Enphase Energy Inc (ENPH) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Enphase Energy's Fourth Quarter 2016 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Ms. Christina Carrabino. You may begin.

Good afternoon, and thank you for joining us on today's conference call to discuss Enphase Energy's Fourth Quarter and Year-Ended 2016 results.

On today's call are Paul Nahi, Enphase Energy's President and Chief Executive Officer; and Bert Garcia, Chief Financial Officer. After the market closed today, Enphase issued a press release announcing the results for its fourth quarter and fiscal year ended December 31, 2016.

During the course of this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to Enphase Energy's financial performance, market demand for its current and future products, advantages of its technology and market trends.

These forward-looking statements involve significant risks and uncertainties, and Enphase Energy's actual results and the timing of events could differ materially from these expectations. For a more complete discussion of the risks and uncertainties, please see the company's quarterly report on Form 10-Q for the quarter ended September 30, 2016, which is on file with the SEC, and the annual report on Form 10-K for the year ended December 31, 2016, which will be filed with the SEC in the first quarter of 2017.

Enphase Energy cautions you not to place any undue reliance on forward-looking statements and undertakes no duty or obligation to update any forward-looking statements as a result of new information, future events or changes in its expectations.

Also, please note that certain financial measures used on this call are expressed on a non-GAAP basis unless otherwise noted and have been adjusted to exclude certain charges. The company has provided reconciliations of these non-GAAP financial measures to GAAP financial measures in its earnings release posted today, which also can be found in the Investor Relations section of its website.

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

Good afternoon, and thanks for joining us today to discuss our fourth quarter and full year 2016 financial results. We reported revenue of $90.6 million for the fourth quarter of 2016. We shipped approximately 194 megawatts AC or 815,000 microinverters, an increase in megawatts of 50% compared to the fourth quarter of 2015. GAAP gross margin was 17.9%, and non-GAAP gross margin was 18.2%.

There are currently more than 580,000 Enphase systems deployed in over 100 countries. Since inception, we've shipped over 13 million microinverters, representing more than 3 gigawatts of installed generating capacity. Enphase systems have produced approximately 8 terawatt hours of clean renewable energy.

For the full year 2016, we reported revenue of $322.6 million and shipped a record 726 megawatts AC or 3.1 million microinverters. GAAP gross margin was 18%, and non-GAAP gross margin was 18.4%.

Enphase has been executing on a business strategy detailed in late 2015, regaining market share by offering competitive pricing, enabled by cost -- aggressive cost reduction and providing a richer, more comprehensive energy solution for our customers. In addition, we've committed to reduce our cost structure with the goal of enabling consistent profitability.

Our lower pricing strategy put pressure on revenue and gross margin during 2016. As a result, we took several actions in the second half of 2016 and in the first quarter of 2017 to reduce our operating expenses in order to create a faster path to sustain profitability. Bert will go into better detail about these actions and our financial results later in the call.

We saw the effectiveness of our lower pricing strategy with new customer wins and an increasing share with existing customers. During the second half of 2016, we had significant market share growth in almost every geography in which we participate.

Based on third-party estimates as well as our own data, we believe our market share in the United States increased from approximately 20% in Q1 to over 30% in Q4. In addition, we believe we're the residential market share leader in Mexico, Puerto Rico, France and New Zealand and have gained significant share in the Netherlands, Switzerland and Australia. Our success in these regions has given us further confidence that our strategy is working.

An important element of our strategy was to target approximately 50% product cost reduction over 2 years from the fourth quarter of 2015 to early 2018. During 2015, we continued to aggressively drive down the overall cost of our microinverter system. As part of our commitment to deliver new products and technologies that provide additional functionality, reduced costs and enhance the simplicity of installers, we'll be launching our Enphase Home Energy Solution with IQ, our next-generation integrated solar, storage and energy management solution in the U.S.

We're excited to have already received the purchase orders and expect delivery starting in March on time and under budget. The Enphase Home Energy Solution with IQ features our sixth generation Enphase microinverter system, which supports just about every 60- and 72-cell solar module and continues to simplify design and the installation process.

Our cost reduction activity is underway for 2017, and we are well on track to meet our targets. The introduction of our seventh generation microinverter, the IQ 7, is on track for the first quarter of 2018, thus further reducing our product costs while still offering our customers with quality, features and functionality they've come to expect from an Enphase product.

We have been relentlessly focused on pulling in profitability. This required us to make some very hard decisions, but we understand the importance of creating a strong financial foundation and delivering consistent profitability to our shareholders. We feel that the actions we have taken should result in Q2 non-GAAP operating expense of approximately $18 million and will enable us to accelerate our path to profitability.

In addition to our focus on cost reduction, our product road map is more exciting than ever. We, along with our partners, have developed a new generation of integrated AC solar modules for the worldwide market. The AC module is defined as a microinverter integrated directly on the solar panel and represents the ultimate integration of the inverter and the solar panel.

We firmly believe the AC module is the future of rooftop solar. There's a significant increase in demand from large solar distributors, installers and fleet owners for a reliable, cost-effective and high-performance AC module. Our sixth generation microinverters will be included in the AC modules from LG, SolarWorld and JinkoSolar.

By integrating our sixth generation microinverters onto modules directly, we are creating an even simpler, more consolidated solution. The AC module will reduce working capital requirements, simplify inventory management, reduce installation time and enable easier operations and maintenance.

In addition, the AC module also enables a simpler warranty process, one-stop technical support and other asset management advantages such as remote monitoring for both the microinverter system and the module. We expect these modules to be available in the U.S. during the second quarter of 2017.

We began shipping our AC Battery storage solution to some U.S. markets during the fourth quarter, and we're pleased with the initial reception and the feedback of our customers. We believe the simplicity, ease of installation, modularity and performance of our AC Battery is unique in the industry.

We increased our presence in Europe during the fourth quarter by expanding existing partnerships and developing new ones, and revenue was up 34% sequentially. We introduced our AC Battery in Europe during the quarter and are pleased with its reception.

In the APAC region, we continue to be pleased with our progress in Australia and New Zealand, where revenue in the fourth quarter was up 146% sequentially. The response to our AC Battery storage solution in Australia and New Zealand has been extremely positive, and all of its advantages are clearly resonating with customers.

Turning to our other markets. We continue to see growth in both the residential and commercial markets in Latin America during the fourth quarter, particularly in Mexico and Puerto Rico. We estimate our current market share to be over 30% in Mexico and over 75% in Puerto Rico. In fact, we just unveiled the world's largest, microinverter-powered, small utility scale solar plant in Panama at 2.44 megawatts. We remain optimistic about our opportunities in Latin America during 2017 and are expanding our customer base and geographies we sell into that region.

The gains we've seen in our inverter markets here in the U.S. and the global residential markets, along with the positive reception of the Enphase Storage System in Australia, the U.S. and Europe, and the upcoming introduction of our AC module product, validate Enphase's decision to realize the global potential of solar energy through our technology innovation.

I'll close my comments by noting we are excited about our opportunities in 2017 and are encouraged by our market share gains worldwide.

We're working diligently on creating what we believe is the path to sustain profitability. I'd like to thank the entire Enphase team for their ongoing hard work, passion and dedication as we work together on developing new technologies that make energy more intelligent, more connected and more cost-effective than ever before.

Now, I'll turn over to Bert for the review of our financial results.

Thanks, Paul. I'll provide more details related to our fourth quarter and fiscal year 2016 financial results as well as our current financial status and business outlook for the first quarter.

As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis unless, otherwise, noted.

Total revenue for the fourth quarter of 2016 was $90.6 million, an increase of 2% sequentially and an increase of 38% compared to the fourth quarter of 2015. Total revenue for 2016 was $322.6 million, down approximately 10% from fiscal 2015.

We shipped approximately 194 megawatts AC or 225 megawatts DC in the fourth quarter of 2016, a decrease in megawatts of 5% sequentially and an increase in megawatts of 50% compared to the fourth quarter of 2015. The megawatts shipped represented 815,000 microinverters, all of which were our fourth and fifth generation microinverter systems.

Noninverter revenue increased 22% sequentially, driven by increased penetration of our AC Battery storage solution.

In 2016, we shipped a record 3.1 million microinverters, representing 726 megawatts AC or approximately 845 megawatts DC, a 3% year-over-year increase.

GAAP gross margins in the fourth quarter of 2016 was 17.9%. Non-GAAP gross margin was 18.2%, sequentially flat from Q3. Non-GAAP gross margin excludes approximately $281,000 of stock-based compensation expense.

For the full year of 2016, GAAP gross margin was 18% and non-GAAP gross margin was 18.4%.

As discussed in our last call, at the end of Q3, we made the difficult decision to reduce our global workforce by approximately 11% and eliminate certain noncore projects, resulting approximately $20 million of annualized non-GAAP expense savings starting in the fourth quarter of 2016. This restructuring initiative was materially complete in the fourth quarter.

As a result, non-GAAP operating expense was $23.4 million for the fourth quarter compared to $28.6 million for the third quarter. Non-GAAP operating expense for the fourth quarter excludes $1.1 million of additional restructuring charges related to the consolidation of corporate headquarter facilities and related asset impairments as well as a gain on the divestiture of our securities -- services business, excuse me, and $1.8 million of stock-based compensation expense.

Non-GAAP operating expense for 2016 was $107.6 million compared to $115.7 million in 2015. In the fourth quarter, R&D expense was $10.5 million, sales and marketing expense was $7.2 million, and G&A expense was $5.7 million. For fiscal 2016, our R&D expense was $46.8 million, sales and marketing expense was $36.5 million, and G&A expense was $24.3 million.

For the fourth quarter, our GAAP operating loss was $10.1 million, and our net loss was $13.2 million, resulting in a loss of $0.21 per share. On an non-GAAP basis, our operating loss was $6.9 million and the net loss was $9.3 million, resulting in a loss of $0.15 per share.

GAAP operating loss for the full year of 2016 was $62.7 million and net loss was $67.5 million or a loss of $1.34 per share. On a non-GAAP basis, operating loss is $48.4 million and net loss was $52.4 million or $1.04 per share.

Before I move on, I want to take a moment discuss the additional restructuring action that we announced on January 30. As disclosed, this action impacted approximately 18% of our global workforce will result in further non-GAAP OpEx reductions totaling approximately $18 million on an annualized basis, bringing our non-GAAP operating expenses rate to approximately $18 million per quarter starting in Q2.

As difficult as the recent restructuring history had been, we believe these actions significantly improve our overall financial footing and advance us towards achieving near-term profitability.

Now, turning to the balance sheet. We decreased inventory levels by over $7 million from the third quarter, ending the year with $32 million. We exited the fourth quarter with a total cash balance of $17.8 million. At the end of the fourth quarter, we had $10.1 million drawn on our credit facility and a $23.8 million balance on our term loan, which is net of deferred financing costs.

Based on our liquidity position at December 31, 2016, as well as our history of operating losses, we acknowledge there is substantial doubt about our ability to continue as a going concern. In light of these challenges -- in light of the challenges that we faced in 2016, these concerns are understandable. However, it's important to note that we have taken a number of meaningful actions that we believe will directly address many of these concerns and taken together, will significantly improve our financial condition in 2017.

On the financing front, these actions have included the secondary offering of our common stock in 2016, resulting in net proceeds of approximately $16.2 million as well as an aftermarket issuance of the ATM sales agreement that we entered into in December 2016, providing for up to an additional $17 million in gross proceeds in the sale of common stock.

As of December 31, we had not sold any shares under the ATM. However, during the first quarter of 2017, we have realized net proceeds to date of approximately $11.3 million of common stock still under the ATM.

In addition, in January, we announced a strategic investment from John Doerr and T.J. Rodgers. We believe this investment underscores the value of and competence in our technology and vision.

Finally, on February 16, we announced the extension and refinancing of our term loan facility from $25 million to $50 million. In connection with this refinancing, we consolidated our lender relationships by repaying the $10.4 million of principal and interest outstanding under our existing line of credit facility with Wells Fargo and closed that facility.

On the restructuring front, as previously mentioned, the combined impact of the actions that we took in Q3 and more recently in January resulted in a $38 million reduction in operating expenses on an annualized basis. These actions have helped create an operating structure that more closely aligns with the scope of our business today and positions us well to achieve maximum operational leverage as the business continues to grow. Most importantly, we believe these actions significantly accelerated our time line towards sustaining profitability and positive cash flow.

Finally, on the product front, we had made considerable investments to significantly drive down the cost of our sixth and seventh generation microinverters, known as our IQ series. We delivered the cost reductions on the sixth generation microinverter as promised, and we're excited to begin shipping that product next week.

I'm also extremely encouraged by the progress that we've made on our seventh generation product, which will deliver even deeper cost reductions when it's released in Q1 of 2018, further driving our margin improvement.

In addition to the investments we've made in cost reduction, our focus on new product development has also begun to bear fruit. As discussed, we launched our AC Battery storage solution in Australia during Q3, in U.S. and in Europe -- in Europe and the U.S. in Q4. We believe our AC module, which is scheduled for initial shipments in late Q2, will fundamentally change the installation landscape.

In summary, the steps that we've taken on the financing, restructuring, product development fronts speak directly to our commitment to our customers, vendors, employees and shareholders. All of them continued to express their confidence in us.

Now, let's discuss our outlook for the first quarter of 2017.

We expect our revenue for the first quarter of 2017 to be within a range of $60 million to $65 million. While our first quarter results are typically impacted by normal seasonality, the extraordinarily wet winter in California, where we have a strong presence, has negatively impacted our first quarter guidance. We estimate that the residential key market in California will be off by as much as 50% in Q1. However, we believe that the California market will recover in Q2 and return to normal growth rates.

Turning to margins. We expect GAAP and non-GAAP gross margin in Q1 to be within a range of 16% to 20%. Non-GAAP gross margin excludes approximately $250,000 of stock-based compensation expense. We expect GAAP operating expense for the first quarter to be within a range of $27.5 million and $29.5 million and non-GAAP operating expense to be within a range of $19 million to $21 million, excluding an estimated $1.5 million of stock-based compensation expense and approximately $7 million of additional restructuring expense.

Now, I'll open up the line for questions.

(Operator Instructions) Our first question comes from Colin Rusch with Oppenheimer.

This is Kristen on for Colin. I just wanted to talk a little bit about what you're seeing in channel inventories. Just given the slow start to the year, you mentioned some of the weather impact in California. Can you give us a little bit more color on that?

Sure. Channel inventories right now are very much in line with our yearly averages. What you're seeing right now is a result of the inclement weather in California that reduced sales. But it is a reflection of the fact that we're actually not adjusting for that by taking a larger channel inventory. So I would say that they're very much in line with the seasonal averages.

Okay. And then if you could give us an additional update on the incremental energy storage orders, I know you mentioned that a little bit, but just looking for a little more detail there.

Well, we don't break out storage as a separate product, but what I will say is that the reception to the product has been fantastic. The features and attributes of our storage solution, the modularity, the simplicity of installation has clearly resonated with customers in Australia, in Europe and in the U.S. So I'm expecting that we're going to continue to see a growth in demand for storage, and I think Enphase is poised to take a leadership position in that space.

Our next question comes from Jeff Osborne with Cowen and Company.

Yes, I just wanted to follow up. I had 2 questions. A follow-up on the channel inventory comment, Paul. I guess what's the trade-off of just -- in the past, I think you guys have talked about a 3-quarter process or so of implementing a new product cycle into the channel. How do we think about the cadence of the sixth gen ramping up? I guess what's the trade-off of just blowing out the fourth and fifth gen at a much lower margin to deplete the channel inventory at a faster pace?

That's a -- it's a good question. The introduction of the IQ product actually is more than just a pure inverter at this point. We've actually reduced the -- we've changed the cabling from a 4-wire cabling to a 2-wire cabling, which is yet again simpler. And we've enhanced the communications technology as well. So because of that, the transition is going to be slightly more involved than previous transitions.

What we're expecting to do right now is, we'll be shipping this quarter. We'll start shipping. We'll be ramping up in Q2, more towards the end of Q2. I expect that by Q3, we will be mostly shipping the new IQ products. And by Q4, it will be almost entirely the IQ product.

That's great to hear. And then just 2 follow-ups. One is how do we think about pricing over the next couple of quarters as you implement this process, is question one. And then two is just AC modules were kind of hyped 3 to 5 years ago and it didn't work out that well. Can you just reflect on your time in the industry, what happened then and why it didn't work and why you're excited about the future of the AC module industry?

Sure. So in terms of pricing, what we saw in 2016, I think, was exceptional, certainly for Enphase, and that was, in large part, due to the fact that we sort of had to catch up, if you will, with the market prices. We expect pricing in 2017 to continue to decrease, but for Enphase, at least, at a more moderate pace. And because of the work we've done on cost reduction and the introduction of our IQ series of microinverter, we certainly expect that our gross margins will expand throughout the year.

In reference to your second question about the AC module, I think there is -- it's -- there are several answers to that question. Number one is that when we first introduced an AC module, it was with a module manufacturer who was slightly less known. They were a great partner, but they weren't a name brand, and it was slightly too expensive. I mean, one thing that we learned is that as powerful as the AC module is in its ability to reduce working capital requirements for installers, simplify the installation process, simplify OEM, they're still hesitant to pay more for a combined unit than they would pay for the individual components.

So one of the -- so we've learned that lesson, and one of the initiatives that we're adhering closely to right now is to ensure that with our current partners, that the AC module is not more expensive than the individual components. In addition to that, we have 3 fantastic partners, LG, SolarWorld and Jinko, and each one really focuses on a unique market segment. And what that allows the installer to do is really choose the ideal solution for them while focusing and building their infrastructure around an Enphase microinverter system. So it's the same cabling system, the same monitoring system, the same commissioning system, and yet they can choose the module that fits their market and that comes with the best.

I think the combination of finding the right price point, coupled with offering our customers an opportunity to pick the product that best suits their needs are both going to help accelerate the adoption. In addition to that, we have seen competitive solutions out there, and they have been very well-received. People have been using them and noticed that they had significantly lowered their install times, and as a result, they've come to us requesting something very similar. So I think the -- sometimes, when you introduce a new product or new technology, it's all about timing. I think perhaps we were a little too early in the market before. The timing now feels right.

Our next question comes from Vishal Shah with Deutsche Bank.

This is [Tyler] on for Vishal. I just had a quick question about the California market volumes. I know, last quarter, you guys had discussed the fact that we thought the California slowdown should be temporary due to the fact that the economics between NEM 1.0 and 2.0 aren't very different. So I'm just trying to understand kind of what was going on in the last quarter here.

Right. So what we saw in the last quarter was almost entirely a function of weather. We had very few days, install days, where installers could get out on the roof and install a solar module. Remember that it's a very, very dangerous for a solar installer to be on a roof in that kind of weather with a devise that could potentially attract lightning or some other issues.

So in the appropriate expectation of safety, our installers just were, unfortunately, grounded for much of the quarter. The effect you're seeing, it has very little to nothing to do with the NEM transition. That, I think, is going very smoothly and is going actually very much along the lines that I've discussed.

The reason that Bert had mentioned in his remarks that we feel that Q2 will sort of go back to normal, if you will, is because of what we're seeing in Q1 is what we believe to be just a onetime weather-related issue.

Perfect. Okay. And just a quick follow-up. I'm just wondering if you guys could provide any outlook on what you guys are seeing. Are you thinking about the California resi solar market going forward?

Yes, so basically, it -- as we look out through the rest of the year, we think that the California resi market will grow, perhaps a bit more modestly than it had in the past, call it anywhere between 10% and 15%, which we think frankly mirrors some of the growth in the rest of the country as well. As we talked about, I think that the NEM transition is going well, and I think that there are a lot of favorable factors in the state that should bode well for residential solar PV.

Our next question comes from Michael Morosi with Avondale Partners.

I guess, first off, with respect to the guidance, you keep talking about a return to normal. Is that a normal seasonality as in up 15% to 20% sequential shipments? Or is that a normal overall run rate of shipments?

So what we've seen in Q1, what we are seeing in Q1, is a combination of normal seasonality, as you note, coupled with just a lot of rainy weather. That -- so when I refer to sort of not -- Q1 not being normal, that's what I'm referring to. When we say that Q2 should resume its "normal course", what we're saying is we don't believe that Q1 resets the baseline for Q2, that Q2 simply resumes where it would have had -- that Q1 not have been so rainy.

Okay. Very good. I understand. And this one's for Bert. It looks like AR stayed stubbornly high in the quarter. I wonder if you could just talk about any dynamics around that and how we should expect that to track going forward.

Sure. Thanks for the question, Michael. So AR, we ended at about, I would say, about [$61 million] (corrected by company after the call) in AR. Really -- up sequentially a little bit from Q3, really in line with revenue. And so if you think about our AR balances, it's affected mostly by the linearity of revenue in a quarter. And so the back -- the more back-end loaded we technically -- -- we are in any particular quarter will essentially determine how much AR we have at the end of any period.

Okay. And then in terms of just the absolute contribution from noncore products this year, be it kind of AC module or storage, just even directionally, should we expect this to be a 10% contributor? Is that more? Is it less? Just in terms of thinking through the magnitude of some of these opportunities.

I understand the question, and I understand that it gets a little bit more challenging because, as you mentioned, we are going to have a much broader product portfolio, whether it includes storage or the AC module, the Combiner Box and everything else. So I would say that clearly, north of 10% and very likely growing throughout the year. But we don't guide through the specifics. However, we are seeing an increase in a portion of our revenue as a result of nondirectly microinverter-related products.

Our next question comes from Philip Shen with Roth Capital.

Earlier, Paul, you talked about margins expanding through the year. Can you talk about how much expansion we might see? And then when do you think we could see a breakeven as a result?

So let me take that -- the second part of the question first. We took the actions we did to drive OpEx down in order to pull profitability in. The message we had given before was that, that we expected profitability to be in the second half of the year, and now we're saying very explicitly that we expect to pull that in.

In reference to the gross margins, we don't guide to specific numbers. But what I would say is that the -- as we see the IQ a bigger and bigger portion of our mix, you'll see the effect of its cost on our gross margin and that will certainly contribute to some of the expansion.

The other element that's definitely going to contribute to the expansion is the advent of these higher power modules. We have seen a faster transition away from lower power modules to higher power modules than we have in a very, very long time. I think the rapid reduction in ASPs and module ASPs has really accelerated that transition. And as you know, the higher power modules are better for Enphase. So I think the combination of the shift to IQ plus a more rapid shift to higher power modules will both contribute to gross margin expansion.

Great. As it relates to the California resi volumes going forward, when we saw San Diego going through this transition, the NEM 2.0, the monthly volumes literally stepped down, call it, 35% as a result of NEM 2.0. PG&E is going through that transition now, or went through it as of December. When you look at your volumes and talk to your installer base about Q1 and what the exchange so far in Q -- well, in February, what are they seeing? Are they seeing a similar step-down in volumes? If not, do you know why not?

Yes. Unfortunately, because the weather has been so bad, there is such tremendous backlog with all of our installer partners that they -- that there isn't any visibility to any effect of the NEM. Right now the biggest issue that everybody is facing is the backlog due to rain. In fact, many of our installer partners have crews working both Saturdays and Sundays throughout the rest of the quarter.

Having said that, in our discussions with our partners, to your point, I think the transition started in December, and I don't think you would have seen a very material effect on demand, absent seasonality, in Q1 due to that transition. Again, because the -- of the severe weather and because that had such a disproportionate effect on sales, it would have masked anything that would have happened with NEM in Q1 anyways.

Okay. Fair enough. And then as it relates to C&I, I think there was a bit of weakness in Q4 for your C&I volumes, especially in California. How do you expect C&I to trend going forward?

We see it trending sort of very consistent with historical averages, somewhere in the range of 15% of total volume.

Our next question comes from Brad Meikle of Craig-Hallum Capital.

Yes, it's Brad Meikle. In storage, can you give us some sense for the size of the market? You had $85 million of preorders in September when you started shipping. What's that looking like now? And then within the solar business, are you seeing growth in the U.S. market overall and international? And what's your sense of the overall demand picture there?

Sure. So as we had mentioned, the -- we're very pleased with the reception that we've had through our storage products and the entrance and the adoption in Australia and Europe, by the way, and even the initial response in the U.S. In fact, we have customers in the U.S. who are very interested in actually including storage, at least one of our AC batteries, as part of a standard solar system that they offer for everybody.

In reference to the preorders, it's a young market and we're all being very cautious and looking at where forecasts are going. We expect that some of those preorders may very well drop out. But for the most part, we feel like we're on track to meet our goals, both in Australia as well as the rest of the world.

In reference to just on the solar side, again, we've seen tremendous uptick in demand. We've talked about the fact that we started 2016 off at 20% share in U.S. resi. We ended north of 30%, and we're seeing similar share gains in many other countries we're in. And I think it's because the value proposition of the microinverters resonating and frankly, we found the right price point. And we've seen that again in multiple geographies.

The AC module, I think, is going to accelerate that yet again and give us an even bigger share in the U.S. And as we continue to execute on our storage solution and the home energy solution, it puts us in a more unique position, and I think that will translate into demand. So I'd say, all in all, we're seeing demand increase across the board in 2017.

Are you going to be free cash flow positive in the second quarter? And when could you get to a 10% free cash flow margins where you're actually producing some substantial cash that addresses the -- everyone's insolvency bankrupt balance sheet concerns?

Hey, Brad, it's a fair question. I'll remind everybody what we said when we spoke last. Given the actions that we took at the end of Q3, we had signaled that we believe we'd be sustainably profitable and cash flow positive in the back half of 2017. Given the actions we've taken here in the first quarter, you can imagine we feel very good about being able to pull that in. And so we feel again very good about the action we've taken, not only on the capital-raising front but also on the structuring front, that will enable us to pull in profitability a bit earlier.

So will be there any need for future capital raises from here, or you feel like you're good?

Given the combination of the restructuring and the capital-raising we've done to date, we feel really good about our capital position. So yes, I think we're in good shape.

Okay. And can you talk a little bit about the U.S. residential market? SolarCity obviously missed their target by 100 megawatts. It's probably going to be down 25% this year. What are you seeing in terms of the smaller mid-sized players where you tend to be stronger and have higher market share? And then give a little context to that transition that the industry is seeing to get smaller-sized players actually growing more rapidly than the big third-party ownership companies.

I think you're certainly right that there are some larger third-party ownership companies that are feeling the effects of the growing presence of the Tier 2 and Tier 3 installments. And we're definitely seeing more and more of the mid- and small-sized installers coming up. In fact, in Q4 alone, we added 70 new smaller installers. Having said that, there are definitely some big companies that are doing very well with this transition, and I think it really is on a case-by-case basis.

As a whole, I think it's very clear that we're seeing more loans, and the advent of the loan has helped a lot of the Tier 2 and Tier 3 players compete with some of the larger companies. So as a trend, I; do think we're going to see more -- a larger and larger share shift to some of the Tier 2, Tier 3 installers. At the same time, I think some of the larger installers, a select few, will also continue to grow, and I think there's space in the market for both of them.

Okay. And so your cost reduction target had been at 50% by the end of this year, and that was with the launch of the IQ 7. So did that get pushed to Q1 of next year? And are you still -- I think that was kind of what's been reiterated with the new road map. And can you just talk about when we're going to see the benefit of lower cost per watt?

Well, we're certainly going to see the effect of the lower cost per watt with the IQ 6 and as it becomes a larger and larger part of our product mix. And IQ 7 is scheduled for the end of this year, early next. It's a little too early for me to be any more specific than that, but we're on track to hit the general time frame.

Our next question comes from Edwin Mok with Needham & Company.

So obviously, there's a lot of questions in the U.S. or California. Just -- but on internationally, you highlight a few markets that you've done well. Can you maybe just give us a rough idea how much of your business is in international? And I think you sensibly talked about Europe. Maybe talk about your position in Europe and if you have room to gain share in that market.

Sure. So on average, we're about 20% rest of world and 80% domestic. In Europe, we have a very, very strong presence in France. Again, we're the leading residential inverter there. I believe our market share is north of 40%. It's very, very strong. We're a recent entrant into Holland, and we have -- we doubled market share at 2016 over 2015 and are actually on track to do that yet again in 2017. So gaining share there. And we have a very strong presence in Switzerland. We're going to see a much broader penetration into the rest of Europe in 2018. The reason for that being that the next generation microinverter, the IQ 7, is actually a global product. The same product will be able to work in the U.S. and internationally and will enable us to be able to enter countries like Germany, Italy and other European countries.

In fact, that, if I may digress for just a moment, that really highlights a huge advantage of the Enphase solution. One of the reasons that we can systemically have a lower R&D cost is that our one product, the IQ 6 or the IQ 7, supports a very, very wide range of installations from one module up to multi megawatts. And we're leveraging that, specifically the IQ 7, that would give us an entry into the rest of Europe and frankly, the rest of Latin America as well.

All right. That's helpful. If I may just circle back on the margin commentary, you said you expect margin to improve. I remember you guys talk about potentially reducing the cost by as much as 50% as you go to Gen 7, right, and you executed a road map. We're just trying to understand how that translates into margins as we go look beyond the March quarter. It seems like March quarter, you're kind of guiding flattish or even down a little bit on gross margins, and you comment about Gen 6 phasing in and maybe all of your shipments in 3Q weaken. So should we expect a pivot step-up by that time frame? Or if you can kind of give us some color and then your idea of that expansion, margin expansion.

Sure. So we've done a pretty good job on cost reduction even in 2016. However, with the aggressive price reduction we took, unfortunately, it was rather masked. As we talked about before, I think 2017, we'll also see normalized price reduction, but we can very likely outpace it with our cost reduction. IQ 6 is really going to represent a cost reduction for us, and you will see the effect of that and the expanding market -- expending margins throughout the year as IQ 6 becomes a bigger and bigger portion of our mix. And the same is true for IQ 7, which is targeted to launch, call it, end of this year, early next, and its effect on 2018 as well. So we feel very good that we will have effectively met the target by -- with the IQ 7 by the end of this year, and we'll see the commensurate rise in gross margin as a result, even considering that we're fully expecting for price reductions the rest of this year.

Okay. Great. Last question I have on the AC module. I just sort of trying to understand. If the customers are buying -- if module customers are buying your inverter and then store -- or put in on the module and ship it, right? Does that mean that you might see -- you might be further down away from the installer and therefore might potentially see a greater swing as a result of inventory? And as customer RAM, you might see a huge RAM and then as customer collect or go up inventory, you might see a pause in the business. Should we expect more of a swing in your businesses as a result of AC module, I guess, that's the question?

I don't think you're going to see any change in the purchasing or sales profile of an AC module versus just a standard microinverter. The agreements that we currently have with all 3 of them, Jinko, SolarWorld and LG, involve us selling a microinverter to them, them installing it at their factory and then them selling it in the channel to their customers. Once a customer receives an AC module, then the installation process and the commissioning and the O&M is really incumbent upon Enphase, and we work with all of our -- all of the end-user customers, the installers, to make sure that, that is the same seamless experience that they've had since day 1.

The only difference is, they don't have to buy a bunch of inverters and a bunch of modules and then go on the roof and install the inventers and then put the modules on top. They just order one SKU that has been totally integrated and then they just take the modules on the roof, plug them in like they normally would. They just happen to be installing the inverter as well, and then commission the system and they're done.

(Operator Instructions) Our next question comes from Krish Sankar with BofA Merrill Lynch.

I have a couple of them. Paul, can you talk a little bit about the competitive landscape? I'm kind of curious, obviously, of SolarEdge, but I'm trying to figure out how the Chinese and what are they doing, especially, it looks like Huawei might be coming out with a product too. So I wanted to find out the lay of the land over there.

Sure. So we've had, obviously, Chinese inverters in the U.S. for many, many years now and we have been able to compete successfully against them. We have heard the same rumors you have about Huawei entering the market with an optimizer solution. We have not seen it yet, but every indication is that it's coming out. The focus that we have on cost reduction is to ensure that we can maintain our ability to compete, even with offshore inverters. So we haven't seen it yet, but our anticipation is that it will come, and we're ready.

Got it. Got it. And then as a follow-up, the IQ 6 product, is this a product which can actually work on all panels, including large panel size, because I believe prior products had that shortcoming where you can't use it to scale it up on bigger panels?

So the answer is yes. You can use the IQ 6. There's actually 2 versions, the IQ 6 and the IQ 6+. You can use these on modules up to 380 watts, so far in excess of any modules that will be on the market. It's actually not true that our previous generation was somehow hindered by that as well. We have a 215-watt inverter and a 250-watt inverter. The 250-watt inverter could support modules into the 315, 320 range. So we've been always been able to do it, but we've pushed it up yet again with the IQ series to ensure that there are no modules that we cannot support. In fact, as I mentioned earlier, we not only welcome, we encourage higher power modules because of the better economics.

Our next question comes from Philip Shen with Roth Capital.

Our analysis of the California insulation data suggests that SunPower, with their SolarBridge product, has gained a substantial amount of share. So I think they started the year off with about 1% market share in the resi segment and ended the year in December around 12%. So I was wondering if you could comment on domestic competition. Have you seen this play out with your discussions with your customers, if at all? And what's your view on the rise of their inverter?

So I think you're missing on a very key point. What they have introduced is an AC module. I think the AC module has proven to be a very attractive solution for the installer and for all the reasons we had mentioned, everything from simplicity, through working capital management, ease of installation. And installers have seen that, and they've seen that with an AC module, they can have a more productive and more lucrative business. And I think that is a primary driver of what -- where that market share gain is. Now if there were other AC modules that had an Enphase microinverter, which is the highest quality, the best microinverter the world, coupled with multiple choices of modules at a much lower price, we feel that we can be extremely competitive and in fact, take share from competing solutions. So for us, that is all good news and that just represents and highlights the interest and demand for an AC module.

(Operator Instructions) I show no further questions at this time. I would like to turn the call back over to Mr. Nahi for closing remarks.

Thank you for joining us today. We look forward to speaking with you again next quarter.

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.