Enphase Energy Inc (ENPH) — Q1 2020 Earnings Call Transcript

Good afternoon. And thank you for joining us on today's conference call to discuss Enphase Energy's first quarter 2020 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 close today, Enphase issued a press release announcing the results for its first quarter ended March 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 future financial performance; the capabilities, launch and availability of our technology and products, our performance in sales and operations, and our expectations as to the impact of the COVID-19 pandemic. 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, 2019, which is on file with the SEC, and quarterly report on Form 10-Q for the quarter ended March 31, 2020, which will be filed during the second 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?

Good afternoon. And thanks for joining us today to discuss our first quarter of 2020 financial results. I hope all of you are staying safe and healthy. We had a good quarter considering the COVID-19 pandemic. We reported revenue of $205.5 million and shipped approximately 2 million microinverters. I'm very proud of the fact that our global teams did an excellent job navigating the manufacturing and logistics disruptions in China due to COVID-19 in order to ensure on-time customer deliveries. We reached an all-time record for gross margin, driven by both disciplined pricing and cost management. We exited the first quarter at approximately 40%, 14%, and 26%, outperforming our baseline financial model. This means 40% gross margin, 14% operating expenses, and 26% operating income, all as a percentage of revenue on a non-GAAP basis. As a reminder, our target baseline financial model is 35%, 15%, 20%. When we last spoke in mid-February, the general concern was primarily around supply disruptions in China due to COVID-19. At that time, our teams were on top of the situation on a daily basis and managed the situation very well. The demand in the US remained strong through early March, as distributors wanted to ensure they had adequate inventory. We were seeing excellent bookings for Q2 at that time and were poised to rebound well from a seasonally soft Q1. However, since early March, the spread of the pandemic worldwide has resulted in a significant downward pressure on worldwide demand due to current shelter-in-place restrictions. Even though solar installations have been allowed as essential services in some locations, the ability to generate new sales has been hindered due to social distancing and economic uncertainty. I'll give you more color on the regions later in the call. Let's now talk about how we are servicing our customers in these times. I'm very happy to report that our customer service personnel in all four worldwide locations – US, Europe, India, and Australia – are fully supporting our installers and homeowners while working from home. We have not missed a beat in supporting them as all our systems are cloud-based. I'm particularly pleased that our Q1 net promoter score in North America was 72% compared to 56% in Q4. This dramatic quarter-over-quarter improvement was the result of many initiatives, such as retraining our agents, matching orphaned sites to active installers for better servicing, and improving our tools, processes, and systems. Our average call wait time increased slightly in Q1 to approximately 90 seconds. We have taken corrective actions, such as optimizing customer notifications from our Enlighten cloud, enhancing self-service and chat capabilities to reduce call volumes and lower our wait times to 60 seconds or less. In addition, we are working regularly on continuous improvement to the Enlighten mobile app for homeowners as well as installers. We're also very pleased with the momentum in the Enphase online store in the US, which now has many of our latest products, including IQ 7-based AC modules available for sale. I want to spend a couple of minutes on quality. We made excellent progress in 2019, dropping our IQ 7 defects by a third and getting closer to our 0.05% annual failure rate target. Our always-on connectivity strategy, combined with our semiconductor and software-defined architecture, along with 8D problem-solving methodology were instrumental in making this happen. While we're planning to continue these actions aggressively in 2020, we have started focusing on storage as well. For example, our quality teams have been intimately involved in the design and reliability of our Encharge storage system from day one. We believe that designing in quality and reliability upfront will improve our top line due to better customer experience and bolster gross margins due to warranty expense reductions in the long term. Let's now turn our attention to our Mexico contract manufacturing facility that continues to ramp nicely for us. The facility has been deemed essential and has not experienced any significant production disruptions to date. We manufactured more than 700,000 IQ 7 microinverters in Mexico during Q1 and exited the quarter at a weekly run rate of more than 70,000 units. We feel very confident in the ability to produce over a million units by Q4 2020, if justified by product demand. Let's touch upon overall inventory management. Given the reduced demand situation in Q2 of 2020, we are working closely with our contract manufacturing partners to optimize our inventory builds both in China and Mexico. Maintaining a tight lid on inventory is very critical for us, especially in times like this. However, it is important to note we are not compromising one bit on our Encharge storage ramp and are executing on all the necessary builds there. Moving on to the regions. Our US and international mix for Q1 was 84% and 16%, respectively, excluding safe harbor revenue. Europe, Asia-Pacific, and Latin America all demonstrated sequential growth in Q1 compared to the US that had a slight seasonal decline in Q1. We continued to make solid progress in acquiring new installers and growing our US business in Q1. As a result, we have seen a strong increase in sell-through from our distributors to installers, approximately 37% over the last six months ending March. Recent installer wins include PetersenDean, Amica Solar, RSI Energy and a whole bunch of small and medium-sized installers. A number of these new installers also plan to offer storage in addition to solar. We are excited about bringing them on board and look forward to ramping the business with them as COVID-19 subsides. In the US, we are hearing industry reports of a 30% to 50% drop in residential installations in April. Some states like New York and California are experiencing even bigger drops. With the near-term demand disruptions to the industry, we are taking all necessary reactions to keep our channel inventory in check. With the lower sell-through in April, we are working closely with installers and distributors to optimize their existing inventory. We believe that this will result in a healthier organic pattern when installer sales activities pick up after restrictions on shelter-in-place are relaxed. While the short term is painful and uncertain, we see a few long-term benefits for Enphase and the solar industry. Let's talk about the first one. For example, San Luis Obispo County in California introduced electronic permitting for microinverter-based PV systems in early April 2020. We are pleased that the building department recognizes the safety advantages of our AC architecture. The second benefit is installers are rapidly adapting to the COVID-19 challenge by embracing virtual selling using digital tools. This is going to be a major trend in the future. Third, we also believe that the pandemic will bring self-sufficiency to the forefront of the homeowner's mind, particularly around energy storage, and we are in a great position to service homeowners, especially as our high-quality solar and storage solutions can help them save money during difficult economic times, as well as providing energy security. Now, let's talk about Europe. We made nice progress in Q1, more than doubling the revenue from Q4. As previously discussed, we have tripled our sales force in that region and we are working diligently with installers and distributors, while leveraging our high quality and customer service. We are excited by the opportunities in the Netherlands, Spain, Germany and Belgium. We also have a couple of AC module solutions that provide us with added differentiation. In fact, we expect Q2 sales to be in line with Q1 despite the pandemic, reflecting the nice progress we are making. We previously indicated that our goal this year was to double sales in Europe from the prior year. It's going to be a little bit difficult given the pandemic, but we have not given up on it yet. Both Asia-Pacific and Latin America demonstrated revenue increases compared to Q4. In Australia, we secured RACV, the equivalent of AAA in the United States, with 2.2 million members as a new landmark customer. We also introduced a partnership with Rexel to expand our Australian solar distribution network. Again, our strategy here is pretty simple. Focus on the basics like increasing installer visits and training and promoting high quality safe AC. We do expect a slowdown in this region in Q2 due to the pandemic, but with our solid growth initiatives and the talented team in place, we believe we are well positioned to grow for the long term. In Latin America, our Q1 revenue sharply increased, primarily due to sales of our IQ 7 microinverters in Puerto Rico. We expect to make a lot more strides in this region with our Encharge storage product, which is coming soon. Let's now turn to new products. I want to talk a little bit about how our engineers are doing. Despite the restrictions imposed by the lockdowns, our engineers have been working very hard to find ways to accelerate development, automate testing efforts and implement remote debugging. In the US, we are in complete lockdown with the exception of very few engineers to support essential business activities or minimum basic operation. In New Zealand, the government imposed a complete lockdown and just allowed partial opening up offices in the last week of April. In India, a handful of engineers were able to get permission from the local authorities to do essential work. We acknowledge the effort from all of our employees for their tremendous dedication to Enphase in these times. I'm really proud of them. Nevertheless, the shelter-in-place rules implemented in March impacted our overall engineering activities, such as testing and compliance of our Encharge battery storage system. As a result, we will be unable to ship beta units before the end of the quarter – first quarter as we originally planned. As of now, all testing is complete and we expect to start shipping beta units to installers shortly. Barring any further impact from COVID, we do expect to have meaningful revenue in Q2 from production shipments of our Encharge battery storage systems. Installer training is critical for Encharge's success. We trained 654 people at our Fremont headquarters in Q1 and were limited in being able to train more due to shelter-in-place rules. We are switching over to online training in the coming weeks. And after completing all coursework online, installers will receive provisional certification and will have a video inspection of their first installation by an Enphase field application engineer. We believe this process adequately ensures the skill verification that we require of our certified installers. As I mentioned in my recent letter to shareholders, new products are the lifeblood of Enphase. The IQ 7 family of products has put us in a very solid position today. We have an incredible product lineup awaiting us. First, we are committed to launching IQ 8, the grid-agnostic microinverter for residential rooftops which will add even more differentiation on top of IQ 7. Second, our small commercial offering, IQ 8D, the 640-watt AC microinverter for two panels, is coming along well. We expect this product to provide high quality, rapid shutdown compliance in addition to outstanding CEC efficiency of 97.5%. Third, we are adapting the Ensemble in a box product we announced at our 2019 analyst day and expect to introduce it initially for the US followed by India. This product will be portable, with a battery capacity of 1.7 kilowatt hour, providing energy security inside the home, as well as energy on the go for outdoor activities such as camping. The battery can be directly charged from the grid or from portable solar panels depending on whether the product is used indoors or outdoors. The product will have our trademark characteristics - high quality, always-on connectivity, and exceptional customer experience. We are looking forward to introducing the product later this year. Let me talk about another big initiative we are embarking on – digital transformation. Today, we are engaged digitally with our installed base of more than 1.1 million sites through the Enlighten mobile and desktop applications, putting us in a unique position to understand our customers' energy needs well. Similarly, we work very closely with a few thousand installers and engage with them through mobile app training workshops, customer visitations, and installer newsletters. We want to create an incredible experience for both installers and homeowners by developing a comprehensive digital platform. It is our desire that both existing and new homeowners come onto your platform, are seamlessly connected to our great installer network, and have an efficient interaction all the way through installation, activation, and operations and maintenance. It is our vision that, when done right, this platform will serve as a powerful catalyst, accelerating our solar and storage sales. In order to build such a powerful platform, we are planning to create several tools for the installers to make the entire installation process a lot more efficient. This involves building software expertise both organically as well as inorganically. We expect to make significant progress on this front in 2020. Although there is short-term uncertainty due to COVID-19, we have tremendous confidence in the strength of our business in the long term. Our supply chain is flexible and resilient, aided by our strong contract manufacturing partners. We are laser focused on operational excellence and customer experience. We have a very strong balance sheet, with additional cash from the recent convertible debt offering and good cash flow generation capability. Our strategy is to manage the current circumstances by investing in innovation and creating new products with unmatched value based on our three pillars of differentiation – semiconductors, software, and Ensemble. In summary, we are pleased with the results of the first quarter considering the COVID-19 pandemic. We extend our deepest sympathy to those impacted by this pandemic. While it is impossible to know how the crisis is going to unfold, our top-most priority is to ensure the health and safety of our employees, customers, and partners. We will also do whatever possible to ensure uninterrupted supply and support of our high-quality products to our customers and partners. With that, I will hand things over to Eric for his review of our finances. Eric?

Thanks, Badri. I will provide more details related to our first quarter of 2020 financial results as well as our business outlook for the second quarter of 2020. We have provided a reconciliation of these non-GAAP to GAAP financial measures in our earnings release posted today, which can also be found in the Investor Relations section of our website. Total revenue for the first quarter of 2020 was $205.5 million, including approximately $44.5 million of safe harbor revenue. Total revenue for the first quarter of 2020 decreased 2% sequentially and increased 105% year-over-year. Excluding safe harbor revenue, first quarter revenue decreased 7% sequentially and increased 51% year-over-year. We are pleased with this result considering the typical industry seasonality in the first quarter and the supply chain disruption in China from COVID-19 pandemic. We shipped approximately 643 megawatt DC in the first quarter of 2020. Non-GAAP gross margin for the first quarter of 2020 was 39.5% compared to 37.3% for the fourth quarter of 2019. The sequential improvement resulted from our continuous focus on pricing management and cost reduction initiatives. Non-GAAP operating expenses were $28.5 million for the first quarter of 2020 compared to $26.1 million for the fourth quarter of 2019. The sequential increase was primarily driven by the hiring of sales personnel in Europe and higher payroll taxes related to equity vesting. A significant portion of expected operating expenses for 2020 has been allocated to sales and marketing to support our international growth and to research and development for both hardware and software innovation, as well as the expansion of our digital platform. GAAP operating expenses were $36 million for the first quarter of 2020 compared to $33.4 million for the fourth quarter of 2019. GAAP operating expenses for the first quarter of 2020 included $6.9 million of stock-based compensation expenses and $546,000 for amortization expenses for acquired intangible assets. On a non-GAAP basis, income from operations was $52.8 million for the first quarter of 2020, a record for the company compared to $52.3 million for the fourth quarter of 2019. On a GAAP basis, income from operation was $44.7 million for the first quarter of 2020. We are pleased with the increase in non-GAAP income from operation on a sequential basis, despite the modest seasonal decline in revenue. On a non-GAAP basis, net income for the first quarter of 2020 was $51.9 million, basically unchanged from the fourth quarter of 2019. This resulted in diluted earnings per share of $0.38 for the first quarter of 2020 compared to $0.39 for the fourth quarter of 2019. GAAP net income for the first quarter of 2020 was $69 million compared to $116.7 million for the fourth quarter of 2019. GAAP net income in the first quarter of 2020 included $15.3 million benefit from changes in fair value of derivatives and $11.9 million income tax benefits compared to the prior quarter that included $72.2 million tax benefit for the release of valuation allowance against deferred tax assets. GAAP diluted earnings per share was $0.50 for the first quarter of 2020 compared to $0.88 for the fourth quarter of 2019. GAAP earnings per share for the first quarter of 2020 included a $0.11 gain from change in fair value of derivatives and a $0.09 income tax benefit compared to the fourth quarter of 2019, which included a $0.54 non-cash benefit from the release of the valuation allowance. Now turning to the balance sheet. Inventory was $34.6 million at the end of Q1 2020, and included approximately $3 million allocated to Encharge battery storage product. Inventory at the end of Q4 2019 was $32.1 million. Accounts receivable were $95.5 million at the end of Q1 2020 compared to $145.4 million at the end of Q4 2019. The reduction was primarily due to safe harbor shipments in Q1 2020 having been prepaid in Q4 2019 and improved shipment linearity in the first quarter of 2020. We exited the first quarter of 2020 with a total cash balance of $593.8 million compared to $296.1 million for the fourth quarter of 2019. The cash balance includes a $320 million aggregate principal convertible note issuance in March that resulted in net proceeds of $313 million. In addition, the purchase of the call spread to increase the effective conversion premium to 100% had an additional net cost of $17.5 million. The tax deductibility of the convertible note hedge effectively offsets the upfront net cost over the five-year duration of the notes. The cash balance in the quarter was reduced by $34.3 million for employees' withholding taxes to net settle the stock compensation grants that vested in the first quarter of 2020. This prevented the issuance of 938,000 shares and does not count toward the $200 million share repurchase authorization that I will discuss in a moment. Ending cash balance would have been $628.1 million instead of $593.8 million if we did not execute on these anti-dilutive transactions. We generated $39.2 million in cash flow from operations and $35.9 million in adjusted free cash flow for the first quarter of 2020. Capital expenditure was $3.4 million for Q1 2020, mainly to increase our microinverter supply capacity in Mexico and Encharge battery capacity to support our ramp in Q2. Now, let's discuss our outlook for the second quarter of 2020. We expect our revenue for the second quarter of 2020 to be within a range of $115 million to $130 million. Turning to margins, we expect GAAP and non-GAAP gross margins to be within a range of 37% to 40%. We expect our GAAP operating expenses to be within a range of $33 million to $35 million, including a total of approximately $7.5 million estimated for stock-based compensation expenses and acquisition-related amortization. We expect non-GAAP operating expenses to be within a range of $25.5 million to $27.5 million. The actual operating expense as a percentage of revenue will be above our target baseline financial model in the near term, but we expect to trend towards this model as demand rebounds later in the year. I would like to spend a few minutes discussing the resiliency of our business model considering the current economic backdrop. Our outsourced manufacturing model results in low fixed cost of goods sold, and we have no material minimum volume commitments or take-or-pay provisions with our contract manufacturers or critical vendors. We pay slightly more per unit when volumes decline and we are working with our contract manufacturers and suppliers to navigate through these unique circumstances. Based on the gross margin guidance for Q2, it should be clear that these higher costs do not materially affect our gross margin. Then it becomes up to us to control operating expenses in the near term by restricting new hires to essential or strategic positions, deferring travel, and discretionary spending actions. We have built a talented global team of employees. We seek to retain and are not reducing any headcount at this time. It is important to note that we are doubling down on our new products and want to introduce them faster. We believe this will enhance our differentiation, making us emerge even stronger after the global economy gets back on track. Before turning the call over for questions, I would like to touch on one of our capital allocation strategies. On April 21, our Board of Directors authorized the repurchase of up to $200 million of Enphase Energy common stock to minimize shareholder dilution related to employee equity issuances. The purchases will be completed from time to time in the open market or through a structural repurchase agreement with third parties. Such purchases are expected to continue through March 2022 unless otherwise extended or shortened by our Board of Directors. This adds another tool to our toolkit to increase shareholder value when management believes the market value of the stock deviates materially below the conservatively calculated intrinsic value. With that, I will now open the line for questions.

If you could talk about the themes and demand patterns that you've seen across different countries in Europe and also the different states in the US, that would be great. And then, also secondly, have you seen any supply interruptions and can you talk about your timing of your new products in the second half, namely, the IQ 8, the roof top and the Ensemble storage? Thank you.

Right. So, regarding the demand situation, let me tell you the story. In the last earnings call in February, we were all looking forward to a nice Q2. And we were quite healthy booked at that time. And then, suddenly, in early March, we started seeing the pandemic spreading to the US. So, in the last three weeks of March, we started seeing residential installations go down. For Enphase, particularly, we were actually 100% linear at that time. So, we were shipping perfectly. Yes, we did experience a slowdown in the last three weeks, yet we managed to make our numbers. Then in April, the pandemic spread was a lot more severe. We have seen it particularly severe in California due to the shelter-in-place rules and in New York where it is really severe unfortunately at this point in time. I already said 30% to 50% drop according to industry reports that we see in overall residential installations. In some places like Texas, it's on the side of 30%. In some places like New York and California, it's even more than 50%. In Florida, it's a little bit less on the lower side. We find our small and medium-sized installers are going to be a lot affected. What we are doing, Enphase, if you see our midpoint of guidance, this time in Q2 is about $122.5 million, which is the midpoint of our guidance for Q2. We are well booked above that number right now. But we know that we have to work with a lot of customers and make sure that we don't overload the channel. It's important for us that we support our customers in this time. We are working with each customer to make sure they have the right inventory because we have no interest in stuffing the channel. We are looking forward to a great Q3. As of now, we are in the beginning of May. California is locked down till the end of May, shelter-in-place till the end of May. The other states have been a little bit more aggressive. New York is also going to be similar to California. We expect if things are optimistic, we expect to start seeing more activity towards the end of May and into June. Demand may pick up. But right now, with the visibility we have, we thought it is important for us to be realistic, give you the right guidance to work with our installers and to make sure we don't have excess inventory in the channel so that we are ready for a nice ramp in Q3.

Thanks, Badri. Is the change in Europe different from the US, more severe or less severe?

Yeah, the situation in Europe, sorry, I didn't answer that question. The situation in Europe – Italy, we are not in Italy. Unfortunately, Italy has been a lot affected in Europe, but we're not there. Netherlands, despite the pandemic, is modestly affected, and our share in the Netherlands has been quite low, maybe sub 10%. We tripled our sales team. We hired some great people in the Netherlands. We are working on distributor partnerships. We are working to win installers. For us, the Netherlands, I would say it's more of a share gain from our perspective because of our efforts. In terms of Germany, Germany is affected by COVID. However, we don't do much business there. That's the nice thing about it. We were able to make a modest impact in Q1, and we expect to grow that in Q2. Spain is another place where we have started efforts. We have a team of three or four good people. We expect them to start making significant progress for us in Q2 and beyond. That's why you've seen Europe – although Europe is hit by the pandemic, for us, Enphase we think we will be in line with Q1 for Q2. So, that's the situation. In Australia, Australia is similarly affected. Right now, Australia is doing a lot better than the US, but they do predict a drop in demand. Our numbers in Australia are also flat compared to Q1. Q2 numbers are flat compared to Q1. If I were to summarize, the rest of the world business is doing better than the US and the US is a lot affected by the pandemic.

Now, you've asked the question on manufacturing. Manufacturing is not an issue. Supply chain is not an issue. We have a lot of options. Basically, you know we have China. We have Mexico. They're all doing well. We are working with contract manufacturers to optimize inventory in both workplaces. This is a time where cash is king and we want to make sure we don't spend money unless we need to. At the same time, we are not compromising on our batteries. As Eric said, we've built an inventory of $3 million for battery at the end of March and now it is even more. So, we are getting ready for the ramp there. In terms of manufacturing supply chain, we are also diversifying to another location, meaning another site, neither in China nor in Mexico. We'll announce it when we are ready, but we'll be able to start manufacturing microinverters there in the fourth quarter.

Hope everyone is doing well and staying safe. First question I had was on the inventory. Badri, it sounds like you don't think inventory is a problem right now. You're pretty lean. You want to keep it that way as well. So, can you give us some sense on where inventory levels are and also lead times right now in terms of, I guess, number of weeks? And then, remind us on kind of where the target or healthy ranges are that you typically try to operate within?

Yeah. Our inventory target is usually – we have 30 days. Are you asking for channel inventory or Enphase inventory, Brian?

Yeah. It sounds like you guys are lean, but the channel would be great. If you have some visibility on the channel. I think you've said 8 to 10 weeks in the past, but if you could just kind of refresh us on that and where you are today.

So, we misunderstood the question. Sorry. Yes. So, if you're asking about the channel, in the past, we have always said 8 to 10 weeks. Obviously, the downward pressure on demand means that the installations didn't happen much in April. That means, when you look at forward-looking inventory based upon what actually happened in April, you're going to end up with a big number of weeks of inventory. But what we are doing at this time is it's pretty clear, right? We are saying, okay, yes, you guys have stopped installing, therefore, there is no point to us to put more inventory into the channel. And therefore, we will make sure that we work with you, and we push out your orders into the next quarter and ensure that the channel inventory is always healthy. If the channel inventory is always healthy, then when the demand comes back up, when the channel depletes a bit, we can basically refresh the material back. We can do it mathematically. We have a lot of experience in this. In good times, obviously, inventory is going to be low. In bad times, the trick is to see how we can prevent inventory from ballooning up. And it's mathematically done, formulaically done, and we work with our installers. So, that's what we're doing.

Okay, that's helpful. And I guess maybe just related to that, I wanted to understand one of the comments you made, Badri. You said bookings – you're well above the midpoint right now. For Q2 guidance, you said the $122.5 million, you're well above that from a bookings perspective. Clearly, you don't want to overload your customers with inventory. So, is that to suggest you're worried about some of those bookings, as you're describing them being canceled? Or are you seeing a high degree of cancellations right now? Because it sounds like if we didn't have the COVID uncertainty, maybe with the level of bookings you'd have, you'd be guiding above the targets you're providing today for Q2. Just trying to parse those comments and understand sort of the level of visibility you have versus the level of maybe conservatism you're baking in, just given all that's going on?

I think you've got it right. Yes, we are booked quite well. We are booked a lot more than the midpoint of the guidance. But our visibility is lowered this time and the uncertainty is high. If April were a proxy of things, we expect a little bit more cancellations and push out. On the other hand, if May or June is a lot more positive, we'll have a chance to hit the high point. So, we thought we should give you a number that takes into account all of these puts and takes. And that's why I'm giving you a full visibility. You guys know what I know.

Okay, that's great. And then, maybe just last one and I'll pass it on. On gross margins, you guided 36% to 39% for Q1. You beat that range. Now, you're guiding 37% to 40% on 40% lower revenue. So, the model is pretty resilient irrespective of volumes. That's pretty clear. But once volumes do pick up later in the year coupled with some of the new products that are ramping, it seems like you'd have some upside to that margin range. I'd be curious sort of what your views are on that. Margins in a healthier volume environment, kind of if they pick up from here. And then, on the flip side of that, you also mentioned you've got some of the longtail customers, maybe some of those customers are more challenged in this kind of environment right now. Any worries around bad accounts and sort of charges related to that? Maybe just some context around that, if you're seeing that or if you have anything to suggest that you have the ability to mitigate that.

Right. Let me answer the question on gross margin. Yes, absolutely. We are highly confident of our gross margins. And that's why we gave you guidance of 37% to 40% despite these times. Why is that? Gross margin comprises pricing management and cost management. We have a pricing team, which I established a couple of years ago, and they do a great job optimizing every transaction. That’s extremely important for us and we do value-based pricing. We will continue to do that. Absolutely. So, pricing is one of the big reasons why our gross margin is where it is. The second is cost management. Cost management comprises a lot of tactical pieces and a few strategic pieces. Tactical pieces are blocking and tackling in order to do supply chain optimization, finding second sources here and there, dropping costs, negotiation with customers. The second piece is tariffs. We have systematically designed the supply chain such that microinverters produced in Mexico do not require a tariff and we are extending the same to accessories in the future. That's two. Number three. Also tactical is, you saw us doing a lot of expedites two or three quarters ago. Expedites are no longer required for us because we have solved the power transistor problem and the component shortage problem. Therefore, expedites are going to be noise. That's one more thing. And then number four is a little bit more strategic piece. When it comes to cost reduction, we have an ASIC strategy. In the ASIC, we have basically the digital portion and then we also have the analog integration of the ASIC. We are able to integrate analog chips used in the microinverter on to the AC. Even if it means $0.20 cost reduction, $0.20 multiplied by, let's say, 8 million units a year, that's a big deal, $1.6 million. So, every cent we take out of the micro by integration into the SIC is extremely critical. In addition to the last few things, how can we fundamentally change the architecture of our transformers that are used? How can we go from 300 components down to 50 components, how can we reduce the microinverter to the size of an iPhone? Those are some of the long-term strategic cost reductions that we are thinking about. To answer your question, we have a very high degree of confidence. Especially when the demand comes back, we do have upside in gross margins.

Yeah. So, thank you for the question, Brian. As you know, on note 3 of our 10-Q filing that we just published, we disclose our allowance for doubtful accounts. You can see that it is very small. The reason that it is very small is because most of our business is through distribution. Most of the distributors we do business with have pretty strong balance sheets. Not only that, they also manage the cash and the days of inventory very well. They put some things that go into a conversation with the installer of all their point of sale data from the distributor. It's normally done on a triage with the distributors as well, which they own the credit phase with the installer. At this point, we don't hear any issues associated with the payment terms or paying. Some of our installers are requesting a little bit of an extended payment term, but for the most part, all of them are okay. So, at this point, as of the time of this filing, we don't see or foresee any issues on collections associated with my receivables at the end of the quarter.

Thanks, guys.

Thank you.

Thanks so much. As you look at the market for energy storage and your ability to drive costs down, obviously, it's a little bit early days, and you just walked through a lot of detail. How much opportunity is there for you guys over the next couple of quarters to support your gross margin trajectories as you scale up a little bit on the margins? And then, I'm curious about it, on a 12 to 18 month basis as well.

Right. If you look at the Encharge battery, the subcomponents inside the Encharge battery, or the cell battery pack, then you have the battery management unit, which is the BMS, then you have a battery controller that communicates to the gateway, and then you have the microinverters. As we drop the cost of the microinverters, that's going to go down. We do have plans to integrate the battery management unit and the battery controller into one board, and we do plan to use an ASIC to achieve even higher levels of integration. Now then we are left with the cell pack. The beautiful thing about that is we work with so many cell pack vendors, and therefore, if they drop their cost, they are going to pass that cost on to us. So, I would say there is nice potential for us. Especially as we start ramping volumes, we can probably get a lot of costs out in the first couple of years, and then it translates into steady progress after that.

Great. Thanks so much. And then, looking out a couple of quarters and considering the long tail of installers that are customers for you guys, how much visibility do you get into the cash flow dynamics and the strength of their balance sheets? There's an awful lot of small operations in various localities, but how much information can you really gather at this point to looking at that portion of the customer base?

Yeah. So, it appears that, for the most part, the installers are taking advantage of some of the generous programs issued by the federal government. Most of them actually qualify for those programs. Some of them are taking some time to get them administratively completed because they don't have a big accounting group to manage and to chase their reimbursements. But I don't hear – I have quite a bit of visibility, and I don't hear any big issues on installers not being able to sustain through their balance sheet during this period for now. Now, if this situation continues and deteriorates even more, the first ones to be affected will be distributors, in which eventually we will need to triangulate that into what it means to us. But at this point, surprisingly, the small installers are doing pretty well. Some of them manage their cash very tightly. They don't have a large OpEx or a big infrastructure to support, and they can hunker down into a smaller operation and then be ready for the comeback when needed. So, I'm actually okay with that.

All right, great. Thanks so much, guys.

Thank you, Colin.

Thanks very much for taking our questions. Can you just touch on the competitive dynamics? Any signs that some of your weaker competitors may be looking to exit the market? Any evidence that your kind of fortress balance sheet that you've built is allowing you to take any market share? And then, kind of lastly, as a follow up to that, are there any interesting competitors or technologies that are out there that could potentially be struggling during this downturn that you think could be interesting M&A opportunities?

Hi. This is Raghu. So, let's take your first one, which is on the competitive dynamics. We are not hearing of any competitors at this time exiting the market. We, obviously, keep track of it, but we are not hearing anything. So, we expect that to continue. Your second question was on any interesting technologies that are available for us to look at. Absolutely. Badri mentioned that one area that we are looking at as part of our digital transformation technology is to look at building out an end-to-end software platform that can significantly improve the customer experience. Everything from generation – from the sales lead all the way through procurement, through installation, commissioning, operations, and maintenance, and I think we're going to grow that business both organically and look at growing it inorganically as well. Yes, absolutely, we're looking at a bunch of different software companies out there that can help us in that endeavor. I think in the long run as well, we have talked about – given as Ensemble transitions into a more sophisticated energy management system, there's a tremendous opportunity to look at companies that are doing some interesting work in forecasting engines and machine learning and AI type work, managing big data, etc. So, all of those are tremendous opportunities as we start bringing all of our new products into the marketplace.

Okay. Got it. That's it for us. Thanks very much.

Thank you.

Yeah, great. Just a couple of questions. In response to Colin's question, could you break out, roughly speaking, the mix of small customers versus larger? I would assume it's 70%, 80% smaller through distribution, but I didn't know if you could...

That's close enough.

Okay. And then, in terms of the – I know I've asked you this before in past earnings calls, Badri, but the battery piece, a lot of discussion of costs and certainly LFP prices have come down. I assume it's still an LFP based battery, but is that still anticipated to be in line with the corporate average now that you're approaching 40%? Or should we be modeling something less than that as the storage piece ramps up?

Yes, LFP. Yes, in line with 40%.

Okay. Good to hear. And then, given the uncertainty in the market, how should we think about share shifts between you and other competitors? Are we at a point in time where people are transitioning from door-to-door and sitting down at the kitchen table to digital sales where people would want to learn new technologies and potentially replace a different inverter company with yourselves, or are people still hunkering down with the status quo? I just didn't know if you're seeing over the past, call it, six to eight weeks any inbounds as it relates to people wanting to get trained that maybe hadn't heard of in the past or were aligned with a competitor.

It's still early days, but the nice things we have seen are our traffic; the leads have increased a lot. We don't do too much business digitally today, but that is increasing. Our traffic to the online store is increasing. That's why I talked about the digital platform. The digital platform is not something that we are taking lightly as yet another effort. This is going to be a really powerful platform if we do it right. What does that mean? You've got a homeowner coming to you and you've got a lead coming to you, and how effectively you transfer that lead to your installer network. Enphase has got an installer network of 500 loyal installers. They are amazing partners for us. They are why we exist. Imagine if we generate thousands of leads, maybe it'll become tens of thousands of leads and maybe it'll become hundreds of thousands of leads soon, but, let's start with thousands of leads, we pass it to our Enphase loyal installer network, we help the homeowner make a decision there, and we then create a platform for the homeowner and the installer and Enphase to interact seamlessly. Then we start to take care of things, like, all the way from appointment setting, design closure, contract closure, bill of materials procurement, permitting, planning, and then activation when it shows up on our Enlighten database and then operations and maintenance after that. If we can help our installers to digitize all of this, and these are – yeah, I'm talking about small and medium-size installers because they are the ones who have manual systems. They don't have time to screw around with failures. They don't. So, if we can maintain our NPS above 60 – this quarter, we did 72. That's a phenomenal quarter. If we can do that, if we can answer the phone in less than 60 seconds, 0.05% annual defectivity, if we can extend that to batteries, our all-in-one solar and storage solution is going to dominate. No questions.

Great to hear. Thank you for the detail.

Hey, guys. Thanks for the questions. Badri, what you were just talking about there in terms of the lead gen machine, sounds like it can be very powerful. Can you give us a little bit of a history on that? Meaning, where were your leads at Q1 and where do you think you could end the year at in terms of your lead generation that you can pass on to your partners? And what kind of close ratios have you experienced? I can imagine they're quite high because there are programs like this out there, and it seems like, again, this could be powerful. So, want to see what kind of ramp we could see ahead. And then also, what kind of capital are you willing to invest here? One of your peers spends millions of dollars on TV ads, for example. I don't expect you guys to do that, but just curious what kind of money you might be putting behind this?

Right. So, Phil, you know that we are a disciplined company. We are not going to give you metrics without thinking. So, you've got to be a little bit more patient for those metrics. But what I will tell you is this. We have 1.1 million sites today. These are Enphase sites. And, okay, I have the ability to generate leads by spending a lot of extra money on my right hand. And I have all the 1.1 million homeowners on my left hand. What do I choose? The answer is obvious. Those are Enphase customers, and therefore the low-hanging fruit is those Enphase customers. We are already working on such upgrade programs. We do talk about one particular upgrade program that we issue press releases on, which is the upgrade program for the Enphase's first and second generation microinverters, transitioning from the M190 base products to IQ 7 and sometimes IQ 7-based AC modules. Those are examples of programs that you will start seeing more and more from us. But you're absolutely right. It's a powerful concept. If it can be done right, we'll be in a different place.

Great. As it relates to Q3, I know visibility is limited, uncertainty is high, but I do believe we've seen an inflection point in terms of sales having troughed out and they're improving week over week. So, things are improving a little bit. Just curious to see if you guys have seen an improvement in Q3, like what kind of visibility in Q3 do you have?

Phil, at this point, we don't have visibility for Q3.

Got it. Okay. And one last one here. In terms of your guide for Q2, you talked about meaningful storage revenues in that Q2 guide. I don't think you quantified it. I was wondering if you might be able to quantify Q2 and then also talk about the cadence of how storage revenues ramp in Q3 and Q4?

We are not going to quantify it. We may separate it out later. Eric already told you guys that last quarter. But in order for you guys to think about a lower number, we gave you the inventory of storage product that we built, which was at the end of March. That number was $3 million. So, you can do the calculation and have a base number. That’s the base number. Obviously, that's not all of it. But that will help you to at least have some number instead of shooting in the air.

Hi, everyone. Most questions asked here, but I guess I'll just go with – so Ensemble in a box, I know that was a big topic at the analyst day in India. Just thought process on bringing that to the US now. How you view it competitively in the market? And then, if you have any thoughts on the overall market opportunity.

Yeah. I think one of the key things – as this disruption happened, we got together and we said, what is it that the people are thinking about? A lot of people are thinking self-sufficiency and resiliency is top of mind, especially in the US. That's why we decided, not long ago, that we were going to prioritize getting the Ensemble in a box product here. We did our competitive analysis and survey, and really felt that we have a great technology in Ensemble that we can leverage to bring a competitive product into the marketplace. The forefront of it being reliability, always-on connectivity, and finally, the customer experience part. We can address both resiliency when you're inside the home or self-sufficiency part, and it's a mobile device. It's basically energy on the go both for recreational use and for emergency purposes in the event of a catastrophic event. We think it's a complementary product to the complete Ensemble solution that we have with PV on the roof and beta in charge storage solutions with Enpower. So, I think it's a really complementary solution for about 1.7 kilowatt hours. I think it plays really well with our set of products that we have. So, the opportunity is going to be very big here in the US to begin with.

And is that something you think as a contributor? Can be a meaningful contributor in 2021?

Absolutely, yes. That's when we plan to introduce it, in the second half of this year, and it will play a big role in 2021.

Hi. Thanks for taking the question, everyone. I hope you all are doing safe. Could you just talk more about the software strategy? How should we think about it? Is it a new product or service for the installers? Or should we think more of a platform for your core installers? And apart from any M&A opportunities for the Encharge solution, do you see any M&A opportunities for the software strategy?

Yeah. As Badri mentioned, it's a very key element of our overall strategy. This is the digital transformation piece. The key here is to provide fantastic customer experience end-to-end, which means starting from that lead all the way through matching the installer with the homeowner, managing through the process, with digital permitting. You're seeing some of the HAs moving to that environment as well. There's a general push towards moving everything into the digital world. We want to provide a seamless platform. That platform then continues to extend beyond into the actual operation of the Ensemble technology, which is the energy management piece. We think about it as disparate elements, meaning the frontend which is about sales and procurement and installation. Then there is this Enlighten piece or Ensemble energy management piece, which is product-related. Imagine if that whole experience was completely seamless; there's a lot to do and a lot of software to be developed. We are going to be very thoughtful about what we can build in-house. The core Ensemble technology has significant IP, and we have built that in-house. Then there is the piece around the front end, which I think we'll build some and we'll look for some organic and inorganic M&A. On the product side, of course, there is the micro part, the battery. We know what we are going to do. We know where all our IP lies. All our IP is in the power management piece, the communications piece, the software piece. What we are not in the business of is manufacturing solar panels or cell packs. So, everything in between is significant IP to be developed, particularly around the software part, which is everything software-defined power conversion, all the way to economic optimization, which is what we refer to as tertiary control. That is core IP for us. That whole experience needs to be completely seamless.

That's helpful. Thanks. And actually, one last for me on batteries. Could you just remind us which countries you will be buying the batteries from, just trying to get ahead of any trade escalations in the country? And also, it is a 5% battery attachment rate by the end of the year. Does that still hold? I know it's probably been pointing to one small number here, but any clarity on that will be helpful.

Right. So, the answer is China. And we have one source now. We will have one more source in the second half of the year. And then, yes, the 5% hold in Q4 of 2020.

Thanks for answering my questions.

Good afternoon. I wanted to ask you, have you disclosed how many of the 1.1 million installed Enphase customers are on legacy micros at this time?

No, we have not.

Okay. But is it safe to say that it's still a fairly sizable amount?

Right. Correct.

Okay. As I've listened to you describe the digital platform in a number of different ways, it sounds similar to the approach of some large installers. Is it correct? At least optically. Is it correct to say that the main point of the initiative is to increase the sales potential of the smaller installer?

That's right.

And kind of following on that, can the digital platform positively impact Enphase internal operations in some way?

Not really. When you say impact the Enphase operations, I'm not sure what you mean.

Well, I'm saying, for example, would it make your sales ever more efficient? So, maybe you'll get more out of less headcount or would it somehow positively impact your inventory because it provides you maybe with another source of feedback that you're not getting now. Just wondering if there's any feedback loops there for you.

It's going to make our installers' lives a lot better, the small and medium-sized installers. It's got to make the homeowner's life a lot better. In order for us to achieve such a seamless experience, it's going to take us time. We need world-class software. It’s going to take us more people to do this. Fortunately, for us, our gross margins are strong, and we have a nice balance sheet, so we are in the right time to invest and help both our homeowners as well as small and medium-sized installers. The final point on this digital platform thing, just to confirm. If this works the way you want it to, is it reasonable to think that it's going to attract additional installers to you that you may not be working with now, and could that be significant? That's right. Yes.

Okay, great. And just one question on a different subject. I was just wondering, is the IQ 8D still – because I know we have all these COVID-19 headaches. Is it still moving along fairly smoothly? And do you still expect to release it in the fourth quarter?

I did mention it in the call actually earlier. We are pleased with the progress that we're making on IQ 8D. IQ 8D, to remind everyone, it's a small commercial product, 640-watt AC. It will basically service two panels. Our differentiation there is the trademark Enphase high quality, rapid shutdown implementation, and essentially very high efficiency product. Yes, it is on track.

Great. Thank you.

Thanks for taking the question, guys. You have not been asked about manufacturing. You mentioned that there are no issues. Mexico has been under a lockdown, maybe a weak one, but a lockdown since the end of March. I'm curious if there have been any disruptions in terms of labor availability or the social distancing requirements at the fab in Mexico.

Our factory has been declared an essential business, and there have not been interruptions. Additionally, as I said in my prepared remarks, this is a quarter where we are building less inventory, not more. We are carefully balancing the inventory between China and Mexico. Due to COVID, the inventory that we have to build is quite small.

Okay. Let me ask one more regulatory question. From the perspective of your customers that are postponing installations, and you referenced the New York area in particular, is that because of lockdowns and stay-at-home orders or is it more of a precautionary measure? Because my understanding is most states do not push solar installation because it has been considered an essential business.

From an installation point of view, people are cautious about having other people come and interact with them in their house. I think that's one slowdown. The second slowdown, obviously, is also on the permitting side. Not everybody is like some of the counties that you're seeing in California, like San Luis Obispo, who have gone completely digital. The third element is around permission to operate, the PTO, which is in both inspection and PTO. You're seeing friction in the system as a result of social distancing. I think that is the biggest challenge. On the sales side, again, kitchen table sales are now less likely to happen or not happening. However, we are seeing that many of our installer partners are adapting to doing this more virtually using digital tools. So, we're experiencing those processes right now.

Understood. Thank you, guys. Stay safe.

Thank you.

Thank you guys for taking my questions. You indicated that you're being aggressive on product introductions, but at the same time you're seeing some push-outs relative to go-to-market for existing products in the pipeline. I just wanted to understand what the timeframe for these new product introductions will look like. Is it something that may transpire in this calendar year or are we talking a little bit more further out?

The delay on Encharge is because of social distancing and work from home. The engineers essentially do not have – they have not been working together. Because of that, some engineering activities and compliance activities were delayed. That's kind of behind us now. It was a short-term blip. Two months ago, I thought we were going to ship Encharge by the end of March. That didn't happen because of this. Regarding the other products, I plan to introduce IQ 8, the grid-agnostic microinverters for residential rooftops, in the second half. I also plan to introduce IQ 8D in the second half, along with Ensemble in a box. We have a lot of engineering teams in the company. They’re a little bit hampered working from home, but hopefully, that will change in June, and we still see that we're on track to get them out in the second half.

Understood. Thank you for that. Just last one for me. Have you acted on any buybacks so far?

No.

Got it. Thank you.

All right. Thank you for joining us today, and for your continued support of Enphase. We look forward to speaking with you again during our Q2 2020 earnings call. Bye.