Enphase Energy Inc (ENPH) — Q2 2023 Earnings Call Transcript

Good afternoon, and thank you for joining us today to discuss our second quarter 2023 financial results. We reported quarterly revenue of $711.1 million, shipped approximately 5.2 million microinverters and 82.3-megawatt hours of batteries, and generated free cash of $225.5 million. Approximately 78% of our Q2 microinverter shipments were IQ8. We exited the second quarter with a 46% gross margin, 14% operating expense, and 32% operating income, all as a percentage of revenue on a non-GAAP basis. Mandy will go into the financials later in the call. Let's now discuss how we are servicing customers. Our worldwide NPS was 74% in Q2, compared to 75% in Q1. Our North American NPS was 77%, the same as Q1. Our average call wait time was 1.1 minutes compared to 1.2 minutes in Q1. We continued to focus on root cause fixes of customer issues and expanded our customer service and field service teams globally. Let's talk about microinverter manufacturing. Our overall supply environment remains quite stable, and there are no major shortages right now. Let's come to our IRA. We expect the IRA to increase the overall solar demand in the U.S. and accelerate domestic production. We are pleased to be part of creating new jobs in the U.S. and advancing the country's clean energy economy. We shipped 50,000 microinverters to customers in Q2 from two of our contract manufacturers, Flex in South Carolina and Foxconn in Wisconsin. We are on track to begin with the third contract manufacturer in Q3. We expect to ship approximately 600,000 microinverters to customers in Q3 from our U.S. manufacturing facilities. Let's now cover the regions. Our U.S. and international revenue mix for Q2 was 59% and 41%, respectively. Q2 was a record quarter for our international revenue primarily due to the growth in Europe and Australia. In the U.S., our revenue decreased 12% sequentially and decreased 1% year-on-year. The overall sell-through of our microinverters in the U.S. was up 2% in Q2 compared to Q1. In Europe, our revenue increased 25% sequentially and more than tripled year-on-year at a healthy gross margin. Our sell-through of microinverters in Europe was 13% higher in Q2 compared to Q1. We are now shipping IQ8 microinverters into Germany, France, Netherlands, Spain, Portugal, and Poland. In addition, we are shipping IQ batteries into Germany, Belgium, France, Netherlands, Spain, Portugal, Austria, and Switzerland. I'll now provide some brief commentary on Australia, Latin America, and Brazil. Our revenue in Australia more than doubled year-on-year. We started shipping our IQ Battery P5 to Australia during the second quarter. In Latin America, we introduced the new battery in Q2 while in Brazil, we introduced our Solargraf software platform which will help installers with design and proposal for their residential customers. Let me provide some additional color on the U.S. followed by Europe. We recognize revenue when we ship product to distributors and large installers. It is therefore relevant to talk about the sell-through trends of our products from our distributors to installers. Since we have a healthy share in the U.S., our statistics are a meaningful representation of business strengths. The overall U.S. market is experiencing a broad-based slowdown due to high interest rates. As I said earlier, our Q2 sell-through of microinverters in the U.S. was only up 2% compared to Q1 and only up 2% year-on-year. The second quarter is typically stronger than the first quarter; that did not happen this year due to the market environment. Let's now discuss the market trends we are seeing in the U.S. split by California and the rest of the U.S. For non-California states, the Q2 sell-through of microinverters was 6% lower compared to Q1 and 11% lower year-on-year. The sell-through was disproportionately worse in Texas, Florida, and Arizona. In these states, the economics of loan financing have worsened due to the combination of rising interest rates and lower utility rates. In California, the Q2 sell-through of microinverters was 20% higher compared to Q1 and 34% higher year-on-year. The higher sell-through was driven by a high backlog of NEM 2 installation, which is expected to last through this summer. We expect NEM 3.0 will have a greater impact on results beyond Q3, and I will speak more on what we are seeing there later. I'd like to provide some more context about our revenue guidance for Q3. Our microinverter sell-through in the U.S. peaked in the fourth quarter of 2022. The sell-through in the first half of 2023 in both Q1 and Q2 was approximately 20% below the fourth quarter due to the high interest rate environment in the U.S. Our sell-in to the channel was only 10% down in the first half of 2023 relative to the fourth quarter. We were expecting a seasonally strong Q2 '23, but that didn't materialize. This has increased the inventory in the channel. Plus we are assuming the same level of uncertainty continues going forward. Therefore, we are taking aggressive and prudent actions in the U.S. to manage down the channel inventory, and this is reflected in our light third quarter guidance. Let me say a few words about market share. We see stable high market share today for microinverters based on both internal and third-party data. Competition is not new for us, and we have always relied on our differentiated technology with distributed architecture, product quality, and customer service to win market share, and we expect to continue doing so. We have many tools at our disposal for installers, and our partnerships deepen during a downturn. For storage, we have shipped approximately 1 gigawatt hour of battery systems cumulatively by the end of the second quarter. We continued to manage our storage channel inventory in Q2 and expect further improvement in Q3. As we introduced our third-generation IQ Battery 5P to the U.S. market in Q2, we reduced pricing for our second-generation battery. We also expanded the warranty for both batteries to 15 years. We see the new price point and warranty for both batteries, as well as strong early customer adoption of the new battery, driving increased sell-in and sell-through during Q3. We believe there will be a bigger inflection for Q4 and beyond as California battery attach rates increase with NEM 3.0. Before moving to Europe, I'd like to speak a little bit about NEM 3.0. Early anecdotes on NEM 3.0 activity from our installers are encouraging. Since the crossover date in April, we have seen an increasing rate of NEM 3.0 California proposal activity with healthy storage attach rates. We offer a comprehensive NEM 3 solution, which includes a smart battery and power control system to avoid main panel upgrades and an energy management system that maximizes ROI for homeowners. The smart battery can do both backup and utility rate arbitrage. Grid-tied batteries require less labor and fewer balance-of-system components, making them significantly easier and faster to install. Our Solargraf design and proposal tool can model the complex interactions between solar, batteries, consumption, and tariffs, and provide a simple proposal. Our financial analysis shows that for a cash system, homeowners can expect a bill offset between 70% and 90% and payback between 5 and 7 years. We think installers can effectively sell these economics to consumers. Let's now cover Europe. Our European business remains strong. Q3 is typically down due to summer vacation, but our year-on-year growth trend is very robust. We plan to introduce IQ8 microinverters and batteries into more countries in Europe such as Sweden, Denmark, Greece, the UK, and Italy later this year. We saw strong broad-based growth across Europe in Q2. Netherlands and France continued to be very strong for us. We are starting to gain real traction in Germany, in both residential solar and batteries. The residential solar market in Germany, the biggest in Europe, is roughly 3 gigawatts and the attach rates for batteries are approximately 80%. We saw strong quarterly sequential growth in installer count, sell-through, and activations of both solar and batteries in Germany during Q2. During Q2, we also launched our IQ router family of devices, which is part of our home energy management system in Germany and Austria to enable the integration of select third-party EV chargers and heat pumps into Enphase solar and battery systems. There is a great push towards whole home electrification in Europe, and countries like Germany are leading the way in adopting renewable technologies to support heat pumps, EVs, and other home loads. Self-consumption is the norm as consumers want energy independence. As we think about our competitive positioning in Europe, we see increasingly complex power markets and home energy management needs playing right into our strengths. Our complete home energy management system solution delivers use cases like self-consumption and green charging, along with newer software features that we plan to release this year, which are key differentiators in addition to our quality and service that will help strengthen our market position. Let's cover more new products. We launched our third-generation IQ Battery 5P in Australia, the U.S., and Puerto Rico in Q2 with plans to launch in Europe by the end of the year. As I previously discussed, the battery has a modularity of 5 kilowatt hours and delivers double the continuous power and triple the peak power for the same kilowatt hour compared to our prior generation of batteries. The higher charging and discharge rate of our third-generation battery will be uniquely beneficial for NEM 3.0 systems in California through its ability to generate revenue by exporting into the grid at appropriate times. In addition, our third-generation battery is easy to install and commissioned, with the targeted sub-30-minute commissioning times. We are excited about the positive feedback we have received from our Australian and U.S. customers. We have now certified over 3,500 installers worldwide to install our IQ batteries. Let's now talk about our latest new product for the residential segment in emerging markets. This product, the IQ8P microinverter, will deliver 480 watts of AC power, supporting panels up to 650 watt DC for Brazil, Mexico, India, Spain, and other emerging markets. We are on track to release this IQ8P microinverter variant to production later this year. The other variant of the IQ8P microinverter with the new 3-phase cabling system is well-suited for small commercial solar installation ranging from 20 kilowatts to 200 kilowatts. These microinverter systems offer the same grid compatibility, high quality, and rapid shutdown capability as our standard residential products. We expect to release this product into the U.S. small commercial solar market later this year. In general, we see the global commercial opportunity as greater than 11 gigawatts. We are extremely bullish about this small commercial solar market, where we believe we can add tremendous value to business owners and installers in Europe and the U.S. with our high-quality rapid shutdown capability and micro-grid forming capability of our microinverter systems. Let's discuss our U.S. EV chargers. We shipped over 6,600 EV chargers in Q2 compared to 8,600 in Q1. We expect to introduce IQ smart EV chargers in Q3. These smart chargers will have Wi-Fi connectivity, enabling use cases like green charging and allowing homeowners full visibility into the operation of the Enphase solar, battery, and EV charger system through the app. Let's now discuss the installer platform. We released updates to our Solargraf design and proposal software platform in Q2, including NEM 3.0 functionality. The updated Solargraf platform offers a simplified experience for designing NEM 3.0 systems by optimizing panel placements for both grid-tied as well as grid-agnostic systems, configuring battery sizing by leveraging modularity, and enhancing system operations for time-of-use management and energy export to deliver the best possible electricity bill offset and payback. Let me conclude. We are managing through a correction in the U.S. solar market after three years of phenomenal growth, a period in which the residential solar market doubled and Enphase sales tripled. Even so, residential solar has only achieved 4% to 5% penetration in the U.S. We believe there are several positive long-term drivers that will accelerate adoption, such as the 30% ITC tax credit, rising utility rates, increased grid instability, climate change, and increasing EV adoption. There is no doubt that these will drive meaningful solar plus battery growth over the long term. Our strategy is clear and unchanged. We manage for the long term. We will make best-in-class home energy systems with a laser focus on innovation, quality, and customer experience. We are doubling down on our relationships with customers. We are driving down installation times and investing in our service teams. We are investing even more in new product innovation. We are expanding our IQ8 microinverters and battery reach globally, accelerating our business in Europe, introducing IQ8P microinverters for small commercial solar and emerging residential markets worldwide, and making continuous enhancements to our installer platform. Before I turn the call over to Mandy, I'm happy to announce that our Board of Directors has authorized a new share repurchase program. Given our confidence in Enphase's future growth, free cash flow generation, and the value we see in our stock, our Board has authorized an additional $1 billion for share repurchases. With that, I will turn the call over to Mandy for her review of our finances.

Thanks, Badri, and good afternoon, everyone. I will provide more details related to our second quarter of 2023 financial results, as well as our business outlook for the third quarter of 2023. We have provided reconciliations of these non-GAAP to GAAP financial measures in our earnings release posted today, which can also be found in the IR section of our website. Total revenue for Q2 was $711.1 million. We shipped approximately 2,121.3 megawatts DC of microinverters and 82.3 megawatt hours of IQ batteries in the quarter. Non-GAAP gross margin for Q2 was 46.2% compared to 45.7% in Q1. The increase was driven by increased IQ8 product mix and improved logistics. GAAP gross margin was 45.5% for Q2. GAAP and non-GAAP gross margin for Q2 included $1.6 million of a net IRA benefit for our microinverters made in the U.S. and shipped to customers in the quarter. Non-GAAP operating expenses were $98.2 million for Q2 compared to $98.4 million for Q1. GAAP operating expenses were $153 million for Q2 compared to $158.7 million for Q1. GAAP operating expenses for Q2 included $51 million of stock-based compensation expenses and $3.9 million of acquisition-related expenses and amortization for acquired intangible assets and $208,000 of restructuring and asset impairment charges. On a non-GAAP basis, income from operations for Q2 was $230.5 million compared to $233.6 million for Q1. On a GAAP basis, income from operations was $170.3 million for Q2 compared to $167.7 million for Q1. On a non-GAAP basis, net income for Q2 was $205.6 million compared to $192.3 million for Q1. This resulted in non-GAAP diluted earnings per share of $1.47 for Q2 compared to $1.37 for Q1. GAAP net income for Q2 was $157.2 million compared to GAAP net income of $146.9 million for Q1. This resulted in GAAP diluted earnings per share of $1.09 for Q2 compared to $1.02 for Q1. We exited Q2 with a total cash, cash equivalents, and marketable securities balance of $1.8 billion compared to $1.78 billion at the end of Q1. We repurchased approximately 1.25 million shares of Enphase common stock in Q2 at an average price of $159.43 for a total of approximately $200 million. This completed our $500 million share repurchase authorization from our Board of Directors. As Badri mentioned, our Board of Directors has authorized a new $1 billion share repurchase program. In addition, we spent approximately $12.7 million by withholding shares to cover withholding taxes for employees divesting in Q2. That reduced the diluted shares by approximately 72,000 shares. We expect to continue this anti-dilution point throughout the year. In Q2, we generated $269.2 million in cash flow from operations and $225.2 million in free cash flow. Capital expenditure was $44 million for Q2 compared to $22.5 million for Q1. The increase was primarily due to investment in U.S. manufacturing and R&D equipment. Now let's discuss our outlook for the third quarter of 2023. We expect our revenue for the third quarter of 2023 to be within a range of $550 million to $600 million, which includes shipment of 80 to 100 megawatt hours of IQ batteries. We expect GAAP gross margin to be within a range of 41% to 44% and non-GAAP gross margin to be within a range of 42% to 45%, which excludes stock-based compensation expenses and acquisition-related amortization. Our gross margin guidance numbers do not include any IRA benefit. We expect the net IRA benefit to be between $14.5 million and $16.5 million on estimated shipments of 600,000 units of U.S.-manufactured microinverters. We expect our GAAP operating expenses to be within a range of $159 million to $163 million, including approximately $58 million estimated for stock-based compensation expenses and acquisition-related expenses and amortization. We expect our non-GAAP operating expenses to be within the range of $101 million to $105 million as we will continue to invest in product innovation, customer service, and international growth. Moving to tax. Since we have utilized most of our net operating loss and research tax credit carryforward, we are now a significant U.S. cash taxpayer. We expect GAAP and non-GAAP annualized effective tax rate for 2023 to be at 21%, plus or minus 1% with IRA benefit. Now I'd like to discuss how the advanced manufacturing production credit from the IRA is reported in our earnings. We had originally thought that the production credit would be reflected in income tax expenses. But based on the latest guidelines from the U.S. Treasury, we expect to claim the production credit by direct pay, and therefore, account for the production credit as a reduction in the cost of goods sold. We expect the production credit, net of any incremental costs for domestic manufacturing, to be in the range of $24 to $28 per microinverter sold to customers in Q3. We expect to ship 600,000 microinverters to customers this quarter. We plan to have our U.S. contract manufacturing facilities fully operational by the end of 2023. We estimate shipments to reach our U.S. capacity of 4.5 million microinverters per quarter by the end of 2024, assuming robust demand. With that, I will open the line for questions.

Hi everyone. Thanks for taking my questions. Sorry, I'm bouncing between calls. So I wanted to check in on what you're doing with pricing on micros in the U.S. Our checks this week suggest your recent spot discounts may be aggressive with big customers in exchange for semi-exclusivity. Our contacts suggest that maybe in response to some of the volume that may be going to Tesla. Can you quantify what the magnitude of the discounts might be, if anything? Or what it might mean, if anything, on a blended ASP basis ahead? I know historically, you always have some kind of spot discount, but incrementally, is it greater now to try to maintain that business? Thanks.

Right. We are not planning any microinverter pricing reductions in general, overall. As regarding pricing pressure, it is normal for us. Since inception, we have always dealt with pricing pressure. We have always competed with string inverters from Day 1. This company was founded based on distributed architecture wins. Distributed architecture basically means no single point of failure. So distributed architecture means that it's a semiconductor-based architecture, which has fewer components and very high quality, which means 0.05% failure rates. It also means 25 years of warranty versus other string inverters that may have half that many years. In addition, we service customers very well. 24/7 customer service, 74% NPS. Also, we strongly believe in AC coupled architecture, which means that the combination of it's an Enphase system for solar, it's an Enphase system for storage. It is a full home energy management system with an Enphase EV charger as well. And that is starting to become more and more important as NEM 3.0-type tariffs come. And those tariffs are already there in Europe, for example. So SPAs, standing for special pricing adjustments, are a fact of life. We do that always. We are disciplined. We have a pricing team. And it always depends upon the volumes. And of course, we do form deeper partnership with customers in times like this. We have many tools at our disposal. We have done our recent M&As and digital transformation. The Solargraf software platform is invaluable for us at this time because we are able to give customers the option of designing— for example, showing an M3 design and making sure they can sell that effectively to homeowners. So Solargraf, even lead generation company we acquired, is coming of use in times like this. So basically, to answer your question, pricing is normal. We aren't planning on any pricing reduction on microinverters. On batteries, it's a different story. On batteries, I was very clear a month back in the public call, saying that, yes, we introduced our third-generation battery, and we cut the price of our second-generation battery. And both of them coexist. We believe that the second-generation battery will be very good for grid-tied NEM 3.0 as well as grid-tied batteries in Europe. The third-generation battery that comes with a 30-minute commissioning time, which we are very happy about, that is priced appropriately for backup. So—and these pricing decisions aren't made on the fly. They are done with extensive planning. We do have upper pricing protection to our channel partners. We believe in doing things in a structured way. This is no exception.

Great. Thanks, Badri. You just talked about price protection. And that was for storage, and we had read about that as well for the channel inventory. From an accounting standpoint, which quarter does that price protection hit? Did we already see it in Q2 results? Or should we expect it in Q3? What was the magnitude? And then hypothetically, if you pursue a price cut for micros, would you provide price protection for the existing micro channel inventory as well since the channel is a little bit full? Thanks.

Phil, the price protection for storage has been accounted for in our earnings. There will be no other impact in Q3 or going forward. And price protection is something we offer to distributors as a policy. So in that case, if we lower our ADLP for micros, we will provide price protection. However, at this point, we are not planning to do that.

Okay. Thanks Mandy. Okay. I'll pass it on.

Thanks so much guys. Can you talk a little bit about your opportunities for driving cost out of the supply chain? It sounds like there's plenty of supply available and your ability to continue to walk that cadence down here over the next several quarters.

Yes. I mean, we work on world-class cost initiatives for microinverters and batteries. On microinverters, there is a lot of tactical negotiations that we do. Let me put that aside. But that’s not insignificant. That’s a nice number, especially in times like this, a procurement organization is extremely active. The other one, which will take over three to six months, is opportunities where we design in multisource. For example, when we have three sources of transformers, adding a fourth and fifth source, especially in times like this. When you have, for example, three versions of integrated circuits for our AC gate drivers, having a fourth one. Those are also extremely active with our microinverter group running extensive qualification because we are very careful on that 500 DPPM quality. The last thing we need is a quality excursion. So that’s the first and foremost priority for us, making sure that quality is preserved through all of that. The third one is a little bit more long term, which is over nine to 12 months. We look at packing material. We look at ASIC. Is there an opportunity for us to redesign the ASIC in another platform to save cost? Is there an opportunity for us to integrate and open for a comparator into the ASIC so that we can save $0.20? For example, a $1 savings in our microinverter, assuming we shipped 20 million units worldwide a year, that’s $20 million. So you’re looking at $0.01 being $200,000. It’s a big amount. And so we have a massive program called World-Class Cost. That’s where you see, even in Q2, our gross margin continues to increase. On batteries, many people keep asking the same question, can you make money on batteries? My answer is always the same. We never enter a business until we are convinced that the business will make at least my baseline gross margin. On batteries, we are getting better. Generation 1 was higher cost. Generation 2 is a little bit lower. Now we are in Generation 3, where we have figured out a lot of ways to take cost out. On top of that, in terms of warranty, we are getting a lot better on batteries. We are introducing serviceability on batteries, where instead of you having to replace the entire battery, you simply replace a board inside because we have figured out that the cell pack, the battery pack never fails, and it’s the power electronics, which consists of power conversion, battery management, and even mechanical components. Those are the ones that fail, and we are making them bulletproof. But coming back to that, we don’t need to replace a $3,000 battery; we can replace a $40 board. We don’t need to take the battery off the wall; we can replace it in situ. Therefore, the customer downtime is very low. Our standard, as we want the customer downtime to be no more than 24 hours, and we are driving our teams to achieve that. When we achieve that, you will find your warranty and your replacement costs are minimized a lot. So that’s on the third generation. Now what’s happening on the fourth generation? The fourth generation of batteries is scheduled to come approximately within a year, maybe within 9 months if I am a little bit more aggressive. It has got a fundamentally transformative cost structure. What we are doing there is we are combining power conversion and the battery management into one board. So 7 boards in the third generation will now become two boards. This is accompanied by significant component count reduction, significant cost reduction, and that will get us even better on the gross margin curve. So, I gave you a bunch of puts and takes on microinverters, batteries. We are also serious about our accessories. We ship combiner boxes. We have cellular modems. We have the gateways. For example, in Europe, in Q3, we are going to be introducing a combiner box. That is going to be very cost-effective for installers. So a lot of actions in the company. We started this six years ago, and we have not stopped since then.

Excellent. Thanks so much guys. Just a simple follow-up here. You've historically talked about wanting to have 8 to 10 weeks of channel inventory. Will the guidance that you're indicating here for 3Q get you to those levels in the U.S. from what you're seeing at this point?

Right. So let me provide some more context in general because it may not have been clear to everybody. Our sell-through of microinverters in the U.S. peaked in the fourth quarter of 2022. The sell-through in Q1 '23 was about 20% below that. The sell-through in Q2 '23 was at the same level, which is 20% below Q4. So we find ourselves with excess inventory in the channel. The responsible thing to do is to correct that. We are doing a one-time correction to reduce inventory in the channel. Therefore, we expect the channel inventory, the weeks on hand, to come back more to normalized levels by the end of Q3.

Great. Thank you very much for taking our questions. Just thinking about valuations coming down across the space, and how you're weighing potential M&A versus prioritizing this new $1 billion buyback.

Right. First of all, our capital allocation process starts with taking care of the business needs. That involves domestic manufacturing, building a new R&D lab, and investing in the domestic battery supply chain. Those are our foremost necessities. Second, we look for M&A opportunities to see if we can increase the value of the company significantly, particularly in the small commercial space or the software and home energy management space as well as in the battery space. But we are not going to make hasty decisions. We generally prefer bolt-on acquisitions, which are easy to integrate because we are aware that most integrations fail in big companies. We are always very cautious about that. We also have clarity that we will not buy a company to do anything specifically on inverters because we think we have enough homegrown talent that we can continue to grow organically. So that’s the second piece, actively looking for M&A opportunities. The third is assessing if we can buy back stock at a conservatively estimated value below the intrinsic value of the stock. We have bought $200 million of stock last quarter, approximately 1.25 million shares at $159. We are disciplined about this, and our Board has authorized another $1 billion for share buyback, considering we generate close to $200 million of free cash flow every quarter. Expect us to be disciplined and take actions when it makes sense and not to be overly aggressive.

Okay. Thanks, Badri. And then just a follow-up. I think you touched on this a bit on California, but maybe just repeat what you said about the 3Q guidance assumes, as far as NEM 2.0 systems and when you expect that backlog to be removed and start selling NEM 3.0?

We think NEM 2.0 will continue through Q3. That’s what we are hearing from our installers. It will continue through the summer until September. We believe Q4, NEM 3.0 will start. The anecdotes we are hearing from some of our big installers say that their battery attach rates are pretty nice, higher than 50%. Most installers need to get educated on NEM 3.0, but the fact of the matter is that, even for pure solar, NEM 3.0 payback is between 7 and 8 years. Even for pure solar, when you add a battery—let’s say, when you add a 10-kilowatt hour battery, which seems to be kind of standardizing, you achieve even better payback. So payback comes down from 7 to 8 years to 5 to 6 years with a high enough battery system. Once the installers realize those economics, they will be a lot more confident in selling NEM 3.0. Our Solargraf tool provides those insights exactly. Also, another phenomenon is that California is likely going to transition to a majority of grid-tied systems. That’s how Germany evolved. And in Germany right now, most of the solar plus storage are grid-tied today. California may evolve in that direction, which makes installation easier. You don’t have to worry about main panel upgrades and all that. Yes, the battery provides savings, and the battery is particularly beneficial for a few months in summer when the grid needs help and the battery can export energy back to the grid. But having said that, NEM 3.0 is new, and installers will need time to ramp up. We will start seeing solar and storage normalize in 2024.

Great. Thanks so much for the question. I just had a follow-up question to Phil's question earlier—so pricing appears to be relatively stable. So in that context, it appears like the 3Q guide is really volume-driven. Can you maybe just discuss between regions, what your expectation is on volume in the third quarter, specifically? And if you could just start to provide more context around how you expect that to rebound or change in the fourth quarter, that would also be helpful. Thank you.

Yes. Just for context, in Q2, we grew about 25% in Europe compared to Q1. We expect Europe to be slightly down compared to Q2 due to seasonality. Europe for us is underpenetrated. In general, we are very strong in Netherlands and France. We are making our way into Germany. However, the other countries are almost blue oceans for us—like Italy, the U.K., Sweden, Denmark, Greece, Austria, and Switzerland. We are entering all of those regions, and so we are extremely bullish on Europe. In the U.S., we noted that revenue decreased by 12% sequentially in Q2 compared to Q1, but we are expecting a heavier hit in Q3 due to the sell-through indicative of real customer demand being 20% down overall in the U.S. compared to Q4, which was our peak. As discussed, the sell-through rates in Q1 and Q2 were 20% below Q4. We reduced our shipments to the channel by only 10%, as we thought Q2 would be a strong seasonal recovery quarter. This did not happen, leading to excess inventory in the channel. Thus, our guidance for Q3 reflects a correction related to the depressed levels of demand going forward. The revenue for us will mimic the percentage demand drop on a quarterly basis.

Excellent. Thank you. Good afternoon, team. I appreciate it. Can you talk a little bit more about the inventory levels and any write-down risk here? Can you talk a little about the backdrop on that front? And more importantly, just the normalizing functions as you think about these different inventory levels across geographies, especially thinking to continued European growth, what might be implied by inventory levels, etc.

Yes. I just answered the question for Europe. The inventory level in Europe is a little bit normal, although it's on the higher side at approximately 10 weeks. That is why we said Q3 is a seasonally down quarter in Europe, and we expect slightly lower revenue compared to Q2. However, we are introducing several new products to account for our growth in Europe. Therefore, we are not worried about revenue or inventory there. In the U.S., at the end of Q4 '22, we were in great shape, and sell-through was at its highest. Our channel inventory was very healthy. What changed was the sell-through rates declined overall in the U.S., 20% compared to Q4, which left us with two quarters of extra inventory. Hence, we are taking a one-time correction for shipments into the channel. This is why our guidance is light for Q3.

Right. Effectively equal to that excess inventory. Great. And then just related here, if you can comment on gross margins. I mean, obviously, you guys have been providing consistently improving gross margin guidance over time. Implicit within that is the confidence to sustain that for at least some time, several quarters as far as I read it. You still feel confident in supporting these higher gross margin levels here despite this backdrop through this period of time for several quarters?

We are careful on the gross margin guidance. Our non-GAAP guidance that we provided is 42% to 45%. For example, in logistics, last quarter, we saved $8 million. Therefore, we have many initiatives for World-Class Cost, which are yielding savings in component costs and quality improvement initiatives. We are now moving to a higher IQ8 mix, which has a slightly higher gross margin than IQ7. On batteries, we are also seeing improvements in gross margin. We see the opportunity to better service and warranty expenses with our batteries. We’ve structured warranty replacements in such a way that it reduces overall costs, and we are improving our logistics. Our fourth generation batteries are projected to significantly decrease our costs related to power electronics and component count. In general, we are confident in our gross margin trajectory on both microinverters and batteries.

So based on the feedback that you're receiving from your distribution network, are you getting the impression that sell-through in non-California will have bottomed by 3Q? Or do you still believe non-California is in the process of recalibrating? And then you said that the early NEM 3.0 data is encouraging from your larger installers. Can you maybe just speak to - wait, attachment is down to 50%. Can you just maybe speak to where we are on year-over-year trends, just based on the leading-edge data?

To answer your question, the sell-through for non-California has not changed much in Q1 and Q2. In fact, I said Q2 was worse compared to Q1, by about 6%. Therefore, it is expected to stay at this level until the interest rates take a meaningful turn for the better. Regarding NEM 3.0, right now, we only have anecdotal evidence. The channel is still NEM 2.0, and many of our distribution partners noted that some installers may continue doing NEM 2.0 until October or November. We expect most of Q3 to still feature NEM 2.0 installations, with concrete sales data on NEM 3.0 expected to manifest in Q4. However, we see an increase in design and proposal activity due to our Solargraf platform. A lot of designs on NEM 3.0 are underway, so we are optimistic about those trends.

Thank you for that color. And then maybe for my follow-up question. Clearly, demand is tracking beneath expectations as you're adding a significant amount of capacity to the U.S. Do you have the ability to ramp U.S. to peak capacity by throttling back in Mexico, India, and Romania? Or are there minimum activity levels that you would need to maintain per your agreements with your contract manufacturers?

Good question. We have a total of 3 contract manufacturers right now. Two of them have been with us since the start. That is one of the reasons we even chose those two, because we have deep relationships with them; and we are highly sensitive regarding how we load their factories outside the U.S. versus their factories inside the U.S. Our expectation is to ramp steadily from Q2 of 50,000 units to the Q4 '24 number of 4.5 million units, pending robust demand. But this is a long-term decision, and we do expect healthy demand by then. If not, we will work with our contract manufacturing partners to ensure appropriate factory loads.

Good afternoon, everyone. Thanks for taking my questions. Just a quick one for me. Just curious if you could give us a little more detail on the EV charging side of things, what it takes to break into - grow that business to a bigger segment, and then the eventual progression toward bidirectional charging and how you're viewing that?

Right. We bought a company called ClipperCreek towards the end of 2021. Now we have moved the manufacturing of those EV chargers so that we can scale a lot at Flextronics in Mexico. That’s Phase 1. The next step, which we will release in Q3, is an IQ smart EV charger. We are adding connectivity to our ClipperCreek EV chargers and rebranding them as IQ smart EV chargers. Once you have the connectivity and the integration into Enphase solar plus storage systems, you can configure your app to only charge your EV from solar, for example. That comes in Q3 . In terms of Phase 3, we’re working on introducing these EV chargers into all countries in Europe by Q1 and Q2 of '24. Our existing partners are all selling our solar and storage systems; it makes sense for them to sell Enphase solar plus storage plus EV chargers. We’ve demonstrated bidirectional EV charging; it aligns with our Ensemble architecture. We tap into the digital interface of the vehicle, and our inverters will convert that DC into our energy management system. We plan to launch the bidirectional inverter by Q4 of next year.

Hi guys. Thanks for taking the questions. Apologies about earlier. I had a question about the destock and how you're reading the channel. I appreciate, Badri, all the detailed disclosure about the quarterly cadences you've experienced. So if I do the math, you kind of shipped 10% more than sell-through for 2 quarters in a row based on your commentary in the U.S. So roughly, let's call it, $100 million, if my math is correct. Your guidance is effectively down that much sequentially, if not a little bit more. So does this imply you're entirely resetting the channel all at once in 3Q? And then as you get into Q4, are we going to start to be looking at a normalized environment, and you're starting to fill the channel again? Like what's sort of the implication here, if that math is correct to begin with?

To answer your question, yes, the implied math suggests that we are taking the appropriate steps to reset the channel due to market uncertainties. We are not assuming any optimistic demand for Q3. Therefore, our guidance reflects a correction of the channel. However, with new products launching and adjustments being made, we anticipate a bounce back in the dynamics thereafter.

Hi everyone. Thanks for sneaking me in here at the end. So, if I understand correctly, it sounds like you feel pretty good about battery inventory in the channel. And again, I do appreciate everything you gave on the microinverter side. But just curious, with that in mind, with Gen 3, the launch and getting into the market. And then NEM 3.0 expected to start in 4Q, I mean, are you willing to call a bottom? I think last quarter you said that you thought Q2 might be the bottom for battery volumes. Is that still a fair expectation?

Yes. I mean, that's right. That is still a fair expectation. We are exactly on track for that. We feel really good on batteries. We have started shipping our third-generation battery. The third-generation batteries solve some unique problems in the second generation. Although on the second generation, we have cleaned it up. The third generation has outstanding commissioning times. The beautiful thing in Australia is that we have the one product that combines the gateway plus the isolator. It is easy to install, with the commissioning times being under 30 minutes. Plus, our third-generation battery has greater continuous and peak power than the prior generation. We believe our battery business—Q2 was the bottom, and we are guiding Q3 to be in the same range of 80 to 100. We think with NEM 3.0, along with our entry into new countries in Europe, we should see growth starting to take off.

Hi guys. Thanks for taking the questions. Just wanted to clarify - sorry to ask a similar question to some others. But the impact of the inventory reset from the first half of the year that you're going to do in Q3, can you just identify what that catch-up is as opposed to kind of ongoing inventory changes? Just the impact of -

We are taking our revenue numbers from an actual Q2 of $711 million to Q3 guidance for $550 million to $600 million. Most of it, approximately 85%, is linked to the one-time correction, while the rest is due to seasonality in Europe.

Hi. Good evening, team. Most of my questions have been answered at this point. But maybe if you can help me understand the impact of the IRA benefit into next year.

Yes. We are breaking out the net benefit from IRA for clarity. In Q2, the net benefit was $1.6 million from 50,000 units shipped at roughly $30/each. For Q3, we expect shipments of 600,000 units with an estimated IRA benefit of $14.5 million to $16.5 million. We will continue providing the net benefit range based on shifting product mix. As previously stated, with demand expected to be robust, we project achieving a capacity of 4.5 million units per quarter by the end of Q4 '24.

Hi. Good afternoon. Thank you for squeezing me in. I wanted to ask you a question on kind of go-to-market strategy, particularly as you expand to Europe, where competition is higher across different product lines. Does it make sense for you to, I guess, launch some kind of brand awareness campaign aimed at the end consumer?

Our approach in the U.S. has always prioritized installers as our front line to homeowners. We find success through our installer relationships. That said, we do leverage social media tools for brand awareness aimed at end consumers. However, our main focus remains enabling our installer partners to effectively market our products to homeowners.

Great. That's all for me. Thank you.

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