Ladies and gentlemen, thank you for standing by, and welcome to the Enphase Energy's third quarter 2019 financial results conference call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Christina Carrabino. Thank you. Please go ahead, ma'am.
Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's third quarter 2019 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer, Eric Branderiz, Chief Financial Officer, and Raghu Belur, Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September 30, 2019. During this conference call, Enphase management will make forward-looking statements, including but not limited to statements related to Enphase Energy's financial performance and the capabilities and performance of its technology and products, operations including service and capacity, and current and future market and customer demands and trends for its services and products. These forward-looking statements involve significant risks and uncertainties, and Enphase Energy's actual results and the timing of events could differ materially from these expectations.
For a more complete discussion of the risks and uncertainties, please see the company's annual report on Form 10-K for the year ended December 31st, 2018, which is on file with the SEC, and the quarterly report on Form 10-Q for the quarter ended September 30th, 2019, which will be filed with the SEC in the fourth quarter of 2019. Enphase Energy cautions you not to place any undue reliance on forward-looking statements and undertakes no duty or obligation to update any forward-looking statements as a result of new information, future events, or changes in its expectations. Also, please note that financial measures used on this call are expressed on a non-GAAP basis, unless otherwise noted, and have been adjusted to exclude certain charges.
The company has provided a reconciliation of these non-GAAP financial measures to GAAP financial measures in its earnings release posted today, which can also be found in the investor relations section of its website. Now I'd like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy. Badri?
Good afternoon, and thanks for joining us today to discuss our third quarter 2019 financial results. We had another very good quarter. We reported revenue of $180.1 million, up 34% from the second quarter and up 131% year-on-year. Demand was strong as our customers continued to appreciate our differentiated products, services, and quality. We stabilized our component supply in the third quarter and shipped approximately 1.8 million microinverters. I will talk in detail about our supply later in the call. Our non-GAAP gross margin in the third quarter was 36.2%, and our non-GAAP operating income was $40.2 million. Our gross margin was negatively impacted by approximately 220 basis points due to expedite fees related to component shortages.
We expect this expedite fee to decrease to within a normal range of 0 to 100 basis points in 2020. I hope to stop talking about them going forward. Let me provide some additional color on our gross margins. I often get the question on how high our gross margin can go and how sustainable that would be. The answer is that we are always working on improving our gross margin as it is embedded in our DNA. We see opportunities to increase our gross margin through multiple efforts: optimizing pricing, introducing differentiated products like Ensemble, eliminating expedite fees, addressing tariff costs, optimizing supply chain, and implementing engineering cost reductions through ASIC integration. Let's now talk about cash. We exited the third quarter with a cash balance of $203 million and generated $5 million of cash flow from operations.
We increased inventory on hand in Q3 to better service our customers. We expect to end Q4 2019 with a significantly higher cash balance due to prepayments for the ITC safe harbor product shipments we will make in Q1 2020. We also exited Q3 at approximately 36%, 14%, and 22%. What this means is 36% gross margin, 14% operating expenses, 22% operating income, all as a percentage of revenue on a non-GAAP basis. Eric will go into greater detail about our financial results later in the call. Let's now talk about ease of doing business, on how customers perceive us. Our Q3 Net Promoter Score was 54% in North America, compared to 53% in Q2. Our call wait times are approximately two minutes on average, and we are working to get them to less than a minute by the end of Q4.
We are pleased to announce that as of today, more than 6,300 homeowners in North America have joined our Enphase upgrade program. This program is for approximately 30,000 early adopters of our legacy microinverters. That reflects our commitment to quality and customer service. Our homeowner NPS for this legacy product upgrade program was 64% in Q3 of 2019. Let's cover tariffs. As previously stated, we shared the cost increases due to tariffs with our customers. We expanded our manufacturing with Flex in Mexico to help mitigate the Section 301 tariffs, increase global capacity, as well as improve delivery. We started shipping our IQ 7 family of microinverters from the Flex Mexico factory in late Q2 and increased shipments in Q3. We manufactured approximately 137,000 microinverters in Q3, a little short of the planned 200,000 that I mentioned on the last earnings call.
However, our teething troubles are over, and the team is making great progress towards shipping approximately half a million microinverters in Q4. In fact, our weekly run rate right now is 35,000 units a week. Our plan is to service a significant portion of the North American business from Mexico by Q1 of 2020. Let's now discuss our capacity in detail. In the past few quarters, we talked about component shortages, which were mainly on the 600-volt power transistors. As a result of our agreements with Infineon and a few other suppliers, we have now stabilized our component supply. In addition, with Mexico coming online, we have capacity in place for 2.5 million microinverters in Q4. Consistent with our revenue guidance, we expect to ship between 2.1 and 2.2 million microinverters to our customers in Q4. This represents roughly a 15% buffer between demand and supply.
We have instituted a six-quarter forecasting process at Enphase, where we review our unconstrained demand on a monthly basis and ensure there is enough surge capacity available in order to service customers well. Moving on to the regions. Our U.S. and international mix for Q3 was 84% and 16%, respectively, compared to 74% and 26% in Q2. Our third quarter revenue in the U.S. was up 51% sequentially and up 175% year-on-year due to strong demand from new and existing customers. As we have stated over the last year, our channel inventory has been tight, and for the first time this year, our supply was enough to accommodate customer demand. In Europe, our third quarter revenue was down 21% sequentially and up 47% year-on-year.
After a strong Q2, in which our channel inventory returned to normalized levels, our Q3 revenue in Europe was in line with our sales run rate. Netherlands and France remain strong markets for us. However, we are not satisfied with the progress we are making in rest of Europe. Our executive team was in Brussels during the third quarter and identified many strategic initiatives for growth in the rest of Europe, including bolstering our sales force immediately. Our growth in Europe will be a major focus area for me personally in 2020. The opportunities are great. The market is a growing market, and we have a very strong product market fit. We simply need to execute better. In APAC, our third quarter revenue was down 16% sequentially and down 22% year-on-year. During the quarter, our executive team also reviewed the strategic plan for our Australian business.
We are beginning to execute well on that plan by hiring top-notch sales managers, calling on the long tail of installers, and selling our value proposition of safe AC on roof, high quality, and superior customer experience. I'm confident that this region is going to bounce back as we transition into 2020. In Latin America, our third quarter revenue was up 50% sequentially and up 47% year-over-year. We are excited about the growth opportunities in Latin America and are targeting more areas within Mexico and other LatAm countries. We continue to work with some of our customers in North America on their ITC Safe Harbor demand. We plan to ship approximately $35 million of product for ITC Safe Harbor to a new customer in Q4. In addition, we expect Q1 to be an equally significant quarter for Safe Harbor. Let's now cover new products.
We are pleased to announce the general availability of our latest product called IQ 7A, a high-power microinverter targeted for modules up to 450 W DC. Installers will be able to pair the IQ 7A microinverter with monofacial or bifacial modules. Let's come to AC modules. We continued to make steady progress with our AC module partners during Q3, including SunPower, Panasonic, and Solaria, to mention a few. Enphase Energized ACM from our module partners have now been adopted by more than 600 installers in the U.S. as of this date. I'd now like to talk about Ensemble. First, the off-grid product, and then the storage product for North America. Let's come to the off-grid product. We expect to ship several thousand units of the off-grid product, we call that as IQ8, to our partners in Q4.
We plan to deliver the final requirements shortly to our partner in order to enable their ramp. Let's now talk about Ensemble 1.0, which is focused on enabling high-capacity storage for North America. Storage is enabled by our Encharge battery, which is a modular 3.3 kilowatt hour solution. The modularity allows for ease of installation, flexibility, and scalability while helping to streamline our supply chain. The Encharge battery will be available in two variants, 3.3 kilowatt hour and 10 kilowatt hour. The 3.3 kilowatt hour battery contains four IQ8 grid-agnostic microinverters internally. As you're all aware, there have been fires in Sonoma County in the last few days. Many of the employees in Petaluma, as well as their families, are affected and have been evacuated. Our thoughts are with those whose lives have been impacted.
As a side effect from these fires, many of us, including me, have lost power for an extended period of time. The unfortunate reality is that homeowners are not prepared for these blackouts. Encharge, powered by Ensemble Technology, will be an ideal product to address blackouts and keep our homes always on. What do I mean by always on? Ensemble is a technology that brings together solar, storage, grid, and even a generator onto a single energy management platform to keep the home always on. This technology optimizes the usage of these resources under all conditions. For example, when the grid is down, Ensemble can balance the usage of solar, storage, and the generator to keep the lights on. When the grid is up, it can make an economic decision regarding the source of energy. Today, we release some installer-specific content for Ensemble on our website.
At the recent SPI conference in Utah, we held several installer roundtables with a total of approximately 50 installers. The feedback from the installers was to provide enough information on our website a little bit earlier to make it easier for them to pre-sell Encharge, and we did exactly that. We are in the process of installing Ensemble 1.0 alpha systems at a few Enphase sites, as well as a few employees' homes. When we complete comprehensive software testing on these alpha systems, we plan to take pre-orders in December through our distribution partners. We expect production shipments in the first quarter of 2020 after completing real-world beta installations with nearly 20 installers. After the release of the storage product, we expect further revisions of Ensemble to be released in 2020 with a focus on IQ 8-PV or IQ8 solar installation.
The advantage of IQ8 on the roof will be that these grid-forming microinverters will produce power from panels even during blackouts, as long as the sun is still shining. It addresses a major pain point without the need for storage and is completely differentiated in that respect. In summary, we are pleased with our overall progress we have made this year. Our base microinverter business continues to grow and is pretty healthy. Our component supply has stabilized. We are excited about our upcoming storage product and remain focused on delivering Encharge to the market. I would like to make one more important announcement. We will be hosting an analyst day during the second week of December to provide deeper updates on strategic initiatives, our financial model, as well as new products. More details on our analyst day will follow over the next few weeks.
With that, I will turn the call over to Eric for the review of our financial results. Eric?
Thanks, Badri. I will provide more details related to our third quarter of 2019 financial results, as well as our 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. 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 investor relations section of our website. Total revenue for the third quarter of 2019 was $180.1 million, including approximately $8 million of Safe Harbor revenue. Total revenue for the third quarter of 2019 increased 34% sequentially and increased 131% year-over-year. We shipped approximately 584 megawatts DC in the third quarter of 2019, an increase in megawatts DC of 40% sequentially and an increase of 186% from the year-ago quarter.
The megawatts shipped represented approximately 1.8 million microinverters, approximately 99% of which was IQ7. Non-GAAP gross margin for the third quarter of 2019 was 36.2%, compared to 34.1% for the second quarter of 2019. Component shortages negatively impacted our Q3 2019 non-GAAP gross margin by approximately 220 basis points. Non-GAAP operating expenses were $25 million for the third quarter of 2019, compared to $22.5 million for the second quarter of 2019, and $18.6 million for the third quarter of 2018. GAAP operating expenses were $31 million for the third quarter of 2019, compared to $27.9 million for the second quarter of 2019 and $25.6 million for the third quarter of 2018.
GAAP operating expenses for the third quarter of 2019 included $4.9 million of stock-based compensation expenses, $546,000 of amortization expenses for acquiring tangible assets, and $469,000 of restructuring expense. On a non-GAAP basis, income from operations was $40.2 million for the third quarter of 2019, compared to $23.2 million for the second quarter of 2019, and $7 million for the year ago quarter. This increase in operating income is reflective of our continued improvement in operational excellence and product leadership. On a GAAP basis, income from operations was $33.7 million for the third quarter of 2019. On a non-GAAP basis, net income for the third quarter of 2019 was $39.5 million, compared to $23.2 million for the second quarter of 2019, and $4.6 million for the year ago quarter.
This resulted in basic earnings per share of $0.32 and diluted earnings per share of $0.30 for the third quarter of 2019, compared to basic earnings per share of $0.20 and diluted earnings per share of $0.18 for the second quarter of 2019. GAAP net income for the third quarter of 2019 was $31.1 million, compared to $10.6 million for the second quarter of 2019, and a loss of $3.5 million for the third quarter of 2018. This resulted in basic earnings per share of $0.25, and diluted earnings per share of $0.23 for the third quarter of 2019, compared to basic earnings per share of $0.09 and diluted earnings per share of $0.08 for the second quarter of 2019. We are happy to report that we achieved the important financial milestone of four consecutive quarters of cash generation and GAAP profitability.
As we continue to maintain profitability, there is a reasonable possibility that we may release our valuation allowance against the deferred tax asset in the near future as disclosed in our 10-Q. Now turning to the balance sheet. Inventory was $30.2 million at the end of Q3 2019, compared to $20.1 million at the end of Q2 2019, and $17.9 million at the end of Q3 2018. We ended at 24 days of inventory on hand as of September 30, 2019, significantly below our internal target of 30 days, up from 21 days in the second quarter, and down from 31 days in the year-ago quarter. The increase in days of inventory on hand as of September 30th, 2019, was intended to improve shipping linearity to our customers and better serve increasing demand. Inventory management continues to remain one of our key cash management initiatives.
We exited the third quarter of 2019 with a total cash balance of $203 million compared to $206 million for the second quarter of 2019. We generated $5 million in cash flow from operations and $769,000 in adjusted free cash flow for the third quarter of 2019. Capital expenditure was $4.2 million for Q3 2019, mainly to ramp up our supply capacity in Mexico and China. As Badri mentioned, we expect to end Q4 2019 with a significantly higher cash balance due to prepayments for the ITC safe harbor product shipment in Q1 2020. Let's discuss our outlook for the fourth quarter of 2019. We expect our revenue for the fourth quarter of 2019 to be within a range of $200 million-$210 million, including approximately $35 million of shipments for ITC safe harbor to a new customer.
Turning to margins, we expect GAAP and non-GAAP gross margin to be within a range of 34%-37%. We expect our GAAP operating expenses to be within a range of $31.5 million-$33.5 million, including a total of approximately $7 million estimated for stock-based compensation expenses for structuring and acquisition-related amortization. We expect non-GAAP operating expenses to be within a range of $24.5 million-$26.5 million. With that, I will now open the line for questions.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question is from Philip Shen from Roth Capital Partners. Your line is now open.
Hi, everyone. Thanks for the questions. In terms of your guidance for Q4 in the $35 million safe harbor for a single customer, to what degree did you prioritize the need of a single customer? Had you not served that customer, how much volume do you think you could have sold into the broader U.S. market?
Well, we gave you a clear view on our capacity. Basically, in Q4 of 2019, which is this quarter, we have a capacity of 2.5 million microinverters. Our guidance reflects basically shipments of 2.1 million-2.2 million microinverters. Our capacity problems are over, and we are basically back to a demand-limited environment.
Great. Badri, I think you mentioned for Q1, you expect a similar level of safe harbor, is that correct?
That's exactly right.
Okay. Is it for the same customer, or do you expect it to be for other customers as well?
At this time, I am unable to provide you that color. All I know is that it'll be the same. It'll be the equivalent amount.
Got it. Great. Then, as it relates to storage, I know you gave us a ramp there. Can you comment on when you expect to see the storage product really hitting meaningful volumes?
Look, like what I said, we released our website this afternoon. That is going to give installers a lot of installer-specific information to help them pre-sell the product. We plan to take pre-orders in December once we have basically installed it at few of our homes, which is myself, Eric, Raghu. Our systems are functioning well, and we personally ensure that it is high quality. We will begin taking pre-orders. We will start shipping production in the first quarter of 2020, and we are going to be prepared for a good ramp. You know that ramps are often difficult. Ramps are often uncertain, very difficult to predict. I would say, by the second half, we should have ramped fully. Q2, I would expect to be reasonably significant as well.
Okay, great. One last one from me. Can you talk about the visibility you have into Q1? I know you don't have guidance officially, but can you comment on the seasonality that you might expect to see in Q1 and what the overall direction of Q1 could be relative to Q4?
It's too early to give you specific numbers and guidance, but we expect to see the typical seasonality associated with the industry in Q1.
Okay, great. Thanks, Badri. I'll pass it on.
Thank you. Our next question is from Brad Meikle from Williams Trading. Your line is now open.
Hi. Thanks for the question. As you're well aware, we've been without power in Northern California for the last five days, 2.5 million households. I think if you guys did 100,000 homes, that would be $1 billion in revenues. Could you speak to how much you will or will not be capacity constrained in terms of being able to ramp your battery shipments? I think you had a couple sources on the cell supply, right? Thank you.
Right.
I certainly follow up.
Right. The question is on the capacity of batteries and will we be able to handle the ramp, considering there's going to be a huge demand here in Northern California. The answer is yes. We have announced partnerships with A123 on the battery supply. That is public. We basically have good capacity with them. We have also signed agreements with one other battery supplier, a Chinese-based battery supplier that we have not announced. However, we are well into the qualification stages with them, and we expect them also to come on in early 2020. Both of them have promised us nice capacity numbers. I think it will be well aligned with our ramp. If we need to bring in a third supplier, we will not hesitate to bring one.
Okay, thanks. The follow-up I had was, there's been a lot of speculation around inventory in the channel and whether you've been stuffing the channel. Can you tell us how many weeks your distributors have, how many weeks your direct customers have, and whether the inventory level has been growing, and whether you feel like you're stuffing the channel? Could you add some color to that, please? Thank you.
Right. Let me give some background there. In the last four quarters, we have been unable to meet our customers' demand. We've been supply limited. Prior to entering every quarter, we were fully booked. There was no question that we were building inventory. We were hand to mouth. We didn't have enough supply. Q3 is the first quarter where supply was able to keep up with demand. Now, let me come to channel management. I have what is called a ship review every week, where we look at the revenue for the corporation. Basically, we have a channel management business process, which means that we look at every distributor. We basically look at what is their sell-through every week. Sell-through is how well that distributor is doing in order to sell to the end customer, which is the installers, the tier 3, tier 4 installers, particularly.
Essentially, we do both the tops-down as well as bottoms-up, which is we do have distribution managers whose job is to watch the inventory. We also have sales people who are called as the tier 3, tier 4 sales folks. All they do is they generate a lot of demand bottoms-up so that the distributors can sell through the product to those installers. We do a combination of both. We have strict limits, which is, if we find that a distributor does not have enough sell-through for a previous week, we have formulas in place where we consciously limit shipment into the channel. It is no longer an art, it is a science, and it is not yet run by a computer. It will soon be run by a computer. Our channel management is well under control.
How many weeks on average, can you say?
Huh?
Can you say how many weeks on average? Thank you.
Historically, we have not talked about the weeks of inventory. We do not talk about the weeks of inventory. However, I'll tell you a good best practice that we've talked about in the past, is to have eight to 10 weeks of inventory in the channel. That's the guideline I can give you, Brad.
Thank you very much. Great job on the quarter.
Thank you.
Thank you. Our next question is from Mark Strouse from JPMorgan. Your line is now open.
Yeah, good afternoon. Thank you very much for taking our questions. Just curious if you can comment on any changes you've observed in the competitive environment, if any, either from anything that you saw at SPI or any conversations that you've had with your distributors or installers over the last quarter?
Yes. There have been several competitors that emerged with SPI announcements. We are closely watching everyone. Our strategy is the same. While we continue to watch competition, what we do is focus on the value we can provide. I've always told you, and I'm like a broken record here. Basically, we have three things: product innovation, quality, and customer experience. When it comes to product innovation, let's start with IQ 7. We introduced IQ 7 in Q1 of 2018. IQ 7 was a software-defined architecture. Even though it was a software-defined architecture, we still have come with generations of IQ 7, IQ 7+, IQ 7X, IQ 7A, progressively increasing power with the same base platform. Soon we will introduce an even more higher-powered version, very soon in the coming months.
With the same platform, we were able to leverage the hardware to basically increase the AC power, and increasing AC power is important. The more AC power the product has, the more gross margin I make. It's extremely important there. Having talked about IQ 7, the biggest deal is Ensemble. What is the fundamental point of Ensemble? It is that Ensemble is a unique kind of product. Ensemble can function, meaning microinverters based on Ensemble technology called IQ 8, can function on the roof when the grid is down, when the sun is shining. I have not seen such an elegant product available yet in the research that I have done. We are unique and differentiated in that respect. The second is Ensemble, more than the microinverter, is a technology. It's an energy management technology.
Energy management technology that manages, like what I said, it manages solar, it manages storage, it can even manage the generators, and can manage the grid. If you start progressing, if I don't have anything except the grid, it is very easy. The consumption equals the grid. If I have solar, then I have solar and the grid to optimize consumption. It gets starting to get a little complex. If I have storage, I have now solar, storage, and the grid. If I have a generator, I have solar, storage, a generator or a fuel cell, and the grid to optimize consumption. Ensemble technology can exactly do that. It can keep you always on, regardless of what is happening right now. I just wish our product were a little bit earlier, but regardless of the grid.
If the energy sources are managed right, people can have their homes always on during these blackouts. That's what we are all about. Bottom line, focus on product innovation. Of course, product innovation is not enough. We need the quality. 500 DPPM is our target, which is of 1 million microinverters shipped annually, 500 come back to us. That's called 500 DPPM, which is 500 defective parts per million. That is not easy to do. This is with very tight business processes, root cause corrective action methodologies, ASIC integration, over-the-air firmware upgrade. All of these are required in order to achieve this kind of quality level. Of course, customer experience. Next is customer experience. Customer experience is, we pride on ourselves being able to answer the phone in two minutes or less, and I'm not satisfied with that.
How about we answer the phone when it rings? That's what I tell my team. Which is get down even further. Our goal is to get out of Q4 with sub one minute of wait times, then eventually get to pick up the call when it rings. Product innovation, quality, customer experience, these are our differentiating aspects. We focus on that all the time. I hope I answered your question a little bit there.
Yeah. That's very helpful, Badri. Thank you very much. Then just lastly, if I look at the guidance for 4Q and strip out the $35 million or so for safe harboring, and strip out the $8 million from this quarter, it kind of suggests relatively flattish revenue quarter-over-quarter. Can you just go back to your commentary you provided earlier, kind of by geography, and if you had to boil down that flattish revenue quarter-over-quarter to any particular geography or product, is there a way to do that, or is that not a really fair way of looking at the revenue?
Well, your observations are right. On the base business, there are a lot of puts and takes in the base business. Realize one thing, that we have basically been supply limited for the last four quarters. We have never been able to catch up on the demand. This is the first quarter we actually caught up on the demand. Having said that, to answer your question, I already told you, Europe, I'm not happy with Europe. The performance of Europe is not that great. Although we have improved a lot compared to last year. We said 47%, if I'm right. 47% year-on-year. I'm not happy with the progress we are making in the rest of Europe. Netherlands is a very nice market for us. Netherlands is the biggest growing market in Europe. We are doing well there.
France, we have majority of share in France. France is also growing. We are still yet to make progress in Germany. We are yet to make progress in Belgium. Our market share in Belgium is quite low. We look forward to making progress in other Eastern European countries, Poland, Hungary, those places. Yes, we have work to do.
Very helpful. Thank you very much.
Thank you. Our next question is from Eric Stine from Craig-Hallum. Your line is now open.
Hi, everyone. Just want to come back to storage a little bit. Sounds like you won't be capacity constrained, and I know it's still early. You're just out with the early units and running those. Based on conversations with the channel, any thoughts on where you think attach rates could be? Whether it's early or whether it's when things are really rolling as you get into 2020.
Our suppliers as well as our competitors have kind of provided an attach rate already. Basically, Sunrun talks about 25% attach rates in California, and we expect that to be true. We also expect the blackouts to be accelerating that. Also for us, it's not only that. In addition, we have an install base. If you look at our install base, as of today, our install base is over 1 million homes.
Of over 1 million homes, maybe 70% is in North America. These are all loyal Enphase customers. They've been waiting for some time for Ensemble Storage. There's going to be a lot of demand from there, too, in addition to the demand generated from blackouts. Of course, California has got a nice attach. Hawaii has got a nice attach. Other countries are coming. Puerto Rico has got a nice attach. Texas is going to come soon. Massachusetts is going to come soon. We are going to start seeing adoption.
Okay. Just when talking about that installed base, the majority of that installed base is the IQ platform. Is that right? That is what would be required for those homeowners to use storage.
Right. Yes is the answer. A significant portion is the IQ platform, not the majority. We do have our M215 and M250 products.
Okay.
The customers are quite clear there that they basically actually want to upgrade to the latest and greatest technology. A technology that gives them superior power production technology. It is comparable to Ensemble. Enphase will be a one-stop shop for solar storage communication. Yeah.
Okay. Maybe last one for me, just the recent announcement, the IQ 7A launch. It seems to me like that's kind of an entry into the C&I market. Just curious, should we view it that way? Is that something that's just based on your installers and what parts of the market they go after? Any thoughts on that would be helpful.
Yeah, go ahead, [Janakiram].
Yeah. To begin with, the IQ 7A was really being targeted for the residential market as the power continues to increase. However, I'm sure some of our market, some of our installers will be opportunistically looking at using the IQ 7A on the C&I business as well. Having said that, we really target it towards the residential. That's what we see the demand.
Okay, thanks.
Thank you.
Thank you. Our next question is from Jeff Osborne from Cowen and Company. Your line is now open.
Hey, good afternoon. I just wanted to circle back to Mark's question about the flattish revenue and asking it a different way. As you look at your 6-quarter pipeline that you highlighted for your forecasting methodology, can you just give us a sense of the 2.5 million units of capacity, where you think that'll be exiting next year? Clearly, you had the surge of 4 quarters where you were capacity constrained. Now you've been able to catch up, which is great, and customers will be more satisfied with that. I'm just trying to get a sense of, as you have the Safe Harbor surge in Q1, do you become safe capacity constrained? How do we think about the timeline or process for you to add more capacity, whether it's in Mexico or China?
Right. As an executive team, we decided that we will never be constrained by capacity. That's basically our thinking. We look at our unconstrained demand on a 6-quarter basis, and then we have enough, meaning plenty of surge capacity, almost 35%, 40% of surge capacity that is available so that we can meet abnormally or demand spikes that happen. Having said that, yes, you can say that in Q4, the base business, if you exclude Safe Harbor, Q4 and Q3 are flat. Note that the Safe Harbor business came from a brand new customer that was not there before, that's a big deal. Also, going forward, we expect Ensemble, once it kicks in Q1 of 2020, that to drive major customer adoption. That's what we are all about. We are getting prepared for Ensemble.
Your question on can we add more capacity, for example, if I find I need to go to 4 million units in Q4 of 2020, and if my six-quarter forecast shows I need that, it will not be a problem for us to do that. It will take us anywhere from three to six months, in order to build that kind of capacity.
In the meantime, if I'm hearing you right, Badri, that you could do easily 3 million, paying overtime at Flex, if there was a surge next summer, even though you have a nameplate of 2.5. Is that the right way to think about it?
Right. As of today, like what I said, clearly our capacity is 2.5 million units. I told you 2 million units a couple of quarters back. Now we have increased it to 2.5. We increased it because we are hovering around that for demand, I talked about a buffer. Obviously, we are not going to do capacity changes in a vacuum. It will always be predicated by demand, which is why we have forecasting process. If the forecasting process tells me that my demand is going to be 3 million units, it's got to be no problem for me to get to that.
Got it. Good to hear. I just had two financial questions for Eric. One is, you made reference to the valuation allowance possibly being reversed. Given you called it out, I would assume that that happens at some point. Can you just remind us of how we should be thinking about tax rate modeling and the financial impact of that reversal?
We will provide more clarity on that one as part of the Analyst Day. The reversal can be as early as Q4. That will be likely we're going to put as a GAAP-only treatment because it's a big, large release of the allowance, which will be a big credit on the balance in the P&L. In terms of tax rate, I will use for now the corporate tax rate. Remember, we have NOLs on the books. You can probably back into numbers that way until we provide more guidance in Analyst Day.
Got it. The last question I had was just as you look at the guidance of 34%-37%, can you just talk about, given the visibility you have, what would get you to the low end of that range versus the high end of the range?
Historically, we have given a three percentage point range. In general, we give ourselves a lot of room for any execution issues that happen in the quarter, et cetera. It's basically short-term fluctuations. What's more exciting is the long-term view of gross margin. Everybody keeps asking me, "Is 35% it?" The answer is no. The 35% is not it. We have a lot of opportunities for us to improve gross margin. That's what we do. Every week, we run a world-class cost meeting where the focus is on improving costs of our system. System cost, not microinverter only. Microinverters, cable, batteries, accessories, combiners, everything. We also run a pricing meeting. There, again, the focus is on pricing optimization.
Multiple initiatives, optimizing pricing, like what I said, introducing products like Ensemble and IQ 7A, eliminating expedite fees as a component supply situation stabilizes, addressing tariff costs, doing cost reductions through ASIC integration. These are all something we are continuously doing. That's why you're seeing the gross margin execution over the last year. We have steadily been climbing on gross margins.
That certainly has been impressive. Thanks for all the detail. I appreciate it.
Yeah.
Thank you. Our next question is from Colin Rusch from Oppenheimer. Your line is now open.
Thanks so much. With the Ensemble technology development and kind of the preparedness to ramp that here, we knew that the firmware was one of the last remaining pieces that you guys were working on. Can you talk about where you're at in that development? Then as you think about the updates as you go through testing next year, can you talk about your expected cadence for improvements as you go throughout the year?
Right. I'll talk about something I've not talked about before. There are multiple levels of testing that we do. One is called the unit testing on all the boards that we use inside products like Encharge, Enpower, the combiner box, et cetera. That's called a unit testing. The other is called as product testing, which is product testing means I test the battery using a certain stimulus, and that's called as product testing. If I need to test the battery properly, I need to make sure the battery management unit, the cells themselves, the micro-inverters, the battery controller, all of them are working together and responding right to stimulus, to external stimulus. We covered unit testing, we covered product testing. The third, which is the most important, is actually system testing. What do I mean by a system?
A system is how you or me would use it in the house, which means I need to have a solar simulator for solar. I need to have the battery. I need to have my Enpower switch. I need to have the grid, and I need to have my communication equipment and the cloud. All of them will have to be real-life. They have to be like how you are living in your home with your normal loads being consumed. We have to simulate with all kinds of loads. We have to do grid-on, grid-off simulation. We have graduated from component testing, which is what I said, that's the first basic testing, to product testing. Now we are doing system testing. System testing means we install the unit, like what I said, it could be my house, it could be Raghu's house, Eric's house.
In fact, they already have their system installed right now. We need to beat on them to make sure all the use cases are covered. In all of these, what is unique about Ensemble is that the hardware is done, which is the hardware that makes you grid agnostic. That is done. The software that helps you manage all of these resources, which I told you about, solar, storage, grid, even a generator, and the loads. That need to be working well in real life. Which is why once we finish our alpha installations, which will be primarily focused on the system software testing. Once we do that properly, we will then start taking pre-orders, because our confidence moves from 85% to 95% at that point. Then we basically start to ship that product after we finish real-life installation.
We already have about 24 installers who are ambassadors for us. They already have signed up to receive beta installations from us. We will be doing these betas. These are real products, and we'll be doing so many installs, 24 installs. We will be getting feedback from all of them. We will determine if we have to course-correct or not, and maybe there are minor course corrections we will do, and then we will release the product to production. It's all coming together right now. I'm just giving you the full picture so you guys know exactly the same thing as me.
Of course, we will never release something which does not have the quality and customer experience, which means if you have an Ensemble system at home, you should be able to, or we should be able to upgrade you to the latest software in the event we have to make changes. That's called over-the-air firmware upgrade. Those all need to be working seamlessly. It's basically that is going on right now, but we are confident that by early December, that would be done, and we would start taking pre-orders.
Perfect. Then just in terms of the geographies you mentioned where your sales efforts aren't as productive as you had hoped, can you talk about what the sticking points are? Certainly, getting designed into a base level design for systems ends up being very important for folks. What are the challenges? Is it familiarity with the product? Is it that design cycle? Is it just availability of product to those geographies? Help us understand what's going on there.
Colin, it's pretty simple. It's a focus issue. We have not paid attention, and basically, the way we paid attention to North America by staffing with the best-in-class salespeople in North America, we need to do the same thing. Our products are world-class. Our products have a great fit for the market. The market is a growing market. We just need to execute.
Okay. Thanks, guys.
Thank you. Our next question is from Jeffrey Campbell from Tuohy Brothers. Your line is now open.
Congratulations on the quarter, and thanks for taking my call. My first question is with regard to the safe harbor sales that you've identified in the first quarter of 2020. Are they somehow receiving the 30% ITC deduction, or is this activity that's actually pegged to the lower 2020 ITC?
They are going to receive the 30%.
Okay, great. My second question is, back to the IQ 7A. Do you envision this as primarily an ACM solution?
Not really, no. It can cater to both discrete as well as AC modules.
Okay. Excellent. Thank you. That's it from me.
Thank you.
Thank you. Our next question is from Amit Dayal from H.C. Wainwright. Your line is now open.
Thank you for taking my questions. Badri, just with respect to this 1 million install base, how are we reaching out to these folks? What is the plan of attack over here? Has that effort already started, or are you waiting until you complete some of this testing, et cetera?
We'll provide.
Related to the storage uptake. Sorry.
Right. We will provide some more color during the analyst day. Here is the short story. The million homes or 997,000 homes, they all communicate with us through the Enlighten app. That is a mobile app that we have, that is their gateway to providing a view of their power. They already contact Enphase all the time. Both homeowners as well as installers. Having said that, our strategy for Ensemble is making sure that these beta installations are right, we have the right customer experience, and then we can introduce our homeowners to do upgrades online, or introduce them to programs like the legacy product upgrade. Which is a very successful program, where about nearly 30,000 homeowners who bought product 10 years or eight years ago, they want to all replace by IQ cells.
It will be a similar program, but we'll do it only when we are ready, when we are finished the beta installations, and then we will start on those.
Understood. With the Ensemble and IQ 8, et cetera, now coming into play, how should we think about the addressable market for Enphase and your opportunity to take a good share of that market?
Like what I told you. Today, with pure microinverters, we do roughly about $2,000 a home. With batteries, meaning storage, we will do more than $10,000 a home. That means, even if the attach rate is 20%, it is still significant dollars for us. That's the way to think about it.
Yeah.
Still, storage is nascent. There are only a couple of states like California and Hawaii who have really ramped on storage. The value proposition for the other states is not as straightforward as California, for example. There are blackouts, it's simply a peace of mind. That value proposition needs to come through. Basically, storage is going to start becoming mainstream. That's going to happen very soon. Then, with $10,000 a home, we should be getting our fair share of what we get for microinverters today.
Got it. Just one last one from me. Your comments on the expedite fee, given that your capacity and shipments sort of expectations you've laid out. Is this expedite fee gone by 1Q 2020 results?
That's what I said. I said from 2020, I really hope it's going to be gone. I really hope I'm going to be not talking about it. It needs to fall within 0-100 basis points, so that we stop talking about it.
Yes. Thank you. That's all I have. Appreciate it.
Thank you.
Thank you. Our next question is from Maheep Mandloi from Credit Suisse. Your line is now open.
Hi. Maheep Mandloi from Credit Suisse. Thanks for squeezing me in. Most of my questions have been answered. Just maybe if you can touch upon operating expense. It seems more or less flattish in Q4. How should we think about that going forward in 2020, especially as you increase the focus in European markets and expand the Ensemble attachment rates?
Yeah. Our OpEx, if you look at today, what we reported in Q3 is about 14% of sales. Overall OpEx. Our OpEx at the midpoint of guidance for Q4, I think it's around 12.4% or something like that. OpEx is definitely under control, and we plan to keep it in this range. Of course, if we need to keep it in this range, our expectation is that we will continue to grow with the vectors of Ensemble, like what I said. That's it on OpEx. Right.
Got it. Probably one last question from me. You earlier spoke about Ensemble being able to connect with home generators. Is that something which you could look forward to kind of collaborating with any generators out there or have they reached out to you for that?
Yeah. Hi, this is Raghu. We really think about it in a much broader context than any specific type of a generation resource, right? If you think about, we look at solar, we look at storage. We think about generation resources like fuel cell, fossil fuel, DG, et cetera, and even load for that matter, right? Because load's also controllable. It's a very comprehensive, what I call it, a master platform that can bring all of these resources together and manage them in a very seamless manner. We are not fixated on any. Of course, we want to be clean and green, and so our focus on solar and storage is extremely vital. We also manage the grid, as you know.
We have a complete solution, bottom line. If there's a particular resource that wants to come onto the platform via Ensemble, obviously we'll do that, and we'll manage it in a very effective manner in order to ensure that home is always on. Because at the end of the day, that is the most important function that we are providing for the homeowner.
Maheep, I want to make a clarification on OpEx, right? The fact that Raghu mentioned that the midpoint is about 12.4% that we are guiding for Q4, that doesn't mean there will be a new baseline of OpEx for 2020, right? That's a guiding element of particular dynamics in Q4. Think about the investments or R&D that we need to continue making. Think about the growth that we need to experience in Europe and Asia Pacific. We still have our 30-20-10 . Obviously, there is here much better outcomes than the original target setting on the financial model, and we're going to revisit that one as part of the analyst day, right? I just want to make sure we don't model thinking that that is the benchmark, the new benchmark for OpEx, right?
Got it. Thanks for the color, Eric, and I look forward to more details at the analyst day. Yep. Thanks for bringing your questions.
Thank you. Our next question is from Pavel Molchanov. Pardon me. Our next question is from Brad Meikle from Williams Trading. Your line is now open.
Hi, thanks. I had a quick follow-up. I think that the three publicly traded installers are the only ones really safe harboring this year, and two of them are clients, and the largest one historically hasn't been. Are you telling us that the third one has become a client of Enphase?
Brad, I'm not going to talk about it.
Okay. Well, I guess that some may read through to the way you're reporting the safe harbor that the non-safe harbor was flat in Q4. Is it your feeling that the business is still growing or is this a peak revenue quarter for you guys?
Well, it should have been clear from the way I answered, is we are very excited about Ensemble. We are very excited about storage. Storage has got a massive potential for us. It takes us from $2,000 a home to $10,000 a home. The attach rate of storage is only going to increase. California's blackouts is going to accelerate the adoption of storage. We are going to be coming out with the product in Q1 of 2020. We are very excited there, and we are very excited about our growth. We're going to follow up storage immediately with the IQ 8-PV. The IQ 8-PV is going to be, you're going to have IQ8s on the roof, which will produce power when the grid is down, when the sun is still shining. That's a massively differentiated product. Yes, storage is the next leg.
The IQ 8-PV is another leg. We really have a lot of legs for growth.
Yep. Okay, just one last quick one.
Also, Brad, think about Q4.
Yeah.
We monitor the point of sale data out of distribution, the channel very well, right? All the numbers that we've seen is that we are growing, right? The POS data activity is higher, right? That's a key point. One quarter doesn't make a trend, right? Safe Harbor created a lot of interesting dynamics into the quarter as well, right? I just want to point out that this observation about taking a midpoint, carving out a number, and trying to look at the trends with the prior quarter, it may not be as logical as you may probably ultimately think it is, right?
Thanks, Eric. How do you think about gross margins, Eric? If most of your non-SunPower U.S. business in Q1 is out of Mexico, you basically have a 35% reduction in your cost of goods sold on that product. I guess you'll pass some of that through to customers at some point.
Yeah.
It sounds like margins are going higher and, you're already above your.
Okay.
-previously.
Yeah. Badri mentioned how we think about margin very well in the script. You can read the early part of the prepared remarks. We don't see these checkpoints or midpoint numbers as anything more than a new potential target that can make it better as we execute on all the other elements that Badri mentioned. On cost reduction, the way we are managing pricing, the way we are introducing new value differentiated products. In terms of the tariff, 35%, remember, it's 25%. Definitely that is very closely tied to our ability to have adequate supply to fulfill the domestic non-SunPower demand. We're always cautious on how we see that, but we don't see that as a ceiling in any way.
We look at margins as a way of accretion into the future, as long as we can execute and as long as the dynamics of the margin, competitive pricing, our ability to execute, all of those things materialize, right?
Thank you.
Thank you. Our next question is from Pavel Molchanov from Raymond James. Your line is now open.
Thanks for taking the question. Two quick ones, if I may, about the competitive landscape. You touched already on some of the products launched at SPI. Can you comment specifically on LG's announcement of a module product incorporating its own microinverters and whether you guys are still selling your micros to LG directly?
Pavel, we won't comment about any specific competitor like that. I would just want to be very clear about how we think about a very broad differentiation when it comes to our technological Ensemble. That's what we are focused on. For us, it is the entire solution. You have to be a one-stop shop, one warranty. You have to have the most resilient solution that's out in the marketplace. You have to have a scalable solution and a very simple solution, a plug-and-play solution as well. We really think about it, not as a single little widget or a single little device, but the entire solution. I think we are just going in a different direction, bottom line. That's the way to think about it.
Understood. Can you also touch on bifacial tariffs being revived as of last month? Does that have any impact, positive or negative, on your business, particularly vis-a-vis the AC module products?
Yeah. It's actually, in general, when power goes up, it's beneficial for us because we get to leverage the same platform and develop products using the same leverage, the exact same platform, develop higher power products. Higher the power, it's a more differentiated product as well, as you get a family of products that way and we can optimize pricing better. In general, higher power is good, and of course, bifacial is one way to get the higher power. As far as the tariff on bifacials are concerned, it's been in, it's been out, there's been noise around that. We pay attention to it on a peripheral basis, but we are pretty excited about the IQ 7A product, which really targets those higher power modules, and more importantly, it leverages the base IQ7 platform, which is completely software defined.
Got it. Thank you very much, guys.
Thank you.
Thank you. Our next question is from Jeffrey Campbell from Tuohy Brothers. Your line is now open.
Hi. Thanks for taking my follow-up. I just wanted to get a little clarity. The 25% Ensemble attach rate that you referenced for California, is this referencing a go-forward new home solar installations under the California All Solar mandate, or is it something else? I'm asking because we know that SunPower has a high penetration rate of new home solar prior to the mandate.
Right. First of all, let me actually correct it. This is not an Ensemble attach rate. We were referring to what the customers, competitors basically referred to at their earnings call. This is public information. Companies have said that they are seeing an attach rate of 25% to their existing install base. That is in 2019. It's got nothing to do with the new home mandate, et cetera, and that is going to influence it, but I do not know the answer there. However, the attach rate right now is what they have seen.
Okay. We could at least say that, based on the third party, they're seeing a 25% attach rate. The new solar is not attached to that, so it could be upside.
Sure.
Great. Thank you. Appreciate it.
Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Badri Kothandaraman for closing remarks.
All right. Thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you again during our Analyst Day in December.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.