Power One Inc (NASDAQ:PWER)
Q3 2010 Earnings Call
October 28, 2010 5:00 p.m. ET
Kevin Trosian – Vice President, Investor Relations
Richard Thompson – President and Chief Executive Officer
Gary R. Larsen – Senior Vice President, Finance, and Chief Financial Officer
Colin Rush – Think Equity
Bill Ong – Merriman & Company
Joe Maxa – Dougherty & Company
Bryce Dyl [ph]
Walter Nasdeo – Ardour Captial
Good day Ladies and Gentlemen, and welcome to your Q3 2010 Power-One Earnings Conference Call. (Operator Instructions)
And now I’d like to introduce your host today, Kevin Trosian, Vice President of Investor Relations.
Good afternoon everyone, and thank you for joining us today to discuss Power-One’s 2010 Third Quarter Results. Joining me today are Richard Thompson, Chief Executive Officer, and Gary Larsen, Chief Financial Officer.
By now, you should have received a copy of today’s press release. If not, it is available on the company’s website at www.power-one.com.
Before we begin, I would like to remind you that this conference call may contain forward-looking statements reflecting Power-One’s use of future events, projections, or expectations. Any such forward-looking statements may deal with or include matters which involve risks and uncertainties. Power-One’s actual results may differ materially from those results as discussed, or information provided in the forward-looking statements. We refer you to the company’s reporting documents as filed with the SEC for a discussion of the risk factors that may have a material impact on results. Today’s call may also contain historical non-GAAP financial measures.
Additionally, in adherence with Regulation FD, we have opened up this call so that all interested investors are free to listen in. The press release in this conference call will be our only forum to answer questions regarding our estimated performance going forward.
Consequently, should you have any questions regarding our estimates of sales and profits, or other financial matters for the upcoming quarter, as well as how they may affect our income statement models and balance sheet, this is the time that we are able to respond to these questions.
I will now turn the call over to Richard Thompson, the company’s Chief Executive Officer. Please go ahead, Rich.
Thank you Kevin. I will begin today’s call with an overview of Power-One’s third quarter performance, provide some metrics and insight into our SBU’s, and discuss how the company is positioned to continue taking global market share while driving increasing cash flow.
After my remarks, Gary Larsen, our Chief Financial Officer, will provide greater detail on the financial statements, including results for the quarter and guidance. We will then answer your questions.
Let me begin by highlighting a few of our key accomplishments this quarter. First, we achieved record profitability posting over $100 million in EBITDA, and $63 million in net income, and $0.40 in earnings per share.
Second, we moved into second place for global and invertor market share as measured by IMS up from ninth place in 2008. These gains were driven by our product yield, technology, reliability, and customer service. For the quarter, we shipped 867 megawatts of inverters. And 1.7 gigawatts year-to-date.
Third, the Power Solutions SBU is near breakeven as we continue to improve our supply chain, and rationalize cost.
And fourth, consistent with goals discussed in prior calls, we launched facilities in the United States and Canada as we’re expanding our geographic footprint. Combined with our China facilities, these locations will provide up to 2 gigawatts of capacity in 2011 for Power-One.
In the third quarter, we executed a number of strategic goals that position the company for the long term profitable growth. These include our acquisition of the assets of Fat Spaniel technology, the launch of our U.S. invertor products, the opening of our facilities in Arizona and Canada, and the continued build out of our service footprint. In particular, the Fat Spaniel acquisition and the growth of our service business enhance our product offerings as we increase the value of the invertor and Power-One to our end customers. Our strategy is simply to create more value add to our customers from the panel to grid connection, and to reduce their total cost of ownership.
First, let me begin by highlighting the value that Fat Spaniel brings to Power-One and our customers. By integrating Fat Spaniel software with our products, we are providing our customers with another tool to drive improved yield permanently renewable energy assets.
Further, our customers, who include utilities, EPC’s, PPA’s, and large commercial owners, view the invertor as a value added and critical component in the solar array. The technology we purchased increases the control the invertor provides while at the same time adding improved communication and management features.
Not only does the Fat Spaniel software gather data and provide alerts to the user, it also offers predictive capabilities, monitoring, security, compliance, and other features that dovetail nicely with our enhanced service offering, which I will describe in a moment.
Second, as many of you at Solar Power International Show in Los Angeles saw, we launched our string and central invertors for the North American markets. We view the U.S. and the Canadian markets as critical to our geographic expansion, which is why we’ve already begun manufacturing in Canada, and will roll our first products off the Arizona lines this quarter. We believe our products, proven successful overseas, will enhance and will enable us to effectively penetrate the market in our own back yard.
Third, we launched our service offerings for renewable energy solutions. We now offer tiered services, extended warranties, performance guarantees, software communication integration, and support for our invertor products. We are using a highbred strategy of internal personnel and outside contractors to provide the reach necessary to meet our customer’s needs. We established three geographic centers with multiple sub-regional testing and technical teams. Based on our experience, we believe providing customers with higher levels of service provides a significant differentiator to our competition, while at the same time offering new revenue opportunities as we expand our customer touch points.
Now I’d like to provide SBU highlights including the third quarter performance, and future tactical issues, and strategic initiatives.
Our renewable energy solutions SBU continues to record impressive results. In the third quarter, we shipped 867 megawatts of invertors, more than doubling our output through the first half of 2010. Our market share gains have been led by a quality and design of our invertors, which provide greater energy harvesting, in turn leading to higher yields and lower total cost of ownership for our customers.
Looking at the solar market as a whole, we have visibility into and see strong demand for 2011. However, as we mentioned on prior calls, we anticipate that demand in Asia and North America will grow, while Europe as a whole will be flat to modestly lower.
Additionally, we expect increased competition as industry capacity ramps, and the supply chain loosens. While we chose not to raise prices to our customers during the invertor supply demand imbalance, some of our competition did. We believe this will affect pricing, and as a result, their profitability, but to a greater extent for those companies that chose to raise their prices during the invertor shortages.
In 2010 so far, we have not exhibited appreciable signs of price erosion. We believe the invertor industry as a whole could see average pricing decreases of up to 8% to 10% in 2011. That said, we believe we are well prepared to manage multiple industry scenarios as we have introduced lower-cost products for many regions. And are bringing new designs to the market with even better cost points, while at the same time, adding more features and services to protect our ASP’s.
As with last quarter, some invertor components remain tight. However, we are making investments to bring rate times back to more normal levels. Our goal is to bring rate times to two to four weeks for string invertors, and six weeks for large central invertors over the next few quarters. As such, we believe the market will move back to its norm of being a turns business with shorter lead times. To meet the shorter lead times, we must invest wisely to increase capacity, including adding factories, lines, and inventory. While this is not a CapEx intensive business, as a technology, quality, and wide range of product offerings differentiate us from our competitors, reducing lead times is important to our customers as they typically do not expect to hold inventory.
At the end of 2011, we anticipate having approximately six gigawatts of annual capacity. This includes the launch of our Chinese facility, which will begin production in January.
Also I’d like to point out that we plan to run our factories at 85% of practical capacity providing us the flexibility to meet the ebbs and flows of customer demand. This means we can manage our capacity down while having a negligible effect on margins as our efficiency will increase while absorption decreases.
In order to continue our share gains, we are investing in our go-to-market strategy. This includes hiring more engineers, adding to sales and marketing, expanding capacity in Asia and North America, and launching our service offering as I mentioned earlier. With our go-to-market initiatives including our new marketing campaign and website, we believe we will bring margins more in line with our target operating model. We anticipate these effects will be seen as a new facilitates and teams ramp up in the next few quarters.
Turning to product introductions, we launched our National Electrical Manufacturer’s Association or NEMA 3R U.S. compliant 200 kilowatt and 300 kilowatt outdoor central invertors, as well as our isolated U.S. string invertors, and tranformerless products, enabling us to work agnostically with any panel manufacturer via thin film or Crystalline.
Further, we are one of only two invertor companies to make the German BDEW standard for grid stabilization providing a significant differentiator for our products. We anticipate other regions will begin to place more stringent standards for connectivity to the grid in the future.
For those of you who attended FPI, you likely walked into our solar field vault, which houses 1.2 megawatts of inversion power. We designed this to meet the needs of our customers who are looking to increase power density, and to do more with less. The vault, which in the future will hold even greater power densities at a lower weight and size of the shelter, reduces installation, and other balance of system cost.
Further, the vault, our service offering, and Fat Spaniel acquisition are excellent examples of how we are providing value add to meet our customer’s needs. As with all our products, our goal is to reduce the total cost of ownership to our customers. This includes high power density, cost effective invertors that harvest more energy while producing industry leading reliability, and uptime over the life of the product.
This quarter, look for our 400 kilowatt isolated central invertors. And in the first quarter of 2011, watch for our 250 kilowatt and 500 kilowatt China-specific central invertors. We view the Chinese market as a great opportunity for us next year and beyond as well as other countries in the Asia Pacific region.
Throughout 2011, we will be introducing our fourth generation of products as well as our micro-invertors, and our 700 kilowatt, one megawatt, and 1.4 megawatt liquid cooled solar invertors.
Turning to the Power Solutions SBU, we are continuing to drive improving operating results. Shipment volume grew quarter over quarter as component shortages began to ease enabling us to better meet our customer demand. However, material cost and expediting charges offset some of the savings we realized with the closure of our Dominican Republic facility.
In the quarter, we continued the shifting of our European production to our Slovakian plant as well as the consolidation of our plants into a single factory in Shenzhen, China. Both moves are improving overall efficiency for the power SBU.
Further, in power, we continue to develop new and innovative products to expand revenue opportunities. In the quarter, we’ve launched our platinum technology AC to DC front end. And signed new license agreements for our digital power offerings. .
We anticipate modest revenue improvements in the fourth quarter as we continue to focus on customer satisfaction.
Further, we are aligning our spending with the market as we reduce costs and drive profit improvements in this business.
As we look to the future of Power-One as a whole, we are excited with the changes we made and the opportunities for operating improvement that lay before us. In one year, we are more than doubling our revenue from $432 million in 2009 to over $1 billion in 2010 based on our guidance. Our focus on technology, value add, and customer service has driven sales of our RE products will be a driving source for power as we bring this business to sustain profitability as well. We have been generating and expect to continue driving strong cash flow. We have a solid capital structure to support investments in both businesses, and will continue to grow the business as we add to the bottom line for our shareholders.
I’d now like to turn the call over to Gary for a detailed discussion of Power-One’s financials.
Thank you, Rich. Before providing more detailed metrics, I would like to highlight a number of key accomplishments we achieved in the third quarter of 2010.
First, Power-One achieved profitability for the fourth straight quarter.
Second, gross margin increased over 400 basis points to 41.1%.
Third, operating income grew over 100% sequentially, and last, we continue to strengthen our balance sheet with cash increasing by $50 million in the quarter.
Now I’d like to provide deeper insight into the details that drove our financial performance.
During the third quarter of 2010, we recorded revenue of $314 million, an increase of 46% from the second quarter of 2010 revenue of $215 million. Renewable energy products were the main driver of the sales increase growing 61% sequentially. The out-performance ahead of our prior guidance was driving by our ability to rapidly increase capacity, successfully manage our supply chain, and the availability of components for the power SBU, and the rising value of the Euro.
Net income attributable to common shareholders for the second quarter was $63 million, or $0.40 per diluted share compared to $24 million, or $0.17 per share for the second quarter of 2010.
We posted operating profit of $101 million, or a 32% operating margin.
Gross margin for the third quarter improved to 41% compared to 37% last quarter. Better product mix, factory efficiencies, and increased volume all contributed to the improvement. While we saw efficiencies from the closure of the Dominican Republic facility, expedited freight and delivery charges partially offset these gains.
As we have previously mentioned, we anticipate that as we add capacity, including manufacturing in North America and Asia, RE gross margins will reach more sustainable levels, which will be partially offset by improved operating metrics and Power Solutions.
Operating expenses were $29 million for the quarter, decreasing as a percentage of revenue to 9% of sales as compared to 14% in the second quarter to 2010, or $30 million. The reason for the decrease was due to a reduction in restructuring costs from the second quarter. Excluding restructuring costs, we spent approximately 2 million more in OpEx.
We anticipate increased sales in marketing and R&D expenses going forward as we invest to accelerate market share gain.
Full time head count increased by 330 employees to 3,284 from 2,954 last quarter as we invest in capacity and operations. I will note that our head count is well below the peak to 4,900 full time employees when we began cost reduction activities in 2008.
During the SBU’s in the third quarter, RE solutions posted $228 million in revenue, and $106 million in operating income. Operating margin was strong due to a reduction in material costs, and higher cost absorption due to increase in factory utilization.
As we add manufacturing capacity in the U.S. and China, and as we add to our service go-to-market and engineering footprints, gross and operating margins are expected to return to more sustainable levels. These investments are instrumental for the long term growth of the company, and to insure we are meeting customer demand with shorter lead times, gaining worldwide market share, and providing market leading products, sales, and service.
Core areas of strength for RE solutions included Italy and Germany with Australia, and the Middle East highlighting new regions of growth. Europe accounted for 94% of RE revenue with Asia representing 5% and North America 1%. With the launch of our new products, we anticipate our geographical mix will shift in 2011 to include a greater percentage from Asia and North America.
For the RE SBU, distributed accounted for 59% of sales, EPC’s 34%, and OEM’s 6%.
Turning to Power Solutions, revenue was $86 million in the third quarter versus $72 million in the second quarter. Revenue grew as component shortages began to evade. Power Solutions posted an operating loss just below break-even at $100,000, which included higher legal related costs as well as freight and expediting costs associated with the component shortages.
As with last quarter, revenue was split evenly across all three geographies for the Power SUB. OEM’s comprised 80% of revenue while distributors contributed 20%.
In addition to the operating expenses incurred by the RE and Power SBU’s, corporate and other operating expenses were $5.7 million.
Interest expense of $1.2 million included interest in amortization of related costs from convertible debt outstanding.
Other expense, $3 million primarily reflect unrealized foreign exchange losses related to the strengthening of the Euro.
We recorded approximately $900,000 related to the accretion and dividends of the preferred stock issued to Silver Lakes Sumeru.
The third quarter affected tax rate was 34% down from 48% in the second quarter of 2010. The affected tax rate decline was driven by improved mix of profit and losses among our legal entities.
EPS this quarter was $0.40 per diluted share versus $0.17 in the second quarter of 2010. Due to increased net income levels, the two class method of computing earnings per share was used as Power-One’s capital structure includes preferred shares that participate in dividend equally with common shareholders according to a pre-determined formula. The diluted shares using the diluted EPS computation excludes the preferred shares in the total share count. And also excludes some net income the earnings allocated to the preferred shareholders. Therefore, diluted EPS under the two class method is comparable to diluted EPS using the if-converted method.
Moving to the balance sheet, our cash grew to $195 million from $145 million in the second quarter of 2010 due to profitability and strong working capital management. During the third quarter, cash generated from operating activities reached $68 million. DSO’s modestly increased to 60 days. And inventory turns reached 5.9 times. Consistent with our guidance last quarter, and given the growth in the business, we anticipate modest increases in DSO’s and inventory from current levels.
In the third quarter, we announced the call for redemption on the remaining $34 million notes outstanding on our 8% senior secured convertible notes. All these notes were converted into approximately 17 million shares.
Toward the end of the quarter, we also announced the share repurchase for 10 million shares over a two year period. We successfully repurchased 2.5 million shares, or nearly 3% of our float at an average price of $9.19. We completed this in a very short period as we only had three days to execute the transaction before our third quarter blackout window. We will continue to opportunistically repurchase shares and look at other ways of minimizing dilution in the company.
Finally, I would like to speak to you about our guidance for the next quarter, and our views in 2011.
As mentioned earlier, our customers are looking for shorter lead times, meaning invertor sales will move back to being a traditional turns business making the bookings number less relevant as an indication of our future growth. We believe the analysts and investors should focus on the drivers of our industry, which includes shorter lead times, product quality, invertor yields, and a low CapEx environment, and not apply metrics from other sectors that may not be relevant to the invertor industry.
In the fourth quarter of 2010, we anticipate revenues of $340 and $360 million. As in the prior quarter, we are no longer providing backlog estimates, nor will we now provide our bookings number. This is in line with the industry norm as none of our significant peers provide these formal metrics. Consistent with our peers and their guidance, we will provide our capacity plans for 2011 as well as our target utilization. We are expanding capacity to six gigawatts by end of 2011, and target running our factories at 85% of practical capacity. We believe this enables us to operate our business profitably, and increase tax flow as we have consistently done over the past year. We believe it is also important to note that our capacity is flexible as we can just our shifts and lines to meet demand while maintaining solid margins. Given these parameters, we believe we continue to gain invertor market share worldwide in 2011.
We’ll be happy now to take your questions. Kevin.
Thanks, Gary. Before we begin the Q&A session of today’s call, we’d like to ask analysts and investors to limit themselves to one question and one followup. If you have more questions, we ask that you proceed back into the queue to allow others to ask their questions.
Operator, will you please open the queue?
(Operator Instructions) Our first question on the phone comes from Colin Rush with Think Equity.
Colin Rush – Think Equity
Good afternoon, gentlemen. Can you give us an update on component supply availability pricing on those components, and then also talk about makeshift towards smaller or larger inverters for the – in the quarter and the – as you look at the guidance for the fourth quarter?
Sure Colin. As we mentioned in our prepared comments, the market is starting to abate a bit, and components, while there’s some that are still difficult or tight, most of the capacity has been loosened and we’re able to find components rather easily in renewable energy. We still have issues with some large capacitors and [inaudible] cores, but we’ve been able to secure supply that matches our product needs.
Pricing has started to abate, as you know, during the bubble prices increased dramatically as you tried to get guarantee supply for your factories, but we’ve seen those level off a bit. And we would expect next year to be a rather good environment and we would expect component costs down year over year.
As to our capacity, string and inverters together are still our largest shipments in the 10 to 12 ½ kilowatt range. But we are seeing a move as we change our geographic location to more central inverters. As we look into 2011, we would expect to ship more central inverters in the U.S. and into China.
Colin Rush – Think Equity
And can you give us an update on your technology roadmap, the products that you’re expecting to build and introduce next year? Can you talk about the development of DC-DC optimizers and microinverters, you know, and the transformer list converter that you announced. Just how soon exactly are you going to have those products on the market and what events that you see right now on the sales front.
Okay, great. We already are manufacturing the transformer list products and they’re available for shipment now, and we are shipping them.
Looking in as we said in our comments, it’s key to us to get to market our 250 kilowatt and 500 kilowatt central inverters for the Chinese market. Those will be manufactured in our plant in Chengdu. We expect the first production to roll of at the end of this year, first of next year. So that’s great advantage.
And then of course, we’re already taking orders and it’s a very robust market in China. Looking at our other products, throughout the year we will introduce our liquid-cooled central inverters, 700 kilowatts, 1 megawatt, 1.4 megawatts. The advantage to those units is it allows our customers, particularly in solar-ray vaults to get more inversion power at a lower cost of ownership. So we’re really pleased with those inverters.
We also expect to be launching other products throughout the year. I won’t go too much into our roadmap for competitive reasons, but we feel very comfortable that we’re on the right track. Looking at micro inverters, we are on track to start shipping micro inverters mid-year. We watch that program very carefully. It takes quite a bit of engineering capabilities to achieve our program dates, but we are certainly on target.
If you look at digital optimizer, it’s a technology that we’re certainly exploring. I would suggest that we’re beyond exploring it, but I won’t share much more than that.
Colin Rush – Think Equity
And the one final question for me, can you talk about the potential costs on next-generation designs, and how you would except to be able to pull out the cost of these designs relative to any sort of pricing movement that you’re expecting over the next 12 to 24 months?
Okay. I won’t get specifically into those because that this competitive, as you can appreciate, Colin, but we’ve got some pretty aggressive control targets as we enter Asian markets. Their price points are much lower for center inverters, which we know to be around $0.20 per watt in the Western world. We expect China to be as much as 25% lower than that.
Our products and the cost structure of those products will allow us to still be able to achieve very – very good margins similar to our profile today. So we feel that our engineers have the right price points, we’re designing products, we’re able to achieve them, certainly in the lab. And as we go through the new product introduction and prototyping, we expect this to prove out well for us.
So we’re depending on better design functions that only are needed in the market. We’re not going to overdesign a product, and we expect with our scale growing that we’re going to get actually better pricing due to those economies with our suppliers.
Colin Rush – Think Equity
Thanks a lot. Congratulations.
Thank you very much.
Our next question comes from Bill Ong.
Bill Ong – Merriman & Company
Yes. Good afternoon, gentlemen. Congratulations, another solid quarter.
Thank you, Bill.
Bill Ong – Merriman & Company
I have two questions. On is modeling and the follow up. So modeling, is our 40% type of gross margins sustainable going forward? And what type of tax rate should I look at going forward as well?
Yeah. This is Gary. We don’t provide margin guidance going forward, but just to kind of hit on some of the points that I believe Rich and I both had in our prepared statements, you know, we have benefited substantially this year from being able to run our factories at a very high utilization level.
Going forward, we’ve made the strategic decision to add manufacturing in the U.S. and then China for the RE business. As those costs come on, you know, we do expect, you know, those additional costs and say a lower level of factor utilization to impact our margins.
We’re also adding to our service footprint, at additional services, that will be incremental costs going on the cost of sales line.
So looking forward, you know, we still expect healthy margins, but they will be impacted by these investments that we’re making.
Referring to your second part, the ETR, year to date our effective tax rate is 42%, so that didn’t come down. It is a reflection of where we make our income. And in particular, in some locations where we are running at a taxable loss, you know, we don’t get a tax benefit in those locations and that’s what negatively impacts our ETR going forward.
So looking forward, I mean, we are evaluating our tax structure to see if there’s a potential planning action we can take to maybe help reduce that tax rate, and that’s something that we will be looking at.
Bill Ong – Merriman & Company
Okay. And then my next question would be, can you talk about your competitive landscaping in different regions? On one level, your entry to Italy and other european markets were relatively easy as you entered a few years back. Now that you’re competing in the U.S. market with [inaudible], SMA America, a lot more competitive. Maybe talk about some of your differentiated position where you gain share in the U.S. as well as in China.
Okay, great Bill. This is Rich. Let me talk a bit first. As you look at the European landscape, remember our competition is the fiercest in the industry. SMA, K-Co, others. As we go into the U.S., some of the competitors you name are quite a bit smaller, have less resources, not the breadth of product that we have.
We’ve been very successful in Europe, as you know. We’ve taken a lot of market share over the past two years and we’re pleased to find that our customers who value our products and service are also coming into the U.S. market and into the Asia market. So these include EPC and distributors that we have very long relationships with relatively speaking as this is a young industry.
So we believe that our products, our success in Europe, our branding processes and worth of our products will be able to take share in the U.S. We’ve already – we’ve got a sales force on the ground. They’ve been learning the market, learning all the touch points ni the market, and we expect to do well in the U.S. and we’ll do well in China also. In China, if you recall, we do have a manufacturing facility. We’ve been in the China Region over 20 years and we already have a reputation and a brand there. And we have a number of sales resources that are familiar with the area as well as a very strong supply chain in China for both renewable energy and for power conversion.
So we believe we’ll be successful in these markets. We understand that there is competition. They do have market share already, all be it a very small market. We think we’re in a great position as the U.S. market starts to take off.
Bill Ong – Merriman & Company
That’s helpful. Nice job, gentlemen.
Our next question comes from Jessie Hitchel.
Hi. Good evening. Congratulations on a great quarter and guidance. Sorry I was late for the call. Could you help me quantify how much of your business is now the central invertor business and can you talk about some of the traction that you’ve seen with some of your new products in that area?
Sure. Jessie, we haven’t in the past disclosed the percentage from central versus string. You know, traditionally that’s something we consider very proprietary, as you can appreciate, especially as we enter new geographies. But the markets we’re entering on are central markets, so you can imagine we’re spending a fair share of our engineering dollars and a fair share of our service dollars to be ready to cope with what we think will be a very large and growing revenue stream from central invertors.
Can you share with us some of your strategy there for penetrating the U.S. market?
Sure. In the U.S. market, we have been very careful with our go-to-market. We’ve launched a new website, we brought the product to the SPI Show, we’ve had sales resources calling on a multi-tiered sales channel. As you can appreciate in the U.S., you have to deal with PPAs, in some cases large utilities, certainly EPCs. So you have to sell at a number of different levels. It takes a very highly-capable and professional sales person and all of our sales people we have, we have close to a dozen resources now in the U.S. are all from the industry.
Additionally as I mentioned earlier answer Bill Ong’s question, a lot of our customers from Europe are also investing in the U.S. and those relationships are going to help us be successful as well.
Increasingly for the central inventors, we’re seeing the banks become a little bit more involved in some of the decisions and you know, is the invertor bankable. Give that the your 330 is just, you know, the invertor of choice, you know, in Souther Europe, you know, is that bank relationship at all to play in the U.S., or not yet?
Yes, it will be. Actually, we’ll have our bank ability studies published this quarter. We’re in the process of doing it. We have a number of successful PPAs as well who aren’t banks, but private investors who have used our products in Europe and now into the U.S. So we’re looking forward to extending those relationships. And as I mentioned, those are some of the new relationships we’re creating in the U.S. as well.
We understand that each solar ray is going to be a more high-capital touch point than perhaps our traditional business was, and we understand that these are long-term relationships we have to develop now.
Great. Well, congratulations, gains.
Our next question comes from Steve Sanders.
Hey, good afternoon, everyone. Great quarter.
Thank you, Steve.
Just to start, Rich, maybe from an industry perspective, I want to see if you could talk a little bit about which countries in Europe look like they’re still good growth opportunities next year versus maybe the ones like Germany that potentially have some challenges?
Okay. Well, those are all tied really to the feed-in-tariffs are much publicized. We’ll have to wait until the second half to see what happens in Germany, but as ROIs are down because of their feed-in-tariff reductions, we still think it’s going to be a relatively stable market.
We believe that because the panel cost is stabilized as well. So you know, we think German will certainly be an important market for anybody in the world; Italy is still a growing market; more difficulties in France. As we look, we also have created relationships in Northern African and the Middle East. So these are new relationships, we’ll talk more about it in the next few quarters.
So we see Europe to be flat to down next year. We think it’s going to be a tale of two cities, we’ll see what happens in half one. We’re expecting around a robust half one based on our total view of te industry, and then we’ll see where we’re going in half two.
We will expand geographically, as you know Steve, into the U.S. and into Asia, which will relatively be new revenue streams for us.
Okay. And you make the comment that you expect industry pricing to be down 8 to 10%, but also that you’re starting from a lower base maybe than some of your competitors. Is it fair to say if industry pricing is down 8 to 10%, the impact on you will be less?
Yeah, that’s what we were trying to allude to. During this demand bubble, we made a very conscious decision, we spent a lot of time analyzing and we decided not to raise prices. Many of our competitors have raised prices. So as you know, when we entered into Europe, we priced, or targeted our prices about 3% below the market and that’s where they stayed. So if other competitors want to come down to 3%, they’re going to have to take it at the expense of their P&L. If they want to go further than that, we feel that our industry-leading profitability gives us much more flexibility than competition to address price.
Having said that, and to add to Gary’s comments that while we think there’ll be some excess capacity, there’ll be some pricing adjustments, we’re already working on the next generation of products that has lower cost points. So we’re – we feel pretty confident that we’re going to be able to deliver and continue to deliver the best P&L in the industry.
Okay. And then I know it’s early, but can you talk a little bit about the integration of Fat Spaniel into your product line, and then maybe talk a little bit more about the kind of reception you’re getting on your initiatives in North America. You know, not so much with the companies that you’re already doing business with, but with some of the newer players and that you’re going to have to develop relationships with, do they seem receptive to your products and your position? How would you characterize that?
Okay, great. Let me talk to first, to Fat Spaniel. One of the importance of the Fat Spaniel acquisition is we had join us, let’s say 15 to 20 excellent designer engineers. We were very fortunate that they shared the vision we have as the importance of their software in the industry and we’re glad that they joined the company. We’re now talking to our various customers base, we’re talking to EPCs, we’re talking to PPAs, we’re talking to the owners and in that process we will enhance the software.
Again, we had a data logger, No. 4 Fat Spaniel, now their product help us enhance the gathering of data and providing alerts to users. We’re also – we’ll be able to add the predictive capabilities as I mentioned, monitoring, security, compliance, and other features. These additional features in the value add we bring to our product line will also protect our ASPs over time. So we’re certainly pleased with Fat Spaniel. We’ve been very, very excited with their enthusiasm for Power 1 and for helping us bring this product to even more capabilities for our customers.
Talking a bit about our entry into North America, our products as you may recall, Steve, were industry-leading products. We offer some of the best reliability, the best efficiency and a very, very good total cost of ownership proposition for our customers. That’s been resonating very well with our customers and we are already taking orders both from established customers and new customers.
Likewise, if you look at some of the very large solar array fields, these are very large projects. They’re funded by a large utility. I won’t share the names with you, that’s proprietary with you, but we are making end roads into large solar fields and we feel very pleased with our progress so far.
Okay, great. Thank you very much.
(Operator instructions) Our next question comes from Joe Maxa.
Joe Maxa – Dougherty & Company
Thank you. I just wanted to talk a little bit about the, you know, bookings. I know you decided not to give bookings and backlog, but I think the typical [inaudible] we should think about for modeling purposes is that 0.9 to 1.1. I think that’s what you talked about last quarter. Please, just some commentary on that and the plus, maybe help us with what you would expect to be typical seasonality as we move through the year.
Okay, Joe. A couple difficult questions, but let me see if I can field them. Basically, as we look at our business we shared that most of the ther competitors are a billion-plus dollar range. We shared with you our capacity and we’ve shared with all of the investors what our utilization is. We believe with those numbers, one can quickly see that we delivered 867 megawatts in Q4 and a revenue guidance we gave you probably indicates around a gigawatt in Q4.
So based on that, we’ll exit the year about 4 gigawatts. We’ll add another 2 gigawatts through the year and we expect to be at 85% practical.
Now, why do we keep harping on the practical capacity? For us, it’s a gain-share strategy, we’ve used it successfully for two years. It allows us to have product on – in very short notice. As a matter of fact, off the shelf for our customers. And we’re going to continue do that in all geographies, not just Europe. So I think as you look at our capacity as we added, one could say linearly from 4 gigs to 6 gigs throughout the year. I think you can model what our expectations are.
And to seasonality, generally the first quarter is a seasonal quarter in this business. I won’t give you guidance. I don’t know if we’ll see that pattern in 2011, but we would expect to have some seasonality, don’t know if it’s going to be modest or more like in the 10% down range that we’ve seen in past years.
Throughout the rest of the year, you usually see a recovering Q2 and 3, and it now is more at the result of feed-in-tariffs and what will happen in each country where we’re doing business with. And you know, the threat of [inaudible] reductions always sees a rush to add capacity and we don’t think that will change until we’re at Parody with the grid.
Joe Maxa – Dougherty & Company
Very good. Thank you. That’s helpful.
Our next question comes from Bryce Dyl.
Bryce Dyl [ph]
You know, you covered my question mostly with your last answer, but you know, if you could walk through again sort of the strategy in the acquisition of Fat Spaniel and then potentially since you’re generating a significant amount of cash flow and have a lot of cash on the balance sheet, do you have further acquisition kind of built into expectations going forward at this point?
Okay, great. I’d be glad to answer that Bryce. Again on Fat Spaniel, it’s very – a very strong product line that we acquired. The issues that one might have heard of Fat Spaniel before was some quality and customer service issues. We’re investing that those don’t repeat themselves. So we’re confident that the management of that software function will be able to overcome let’s say past deficiencies very easily. We will also be adding software engineers as required. We want to get this product recharacterized into Power-One branding and we will add these other features we mentioned. We’re in the process now of going to markets, speaking to customers and understanding the features sets they really want in a software management system. And we believe we’ll be able to bring those in very quickly to the market. We would expect a roll out of significant new product in about six months.
The importance of this product line to us besides adding more value for the panel to the grid is that we believe these features will actually pull more invertors through our revenue stream, that the added features that the Fat Spaniel offers to our customers will certainly enhance our sale of invertors. So we’re quite pleased with that.
Our next question comes from Eric Stein.
Thanks for taking the questions. Congrats on the quarter.
Sorry if I missed this, but just on the renewable energy side, can you talk about the utilization level in this quarter, how we should think about that versus lower component cost? I know over time, 80 to 85% utilization is the target, but that would be helpful to frame, you know, how long it takes to normalize on the margin line.
Okay, great. We actually added capacity throughout this quarter. That enables us to meet more of our customer’s expectation. Our factory in Italy particularly did a wonderful job of adding capacity and the supply change in Europe, likewise performed well to meet customer expectations. And in some cases to actually better their expectations.
So we, I mention that because we were close to full utilization of that factory, but remember, we were adding capacity throughout the quarter. As we go forward, we would expect because there are brand new factories in both Asia and North America, we would expect modest ramp up costs in the quarter before they start manufacturing or hit production rates. So we’ve been alluding to that last quarter. We actually had some ramp-up costs in this quarter, particularly for the Phoenix site and we’ll have ramp up costs for both sites next quarter.
As you saw, we were able to absorb those costs this quarter with a higher volume. We’ll have to see where it takes us in that current quarter.
So normally that’s the practice, you’re at capacity, as you bring in a management staff and train people, you have ramp-up costs. Additional capacity added to those two sites in the future though will not have a significant ramp up cost. It will just be adding in in capacity, adding in [inaudible] SMT capacity and assembly capacity without having to put in the roof in the back end.
So we’re pleased with how our team’s managing the P&L, managing our factory costs and we believe that 85% of practical has been a historic target of ours and we proved that in 2009 it was a very good target in that we were able to optimize our P&L and take advantages of the marketplace by having shorter delivery times than the rest of the industry.
So you’ll see us do that again. We’re going to have very short delivery times. We’ve talked about it a bit, we’re planning to get our lead times down on our string invertors to 2-to-4 weeks, that’s a global target and you’ll see availability of central invertors in about six weeks. We’ll achieve those early in the first half of the year and that’s certainly going to be advantage to us and to our customers. It allows our customers to basically place orders on a short leash, not mess up their balance sheet if you like. We’re glad to provide that working capital and on the other side of the coin we asked for more reasonable terms on DSO.
So I think it’s a good combination for both of us.
Okay, that’s helpful. Just one last question. I saw that your largest competitors opened an office in India. I’m just curious about that market, if you have any plans there and how you view that overall market potential?
Well, we see India as an important country in Asia. Let me say we’ve already had invertors on the ground with customers in India. We’re establishing relationships not only for solar, but for wind as well. So we think India is certainly an area you can’t ignore. It’s a challenging environment to be in. You’re going to have to have some value add locally and we have to figure out the best way for us to do that. And in the long term though, you’re going to have to – you’re going to have to be in the India market to continue to gain share globally. So we’re putting our toe in the water if you like. We’ve done it throughout 2010 and we’ll see where it takes us into 2011.
But in the near term, we are going to focus on China. Let’s not mistake that. We are going to continue our build out and we’re adding more sales force coverage. We’ll have a worldclass factory to show – to build our products in and to share with our customers. So China first, we’re still exploring India though. We do have resources there. We haven’t physically opened an office, but we do have some inverters that are being tested by large EPCs in India now.
Okay. Thank you very much.
Our next question comes from Walter Nasdeo – Ardour Capital
Walter Nasdeo – Ardour Captial
Thank you very much. Good afternoon, guys.
Walter, how you doing?
Walter Nasdeo – Ardour Captial
As you can imagine, almost all my questions have been answered. My – what I was curious about was how the development for the wind invertors are coming in? I know we’re all focused on solar right now, that’s probably where most of the effort is going, but can you just give me a little update on how that’s going and what your plan is for the next few quarters in that area?
Okay, great. It’s going to be more than a few quarters. We do have a 2 ½ megawatt invertor. We working with a number of turbine manufacturers. We use a permanent magnet design. This is the next – the best technology we believe. The relationship takes a long time. We have to partner with them. We have to develop an invertor that matches their turbine and they have to go have at least six month field data to feel like this is a good match for them.
So those are in process with more than one turbine manufacturer. So we – this is an important market. The technology that we have created, the liquid cooled technology is excellent for that market and it’s had some side benefits. We’ve had some byproducts in our designs to solar, we’ve taken the same – the same design as the 2 ½ megawatt, we’ve actually enhanced it and been able to create the 700 kilowatt, 1 megawatt, 1.4 megawatt design.
These units also are scalable, which has not been seen in the industry. We have found methodologies to actually warm swap modules in a liquid-cooled environment, which is going to be a great addition to our product line and a great competitive advantage.
Walter Nasdeo – Ardour Captial
Interesting. Thank you very much. I appreciate it.
Our next question comes from Carter Driscoll.
Hi. Good afternoon, gentlemen. Given the fact that such an overwhelming percentage of sales is still geared to Europe, I was hoping you could elaborate on the, you know, your defensibility of their marketplace given what looks to be modest growth, year over year. And then talk about it from a price context, obviously you did not raise prices and that was a bit of an advantage, versus your certification receive in Germany and your expectations for how other countries may use that as a potential barrier to entry. Maybe you can just qualify how you’re going to – for your European sales.
Okay, great. Germany, the BDEW certification is very important. Another one of the large competitors have [inaudible]. The competitors at the lowest don’t. We believe that the certification, while it is required if you’re going to sell above a certain amount – above 1 megawatt in Germany, and we think other countries to increase the ability as the solar power enters the grid, we think other countries will be establishing similar requirements.
So being on the leading edge of this is going to be important to us in those largest sales. As we look through the rest of Europe, we have a very strong position in Italy. As I said, we’re pleased with the direction of France although the feed-in-tariffs are going to make it a slower growth market next year in 2011.
So we’ll – we believe we’re going to have a strong first half in Europe and we’ll have maybe enough end roads into U.S. and to China that if there happens to be a slowdown, or a flattening in Europe, we’ll be able to offset and continue to grow.
You mentioned a bit again about the pricing environment, we’ve done well in this pricing environment. We’ve been able to create best-in-class profitability and not have to have the highest price. So I think when one is entering a market where other competitors are threatening cost actions, it’s always best to be in the strongest P&L position, which Power-One is.
So we’ll be glad to talk through with our customers, their needs on pricing and we’ll certainly be meeting the competition, but we’ll be meeting them from a stronger P&L. So we believe we’re in great shape. Our products are in good shape, they offer distinct advantages on, again, efficiency, reliability, etcetera. And we’re not going to have to undercut price to continue to take share.
At this time, I would now like to turn the conference back to our host, Mr. Rich Thompson.
Great. Thank you all for joining us today. This was a very pleasing quarter. I want to thank the men and women of Apollo 1 for the hard work they’ve done in servicing their customer and creating a category-leading business.
We look forward to our discussion at the end of Q4. We’ve given you very solid guidance that we believe in and hopefully we’ll be able to share with you very similar results when we talk next.
So thank you very much for your interest.
Ladies and Gentlemen, thank you for your participation in today’s conference. This concludes the program, you may now disconnect.
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