Enphase Energy's (ENPH) CEO Paul Nahi on Q2 2016 Results - Earnings Call Transcript

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Enphase Energy Inc. (NASDAQ:ENPH) Q2 2016 Results Earnings Conference Call August 2, 2016 4:30 PM ET

Executives

Christina Carrabino - Investor Relations

Paul Nahi - President and Chief Executive Officer

Kris Sennesael - Chief Financial Officer

Analysts

Edwin Mok - Needham & Company, LLC

Philip Shen - ROTH Capital Partners

Michael Morosi - Avondale Partners

Vishal Shah - Deutsche Bank

Colin Rusch - Oppenheimer

Jeffrey Osborne - Cowen and Company

Chirag Odhav - Bank of America Merrill Lynch

Pavel Molchanov - Raymond James & Associates

Carter Driscoll - FBR

Operator

Good day, ladies and gentlemen and welcome to the Enphase Energy’s 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. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to our host for today, Christina Carrabino, you may begin.

Christina Carrabino

Good afternoon and thank you for joining us on today’s conference call to discuss Enphase Energy’s second quarter 2016 results. On today’s call are Paul Nahi, Enphase Energy’s President and Chief Executive Officer; and Kris Sennesael, Chief Financial Officer. After the market close today, Enphase issued a press release announcing the results for its second quarter 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-K 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 third quarter 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 Nahi, President and Chief Executive Officer of Enphase Energy. Paul?

Paul Nahi

Good afternoon and thanks for joining us today to discuss our second quarter 2016 financial results. We reported revenue of $79.2 million for the second quarter of 2016. We shipped 186MW or 796,000 microinverters a 30% sequential increase. Competitive pricing and the introduction of our home energy solutions are driving multiple customer wins and significantly increasing our global market share.

At competitive prices we've been very successful in winning new customers based on our simplicity, quality and rich feature set. We have currently more than 500,000 Enphase systems deployed in over 100 countries. Since inception, we have shipped approximately 12 million 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 second quarter revenue rose 20% sequentially as strong demand for energy systems increased our share with existing customers and extended our customer base. Our solar acquisition strategy continued to deliver results with multiple new wins including 8 new installers that combined represents 70 MW of new business over the next 12 months.

Our microinverter solution continues to gain interest in new and existing customers because we have been able to lower our cost of solar systems while providing the highest quality and most advanced features and functionality. We addressed the need to reduce costs in three ways. First, by providing a competitively priced microinverter system; second, our technology enables installers to reduce their operating costs by simplifying designs, installation and inventory management.

In addition, our forthcoming AC module and next generation AC Combiner Box will provide for this simplicity. Third, our superior communications technology allows installers to quickly and accurately determine the health of the solar systems reducing time and effort of operations and maintenance.

As the 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 are the gold standard for quality and our newest microinverters are the highest quality and most reliable we've ever built. And the pace of innovations has accelerated.

In addition to supporting our partners and consumers with new technology, we're also [indiscernible] with several utilities. We recently announced a program with PG&E in California to integrate and optimize microinverters into the grid. PG&E will evaluate how smart microinverters from Enphase used with distributor 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 the 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 are excited to work with PG&E and believe that it has an energy technology provider we are uniquely positioned to support their requirements.

Our 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 second quarter we expanded our distribution channel and our business with several major residential installers including four key distribution partners who will further strengthen Enphase's operations and influence in the Benelux region.

We were pleased to receive the top 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 are seeing tremendous growth in solar adoption and the Enphase system. The regions high energy prices, solar friendly weather and the increasing need for energy resource diversification is helping fuel this growth.

In Australia revenue is 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.

Our 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 1000 installers located in the region will be the first 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 the storage solutions 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 kWh building blocks, ease of design and installation and overall performance and architecture. In fact, a complete 4.8 kWh solution can be installed in less than one 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 sixth 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 progressive cost reductions 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 are 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 will continue to monitor the market.

I will close my comments by noting we are encouraged by our sequential growth and market share gains worldwide. We are excited about the many opportunities ahead including the upcoming launch of our AC Battery storage solution.

Now, I'll turn it over to Kris for his review of our financial results.

Kris Sennesael

Thank you, Paul. I will provide some more details related to our second quarter 2016 financial results as well as our business outlook for the third quarter of 2016.

Total revenue for the second quarter of 2016 was $79.2 million in line with the business outlook we provided last quarter and an increase of 24% sequentially. We shipped 186 MW AC or approximately 219 MW DC during the second quarter of 2016 an increase of 30% compared to the first quarter of 2016. The megawatts shipped represented 796,000 microinverters, all of which were our fourth and fifth generation microinverter systems.

GAAP gross margin for the second quarter of 2016 was 17.9% and non-GAAP gross margin was 18.2% approximately flat compared to the first quarter 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 roadmap and have 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 second quarter of 2016 were $29.9 million and non-GAAP operating expenses were $27.54 which excluded $2.4 million of stock-based compensation expense. During the second quarter of 2016 R&D expenses on a non-GAAP basis were $12.1 million. Sales and marketing expense were $9.4 million and G&A expenses were $6 million.

We reported GAAP operating loss of $15.8 million and a net loss of $16.7 million in the second quarter of 2016 resulting in a loss of $0.36 per share. On a non-GAAP basis operating loss was $13 million and net loss was $13.9 million resulting in a loss of $0.30 per share.

Turning to the balance sheet and cash flow. During the second quarter we improved our cash flow and reduced inventory levels substantially resulting in $7.3 million of positive cash flow from operations. Inventory decreased from $45.6 million at the end of the first quarter to $39.3 million at the end of the second quarter.

Capital expenditures during the second quarter were $4.8 million. We started the second quarter with $13 million in cash and $20 million draw on our credit facility. During the quarter, we paid down $7.5 million on the credit facility and ended the quarter with $8.2 million of cash and $12.5 million draw on the credit facility. Cash net of borrowings increased by $2.7 million sequentially.

To facilitate our continued growth we entered into a term loan agreement on July 08, and borrowed $25 million that was fully drawn upon closing. The second lien term loan facility has a term of four years with interest only during the first year and monthly repayments in equal installments during the last three years. Terms and conditions are in line with the market for this type of facility. There are no warrants preferred or 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 third quarter of 2016. We expect revenue for the third quarter of 2016 to be within a range of $87 million to $93 million 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 third quarter of 2016 to be within a range of $30 million to $32 million and non-GAAP operating expenses to be within a range of $27 million to $29 million which excludes approximately $3 million of stock-based compensation expense.

Now, I will open the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Edwin Mok from Needham. Your line is now open.

Edwin Mok

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 revenues in Europe of 48% sequentially. I was wondering how much international aggregate is now as a percent of total sales? And with these kind of stronger growth do you is sustainable that this growth rate is extending during the second half of the year?

Paul Nahi

So, international markets represent approximately 15% of our total revenue. While they are growing very dramatically, it is 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 is a little hard to say and it is 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 are 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 is going to I think distort the total revenue relative to the U.S. market. But I do believe that we are going to be able to continue growing share in all these international markets, both this year as well as next.

Edwin Mok

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 reasonable costs, or lower pricing Chinese company entering kind of smaller scale side of the market we saw them going in the utility side.

I was just wondering how is their environment like, I think you mentioned on the quarter you see pricing being more stable? With the Chinese entering are you seeing that starting to have an effect? And also kind of in terms of the market push towards more rapid shutdown in several states has that helped you guys because they were all high costs so if you can kind of give some color on that?

Paul Nahi

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 – there's 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 is 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 is important to keep in mind that they've 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 are keeping a very close eye on it and we will monitor it very tightly, but as of today we're not seeing that.

Edwin Mok

Okay, that's helpful. Last question I guess I have for Kris, just talk a little about kind of your capital structure, you talked about kind of new term loan which will 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 to kind of fill back up inventory for second quarter ramp and is there more room you can work that down? I also noticed payable is up quite a bit, is that kind of the higher note where you can bring payables or do you think you can extend that?

Kris Sennesael

Yes, so first of all I'm pleased with the fact that we generated $7.3 million of positive cash flow from operations during the second quarter. In big part that was driven by a drastic reduction of inventory of approximately $6 million. 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 optional doors 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 $8.2 million of cash on the balance sheet. We have our working capital facility with Wells which is a up to $50 million working capital facility with a $25 million accordion feature on top of that and then after closing of the quarter we added $25 million of cash to the balance sheet with the term debt facility that we entered into.

Edwin Mok

Okay, great. Can I just squeeze one more, and I noticed that gross margin declined 60 basis points sequentially, so your plan is only down 5% is that something to do with the mix of individual versus also any product or any kind of color you can report on that?

Kris Sennesael

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 instead of the 250 and so there was a little bit of a mixed 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 were pressing will go over, 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.

Edwin Mok

Great, very good color. That’s all I have. Thank you.

Operator

Thank you. And our next question comes from Philip Shen from ROTH Capital Partners. Your line is open.

Philip Shen

Hey guys, thanks for the questions. I would like to follow up on a topic you just mentioned Kris, you mentioned that the mix of M215 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 215s was in Q2 and then perhaps how that might trend in Q3 and Q4?

Kris Sennesael

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 50-50 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 shift in Q2 the mix shifted slightly more towards 215, but I do not believe that this 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.

Philip Shen

Great, I think we see 80-20 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?

Paul Nahi

So I don’t think it's going to be, so this is Paul. I don’t think it's going to be that dramatic that fast. We completely agree with your comment and are seeing both from the suppliers more and 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 or early next, that will be yet again even higher power to support the even larger modules that are coming out. So, I think that 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.

Philip Shen

Great, thanks Paul. Kris you mentioned earlier that you expect inventory turns and the absolute dollars to come down over the next couple of quarters, anyway you can quantify that at all?

Kris Sennesael

No, so in second quarter it was a reduction of $6 million over the next couple of quarters we're looking at $1 million or $2 million per quarter.

Philip Shen

Okay, good that’s helpful and with the new term loan your interest expense on an annualized basis should be now close to the $4 million plus. Can you talk about what kind of operating cash flow we should see in Q3 and Q4?

Kris Sennesael

So, that the interest is not $4 million a quarter, right? Did you say $4 million a quarter?

Philip Shen

Sorry if I said that, I mentioned $4 million a year.

Kris Sennesael

Right, right, so yeah, so we obviously have dialled in interest. By the way the term loan first year is interest only and then in the last three years it is a straight amortization and equal installments. So that obviously is all dialed in, into our cash flow.

Philip Shen

Great. And then what kind of operating cash flows could we see in Q3 and Q4?

Kris Sennesael

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 million. So when I look at the second half of 2016, we are not going to repeat $6 million per quarter inventory reduction. So it is going to be less than that $1 million or $2 million a quarter as I indicated. As a result of that, there is still going to be cash burn in the second half of 2016, although when I look down to the first quarter of 2017, in part due to the seasonality of the business, we do expect to generate cash in the first quarter of 2017.

Philip Shen

Great, thank you, Kris. Thank you, Paul.

Kris Sennesael

Thank you.

Operator

Thank you. And our next question comes from Justin Clare from ROTH Capital Partners. Your line is open. If your phone is on mute, please unmute. If your phone is on mute Justin, please unmute. And our next question comes from Tony Wayne [ph] from ROTH Capital Partners. Your line is open.

Kris Sennesael

All three of them were from ROTH. So I think we should move on to the next one.

Operator

And our next question comes from Michael Morosi from Avondale Partners. Your line is now open.

Michael Morosi

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 products which you will be shipping in the quarter and going forward do you anticipate breaking out revenue across products?

Kris Sennesael

So the guidance does include a couple million dollar 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 in more meaningful revenue in Q4 of 2016 and beyond in 2017.

Michael Morosi

Very good, yes with respect to the overall market obviously you are a large player in the U.S. residential segment who continues to walk down guidance. And there is some debate as to how much is company specific or whether it is attributable to your 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?

Kris Sennesael

It is actually a very good question, one that we are bit wrestling with ourselves. Clearly, the market itself is very fragmented. We are 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 in 2016 over 2015, but we are going to remain cautious a little bit right now until we get a few more data points.

Michael Morosi

Okay. That is helpful and then with respect to the pilot that you have at PG&E, are you recognizing any revenue from that and just bigger picture did you view this as pretending essentially new products line and what are you seeing in terms of your 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 smartgrid investment programs?

Paul Nahi

Right. So I think I would start by saying that it seems inevitable that utilities need to be a participant in the solar market for us to continue to grow. It is in part because we need to find a business model that accommodates both utilities as well as the solar industry and it is 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 and 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&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&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 both a 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 in 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.

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 competencies. So we're going to – we're going to stay very active and engaged on this, and as we develop the business models with our utility partners we will keep you up to speed and up to date.

Michael Morosi

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 is leveled out or what are other factors that are driving that outlook?

Paul Nahi

Well, 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 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 2016. And in speaking to our customers in the markets we're seeing that the pricing environment seems to have generally stabilized, that doesn't mean that it is exactly stable, it just generally stabilized. And we're going to continue to monitor it and then obviously, if we see things change we will 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.

Michael Morosi

Great, thanks guys.

Paul Nahi

Thank you.

Operator

Thank you. And our next question comes from Vishal Shah of Deutsche Bank. Your line is now open.

Vishal Shah

Yes, hi, thanks for taking my question. Paul, in the conference call one of the larger EV [ph] companies mentioned that they have advanced power electronics capability and that were looking to make a new order 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 [ph] companies getting into the new order space and then how do you see some of the Chinese competitors also reacting to the marketplace right now?

Paul Nahi

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 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 three 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 we're collecting today somewhere in the neighborhood of two or three 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 talked about all the capabilities that are now required in a microinverter. They go far beyond 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, I haven’t even begun 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 interested in this space, and I think new entrants are healthy and they may bring some new technologies, but I feel very comfortable that we have a very strong and defensible position that it would be very challenging for a new entrant to match at this time.

Vishal Shah

That's helpful. Can you maybe talk about your assumptions that you’re baking into your guidance for positive cash and cash generation in Q1 of next year and what kind of margins do you to expect, you assume – are you assuming just 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 existing portfolio and new product as well?

Kris Sennesael

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 the time period of two years. So towards the end of 2017, and in the meantime, we continue to drive down the cost of our fourth generation product, which is the majority of the shipments that we do right now towards the end of 2016.

And then ramping in 2017 we will introduce our sixth 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 seventh 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 sixth 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 our product.

The cost of that product is on target even slightly below were we targeted that, and we feel good as well on the execution towards the seventh generation towards the end of 2017 as well. So I think that is 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.

Vishal Shah

Thank you very much.

Operator

Thank you. And our next question comes from Colin Rusch from Oppenheimer. Your line is now open.

Colin Rusch

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 is that’s going to be drag on cash at all as we go into the back half of the year?

Kris Sennesael

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 the increase in payable. And so as we continue to grow the business and continue the unit shipments 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 2016.

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.

Colin Rusch

Okay, great. And then as you start [ph] out the energy storage product, what is your expectation here in the first couple of quarters on the impact to gross margins? I understand it's a fairly small amount of revenue, but that product profitable at the gross margin level and is it enhancing or really dragging a little bit on the overall gross margin?

Paul Nahi

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 it will 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 – it just in this quarter.

Colin Rusch

Okay, thanks guys. I'll take all the rest offline. Thank you.

Paul Nahi

Thank you.

Operator

Thank you. And our next question comes from Jeff Osborne from Cowen and Company. Your line is now open.

Jeffrey Osborne

Great, I just had two questions and a clarification. Just maybe a clarification on Colin's question there on the corporate gross margins, obviously the corporate gross margins have changed a lot over the past year and a half. So if I'm hearing right do you expect them to be in the high teens for storage or 30% where you used to be?

Paul Nahi

Well, I think it's going to fall our corporate gross margin. So I think you can assume that as our corporate gross margins increase it will increase with it for the same reasons at the corporate gross margin will increase.

Jeffrey Osborne

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 the third of the value of it, but that third party content won't be a drag on that at steady state year from now?

Paul Nahi

So the AC Battery consists of obviously all the mechanicals, all the cabling, the microinverter itself, several other controller boards are go inside the – inside the AC Battery. And all of these as we ship our first generation product are exactly that our first generation products. So there is 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 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 and 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.

Jeffrey Osborne

Got it. It’s helpful, I appreciate that Paul. Just two other ones, so if I'm hearing you right kind of reading between the two waves it sounds like the inventory levels were maybe a bit bloated on the M215 side, and then you substantially discounted those this quarter 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 215s that need to be cleared out?

Paul Nahi

No, there was no – we didn't do anything on pricing to clear out either to 215s or to 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.

Jeffrey Osborne

You might not know this, [indiscernible] there was the 215 demand outside of the U.S., I mean it's just a very low watch system [ph]?

Kris Sennesael

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 at 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 is up into the right in terms of module power. And we're seeing costs come down on the 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.

Jeffrey Osborne

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 on a pennies per watt or percentage premium so to speak for all of 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?

Paul Nahi

Right. So yes 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 he felt that they just simply can't afford the premiums that they used to have to pay for it and that and so 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 is very hard to say, because it really depends on any individual installer. I would say that it could be anywhere between 10% and 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 the market itself is rather fragmented in that respect.

Jeffrey Osborne

I appreciate it, thanks guys.

Paul Nahi

Thank you.

Operator

Thank you. And our next question comes from Krish Sankar from Bank of America-Merrill Lynch. Our line is open.

Chirag Odhav

Hi this is Chirag Odhav on for Chris. So some people are forecasting a potential over capacity on the module side, which could lead to prices going lower for modules, do you see this having any impact on inverters, DC like a decline on the module and softening any expected price declines for inverters?

Paul Nahi

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 front on inverters. I do think, again to point out a 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 one quarter more 215s, another quarter more 250s, I think that there may be some volatility there, but I don't think it's going to have a significant impact on an inverter pricing.

Kris Sennesael

Yes, and so obviously the panel market or the module market is 60 gigawatt worldwide and is 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, a totally different market.

Chirag Odhav

All right, got you, thanks.

Operator

Thank you. And our next question comes from Pavel Molchanov from Raymond James. Your line is now open.

Pavel Molchanov

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, you know 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?

Paul Nahi

Right so it is 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 estimates, 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 is more about rate arbitrage and Queensland is 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 installed 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 is from China or whether it is from the U.S., whether it is from Germany or Europe and 201 [ph] 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 kWh in one hour. I don't believe that there is a competitive solution around that can make any claim anywhere near that and yet we are 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 source.

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 are consuming, what is 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 marketing 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 kWh blocks so you can tailor that system, the size of the system because it is 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, so that combination of simplicity, cost effectiveness and providing that totally integrated symptoms is what is enticing and providing the excitement for our customers and it is what is driving our confidence.

Pavel Molchanov

Okay, given that you haven’t, as you said, haven’t sold any commercial deliveries yet, conceptually how even are we pricing this? It is a brand new market. You are a new player in that market. So what's the price calculation like?

Paul Nahi

So the current pricing is very competitive with similar parts on the market. I would say it is middle to low end of the range which is just pure CapEx. What we did is, we looked at it two ways, one was obviously evaluating the competitive environment and two, was looking at the current rate structure to provide the economics that would make the solution in general very interesting. That is sort of what led us to the existing pricing where we are.

Obviously over time we will be reducing our cost 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 are 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.

Pavel Molchanov

All right. I appreciate it guys.

Paul Nahi

Thanks.

Operator

Thank you. [Operator Instructions] And our next question comes from Carter Driscoll from FBR. Your line is open.

Carter Driscoll

I appreciate you taking my questions gentlemen. I wanted to get a sense of the amount of share that you think you've regained since you instituted your aggressive pricing cuts late last year, do you feel that you've regained and maybe even taken share in the U.S. residential market? How do you think about that quantitatively? And then I have a followup.

Paul Nahi

So, we think that between Q1 and Q2 we've gained around 6 percentage points which is approaching around 30% share.

Carter Driscoll

Very helpful, thank you. In terms of your comments which I thought was very interesting, your pilot with PG&E and future kind of growth in those market hike with the utilities really adopting DG or becoming more comfortable with it, you mentioned some other utilities that or maybe with the solution maybe have recent pilot stage, can you talk about the geographies that are outside of which you had mentioned was Hawaii and then California, are there other states that you think? I'm trying to get a sense of which utilities might be more forward thinking or acceptable moving forward in helping push DG forward outside of the traditional territories?

Paul Nahi

Right, right, it is actually a very good question. Unfortunately I am 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 are 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 the 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 does not 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 thing we're in a very good position to help them work through some of these issues.

Carter Driscoll

And how long do you envision the pilot phase with PG&E will last? I mean has it really come up to whether it can be rate based or what types of other qualitative issues they have to work through to accelerate the pilot program if you can?

Paul Nahi

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 lot of a goal and it is one that we're after. The initial goal of the PG&E engagement is really to test out the different technologies, try to understand how PG&E can work with 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 will 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

Carter Driscoll

I appreciate you answered my question. I will get back in queue.

Paul Nahi

Great, thank you.

Operator

Thank you. And this does conclude our question-and-answer session. I would now like to turn the conference back over to Paul Nahi for any further remarks.

Paul Nahi

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

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.

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