Thank you for standing by, and welcome to the Enphase Energy First Quarter 2021 Financial Results Conference Call [Operator Instructions]. As a reminder, today's conference call is being recorded. And now I'd like to hand the conference call over to Adam Hinckley. Please go ahead, sir..

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's first quarter 2021 results. On today's call are Badri Kothandaraman, Enphase's President and Chief Executive Officer; Eric Branderiz, Chief Financial Officer; and Raghu Belur, Chief Products Officer.

After the market closed today, Enphase issued a press release announcing the results for its first quarter ended March 31, 2021.

During this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to Enphase Energy's expected future financial performance; the capability of our technology and products, including availability and features; our operations, including in manufacturing and customer service; the anticipated growth in our sales and in the markets in which we operate and target; and the capabilities of our installation partners.

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, 2020, which is on file with the SEC, and quarterly report on Form 10-Q for the quarter ended March 31, 2021, which will be filed during the second quarter of 2021.

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 statement as a result of new information, future events or changes in its expectations.

Also, please note that the financial measures used on this call are expressed on a non-GAAP basis unless otherwise noted and have been adjusted to exclude certain charges.

The company has provided a reconciliation 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 Web site. Now I'd like to introduce Badri Kothandaraman, President and Chief Executive Officer of Enphase Energy.

Badri?.

Good afternoon, and thanks for joining us today to discuss our first quarter 2021 financial results. We had a good quarter. We reported revenue of $301.8 million, shipped approximately 2.45 million microinverters, achieved non-GAAP gross margin of 41.1% and generated strong free cash flow of $81.5 million.

We exited the first quarter at approximately 41, 14, 27. This means 41% gross margin, 14% operating expenses and 27% operating income, all as a percentage of revenue on a non-GAAP basis. As a reminder, our baseline financial model is 35, 15, 20. Eric will go into details about our financials later in the call.

Let's discuss how we are servicing customers. Our Q1 Net Promoter Score worldwide was 63% compared to 62% in Q4 and our North America Net Promoter Score was 69% compared to 68% in Q4. Our average call wait time in Q1 was more than 5 minutes as we onboarded new installers and fielded calls related to our storage systems.

We are working diligently to bring wait times down under a minute. We also expect our 24/7 global customer support to help reduce wait times. The round the clock support is another step forward towards delivering an outstanding customer experience and will supplement the Enphase Community and training platforms. Let's talk about manufacturing.

As we discussed in the last call, the semiconductor supply chain is under stress. In Q1, we experienced constraints on the supply of ASICs and AC FET drivers, which limited shipments. Our contract manufacturing facility in Mexico shipped more than 900,000 microinverters.

Our contract manufacturing facility at Salcomp, India shipped nearly 500,000 microinverters. We are very pleased with the production ramp, product quality and manufacturing cost of this fully automated facility in India. Given our strong demand, we are expanding manufacturing capacity in Mexico and India further.

In Mexico, we are improving operational efficiency and expect to reach quarterly capacity of 1.5 million microinverters. At our facility in Chennai, India, production is around the clock, bringing quarterly capacity to 700,000 microinverters from one manufacturing line.

We have already purchased equipment for the second manufacturing line and expect to begin ramping in Q3. Looking to Q2, our shipment volumes will be constrained by semiconductor component availability. We have qualified new suppliers for our ASIC and AC FET drivers, which will result in increased shipments for Q2 compared to Q1.

But the ramp from these new suppliers is slower than what we had anticipated before. We expect these component constraints to remain for the rest of the year. In terms of our Enphase Storage Systems, we shipped 42 megawatt hours in Q1, representing a sequential increase of 30% and in line with our expectations. Let's now move to the regions.

The US and international revenue mix for Q1 was 82% and 18%, respectively. The US market was quite strong in Q1 despite typical seasonality. US revenue was up 14% sequentially. We achieved very good microinverter sell through from our distribution partners.

I am proud of our operations team for navigating the supply constraints and ensuring customers had continuous supply of product. With higher microinverters shipments in Q1, our channel inventory is better but still tight. With Q2 through Q4 being seasonally robust quarters, we expect the channel tightness for microinverters to continue.

In Europe, we reported record Q1 revenue. Revenue increased 17% sequentially. We saw strength in Netherlands and France while building on new markets such as Germany, Poland and Austria. Our AC module strategy is also gaining momentum in Europe.

We expect to introduce Enphase Storage Systems for the European market in the second half of 2021, first in Germany and then in Italy, adding yet another growth driver. I'm very pleased with our performance in Europe. In Australia, we had record revenue and record installer count. Q1 revenue was up 58% sequentially.

The strong growth of the Enphase Installer Network or EIN and rapid market penetration of our IQ 7A product contributed to our success. In addition, we are focusing both on installer and homeowner experience, launching 24/7 customer support, conducting technical training and collaborating on branding initiatives with installers in Australia.

We expect to introduce Enphase Storage Systems to Australia also in the second half of 2021. In Latin America, Q1 revenue was down a little 33% from the prior quarter, which had benefited from large storage orders. Puerto Rico continues to be a solid market in terms of both microinverters and storage.

We are also making plans to enter the Brazilian residential solar market, which is expected to be over 1 gigawatt this year. We have already hired [Marco Krapels], an experienced sales leader to accelerate our entry into Brazil. Now that we have covered the region, let's discuss the overall bookings for Q2.

Now once again, our customer demand for Q2 significantly exceeds the higher end of our guidance range. We remain supply constrained for Q2, as I said before. The component availability is improving but not at the rate of growth in demand.

While it is very early to talk about Q3, our customer bookings are quite higher than what they would normally be at this time of the quarter. We are planning for much higher capacity in Q3 for both microinverters and storage.

We're obviously pleased with the overall demand but we are cautious about the supply situation, which is not very predictable today. Let's now move to our storage system rollout. We shipped 42 megawatt hours of storage systems in Q1, representing sequential growth of approximately 30%.

Cumulatively, 623 unique installers commissioned at least one Enphase Storage System by the end of Q1. We're also making good progress with the Tier 1 and 2 installers. We previously announced solar plus storage partnerships with Sunnova, Momentum Solar, Solar Optimum and Power. We expect to announce more partnerships soon.

Let's now turn to training for our Enphase Storage Systems. By the end of Q1, we trained 1,776 installers cumulatively online, representing 1,035 unique companies. We plan to resume in person training soon, beginning with our mobile van training in Texas. Other states will follow shortly.

In addition, we are resuming the build out of training centers at various distributor locations. As you're aware, we are laser focused on customer service and making sure we are the easiest company to do business with.

With these principles in mind, we started weekly installer round tables in Q1 to understand how we can improve the Enphase storage product. The findings are clear, improving the commissioning experience for installers and making life easier for homeowners.

By leveraging the feedback, we have made a number of updates to our software and commissioning process. Our engineering teams have been working hard to reduce commissioning times on our storage systems from many hours to approximately two hours through software improvements and training initiatives.

Our goal is a 60 minute commissioning time, which will allow our installers to visit the site, install and commission an Enphase Storage System in a few hours. We expect to release a couple of new features for our Enphase storage system, as discussed in our last earnings call and these include load control and generator support.

Load control is the ability to turn loads on and off. We envision that most homeowners will opt for a full backup of their entire home rather than a partial backup with the capability to shed loads when needed. We have four circuits for load control designed into our Enpower smart switch. Homeowners can choose up four loads they want to control.

For example, an air conditioner can be controlled through one circuit and a pool pump can be controlled through another circuit. These loads will be on during the grid tight mode and can be shared instantaneously during the off grid mode simply via the app.

In addition, excess solar can also be configured to be shared through one of these four circuits. This enables the homeowners to save money by not oversizing their battery storage systems. The next feature is generator compatibility. Unlike some of the others, there is no need to install a generator ATS when used with Enphase Storage Systems.

The generator can plug in to our smart switch called Enpower, which has built in safeguards that ensure generator is only connected to the home when the home is off grid. When the home is disconnected from the utility, Enphase microinverters in the battery seamlessly form a micro grid to ensure there is no disruption. The lights will not flicker.

The clocks will not reset. Next, our smart switch starts the standby generator. Once the generator is stable, the system synchronizes the microgrid to the generator's voltage and frequency. Our smart switch then seamlessly connects the home to the generator.

The Enphase solution provides increased resilience in the off grid mode by enabling solar, storage and the generators to run together. The generator control will also be integrated into our mobile app so that homeowners have full visibility and control from one app. There are two modes of operation.

One is the basic mode, where the generator simply turns on during an outage. And the other is that the generator can be configured to turn on depending on the state of charge of the battery during an outage. For example, when the battery charge goes below 20% in an outage, the generator turns on, charges the battery, supports the home loads.

And once the battery reaches 90%, the generator returns off. These are two powerful features and we expect to release them this quarter after beta testing with customers, which is underway. We are seeing a good amount of interest from customers.

And these features can be enabled simply by over the air software upgrades for existing storage systems, along with some additional minimal work to be done by the installers. In summary, we are happy with our Q1 storage shipments reaching 42 megawatt hours.

And as I said, we expect to introduce a couple of differentiated new features to improve the homeowner experience. We expect to reduce the commissioning times to improve the installer experience, and we expect to make significant go to market changes to improve the brand experience.

We expect our storage shipment volumes between 40 and 50 megawatt hours in Q2. Let's talk more on upcoming new products. First, I'd like to cover more details on what else is new for storage. In addition to the new features we talked about, we are partnering with aggregators and utilities to enable grid services.

This will enable utilities to leverage home battery storage systems instead of turning on peaker plants. And in doing so, the homeowners can get paid for providing that service. We have formed a 20% grid services team at Enphase now, consisting of software, product management, business development and policy experts.

This team has already made tremendous progress on technical and business fronts and we plan to expand the team significantly to engage with more utilities and aggregators. Final point on storage. We are working hard to introduce the Enphase Storage Systems internationally, as I said before.

We want to ensure that all learning from North America is captured and that we are fully staffed to support customers. We expect to introduce Enphase Storage Systems first into Europe and then into Australia in the second half of 2021. Let's cover our upcoming IQ 8 and IQ 8D product launches.

IQ 8 is the world's first grid agnostic microinverter for residential solar, and IQ 8D is a high power microinverter capable of supporting two panels for small commercial installer. We are making good progress on the compliance, reliability and system testing on these products.

However, with the microinverter supply chain constraints due to semiconductor component shortages, we expect a slower ramp beginning in Q3. We also plan to introduce the Enphase portable power station consumer products in Q4, assuming component shortages are under control. Let's now turn to digital transformation.

I'm excited about our two completed acquisitions, Sofdesk and the solar business of DIN Engineering. The former Sofdesk team, now known as Enphase Montreal, provide design and proposal software for solar and roofing companies.

The team acquired from DIN Engineering, now known as Enphase Noida, provides proposal and permitting services to the installers. By providing these services to installers, we aim to simplify the sales process while reducing [soft’s] costs and providing an enhanced buying experience for homeowners.

The obvious opportunity for Enphase is to expand both these offerings to our network of long tail installers. This is an important initiative for us and we will be integrating these two company operations into our digital platform.

We have now onboarded 476 installers in North America and 138 installers in Australia to our Enphase Installer Network, EIN, through a highly selective process focused on quality and homeowner experience. We recently launched our EIN in Europe and India.

Our EIN installers enjoy a variety of benefits, including branding, promotion and tools and services on the digital platform to help make sales and installation process faster and easier. In summary, we are happy with our performance, and we are pleased with the increased demand for our products.

We look forward to introducing our new products, ramping our storage systems, supporting our customers better and accelerating our digital transformation. As always, the health and safety of our employees, the customers and partners remain our top priority as the world continues to be impacted by COVID-19.

With that, I will hand the call over to Eric for his review of our finances.

Eric?.

Thanks, Badri, and good afternoon, everyone. I will provide more details related to our first quarter of 2021 financial results, as well as our business outlook for the second quarter of 2021.

We have provided a reconciliation of these non-GAAP to GAAP financial measures in our earnings release posted today, which can also be found in the IR section of our Web site. Total revenue for Q1 was $301.8 million, representing an increase of 14% sequentially.

We shipped approximately 830 megawatts DC of microinverter and 42 megawatt hours of storage systems in the first quarter, equivalent to 16.1 megawatts of power. Non-GAAP gross margin for Q1 was 41.1% compared to 40.2% for Q4. The increase was driven by disciplined pricing and cost management. GAAP gross margin was 40.7% for Q1.

Non-GAAP operating expenses were $43.7 million for Q1 compared to $34.2 million for Q4. The sequential increase was primarily due to R&D investments, increased hiring, payroll tax associated with employee stock vesting and first time consolidation of Sofdesk operations in late January.

GAAP operating expenses were $61.6 million for Q1 compared to $42.8 million for Q4. GAAP operating expenses for Q1 including $13.9 million of stock based compensation expenses and $4 million of acquisition expenses and amortization for acquired intangible assets.

On a non-GAAP basis, income from operations was $80.2 million for Q1 compared to $72.4 million for Q4. On a GAAP basis, income from operations was $61.4 million for Q1 compared to $79.1 million for Q4. On a non-GAAP basis, net income for Q1 was $78.7 million compared to $71.3 million for Q4.

This resulted in diluted earnings per share of $0.56 for Q1 compared to $0.51 per share for Q4. GAAP net income for Q1 was $31.7 million compared to GAAP net income of $73 million for Q4. GAAP diluted earnings per share was $0.22 for Q1 compared to diluted earnings per share of $0.50 for Q4.

The GAAP results in the first quarter included a noncash loss of $56.4 million on the partial settlement of convertible notes due 2024 and 2025 or approximately $0.40 on a per share basis. Now turning to the balance sheet and the working capital front. Inventory was $34.9 million at the end of Q1 compared to $41.8 million at the end of Q4.

The sequential decrease in inventory was driven by an increase in customer demand coupled with supply constraints. Days of inventory outstanding decreased to 18 days compared to 27 days in Q4. This sequential decrease was driven by the lower average inventory balance and higher shipment volumes.

Our target is 30 days, but we were hampered by supply cost trends. Accounts receivable were $236.1 million at the end of Q1 compared to $182.2 million at the end of Q4. The sequential increase was due to the higher revenue in Q1 and shipments being weighted to the second half of the quarter.

DSO of 56 days increased from 50 days in the prior quarter due to the timing of shipments. We exited Q1 with a total cash balance of approximately $1.5 billion compared to $679.4 million for Q4.

The cash balance includes net proceeds of approximately $1.2 billion for the comparable notes issuance in May 2021, which are partially offset by $304.8 million paid in principal amounts for the partial repurchase and conversions of the convertible notes due 2024 and 2025 and $65.4 million paid for the call spread on the new convertible notes issuance.

We did not make any share repurchases against our $200 million share repurchase authorization. In March, we issued green convertible notes in two tranches for total gross proceeds of approximately $1.2 billion. Both tranches have zero coupon. The five year tranche due 2026 raised gross proceeds of $632.5 million.

With a 70% conversion premium, these notes are in the money at the share price of approximately $307. The seven year tranche due 2028 raised gross proceeds of $575 million with 57.5% conversion premium. This tranche is in the money at the share price of $285.

Concurrent with the notes offering, we entered into a call spread overlay, which effectively increased the overall conversion price to about $398 per share. The terms of this capital raise were some of the most favorable to an issuer in history. We have a very strong cash position on a business that generate healthy free cash flow.

We will invest in the business through organic and inorganic activities. We have a CapEx light business model, which provides for continued investment in new product development, new market entry and marketing to build our brand awareness with homeowners.

On the acquisition front, we have an active pipeline and we are careful to only pursue deals with the right strategic and cultural fit, while meeting our return hurdles. In Q1, we generated $75.8 million in cash flow from operations and $81.5 million in free cash flow.

Capital expenditures was $9.9 million for Q1 to increase manufacturing capacity for both microinverters and storage and costs related to enlighten software app development, corporate Web site development and office space expansion. Now let's discuss our outlook for the second quarter of 2021.

We expect our revenue for the quarter to be within a range of $300 million to $320 million. We expect GAAP gross margin to be within a range of 37% to 40% and non-GAAP gross margin to be within a range of 38% to 41%, which excludes stock based compensation expenses.

We expect our GAAP operating expenses to be within a range of $70 million to $73 million, including a total of approximately $17 million estimated for stock based compensation expenses and acquisition related expenses and amortization. We expect non-GAAP operating expenses to be within a range of $53 million to $56 million.

All guidance estimates include the contribution from both Sofdesk and DIN for the entire quarter. Let me provide some additional color on a few topics. First, given the component supply constraints, we are expediting components and finished goods in Q2 to ensure customers have an adequate supply of our products.

Even as component availability starts to improve this quarter, we must rush to get those components into final products into our customers’ hands. As a result, our GAAP and non-GAAP gross margin guidance incorporates a material sequential increase in expedite expense.

While we expect Q2 to be the peak, logistics costs will likely remain elevated for the rest of 2021 due to the semiconductor supply chain constraints. Next, I would like to touch upon our OpEx guidance.

Our non-GAAP operating expenses are increasing from Q1 to Q2 due to hiring to support our growth plans, the consolidation of acquisitions and necessary investments in software, branding and the development of IQ 9 and IQ 10 microinverters.

It is possible that our OpEx may be slightly above our 15% target at times, but we'll still expect to comfortably exceed our baseline financial model target of 20% operating income. Regarding the two acquisitions [not only] do have the operating expenses of those business, but we also include accruals for the payment of deferred cash consideration.

These are cash expenses, which is why we included them in non-GAAP guidance, but there are nonrecurring in nature beyond the specific earn out periods for each acquisition. For Q2, accruals for deferred consideration are expected to be approximately $3.5 million. With that, I will now open the line for questions..

[Operator Instructions] Our first question comes from the line of Aric Li from Bank of America..

I have question, first and foremost, around the component and [Technical Difficulty]. So you talked about improving channel inventory in 1Q, but the constraints remain. And it seems like that's weighing on shipments for both solar and storage.

Can you talk about when you expect those new suppliers to really help ease the component constraints, would that be more into the back half or would that not really be until 2022? And just how much lower is that going to drive channel inventory relative to the 8 week target?.

So let me first make a couple of things clear. First of all, the constraints are only on the solar side, which is solar microinverters.

And although, we are increasing the capacity of solar microinverters every quarter and the demand is increasing every quarter, the supply is unable to keep up with demand because of semiconductor component constraints. The semiconductor component constraints are mainly because of two specific components. One is the ASIC chip that we have.

The other is an AC FET driver that drives the gate of the 600 volt transistors. And what we have done is, on both of them, we have bought on multiple suppliers. For example, on the AC FET drivers, we had two suppliers before. Now we are going to have three suppliers. On the ASIC, we were producing it in one foundry before.

Now we are going to qualify an additional foundry. However, our demand is so high for Q2 and we expect a similar demand situation for Q3 that even though our available supply is higher than the prior quarter, it is still not sufficient to meet our demand. This is on the solar side. On the storage side, it's pretty simple.

We shipped 32 megawatt hours in Q4. We shipped 42 megawatt hours in Q1 that is 30% higher, and we are making tremendous progress there. Our strength in storage is taking care, meaning introduced storage to our long tail installers. And we have trained 1,776 installers, representing 1,035 unique installation companies. That's our bread and butter.

These are the folks who are engaged with us on the solar side and they have started buying storage. We are also engaged with the Tier 1 and 2 customers on storage, and we expect more progress here. In addition, like what I said, we have started roundtables every week with our long tail installers to understand all their pain points.

And if I look at it, what are the installer pain points? The storage is still immature as a business for the installers. They have to make multiple trips per home because it is so new. The system sizing tools aren't up to speed yet, which is something we are going to be working on with our Sofdesk acquisition. Every job is a custom job.

We are trying to standardize that with load control, having whole home backup instead of partial home backup. The homeowners are demanding because all of a sudden you're now in the path of power. And so the sales, meaning the customer service that the installers have to do, is much higher than the solar side.

On top of it, we have permitting delays from the countries because, again, it's a new product and not everybody is used to it. And Enphase can help in all of the above. We are going to provide exceptional customer service. We are going to have field service teams to help installers. We bought a company to do solar and storage design software.

We bought a company to enable permitting services. And so we have all of the tools to help the installers. However, this is going to take time. And that's why you see our growth is steady growth that we are talking about. We grew 35% from Q3 to Q4. We grew 30% from Q4 to Q1.

We are growing modestly from Q1 to Q2, but we have no doubt that we are doing the right thing. And in addition, the other thing that would spur demand is international locations. It's got to be similar. We are going to take care of long tail installers internationally.

We are going to introduce product imminently second half of the year early into Europe and then into Australia in the latter part of 2021. And in addition, I talked about the things we are doing on the homeowner side is introduce load control, which is the ability to turn on and turn off loads.

The turning off loads is critical when you're in an off grid situation so that the homeowner experience is pristine. So we are focused on those. And we are also going to up our game on the marketing side. I recently -- yes, last quarter, I announced our CMO.

And we are going to go all out on that front in terms of promotions, branding, looking at multiple channels, looking at the way we go to market, partnering with loan providers and 24/7 support, field service. We believe all of these tools are necessary, and it will help us make steady progress on storage every quarter.

A long answer but I hope I answered the question..

Just as a follow-up question, specifically on storage. I believe you provided the guidance of 40 to 50 megawatt hours in 2Q, is that right, relative to 42 megawatt hours in 1Q.

Can you just talk about expectations into the back half? Seemingly, I wasn't sure if there was some sort of chip constraint for the microinverters that would be using the storage, too, given the same product there.

But could you just talk about expectations at the back half and perhaps bring additional suppliers and what that means for capacity into 2022?.

Well, like what I said, we expect to make steady progress on storage every quarter. We gave you guidance for Q2. Q3 will be steady progress on top of that. In terms of constraints on the storage systems, it's really, yes, microinverters are also included, yes, in the storage system. Every 10 kilowatt hour battery has got 12 microinverters.

But in the big scheme of things, it's a small number relative to our overall demand. So we don't expect that to play a big deal there. And we are comfortable with the capacity that we have on the storage side. And like what I always said, we will bring in additional suppliers in 2023. And we have two suppliers today..

Our next question comes from the line of Brian Lee from Goldman Sachs..

Maybe just big picture. Last quarter, Badri, Eric, you guys said that you sort of had visibility that the supply chain constraints, which everybody has been experiencing through the year, for you, you felt like April, you called out the month of April as being a potential having line of sight that things would start to ease around then.

Now you're saying you're expecting the supply constraints on the solar side to persist through the year. So just a simple question, kind of what's changed between then and now, did you misread the market? Or what's kind of changed between the April view and now seeing this impact through the year? And then I had a follow up..

It's pretty simple. The supply is not very predictable. Our demand is going higher and higher. We are increasing our supply every quarter. We are putting in much higher capacity in place for Q3 and Q4. But if you ask me today how confident our view on the supply, and it's tough because the situation is unpredictable.

And the decommits are -- there are often decommits that we have to dance around. I am working with the CEOs of all three companies directly. And for example, on the AC FET drivers, but the situation is stressed globally and I don't think it is unique to us. Our architecture uses semiconductors. So the supply is -- yes, it's what it is.

The good news is the -- yes, the demand has increased a lot for Q2 and Q3, stressing the supply situation even more. And that's what changed from the previous call. Yes, that's the truth..

And so, I mean, it sounds like what you're saying is supply continues to be unpredictable, which makes sense, and then demand has actually probably gotten better. So follow up I had you is just maybe a little bit of numbers or quantification. This is the second quarter in a row where you're saying that you have bookings in excess of your guidance.

You're basically undershipping demand. So maybe just a two part question here on the quantification. Can you give us some sense how much you are undershipping demand? Would guidance have been $10 million, $20 million, 10% higher? Just any sense on that? And then Eric also made some mention around margins.

Q2, you're going to have some peak pressure from a freight cost perspective, but it doesn't get worse. What sort of margin impact is that in the quarter, 100 bps, 200 bps? It doesn't sound like it eases right away, but just trying to get a sense of what that is.

And then just lastly, if you're seeing some of these cost increases, the tightness, are you raising prices? Are you having those negotiations or discussions with customers? And if not, given your market share position and how critical you are to your customers, why not potentially start to raise prices?.

You asked me for some numbers. I'm not going to say exact numbers, but I'm going to say one thing, that the demand is higher than all the numbers that you quoted, which is the good news. The second question, what is the second question? The third question, pricing. I'm not changing pricing. The second question on gross margin.

Our gross margin guidance, non-GAAP is 38 to 41. We are not going to exactly break out what we did for expedite, but it's a big number. And you expect that because when you have supply chain problems, the factories are running hand to mouth. The factories are running hand to mouth, there is no time to put product on a boat.

The only way we can get product to customers is air ships. Air ships per unit pricing to put a microinverter on the plane is enormous. It's usually 10 times or 15 times the price that it takes to ship on the ocean as expected. And these are all not new. They are standard. So hopefully, I gave those numbers..

On the margins, Brian, I think that the comment about operation, meaning we need to live with expedites for a while. But we are pretty predictable in the way we manage our margins. On that front, on the cost reduction schedules and the way we negotiated prices, short and long term, I don't see a problem there.

And I think you're seeing -- we look at a midpoint of the guidance that it's been pretty consistent, and we just need a little bit of time to get the supply challenges in the industry figured it out. And from the comment about April to today, adding to what Badri said, things changed. It changed quite a bit.

I mean, the predictability on the level of inventories at the contract manufacturing level and even at the supplier level, it got depleted because of the V-shaped recovery. So that created a little bit more variations on the predictability, now relying on purely what is on the line.

So that created a difficulty for even them to forecast their commitments. So that's kind of where we are on that. But I think that the -- I feel okay with the margins, so I think we got a profitable business, and we keep the eye on the ball here..

Our next question comes from the line of Philip Shen from ROTH Capital Partners..

Just as a follow-up on the chip shortage. I know this was partially asked earlier, but just to put a finer point on it.

Of the three companies that you're working with, Badri, are they giving you a sense for, hey, we think we can resolve this by Q1 of '22, for example, or is the situation even for them very unclear? So is this potentially a problem that could persist, for example, through a bunch of 2022?.

Yes, I mean, like what I said, I don't have that much visibility right now, but I do expect the supply situation to get better every quarter, especially because we have bought on a third supplier and that third supplier will eventually start ramping. So I do expect Q3 to get better. I expect Q4 to get even more better.

But will that match our demand? I cannot predict it now..

So shifting gears back to storage. You shared the megawatt hours for Q1 and the guide for Q2.

Can you share revenue by chance? And also, what do you think the margin profile of the sales in Q1 and what you expect in Q2 is? Are you close to corporate average or is it meaningfully different?.

We are not going to break out revenue. Now with regarding gross margin, we will not enter any business unless we have a view to achieving our corporate gross margin..

Our next question comes from the line of Colin Rusch from Oppenheimer..

We just talked about the pricing in the energy storage and the movement around that, so as you layer in these additional functionalities.

Are you able to charge higher prices or is that really just about maintaining your current price levels? And does it ultimately expand the market short term or is this really a longer term play around functionality that you think is important in the market?.

It's a longer term play, load control, generator functionality, grid services. These are all functions that we progressively want to introduce to existing homes. At this point, at least for load control and generator functionality, we are not charging for it. Grid services is a separate story because there is clear financial component there.

So once we get ramped up there, we'll figure out how to properly do value based pricing there. But in terms of storage, overall, our pricing strategy has always been value based. Our pricing will be next best alternative plus the value we add on top of that.

Yes, for example -- in micro inverters, for example, is we compare to the competition, that's the next best alternative. And then we say, what do we do better? We do quality. Our PPM defects -- defective parts per million, that's much lower and our customer services is much better. So similar things apply to storage as well.

Of course, it's a maturing market and so we need to be competitive, but we will always follow our value based pricing story. And if we don't add value, then it's pretty clear, right? We are going to be competing against competition. There's going to be price competition, and we never want to be like that. So that's why we are adding these features.

And these features are the differentiated features, which is load control, generation functionality, grid services and a lot more soon..

And then just shifting gears on the commercial solar business as you enter into that with IQ 8D.

Can you talk a little bit about the maturity of the finance partners that you're working with, who have qualified you and are ready to work with the solution, are comfortable with you? And how wide the geographic footprint will be as you start to roll out that product later this year?.

I mean, there the story is we're making a lot of progress there, both in terms of the business as well as the product features and compliance. The problem there is mainly with the supply situation uncertain, I don't want to ramp yet another new product with the same components, while I'm not servicing my current customers proper.

So that's why I made a decision on, let's make sure that we cautiously ramp that product. But it's a fantastic product. We are working with design tool partners. In our design and proposal partners, we are working with -- we are beginning to work with financials. We haven't made too much progress there, but we are beginning to work there.

And most of our business right now is focused on North America. That's the first product. And then in six months, we will introduce it in Europe as well as Australia where there's even bigger time for small commercial..

Our next question comes from the line of Mark Strouse from JPMorgan..

I wanted to go back to your comments about expanding capacity in Mexico and India. I believe on the last call, you mentioned having between 4 million and 5 million unit production capability per quarter by year end.

Are the comments today incremental to that number?.

No, the comments are consistent with that number. You can break down the 5 million the following way. Mexico capacity is roughly -- we'll get to 1.5 million units a quarter. Salcomp, India capacity will get to 1.5 million units a quarter, at least minimum quantities. China is already a couple of million units a quarter.

So 1.5 plus 1.5 plus 2, 5 million units a quarter, all by the end of 2021. So that's completely consistent with what I said. Now that capacity, that's the capacity of the factory, that's got nothing to do with supply.

The supply of the semiconductor components needs to improve, needs to become consistent, need to become predictable for me to cater to such a big demand. And that, today, I do not have visibility into those numbers..

And then just a quick follow up on the plans to enter the Brazilian market.

Will that require any kind of new manufacturing capacity, local manufacturing capacity? And then can you just remind us what you've said as far as what the product road map within Brazil will be as far as solar and then solar plus storage and then potentially the commercial sales?.

We are not going to manufacture something locally yet in Brazil unless the demand builds up to a significant number. So for now we would still manufacture remote, meaning not in Brazil. And first, we will start off with solar. [Marco Krapels], whom we hired in order to enter in Brazil, he is the GM of that business.

He believes that there is a substantial differentiation with IQ 8 entering into Brazil. Of course, in the short term, we are going to be supply constrained but we are talking about long term here. So first, I would start with solar and then I would add on storage to that market. Yes, basically.

Raghu, do you want to say anything?.

Just a couple of things is that from a product point of view, again, it's leveraging the platform. So we don't have to build a new hardware necessary to service the Brazilian market. It's a software change for us. It's a former change for us to meet their grid requirements.

In fact, today, IQ 7 is already certified as a unique specific certification requirement called in [metro], and we're already certified for the Brazilian market. So we are going to leverage our platform, which is what we've been doing for every new geography and playing very well..

Our next question comes from the line of Jeff Osborne from Cowen and Company..

I was wondering if you could rank order between the AC FETs and the ASICs.

Which of the two is more acute in terms of the problem?.

The AC FET by far..

And then the ASIC I always view as sort of the brain of your product. You're a fabless company that uses a third party today as you flagged one. To do that, typically, it's multiple quarters to qualify a new ASIC producer.

Do you anticipate that to take multiple quarters or have you been working on this for some time?.

We have been working on this for some time. And our current foundry is -- I mean, we have talked about this before. This is not new. Our current foundry is TSMC and we are qualifying an additional foundry..

Our next question comes from the line of Kashy Harrison from Simmons Energy..

So my first question is around just the rollout of IQ 8. I was just wondering how long do you think it would take or it could take to completely transition from selling majority IQ 7 to selling majority IQ 8, a year or two years? Just some rough numbers would be great..

Yes, IQ 7 took four quarters. So IQ 8 will take a similar time. And with the supply constraints, maybe you can add one or two quarters more, four to six quarters..

And then my second question. So I was reading your letter to the shareholders, and you talked about gallium nitride as you think about IQ 9 and IQ 10. I know that's a long ways away, probably still early in development. But when you think about the opportunity there, as you think about your product over the next several years.

Should we be anticipating step shift reductions in costs from the transition to gallium or do you think maybe we're getting close to the limit on your ability to take costs out of the manufacturing system?.

The reason why we are doing it is to reduce the footprint, to increase power, to increase efficiency and drop costs. And I'll give you a quick example. Today, we have 4 AC high voltage FETs. They are the 600 volt FETs, 4 600 volt FETs. And then we have two AC FET gate drivers, which is ahead all the shortages.

Those two AC FET gate drivers are driving the four 600 volt FETs. So we have four plus two, six components there. With gallium nitride, what we could do is to collapse two of those 600-volt FETs into one and we could integrate that AC gate driver also into the same package. So six discrete components will go to two discrete components.

Of course, cost of gallium nitride will be a little bit higher, but the integration capability is very powerful. And what does that mean is I can run my AC FETs now at a higher frequency. Today, I run them at 100 kilohertz. I can run them at a much higher frequency.

If I run those if I run those FETs at a higher frequency, then all of a sudden, I can drop my transformer size. My big transformer, which is there in the microinverter, can drop in phase drastically, dropping the footprint. So we are working concurrently on planar transformers in addition to gallium nitride FETs. That's the name of the game.

If we're able to optimize that properly, there is huge wins for us. And it will help us to increase the power of the microinverter while keeping the cost down, while keeping the footprint down, while keeping the economics intact. So that's what we are working with multiple companies, and it is R&D.

It's going to take us 2022 or 2023 to get an IQ 10 product, but IQ 9 will be a little bit before that, but it's R&D..

Our next question comes from the line of Tristan Richardson from Truist..

Just one from me. I think we heard from a market participant yesterday in moving to almost an exclusively bundled model for solar and storage. I think the dynamics there sound somewhat company specific, but just wanted to ask.

Are you guys seeing any signs of that in your installer network? And do you guys see it as an opportunity for Enphase on the market share side for either a stand alone storage product or otherwise?.

I mean, that's the name of the game. Storage by itself, some people say it makes sense. But in order to have a regenerative system that can function off grid, you want solar as well. So solar plus storage is a big deal. And that is precisely why we are focused on our long tail installers because they already sell in phase microinverters for a living.

And now if they start selling Enphase storage systems and more actually home energy management systems, which are solar plus storage systems that would be a big win.

So all of our efforts are taking our Enphase Installer Network and even bigger than that, taking our long tail installers, which is much more than the Enphase Installer Network, work really closely with them, train them properly, remove their installer pain points, help them with 24/7 support, help them with field service so that they can ramp solar plus storage with us, that's the opportunity..

But you're not necessarily seeing any installers kind of go from mandatory bundled model, are you?.

Mandatory bundles, not yet. But I'm sure it's coming..

Our next question comes from the line now of Jim Ricchiuti from Needham & Company..

Just a question on the expediting costs that you're incurring. And Eric, I may have misheard it, but you seem to suggest that's going to improve in the back half. And I guess, I know you're bringing on production, but by the same token, it looks like you're going to continue to be facing these supply constraints.

So how confident are you that you're going to see those costs come down in the back half?.

Yes, I mean, the expedite is going to be around with us as long as we get these challenges associated with supply constraint. So we should kind of get used to the concept that those are going to be embedded. What I'm saying is that, that is not going to get the margin worse.

What I'm saying is we got a very credible, predictable cost reduction road map in the near term that gives me confidence that we can continue honoring our financial operating model and my comments associated with operating income, which all is driven when you're thinking about OpEx may go up a little bit, right, because we need to make the investments.

That's what I said on my script. And then the question is, okay, so you have this expedite. What's going to happen with your operating income? Well, we feel confident that the cost road map will be there to deliver their goods.

As we continue ramping complicated products like storage and the new products that Badri has in time for Q3 and Q4, IQ 8 on the roof and IQ 8D. So there is one area that we should feel comfortable is that margins continue to be fairly predictable in the short term.

And in the long term, you can always use the financial operating model that we publicize size already. So that's the context within my comments..

And I wonder if you would just comment with respect to, is there a point at which you might begin to calibrate your operating expense, the investments you're making in the business over the next couple of quarters depending on whether this supply constraint issue potentially doesn't improve in the back half?.

I mean, I'm not quite sure I cannot follow your question. But if I understand correctly, you're saying, Eric, you're planning to continue spending money on doing acquisitions and potentially your OpEx is going to go up. And then your….

What I'm suggesting is if it looks like we're in for a period of a couple of quarters of pretty acute component shortage issues.

Is there a point at which you say we may dial back certain investments that we're making until the situation improves more markedly? And you may not because you feel like it's worth investing just as you think about the outlook for 2022 and presumably, it's going to be behind us..

So let me clarify. We are in growth mode.

And my message, hopefully, comes across very clear that we are not going to stop making the right investments at the right time either by processing our pipeline of deals that we have as we continue evaluating M&A or made the right OpEx investments, as I discussed on the script, on the prepared remarks, which are specific to go to market with products, including sales and marketing activities globally and so on.

We did really well internationally because we never compromise on making the right investments. The good news on that is despite of this and despite of the expedites, I have my margins there to deliver the goods.

So I can continue generating cash according to my model as I try to catch up with my revenue profile to fulfill my demand that right now is being hampered by the component supply constraint challenges that we have. I hope that answers your question..

Our next question comes from the line of James West from Evercore ISI..

So Badri, if I hear you correctly, the installer experience, the customer experience are getting better. You've got this product cycle that's underway. You're not meeting demand of your customers, and you're rapidly expanding into new geographies.

So when we get past this period of equipment shortage, you're going to have a lot more capacity because, as you mentioned earlier, you're going to keep investing. Will you, at that point -- let's say, we're into 2022.

Will you at that point finally manage to catch up with demand? Do you think demand will still outrun you?.

But, it's the same answer. I hope by the end of 2021, these problems go away. But right now, I'm living from day to day. Supply is unpredictable. The semiconductor -- it's not a situation only for me, it's a situation where every company who use the semiconductors. I don't have a crystal ball to predict the future..

And then, I guess, one other question, follow up from me. With the situation in India right now with the pandemic, is that having any impact? I know you're pretty automated in that facility.

Does that have any impact in your operations this quarter?.

Yes. I mean, it does. Many of the folks in our teams are affected by it, either their families are affected or they are affected. They're all working from home, following all safety protocols. I mean, India, if you know, it is not in such a great shape today, in general, as a country. I mean, we are heartbroken by it. It's 300,000 plus new cases a day.

So yes, I mean, some employees are affected, but they are also -- it lasts for about 10, 15 days. And during that time, they have full freedom to take care of themselves, and we will do all it takes to support them. But usually, they are back after two week break. And they are in the process of getting vaccinated.

And I'm hoping within a quarter, the situation will come back to normalcy, but we are taking care of all of our employees absolutely..

Our next question comes from the line of George O'Leary from TPH & Co..

Just curious, you guys have built up an impressive cash war chest and the free cash flow generation continues. You don't have much need from an organic CapEx spend. Clearly, there's a big R&D budget that's ongoing. But just curious if there are some larger bites at the apple from an inorganic standpoint that you might be contemplating.

You've done some M&A here recently but smaller stuff.

So just curious what you're thinking about on the M&A front, if there's anything on that medium or larger size front that piques your interest at this point?.

I mean, I'm not going to comment on details, but I'm telling you, Raghu, right now and Adam, both are in the call, have very ambitious plans, and they have great ideas. And they bring all sorts of very interesting stuff in for Badri and myself that we are evaluating carefully. The beauty about the having -- think about it.

They have $1.5 billion of cash, of which I need probably to run the company only $300 million flowing cash, that's what maybe a little bit more now that we are getting bigger. So the rest is available for us to take advantage of the best opportunities that are available in the market.

When you see things like what's happening right now with these packs kind of contracting a little bit that reopens the conversations very quickly. And certainly, the pricing on those conversations become much more reasonable to digest, I guess. And so we are aggressively looking at every opportunity.

And on software, maybe selectively some hardware R&D houses, ongoing businesses completely that we can buy. And we demonstrated that we can absorb them, integrate them, culturally fit and then we run them fairly well. And it's going well, for example, with the two we just did in Q1. So I think that everything is on the table..

And then just one more on an unrelated note, but you mentioned improving the installer and the customer experience is a goal, which makes a lot of sense.

Just wondering if there were any analogues from a geographic standpoint outside of your core markets today where that customer and installer experience is better where you can take lessons learned from those installers and translate them to the US or other geographies. I know Germany has much lower soft cost than the US, for example.

Just curious if there's any pathway that's already laid out from any geographic analogues out there in the market?.

Well, not really. Our 82% of our revenue comes from here. Yes, we need to diversify but most of our product experience comes from here. But having said that, it is true that, for example, places like Europe, Australia, even India, they do have an outstanding cost structure in general.

And we need to really take costs out of all aspects, not just products but things like permitting, things like design and proposal, look at all inefficiencies in the chain. That's something that we've just started doing with the acquisitions. We'll do a lot more.

And the name of the game, once again, is to collapse and consolidate all of those services for the installers onto the digital platform, so we can help them reduce the soft costs..

Our next question comes from the line of Maheep Mandloi from Crédit Suisse..

Just quick on the battery supplier, I think you previously talked about the third supplier in the second half. Can you talk about the status of that? And just had a follow-up on grid services..

We have two suppliers today, the second supplier is ramping just now, the first supplier is what we are using right now. Second supplier is just ramping. The third supplier, we do have good plans. However, I think it will turn on only in 2022..

And just on grid services, I know you said it's early in early stages and you're ramping up the software and hardware capabilities for it.

But when do you expect it to contribute any material revenues? And would that kind of a grid service optionality work with third party batteries or would it be predominantly for the Enphase storage product?.

It will be predominantly 100% for Enphase storage. And we're already tightly engaged with a few aggregators in the East Coast. We are going to enable selling, meaning we're already enabling selling of storage systems there and we will turn on grid services within the next three months for them.

Additionally, we are working with a couple of utilities as well who have directly approached us ad we are working with them, both in the East Coast and elsewhere here in the US. It does require a lot of software effort and the name of the game for us is, we have a long tail installer network that can help sell grid services properly to the homeowner.

We can integrate grid services to the Ensemble home energy management system so that we take care of customer experience properly. And at the end of the day, if we enable homeowners to save a certain dollars, $500 a year while giving them this peace of mind that will be a big deal.

So when we have an Enphase storage population that becomes tens of thousands, then VPP, meaning virtual power plant, will be very meaningful at that time. We are probably a year or two away from that but we are making a lot of progress in the interim with aggregators, with utilities. And we expect a lot more engagements with them..

[Operator Instructions] Our next question comes from the line of Eric Stine from Craig-Hallum..

Just a quick question, most have been taken.

But I know it's a little bit longer play but on the grid services side, is that something that you potentially can get a portion of those revenues as the enabler of that, or is that something that, as you said, you price based on value that you would potentially just try to capture on the front end?.

Yes, we can get a portion of it. The primary thing here is, in the model where we work with a few aggregators who work with the utility there, the homeowner reaps the benefit and we provide a service for a fee. And where we directly work with the utilities, financially, there may be more opportunities for us there.

And like what I said, we are right now scratching the surface. We are working with aggregators who are working with the utilities. We are in some deep engagement. So we first understand the business properly and develop our home energy management APIs and micro services for the same, but it's not going to be that far off.

In a few months, we would be able to work directly with the utilities..

Our next question comes from the line of Sean Milligan from Williams Trading..

I wanted to talk a little bit more about storage, I guess. Before, you mentioned that storage, there were financing problems with storage.

And so I wanted to just get your thoughts on where that market was in terms of being able to finance storage, which might drive additional growth for you?.

I mean, solar is very mature. The industry has got 25 years of warranty. So extended loans really helps the homeowner. And I think the rough breakdown in the industry between cash, loans and lease is about 10%, 60% and 30%, respectively, which means loans are roughly about 30% -- I mean, about 60% of the business.

Now we need to enable storage to also have attractive loans. In order for them to have attractive loans, solar bundling with storage is one option. Having the right warranty structure on storage is another option, and we need to do both.

And Enphase can help a lot here because this is what we are good at, power electronics, quality and customer experience. So we are thinking hard on working with partners. We have a lot of partners we're working with. And we can change the -- we have to work on the product quality to increase the warranty from 10 years to whatever we can.

And once we do that, we will unleash loans to become more economical for the homeowners. It will increase the demand that's required for the long tail installers. So it's a long range. Eventually, this has to be done. But we are taking proactive steps to ensure product quality is right..

And then just the competitive landscape in storage, like there's been new entrants, and people are giving performance guarantees. And I would expect storage to become even more competitive as additional battery cell manufacturing comes online over the next kind of three years or three to four years.

So just to get your sense on kind of the competitive landscape within storage and how you're competing against people that are giving performance guarantees or competing on price?.

We believe we must add value. We are not seeing a major problem on cell packs. I think we will be competitive and we have the right procurement organization to drive those costs down. The name of the game in storage is how can we provide outstanding quality and customer experience. It's the same thing which I told you.

The long tail installers need not look storage as a drag on their margins. The storage needs to be a highly profitable business for them. Instead of going to the home multiple trips multiple times for an installation, it should be one and done. The sizing needs to be clear. Installations need to be a cookie cutter model.

The permitting needs to be streamlined. The expectations for the homeowners need to be met. So things like load control are extremely critical. So we are going to be working on all of those things. And we believe that quality and customer experience will ultimately win, and that's what we do for a living.

It's a model that has worked well for microinverters with our long tail installers, and now we are going to ramp storage with our long tail installers. And yes, it is tough. It takes time. It's slow and steady progress. And those are the kinds of businesses we like, healthy, profitable businesses..

Our final question for today comes from the line of Pavel Molchanov from Raymond James..

When you expanded the installer network into Europe, which as one of the other questions asked about has much lower soft costs.

What's the main selling point of joining that network for an installer in, for example, the Netherlands or Belgium?.

First of all, the installer networks, in Europe, there are going to be multiple of them, because Europe, you cannot generalize Europe.

I think like what you said, Netherlands, our installer network there, they need something else versus installer network in Germany versus the installer network in the UK versus the network in Spain versus the network in Poland. That's the first thing to recognize.

The second thing to recognize is what do they want? What is the rate for them, right? What is the rate for them? The important thing is if they can have one platform on which they can get all kinds of services, that's extremely important for them. New product availability, extremely important for them.

They want to differentiate themselves from other installers. So they want nothing but the best. Like that, I could go on. There are multiple services that they need. So depending upon the tier of the installer, we have three tiers, platinum installers, gold installers, silver.

And the way we categorize those three tiers is pretty simple, based upon their quality and based upon how they rate on customer experience that's measured, not by us, by the homeowners. So we rate it like that and then we make it attractive for platinum installers to be with us in terms of pricing, in terms of services we do.

And we make sure there's healthy competition there. It's a much broader strategy and we are very cautious in introducing installer networks to every region without adequate planning. So last year, we spent the entire last year introducing installer network for the US and Australia.

This year, we just started in Europe and we will introduce in India as well, but a lot more to come in Europe..

My second question is about one more about component sourcing. Historically, there has never been a need for you to sign truly longterm supply contracts, let's say, five, seven year type of supply contracts with your key component players.

Do you envision going out to that long term time frame, given what we're experiencing right now?.

No. I mean, I'm wary of such deals. I usually not do such deals. I don't envision doing those. I hope and pray, this will be with us for a couple of more quarters and will be gone. And we'll be a better company because we have three suppliers instead of two, or we might even add one more. So we can always have supply diversification.

We'll learn best practices from it. We'll institute our business processes within the company, and we will become better..

Thank you. This does conclude the question and answer session of today's conference call. I'd now like to hand the program back to Badri Kothandaraman..

All right. So thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you again next quarter. Bye..

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day..