Welcome to the Enphase Energy's fourth quarter 2018 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Christina Carrabino. Ma'am, you may begin.
Good afternoon. Thank you for joining us on today's conference call to discuss Enphase Energy's fourth quarter and year-end 2018 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 fourth quarter and year ended December 31st, 2018. During this conference call, Enphase Management will make forward-looking statements including, but not limited to, statements related to Enphase Energy's technology, products, and financial performance, operations, including supply and lead times, and current and future market and customer demands and trends. 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 quarterly report on Form 10-Q for the quarter ended September 30th, 2018, which is on file with the SEC. The annual report on Form 10-K for the year ended December 31st, 2018, which will be filed with the SEC in the first 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. Please note the 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. I'd like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy. Badri?
Good afternoon. Thanks for joining us today to discuss our fourth quarter and full year 2018 financial results. We had a solid quarter. We reported revenue of $92.3 million. We had strong customer demand as our financial strength and robust balance sheet reaffirmed customer confidence. Our biggest challenge in Q4 was meeting this additional demand due to component shortages that constrained our revenue. We are fully booked for Q1 2019, just as we saw in Q4 2018. I will provide an update later in the call on our plans to mitigate component shortages. Our non-GAAP gross margin in the fourth quarter was 30.7%, and our non-GAAP operating income was $8.6 million. Our gross margin was negatively impacted by 4.3% due to expedite fees related to component shortages. The expedite fees were in the form of air shipments that we chose to make in order to service our customers.
We exited the fourth quarter with a cash balance of $106.2 million, net of a $10 million final payment to SunPower. The strong cash balance also enabled us to completely repay on January 28, 2019, our high interest-bearing senior secured term loan of approximately $39.5 million, plus accrued interest and fees. Let's talk about 30/20/10, our target financial model. We introduced 30/20/10 at our Analyst Day in June of 2017 and committed to meeting the model in Q4 of 2018. 30/20/10 stands for 30% gross margin, 20% operating expense, and 10% operating income. We made significant progress towards making that model a reality as we exited 2018. Eric will go into greater detail about our financial results later in the call. An important focus item that we discussed in the past few quarters is ease of doing business, how customers perceive us.
Quality and customer service are the cornerstones of our strategy, and our objective is to deliver exceptional customer experience. Our business processes are maturing, and we are prioritizing customer experience to be number one in all aspects of our business. During Q4, we made several improvements in our call center and online support, particularly in Europe and Asia Pacific. We also rolled out an Enphase Upgrade Program, a service program for early adopters of our legacy microinverters, and announced that over 1,000 homeowners have joined the program. The key metric we use to measure customer experience is the Net Promoter Score, or NPS. This metric is calculated based on feedback from customer surveys on how likely customers or partners will recommend Enphase to a friend or colleague.
Our NPS in North America was approximately 51% in Q4. Our target is to achieve a worldwide NPS of 60% or higher in 2019. Let's talk about the 301 tariffs that became effective in September of 2018, impacting Enphase microinverters and accessories. As we discussed last quarter, we are mitigating the existing 10% 301 tariffs by sharing the cost increases with our customers and expanding our manufacturing agreement with Flex in Mexico starting Q2 of 2019. This additional line in Mexico is expected to help Enphase better service our North American customers by cutting down cycle times and streamlining inventory at a similar manufacturing cost as China. Turning to our regions. Our U.S. and international mix for Q4 was 77% and 23%, respectively. All of our regions were impacted by component shortages.
Our fourth quarter revenue in the U.S. was up 38% sequentially and up 29% year-on-year due to strong customer demand across the board. Note that the U.S. revenue includes volume shipments of our IQ7X microinverters to SunPower, as we previously planned. In Europe, revenue was down 2% sequentially, but up 27% year-on-year. The megawatt shipments were up 26% sequentially and up 31% year-on-year, setting a new record for Europe. Note that the Q3 2018 revenue for Europe included a $3.3 million of milestone achievement from a partner on IQ8. We are encouraged by the growth outlook in the new build and social housing sectors in Europe. In APAC, our revenue was down 61% sequentially and down 74% year-on-year. As we previously mentioned, the region had built up significant channel inventory over time, and we took this opportunity to bring the inventory down.
We recently appointed Ralph Johnston as our new general manager for the region, and we believe his years of international executive management experience will help strengthen our APAC business. In Latin America, fourth quarter revenue was down 41% sequentially and down 14% year-on-year. Unfortunately, component shortages significantly impacted our Q4 sales to this region as well. Now that we are financially stable, a large portion of our time is spent on profitable top-line growth. We plan to achieve this growth through differentiated products and services. Our four levers for profitable top-line growth remain IQ7 regional expansion, high power and high performance products, AC Modules, and Ensemble solar and storage technology. The first lever for profitable top-line growth is IQ7 regional expansion. Approximately 84% of our microinverter shipments in Q4 were IQ7, up from 78% in Q3. As I mentioned earlier, component shortages constrained our revenue in Q4.
We have been working with our customers and partners to manage these shortages, and we are thankful for their efforts and patience. The additional capacity based on an investment we made with one of our suppliers earlier in 2018 is now online. This has allowed to increase our microinverter supply for Q1 2019, but with the growth we are seeing, our lead times are still around 13 to 15 weeks. We have recently signed two new long-term contracts for additional high voltage transistors. This additional supply is expected to become available in the second half of this year, which we believe will help improve our microinverter lead times to six to eight weeks. The second lever for profitable top-line growth is releasing high power and high performance new products.
The IQ7X product addresses 96 cell PV modules up to 400 watt DC, and with its 97.5% CEC efficiency, it's ideal for integration into high power modules like SunPower and Panasonic. In addition, we shipped limited quantities of our new product, IQ7A, which addresses up to 450 watt DC modules. The third lever for profitable top-line growth is AC Modules. We had volume shipments of our IQ7X microinverters to SunPower in the fourth quarter, and as previously announced, we expect a continuation of the ramp in 2019. In addition, we are making steady progress with module partners such as Solaria and Panasonic in ramping Enphase Energized AC Modules. These integrated systems allow installers to be more competitive through improved logistics, reduced installation time, faster inspection, and training.
Since their release in October 2017, Enphase Energized ACM from our module partners have been adopted by about 420 installers in the U.S. as of today. Finally, a major catalyst for our profitable top-line growth in the long term is our Ensemble solar and storage technology. The IQ8 system is based on our grid-agnostic, always-on technology called Ensemble. This system has four components, energy generation, which is accompanied with the grid-agnostic microinverter IQ8. Energy storage, which is achieved by Encharge battery with capacities of 3.3, 10 kilowatt-hour, 13.2 kilowatt-hour. Communication and control called Enpower, which consists of the automatic transfer switch and the combiner box with the Envoy gateway. The fourth and final component is Enlighten, which is the IoT cloud software. We are working hard on each of these four components of the IQ8 system.
There are over 100 engineers working on the project across multiple time zones. However, given the high complexity of the technology in terms of hardware and software, we are running a little bit late. We believe in making the right decisions for the long term and getting the customer experience right. Therefore, we now anticipate introducing Ensemble in a phased manner starting in the fourth quarter of 2019. Let me remind you that there are two major market segments Ensemble technology addresses. One is the pure off-grid segment, and the other is the grid-agnostic segment. We just talked about the grid-agnostic solution being delayed to the fourth quarter of 2019. However, the pure off-grid microinverter solution is on track.
We shipped limited quantities to our partner on IQ8 during the fourth quarter of 2018, and we expect to ramp production in the first half of 2019. We also expect the final milestone revenue from this partner in the first quarter of 2019. In summary, we are encouraged by our progress in 2018. Our top priorities remain providing superior customer experience and focusing on our four profitable top-line growth vectors. I would like to thank our employees for their hard work and our customers, partners, and shareholders for their strong support. With that, I will turn the call over to Eric for his review of our financial results. Eric?
Thanks, Badri. I will provide more details related to our fourth quarter and full year 2018 financial results, as well as our business outlook for the first 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 fourth quarter of 2018 was $92.3 million, an increase of 18% sequentially and an increase of 16% year-over-year. We shipped approximately 257 megawatts DC in the fourth quarter of 2018, an increase of megawatts of 25% sequentially and an increase of 16% from the year-ago quarter. The megawatts shipped represent about 820,000 microinverters, approximately 84% of which was IQ7. Both IQ6 and IQ7 represented 91% of Q4 microinverter shipments.
Non-inverter revenue, which includes our AC battery storage solution, Envoy communications gateway, combiner box, and accessories, increased as a percentage of revenue compared with the prior quarter. Total revenue for 2018 was $316.2 million, up 10% from 2017. In 2018, we shipped approximately 2.8 million microinverters, representing 972 megawatts DC, a 13% year-over-year increase in megawatts shipped. Non-GAAP gross margin for the fourth quarter of 2018 was 30.7%, compared to 32.8% for the third quarter. Note that Q3 '18 non-GAAP gross margin, including a $3.3 million milestone achievement from a partner on IQ8. Even though we share some of the expedite fees with our partner, component shortages negatively impacted our Q4 gross margin by approximately 4.3%. Non-GAAP operating expenses were $19.7 million for the fourth quarter of 2018, compared to $18.6 million in Q3 and $18 million in the fourth quarter of 2017.
2018 was our first year of SOX-compliant efforts, as a result, we incurred higher-than-expected expenses in internal audit, plus additional consulting and advisory fees. These higher-than-normal expenses will also continue into Q1 2019. Non-GAAP operating expenses for 2018 were $75 million, compared to $72.8 million in 2017. GAAP operating expenses were $23.2 million for the fourth quarter of 2018, compared to $25.6 million in Q3 and $21.1 million in the fourth quarter of 2017. GAAP operating expenses for the fourth quarter included $1.5 million of stock-based compensation expenses, $1.5 million of restructuring expenses, and approximately $400,000 of acquisition-related expenses and amortization. GAAP operating expenses for 2018 were $92.8 million, compared to $95.4 million in 2017. On a non-GAAP basis, income from operations was $8.6 million in the fourth quarter of 2018, compared to $7 million in Q3 and $1.3 million in the year-ago quarter.
This improvement in operating income is reflective of our improved operational excellence and continued product leadership. On a non-GAAP basis, net income for the fourth quarter of 2018 was $5.1 million, compared to $4.6 million in Q3 and $683,000 in the year-ago quarter. This resulted in basic earnings per share of $0.05 and diluted earnings per share of $0.04 in the fourth quarter of 2018, compared to basic and diluted earnings per share of $0.01 in the year-ago quarter. GAAP net income for the fourth quarter of 2018 was $709,000. We are happy to report that this was the first quarter in the company's history that we reported GAAP net profitability. Now, turning to the balance sheet. Inventory was $16.3 million in the fourth quarter of 2018, compared to $17.9 million in Q3 and $26 million in the year-ago quarter.
We ended at 23 days of inventory on hand as of December 31st, 2018, significantly below our target of 30 days and down from 31 days in the third quarter, and also down from 39 days in the year-ago quarter. Although most of the inventory reduction was due to high demand constrained by component shortages, inventory management continues to remain one of our key cash management initiatives. We exited the fourth quarter of 2018 with a total cash balance of $106.2 million, compared to $116.2 million in Q3. The Q4 balance includes the final payment to SunPower of $10 million for the acquisition of its microinverter business. We also generated $1.9 million in cash flow from operations and $4.1 million in adjusted free cash flow.
The $1.9 million in cash flow from operations in Q4 would have been $5.9 million as we allocated $4 million out of the $10 million payment to SunPower in operating cash flow for the acquired customer relationship acquisition-related intangibles. As Badri mentioned, on January 28, 2019, we repaid in full our high-interest bearing senior secured term loan with Tennenbaum Capital Partners, an indirect wholly-owned subsidiary of BlackRock, Inc. The repayment included a principal amount of approximately $39.5 million, plus accrued interest and fees. The repayment also terminated the liens of all Enphase's assets, providing graded operating flexibility going forward. Let's discuss our outlook for the first quarter of 2019. We expect our revenue for the first quarter of 2019 to be within a range of $90 million-$95 million. Turning to margins, we expect GAAP and non-GAAP gross margin to be within a range of 31%-34%.
Note that our Q1 gross margin guidance includes a negative impact of approximately 2%-3% due to expedite fees resulting from component shortages. We expect our GAAP operating expenses to be within a range of $25 million-$26 million, including a total of approximately $4.5 million estimated for stock-based compensation expenses, additional restructuring expenses, and acquisition-related expenses and amortization. We expect non-GAAP operating expenses to be within a range of $20.5 million-$21.5 million. I will now open the line for questions.
Ladies and gentlemen, if you have a question at this time, please press the star, then the 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, that's star then 1 to ask a question. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from Brad Meikle with Williams Trading. Your line is now open.
Hi. Thanks for the question. Could you add a little more color in terms of your visibility into second quarter and the second half of the year from a demand standpoint? Also, as you're ramping, it sounds like you prioritize the ramp of the IQ7 and to alleviate the shortages and catch up with customer demand. Can you comment on how much more capacity you'll have as you go into the second and third quarter? Thanks.
Brad, thanks for the question. As you know, we're not going to provide guidance beyond the quarter, and we guided $90 million to $95 million of revenue for Q1 of 2019. Having said that, we are unlocking three of the four top-line growth vectors that I said. The first one was IQ7 regional expansion, the second is the AC Modules, and the third is the high-performance, high power products. I'll take each of them. In the first one, obviously, our balance sheet has significantly improved. We are very financially stable. We have a great cash balance. Customers are coming back to us. In addition, we pride ourselves on offering the highest quality and customer experience. With all of this, our demand has started to increase.
What we did was, we recognized this sometime last year, and we worked with one of our suppliers to increase our 600-volt transistor supply, which is a key component in our microinverters. We did that early in 2018. We locked some capacity down, and that capacity is coming on in Q1 2019. In fact, it is online right now. Having said that, as we unlock more of our top-line growth vectors, we found that that is not enough. We found that in the fourth quarter that we had to scramble for more capacity. I personally went down and talked to the CEOs of these companies, and we were able to get two additional long-term contracts done. The result is that from middle of 2019, meaning from second half of 2019, the incremental supply will turn on and we will start to service customers a lot better.
The answer to your question is Q1 2019 will be better than Q4 of 2018. Q2 2019 will be better than Q1 of 2019, and Q3 and Q4 will be a lot more comfortable for us.
Thanks, Badri. I guess, just to ask it another way, I think you'd said in the past that the new Power MOSFET line could be 60% of your output when ramped, and I'm not sure exactly how long that takes to ramp, but that really implies close to a doubling of capacity, depending on how your existing contracts sort of look. Is that the right way to think about it?
Well, yes, that is the right way to think about it. Let me say this. In the second half of the year, we will be in a very comfortable spot in terms of our supply. I hope supply will not be a major problem in the second half.
Are you sold out through the second quarter at this point as well?
We're not going to talk about the second quarter, Brad. We are sold out for the first quarter, though.
Okay, thanks. Just last question. Could you speak to the battery ramp? We've heard of some high attach rates in California of 25%+, and obviously you make probably 8 times as much on a storage installation with your customers. Could you comment on what you're seeing from customers that you're talking about in terms of storage attachment and what that could mean for the business? Thanks very much.
Yeah. We are extremely excited about storage. As I said in the prior quarter, storage represents a significant opportunity for us to increase the revenue potential per home from $2,000 to $10,000. A key part of Ensemble is Encharge. Encharge is going to have capacities of 3.3 kWh, 10 kWh, 13.2 kWh. It is going to have a C over two charging rate. It is going to have LFP chemistry, which is going to be very safe for residential application. Most importantly, it's going to use IQ8, the same IQ8 microinverter. We are furiously working on Encharge. Having said that, like what I said, it is a little bit delayed to the fourth quarter of 2019. We are extremely optimistic about our prospects in storage. Yeah, I'll leave it at that.
Thanks. I'll get back in the queue.
Thank you. Our next question comes from Carter Driscoll with B. Riley FBR. Your line is now open.
Afternoon, gentlemen. Can you just talk about your assessment of the opportunity for Ensemble and the grid-tied versus not necessarily having to be grid-tied and, the delay of when you're going to ramp the second portion of that market? Just trying to get a sense of relative market opportunity.
Right. Ensemble is designed to service two markets. One is grid-agnostic market segment. The other is the off-grid market segment. I'll come to the off-grid market segment where we are on track. We started sampling the product to our lead customer in the fourth quarter of 2018. We are expecting to ship a significant quantity to them in the first quarter of 2019. What I'll say is this, if you look at the countries where the off-grid technology is going to play a major part, it's going to be places like India and Africa. India and Africa are the places where you will see, of course the PV and the storage systems are not going to be that big. They're going to be small. Imagine a hut, having one or two AC Modules, or one or two modules with microinverters.
That will be just perfect for the architecture of a microinverter. It's still too early for us to assess, to talk about volumes and talk about ramps. We're excited that our product is there, our product is sampling. We have a strong partner. We'll talk about it in the coming quarters on progress. That's on the pure off-grid microinverter. On the grid-agnostic one, it gets more exciting. The grid-agnostic one, obviously, there is a lot of cases. We service somebody who wants to be completely grid independent. We service somebody who wants to be totally dependent on the grid, just wants backup as a peace of mind. Ensemble is a technology that can do whatever the customer wants. That's why we call it as grid-agnostic. Ensemble is complex.
It has got four components, which is the micro, the battery, the automatic transfer switch, the combiner, and the cloud. Having working all of these together seamlessly in terms of hardware and software, is something that we have been challenged with. I think that's why we are experiencing the delay. The way I think about it is two big opportunities on the Ensemble side is, one is the storage, which is Encharge, which takes our revenue per home from $2,000 to $10,000. The other is, even if there is not much storage attachment, what would people want? A grid-agnostic solar or a grid-tied solar? We think that most people would want a grid-agnostic solar, given a choice. Once again, we are extremely excited about that technology. We're extremely excited about Ensemble. We do not want to get ahead of ourselves.
Right now we are basically having our heads to the table. We are focused on execution. We are focused on getting this product out in the fourth quarter of 2019.
Okay. Maybe just another one. Can you maybe talk about the percentage shipped to AC modules in the form factor, or range, where you have been in four Q and where you think it could go by, say, year-end 2019?
We're not going to break out the percentage shipments, but AC modules have been increasing slowly and steadily. It starts with customers like SunPower, which is all AC modules. The microinverters IQ7X that we ship to SunPower is in their Equinox AC modules. In addition, partners like Solaria are all gaining a lot of traction in their market. Solaria has got a 355-watt AC module. They use our IQ 7+ microinverter, which is a 295-watt AC output. Basically, a DC AC ratio of 1.2 there. Solaria value proposition is, it's a sexy module. It is aesthetic, and that's why everybody likes it. That's that. Earlier in the year, we announced our partnership with Panasonic. That's slowly getting to be a reality, and we'll announce when we are ready there. Basically, these are our very strong partners.
In addition, we have a few more that we are working on in the international regions, which we'll announce when we are ready.
Maybe just last one from me. To get to the high and low end of your margin guidance for 1Q, can you just talk about the factors? Is it some combination of mix? Obviously, what you've done and potentially in terms of sharing the tariff impact. Maybe just talk about those factors, the more important ones to get to that 300 basis points delta.
Yeah. Look, we are already sharing the tariff costs with our customers. We did that effective in Q4 of 2018, which is what we said we would.
Yeah.
We're doing that. Really, the percentage on gross margin, the 4.3% really comes from air shipping our microinverters so that we provide customer service. To tell you the truth, I prioritized customer service in Q4, and therefore, we spent a lot of money air shipping product. Now, a few of our customers were also willing to pay for air ships. That basically offset us a little bit, but even after that, we still had a gross margin hit of 4.3%, as we said. Now, in Q1 of 2019, with our supply situation a little bit better, we're not going to be spending so much of money, but still it is significant. 2%-3% in terms of air shipments is still significant, and that's really accounted in the guidance of 31%-34%.
I'm sorry. If I may just sneak in a last one. Just talk about the competitive environment, whether from existing and then maybe new entrants. What you're seeing both last quarter and what you expect in 2019.
The competitive environment remains pretty much the same. There is not much change. Of course, we are all talking about Huawei. We do not see them that much in the residential space right now, but of course, they're a formidable competitor. We are watching the space. Let me remind you that our product is unique. Our product is differentiated. It's a microinverter. We focus on differentiation through innovation, so we'll be prepared to meet competition.
Appreciate you taking all my questions. I'll give it back in queue, guys. Thank you.
Thank you. Our next question comes from Eric Stine with Craig-Hallum. Your line is now open.
Hi, everyone. Maybe just wanted to start with SunPower, and I might've missed this, but did you break out the percentage of your revenues in fourth quarter there? Just curious if you could talk about the ramp. I know it's still early, but the ramp, and maybe how it's progressing versus your expectations when you made the acquisition a couple of months ago.
Yeah. We are not going to break out the percentage of SunPower revenue. I'll tell you what. The ramp is very much in line with our expectation. I expected volume shipments beginning Q4 2018, and we are exactly at that point where we had volume shipments to SunPower on our IQ7X microinverters in Q4 2018. I expect Q1 2019 to be a ramp, a nice ramp, and I expect us to be done by Q2 2019, as I previously communicated.
I guess you touched on this on your answer to the previous questions, but I'm just curious with SunPower, with some of the traction you're getting with some of your other AC module partners, just curious what you're seeing from the rest of the market. What that's doing in terms of interest, people coming to you looking for their own solution. Anything along those lines would be helpful.
Yeah. If you really see it, an AC module is actually perfect when you see that the modules are going to higher and higher power. We can easily scale our microinverters, so it's actually advantageous for us in terms of gross margin as well. Having said that, SunPower is the biggest, and then people like Solaria, for example. I'll reemphasize that again. It's a 355-watt AC module, and it is a really neat module, 72-cell module, and very high aesthetics, black on black, and it really looks nice. Those are the kind of partnerships we are actually getting. We are getting many such partnerships across the world. Like for example, in Europe, there are a couple of partnerships which we are working on. We cannot announce them yet, but they are making rapid progress.
Got it. Let's see. Maybe last one for Eric, just on the OpEx. You mentioned that in fourth quarter you had some professional fees and some other stocks related items that ran a little hotter than you thought. In the guide for first quarter, it sounds like it's going to persist. Maybe beyond first quarter, maybe a way to think about OpEx at a more normalized level.
Yeah, I think that when we think about OpEx for 2019, except for the qualifications on Q4 and Q1, Eric, we should think it in terms of the model, the financial operating model that we set up, right, which is cash generating. The 20% number is still relevant. It may go up a little bit, it may go down. It's the whole model of the 30/20/10 that we basically live by, and that will be the guiding principle outside these unique, specific circumstances, right?
Okay. Thanks for that.
Thank you. Our next question comes from Jeff Osborne with Cowen and Company. Your line is now open.
Yeah. Excellent. Maybe just following up on Eric's question. Eric, is there a way you can quantify what the OpEx increase was in Q4 for stocks and professional fees, or will that be broken out in the 10-K?
Yeah, it will be broken on the 10-K. You actually can see that as well, I believe, in the tables of the press release, right? For the most part, you can see there is stock component $1.5, another portion associated with the restructure fees. Everything is neatly easy to follow there compared with the prior quarter, and then you can take it into the following.
Got it. Then, I think Badri had in his prepared remarks a comment about the last, if I heard you right, Badri, the last milestone payment would be showing up in Q1 from your partner for IQ8. Can you, A, confirm that, and then, B, is there a way to think about what the magnitude of that payment is?
Yeah, confirmed. Yes, it'll be Q1 of 2019, and it'll be under $1 million.
Okay. I just noticed you didn't break that out when you were talking about the puts and takes on the gross margin side, but if it's under $1 million. Is that the last of the payments, or is there any additional.
Correct
payments in the future?
That's the last of the payments.
Got it. Another question on SunPower. I know you can't break out specifics, but is there a way you can talk about what your level of engagement is with their channel, their dealer network? Is that something that you have more than half of their channel has been exposed to the product, or is that still an uphill battle over the next 6 months for you to penetrate that channel?
No, it's not an uphill battle, but it is not for us to penetrate the channel. SunPower is going to exclusively use Enphase microinverters, and therefore it is in SunPower's best interest to promote these microinverters and the future microinverters to their dealer network. Our job is a little bit easier there because SunPower is making all the effort to make sure that everybody is trained, the dealer network is trained, and of course, we are helping them every step of the way.
Got it. That makes sense. The last question I had was on the component side. Two-part question. One is on IQ8. Does that use more or less of the 600-volt transistors? I know it's a slightly different form factor and more cost optimized, but I wasn't sure if it's more intensive on the transistor side in particular.
The IQ8 uses the same four high voltage transistors.
Got it. Then as part of these now, I guess, three contracts you have on supply, is there any notable cash payments upfront that would be disclosed in the 10-K as that's published, or how do the mechanics of these work? The second part of that question would be, what are the general duration of these types of contracts, just in the event, say, the auto industry or some other industry comes back and these components continue to have a problem later in the year and in 2020?
Yeah. We have two arrangements that we have on top of the one that we have existing before. One of the two that are new, that Badri set up, is actually a continuation of the existing one with some prepaid arrangements similar to the one we had before. The other one is with another one, it has a take-or-pay that is very short time frame. Probably I wouldn't think beyond 18 months to two years. This gives us enough runway to get the problem resolved, but at the same time, doesn't commit the company on a structured pricing arrangement on a take or pay for a long term.
Got it. That's very helpful, Eric. I appreciate it.
Thank you. Our next question comes from Amit Dayal with H.C. Wainwright. Your line is now open.
Thank you. Good evening, guys. Most of my questions have been asked. Maybe just on the leverage of the business, now that we're seeing some revenue ramp coming through, what is the opportunity over here? Should we expect operating costs to sort of normalize at these levels, or should these expected to increase with the ramp in revenues?
Right now, you should think about the OpEx as our long-term model is 20% of revenue. We are not going to deviate from that. We incurred restructuring expenses to make sure we have the right people in the right places. We are very confident that we can meet that. That's not an issue. While we ramp revenue, we will control OpEx at 20% of sales. Okay?
Got it. The 30/20/10, no update to that? Maybe in the next few quarters?
Look, the 30/20/10 is more and more looking like 32/22/10. What you should be looking at is, the 30/20/10 spirit is what? It's the 10% operating income. As long as that is met, the numbers will fluctuate a little bit. Having said that, we feel good about our profitable top-line growth vectors. We feel good that even if Ensemble is late, we feel that the other three vectors are actually kicking in and more than compensating for that. We feel really good about that. Still, we are not going to guide more than one quarter out. We know this is the solar industry. Anything can happen overnight. We know if the government sneezes on this a little bit, things can go south. We're not going to update the model right now.
Right. In the context of your pretty strong sort of guide for the first quarter relative to the fourth quarter, should we expect Ensemble to really contribute anything meaningful this year? Or should that be pushed out in terms of expectations from 2020?
Well, look, when we introduce the product in the fourth quarter, obviously, that will be only the ramp, right? There won't be much significant revenue from Ensemble in 2019.
Got it.
That's right.
Understood. Yeah, that's all I have, guys. I'll follow up offline. Thank you.
Thank you. Our next question comes from Colin Rusch with Oppenheimer. Your line is now open.
Thanks so much, guys. It looks like you increased the working capital a little bit here with AR getting up to almost 78 days for the quarter. Can you talk a little bit about what happened there and what your expectation is for working capital needs as you go into the first part of 2019?
Yeah. I'll take the first part, and Badri can probably cover the business aspect of it, Colin. If you think about it, the FIT supply component, the cell shortages, it has created challenges on our linearity, right? What you see is significant amount of shipments taking place sometimes even on an expedite costing basis on air shipping toward the end of the quarter, right? That has been aggravated since Q3. Now I believe we are turning a corner, in which you can see receivables with day sales outstanding of 70 days, right? At the same time, that compensates with the payable side of it, which we have a lot of purchases of inventory taking place toward the end of the quarter.
With that being said, you end up with super low levels of inventories on the working capital front, maybe a little bit below our comfort level for operational flexibility. Now at 23 days, with a total cash conversion cycle of 24 days for working capital in the quarter, right? We believe with the linearity challenges being started to get resolved in Q1 and pretty much gone by the end of Q2, we are in good shape to normalize the business back again and start seeing receivables, payables getting to our own internal target.
You go into 2019, so you're checking that 10/20, so it should be a source of cash in your expectations for March and June?
I didn't quite follow your question. Say that again.
You should be generating a bit of cash from the working capital as you go into March and June. Do you feel like you're going to consume that as you ramp up?
Let's just talk a little bit about cash a little bit, right? We feel confident about our cash-generating capability based on our financial operating model that we have, right? 30/20/10, or like Badri reported, 32/10, right? That model is a cash-generating model, right? With all the things that we took into account, I believe we're going to continue going forward into the year by resolving the linearity challenges and increasing our cash coffers, right?
Okay. That's helpful. Then you broke out international and domestic sales. As you look into 2019, how is that shifting at all? Is there a price component that you're going to see a benefit or any sort of headwinds on from next on a geographic basis?
Look, it's still going to heavily be skewed towards North America because of SunPower. Having said that, we are really excited about Europe. We had the highest megawatt shipments like what we noted. Really excited about the social housing boom in Netherlands. We have very strong distribution partnerships in France. Once the component shortages are resolved, we hope to break into other regions, like start ramping in Germany, start ramping in Austria. Those are the places we would like to start ramping. Yeah. If you look at Australia and the Asia Pacific, Australia, New Zealand, et cetera, there, we really took the opportunity with the component shortages in order to correct our inventory, correct the inventory in the channel. We did that in Q4. We brought on a general manager, and his expertise is he's a solar guy.
He understands storage as well. We really want him to grow the battery business there. The last one is India. We're not talking about India much, but with the off-grid product starting to come, the pure off-grid product, I'm really excited about the prospects in India as well. There are some niche applications that I'm not going to talk about right now. As our pure off-grid product rolls out in the first half of the year and as Ensemble turns on, there are exciting prospects there as well.
Okay. Thanks so much, guys.
Thank you. Our next question comes from Philip Shen of Roth Capital Partners. Your line is now open.
Thanks for the questions, guys. I'll follow up on the last question there by Colin. I think we're seeing some really nice growth internationally. Is there a situation where you can see the international growth rate actually being faster than the U.S., or do you look at it in that way at all? If so, do you see potential for getting to an international versus U.S. mix of call it 60/40, even 50/50 someday, in the near, call it medium term, two to three years out?
Yeah. That's our goal, Philip Shen, to obviously get to parity in terms of U.S. versus Europe versus Asia, to get to something like 33, 33. Having said that, the U.S. business is the strongest at this point in time, especially with SunPower, especially with their financial stability, with the long tail of customers coming back because of our product quality, because of our customer experience. U.S. is really fighting on all cylinders right now. I think 2019 is going to be about the U.S. I'm optimistic that 2021 timeframe, we can start being more balanced in terms of all the geos.
Great. That makes a lot of sense. We're even starting to hear about some really aggressive growth rates for the overall U.S. market. I think people have been thinking about 15% year-over-year growth, I'm hearing now 20, maybe even 25% or 30% growth in the U.S. as a market overall. Are you guys seeing any of that? Let's put your internal supply constraints or component shortages aside. When you look at the U.S. market, is there any validation or potential you think that the overall U.S. market can actually grow 25% year-over-year in 2019 versus 2018? When I say overall, let me specify that for residential, and if you want to speak to commercial, feel free.
Yeah. I'm going to talk only about the residential space. Look, what I said in the last conference call is that we could not ship more than $10 million of demand. I said that in the Q3 conference call, that number is a little bit higher for Q4. Basically, there is a lot of demand out there, we are seeing a lot of demand because of our financial stability, because of our strong balance sheet, because IQ7 is the latest and greatest product that we have, our customer experience, our high quality. Demand is strong. It is all supply limited at this point in time, I expect the next two quarters like that, I'm optimistic about Q3 and Q4.
Great. Following up on that thought there, Badri, can you talk about Q1? Your official guide is $90 million to $95 million. I know you're sold out. I know you had internal constraints, how much revenue do you think you're leaving on the table as it relates to Q1 specifically?
Phil, we are not going to break that out. I broke that out in Q3 because just to show that our top line is starting to break out. We are not going to get into the habit of breaking that out. I'll just tell you this, we feel really good. The demand is strong. What we feel bad is we are still not servicing customers well in terms of deliveries, and we need to fix that. That's what I'm working on day and night. That's what our top priority is. To not be internally focused, but to be focused on what customers want. We need to do a lot more work there.
Great. One last one for me on the competitive dynamics in Europe. I know we were just talking about Huawei and more skewed to the U.S., but in Europe, they have been selling their product for some time. Can you talk about whether or not you're running into them at all as it relates to installers and customers? Are you competing with them, you think? Or do you feel like the overall market demand is so strong, it's really not an issue? Would love to get your thoughts on that in Europe. Thanks.
Hey, Phil, this is Raghu. Yes, we definitely see them in the market in Europe. We are competing with them very effectively. Of course, in the markets that we are more active in Holland, Netherlands, and in France and a couple of other countries in that region. We do run into them, but we clearly are being very effective there and doing well. Given that in Q4, we had the highest megawatt shipped ever in Europe, both in terms of megawatts, actually, as well in terms of units. I think it is, Badri mentioned this earlier on, it's because we have a really well-differentiated product. We do microinverters. They do string, with or without optimizers. Right?
I think the fact that it's a microinverter that is the highest performance and very high quality and reliability, as well as the customer experiences itself, including customer support in the work that we have done, is what I think separating us from all the other string players that are out there, which obviously there's more than just Huawei. The other thing also is, we touched upon this earlier on, that ACM, AC Module, is going to be very interesting in Europe. We are now actively engaged with a few partners that we'll announce when we are ready. There's clear value generation when installers install AC Modules, both in terms of the savings, both on the logistics side as well as the installation time and quality of installation, training, inspection, et cetera.
All in all, we feel very good about Europe, and it's shown in the numbers, right? Like I said, we did record numbers in Q4.
Great. Thanks, Raghu and Badri. I'll pass it on.
Thank you.
Thank you. As a reminder, ladies and gentlemen, that's star then one to ask a question. Our next question comes from Pavel Molchanov with Raymond James. Your line is now open.
Thank you. Taking the question, guys. Given the deleveraging that you've recently accomplished with the debt paydown and the cash flow that you'll likely generate in 2019, I'm curious if you're becoming more open to acquisition opportunities above and beyond what you've purchased from SunPower. I know that hasn't historically been the Enphase business model to do M&A. Any changes on that front?
Yeah. The conversation about the strategic targeted, accretive, short payback acquisitions, similar to something like SunPower on different parts of the spaces, right, more in line with the complementary to Ensemble or potentially in the commercial sector, are always part of the discussions here, right? The success on how we integrated, paid for, and we are studying the harvesting the benefit associated with the SunPower transaction, put a high bar in terms of what we are trying to achieve, right? We have cash. We feel very comfortable, we want to be very careful on how we're going to go about spending it and targeting.
Trust me, Pavel, there will not be the kind of big diversions to what we are trying to do for 2019 strategy or potentially decisions that we eventually will need to have a payback that extends beyond 18 months or maybe two years, right? That's kind of how we are seeing it.
Okay. Can we get a quick update on the tariff exemption process, with relation to the AC Modules? I know that's been a work in progress for a while.
Yeah. Yes, you can get an update, and the update is that we have not heard back.
I can understand how that can be. All right. Thanks, guys.
Thank you. Our next question comes from Brad Meikle with Williams Trading. Your line is now open.
Hi, thanks. Just to follow up. You've spoken about one Power MOSFET line that's running, another one that's coming up, and as well as a couple of contracts, I think, from a supply standpoint. That obviously implies a lot more demand out there and a lot more supply. Can you speak to your level of confidence that the demand is there and I know you're not guiding on the second half, but just kind of what your demand visibility is for the second half. Just as part of the capacity ramp-up, I also want to know what portion you expect of U.S. demand to be from Guadalajara in the second and third quarter. Thank you.
Brad, you already know we are not going to be talking about specific demand beyond Q1. Having said that, our objective is to basically make sure we take all supply-related problems off the table. That's what we would like to do. That is why I went and did, in the last couple of months, I went and did these additional two long-term contracts. Guadalajara coming on is an interesting dynamic. It doesn't change anything on the supply scenario. It does one thing, which is streamline inventory and cycle time to all our customers, which we think is important, especially as we service the U.S. If we do a good job in ramping the Flex Mexico, there's no reason why we cannot ship almost all of the North American demand from Mexico.
Time will tell in terms of the quality of that plant, et cetera, which we will have to see. We are working towards that.
Thank you. Just last question is, I guess solarquotes.com.au in Australia reported SolarEdge threatening to sue some of the customers around failure rates being higher, I guess, than expected in that region. We've heard about it in the U.S. as well. Can you speak to whether you think that Enphase will benefit from market share shift away as a result? Just broadly speaking, what your feeling is in terms of your potential for a market share gain. Thanks.
Brad, we are not going to comment on the competition, what their strategy is, et cetera. I sound like a broken record. Our core strengths are the product quality, superior customer experience. That is what we do. Ease of use, high quality, high customer service. We will continue to offer that to customers. If they pick us, we are more than happy. We need to solve these component shortages. We can start servicing them right.
Thank you.
Thank you. Once again, ladies and gentlemen, if you have a question at this time, please press star one. I am not showing any further questions at this time. I would now like to turn the call back over to Badri Kothandaraman for any further remarks.
Thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you, and once again on our call next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.