SolarEdge Technologies, Inc.
Q4 2016 Earnings Call Transcript

Published: 15 Feb 2017

[Operator:]

Welcome to the SolarEdge Conference Call for the Quarter Ending December 31, 2016. This call is being webcast live on the company's website at www.solaredge.com in the Investor Section of the event calendar page. This call is full property and copyright of SolarEdge with all rights reserved and any recording, reproduction or transmission of the call without the expressed written consent of SolarEdge is prohibited. You may listen to the webcast replay of this call by visiting the event calendar page on the SolarEdge Investor website. I'd now like to turn the call over to Erica Mannion of Sapphire Investor Relations. Investor Relations please go ahead.

[Erica Mannion:]

Good afternoon. Thank you for joining us to discuss SolarEdge’s operating results for the quarter ended December 31, 2016 as well as the Company’s outlook for the first quarter of 2017. With me today are Guy Sella, Founder, Chairman and CEO; and Ronen Faier, Chief Financial Officer. Guy will begin with a brief review of the results for the quarter ended December 31, 2016. Ronan will review the financial results for the quarter and provide the company’s outlook for the first quarter of 2017. Then we will open up the call up for questions. Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from what management’s current expectations are. We encourage you to review the Safe Harbor statements contained in our press release and the slides published today for a more complete description. All material contained in the webcast is a sole property and copyright of SolarEdge Technologies with all rights reserved. Please note this presentation describes certain non-GAAP measures, including non-GAAP net income and non-GAAP net diluted earnings per share, which are not measures prepared in accordance with US GAAP. The non-GAAP measures are presented in this presentation as we believe it will provide investors with the means of evaluating and understanding how the Company’s management evaluates the Company’s operating performance. These non-GAAP measures should not be considered in isolation from, as a substitute for, or superior to financial measures prepared in accordance with US GAAP. Listeners who do not have a copy of the quarter ended December 31, 2016 press release or the presentation may obtain a copy by visiting the Investor section of the Company’s website. Now, I will turn the call over to CEO, Guy Sella.

[Guy Sella:]

Thank you, Erica. Good afternoon and thank you for joining us on our conference call. We concluded the quarter with revenues of $111.5 million and record gross margins of 35%. We have a non-GAAP net income of $14.7 million and the non-GAAP diluted earnings per share of $0.32 and we generated $24.7 million of positive cash flow from operations. In the quarter ended December 31, 2016, we shipped 430 megawatt of AC nameplate inverters approximately 271 megawatt of which was shipped to North America. Overall, we shipped over 1.3 million power optimizers and 57,000 inverters. As we had been anticipated, the general slowdown in the growth rate of the residential PV business in the US had a downward effect on our revenues this quarter, it is important to mention that from everything we can measure, we continue to gain market share in the US and in Europe. Specifically revenues in Europe and other countries outside of North America grew significantly when compared to the same quarter last year. While the European market is starting to return to growth, the US market is still showing significant signs of softness. In the rest of the word, our business is growing at a healthy rate. Given our growth outside of the United States and our continued investments in new markets in different regions, we're confident that we can continue to grow our revenues in 2017. As we have said in the past, while growth in revenues is important, more important are our bottom line numbers. On this front, we continued to control ASP and improve gross margins by continuing to implement cost reduction measures and to improve operational execution. Specifically our 2016 ASP erosion excluding product mix effect relating to an increase in commercial sales was lower than 10% which is in line with our expectation. Gross margin this quarter reached a record high of 35%, approximately 33% of which came from continued execution improvement and 2% which we consider a one-off, a result of a reduction in our RMA expenses which affected our support warranty accrual. Ronen will explain further on this in a little while. We continued to hear market rumors about completing technology particularly from Chinese manufacturers. As of yet we have not seen any third product. We remain confident that our technology leadership, superior customer support services, quality and reliability as well as our financial strength will help us to maintain our market leadership even once this product services. This quarter we began shipment of our 3 and 3.8 kilowatt HD-Wave inverters in the US. In Europe, shipments of 3 and 4 kilowatt HD-Wave inverters began already last June and we are no longer selling all the generator and inverters of these sizes. As you may know this technology received the prestigious Intersolar Award in 2016 and we are proud that this product line is receiving wide acceptance. We will continue to expand our HD-Wave size operating to higher capacity single-phase inverters in 2017 as planned. And with this I had the speaker over to Ronen who will review our financial results.

[Ronen Faier:]

Thank you Guy, and good afternoon everyone. Before starting the review of our financial results for the quarter ended December 31, 2016, I would like to mention that while the overview will be on a GAAP basis; in certain cases I will be discussing non-GAAP numbers and measures which exclude the impact of stock-based compensation and deferred tax as well as non-GAAP earnings per share. Full reconciliation of the pro-forma to GAAP results discussed on this call is available on our website and in the press release issued today. I would also like to mention that at the end of this quarter we changed our fiscal year to match the calendar year. A form 10K/T will be filed in the next few days and from this call and moving forward our quarterly discussion will be on a calendar quarter basis. Now let's start with the financial results for our quarter ended December 31, 2016. Total revenues were $111.5 million compared to $128.5 million last quarter and $124.8 million in the prior year’s period. Our geographic distribution of revenues remained similar to last quarter with US revenues just under 70%. Gross margins for the quarter were 35% compared to 32.6% in the prior quarter and 30.9% in the same quarter last year. This record gross margin is partially attributed to our continued cost reduction activities related to existing products and increased level of sales of HD-Wave product mainly in Europe. In addition, the increase in gross margin was the result of cost reduction related to our RMA expenses associated with reduced cost of products we send as replacement units. Well having a moderate impact on our quarterly expenses, these cost reductions reduced our accrual for future warranty obligations. In addition, following remuneration from our insurance company covering a bad debt from a former customer that declared bankruptcy, we're reversed a right-off of inventory sold to that customer. Gross margins from our ongoing operations excluding these one-time items were approximately 33%. Moving to operating expenses. Research and Development expenses were $10.3 million, an increase of 4.1% compared to the previous quarter and an increase of 24.6% compared to the same quarter last year. This increase is mainly attributed to the planned increase in headcount in R&D. sales and marketing expenses for the quarter were $10.4 million, an increase of 3.7% compared to the previous quarter and a 17.8% increase compared to the same quarter last year. G&A expenses were $3.1 million for the quarter, a decrease of 14.7% compared to the prior quarter and an increase of 42.9% year over year. G&A expenses this quarter were partially offset by the reversal of a bad debt accrual from the remuneration from our insurance company related to a customer bankruptcy a few quarters ago. In total, operating expenses for the quarter ended December 31, 2016 were $23.9 million or 21.4% of revenue. Relatively flat on a dollar basis compared to $23.6 million or 18.4% of revenues in the prior quarter and to $19.3 million or 15.5% of revenue for the same quarter last year. Operating income for the quarter was $15.1 million compared to $18.2 million in the previous quarter and to an operating income of $19.3 million for the same period last year. Financial expenses for the quarter were $3.9 million compared to a financial income of $0.4 million in the previous quarter and a financial expense of $1 million in the same period last year. These high financial expenses most of which are not realized yet are a direct result of a sharp decline in the euro rate compared to the US dollar which affected euro denominated balances associated with European accounts receivable and euro cash balances. This quarter we recorded income tax expenses of $2.2 million compared to income tax expense of $3 million in the previous quarter and an income tax benefit of $5.8 million for the same period last year. As in previous quarter, some of these expenses are related to a reversal of a tax asset created in Q4 2015 and are not necessarily reflecting cash payments. GAAP net income for the quarter ended December 31, 2016 was $9.8 million compared to a GAAP net income of $15.6 million for the previous quarter and a GAAP net income of $24.1 million for the same quarter last year. Our non-GAAP net income was $14.7 million compared to a non-GAAP income of $20.9 million in the previous quarter and a non-GAAP net income of $19.8 million for the same quarter last year. GAAP net diluted earnings per share was $0.22 for the quarter compared to $0.35 in the previous quarter and $0.55 net diluted GAAP EPS for prior year period. Non-GAAP net diluted EPS was $0.32 compared to a non-GAAP net diluted EPS of $0.46 in the previous quarter and a non-GAAP net diluted EPS of $0.44 in the same quarter last year during. Turning now to the balance sheet, as of December 31, 2016; cash, cash equivalents, restricted cash and investments were $224.3 million compared to $206.7 million at September 30, 2016. During the quarter ended December 31, 2016, we generated $24.7 million of cash flow from operation, reduction of AR balances and further reduction of inventories contributed to these high cash flow generation from operations. From a customer concentration perspective, this quarter we had two customers with revenues of more than 10% of total revenues. Revenues from our Top Five customers together were 39% slightly lower than in the last quarter. As of December 31, 2016, our inventory level net of reserves were $67.4 million compared to $68.4 million in the prior quarter. As previously mentioned, as of December 31, 2016, we have changed our fiscal year to match the calendar year. While full reconciliation of our quarterly results into the calendar year basis is available on our website, the following should be noted for calendar 2016. Total revenues for calendar 2016 were $490 million, a 15% increase compared to $494.7 million in calendar 2015. Gross margins for calendar 2016 were 32.8% compared to 29.2% in calendar 2015. GAAP net income for calendar 2016 was $63.5 million; an 18% increase compared to $53.8 million in calendar ’15 and non-GAAP net income was $78.9 million, a 35% increase compared to $58.6 million in calendar ‘15. During calendar 2016, the company generated $81.7 million of cash flow from operating activities. Our guidance for the quarter ending March 31, 2017 is as follows. We expect revenues to be within a range of $110 million to $120 million and gross margins to be within a range of 31% to 33%. I will now turn the call over to the operator to open it up for questions. Operator, please.

[Operator:]

[Operator Instructions] And we’ll take our first question from Mark Strouse with J.P. Morgan. Please go ahead.

[Mark Strouse:]

Thank you very much for taking our questions and congrats on the strong results. So I just wanted to go back to the commentary you made about - you expect revenue to grow during 2017, and can you just talk about what gives you the confidence to make those comments. Is that more international growth or you expecting a rebound in the US. And then a quick follow up to that would be within the US, can you just talk about where you stand in making the shift in your sales strategy towards the smaller installers and away from the big three. Do you think that there's you’re set there or do you think there's more room for improvement?

[Guy Sella:]

I believe there were like three questions, I will try to hope - if I missing a part of the question just help and repeat it. Our assumption is that the US in 2017 is place where it might still be softness and we are not expecting that the market in general will grow dollar wise in the residential segment. In the residential segment, it depends what you measure but based on let’s say Greentech Media, we feel that we are in around 35% to 40%. Therefore we feel we can still take bigger market share. In the commercial we definitely have lots of room to grow. And with new HD-Wave inverter and you probably saw it as we released them at 15% discount price. We feel that we can further increase our market share and part of it or the majority is not a long tail but the 200 net size installer after the big four or five. As mentioned by Ronen, already the big - if you aggregate information that we share with you in the last couple of calls you see that already today in the last few quarters the biggest customers we have are distributors and this is our channel to the long tail and the next 200 customers. And we feel very comfortable that we are growing and taking market share basically we follow at least of this let’s say around 200 customers and analyzing our gain of new logos, our losses and we feel comfortable that we are gaining our market share within this segment of installers. Outside of the US, we did lots of effort in 2016 to grow our business in Australia, Japan and India. While I'm not expecting that in 2017 one of these will become in the size of Europe, but I’m quite confident that the combination of the three will create a very interesting amount of that dollars that will assist us in growing as we mentioned.

[Operator:]

And we’ll take our next question from Vishal Shah with Deutsche Bank.

[Vishal Shah:]

Guy, just onthe HD-Wave segment, can you talk about what your mix is going to look like exiting the year and during ‘17 and how should we think about margins in the commercial as well as maybe the HD-Wave segment relative to the bottom mix.

[Guy Sella:]

Not sure I follow up, I will answer according to what I think I understood and correct me if I didn't answer the exact question. So HD-Wave, as I think we shared this in last couple or three calls even, we did major change of generation of products in optimizer twice in the history of the company and inverter one and a half times and we have I think a good methodology how to do this shift without us stacking with all the inventory and without our channel stacking with all the inventory and we feel very, very responsible not only to our old product inventory but at the same level if not more to our channel inventory. So we basically manage to move in tempered way, so we start from lower size inverters to higher size inverters. As mentioned in the script, we already finished all the transition of the low size inverters in Europe one-phase to HD that practically anything you can buy today from us in the end of Q4 beginning of Q4; we're trying - starting now to transient European larger size. And we’ll transient all of the - all the one-phase design to the new HD-Wave technology by Q3 worldwide. Three-phase inverters I think that’s what you’re referred to is not yet based on the three on what we call three generation technology. The first three-phase inverter based on the third generation technology will be available for us by the end of the year and will probably start to ramp up it sometime between the end of the year beginning of next year. The cost reduction of the three-phase inverters for 2017 are based on the current technology improvements and the same methodology we used in last few years to reduce the price of those products. Okay or I need…

[Operator:]

And we’ll take our next question from John Quealy with Canaccord Genuity.

[John Quealy:]

Two questions, first on research and development, can you talk about relative spend levels in ‘17 seventeen and your priority specifically build versus buy in terms of M&A. Where are you looking different parts of energy efficiency but - so two things R&D platform and spend and then also potential M&A ’17, ‘18. Thank you.

[Guy Sella:]

Well that's really strategy, I’m not sure if we can answer all these. But let's try one by one. So far 100% of the technology we have and we sell is homemade technology and in the core business of the company I don't see any reason to change this approach. We are investing more and more in R&D, Ronen probably knows the ratio in proportion, but in general we’re increasing in a very high level we’re increasing the expenditure in R&D this year. If I remember correctly by almost 20% and we feel very comfortable with the amount of people, with the talent, we grew most of these people internally, we have excellent labs and we feel very comfortable that we can keep and be the leaders of innovation in the space in optimizer and inverters. When you come to other spaces, adjacent areas or spaces that we can activate, the area of electric vehicle, UPS, motor drives, we are analyzing for the last year and a half lots of opportunity. We of course try to find something that will in one hand bring our core benefits and inherent the strength, on the other hand will give us a market that have the growth, the profitability et cetera. We didn't yet find a perfect match, but we're working on it.

[Operator:]

And we’ll take our next question from Philip Shen with Roth Capital Markets.

[Philip Shen:]

Looks like the US market is quite soft as you talk about the international markets being a source of strength. Can you talk about margin profile of Australia and Japan and your Indian sales, in addition to what the mix of business is in each of these countries between resi and commercial?

[Guy Sella:]

I think there are three questions. I will try to fill in and if I’m missing something please repeat I will try to answer. So Japan in general, the profitability is a bit better than in the US which is in a bit better than Europe. Historically, when markets were a little bit more stable like couple years ago, you could see as the product being 20% more expensive in Japan than in the US. And 20% cheaper in Europe than the US today, with the first time that we see that specifically for commercial inverters the US in equal prices to Europe and maybe even a little bit cheaper. And Japan is not a 20% higher prices but still in Japan we have a bit better gross margin. Australia is similar in a way to Europe. I don't think we can find any significant difference between the two, as you probably remember Australia went through for a cycle were European workers were very strong there, they’re still the leader. Then for a few years, Chinese inverters were by far taking the biggest market share. Then due to reliability and limitation and certification it’s back again, we’re SMA [indiscernible] leading the market and we're starting to gain market share. I believe that in couple of years the situation will be similar to what we see in the US. Now help me with what was part of the question regarding to commercial?

[Philip Shen:]

It was just - what is the mix of business in each of these countries between residential and commercial?

[Guy Sella:]

Well, I don't even know, but it’s Japan, it’s easy because currently we don't have certification yet for resi, so 100% for our business is commercial. Australia, it's complete guess, you caught me on this one. I would assume that it’s 75% resi and 25% commercial but it's not - if it’s important Ronen will give you the exact number. I didn't prefer this answer, sorry.

[Philip Shen:]

That's fine. And then in the quarter I think you guys talked about 65% of your shipments, 271 megawatts was to North America. Can you share with us in the balance how much was Europe and how much was these three countries; Japan, Australia, India?

[Guy Sella:]

From the remaining shipments it’s starting to stabilize at around two-thirds to three-quarters Europe and the remaining are split between Australia and Japan.

[Philip Shen:]

One more question here and I'll jump into the queue here. In terms of on the border adjustment tax that might be coming down, what's your view on the potential impact of what that gives you for the business and how that would affect things? Thanks.

[Guy Sella:]

Border adjustment tax meaning different customs or…?

[Philip Shen:]

Well, in the US, Trump is talking about the potential for putting that on in a variety of industries. Have you…

[Guy Sella:]

I didn’t see, I must admit in my ignorance, I didn't see any number. I heard about talking in general, I’ve never seen any number specific number, did you see any specific number that we can refer to?

[Philip Shen:]

I don’t think they've shared details on that yet. So it would just be a general kind of…

[Guy Sella:]

In general, we have production in China, we have production in Europe and we are in the process of build the ability to move production to the US if something significant will change in the global custom or taxes structure.

[Operator:]

And we’ll take our next question from Edwin Mok with Needham & Company. Please go ahead.

[Edwin Mok:]

First I guess just a housekeeping for the guidance, Ronen, how do you think about the OpEx as you go into first quarter and for the rest of the year and then what are you modeling for tax?

[Ronen Faier:]

So with regard to operating expenses, as Guy mentioned before related to R&D we expect for the year approximately a 20% increase. All of the other expenses mostly related to sales and marketing and G&A are bound or at least planned to increase in similar or somehow smaller amount, especially when it comes to G&A because we feel that today on G&A, we have most of everything that we need, we do not need to add anything else, but in general, I would say that with the exception of R&A where we believe that everything is an investment, of course, we always try to adjust those expenses related to our changes in revenues and therefore, it will see and will basically continue to do these. So, it will see growth. We can invest a little bit more and if we see that growth is somehow smaller, we can invest a little bit less. But in general, our intention is to continue and grow gross margins, while still making the overall percentage -- decreasing percentage of our revenue. And second question was related to tax. So here again, the tax rate that you see, the combination of both cash payments that we do and also the reversal of the tax asset we created in the fourth quarter of 2015, I can say that within the US, Germany and most of the other jurisdictions that we are active in, with the acceptance of Israel, we're already paying taxes based on the transfer price policy that we have. This is less than $1 million on a quarterly basis. In Israel, we are subject to what's called approved enterprise status, that means that we have two years of a complete tax holiday and once this tax holiday will be over, right now, there is a law that was passed in the Israeli parliament to decrease corporate tax rate for tech companies to 12%. So for two years, we expect no taxes in Israel or marginal taxes and afterwards, we'll have about 12% on our taxes in Israel. In any case, this quarter, we fully consumed all of our net operating losses for tax purposes and which means that we've activated this two years period in his Israel.

[Edwin Mok:]

Okay, great. Thanks for the detail there. Can we talk about, a little bit about pricing or ASP as you suggested, your product by product ASP on average has actually declined 10%, which is a lot better than the industry. I think some of your competitors are a little more aggressive in terms of thinking about pricing to decline this year, have you thought about market pricing decline and can you continue to manage your pricing to have a lower erosion in the market?

[Ronen Faier:]

Well, it’s exactly, in the first part, sorry, in the first part of the question, you mentioned that the results for 2016 were better than our competitors and what was the exact question, Edwin.

[Edwin Mok:]

Yeah. I’m just, basically just trying to understand how do you think about price erosion for this year and what can you do to maintain this better or lower price erosion than your competitors?

[Ronen Faier:]

So I think I said it last time that my feeling is that this year, the price erosion will be a little bit higher than 10%, but probably not higher than 15%. I think I told people maybe not all, wherever asked that this is a complete feeling based on the fact that I do believe that some of these Chinese rumors will become mature and product will come and then we will need to reduce prices a little bit more than the 10% that we did in 10`6. This is well aligned with yearly cost reduction plan. So we feel very comfortable that we will be able to be a bit more aggressive on prices and still increase gross margin during the year.

[Edwin Mok:]

Okay, actually that’s a great answer for my question. Last question I have on competition front. We heard about I think historically, you guys have done a really good job gaining share and have really have very limited competition on the MLP side, have you seen any change there from your direct competitor, here in US as well as and our smaller competitor that now is being owned by or partially owned by the large SME, have you seen any change from those guys?

[Guy Sella:]

So specifically, I think two main fronts. One front is an Enphase and one front is as a combination of SMA-Tigo. So on the front of Enphase, we see clearly that we are gaining market share. It’s now in small rates. We’re gaining market share, but it’s not -- it’s become in a matter of, we don’t know how to estimate it, because we get the Greentech Media data like 8 weeks post the end of the quarter, maybe 9, 10 weeks. So we will know better in a couple of weeks, like you will know and we’ll see the data, but when we count locals that we win when we count them out of customers that move 100% of their business to SolarEdge, I think we feel comfortable to say that we are gaining in an average market share against Enphase of another 1%, 1.5% a quarter. Again, there is a logical limitation. I think that in average, everybody will want a second source. So I think that realistically, we can get up to 45, maybe in some countries 50% market share. I'm not expecting in the next two years to reach above 45%, 50% in any of the markets we’re operating in. As of Tigo, we have a very long history of Tigo, the founders, Israelis, they’re no longer in the company last three, four years, but the last time that we actually saw them in the marketplace was in 2010, 2011. Since then, I'm not aware of any specific competition. They had one big win, which was Trinasmart that didn’t -- as far as I understand, I'm just telling you what Trina told me and so I am here a middle man. It didn't work well for Trina and as far as I understand, Trina is not anymore offering Tigo products. SMA just announced that they will operate in Europe. We have not seen any bid or anywhere where we actually see them in the field, but I would expect that in Q2, we'll see some more competition, especially in Europe with this combination. I don't think it will change something dramatically. This is a very small company today, around 30 people. I wouldn't expect big changes in 2017.

[Operator:]

And we’ll take our next question from Joe Osha with JMP Securities.

[Joe Osha:]

I have two questions. First, looking at the US, you can look at the numbers and see that California has been very, very soft. I'm wondering if you saw perhaps a better performance in some other states that might have caused the overall US performance to not be as bad. And then I have a follow up.

[Ronen Faier:]

I think we shared the same view on California. I think that if cost is a little bit better and we start to see some business coming from Florida, but -- that's why I said that if I had to guess, I would have guessed that the total inverter business in the resi segment in 2017 dollar wise will be flat compared to 2016 in the US.

[Joe Osha:]

Okay. Are you may be starting to pick up some more share in the US in the C&I business, community solar that that sort of scale of installation that could be compensating a bit?

[Ronen Faier:]

In the commercial space, for sure. We take market share all the time and that's what I was mentioning before that I think that we have very good potential in gaining dollar business and market share in commercial. Community solar from our perspective is in a way a part of this business and therefore the answer really, the C&I is pretty much covering the community solar as well.

[Joe Osha:]

Okay. And then I do have a follow-up. If you look at your HD-Wave and you look at three phase, just understanding is I think I do have the technology works you, would it be fair to say that your cost advantage against conventional three phase would be larger, once you roll out HD-Wave three phase. Just some color on how you see that rolling out in the three phase market would be helpful?

[Guy Sella:]

In theory, yes. In theory, in sizes up to around 100 kilowatt, so let's say 3 to 100 kilowatt with the new topology, at three phase, you gain more than what you gain even in one phase. But it's very much related to the exact type of inverter and exact type of code. In the US for example, bigger portion of the costs related to switches, fuses, size of the actual combining compartment, so improvement in electronics diluted a little bit in compared to European inverters. In European inverters, since the code is much more comfortable on the installers, the benefit of the new topology will be a little bit more helpful.

[Operator:]

Thank you. And we’ll take our next question from Colin Rusch with Oppenheimer.

[Shivani Sood:]

Hi. This is Shivani Sood on for Colin Rusch. Can we first just get an update or automation levels for production currently, just kind of where you expect to be at the end of the March quarter and the June quarter.

[Ronen Faier:]

So we have, the first line, we installed in Hungary is fully working at a very, very high yield and uptime. We have two lines in China waiting for some custom procedure to be released and should be installed during the end of this quarter, beginning of next quarter. I would expect that both of them will be at 80% ramp-up by the end of Q2.

[Shivani Sood:]

Great. And then just one more. How do you think the competitive landscape is changing in Europe? Are you seeing new competitors come on, as competitors fade? Thanks so much?

[Guy Sella:]

So I think this time in the evolution of the inverter business, I would be surprised if we'll see something completely dramatic different from what we saw because I think that today it will be almost impossible to get into this market with reasonable investment. Huawei course is becoming very valid, strong competitor, both in Europe and in the US, but I don't think that’s news. Out of the smaller Chinese players, specifically in England, in UK and Netherlands, they’re strong, but when we entered the UK there, we’re number one, we are by far number one in Netherlands, which is like around probably forty plus percent market share. So I don't think we see any shift. I think that the smaller -- I think that in general and again, it’s a gift -- it's not -- nothing to, Huawei is stable, it’s a quality product. They can compete, they will survive. I think that from the smaller, mostly one phase like [indiscernible] you will see some reduction in the amount of logs. They don't think that all these logs will be able to survive because they're offering more or less the same product.

[Operator:]

And we’ll take our next question from Jeff Osborne with Cowen and Company.

[Jeff Osborne:]

Good evening, guys. Congratulations on the results. I had three, so you can keep your answers brief. But one, first one was on channel inventory, just Ronen, what kind of feedback are you getting from your distributors and other key customers about the older product as you have the product cycle and then I had two follow ups?

[Guy Sella:]

As part of the seasonality that we see in Q4, I think we referred to hit last time is a mutual interest of us and the channels to reduce in general the inventory level at the channels and to reduce it to very, very little number, especially in the North America for 3 and 3.8 kilowatt inverters. And I think we're following this plan. So I think that in general and Ronen can comment of course, the channel inventory by the end of Q4 is lower than what we had in Q3 and I would expect that by the end of Q1 because of the fact that people will be ready for Q2, which is a stronger quarter, the level of revenues will be as it is today or maybe a little bit higher, we feel things were in transition, we'll do everything in our power, not to build, not to ramp up inventory channels until end of Q3 where we will be completely finishing the transition of [indiscernible].

[Jeff Osborne:]

HD-Wave. Perfect. That's good to hear. And then on the Q1 seasonality, historically, that's been a down quarter. What's the driver of the upticking revenue guidance relative to the results you just printed? Is it receptivity to the 15% reduction in prices that you announced with the HD-Wave product or share gains, what exactly is going on there?

[Guy Sella:]

I think it's a combination of three things. First, in a way and that's what we said last time, for us, we saw the seasonality more in Q4 because of the combination. People do not like to end the year with inventory plus the fact that they are aware of the change, nothing, we are not hiding anything. So we are expecting that the seasonality for us will be in Q4 and not in Q1. So it's pretty natural growth, I don't think that there is any specific contribution for what we're expecting to be a bit stronger quarter. I think it's a combination of a bit more attractive price for one phase in the US plus the fact that the business is ramping and growing nicely in Europe. I think Italy is definitely growing and Germany, I would be very surprised if 2017 won't be the first growth year after 2012. I would expect that we will see 2017, 10%, 20% dollar growth in general in Germany after five years of decline in market size.

[Jeff Osborne:]

Excellent. And the last one I had Guy was just on the visibility that your customers are giving, do you find relative to six months ago that it's the same or worse in terms of shorter lead times, just trying to get a sense of here we are in the middle of February, how much visibility you have into the quarter itself and maybe even into the spring?

[Guy Sella:]

So it's not better than before and I don't think that it's dramatically different than before. So I think that our visibility is good for Q1. We feel comfortable with the visibility, but it's never over till it's over and in Q1 specifically, historically the business is less linear, you see more business in March than in February and more business in February than January. It's always a complex quarter. This quarter started a bit better in Europe, because the big snow season came in February, not in January. I think by the middle of the quarter, but I don't see different probability risk in this quarter than any quarter we reported before.

[Operator:]

And we’ll take our next question from Carter Driscoll with FBR Capital Markets.

[Carter Driscoll:]

Good afternoon, guys. A lot of my questions have been answered. Just a couple of quick ones. Can you talk about within Europe, any surprises, you talked about little bit better environment, is it usual suspect your strength kind of in Germany and Netherlands, Italy and any surprise countries? And then as a follow-up geographically you talked about pricing environment to one of the earlier questions and some of the target markets, Japan, India, Australia, well, you could talk about penetration levels on the resi side, maybe in particular in India about a lot of reliable market data and your expectations about maybe any incremental investment to penetrate that market? And then I just have one follow-up.

[Guy Sella:]

One question is very easy. I don't think that today there is any residential market in India. We are trying with a very strong partner to build residential market. It’s a company without giving too much details, they do have most of their business is in appliances and we’re trying to build the business with them. Any guess yours or mine will be the same if it’s doable. We won’t know anything in big numbers before I believe 2019. The business in India is utility and commercial. We feel very comfortable in our commercial business in India. The combination of our benefit in safety monitoring, the fact that the western companies are doing well with completely reasonable prices in India, we feel we can compete and all our assumptions regarding 2017 and 2018 in India coming from commercial, and not from residential. There was another part for the question that I'm not sure I understood. I will answer what I think was the question and if I’m mistaken, please correct me. In Europe, we do see a bit of new market. We see some business in Sweden, some business coming in Norway. Poland is for the second or third year is almost in interesting market. But I think the combination of these three still this year aggregated will be below the expected growth in Germany alone. So it's still not just to give the proportion, if Germany's went down to somewhere like 1 to 1.2 gigawatt depends who is measuring what. Italy's probably and Netherland is in the area of 500 to 600. France is close to giga and we’re weak in France, we still have work to do there and Italy is growing, probably will reach this year close to 400, maybe 500. All the other markets in Europe aggregated I would expect will be less than 200 megawatt. Not including UK, UK is at 200. I was referring to Sweden, Norway, Poland and a little bit here and there.

[Carter Driscoll:]

UK is a bit of unique market right now. Just lastly, you haven’t talked -- in the past, you talked about potentially looking at the -- targeting the utility scale market and if I heard you correctly, you said we certainly know the commercial and utility scale as much bigger opportunity right now in India. Do you have any plans you can share with us about early R&D, targeting significantly higher inverter to target that market, and you could share with us over the next say four to five quarters, targeting utility scale?

[Guy Sella:]

So I'm not in a position to give the target for, I will give you exactly what we know. So, a little bit is the case of the finishing. Today, we have a reasonable amount of installation in the ties of around 5 megawatt, which we consider from the technical perspective, the fact that you are connected to medium voltage and working with big transformer, et cetera as utility technology. We do it with inverters that are a perfect fit for commercial and definitely not a perfect fit for utility. We do it in the US with 33 kilowatt inverters and in Europe with 27.6. By the end of the year, we'll have the first -- third generation topology, what we call Jupiter 3, the equivalent of the same topology as to HD-Wave, but for three phase sizes. At alpha level, at sizes probably around 100 kilowatt, which we believe is the best combination for utility. In general, there is a worldwide tendency to moving utility to string inverter on favor of centralized inverter, mainly from two, three parameters. One is cost, it would become much cheaper to do string. Second is uptime and the third one is ease of installation. And we believe that by the end of 2018, we'll have the full package of everything needed to start, to start to take a reasonable market for a utility.

[Operator:]

[Operator Instructions] We’ll take our next question from Michael Morosi with Avondale Partners.

[Michael Morosi:]

Hi, guys. Thanks for taking the questions and appreciate the candor as always. First, I guess if you look at this quarter, the core gross margin came in 100 basis points ahead of the high end of guidance and based on the revenue growth for next quarter, your margins also seem to be tracking a little better than expectation. And so what exactly are the factors you're seeing that HD-Wave really isn't a factor to later in the year and C&I is increasing?

[Ronen Faier:]

So when giving the guidance of the gross margins, we usually look at several trends. The first one is the cost reduction that we expect to achieve during the quarter, which is a combination of what we're manufacturing, the mix of products that we're selling and also the level of inventories that we have compared to the last quarter. And the second one is the ASP that we expect. And on top of everything, we always have the unpredictable effects related to either exchange rates when it comes to euro/dollar and when it comes to our warranty and other expenses. Now when we look into Q1 and by the way, we traditionally try to be relatively careful in predicting the gross margin simply because of the fact that we have a good understanding of the ASP environment and the cost reduction environment, but most of the rest is beyond our control. So that's number one. With regard to the next quarter, it's mostly related to the fact that in this quarter, we enjoyed this 2% of the one-time item that we do not expect. This is bringing us to 33% which is still the range that we projected. And we believe that as Europe may get a little bit of a higher portion of sales and given the fact that the new HD-Wave price point in the US is starting at the lower point compared to the previous products by 15%, then this may affect. On the overall trends, looking both at ASP and cost reductions, all of the factors that allowed us to grow the gross margins in the previous quarters are continuing and we feel comfortable with our ability to continue and grow them, but again we prefer to be responsible in the way that we guide.

[Michael Morosi:]

All right. That’s helpful. And then looking at the cash flow statement, operating cash for the quarter benefited from a few one-time benefits, but fiscal ’16 cash flow was obviously very strong. How should we think about the normalized conversion of operating profit to operating cash flow going forward?

[Ronen Faier:]

So in general, there are two layers. I’ll start with, of course cash flow is eventually on the long term very much related to the non-GAAP profitability that you see simply because of the fact that you cannot generate much more cash than you are making on a non-GAAP basis over the long term. And here comes I would say the more seasonal effect that may change it. In general, you should see stronger cash flow from operations in the smaller or the declining quarter and revenues because of seasonality, simply because of the fact that you give a little bit less of a credit and you collect a little bit more in the quarter as a residual of the previous quarter. And therefore, we should at least ideally expect levels of cash flow to be higher than profitability in Q3 and Q4 and usually a little bit less in Q1 and Q2 when we are either selling more or building inventory, which is of course affecting our payments to vendors. That said, of course, we're always trying to be very effective in the way that we collect and trying to be as less generous as possible with the payment terms with our vendors in order to increase cash flow from operations, but of course this is not something that you can maintain over the long term.

[Michael Morosi:]

And then finally, with respect to the ongoing cash generation and the pretty sizable cash hoard on your balance sheet, has your thinking changed at all with respect to uses of the cash and would you consider returning some of that to shareholders, to the extent that you have enough of a buffer to grow?

[Guy Sella:]

As mentioned a few times, we are looking in a very aggressive way on how to grow the company outside of the classical solar and we are confident that with time and here, it can take a year, it can take two, we really don't know what is the time needed. We'll find very good use of the cash in order to grow the company to stable it on two legs. Not only solar and to create a great benefit for the shareholders. So we will keep the money to grow into new industries and mainly acquisition.

[Operator:]

And that concludes today’s question-and-answer session. Mr. Sella, I’d like to turn the conference back over to you for any additional or closing remarks.

[Guy Sella:]

In summary, despite tough market conditions, we ended 2016 with year-over-year revenue growth of 15% and year-over-year non-GAAP bottom line profitability growth of 35%. We are confident that based on our leading position in the market, our strong balance sheet, our innovative technology and our new product offering, both those that we released this year and those to be released by mid-year, we can continue our growth in 2017. Thank you very much for joining us on today's call and Happy Valentine's Day.

[Operator:]

And that concludes today’s presentation. We thank you all for your participation and you may now disconnect.