Good afternoon, and welcome to Enphase Energy's Third Quarter 2023 Financial Results Conference Call. Please also note that this event is being recorded today. I would now like to turn the conference over to Zach Freedman. Please go ahead, sir.

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's third quarter 2023 results. On today's call are Badri Kothandaraman, our President and Chief Executive Officer; Mandy Yang, our Chief Financial Officer; and Raghu Belur, our Chief Products Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September 30, 2023. During this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to our expected future financial performance, market trends, the capabilities of our technology and products and the benefits to homeowners and installers; our operations, including manufacturing, customer service and supply and demand; anticipated growth in existing and new markets; the timing of new product introductions and regulatory and tax matters. These forward-looking statements involve significant risks and uncertainties, and our 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 our most recent Form 10-K and 10-Qs filed with the SEC. We caution you not to place any undue reliance on forward-looking statements and undertake no duty or obligation to update any forward-looking statements as a result of new information, future events or changes in expectations. Also, please note that financial measures used on this call are expressed on a non-GAAP basis unless otherwise noted and have been adjusted to exclude certain charges. We have provided a reconciliation of these non-GAAP financial measures to GAAP financial measures in our earnings release furnished with the SEC on Form 8-K which can also be found in the Investor Relations section of our website. Now, I'd like to introduce Badri Kothandaraman, our President and Chief Executive Officer. Badri?

Good afternoon and thanks for joining us today to discuss our third quarter 2023 financial results. We reported quarterly revenue of $551.1 million, shipped approximately 3.9 million microinverters and 86 megawatt hours of batteries and generated free cash flow of $122 million. Approximately 86% of our Q3 microinverter shipments were IQ8. We exited the third quarter at 48% gross margin, 18% operating expense and 30% operating income, all as a percentage of revenue on a non-GAAP basis and including the IRA benefit. Mandy will go into our financials later in the call. Let's now discuss how we are servicing customers. Our worldwide NPS was 77% in Q3, compared to 74% in Q2. Our NPS in North America was 78%, compared to 77% in Q2. Our average call wait time was 1.3 minutes, compared to 1.1 minutes in Q2. We made significant progress on root cause fixes of some customer issues and expanded our field service teams globally. Let's talk about operations. In general, the overall supply environment for microinverters and batteries is quite stable right now. Let's cover microinverters specifically U.S. manufacturing. We began manufacturing at Salcomp's facility in Arlington, Texas during third quarter. We shipped approximately 531,000 microinverters to customers in Q3 from our three contract manufacturers in the U.S.: Flex in South Carolina, Foxconn in Wisconsin, and Salcomp in Texas. We expect to ship approximately 1 million microinverters to customers from our U.S. manufacturing facilities in Q4. Let's talk about batteries. For IQ batteries, we have two cell pack suppliers, both of which are in China. We have a manufacturing capacity of 300 megawatt hours per quarter, positioning us well to ramp up in 2024. We are looking at bringing manufacturing of IQ batteries into the U.S. by the middle of 2024. Let's now cover the regions. Our U.S. and international revenue mix for Q3 was 64% and 36% respectively. In the U.S., our revenue decreased 16% sequentially and 22% year-on-year. The overall sell-through of our microinverters was down 12% in Q3 compared to Q2. On the other hand, the sell-through of our IQ batteries in the U.S. was up by 34% in Q3 compared to Q2. In Europe, our revenue decreased 34% sequentially and increased 26% year-on-year at healthy gross margin. The sell-through of our microinverters in Europe was also down 35% in Q3 compared to Q2. The sell-through of our IQ batteries in Europe was down by 14% in Q3 compared to Q2. We are now shipping IQ microinverters and batteries into many countries in Europe. We recently entered U.K., Sweden, Denmark, and Greece markets with both IQ8 microinverters and IQ batteries. Combined, these new markets represent more than 1.5 gigawatts of residential solar opportunity with countries like the U.K. having a healthy battery attach rate of 30%. I'll provide some brief commentary on Australia. Our revenue in Australia more than doubled year-on-year. We are quite pleased with the launch of our Enphase Energy System. It is state-of-the-art, powered by IQ8 microinverters plus a third-generation battery. Let me comment on the rest of the world. In Brazil, we launched our IQ8P microinverters, 480 watts AC, the highest power microinverters that we have. We also launched the Solargraf software platform and have good feedback from installers there. In addition, we started shipping both the 384 watt IQ8 HC and the 480 watt IQ8P microinverters into India to support high-powered solar panels. Let's now talk about Q4 guidance. We are guiding revenue for Q4 in the range of $300 to $350 million. This reflects approximately $150 million of channel inventory correction in the U.S. and Europe. In other words, we are under-shipping to the end market demand for our products by approximately $150 million. We anticipate under-shipment will continue in Q1 and expect our channel inventory to normalize in Q2. Of course, we are conservative and are assuming the demand picture is unchanged from the current level. So what has changed since 90 days ago when we told you that the inventory levels would normalize by the end of Q3? We have seen a substantial demand reduction in Europe. We've also seen the U.S. market continue to fall, driven by California. When the demand falls, we think more decisive inventory correction becomes necessary. We are being conservative in our assumptions of no demand recovery until Q2 in this framework. So that explains the guidance. Despite the large reduction in Q4 guidance, we are maintaining our non-GAAP gross margin above 40% in our guidance without the IRA benefit. We aren't making any broad-based pricing changes at this time on microinverters, and we have already made the necessary changes on batteries before. Our pricing and operations team are doing an excellent job of managing pricing and reducing costs. Let's discuss some market trends. I'll give you a little more than usual color on markets. Let's split the U.S. market by non-California states and California. For non-California states, the sell-through of our microinverters was 4% lesser in Q3 compared to Q2. We see this business starting to stabilize given the weekly sell-through trends. In California, the sell-through of our microinverters was 25% lesser in Q3 compared to Q2 due to the NEM 3.0 transition. It will take a few more quarters for our installers to fully transition to NEM 3.0 and normalize sales to NEM 2.0 levels. Utility rates are continuing to move higher in California with one California utility recently requesting a 22% rate hike, assuming that even half of that rate hike is approved by the CPUC. The payback period for an NEM 3.0 solar plus a battery system will become close to an NEM 2.0 solar only system. So that's good. Let me say a few words about U.S. market share before I give more color on Europe. We see stable share today for our microinverters based on both internal as well as third-party data. Competition is not new for us. We have always relied on our differentiated technology with our distributed AC architecture, product quality, and customer service to win share. And we expect this to continue. We have many tools at our disposal, such as the installer services that we have bought. We made several acquisitions over time in the last couple of years, such as the software tool for design and proposal, the permitting tools, lead management, etc. We have a lot of tools at our disposal to help our installers and our partnerships go a lot deeper in the downtown. Let's talk about Europe demand a little bit. We are facing two challenges in Europe. And the situation has dramatically changed from the last quarter, from 90 days ago. We saw a much weaker demand recovery from summer. We also see a lot of distributors facing oversupply of solar equipment, particularly panels, leading to much more aggressive destocking. Despite this temporary weakness, we think that the pullback in Europe will be temporary as the fundamentals remain strong. And we are relatively underpenetrated in the U.S. We are entering lots of new geographies with our IQ8 microinverters and batteries. So we remain very bullish about Europe. Let me spend a few minutes discussing our three largest markets in Europe, the Netherlands, France, and Germany in detail. In Netherlands, our largest European market, our Q3 sell-through was down 40% compared to Q2. This was our first sequentially down quarter in the last two years. Installers tell us that the customers' fear of an export penalty and confusion around ending of the net metering has caused the market pullback. I was in Netherlands two weeks ago. I visited with our leading installers. I came away confident that this pullback will be short-lived. We think that the plan for net metering will be clarified after the country's elections in November. The payback periods are continuing to be attractive in Netherlands. In addition, total system solutions which includes batteries, solar and EV chargers are going to become the norm as dynamic tariffs become more prevalent in Netherlands. We are well positioned to take advantage of these changes. In France, our Q3 sell-through was down 34% compared to Q2, driven by seasonality. We see potential for this market to rebound very quickly. We are already seeing that as utility rates recently moved higher and are expected to increase even more in early 2024. In Germany, our Q3 sell-through was down 32% compared to Q2. We saw strong sequential growth in installer count and activations and we are continuing to gain traction there. Let's talk about our new products, IQ batteries. Our sell-through for batteries has been steadily increasing over the last couple of quarters. We are at an inflection point for our battery business. With our IQ battery 5P, we can deliver the best power specs and the best commissioning times of any Enphase battery to date at an industry-leading 15-year warranty and at the right price point. The battery adoption rates are on the rise globally. We are well positioned to grow battery sales throughout 2024. And we are working on entering even more countries in Europe and Asia in the next few months with our IQ battery 5P. In addition, we expect to introduce our fourth-generation battery in the middle of 2024. That will have a much reduced form factor and a reduced cost structure. As previously discussed, we have entered many new markets with the IQ8 family of microinverters. We plan to enter many more new markets in Europe and Asia in the next several months. Let's talk about our latest microinverter for the residential segment in emerging markets. I did mention this before. This is the IQ8P microinverter, our highest power microinverter to date, 480 watts of AC power. That can support solar panels up to 650 watts DC for Brazil, India, South Africa, Mexico, Spain, and other emerging markets. We have started shipping the product into Brazil, South Africa, and India in Q3 and are on track to start shipping in Mexico and Spain in Q4. The other variant of the IQ8P microinverter with a new three-phase cabling system is well suited for small commercial solar installations ranging from 20 to 200 kilowatts. We are doing beta installations as we speak there and we expect to release the product this quarter into the U.S. market. We are very bullish about the small commercial solar business where we believe we can add value to our business owners and installers with our quality and good customer experience. Let's cover EV charging. We shipped over 3,500 chargers in Q3 compared to over 6,600 chargers in Q2. We launched our IQ smart EV chargers in the U.S. just a few days ago, both U.S. and Canada, actually. The IQ EV charger is Wi-Fi enabled. It includes smart control and smart monitoring capabilities. It seamlessly integrates into our solar and battery systems to help homeowners maximize savings, for example, by directly charging from solar energy only. That's called green charging. We are also working on developing IQ EV chargers for many countries in Europe and we expect to introduce them in the middle of 2024. Let's now discuss our installer platform briefly. Solargraf, our cloud-based design proposal software platform, now provides M3.0 functionality for solar and battery systems in California. We are now offering 3D and shading features and continue to make progress on our new features and functions. The software platform is now available to installers in U.S., Germany, Austria, and Brazil. We expect to make this software release as part of our standard offering to any country that we enter. Let me conclude. We are managing through a slowdown in our overall demand. In the U.S., it is due to high interest rates and NEM 3.0. In Europe, it is due to broad macroeconomic conditions. Despite this, we are very bullish about our business long-term. We see several positive drivers that will accelerate adoption such as the 30% ITC tax credit in the U.S., rising utility rates globally, increased grid instability also globally, climate change, and of course, increasing EV adoption worldwide. We have no doubt that these will drive meaningful solar plus battery growth. Our strategy is very clear. We manage for the long-term. We are doubling down on our relationships with our customers during these times. We are driving down installation times and investing in our customer service teams. We are also strongly investing in innovation. We are working on IQ9 and IQ10, our next two generations of microinverters, as well as the next two generations of batteries. We are also rapidly expanding worldwide with systems comprising of IQ8 microinverters, IQ batteries, IQ EV chargers, and home energy management software. We are introducing products for the small commercial and emerging residential solar markets. And we are making continuous enhancements to our installer platform in addition to driving towards world-class costs on our products. We remain very positive about our future growth and profitability and will continue to make best-in-class home energy systems with a laser focus on innovation, quality, and customer experience. With that, I will turn the call over to Mandy for her review of our financial results. Mandy?

Thanks, Badri, and good afternoon, everyone. I will provide more details related to our third quarter of 2023 financial results, as well as our business outlook for the fourth quarter of 2023. We have provided reconciliations 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 website. Total revenue for Q3 was $551.1 million. We shipped approximately 1,585.6 megawatts DC of microinverters and 86.2 megawatt hours of IQ batteries in the quarter. Non-GAAP gross margin for Q3 was 48.4%, compared to 46.2% in Q2. The increase was driven by increased net IRA benefit. GAAP gross margin was 47.5% for Q3. GAAP and non-GAAP gross margin for Q3 included $14.5 million of net IRA benefit for our microinverters made in the U.S. and shipped to customers in the quarter. Non-GAAP operating expenses were $99 million for Q3, compared to $98.2 million for Q2. We are diligently managing operating expenses and will continue to do so in the coming quarters. GAAP operating expenses were $144 million for Q3, compared to $153 million for Q2. GAAP operating expenses for Q3 included $41.1 million of stock-based compensation expenses and $3.9 million of amortization for acquired intangible assets. On a non-GAAP basis, income from operations for Q3 was $167.6 million, compared to $230.5 million for Q2. On a GAAP basis, income from operations was $118 million for Q3, compared to $170.3 million for Q2. On a non-GAAP basis, net income for Q3 was $141.8 million, compared to $205.6 million for Q2. This resulted in non-GAAP diluted earnings per share of $1.02 for Q3, compared to $1.47 for Q2. GAAP net income for Q3 was $114 million, compared to a GAAP net income of $157.2 million for Q2. This resulted in GAAP diluted earnings per share of $0.80 for Q3, compared to $1.09 for Q2. We exited Q3 with a total cash, cash equivalents and marketable securities balance of $1.78 billion, compared to $1.8 billion at the end of Q2. As part of our $1 billion share repurchase program authorized by our Board of Directors in July 2023, we repurchased approximately 847,000 shares of Enphase common stock in Q3 at an average share price of $129.92 for $110 million. In addition, we spent approximately $8.5 million by withholding shares to cover withholding taxes for employees' stock vesting in Q3. That reduced the diluted shares by approximately 59,800 shares. We expect to continue this anti-dilution plan. In Q3, we generated $145.9 million in cash flow from operations and $122 million in free cash flow. Despite the macroeconomic challenges, we continue to generate healthy free cash flow as a result of our strong financial discipline. Capital expenditure was $23.8 million for Q3 compared to $44 million for Q2. Capital expenditure requirements decreased as we largely completed building out our U.S. manufacturing lines. Now let's discuss our outlook for the fourth quarter of 2023. We expect our revenue for Q4 to be within a range of $300 million to $350 million, which includes shipments of 80 to 100 megawatt hours of actual batteries. We expect GAAP gross margin to be within a range of 46% to 49% with net IRA benefit and 38% to 41% before net IRA benefit. We expect non-GAAP gross margin to be within a range of 48% to 51% with net IRA benefit and 40% to 43% before net IRA benefit. Non-GAAP gross margin excludes stock-based compensation expenses and acquisition-related amortization. We expect the net IRA benefit to be between $26 million and $28 million, an estimated shipment of 1 million units of U.S. manufactured microinverters. We expect our GAAP operating expenses to be within a range of $142 million to $146 million, including approximately $57 million estimated for stock-based compensation expenses and acquisition-related amortization. We expect our non-GAAP operating expenses to be within a range of $85 million to $89 million. We are reducing our non-GAAP operating expenses by 12% in Q4 as compared to Q3, but will not compromise on investing in customer service, innovation and sales. Moving to tax. Since we have utilized most of our net operating loss and research tax credit carryforwards, we are now a significant U.S. cash taxpayer. We expect GAAP and non-GAAP annualized effective tax rate for 2023 to be at 22%, plus or minus 1% with IRA benefit. We expect the production credit net of any incremental cost for domestic manufacturing to be in the range of $26 to $28 per microinverter sold to customers in Q4. We expect to ship 1 million microinverters to customers this quarter. We now have all three of our U.S. manufacturing facilities operational. With that, I will open the line for questions.

At this time, we will take our first question, which will come from Brian Lee with Goldman Sachs. Please go ahead.

Hey, guys. Good afternoon. Thanks for taking the questions. I know the environment's pretty uncertain, so appreciate the additional out-quarter visibility and some of the market-by-market color, Badri. So can I just ask, as you think about the framework, you said you'd under-ship in Q1 the way that you're under-shipping Q3 and Q4? Can you give us, one, a sense of how much you expect to under-ship in Q1, and then — you made the comment that this is all contingent upon demand trends staying about where they're at. Can you give us a sense of what your internal expectations for demand trends are? It sounds like you don't expect them to get worse but can you quantify that a bit? And then I have a follow-up.

Yes, I think there are a few puts and takes. First to answer your question is, is the under shipment going to be close to $150 million in Q1? We expect it to be a little bit less than $150 million, but not too much less. That's our expectation. And second I will talk about markets, and then it'll become clear to you. First of all, we see the non-California states stabilizing. We see that. So therefore, we aren't that much worried there. Of course, things could go a lot south during the winter, but we are already at pretty low levels, so we don't think so. California is definitely a wild card. But even if that goes down 10% more, I think we'll be fine. Because we expect Europe to recover a little more. Europe right now, for all the reasons I said, we basically are undershipping quite a bit in order to normalize inventory. And that will be the fastest to normalize. So we expect Europe revenue to come back a little bit up in Q1. Therefore, what we expect, at least, what we expect internally is that our revenues, sell-in revenues, we think will be close to what we are looking at in Q4. Of course, I don't have a crystal ball. I'm not giving you Q1 guidance. This is our expectation right now. And Q2 onwards, we think the channel inventory is going to approach normalized levels. And therefore, that normalized level, assuming the demand picture is unchanged, that normal level is what we said, roughly around $450 million to $500 million is the normal level. That assumes no change in demand from the current situation. So we expect our revenue to approach that number in the second quarter. But of course, that doesn't tell you too much, because I'm assuming that the demand is the same at the current depressed level. One thing which I forgot to say is, in France, which is another very big market for us, we already see the sell-through rates, for example, in the first three weeks of this quarter, are already back up high, which is good. Basically, there was a utility rate hike in August. There is one more expected in February. So we think France will recover fast. Netherlands, we have some education to do. Like what I told you, there is some political uncertainty there. We think that will get cleared after Q4. So I think Q1 will be definitely better. And that's a great market, where that market is now, in addition to solar, I think with the dynamic tariff starting to become prevalent in Netherlands, there is opportunity for battery storage in 7 million homes. Today, just so that everybody understands, Netherlands, there is 7 to 8 million homes. Solar is there in 2.2 million homes today. And now, with this opportunity, where net metering is going to evolve into something similar to California, not exactly the same, but very similar, what's going to happen is it opens up opportunity for solar plus storage in all 7 million homes. So I think long-term is going to be great for us. But I told you what's going to happen in the short term.

Yes, that's great context. I appreciate it. Just a second one here, and I'll pass it on. On the margins, gross margins, non-GAAP, it seems like you're guiding the low 40s, ex-IRA benefit. How much of that, it's down a couple hundred basis points from what you've been tracking at recently. How much of that is due to pricing? How much due to mix? Maybe can you give us a sense of the margin puts and takes into year end? And then do you see anything that would put incremental pressure on the margins into next year? Thank you.

It's pretty simple. And Brian, you will understand it quickly. You can see our storage business is actually going a little bit up. Our microinverter business is the one that is going a lot down now because of our under-shipment. And therefore, if you see the product mix issue, microinverters have a little bit more gross margin than storage. And therefore, with this product mix, that's why we have the guidance of non-GAAP gross margin 40% to 43% for the company without IRA. With IRA, non-GAAP gross margin of 48% to 51%. So in terms of pricing, I mean, we are not planning to make any broad-based pricing changes. Of course, there is a lot of competition, but we have seen competition for the last few years since I've been here. We have a very disciplined business process. It's a pricing business process. It's called SPA. Phil Shen likes to talk about it. It's a special pricing adjustment. We have been doing that forever, and it is not new. That's one. And also in these times, of course, underloading, we have to work with our contract manufacturers to take care of underloading. But in these times, especially when you have multiple suppliers for a particular component, multi-sourcing for a component, this is the opportunity where we can drop costs a lot. So our target, I mean, any good company in these times, we should be able to drop our cost by 10% per year. And we'll be targeting that. And so we have to talk both equations, pricing and cost. And so we are quite confident in our gross margins. This is what we do. It is not new. This is what we established when I joined the company. We have a pricing team that prices based on value. We have a world-class cost team that works on costs. And it's business as usual for us in these environments.

Our next question will come from James West with Evercore ISI.

Hey, good afternoon, Badri.

Hi.

Badri, as we're going through this period of destocking and some weakness in certain markets, understanding that you've always faced competition and you have a very value-based pricing strategy, are you seeing any behavior by your competitors that is somewhat irrational? Or is the market overall behaving rationally, understanding that this will get out of this in a few quarters?

Well, I'll be lying if I tell you I'm not seeing something irrational. Of course, installers are very stressed, right? They do want to take advantage of the lowest cost available at a given point in time. So therefore, sometimes without understanding, they may want to switch to somebody who's offering low cost. But we usually, most of our installers are, they have a lot of experience. They're very well trained now. And they understand the importance of distributed architecture. They understand the importance of no single point of failure. They understand quality. They understand customer service. And therefore, you might save a few dollars up front, but if you have a quality problem, a service call by the installer is a truck roll. You spend a lot of money in one truck roll. And if you just do one more, I mean, that's it, you have no more room there despite the low cost. So it's a penny wise, pound foolish strategy to do that. And they've all realized it. And, if you actually put things in context, let us say the pricing is $3 or $3.50 for what? You look at the inverter bill of materials, probably of the order of 10%. Should you play around there? Should you take a lot of risks there? And it's their call at the end of the day. And many of them are wise to say, we're not going to make that call. So, I mean, we have a lot of robust discussions. This is the time where we are talking to customers more than ever. We have a lot of other tools at our disposal. For example, Solargraf. We do design and proposal. We can generate leads for installers at very economical rates. We can help them on permitting services, for example, sometimes even free of charge. We have a lot of tools at our disposal to reduce their soft costs. And that's critical because we have to look at everything. We cannot look at component level. We have to look at the full system level in these times. And once you start looking at that and have these discussions, usually it comes back to, we get more market share, not less. And more installers want to move to us, not less. You can see some evidence of that in the third-party reports.

Okay, okay, got it. That's very helpful, Badri. Thank you. And just one quick follow-up for me. You mentioned producing IQ batteries in the U.S. by mid-2024. Did you give a capacity number along with that?

No, we have not given. We will provide more details as we come close to that date.

Our next question will come from Eric Stein with Craig-Hallum. Please go ahead.

Hi, everyone. So just talking about California, I can appreciate thinking about that as a wild card given what's going on in the market. But if I think about the expectation that that market stays flat, but then the hangover from NEM, which you said has a few quarters here left to work out, I don't want to put words in your mouth, but is it fair to say that there is some cautious optimism about California as we get into the back half of next year?

Absolutely, yes. As we get into the back half, absolutely. Meaning one is the utility rates are continuing to go up. The second is, let's assume the utility rates go up even by half the amount they are advertised, the payback for a solar plus storage system is going to become almost the same as a solar-only NEM 2.0 system. And the economics are there actually today. The battery can not only provide resilience, it can help the grid during times of stress in August and September when the grid needs it the most. So it's a combination of you get resilience for yourself, you make money by providing grid services, which is incorporated into the utility rates right now. And we are well positioned to do that. Why? Because we have great microinverters, number one. We have batteries now that can discharge at very high power, double the power of our earlier batteries. Why is that important? Because during certain hours, you have the utility paying you a lot for exporting power to the grid. And what we can do because of a high discharge rate, during those times we can maximize the power. So we can do that. So we have solar plus storage. And of course we have complete energy management software. And we couple that with our Solargraf design and proposal tool. We have everything, all the optimization at the fingertips of the homeowner. And many times he needs to do nothing. He just needs to turn on our optimization engine. It'll do the right thing for him. So we're absolutely very bullish about California towards the second half of 2024.

Got it. And maybe just sticking with California for my follow-up, with NEM, is that transition the biggest factor? I mean, what are some of the other factors that could cause California to be a wildcard? What are the things that are top of mind for you that could cause that market to take another leg down?

This is Raghu. And as Badri mentioned, all of the potential tailwinds that are there, remember in an environment where the demand per home is continuing to go up, people are continuing to electrify. People are buying more and more EVs, heat pumps, etc. And couple that with utility rates where they are and going further up, this is the right solution. Solar plus battery is the right solution. The energy management software is absolutely the right solution in order to drive your ROI as well as reduce your payback. And to that end, what we have done as well is a lot of education into the marketplace in terms of explaining to people what the benefits of a solar plus battery system with energy management are. And going out there and educating the market as well as providing them with a lot of tools. So in this environment where demand is going up, you have the education, you have the tools, the financials are there, the payback is very good. That's the reason why we are extremely bullish about California coming back strongly.

So to answer the question in another way, the headwinds that we see are if installers aren't educated by us properly. If we don't do a good job of educating the installers, things can stall out a little bit. So it is important for us and other companies in this space to make sure the installers, whatever we provide installers, the tools are very easy to use so that they can sit at the kitchen table and look at the homeowner and say, your payback is six years. And here is why your payback is six years. And explain to them very confidently. And it's not just Enphase, it is Enphase plus our competition, plus all of the energy companies. All of us have to do our job in training the installers. And I think that is, of course, a piece that is not very easy to do. And you cannot have enough of it. So that's the biggest headwind that I see.

Our next question will come from Colin Rusch with Oppenheimer. Please go ahead.

Thanks so much, guys. Can you talk a little bit about how much modulation you can do with the OpEx? As you look at investing in these incremental programs and bringing these products to market, is there some incremental cutting that you can do? Or is there going to be a regular spend increase on the R&D side?

No, I mean, we are cutting OpEx by 12% from Q3 to Q4. How are we doing that? We are on a hiring freeze, except for critical positions, for example, in sales and customer service, and a little bit on the innovation side. So basically, that has a big effect on bringing down costs. The other ones are a few professional expenses. This is the time where we look at a lot of fat, cutting out a lot of fat in the company. For example, when companies are doing well, we do hire a lot of contractors. And we are looking at all of those, and we have taken all the necessary actions to cut that level as well. And of course, as we continue to grow, I cannot deny that there is some fat that we found we can easily cut in other areas. We're able to cut about 12%. We are always looking for further room to cut because we'd like to get back to our baseline of OpEx pretty quickly, which is 15% of sales. So we'll give the guidance accordingly. And of course, this is a dislocation in revenue, and that is temporary, but we're very cognizant of that, and we are always going to be trying to operate close to our model, which is 15% of sales.

Excellent. And then on the component side, given the change in volumes that you guys are working through on the microinverter side, obviously you're guiding to reasonably stable gross margins here, but I'm assuming that there's going to be some breakpoints on the components that you may run into with a negative impact. Can you just talk a little bit about how your suppliers are scaling down with you here over the next quarter or two or three, and what that might do to your COGS line?

Yes, I mean, it is a tough situation for our contract manufacturers, no question. But we have great partners here. We have Flex, an amazing partner who helped us when we were, especially 2017, 2018, when we had some tough times, they were there right with us. Salcomp, also a great partner. So we work well together. We do have — this is the time where both of us can recognize saying, okay, is this a short-term problem? Is this a long-term problem? Can we do things structurally? We recognize that both of us need to be profitable, not just one versus the other. And we do take some necessary actions and all of those are confidential in terms of our relationships. I mean we cannot disclose the actions we are taking but our P&L always incorporates all of these. And so the message is over the next few quarters we will continue to work with them. We will give you the P&L transparently in the guidance for gross margin but we are very confident that we are finding the right solutions working together.

Okay thanks so much guys.

And our next question will come from Philip Shen with ROTH Capital. Please go ahead.

Hey guys thanks for taking my question. Badri you brought up SPA so I figured I'd jump in with a question on that. As you know our checks have come up with lower micro pricing under a bunch of SPA agreements on the order of 10%. Does that resonate with you at all or is that off base? I know you often will get something in return for some kind of price when you negotiate the SPA maybe exclusivity or higher volume. Can you just talk through that a little bit? And then Mandy can you talk through how SPA accounting might work on your financial statements? For example do you net the SPA like the refunds against your sales? Do you have net sales or do you accrue a liability on your balance sheet? Thanks.

So SPA first of all for the others in the call, SPA stands for special pricing adjustment. It is a business process that has been forever at Enphase and it is always happening. It's business as usual. A large fraction of our business usually happens at what we call ADLP which is the distributor list price. And you know if business happens at ADLP there is no SPA. But for a small fraction of our customers depending upon how their volumes may go up within the quarter, next quarter, depending on their forecast we do SPA. SPAs are when you have a volume price curve and when the volume goes up the price comes down. And that's how it is. And that process is very active. It's always been active. It's the one I instituted six years ago when I came and the accounting for that is unchanged. Whatever it is exactly what we have done in the last six years. So you talk about a $10 reduction. All of those are anecdotal. They don't matter. One customer doesn't matter. It's not a trend. A large fraction of our customers buy at the list price. So I'd like you to note that if there is a broad-based pricing adjustment we will tell you. And we are telling you right now that there is no broad-based pricing adjustment from us. Yes we will continue to do SPAs. That's the way of life for us. And sometimes it is a way for us to lock market share for the next X amount of quarters. And we'll do that. It's business as usual. Nothing new.

So Phil to answer your accounting question. Yes we accrue for SPA rebates as a liability. When we recognize revenue the associated future potential rebates for the current quarter we accrue a reduction in revenue and a liability on our balance sheet. Same accounting process. No change.

Great. Thanks guys. Okay and then shifting gears. Appreciate that color. Thank you. I know you don't have any official guidance for 2024 but was wondering if you could talk through how you expect margin to trend by quarter in 2024. So you gave some perspective on Q1. There's under-shipment there, close to Q4, so due to product mix. So should we expect Q1 margin to be similar to Q4 because that product mix is maybe more heavily skewed to batteries again. And then due to product mix returning back in this base case to micros more micros in Q2 after the under-shipment in Q4 and Q1, would you expect margins to return back to the pre-under-shipment levels in Q2 of 2024 and back out next year? Thanks.

Yes, I mean, that's logical. If at Q1 what you said is right, we expect similar levels. Of course, I'm not giving guidance, but I'm just giving trends. And then Q2, we expect it to improve because the mix is going to change. The microinverter mix is going to be a little bit higher than the prior quarter. So we expect that logically. That's correct.

Our next question will come from Mark Strouse with JPMorgan. Please go ahead.

Yes, thanks for taking our questions. I believe I asked this on the Q2 call as well, but just kind of given the precipitous decline in valuations across the space, I thought it's worth revisiting. So you're obviously sitting on a pile of cash. You continue to generate cash. Just curious, your latest thoughts on M&A, if that's something that you're planning on leaning into until the macro improves here?

Yes, we do take a look at a number of companies all the time, every week. I have an M&A meeting. There are a lot of companies that come. We are very careful, especially in these times, to not buy something in a hurry. We're also careful of making sure that that company is aligned, of course, in terms of strategic fit and cultural fit. The former is extremely important. The latter is practically even more important. So the areas that we usually look for are more in the energy management software, sometimes in home automation, for example, small commercial solar, any innovation in batteries. We look for these. Usually we like smaller companies, bolt-on acquisitions. That's what we have done till now. But we are looking at all kinds of companies. Please stay tuned. If we are going to move on something, it won't be without you knowing.

Okay, thanks, Badri. And then just a real quick follow-up. I apologize if I missed this, but was there an update on the small commercial product, the timing or any color there?

Yes, there was. We are right now doing beta installations as we speak. The product is working great. We expect to introduce this product in this quarter, current quarter, and we expect to make some reasonable revenue out of this product in Q4.

Our next question will come from Steve Fleishman with Wolfe Research. Please go ahead.

Yes, hi, thank you. The $150 million of under-shipped that you're talking about, could you break that out between the U.S. and Europe?

I would say approximately equal between the two.

Thank you. And then in Europe, the impact of, you mentioned weaker demand and distributor destocking. Could you just give some flavor of what, when you look at the weakness, are they about equal drivers? Is one dominating the other?

Yes, actually, to tell you the truth, every country is a little bit different. Clubbing them together under macroeconomics will not do justice, but there are a few factors that can be generalized. If you rewind to last year, all distributors, installers, consumers were a lot more aggressive due to the Ukraine crisis. The Ukraine crisis, the shortage of natural gas, caused many countries to be very aggressive to pull in their plans for renewables. We saw a huge spike in virtually every country in Europe. Solar plus storage, everybody started stocking up a lot. And we also profited from that. Our revenue also peaked. But then that enthusiasm is a little bit tempered right now. Because of that, distributors are suddenly realizing that they have more on their hands. Earlier, maybe a year and a half back, product availability wasn't that high because of that increase in demand. But now, all of the suppliers have geared up, especially panels. Product availability of panels is very high. So a lot of over-inventory, particularly on panels, has happened. That is putting pressure on distributors because they've purchased inventory at high prices before, and now the prices have collapsed on panels. So there is some financial weakness there. They are conservative now and want to hold as little inventory as possible. Now let's come to Netherlands, our biggest market. When I went there two weeks ago, because I heard that our demand was dropping, I got concerned. I went there. When I looked at it, the Netherlands situation is actually not so bad. Their payback is about six years. But they had a scare recently where an energy company called Vandebron basically said that to the consumer, we are going to charge you a penalty to export solar back into the grid. Vandebron is a very small fraction of the market, serving about 3% of customers. They were trying to put pressure on the government, saying net metering needs to be clarified. The simple fact is Netherlands has wind and solar; there are 2.2 million homes with solar out of 7 million homes. If they start to export solar energy in a random manner, the energy companies are finding they cannot handle that easily. So they are putting pressure on the government to say, net metering needs to evolve into something where customers have self-consumption, which is solar plus storage. That's actually extremely good for us there. But the way they are doing it is a little disruptive. So the government will respond once it is in place. There is an election happening; net metering clarity is likely to come probably after that. Net metering will still last until 2025, so we are covered for the next two years with good payback. Then the payback will be maintained after that with the combination of solar plus storage plus dynamic tariffs, which is getting popular there. Many European countries are evolving similarly. Many have adopted dynamic tariffs. Germany is a little bit ahead. They introduced feed-in tariffs early, similar to net metering, where export is not paid as much as import. That is why Germany shows an 80% battery attach rate. So long answer to your question, but that's the color of Europe.

If we move away from the Ukraine-driven energy crisis conditions, can your expectation of Europe improving be driven just by these market-by-market changes or do you need to see a move up in energy prices again?

Energy prices have also increased. In places like France energy prices are going up, so energy prices are a tailwind. But despite all of this, in a place like Netherlands, two gigawatts of solar, in a place like France the payback is extremely good — five to six years for solar. It will evolve into solar plus storage with paybacks maybe seven to eight years but still very good for a 25-year product. So there is a small dislocation right now due to inventory issues, but we expect a quick revenue recovery in Europe.

Our next question will come from Jeff Osborne with Cowen. Please go ahead.

Badri, I was just curious on your expectation for a Q2 recovery. What is your working assumption on normalized inventory in the channel? I think in the past you talked about 8 to 10 weeks and assuming that is still the case, I guess, is there an argument that now that manufacturing is localized and continent by both you as well as competitors that why wouldn't that number be 5 or 6 weeks and maybe pressure would continue into Q2?

What you're saying is possible, but we don't think so. I'll give you a quick primer on weeks on hand. If you start with 100 units in the channel and demand is 10 units a week, and you ship 10 units a week, you end with 100 units — weeks on hand is 10 weeks. Now if demand drops 40% to 6 units a week but you continue to ship the same amount because you are slow to react, you will accumulate inventory. You could end the period with 152 units, and weeks on hand becomes 152 divided by 6, which is about 25 weeks. So weeks on hand can blow up disproportionately from small changes in demand if shipments to the channel don't quickly adjust. Distributors will logically reduce shipments; even 10 to 12 weeks will be a similar dollar number as in the past. End market demand could change quickly, so weeks on hand is a volatile metric and can change drastically with small demand moves.

I appreciate that. My follow-up — correct me if I'm wrong — I think you're allowed under the IRA to export U.S. manufactured goods to international jurisdictions. Is that something you're already doing or do you intend to do in 2024?

Not doing today, but of course we will consider it.

Our next question will come from Julien Dumoulin-Smith with Bank of America. Please go ahead.

Hey good afternoon, team. Thank you guys very much for the time. Appreciate it. I just wanted to pivot to a slightly different direction here. You have a few of these exclusive deals across a number of different customers, some larger ones. I'm curious, how do you think about how locked in those are going into next year? And how do you think about working together realistically as partners, optimizing your value proposition while addressing their respective needs, which are clearly dynamic, especially given the backdrop in California?

I presume you're talking about one large customer, that's the only one we have officially. We love our partners and work very closely with them. We value their relationships a lot and are at their service on quality and customer experience. We will be looking to renew all of those relationships.

Right. Fair enough. And then coming back to the contract manufacturing relationships, how do you think about underutilization costs? What are the commitments like and how flexible are the terms as you look at flexing down and up volumes through the year under these arrangements?

As I mentioned earlier, we have great contract manufacturing partners. Flex helped us when we were in trouble in 2017. Our relationship is healthy. During these times we work together to determine if the problem is short- or long-term and, if necessary, restructure. All of those accounting impacts are reflected in our P&L. We view the current situation as temporary, but we are cognizant that under-loading is a pain for our contract manufacturers, so we aim to ensure both sides are profitable and share the pain.

Our next question will come from Andrew Percoco with Morgan Stanley. Please go ahead.

Hi, thanks so much for squeezing me in. So I just wanted to come back to a prior question. It's clear the demand backdrop could be tough for the next few quarters. Can you discuss the health of the average installer that is a recurring user of your equipment and their ability to manage through this period and transition to leasing models? I know there have been some challenges around working capital and tax equity. So curious what you're seeing from repeat buyers on the smaller scale side of the installer community. Thank you.

We see some transition to leasing models. We work with great partners in that space such as Sunnova, SunPower and Sunrun. For us, if loans move to leases, we could see some product mix changes but nominally the business isn't impacted. We have heard anecdotes from industry sources that some long-tail installers in California are out of business, but we don't have direct data. We are trying to help installers with leads and services like Solargraf and NEM 3.0 support. The majority of our business is through distribution, so we have a layer between us and the long tail installers.

Our next question will come from Tristan Richardson with Scotiabank. Please go ahead.

Hey good evening guys. Thank you so much. I appreciate all the commentary on 2024. Should we think there could be a swing factor with some of the new markets you've entered, whether the U.K., Greece, Denmark, even India — could that be a meaningful factor that affects timing of stabilization or present a growth wedge above that Q2 timeframe you're talking about?

Absolutely. We have many vectors of growth. In the color I gave you, we did not assume all of that growth. We have introduced batteries and microinverters in many new countries: Austria, Spain, U.K., Sweden, Denmark, Greece and plan to introduce in about 15 countries in the fourth quarter. New geographies are important, but it takes time to build installer infrastructure and train them. We have new markets in Asia like Taiwan, Korea, and we continue to expand in places like Indonesia. Small commercial is significant — about 1 gigawatt in the U.S. and over 10 gigawatts in Europe. We are introducing a product this quarter for small commercial. EV charging is another vector; our connected EV charger launched in the U.S. and will be introduced in Europe next year. Home energy management software is another driver: we can connect to third-party EV chargers and heat pumps, giving homeowners one app to manage everything. We have many levers and are being conservative in our current assumptions.

Our next question will come from Moses Sutton with BNP Paribas. Please go ahead.

Hi Badri. Thank you for squeezing me in. I wanted to follow on Andrew's comment about the long-tail installer. Are you seeing stress outside of California? Are distributors asking for price concessions or changes in receivable terms? Curious if you could give more color on the health of the long tail.

The non-California business is stabilizing. Q3 was down 4% from Q2. The first three weeks of Q4 are a little bit up. We think the non-California business is decent, but it is still down from the high levels in Q4 2022 by nearly 30% to 35%. The long tail represents a large portion of our business — perhaps 75% to 80% — and we see similar trends across them. We don't have direct data that many are out of business, and our major partners are strong. The color is that things are stabilized outside California.

That's helpful. Any sense on Texas and Florida specifically? I know outside California is averaging better, but those markets seem important.

They were disproportionately down because utility rates aren't as high compared to the impact of interest rate increases. So they were more affected. We do see some movement to leasing models there and we see those markets starting to recover.

Our next question will come from Joseph Osha with Guggenheim Partners. Please go ahead.

Hey thanks for fitting me in. Badri, appreciate it. Two questions. First, following on the previous one, Sunrun, Sunnova, and SunPower accessing third-party ownership — do you know if the long tail has found any other solutions for third-party ownership? Or when you talk about that avenue, is it basically those third companies that you're seeing?

Majority is those companies, and there are a few smaller leasing companies emerging as well. But about 90% is those three companies.

Okay. And philosophically, have you done analysis on whether the business could generate higher bottom-line earnings if you grew faster and accepted a lower gross margin, say 35%? Just curious about your philosophy as to why gross margin has to stay where it is.

That's the eternal question: can I grow faster by dropping prices? For us, pricing is value-based. The moment you base pricing on cost and stop generating value, you lose the differentiation. We focus on adding value in microinverters, batteries, and software. Innovation is essential — innovate or die. Our philosophy is that high quality leads to high volume and appropriate pricing based on value.

Our next question will come from Vikram Bagri with Citigroup. Please go ahead.

Good evening everyone. Very helpful color on demand and supply dynamics in European countries. Badri, you mentioned you expect to recover a bit and you referred to the $150 million of inventory reductions over the next two quarters. Is that rebound a function of Enphase entering new EU countries and gaining market share in existing markets such as Germany, or does the outlook for inventory reductions assume base demand rebounds in Q1 and then new market share helps on top of that? Also, on the U.S. market, you said you see stable market share — are you prepared to defend that if needed?

All our assumptions are based on the demand picture not changing from where it is today. I'm not giving Q1 guidance, but that's the framework. On the U.S., we work closely with customers and deepen partnerships, with executives visiting customers frequently. We have many tools to gain market share and defend against competition: innovation, quality, customer experience, installer services, and made-in-America manufacturing. We are always working to defend and expand market share.

Thanks Badri. And as a follow-up on capital allocation, you repurchased about $110 million in shares in Q3 versus $122 million of free cash flow. Should we expect buybacks to follow free cash flow generation going forward?

We have a lot of cash, about $1.8 billion. We have shown we will buy back stock in a disciplined fashion. We have bought back $310 million in total over the last two quarters and will be opportunistic about repurchases depending on valuation and other priorities.

Our next question will come from Praneeth Satish with Wells Fargo. Please go ahead.

Thanks for squeezing me in. I wanted to ask about Tesla's new Powerwall 3 offering and what the puts and takes are comparing that against your IQ8 and 5P battery. Do you anticipate any market share changes when that product is launched next year?

Competition is not new to us. If you break it down, we produce more energy because we do maximum power point tracking on a per-module basis with power conversion at the module. We are much more reliable with no single point of failure. If one module or micro fails, the rest of the system continues to operate. String inverters represent a single point of failure. Our design, installation, and maintenance advantages include no string design, plug-and-play installation, and per-module performance visibility. On safety, we avoid high-voltage DC in the home and use LFP chemistry for batteries, which is safer. Our IQ battery 5P offers high power discharge enabling homeowners to export significant power at times when utilities compensate for exports. We offer long product warranties, modularity for right-sizing, and strong customer service that is open 24/7. The total system — distributed inverter architecture, safe battery chemistry, connected EV chargers, software, and customer experience — gives us competitive moats against other solutions.

That's helpful. Switching to California, you mentioned educating installers about NEM 3.0 and Solargraf automating calculations. Permits are moving down week over week though. Is there anything else you can do to simplify the process and help convert leads to signed contracts, or is it just waiting for macro and rates to improve?

It's a matter of time and continued effort. We and the industry must continue educating installers and homeowners and provide tools to make it easy to show paybacks and system designs. The economics are there; it's getting in front of homeowners and convincing them using tools like Solargraf. We are out there educating and helping installers and expect the California market to turn around.

This concludes our question-and-answer session. I would now like to turn the conference back over to Badri Kothandaraman for any closing remarks.

Yes. Thank you for joining us today and for your continued support of Enphase. We look forward to speaking with you again next quarter.

The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.