Advanced Energy Industries Inc (AEIS) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Advanced Energy Earnings Conference Call. At this time, all participants are in listen-only mode. We will conduct a question and answer session toward the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Annie Leschin, Investor Relations. Please proceed.

Thank you, Operator, and good morning, everyone. Thank you for joining us this morning for our third quarter 2011 earnings conference call. With me are Garry Rogerson, Chief Executive Officer, Danny Herron, Executive Vice President and CFO, and Yuval Wasserman, President of the Thin Film Business Unit. By now, you should have received a copy of the earnings release that was issued last evening. For a copy of the release, please visit our website at www.advancedenergy.com or contact us at 970-407-4670. This quarter, Advanced Energy will be participating in the Barclay's Global Technology conference on December 7 in San Francisco. The Company will also be hosting an analyst event on November 21 at the NASDAQ market site in New York. As other events occur, we will make additional announcements.

I'd like to remind everyone that except for historical information contained herein, the matters discussed on this conference call contain certain forward-looking statements subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Statements that include the terms believe, expects, plans, objectives, estimates, anticipates, intends, targets or the like should be viewed as forward-looking and uncertain. Such risks and uncertainties include, but are not limited to, the volatility and cyclicality of the industries we serve, the timing of orders received from our customers and unanticipated changes in our estimates, reserves or allowances, as well as other factors listed in our press release. These and other risks are described in Forms 10-K and 10-Q and other reports filed with the SEC. In addition, we assume no obligation to update the information that we provide you during this conference call, including the fourth quarter guidance provided during this call and in our press release. Guidance will not be updated after today's call until our next scheduled quarterly financial release. I'd now like to turn the call over to Garry Rogerson, CEO of Advanced Energy.

Welcome, everyone. Thank you for joining us this morning. I will start with a few comments on the quarter's results and then discuss the recent restructuring actions we've set in place and how they fit into the larger context of our strategy.

Before I begin, I'd like to mention that the former head of the Solar Energy unit is no longer with the Company. We made a change in Management that did not turn out to be the right decision. Danny Herron will be serving as interim head of our Solar Energy business.

Let's begin with slide 4. Global demand for our products was mixed this quarter, leading to financial results that were mixed as well. The pull back in capital spending felt across virtually all of our thin film end markets, while demand for large scale inverters in North America grew despite the difficulties that the solar panel market continues to endure. Revenues of $128.5 million were 7% below last quarter and 9% lower than the same quarter last year. Operating margins at 8.3% were also below last year and down from 12.5% from last quarter. Non-GAAP earnings per share was $0.21. Although we met our earnings per share projections, excluding restructuring costs, we are clearly not satisfied with these results. Our goal over the next 3 years is to decrease our breakeven such that even in downturns we're able to stay profitable without making substantial changes to the organization.

Turn to slide 6. At the beginning of the year, we divided the Company into 2 distinctive business units -- Thin Films and Solar Energy. This decision was made so that each business unit could tailor its efforts to the unique wants and needs of its very different customer groups. In the last couple of months, we have been assessing the businesses and have concluded that as we develop our strategy to increase shareholder value, fundamental changes have to be made. We are in the process of developing this plan and immediately implementing items that we can quickly move forward with. Our strategy plan can be divided simplistically into 2 phases -- cost and margin improvement and acceleration of revenue growth. We'll go into more detail in both areas in our analyst meeting.

Today, though, I will talk mainly about the cost and margin initiatives. As recently announced, the thin films business has reduced its head count significantly, moving R&D much closer to its customers, for example, Silicon Valley, California and Seoul, Korea. These actions have put us nearer to our key customers and at the same time, reduced our cost structure. The total savings for the Company will be approximately $6 million annually. We are moving to incentive plans that pay for performance, which are optimized for each of the business unit's needs and pay only on success. These will be implemented for the next financial year and should result in significant efficiency improvements.

A noncash issue, but one that certainly affects the GAAP P&L and EPS is the use of share options. Dilutions will be annualizing at 4% and will reduce to about 1.5%. Because of the overhang, it will take about 3 years to fully implement, improving our P&L, reducing dilution and thus improving EPS.

We are consolidating facilities across the world. At the same time, we're transferring the subassembly manufacturing for our Solar Energy business and some engineering to our world-class facility in Shenzhen, China. China should become the hub for all of our manufacturing. This should take about 18 months. These activities, when completed, should have a significant effect on our expenses, improving gross margins and reducing operating expense, which should lower our breakeven point and allow us to better manage through industry downturns and benefit more from the peaks. These costs should not come back.

The actions I have described are only a piece of the equation. We need to accelerate our revenue growth. This should come from a combination of our strong investments in R&D, some of which you'll hear about today, the broadening application of our products into new areas and our expansion into new geographies. We will try to accelerate the process by utilizing our cash for potential acquisitions. There are many opportunities out there that may fill product line gaps in our portfolio or help us expand into adjacent applications and other geographies. Acquisitions need to be complementary to our strategy and quickly accretive.

As we improve the efficiency of our organization and accelerate revenue growth, EPS should improve significantly. With an increased focus on working capital, we should also be able to generate significant free cash flow. Together, these results will bring value to our shareholders.

Now I'd like to turn the call over to Yuval, who will talk you through the thin film markets.

Thank you, Garry. Total Thin Films Business unit sales were $76.8 million; a decline of 21.1% from last quarter, contributing 60% of total sales. Thin films operating income declined $4 million sequentially to $16 million this quarter, while operating margin improved slightly to 21%, due to a combination of product mix.

Turning to slide 7, let me begin the end market discussion with semiconductors. Last quarter, demand for semiconductor capital equipment began to slow as the high levels achieved for the last several quarters began to wane. This quarter, the industry abruptly pulled back, evidenced by the 32% sequential drop we saw in our revenues to $29.6 million or 23% of total sales.

As you know, industry-wide wafer fab equipment book-to-bill continued to decline. The inventory level rose and fab utilization rates fell to 80% versus the 90% needed to drive capital spending. The outlook for the remainder of the year remains difficult. From our vantage point, we believe that the trough this cycle may occur towards the end of the first half of 2012. Technology advancement is nonetheless continuing and some important trends are emerging in device architecture and process and manufacturing technology. They involve the acceleration of processing equipment development and customization. This, combined with the market's [shift] from PCs and tablets and mobile devices is expected to spur the majority of growth in semiconductors over the next several years, making early engagement and collaboration between suppliers and customers even more vital, with increased time to market and decreased device costs.

At AE, we're localizing engineering labs and teams in the San Jose area and in Korea in order to work closely with our [T]OEMS on next generation to position and edge application for new technology nodes and for 450 millimeter wafer processing tools. By the end of 2012, our localized production line in Korea plans to start the final assembly and tests of selected semiconductor power solution components to address the need for local content. This line is already proven, as we have been shipping power supplies and components for the local flat panel display since 2010.

Moving on to the flat panel market, revenues fell 31% to $8.6 million or 6.7% of total sales. As the record investments in OLED for [Gen] 5.5 slowed this quarter, while the industry has been absorbed the new capacity coming online. This market is following the trend towards mobility and connectivity, which has been responsible for much of the CapEx in 2011. The industry is investing in the overall user experience, driving more advanced technology in tablet computers and mobile devices, focused on better resolution, colors and pictures. This is pushing out investment in larger subset manufacturing capacity.

With the high levels of investment already seen in 2011, we anticipate a pause as new technologies develop and some Korean manufacturers reconfigure their strategy after the recent capacity build up. Longer term, we anticipate further build out of Gen 5.5 [AMOLED], as well as equipment buys for Gen 8 AMOLED.

Turning to the thin films renewable market, conditions in the solar panel industry continued to deteriorate this quarter, as ASPs slid further and solar modules sold below $1 per watt. While we had anticipated the leveling off in the second half of the year, China significantly reduced capital equipment purchases due to excess supply. This led to a [17.8%] sequential decline to $14.7 million dollars in sales or 11.4% of total sales. With a large amount of end product currently in the market, especially in crystalline silicon, the decline could continue well into next year. On a positive note, new innovations in thin film solar cells are driving incremental investments in R&D in limited fab projects, some with large manufacturers. We are positioning our ascent in crystalline power supplies for both the PE solar market and the flat panel markets for large area thin filmed position processes and our increasing penetration with European and Korean OEMs.

Moving on to our service business, we saw a slight 2% sequential increase in revenues to $13.4 million or 10.4% of total sales as Korea and the US stabilized. This was partially offset by a decline in Taiwan as utilization rates reached as low as 60% to 70% in 300 millimeter fabs. Service activities in the divested flow business also decreased this quarter, offset by share wins from a number of end users in Asia. Looking ahead, we anticipate a normal seasonal decline in the fourth quarter in our service business, due to holidays, vacations and fab spending controls in place. We continue to focus on service product development and market share opportunities to propel this business forward.

The recent restructuring of our thin film business unit is the first in a multi-phase strategy aimed at increasing our profitability and speeding our time to market. In concert with the steps taken this quarter to reduce head count in transition to low-cost regions, we are in the process of consolidating facilities and reducing our centralized footprint in Fort Collins by about 56,000 square feet by year end. Throughout the next year, we plan to combine other facilities worldwide to improve our service offering through the co-location of support functions in close proximity to our customers. In addition, throughout 2012, we plan to transform our industry-leading factory [insension] into a flexible line manufacturing methodology with demand flow technology, which we expect should drive costs down, increase inventory turns and reduce lead times.

Lastly, we continued to increase the flexibility of our cost structure by outsourcing a variety of support functions across our business, allowing us to better manage through the cycles of our end market.

I'd now like to turn the call over to Danny Herron, who will go through our solar energy business unit and AE financials in more details. Danny?

Thank you, Yuval. Turning to our Solar Energy business unit on slide 8. Falling government subsidies and low volumes continue to drive down prices for solar equipment this quarter in a time when module oversupply was already rampant. Consequently, many developers held off purchases and projects in the hopes of even lower prices, confounding installers' business plans. With the looming end to the accelerated depreciation of the 1603 Department of Energy cash grant, some developers began shell projects in order to benefit from these incentives prior to their expiration at the end of 2011. Despite these conditions, demand for commercial and utility scale inverters grew yet again this quarter. Our revenues climbed 26.7% from last quarter to $51.7 million or 40% of total sales.

We shipped 202 megawatts versus 160 last quarter. Ongoing growth in PV Powered and solar products over 250kW drove the majority of our revenue. During the quarter, our book-to-bill was 1.24 to 1. Operating income in our Solar Energy business unit increased $1.3 million or 2.5% of revenue compared to 1% of revenue last quarter, clearly not an acceptable level of profitability. We saw competition intensify as Europe's weakened state drove many European companies to the North American market. With a growing number of competitors vying for a limited amount of large-scale installations, price pressure for inverters also escalated. With our products specifically designed for the North American market, we continue to gain market presence.

While the environment in the solar industry remains uncertain, AE is taking decisive action. Beginning with the restructuring, we are taking several productive steps to expand our worldwide presence, streamline our cost structure and significantly improve the profitability profile of our solar energy business. Moving the manufacture of subassemblies to China in 2012 should optimize our costs so that we can better adapt to market conditions, stay close to customers and earn our keep.

We're also exiting in several off-site facilities in the fourth quarter, resulting in about $400,000 in annual savings and generating improved cash flow as we reduce our inventory levels. Our focus is to create a platform that cannot only grow with the industry, but better withstand market changes and improve our profitability. Innovation will continue as we broaden our product and technology portfolio and employ increasingly stringent criteria to our offerings. Whether expanding into markets or improving performance, our products must not only present compelling differentiation to customers, but also meet our profitability parameters.

At the recent [SDI] show in Dallas, we showcased a new PV Powered 500kW monopolar inverter for the largest segment of the commercial and small utility market in North America, estimated at approximately $500 million in 2012. This product allows us to address an adjacent segment of our markets where monopolar products are exclusively utilized, delivering better value to our customers and replacing the smaller 260kW product in larger scale commercial projects.

We also added a new line of high-performance, PV Powered HE string inverters aimed at the North American residential and small commercial installations. With these new offerings, AE continues to deliver one of the industry's highest performing and broadest inverter portfolios. Finally, we anticipate strong inverter revenue growth in the fourth quarter. Though normal winter weather patterns and slowdown of installations should lead to seasonal softness in the first quarter. We are excited about our opportunities in 2012, and expect to see revenue and profit growth next year as the North American market continues to expand.

Now, I'd like to continue with the discussion of our financial results. During the course of my remarks, I will refer to non-GAAP results. Non-GAAP measures exclude the impact of the previously announced $3.1 million restructuring charge recorded in the third quarter. The reconciliation of non-GAAP income from operations and per share earnings is provided in the press release tables.

Turning to slide number 10, in the third quarter, revenues declined 7% sequentially and 8.8% annually to $128.5 million from $141 million in the third quarter of 2010. We had healthy revenue growth in our Solar Energy business unit, but the slowing of capital spending impacted our thin film markets, as previously discussed. Our restructuring initiatives and globalization strategy should help offset some of the cyclical trends of our markets, improve our profitability and benefit us significantly as the markets recover.

On slide 11, operating margin in the third quarter was 8.3%, down from 12.5% in the second quarter. Non-GAAP operating margin for the third quarter was 10.7%. On slide 12, despite the lower sales, operating expenses were flat at $38.2 million compared to $38.1 million in the second quarter. Note that the third quarter benefited from the reversal of approximately $3.2 million in year-to-date incentive compensation. R&D expenses increased 2.7% sequentially to $17.6 million, or 13.7% of sales the third quarter as a result of ongoing product development efforts in the Solar Energy business. SG&A decreased 17.6% from the second quarter to $16.5 million, representing 12.8% of sales primarily due to the incentive compensation reversal.

As Garry highlighted, during the quarter, we took a $3.1 million charge related to the restructuring plan announced on September 28, 2011. The anticipated savings from the first phase is approximately $6 million annually. The second phase, to be implemented over the next 12 to 18 months, should result in charges of approximately $8 million to $12 million, principally for space consolidation and another $1 million in additional severance costs. In fact, we expect a charge in the fourth quarter of approximately $4.5 million as we accelerate the exiting of several facilities during the quarter. The savings from this consolidation is approximately $1 million per year. Once complete, the 2 phases of the plan, along with other cost savings initiatives and margin improvements are expected to deliver annual savings of $16 million to $20 million, which should result in EPS improvements of $0.27 to $0.34 in earnings per share at an annual tax rate of 25%.

The total tax rate for the quarter increased to approximately 31.1%, due to the change in the geographic mix of income and a shift in profit contribution from our Thin Films business unit to our Solar Energy business unit. We now expect our full-year tax rate at the higher end of the previously guided range of 24% to 26%.

Income from continuing operations in the third quarter was $7.2 million or $0.16 per diluted share. This compares to income from continuing operations of $13.5 million or $0.31 per diluted share in the second quarter and $17.6 million or $0.40 per diluted share in the same period last year. On a non-GAAP basis, excluding the impacts of the restructuring charge, continuing operations generated income of $9.3 million or $0.21 per share for the quarter.

Turning to our balance sheet on slide number 14, we ended the third quarter with cash and investments of $154.9 million, a $9.2 million increase over June. Under our new restructuring plan, we are currently assessing the most strategic ways to utilize our cash going forward in order to grow and expand our business in a most profitable way. Trade working capital decreased by $6.1 million to $174 million and inventories dropped $8 million to $92.8 million. Stock option expense for the quarter was $3.2 million, fixed asset depreciation was $2.8 million and intangible amortization from the acquisition of PV Powered was $1 million for the quarter.

Finally, turning to slide 15, you will see our guidance for the fourth quarter of 2011. We expect revenues between $105 million and $120 million and non-GAAP EPS at approximately a breakeven. Guidance reflects our view that capital spending levels and our key thin film markets will remain depressed, while growth in our solar energy business should continue.

This concludes our prepared remarks for today. Operator, I'd like to open up the call for questions.

(Operator Instructions) Krish Sankar, Bank of America Merrill Lynch.

Thanks for taking my questions. I had a couple of them. Danny, could you help us reconcile your guidance from a quantifiable standpoint, in terms of thin film inverters? How much you expect inverters to grow in Q4, and how much you expect implement semis to dip?

Sure. Our revenue projections of the 105 to 120 are based on about a 25% to 30% decline in our thin film business, as the semiconductor and capital equipment markets continue to slide. We're projecting about a 15% growth in our inverter business in Q4, which is below where we were expecting a couple of quarters ago, but as everyone knows, the inverter market has been soft, due to the continual decline of panel prices.

Got it. And did you say that the semi business is expected to bottom out in the first half 2012 or late 2011? I didn't get that exactly.

I believe in our prepared remarks, we talked about the thin film business would be nearing the bottom of the trough in the first half of the year, towards the end of the first half, and we would expect to see the second half of 2012 start to improve.

My follow-up to that is, if you assume that the semi weakness continues into Q1, and you see a seasonably slow Q1 on the inverter side, is it fair to assume you could lose money in Q1, given the fact that the restructuring would not kick in by then?

At this point, we are working hard with our restructuring plan to realign our breakeven costs, to where, as Garry said in his remarks, we want to be able to maintain profitability, even in the low troughs of these cycles. So, that's what we're shooting for.

Final question -- can you give us the R&D split between thin film and inverters?

We don't break that out publicly. We only talk about our operating income. But suffice it to say, the R&D and the thin film part of our business is significantly higher as a percentage of sales than it would be on our inverter business. But, they're 2 different business models, as you know.

Thank you.

Edwin Mok, Needham & Company.

A question on the thin film side, Dan, you mentioned it's down 25% to 30% in the coming quarter. Just wondering, is it mostly driven by semi equipment, or is it the other markets you also expect to decline? Specifically, which market are the ones that you present as seeing the sharpest decline in the coming quarter?

Edmund, hi. This is Yuval Wasserman. The decline in Q4 is a combination of the free market, major markets we serve. It's a semi market, flat panel displays and the PV solar market for those panel manufacturing sites, mainly driven by China. It's not only semi, it's a combination of all 3.

Its Garry. I think the key here is, we're break-- I'm answering both questions really, is that we get to a breakeven point that we can withstand these troughs. Everything we're doing, every action we're taking, is so that we do not have cut people, cut out strategic initiatives when we're going through these troughs and we're doing a good job.

We're urgently taking costs out. You know we've reduced our head count and I'm not talking about manufacturing head count that goes up and down as we manufacture, I'm talking about structural head count that we've taken out. We're taking out buildings as quickly as we can to really reduce our breakeven. This quarter's going to be a bit turbulent because of that.

But the benefits of doing this are going to be huge in the future. As we pick up in the second half of next year, we should be getting many more dollars down to the bottom line in earnings per share. We intend to hold these costs right down as we start picking up in the second half of the year, so we'll be in a much better state.

In the solar industry, I just touch on that, but sort of the same thing. We're growing our revenues, but I'm sure you can see we're not profitable. We've got to be profitable at $60 million, $50 million per quarter, and we're getting ourselves into a position so that we are profitable, so that we can grow profits, not just our revenues. So, the game is changing, and we're trying to change the way we do business. We're not just trying, we're doing it. Just to cover globally what I'm sure you're trying to understand at the moment.

Thanks. Very helpful there. Since you talked about profitability on the solar business, I was wondering, is it more a function of market price that is pressuring the profitability of the solar business, or is it just the cost that you felt that you can (multiple speakers)

It's both. There's clearly pricing pressure, as there always will be. But the reality is, we haven't put ourselves into a position to design low-cost, manufacture low-cost product. We're a great innovator. We've got fantastic products. In the marketplace, customers like them.

Our issue is, manufacturing them and delivering them to our customer at the lowest possible cost. That's why we're moving the assemby of these products, the manufacture of these products, sorry, to Shenzhen in China. We have a world-class facility for semiconductor and we're going to utilize that for solar.

It's obvious. We have a great facility in China, we're going to utilize that facility. So, we've got to get those manufacturing costs down. There are other costs that I've already talked about which will affect the operating margins of that business. We can affect both the operating margins and the gross margins of the business. There's a lot of low-hanging fruit, and we're picking it as fast as we can. I think Danny mentioned the square footage we're getting.

Yuval, you mentioned the square footage. We're reducing our square footage, which, of course, we talk about the cost of the square footage, it's really the cost savings, is what's in that square footage. It's what's in there. Yes, we save on the leases and all this stuff, but its the inventory that's there, you see. It's just the maintenance of that building.

And then Yuval, just quickly touch on your commentary. Your commentary suggests that you think both thin film and (inaudible) may actually be even weaker in 2012. Did I read that correctly? And if so, same comment regarding the trough of the semi cap business? Do you have a view about the trough of those businesses? Is that going to be in 2012, or what?

Yuval will give you much more color than myself. But we believe in the thin film business, this quarter is the bottom on the revenues. But what we're saying is, that probably January, February, March, we'll be at that same bottom. April, May, June will be at that same bottom.

We'll probably start seeing more order activity in that 6-month period. Near the end of that 6-month period, which will result in shipments in the second half of the year. That's how we see it at the present time. As you know, we're getting a lot of information in from our customers and we get to what we think's going to happen at the present. It seems to be roughly what others were talking about.

And Edwin, the other thing that I think is really, really important to note is, the end user timing of populating new fabs is not synchronous. They don't all take equipment at the same time. Then if you look at the wafer fab equipment companies, they don't have a uniform content within these fabs.

So, it's a combination of product mix, our content within the wafer fab equipment manufacturers, and then the timing of these fab populations will start taking place. Without really having the clear announcement that we expect to see in January by some of the leading IC makers, we rely on information we gather from our customers and analyzing our sales. Pretty much as Garry said, we believe that the bottom is Q4, and then Q1 and Q2 will be the turning point when we start booking for future growth in the second half.

I see. Great. Very helpful. Danny, just a question on the earnings guidance. A 2-part question -- first is, do you expect that incentive reversal to come back in the fourth quarter and therefore, you would have a higher operating expense in the fourth quarter? That's the first part of the question.

The second part is, even if I factored that in, that would imply you have a lower gross margin in the fourth quarter. Does that mostly come from a higher mix of the solar product or does that come from other pieces? Thank you.

The first question, we will not be seeing impact from the incentive. We got a favorable impact in Q3 that won't exist in Q4, and we won't be accruing incentive compensation in Q4, given the current outlook for the business. The other part of the question, on the gross margin for the Company, obviously, as the solar business increases as a percent of the total revenue, the overall Company gross margin will go down, because the thin film business experiences a much higher gross margin than solar. That is the other impact on the gross margin driving to the expected breakeven for Q4.

Yes. Just a longer-term comment there on the incentives. You will not see the same sort of accrual in the future as you've had in the past in this Company. So, going forward from January onwards, we are taking a very, very hard look at how we award incentives, and clearly, they're only going to be there if we win. So, there won't be accruals of this type of size into the future.

Great. That's all I have. Thank you.

Zach Larkin, Stephens.

This is Chris [Godbee] in for Zach Larkin and Stephens. First of all, within thin films, could you talk about how increasing competition on top of certainly, the uncertain outlook is impacting pricing and your expectations a bit more?

Sure. In the thin film area, mainly in semiconductors, I can rely on a report from BLSR Research from 2010, we have increased our market share, and we believe we continue to do so. The competition is there, the market is fairly mature and consolidated into power supply area, and we continue to perform as evident by a recent Best Supplier award that we have received from Applied Materials this quarter, and it's an indication of customer satisfaction and competitive stands.

The competition in the other areas is more global, especially in the thin films. In the flat panel display market and in the PV solar market, the dynamics is very different as we have more local suppliers emerging. However, with our local presence in Korea, with the fact that we manufacture product supplies in Korea for the flat panel display market, we have a very strong position; again, very competitive stands over there.

Just a comment there -- I visited some customers in this area, obviously, and what I can comment is, how happy they are with us and how happy they are with the quality of product that we are producing. I mean, apparently many years ago, we didn't have the quality.

Now we're clearly a leader in quality and we're starting to get accolades and awards because of it, and our market presence is increasing because of that quality. So I think, in the thin film area, we're very, very well-positioned and continue to get good wins.

Okay. Great, great. Thank you very much. And just one more question, and you've touched on this quite a bit so far -- but certainly you are facing quite a bit of pressure on margins in thin films, and you've talked about how you're addressing it long term with the restructuring --

Okay. We're not facing a lot of pressure. Obviously, there is pricing pressure. The key in thin film is what we want to happen, is when we're in a downturn is that we don't have to reduce salaries, cut things. Obviously do the normal stuff one does when you go into a downturn, but not be dramatic so that we can keep our employees, keep moving in the strategic direction we want to go in for the future so that when we come out, we're going to deliver way more to the bottom line.

We're going to show you, at the analyst meeting, November the 21, we're going to show you what is going to happen. We'll probably show you a quarter that we've had in the past and what will happen in the future in that same quarter with that same sort of mix, and we should get much more dropping to bottom line.

So I think thin film is getting itself into great shape, actually. With customers we're winning, we've our costs more under control, they're getting better under control. So, we should be able to deliver more cash and improve our earnings per share.

Okay. Great. Certainly I understand where you're going long-term there, but are you able to provide maybe a bit more color of where maybe you'll be in the short-term, say, in the first half of '12?

Well, I keep saying -- I think we're keeping saying that we think we've hit the trough --

Sure.

-- this quarter in Q4, and so, we think we're going to be roughly break even in Q4. So, you can extrapolate from that.

Okay. Great. Thank you very much.

Timothy Arcuri, Citigroup.

Couple things -- first, in semis, I'm still a bit confused. If I strip out the flow business, all of your customers are shipping at a run rate that's about equal to what they were shipping in early 2010, give or take, whether it be Q1 or Q2, it's somewhere in that time frame. Even if I adjust for the flow business, you're nowhere close to that.

You're still $5 million to $10 million shy of that, which is a big number, and I'm wondering what's the dynamic there? It seems like you lost a lot of semiconductor market share. So, that's my first question and then I had a number of others.

Firstly, we don't believe we've lost market presence, we believe we've gained it. I think Yuval will now answer the nuances of that.

Right, Tim, we definitely do not believe that we lost market share. If you look at the dynamic in the market, as I mentioned before, it's a combination of timing and mix. If you look, compared to other companies in our sector, some companies had their peak in Q2, we hit our peak in Q1. We're going to have our trough in Q4. The dynamic is that, we continue to serve a well-defined group of customers, wafer fab equipment customers, and they serve the fab areas in a different way.

Not all of them have all the applications, and we are not present in all these equipment for all these applications. So, there is a timing impact that affects our sales, and we believe that if you look that one quarter at a time, you may see a skewed picture.

I think the right approach to look at market share analysis is to look at the longer term, a whole year or even more than that as you go through the whole cycle of fabs building and equipment installations. This change in mix of customers, mix of products and mix of end users creates that impact that may skew the picture.

Yes. Even if I look at it on a lagging basis, it just seems like it's nowhere close. Maybe we can follow up on that. The second question is on the inverter business, if you look at your operating margins, you're basically breaking even. And, of course, it depends on mix, it depends on whether you're doing a lot of residential, whether you're doing a lot of large scale, but you're basically breaking even in the business at sort of a $180 million annualized run rate.

With this new plan, what is the inverter business breakeven? What is your target? So, when you size the business, where are you sizing breakeven to, from a revenue perspective in that particular business?

Tim, this is Danny. We are working hard on trying to reduce the breakeven cost on our inverter business. It's been anticipating a bigger rebound in the second half of this year than has really occurred.

So, we have some structural changes we need to make to bring the breakeven down to less than a $50 million a quarter number and I think that's what we're shooting at. Right now, you're right. We're about at breakeven on $180 million. We do see next year continuing to grow, but we'll set the business up to be profitable at next year's numbers.

Okay. So you have no specific target?

We're going to go into our targets in a lot of detail at our analyst day. So, we'll give you some things to hold us accountable for in 2012.

We're going to give you, on the analyst day, what we think might happen over the next 3 years with some reasonable milestones in there. Obviously that solar business -- the profitability of it is unacceptable, it's unacceptable. That needs to change, and there are a lot of things we're doing and have done to improve the margins.

We'll be more granular in November as we go forward, but the good thing here is there's plenty of low-hanging fruit. We've shared some of that with you and the revenues continue to grow. You saw through the press release that the orders were strong in Q3 and they were stronger than the shipments. So, we've gained a bit of backlog. So, from that point of view, the customer acceptance of the products is excellent.

Right. Okay. So you're going to hold the details. Got it.

The customer acceptance is excellent. The products -- we're releasing new products. I think we mentioned the 500 gigahertz product which will start shipping in volume in March/April of next year. We have a cost issue. We know it, and we're dealing with it.

Got it. Last thing for me -- your dollar per megawatt this year looks like you're going to be, in the inverter business, you're going to be in the $0.25 range, which is very are consistent with what SMA is saying as well. They're saying sort of like a 21 Eurocent. So, it's not that far off.

But in looking at next year, it's tough to say, but what do you think the mix will be between residential commercial, which has obviously a much higher ASP, in the $0.40 range, if not higher and large-scale utility, which is less than $0.20. As I try to project what the ASP will be next year, what do you think the mix will be between those 2 vastly different verticals?

Tim, in our current business, about 10% of our revenues derive from residential. We don't break out commercial and utility. The rest of that is commercial utility. You're right. They have a lower ASP, but I'd just remind all of us on the call that ASP doesn't deliver profit.

Profit's delivered by the gross margin of the product. While ASPs are very high on residential, their profitability is very low. We play in the utility scale, we've done very well. We're up 27% for the quarter. So, we're gaining traction and we're focused on utility and commercial-scale projects.

Okay. Thanks.

Jim Covello, Goldman Sachs.

This is Mark Delaney calling in for Jim. First, I was hoping you could help us understand what the dynamics are in the inverter business, just from a product standpoint? You guys have talked a lot in the call about how the profitability's not really where you want it to be, but I think you guys have talked as you've rolled out these products that the efficiency on your products is already very good.

So, is it just a cost implementation that you guys need to do to bring down the cost structure or are there changes you still think you need to make on the product side to get the profitability to the levels you're hoping to get?

We've clearly got good products. We've grown in a tough market, the last quarter. We've got good products. At issue is our costs. That's our issue. It's our cost of manufacture.

At the moment, we manufacture our products in [Bend], and in Colorado and they have been designed for very, very high performance, which isn't always necessary. So there are multiple ways we can reduce or improve our margins and reduce our operating expenses in that solar business, and we're doing that.

We assume pricing is going to go down. We assume that. It's pretty large at moment, but we assume it. Danny, do you want to add a little bit more?

Once again our overall cost structure, in addition the manufacturing cost, which we will capture productivity improvements by moving the subassemblies into the Asian market. Our overall structure has been set up for a lot higher revenue growth, and we have to address that and are addressing that. We'll give you the details at the analyst day, but we understand the business profitability is not acceptable in today's terms, and we're working hard to fix that.

Got it. Garry, in your prepared remarks, you talked about hoping to enter some new markets. Any more color you can provide us on that?

No more color. I can add color, of course I can, but no more specifics. There are plenty of acquisition opportunities in both thin film and solar. I've been to a few already.

That's not to say, don't, for goodness sake, get excited by me saying I've visited, seen places. We're starting to look at different acquisitions. There are a lot around.

They have to fit into our strategy. They've got to fit with us. You can tell where we've got holes in solar. It's pretty obvious. We also have holes in our thin film business. Not so obvious, but we do have some holes in our product lines and we can expand into new markets with our technology. So, we're looking around, we're looking at ways to grow.

We have the cash to do it, and we've got a lot of cash on our balance sheet at the moment and from our modeling, it looks as though the cash can only build up next year. So, we can use cash in 3 ways. We can use it 1, to improve ourselves, and that's what we're doing at the moment. We're trying to invest in ourselves to improve. 2, we can use it for acquisitions, good acquisitions that will be accretive pretty quickly, give us good payback times, all the usual things there. Then, 3, as we exhaust those possibilities, we would need to think about giving back that cash to our shareholders in a buyback. If you think about it in the order of what we'll do, that's how we look at it, or that's how I would look at it.

Got it. And just one last one for me, sounds like you guys are reducing your stock option expenses, but also wanted to increase your variable pay in terms of the pay for performance. Just wondering how you're balancing and cutting the options and increasing the variable comp --

So, not exact numbers, but rough numbers. I think we were giving out about 4% of our stock as options per year. That's what we were doing and have done in the last few years. We're bringing that down to about 1.5% from now on. So, it's going from 4.4% to 1.5%.

As we all know, that affects the GAAP P&L and affects the dilution. Both affect our earnings per share. But, the problem here is an overhang of options are being given in the past, so it's going to take about 3 years to get the full effect from that program.

But that will happen in this beginning of this year. We'll go to roughly that 1.5%. On incentive plans within the organization, they're going to be fine-tuned to projects. So, it will be relating directly to our strategy.

It may be a new product introduction, it may be a moving of a product. It will be a specific action that will improve the profitability of the Company. Obviously, these incentive plans or bonus plans, whatever you want to call them will have a block where they don't pay out if the Company doesn't perform, as well.

Got it. Thank you very much.

Colin Rusch.

Just a follow-up on Tim's questioning, we're just trying to reconcile your performance versus peers on a few different timings basis. Is there a change in chip maker's approach to stocking inventory going on right now?

I'm not sure we can talk for our customers plans. We operate with contracts where we have specific inventory plans with our customers, and they pace their pool of components from these inventory or adjusting time inventories. We did not see a lot of change in the way they do business. So, in that sense, I believe that they consumed some inventory in their floors, but we did not have visibility to that.

Okay. Great. Just changing gears, on the solar cost problem, with 70% to 80% of cost coming from components, can you talk us through how much of the cost reduction is really going to be coming from redesign of products? How long you think those redesigns are likely to take? How much you'll get from moving to a new facility and the synergy from being at a new facility?

So, there are 3 real phases to any cost reduction program -- operational expenses, and we have started to take those actions now, to moving the product line to low-cost areas. We're doing that now. It will probably take us 18 months to fully do that. Then local sourcing and that local sourcing is within that 18 months. So. those 3 things will happen within the next 18 months.

Redesign of product for low-cost manufacturing, what we're talking about is new products, and that takes a longer time really to bake into the brains of the Company, I think. On the amount of savings we're going get, I think we've said, for the whole Company, $16 million to $20 million out of the first actions we're taking and I think you could take that by revenues. Danny, would that be a (multiple speakers)

Over time. Our $16 million to $20 million, as Garry mentioned, it's over the next 12 to 18 months as we exit facilities, as we get manufacturing subassemblies transferred, and as we implement the incentive compensation plans and the stock option plans that Garry has talked about. Over the next 12 to 18 months, we should improve our operating income by the $16 million to $20 million, or I believe the number is about $0.27 to $0.34 a share.

I think the question was a little bit more granular between solar and thin film, and what I'm saying is, if you proportion it to revenues would that be a fair thing to do?

It would be at this point. We'll give more details, obviously, on the 21st.

Okay. Great. Just one final one, with moving manufacturing, the Company's had a nice position in the CJES program with the program with the Department of Energy, I think, has been of significant value in your product development over time. Are you putting that relationship at risk, and are you putting your domestic content value proposition at risk by moving things overseas?

The answer's no, no. No, we're not. We'll have final assembly here. We'll have a certain amount of R&D that's going in here. So, the answer to that is no, but I'll tell you in the long term, it's all about cost. I can't believe in 3 years, it's going to be about subsidies. It's and going to be about cost, and that's what I'm interested in, really.

Perfect. Thanks, guys.

Mark Bachman, Avian Securities.

Danny, did I hear you correctly that you said inverter shipments were 102 megawatts in Q3 versus 160 in Q2?

It was 202 versus 160, Mark.

202. Okay. Great. Thank you. And how do we think about inverter volumes in terms of megawatts, then, looking into Q4, given that you believe the revenue on this segment's actually going be up about 15%?

It would be very similar. While there are pricing pressures out there, our mix should stay relatively constant in Q4 versus Q3, and the pricing pressures staying about where they were in Q3. We have a little bit of pick-up for 1603, but certainly not to the magnitude we saw in 2010 when 1603 really accelerated Q4.

So, can you give us an idea then, just on the inverters as a whole, how much degradation you saw in ASPs in Q3, and how much more you expect to see in Q4?

Well, if you just do the top side math, which we don't break it out into the components of residential or commercial utility, I think the topside math, the ASP stayed at about $0.25 a watt Q3 versus Q2. So, there was really no change.

Okay. But the bottom line is there, you're still expecting the same level of degradation then, as you head into Q4?

Yes. But the Q2 to Q3, on an overall basis, the average ASP didn't change. That's because commercial came back a little bit in Q3 versus Q2. If those constants stay the same, we'll see some price pressure in Q4. But right now, 1603 seems to be exacerbating some of that normal price pressure you would see.

Okay. And then lastly, can you just go over a little bit more of this incentive compensation reversal that you went through, what the makeup of that was, why they won't repeat themselves, or have to be reversed going forward?

So, we've been incurring incentives as the years go on with the expectation of a certain profitability in volume. That expectation hasn't occurred and isn't occurring, so those accruals reverse. They not only reverse, we also don't accrue. So, we've built up a pot, which has reversed, and then, as we're going forward, we don't accrue, in Q3 we didn't accrue, and we won't accrue in Q4. Now, going forward, we've changed the way we do this.

The incentives are going to be very specific for very specific jobs within the Company. I described that, added a little color there before. This will actually create savings within the Company and also be a more efficient way for the Company to give out incentives. Again, we'll go into that in more detail in November, but --

This is the last question for me -- this begs the question, if you take away incentives that are based upon driving profitability in the Company, how do you think that this affects your employees in terms of motivating them?

Firstly, I didn't say that. I said we'd create incentives that get people to do things for our strategic plan, and our strategic plan is all driven towards profitability, really not much else. The thing we're driven toward is earnings per share.

So we will give money towards projects that increase our earnings per share. That's what we'll do. In the past, our plans have been inefficient and have not driven profitable growth. You can see that they have not driven profitable growth and we're into growing our profits, not growing our revenues.

Obviously, there's a balance here. But we've got to get our costs under control. We've got to focus on growth activities, which our incentives will do, which will drive revenue growth. Very comfortable with what we're doing.

Excellent. I appreciate the color. Thank you.

Due to time constraints, we will now conclude our Q&A segment. I would like to hand the conference back over to Annie Leschin for closing remarks.

Thank you, operator. I'd just like to take a quick minute to reiterate the internal execution risks. They include the consolidation of facilities, relocation of certain activities, such as subassembly manufacturing and R&D, the extreme volatility of our markets and potential impact of macro events, the timing of orders received and unanticipated changes in our estimates, reserves or allowances. Having acknowledged that, we feel comfortable with our guidance and look forward to discussing our long-term plan at our analyst event on November 21. Thank you, everyone, for joining us.

Thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.