Good day, ladies and gentlemen, and welcome to Enphase Energy's third quarter 2017 financial results conference call. At this time, all participants are on a listen-only mode. If anyone should require assistance during the call, please press star then zero on your touchtone telephone to reach an operator. Later, we will conduct a question and answer session. Instructions will follow at that time. As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Ms. Christina Carrabino. Ma'am, please go ahead.
Good afternoon. Thank you for joining us on today's conference call to discuss Enphase Energy's third quarter of 2017 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer, Bert Garcia, Chief Financial Officer, and Raghu Belur, Co-founder and Chief Product Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September thirtieth, 2017. During the course of this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to Enphase Energy's financial performance, market demands for its current and future products, advantages of its technology, and market trends. These forward-looking statements involve significant risks and uncertainties. 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 thirty-first, 2016, which is on file with the SEC. The quarterly report on Form 10-Q for the quarter ended September thirtieth, 2017, which will be filed with the SEC in the fourth quarter of 2017. 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 that certain 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 reconciliations 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, and thanks for joining us today to discuss our third quarter 2017 financial results. We had a good quarter. Our 30-20-10 transformation is going very well. We were almost breakeven in non-GAAP operating income during the third quarter, and we have stabilized our cash position. We reported revenue of $77 million for the third quarter of 2017, an increase of 3% compared to the second quarter of 2017. We shipped approximately 231 megawatts or 790,000 microinverters. Our GAAP gross margin was 21.4%, and non-GAAP gross margin was 21.8%. Our focus on operational excellence resulted in gross margin expansion, lower OPEX, and overall improvement to our financial position in the third quarter.
We are laser-focused on further gross margin improvement through supply chain optimization, new product introduction, and pricing management, and are on track to reach our 30-20-10 target operating model by the fourth quarter of 2018. Bert will go into greater detail about our financial results later in the call. Turning to our markets, the third quarter revenue in the U.S. was up 2% sequentially. We completed the transition to our IQ 6 product for our U.S. and Latin American customers during the quarter, and nearly all fourth quarter inverter shipments to these regions will be the IQ 6 product. Shipments for our AC module product also increased sequentially. In the Latin American market, the third quarter revenue was down 9% sequentially as a result of the devastating hurricane in Puerto Rico at the end of the quarter, which impacted overall shipments to the region.
We look forward to playing a key role in the future as the island rebuilds and diversifies its electrical infrastructure. Raghu, our Chief Products Officer, will provide details later in the call on a key new technology that will be central to this effort. In the APAC region, the revenue increased 35% sequentially as the demand for our products continued to grow. We established new partnerships with distributors, installers, and module manufacturers in India during the quarter, resulting in our first shipments to the region. In Europe, revenue was up 3% sequentially and 114% year-over-year. The third quarter was a record quarter for unit shipments and revenue in the region as we continued to grow our customer base. Moving on to products. We believe the IQ 6 microinverter system and our AC modules will help drive profitable growth with new and existing partners, thus increasing our share of market.
We remain focused on operational blocking and tackling to achieve this goal. With the introduction of our IQ 7 product in the first quarter of 2018, we expect to grow revenue by increasing our served available market. IQ 7 will be a single worldwide product SKU that allows us to penetrate new markets in Europe, Asia-Pacific, and Latin America, while also helping to drive gross margin expansion. In summary, we are pleased with our overall progress during the past three months. My top priorities over the next six months are to improve cash flow, further expand gross margin with the introduction of IQ 7 worldwide, and achieve sustained profitability, creating a solid financial foundation.
We will also continue to provide customers with the value, quality, and customer service they have come to expect from Enphase. With that, I would like to turn the call over to Raghu, our Chief Products Officer, to provide an expanded update on our products.
Thanks, Badri. As part of our commitment to deliver increased value to our customers, we transitioned over the past few quarters from our M-Series to our IQ Series product. IQ is an integrated solar, storage, and energy management platform that enables self-consumption and delivers a core value proposition of yielding more energy, simplifying design and installation, and improving system availability, uptime, and reliability. In addition, IQ provides advanced grid functions that are capable of meeting worldwide regulatory requirements. IQ also enables our AC module product, further simplifying the installation process, reducing installation time, and streamlining logistics. IQ 6 delivers more power and higher efficiency while further reducing the balance of system cost due to its simplified wiring, reduced size, and weight. Much of IQ 6's performance was achieved by silicon integration with our new ASIC.
With IQ 7, we will yet again offer greater power and a smaller, lighter, and easier-to-install product. What is unique about our IQ 7 is that it's a single worldwide SKU, achieved as a result of our software-defined architecture. Similar to IQ 6, we have developed a new ASIC for IQ 7 that enables greater semiconductor integration. Solar plus storage, which includes our AC battery product, is central to our product strategy. Our storage business continues to expand worldwide because of the unique features of our AC battery solution. We believe the storage market will continue to improve over the next 12 months as costs come down and as utilities better understand how to incorporate distributed storage onto the grid. Now, let me talk about our next generation IQ 8 product, expected to be introduced in 2019 based on our Always-On technology called Ensemble.
One of solar's biggest challenges is that it is grid-tied. What this means is that if the grid fails and the sun is still shining, there will be no production out of your solar system. Most customers are unaware of this limitation with today's solar technology. To address this limitation, we have invented a microinverter technology that is completely grid-agnostic. This means that even if the grid fails and there is sufficient sunlight, the Enphase system will continue to produce energy and meet the demands of the home or business. The Enphase microinverter system's capability is further enhanced when the Ensemble technology is incorporated into our AC battery storage solution. With IQ 8, you can have a system that will continuously produce energy regardless of the presence or absence of the grid. That is solar during the day and storage at night.
That is what we mean by Always-On, and it can address challenges like those experienced in Puerto Rico, other island nations, and countries with weak grids. We also believe IQ 8 will grow our total addressable market worldwide. For example, there are over 1.2 billion people with limited or no access to energy in regions such as India and Africa. IQ 8 is uniquely positioned to address the energy challenges inherent in these and other regions of the world. We'll continue to update you on IQ 8's progress over the coming quarters. I'll turn the call over to Bert for his review of our financial results.
Thanks, Raghu. I'll provide more details related to our third quarter 2017 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. Total revenue for the third quarter of 2017 was $77 million, an increase of 3% sequentially. Total net revenue per DC watt was unchanged from the prior quarter, reflecting relatively stable ASPs. On a year-over-year basis, total net revenue per DC watt decreased by 11%, directionally consistent with the broad reduction in ASPs. We shipped approximately 231 megawatts DC in the third quarter of 2017, an increase in megawatts of 3% sequentially, and a decrease in megawatts of 3% on a year-over-year basis. The megawatts shipped represented 790,000 microinverters, approximately 60% of which were our new IQ microinverter systems.
As Badri mentioned, we completed the transition to our IQ 6 product for our U.S. and Latin American customers during the third quarter. As a result, nearly all fourth quarter shipments to these regions will be our IQ 6 product. Non-inverter revenue, which includes our AC Battery storage solution, Envoy communications gateway, and all accessories, was consistent as a percentage of revenue with our prior quarter results. Non-GAAP gross margin for the third quarter of 2017 was 21.8%, compared to 18.4% in the second quarter. Non-GAAP gross margin excludes approximately $347,000 of stock-based compensation expense. The improved gross margin reflects the transition to our IQ microinverter system in North America, as well as the improvements to date that we've implemented on our supply chain optimization initiatives.
The improvement to our gross margin was slightly offset by approximately negative 1.8% related to expedite fees that we incurred as a result of industry-wide component shortages mentioned on our Q2 call. Non-GAAP operating expense decreased $865,000 sequentially from $17.8 million in Q2 to $16.9 million in Q3. Compared to the year-ago quarter, we reduced non-GAAP operating expense by 41%, or $11.7 million, reflecting the cumulative impact of restructuring actions and operational efficiencies we've implemented. Non-GAAP operating expense in the third quarter of 2017 excludes $4.1 million of restructuring charges and $1.4 million of stock-based compensation expense. On a non-GAAP basis, income from operations was essentially breakeven with a loss of $102,000, compared to an operating loss of $4 million in Q2. We're extremely pleased with the progress we've made on operating income and have increased confidence in our ability to achieve non-GAAP operating profitability in the fourth quarter.
Our non-GAAP net loss was $964,000, resulting in a loss of $0.01 per share, compared to a net loss of $6.6 million in Q2, or a loss of $0.08 per share. Turning to the balance sheet. Inventory levels were $25.3 million for the third quarter, compared to $20.8 million in the second quarter and $39.1 million in the year-ago quarter. Inventory levels increased from the second quarter, primarily a result of the timing of shipments. We exited the quarter with a total cash balance of $28.9 million, a slight decrease from the Q2 balance. We expect to be cash flow positive in the fourth quarter. Let's look at our outlook for the fourth quarter of 2017. We expect our revenue for the fourth quarter of 2017 to be within a range of $72 million-$80 million.
Turning to margins, we expect GAAP and non-GAAP gross margin to be within a range of 21.5%-24.5%. Note that our Q4 gross margin guidance includes the negative impact of higher expedite fees resulting from industry-wide component shortages. Non-GAAP gross margin excludes approximately $300,000 of stock-based compensation expense. We expect our GAAP operating expense for the fourth quarter to be within a range of $19.5 million-$21.5 million and non-GAAP operating expense to be within a range of $16 million-$18 million, excluding an estimated $1.4 million of stock-based compensation expense and approximately $2.1 million of additional restructuring expense. I'll note that we do not expect to incur significant restructuring expense beyond the fourth quarter. At the midpoint of our guidance range, we expect to be profitable on a non-GAAP operating income basis in Q4. I'll open up the line for questions.
Ladies and gentlemen, if you'd like to ask a question at this time, please press the star then the number 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, you may do so by pressing the pound key. Again, if you'd like to ask a question at this time, that's star then 1. Our first question comes from the line of Eric Stine with Craig-Hallum. Your line is now open.
Hi, everyone. Thanks for taking the question, or the questions. Maybe just starting with the AC modules. Maybe just some commentary on early returns. Are you still targeting an additional module partner by the end of the year?
Let me give you some color on AC modules. This is Badri. We started shipping AC modules to LG in the second quarter of 2017. We said in the June Analyst Day presentation that we shipped about 18,000 units to LG. Our shipments increased sequentially in Q3 of 2017. LG, as you know, introduced the IQ 6+ NeON AC module in July. That product is making its way through the channel now. It's too early to say, we've done a lot of interviews with the installers, and those interviews have been very encouraging. There is clear savings on installation time, as well as streamlined logistics on the ACM. We announced the Jinko Eagle and IQ 6 AC module at SPI, and we expect to start shipping that shortly. We also announced Waaree, a module partner in India.
We are working with a few other partners as well and will announce when we are ready.
Sticking with India, with Waaree, is that a little bit different version? What you're able to talk about, is that a little different version or scaled-down version versus LG or Jinko? If so, is that something that you're working to replicate with other partners in different markets?
No, it's not a scaled down or a different version. We have a AC module product strategy, and it is in line with all the other partners as well. The only difference being LG would be is a 60-cell module, Waaree will be a 72-cell module because in India, primarily the market segment is 72. What's really good is that the IQ 6+ and the IQ 7+, the same product works on both 60-cell and 72-cell modules.
Got it. Okay. Thanks for that color. Maybe last question from me, just an update on installer trends. You mentioned the good feedback you're getting early with LG. Clearly things move into tier 2 and tier 3 installers. Just any thoughts or color there would be helpful. Thanks a lot.
Yeah, we are continuing to reach out to all the installers who have either done the installs as well as we are on road shows collecting data, the feedback has been pretty consistent. The value is there. There's install time value, logistics value, the good matching between the power production because of the inverter and the module being closely matched. Qualitatively speaking, good quality install as well because it's a very fast and very clean install. A lot of outreach is going on. We're on the road right now, showing it to a number of the tier, the long-tail installers as well. The feedback's been good.
Just market share there, I mean just overall share with tier 2 and tier 3. Any thoughts on how that's trended? I know you gave an update at the Analyst Day, maybe anything that might be refreshed from over the last couple of months?
No, it's too early to tell at this time.
Okay. Thank you.
Our next question comes from the line of Bradford Meikle with Coker Palmer. Your line is now open.
Hey, guys. Good afternoon. First question is, do you think that the revenues you were able to achieve this quarter were limited by the 201 case impact, which has increased module prices and made them more scarce in some cases, and also due to the component shortages that you've had?
Hey, Brad. No, I think there's been, as everybody can understand, a lot of concern around the 201 case. As I think everybody saw, the preliminary recommendations that were made were certainly less punitive than I think everybody was expecting. That's good news. That said, looking at the third quarter, we really didn't see any impact related to 201 in terms of revenue shipments. The second part of your question was.
Component shortages
Component shortages?
Yeah, I'll take that.
If revenue is limited, we're limited by component availability, yeah.
Brad, the revenue was not limited by component shortages, but the gross margin was limited. As we noted, the Q3 gross margin was negatively impacted by about 1.8%, resulting from expedite fees. Those expedite fees were a result of us having to do air ships compared to ocean ships. In Q4 2017, we still see continued pressure on memories and high voltage FETs, and that's why we said we expect to incur expedite fees in Q4 2017 as well. We are putting in some business processes in place, like qualifying multiple sources as mitigation actions, but we really need the supply situation to improve. At this point, we see the situation persisting into the first half of 2018.
Yeah. It sounds like lead times are coming down already for the FETs. On the IQ 7, what portion of the market would you say is high voltage modules that had not really been suitably served by your power rating on the M280 or the IQ 6? Like how much more of the market does it open up to you?
Sure. Hey, thanks, Brad. This is Raghu. One of the nice things about, again, the IQ 7 being a universal platform, almost like a worldwide SKU, is that it does open up the market for the 96-cell module as well. There are a couple of players who are doing 96-cell modules as well. Panasonic has now entered the market with a 96-cell product. We already know there's another player here locally who's also a 96-cell product, the IQ 7 does open up those markets for us as well from a technology point of view.
Yeah. I think it's about a 1/4 or a 1/3 of the U.S. residential market probably. Is that right?
Yeah, probably a little bit of that order or a little bit less actually.
Okay. This is the last question. Thanks for the time. On the IQ8, could you talk a little bit more about the types of companies that are currently serving this market? I've read about a half dozen that are well capitalized in Africa, doing small one-panel installations that enable light, and some articles have talked about AC output enabling air conditioning and refrigeration, which is limited by the current DC output. Would love to hear any more about the dynamics of what you see out there in that market.
I think it's Africa and it's also India as well. I think there are a number of players. The go-to-market is the problem that needs to be solved there. I think we have solved the technology problem. Clearly we have seen this, that both in Africa and in India, there are a number of companies that are working on the go-to-market problem and have had varying degrees of success there. Yes, there are a number of companies that are out there. We are not making any announcements at this time.
All right. Thank you.
Our next question comes from the line of Philip Shen with Roth Capital Partners. Your line is now open.
Hey, guys. Thanks for the questions. First one here is on the IQ 7. I think in your release you talked about getting that out there in Q1 2018. What do you expect the mix of IQ 6 and 7 to be starting Q1 2018, and how do you expect that mix to trend as we go through 2018?
Just to give you some color on IQ 6, the IQ 6 transition took us three quarters to complete. We expect the IQ 7 transition to take us similar time, maybe a little bit lesser. A new product transition, as you know, is always tough to predict, but we are doing a lot of detailed planning to counter surprises. Having said that, the IQ 7 platform uses the same balance of system as IQ 6, so that'll make it a little bit easier. Also one more thing is the transitioning, for example, IQ 7 to North American customers is going to be easier than transitioning worldwide. I expect that to be done faster, maybe in a couple of quarters, compared to worldwide, that might take full three quarters timeframe. More to come there, but we are doing a lot of detailed planning.
Good. Thanks, Badri. If you can remind us or update us on what kind of margin benefits we should see as you fully transition from IQ 6 to IQ 7.
Right. As I told you, we are focused on building a healthy financial foundation. We are laser-focused on gross margin and operational excellence leading to profitability. We told you that we will reach the 30-20-10 target operating model by Q4 of 2018, and we are on track to do so. The 30-20-10 stands for 30% gross margin, 20% OPEX, and 10% operating income. The IQ 7 transition will not only help in improving gross margin but will also help to expand the served available market into more regions in Europe and Asia Pacific to increase the top line. We also see the ACM as an important driver of the IQ 7 platform. With the IQ 7, with all the supply chain optimizations that we are doing, we expect to reach our target operating model by the timeframe that we said, which is Q4 of 2018.
Okay. Great. Moving the question to the top line a bit. I think your blended ASP decline in the quarter was roughly 12% year-over-year. Do you continue to expect that rate of decline? I think that was for Q3. Do you continue to expect that for Q4? What are you seeing now for Q1, and what do you expect for 2018?
Well, for 2018, we have a number of factors. I'll come to that later. For Q4, I see the pricing pretty stable at about 2% erosion a quarter. In 2018, I have a couple of factors which could contribute to the pricing environment. One is the Suniva trade case. We all don't know what the final outcome is going to be in January. That could influence that. The second one is the potential Huawei entry in middle of 2018. If I pretend that those two were not there, I expect a pretty stable pricing environment. Yeah, similar to 2017.
Okay. Good. Finally, as it relates to your non-GAAP profitability, it sounds like you're on track for Q4. I know you haven't provided guidance for 2018. Do all signs kind of give you a sense that you can maintain that through 2018, and what are the puts and takes? Maybe you just mentioned a couple with the 201 and Huawei. How are you thinking about profitability as we go through 2018?
Yeah. Hey, Phil, it's Bert. You're right, that we did signal non-GAAP profitability at the midpoint of the range for the fourth quarter. If we transition out into 2018, you're right, we don't provide guidance out that far. Clearly the work we've done to date to restructure has began to yield significant benefits for us. If we think about the transition to IQ 7, that's certainly going to continue to help, not only margin expansion, but also help grow the top line. As Badri mentioned, IQ 7 does open up a couple of new markets for us, and that's certainly helpful. Bear in mind, a lot of the work that we've done around restructuring, even here in the tail end of 2017, will continue to bear fruit out into 2018. It's more of a process, not an event, so to speak.
We do expect to continue to see benefit from our broad supply chain optimization and our focus on operational excellence also continue to help move margins and profitability along in 2018.
Great. Thanks, Bert. I'll pass it on.
Okay.
Our next question comes from the line of Edwin Mok with Needham & Company. Your line is now open.
Great. Thanks for taking my question. First, just in terms of the 4Q guidance, can you talk a little bit about puts and takes on that? It seems like you're going flattish, right? Is it mostly just seasonality in the fourth quarter, or do you see the market recovering after this 201 is settled? Do you have any color on that?
I think what you're seeing in our guidance really is us holding share. The way we're thinking about it, but more importantly, what you're seeing, Edwin, is some pricing discipline. We're being very disciplined on pricing, optimizing for profitability, if you will. That is, of course, reflected in our top-line guidance. In terms of puts and takes, again, as I mentioned to Brad, we're not seeing any impact from Suniva on our top line, and that's not really a factor in our guidance. It really is a factor of us holding share and being disciplined on pricing.
Okay, that's helpful. Then maybe talk about gross margin. Given that you have this exit fee continuing to happen because of the shortage, right, how much impact have you factored that into your gross margin guidance? Do you have any kind of view when we should start to have this stabilize and you can stop paying this fee?
Yep. Just to level set and anchor you back on Q3, was about 1.8% negative impact on Q3. We expect somewhere between 1% and 2% in Q4. Then expect to start seeing it tailing off into 2018. It's a little early in these things. It's not entirely within our control, but our best guess right now is that we'll start to see a tailing off of that impact in Q1.
Okay, that's helpful. I guess I'll stick with you, Bert. I saw that the balance sheet receivable has been going up, and then I think payable has also gone up a lot this quarter, right? Do you expect those to normalize as you go to fourth quarter, or would that take some time?
Yeah. Yes, we do expect them to normalize, and they are somewhat related. On the receivables line, it was really impacted by the linearity of sales in Q3 relative to Q2. That's really what drove the increase there. On the AP side, it was actually related to inventory. We had some late receipts of inventory in September. That's reflected in the increase sequentially in inventory. It's also in our AP. The other thing that's in our AP line that's beyond the inventory, and it's really part of the work that we've been doing on supply chain optimization and working capital management, in particular inventory management, is working with our vendors to get gentler terms, and you see some of that in our AP in Q3. Just a slight improvement in AP terms.
Okay, great. One last question I have. On IQ 7, I think you mentioned 1Q, you start to launch that, and you mentioned it will penetrate some new markets. Is it just the kind of software feature allow you to have all these great interface for different regions of the world? Or what allows you to penetrate these new markets? I noticed that Japan is not mentioned there. Where do we stand on Japan?
Yes, this is Raghu. The architecture is such that, as you know, it's a digital architecture. It's a piece of power electronics, not a big box power. We are built around an ASIC. It is a completely software-defined device that allows us to configure them based on the geography that you're in to meet the interconnection requirements and the regulatory requirements. That's correct. Of course, right now we are focused on IQ 7 is our SAM expansion plan, and Japan is on the roadmap. We are not exactly talking today about the timing on that, but it does open up. As I said, it's a worldwide SKU that is capable of being configured for virtually all the geographies. We're going to be attacking more geographies over time.
Do you see IQ 7 accelerate ACM adoption, or are those mutually exclusive?
Oh, no, absolutely. IQ 7 is, again, much smaller, much lower profile. It's actually been designed and architected with the ACM in mind because ACM is absolutely a very key strategy for us. Yes, it does, in fact, accelerate ACM and accelerate new partners as well.
Great. That's all I have. Thank you. Appreciate it.
As a reminder, ladies and gentlemen, if you'd like to ask a question at this time, that's star then one. In the interest of preventing background noise, we ask that you mute yourself while receiving your answers. Our next question comes from the line of Colin Rusch with Oppenheimer. Your line is now open.
Thanks so much. Guys, can you talk a little bit about the pricing dynamics on a regional basis? It looks like you're flat quarter-over-quarter, with the growth in Asia, is that offsetting some price pressure in other geographies?
With regarding the pricing environment, like what I said, we see pricing pretty stable at about 2% erosion quarter-on-quarter. If you ask me what it was for 2017, it was about 7%-10%. Okay?
Okay. You're seeing that 2% across the board.
Right
Regardless of regions. Okay.
Yes.
With the working capital dynamics, as you guys get into a more robust financial position and operational cash flow, are you seeing opportunities to go back to your suppliers and get better terms and support some of the balance sheet with longer payment terms on the payables line?
Yeah. In fact, I just mentioned with the last caller that one of the things that's driving AP up a little bit sequentially are those better terms. You're hitting on something that's really important, Colin, which is, as our financial performance improves, naturally my cost of capital comes down. I expect to see that reflected in terms not only with my vendors but also with our lender. We're excited about the opportunity to go back and recast some of those relationships in a more positive light.
Okay. The last question from me is really about the warranty obligations. They haven't really moved much here for a little while, and obviously, you've got growing sales. Can you talk a little bit about some of the reliability data that you're seeing and how those things are rolling off for you guys in terms of the forward risk?
Sure. I can handle both of those here. I may ask Raghu to weigh in a little bit on the reliability piece, but let's just take them in reverse order. On the reliability piece, we're seeing tremendous reliability returns from our most current product. It's really performing very well. The reliability is very high, and as a result, the returns are understandably low. From a warranty perspective, bear in mind, you're right, our install base is growing, but we are relieving the warranty liability as we build it. What you're seeing is really the netting of those two things over time. Again, as we ship more units into the install base, the warranty liability would go up. As we settle the warranty obligations for a large and growing install base, you'd see that liability come down.
Colin, from a product point of view, what's core to our product strategy is semiconductor integration. Every generation of product from the M-Series to IQ 6 to IQ 7, we have a new ASIC in there, a new chip in there. What that chip does is more and more integration to went from 1.8 million gates, 2.8 to 3.8 million gates now with the IQ 7. More integration means just better reliability because you have got fewer and fewer components on it. Internally, all our testing just gets more sophisticated over time. The data that comes back from the field, as you know, all our systems are connected, so we get very high-quality data from the field on how our systems are performing. All of that informs the quality and reliability of our product.
The combination of a semiconductor strategy, which is core to Enphase, coupled with all of the feedback that we get from the field, just creates this nice virtuous cycle that's really of having a digital architecture in power electronics.
Great. Thanks so much, guys. I'll hop back in queue.
As a reminder, ladies and gentlemen, we ask that you mute yourself when receiving your answers from the speakers to avoid background noise. Our next question comes from the line of Pavel Molchanov with Raymond James. Your line is now open.
Thanks for taking the question, guys. Given that Jinko and a few other Chinese companies, as your partners, do not have manufacturing assets in the U.S. currently, would anything change in your relationship depending on how the tariff decision ends up coming out?
No, we don't expect any significant change there. Again, as far as tariff's concerned, it's on the module. We don't know all the details as yet, but our expectation is that it won't change. Second is, we also think about ACM as a worldwide SKU. It's not just simply a North American SKU alone. Coupled with the fact that IQ 7 is a worldwide product and it's going to also inherit the ACM, we think that the risk is low or manageable.
Okay. There was a comment you guys made earlier about the percentage of non-inverter revenue remaining stable quarter-over-quarter, if I heard that correctly. Will that percentage, in theory, increase over time, particularly as battery sales become more meaningful? Should it be increasing?
Yeah. That's very intuitive. It should. You're right. As ACM becomes a larger and larger portion of our mix, it would be an increasing portion of that non-inverter revenue mix. That's right.
All right. [inaudible], appreciate it.
Thanks, Pavel.
As a reminder, ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number 1 key on your touchtone telephone. Our next question comes from the line of Vishal Shah with Deutsche Bank. Your line is now open.
Hi. Thanks for taking my question. Just a couple of questions on the pricing environment and the competitive environment. You mentioned stable pricing in the near term. What are your conversations with your customers suggesting as for its pricing is going to be in the next quarter or 2, and what kind of seasonality are you seeing in the business? You mentioned Huawei is rolling out product in the second half of 2018. What's the initial feedback you're hearing from the field on that product from your customers? Thank you.
As I talked about, the pricing environment has been pretty stable. It's at about 2% erosion per quarter. For the entire year, we have been at about 7%-10%. Coming to 2018, there are two factors, like what I said again. Suniva, as well as potential Huawei entry. In the case of Suniva, the final outcome is not yet out. After that, we'll be able to see what happens. In the case of Huawei, we don't even understand what their product is yet. Once that is announced, we can react better. Let me give you some color on our pricing management. The way we think about pricing is by doing value-based pricing. What do you mean by value-based pricing? We take the next best alternative, which is offered by our competition, and then we think about what value does our product offer
Compared to the next best alternative. For example, in ACM, it is installation time saving, it is streamlined logistics, it is improved quality, it is enhanced power production. We say, "Here is the value we ascribe to that," and we tell the customers that, "Look, we'll share some of that value with you." We do this transactional discussion with every one of our customers. This is transactional pricing, which means it's literally hundreds of line items every quarter. In some cases, if the customer doesn't see the value, then we go and look at what we should do on that case. There are literally a lot of cases like that. It is a process. It is not an event. We are getting better at it.
Pricing management is key for us to improve our gross margin and to reach our 30-20-10 operating model by Q4 of 2018.
That's helpful. Just a follow-up on the first quarter outlook. Are you seeing a slowdown as the normal seasonality would suggest? Or you think the first quarter this year would be, or next quarter actually would be different, considering some of the 201 dynamics? Thank you.
Vishal, we don't guide beyond the current quarter. There's no reason to believe that normal seasonality patterns aren't going to hold and are likely not going to be necessarily impacted by Suniva.
Okay, great. Thank you.
All right.
As a reminder, ladies and gentlemen, if you'd like to ask a question at this time, that's star then one. I'm showing no further questions in queue at this time. I'd like to turn the call back to Badri Kothandaraman for any closing remarks.
Yeah. Thank you for joining us today. We are extremely pleased with our progress in the third quarter towards our 30-20-10 target operating model. We look forward to speaking with you again on our call next quarter.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.