Power-One Inc. Q1 2009 Earnings Call Transcript

Executives

Richard Thompson - Chief Executive Officer

Linda Heller - Chief Financial Officer

Kristyn Hutzell - Investor Relations

Analysts

Todd Cooper - Stephens Incorporated

Zach Shafron - Allen Reed

Power-One Inc. (PWER) Q1 2009 Earnings Call April 23, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen and welcome to the Power-One first quarter 2009 earnings conference call. My name is Melanie and I’ll be your coordinator today. At this time all participants are in a listen-only mode. We will conduct the question-and-answer session at the end of this conference. (Operator Instructions)

I would now like to turn the call over to Ms. Kristyn Hutzell with Investor Relations; please proceed.

Kristyn Hutzell

Good afternoon everyone. Thank you for joining us today to discuss Power-One’s 2009 first quarter results. Joining me today are Richard Thompson, Chief Executive Officer and Linda Heller, Chief Financial Officer. By now you should have received a copy of today’s press release. If not, it is available on the company’s website at www.power-one.com.

Before we begin, I would like to remind you that this conference call may contain forward-looking statements, reflecting Power-One’s views of future events projections or expectations. Any such forward-looking statements may deal with or include matters which involve risks and uncertainties.

Power-One’s actual results may differ materially from those results as discussed or information provided in the forward-looking statements. We refer you to the company’s reporting documents filed with the SEC for a discussion of risk factors that may have a material impact on results.

Additionally, in adherence with Regulation FD, we have opened up this call so that all interested investors are free to listen in. The press release and this conference call will be our only forum to answer questions regarding our estimated performance going forward. Consequently, should you have any questions regarding our estimate of sales and profits or other financial matters for the upcoming quarter, as well as how they may affect our income statement models and balance sheet, this is the time that we are able to respond to these questions.

I will now turn the call over to Richard Thompson, the company’s Chief Executive Officer. Please go ahead Rich.

Richard Thompson

Thank you, Kristyn. Good afternoon and thank you for joining us for our 2009 first quarter conference call. Our first quarter results were affected by the continued global economic market conditions which impacted all of our product families, geographies and market channels.

As our earnings release outlined, we had a number of items impacting our first quarter results and Linda Heller, our Chief Financial Officer will begin the call with the review of those items and the impact to our financial statements, as well as provide the details on the refinancing that we announced earlier today. Following Linda’s remarks, I will discuss our operational performance for the quarter, and the progress we are making towards our 2009 objectives. We will then be happy to take your questions.

Please go ahead Linda.

Linda Heller

Thank you, Rich. During the first quarter of 2009, we recorded revenue of $97.8 million, a decrease of approximately 17% from last year’s first quarter revenue of $117.8 million. Revenue for the quarter was negatively impacted by the global economy, which resulted in an overall decline in demand.

Net loss for the first quarter was $0.70 per share, compared to a net loss of $0.16 per share for the first quarter of 2008. This loss includes a number of one-time items, the largest being a non-cash goodwill impairment charge of $57 million or $0.65 loss per share, as a result of the adverse equity market conditions and the resulting decline in the company’s share price.

Also included in the loss for the quarter is a non-cash charge of $6 million or $0.07 loss per share, for inventory that was written down due to weakening demand in order cancellations and a restructuring charge of $1.1 million or $0.01 loss per share related to the reduction in the company’s headcount.

The total sum of these impairments and charges is $64.1 million or a loss of $0.73 per share. Offsetting a portion of these expenses was a net gain of $3.1 million or $0.04 per share, from the repurchase of $7 million face value of our convertible debt.

Looking at the composition of our sales by geography during Q1, all geographies were impacted by our network telecom power systems product line, which had weak demand from the wireless service providers. First quarter sales as a percentage of revenue in Europe rose by three points compared to the first quarter of 2008, as the decline in demand from the network power systems revenue was offset by the increase of renewable energy sales in Europe year-over-year.

Sales in North America as a percentage of revenue were flat to the year ago quarter, primarily due to reduction in demand from several key customers in networking and storage, as well as a decline throughout the distribution channel. Asia declined by four points as a percentage of net sales during the quarter, as a direct result of the delayed wireless telecom rollout.

In terms of markets, the softening demand resulted in weakness across all segments, with particular weakness in the network telecommunications equipment market, which generated $31 million or 32% of sales and was impacted by delayed rolled out investment from wireless service providers in certain emerging regions within Asia Pacific, Africa, Russia and Eastern Europe.

Sales in the industrial market were relatively stable due to continued investment in certain rail and transportation markets and accounted for $24 million or 24% of sales during the quarter. Computer and office equipment sales of $23 million or 23% of sales were fairly strong, primarily attributable to new product introductions of several key customers.

Renewable energy, while showing year-over-year growth was below our expectations for the first quarter with sales of $13 million or 13% of sales, due to delayed customer financing for commercial projects across Europe and poor weather conditions which delayed planned installation programs. Other markets represented the remaining sales of $7 million.

The OEM channel totaled 72% or $71 million of net sales for the first quarter, slightly down from historical levels. Distributors increased to 26% of net sales or $25 million, while service providers decreased to 2% of net sales as compared to the same period last year. Our 90 day backlog at the end of Q1 was approximately $49 million, compared to approximately $109 million from the same quarter last year.

Net bookings for the quarter were $77 million compared to last year’s first quarter bookings of $155 million. During the quarter we experienced a decline in backlog as a result of our customers and contract manufacturers reducing visibility to firm purchase orders based on known demand. In addition, the markets for renewable energy and network power systems products have lead time expectations fewer than six weeks. Due to the changing business profile as we move forward, we expect backlog composition to remain less than historic norm.

Our total gross margin for the first quarter was 14.2% compared to 18.1% for the year ago quarter. While some of this decrease was due to the lower volumes from challenging market environment, the substantial portion of the decrease was primarily due to higher than usual inventory charges incurred during the quarter. Excluding the inventory charges, our gross margin would have shown an improvement over historical levels on similar run rates.

Operating expenses for the quarter, excluding goodwill and restructuring, decreased 21.2% of sales as compared to 27.4% of sales in the first quarter of 2008 and 21.7% in Q4 ’08, as a result of continued efforts to reduce the company’s cost structure. SG&A expenses decrease to $13.2 million compared to $20.2 million in the first quarter of 2008.

Engineering and Quality Assurance expenses decreased to $17.5 million compared to $12 million incurred during the same

(Technical Difficulty)

To $1.8 million of foreign currency transaction gain. Our consolidated tax benefit for the first quarter was $0.9 million due to the reversal of FIN 48 provision.

I’ll now discuss our cash flow and balance sleet. Our cash balance of $28.4 million at the end of the first quarter was comparable to our cash balance at the end of Q4, 2008. During the quarter we used $3.5 million to repurchase bonds and pay down approximately $3 million in our foreign credit facilities. Cash generated from operations was approximately $7 million, primarily from the reduction in accounts receivable and inventory, which was partially offset by the reduction in accounts payable.

We continue to make improvements in reducing the inventory which declined by $13 million. Accounts payable also decreased by $21 million from both our continued effort to improve supplier relationships and lower material purchases. Accounts receivable decreased by $32 million, primarily due to the lower sales volume during the quarter (Technical Difficulty).

Lower revenue contributed to an increase in DSOs to approximately 103 days in Q1, up three days from 100 in the previous quarter, with Asia having the most significant increase across our geography. Likewise, working capital went from 101 days last quarter to 114 days in this first quarter.

I will now provide details on our refinancing transaction that was announced earlier today, which recapitalizes the company by amending the terms of the existing 8% senior secured convertible notes, reducing the debt related to those notes and providing $60 million privately issued minority investment from Silver Lake Sumeru.

The decision to recapitalize was based on several reasons. First, the infusion of new capital improves our capitalization and cash balances. Second, the total transaction provides additional flexibility to continue the company’s restructuring activities to improve future earnings by accelerating cost reductions and enabling strategic initiatives.

Finally, the new capital allows the company to continue to invest in growth opportunities, specifically in renewable energy, design opportunities and service capabilities. In connection with the recapitalization, the company received majority approval from the 8% senior secured convertible note holders to announce specific provisions of the indenture.

Amongst other things, the amendment decreases, the minimum cash covenant requirement to either $20 million or 50% of the outstanding notes, whichever is less, as well as the minimum tangible net worth and total debt financial covenant and loosens other restrictions that limit our ability to secure new debt or execute our business strategy. In addition, we will repurchase $21.75 million of the outstanding 8% senior notes upon closing the transaction.

The investments from Silver Lake Sumeru, will be uniform of $239.6 million of convertible preferred stock with voting rights. $36.4 million senior convertible notes due 2019, and $8.7 million warrants with an exercised price of $1.33 and an expiration of seven years.

There is a quarterly dividend payable on a preferred stock at a rate of 10% per year. The things convertible notes will pay interest semi-annually at a rate of 6% the first year, 8% the second year and 10% thereafter. The conversion price of the preferred stock and notes is $1.35.

There are limitations on the Silver Lake Sumeru conversion rights, if the exercise are of those rights would result in ownership of more than 19.9% of our common stock. Additionally, the instruments may not be transferred by Silver Lake Sumeru until 12 months after the transaction closes. Both the preferred stock and the notes are redeemable by either Power-One or the holders after five years of issuance. We expect to close the transaction by May 8, 2009, subject to certain closing conditions.

Going forward, we are focused on our recovery efforts and are committed to aggressively managing our expenses in order to align with current market dynamics. Given the continued economic uncertainty, we will not be providing guidance for the second quarter was full year at this time.

I will now turn the call over to Rich, for a discussion on our operational performance during the quarter.

Rich Thompson

Thank you, Linda. As mentioned, our first quarter results were impacted by the economic recession, which negatively affected demand on all levels. Our customers reacted to the broadening economic crisis by consuming their current inventory, pushing out orders and delaying new projects. Towards the end of the quarter, we began to see signs of improvement, particularly in the renewable energy market, but we’re still in the midst of a very difficult market environment.

I’ll now recap the progress we have made on our 2009 objectives. As you may recall at the end of last quarter, I provided several company wide objectives for 2009 that are critical in our restructuring initiative to become a lean, efficient and consistently profitable company.

Our first initiative is to continue to increase our share within new and existing markets, while consistently providing our customers with the highest level of service, quality and performance. Our second initiative is to further improve our on-time delivery performance to customers. The third is to increase our gross margin to the mid-20s by the end of 2009 and last, we must continue to reduce our working capital, to liberate resources to invest as required.

Over the next few minutes, I will outline the progress on these objectives made during the first quarter. Regarding our effort to grow market share, we maintained a solid project pipeline and expect these projects to contribute significant new revenue in 2009 and beyond.

We also continue to aggressively expand our product portfolio and currently we have over a 130 product development projects underway. These projects include standard, custom and nonstandard products for power conversion, as well as renewable energy.

In the digital power market, we have also now licensed our digital power to two leading semiconductor providers. We’re also in discussions with other embedded modular power manufacturers to license our digital power technology.

In addition to the profit and cash flow that these agreements bring to Power-One, they open a digital market by providing viable, digital power silicon for our customers who prefer to self design circuit boards, and viable second sources, modular suppliers as requested by our customers.

Though sales were impacted this quarter by the softening economy, we continue to broaden our footprint, especially in renewable energy markets with innovative new products. In March, we introduced three new series in our Aurora family for renewable energy inverters for North American installations.

These grid connected products already have demonstrated acceptance in European markets and offer a unique combination of ultra high efficiencies, installer friendly designs and long service life and a competitive initial acquisition cost. Also our 2.5 mega watt, mega line inverters, which are designed to address the wind market, are on track to be launched towards the end of this year.

We continue to expand our renewable energy business throughout Europe and expect that our best-in-class products and investment in sales and infrastructure will drive significant market share gains as the economy recovers and demand increases.

Our second objective is to improve our on-time delivery to customers and we are now regularly exceeding 90% on time delivery and are on track to achieve our goal of 95% for 2009. This metric is a organization-wide initiative involving sales, engineering, manufacturing, supply chain and logistics and we’re continually raising the bar to provide the lean service level our customers demand.

Our ability to deliver product timely, will improve our capability to respond to customers’ un-forecasted demand within the quarter as customers continue to carefully manage their balance sheet.

During the quarter we also continue successful transfers of high volume manufacturing to China and are making headway toward our goal to operating each of our factories at 85% of practical capacity. Also our supply chain and logistics group undertook aggressive actions to significantly reduce our materials and logistics costs.

Much like the on-time delivery improvement initiative this action is complex and requires precise execution by all facets of supply chain management. To date we have contracted with our vendors to achieve significant cost savings on both materials and logistics throughout 2009.

The sales and operation planning process that was implemented mid 2008 is hitting full stride, and contributing to on-time delivery improvements, customer satisfaction, factory cycle time reduction and inventory savings. This execution is especially critical during challenging economic conditions and we are closely monitoring the input and the output of the process to protect our balance sheet.

Our third objective is to increase our gross margin to the mid 20% by the end of the year. In the first quarter our gross margin was impacted by inventory charge and decreased revenue levels. That excluding the one-time cost, our gross margin has improved over historical levels, based on similar level run rates, indicating that we are making progress on lowering total expense levels, while improving overall service to our customers.

Our final objective in 2009 is to significantly reduce our working capital in order to increase our cash flow. Our performance to-date has not yet yielded significant progress on reduction of day’s working capital or DWC, a common performance metric for working capital.

During the first quarter however, we continue to implement enhanced collection efforts and made progress in lowering our amount of past due accounts receivables. Progress was also made toward lowering our inventory balance, which decreased roughly $13 million during the quarter, largely due to the detailed management from the scheduling team and the maturation of our S&OP process. We expect to see these improvements in accounts receivable and DSO, once revenue streams return to stable levels.

We also completed the reduction in headcount we announced at the end of last quarter, for an expected analyzed savings of over $7 million. Since the company’s peak headcount of around 4900 last summer, we had reduced headcount by nearly 28% to better align the company with the current demand level.

Additionally, we continue to focus on improving the balance sheet and took advantage of the market price dislocation on the 8% convertible note and retired $7 million face value of the notes for a gain of approximately $3.1 million. Today we have repurchased $17 million face value of the 8% 2008 notes.

As Linda discussed in detail, we have reached a definitive agreement with Silver Lake Sumeru for an investment of $60 million in new capital. Silver lake is highly regarded in the technology sector for their operational expertise and we are pleased to be partnering with them as we continue in our turnaround efforts and aggressively pursue operational excellence. This relationship not only strengthens our capital structure, but it also enables us to pursue future growth opportunities and profitability.

At the closing of the transaction, silver lake will appoint two members to the Power-One Board of Directors. We look forward to the additions to our existing board and to working closely with Silver Lake Sumeru, as we build on our strong technology foundation and drive the company to new levels of growth and profitability.

Entering the second quarter, there is continued uncertainty as our customers remain cautious in their ordering patterns and thereby shortening lead times. As we operate in an extremely challenging environment, we will continue to improve our cost structure and implement necessary initiatives in order to ensure that we emerge lean, efficient and a consistently profitable company.

We’ll now open up the call to your questions. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Todd Cooper with Stephens Incorporated, go ahead.