Enphase Energy, Inc. - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________________________

Form 10-Q

____________________________________________

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-35480

____________________________________________

Enphase Energy, Inc.

(Exact name of registrant as specified in its charter)

____________________________________________



Delaware (State or other jurisdiction of incorporation or organization)		20-4645388 (I.R.S. Employer Identification No.)

1420 N. McDowell Blvd. Petaluma, California		94954
(Address of principal executive offices)		(Zip Code)

(707) 774-7000

(Registrant’s telephone number, including area code)

____________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an “emerging growth company.” See the definitions of “large accelerated filer,” “accelerated filer, ” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:



Large accelerated filer	¨	Accelerated filer	¨

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	x

Emerging growth Company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of May 2, 2018, there were 96,848,549 shares of the registrant’s common stock outstanding, $0.00001 par value per share.

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ENPHASE ENERGY, INC.

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2018

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		Page
	PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	3
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Operations	4
	Condensed Consolidated Statements of Comprehensive Loss	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	52
	Signature	54

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PART I. FINANCIAL INFORMATION



Item 1.	Financial Statements (Unaudited)

ENPHASE ENERGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(Unaudited)



	March 31, 2018			December 31, 2017
ASSETS
Current assets:
Cash and cash equivalents	$	53,255		$	29,144
Accounts receivable, net of allowances of $2,927 and $2,378 at March 31, 2018 and December 31, 2017, respectively	55,622			65,346
Inventory	18,541			25,999
Prepaid expenses and other assets	20,435			9,957
Total current assets	147,853			130,446
Property and equipment, net	24,926			26,483
Goodwill	3,664			3,664
Intangibles, net	439			515
Other assets	35,236			8,039
Total assets	$	212,118		$	169,147
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	14,087		$	28,747
Accrued liabilities	30,223			22,447
Deferred revenues, current	37,408			15,691
Warranty obligations, current (includes $3,041 and $2,240 measured at fair value at March 31, 2018 and December 31, 2017, respectively)	7,699			7,427
Debt, current	14,268			17,429
Total current liabilities	103,685			91,741
Long-term liabilities:
Deferred revenues, noncurrent	78,265			29,941
Warranty obligations, noncurrent (includes $8,678 and $7,550 measured at fair value at March 31, 2018 and December 31, 2017, respectively)	22,926			22,389
Other liabilities	1,934			1,880
Debt, noncurrent	36,459			32,322
Total liabilities	243,269			178,273
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.00001 par value, 10,000 shares authorized; none issued and outstanding	—			—
Common stock, $0.00001 par value, 125,000 shares authorized; 96,765 and 85,914 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively	1			1
Additional paid-in capital	309,019			287,256
Accumulated deficit	(339,803		)	(295,727		)
Accumulated other comprehensive loss	(368		)	(656		)
Total stockholders’ deficit	(31,151		)	(9,126		)
Total liabilities and stockholders’ equity	$	212,118		$	169,147

See notes to condensed consolidated financial statements.

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ENPHASE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



	Three Months Ended March 31,
	2018			2017
Net revenues	$	69,972		$	54,751
Cost of revenues	51,657			47,703
Gross profit	18,315			7,048
Operating expenses:
Research and development	7,620			9,605
Sales and marketing	6,227			6,458
General and administrative	6,943			5,833
Restructuring charges	—			7,247
Total operating expenses	20,790			29,143
Loss from operations	(2,475		)	(22,095		)
Other income (expense), net:
Interest expense	(2,292		)	(2,139		)
Other income (expense)	(126		)	1,060
Total other expense, net	(2,418		)	(1,079		)
Loss before income taxes	(4,893		)	(23,174		)
Provision for income taxes	(235		)	(131		)
Net loss	$	(5,128	)	$	(23,305	)
Net loss per share:
Basic and diluted	$	(0.06	)	$	(0.30	)
Shares used in per share calculation:
Basic and diluted	91,422			76,651

See notes to condensed consolidated financial statements.

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ENPHASE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)



	Three Months Ended March 31,
	2018			2017
Net loss	$	(5,128	)	$	(23,305	)
Other comprehensive loss:
Foreign currency translation adjustments	288			(339		)
Comprehensive loss	$	(4,840	)	$	(23,644	)

See notes to condensed consolidated financial statements.

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ENPHASE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Three Months Ended March 31,
	2018			2017
Cash flows from operating activities:
Net loss	$	(5,128	)	$	(23,305	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	2,276			2,328
Provision for doubtful accounts	600			142
Asset impairment and restructuring	—			1,920
Amortization of debt issuance costs	537			945
Stock-based compensation	1,571			1,929
Changes in operating assets and liabilities:
Accounts receivable	9,125			11,975
Inventory	7,457			(1,848		)
Prepaid expenses and other assets	(1,039		)	(3,114		)
Accounts payable, accrued and other liabilities	(11,667		)	(17,458		)
Warranty obligations	809			580
Deferred revenues	(1,180		)	1,395
Net cash provided by (used in) operating activities	3,361			(24,511		)
Cash flows from investing activities:
Purchases of property and equipment	(1,043		)	(3,466		)
Net cash used in investing activities	(1,043		)	(3,466		)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs	19,923			26,522
Proceeds from debt	2,309			24,162
Principal payments on term debt	(771		)	—
Payments under revolving credit facility	—			(10,100		)
Proceeds from issuance of common stock under employee stock plans	269			2
Net cash provided by financing activities	21,730			40,586
Effect of exchange rate changes on cash	63			(418		)
Net increase in cash and cash equivalents	24,111			12,191
Cash and cash equivalents—Beginning of period	29,144			17,764
Cash and cash equivalents—End of period	$	53,255		$	29,955
Supplemental disclosures of non-cash investing and financing activities:
Purchases of fixed and intangible assets included in accounts payable	$	117		$	1,309
Deferred debt and offering costs included in accounts payable	$	—		$	231
Warrants issued in connection with debt	$	—		$	1,447

See notes to condensed consolidated financial statements.

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ENPHASE ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

Enphase Energy, Inc. and subsidiaries (the “Company”) deliver simple, innovative and reliable energy management solutions that advance the worldwide potential of renewable energy. The Company’s semiconductor-based microinverter system converts direct current (DC) electricity to alternating current (AC) electricity at the individual solar module level and brings a system-based, high technology approach to solar energy generation leveraging our design expertise across power electronics, semiconductors, networking, and cloud-based software technologies. Since inception, the Company has shipped approximately 17 million microinverters, representing over 3.8 gigawatts of solar photovoltaic (PV) generating capacity, and more than 760,000 Enphase residential and commercial systems have been deployed in over 110 countries.

Basis of Presentation and Consolidation

The accompanying condensed consolidated financial statements are presented in accordance with accounting principles generally accepted in the U.S, or GAAP. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Unaudited Interim Financial Information

These accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring items, considered necessary to present fairly the Company's financial condition, results of operations, comprehensive loss and cash flows for the interim periods indicated. The results of operations for the three months ended March 31, 2018 are not necessarily indicative of the operating results for the full year. Certain information and footnote disclosures typically included in annual consolidated financial statements have been condensed or omitted. Accordingly, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Other than as discussed in Note 2. “Revenue Recognition,” there have been no material changes in the Company’s significant accounting policies during the three months ended March 31, 2018, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Reference is made to the disclosures therein for a summary of the Company’s significant accounting policies.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Significant estimates and assumptions reflected in the financial statements include revenue recognition, inventory valuation and accrued warranty obligations. These estimates are based on information available as of the date of the financial statements; therefore, actual results could differ materially from management’s estimates using different assumptions or under different conditions.

Recently Adopted Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amended guidance, herein referred to as Topic 606, is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted for public companies effective for annual and interim reporting periods beginning after December 15, 2016. The Company has adopted Topic 606 effective January 1,

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2018, using the modified retrospective transition method. The Company recognized the cumulative effect of applying the new revenue standard as an adjustment to the opening balance of retained earnings on January 1, 2018. The comparative information has not been restated and continues to be reported under the accounting standards in effect for the period presented. See Note 2, “Revenue Recognition,” for additional accounting policy and transition disclosures.

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” which amends certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Changes to the current guidance include the accounting for equity investments, the presentation and disclosure requirements for financial instruments, and the assessment of valuation allowance on deferred tax assets related to available-for-sale securities. In addition, ASU 2016-01 establishes an incremental recognition and disclosure requirement related to the presentation of fair value changes of financial liabilities for which the fair value option has been elected. Under this guidance, an entity would be required to separately present in other comprehensive income the portion of the total fair value change attributable to instrument-specific credit risk as opposed to reflecting the entire amount in earnings. ASU 2016-01 is effective for fiscal years and interim periods beginning after December 15, 2017, and upon adoption, an entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet at the beginning of the first reporting period in which the guidance is effective. Early adoption was not permitted except for the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. The standard, which was adopted in the first quarter of 2018, did not have a material impact on the condensed consolidated financial statements.

In November 2016, the FASB issued Accounting Standards Update No. 2016-18 (ASU 2016-18), “Statement of Cash Flows,” which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The standard, which was adopted in the first quarter of 2018, did not have a material impact on the condensed consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09 (ASU 2017-09), "Compensation - Stock Compensation." ASU 2017-09 was issued to provide clarity and reduce both 1) diversity in practice and 2) cost and complexity when applying the guidance in Topic 718 to a change in the terms or conditions of a share-based payment award. ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. ASU 2017-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The standard, which was adopted in the first quarter of 2018, did not have a material impact on the condensed consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Effective

In February 2016, the FASB issued Accounting Standards Codification (“ASC”) 842 (“ASC 842”), “Leases” which replaces the existing guidance in ASC 840, Leases. ASC 842 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. ASC 842 requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use (ROU) asset and a corresponding lease liability. For finance leases the lessee would recognize interest expense and amortization of the ROU asset and for operating leases the lessee would recognize a straight-line total lease expense. The Company is currently evaluating the impact of adoption on the consolidated financial statements.

2. REVENUE RECOGNITION

On January 1, 2018, the Company adopted Topic 606 and applied the modified retrospective method to all contracts that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect in the prior period. The Company recorded a net reduction to opening equity of $38.9 million on January 1, 2018 for the cumulative effect of adopting Topic 606. The impact to net revenues from the adoption of Topic 606 for the three months ended March 31, 2018 was a net increase of $0.4 million.

Changes in accounting policies as a result of adopting Topic 606 and nature of goods

The most significant impacts upon adoption of Topic 606 were how the Company accounts for revenue related to its Envoy communications device and related Enlighten service and the timing of when certain sales incentives are recognized. Under ASC 605 the Company’s Envoy communications device and Enlighten service were

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considered two units of accounting, and the portion of the consideration related to the hardware was recognized at the time of sale with the remaining consideration deferred and recognized over the estimated service period. Under ASC 606 the full consideration for these products represents a single performance obligation and is deferred and recognized over the estimated service period. This treatment resulted in an increase to deferred revenue of $77.5 million, an increase in deferred costs of $43.4 million and an increase in accumulated deficit of $34.1 million upon adoption of ASC 606.

Under ASC 605 the Company recorded certain contra revenue promotions at the later of the date revenue was recognized or the date at which the promotional offer was extended. Under ASC 606 all such contra revenue programs are treated as variable consideration and recognized at the time the related revenue is recorded. This change in timing resulted in an increase in accrued liabilities of approximately $5.6 million and an increase to accumulated deficit of the same amount upon adoption of ASC 606.

Topic 606 requires upfront contract acquisition costs, such as sales commissions, to be capitalized and amortized over the estimated life of the asset. For contracts that have a duration of less than one year, the Company follows the Topic 606 practical expedient and expense these costs when incurred. Commissions related to the Company’s sale of monitoring hardware and service are capitalized and amortized over the period of the associated revenue, which is 6.5 years. This treatment resulted in an increase in deferred costs of approximately $0.8 million and an increase in accumulated deficit of the same amount upon adoption of ASC 606.

Revenues are recognized when control of the promised goods or services are transferred to the Company’s customers in an amount that reflects the consideration that is expected to be received in exchange for those goods or services. The Company generates all of its revenues from contracts with its customers. A description of principal activities from which the Company generates revenues follows.

Products Delivered at a Point in Time

The Company sells its products to customers in accordance with the terms of the related customer contracts. The Company generates revenues from sales of its microinverter systems, which include microinverter units and related accessories, an Envoy communications gateway and Enlighten service, communications accessories and AC Battery storage solutions to distributors, large installers, OEMs and strategic partners. Microinverter units, microinverter accessories, and AC Battery storage solutions are delivered to customers at a point in time, and in accordance with Topic 606, the Company recognizes revenue for these products when the Company transfers control fo the product to the customer, which is generally upon shipment.

Products Delivered Over Time

The sale of an Envoy communications gateway includes the Company’s Enlighten cloud-based monitoring service. Under Topic 606 the full consideration for these products represents a single performance obligation and is deferred at the sale date and recognized over the estimated service period, which is 6.5 years.

The Company also sells certain communication accessories that are delivered over time. The revenue from these products is recognized over the related service period, which is typically 5 or 12 years.

Disaggregation of Revenue

The Company has one business activity, which is the design, manufacture and sale of microinverter systems for the solar photovoltaic industry. The following table provides information about disaggregated revenue by primary geographical market and timing of revenue recognition for the Company’s single product line (in thousands):

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	Three Months Ended March 31, 2018
Primary geographical markets:
United States	$	43,130
International	26,842
Total	$	69,972

Timing of revenue recognition:
Products transferred at a point in time	$	59,371
Products and services transferred over time	10,601
Total	$	69,972

Contract Balances

As of March 31, 2018, receivables, contract assets and contract liabilities from contracts with customers consist of the following (in thousands):



	March 31, 2018
Receivables	$	55,622
Short-term contract assets (Prepaid expenses and other assets)	13,896
Long-term contract assets (Other assets)	33,762
Short-term contract liabilities (Deferred revenues, current)	37,408
Long-term contract liabilities (Deferred revenues, noncurrent)	78,265

The Company receives payments from customers based upon contractual billing schedules. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract liabilities are recorded as deferred revenue on the accompanying condensed consolidated balance sheets and include payments received in advance of performance obligations under the contract and are realized with the associated revenue is recognized under the contract. Contract assets include deferred product costs and commissions associated with the deferred revenue and will be amortized along with the associated revenue. The Company had no asset impairment charges related to contract assets in the three months ended March 31, 2018.

Significant changes in the balances of contract liabilities (deferred revenues) and contract assets (prepaid expenses and other assets) during the period are as follows (in thousands):



	March 31, 2018
Contract Liabilities
Balance on January 1, 2018	$	116,830
Revenue recognized	(10,601		)
Increase due to billings	9,444
Balance as of March 31, 2018	$	115,673
Deferred revenue, current	37,408
Deferred revenue, noncurrent	78,265

Contract Assets
Balance on January 1, 2018	$	47,862
Amount recognized	(3,939		)
Increase	3,735
Balance as of March 31, 2018	$	47,658

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Remaining Performance Obligations

The following table includes estimated revenue expected to be recognized in future periods related to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period (in thousands).



	March 31, 2018
Remainder of 2018	$	29,698
2019	28,199
2020	22,695
2021	16,147
2022	11,097
Thereafter	7,837
Total	$	115,673

Practical Expedients and Exemptions

The Company generally expenses sales commissions related to products delivered at a point in time when the commissions are incurred because the amortization period would have been less than one year. The Company records these costs as sales and marketing expense. The Company expenses shipping and handling costs as incurred.

Impact of Adoption of Topic 606

In accordance with Topic 606, the disclosure of the impact of adoption to the Company’s condensed consolidated statements of operations and condensed consolidated balance sheets was as follows (in thousands):



	Three Months Ended March 31, 2018
	As Reported			Adjustments			Without Adoption of Topic 606
Net revenues	$	69,972		$	(439	)	$	69,533
Cost of revenues	51,657			(169		)	51,488
Gross profit	18,315			(270		)	18,045
Total operating expenses	20,790			(35		)	20,755
Loss from operations	(2,475		)	(235		)	(2,710		)
Total other expense, net	(2,418		)	—			(2,418		)
Loss before income taxes	(4,893		)	(235		)	(5,128		)
Provision for income taxes	(235		)	—			(235		)
Net loss	$	(5,128	)	$	(235	)	$	(5,363	)
Net loss per share:
Basic and diluted	$	(0.06	)	$	—		$	(0.06	)
Shares used in per share calculation:
Basic and diluted	91,422			91,422			91,422

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	March 31, 2018
	As Reported		Adjustments		Without Adoption of Topic 606
Prepaid expenses and other	20,435		(10,761	)	9,674
Other assets	35,236		(27,330	)	7,906
Accrued liabilities	30,223		(5,736	)	$	24,487
Deferred revenues	37,408		(21,350	)	$	16,058
Deferred revenues, noncurrent	78,265		(49,714	)	28,551
Accumulated deficit	(339,803	)	38,709		(301,094		)

3. INVENTORY

Inventory as of March 31, 2018 and December 31, 2017 consists of the following (in thousands):



	March 31, 2018		December 31, 2017
Raw materials	$	1,965	$	2,341
Finished goods	16,576		23,658
Total inventory	$	18,541	$	25,999

4. WARRANTY OBLIGATIONS

The Company’s warranty activities during the three months ended March 31, 2018 and 2017 were as follows (in thousands):



	Three Months Ended March 31,
	2018			2017
Warranty obligations, beginning of period	$	29,816		$	31,414
Accruals for warranties issued during period	758			834
Changes in estimates	1,450			291
Settlements	(1,676		)	(1,617		)
Increase due to accretion expense	419			495
Other	(142		)	578
Warranty obligations, end of period	$	30,625		$	31,995
Less current portion	$	(7,699	)	$	(8,376	)
Noncurrent	$	22,926		$	23,619

As of March 31, 2018, the 30.6 million of warranty obligations included $11.7 million measured at fair value. See Note 5, “Fair Value Measurements” for additional information.

5. FAIR VALUE MEASUREMENTS

The accounting guidance defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance.

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. An asset’s or liability’s categorization within the fair value hierarchy

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is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:


•	Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of such assets or liabilities do not entail a significant degree of judgment.


•	Level 2—Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.


•	Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

The following table presents the Company’s liabilities that were measured at fair value on a recurring basis and its categorization within the fair value hierarchy at March 31, 2018 and December 31, 2017 (in thousands):



	Fair Value Hierarchy	March 31, 2018		December 31, 2017
Liabilities:
Warranty obligations	Level 3	$	11,719	$	9,790
Third party option to purchase receivables at a discount	Level 3	300		700

Fair Value Option for Warranty Obligations Related to Microinverters Sold Since January 1, 2014

The Company’s warranty obligations related to microinverters sold since January 1, 2014 provide the Company the right, but not the requirement, to assign its warranty obligations to a third-party. Under Accounting Standards Codification (“ASC”) 825—Financial Instruments, (“fair value option”), an entity may choose to elect the fair value option for such warranties at the time it first recognizes the eligible item. The Company made an irrevocable election to account for all eligible warranty obligations associated with microinverters sold since January 1, 2014 at fair value. This election was made to reflect the underlying economics of the time value of money for an obligation that will be settled over an extended period of up to 25 years.

The Company estimates the fair value of warranty obligations by calculating the warranty obligations in the same manner as for sales prior to January 1, 2014 and applying an expected present value technique to that result. The expected present value technique, an income approach, converts future amounts into a single current discounted amount. In addition to the key estimates of failure rates, claim rates and replacement costs, the Company used certain Level 3 inputs which are unobservable and significant to the overall fair value measurement. Such additional assumptions included a discount rate based on the Company’s credit-adjusted risk-free rate and compensation comprised of a profit element and risk premium required of a market participant to assume the obligation.

The following table provides information regarding changes in nonfinancial liabilities related to the Company’s warranty obligations measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods indicated (in thousands):



	Three Months Ended March 31,
	2018			2017
Balance at beginning of period	$	9,790		$	10,332
Accruals for warranties issued during period	758			830
Changes in estimates	1,785			(266		)
Settlements	(891		)	(342		)
Increase due to accretion expense	419			495
Other	(142		)	578
Balance at end of period	$	11,719		$	11,627

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Quantitative and Qualitative Information about Level 3 Fair Value Measurements

As of March 31, 2018, the significant unobservable inputs used in the fair value measurement of the Company’s liabilities designated as Level 3 are as follows:



Item Measured at Fair Value	Valuation Technique	Description of Significant Unobservable Input	Percent Used (Weighted-Average)
Warranty obligations for microinverters sold since January 1, 2014	Discounted cash flows	Profit element and risk premium	16%
	Discounted cash flows	Credit-adjusted risk-free rate	17%
Third party option to purchase receivables at a discount	Discounted cash flows	Counter party credit-adjusted risk-free rate	4%

As of December 31, 2017, the significant unobservable inputs used in the fair value measurement of the Company’s liabilities designated as Level 3 are as follows:



Item Measured at Fair Value	Valuation Technique	Description of Significant Unobservable Input	Percent Used (Weighted-Average)
Warranty obligations for microinverters sold since January 1, 2014	Discounted cash flows	Profit element and risk premium	17%
	Discounted cash flows	Credit-adjusted risk-free rate	17%
Third party option to purchase receivables at a discount	Discounted cash flows	Counter party credit-adjusted risk-free rate	4%

Sensitivity of Level 3 Inputs

Warranty Obligations

Each of the significant unobservable inputs is independent of the other. The profit element and risk premium are estimated based on requirements of a third-party participant willing to assume the Company’s warranty obligations. The credit-adjusted risk free rate (“discount rate”) is determined by reference to the Company’s own credit standing at the fair value measurement date. Increasing or decreasing the profit element and risk premium input by 100 basis points would have a nominal impact on the fair value measurement of the liability. Increasing the discount rate by 100 basis points would result in a $0.5 million reduction of the liability. Decreasing the discount rate by 100 basis points would result in a $0.5 million increase to the liability.

6. GOODWILL AND INTANGIBLE ASSETS

The following table presents the details of the Company’s goodwill and purchased intangible assets as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018							December 31, 2017
	Gross		Accumulated Amortization			Net		Gross		Accumulated Amortization			Net
Goodwill	$	3,664	$	—		$	3,664	$	3,664	$	—		$	3,664

Other indefinite-lived intangibles	$	286	$	—		$	286	$	286	$	—		$	286
Intangible assets with finite lives:
Patents and licensed technology	1,665		(1,512		)	153		1,665		(1,436		)	229
Total purchased intangible assets	$	1,951	$	(1,512	)	$	439	$	1,951	$	(1,436	)	$	515

In July 2014, the Company purchased certain patents related to system interconnection and photovoltaic AC module construction. The patents were amortized over their legal life of 3 years. In October 2015, the Company licensed certain technology related to ASIC development for a 3 year term, which is also its estimated useful life.

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For the three months ended March 31, 2018, amortization expense related to intangible assets was $0.1 million. The remaining $0.2 million of patents and licensed technology will be amortized during the remainder of 2018.

7. RESTRUCTURING

In the third quarter of 2016, the Company began implementing restructuring actions to lower its operating expenses. The restructuring actions have included reductions in the Company’s global workforce, the elimination of certain non-core projects, consolidation of office space at the Company’s corporate headquarters and the engagement of management consultants to assist the Company in making organizational and structural changes to improve operational efficiencies and reduce expenses. The Company substantially completed its restructuring activities in 2017.

The following table presents the details of the Company’s restructuring charges for the periods indicated (in thousands):



	Three Months Ended March 31,
	2018		2017
Employee severance and benefit arrangements	$	—	$	1,592
Asset impairments	—		522
Consultants engaged in restructuring activities	—		4,000
Lease loss reserves and contract termination costs	—		1,133
Total restructuring and asset impairment charges	$	—	$	7,247

The following table provides information regarding changes in the Company’s accrued restructuring balance for the periods indicated (in thousands):



	Employee Severance and Benefits			Asset Impairments			Lease Loss Reserves and Contractual Obligations			Total
Balance as of December 31, 2015	$	—		$	—		$	—		$	—
Charges	1,263			2,575			579			4,417
Cash payments	(1,065		)	—			(95		)	(1,160		)
Non-cash settlement	—			(2,575		)	—			(2,575		)
Balance as of December 31, 2016	$	198		$	—		$	484		$	682
Charges	2,827			522			13,568			16,917
Cash payments	(2,796		)	—			(12,958		)	(15,754		)
Non-cash settlement	—			(522		)	—			(522		)
Balance at end of period as of December 31, 2017	$	229		$	—		$	1,094		$	1,323
Cash payments and receipts, net	(229		)	—			34			(195		)
Balance at end of period as of March 31, 2018	$	0		$	—		$	1,128		$	1,128

8. DEBT

Term Loan

In July 2016, the Company entered into a Term Loan Agreement (the “Original Term Loan”) with lenders that are affiliates of Tennenbaum Capital Partners, LLC. (the “Lenders” or “TCP”). Under the agreement, the Lenders committed to advance a term loan in an aggregate principal amount of up to $25.0 million with a maturity date of July 1, 2020. The Company borrowed the entire $25.0 million of term loan commitments on the loan closing date. Monthly payments due through June 30, 2017 were interest only, followed by consecutive equal monthly payments of principal plus accrued interest that were to begin on July 1, 2017 and continue through the maturity date. The term loan provided for an interest rate per annum equal to the higher of (i) 10.25% or (ii) LIBOR plus 9.5625%,

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subject to a 1.0% reduction if the Company achieves minimum levels of Revenue and EBITDA (each as defined in the Term Loan Agreement) for the twelve-consecutive month period ending June 30, 2017 as set forth in the Term Loan Agreement. In addition, the Company paid a commitment fee of 3.3% of the loan amount upon closing and a closing fee of 10.0% of the loan amount is payable in four equal installments at each anniversary of the closing date. The Company could elect to prepay the loan by incurring a prepayment fee between 1% and 3% of the principal amount of the term loan depending on the timing and circumstances of prepayment.

In February 2017, the Company entered into an Amended and Restated Loan and Security Agreement (the “Loan Agreement”) that amended and restated the Original Term Loan. The Loan Agreement provides for a $25.0 million secured term loan to the Company (the “New Term Loan”), which is in addition to the $25.0 million secured term loan borrowed by the Company under the Original Term Loan (together with the “New Term Loan” the “Term Loans”). The New Term Loan has the same July 1, 2020 maturity date that was applicable to the Original Term Loan. The New Term Loan was fully drawn at closing, with approximately $10.3 million of the proceeds used to repay existing combined principal and interest due under the Company’s Revolver with Wells Fargo. Upon the repayment of loans under the Wells Fargo Revolver, the Wells Fargo Revolving Credit Agreement was terminated. The Company expects to use the remainder of the proceeds from the New Term Loan for general corporate purposes.

Monthly payments under the Term Loans through February 28, 2018 are interest only, followed by consecutive equal monthly payments of principal plus accrued interest beginning on March 1, 2018 and continuing through the maturity date. Interest on the Term Loans is the greater of (a) 10.3125%, and (b) a fluctuating rate of interest per annum equal to the three-month LIBOR Rate (rounded up to the nearest 1/16th of one percent) plus 9.25%. In addition, the Company paid a commitment fee of 3.0% of the New Term Loan amount upon closing and a closing fee of 4.0% of the New Term Loan amount, which is payable with the closing fee under the Original Term Loan in four equal installments at each anniversary of the closing date of the Original Loan Agreement. The Company may elect to prepay the Term Loans by incurring a prepayment fee between 1% and 3% of the principal amount of the Term Loans depending on the timing and circumstances of prepayment.

On February 28, 2018, the Company entered into a Second Amendment to the Term Loans. The Amendment decreases by 50% the amount of principal repayments required under the Loan Agreement for the period from March 1, 2018 through December 31, 2018 and provides that the Company shall not prepay any part of the Term Loan during that same period without the Collateral Agent’s prior written consent.

The Term Loans are secured by a first-priority security interest on substantially all assets of the Company; provided, however, that the security interest in the Company’s intellectual property may be released if the Company satisfies certain requirements. The Company’s obligations under the Term Loans are not guaranteed by any of the Company’s existing subsidiaries, nor have any existing subsidiaries of the Company pledged any of their assets to secure the Term Loans.

The Loan Agreement requires that (i) at all times from the closing date to and including March 31, 2018, the Company, and any future guarantors, have Unrestricted Cash (as defined in the Loan Agreement) of at least $10.0 million; (ii) at all times from the closing date to and including March 31, 2018, that the aggregate amount of Consolidated Unrestricted Cash, plus the value of Consolidated Receivables, plus the value of Consolidated Inventory (each as defined in the Loan Agreement) divided by the outstanding principal amount of Term Loans, shall equal or exceed 1.5; and (iii) at all times from April 1, 2018 and thereafter, that the aggregate amount of Consolidated Unrestricted Cash, plus the value of Consolidated Receivables, plus the value of Consolidated Inventory divided by the outstanding principal amount of Term Loans, shall equal or exceed 1.75. In addition, the Loan Agreement is subject to customary affirmative and negative covenants including restrictions on creation of liens, dispositions of assets, mergers, changing the nature of its business and dividends and other distributions, in each case subject to certain exceptions. The Term Loan Agreement also contains certain customary events of default including, but not limited to, failure to pay interest, principal and fees or other amounts when due, material breach of any representation or warranty, covenant defaults, cross defaults to other material indebtedness, events of bankruptcy and the occurrence of a material adverse change (as defined in the agreement) to the Company’s business. The Term Loan Agreement offers TCP typical rights and remedies in any event of default, including the ability to declare all amounts outstanding immediately due and payable. The Company was in compliance with all financial covenants as of March 31, 2018.

In connection with the New Term Loan, the Company issued to the Lenders warrants to purchase an aggregate 1,220,000 shares of the Company’s Common Stock at an exercise price of $1.05 per share. The

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warrants have a term of seven years and contain a “cashless exercise” feature that allows the holder to exercise the warrant without a cash payment upon the terms set forth therein.

The Company estimated the fair value of the warrants by using the Black-Scholes approach and the following assumptions: stock price of $1.56; strike price of $1.05; volatility of 85.9%, risk-free rate of 2.23%; dividend yield of 0%; and a 7 year term. The resulting fair value was used to allocate the proceeds from the Term Loan between liability and equity components.

The Company classified the warrants as equity and allocated the proceeds from the Term Loan and warrants using the relative fair value method. Using this method, the Company allocated $1.4 million to the warrants, which was recorded as equity. This amount represents debt discount that will be amortized to interest expense over the term of the loan. The Lenders converted the warrants into 912,067 shares of the Company’s common stock in a cashless exercise in 2018.

As of March 31, 2018, the estimated schedule of principal payments due on the term loan is as follows (in thousands):



Year	Amounts
2018	$	7,062
2019	25,238
2020	16,929
Total	$	49,229

Sale of Long Term Financing Receivables

The Company entered into an agreement with a third party in the fourth quarter of 2017 to sell certain current and future receivables at a discount. In December 2017, the third party made an initial purchase of receivables resulting in net proceeds to the Company of $2.8 million. This transaction was recorded as debt on the accompanying consolidated balance sheets, and the debt balance will be relieved by January 2019 as the underlying receivables are settled. In March 2018, the third party made an additional purchase of receivables resulting in net proceeds to the Company of $2.3 million. This transaction was recorded as debt on the accompanying consolidated balance sheets, and the debt balance will be relieved by January 2020 as the underlying receivables are settled.The buyer has the option to purchase certain additional future receivables at various fixed discounts. This option was valued at $0.7 million and was recorded as a liability with a corresponding offset to debt as of December 31, 2017. As of March 31, 2018, this option was valued at $0.3 million. See Note 8, “Fair Value Measurements” for additional information.

Long-term debt was comprised of the following at March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018			December 31, 2017
Term loan	$	49,229		$	50,000
Less unamortized discount and issuance costs	(1,828		)	(2,111		)
Carrying amount of term loan	47,401			47,889
Sale of long term financing receivable recorded as debt	3,626			2,562
Less value of future purchase option	(300		)	(700		)
Carrying amount of sale of long term financing receivable recorded as debt	3,326			1,862
Total carrying amount of debt	50,727			49,751
Less current portion term loan	(12,133		)	(15,715		)
Less current portion of long term financing receivable recorded as debt	(2,135		)	(1,714		)
Long-term debt	$	36,459		$	32,322

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Revolving Credit Facility

The Company had a $50.0 million revolving credit facility with Wells Fargo Bank, N.A. (“Wells Fargo”) that was entered into in November 2012. The Revolver had a balance of $10.1 million as of December 31, 2016 and was fully repaid and terminated in February 2017.

9. COMMITMENTS AND CONTINGENCIES

From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company is not involved in any material legal proceedings. However, the Company is involved in a dispute with one of its suppliers regarding purchase volume commitments. The Company believes that the supplier’s claims are without merit and that the Company has a legally defensible position in this matter. In an effort to avoid the potential of protracted legal action, the Company made an offer in April, 2018 to settle the dispute and has recorded a charge and recognized a contingent liability in the first quarter of 2018 in the amount of $1.8 million. If the supplier does not accept the settlement offer, the offer will be rescinded and the Company will vigorously defend any and all claims that may be brought by the supplier. The Company may also be involved in material legal proceedings in the future. Such matters are subject to uncertainty and there can be no assurance that such legal proceedings will not have a material adverse effect on its business, results of operations, financial position or cash flows.

10. SALE OF COMMON STOCK

On February 4, 2018, the Company entered into a securities purchase agreement with an investor pursuant to which the Company, in a private placement, issued and sold to the investor 9,523,809 shares of the Company’s common stock, at a price per share of $2.10, for gross proceeds of $20.0 million.

11. STOCK-BASED COMPENSATION

The Company has adopted certain equity incentive and stock purchase plans as described in the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Equity Awards Activity

Stock Options

The following is a summary of stock option activity for the three months ended March 31, 2018 (in thousands, except per share data):



	Number of Shares Outstanding		Weighted- Average Exercise Price per Share
Outstanding at December 31, 2017	8,426		$	1.77
Granted	69		2.86
Exercised	(134	)	2.00
Canceled	(34	)	1.98
Outstanding at March 31, 2018	8,327		$	1.77

The intrinsic value of options exercised in the three months ended March 31, 2018 was $0.3 million. As of March 31, 2018, the intrinsic value of options outstanding was $25.0 million based on the closing price of the Company’s stock as of March 31, 2018.

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Restricted Stock Units

The following is a summary of restricted stock unit activity for the three months ended March 31, 2018 (in thousands, except per share data):



	RSUs		Weighted Average Fair Value per Share at Grant Date
Outstanding at December 31, 2017	3,505		$	2.03
Granted	595		2.36
Vested	(281	)	3.28
Canceled	(199	)	1.96
Outstanding at March 31, 2018	3,620		$	1.99

The total intrinsic value of restricted stock units that were vested in the three months ended March 31, 2018 was $0.8 million. As of March 31, 2018, the intrinsic value of restricted stock units outstanding was $16.5 million based on the closing price of the Company’s stock as of March 31, 2018.

On April 3, 2017, the Company commenced a Tender Offer (Offer) to exchange out of the money stock options for restricted stock units. The Offer expired on Monday, May 1, 2017. Pursuant to the Offer, the Company accepted elections to exchange options to purchase 2,362,470 shares of common stock and issued replacement awards of restricted stock units for 733,559 shares of common stock. As the transaction approximated a value-for-value exchange, it did not have a material impact on the Company’s stock based compensation expense.

Stock-Based Compensation Expense

Compensation expense for all stock-based awards expected to vest is measured at fair value on the date of grant and recognized ratably over the requisite service period. The following table summarizes the components of total stock-based compensation expense included in the condensed consolidated statements of operations for the periods presented (in thousands):



	Three Months Ended March 31,
	2018		2017
Cost of revenues	$	198	$	239
Research and development	618		751
Sales and marketing	361		378
General and administrative	394		561
Total	$	1,571	$	1,929

The following table summarizes the various types of stock-based compensation expense for the periods presented (in thousands):



	Three Months Ended March 31,
	2018		2017
Stock options and restricted stock units	$	1,317	$	1,599
Employee stock purchase plan	254		330
Total	$	1,571	$	1,929

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The following table presents the weighted-average grant date fair value of options granted for the periods presented and the assumptions used to estimate those values using a Black-Scholes option pricing model:



	Three Months Ended March 31,
	2018			2017
Weighted average grant date fair value	$	1.83		$	0.68
Expected term (in years)	4.2			4.0
Expected volatility	86.4		%	83.6		%
Annual risk-free rate of return	2.4		%	1.7		%
Dividend yield	0.0		%	0.0		%

As of March 31, 2018, there was approximately $10.3 million of total unrecognized compensation expense related to unvested equity awards expected to be recognized over a weighted-average period of 3.0 years.

12. INCOME TAXES

The Company used the discrete tax approach in calculating the tax expense for the three months ended March 31, 2018 and 2017 due to the fact that a relatively small change in the Company’s projected pre-tax net income (loss) could result in a volatile effective tax rate. Under the discrete method, the Company determines its tax (expense) benefit based upon actual results as if the interim period was an annual period. The tax provision recorded was primarily related to income taxes attributable to its foreign operations.

13. NET LOSS PER SHARE

Basic net loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted loss per share is computed in a similar manner, but it also includes the effect of potential common shares outstanding during the period, when dilutive. Potential common shares include outstanding in-the-money stock options, restricted stock units, shares to be purchased under the Company’s employee stock purchase plan and warrants to purchase common stock. The dilutive effect of potentially dilutive common shares is reflected in diluted earnings per share by application of the treasury stock method. To the extent these potential common shares are antidilutive, they are excluded from the calculation of diluted net loss per share.

The following table presents the computation of basic and diluted net loss per share for the periods presented (in thousands, except per share data):



	Three Months Ended March 31,
	2018			2017
Numerator:
Net loss	$	(5,128	)	$	(23,305	)

Denominator:
Weighted average common shares outstanding	91,422			76,651

Net loss per share, basic and diluted	$	(0.06	)	$	(0.30	)

As the Company incurred a net loss for all periods presented, potential dilutive securities from employee stock options, restricted stock units and warrants have been excluded from the diluted net loss per share computations because the effect of including such shares would have been anti-dilutive. The following table sets forth the potentially dilutive securities excluded from the computation of the diluted net loss per share (in thousands):

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	Three Months Ended March 31,
	2018	2017
Employee stock options	8,418	8,458
Restricted stock units	3,659	526
Warrants to purchase common stock	—	664
Total	12,077	9,648

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Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements reflecting our current expectations and involves risks and uncertainties. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential” or “continue” or the negative of these terms or other comparable terminology. For example, statements regarding our expectations as to future financial performance, expense levels, liquidity sources and timing of new product releases are forward-looking statements. Our actual results and the timing of events may differ materially from those discussed in our forward-looking statements as a result of various factors, including those discussed below and those discussed in the section entitled “Risk Factors” included in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2017.

Overview

We deliver simple, innovative and reliable energy management solutions that advance the worldwide potential of renewable energy. Our semiconductor-based microinverter system converts direct current (DC) electricity to alternating current (AC) electricity at the individual solar module level, and brings a system-based, high technology approach to solar energy generation leveraging our design expertise across power electronics, semiconductors, networking, and cloud-based software technologies. Our technology was designed to increase energy production, simplify design and installation, improve system uptime and reliability, reduce fire risk, and provide a platform for intelligent energy management. Since inception, we have shipped approximately 17 million microinverters representing over 3.8 gigawatts of solar PV generating capacity, and more than 760,000 Enphase residential and commercial systems have been deployed in over 110 countries.

We sell our microinverter systems primarily to distributors who resell them to solar installers. We also sell directly to large installers and through original equipment manufacturers (“OEMs”) and strategic partners.

New Products

Enphase IQ Microinverter System

In the first quarter of 2018, we began shipping our seventh-generation Enphase IQ™ microinverters for the Enphase Home Energy Solution with IQ™, our next-generation integrated solar, storage and energy management system, to distributors in the United States. IQ 7, with its single worldwide SKU, will be phased into markets around the world throughout 2018.

Enphase IQ 7 Micro™ and Enphase IQ 7+ Micro™ support high-powered 60-cell and 72-cell solar modules and integrate with AC modules. We plan to offer a high-powered variant, the IQ 7X, to address 96-cell modules.

Our next generation system, IQ 8, is built on our grid-agnostic “always on” Ensemble™ technology. The IQ 8 ASIC, is fully functional, which demonstrates the technological feasibility of Ensemble. This ASIC is made in 55nm technology at TSMC, enabling very high speed digital signal processing. We are continuing to commercialize IQ 8 and expect it to be introduced in 2019.

The Enphase IQ microinverter is a key component of the Enphase Home Energy Solution, which can also include our Envoy™ Communications Gateway with IQ Combiner+, Enphase Enlighten™, a cloud-based energy management platform, and our Enphase AC Battery™. System owners can use Enphase Enlighten to monitor their home’s solar generation, energy storage and consumption from any web-enabled device.

Enphase Energized AC Modules

We began shipping Enphase Energized AC Modules in North America in the second quarter of 2017. The Enphase Energized AC Modules with IQ utilize our sixth and seventh generation microinverters and are produced through our AC module partnerships with LG Electronics Inc., JinkoSolar Technology, SolarWorld AG, and Waaree Energies Ltd. In 2018 we announced new AC Module partnerships with Panasonic Corporation and Solaria Corporation.

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Enphase AC Battery™

The Enphase AC Battery is a scalable, modular energy storage system with a 1.2kWh energy capacity. We began shipments to customers in Australia, New Zealand, the United States, France, the United Kingdom and the Netherlands in 2016.

Components of Condensed Consolidated Statements of Operations

Net Revenues

We generate net revenues from sales of our microinverter systems and related accessories, which include microinverter units, AC Battery storage systems, an Envoy communications gateway and our Enlighten cloud-based monitoring service.

Our revenue is affected by changes in the volume and average selling prices of our microinverter systems and related accessories, supply and demand, sales incentives, and competitive product offerings. Our revenue growth is dependent on our ability to compete effectively in the marketplace by remaining cost competitive, developing and introducing new products that meet the changing technology and performance requirements of our customers, the diversification and expansion of our revenue base, and our ability to market our products in a manner that increases awareness for microinverter technology and differentiates us in the marketplace.

Cost of Revenues and Gross Profit

Cost of revenues is comprised primarily of product costs, warranty, manufacturing personnel and logistics costs, freight costs, depreciation and amortization of test equipment and hosting services costs. Our product costs are impacted by technological innovations, such as advances in semiconductor integration and new product introductions, economies of scale resulting in lower component costs, and improvements in production processes and automation. Certain costs, primarily personnel and depreciation and amortization of test equipment, are not directly affected by sales volume.

We outsource our manufacturing to third-party contract manufacturers and generally negotiate product pricing with them on a quarterly basis. We believe our contract manufacturing partners have sufficient production capacity to meet the anticipated demand for our products for the foreseeable future. However, shortages in the supply of certain key raw materials could adversely affect our ability to meet customer demand for our products. We contract with third parties, including one of our contract manufacturers, to serve as our logistics providers by warehousing and delivering our products in the United States, Europe and Asia.

Gross profit may vary from quarter to quarter and is primarily affected by our average selling prices, product cost, product mix, warranty costs and sales volume fluctuations resulting from seasonality.

Operating Expenses

Operating expenses consist of research and development, sales and marketing, general and administrative and restructuring expenses. Personnel-related costs are the most significant component of each of these expense categories other than restructuring expense and include salaries, benefits, payroll taxes, sales commissions, incentive compensation and stock-based compensation.

Research and development expense includes personnel-related expenses, third-party design and development costs, testing and evaluation costs, depreciation expense and other indirect costs. Research and development employees are primarily engaged in the design and development of power electronics, semiconductors, powerline communications, networking and software functionality, and storage. We devote substantial resources to research and development programs that focus on enhancements to, and cost efficiencies in, our existing products and timely development of new products that utilize technological innovation to drive down product costs, improve functionality, and enhance reliability. We intend to continue to invest appropriate resources in our research and development efforts because we believe they are critical to maintaining our competitive position.

Sales and marketing expense consists primarily of personnel-related expenses such as salaries, commissions, stock-based compensation, employee benefits and travel. It also includes trade shows, marketing, customer support and other indirect costs. We expect to continue to make the necessary investments to enable us to execute our strategy to increase our market penetration geographically and enter into new markets by expanding our customer base of distributors, large installers, OEMs and strategic partners. We currently offer microinverter systems targeting the residential and commercial markets in the United States, Canada, Mexico and certain Central American markets, the United Kingdom, France, the Benelux region, certain other European markets, Australia,

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New Zealand, India and certain other Asian markets. We expect to continue to expand the geographic reach of our product offerings and explore new sales channels in addressable markets in the future.

General and administrative expense consists primarily of salaries, incentive compensation, stock-based compensation and employee benefits for personnel related to our executive, finance, human resources, information technology and legal organizations. General and administrative expense also includes facilities costs and fees for professional services, which consist primarily of outside legal, accounting and information technology consulting costs.

Restructuring charges are the net of charges resulting from restructuring initiatives implemented in 2016 and 2017 to improve operational performance and reduce overall operating expense and gain on divestiture of our services business. Costs included in restructuring primarily consist of fees paid to management consultants engaged to assist us in making organizational and structural changes to improve operational efficiencies and reduce expenses, severance for workforce reduction actions, non-cash charges related to the disposition of assets and impairment of property and equipment, and the establishment of lease loss reserves. Our restructuring initiatives were largely completed in 2017. See Note 7, “Restructuring and Other Charges” to the condensed consolidated financial statements for additional information.

Other Expense, Net

Other expense, net primarily consists of interest expense and commitment fees under our term loans and non-cash interest expense related to the amortization of deferred financing costs. Other expense, net also includes gains or losses upon conversion of foreign currency transactions into U.S. dollars.

Provision for Income Taxes

We are subject to income taxes in the countries where we sell our products. Historically, we have primarily been subject to taxation in the United States because we have sold the majority of our products to customers in the United States. As we have expanded the sale of products to customers outside the United States, we have become subject to taxation based on the foreign statutory rates in the countries where these sales took place. As sales in foreign jurisdictions increase in the future, our effective tax rate may fluctuate accordingly. Due to the history of losses we have generated in the United States since inception, we believe that it is more-likely-than-not that all of our U.S. and state deferred tax assets will not be realized as of March 31, 2018.

Results of Operations for the Three Months Ended March 31, 2018 and 2017

Net Revenues



	Three Months Ended March 31,				Change in
	2018		2017		$		%
	(dollars in thousands)
Net revenues	$	69,972	$	54,751	$	15,221	28	%