Enphase Energy Inc (ENPH) — Q4 2018 Earnings Call Transcript

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's fourth quarter and year-end 2018 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer; Eric Branderiz, Chief Financial Officer; and Raghu Belur, Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its fourth quarter and year ended December 31, 2018. During this conference call, Enphase management will make forward-looking statements, including but not limited to, statements related to Enphase Energy's technology, products and financial performance, operations including supply and lead times and current and future market and customer demands and trends. These forward-looking statements involve significant risks and uncertainties, and Enphase Energy's actual results and the timing of events could differ materially from these expectations. For a more complete discussion of the risks and uncertainties, please see the company's quarterly report on Form 10-Q for the quarter ended September 30, 2018, which is on file with the SEC, and the annual report on Form 10-K for the year ended December 31, 2018, which will be filed with the SEC in the first quarter of 2019. Enphase Energy cautions you not to place any undue reliance on forward-looking statements, and undertakes no duty or obligation to update any forward-looking statements as a result of new information, future events, or changes in its expectations. Also, please note that financial measures used on this call are expressed on a non-GAAP basis unless otherwise noted, and have been adjusted to exclude certain charges. The company has provided a reconciliation of these non-GAAP financial measures to GAAP financial measures in its earnings release posted today, which can also be found in the Investor Relations section of its website. Now, I'd like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy. Badri?

Good afternoon and thanks for joining us today to discuss our fourth quarter and full year 2018 financial results. We had a solid quarter, reporting revenue of $92.3 million. We had strong customer demand as our financial strength and robust balance sheet reaffirmed customer confidence. Our biggest challenge in Q4 was meeting this additional demand due to component shortages that constrained our revenue. We are fully booked for Q1 2019, just as we saw in Q4 2018. I will provide an update later in the call on our plans to mitigate component shortages. Our non-GAAP gross margin in the fourth quarter was 30.7% and the non-GAAP operating income was $8.6 million. Our gross margin was negatively impacted by 4.3% due to expedite fees related to component shortages. The expedite fees were in the form of air shipments that we chose to make in order to service our customers. We exited the fourth quarter with a cash balance of $106.2 million, net of a $10 million final payment to SunPower. The strong cash balance also enabled us to completely repay, on January 28, 2019, our high-interest bearing senior secured term loan of approximately $39.5 million plus accrued interest and fees. Now let's talk about our target financial model. We introduced the 30-20-10 model at our Analyst Day in June of 2017 and committed to meeting this model in Q4 of 2018. The 30-20-10 stands for 30% gross margin, 20% operating expense and 10% operating income. We made significant progress towards making that model a reality as we exited 2018. Eric will go into greater detail about our financial results later on the call. An important focus item that we discussed in the past few quarters is the ease of doing business and how customers perceive us. Quality and customer service are the cornerstones of our strategy and our objective is to deliver an exceptional customer experience. Our business processes are maturing, and we are prioritizing customer experience to be number one in all aspects of our business. During Q4, we made several improvements in our call center and online support, particularly in Europe and Asia Pacific. We also rolled out our Enphase Upgrade Program, a service program for early adopters of our legacy microinverters and announced that over 1,000 homeowners have joined the program. The key metric we use to measure customer experience is the net promoter score or NPS; this metric is calculated based on feedback from customer surveys on how likely customers or partners will recommend Enphase to a friend or colleague. Our NPS in North America was approximately 51% in Q4, and our target is to achieve a worldwide NPS of 60% or higher in 2019. Now let's talk about the Section 301 tariffs that became effective in September of 2018 affecting Enphase microinverters and accessories. As we discussed last quarter, we are mitigating the existing 10% tariffs by sharing the cost increases with our customers and expanding our manufacturing agreement with Flex in Mexico starting in Q2 of 2019. This additional line in Mexico is expected to help Enphase better service our North American customers by cutting down cycle times and streamlining inventory at a similar manufacturing cost to what we currently have with Flex in China. Now turning to our regions, our U.S. and international mix for Q4 was 77% and 23% respectively. All of our regions were impacted by component shortages in Q4. Our fourth quarter revenue in the U.S. was up 38% sequentially and up 29% year-on-year due to strong customer demand across the board. Note that the U.S. revenue includes volume shipments of our IQ 7XS microinverters to SunPower as we had previously planned. In Europe, revenue was down 2% sequentially, but up 27% year-on-year. The megawatt shipments were up 26% sequentially and up 31% year-on-year, setting a new record for Europe. Note that the Q3 2018 revenue for Europe included a $3.3 million milestone achievement from a partner on IQ8. We are encouraged by the growth outlook in the new build and social housing sectors in Europe. In APAC, our revenue was down 61% sequentially and down 74% year-on-year. As we previously mentioned, the region had built up significant channel inventory over time and we took this opportunity to bring the inventory down. We recently appointed Wilf Johnston as our new General Manager for the region and we believe his years of international executive management experience will help strengthen our APAC business. In Latin America, fourth quarter revenue was down 41% sequentially and down 14% year-on-year; unfortunately, component shortages significantly impacted our Q4 sales to this region as well. Now that we are financially stable, a large portion of our time is spent on profitable top-line growth. We plan to achieve this growth through differentiated products and services. Our four levers for profitable top-line growth remain IQ7 regional expansion, high power and high performance products, AC modules, and Ensemble Solar and Storage technology. The first lever for profitable top-line growth is IQ7 regional expansion. Approximately 84% of our microinverter shipments in Q4 were IQ7, up from 78% in Q3. As I mentioned earlier, component shortages constrained our revenue in Q4. We have been working with our customers and partners to manage these shortages and we are thankful for their efforts and patience. The additional capacity based on an investment we made with one of our suppliers earlier in 2018 is now online. This has allowed us to increase our microinverter supply for Q1 2019, but with the growth we have seen, our lead times are still around 13 to 15 weeks. We have recently signed two new long-term contracts for additional high-voltage transistors. This additional supply is expected to become available in the second half of this year, which we believe will help improve our microinverter lead times to six to eight weeks. The second lever for profitable top-line growth is releasing high power and high performance new products. The IQ7XS product addresses 96-cell PV modules up to 400 watts DC and with its 97.5% CEC efficiency, it is ideal for integration into high power modules like SunPower and Panasonic. In addition, we shipped limited quantities of our new product, IQ7A, which addresses up to 450 watt DC modules. The third lever for profitable top-line growth is AC modules. We had volume shipments of our IQ7XS microinverters to SunPower in the fourth quarter, and as previously announced, we expect a continuation of the ramp in 2019. In addition, we are making steady progress with module partners such as Solaria and Panasonic, and ramping Enphase Energized AC modules. These integrated systems allow installers to be more competitive through improved logistics, reduced installation time, and faster inspection and training. Since their release in October of 2017, Enphase Energized ACMs from our module partners have been adopted by about 420 installers in the U.S. as of today. Finally, a major catalyst for our profitable top-line growth in the long term is our Ensemble solar and storage technology. The IQ8 system is based on our grid-agnostic, always-on technology called Ensemble. This system has four components: energy generation, which is accomplished with the grid-agnostic microinverter IQ8; energy storage, which is achieved by the Encharge battery with capacities of 3.3, 10 kilowatt hours, 13.2 kilowatt hours; communication and control called Enpower, which consists of the automatic transfer switch and the combiner box with the Envoy gateway; and the fourth component is Enlighten, which is the IoT cloud software. We are working hard on each of these four components of the IQ8 system. There are over 100 engineers working on the project across multiple time zones. However, given the high complexity of the technology in terms of hardware and software, we are running a little bit late. We believe in making right decisions for the long-term and getting the customer experience right. Therefore, we now anticipate introducing Ensemble in a phased manner starting in the fourth quarter of 2019. Let me remind you that there are two major market segments Ensemble technology addresses. One is the pure off-grid segment and the other is a grid-agnostic segment. We just talked about the grid-agnostic solution being delayed to the fourth quarter of 2019. However, the pure off-grid microinverter solution is on track. We shipped limited quantities to our partner on IQ8 during the fourth quarter of 2018 and we expect to ramp production in the first half of 2019. We also expect the final milestone revenue from this partner in the first quarter of 2019. In summary, we are encouraged by our progress in 2018. Our top priorities remain providing a superior customer experience and focusing on our four profitable top-line growth factors. I would like to thank our employees for their hard work and our customers, partners, and shareholders for their strong support. With that, I will turn the call over to Eric for his review of our financial results. Eric?

Thanks, Badri. I will share additional details about our fourth quarter and full year 2018 financial results, as well as our business outlook for the fourth quarter. Please note that the financial measures I will present are on a non-GAAP basis, unless stated otherwise. We have included reconciliations of these non-GAAP financial measures in our earnings release posted today, which is also available in the Investor Relations section of our website. Total revenue for the fourth quarter of 2018 was $92.3 million, reflecting an 18% increase sequentially and a 16% increase year-over-year. We shipped about 257 megawatts DC in the fourth quarter of 2018, a 25% sequential increase and a 16% increase from the same quarter last year. The megawatts shipped corresponded to approximately 820,000 microinverters, about 84% of which were IQ7 models. Both IQ6 and IQ7 made up 91% of Q4 microinverter shipments. Non-inverter revenue, which includes our AC Battery Storage Solution, Envoy Communications Gateway, combiner box, and accessories, increased as a percentage of total revenue compared to the previous quarter. Total revenue for 2018 was $316.2 million, a 10% increase from 2017. In 2018, we shipped around 2.8 million microinverters, equivalent to 972 megawatts DC, representing a 13% year-over-year increase in megawatts shipped. The non-GAAP gross margin for the fourth quarter of 2018 was 30.7%, down from 32.8% in the third quarter. Keep in mind that Q3 2018 non-GAAP gross margin included a $3.3 million milestone achievement from a partner on IQ8. Although we shared some expedited fees with our partners, component shortages adversely affected our Q4 gross margin by about 4.3%. Non-GAAP operating expenses for the fourth quarter of 2018 totaled $19.7 million, compared to $18.6 million in Q3 and $18 million in Q4 2017. 2018 marked our first year of SOX compliance efforts, leading to higher than anticipated expenses in internal audit, as well as additional consulting and advisory fees. These elevated expenses are expected to continue into Q1 2019. Non-GAAP operating expenses for 2018 reached $75 million, compared to $72.8 million in 2017. GAAP operating expenses for the fourth quarter of 2018 were $23.2 million, down from $25.6 million in Q3 and up from $21.1 million in the fourth quarter of 2017. GAAP operating expenses for Q4 included $1.5 million in stock-based compensation, $1.5 million in restructuring expenses, and about $400,000 of acquisition-related expenses and amortization. For 2018, GAAP operating expenses were $92.8 million, compared to $95.4 million in 2017. On a non-GAAP basis, income from operations was $8.6 million in the fourth quarter of 2018, an increase from $7 million in Q3 and from $1.3 million in the same quarter last year. This improvement in operating income reflects our enhanced operational excellence and ongoing product leadership. On a non-GAAP basis, net income for the fourth quarter of 2018 was $5.1 million, compared to $4.6 million in Q3 and $683,000 in the same quarter last year. This resulted in basic earnings per share of $0.05 and diluted earnings per share of $0.04 for the fourth quarter of 2018, compared to $0.01 for both basic and diluted earnings per share in the prior year quarter. GAAP net income for the fourth quarter of 2018 was $709,000, marking the first quarter in the company’s history that we reported GAAP net profitability. Now turning to our balance sheet, inventory stood at $16.3 million in the fourth quarter of 2018, down from $17.9 million in Q3 and $26 million from the same quarter a year ago. We ended with 23 days of inventory on hand as of December 31, 2018, significantly less than our target of about 30 days, and decreased from 31 days in Q3 and 39 days in the year-ago quarter. Although much of the inventory reduction was due to high demand constrained by component shortages, inventory management remains a key focus of our cash management efforts. We exited the fourth quarter of 2018 with a total cash balance of $106.2 million, a decrease from $116.2 million in Q3. This balance includes a final $10 million payment to SunPower for the acquisition of its microinverter business. We also generated $1.9 million in cash flow from operations and $4.1 million in adjusted free cash flow. The $1.9 million in cash flow from operations in Q4 would have been $5.9 million if we had not allocated $4 million of the $10 million payment to SunPower toward operating cash flow for the acquired customer relationship intangibles. As Badri mentioned, on January 28, 2018, we fully repaid our high-interest-bearing senior secured term loan with Tennenbaum Capital Partners, an indirect subsidiary of BlackRock Inc. This repayment included a principal amount of about $39.5 million along with accrued interest and fees, and it also terminated the liens on all of Enphase’s assets, granting us greater operational flexibility moving forward. Now let's discuss our outlook for the first quarter of 2019. We anticipate our revenue for Q1 2019 to be between $90 million and $95 million. In terms of margins, we expect both GAAP and non-GAAP gross margins to range from 31% to 34%. Please note that our Q1 gross margin guidance accounts for an adverse impact of roughly 2% to 3% due to expedited fees arising from component shortages. We expect our GAAP operating expenses to fall between $25 million and $26 million, which includes around $4.5 million estimated for stock-based compensation, additional restructuring expenses, and acquisition-related costs and amortization. We forecast non-GAAP operating expenses to range from $20.5 million to $21.5 million. With that, I will now open the line for questions.

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

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

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

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

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

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

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

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

Thanks. I'll get back in the queue.

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

Right, so Ensemble is designed to serve two markets: one is the grid-agnostic market segment, and the other is the off-grid market segment. Regarding the off-grid market segment, where we are on track, we started sampling the product to our lead customer in the fourth quarter of 2018 and we are expecting to ship significant quantities to them in the first quarter of 2019. If you look at the countries where the off-grid technology is going to play a major part, it will be places like India and Africa. In India and Africa, PV and storage systems won't be that big; they have to be small. But imagine having one or two AC modules or one or two modules with microinverters. That will be perfect for the architecture of a microinverter. It's still too early for us to assess volumes and talk about ramps, but we're excited that our product is there, our product is sampling. We have a strong partner and we will talk about progress in the coming quarters. The grid-agnostic market is also very exciting, as we service someone who wants to be completely grid-independent and also someone who wants to be totally dependent on the grid but just wants backup as peace of mind. Ensemble technology that can do whatever the customer wants. That's why we call it grid-agnostic and Ensemble complex. It has got four components, which are the micro, the battery, the automatic transfer switch, and the combiner and cloud. Working all of these together seamlessly in terms of hardware and software is something that we have been challenged with, and I think that's why we are experiencing the delay. But the way I think about it is two big opportunities on the Ensemble side: one is storage, which is Encharge, which takes our revenue per home from $2,000 to $10,000. The other is that even with no storage attachment, people will want grid-agnostic solar or grid-tied solar. We think that most people would prefer grid-agnostic solar if given a choice. So once again, we are extremely excited about the technology, but we did not want to get ahead of ourselves. Right now, we are focused on execution and getting this product out in the fourth quarter of 2019.

Okay. Maybe just another one: could you talk about the percentage shipped to AC modules and the form factor or a range? Where you have been in Q4 and where you think it could go by say year-end 2019?

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

Maybe just last one for me. To reach the high and low end of your margin guidance for Q1, can you just talk about the factors? Is it some combination of mix? Obviously, what you've done in terms of sharing the tariff impact. Maybe just talk about those factors and the more important ones to get to the 300 basis point delta?

Yes. I mean, look, we are already sharing the tariff costs with our customers. We did that effectively in Q4 of 2018, which is what we said we would do. The puts and takes on gross margin; the 4.3% really comes from air shipping our microinverters to provide customer service. Yes, a few of our customers are also willing to pay for air shipping, so that offsets us a little, but even after that, we still had a gross margin hit of 4.3%. Now in Q1 of 2019, with the supply situation a little bit better, we are not going to be spending so much money, but still, there is a significant impact of 2% to 3% in terms of air shipments. That's really accounted for in the guidance of 31% to 34%.

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

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

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

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

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

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

Yes, I mean, if you really see it, an AC module is perfect when you see that the modules are going to higher and higher power. Because we can easily scale our microinverters. So, it’s advantageous for us in terms of gross margin as well. Having said that, SunPower is the biggest, and partners like Solaria are also gaining a lot of traction in their market. Solaria has a 355 watt AC module, which is a really neat 72 cell module with a very high aesthetic black on black finish, it really looks nice. We also announced our partnership with Panasonic, which is slowly getting to be a reality and we'll announce when we are ready there. So these are our strong partners, and in addition, we are working on a few more in the international regions, which we will announce when we are ready.

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

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

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

Yes, it will be broken out in 10-K; you can see that as well in the table of the press release. For the most part, you can see there the stock component of $1.5 million, and another portion associated with the restructuring fees. So everything is clearly easy to follow there compared with the prior quarter, and you can take it into account for the following impact.

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

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

I noticed that you didn't specify that when discussing the factors affecting gross margin, but if it's under $1 million, is that the final payment? Or will there be more payments in the future?

That's the last of the payments.

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

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

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

The IQ8 uses the same high-voltage transistors.

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

Yes, we have two arrangements that we have on top of the existing one that Badri set out. One of the two new contracts is actually a continuation of the existing one with some prepaid arrangement similar to what we had before. The other one is with another supplier with a take-or-pay arrangement that is very short timeframe. So, I wouldn't think it would extend beyond 18 months to two years, which gives us enough runway to resolve the problems. However, we want to be cautious on our structure pricing arrangement on a take-or-pay for the long-term.

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

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

Right now, you should think about OpEx; our long-term model is 20% of revenue, and we are not going to deviate from that. We incurred restructuring expenses to ensure we have the right people in the right places. So, we are confident that we can meet that objective. While we ramp revenue, we will control OpEx at 20% of sales.

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

Look, it seems the 30-20-10 is looking more like 32-22-10. The important aspect to focus on is the 10% operating income. So as long as that is met, numbers will fluctuate a little. Though we feel good about our profitable top-line growth vectors. Even if Ensemble is late, we feel that the other three vectors are compensating for that. We feel good about this, but we’re not going to guide more than one quarter out. We know this is a solar industry; anything can happen overnight. If the government sneezes on this a little bit, things can go south. So, we’re not going to make updates right now.

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

Well, we expect that when we introduce the product in the fourth quarter, that will only be the ramp. There won't be significant revenue from Ensemble in 2019.

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

Yes, I'll take the first part, and Badri can probably cover the business aspects of it, Colin. But if you think about it, the supply component shortages have created challenges with our linearity. Significant shipments took place towards the end of the quarter, even an expedited costing basis on air shipping. This has been aggravated since Q3. I believe we are turning a corner where you can see receivables with day sales outstanding of 70 days. At the same time that compensated with the payable side, we have a lot of purchases of inventory taking place towards the end of the quarter. While this results in super low levels of inventories on the working capital front, it is still below our comfort level for operational flexibility at 23 days with a total cash conversion cycle of 24 days from working capital at the end of the quarter. We believe the linearity challenges are starting to get resolved in Q1 and will be pretty much gone by the end of Q2, and we are in good shape to normalize the business back again.

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

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

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

Look, I mean, it's still going to be heavily skewed towards North America because of SunPower. That said, we are really excited about Europe; we had the highest megawatt shipments, as noted, in Q4. We are really optimistic about the social housing boom in the Netherlands and have very strong distribution partnerships in France. Once the component shortages are resolved, we hope to break into other regions, like start ramping in Germany and start ramping in Austria. If you look at Australia and New Zealand, we really took this opportunity with the component shortages to correct our channel inventory. We did that before we brought on a general manager. His expertise is in solar, and he understands storage as well. We really want him to grow the battery business there. Lastly, in India, we’re not talking about India much, but with the off-grid product coming, we are really excited about the prospects in India. There are some niche applications that I am not going to discuss right now. But as our pure off-grid product rolls out in the first half of the year and Ensemble turns on, there are exciting prospects there as well.

Okay. Thanks so much, guys.

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

Yes, I mean, that's our goal to obviously get to parity in terms of the U.S. versus Europe versus Asia to get to something like 33-33-33. But having said that, the U.S. business is the strongest at this point in time, especially with SunPower and our long history with many customers. 2019 is going to be about the U.S.. But I am optimistic that by 2021, we can start being more balanced in terms of all the deals.

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

Yes, I mean, I mentioned in the last conference call that we could not ship more than $10 million of demand. I said that in the Q3 conference call, and that number is a little bit higher for Q4. There is a lot of demand out there, and we are seeing a lot of demand because of our financial stability, our strong balance sheet, because the IQ7 is the latest and greatest product that we have, and our customer experience and high quality. Demand is strong, and it is also probably the middle at this point, and I expect the next two quarters to be similarly strong, but I'm optimistic about Q3 and Q4.

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

So, Phil, we are not going to break that out. I broke that out in Q3, just to ensure that our top-line is starting to break out. Now, we are not going to get into the habit of breaking that out. I’ll just tell you this: we feel really good about demand being strong, and what we feel bad about is that we are still not servicing customers well in terms of deliveries, and we need to fix that. That's what I'm working on day and night, and that is our top priority to focus on customer demands.

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

Hey Phil, this is Raghu. Yes, we definitely see them in the market in Europe. We are competing very effectively with them, especially in the markets where we are more active in the Netherlands, France, and a couple of other countries in that region. We do run into them, but we clearly have been very effective there and doing well, given the fact we had record shipments in Q4 in Europe, both in terms of megawatts and units. Our core strength lies in our product quality, superior customer experience, high-quality, and reliability, as well as the customer support in the work that we have done, separating us from all the other string players out there, not just Huawei. The AC module will also be very interesting in Europe. We are now actively engaged with a few partners that we’ll announce when we are ready, and there is clear value generation when installers have installed AC modules regarding savings on logistics, installation time, training, and inspection quality. All in all, we feel good about Europe, and it's shown in the numbers; we did record numbers in Q4.

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

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

Yes. The conversation about strategic targets for accretive, short-impact acquisitions, similar to something like SunPower on different parts of the space, is part of the discussion. The success on how we integrated the acquisition and harvesting the benefits associated with it has set a high bar in terms of what we are trying to achieve. We have cash, and we feel very comfortable, but we want to be very careful on how we are going to go about spending it and targeting. Trust me, Pavel, there will not be a big diversion from our strategy for 2019 or potentially decisions that we will need to pay back that extends beyond 18 months or maybe 2 years.

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

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

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

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

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

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

So Brad, we’re not going to comment on the competition or their strategies. But let me repeat my core strength: product quality and superior customer experience. That is what we do — ease of use, high quality, and high customer service. If they pick us, we're more than happy; we need to solve these component shortages to start servicing them right.

Thank you.

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