Good day, ladies and gentlemen, and welcome to the Enphase Energy Second Quarter 2016 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 be given at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host for today, Christina Carabino.
You may begin.
Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's 2nd quarter 2016 results. On today's call are Paul Nahee, Enphase Energy's President and Chief Executive Officer and Chris Sendesall, Chief Financial Officer. After the market closed today, Enphase issued a press release announcing the results for its Q2 ended June 30, 2016. 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 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 ks for the year ended December 31, 2015, and in Enphase Energy's quarterly report on Form 10 Q for the quarter ended June 30, 2016,
which will
be filed with the SEC in the Q3 of 2016. 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 certain financial measures used on this call are expressed on a non GAAP basis 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. Now, I'd like to introduce Paul Nahee, President and Chief Executive Officer of Enphase Energy.
Paul?
Good afternoon, and thanks for joining us today to discuss our Q2 2016 financial results. We reported revenue of $79,200,000 for the Q2 of 2016. We shipped 186 Megawatts or 796,000 microinverters, a 30% sequential increase. Competitive pricing and the introduction of our home energy solution are driving multiple customer wins and significantly increasing our global market share. At competitive pricing, we've been very successful in winning new customers based on our simplicity, quality and rich feature set.
There are currently more than 500,000 Enphase systems deployed in over 100 countries. Since inception, we've shipped approximately 12,000,000 microinverters, representing more than 3 gigawatts of installed generating capacity. Enphase systems have produced over 6 terawatt hours of clean energy. In the U. S.
Market, 2nd quarter revenue rose 20% sequentially as strong demand for our energy systems increased our share with existing customers and expanded our customer base. Our installer acquisition strategy continued to deliver results with multiple new wins, including 8 new installers that combined represent 70 megawatts of new business over the next 12 months. Our microinverter solution continues to gain interest from new and existing customers because we enabled a lower cost solar system while providing the highest quality and most advanced features and functionality. We address the need to reduce costs in 3 ways. 1st, by providing a competitively priced microinverter system.
2nd, our technology enables installers to reduce their operating costs by simplifying design, installation and inventory management. In addition, our forthcoming AC module and next generation AC combiner box will provide further simplicity. 3rd, our superior communications technology allows the installer to quickly and accurately determine the health of the solar system, reducing time and effort for operations and maintenance. As to features and functionality, we continue to rapidly innovate. We're focused on providing our installer partners with a more compelling sales proposition and the consumer with exciting new solutions such as a fully integrated energy system, seamlessly combining solar generation, storage, load control, consumption monitoring and an energy management system that ensures the best consumer experience with the highest possible return on investment.
Importantly, we're the gold standard for quality and our newest microinverters are the highest quality and most reliable we've ever built. And the pace of innovation is accelerating. In addition to supporting our partners and consumers with new technology, we're also working closely with several utilities. We recently announced a program with PG and E in California to integrate and optimize smart microinverters into the grid. PG and E will evaluate how smart microinverters from Enphase used with distributed solar can be coordinated and controlled for grid management and voltage optimization.
In fact, we've already been working with other utilities to integrate our smart inverters and to help transform distributed energy resources into grid assets. We see utility integration as an ongoing service opportunity that we can address with our Enlighten platform. Ultimately, cost effective smart inverter integration will enable faster and wider deployment of solar. We're excited to work with PG and E and believe that as an energy technology provider, we are uniquely positioned to support the requirements. Unique value proposition as well as the superior quality and reliability of our energy system resonates with customers globally.
In Europe, revenue was up 48% sequentially as we continued to gain share, especially in France and the Netherlands. During the Q2, we expanded our distribution channel and our business with several major residential installers, including 4 key distribution partners who will further strengthen Enphase's operations and influence in the Benelux region. We were pleased to receive the top PV brand seal of approval from EUPD Research for commendable brand management and brand awareness amongst installers and solar professionals in the Netherlands. The award of this respected industry seal offers more confirmation of Enphase's commitment to product innovation, quality and technology leadership. Latin America is another region where we're seeing tremendous growth in solar adoption and the Entei system.
The region's high energy prices, solar friendly weather and the increasing need for energy resource diversification is helping fuel this growth. In Australia, revenue was up 43% sequentially, continued to gain share in this market. We look forward to the launch of our AC battery storage solution in Australia and New Zealand with volume shipments starting in a couple of weeks. In fact, we've already had multiple beta sites up and running for some time and the response to our solution has been extremely encouraging. A strong solar and storage market combined with our formidable presence and growing market share make Australia a perfect location for the global launch of our AC battery, storage and home energy solution.
Our partner network of more than 1,000 installers located in the region will be the 1st in the world to have access to the Enphase AC battery. We expect initial demand to be driven by installers looking to retrofit existing residential solar PV systems with a storage solution as well as new system owners seeking a cost effective energy solution that will support local regulatory requirements. We believe that with our AC coupled architecture, we are uniquely suited to support both of these markets. The Enphase AC battery storage solution has been very well received in the Australian market because of its elegance, simplicity, modularity with our 1.2 kilowatt hour building blocks, ease of design and installation and overall performance and architecture. In fact, a complete 4.8 kilowatt hour solution can be installed in less than 1 hour by just one technician in any retrofit or new installation.
We believe this represents an unprecedented standard in installation simplicity compared to any competitive product on the market. And this is made possible only because of our latest microinverter technology. Installers have placed preorders with our key distributors in Australia and New Zealand for over 60,000 Enphase AC batteries for delivery in the next 12 months. After the initial launch in Australia, we plan to bring the storage solution to the U. S.
Starting in Hawaii and Europe with first shipments to both markets expected by the end of 2016. We continue to make great progress on our cost reduction roadmap and the development of our complete home energy solution, Our 6th generation microinverter with higher performance and new advanced features is on track to meet our aggressive cost target by the end of this year. In addition, cost reduction activities are well underway for 2017 and we're on track to meet next year's cost targets as well. Enphase has been executing on an effective business strategy detailed last year, regaining market share by offering competitive pricing enabled by aggressive cost reduction and providing a richer, more comprehensive energy solution for our customers. In fact, we believe the company has a clear path to develop the world's only fully integrated solar, storage and energy management solution.
We're seeing significant market share growth in almost every geography in which we participate, including the U. S, Mexico, Puerto Rico, Latin America, Europe, especially in France, the Netherlands and Switzerland, Australia and New Zealand. Our success in these regions gives us further confidence in our strategy. As for pricing, we currently believe prices will generally stabilize throughout the remainder of this year. However, we'll continue to monitor the market.
I'll close my comments by noting we are encouraged by our sequential growth and market share gains worldwide. We're excited about the many opportunities ahead, including the upcoming launch of our AC battery storage solution. Now I'll turn it over to Chris for his review of our financial results.
Thank you, Paul. I will provide some more details related to our Q2 2016 financial results as well as our business outlook for the Q3 of 2016. Total revenue for the Q2 of 2016 was $79,200,000 in line with the business outlook we provided last quarter and an increase of 24% sequentially. We shipped 186 Megawatts AC or approximately 2 19 Megawatts DC during the Q2 of 2016, an increase of 30% compared to the Q1 of 2016. The megawatts shipped represented 796,000 microinverters, all of which were our 4th and 5th generation microinverter systems.
GAAP gross margin for the Q2 of 2016 was 17.9% and non GAAP gross margin was 18.2%, approximately flat compared to the Q1 of 2016. As previously discussed, we have adopted a more competitive pricing strategy ahead of product cost reductions. As we continue to execute on our cost reduction road map and as year over year price erosion returns to historical levels, we expect to see gradual improvements in gross margins going forward. GAAP operating expenses during the Q2 of 2016 were $29,900,000 and non GAAP operating expenses were $27,500,000 which excluded $2,400,000 of stock based compensation expense. During the Q2 of 2016, R and D expenses on a non GAAP basis were $12,100,000 sales and marketing expense were $9,400,000 and G and A expenses were $6,000,000 We reported GAAP operating loss of $15,800,000 and a net loss of $16,700,000 in the Q2 of 2016, resulting in a loss of $0.36 per share.
On a non GAAP basis, operating loss was $13,000,000 and net loss was $13,900,000 resulting in a loss of $0.30 per share. Turning to the balance sheet and cash flow. During the Q2, we improved our cash flow and reduced inventory levels substantially, resulting in $7,300,000 of positive cash flow from operations. Inventory decreased from $45,600,000 at the end of the first quarter to $39,300,000 at the end of the second quarter. Capital expenditures during the second quarter were $4,800,000 We started the 2nd quarter with $13,000,000 in cash and $20,000,000 draw on our credit facility.
During the quarter, we paid down $7,500,000 on the credit facility and ended the quarter with $8,200,000 of cash and $12,500,000 draw on the credit facility. Cash net of borrowings increased by $2,700,000 sequentially. To facilitate our continued growth, we entered into a term loan agreement on July 8 and borrowed $25,000,000 that was fully drawn upon closing. The 2nd lien term loan facility has a term of 4 years with interest only during the 1st year and monthly repayments in equal installments during the last 3 years. Terms and conditions are in line with the market for this type of facility.
There are no warrants preferred for common shares or other equity rights given with this facility. We believe our current cash balance as well as the cash available through our working capital facility and debt financing is sufficient to fund the growth of our business. Now let's discuss our outlook for the Q3 of 2016. We expect revenue for the Q3 of 2016 to be within a range of $87,000,000 to $93,000,000 as we continue to see the expansion of our business with wins at new and existing customers worldwide and include some incremental revenue from our AC battery storage solution. We expect GAAP and non GAAP gross margin to be within a range of 17% to 20%.
Non GAAP gross margin excludes approximately $300,000 of stock based compensation expense. We also expect GAAP operating expense for the Q3 of 2016 to be within a range of $30,000,000 to $32,000,000 and non GAAP operating expenses to be within a range of $27,000,000 to $29,000,000 which excludes approximately $3,000,000 of stock based compensation expense. Now I will open the line for questions.
Thank you. And our first question comes from Edwin Mok from Needham. Your line is now open.
Hey guys, thanks for taking my question. Congrats on a good quarter. So first question I have, Paul, you mentioned a few international areas where you guys see really strong growth. I think you said you grew 48 percent sequentially. I was wondering how much international aggregate is now as a percentage of total sales?
And with these kind of stronger growth, do you think it's sustainable that this growth rate can extend into the second half of the year?
So international markets represent approximately 15% of our total revenue. While they are growing very dramatically, it's also true that the U. S. Market is growing. So it makes it a little bit difficult to sort of catch up and get ahead.
However, we still maintain our view that we expect the international markets to be a larger portion of our total revenue than they are today. In reference to the ability to maintain the rate of growth in those markets, it's a little hard to say, and it's going to be a little bit complicated by the fact that in several of these markets, specifically in the Asia Pacific region and in Europe, we're going to start introducing the AC battery storage solution and the total energy management solution. That will obviously have a positive effect on revenue and it's going to I think distort the total revenue relative to the U. S. Market.
But I do believe that we are going to be to continue growing share in all these international markets, both this year as well as next.
Okay. That's helpful. So maybe shifting gears to the U. S. Market, we've seen, I guess, more talks at least about kind of really low cost, low end or lower pricing Chinese company entering kind of smaller scale side of the market.
We've already seen them go in the utility side. I was just wondering, how is the environment like? I think you mentioned on the call that you see pricing being more stable. With these Chinese entering, are you seeing that starting to have an effect? And also, kind of in terms of a market push towards more rapid shutdown in several states, does that help you guys?
Because obviously, they were higher costs. So if you can kind of give some color on that.
Sure. So, you bring up
a very good point. With rapid shutdown, it does certainly change the equation, in part because it does increase the cost of a string inverter. And also it requires that now there are electronics put on a roof and that has its own complications. Clearly, Enphase is very experienced with this, with our warranty and our quality, but I can tell you from experience that getting the kind of quality that you need to have something sit on a roof for multiple years in very adverse conditions is extremely challenging. And that now represents a single point of failure for the string inverter.
So I think it's going to add both cost and complexity to those designs. In reference to whether we are seeing those the low cost offshore string inverters in the current U. S. Marketplace, I think it's important to keep in mind that they have been here in one form or another for many years now and we haven't seen them take a very large foothold in the residential market. We're not seeing that change that dramatically today, that dramatically if at all.
However, we're keeping a very close eye on it and we'll monitor it very tightly. But as of today, we're not seeing that.
Okay, that's helpful. Last question, I guess, I have for Chris. Just talk a little bit about your capital structure. You talked about kind of new term loan, which obviously give you guys more capital to work with. But in terms of working capital, this quarter you guys have working capital improvement.
Do you expect that you have to kind of build back up inventory for a second half ramp? And is there more room you can work that down? I also noticed payables quite a bit. Is that kind of the high end of where you can bring payables or do you think you can extend that?
Yes. So first of all, I'm pleased with the fact that we generated $7,300,000 of positive cash flow from operations during the Q2. In big part, that was driven by a drastic reduction of inventory of approximately $6,000,000 I do believe that we can continue to further improve our inventory turns and actually further reduce inventory levels in absolute dollars as well, at least in the next couple of quarters. Of course, as the business continues to grow multiple quarters out there, there will eventually be an increase in absolute dollars of inventory levels, but still improvement in terms of inventory turns. Turning to the payables, keep in mind that Q2 volume in megawatts or unit shipments was up 30% sequentially.
And so as a result of that, you do see somewhat of an increase in the payables as well, although slightly more than 30%. And that has to do with some of the timing of the payments of certain of those vendors. Overall, I feel comfortable with the balance sheet as it is right now. As you know, we ended with $8,200,000 of cash on the balance sheet. We have our working capital facility with Wells, which is a up to $50,000,000 working capital facility with a $25,000,000 accordion feature on top of that.
And then after closing of the quarter, we added $25,000,000 of cash to the balance sheet with the term debt facility that we entered into.
Okay, great. Can I just squeeze one more in? I noticed that gross margin declined 60 basis points sequentially, but your blended ASP only down 5%. Is that something to do with the mix of kind of inverter versus auxiliary products, any kind of color you can provide on that?
No, the mix was relatively stable between inverter and accessories for the last three quarters in a row. We did see a little bit of a shift back to the $215,000,000 instead of the $250,000,000 And so there was a little bit of a mix shift there that was putting some pressure on the margins. But I would say in general, the margins have bottomed out in the high teens, 18, 18.2 going forward as we execute on our product cost reduction roadmap. And of course, depending on where pricing will go, but we do definitely see a little bit of a slowdown in terms of year over year price erosion. And so when you combine that, we do expect some gradual improvements on the margins in the next couple of quarters.
Great. Very good color. That's all I have. Thank you.
Thank you. And our next question comes from Philip Shen from ROTH Capital Partners. Your line is now
I'd like to follow-up on a topic you just mentioned, Chris. You mentioned that the mix of M215s was greater in the quarter. There appears to be a strong trend in the industry where installers and developers are demanding higher powered panels, and the premiums required in those panels are coming down. Do you expect on a go forward basis a greater demand for the M250? Can you share what the mix of 250s versus 250s was in Q2 and then perhaps how that might trend in Q3 and Q4?
Right. And definitely over the last couple of quarters, we have seen a shift from the 215 to the 250. I believe it was roughly fifty-fifty. And going forward, we definitely continue to see that shift to higher power modules being paired with higher power microinverters. Due to some customer mix and other shifts in Q2, the mix shifted slightly more towards 215, but I do not believe that this is a trend.
On the contrary, I think the trend is definitely a shift towards higher power modules and higher power microinverters in the next couple of quarters.
Great. Could we see eightytwenty or something that start as soon as the next couple of quarters? Or do
you think it will be a
more leisurely or slower pace?
So I don't think it's going to be Phil, this is Paul. I don't think it's going to be that dramatic, that fast. What we completely agree with your comment and are seeing both from the suppliers more higher power modules and more of a demand for higher power modules from the installers. However, these transitions can take a little bit of time. So I would caution against assuming too rapid a shift.
But if you look at our next generation microinverter, which is coming out end of this year, early next, that will yet again even higher power to support the even larger modules that are coming out. So I think certainly over the next number of quarters, we're going to see a shift, a fairly dramatic shift away from the lower power inverters to the higher power inverters.
Great. Thanks, Paul. Chris, you mentioned earlier that you expect inventory turns and the absolute dollars to come down over the next couple of quarters. Any way you can quantify that at all?
No. So in Q2, it was a reduction of $6,000,000 Over the next couple of quarters, we're looking at $1,000,000 or $2,000,000 per quarter.
Okay. Good. That's helpful. And with the new term loan, your interest expense on an annualized basis should be now closer to $4 plus 1,000,000 Can you talk about what kind of operating cash flow we should see in Q3 and Q4?
So the interest is not $4,000,000 a quarter, right? Did you say $4,000,000 a quarter?
If I said that, I meant $4,000,000 a year.
Right, right. So yes, so we obviously have dialed in interest. By the way, the term loan 1st year, it's interest only. And then in the last 3 years, it's a straight amortization and equal installments. So that obviously is all dialed in into our cash flow.
Great. And then what kind of operating cash flows could we see in Q3 and Q4?
So again, we were pleased with the fact that we generated cash in the second quarter, in part, of course, because of the inventory reduction of approximately $6,000,000 So when I look at the second half of 2016, we are not going to repeat $6,000,000 per quarter inventory reduction. So it's going to be less than that $1,000,000 or $2,000,000 a quarter as I indicated. As a result of that, there is still going to be cash burn in the second half of twenty sixteen. Although when I look then to the Q1 of 2017, in part due to the seasonality of the business, we do expect to generate cash in the Q1 of 2017.
Great. Thank you, Chris. Thank you, Paul.
Thank you.
Thank you. And our next question comes from Justin Clare from ROTH Capital Partners. Your line is now open. If your phone is on mute, please unmute. And our next question comes from Tony Wang from ROTH Capital Partners.
Your line is now open.
All three of them were from Roth. So I think we should move on to the next one.
And our next question comes from Michael Morisso from Avondale Partners. Your line is now open.
Hi, guys. Thanks for taking the question. First, just to clarify with respect to 3Q guidance, does that include any revenue from the AC storage product, which you will be shipping in the quarter? And going forward, do you anticipate breaking out revenue across products?
So the guidance does include a couple of $1,000,000 revenue from AC battery storage solution in Q3. Obviously, we are just starting to ship that product and that solution. We do expect a very steep ramp and more meaningful revenue in Q4 of 2016 and beyond in 2017.
Very good. With respect to the overall market, obviously, you have a large player in the U. S. Residential segment who continues to walk down guidance. And there's some debate as to how much is company specific or whether it's attributable to a broader slowdown in demand.
What are you guys seeing in terms of overall growth in the back half of the year in conversations with your customers and any indications of how the growth outlook is tracking into 2017?
It's actually a really good question and one that we're a bit wrestling with ourselves. Clearly, there is the market itself is very fragmented. We're seeing perhaps a slowdown in the California market, but burgeoning markets in other areas like Texas. However, still a much smaller market. Our view still remains fairly consistent that year over year we expect 25% to 28% increase 2016 over 2015.
But we're going to remain cautious a little bit right now until we get a few more data points.
Okay. That's helpful. And then with respect to the pilot that you have at PG and E, are you recognizing any revenue from that? And just bigger picture, do you view this as pretending essentially new product line? And what are you seeing in terms of incremental revenue from this utility segment longer term?
And how are you thinking about the potential for utilities to even potentially rate base inverters as essentially part of their smart grid investment programs?
Right. So I think I would start by saying that it seems inevitable that the utilities need to be a participant in the solar market for us to continue to grow. It's in part because we need to find a business model that accommodates both utilities as well as the solar industry and it's important simply for grid stabilization. We partnered with HECO in Hawaii to help address some of the challenges they had because of our smart inverters down there and because of our ability to remotely both provide monitoring capabilities of the grid itself as well as then an ability to change operating characteristics of our inverters, we were able to help them stabilize their grid. And we have we do have a revenue contract with HECO to help sort of continue that.
In reference to PG and E, we're still in the very early stages of establishing what the technologies need to be in order to provide the same services. And then the second phase of that would be a deeper understanding of the exact business models. So right now, it is PG and E doesn't have a lot of experience yet with the remote management and monitoring of solar inverters. We're helping provide both the power electronics to make that happen as well as the communications and the big data analytics that together give PG and E both the visibility on the grid and the ability then to make certain requests, which we would then implement on the inverters themselves. We are also seeing similar requirements or similar explorations in the Asia Pacific region as well with some of the utilities down there.
So I think overall, it's almost inevitable that there needs to be a deeper integration between the utilities and the solar industry. And through that through the course of that, I think that the opportunity to rate base either the product or the service certainly exists. And we have had some initial discussions about that as well. And it's very much aligned with our current strategy. So strategy both and core competency.
So we're going to stay very active and engaged on this. And as we develop the business models with our utility partners, we'll keep you up to speed and up to date.
Great. Thanks for that, Paul. And then just one last one. With respect to the guidance that you expect pricing to stabilize in the back half of the year, what's giving you confidence in that outlook? Is it that you've been kind of in control of your pricing all along and Enphase as the aggressor is deciding to take a step back based on where your market share has leveled out?
Or what are other factors that are driving that outlook?
There are quite a few factors. Clearly, the biggest one for us is just looking at the market itself and looking at the empirical data that we're seeing. As we had spoken about in the prepared remarks, we have seen that once we get to competitive pricing, we do believe that we can win a majority of the deals and we've seen that empirically because of the advantages of our solution, the simplicity, the ease of design and installation, the extra energy production, the holistic solution. And we took some very aggressive pricing actions, both the latter part of 2015 as well as the first half of twenty sixteen. And in speaking to our customers and the markets, we're seeing that the pricing environment seems to have generally stabilized.
That doesn't mean that it's exactly stable, it's just generally stabilized. And we're going to continue to monitor it. And then obviously, if we see things change, we'll respond accordingly. But we'll stay abreast of that and adjust our operating metrics based on our target market share numbers and net income and cash flow management.
Great. Thanks guys.
Thank you.
Thank you. And our next question comes from Rajat Shah of Deutsche Bank. Your line is now open.
Yes. Hi. Thanks for taking my question. Paul, on a recent conference call, one of the larger EUV companies mentioned that they have advanced power electronics capability and that they were looking to make and convert it themselves. I guess my question is, what do you think about new entrants getting into the space?
What do you think about some of the large EV companies getting into the inverter space? And then how do you see some of the Chinese competitors also reacting to the marketplace right now?
Sure. So as I mentioned before, in terms of the offshore inverters, they've been around for quite some time. That's nothing new. We are hearing more about them and I think they're making a lot of noise right now. We're not seeing a very dramatic shift in our customer base to the offshore manufacturers, but we'll stay abreast of that and if it changes, we'll certainly let you know.
But we're not seeing that shift right now. In reference to other people getting interested in power electronics, I think it there are those companies that have that may have that expertise and we may or may not see them as successful in this space. Remember that in order to produce a successful product, you need 3 distinct technologies. You need the power electronics, which in the case of a microinverter, it also includes deep semiconductor expertise. You need a communications technology and you also need big data analytics, cloud based analytics.
We've said many times that collecting today somewhere in the neighborhood of 2 or 3 terabytes of data every day and we're using this data to provide analytics to our partners and we have a very robust and very heavily used API that our partners use all the time to extract the data for their use. On the power electronics side, we've talked about all the capabilities that are now required in a microinverter that go far beyond the DC to AC conversion. And communications is a vastly complex subject that involves not just communications from the inverter to the gateway device, but then an understanding of the division of labor, if you will, in compute power between what's being done at the inverter, what's being done at the gateway and then what's being done at the cloud and then managing that. So and then obviously, I'm not even having to begin to talk about the manufacturing requirements in order to get to the kind of quality levels we've achieved. So I'm sure that there are people who are very strong and defensible position that would be very challenging for a new entrant to match at this time.
That's helpful. Can you maybe talk about your assumptions that you're baking into your guidance for a positive cash flow generation in Q1 of next year? And like what kind of margins do you expect you assume are you assuming continuous margin improvement? And then you mentioned pricing is stabilizing, cost reductions will improve. Can you talk about what kind of cost reductions we should assume over the next 12 months with the existing portfolio of new products as well?
So yes, I can talk a little bit about that. We have laid out an aggressive but realistic cost reduction roadmap during our Analyst Day in November of 2015, and the target there was to go and drive down the cost 50% over a time period of 2 years, so towards the end of 2017. And in the meantime, we continue to drive down the cost of our 4th generation product, which is the majority of the shipments that we do right now. Towards the end of 2016 and then ramping in 'seventeen, we will introduce our 6th generation product that we will then also continue to further cost reduce. And then towards the end of 2017, ramping up in 2018, we will bring our 7th generation product to the market there.
And that will be on or about 50% cheaper from a cost point of view than where we were at the end of 2015. So we feel really good about the execution on that product cost reduction roadmap. A lot of progress has been made. Our 6th generation product is up and running, has been placed on roofs, is going through the long term quality and reliability testing right now, and we feel really good about that product. The cost of that product is on target, even slightly below where we targeted that, and we feel good as well on the execution towards the 7th generation towards the end of 2017 as well.
So I think there's great execution in driving down the cost. When you talk about margin, there again, you have to bring the other side of the equation, pricing into it. And I think Paul has talked about that. We do expect to return to more historical levels in terms of year over year price erosion. And so the combination of those two will help us to gradually improve the margins in the next couple of quarters.
Thank you very much.
Thank you. And our next question comes from Colin Rusch from Oppenheimer. Your line is now open.
Thanks so much.
You guys have talked a
little bit about the inventory, but not so much about the receivables levels or the payable levels. Payables are up pretty substantially for the quarter. Can you give us a sense of where you expect that to level out and if that's going to be a drag on cash at all as we go into the back half of the year?
Yes. As I stated before, payables are up sequentially. But again, take into account that unit shipment was up 30% sequentially. And so that definitely drove a lot of an increase in payable. And so as we continue to grow the business and continue the unit shipment and megawatt shipments, you can expect that the payables will continue to grow as well.
Now there is sometimes some seasonality to that as well. And depending on certain payments to certain vendors, you will see some fluctuations there quarter to quarter. So definitely, Q2 is somewhat on the higher end in terms of payable, And so that will not repeat itself in Q3 and Q4. And that's why as I answered the previous question, I do believe that there will be some cash burn in the second half of twenty sixteen. But again, as revenue improves, as margins start gradual improving, as we continue to manage our operating expenses and drive improvements on the bottom line and continue to work on the balance sheet as well by further inventory level reduction.
You will see the cash burn to reduce over time and get back to positive cash flows into Q1 of 2017.
Okay, great. And then as you start rolling out the energy storage product, what's your expectation here in the 1st couple of quarters on the impact to gross margins? I understand it's a fairly small amount of revenue, but is that product profitable at the gross margin level? And is it enhancing or really dragging a little bit on the overall gross margin?
So the steady state
volume production of the storage unit is going to be at corporate gross margin. So we feel very good that it's going to be a very positive influence both on the bottom line as well as cash. And as I said, we'll be at corporate gross margin. Initially, in our first shipments, it may be slightly less, but that's just some issues associated with ramp up in Q just in this quarter.
Okay. Thanks guys. I'll take all the rest offline. Thank you.
Thank you.
Thank you. And our next question comes from Jeff Osborne from Cowen and Company. Your line is now open.
Great. I just had two questions and a clarification. Just maybe a clarification on Collin's question there on the ad corporate gross margins. Obviously, the corporate gross margins have changed a lot over the past year and a half. So if I'm hearing you right, do you expect them to be in the high teens for storage or 30% where you used to be?
Well, I think it's going to follow our corporate gross margin. So it's I think you can assume that as our corporate gross margins increase, it will increase with it for the same reasons that the corporate gross margin will increase.
Got it. So that's just because of the I guess I was just trying to figure out because there's a lot of third party content in the storage product. Obviously, you're making a microinverter component as part of the feature set that maybe is a third of the value of it, but that 3rd party content won't be a drag on that at steady state a year from now?
So the AC battery consists of obviously all the mechanicals, all the cabling, the microinverter itself, several other controller boards that go inside the AC battery. And all of these, as we ship our 1st generation product, are exactly that, our 1st generation product. So there's going to be a tremendous amount of opportunity to continue to reduce everything other than the chemistry itself. The chemistry itself, again, the industry, the residential storage industry is very nascent. It's just starting.
So we fully expect to see a significant reduction in cost on the batteries themselves, which should also help in gross margin. So you're exactly correct that there is more third party content in the AC battery than there is in just the microinverter, but there's still a tremendous amount of room in everything that we add value to around that to reduce costs and we expect to stay ahead of the cost reduction curve on the chemistry itself.
Got it. That's helpful. I appreciate that, Paul. Just two other ones. So if I'm hearing you right and kind of reading between the tea leaves, it sounds like the inventory levels were maybe a bit bloated on the M215 side and then you substantially discounted those this quarter or during the first half of the year to kind of clear that out.
Is it right
to think that the bulk
of the finished goods inventory is more at the M250 level, which better aligns yourself with what the industry wants? Or do we still have some 250s that need to be cleared out?
No. There was no we didn't do anything on pricing to clear out either 215s or 250s. We this was just sort of good inventory hygiene. That's all. In terms of mix, the mix is the mix that we have in inventory right now remains very similar to the mix we had prior to the quarter starting, just less of it.
You might not know
this off the top
of your head, but was the 215 demand outside of the U. S? I mean, that's just a very low watts? No,
no, it's both inside and out. Again, because we are tied to a particular module, we will fluctuate a bit based on the volatility of the module market. So if there is an influx of lower power modules that may be very low cost, we may see an increase in the 215s. I think as was brought up before, the general trend is very clear. It's up into the right in terms of module power.
And we're seeing costs come down on higher power modules very significantly. So we there's no question that the trend is towards higher power microinverters. But in the short term, quarter on quarter, you're going to see fluctuations.
Got it. The last question I had is just as you've undertaken this pricing strategy the past couple of quarters, what is your sense after speaking with customers and then seeing the elasticity of demand, which is certainly playing out based on the unit shipments of either on a pennies per watt or percentage of premium, so to speak, for all the advantages that you mentioned of ease of installation and other items, Paul, that people are willing to pay. Is that 10%, 20%, just how do you think about what the right premium pricing strategy is going forward relative to string or optimizers? Obviously, it was much higher before, but looking forward, how do we think about what that premium should be?
Right. So yes, you're exactly correct. Before, it was much higher, But the reality of the environment today is that our customers are facing a very competitive environment themselves. And while they have expressed a desire to use Enphase, some of them have felt that they just simply can't afford the premium that they used to have to pay for it and that and so they some of them had moved away to a cheaper product. Now that we are more price competitive, we're seeing them come back and we're gaining new customers all the time.
In reference to your question about how much of a premium, it's very hard to say because it really depends on any individual installer. I would say that it could be anywhere between 10% 20% that we see that we will win the majority of those deals. Some installers are going to be far more sensitive to pricing, others place a greater value on our future set and simplicity and are partnering with us on some other software initiatives as well. So I know it's a relatively broad range, but that's the market itself is rather fragmented in that respect.
Appreciate it. Thanks, guys. Thank you.
Thank you. And our next question comes from Krish Sankar from Bank of America Merrill Lynch. Your line is now open.
Hi. This is Chirag Odev on for Krish. So some people are forecasting a potential overcapacity in on the module side, which could lead to prices going lower for modules. Do you see this having any impact on inverters? Do you see like a decline on the module end softening any expected price declines for inverters?
I think the inverters have their own price decline that's been going on. I don't think that lower cost modules will have any significant impact on the pricing trend on inverters. I do think, again, to point out previous caller's remarks, I think that does mean that there's going to be a fluctuation in mix that as the prices come down, we may see 1 quarter more $215,000,000 to another quarter more $250,000,000 I think that there may be some volatility there, but I don't think it's going to have a significant impact on inverter pressing.
Yes. And so obviously, the panel market or the module market is 60 gigawatt worldwide and it's used in utility scale projects and commercial projects and residential projects, the inverter market is much more fragmented and string inverter or central inverter for utility scale has nothing to do with a inverter for a residential system in the U. S. Market, totally different market.
Okay, got you.
Thanks. Thank
you. And our next question comes from Pavel Molchanov from Raymond James. Your line is now open.
Thanks for taking the question guys. I wanted to kind of dive down into the Australian storage opportunity. You clearly seem very optimistic about customer adoption, but there are a lot of companies chasing that market from Germany, from China, from the U. S. And some local players as well.
What gives you the confidence that your individual solution versus all of the other battery solutions in Australia will be capturing the relatively limited demand that there is?
Right. So it's hard to gauge let me address the last part of your question first. I don't know what the demand is yet. We have our own estimate. But it could be very significant depending on several factors.
We know that the economic case for storage is very different in different parts of Australia. In New South Wales, it's more about rate arbitrage. In Queensland, it's more about power export limiting. And I think those will drive different demand profiles. As to our confidence, it was very clear that we actually haven't sold an AC battery yet.
So all of our thoughts, all of our confidence comes from the fact that we have multiple beta sites already in Australia. The people who have installed our systems have also installed competitive systems, whether it's from China, whether it's from the U. S, whether it's from Germany or Europe. And 201, we have heard that our solution is not only the simplest, but its modularity provides an ability to customize that solution for that particular consumer. Remember, as I mentioned in the prepared remarks, one person can install approximately 5 kilowatt hours in 1 hour.
I don't believe that there is a competitive solution around that can make any claim anywhere near that and yet we're seeing that happen. So on one hand, we are very competitively priced just from a CapEx perspective. We have far and away the simplest installation process. So we reduce installation costs. Our communications technology and our big data analytics allows us to extract the data and then provide an energy management system to appropriately manage that storage.
Remember, the minute you add storage to a solar system, you must have now an energy management system. You need to know what you're generating, what you're consuming, what the state of charge of the battery is, what the weather is, what the rate structure is, what the regulatory requirements are, so that you can then decide how to manage that battery, when to charge and discharge to provide the highest return on investment for the consumer. We are today the largest residential solar monitoring company in the world. We know data and data management very likely better than any other solar company. So we have that aspect of it as a core competency.
Our microinverter gives us the ability to provide the modular solution. So you can have 1.2 kilowatt hour blocks so you can tailor that system, the size of the system. Because it's AC coupled, we work in retrofit markets. Many of the existing systems don't work in retrofit markets and are only working in new systems and yet it is our belief that a large portion of the Australian market is going to be retrofit, specifically New South Wales. And again, the so that combination of simplicity, cost effectiveness and providing that totally integrated system is what's enticing and providing the excitement for our customers and it is what's driving our confidence.
Okay. Given that you haven't, as you said, haven't sold any commercial deliveries yet, Conceptually, how are you going to be pricing this? It's a brand new market. You're a new player in that market. So what's the price calculation like?
So
the current pricing is very competitive with similar products in the market. I would say it's middle to low end of the range. This is just pure CapEx. What we did is we looked at it 2 ways. 1 was obviously evaluating the competitive environment and 2 was looking at the current rate structure to provide the economics that would make the solution in general very interesting.
That's sort of what led us to the existing pricing where we are. Obviously, over time, we'll be reducing our costs and our price and getting more and more competitive and looking at larger and larger markets, not just in Australia, but in Europe and in Hawaii and other locations as well. But we feel that we have a good balance right now to address the existing market and our customers have told us and I think that the backlog that we currently have would be indicative of finding that right price point. Again, we know we're going to have to over time reduce it and that's the nature of the business. But I think for the time being, we feel that we've found a sweet spot.
All right. Appreciate it, guys.
Thanks. Thank you. And our next question comes from Carter Driscoll from FBR. Your line is now open.
I appreciate taking my questions gentlemen. Wanted to get a sense of the amount of share that you think you've regained since you instituted your more aggressive pricing cuts late last year? Do you feel that you've regained and maybe even taken share in the U. S. Residential market?
Or how do you think about that quantitatively? And then I have a follow-up.
So we think that between Q1 and Q2, we've gained around 6 percentage points, which is pushing around 30% share.
Very helpful. Thank you. In terms of your comment, which I thought was very interesting, your pilot with PG and E and future kind of growth in this market tied to the utilities really adopting DG or becoming more comfortable with it. You mentioned some other utilities that are maybe looking at the solution, maybe have reached the pilot stage. Can you talk about the geographies, if they're outside of what you had mentioned with Hawaii and then California, are there other states that you think?
Trying to get a sense of which utilities might be more forward thinking or acceptable and moving forward and helping push DG forward outside of the traditional territories?
Right, right. It's actually a very good question. Unfortunately, I'm not at liberty to talk about the specific utilities that we're talking with right now, but they are not in well, in addition to the utilities we're talking about in Hawaii and California, there are definitely other utilities both in the Central Midwest and Northeast United States that we are in discussions with. I think the larger point here is that and Enphase has never taken a confrontational stance with utilities. We understand that they have to find business models to make this work and they need to make sure that the application of distributed resources doesn't disrupt the grid.
We believe that there are multiple ways to find not just the right technologies, but the right business models. And as an energy technology provider, we think we're in a very good position to help them work through some of these issues.
And how long do you envision the pilot phase with D and G will last? I mean, has it really come up to whether it can be rate based or what types of other qualitative issues do you have to work through to accelerate the pilot program if you can?
I don't know that the target goal of this pilot is to get to a rate based solution, although I think that getting to a rate based solution is certainly a laudable goal and is one that we're after. The initial goal of the PG and E engagement is really to test out the different technologies to understand how PG and E can work with a distributed energy resource provider like Enphase to both monitor the grid as well as provide the appropriate controls. And then this is on a limited basis initially and then we'll follow-up with discussions on how to go wider, how to institutionalize the process and then of course what the right business model is which of course would include the potential to rate base it.
Appreciate you answered my question guys.
I'll get back in queue.
Thank you.
Thank you. And this does conclude our question and answer session. I would now like to turn the conference back over to Paul Nahee for any further remarks.
Well, thank you for joining us today and we look forward to speaking with you again next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect.