Good day, ladies and gentlemen, and welcome to Enphase Energy's second quarter 2013 financial results conference call. At this time, all participants will be in a listen-only mode, but later there will be a question-and-answer session, and instructions will be given at that time. If anyone should require audio assistance, you can press star, then zero, and an audio operator will assist you. As a reminder, today's conference is being recorded. Now, I would like to turn the conference over to your host, David Niederman.
Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's fiscal second 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 second quarter 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 of 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. Now, I'd like to introduce Paul Nahi, Chief Executive Officer of Enphase Energy. Paul?
Thanks, David, and welcome to everyone joining us for our second quarter 2013 earnings call. Today's call will follow our normal format. I'm going to start with an overview of our Q2 performance and provide an update on our progress against some of our key initiatives. Kris will take us through the financials and next quarter guidance, and then we'll go to Q&A. The second quarter of 2013 was another solid quarter for Enphase with great execution on our goals. Revenue, gross margin, and operating expenses are all in line or better than our guidance for the quarter. We had strong sequential top-line growth of 28% with revenue of $58.2 million. We set another gross margin record at 28.1%, and we kept our operating expenses flat for the third quarter in a row. We also made significant progress in reducing the negative cash flow from operations to $1 million.
On balance, our second quarter financial performance was very strong and continues to reflect ongoing progress as we grow and move forward on our path to profitability and sustainable positive cash flows. Now let's talk about some of our other second quarter highlights. In our last call, we told you we will focus on and execute the key initiatives we believe are critical to our success. These include providing superior microinverter systems and services, reducing product and system costs to the customer while increasing gross margins through our semiconductor-based business model, growing market share in our core markets, seeking out new market opportunities, expanding our geographic footprint, and continuing to chart our path to profitability and sustainable positive cash flows.
I'm pleased to be able to share tangible evidence of progress we're making in these areas, starting with the introduction of our fourth generation microinverter system featuring the new M250 microinverter. This is yet another example of driving stakeholder value through cutting-edge hardware and software technology development. During the second quarter, we made our initial shipments of the M250 microinverter and our new Enlighten software monitoring system with a general availability in North America scheduled for September. Optimized for high-power solar modules, the M250 microinverter produces 250 watts peak AC output power and pairs with modules up to 300 watts. The M250 is rated at 96.5% CEC weighted efficiency, the highest efficiency in the industry for microinverters. In addition, the M250 has been built to withstand the most grueling environmental conditions.
It is NEMA 6 rated and has undergone over 1 million hours of testing in extreme temperature and humidity environments prior to launch. The M250 also supports a new integrated ground feature, again, a first in the industry for microinverters. The M250 microinverter no longer needs a separate grounding electrode conductor to each microinverter. This improvement creates a more streamlined and cost-effective installation process by reducing installation time and decreasing materials costs. The fourth generation Enphase system also introduces enhancements to our intelligent software platform, Enlighten. Enlighten is a critical tool for both installers and owners of the solar system. To best serve the different needs of both the solar professionals and system owners, Enlighten is now available in two different versions. For solar professionals, Enlighten Manager offers increasingly sophisticated back-end, web-based tools to monitor and manage multiple installations, further streamlining the operations and maintenance process.
Energy system owners, MyEnlighten offers an engaging interface to view and easily share production and environmental benefits of solar energy with friends and colleagues through seamless integrated social media connections. Recognizing that two software interfaces allows us to increase the functionality for each user, we see this evolution in our software platform opening, yet again, new avenues for value creation. In addition, while the new M250 microinverter brings increased value for our customers and end users, as with each new generation of our product, we continue to reduce product costs and improve gross margins. We expect to see the gradual benefit in our financials as we phase in the new product, which typically takes around four quarters.
In addition to being the technology leader, we were recognized as the number one residential inverter supplier in the Americas for 2012 by IHS Markit, with 53.5% share of revenue and the number one power electronics PV monitoring provider globally by number of sites in 2012. Surpassing traditional inverters was an important milestone for us and further validates the microinverter technology for rooftop solar applications. Turning to our international business, we had substantial growth in revenue generated from outside of the U.S. in the second quarter, as it surpassed 20% of total revenue. In Europe, our performance was particularly strong in France, which is up over 150% year-over-year, and in the U.K., which has grown to our second-largest European market behind France. These results reflect the early benefits of the realignment of our European organization, which we announced last quarter.
We continue to increase our market share and presence in Europe by leveraging existing partnerships and developing new ones. As an example, during the second quarter, working with our distribution and installation partners, we became involved in a new project in the U.K., putting solar on 600 homes. This will be our largest project to date in the U.K., with an average size of three kilowatts per home. Installations for this project have begun and are ongoing. It's also important to note our growth in Europe is against the backdrop of a challenging market with reductions in feed-in tariffs in several countries and uncertainty related to potential import duties on Chinese modules. To date, we're making great progress, and we've learned a lot from our expansion into Europe.
To capitalize on this experience, we've recently deployed a team to more fully evaluate the things we did well, amplify our performance, and identify the things we can improve as we look to further international expansion. This is creating a systematic and repeatable process that will allow us to more seamlessly move into other target markets. Closing on international, we're beginning to see signs of recovery in the Canadian market as demand is improving. We're also starting to gain some early traction in Australia and are signing up new distribution partners. In addition, we just participated in our first trade show, Clean Energy Week 2013, which is Australia's biggest event for the renewable energy industry. Our presence at the event helped us significantly build our profile in the Australian market as we met with hundreds of installers and prospective customers.
In fact, at the show, we received an order for a 100-kilowatt system, which will be our largest to date in Australia. Turning to expansion of our core markets, we're making progress with our work in the commercial and new housing market segments. As an example of the traction we're gaining in the commercial segment, a 2-megawatt project using Enphase inverters just came online. This is the largest commercial project using microinverters and is a great example of our product being successfully deployed in a large commercial installation. We'll be sharing more about this project in the coming weeks in a more formal announcement. In addition to this success story, we recently announced a new commercial initiative for the European markets. To help fuel the momentum of commercial solar, we're now providing our installers with a full solution to meet the demands for small commercial projects.
Our Enphase system offers installers and owners a technology solution with a modular architecture, integrated intelligence, lower levelized cost of energy, and increased project profitability. It includes the M250 microinverter, both three-phase and single-phase engaged cabling, our Envoy gateway, the Enlighten monitoring platform, along with training and project design support. This offering will enable us to address the fast-growing market of small commercial systems up to 100 kilowatts with our microinverter system. Next, I'd like to update you on our efforts to address the new home market. We've recently formed a strategic relationship with one of the leading U.S. home builders, Lennar, through its newly created subsidiary, SunStreet Energy Group. Lennar chose Enphase in part because of our leadership in the industry and because the microinverter provides the most flexible and productive technology for the new home market.
In addition, you'll recall last November, we were selected as the exclusive inverter partner of CertainTeed, one of the nation's largest building materials manufacturers. In combination, these relationships provide an ecosystem to deliver high-quality interactive solar solutions that benefit the builder and homeowner with Enphase as the technology of choice for modern solar living. We view this as an important step in providing us additional access to the new home market. You'll recall that last quarter I mentioned there are only approximately 250,000 solar homes in the U.S., but there are more than 70 million homes in total, and industry analysts expect nearly 1 million new homes to be built in 2013. Our strategic relationships with Lennar and CertainTeed are an important step in developing a channel to address this growing market opportunity. In summary, our efforts are bearing fruit.
In addition to being named the number one residential PV inverter supplier in the Americas and the number one global power electronics PV monitoring provider in 2012, we recently achieved an important milestone, surpassing over 1 terawatt-hour of clean energy production from systems reporting to Enlighten. We're extremely proud to have reached this milestone and to be acknowledged as the industry leader, but our work is far from complete. We aspire to be the number one rooftop PV inverter supplier worldwide, expand our share in the commercial segment, and further distance ourselves from the competition in the use of data provided by our intelligent monitoring systems. Now, before turning it over to Kris to go over the financials, I want to close with some industry comments. We're extremely pleased with our progress in the first half of 2013.
We continue to see strong POS or sell-out by our channel partners, and demand from installers and end users continues to increase. However, as Enphase and the broader U.S. solar industry continue to grow, it is not without challenges, and we're seeing a stronger focus on working capital management within the industry. Consequently, our channel partners are starting to pare back their inventory levels. In addition, as we transition from the 3rd-generation to the 4th-generation microinverter system, certain distribution partners are reducing inventory levels of the 3rd-generation product as well. While our guidance for Q3 reflects the impact of this temporary channel correction, the fundamentals of Enphase and the broader industry are stronger than ever, and we will continue to execute on our strategy, which has proven to be a winning approach. With those comments, I'll turn it over to Kris.
Thank you, Paul. First, I will go over the financial results in more detail for the second quarter of 2013, then I'll turn to the business outlook for the third quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis, unless otherwise noted. As Paul indicated, we are pleased with the solid performance of the company during the second quarter of 2013. Total revenue for the second quarter was $58.2 million, slightly above the midpoint of the revenue guidance of $56 million-$60 million. This is a strong sequential increase of 28% and an increase of 4% on a year-over-year basis. However, the second quarter of 2012 included approximately $19 million of 1603 related revenue. If we normalize for the 1603 related revenue, the second quarter of 2013 is up more than 58% on a year-over-year basis.
During the second quarter of 2013, we shipped 399,000 microinverters or 86 megawatts. The sequential revenue growth was strong on both the domestic and international fronts, with approximately 80% of the revenue coming from the U.S. and 20% comprised by our international markets, mainly from Canada, France, U.K., Belgium, the Netherlands, and Australia. We are especially pleased with the progress that we are making in our international business, which has shown steady growth, increasing from approximately 10% of our total revenue in Q4 of 2012 to 15% in the first quarter of 2013, and now further improving to 20% of total revenue. We will continue to focus on our international expansion as a key driver of our top-line growth. In addition to the strong sequential revenue growth, we continue on our path of improving gross margins.
We set another company gross margin record in the second quarter with the gross margin at 28.1%, an increase of 360 basis points compared to the 24.5% in the second quarter of 2012, and an improvement of 110 basis points from the first quarter of 2013. The second quarter's gross margin is particularly impressive when taking into consideration a price reduction within the quarter and almost no benefit from the launch of our 4th-generation product, as we only began shipments during the second quarter. Gross margins have steadily improved over the last couple of years from approximately 10% in 2010 to approximately 20% in 2011 and 25% in 2012, with a new record now in the second quarter at 28.1%. We are well on our way towards our long-term target gross margin of 35%-40%.
We also continue to deliver on our operating expense management strategy and the ability to leverage the infrastructure that has been put in place. We have kept our operating expenses flat for three quarters in a row and well below the level of the third quarter in 2012, which was $23.1 million. Total operating expenses for the second quarter were $20.4 million, with R&D at $8 million, sales and marketing at $7 million, and G&A at $5.4 million. Sales and marketing expenses are slightly up from the first quarter, driven by our international expansion efforts, but offset by a slight reduction in R&D and G&A expenses. These non-GAAP operating expenses did not include $1.4 million in stock-based compensation expenses. We ended the first quarter with 384 employees, flat compared to the last three quarters.
As a result of the sequential top-line growth, record gross margin, and flat operating expenses, Second quarter of 2013, net loss was $4.8 million, or a loss of $0.12 per share. On a GAAP basis, the net loss was $6.4 million, or $0.15 per share. Finally, I want to point out the significant progress we are making towards our goal of sustainable positive cash flows. We improved the cash flow from operations by $6 million over the first quarter of 2013, closing the second quarter with a negative cash flow from operations of $1 million and a negative net cash flow of $2.5 million. As a result, the company exited the quarter with a total cash balance of $34 million. We did not draw on our available debt facilities, and we did repay approximately $600,000 on our existing term debt.
Working capital improvements were mainly driven by an increase in the inventory turns from six to nine times, with inventory at the end of the second quarter at $17.9 million, down $4.4 million from the first quarter. This is a result of stronger focus on inventory management, overall business planning, and our logistic processes. Capital expenditures during the first quarter were $1.8 million, and depreciation and amortization was $1.7 million. Now, I would like to turn to our guidance for the third quarter of 2013. We expect revenue for the third quarter to be in the range of $59 million-$63 million. This takes into account an anticipated reduction of the inventory levels within our distribution channel, partially as a result of the transition from the third to fourth-generation microinverter system and the ongoing rationalization of inventory levels within the industry.
Regarding gross margin, we expect the gross margin to be within a range of 27%-29%. We expect to see the benefit of the higher gross margins on the fourth-generation product to start improving our overall gross margin over time as we start ramping the sales of our new microinverter system. We also expect non-GAAP operating expenses to be roughly flat compared to the second quarter. Now, I'll open the line for questions.
Okay. At this time, ladies and gentlemen, if you do have a question or comment, press the star followed with the one key, and you'll be placed into a question queue. Again, for any questions or comments, press the star followed with the one key to be placed into the question queue. We'll go with our first question from Vishal Shah from Deutsche Bank. Vishal, please go ahead.
Hi, guys. This is Jeremiah calling in for Vishal. I was just hoping you could touch on the outlook for how margins might look like once you've completed the transition to the fourth-generation microinverter.
Obviously, we're not guiding to forward-looking margins beyond this quarter. What I can say is that we expect to see similar improvements in gross margin with the Gen 4 as we have in previous generations. I would remind you of is that that doesn't necessarily happen right away. We'll introduce a next-generation product, and then over the lifetime of that product, we'll continue to reduce cost. It's throughout the lifetime of that product that you'll see the increase in gross margin.
Okay. That's helpful. I know you're only giving official third-quarter guidance, but how should we think about the fourth quarter and into next year? Are we going to see those inventory rationalizations start to turn around, or how should we think about that?
The inventory rationalizations that we're seeing this quarter are unique and we believe will be contained to this quarter. At the same time, we'll be introducing our fourth-generation product, and that transition will take a couple of quarters. We definitely think that the rationalization that we're talking about now is limited to Q3. We expect to continue growth both in 2013 as well as 2014.
All right. That's very helpful. Thanks, guys.
Okay. Thank you. Our next question is from Colin Rusch from Northland Capital. Colin, please go ahead.
Hey, guys. You've talked about basically a four-quarter ramp for the Gen 4 product. You could talk about why you think this channel clearing is only going to take a quarter to work its way through, and why it wouldn't be an overhang over multiple quarters?
The bulk of it will happen upfront. For obvious reasons, as we introduce a new product, people are going to want to make way for it. At the same time, we have to remember that the M215 will continue to be sold for many quarters from now, and the transition as we move to a higher and higher concentration of the M250s will result in a lower concentration of the M215s. The effect of the dwindling M215s over time will be less pronounced. I think what you're going to see is a bulk of the effect coming upfront, maybe not all of it in Q3, but a good chunk of it, and then it dwindling off rapidly after that.
Okay. Can you talk about the magnitude of the impact on 3Q? Are we thinking about something as much as 20% or 30% of revenue would be impacted by this channel clearing?
It's hard to quantify exactly. What I'd say is that the rationalization is probably in the neighborhood of a couple of weeks.
Okay. Then the last one is just on the cost structure. You guys have done a very nice job of leaning up the overhead. Is there more to do on the R&D side or on the G&A side, or should we expect to see those things kind of flatten out or start to grow going forward?
We feel that we've made multiple investments early on. This is going back to 2011 and 2012, even early in 2013. We feel comfortable with where we are today. I don't see necessarily a significant reduction in those expenses. We're still investing in R&D. We do have our 5th-generation product that's well underway in development. In fact, it's up and running in the lab. We're continuing to invest in products and technologies and services to keep us well ahead of the competition. Even if there is a modest increase, it'll be commensurate with sales. I don't expect to see any spike up or down.
Perfect. Thanks a lot.
Thank you.
Just to remind everyone, if you would like to ask a question, to press the star followed with the one key. We'll take our next question from Edwin Mok from Needham & Company. Edwin, please go ahead.
Hey, thanks for taking my question. I guess, just coming back to the channel inventory. Anything specific to, like, any specific distributor or any regional that you might see more of that inventory work down, or is it more across the board, across the States here?
In general, it was across the board. It definitely is contained to the U.S. This is definitely a North American challenge, nothing more specific than that.
Okay. That's helpful. You mentioned that part of it was due to kind of ramp down this fifth-generation inverter. Any way you can kind of quantify how much of your channel inventory is currently fifth-generation, and how much do you think that would change by, let's say, end of this quarter?
It would be very difficult to quantify or sort of break out the effects of both the ramp down on the 215 as well as the rationalization of the channel itself. What I will say is that I think what we're seeing this quarter is really the confluence of both of those events. A combination of the channel wanting to engage in perhaps more effective cash management, coupled with the fact that they have an opportunity to leverage the fact that we're transitioning to the M250, they're going to want to be very careful on the volume of M215s that they hold. That combination, I think, is what you're seeing this quarter, breaking them out would be a little bit difficult.
Okay. That's fair. One question I have on international. You mentioned U.K. as you highlighted U.K. as one of the markets that is strong. I understand that market actually has a pretty I think some of your competitors already sell into that market. Did that actually help you penetrate that market faster because customers are already kind of used to seeing microinverter or even DC optimizer solution? Do you see that other markets that already have microinverter or DC optimizer as potential markets that can grow faster in the near term?
Let's talk about U.K. specifically. While there were an entrant or two, their market penetration was really so low as to not have much of an effect for us. Unfortunately, it wasn't as if the microinverter concept had been well understood and widely used. Our competition continues to be the central and string inverters. Today, that's who we spend most of our time competing with in the U.K. As we mentioned, we're making tremendous progress in there. There are very few countries that have any real experience with a microinverter. The more countries we enter and the more experience we get, we recognize that we are not just introducing Enphase, but we are also introducing the concept of microinverters across the world. This is both good and bad, but I would say on balance, it's definitely more good.
We're able to communicate our vision, the value, and the benefits of the Enphase microinverter. They're able to start off with the highest reliability microinverter in the world, which we think all in all benefits Enphase and the industry.
Okay, great. One last question. Can you remind us what would be your break-even revenue, what level and what kind of margin are you targeting based on that?
We have a break-even model with $80 million of quarterly revenue and 30% gross margin and 30% OPEX that makes it break even. Keep in mind that 30% OPEX on $80 million is $24 million of OPEX. Currently, we are tracking well below that $24 million. Last quarter was $20.4 million, we intend to keep that as flat as possible.
Great. That's all I have. Thank you.
Thank you.
Thank you. We'll take our next question from Colin Rusch from Northland Capital. Please go ahead. Colin, you may want to check your mute button. We'll go into our next question for Philip Shen from Roth Capital Partners. Philip, please go ahead. Colin, your line is open as well. Would you check your mute button?
Hey, this is Phil. Can you hear me?
Yes, we can, Phil.
Okay, great. In your prepared remarks, you discussed the number of international markets. Can you give us a sense for what your megawatt or market share targets might be in Australia and the U.K., and perhaps over what time frame?
The way I would characterize that is to say that both the U.K. and Australia are viewed as core markets for us, and a core market by definition means that our goal is to be number one or number two in that space. We have lofty goals in those areas, but based on the traction that we've had and the reception that we're receiving, we feel very confident that we can achieve those goals.
Okay. In terms of the time frame, any thoughts on that at all?
Nothing that's specific enough to be able to share. What we have learned in the process of globalization is that it does take time to set up shop, to get all the logistics prepared, and then to educate and train the installers as we did in the U.S. The good news for us is that we have a blueprint for success. We know what it takes, and we're able to duplicate that in various international markets, it's something that's really measured in quarters or years. It's not something that happens necessarily overnight.
Okay, great. I know you talked about the phase-in of the 250 taking 4 quarters or so. Can you talk about your expectations of product mix between the M215 and M250 over these coming 4 quarters?
I would look at it as a sliding scale, that initially you're going to see more M215s than M250 as we ramp up on the M250, that balance will shift over 4 quarters to be more 250 than 215. Clearly, the 250 has a lot of advantages in that it's able to support higher power modules. It has higher efficiency, it has integrated ground. These are all tremendous attributes. At the same time, there are modules out there, lower power modules, for which the M215 may be more appropriate from a power perspective. We're going to see a continuation of the M215 for a while and the market migration away from the M215 to the M250 as we see more and more predominance of higher power modules.
Okay. Thanks, Paul. One last one, I'll jump back in queue. Perhaps you can talk in general about how the reception of the M250 has been among customers. Have there been any challenges at all or any hiccups at all? If not, perhaps you can just talk about the overall reception.
Sure. The reception has been extremely strong. In fact, today, demand outstrips supply. We are sold out of everything we can make. As we introduce a new product, we like to ramp manufacturing in a very steady manner to maintain the quality and the processes that we feel are necessary for the reliability of the unit. As a result, we are limited in supply initially. Basically, everything we can make right now we are selling, and the response has been tremendous.
Great. Thanks again, Paul.
Thank you.
Okay, I'm showing no further questions in the queue. I'd like to turn it back to your host for any concluding remarks.
Thank you, thanks for joining us for today's call and your interest in Enphase. Our second quarter was one of significant achievement as demonstrated by our results. We're very pleased with our ability to execute well on our strategy, progress on many of our key initiatives, and solidify our position as the industry leader in our market segment. Of course, none of this could have been accomplished without the collective efforts of the entire Enphase team, who are doing a fantastic job. We look forward to speaking with you again next quarter.
Okay, ladies and gentlemen, this does conclude our conference. You may now disconnect.