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Power-One (NASDAQ:PWER)

Q3 2012 Earnings Call

October 25, 2012 5:00 pm ET

Executives

Larry Clark

Richard J. Thompson - Chief Executive Officer, President and Director

Gary R. Larsen - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance, and Treasurer

Analysts

Amir Rozwadowski - Barclays Capital, Research Division

Shawn E. Lockman - Piper Jaffray Companies, Research Division

Wes Anderson - Stephens Inc., Research Division

Kelly A. Dougherty - Macquarie Research

Pavel Molchanov - Raymond James & Associates, Inc., Research Division

Carter W. Driscoll - Capstone Investments, Research Division

Mark W. Bachman - Avian Securities, LLC, Research Division

Joseph A. Maxa - Dougherty & Company LLC, Research Division

Edwin Mok - Needham & Company, LLC, Research Division

Operator

Good day, everyone, and welcome to the Power-One Inc. Third Quarter 2012 Earnings Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Mr. Larry Clark, Investor Relations for Power-One. Mr. Clark, please go ahead, sir.

Larry Clark

Good afternoon, everyone. Thank you for joining us today to discuss Power-One's 2012 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. In addition, this quarter, we are including an accompanying slide presentation that you can refer to during the call. You can access these slides in the Investor Relations section of the website.

Before we begin, I would like to remind you that this conference call may contain forward-looking statements reflecting Power-One's views 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 and 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, Power-One's Chief Executive Officer. Please go ahead, Rich.

Richard J. Thompson

Thank you, Larry. Good afternoon. I'll begin today's call with a recap of our third quarter performance, including a review of some of our key operational highlights. I will then spend time providing our current outlook for the global PV market and our approach to its changing dynamics. After my remarks, Gary Larsen, our Chief Financial Officer, will discuss the key operating metrics and drivers for our Renewable Energy and Power Solutions business units and provide greater detail on the financial statements, including the results for the quarter and fourth quarter guidance. After our prepared remarks, we will answer your questions.

In the third quarter, we recorded total revenue of $284 million, up 16% year-over-year. Our Renewable Energy business delivered continued strong performance by shipping 1.0 gigawatts of inverters in the first quarter as we benefited from higher demand in Europe and growth in residential and commercial installations in North America and Asia Pacific.

Our Renewable Energy business generated $216 million, or 76% of total revenues, and our Power Solutions segment revenue was $67 million or 24% of the total.

The Power business continues to be impacted by ongoing global macroeconomic uncertainties, as revenues were flat sequentially and down 5% year-over-year. Despite the lower-than-planned sales, the Power team has steadily improved both EBITDA and working capital utilization.

On a consolidated basis, we generated strong operating income and cash flow in the quarter, which was a result of our focused efforts to increase operational efficiency and to improve -- and to introduce new products that improve our operating margins. Operating income was $43 million, up 27% year-over-year, and cash from operations was $32 million. Net income for the quarter was $21 million, or $0.13 per share. That includes an after-tax loss of $0.03 per share on foreign currency remeasurement.

First, I'd like to share some operational highlights for the third quarter. We maintained our solid #2 position in the global PV market. Based on preliminary figures from IHS, formerly known as IMS, we estimate that our worldwide market share was 13% in the third quarter, up from 11% for the full year of 2011. This was partially driven by our strong growth in North America and Asia Pacific. Specifically, in Australia, where we have increased our market share to greater than 20%.

Second, our commercial rooftop and residential products continued to gain traction. Our 3-phase TRIO line of string inverters that address commercial rooftop applications, and our single-phase inverters for residences are being well received in the marketplace. We shipped over 450 megawatts of these product lines during Q3 and 1,070 megawatts year-to-date.

Third, we experienced only modest price declines in the third quarter. The average revenue per watt increased in the quarter due to a shift towards lower wattage products in the commercial and residential segments. I will discuss near-term pricing a bit later in my remarks.

Fourth, we continued to improve our manufacturing performance in the U.S. Although our new management team in Phoenix has only been together for 3 months, they have made significant progress on a number of fronts. Our delivery times are improving, and we are experiencing better absorption and have improved both quality and costs on our existing production. This progress is leading to increased volumes and higher customer satisfaction in North America.

Finally, we introduced 10 new product offerings across both businesses in the past few weeks. These include our game-changing liquid-cooled Ultra line that addresses the utility scale market, our TRIO inverters that have been adapted for the U.S. commercial market, our single-phase UNO line and our micro-inverter [ph] that addresses the residential market. In addition, our Power Solutions unit released 2 versions of a new, high-power 3-phase bulk [ph] power product aimed at heavy industrial applications, such as laser tooling and semiconductor manufacturing. It has also introduced the MELCHER Brand HR-Series, which is the world's first DC-to-DC converter with an input voltage greater than 10:1. This product addresses the rugged environment application needed -- typically seen in the rail and transportation market, and it's the first power supply that covers all nominal battery voltages from 24 volts to 120 volts.

I would now like to spend some time discussing the global market outlook for photovoltaic. We recognize that the global PV demand is shifting from the more mature European markets to the growth markets of North America, Asia Pacific and Latin America. We are prioritizing our RE business to be a strong global competitor, with a full complement of product offerings and service capabilities in every key market around the world. To continue building our global expansion, we acknowledge that each key market has unique characteristics and many require a tailored go-to-market strategy. While it will take us longer to penetrate some markets than others, we plan to have a strong presence in all key global markets.

First, let me talk about Europe. As you know, the region has been very strong in the first 9 months of 2012, driven by demand in Germany and Italy and in anticipation of the changes in feed-in tariff. The demand has exceeded expectations, and we have benefited from this strength. However, inverter demand in EMEA, which is substantially made up of Europe, is expected to decline between 13% and 20% in 2013. While the declines in Germany and Italy are expected to be greater than the market decline, the rest of the region is expected to grow between 30% and 40% in 2013. This growth is being driven by a number of countries that still have favorable subsidy programs and others that have or are expected to reach grid parity, which is creating demand in unsubsidized product -- projects.

While total demand in Europe will decline in 2013, it is expected to rebound in 2014. We believe that the region will continue to be a key global market as the cost of conventional electricity remains high, as more countries reach grid parity and as political leaders continue to understand the economic and social benefits of pro-solar policies.

Let me spend a few minutes providing an update on the Italian market. Conto Energia V was recently enacted into law, and the new feed-in tariff became effective August 27. We estimate that there are approximately 2.6 gigawatts of projects for future installations, creating demand for inverters well into 2013. In addition, the program favors residential and small commercial projects, and there are indications that projects under 12 kilowatts, which currently have a faster track registration, may end up receiving more favorable treatment going forward.

Finally, southern Italy was the first European region to reach grid parity as high electricity rates and high irradiation yield attractive returns on investment. We estimate that the unsubsidized market for Italy will expand as we are already bidding on projects each in the 50 to 100-megawatt range. Our strategy for Italy and the entire European market for that matter is to build on our strong reputation and continue to gain market share, particularly as some of the smaller regional players struggle to survive.

In North America IHS expects the market to grow by over 40% in 2013, to in the range of 5 to 5.5 gigawatts. This growth is expected to be greatest in the commercial and utility segment, which is being driven by state renewable portfolio standards and the federal investment tax credit features [ph]. We are well positioned to benefit from this growth with our very compelling ULTRA product and our TRIO line, which has been adapted to the U.S. market. We recently were awarded our first commercial contract with a major EPC for ULTRA and are working on a number of other opportunities.

The residential market is also expected to show healthy growth rates, driven by lower system costs and the widespread availability of installation and project financing. We have had good success in this market over the last 2 years and are now the #2 provider of traditional residential inverters.

To give you an example, in California, which is our largest residential solar market in the U.S., we have over doubled our residential market share in the last year to 22% and currently hold the #2 position. We expect to build on our success in this segment of the market with our recently introduced new product offerings, including our upgraded UNO series and our new micro-inverters [ph].

Overall, in 2013, we expect North America to contribute a significant larger portion of our total RE segment revenues as we are targeting a combined market share of approximately 20% by the end of 2013.

Now turning to Asia Pacific, our greatest success in this region in 2012 has been in the Australian market, where we have experienced over 200% revenue growth year-to-date and now hold a greater than 20% market share. We have achieved this success in the residential and small to medium commercial rooftop markets and plan to continue to build upon our overall market leadership as the Australian market begins to open up to larger commercial and utility scale projects. We believe our ULTRA and our PLUS line of central inverters will sell well into this segment of the market.

Asia-Pacific market demand will be strong in 2013, primarily driven by China, India and Japan. It is expected that over 12 gigawatts of installations will occur in these 3 countries alone. We have plans in place to participate in each of these key markets.

First, China is primarily a large-scale commercial and utility market, with a large number of smaller domestic inverter suppliers competing on price. We will approach this market selectively by focusing on EPCs and utility companies that appreciate our value proposition and are looking to minimize our total LCOE, or the levelized cost of energy, over the life of the project. While this market is very price sensitive and highly competitive, we believe our product cost structure will allow us to achieve reasonable margins. Additionally, our strong balance sheet and product warranties will help us win business.

In India, we had great success in 2011 with almost 200 megawatts shipped. 2012 has been a challenging year for the market and for Power-One, as many areas in the country have been dealing with unstable grid conditions and bureaucratic delays in connecting systems to the grid. However, the prospects for the country are favorable, given a number of factors, including the high cost of electricity, the expected growth in electricity demand, the need for more reliable grid and off-grid distributed power and the country's high irradiation levels. These factors have caused the government to institute pro-solar policies, which should guide PV demand for years to come.

Japan, which is traditionally a residential rooftop market, is expected to experience strong growth in 2013 and beyond as a result of the government's efforts to kickstart large commercial and utility markets in order to diversify away from nuclear power. Very attractive feed-in tariffs have been put in place, and the market is already responding positively. The residential market is also expected to continue to grow, adding to the market's attractiveness.

Due to the Japanese market being a relationship market, we are in discussions with large technical and commercial partners. We hope to be able to enter the market in 2013 and to begin generating meaningful revenue in the second half of the year.

Now I'd like to touch upon the pricing dynamics that we're experiencing in the inverter market. In the third quarter, our pricing was modestly lower after an approximate drop of 7% in the first half of the year, which mostly occurred in the first quarter. We anticipate that the inverter price erosion in the fourth quarter will resume and we expect to exit 2012 at the pricing levels of 10% to 12% lower than we entered 2012. As we have said before, we plan to offset pricing declines with improved variable costs in material, better manufacturing efficiencies and the benefits of new products designed for lower cost.

Before I turn the call over to Gary, I want to spend a few moments discussing the outlook for our Power Solutions business. We've just recorded our 8th consecutive quarter of profitability as the management team has made significant progress in operational performance over the time period, including improvements in cost, quality, supply chain management and lead time.

However, achieving revenue growth in 2012 has been a challenge, reflecting cautious customer behavior due to ongoing global macroeconomic issues. We are optimistic about our ability to grow revenues going forward. We plan to increase market share in existing markets by leveraging our strength in power density, power efficiency and rugged packaging to serve the largest OEMs in these markets.

For example, we recently launched new products aimed towards ruggedized industrial and transportation applications. Additionally, we are continuing to develop products for customers in the medical and military sectors. We are also in the process of gaining new business in higher-margin and higher-growth adjacent markets such as power conversion application for hybrid electric vehicles and heavy duty trucks and buses, also in military vehicles, as well as hybrid power systems for off-grid or poor-grid [ph] environments, utilizing our higher efficiency rectifiers [ph] and controllers,integrating multiple power sources from PV, wind and diesel generators.

These markets and applications are well aligned with our strategy and capability and are leveraging our industry-leading technology platform. In the Service, Storage and Networking segment, high power density and high efficiency programs [ph], including our currently available Platinum and recently announced Titanium-level efficiency products, are also allowing us to make headway with the Tier 1 customers.

Lastly, market demand for digitally controlled DC-to-DC board mounted product offerings are starting to grow. And we have completed the development of our second-generation digitally controlled point of load devices. Additionally, we added 2 more semiconductor licensees during the period for our Digital Power Technology, bringing the total number of licensees to 15. We look forward to delivering revenue growth and increased profitability in our Power Solutions business in 2013.

I'd now like to turn the call back over to Gary for a detailed discussion on the performance in each of our SBUs, our consolidated financials and guidance for the fourth quarter of 2012.

Gary R. Larsen

Thank you, Rich. Now I'd like to provide more details on our third quarter financial performance. During the third quarter of 2012, we recorded revenue of $284 million, beating our guidance range of $260 million to $280 million. As Rich mentioned, this was driven by strength in the Renewable Energy SBU, and we experienced continued strong demand in Germany and Italy and growth in our residential and commercial installations in North America and Asia Pacific.

Consolidated gross margin for the third quarter was 29%, a slight decline from the 30% in the second quarter. Gross margin was positively impacted by lower material costs and improved manufacturing efficiencies in our Phoenix facility, which was offset by modestly lower pricing and lower European factory volumes than were achieved in our record second quarter. Ramp-up cost for new products, which are primarily recorded in cost of sales, also impacted our results by $2 million.

Operating expenses were up sequentially to $39 million for the quarter versus $38 million in the prior quarter. The sequential increase reflects higher expenses in sales and marketing in support of our active new product introductions in the quarter.

Income from operations in the third quarter was $43 million versus $60 million in the second quarter and $34 million in the third quarter of 2011. As compared to the third quarter of 2011, we benefited from the higher revenues and improved gross margins in the Renewable Energy SBU.

Net income attributable to common stockholders for the third quarter was $21 million or $0.13 per diluted share. This quarter's net income included a $6.3 million or approximately $0.03 per share after-tax loss on foreign exchange remeasurement related to the euro strengthening versus the dollar.

In addition, EBITDA was $42 million in the quarter, down from $77 million in the second quarter, primarily as the result of the lower volume and the $12 million FX gain in Q2 versus the $6 million FX loss in the current quarter.

Our Renewable Energy SBU posted $216 million in revenue for the third quarter versus $255 million in the second quarter and $174 million in the third quarter of 2011. Operating income was $47 million, resulting in an operating margin of 22%.

Our geographic revenue in the third quarter reflects the strong growth in Asia Pacific and North America, both sequentially and year-over-year, as we experienced increased demand for our residential and commercial products in those markets. EMEA represented 82% of RE revenue, with 43% of total revenue coming from Italy and 22% from Germany. Asia Pacific increased 7% sequentially to 11% of total RE revenue, and North America increased 2% to 7%.

Going forward we anticipate our geographic mix will include a greater percentage from Asia Pacific and North America as we further penetrate these markets and as demand in Europe declines.

Our end market penetration was primarily in the commercial segment, which represented 59% of megawatts shipped and was driven by the strong commercial rooftop segment in all of our markets and the success of our TRIO product line. Shipments to the residential sector were 28% of total megawatts shipped, and the utility sector represented the remaining 13%.

Turning to the Power Solutions SBU, revenue in the third quarter was $67 million, flat versus the second quarter of 2012 and down 5% from the third quarter 2011. As Rich mentioned, we continued to experience customer caution in a number of our key markets in light of the uncertain global macroeconomic environment. However, we continued to see strength in Industrial and Transportation segment, where our products are having success in the rail, medical and military sectors.

Revenue from the Servers, Storage and Networking end markets was 49% of the total Power Solutions segment revenue, while the Industrial market represented 43% and the Network Power Systems was the remaining 8%. Regarding the regional sales breakdown, Asia Pacific accounted for 40% of revenue; North America, 37%; and EMEA, 23%.

Power Solutions operating income for the quarter was $4 million, resulting in an operating margin of 6%, a significant improvement both sequentially and year-over-year as we benefited from improved operational efficiencies, lower material costs and a positive shift in our mix with higher margin products.

Turning to the other income expense line, this has been volatile for Power-One over the last few quarters as a result of foreign exchange gains and losses. From a balance sheet remeasurement standpoint, Power-One is short euro, meaning that we record FX gains and other income when the euro weakens and losses when the euro strengthens. This reflects our currency exposures, including cash and intercompany balances denominated in U.S. dollars on the books of our European subsidiaries, which use the euro as their functional currency.

In the third quarter, we recorded a $6.3 million pretax foreign exchange loss as the euro strengthened. Considering the revenue we generate in European markets and macro concerns on the euro, we believe the short euro exposures are prudent. However, it does mean that the changes to the euro can result in material gains and losses on the other income line until we reduce these exposures.

The third quarter effective tax rate was 42%, which increased sequentially from 35% in the second quarter. The higher effective tax rate was due to our inability to fully utilize our U.S. losses, as well as some one-time adjustments in Europe. We expect our ETR to remain in this range in the fourth quarter but to decline going forward to the low 30% range as our profitability improves outside of Europe.

Moving to the balance sheet, our cash and investments balance was $287 million ending the third quarter of 2012, an increase of $83 million since the beginning of the year. Cash generated from operating activities was $32 million, while capital expenditures were $9 million.

As we have said before, we view our strong cash position as a competitive advantage in the marketplace as it enhances our bankability in the renewable energy market and it provides our customers with the confidence that we will be able to stand behind our long-term product warranties.

Additionally, our Board of Directors has approved a new share repurchase plan of up to 15 million shares over the next 3 years. This replaces the prior share repurchase plan, which expired in September of this year. As in the prior plan, share repurchases will be made as appropriate, considering business conditions and our cash needs.

Looking at working capital, days sales outstanding were 80 days, an increase of 6 days from the second quarter level. DSO was unfavorably impacted in the second quarter by advanced payments by customers to secure product in response to the stronger demand environment. Inventory turns of 4.3x reflects the building of finished goods inventory levels that have been depleted in the second quarter.

To conclude, I would like to speak to you about our guidance for the fourth quarter of 2012. As demand in Germany and Italy is expected to decline, our forecast for the fourth quarter 2012 revenue is a range of $210 million to $230 million. From a geographical mix standpoint, we expect our RE business in North America to increase sequentially from the third quarter and to represent approximately 15% of total segment revenue.

In terms of gross margins, while we do not provide specific targets or models, we anticipate margins for the fourth quarter will be in the mid-20s range. This reflects the absorption impact of the lower volumes along with new product ramp-up costs and pricing reductions. Regarding operating expenses, we expect them to be roughly flat versus the third quarter.

Operator, we are now ready to poll for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first questioner in queue comes from the line of Amir Rozwadowski with Barclays.

Amir Rozwadowski - Barclays Capital, Research Division

In looking at sort of the expectations around sort of the declining demand in Europe and sort of your ramp-up expectations for developing markets such as the U.S., you mentioned that, I believe, the European market is expected to decline this 13% to 20% next year. And clearly with the exposure in Italy, I was wondering -- you folks were sort of managing through that. I was wondering if you could give us some color in terms of where you expect sort of overall sales trajectory. I mean do you think that given your exposure relative to the market, you'll be a bit weaker in the near term? Or do you think that there's opportunity for share gains that could sort of enable you folks to outperform the market? Just trying to understand sort of a little bit more clarity there.

Richard J. Thompson

Okay, great. As you look at Europe going forward particularly into 2013, there will be a pretty sharp market decline due to change in feed-in tariff. We believe we've positioned ourselves well though as we are concentrating on gaining share with our TRIO product, and we're already shipping our ULTRA product into this region. Additionally, we are seeing great quoting opportunities in unsubsidized fields in southern Italy. We're seeing quoting activity increasing in the Middle East and Israel -- including Israel, and other parts of Europe particularly Eastern Europe, France and the U.K., we're seeing pockets of strength. So overall, we still will have a difficult time to replace all of the European revenue. Locally, we expect it to go down certainly in Europe next year, but we think we can offset part of the marketplace decline with better performance.

Looking to the other geographies, North America is certainly expected to grow dramatically to, some pundits say, 5.5 gigawatts. But we believe that our 20-plus percent share in string and the addition of the ULTRA line, which we are already shipping in modest quantities in North America, will certainly help us capture share. And as we mentioned in our comments, we expect to be 20% market share leaving next year.

As you look to Asia Pacific, it's certainly been a roller coaster ride. China is growing dramatically. Most of that inverter needs in China are taken over by indigenous companies in China. But we found ways to compete, and we hope to be able to announce relationships with EPCs that will lead us to gain market share in China. Additionally, the Australia market, albeit smaller, it's scheduled to be about 1 gigawatt next year. We have a significant share in Australia. That market is generally residential and commercial rooftop, but we also see utility-grade projects coming to the market, so we look forward to continued growth in Australia. And lastly, Japan, we are entering Japan and we're getting our products certified, JET certified as we speak, and we're forging relationships with large industrials, so that we can get into the Japanese market quicker than from a greenfield start. Having said all of that, we do expect to have a very good year next year. Obviously, you've seen our guidance for the fourth quarter. We haven't given guidance for next year, but we expect to offset some of the losses, if you like, in Italy and Germany with improvement in these other geographies.

Amir Rozwadowski - Barclays Capital, Research Division

That's very helpful. And then I guess you talked about sort of this market share gains in the U.S. Clearly this quarter it seems as though you gained some traction in the residential and commercial market. What gives you confidence in terms of the ability to gain in the utility scale side? Because it seems as though, based on the outlook that you have, it seems as though you are expecting a pretty significant improvement there?

Richard J. Thompson

That's a very good question. On the U.S. market, we see that the ULTRA will have the same success as the TRIO has had. This is a very highly efficient unit. It has a great cost point, and it is a smaller footprint for our customers in a NEMA 4X box. So we think this will be a highly competitive product. It goes up to 1.55 megawatts per unit. Additionally, we're introducing the 400 unit. This is a 400-megawatt unit. As many as 5 can be linked together to form 2.0 megawatts in a cabin, tremendous capabilities and flexibility. Both products have our modular design, which has been one of our hallmarks as we bring products to the market. And that should increase the availability, the online availability and our capabilities that if there is a maintenance required that we cannot effect the whole inverter as we provide that maintenance. So we believe that these are industry-leading products. We are now in discussions, actually beta testing, with 2 of the largest EPCs in the world. And we hope to be able to announce cementing of those relationships very soon.

Operator

Next questioner is Ahmar Zaman with Piper Jaffray.

Shawn E. Lockman - Piper Jaffray Companies, Research Division

This is Shawn for Ahmar. I was wondering if we could just touch back a little bit on the market share questions. I mean as we talk about 40% of your total segment revenue for renewables shifting outside of Europe next year, can you give us a sense of what your share of Europe was or has been this year and what you would look for it to be next year?

Richard J. Thompson

Okay, great. As we look at EMEA this year, it was -- our total market share, we're talking market shares now in megawatts, was approximately 13% as we mentioned at the end of Q3. Of that, our share in EMEA was roughly 22%, and that was made up of a large share in Italy and a lesser share in Germany. North America and APAC as a percent of market share are smaller. If you look at the megawatts that we have shipped into the marketplaces, the numbers are very similar in our market share number. So by geography, Power-One is approximately 82% in EMEA in Q3. That was down from 91-plus percent in Q2. And North America and Asia Pac were 18%. So while we have to double North America and Asia Pac, we can see our way to that with a growth in those markets and our new product introductions. So we feel confident that over time, over next year, we'll be able to achieve a very large position outside of Europe next year.

Shawn E. Lockman - Piper Jaffray Companies, Research Division

And I know you had mentioned in your prepared remarks, commentary that pricing erosion will resume a bit in 4Q. Can you give us a picture yet of how you're looking at price declines for 2013?

Richard J. Thompson

Yes, as we discussed, we saw less price declines in Q3 as in Q2. They were very strong quarters for demand. We expect the price declines to continue though into Q4, and year-on-year, we would expect in the 10% to 12% range, while the overall market is looking at a 15% drop in their pricing. Please keep in mind that we're in most favorable pricing situations, a lot of instances to our largest competitor. And we'll continue with that strategy. Looking into next year, we haven't talked through prices yet. The industry is looking for double digits. We haven't given any forecast as of yet.

Operator

Our next phone question comes from the line of Zach Larkin with Stephens.

Wes Anderson - Stephens Inc., Research Division

This is Wes Anderson on for Zach. I'm wondering if you could comment on the concern over excess inventory in the market. And then as a follow-up, what types of utilization you guys are seeing at the Phoenix facility. I may have missed that.

Richard J. Thompson

Okay, great, thanks. We don't see a lot of inventory in the channels. There was some built up in Q3, but it's pretty modest. It's probably less than 100 megawatts is what is being reported to us. As we look into Phoenix, the organization there, as we mentioned in our comments, has been together for about 3 months. They've made tremendous strides. Our on-time delivery is now excellent, close to best-in-class. Our cost is improving each week as we ship. And we are now in the luxury of being able to build our inventory packages to give better on-time delivery. That factory was initially empowered to be 500 megawatts. It can go up flexing itself so 1.0 gig. With the ULTRA unit, it will likely have to do that. Today, we are operating more like 40% to 50% of capacity. We're only doing string there. We have just started up the ULTRA manufacturing and built our first unit. So we see that plant having better utilization into next year. It'll slowly grow though from Q4 into full production at the end of Q2 of next year.

Operator

Our next questioner in queue comes from the line of Kelly Dougherty with Macquarie.

Kelly A. Dougherty - Macquarie Research

When you talk about a 10% to 12% price decline, that's kind of an apples-to-apples basis, right? That doesn't include the mix shift? And then maybe if you could help us think about, as you look into 2013, not necessarily comment on pricing, but any idea as you grow the U.S. and India, China, how the mix shift between the residential, commercial and the utility might change?

Richard J. Thompson

Okay, great. It was apples-to-apples on price. It didn't take into account mix shift, the comment of 10% to 12%. As we look into next year entering these markets and gaining share in North America, as you know, that's about a 50% utility market. Additionally, China, India is also a utility market. Australia is basically both residence and small and large commercial or string environments. So we would expect net-net that our utility sales would grow into next year. With utilities, it brings higher megawatts shipped, but it also affects the equation on price per watt. So that will certainly be something that folks should watch next year.

Kelly A. Dougherty - Macquarie Research

So you have, I'm just trying to look for my number here, utilities as 13% in the third quarter. Obviously that's not necessarily representative of the full year, but do you have any kind of bogey for what you're targeting as a percent of your volume shipments for next year?

Richard J. Thompson

As you look historically, we've been as high as 54% before on utilities. We would expect utilities to go again into the 40% range solidly. The reason we believe that is because of the ULTRA product, the 400 and the 250 and 500 that we'll ship into other areas. The string inverters are doing great. Again, the TRIO 20 and 27.5 have shipped over 18,000 units in the quarter, very much on par with Q2. So this unit is being well received. It brings higher kilowatts to the rooftop. And they can certainly be strung together. We've seen most frequently 4 of them put together to get a megawatt on a rooftop. They're very easily installed. It's just been a great product for us. But having said that, we expect the same out of ULTRA. I know, I mentioned that before, but we're really excited about the product and about its benefits it brings to the customer.

Operator

Our next question comes from the line of Pavel Molchanov with Raymond James.

Pavel Molchanov - Raymond James & Associates, Inc., Research Division

First, just a competitive question. I'm sure you saw the #1 player in your market has had some pretty significant layoffs of late. Have you done anything along those lines? Are you considering it? And do you need it?

Richard J. Thompson

That's a very good question. Obviously, we use a flex capacity model. At any one time, a large part of our headcount, direct labor, is temporary workforce. We recently reduced our workforce, temporary workforce, in Italy by 250 workers. We didn't do an announcement on it. It's something that we have done both flex on and reductions throughout the last few years. It's a normal part of our doing business. So we believe that our headcount reduction, certainly in the manufacturing footprint, are largely behind us. We have lowered our breakeven point. I won't discuss with you what that is, but we have lowered it in both businesses dramatically. In the Power business, you've seen there's steady improvement in EBITDA and operating income despite headwinds on revenue. And in power, you've seen us hold a pretty consistent gross margin, which would tell you we're managing our operating cost well. I will also mention that our fixed costs in our factories tend to be less than some of our brethren. We have gotten more of a flexible footprint as I mentioned. Fixed cost, we tend not to build the highest-end facilities. We lease a lot of our facilities, and we put our capital into the equipment. So we feel good with our cost structure. Obviously, if revenues would go down even more dramatically than we expect, we would have to take actions. But we see ourselves well positioned today.

Pavel Molchanov - Raymond James & Associates, Inc., Research Division

Okay, let me also ask you about your share buyback. If my math serves me right, your cash balance is now 44% of market cap, and of course, your stock is down about 40% off of its high. Can you indicate what your plans might be for buyback in the near term given the multiples at which you're trading?

Gary R. Larsen

It's Gary. So obviously, with your math, we have $287 million of cash available. We just announced the $15 million share -- 15 million share buyback. So I mean the constraint that we have on the cash, it is predominantly overseas, and there's some tax considerations about bringing the money back. So we try to bring that back as it's prudent. Clearly, where the shares are today, they see it as an attractive price for repurchase, and we'll look to bring back money as we can to try to enact the buyback. But also -- and part of that, we also do to take into consideration the importance of the cash balance, particularly as far as proving bankability to our customers and also showing that we have the wherewithal to, say, handle a slowdown in the industry. So we take all those things into account. But primarily right now we're working through the issues of trying to get the money back in a tax efficient way to enact the buyback.

Operator

Next questioner is Carter Driscoll with Capstone Investments.

Carter W. Driscoll - Capstone Investments, Research Division

The question really centers around the competitive environment and maybe in particular in North America. Obviously, we've seen the competitor that had a pretty significant share of the utilities scale market suffer some financial difficulties. And maybe you could help us understand what you think is your strength in the North American market in -- from whether it's the financial strength from your balance sheet, introduction of some of the newer products that lends you to gain so much market share. I mean is it really that some of these competitors are actually exiting the business and that's easy market share, or is it some combination? If you could just kind of rank those characteristics that you think really is going to drive such tremendous share over the next 12 months.

Richard J. Thompson

That's an excellent question. As I think through it, I believe the strength of Power-One going into these marketplaces is our already leading position in string inverters. These include the TRIO, the UNO and the full line in MICRO next year as well. So that's certainly the technology, the ULTRA unit is an excellent unit. We'll prove it as we report to you the EPCs who have ventured into long-term relationships, and also as we start shipping that product. So we think our strength is our marketeers, who are able to really pinpoint the needs of the market; secondly, our engineers who can bring it with incredible technology to the market. Talking through the rest of the points, I think our factories are now improving. I think our on-time delivery, our ability to service the customer will certainly improve as -- going forward. We believe long-term, that's going to be a strength of the company. And last, whoever you are in the marketplace, you have to have bankability. You have to have a strong balance sheet. Remember, our customer base is generally a risk-adversed customer. They use us to create power to run their businesses and their homes, and it's important that they can have confidence in the vendor who is serving them. And as you know, the inverter is a large part of the technology in any grid plant or any solar plant. So we believe those factors, again our technology and our products, our improved customer satisfaction goals and our strong balance sheet are all necessary to continue to grow in this marketplace. Having said that, if you compared us perhaps to the misfortunes of another company in the industry, you'll find that they lacked all 3 of those.

Carter W. Driscoll - Capstone Investments, Research Division

Just as a quick follow-up, your largest competitor made some comments that perhaps China might not be a market they're looking to expand in or really penetrate deeply. If you could just kind of use the comments you just made about the North American market as I'm sure that some of them applied to China. But what gives you confidence that it is a market that you want to be in, obviously, you talk about being cost-conscious market. But is the opportunity as robust as you think it is or is it more APAC in general and China just being a part of that expansion geographically?

Richard J. Thompson

Again, the Chinese market is the largest in the APAC region. I see it's very difficult to ignore what will be, next to Europe, the second-largest market in the world. We don't plan to ignore it. It is a difficult market. Our products are designed with a cost structure that allows us even in the highly competitive cost terrain of China to be successful. Second, I'll remind you that we've had a factory in China for over 20 years, so we're somewhat indigenous in the region. And thirdly, again our balance sheet is strong. We expect to support this area. I know that the working capital needs are much different in China. But it's a market that we've modeled, and we believe we can be successful. We aren't going to ignore the other markets. So again Australia is important to us, Southeast Asia, India. And while we doubt we'll see any appreciable revenue from Japan, that's a market we must be successful in as well. So lots of opportunities. We will go toe to toe with the indigenous Chinese providers of inverters. We believe ours are a much stronger solution. We'll sell them on LCOE over the life of the project, and we believe we can be successful.

Operator

Next questioner in queue is Mark Bachman with Avian Securities.

Mark W. Bachman - Avian Securities, LLC, Research Division

If I kind of take a look at where Italy has peaked already. By my estimates, the market for Italian PV installations peaked in 2011. It's somewhere close to 9 gigawatts, this year closer to 3.5. Didn't you already experience the biggest hit that we're going to see Italy take this year?

Richard J. Thompson

Our numbers on Italy go from roughly 6.6 in '11 to 4 this year, which is an estimate. We're suggesting next year the total market in Italy will be between 1 8 and 2 2. So there's still some movement in the market. We believe though that the market is going largely to a string market both commercially and residentially, and that is our strength -- again, the TRIO products, the UNO products. At the same time southern Italy is now grid parity because of their great [ph] irradiation and high electricity cost. We are seeing some very large projects in the 50 to 100-megawatt range already in unsubsidized situations. So we're thrilled with our position in Italy. It's the strongest in the industry, similar to what SMA is enjoying in Germany. So we believe that we'll still have a very solid Italian and European market next year albeit a bit lower than this year.

Mark W. Bachman - Avian Securities, LLC, Research Division

So if I think about that European market, you mentioned somewhere between down 13% and 20%. That looks like it's only, call it, 2.5 to maybe 3 gigawatts then? Is that correct?

Richard J. Thompson

For which, the Italian market?

Mark W. Bachman - Avian Securities, LLC, Research Division

No, for the European market.

Richard J. Thompson

No, the European market is more -- is much larger. The European market in total is 17, 18 gigawatts last year, 17 this year. It depends on who you listen to. It's going to 13 to 15. So countries like Italy and Germany are going to be down up to 20%, perhaps even more. But then Eastern Europe is coming on again. We mentioned the Middle East. We account this as EMEA, not just Europe. The U.K. is solid, France is solid. As a matter of fact, in the U.K., we are already shipping ULTRA to the U.K. It's been shipped both to Germany sites and to U.K. sites. We see other parts of Europe actually growing. We're doing well in those particular arenas. We're going to be faced with some challenges on financing for Eastern Europe, but we feel that we can overcome those. So all in all, Europe is certainly going to decline next year, some of the countries more than others. There will be some growth in the smaller rest of EMEA, if you like. It will grow as high as 30-plus percent. So a mixed bag. You have to look at this almost on a country-by-country basis.

Operator

Next questioner comes from the line of Joe Maxa with Dougherty and Company.

Joseph A. Maxa - Dougherty & Company LLC, Research Division

I know you're not guiding to 2013 yet, but I just wanted to get a sense on your thoughts regarding seasonality and how you would expect revenue to grow through the year as you look at traditional seasonality plus new products that will take some time to ramp. Should we be thinking of second half being much stronger than first half?

Richard J. Thompson

Good observation, Joe. As the industry goes, we usually have a slowdown in the first quarter because of weather. If you recall last year, it was particularly harsh in Europe, and that the first quarter was by far our weakest quarter. So we normally expect fourth quarter to first, a bit of a drop and then moving up throughout the rest of the year. Ours will certainly be impacted by the new product introductions. Those will be additions though as an example. We ship very little utility-grade products into North America, so we don't have to cannibalize any revenue stream, and we just look at it as new revenue opportunities. So that'll certainly help our growth in North America.

Joseph A. Maxa - Dougherty & Company LLC, Research Division

And a follow-up is, your large competitor talking about concerns of potentially not breaking even. How do you compare yourself to that? And how should we be thinking about your business model compared to theirs?

Richard J. Thompson

Okay, I can't really comment on their business model. I don't know the flexibility of their cost structure. Our model, as we've been relatively open with, is one of flexible capacity at our factories. Additionally, our operating expenses are well managed in both businesses. The OpEx is less -- is approximately 10% in RE, slightly better or higher in power but total about 12% operating expenses. So I believe some of our competition is much, much higher than that. So we manage our OpEx a bit closer to the vest. We always have. That's our legacy from the power industry, where margins are very, very competitive. And we've built up a flexible capacity in each of our factories. Now flexible capacity just helps you with the variable cost on materials and some labor. Obviously if you get to a point where you're well below your target capacity, your practical capacity, you're going to have to take out some cost. Unfortunately, you can't take out fixed assets. We can only take out people. But in response to an earlier question, we've done what we believe we need to do in the near term. If the market throws us any more curveballs, though, we'll respond accordingly.

Operator

Our final question for today will come from the line of Edwin Mok with Needham & Company.

Edwin Mok - Needham & Company, LLC, Research Division

So a question on margins. You mentioned that you expect utility mix potentially go up as it ramps in North American and places like China, right? How do you now think about the margins for those products versus, for example, your string product? And how would that increase mix affect your margins going forward?

Richard J. Thompson

Okay. Well that, Edwin, is a very complex question. It has to do with pricing in different regions and the margin of our products. As we've, I think, alluded to before, we design our products for what we think the price points will be out 2 to 3 years in the future. And after we achieve peak annual run rates so far in our history, we've found that to be true. So we expect a very competitive price structure on these products, or cost structure, and we should be able to improve margins going forward once we overcome the ramp-up cost. Ramp-up costs in new products, particularly like the ULTRA, are higher than what you would see in normal product family extension. This is a whole new product family. It brings into account liquid cooling, much different factory layouts, these products are as much as 10,000 pounds, brings hoist and another fixed costs into place in the plants. But overall we do design for what we believe the future market pricing will bear, and we believe we can keep our gross margin structure over time improving from the previous year.

Edwin Mok - Needham & Company, LLC, Research Division

Great. Actually that was very helpful. And then kind of a follow-up question regarding Europe, right? Did you disclose how much of your sales came from Italy and Germany? And given that you have a high exposure in Italy, do you think that kind of success in other markets, outside of those 2 main markets, will be enough to offset the decline in Italy?

Richard J. Thompson

Well, Italy is a very large part of our revenue stream. It's about 45% of our revenue, and Germany is about 22%. Those markets we expect to decline because of changes in feed-in tariff. They'll be offset partially by unsubsidized projects. But overall, we do not believe that the revenue and other parts of EMEA, meaning again the Middle East, including Israel, South Africa and into Eastern Europe and some countries like the U.K. and France, will likely not be enough to offset the revenue down in Germany and Italy.

Operator

And that does conclude our time for questions. I'd now like to turn the program back over to Mr. Richard Thompson for any additional or closing remarks.

Richard J. Thompson

Great. Thank you. Despite the quarterly swings in demand, we at Power-One strongly believe in the long-term health and importance of the PV markets, the value of energy generation it brings to customers, the attractive project returns it generates for investors, and its positive impact on the environment. As the PV model continues to mature and solar achieves widespread parity with conventional sources of electricity, we believe the industry will continue to grow, and the inverter will remain a critical part of the solar plant. Power-One is well positioned to manage through turbulent market conditions given our strong balance sheet, efficient cost structure and competitively priced products.

Additionally, our Power Solutions business contributes a relatively constant base of revenue that complements our Solar business. Now the men and women at Power-One are single-mindedly dedicated to continue to offer the best solutions in this marketplace.

I thank you for participating in today's call and your interest in Power-One.

Operator

Thank you, gentleman. Again, ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.

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