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Enphase Energy, Inc. (NASDAQ:ENPH)

Q4 2012 Earnings Conference Call

February 26, 2013 4:30 pm ET

Executives

Paul Nahi – President and Chief Executive Officer

Kris Sennesael - Chief Financial Officer

David Niederman - Investor Relations, The Blueshirt Group

Analysts

Pavel Molchanov - Raymond James

Scott Reynolds – Jefferies

Edwin Mok - Needham & Company

Operator

Good day, ladies and gentlemen, and welcome to the Enphase Energy Fourth Quarter 2012 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we'll have a question-and-answer session and instructions will follow at that time.

(Operator Instructions) As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. David Niederman, Investor relations. Sir, you may begin.

David Niederman

Good afternoon and thank you for joining us on today's conference call to discuss Enphase Energy's fiscal fourth quarter and full-year 2012 results. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of Enphase Energy's website at www.enphaseenergy.com.

With me on today's call are Paul Nahi, Enphase Energy's Chief Executive Officer; and Kris Sennesael, Chief Financial Officer. After the market closed today, Enphase issued a press release announcing the results for its fiscal fourth quarter and year ended December 31, 2012. If you would like a copy of the release, you can access it online at the Company's website.

During the course of this conference call, Enphase’s management will make forward-looking statements, including but not limited to statements related to Enphase Energy's financial performance, market demands for its micro inverters, advantages of its technology, market trends, and future financial performance. These forward-looking statements are based on the Company's current expectations and inherently involve significant risks and uncertainties. Enphase Energy's actual results and the timing events could differ materially from those anticipated in such forward-looking statements as a result of these risks and uncertainties.

Factors that could cause results to be different from these statements include factors that Company describes in this press release of today, especially under the section entitled Forward-Looking Statements' as well as those detailed in the section entitled “Risk Factors” of this Company's reports on form 10-Q and yet to be filed 10-K. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website. Enphase Energy cautions you not to place 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 these expectations.

Please note that the financial measures that we use on this call are expressed on a non-GAAP basis unless otherwise noted, and has been adjusted to exclude certain charges. We provide a reconciliation to these non-GAAP financial measures to GAAP financial measures in our earnings release posted today which can also be found in the Investor Relations section of our website.

Now, I'd like to introduce Paul Nahi, Chief Executive Officer of Enphase Energy. Paul?

Paul Nahi

Thanks David, and welcome to everyone joining us for our fourth quarter and full-year 2012 earnings call. I'll give a general overview of our Q4 performance, Kris will take us through the financials, and then we'll go to the Q&A. But first, I'm going to start by reflecting on 2012, our first year as a public company. In 2012, Enphase made substantial progress as we executed on our strategy, achieving strong topline growth along with increasing gross margins. We closed 2012 with $217 million in revenue, a 45% increase year-over-year in what has been a challenging environment for our sector.

During the year, we completed the successful transition to our third-generation products, continued to gain market share in the U.S. residential and commercial markets, and established a European presence selling into France, Italy, the Benelux region, and the U.K. We're pleased with the market share gains in those geographies during the last 12 months and the growing acceptance of our microinverter technology globally.

Based on our analysis of market research data, we believe we ended the year with the number one market share position in our core U.S. residential market. We estimate to have had in excess of 35% market share in 2012 and just over 45% exiting Q4. This underscores our major success in both the traditional cash market as well as the fast-growing third-party financed market, where we established strong partnerships with several key players in this space. As a result, we sold over 1.5 million microinverters in 2012 compared to 1 million in 2011 and passed the 3 million units sold milestone during the fourth quarter.

We continue to execute very well on our gross margin expansion strategy, improving gross margins from approximately 10% in 2010, to 20% in 2011, to over 25% in 2012, while most of the other players in the solar market are facing declining margins. This speaks to the value of our business model of providing highly valued and differentiated microinverter systems while managing our costs through semiconductor development as well as our outsourced manufacturing model. Our increased volume, the transition to our higher-margin, third-generation product, and only a modest erosion of our average selling prices, all contributed to the gross margin expansion.

During 2012, we also took significant steps to further improve the quality and reliability of our products and streamline the manufacturing process. We strengthened our quality management systems and improved our manufacturing capabilities through automation. The result has been a continual increase in quality and decrease in costs of each subsequent generation of our products.

Turning to our operating model, 2012 was the year of investing and building out our core infrastructure in engineering, manufacturing, quality, marketing, sales, and corporate functions. By the end of the third quarter of 2012, we had substantially completed these investments enabling us to realize operating leverage as we execute our balanced profitable growth strategy. Our Q4 results, which included sequential decline in operating expenses and positive cash flow provide a clear indication of the leverage we anticipate.

At this time last year, we were in the midst of our IPO activities which resulted in our initial public offering on March 30, 2012. Later in the year, we put in place additional debt capacity through financing arrangements with Wells Fargo Capital and Hercules Technology Finance. In combination, these activities were significant steps that strengthened our balance sheet and provided the financial flexibility enabling us to pursue our strategic objectives.

Also in 2012, we increased the breadth and depth of our management throughout the organization, both domestically and internationally, to support our growth initiatives. This included rounding out our senior management team, filling leadership roles in quality and reliability, customer service, human resources, and bringing on Kris Sennesael, our CFO.

2012 was a year of significant technology development for Enphase. Our investment in research and development has resulted in advances in both our hardware and software technologies. We now have approximately 100 patents issued or pending and are focused on developing the most advanced solar inverter system technologies in the world. And more recently, our technology leadership was further validated as we were presented with the Technology Pioneer Award by the World Economic Forum. We were honoured to be invited to participate in the World Economic Forum in Davos, Switzerland, engaging in policy discussions with global energy leaders advocating for renewable and advanced forms of energy and introducing Enphase to policy leaders and global energy suppliers.

In summary, 2012 was a year of truly remarkable achievement for Enphase. We continued to grow the topline significantly, increased market share domestically and internationally, expanded our gross margin, and built the infrastructure which positions Enphase for ongoing success and profitable growth. Of course, none of this would have been possible without the contribution and commitment of all our Enphase team members. In my opinion, we have the best people in the industry.

Now let's turn to our fourth quarter results. We had a solid fourth quarter as we posted revenues of $57.6 million compared to $57.1 million in the prior year. This is an increase of 14% compared to the fourth quarter of 2011 when excluding approximately $6.5 million of revenue in Q4 of 2011 facilitated through the expiring 1603 tax grant program.

You will recall that at the end of 2011, the whole industry benefited from the expiration of certain tax benefits, commonly referred to as 1603, which resulted in several customers accelerating product purchases prior to the year end of 2011. Our stronger than expected 2012 fourth quarter topline performance was mainly driven by the strength in the U.S. markets, which was partially offset by a reduction of inventory levels in the distribution channel during the fourth quarter.

Fourth quarter revenue outside of the U.S. was somewhat disappointing. They accounted for approximately 10% of total revenue. Reduced feed-in-tariffs resulted in softer [conditions] (ph) in the Canadian and European renewable energy markets leading to lower sales for the quarter in those regions. However, it's important to note that we are relatively new entrants in the European market, and our product continues to gain acceptance and market share. We believe these markets are a tremendous growth opportunity for Enphase. In addition, we're beginning to see increased activity in Canada as the feed-in-tariff, which had been suspended, was recently reinstituted.

Our gross margin of 28% in the fourth quarter was another record for Enphase and demonstrates our ability to balance with the multiple factors that impact gross margin as we seek continued expansion of this key metric. I'm also particularly pleased with our efforts in the fourth quarter to leverage our investments in infrastructure. For the first time in the Company's history, we saw operating expenses decline sequentially from the prior quarter. Kris will go into more detail on this in his review of the financials.

Finally, I want to point out some recent examples which illustrate the progress we are making in two of our key initiatives, geographic expansion and commercial market application of our microinverters. On January 24, we announced our entry into the Australian market, starting our expansion into the Asia-Pacific region. Leading analysts project Australia to become a gigawatt plus solar market, and Enphase enters at a time when this growing clean economy is gaining promising momentum.

And in February, we announced two commercial projects which featured Enphase microinverters; the first was a 302 kilowatt system installed by Cambio Energy of Tempe, Arizona on the Tempe Plaza carport parking structure. Cambio selected Enphase for safety, simplicity, lower cost of installation, and advanced monitoring system. The second was a 902 kilowatt commercial project, one of our largest to date, at Strain Ranches in [Orchards] (ph) rice processing facility in California. In fact, we just hosted the commissioning ceremony for this project last week. These installations validate the value we bring to large commercial projects and is indicative of the type of opportunities we'll target going forward.

And with those comments, I'll turn it over to Kris

Kris Sennesael

Thank you, Paul. First, I will start with providing some more detail on the financial results for the fourth quarter of 2012, and then I will turn to the business outlook. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis unless otherwise noted. As Paul mentioned, total revenue for the fourth quarter was $57.6 million, slightly above the high end of our revenue guidance. This is an increase of 1% year-over-year, but if we normalize for the 1603 related revenue at the end of 2011, it is up 14% year-over-year. On a sequential basis, revenue was down 5% compared to our record revenue level of $60.8 million in the third quarter of 2012, mainly driven by a reduction in revenue in Canada and Europe as a result of the (indiscernible) rate changes in those areas, and a reduction of inventory levels in the channel in the U.S. as distributors were reducing inventory levels in front of a seasonally softer first quarter.

During the fourth quarter, we shipped approximately 384,000 microinverters or approximately 83 megawatts. Also in the fourth quarter, Enphase set a new gross margin record of 28%, an improvement of 510 basis points compared to the 22.9% in the fourth quarter of 2011 and an increase of 110 basis points compared to the 26.9% in the third quarter of 2012. This improvement was driven by our ongoing cost reduction efforts, combined with a relatively stable pricing environment for Enphase microinverter systems.

Operating expenses in the fourth quarter were $20.3 million, with R&D at $7.8 million, sales and marketing at $7 million, and G&A at $5.5 million. These non-GAAP operating expenses did not include $1.5 million in stock-based compensation expenses and $400,000 in severance costs. During the fourth quarter, we made some changes to our organization realigning departments, improving the critical skill set mix, and making adjustments to our international entities to better serve our customers.

We ended the fourth quarter and full year with 384 employees, the same level as at the end of the third quarter, and up approximately 85 employees from the beginning of the year.

The operating expenses were down approximately 12% compared to the third quarter of 2012. It is actually the first time in the history of the Company that we were able to reduce operating expenses sequentially, mainly as a result of discretionary spend reduction in all areas of the Company. As announced during the previous earnings call, we feel good about the current level of our operating expenses and the size and depth of our engineering, marketing, and sales team as well as the corporate friendships. Going forward, we will continue to focus on keeping our operating expenses as flat as possible and drive the leverage in the model.

For the fourth quarter of 2012, net loss was $5 million or a loss of $0.12 per share. On a GAAP basis, the net loss was $7.7 million or $0.19 per share. In addition to the better than expected revenue performance during the fourth quarter, the record gross margin and the reduction in operating expenses, I'm also very pleased with the positive cash flow from operations during the fourth quarter of $7.6 million and a positive net cash flow of $3.6 million. As a result, the Company exited the year with a total cash balance of $45.3 million, up from the third quarter ending cash balance of $41.7 million.

Accounts receivable at the end of the fourth quarter were $27.7 million or 44 days sales outstanding. Inventory turns are at 8 times, with inventory at the end of the fourth quarter at $19.8 million, slightly up from the $16.7 million at the end of the third quarter. Capital expenditures during the fourth quarter were $1.9 million, and depreciation and amortization was $1.6 million.

Now, I would like to turn to our guidance for the first quarter of 2013. The first quarter of every year is typically a very soft quarter due to weather and other seasonal trends. We expect revenue for the first quarter to be in the range of $43 million to $46 million. At the midpoint of the guidance, this is down 23% sequentially, which is in line with normal or typical seasonality. Also, at the midpoint of the guidance, this is up 5% year-over-year, but if we exclude approximately $9 million of 1603 related revenue during the first quarter of 2012, the midpoint of the guidance is up 33% on a year-over-year basis.

Regarding gross margin, we expect the gross margin to be within a range of 26% to 28%. At the midpoint, this is slightly below our record Q4 gross margin, mainly as a result of the lower volumes in a seasonally softer quarter. We also expect non-GAAP operating expenses to be approximately flat compared to the fourth quarter.

And with that, I will open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Vishal Shah from Deutsche Bank. Your line is open.

Unidentified Analyst

This is [Susie Min] (ph) calling on behalf of Vishal Shah. Thanks for taking my question. I wanted to get a better sense of the cadence of revenues. I know you said Q1 will be seasonally weak, but would we see kind of a pickup in Q2 going through Q4 or would it be very back ended for the year, and then I have a follow-up question?

Kris Sennesael

The normal seasonal trend is Q1 is a soft quarter due to weather and other seasonal trends, and then if we just talk about normal seasonality, we see a strong sequential growth in second quarter followed by further growth into the third quarter, and then typically there is also growth in the fourth quarter, although it slows down a little bit as the channel is preparing themselves for a softer first quarter.

Unidentified Analyst

Great, thank you. And how should we think about your target for profitability, as you said you're improving margins and that's been great as well as the revenue pickup in the next couple of quarters? Is that something we can expect in the second half of 2013 or is 2014 more of a target?

Kris Sennesael

We do not provide full-year guidance, but we just provide guidance one quarter at a time, but as you can see from the numbers, we definitely are making strong progress towards profitability and sustainable positive cash flow. So, we are very pleased with the progress that we make, and we do have line of sight to profitability and positive cash flows without giving a specific timing on that.

Unidentified Analyst

Sorry, may I ask one more question? Just on the OpEx, I mean, you guys did a great job of reducing costs. Is that something that we can expect to stay at those levels or should we just mimic kind of growing but slower than expected revenue growth?

Kris Sennesael

Yes, so for the first quarter, we are very clear in terms of our guidance. We expect Q1 to be approximately flat compared to the fourth quarter, but then also looking forward for the rest of the year, it's definitely our target to keep operating expenses as flat as possible.

Operator

Our next question comes from Pavel Molchanov from Raymond James. Your line is open.

Pavel Molchanov - Raymond James

Hey guys, thanks for taking the question. I noticed that the blended ASP was almost $0.70 this quarter, up about $0.04, a pretty big increase from Q3. Anything in particular that accounts for that?

Paul Nahi

The blended ASP for Enphase is a little bit challenging to calculate, in part because we include cabling, the communications unit which we call Envoy, as well as different product mixes. So, I wouldn't read much into that number. What I would say is that we have been very successful in reducing prices in 2012, and we expect to have built-in further reduction in prices in 2013 for the full year.

Pavel Molchanov - Raymond James

So, I guess since you're not giving guidance for the full year in this current quarter, what sequential ASP decline should we expect?

Paul Nahi

We're not guiding specifically to ASP. What I would say is that, when we do an ASP reduction, we will certainly let you know, but for the time being, we have not announced anything in terms of price reduction.

Operator

(Operator Instructions) Our next question comes from Scott Reynolds from Jefferies. Your line is open.

Scott Reynolds – Jefferies

Thanks for taking my questions and congratulations on a good quarter. I don't get to say that very often in solar land. So, I was wondering overall in 2013, does the Company have some type of expectations that they are looking at for growth in the key markets that they address, and potentially how we should think about overall market shares trending for Enphase in 2013?

Paul Nahi

Sure. So, as we mentioned, we exited the year with tremendous market share in the U.S. In fact, I don't really know of any other solar company that has had this kind of market share. However, I think what we're seeing is a very clear and undisputable trend towards microinverters on the global rooftop market, and as a result, I think what we're going to see is an increased utilization of microinverters across the globe. We clearly lead this space, and I fully expect us to maintain and increase our lead in the markets that we're in and the markets that we're going to be in.

Kris Sennesael

And maybe I would like to add there that looking into 2013, we -- and industry analysts, they expect U.S. residential market to grow 20% to 30% on a year-over-year basis. Obviously, there is going to be some price erosion that will partially offset that growth, but we will definitely continue to push hard to grow our market share as we have been able to do that in the past. In addition to that, we are continuing with our geographical expansion and continue to grow our share outside of the U.S. in Canada and Europe. Those markets nowadays are somewhat challenged, so it's a little bit unpredictable what the growth rates are going to be in those markets, but we definitely continue to expand our geographical reach in those markets.

Operator

Thank you. Our next question comes from Sanjay Shrestha. Your line is open.

Unidentified Analyst

This is [Jacqueline] (ph) on behalf of Sanjay. I was wondering, given the traction you've had with your microinverter product, could you talk about the overall competitive dynamics on the product front, and what are you seeing from your competitors?

Paul Nahi

Sure. Well, we've had competition for a while right now, although it hasn't had a material effect on our sales. This has been primarily from smaller companies. For the first time, we are seeing competition from some of the larger companies. In fact, one of our larger competitors is investing very heavily in sales, in marketing, in outreach, both domestically and internationally for their new microinverter product, and it hasn't had any material effect on our sales. What I think we're seeing quite frankly is the challenge associated with the development of a microinverter. It's a very sophisticated technology. I think while many of our competitors are trying to develop one, I think the challenges associated with the development of a reliable product that can be introduced on a global scale has proved to be, I think, a more significant problem than they anticipated.

Unidentified Analyst

Great. Thank you. And with the improving outlook for various financing structures, especially within the residential market, are you beginning to see any meaningful uptick in demand from this segment?

Paul Nahi

Would that be demand from the finance segment?

Unidentified Analyst

From the residential market.

Paul Nahi

We are. And I think you're correct in assuming that some of that growth, if not much of that growth is being driven by financing. As Kris had mentioned, we are seeing or we are anticipating a 20% to 30% increase in the U.S. market this year. I think a large part of that will be driven by financing, and financing itself I think is also changing in its very nature as well. So we're going to see multiple types of financing in addition to the traditional cash sales.

Unidentified Analyst

Great. Thank you for the color.

Operator

Our next question is a follow-up from Scott Reynolds from Jefferies. Your line is open.

Scott Reynolds – Jefferies

Thanks. Just a follow-up to Susie's question. What do you guys see for overall breakeven levels for revenue? I know it's lumpy quarter-to-quarter on your gross margin side, but how should we think about that?

Kris Sennesael

Our breakeven model calls for revenue at approximately $80 million. We have a gross margin of 30% and obviously OpEx stand at 30%, you get to a breakeven from a non-GAAP operating income point of view.

Scott Reynolds – Jefferies

Alright, thank you.

Operator

Thank you. Our next question comes from Edwin Mok from Needham & Company. Your line is open.

Edwin Mok - Needham & Company

Thanks for taking my question. I remember last quarter you guys talked about channel inventory. Sorry I called in late, you might have mentioned that, where is channel inventory right now, and how do you guys see that progress throughout the year?

Paul Nahi

So, it's very typical for us to see channel inventories drop at the end of Q4, as the channel prepares for a slower quarter in Q1. What we really like to see is a slow build-up in that channel from Q1 through the rest of the year, Q1, Q2, and Q3. We are on track to do that in a very modest way. So, I don't think – there is nothing unusual happening right now. It feels like a normal trend.

Edwin Mok - Needham & Company

Okay, that's helpful. And then, just going back to gross margin, I think previously you guys talked about transition to the third-generation product which will help gross margin rate because of improved design. I was wondering can you give us some yardstick in terms of when do you think you can say get to 50% of your product being third-generation, you know some kind of metric that you think about how that could help gross margin?

Paul Nahi

So, the third-generation product is a product that we are currently shipping and we're almost exclusively third-generation product right now. We have announced that we will be shipping a fourth-generation product later on this year. Our fifth-generation product is up and running in the lab as well, but the fourth-generation product, when it's introduced, will actually be introduced in parallel with our existing third-generation product, and we really can't yet speak to when the transition fully to the fourth-generation product will occur.

Edwin Mok - Needham & Company

Does that transition require a lot of requalification on the customer side or is it not that hard to make a transition from one generation to the next?

Paul Nahi

Well, our experience so far, having done this three times, has been that with each generation of products, we've been able to increase quality, increase the feature set, decrease the price, and decrease the cost. So it's been very, very readily received by all of our customers. So, I don't anticipate this transition to be any different.

Edwin Mok - Needham & Company

Great. That’s all I have, thank you.

Operator

Thank you. I show no further questions at this time, and would like to turn the conference back to Mr. Paul Nahi for closing remarks.

Paul Nahi

Thank you. So, 2012 was a great year for Enphase. Looking forward to 2013, I'm excited about the opportunity to continue driving topline growth and market share gains in our existing markets while continuing our geographical and market segment expansion. In addition, we'll continue our relentless development of next-generation technologies to further increase performance and drive down costs. This, in combination with a focus on balanced growth, will drive the leverage in the model towards healthy profit levels and positive cash flow.

Thank you everyone for joining us today, and we look forward to speaking with you again next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect at this time.

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