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Enphase Energy, Inc (NASDAQ:ENPH)

Q4 2013 Earnings Conference Call

February 18, 2014 4:30 PM ET

Executives

Bob Dentzman - Treasurer

Paul Nahi - President & Chief Executive Officer

Kris Sennesael - Chief Financial Officer

Analysts

Philip Shen - ROTH Capital

Colin Rusch - Northland Capital

Vishal Shah - Deutsche Bank

Pavel Molchanov - Raymond James

Ashok Ramji - Lamoreaux Capital

Paul Strigler - Esplanade

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Enphase Energy's Fourth Quarter 2013 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. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to hand the conference over to Mr. Bob -- Treasurer. Sir, please go ahead.

Bob Dentzman

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

On today's call with me 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 year ended December 31, 2013. If you'd 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 microinverters, 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 of 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 its press release of today, especially under the section entitled Forward-Looking Statements as well as those detailed in the section entitled Risk Factors of the company's reports on Form 10-Q for the quarter ended September 30, 2013. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of the company's website.

Enphase Energy cautions you not to place undue reliance on forward-looking statements and undertakes no duty or obligations 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 this website.

And now, I would like to introduce Paul Nahi, Chief Executive Officer of Enphase Energy. Paul?

Paul Nahi

Thank you. And welcome to everyone joining us for our fourth quarter and full year 2013 earnings call. I'm going to start with a general overview of our fourth quarter performance, and then provide a recap of 2013. After that, Kris will take us through the financials, and we will go to Q&A.

We closed 2013 on a distinctly high note for an exceptional fourth quarter having achieved several key milestones. Our fourth quarter revenue was a record $67.1 million as we shipped over 100 megawatts AC of microinverter systems for the first time in any one quarter. This top line performance was mainly driven by healthy demand and strong business momentum in our core U.S. residential market.

Gross margin for the fourth quarter was also a company record coming in at 32.3%, marking the first time we've exceeded the 30% threshold and representing 430 basis points improvement over the fourth quarter of 2012.

Combined with our ongoing focus on expense management, we delivered an operating profit of $400,000 and positive cash flow from operations of $7.6 million. This is the first quarterly operating profit in Enphase's history, and a major achievement for the company.

Kris will go through more of the fine points regarding our fourth quarter and fiscal year financial results, but I will say that we are very pleased with our ongoing progress. This quarter's results demonstrate the power of the Enphase business model, the demand for Enphase systems around the world, and importantly our ability to execute on key initiatives.

We are extremely pleased to have achieved these milestones during the fourth quarter, and I am very proud of the entire Enphase team for their great work in making this happen.

In addition, we exited 2013 with strong business momentum and a very solid business and operational foundations that will enable our continued success. We are well positioned for 2014 and off to a great start for the New Year.

Since the beginning of Enphase, back in 2006, we have consistently made tremendous progress and our impact on the global inverter and solar industry has been nothing short of disruptive. We have introduced a system-based high technology approach to solar energy generation, which formally did not exist and is transforming the industry.

Our value proposition is being embraced by a growing number of global industry participants that has resulted in Enphase rising to become the leading inverter technology used on homes in the Americas.

Since inception, we've shipped over 1 gigawatt AC or 1.2 gigawatts DC of microinverter systems. We are by far the highest volume inverter company with more than 5 million units shipped. We also passed the key milestone of 1 terawatt-hour of clean energy produced by our microinverter systems.

We continue to build a strong Enphase brand in 2013, both domestically and in the global markets. In the U.S. residential market, we continue to grow our business and increase our market share to become the number one inverter company.

We estimate that our market share in the U.S. residential market is over 45% by megawatts and over 50% by revenue. Internal data obtained through our Enlighten monitoring software reflects that our installations in the U.S. residential market showed very impressive growth of about 45% in 2013 year-over-year as we solidified our position as the dominant inverter technology in this market segment.

Let's speak to the value of our microinverter system, which is being embraced by our growing customer base including thousands of small, medium and larger installers along with third-party financing companies.

During 2013, we experienced even higher growth rates in our businesses outside of the U.S. despite some challenging market conditions as a result of uncertain and declining government incentives.

We believe that markets such as the U.K. and Australia represent tremendous opportunities, and we are very excited about our progress there. Both markets have large relatively stable residential and commercial solar businesses.

In the U.K., we have made great strives in developing the Enphase business by creating brand awareness, building out a distribution network, and most important of all, developing relationships with installers through education, training, and providing the world's most advanced inverter technology. As a result, we estimate our residential market share in the U.K. has grown to over 6% in the fourth quarter of 2013.

In Australia, we have established our team, the corporate infrastructure and are rapidly making an impact. We are now poised for significant market share growth.

As in other countries, which are being both the residential as well as the commercial markets, in fact in December the largest Enphase array in Australia, a 100 kilowatt installation was completed for the Glenlyn care facility in Melbourne. We look to build on this success and others as we continue to grow our business in Australia in 2014.

So in summary, our 2013 international business showed strong growth and we believe we are well positioned for substantial contribution from our international business segments in 2014 and beyond.

During 2013, we continue to look to new partners, markets and channels to accelerate our top line growth. One of these channels is new homebuilders, which is highlighted by our strategic relationship with Lennar, one of the largest homebuilders in the country.

The Enphase microinverter system provides the flexibility, performance, quality and monitoring capabilities that have helped Lennar in the rapid expansion of their very successful Sun Street program.

Nearly 820,000 home starts are projected in the U.S. for 2014, and this relationship offset the course for advancing solar energy adoption in new homes across the country.

In addition to our initiative with new homebuilders, we recently announced that we are working with Ingersoll-Rand Nexia Intelligence to evolve smart home energy monitoring. These collaborative efforts are into integrating performance data from rooftop solar systems using Enphase microinverters with home automation systems and making it accessible via the Nexia Home Intelligence platform. This provides yet another example of how Enphase continues to expand its offerings for U.S. residential solar customers.

Product development and innovation continued to be at the heart of what we do at Enphase. In 2013, we successfully introduced our fourth generation product, the M-250, to the U.S. market to augment our highly successful third generation product, the M-215.

In addition to providing better performance and supporting higher output panels, the M-250 has features that reduce requirements for both labor and material decreasing the cost per watt of our microinverter system, while at the same time being accretive to gross margin.

In early January of 2014, we announced the expansion of the Enphase system with new hardware and software products. Two examples of new hardware products include a Wi-Fi option for the ongoing communications gateway and the new M-215 microinverter with integrated ground.

The Wi-Fi option provides greater flexibility and reduced installation time. The new M-215 now includes our Integrated Ground Technology eliminating the need for a separate copper wire to be attached to each microinverter which saves both labor and material. These features introduced with the M-250 in 2013 are now included in the complete Enphase microinverter product family in North America.

Along with these products, we also introduced the two new Enlighten software products MyEnlighten and Enlighten Manager, which will further improve the solar consumers experience and the installers’ installation and management of their fleet of systems.

MyEnlighten has been specifically designed for the educational and informational needs of solar homeowners, while professionals using Enlighten Manager will see new sophisticated web-based software tools to help them more efficiently and effectively install and manage their solar systems. As an example, Enlighten Managers will help installers identify, confirm, and prioritize maintenance needs across multiple installations, thereby reducing O&M costs.

These recent introductions demonstrate our commitment to the development of new products, which include performance, enhance our customer experience, and reduce cost throughout the value chain. These efforts are ongoing and are in addition to our continued development of successive generations of microinverter systems.

In closing, 2013 was another year of growth, global expansion, technical accomplishment, the achievement of significant financial milestones, and the continued success of our high-technology business model. It required a lot of hard work, cleverness, as well as the grid and perseverance of the Enphase team.

Looking forward to 2014, the business environment for solar appears to be stronger than ever and so is Enphase. We are eagerly anticipating our new challenges and opportunities as we continue to spearhead the industry's transition to micorinverter systems. We are poised to deliver strong results and continue to execute on our balanced profitable growth strategy.

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

Kris Sennesael

Thank you, Paul. First, I'll start by providing some more detail on the financial results for the fourth quarter of 2013, touch on some of the full-year results, and then I will turn to the business outlook. As a reminder, the financial measure that I am going to provide are on a non-GAAP basis unless otherwise noted.

During the fourth quarter, we experienced better than expected strong business momentum. Total revenue for the fourth quarter was $67.1 million, exceeding the high-end of the revenue outlook of $62 million to $65 million that we provided during the third quarter earnings call. $67.1 million of revenue is a new company record, up 8% compared to the third quarter of 2013, and an increase of 16% year-over-year.

We shipped approximately 107 megawatts AC or 123 megawatts DC during the fourth quarter, which is an increase of 14% over the third quarter of 2013, and an increase of 30% on a year-over-year basis. The 107 megawatts shipped represents roughly 485,000 microinverters, of which approximately 20% were our fourth generation microinverter systems. Revenue from outside of the U.S. represents approximately 15% of total shipments.

Fourth quarter gross margin was a record of 32.3%, an increase of 400 basis points compared to the third quarter of 2013, and an improvement of 430 basis points compared to the fourth quarter of 2012.

Our ongoing gross margin improvement has been exceptional, driven by ongoing cost reductions and higher volumes. To provide some perspective, this quarter's gross margin of 32% compares to 8.3% in the first quarter of 2010.

Operating expenses during the fourth quarter were $21.3 million, up slightly over the third quarter mainly as a result of semiconductor tape-out related engineering expenses.

R&D expenses were $8.2 million. Sales and marketing expenses were $7.7 million, and G&A expenses were $5.4 million. These non-GAAP operating expenses did not include $1.8 million in stock-based compensation expenses.

As Paul noted, in the fourth quarter, we posted the first quarterly non-GAAP operating profit in the company's history. Our top line growth and gross margin expansion combined with our efforts to keep operating costs relatively flat resulted in an operating profit of $400,000. This provides some insight into the leverage of our business model as we were able to post our first quarterly operating profit on $67 million of revenue.

For the fourth quarter of 2013, net loss was $700,000 or a loss of $0.02 per share. On a GAAP basis, the net loss was $2.8 million or $0.07 per share.

In addition to our strong top and bottom line performance, we did an excellent job of managing our balance sheet in the fourth quarter. Cash flow from operations during the fourth quarter was $7.6 million, while our net cash flow was $6.3 million, due primarily to improved financial performance and management of our receivables and inventory.

We ended the quarter with DSOs of 44 days, and inventory on-hand of 33 days. Capital expenditures during the fourth quarter were $1.4 million, and depreciation and amortization was $1.9 million. We repaid approximately $600,000 of our existing term debt.

As a result, the company exited the year with a total cash balance of $38.2 million and $8.7 million of term debt. As a reminder, our working capital facility remains undrawn and we recently expanded the maturity of this facility to November 2016.

Closing on my fourth quarter summary, we have repeatedly stated we have line-of-sight to profitability and positive cash flow. This quarter's results underscores the progress we have made. We still have more work to do to improve on this quarter’s result and make them sustainable, but we believe we are well on track to achieve this goal.

Now, I would like to talk about a few of the full year highlights, starting with the top line. Full year 2013 revenue is $232.8 million, up 7% compared to 2012. However, keep in mind that during 2012, we benefited from the 1603 Cash-Grant Program that expired at the end of 2011.

As a result of this, we recognized approximately $28 million of incremental revenue during the first and second quarter of 2012. Some of those units were installed during the second half of 2012, but a large part of them were being installed during 2013 or later.

Excluding the 1603 units, revenue which have been up approximately 23% on a year-over-year basis, which we believe is a better representation of our true growth story. This is also clearly demonstrated in the continuous high growth that we experienced in installations. Fortunately, the 1603 effect is largely behind us, and year-over-year revenue growth comparisons going forward should no longer be materially impacted by this.

Turning to gross margins, our performance in 2013 expanded our track record of remarkable improvements in an industry that is seeing eroding gross margins in general. Our fourth quarter gross margin of 32.3% is a company highlight and with our full year gross margin of 29.1%. We continue to make good progress towards our target of 35% to 40%.

Our ability to expand gross margins based on our balanced pricing actions and continuous focus on cost reductions through innovation in our semiconductor-based product platform is a clear differentiator for Enphase.

Also, 2013 was a year where we shifted our focus from investing in operating expenses to leveraging the infrastructure that has been put in place. For the full year, our operating expenses totalled $82.5 representing only $1 million increase over 2012. We have implemented the financial discipline that will help guide our spending as we move forward.

With that said, we expect 2014 to be a year where we make some incremental investments in operating expenses to continue to fuel top line growth. We expect these investments to be modest and will be aligned with supporting efforts around driving profitable growth.

Finally, turning to cash flow and liquidity, we made great progress in 2013 approaching breakeven in cash flow from operations. Our top line growth, improved margins and financial performance and focus on working capital management resulted in a full year cash flow from operations of negative $900,000.

In addition, our low CapEx model based on outsourced manufacturing resulted in $6.3 million of capital expenditures for the year. We closed the year with $38.2 million of cash. And we believe that our cash on-hand combined with our committed credit facility and improved cash flows gives us ample liquidity for the foreseeable future.

Paul noted that 2013 was a pivotal year for us. The key element of this is our significantly improved financial profile, which positions us well to participate in what is projected to be a very strong 2014 for the solar industry.

Before turning to our outlook for Q1, I'd like to take a moment to discuss an accounting change that we are making, effective this January 1, 2014. This change will affect how we will account for the warranty obligations on our microinverters going forward.

To-date, we have recognized warranty obligations on a undiscounted cost basis. These undiscounted obligations are then settled over a term of up to 25 years. Effective January 2014, we have elected to account for such warranty obligations on a fair value basis. It should be noted that this election is applied on a prospective basis only and will not apply to the warranty obligations incurred prior to January 1, 2014.

Under the fair value accounting, warranty obligations will be presented on a discounted net present value basis at time of sale. These obligations will then be accreted up to their undiscounted cost over the warranty term. We believe the election to present warranty obligations on a fair value basis more accurately reflects the time value of money associated with obligations that are settled over a longer period of time.

Now, let's discuss our outlook for the first quarter of 2014. The first quarter of every year is typically a soft quarter due to weather and all the seasonal threats. However, we continue to experience strong business momentum. As a result, we expect the revenue for the first quarter to be in the range of $54 million to $57 million. At the midpoint of the revenue outlook range, revenue is up 22% compared to the first quarter of 2013.

Regarding gross margin, we expect the gross margin to be within a range of 30% to 33%. This also includes the improvements in gross margins of approximately one percentage point as a result of the introduction of fair value accounting for warranty expenses on a going forward basis.

We also expect operating expenses to be up approximately 5% to 8% compared to the fourth quarter of 2013 as we continue to invest in the growth of the company.

And now I will open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Philip Shen from ROTH Capital.

Philip Shen - ROTH Capital

Hi, guys. Congrats on the performance in the quarter, and especially the margins.

Paul Nahi

Thank you.

Philip Shen - ROTH Capital

Let's talk about 2014 if we can. You’ve got into Q1 clearly -- how should we think about revenue growth in '14? And how, perhaps your international exposure changes because I think you had about 15% mix of international sales in Q4. What are your thoughts on how this evolves in '14 and perhaps what overall revenue growth might be relative to consensus of just around north of 20%?

Paul Nahi

Sure. So, clearly we only guide to the current quarter. So, I can't give you any definitive numbers beyond that. But what I can say is that if you look both historically and what we are doing in the current quarter, you will see tremendous momentum both in our core markets in the U.S. as well as what we are seeing as really fantastic growth outside of the U.S. as well. We expect the momentum both domestically and internationally to continue, and as we continue to build out our operations overseas and continue to invest in new go-to-market channels in the United States, I think we are very comfortable with the current growth path.

Philip Shen - ROTH Capital

Okay. I think given your guidance for Q1, can you just share with us perhaps what the Gen 4 mix of shipments might be that's baked into guidance?

Kris Sennesael

In the fourth quarter, roughly 20% of our shipments were fourth generation. And looking forward to Q1, we expect approximately the same, maybe slightly up -- when you look at the fourth generation, especially the M-250, shipments there are driven by the availability of the higher power modules, and unfortunately in our core markets, the U.S. residential market, there is not a lot of demand for the higher power modules right now. We expect that to continuously increase over time, but for now, there is not a lot of economics that support the use of those higher power modules. And as a result of that, most of our customers continue to use the 250-260 watt DC modules and pair them with our M-215.

Philip Shen - ROTH Capital

Okay. And what do you think what will it take to shift the U.S. market to the higher wattage panels?

Paul Nahi

That's really up to the installers and the module manufacturers. What we have seen is that economics of the lower power modules are better and are quite good right now. I think as the higher power modules will scale up in production, we should see efficiencies there, we should see cost come down there, and I think you will see a more rapid migration. But importantly for Enphase, we are a little bit ambivalent while we would love to see the continued adoption of higher modules, higher power modules. We have a very broad product offering that allows the installer to exactly tailor the installation to the module and the inverter and make sure that it is as efficient as possible for their consumer.

Philip Shen - ROTH Capital

Okay. That's helpful, Paul. How long do you think the transition might take? Originally, you guys were thinking a year. Is it the case that we could see the 215 and the 250 available for another year or even two together?

Paul Nahi

Distinctly possible. Again, since we don't really control the higher, the volume with the higher up of modules or the prices higher up with modules, all we can really do is provide the commensurate inverter for them, which we do. But it looks like certainly throughout the 2014, you are going to see the M-215 do quite well and possibly into 2015.

Kris Sennesael

All right. And I would like to add there. We will of course continue to drive down the unit cost, the product cost of the M-215 down. We announced now the availability of the M-215 with the Integrated Grounds feature, and so we definitely will continue to push hard and drive down the cost of that product as well.

Philip Shen - ROTH Capital

Great. Shifting gears, I think last quarter you guys had, maybe 15% of your sales going to the commercial market. So, I think you are talking about 15% to 20% of your shipments could become -- or could go into the commercial market. What's your view on that now? How is that mix evolving? What are your thoughts there?

Paul Nahi

As of now that the percentage mix is not changing. We feel very good about both the entrance obviously and what we are doing in the residential market as well as our penetration into the commercial market. Now, we do have multiple products under development that very specifically address both the commercial and the utility scale market. But product right now that's being used in the commercial market is much more similar to the residential product than it is to a purpose built commercial or purpose built utilities scaled product. So for right now, we are extremely pleased with the adoption and penetration into the commercial market both domestically as well as internationally.

Philip Shen - ROTH Capital

Great. One more question, and I will jump back in the queue, Paul. We noticed from Greentech Media that the DC optimizers have started to gain some share; I think 17% of overall residential share in '13. Talk just about what you are seeing out there, and how you expect market share to trend in 2014, and if you feel like you are coming more head-to-head -- competing more head-to-head with those technologies these days?

Paul Nahi

Actually our main competition right now continues to be the standard string in central inverters. We are not seeing any significant or any meaningful contribution to the competitive landscape from either the DC optimizers or our competition microinverters. At this point, it become very clear, I think to all inverter companies that if they want to stay relevant in the rooftop, the global rooftop market, they are going to have to produce a microinverter, and several of them have. But once again, they are not really providing yet any meaningful competition. We expect that to change and we expect them to be very strong competitors over time, but not necessarily with their first generation product.

Philip Shen - ROTH Capital

Okay, great. Thanks, Paul. Thank you, Kris. I'll jump back in the queue.

Paul Nahi

Thank you.

Operator

Thank you. And our next question comes from the line of Krish (inaudible) from Bank of America Merrill Lynch.

Unidentified Analyst

Yes, hi. Thanks for taking my question and congrats again on the good results in Q4. I had a couple, the number one, Paul or Kris, I am curious for the reason for the change in the warranty obligation from (January 1st). And along with same target noticed in Q4, the warranty obligation balances up sequentially more than shipments are up. So, was it related to any feel, performance concern? What is going on there?

Paul Nahi

Yes. So let me post it. There has been change in the accounting. We have an ongoing process in which we review our accounting policies and practices. And especially going into a new year, we pay some more attention to it. And for us it's clear that when you have an obligation that is settled over a period of up to 25 year that the fair value accounting is a much better presentation of a long-term obligation. And as a result of that, we are making that change right now starting with the new fiscal year 2014.

In reference to the warranty disclosures last quarter, really what we do as a hardware company is very, very standard. We will every quarter review the data from the field. Remember, we have over 5 million units all over the world in all kinds of environmental conditions. We will review the data from that. And we will make the appropriate modification sometimes up, sometimes down to the warranty obligation based on real field data. So the process we use is very standard. And as you will notice that some products may have gone up, some products will go down. That process will continue.

Unidentified Analyst

All right. And then another case, obviously there is this solar trade coming from the talents from the ITC and Department of Commerce. In a situation where that drives up the price of the modules, does it mean that there is going to be extra pressure on inverter prices to offset, to help offset some of the BeOS cost or how do you kind of view this solar trade case impact on your pricing?

Paul Nahi

I think that there has been consistently pressures on ASPs for inverters. I don't think that's anything new. We won't necessarily opine on this specific case. What we do know is that the industry right now is extremely robust that because of their lower prices of solar in general, because of the rising prices of fossil fuel energy we are seeing a better and better environment for solar within the U.S. and across the world. Clearly, doing something that raises the price of the modules isn't helping. But at the same time we need to find a balance between fair trade and doing something that encourages the development of the solar market.

Having said all of that, in reviewing the trade case, it's our view that on anticipation that whatever changes that may come out as a result of it most likely won't necessarily materially affect the demand in the U.S.

Unidentified Analyst

All right, fair enough. And then a final question from my end, if you look at the Q1 OpEx guidance somewhere around the mid 50 million revenue run rate, OpEx as a percentage of sales is much higher than one you did last Q2 or even like Q4 of 2012. So, is this a new norm on a go-forward basis or is this a one-time OpEx pick up that should probably peel off some time as the year progresses?

Kris Sennesael

So, I am definitely very pleased with the operating expense management that we did during 2013, keeping them flat for almost four quarters in a row with some slight increase towards the end in Q4. But to be honest, that was not really sustainable. If we want to grow the top line, let's say, up about 20% in revenue which is of course more like 30%, 35%, 40% in megawatts, we will have to continue to invest in the future of the company. We will have to continue to invest in R&D resources and sales and marketing resources to support the international growth that we have.

So I think a good way to think about that is if you assume a 20% top line growth, OpEx will grow about half the speed of that. So let's say, more like a 10% year-over-year basis. Obviously if revenue would grow faster, let's say at 25%, then you look more like at the 12.5% growth or if revenue grow slower then that would come down as well. But that's kind of like a good way to look at it in order to support the growth of the company.

Unidentified Analyst

Got it. Thanks, Paul and Kris.

Kris Sennesael

Thank you.

Operator

Thank you. And our next question comes from the line of Colin Rusch from Northland Capital.

Colin Rusch - Northland Capital

Thanks guys. Can you just talk about what's going on at the working capital, obviously both inventory and payables were down pretty dramatically on a percentage basis. Are you starting to see a different cycling with the way customers are ordering or something changing with your supply chain?

Kris Sennesael

Well, let me first address on the receivable side. Q4 is somewhat like in preparation of a softer Q1. And so the business start getting a little softer already in the December month, and then January and February is typically softer and then we start seeing a rebound in the March timeframe. And so that seasonal trend definitely helps to reduce the overall DSOs.

On the inventory side, it's a big focus item for us. We want to manage our inventory levels down and improve our inventory turns. We feel very comfortable with what we have achieved there. And going forward, it's definitely going to be a big focus item for us as well.

Colin Rusch - Northland Capital

And then on the ASP trend, I know there is some mix between the system level and just the inverter mix, but you had a pretty healthy decline quarter-over-quarter, can you just talk a little bit about what's driving that and what you're doing with pricing as we go into 2014?

Kris Sennesael

The pricing for us is -- it's obviously a very important topic that we are looking at on a quarter-to-quarter basis. We are continuously evaluating the competitive landscape, and we are looking at our growth as well and finding the right balance between the right ASP and then obviously getting to an operating profit.

We have said several times in the past that we don't believe that either ASP declines or cost reductions are going to be linear; they're going to be by definition a little bit lumpy. But are we seeing anything right now that would lead us to believe that there should be a very dramatic change in 2014? No. But we do believe that 2014 will be a very competitive environment and we do believe that there will be very significant pricing pressure. And we have obviously built that into all of our models.

Colin Rusch - Northland Capital

Okay. And then just on the product development cycle, historically you have introduced a new product every 18 to 24 months, another generation I should say, where about a third of the way through that short timeframe with the Gen 4, can you talk a little bit about how you see that cycle changing as we going forward and with the relatively slow adoption on the Gen 4 given the availability of the higher power panels, how are you focusing R&D efforts as you look at the Gen 5, where it seems like going to a higher power, a higher power rating, it could have been one of the key drivers for cost reduction?

Kris Sennesael

Sure. Higher power is one element of cost reduction, but there are several others; semiconductor integration, volume, manufacturing efficiencies. So there is a lot more there than just higher power, but higher power is important. But in terms of timing for the introduction of the next generation products, you had mentioned that we had said in the past, 18 to 24 months, that cadence seems accurate, and I don't know that I would make any adjustments to that right now. And those are obviously very approximate.

What is important to know, however, is that the one element of a solar system that is far and away going to need to change the most to adapt to the evolving grid is the inverter. The inverter is where all the intelligence is housed. It is the brain to the system. And as we approach increasing density of solar on a particular grid, on a particular (feeder) network, the inverter is going to have to work far more closely with utility and more interactively with utility to support that. It's one of the reasons why we are spearheading the charge with the working group in California to evolve some of the dynamics required, some of the technical specifications required of the inverter to work in these kind of environments. So there is a lot of work going on within Enphase, a tremendous amount I should say.

For the next generation inverter, that will support these evolving technologies, these evolving requirement, that are not just coming from California, but California, from Hawaii, and from the rest of the world. So we see our R&D actually ramping up to support this. But at the same time, these are going to necessarily be the same path where higher power modules or -- could that potentially slowdown? Yes, it could, but the need for the next generation inverter is higher than ever right now.

Colin Rusch - Northland Capital

I will just sneak one last one in. With the change of the Board, bringing on the gentlemen from Landis+Gyr, which is obviously owned by Toshiba, can you talk about your -- this integration with utility services? Is there new revenue stream that you can see starting to emerge yet in terms of selling this buyback utilities for monetizing it through that, and then also if you could comment on the Japanese market, and your approach at developing parts for that market?

Kris Sennesael

Sure.

Colin Rusch - Northland Capital

Okay, thanks.

Kris Sennesael

Sure. So, the dynamics of the inverter business as it relates to utilities is really two dynamics for me to comment on. We do know that there are going to be some requirements to work within a grid that has higher density of solar. So those are very likely going to be table stakes. But on top of that is there an opportunity to work more closely with the utilities, to provide them information, to help them manage the grid, that is distinctly possible, but again those business models are evolving, the technologies are evolving. So I really can't be having more specific at this time.

Now, in reference to your comment about Japan, we are working very, very closely with multiple Japanese companies looking at both the market as well as the technologies necessary to enter Japan. It's still a work-in-progress for Enphase. There are a lot of obvious challenges associated with the Japanese market. But we feel that the market itself is very well suited to Enphase and to our microinverter system solution.

So we're bullish about our prospects there, although I can't provide any timing. And I will take this opportunity to say that we are very excited to have Richard Mora join the Board of Directors. As the COO of Landis+Gyr, with his experience both with utilities and with metering, we believe that his contributions are going to be very meaningful over the next several years.

Colin Rusch - Northland Capital

Thank you so much, Kris.

Kris Sennesael

Thank you. Do we have the next question? Operator? Hello? We may be experiencing a technical difficulty, if we could ask for everybody's patience.

Operator

Thank you. Our next question comes from the line of Vishal Shah from Deutsche Bank; one moment.

Vishal Shah - Deutsche Bank

Hi, thanks for taking my question. Paul, I was wondering when you think you can hit your margin target of 35% to 40%, you guidance 30% to 33% of the run rate of $50 million, $55 million of revenue would suggest that at some point in 2014 you should be able to hit at least the low-end of the targets, can you just talk about that? And also, as you look into the market in the U.S., I mean where do you think the market -- the demand is coming from, which states are already active right now or do you see broadband trend across all the states or is it only one of two states that are driving the growth?

Then finally, how do you think about the demand from some of the larger leasing companies, I think that pricing has been an issue with some of those leasing companies, are you trying to work with some of those companies to fix the pricing issue? Thank you.

Paul Nahi

Sure. So, for your question on when we plan to hit our models, our goal -- and we've said this many, many times and we will continue to say is we're on a path of profitable growth which means that we need to chart a way to optimize both growth and profitability. If we wanted to focus on, as an example, gross margin, we can get there relatively quickly. We wanted to focus really on growth. We could do that as well. Neither one of those independently other, we feel is the best long-term solution for Enphase. What we are doing right now is focusing on the middle ground, if you will, that nuanced path that allows us to continue to grow, but doing it in a responsible way that allows us to become more and more profitable or chart a path towards profitability with every quarter.

That means that we are not necessarily focused on getting to the target gross margin model right away. That isn't necessarily the goal. The goal is to maintain our growth while increasing profitability and while increasing the gross margin over time. We have also said that gross margin expansion isn't necessarily linear, but it will be lumpy that we don't always (time) a cost reduction with a price reduction, so we may see some up and down over time.

In terms of demand from the U.S., we are definitely seeing the demand come from multiple states. These are the states I think that everybody is familiar with. But we are also seeing an expansion. Our new states coming online, there are new programs coming online, not just with different states, but within a state. So I think that if you look at across the U.S., you are finding that the demand for solar is coming from a wider and wider geography. It is still very concentrated in California, but I think at over time you are going to see that concentration dissipate even as California continues to grow.

In reference to the leasing companies and pricing that's associated with that, we are today -- we work with almost every large and small PPA in the country. In some cases, we are the exclusive microinverter, in some cases maybe not. So we have outstanding relationships and very, very deep ties to many of them. You had mentioned pricings being an instrumental part of those relationships, we couldn't agree more, but we feel that we have a very good handle on where their demand is and are very comfortable with our ability to meet the upcoming pricing requirements, the upcoming ASP requirements in 2014 from the leasing companies.

Vishal Shah - Deutsche Bank

Thank you so much. Well, just on that front, where do you think your market share is in the leasing space and do you expect your share to go up in 2014, would them be leasing market?

Paul Nahi

So we don't talk about this specific percentage within the leasing market. What we do say, however, is that almost every third-party leasing company uses Enphase. And as I mentioned just a moment ago in some cases exclusively. And our share of the leasing market has continued to grow. And yes, we do expect it to grow at 2014 as well.

Vishal Shah - Deutsche Bank

Thank you so much.

Paul Nahi

Thank you.

Operator

Our next question comes from the line of Pavel Molchanov from Raymond James.

Pavel Molchanov - Raymond James

Hey guys, congrats on a nice cash flow in the quarter. Kind of building on the prior question about the drivers behind the growth domestically, have you noticed any changes in your customer concentration, and I ask because you've obviously disclosed publicly some of the relationships that are quite relevant like Vivint. Have there been any changes or not in that sense?

Paul Nahi

I would say, in general, no. We continue to support both the large and small customers that we currently have. But there hasn't been any material change. Now, what is true is that some of the larger companies are growing quite fast. So, that by default would sort of change the mix a little bit. But if you look at it in terms of the number of installers that we're supporting, I think you would see the percentage to be fairly consistent.

Pavel Molchanov - Raymond James

Okay.

Kris Sennesael

And we have approximately two or three customers within the 10% to 20% customer range, and so, that hasn't changed over the last two three years.

Pavel Molchanov - Raymond James

Okay. And yes, your largest customer, I'm not sure if you want to identify it by -- has their share of your revenue increased over the past year?

Kris Sennesael

It has increased over the past year, yes. But it's still within that 10% to 20% range.

Pavel Molchanov - Raymond James

Okay, got it. Then, second point from me is, you've mentioned OpEx is going to go up in a year when you're looking to do some investing. Is capital spending, which I know has not been at that meeting, historically, should that be picking up as well?

Kris Sennesael

No. In 2013, we spent $6.3 million on capital expenditures. For 2014, we definitely target to keep the CapEx below $10 million.

Pavel Molchanov - Raymond James

Okay, but higher than the stakes?

Kris Sennesael

It could be slightly higher than the stakes, yes.

Pavel Molchanov - Raymond James

Okay, understood. I appreciate it guys.

Kris Sennesael

Thank you.

Operator

Our next question comes from the line of Ashok Ramji from Lamoreaux Capital.

Ashok Ramji - Lamoreaux Capital

Hi, Paul and Kris. Congratulations on this quarter's results. A follow-up on the competitive landscapes, you mentioned that the main competition is still in form of central string inverters, are we seeing some press on SMA Sunny Boy microinverter product now coming to market, granted in other parts of the world? Could you comment on this, please? And is their entry into the U.S. still some time away? Thank you.

Paul Nahi

Ashok, we can't comment on the timing for the entry into the U.S. That question would need to be addressed after May. What I will say is that it has been out there for some time. And as I've mentioned before, we're just not seeing it as a strong competitor. Our competition both internationally and domestically remains the string and central inverters. And as we've talked about, as you mentioned SMA and there are other companies out there that have micros. There is a recognition; a clear recognition from these companies that they are going to need to do one. And long-term, we absolutely expect these companies to produce very competitive products, but today we are not seeing any meaningful competition come from other microinverters.

Ashok Ramji - Lamoreaux Capital

Great. Thank you very much.

Paul Nahi

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Paul Strigler from Esplanade.

Paul Strigler - Esplanade

Hey, guys, just a couple of quickies. One, on the slower adoption of the Gen 4 product, are there any penalties with your OEM manufacturing partners, if you don't hit -- if it's a 20% of your volume and you budget it for 30, is there any sort of penalties you might face?

Kris Sennesael

No. So, the answer is no.

Paul Strigler - Esplanade

Great. And then, so when I think about sort of 2014 for the residential market in the U.S, obviously SolarCity is going to be a huge chunk of that growth. And you guys know the residential market probably better than anyone. Sort of, what do you forecast the non-SolarCity growth for the residential market in the U.S. for 2014?

Kris Sennesael

So I probably would not breakout SolarCity versus not. What I would say is that we would expect market growth in the U.S. to grow somewhere between 20% and 30%; U.S. residential market.

Paul Strigler - Esplanade

And so going from how many megawatts to how many megawatts, would that be?

Kris Sennesael

It's probably 750 megawatts plus or minus for 2013.

Paul Strigler - Esplanade

Great. Thanks a lot guys.

Kris Sennesael

Thank you.

Operator

Thank you. And that concludes our question-and-answer session today. I would like to turn the conference back over to Paul Nahi for any concluding remarks.

Paul Nahi

Thank you for joining us on our call today. We're excited with our progress, highlighted by our record fourth quarter revenue and gross margins as well as our first ever operating profit. The focused execution of our business strategy has propelled us to the number one position in the U.S. residential solar inverter market, for a wider platform for global growth, demonstrated our ability to expand our margins and enabled us to chart a path to sustainable profitability and positive cash flow. We are taking this momentum with the 2014, and look to build on what was a great 2013.

In closing, I want to once again acknowledge the efforts of everyone at Enphase. To achieve these outstanding results requires a team effort, and we truly have a great team here at Enphase. We look forward to talking 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 now disconnect. Everyone have a good day.

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