Good day, ladies and gentlemen, welcome to the Enphase Energy's third quarter 2018 financial results conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this call is being recorded. I would now like to turn the call over to Christina Carrabino. Please go ahead.
Good afternoon, thank you for joining us on today's conference call to discuss Enphase Energy's third quarter 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 third quarter ended September thirtieth, 2018. During this conference call, Enphase management will make forward-looking statements including, but not limited to, statements related to Enphase Energy's financial performance, market demands for its current and future products, advantages of its technology, and market trends. 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, 2017, which is on file with the SEC, and the quarterly report on Form 10-Q for the quarter and nine months ended September 30th, 2018, which will be filed with the SEC in the fourth quarter of 2018. 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. Thanks for joining us today to discuss our third quarter of 2018 financial results. We reported revenue of $78 million for the third quarter. The customers continue to appreciate our differentiated products, quality, and service initiatives. Our strong balance sheet was instrumental in driving increased customer demand. Our biggest challenge in Q3 was meeting this additional demand. We experienced supply shortages that constrained our revenue by more than $10 million. For Q4, we are seeing strong demand and are fully booked already. We expect to be supply constrained in Q4 as well. Our non-GAAP gross margin in the third quarter was 32.8%, and our non-GAAP operating income was $7 million. We are pleased to report the fourth consecutive quarter of positive non-GAAP operating income. We have also made a lot of progress on transforming our balance sheet and improving the company's operations.
We exited the third quarter with a cash balance of $116.2 million. Next, I will talk about 30/20/10. We introduced the concept of a 30/20/10 target financial model at our Analyst Day in June 2017, with a commitment to meeting it in Q4 of 2018. 30/20/10 stands for 30% gross margin, 20% operating expense, and 10% operating income. We have now reported five consecutive quarters of improved financial performance and are very close to realizing 30/20/10. Eric will go into greater detail about our financial results later in the call. An important focus item that we have discussed over the past few quarters is ease of doing business, how customers perceive us. Quality and customer service are the cornerstones of our top-line growth, and our objective is to deliver exceptional customer experience.
Our business processes are maturing, and we are prioritizing customer experience as number one in all aspects of our business, be it in product development or operations. During Q3, we continued to make several improvements in our customer contact center metrics and online support. Our service on the go has now enabled majority of customer claims to be handled through self-service via mobile devices. A key customer experience metric we introduced last quarter was Net Promoter Score or NPS. This metric is calculated based on feedback from customer surveys on how likely customers are to recommend Enphase to a friend or colleague. Our customer service NPS was over 50% in Q3 versus 40% in Q2. We have made significant improvement with our customer service in the last four quarters, making it easier to do business with Enphase. Our target is to achieve an NPS of 60% or higher in 2019.
Let's now talk about tariffs. We all know about the 201 tariffs on solar cells and modules. Many of our AC module partners are building factories in the U.S. to counter the tariffs. We all know SunPower recently obtained an exemption from the 201 tariff. In summary, we see the barriers on AC modules seem to be easing up and their production is beginning to ramp. Let's now move on to 301 tariffs, which became effective late September, and their impact on Enphase microinverters and accessories. We expect to mitigate the 301 tariffs by sharing the cost increases with our customers and expanding our manufacturing agreement with Flex to include Mexico. Starting in Q2 of 2019, Flex will begin delivering Enphase products produced in Mexico to the U.S. market.
This additional line in Mexico will help Enphase not only to mitigate the tariffs, but also better serve our North American customers by cutting down cycle times and streamlining inventory at a similar manufacturing cost as China. Turning to our markets. Our U.S. and international mix for Q3 was 65% and 35%, respectively. Third quarter revenue in the U.S. was up 1% sequentially and down 4% year-on-year. We ramped IQ 7 shipments to our U.S. customers during the quarter, along with IQ 7X, our microinverter compatible to 96-cell modules. In Europe, revenue was up 9% sequentially and 31% year-on-year. We entered the German and Austrian solar markets in Q2 with IQ 7 and continued to develop the customer relationships in Q3. We maintained our market share lead in France and were flat in Benelux and Switzerland compared to Q2. In APAC, the revenue was down 7% sequentially and up 18% year-on-year.
The revenue decrease was due to channel inventory on our legacy microinverters. We expect to bleed out the excess inventory in the fourth quarter. We also expanded our partnership with BayWa r.e. to distribute IQ 7 microinverters across Southeast Asia. In Latin America, the third quarter revenue was up 33% sequentially and down 38% year-on-year. We experienced steady growth in Mexico during the quarter. Now that we are financially stable, a large portion of my time is spent on profitable top-line growth. We plan to achieve this growth through differentiated products. Our four levers for profitable top-line growth remain IQ 7 regional expansion, high power and high performance products, AC Modules, and Ensemble solar and storage technology. Of course, quality and customer experience remain cornerstones of this top-line growth. The first lever for profitable top-line growth is IQ 7 regional expansion.
We had a significant IQ 7 ramp in Q3, and we expect to complete the transition in Q4. Approximately 78% of our microinverter shipments in Q3 were IQ 7, up from 22% in Q2. As I mentioned earlier, we experienced supply shortages on high voltage transistors in Q3. We expect this situation to continue in the fourth quarter and have made appropriate investments to alleviate majority of the constraints in early 2019. The second lever for profitable top-line growth is releasing high power, high performance products. As you know, IQ 7X is the highest power and highest efficiency variant of our seventh-generation family of microinverters. The IQ 7X product addresses 96-cell PV modules up to 400 W DC, and with its 95% CEC efficiency, is ideal for integration into AC Modules.
We plan to introduce a new product in the first quarter of 2019, IQ 7A, which is even higher power than IQ 7X, to address up to 450 W DC modules. The benefit of our architecture is that it enables higher value to customers at lower incremental cost for us, thus improving our gross margins. The third lever for profitable top-line growth is AC Modules or ACMs. Last week, we announced a strategic partnership with LONGi to develop Enphase Energized LONGi ACMs based on IQ 7. We expect these ACMs to be available in the U.S. starting in the fourth quarter of 2018. Enphase is now the exclusive module-level power electronic supplier for SunPower's residential business in the U.S., and we anticipate volume shipments of IQ 7X as microinverters in the fourth quarter and an acceleration of ramp throughout 2019.
We expect to add $60 million to $70 million of annualized revenue from this acquisition in the second half of 2019 at 33% to 35% non-GAAP gross margin. Both SunPower and LONGi join leading module manufacturers such as Panasonic, Solaria, and LG in developing Enphase Energized AC Modules. These integrated systems allow installers to be more competitive through capital management, reduced labor costs, and improved SKU management with accelerated design and installation. Since their release to installers in October of 2017, Enphase Energized ACMs from our module partners have been adopted by 330 installers in the U.S. Finally, a big catalyst for our profitable top-line growth is Ensemble solar and storage technology. The IQ8 system is based upon our grid-agnostic always-on technology called Ensemble. This system has four components. Energy generation, which is the grid-agnostic microinverter.
Energy storage, which is the Encharge battery with capacities of 3.3 kilowatt-hour, 10 kilowatt-hour, and 13.2 kilowatt-hour. Communication and control, which consists of the automatic transfer switch that provides fine grain load control and the combiner box circuitry. The fourth component is Enlighten, which is the IoT cloud software. The IQ system with its sophisticated software capabilities can address use cases ranging from grid-tied to off-grid, and any possible hybrid configuration in between. In addition, the grid-agnostic feature of the microinverter can be turned on and off through software remotely. This is just one of the many software configurable options in the IQ8 system, enabling a future service business within our installed base. Consequently, the Ensemble technology enables Enphase to transition from a pure-play microinverter solar company to a complete energy management systems company, bringing about a substantial growth opportunity for us.
We expect our revenue potential to increase from approximately $2,000 per home, selling pure microinverter systems, to over $10,000 per home selling complete energy management systems with Ensemble solar and storage technology. We anticipate introducing the grid-agnostic IQ8 systems to customers in the first half of 2019, and realize meaningful revenue by Q4 '19, while still adhering to 30/20/10. We also expect to release the pure off-grid microinverter solution in Q4 of '18 in limited quantities, as we previously discussed. We have completed the necessary safety certifications, and the off-grid product is currently being field-tested. In summary, our top priority is to improve profitability quarter-on-quarter, creating shareholder value. In the near term, our focus is to optimize the supply chain to meet additional demand, unlocking our growth vectors, and providing outstanding customer experience.
In the next few years, Ensemble represents a transformative opportunity for Enphase to increase our revenue many fold by providing a complete home energy management system. 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 third quarter 2018 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 financial measures to GAAP financial measures in our earnings release posted today, which also can be found in the investor relations section of our website. Total revenue for the third quarter of 2018 was $78 million, an increase of 3% sequentially, and an increase of 1% year-over-year. We shipped approximately 204 megawatts DC in the third quarter of 2018, an increase in megawatts of 1% sequentially, and a decrease of 12% from the year-ago quarter. The megawatts shipped represented about 665,000 microinverters, approximately 78% of which were IQ 7.
Non-inverter revenue, which includes our AC Battery storage solution, Envoy Communications Gateway and accessories, increased as a percentage of revenue compared to our prior quarter. Non-GAAP gross margin for the third quarter of 2018 was 32.8%, compared to 30.5% for the second quarter. We are pleased with the continued progress that we have made expanding our gross margins. The increases reflect the targeted initiatives of our pricing management, transition to IQ 7, and the $3.3 million milestone achievement from an IQ8 partner. We continue to be impacted by component shortages, which negatively affected our Q3 gross margin by approximately 2% due to expedite fees. Non-GAAP operating expenses were $18.6 million for the third quarter of 2018, compared to $19 million in Q2, and $16.9 million for the third quarter in 2017.
GAAP operating expenses were $25.6 million for the third quarter of 2018, compared to $23.3 million in Q2, and $22.4 million for the third quarter of 2017. GAAP operating expenses for the third quarter included $3.7 million of stock-based compensation expenses, $2.6 million of restructuring expenses, and approximately $700,000 of acquisition-related expenses and amortization. On a non-GAAP basis, income from operations was $7 million, compared to $4.1 million in Q2, and a loss of $102,000 in the year-ago quarter. This improvement in operating income for the year-ago quarter is reflective of our hard work, and underscores our commitment towards establishing a solid financial foundation. On a non-GAAP basis, net income was $4.6 million, resulting in basic earnings per share of $0.05 and diluted earnings per share of $0.04. Now, turning to the balance sheet.
Inventory levels were $17.9 million for the third quarter, compared to $17.5 million in the second quarter, and $25.3 million in the year-ago quarter. We ended at 38 days of inventory on hand as of September 30th, up from 30 days last quarter, and down from 38 days in the year-ago quarter. Inventory management remains one of our key cash management initiatives in 2018. We exited the quarter with a total cash balance of $116.2 million compared to $58.5 million in Q2. The Q3 balance includes both net proceeds of approximately $62.7 million from a convertible debt offering and a payment to SunPower of $15 million. We generated $6.8 million in cash flows from operations as well as approximately $11.9 million in positive adjusted free cash flow.
The $6.8 million in cash from operations in Q3 would've been $12.8 million as we allocated $6 million out of the $15 million payment to SunPower in operating cash flow for the acquired customer relationship intangible. Let's discuss our outlook for the fourth quarter of 2018. We expect our revenue for the fourth quarter of 2018 to be within a range of $80 million-$90 million. Turning to margins, we expect GAAP and non-GAAP gross margin to be within a range of 31%-34%. Note that our Q4 gross margin guidance includes approximately 2% of higher expedite fees resulting for industry-wide component shortages. We expect our GAAP operating expenses to be within a range of $25 million-$28 million, including a total of approximately $7.2 million of estimated stock-based compensation expenses, additional restructuring expenses, and acquisition-related expenses and amortization.
We expect non-GAAP operating expenses to be a range of $18.5 million-$20.5 million. With that, I will now open the line for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Again, that is star then one if you would like to ask a question. Our first question comes from the line of Colin Rusch with Oppenheimer & Co.. Your line is now open.
Thanks so much, guys. Can we break down that 10,000 per home opportunity? How much of that is energy storage and Ensemble? Can we break it down between what's hardware and what's actually software and service type revenue?
Yeah. Colin, today we ship a microinverter system that is roughly on the average $100. This includes a microinverter, the Envoy, the combiner box, the cable, and usually there are 20 microinverters per home. That makes it a microinverter system is about $2,000 per home. When we go to the home energy management system powered by Ensemble, we are now talking about additional storage. We are talking about an automatic transfer switch in addition to our usual combiner box, and we are talking about software. If you think about it, let's say for anything from 8 to 10 kilowatt hour system, you are right that the storage will be the $8,000, the storage plus ATS.
Even then, we are only scratching the surface because the software component, like for example, the grid-agnostic service capability, will be available as software, which we are still thinking about it, but we are thinking of having a yearly software fee there, which can be rolled out through our IoT system via the cloud. You're right, it's at least $10,000, we expect to get more.
Okay. Just on the component shortage, obviously you guys are working through the issues on this, how can we expect that to start flowing through over the next several quarters in terms of your ability to actually serve the revenue or the opportunity that you think you have in front of you with your customers?
Just stepping back and looking at it, the supply shortage is on the high voltage transistors. These are the 600-volt transistors. They're complicated devices to make. The people who usually make this, I'm talking about the general suppliers who make it, are a handful. They are basically STMicroelectronics, Infineon, Alpha Omega Semiconductor, onsemi, Toshiba. These are the usual suspects. We have done our homework. We have three of these five suppliers on our AVL today. Despite that, those guys are facing unprecedented demand due to EV charging, their demand exceeds the supply that they have. We recognized this problem about six to eight months ago. I invested money creating a dedicated line for us to create capacity, and that line is coming on board in January of 2019. I expect majority of my supply problems to be gone in Q1 of 2019.
Okay. Thanks so much, guys. I'll hop into queue.
All right. Thank you.
Thank you. Our next question comes from the line of Brad Meikle with Williams Trading. Your line is now open.
Hey, guys. Thanks for the question. Just to follow up on the line that you're bringing on, I guess it's a power MOSFET line exclusively, or can you talk more about how broad the shortages are and what capacity you're bringing on? Thanks.
Yeah. To basically give you a color, we walked away from $10 million of demand in Q3. At this point in time, we are fully booked for Q4 to the guidance that I gave you. It is only early November right now. Obviously, the demand is outstripping supply from our end. In terms of the investment with the supplier, I'm not going to provide too much of details, but all I can say is that we are switching to that supplier as our preferred supplier. They basically have given us assured capacity. They are a very reputed, very reliable supplier. Between that source and our existing other two sources, we expect to have more than the available demand that we need. I expect the problem to be gone in Q1 of 2019.
Okay. Could you elaborate at all in terms of whether it's generally within the industry, is it a specialty memory shortage as well, or is it really the power MOSFETs, capacitors, passive components primarily?
Yeah. Look, the power MOSFET 600 volts is by far the biggest shortage. Yes, there are problems on MLCCs. Everybody knows that, but we have been able to resolve that through spot buys. It's not pretty. It affects our gross margins by a couple of %, as Eric said. We are getting by there with the shortage of MLCCs. The high-voltage transistor FET is an esoteric device. It's made only by the five suppliers I said. Therefore, that's a little bit more complex. Like what I said, we believe we have put in the right actions six to eight months ago. The capacity is coming on board now. It is at the right time. I think this should be behind us soon.
Okay. Thanks. On a separate topic, can you talk about your being sold out for Q4? What's your visibility into the first quarter at this point? Could you share some thoughts, generally on 2019, revenue growth and opportunities that you're looking at? Thanks.
Well, we don't give guidance normally for more than a quarter out. In general, I'll give you some color on 2019. Our four vectors for profitable growth, they are turning on. IQ 7 is catching on. Our balance sheet is very robust now, and that is enabling customers to come back to us, especially. You already know about the SunPower transaction, that is going to add about $60 million-$70 million annualized in the second half of 2019. We have other relationships on the AC Modules. On top of it, we are introducing high power and high-performance products that are high gross margin as well. The biggest icing on the cake is Ensemble. Ensemble solar and storage. Of course, new product development is always very complicated. You can hardly predict the exact timelines you're going to get.
If we are on track there, which we are right now, our revenue per home is going to increase by many folds, that can be transformational for Enphase.
Thanks. The second part of that was just around the first quarter. Do you think the supply problem gets better in the first quarter? Can you grow your amount shipped based on that? Are you sold out on the first quarter already, or what's your visibility into the quarter?
Yeah. Like what I said, I'm not going to provide guidance for Q1 of 2019. Like what I said, our balance sheet is robust. We really feel good. Customers are coming back. Demand is strong. I'm fully booked already for Q4. This is only the beginning of November. I still have two more months. If customers order, they are going to go to Q1 by default. We feel good about Q1.
Thanks, Badri. Last question and thank you for the time. We've heard reports. We do a lot of surveys and checks with installers, a lot of discussions we've had indicate that the SolarEdge failure rates are in the 10%-15% range as compared with, I think, you're in the 0.2% range. This drives warranty reserves, it's created a lot of speculation on how appropriate warranty reserves are. Is there ever a point where you can share what your failure rates are with us, so that we can back into those numbers more precisely?
We are not going to be talking about competition, I'll talk about our strategy. Our quality business process is something which I learned from my previous company over the last 21 years, and that is based upon what is called the root cause corrective action methodology. That is, you review your quality failures every week. You look at the root cause. You ask yourself 5 whys. You put in containment actions in place. You put in interim corrective actions. You look at permanent corrective actions, you change the culture of the company so that everybody reacts to quality in the same way, and it is number 1 priority. That's what we are trying to do here at Enphase. My target personally is to get to 500 PPM. 500 PPM is 0.05% if I'm doing the math.
Yes.
That is my target, to get to 500 PPM. We are working day and night to achieve that target. We have a great leader in place on quality, and like what I told you, we engage in root cause corrective action to fix the problems.
Excellent. Thank you.
Thank you, Brad.
Thank you. Our next question comes from the line of Eric Stine with Craig-Hallum. Your line is now open.
Hi, everyone. Was just wondering on the guidance, the revenue range wider than normal. Just curious, is that in place? Is it all component shortages or is there some other factors that are driving that it's a $10 million range?
That's a good question. I deliberately did this because our supply situation is a little bit like what I told you. We are short of supply. We are getting good news every day. Sometimes we get some bad news every day. We thought we should guide to the right range for you, and I felt that range was $80 million-$90 million.
Okay. In terms of the 30-20-10, just doing the quick math, it looks like the midpoint or a little bit above on revenues would get you to that 10% level for op margins. Below the revenue line, can you just talk about some of the puts and takes that get you to the high end of that range?
You're right. That's exactly how we are thinking about it, too. The gross margin around that range, 32.5 is the midpoint of guidance, and the OpEx in the midpoint of guidance gets us to 30-20-10. The way I want you guys to think about 30-20-10 is that our target operating model. Sometimes we'll overshoot gross margins, sometimes we'll undershoot gross margins, and you should really go by the guidance there. That's our model. That's what we are sticking to. In terms of our OpEx, for example, we are restructuring the company to achieve 20% OpEx. What does that mean? As customers come back to us, we have a strong balance sheet. Customers are coming back to us. We are starting to grow top line. We're starting to invest in Ensemble.
We want to still be very careful on OpEx, which is why we have made the decision to have the right people at the right places, and therefore, we are shifting majority of execution teams to India and New Zealand to control costs. While we will add selected strategic talent in the U.S., India and New Zealand will be a massive base for us in terms of controlling the OpEx. That's why we are confident that 20% OpEx model is the right long-term model for us. That explains to you 30-20-10.
Yep. Okay. Thanks for that. Last one, just for Eric, just to clarify. I missed it. The milestone payment in the third quarter, the amount that was, and then is that something that you expect to get as well, a third milestone payment in the fourth?
Yes, it will be 700K.
Okay. I'm sorry, what was the 3Q number?
The 3Q, 3.3.
Okay. Thank you.
You're welcome.
Thank you. Our next question comes from the line of Philip Shen with ROTH Capital Partners. Your line is now open.
Hi, everyone. Thanks for the questions. First one's on pricing. Can you talk about how much you may be passing pricing on, how much higher is pricing in Q4 in the U.S., and then how much do you expect to raise pricing in Q1?
Phil, with regarding the tariffs, you know that we had the 10% tariff, 301 Tariffs effective September 24th. Basically, what we communicated to our customers is, we will absorb a portion of that while we will pass on a portion of that. Roughly, that is actually equal. About 3%-4% price increases to customers in Q4. Q1, we don't yet have visibility whether the tariff is going to be a 25% tariff or not. In the event it is 25%, our strategy will be very similar. We will share the cost increases with our customers.
Okay. Great. Then as it relates to the SunPower volume, you made it very clear what the revenue contribution can be in the back half next year. To what degree, how much ACM volume could you see in Q4 of this year and also in Q1? My sense is your volumes might be ramping up decently. Is it possible to share what kind of mix ACM for SunPower might be in Q4 and/or Q1? Thanks.
Yeah. Q4, we are starting to ramp. We expect volume shipments in Q4. Q1 will be a really nice ramp. I expect to get most of it in Q1, and we should complete the ramp by Q2.
Okay, great. Then as it relates to I know you can't provide guidance, in the event that we have a 25% tariff on the 301 and in the event that you raise pricing in the way that you talked about. Suffice to say, do you expect margins to be roughly in line with what you are experiencing now? Is there some degree of maybe even upside with the price increases? If you can talk about what the Q1 margin might look like or even the cadence as we go by quarter through our 2019, that would be really helpful. Thanks, Phil.
Yeah. Okay. Thank you, Phil. We don't guide to our gross margins in Q1, I will give you some color. In general, we are making a lot of progress on gross margin. We are working on costs day and night. We are working on this architectural innovation. We are working on accessories, dropping our overhead. In addition, as we transition to higher power, higher performance products, our gross margin is naturally better. We actually feel good about gross margins in Q1. Like what I said, this is the solar industry. We have 201, we have 301. I'm not sure what comes next. Obviously, we are cautious, but we really feel good about gross margins.
Okay, good. That's great color. Finally, in terms of that partner for IQ8, can you give us a little bit more information on that? I know you introduced it last quarter. When do you expect commercial business to come from this partner? Can you share more about this partner? In what country this partner might be based in? Beyond them, are there opportunities similar to them that could be in the near term, call it the next six months to one year, that could be supportive as well? Thanks.
Right. While we cannot give too many details, the opportunities are outside the U.S. That is one. The partner is currently doing field trials with our off-grid version product. We have completed all the safety certifications. We do expect a ramp in the first half of 2019, as I said. With regarding other opportunities, yes, we are bullish about other opportunities, especially in regions like where I am from. In my hometown, in my city, there is no power for eight hours a day in summer. I mean, those are the places where it can actually really help. Off-grid solar and storage will be a game changer for India as well. Of course, granted, we need to work with a partner there too. I mean, the opportunities are big there.
Great. One last follow-up on that. In terms of the ramp in the first half of next year, can you quantify that in any way? Are we talking about tens of millions or single millions?
I cannot quantify it yet, Phil. No.
Okay, great. Thanks for all the color, Badri. I'll pass it on.
Yeah, thank you.
Thank you. Our next question comes from the line of Carter Driscoll with B. Riley FBR. Your line is now open.
Good afternoon, gentlemen. Of the $10 million that you think you couldn't satisfy this quarter, do you think that was a lost opportunity that went to competitors, could have been pushed out? Then at all, if you could either qualify, if so, maybe the mix of customers that were not able to be satisfied with that, either regionally or by type?
Yeah, I mean, the $10 million was evenly spread between both long tail as well as the tier 1 customers. They are going nowhere. They are going to stick with us, and we are going to service them in Q4.
Okay. Excellent. Can you talk about, if you could quantify the kind of tariff mitigation impact from Flex in Q2 relative to your pricing strategy in 4Q and 1Q? I mean, do you anticipate you would be able to lower your prices in response to having Flex up and running, or would that be an incremental margin add?
Well, first I'll answer the question on Flex. Basically, we expect the Flex capacity to come on board in Q2 of 2019. In Q2, we expect to service 50% of the North American demand from Mexico.
Okay.
In Q3, we expect that 50% to go to 90%. We have already put the additional capacity in terms of capital. We've already invested the capital for that. With regarding your question on pricing, we are going to look at the pricing environment at that point in time, we'll make a decision that is right for our customers.
Okay. I think you guys have talked about, when you were not in as strong a financial position just a couple of years ago, that the relationships with the tier one installers was more transactional. Would you characterize it as moving towards more of a relationship, or have you achieved any of those longer-term relationships or solidified them? Is that a fair statement now, or would that be still an unfolding process?
I would say it's work in progress. The reason I say work in progress is we have started the discussions. What the tier ones love is the Ensemble product. The Ensemble Solar and Storage is a game changer for anybody. It provides a clear value proposition, AC marketplace, a complete solar and storage solution, a grid-agnostic solution, and that is difficult to get from anybody else in such an elegant form. The discussions with tier ones are progressing very well, and we'll announce more when we are ready.
Maybe just two quick ones. Do you see anyone anywhere close to, maybe not with an integrated level, but offering something similar to Ensemble at this point or in next quarter or two, even if they're trying to cobble something together?
This is Raghu. We cannot say for sure, but if you look at architecturally how we are built, it's microinverter-based, heavy on semiconductors and leveraging Moore's Law, and all of it is built around, like I said, a custom ASIC, which is a 55-nanometer technology with an Arm core embedded in each one of those ASICs. It's a very high-speed architecture that performs very complex computations, and manages this AC bus or this AC marketplace, at an extremely high rate. Architecturally, we don't know, but I think it's going to be challenging for the string inverters. However, as we get the product out into the marketplace, I think we'll know more. I just want to say that our architecture is quite unique, and it's built around semis and software, and I think that gives us some very unique capabilities, that we are leveraging to release the Ensemble technology.
Okay. Thank you, Raghu. Just last one, is there any noticeable incremental spend in S&M for the rollout of Ensemble? It's just because you're going to different geographies or there's different tapeouts to give early product to some customers or just trying to get a sense of what that might be, the OpEx line?
In general, we are adding more sales and marketing heavy hitters across the board.
Yep.
That is true in general, because as we grow our top line, as we introduce complicated products like Ensemble, it is more of a solution sell. It's more of a technical sell. We are adding heavy hitters there. I expect we will continue to add incremental talent in the sales and marketing side, but you still need to think about a long-term OpEx model at 20%.
Yep. Excellent. Okay. I'll take the rest offline. Thanks, gentlemen.
Our next question comes from the line of Amit Dayal with H.C. Wainwright. Your line is now open. Amit Dayal, your line is now open. If your line is on mute, can you please unmute your line? Our next question comes from the line of Pavel Molchanov with Raymond James. Your line is now open.
Thanks for taking the question, guys. You referenced the SunPower exemption, for the 201, My understanding is there are some additional rounds of exemptions that have yet to be granted. Is there any sense of what has been the reason why yours has not been processed to date? Is it just administrative slowness, or is there something substantive that has been impeding the process?
We don't know this, Pavel. We don't have an answer.
Okay. Any guidance on when you're anticipating or when you're being told this process will run its course?
Well, we have stopped expecting something. On the other hand, the way we are sidestepping this problem is by engaging. I mean, the partners are actually building factories in the U.S. We are sidestepping this problem, and I think it's not a big deal for us in the long term.
Okay. I hear you. Let me ask a quick one about the battery. You've been selling the kind of first-generation battery product, I think, for about two years now. With those sales having moved, I imagine, fairly slowly, what are the learnings or lessons that you've gleaned that will influence how you're gonna go about selling this integrated solution going forward?
Yeah. It's pretty simple. We have shipped over 25 megawatt hours till date on the ACB 1.0. The main target markets have been Europe as well as Australia. Let me tell you the good. It's an Enphase system, so you can expect the high quality and easy installation. It is also very highly modular. It can be scaled very easily. If you want to build a three kilowatt-hour system, you have to buy three of those, string it together, you're done. On the other hand, the negatives are two. One is we've been told that although we do value-based pricing, our prices are high. That's one. Number two is it doesn't support backup. A third one, the capacity of that system is quite low.
We are solving all of these problems, and we are basically building 10 kilowatt-hour system and a 13.2 kilowatt-hour system while still keeping the modularity of 3.3 kilowatt-hour building blocks. That's what we're doing right now.
All right. Appreciate the color, guys.
Thank you.
Thank you. Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star then one on your touchtone telephone. Thank you. This concludes our question and answer session. I would now like to turn the call back to Badri Kothandaraman for closing remarks.
Hi, thank you for joining us today and for the continued support of Enphase. I look forward to speaking with you again on our call next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.