Good day, ladies and gentlemen, and welcome to Enphase Energy's third quarter 2013 financial results conference call. At this time, all participants are on listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance in the conference, please press star then zero on your touchtone telephone. As a reminder, this call is being recorded. I would now like to turn the call over to David Benjamin, investor relations. You may begin.
Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's fiscal third quarter 2013 results. This call is also being broadcast live over the web and can be accessed in the investor relations section of Enphase Energy's website at enphase.com. With me on today's call are Paul Nahi, Enphase Energy's Chief Executive Officer, and Kris Sennesael, Chief Financial Officer. After the market closed today, Enphase issued a press release announcing the results for its fiscal third quarter ended September 30th, 2013. We are providing an accompanying presentation with our earnings call that you can access on the investor relations portion of our website. During the course of this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to Enphase Energy's financial performance, market demands for its microinverters, advantages of its technology, market trends, and future financial performance.
These forward-looking statements are based on the company's current expectations and inherently involve significant risks and uncertainties. Enphase Energy's actual results and the timing events could differ materially from those anticipated in such forward-looking statements as a result of these risks and uncertainties. Factors that could cause results to be different from these statements include factors the company describes in its press release of today, especially under the section entitled Forward-Looking Statements, as well as those detailed in the section entitled Risk Factors of the company's report on Form 10-K for the year ended December 31st, 2012. Copies of these documents may be obtained from the SEC or by visiting the investor relations section of our website.
Enphase Energy cautions you not to place 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 certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We've provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings release posted today, which can also be found in the investor relations section of our website. I'd like to introduce Paul Nahi, Chief Executive Officer of Enphase Energy. Paul?
Thanks, David, and welcome to everyone joining us on the call today. The third quarter of 2013 was a record-breaking quarter for Enphase, with highest-ever revenue of $62 million and highest-ever gross margin of 28.3%. Operating expenses, which totaled $20.4 million, were once again flat for the fourth consecutive quarter. We're continuing to drive leverage in our model by focusing on operating expense control while making the necessary investments to sustain the growth of our business. Our financial discipline, combined with our top-line growth and improving gross margins, enabled us to narrow our loss from operations and improve cash flow. During the third quarter of 2013, Enphase shipped its four millionth microinverter, representing approximately 885 megawatts of AC microinverter capacity. This marks yet another milestone for Enphase as the world's leading microinverter systems provider. Another important achievement is the introduction of the latest Enphase system, which features our M250 microinverter.
You'll recall last quarter we announced that we had shipped the first few thousand units of this fourth-generation product. During the third quarter, we offered our new M250 on a limited availability basis to our North American customers as we continued to ramp production and as our customers started to transition from our highly successful third-generation product to our newest microinverter. During the third quarter, we shipped approximately 60,000 M250s, which represented 15% of total units shipped during the quarter. The transition to our latest microinverter will continue over the next several quarters. We expect our fourth-generation product will represent approximately 20% to 30% of total units shipped in the fourth quarter of 2013. Our latest microinverter system is an example of the step function improvement which accompanies each new product generation.
The M250 contains our most advanced custom semiconductor device, which, in addition to the latest power electronics technology, incorporates our next-generation communications technology. The M250 offers higher output power, increased conversion efficiency, and a labor-saving integrated ground feature. Along with our hardware product innovation, the Enlighten software platform also continues to evolve. We're now collecting over 200 gigabytes of data every day. Managing big data of this kind requires our proprietary analytics engine to turn this data into valuable information for Enphase system owners. We just launched the second version of our Enlighten API, or application programming interface, which makes it even easier to integrate solar system production data from Enlighten into other custom applications. These can include fleet management tools, display kiosks, building management software, billing integration, and mobile apps.
This is just one more example of how we continue to utilize our unique position to provide system performance data that is used and valued by a broad range of constituents in the solar energy value chain. Our new system has been very well received by our customer base, including our direct customers, distributors, OEMs, installers, and system owners. On October 21st, at Solar Power International 2013, we announced the general availability of the fourth-generation system in the North American market. Later in 2014, we plan to introduce the M250 in Europe and Australia as well. Enphase continues to be the clear market leader in the U.S. residential market. In addition, we're making a lot of progress in the commercial market, which is a tremendous opportunity for Enphase as we look to accelerate our top-line growth.
We just announced the completion of a 3-megawatt project for the San Diego Unified School District. This is a 125-building distributed solar project using Enphase microinverters spread across 29 schools and 2 facilities buildings throughout the school district. Our microinverters allow the project developer to focus their installers on a single inverter technology to support 3 megawatts of arrays on more than 125 different systems, each uniquely designed with different roof angles, orientations, and sizes. The challenging rooftops would have made array design logistically impractical with traditional inverters. This project was ideally suited to our microinverters, which can be customized to fit both the smallest of arrays as well as megawatt-scale systems. The design diversity of this distributed 3-megawatt system exemplifies the flexibility and adaptive nature of the Enphase technology. Solar system safety was critical.
Because Enphase microinverters are low voltage, the developer was able to install the system knowing that no dangerous high-voltage wiring would be running through the schools. Speaking of megawatt-scale systems, as a follow-up to our earlier announcement, this quarter, we completed a 2.3-megawatt solar installation for Vine Fresh Acres in Ontario, Canada. In contrast to the previous installation, this array was on a single unobstructed rooftop with no significant shading. This three-phase commercial system is Ontario's largest commercial rooftop solar PV array as part of the province's feed-in tariff program and utilizes over 9,000 Enphase microinverters. We were selected for this project in part because of our higher energy harvest, no single point of failure, ease of installation, and the fact that Enphase systems are easier to maintain because of our module-level monitoring.
Another example of our efforts around market expansion involves our participation in the Clinton Global Initiative Commitment to Action. Enphase is piloting an innovative solar energy microgrid system in Abuja, Nigeria. This microgrid system will help address some of the energy challenges in Nigeria and reduce their dependency on expensive, polluting diesel generators by providing clean, affordable, and reliable alternative sources of energy. Another example of an Enphase microgrid application is our participation in the U.S. Army's SAGE pilot program. Standing for Smart and Green Energy, this program seeks to reduce the quantity of liquid fuels required for electrical power generation for military base camps by employing PV systems, microgrid technologies, and many energy efficiency measures. The Enphase microinverter system is ideal in these types of applications.
Longer term, we expect opportunities for microgrid applications to increase in developed countries as well as grid stability and reliability continues to be a concern. We're constantly evaluating new growth opportunities with several other initiatives underway, and we'll share updates with you as they progress. Our financial results for the third quarter of 2013 were marked by a strong performance from the domestic markets as business in the U.S. was up 13% sequentially, despite a reduction in inventory in the distribution channel and some weakness in the Hawaiian market. Business in Europe during the third quarter was rather soft, mainly due to the summer holiday schedules, resulting in a sequential decline of approximately 25%. Looking at the individual countries, the U.K. market is growing, our business there is developing nicely.
However, the markets in France, Belgium, and the Netherlands, where we now have a top three market share position, are softer as a result of substantial reductions or cancellations in FIT programs. We anticipate these conditions will persist in the near term, tempering demand in these regions, but are encouraged as we gain share in these new Enphase markets and believe they will have robust demand for solar in the coming years. Our business in Australia is starting to ramp. In fact, we recently completed a 100-kilowatt system, our largest project to date, and we continue to build our position and product offering in this attractive market. We're also seeing signs of renewed activity in the Canadian market, resulting from a new and stable FIT program and are pleased with our progress in this market.
Looking into 2014 and beyond, we continue to be extremely bullish on the industry and see potential for significant growth of Enphase's business, particularly in the U.S., the U.K., and Australia. A recent solar industry report by Deutsche Bank stated grid parity is a reality today in roughly 10 states in the U.S. and as system prices continue to decline, they expect this number to increase. The combination of lower system prices, solar financing products, and the reduction in some of the soft costs, such as customer acquisition and permitting, is creating a catalyst fueling the demand for solar over the next several years. With those comments, I'll turn it over to Kris.
Thank you, Paul. First, I will provide some more detail on our third quarter financial results before turning to the business outlook for the fourth quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis unless otherwise noted. During the third quarter, we continued our track record of execution and improving top and bottom line as well as cash flow. Revenue for the third quarter was a record $62 million, up 7% sequentially, and coming in at the upper end of the revenue guidance of $59 million-$63 million. During the third quarter of 2013, we shipped 426,000 microinverters, representing 94 megawatts. Approximately 15%, or 60,000 units, were the Enphase fourth generation microinverter system. Domestic revenue comprised 84% of third quarter total revenue, while the international revenue made up 16%.
As Paul mentioned, our international revenue was down sequentially, mainly driven by a weak seasonal business environment due to the summer holidays and various regulatory actions impacting the solar industry incentives. In the third quarter, we set another gross margin record at 28.3%, which is an increase of 140 basis points compared to 26.9% in the third quarter of 2012, and an increase of 20 basis points compared to our previous gross margin record in the second quarter of 2013. The third quarter gross margin improvement is driven by relatively stable average selling prices, ongoing cost reduction efforts, and the benefit of the higher margin on our fourth generation system. During the third quarter, we continued to focus on our financial discipline, delivering on our operating expense management strategy and leveraging the infrastructure that has been put in place. Operating expenses for the third quarter were $20.4 million.
This is the fourth consecutive quarter we have maintained our spending at this level. R&D was $7.7 million, sales and marketing was $7.6 million, and G&A was $5.1 million. Sales and marketing expenses were up slightly from the prior quarter, but were offset by reductions in R&D and G&A. These non-GAAP operating expenses did not include approximately $2 million in stock-based compensation expenses and $400,000 in severance costs. Our top-line growth, record gross margins, and flat operating expenses enabled us to further reduce our operating loss and net losses. For the third quarter of 2013, we recorded an operating loss of $2.9 million and a net loss of $3.7 million, or a loss of $0.09 per share. On a GAAP basis, the net loss was $6.3 million or $0.15 per share. Let's talk about our continued improvement in cash flow.
Third quarter negative operating cash flow was reduced to $500,000, and net cash flow was a negative $2.2 million as our improved financial performance and focus on working capital management moves us closer to positive cash flows. We exited the quarter with a total cash balance of $31.8 million, and once again, we did not draw on our available debt facilities. During the quarter, we repaid approximately $600,000 on our existing term debts. Turning to working capital, we ended the third quarter with inventory at $24.4 million, up $6.5 million from the second quarter. The higher inventory levels are associated primarily with our current product transition. We expect to reduce inventory levels in the fourth quarter in advance of our seasonally softer first quarter.
We ended the quarter with accounts receivable of $34.7 million, up slightly from the $32 million in the second quarter, in line with the sequential revenue increase. Capital expenditures during the third quarter were $1.4 million, and depreciation and amortization was $1.8 million. I would like to turn to our guidance for the fourth quarter of 2013. We expect revenue for the fourth quarter to be in the range of $62 million-$65 million, which is an increase of 8%-13% on a year-over-year basis. Regarding gross margin, we expect gross margin to be within a range of 29%-32% as we continue to drive down product cost and benefit from the product transition. We also expect non-GAAP operating expenses to be roughly flat compared to the third quarter. I'll open the line for questions.
Ladies and gentlemen, if you would like to ask a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Vishal Shah of Deutsche Bank. Your line is open.
Hi. Thanks for taking my question. Paul, I wanted to just talk a little bit about how you can improve your gross margins going forward. Is it going to be a function of overall product mix, as you start selling more of these higher margin products, or is it also going to be a function of volumes? Just talk a little bit about what your profitability looks like and at sort of what kind of breakeven level are we looking at now? Thank you.
Sure. Currently, our gross margins have been affected by three specific factors. One, clearly, is technology and our ability to integrate more of our device onto a single ASIC, thereby reducing the part count and reducing the size of the inverter. Another element certainly is volume, and the scale associated with that. Another is simply just the growing size of the inverter, the fact that modules are becoming more powerful and an attendant microinverter that's also equally powerful. Going forward, we see those three main factors still at play. There's a lot of technology in front of us, a lot of technology development that's going to help continue to reduce the cost. We've seen that in every subsequent generation of our product. We don't see that slowing down. Our volume continues to increase. That is also having a very significant effect.
Now, I would only caution you that, as we've seen in the past, we have reduced ASPs anywhere between 6%-12% year-on-year. We certainly see a similar trend in the future. There's going to be some downward pressure as a result of normal ASP trends, but the continuing upward momentum on gross margin as a result of technology, volume, and inverter size will continue.
Okay. When should we start? What kind of breakeven levels are we looking at? When do we start looking at profitability at the bottom line?
Right. We have a breakeven model with revenue at $80 million per quarter, 30% gross margin, and 30% OPEX, which is $24 million of OPEX. However, as you have seen in our financials, we have been able to keep our operating expenses well below the $24 million level. It's currently at $20.4, $20.5 million. As a result of that, our breakeven model is actually currently below the $80 million per quarter.
Okay. Appreciate that. Thank you.
Our next question comes from Philip Shen of ROTH Capital Partners. Your line is open.
Hey, guys. Thanks for taking my questions.
Sure.
The revenue guide came up a bit short versus consensus, but it seems like your better-than-expected gross margin guide may completely offset that. If we use the upper end of your guidance range, there appears to even be a touch of upside to Q4 EPS estimates, and you may possibly even reach breakeven on a non-GAAP basis. Can you talk to us about how confident you are in the upper end of your guidance range and what the potential may be to exceed that range in Q4?
Phil, you're absolutely correct. Just mathematically, if we hit the upper end of the guidance with $65 million of revenue and 32% gross margin, we have operating expenses flat at the $20.5 million range. We would hit profitability from a non-GAAP operating income point of view. However, having said that, we provide guidance within a range. The range is $62-$65 for revenue and 29%-32%. There is no commitment or indication as of today that we will hit the high end of the guidance or even do better than that.
Phil?
Our next question comes from Krish Sankar of Bank of America Merrill Lynch. Your line is open.
Hi, guys. This is Andrew. He's on for Krish. One question on competition, just who you're seeing in the U.S. residential market specifically, not really in terms of micros because it's not something that we've seen, but any new competitive threats among some of the new string offerings and just comment on that and perhaps on market share as well.
Sure. Starting with your last question first, we're seeing our market share in the U.S. hold steady. If anything, it may be slightly trending up, but let's call it holding steady for now. In terms of competition, you're exactly right about micros. In fact, at this point, all the largest inverter manufacturers have announced that they are currently selling micros. We have not seen any appreciable effect in our market as a result of that. Clearly, our competition today is coming more from traditional string and central inverters. There, all I would say is that we're not seeing any change in the fundamental landscape. The players are not really changing. Their market shares are staying relatively constant, one versus the other. I don't think we're seeing anything dramatic occurring in that area.
Great. Just one more on. In terms of hitting that $80 million revenue target, whether or not that's breakeven or not, just your level of confidence and your ability to do that while keeping OPEX where it is now and where you see most of that additional revenue coming from. Is it U.S. market, or is it primarily internationally focused? Thanks.
Sure. We're actually growing in a number of new markets. As we mentioned in the prepared remarks, the U.K. and Australia are tremendous residential markets for Enphase, and we are just beginning there. In fact, those markets individually, while not quite as big as the U.S. market, are close to the same size. Our market share in both of those cases is relatively small, simply because we're new entrants in those markets. There's a tremendous amount of growth potential in those new markets. There's also growth potential in the U.S. commercial market, which we're continuing to do well in. Our overall growth trajectory, I think, is going to be very healthy in 2014 and beyond. We see a lot of room, both domestically and internationally for growth.
When you look at Enphase in the scheme of all of solar, even all of DG, you'll find that we are still in the very early innings of this game, and we have a lot of headroom in front of us.
Our next question comes from Colin Rusch of Northland Capital. Your line is open.
Hey, guys. Can you talk a little bit about the cost reduction performance on the Gen 4 product so far? Historically, you've seen, if I recall correctly, about 35%-40% cost reduction on the generational shifts. Are you seeing what you had hoped to see at this point in the ramp?
You're right. Every subsequent product that we introduce does see a significant cost reduction. As we've said in the past, you don't necessarily see all of those cost reductions on day one. Oftentimes, in fact, almost in every case, you'll see some cost reduction immediately, then through the course of that product's lifetime, we'll continue to reduce costs through a variety of different means. We have seen what we have expected to see from the fourth-generation product, primarily as a result of technology and specifically semiconductor design. We also expect to see continued cost reduction throughout its lifetime as well. That is good news on cost reduction, good news on gross margin. It should just be tempered with what we fully expect to be a normal declination ASPs as we've seen in the past.
Okay, as we look at the gross margin guide up from 3Q to 4Q without a ton of revenue increase, how much of that is being driven by mix shift and how much of that is being driven by management of the supply chain?
Part of that is driven by an increase of the fourth-generation. As we mentioned during the call, in the third quarter, roughly 15% was fourth-generation. We expect in the fourth quarter that to increase to 20%-30% of overall shipments. That is definitely helping us. Now, in addition to that, we will continue to drive down the cost on our third-generation product and make further improvements across the board. That altogether gives us a view to 29%-32% gross margin for the fourth quarter.
Great, just one final one from me. Can you talk about the ramp in Australia and the potential entrance into Japan? Obviously, those have been two very strong markets, particularly for applications that you guys would fit well. I'd love to understand how you see that playing out over the next couple of years.
Sure. The team is being built in Australia as we speak. We really do believe it to be a very strong potential market for Enphase. The dynamics of that market are very healthy. It is effectively, while not entirely, it is effectively an unsubsidized market right now in rooftop DG, which we believe to be a very positive trend. The initial indication has been extremely positive. Our product has been very well received. Again, we're just starting, so we feel very comfortable about our current position and our ability to grow that market. Japan is a little bit more complicated for a variety of different reasons. We are actively engaged with several potential strategic partners. Japan has both some marketing challenges as well as some technical challenges which need to be overcome, all of which are eminently doable, but it's just a question of resources and time.
We do view Japan as a strong market for Enphase. Not exactly sure when we're going to enter that market.
Great. Thanks so much.
Thank you.
Our next question comes from Pavel Molchanov of Raymond James. Your line is open.
Hi, guys. This is Ryan Bernier in for Pavel. I just wanted to ask, last quarter you alluded to some excess supply in the channel. Has that subsided over the past three months? Also, have you been able to identify the reasons for that original issue?
The answer to the question is yes, we feel that we have done what we had set out to do, which is reduce the inventory in the supply chain. The reason for that, as we talked about in the past, is in large part due to the transition from the third to the fourth-generation product. I think part of it is just normal course of business. Throughout the year, its inventory levels will fluctuate. Because we have very clear visibility on not just our sell-in data, but sell-out data, it's very important for us to maintain a healthy level of inventory in the channel, which means that we need to manage it from time to time.
All right. Thank you very much.
Our next question comes from Edwin Mok of Needham & Company. Your line is open.
Hey, thanks for taking my question. On the gross margin side, if we think about the fourth-generation product, let's say you ramp that to 400% of your shipment and you get the volume growth that you expect next year and let's say 10% pricing under you're thinking about for on a year-over-year basis, right? What kind of gross margin do you think you can achieve with that product fully ramped?
Edwin, our long-term gross margin target is 35%-40%, and we're well on our way to achieve that. I cannot guarantee, however, that we will achieve that with 100% of fourth-generation shipments, as a lot of that will depend, as you pointed out, on what will happen from a pricing point of view, competitive pricing, and how we react to that with our pricing. That will be a key driver. Yeah, long term, 35%-40%, we do have line of sight to achieve that over time.
Okay, that's fair. On the U.S. side of the market, localized very strong this quarter, can you quantify how much of that come from commercial versus residential? As you look longer term, maybe look at 2014, how do you think that mix will shift?
Sure. Today, approximately 15%-20% of our shipments are commercial. Most of that is in the U.S. Going forward, we expect that to increase. We've already seen a tremendous trend, and there are examples of that which we shared with you in the prepared remark on several multi-megawatt sites. We do expect the percentage of commercial to increase while we increase residential, and we expect that trend to be not just U.S., but also international.
Last question I have, if I can squeeze one more in. What is roughly the timing, at least based on your current plan, the timing for a fifth-generation inverter?
We have not announced the fifth-generation inverter, the timing for the release of the fifth generation. What we have said in the past is that traditionally, if you look historically at what we've done, and if you look at Silicon Valley tech companies in general, from generation to generation can be anywhere approximately 18-24 months. Having said that, I will note that the fifth generation, as you all know, is well underway. It's actually operating. It's on rooftops. We have actually just started the sixth generation as well. We continue to invest heavily, both in hardware and in software, to increase our lead.
Great. That's very helpful. Thank you.
Our next question comes from Philip Shen of ROTH Capital Partners. Your line is open.
Hey, guys. Don't know what happened earlier, but I got cut off. Just a quick follow-up here. In this quarter, you guys had about 16% of your revenues exposed to international sales. It was 20% in Q2. As you look out ahead, what kind of international revenue mix do you expect, perhaps for all of 2014?
We can't speak specifically to 2014. We don't guide to that level of specificity. What we can say is that we're continuing to gain share in just about every international market we're in. The adoption of the product, the reception to the microinverter technology has been fantastic. We're seeing the exact same level of response there that we did see in the U.S., maybe back in 2008, 2009, which gives us a great deal of confidence that we're going to be able to achieve internationally what we've achieved in the U.S. Having said that, of course, there are logistics issues, there are operational issues, having to build teams in those countries, establish sales, customer support, training, and all the rest. We are well on our way to doing that in the core countries that we are focused on right now.
I would say long term, we expect the percentage of sales to come from rest of world to increase very dramatically from where it is right now, and we're very confident we're going to be able to achieve that.
Yeah. Phil, just to add there, the U.K. residential solar market as well as the Australian residential solar market, each of them is approximately the same size as the U.S. residential solar market. It's a really large market, and we have only started our adventures there, we have a tremendous opportunity to go and take share in that market, grow our share, and grow our business.
Great. Thanks, Kris, and thank you, Paul, as well.
Thank you.
I'm showing no further questions. At this time, I'd like to turn the call back over to Paul Nahi for any further remarks.
Thank you for joining us on today's call. The third quarter of 2013 was a record-breaking quarter with strong execution on our strategic initiatives and solidifying our position as the industry leader. We look forward to speaking with you beginning of next year as we report on our fourth quarter and full year 2013 accomplishments.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.