier 1, the gross margin in terms are a little bit lower but as you can see we have made extraordinary improvements in gross margins so you can see despite our huge shipments of safe harbor in Q4 our gross margin increased from Q3 to Q4

[Sameer Joshi, HC Wainwright]

Right. Same with the midpoint of your guidance for Q1 right we got our referencing point there either on the low end or high end of the range in all cases.

[Badri Kothandaraman, President and Chief Executive Officer]

Yes, in all cases, it is pretty healthy.

[Sameer Joshi, HC Wainwright]

Understood. Moving down the operating expenses, the G&A costs or other overall OpEx calls that have been guided for 1Q, are they representative of the rest of the year or does the first quarter have some extra stock-based comp?

[Eric Branderiz, Chief Financial Officer]

Yes. So most of the infrastructure investments that we need to make for the headquarters, many of the IT improvements that we need to do actually will heat OpEx, so what I will say is that we provided the guidelines of 15% of revenue and our view is that the way you guys who know it is by taking that one as kind of base line and then it could be a little bit better than that but for the most part you should consider that to be best I mean investment lines through R&D increases a little bit of the sales in Europe and some of the IT infrastructure security things that we need to do for the company that in the old ways those used to be of a CapEx. Most of the subscription base or license-based IT investment that we need to make is on now P&L, here in the P&L. So that’s the way we are going to be subsidizing through the P&L in the form of investments and our infrastructure growth and supporting the growth.

[Sameer Joshi, HC Wainwright]

Understood. And just maybe just one clarification on the ASP per unit per inverter, if I do a back of envelope calculation based on your revenues and total number of units sold, it seems that the ASP is actually reduced over the last several quarters. I know it is not a accurate way of looking at it, but is this trend expected to continue?

[Badri Kothandaraman, President and Chief Executive Officer]

No, I mean it’s not an accurate way of looking at it. It basically depends the way you look at it, your calculations, take revenue, overall revenue divide it by the number of microinverters is not the real story, because for example, if we do ship our AC batteries which are our first generation batteries. Each of them has got an ASP of $1,000. So we are not breaking those, but your calculation includes those. If we ship a lot of cables for example, if we ship by disproportionate amount of cables, the overall revenue will actually come down. If you ship, I mean, the overall ASP will actually come down. So it’s a heavily dependent on mix. But what I can tell you is this we pay very close attention on what we call as customer variance that we reduced price at a customer – and specific customer and calculate that. And we roll that up. And those numbers are actually very, very less. So, there is really – pricing is very healthy, pricing is flat. And except for what I talked about in terms of the [indiscernible] transition, we don’t see many changes to pricing.

[Eric Branderiz, Chief Financial Officer]

Until it’s good for them to model some price erosion, on their models, right, we always recommend…

[Badri Kothandaraman, President and Chief Executive Officer]

We always model 1% to 2% for our modeling. So that is the right way to think about it.

[Eric Branderiz, Chief Financial Officer]

And it will get a little more complicated with Ensemble coming onboard, right. So we will provide some help hopefully for you guys tomorrow when the meaningful revenue of Ensemble starts to become more clear right.

[Operator]

Thank you. Our next question comes from Pavel Molchanov with Raymond James. You may proceed with your question.

[Pavel Molchanov, Raymond James]

Thanks for taking my question. In its mid-term review, the International Trade Commission talked about potentially adjusting or even setting aside the Section 201 tariffs. As it relates to the AC module relationships you have, is there any read-through depending on what the decision will be?

[Badri Kothandaraman, President and Chief Executive Officer]

No, I think there was a lot of discussion about it, but we have not heard anymore discussion on the tariffs going away and we also know that there is exclusions there. So I don’t believe that, that can play right now.

[Eric Branderiz, Chief Financial Officer]

Most of our volume business with SunPower already is excluded so.

[Pavel Molchanov, Raymond James]

Understood. And you have already asked about one of the new entrants Generac, if I may, let me ask about another one, LG, can you confirm whether LG is currently a customer for your microinverter as a component to LG’s integrated module product?

[Badri Kothandaraman, President and Chief Executive Officer]

No they are not a customer.

[Pavel Molchanov, Raymond James]

Okay, thank you very much.

[Operator]

Thank you. And that concludes our Q&A session. I would now like to turn the call back over to Badri Kothandaraman for any further remarks.

[Badri Kothandaraman, President and Chief Executive Officer]

So, thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you again during our Q1 2020 earnings call in April. Thank you.

[Operator]

Thank you. Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.