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POWER ONE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following management's discussion and analysis should be read in conjunction with our management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended January 2, 2011 filed with the SEC, and all of our other filings, including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, filed with the SEC after such date and through the date of this report. This Quarterly Report on Form 10-Q may contain certain statements that we believe are, or may be considered to be, "forward-looking statements" within the meaning of various provisions of the Securities Act of 1933 and of the Securities Exchange Act of 1934. These forward-looking statements generally can be identified by use of statements that include phrases such as we "expect," "anticipate," "plan," "intend," "continue," "may," "can," "believe" or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals also are forward-looking statements. All of these forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from historical results or from those expressed or implied by the relevant forward- looking statement. We discuss these risks and uncertainties in detail in Part I. Item 1A. of our 2010 Form 10-K together with further risks discussed in Part II. Item 1A. Risk Factors of this Form 10-Q. Introduction Overview We are organized into two Strategic Business Units ("SBUs"), Renewable Energy Solutions and Power Solutions. The SBUs were created during fiscal 2010 to focus on both the products and services we provide and the customers and end markets that we serve. We are focused on improving our operational and financial performance. Our top objectives are to gain additional market share, execute our operational strategy, and increase profitability and cash flows. Our strategy is to gain market share by entering new markets, including North America, Asia Pacific and the Middle East as well as provide our customers with innovative products and additional product offerings. Our new product introductions increase power density and provide our customers with a greater range of options to meet their diverse solar needs. Our new product offering range from a line of liquid-cooled inverters which serve the demands of the utility market, particularly in North America, to microinverters which are currently in the testing phase. In addition, we are adding software management capabilities to our inverter offering in order to allow customers the ability to remotely monitor and control individual photovoltaic plants or assets. We are also expanding our Power Solutions product line which includes our Platinum efficiency for custom front-end applications as well as other applications supporting the medical, rail and industrial equipment customers. As part of our renewable energy solutions operational strategy, we have entered into the North American, Chinese and Indian markets and have established new factories in North America and China, product development laboratories, and continue to build our regional sales and service teams. We will continue to invest in sales and marking, R&D and our global service team as we believe these are key drivers of our business. We are focused on reducing lead times, improving deliveries to customer request dates, and reducing freight and other transportation costs by localizing the supply chain. Lastly, we are continuing to drive profitability and improving our cash flows by refining our manufacturing operations thereby reducing our costs to manufacture and ramping production at our new facilities in North America and China. Renewable Energy Solutions: We offer inverters, management systems, accessories and services for the renewable energy market place that includes both photovoltaic/solar and wind applications. 19 -------------------------------------------------------------------------------- In the renewable energy market, we sell a broad product line of inverters and service offerings that provide our customers with industry-leading efficiency, harvesting power, uptime, reliability, monitoring through software and ease-of-installation. We sell our renewable energy products to distributors/installers, EPCs and OEMs. We are engaged in the design and production of inverters for renewable energy products that convert photovoltaic/solar or wind energy into useable AC power. Our string inverters are used in residential and small commercial applications, while our central inverters are designed for large commercial and utility installations for both the solar and wind markets. These products scale in size from 300 watts up to 2.5 MW. Our product offering also provides our customers with greater control and monitoring of their renewable energy assets using a software-as-a-service (SaaS) platform. Power Solutions: Our power conversion and power management solutions are used in computer servers, data storage, networking, telecommunications and industrial applications. We sell our power conversion products to OEMs, distributors, and service providers. We are engaged in the design and production of the following power conversion products: º • º AC/DC power supplies that convert AC from a primary power source, such as a wall outlet, into a precisely controlled DC voltage. Virtually every electronic device that plugs into an AC wall outlet requires some type of AC/DC power supply, and we provide a broad range of solutions that power a wide variety of OEM equipment; º • º DC power systems that are used by communications and Internet service providers to power their equipment, and are used as backup power for large communications infrastructure equipment; º • º DC/DC converters that modify an existing DC voltage level to a different DC voltage level to meet the power needs of various subsystems and components within electronic equipment. Our DC/DC converters include high-density and low-density "brick" converters that are generally used to control power on communications printed circuit boards and also include Point-of-Load ("POL") converters that power devices within an Intermediate Bus Architecture as well as in other applications; and º • º Additional products that include digital control products for motors and a variety of other application-specific specialty power products. Recent Pronouncements and Accounting Changes-See Part I. Item 1. Note 2-"CHANGES TO SIGNIFICANT ACCOUNTING POLICIES AND RELATED DISCLOSURES-Recent Pronouncements and Accounting Changes" in the notes to the consolidated condensed financial statements, herein. We follow accounting standards set by the Financial Accounting Standards Board, ("FASB"). The FASB sets generally accepted accounting principles ("GAAP") that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. We have updated references to GAAP issued by the FASB in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" to reflect the guidance in the FASB Accounting Standards Codification ("ASC"). Results of Operations Consolidated During the first six months of fiscal 2011, demand in both the renewable energy and power markets remained strong. While certain macro-economic pressures in the European market impacted our ability to increase revenue over the levels achieved during the latter half of fiscal 2010, revenue 20 --------------------------------------------------------------------------------grew by approximately 38% during the first six months of 2011 as compared with the same period of 2010. Net Sales. Net sales increased $137.9 million, or 37.6%, to $504.8 million for the first six months of fiscal 2011 from $366.9 million for the first six months of fiscal 2010. Net sales increased $45.8 million, or 21.3%, during the second quarter of fiscal 2011 as compared with the same period in 2010. The increase in sales is a result of volume increases in the sales of products primarily impacted by the inverter sales for the rooftop market in Italy and Europe as well as by increased sales of renewable energy products into North America and Asia. Net sales by business segment were as follows, in millions: Three Months Ended Six Months Ended July 3, 2011 July 4, 2010 July 3, 2011 July 4, 2010 Renewable Energy Solutions $ 180.0 69 % $ 142.3 66 % $ 331.6 66 % $ 224.4 61 % Power Solutions 80.3 31 % 72.2 34 % 173.2 34 % 142.5 39 % Total $ 260.3 100 % $ 214.5 100 % $ 504.8 100 % $ 366.9 100 % Net sales by customer category were as follows, in millions: Three Months Ended Six Months Ended July 3, 2011 July 4, 2010 July 3, 2011 July 4, 2010 Distributors $ 116.4 45 % $ 105.5 49 % $ 228.4 45 % $ 172.5 47 % OEMs 92.6 35 % 60.6 28 % 179.9 36 % 114.5 31 % EPCs 50.8 20 % 47.2 22 % 93.6 18 % 77.5 21 % Service providers 0.5 - 1.2 1 % 2.9 1 % 2.4 1 % Total $ 260.3 100 % $ 214.5 100 % $ 504.8 100 % $ 366.9 100 % We have redefined our end-markets based on the customers we serve, and have reclassified certain customers. Net sales for the three and six months ended July 3, 2011 and July 4, 2010 by end-markets under this new classification were as follows: Three Months Ended Six Months Ended July 3, July 4, July 3, July 4, 2011 2010 2011 2010 Renewable Energy 69 % 66 % 66 % 61 % Servers, Storage and Networking 14 % 15 % 15 % 16 % Industrial Equipment 11 % 13 % 13 % 16 % Network Power Systems 6 % 6 % 6 % 7 % Total 100 % 100 % 100 % 100 % Six Months Three Months Ended Ended July 3, July 4, July 3, July 4, 2011 2010 2011 2010 Gross Profit Gross profit, in millions $ 87.4 $ 79.4 $ 171.6 $ 125.1 Gross profit margin 33.6 % 37.0 % 34.0 % 34.1 % Gross profit for the first six months of fiscal 2011 was $171.6 million compared with a gross profit of $125.1 million in the comparable period in 2010. As a percentage of net sales, gross margin 21 -------------------------------------------------------------------------------- decreased slightly to 34.0% for the first six months of fiscal 2011 from a gross margin of 34.1% for the same period in 2010. Gross profit for the second quarter of fiscal 2011 was $87.4 million compared with a gross profit of $79.4 million in the comparable period in 2010. As a percentage of net sales, gross margin decreased to 33.6% for the second quarter of fiscal 2011 from a gross margin of 37.0% for the same period in 2010. The decrease in gross margin during the second quarter of fiscal 2011 as compared with the same period of 2010 primarily related to higher factory overhead and start-up costs associated with the new facilities in North America and China. Selling, General and Administrative Expense. Selling, general and administrative expense increased $8.8 million, or 26%, to $42.0 million for the first six months of fiscal 2011 from $33.2 million for the same period in 2010. As a percentage of net sales, selling, general and administrative expense decreased to 8% for the first six months of fiscal 2011 from 9% for the same period in fiscal 2010. Selling, general and administrative expense increased $2.7 million, or 15%, to $20.9 million for the second quarter of fiscal 2011 from $18.2 million for the same period in 2010. As a percentage of net sales, selling, general and administrative was 8% for both the second quarter of fiscal 2011 and fiscal 2010. Selling expense increased $4.0 million, or 26%, to $19.1 million for the first six months of 2011 from $15.1 million for the same period in 2010. Selling expense increased $2.0 million, or 24%, to $10.1 million for the second quarter of 2011 from $8.1 million for the same period in 2010. The increase in selling expense was primarily related to our investment in the expansion of the sales and marketing teams as well as in advertising and trade shows in order to support our initiatives to grow market share and revenue. General and administrative expense increased $4.8 million, or 27%, to $22.9 million for the first six months of 2011 from $18.1 million for the same period in 2010. General and administrative expense increased $0.7 million, or 7%, to $10.8 million for the second quarter of 2011 from $10.1 million for the same period in 2010. The increase in general and administrative expense is primarily a result of an increase in infrastructure to support the revenue growth. Research and Development. Research and development expense increased by $6.5 million, or 38%, to $23.4 million for the first six months of fiscal 2011 from $16.9 million in the first six months of fiscal 2010. As a percentage of net sales, research and development was 5% during the first six months of 2011 and 2010. Research and development increased by $3.5 million, or 41%, to $12.1 million for the second quarter of fiscal 2011 from $8.6 million in the second quarter of fiscal 2010. As a percentage of net sales, research and development increased to 5% during the second quarter of 2011 from 4% during the same period of 2010. The increase in research and development was primarily due to our continued investment in new product introductions and expansion of research and development efforts during 2011. Amortization of Intangible Assets. Amortization of intangible assets was $0.9 million for the first six months of 2011 compared to $0.7 million for the same period in 2010. Amortization of intangible assets was $0.5 million for the second quarter of fiscal 2011 compared to $0.4 million in the second quarter of 2010. Restructuring Charge and Asset Impairment. During 2009, we announced and implemented a plan to restructure our global organization in response to ongoing demand uncertainty and to exit our factory in the Dominican Republic. Through implementation of this action, we were able to (i) realign global manufacturing and sourcing; (ii) improve operational performance; (iii) increase efficiencies in the supply chain and manufacturing process and (iv) improve our ability to respond to customer requirements in a cost effective manner. With respect to the 2009 restructuring plan, during the three and six months ended July 4, 2010, we recorded approximately $2.5 million and $3.4 million, respectively, of restructuring charges in accordance with ASC 420 and ASC 712, as applicable. 22 -------------------------------------------------------------------------------- In addition, we recorded $0.4 million of asset impairment charges in connection with the restructuring related to the consolidation of facilities during the three and six months ended July 4, 2010. No restructuring charges were recorded during the three or six month periods ended July 3, 2011. Income from Operations. As a result of the items above, income from operations was $104.5 million for the first six months of fiscal 2011 compared with income from operations of $70.4 million for the first six months of fiscal 2010. Income from operations was $53.3 million for the second quarter of fiscal 2011 compared with income from operations of $49.3 million for second quarter of fiscal 2010. Interest Income (Expense), Net. Net interest expense was approximately $1.8 million for the first six months of fiscal 2011, compared with net interest expense of approximately $4.0 million for the comparable period in 2010. Net interest expense was approximately $0.9 million for the second quarter of fiscal 2011, compared with net interest expense of approximately $2.0 million for the comparable period in 2010. Loss on Extinguishment of Debt. Loss on extinguishment of debt was $5.7 million for the first six months of fiscal 2010. We repurchased $4.5 million in face value of outstanding 8% senior secured convertible notes due 2013 for approximately $10 million during the first six months of fiscal 2010. Other Income (Expense), Net. Net other expense was $6.7 million for the first six months of fiscal 2011, compared with net other income of $1.5 million for the same period in 2010. Included in net other expense for the first six months of fiscal 2011 were losses on foreign currency transactions of approximately $4.9 million primarily related to fluctuations in the Euro, Swiss Franc and Chinese RMB. Included in net other income for the first six months of fiscal 2010 was approximately $0.5 million of gain due to changes in the market value of the embedded derivatives related to the Company's preferred stock. Also included in net other income for the first six months of fiscal 2010 were gains on foreign currency transactions of approximately $0.4 million. Net other expense was $4.5 million for the second quarter of fiscal 2011, compared with net other income of $0.7 million for the same period in 2010. Included in net other expense for the second quarter of fiscal 2011 were losses on foreign currency transactions of approximately $2.4 million. Included in net other income for the second quarter of 2010, were gains on foreign currency transactions of approximately $0.1 million. Provision for Income Taxes. The provision for income taxes was $34.1 million for the first six months of fiscal 2011 as compared to $33.0 million recorded during the first six months of fiscal 2010. The provision for income taxes was $16.6 million for the second quarter of fiscal 2011 as compared to $23.3 million recorded during the second quarter of fiscal 2010. The provision for income taxes recorded during 2011 and 2010 are primarily related to taxes recorded at certain of our profitable European locations and is a result of the increase in revenue and profitability during the first six months of fiscal 2011 in certain of our taxable jurisdictions. The effective tax rate decreased to 34.7% for the first six months of 2011 from 48.4% in the comparable period of 2010 and to 35.5% for the second quarter of 2011 from 52.9% in the comparable period in 2010 as a result of the change in geographical mix of pre-tax income at our foreign locations. Our effective tax rate varies significantly from period to period due to the level, mix and seasonality of earnings generated in the U.S. and our various foreign jurisdictions. Under ASC 740-270, "Interim Reporting of Income Taxes," we are required to adjust our effective tax rate for each quarter to be consistent with the estimated annual effective tax rate. Jurisdictions with a projected loss where no tax benefit can be recognized are excluded from the calculation of the estimated annual effective tax rate. Applying the provisions of ASC 740-270 could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings versus annual projections. 23 -------------------------------------------------------------------------------- Although we record deferred income tax assets in jurisdictions where we generate a loss for income tax purposes, we also record a valuation allowance against these deferred income tax assets when, in management's judgment, it is more likely than not that the deferred tax assets will not be realized. As a result, we may record no tax benefit in jurisdictions where we incur a loss, but record tax expense in jurisdictions where we record taxable income and have no net operating loss (NOL) carryforward. As a result, few meaningful comparisons can be made on our consolidated tax rates between periods. Equity in earnings of joint venture. During the first six months of fiscal 2011 and 2010, we recorded approximately $0.6 million and $0.5 million, respectively, related to our equity share in the earnings of a joint venture. During each of the second quarters of fiscal 2011 and 2010, we recorded approximately $0.4 million related to our equity share in the earnings of a joint venture. Preferred stock dividend and accretion. During each of the six-month periods ended July 3, 2011 and July 4, 2010, and in connection with the issuance of $23.6 million of redeemable convertible preferred stock to Silver Lake Sumeru, we recorded $1.7 million related to the 10% preferred stock dividend and accretion. Included in expense during each of the six-month periods ended July 3, 2011 and July 4, 2010 was $1.2 million related to preferred dividends declared and $0.5 million related to the periodic accretions under the interest method. During each of the second quarters of fiscal 2011 and 2010, we recorded $0.9 million related to the preferred stock dividend and accretion. Included in the expense during each of the second quarters of 2011 and 2010 was $0.6 million related to the preferred stock dividend and $0.3 million related to the periodic accretions under the interest method. Renewable Energy Solutions Results for the Renewable Energy Solutions business segment for the three and six months ended July 3, 2011 and July 4, 2010 are as follows, in millions: Three Months Ended Six Months Ended July 3, July 4, July 3, July 4, 2011 2010 2011 2010 Revenue $ 180.0 $ 142.3 331.6 $ 224.4 Operating Income 56.0 60.1 101.5 89.2 During the three and six months ended July 3, 2011, demand in the renewable energy market continued to increase at a rapid rate over levels achieved during the same periods of 2010. The revenue growth in the renewable energy market was driven by increased demand in the overall solar market, as well as by our expansion further into Asia, Australia, North America and the Middle East. Operating margins decreased to 31% during the first six months of 2011 from 40% for the comparable period of 2010 and 31% in the second quarter of fiscal 2011 from 42% in the comparable period of 2010 as a result of higher factory overhead and start-up costs associated with the new facilities established in North America and China, as well as increased investment in sales and marketing, service teams, and research and development. Power Solutions Results for the Power Solutions business segment for the three and six months ended July 3, 2011 and July 4, 2010 are as follows, in millions: Six Months Three Months Ended Ended July 3, July 4, July 3, July 4, 2011 2010 2011 2010 Revenue $ 80.3 $ 72.2 $ 173.2 $ 142.5 Operating income (loss) 3.1 (2.5 ) 14.9 (5.7 ) 24 -------------------------------------------------------------------------------- The improved economic conditions in the power conversion industry as well as higher shipments due to order fulfillment of past due orders, improved factory performance and continued efforts in constraining operating expense contributed to increased revenue and operating profit levels during the three and six months ended July 3, 2011. During the six months ended July 3, 2011, revenue increased by $30.7 million, or 22%, as compared with the same period of 2010. Operating income increased $20.6 million to $14.9 million during the six months ended July 3, 2011 from a loss of $5.7 million during the comparable period in fiscal 2010. During the three months ended July 3, 2011, revenue increased by $8.1 million, or 11%, as compared with the same period in 2010. Operating results increased $5.6 million to $3.1 million during the three months ended July 3, 2011 from a loss of $2.5 million during the comparable period in fiscal 2010. Liquidity and Capital Resources Our cash and cash equivalents balance decreased to $142.7 million at July 3, 2011 from $227.9 million at January 2, 2011. Our primary uses of cash in the first six months of fiscal 2011 consisted of $68.4 million of cash used in operating activities, resulting primarily from $136.5 million cash paid for income taxes, decreases in accounts payable of $81.2 million, and increases in inventory of $16.3 million. Income taxes paid primarily represent Italian tax payments for 2010 as well as estimated taxes on Italian income for the first six months of fiscal 2011. In addition, $19.2 million was used for the acquisition of property and equipment, $5.2 million for the repurchase of our common stock, and $1.2 million for dividends paid related to our redeemable convertible preferred stock. Our primary sources of cash in the first six months of fiscal 2011 included net income of $62.5 million, as well as decreases in accounts receivables of $41.5 million. The aggregate limit on all credit facilities was approximately $169.2 million at July 3, 2011. The credit facilities bear interest on amounts outstanding at various intervals based on various applicable published market rates. At July 3, 2011, no amounts were outstanding on the credit facilities, and $0.3 million was committed to guarantee letters of credit. After consideration of these commitments, $168.9 million of additional borrowing capacity was available to us as of July 3, 2011. We have certain long-term notes payable in a European subsidiary and amounts outstanding at January 2, 2011, were $0.1 million and bore interest at an interest rate of 2%. The long-term notes payable agreements require our subsidiary to provide certain financial reports to the lender but do not require compliance with any financial covenants. The company was in compliance with all debt covenants at July 3, 2011. We currently anticipate that our total capital expenditures for 2011 will be in the range of $45 to $55 million primarily for manufacturing equipment and process improvements, equipment related to research and development and product development, additions and upgrades to our facilities and information technology infrastructure, and other administrative requirements. However, the amount of these anticipated capital expenditures likely will change during the year based on changes in expected revenues, our financial condition and the general economic climate. Based on current plans and business conditions, we believe our existing working capital and borrowing capacity, coupled with the funds that we expect to generate from our operations, will be sufficient to meet our liquidity requirements for the next twelve months. We will continue to evaluate our liquidity position, and when and if necessary explore alternatives to maximize our position and we may determine to raise additional funding through the issuance of equity or incurrence of debt. We may from time to time seek to retire or purchase our outstanding debt through cash purchases. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. 25-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements Below we identify and disclose all of our significant off balance sheet arrangements and related party transactions. We do not utilize special purpose entities or have any known financial relationships with other companies' special purpose entities. Operating Leases. We enter into operating leases where and when the economic climate is favorable. Purchase Commitments. We have purchase commitments for materials, supplies, services, and property, plant and equipment as part of the normal course of business. Certain supply contracts may contain penalty provisions for early termination. Based on current expectations, we do not believe that we are reasonably likely to incur any material amount of penalties under these contracts. Other Contractual Obligations. We do not have material financial guarantees that are reasonably likely to affect liquidity. Related Parties. We have entered into certain transactions, or have other arrangements with related parties. (See Note 15 to the Consolidated Condensed Financial Statements in Part I, Item I) Summary of Contractual Obligations and Commitments. A summary of our future contractual payments related to lease obligations and long-term debt is as follows, in millions: Long-Term Estimated Preferred Operating Debt Interest Stock Year Ending December 31, Leases(1) Obligations Obligations(2) Dividend Total 2011 (six months) 2.6 - 3.4 1.2 7.2 2012 4.4 - 3.6 2.4 10.4 2013 4.1 - 3.6 2.4 10.1 2014 3.5 - 3.6 0.6 7.7 2015 1.8 - 3.6 - 5.4 2016 and thereafter 0.8 36.4 12.2 - 49.4 Total 17.2 36.4 30.0 6.6 90.2 -------------------------------------------------------------------------------- º (1) º Our restructuring reserve at July 3, 2011 includes approximately $0.1 million relating to the above operating lease commitments. º (2) º We calculated estimated interest payments for long-term debt as follows: for fixed-rate term debt, we calculated interest based on the applicable rates and payment dates; for variable-rate term debt, we calculated interest based on the most recent applicable interest rates in effect. |