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Power-One (NASDAQ:PWER)

Q1 2008 Earnings Call

April 24, 2008 5:00 pm ET

Executives

Kristyn Hutzell - IR

Richard Thompson - CEO

Jeff Kyle - Chief Financial Officer

Analysts

Amit Daryanani - RBC Capital Market

Todd Cooper - Stephens, Inc.

Yuri Krapivin - Lehman Brothers

Operator

Good day, and welcome to the first quarter 2008 Power-One Earnings Call. (Operator Instructions). At this time I would like to turn the conference to Ms. Kristyn Hutzell, Investor Relations. Thank you Ms Hutzell, you may begin the conference.

Kristyn Hutzell

Good afternoon, everyone. Thank you for joining us today to discuss Power-One's 2008 first quarter results. Joining me are Richard Thompson, Chief Executive Officer and Jeff Kyle, Chief Financial Officer. By now you should have received the 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 current 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 as results discussed or information provided in the forward-looking statements. We refer you to the company's reporting developments filed with the SEC to discuss 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 estimates of sales and profits or other financial matters for the upcoming quarter as well as how they may affect our income statement model 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, Richard.

Richard Thompson

Thank you, Kristyn. Good afternoon and thank you for joining our first quarter 2008 financial results conference call. I will begin this call with a review of the company's performance for the first quarter and a discussion of recent developments. Then I will share with you our recovery plan for the remainder of the year and beyond. After my remarks Jeff Kyle, our Chief Financial Officer will provide greater detail on the financial results for the first quarter and offer you our outlook for the second quarter and the full year. Then we'll be happy to take your questions.

Today we reported net sales of $117.8 million for the first quarter of 2008 and a net loss of $0.16 per share. The 5% revenue decline as compared to the first quarter of 2007 was largely attributable to our not shipping certain products to our customers on time. The revenue shortfall and manufacturing and supply chain inefficiency that caused much of this shortfall had a negative impact on our margins for the quarter.

I am going to discuss our first quarter revenue in more detail and some of the demand trends in our business. Then I will describe the elements of the recovery plan we are in the midst of implementing. We believe we've identified the root causes of our revenue shortfall this quarter and the declining margins we've been experiencing. I'll describe the thorough and systematic process we are using to implement actions to radically improve our operations, to expand our margins and drive sustainable growth and profitability.

We are pleased at the overall strength of our business in the first quarter and the unexpected high demand for some of our products. We saw strong order and backlog growth during quarter. However, we are disappointed in our on-time delivery performance and our manufacturing costs are unacceptably high. During the quarter poor forecasting, inadequate supply chain and manufacturing planning and inefficient factory loading resulted in a number of shipments past due.

While we continue to experience manufacturing supply chain inefficiencies, we are resolving these issues and expect to see progress during this quarter. We believe this progress will manifest itself in a smaller loss in the second quarter and the benefits from our actions will increase throughout 2008 and beyond. We will discuss with you our goal, priorities and initiatives we are implementing since I came on Board as CEO in February. It's my goal to put Power-One back on the path to sustainable profitable growth.

First, I want to discuss what went well in the quarter and the positive trends in the business that we believe will provide the tail win for our efforts to recover our margins. Power-One is the technology leader serving a great set of customers and a number of growing markets. One example is renewable energy inverters sold via a number of channels to both residential and commercial customers. These inverters are used to convert the energy from solar panels and wind turbines and sell it back to the grid.

In this and other markets, our advantage is efficiency. We have the best in-class products with over 96% efficiency. We believe that by the end of 2008, the revenue run rate of our renewable energy business will be more than 10% of our sales and in 2009 the run rate will exceed a $100 million. This will come mainly from Europe, the largest renewable energy market and where we are making excellent progress in a number of countries including Germany, Italy and Spain.

From a market standpoint, we are seeing steady demand across our traditional business increasing demand in service and storage, renewable energy and the custom business that we acquired last year. As previously disclosed our advanced projects use digital power technology which facilitates both high efficiency and high density design that's helping drive our success across virtually all products and markets.

Next, let me discuss our plans to change the company and achieve the operational excellence and the financial performance of which we are capable. Our specific near term goals are to focus on growing segments of the power market while continuing to introduce innovative products to significantly reduce our cost structure and to improve our working capital. We realize we have a lot of work to do, however, while our goals can't be achieved overnight, we believe that solutions to our problems are simply a matter of identify and prioritizing these issues and making a concerted effort to resolve them.

We have already taken the necessary steps to identify root causes and prioritize our challenges and put corrective actions in place. First steps have been taken to make the changes in our business processes that will significantly improve our operational efficiency and financial performance. For now, we are focusing on four near term objectives. First; continue to grow revenues faster than the market. Second; significantly improve gross margin. Third; improve on-time delivery. And last; increase working capital efficiency.

To ensure delivery of our four key initiatives we have identified specific operational issues that require immediate remediation and have created a portfolio of projects that correspond to these issues. Cross functional teams have been established to drive the specific activities and sub-projects required to achieve the goals I mentioned. The majority of the projects have a six month timetable and the teams have already begun implementing these initiatives.

Project success measurements will be continuously monitored to track performance to goals. Dedicated project managers have been assigned to manage projects, schedules and deliverables. Executive sponsors have been assigned to each objective to ensure alignment of activities to objective goals. A program office has also been established to coordinate and integrate these activities. Many of these initiatives will create new processes which will be installed permanently into the business. We believe that the actions, plans and processes being implemented will improve gross margin, reduce operating expenses and lead to a profitable second half of 2008.

Our first initiative is revenue growth. We are making a number of changes in our approach to sales, marketing and product development that we believe will leverage our best in class technology. The opportunities for our standard and custom products are numerous and we will sharpen our focus on high growth markets like networking, in telecom, servers and storage and renewable energy while evaluating exiting certain low growth markets and discontinuing some products with lower than acceptable margins.

To further increase our effectiveness in sales get closer to our customer and offer more responsive support, we have just merged our sales and marketing organizations and created market focus groups. We believe that this new structure will increase our sales especially within faster growing markets like renewable energy by aligning our organization more closely with our customer's requirements. With restructuring of marketing and sales we have also announced a global strategic account manager organization. Dedicated project managers to key customers and aligned our customer service representatives more closely with the customer.

These actions will make it easier for customers do business with Power-One. With our merged sales and marketing teams, we will also have much more knowledge about the accounts and being able to choose the right opportunities. This will increase our success rate in addressing the best projects and we can respond quickly in a lean fashion.

The second objective; improve gross margins is critical to our success. Our goal to improve the gross margin percentage by the mid 20s by the end of the year from 18% we've reported this quarter is ambitious. We are taking significant actions and believe that correcting our manufacturing and supply chain inefficiencies will benefit both on time delivery performance and improve our gross margin.

Our first priority is to complete the transfer of manufacturing to low cost areas and thereby raise the utilization rate of our Chinese factories. This has been slower than anticipated and the transition affected our margins in the quarter and continued to have a negative impact on our manufacturing cost. We're working hard to speed up this process including factory qualification by our customers and we are anticipating that production will be transferred during the next six months.

This will also help reduce component lead times and transfer times from our vendors in China. Instead of a vendor base averaging over a thousand miles from our plant, the average distance from our China plant will be less than a 100 miles. Shipping and handling expenses will be reduced and component availability will be significantly improved.

Our manufacturing strategy is to position China as our high volume factory, while our other factories focus on low to mid volumes and configure to order for renewable energy and telecom systems. We also are bringing on additional capacity with our contract manufacturers in Asia. Material costs which accounts for approximately 60% to 65% of our cost of good sold, is obviously a target for cost reduction. First, we are consolidating our material spend with fewer vendors through a component vendor reduction plan being led by our component engineering staff.

Our goal is to reduce the number of components we use from approximately 40,000 to less than 10,000 over the next few years. Next, we are qualifying vendors nearer to our manufacturing plants and third, we are carefully reviewing our shipping practices to identify a more efficient shipping route and lower cost providers.

The third initiative is on-time delivery. This clearly has been an area in which our performance has been unacceptable and actions are in place to dramatically improve delivery to our customers. One of the root causes of our poor on-time delivery performance has been our suboptimal factory loading. We have already begun implementing a more robust sales and operation planning process with the right forecasting methodologies we can improve our delivery performance by insuring that there is the reserve capacity for the right customers and products.

Further, as part of the actions to improve on time delivery we are analyzing our factory loading and mix. Once we have delivered past due backlog we will load to approximately 85% of capacity to create flexible availability for future un-forecasted upside in terms business. We are also implementing actions to address our suppliers' delivery performance, cut their lead times and along with this we are reducing dependence on sole sourced components.

There is strong demand for our products and we believe by improving our on-time delivery we will be able to convert more of this demand into revenue.

Our last initiative to improve working capital is centered on three areas; inventory, accounts receivable and accounts payable. We will manage these to create cash to support our initiatives and strengthen our balance sheet. We already have teams assigned to each of these areas and are starting to make progress. Inventory will be reduced through a more robust demand planning and forecasting system and that should improve our customer service levels as well. In accounts receivable we will continue to improve invoicing processes and execute a more demanding collections strategy. We will manage accounts payable to market terms and take advantage of vendor held inventory.

Our goal is to have over 10% of our components delivered through vendor managed inventory agreements by year end.

To recap our recovery plan and four initiatives, first; our goal is to achieve 8% to 10% revenue growth in 2008, that is, approximately double the market growth. Second; we are implementing actions to improve gross margin with a goal of mid 20s by year end. Third; our on-time delivery goal is to decrease late deliveries by 75% within six months or sooner. And last; we must be more efficient in working capital management where we expect inventory, accounts receivable and accounts payable to improve by 10% in the next six months, even with a rapidly expanding business.

Finally, I would like to update you on the status of the patent infringement case against Artesyn. We recently announced the court presiding over the case issued a permanent injunction against Artesyn which as you know, is now part of Emerson Electric's network power business unit. The injunction of course is the jury trial verdict in which the jury found that one of Power-One's key digital power management patents had been infringed.

We will actively move to monetize our IP with the trial wind and pursue additional second sources for our technology. Having viable second sources is required to further open the market and increase sales of the digital power management system. While this market will take some time to ramp we believe that digital power management will be a large opportunity for Power-One both because of the potential market size and because of our technology lead in this area.

Additionally, we have implemented digital power in all of our renewable energy inverters as well as virtually all of our custom products and newer AC to DC and power systems. I would like to wrap up by saying a few words about my optimism regarding the opportunity we have before us.

Despite the difficult industry conditions we have experienced for the last several years, we believe that power is an increasingly viable component of technology equipment due to the pressing need to conserve energy. We believe that this trend is beneficial to Power-One as OEMs will increasingly rely on technology leaders to help them efficiently manage the power needs of their system.

While market growth may slow given the current economic slow down, we expect to grow at twice the rate of our market. Our renewable energy business is gaining strength every quarter and we anticipate that this market will continue to experience very strong growth as alternative energy production accelerates with rising oil and energy prices.

We have set in place the right strategic initiatives and recovery plans. We have a strong brand image, global capacity, a blue chip customer base, technology leadership and a broad portfolio. We are determined to fix our manufacturing issues, increase our gross margin, lower expenses and return to profitability in the second half of this year. Jeff will now provide details of our Q1 financials.

Jeff Kyle

Thank you, Richard. During the first quarter of 2008 we recorded revenue of a $117.8 million, a decrease of 5% from last year's Q1 revenue of a $124 million. As previously announced Q1 sales were slightly lower than our original guidance of a range of $130 million to $135 million due to our inability during the quarter to fulfill customer orders on-time. Now, I will give you the revenue split by market, customer segment and geography in Q1.

Sales to the communication market were $61 million or 52% of sales compared with $59 million or 48% of sales during Q1 of last year. Instrumentation and industrial market sales were $23 million or 19% of sales compared with $29 million or 24% of sales in the same period last year. Sales to the server, storage and computer market were $13 million or 11% of sales, down from $19 million or 15% of sales during the same quarter last year. The balance was made up of other markets which include smart motor controls and renewable energy.

The sales growth within the renewable market was approximately 400% as compared with Q1 of last year and accounted for $9.6 million of the current quarter revenue. Sales to OEMs in Q1 were $86 million or 73% of total sales compared with last year's Q1 sales of $99 million or 79% of total sales. The top 10 OEM customers in Q1 was $49 million or 42% of total sales. No customer in Q1 accounted for greater than 10% of sales.

Sales to service procedures were $5 million or 4% of sales compared to $6 million or 5% of sales in Q1 of last year. Sales to distributors were $27 million or 23% of sales an increase from $19 million or 16% of sales during the same quarter last year.

By geography; Q1 sales were as follows, 29% in North America, 47% Europe and 24% Asia versus 39%, 41% and 20% representatively in Q1 2007. Our 90 day backlog at the end of Q1 was $109 million an increase from Q1 2007 90 day backlog of $84 million. Net bookings came in at $155 million a 24% increase over last year's first quarter bookings of $125 million. The increase in backlog and bookings during the first quarter of 2008 is a positive indicator that customer demand remains strong. The increase in our Q1 bookings was primarily attributable to an increased demand in the renewable energy inverters and server storage products.

Our consolidated growth profit in Q1 was approximately 18.1% of sales, a decrease from the gross profit margin of 19.3% for last year's first quarter and lower than our plan for the quarter. The primary factors effecting gross margin were related to manufacturing planning inefficiencies and supply chain constraints. These factors also contributed to our inability to deliver product on-time to our customers.

SG&A expenses were $20.2 million or 17% of sales during Q1 2008, compared with last year's Q1 level of $20.5 million or 17% of sales. Engineering and quality assurance expenses for Q1 remained consistent with last year's Q1 level of 10% of sales.

Our Q1 operating expenses included approximately $1.5 million of severance charges resulting from our recent organizational changes. We also incurred other one-time charges of approximately $0.4 million related in part to the extension of the power bridge loan. We recorded $1.8 million in net interest expense during the quarter primarily due to the acquisition related debt.

Other expenses for Q1 was approximately $0.5 million. Other expenses included approximately $1.8 million of foreign currency fluctuations offsetting the foreign currency losses was a dividend of approximately $1.2 million related to our Asian joint venture. Our consolidated tax benefit for the quarter was approximately $0.4 million. We expect our 2008 tax provision to be in the range of $2 million to $2.5 million.

Net loss for Q1 was $13.6 million or $0.16 a share versus $12.3 million or $0.14 a share in the quarter a year ago. I'll review a few key items on the balance sheet as of March 30, 2008. Our cash and investment balance was $26 million at the end of Q1 compared with a balance of $36 million at the end of Q4. The decrease in cash was primarily related to the following; cash used in the quarter of approximately $10 million consisted of the following, $15.7 million used for operations, $3.2 million used for capital expenditure offset by $3 million received from investments including the joint venture and $5 million borrowed debt.

Our inventory balance at the end of Q1 was $120 million an increase from$106 million at the end of Q4 primarily due to a buildup of materials associated with our inability to meet our sales order commitments. CapEx of $3.2 million included investments in manufacturing and engineering equipment and IT infrastructure. We successfully completed the Oracle migration and integration of the last subsidiary at our recent acquisition during the first quarter. During Q1 we extended the $50 million term loan with Stevens for an additional two years.

Now, I'll give you our financial outlook for the second quarter and the full year. We expect that our Q2 2008 revenue will be in the range of $130 million to $135 million and that our loss will narrow to a range of $0.05 to $0.08. For full year 2008, we estimate revenue growth of around 8% to 10% as compared to 2007. We expect that our initiatives will benefit gross margin, reduce operating expenses and lead to a profitable second half of 2008. The net loss for 2008 is expected to be in the range of $12 million to $20 million.

At this time we would be glad to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Amit Daryanani from RBC Capital Market.

Amit Daryanani - RBC Capital Market

Thanks a lot. Guys, just a quick question to start off with. Looking at your Q2 guidance, $130 million to $135 million, how much of that has built in these revenues have been pushed from Q1 or delayed, but you have potentially recaptured in Q2? Could you just quantify that amount?

Jeff Kyle

Yes, Amit this is Jeff Kyle about $10 million is a part of missed shipments in the prior quarter.

Amit Daryanani - RBC Capital Market

That's helpful. When I look at the full year guidance you guys are talking about on the sales side 8% to 10% growth. Given kind of what you've done in Q1 and Q2 guidance would imply the back half almost growing by 24% - 25% almost versus the first half. Given all the macro consumes that are out there, what gives you the conviction that you should be able to hit those numbers?

Richard Thompson

Yes, Amit, looking at our demand coming from our customers we believe the momentum and renewable energy will certainly allow us to achieve those numbers along with the headway we're making particularly in servers and storage. So we have a very strong backlog, some very great products that we are bringing to market and we expect a strong second half.

Amit Daryanani - RBC Capital Market

Alright. And then just, if I flip that up into the last question, I'll hop off after that, but on the margin side you guys expected to lose about $15 million for the full year net loss. That would equate to actually generating a fair amount of net income in the back half. I realize a lot of the initiatives that you are going through should help you out. But the problem we've seen in the past is when you transfer a lot of work to Asia, for example, you end up having some inefficiencies and issues. Can you just kind of help me in this and again, why you have the conviction to give what at least looks like to me, a fairly aggressive full year guidance right now?

Richard Thompson

Sure. Basically the transition to Asia has been underway for quite some time. We were unsuccessful in Q1. We expect to have a large number of products through Q2 and Q3 into Asia. The plants are basically ready, we had difficulty getting customer approval, running successfully enough product samples to be able to satisfy the quality goals of our customers. But we have our customers in plant today in Asia and we believe that we'll be receiving approval shortly. So our teams are ready to go.

Obviously, the sending teams have a much easier job of moving the product. But we also have receiving teams that are in place. And even a product transfer to a plant is very similar to a new product introduction and the company has been successful with these processes in the past. So we're confident that we have the right processes and we have the right teams in place to affect the transfers in the coming two quarters. That should certainly take away the inefficiencies that we're experiencing today in our China plant. We'll certainly be absorbing in that fixed capacity.

It'll allow us to get to a better mix in DR and the rest of our plants. So, we're out of mix today in those plants. We're producing products in the Dominican Republic as an example that we normally wouldn't manufacture there which has caused inefficiencies, learning curves, as you mentioned and material issues. So, we feel, through our modeling we feel pretty comfortable about the gross margin for the year. Our root cause has certainly pointed to the actions we needed to take and we're now taking those actions.

Amit Daryanani - RBC Capital Market

All right. If I could follow that up and ask you, in absolute dollars, what sort of revenue base are you looking to transfer from North America or Europe to Asia?

Richard Thompson

Basically, the Asian plant will be up to $50 million to $60 million end product run rate by the end of the year.

Amit Daryanani - RBC Capital Market

What's it at today?

Jeff Kyle

Today it's in the low 20s, somewhere between $20 million to $22 million.

Richard Thompson

So we're talking about transferring the equivalent of $30 million annual run rate into our China factory.

Amit Daryanani - RBC Capital Market

Got it, alright. Thank you.

Richard Thompson

You are quite welcome.

Operator

Your next question comes from the line of Todd Cooper from Stephens, Inc.

Todd Cooper - Stephens, Inc.

Rich, if I look at your full year guidance I would suggest fourth quarter numbers in the neighborhood of revenues of $150 million and 25% gross margin just to get to the low end of your guidance of a loss of $20 million, if operating expense stay flat. Is that how we are going to look at that type of improvement?

Richard Thompson

Well Todd, as what we have said is we expect the margins by year end to be in the mid 20s. So I believe your math is correct.

Todd Cooper - Stephens, Inc.

And you do expect operating expense to be lower than the run rate they're at today?

Richard Thompson

Not appreciably, we expect operating expense to be ratchet down over the year as we fine tune our cost structures but the company is focused on operating expenses quite a bit over the last two years. So, there's still some to be had. As an example, emerging sales and marketing was not only a step to create efficiencies in the business, but it has some cost implications as well and lower costs. So we'll continue to take those actions as we see they can improve our business but I believe the OpEx right now is probably at the stage you'll see for the rest of the year.

Todd Cooper - Stephens, Inc.

Okay. One of the revenue growth drivers you talked about is your alternative energy or renewable energy and I think Jeff said $9.6 million in revenue in the first quarter and goal of 10% of revenues by the fourth quarter is that accurate?

Richard Thompson

That's correct. We're having significant ramp ups in that product as I mentioned in my comments. It's being well received particularly our focus in Europe, which is a largest market. So, we're really pleased with that product line. It was created by our scientists out of the Italian factory. We are servicing it today out of our factory in Italy.

Obviously, with that kind of growth, we will have to add on production. We haven't yet decided through a subcontractor or through our own plants. But it's a great opportunity. The run rate that we are seeing in Q2 is phenomenal. So, we have a lot of high confidence in those numbers.

Todd Cooper - Stephens, Inc.

Okay and also you talked about your digital strategy and how it's changed. But I really didn't pick up how it's different from what it was before you took over.

Richard Thompson

Okay. Sure, Todd. Basically a digital -- I think most of our investors had realized that our digital technology is salted throughout our products. It's in most of our topologies that we make in our products today. But as we look at the lawsuit and the, particularly the Z technology, we're going to focus very intently on getting a second source. As you know, for a product to be successful or a technology to be successful in this market you have to have a strong second source supplier. While we have Mirada who is our second source, they are an Asian producer we need to have one of the top names in power to be a second source.

And that's what our goal is. That's what will be a home run for us, while we will be inviting a competitor if you like into the arena, we'll certainly have the lead time to be successful and with our product knowledge we believe that it increases the opportunities dramatically.

Todd Cooper - Stephens, Inc.

And one last question, if I could and allow me to end on a bit more skeptical or cynical note. But some of the initiatives that you walked us through have been discussed for some time at Power-One like component cost reductions and squeezing cash out of working capital. I guess I don't now how to ask it but, what kind of assurance can you give us that we'll really see some improvements in these areas going forward?

Richard Thompson

Well, Todd, I think assurance is hard to give. We're going to have to -- you'll have to see it in performance over the next few quarters. But we certainly have the organization with a process which, as I joined the company I didn't see a process to achieve those goals in the past. We certainly now have understand what the root causes are. I had a difficult time finding any evidence of root cause analysis in the past. So we have root causes. We have corrective actions in place. We understand to achieve this we have to start doing less of something.

So the project teams are looking for non-value added activities which will allow the individual managers to focus on these projects. And lastly, we are empowering the project leaders. We've knocked down silos. We're encouraging and demanding teamwork from the organization and we have a program office which is monitoring these activities weekly meetings. This is now a focus, it's just not words. We're putting a lot of activity and action into it, and I believe it's done in an orderly fashion. We should be able to manage it through a successful completion. But as you pointed out, those are just words you're going to have to see our performance through the quarters.

Todd Cooper - Stephens, Inc.

Hey, Rich, thanks a lot.

Richard Thompson

You're welcome, Todd.

Operator

Your next question comes from the line of Yuri Krapivin from Lehman Brothers.

Yuri Krapivin - Lehman Brothers

Good afternoon.

Richard Thompson

Hi Yuri.

Yuri Krapivin - Lehman Brothers

So Rich, you talked about how you think about EPS progression during the year. How do you think about your cash load generation? When do you think you will turn positive in terms of operating cash flow?

Richard Thompson

Operations cash flow I think if you look through the statement and as you model us out for the second half of the year, I think it would probably put you into cash positive in the third quarter. You may even hit it the second quarter depending on our results. So, it depends on what measurement you use if it's just cash from operations or it's EBITDA, it's up to your calculation math. But we need to turn the tide really quickly. Our balance sheet needs to improve, and Jeff and his team is focused on that. Jeff is actually managing a multi-discipline team to work on inventory, receivables and to make sure payables is not a deterrent to us.

Yuri Krapivin - Lehman Brothers

Okay. With the respect to your inverter business, which I believe was sort of a stand alone operation within Power-One. Are the profit margins in that business satisfactory? Or is it suffering from supply chain and manufacturing inefficiencies as well?

Richard Thompson

No, the product margins are very healthy in that particular area. We are producing them in Italy which is as you compare it to other world class manufacturing, offshore manufacturing if you like, would be 8 or 10 points higher, as you would suspect. But the product line is profitable. We do need higher volume to get better absorption through the Italian plant. The engineering expenses associated with these products is for all intents and purposes has been expended to create the product set. We're going into a next-generation with higher megawatts of power with the same engineering force.

And the go to market cost is a little bit different. We're going to market to installers of these products and VAr's. It's a much different sell than any of our other products and we still have much to learn about how to go to market in this area. So overall, it is profitable for us. It can be much more profitable and it will be as we continue to grow the product line.

Yuri Krapivin - Lehman Brothers

And then based on what you said, you would expect that business to achieve sales of around $25 million by Q4 of '09?

Richard Thompson

Yeah, that's roughly what we're talking about in that order of magnitude. In the quarter we should be in that range.

Yuri Krapivin - Lehman Brothers

Okay. And then sort of going back to your inability to fulfill all orders in the first quarter.

Richard Thompson

Right.

Yuri Krapivin - Lehman Brothers

Are you facing a similar situation this quarter or do you believe you'll be able to meet all customer demand in the June quarter?

Richard Thompson

Well, we have to work through those issues. As Jeff mentioned we expected to ship approximately $10 million of what we didn't ship in the first quarter. So you can just infer from our numbers that was approximately $15 million of shipments that didn't happen that should have happened. So, we're focusing on ameliorating that backlog. It's not an acceptable position. While we should go for the perfect zero of past due backlog, in a more normal quarter it's probably $2 million to $5 million depending on the supply chain. So, we first of all have to satisfy our customers, our delivery to those customers who didn't receive their products is totally unacceptable. We recognize that. The fixing of the issue to get the margin up is obviously those three things I talked about.

We have to better anticipate the customer's need and be able to level load our plants. Secondly; we have to fix our supply chain issues immediately those mean the expedites have to stop. We have to be more predictive of our components which is back to planning. The material reductions will take longer than just a quarter or two. They have to be negotiated and put into place and those already in place have to be brought to the bottom line through inventory.

And lastly, we must get these transfers completed. That is really hamstringing us. We have capacity that's sitting in Asia ready to go. People who are waiting to work and we have to be able to get those product and that work to them. So a lot of moving parts and I apologize, but it is a complex manufacturing environment we have as a global supplier and we are though taking the actions we feel that'll start moving, margin up in Q2 and as we talked about through Q3 and excellent Q4 in the mid 20s.

Yuri Krapivin - Lehman Brothers

Okay. If you remove this $10 million from your Q2 guidance then you would be looking basically at flat sales year-over-year yet your bookings up 24%. Can you address that disconnect?

Richard Thompson

We probably have upside if we can cure our capacity issues. I didn't want to predict that we can cure them all this quarter. And we are being very careful how we commit to our customers going forward. We don't want to create situations where they are expecting our product and it doesn't arrive and they have line downs. So, we're being a bit cautious as we should be. I mean we had two difficult quarters in Q4 and Q1. So, we're trying to be reasonable with our expectations.

Yuri Krapivin - Lehman Brothers

Okay. And then finally, by end market your server storage business was down year-over-year. Is it because this inability to ship the product or does it have to do with the overall end market weakness, because if you listen to distributors Arrow and Avnet, now they both talked about relatively weak demand for servers in both North America and Europe.

Richard Thompson

Our servers were certainly -- our shipments to our server customers were down because of inability to perform. The actual orders from our customers were up. We are on some great programs with some really name brand customers. We happen to be on a few right programs and that was both a blessing and a curse and it was un-forecasted the demand ramp up and secondly we just didn't respond very well to our customer's needs. So, in our mind server and storage or at least in the data we see is actually up for our products. You mentioned distribution, our distribution sales were up in the quarter. We still have opportunities to better serve Arrow and Avnet in the future. We're actually past due with them as well on some products. You might expect that the standard products we ship to those customers usually lower volume, higher mix and they weren't immune from our shipment problems as well.

Yuri Krapivin - Lehman Brothers

Okay. Great. Thanks for your commentary, good luck.

Richard Thompson

Thank you, Yuri.

Operator

(Operator Instructions). You have a follow up question from Amit Daryanani from RBC Capital Markets.

Amit Daryanani - RBC Capital Market

Hey guys, just a couple of quick ones. First off, looking at the bookings number up about 25%. How much of that was that was root of FX, I mean I guess do you even break it out that way for yourselves?

Richard Thompson

No, we haven't broken that out but I'll ask Jeff to take a look at it, please and if we see anything we'll get back to you.

Amit Daryanani - RBC Capital Market

Alright. And then, one other things, you spoke about exiting down the road some low growth and lower margin products. What sort of revenue dollars are we talking about in terms of potential revenue line exiting current product lines?

Richard Thompson

Right, we're doing that work now, but there are a number of products that we have that are lower margin that we don't have an opportunity to review with the manufacturing and engineering to redesign as a reasonable investment to get a return. So, we'll be exiting those products in a very orderly fashion. What we're viewing though now, is can we exit product families? A product doesn't get all the cost out of your business you have to be able to get the unique components that are attached to a product line out of the business. So, we're looking at that carefully. I couldn't speculate what the revenue of that would be and our current view that you have of 8% to 10% we believe that we can absorb any discontinued product lines and still achieve that 8% to 10%.

Amit Daryanani - RBC Capital Market

Alright. I guess, Richard, someone asked you this question earlier in the call too, but maybe in a different way. There have been multiple false starts at the company in the past. Can you maybe just talk about why this one is going to be different and why we should be able to not have the same pitfalls as we've had? And I guess a by-product of that would just be, you spoke about you do not want to give assurances, but at the same time you are giving what looks like, again a fairly aggressive revenue and margin guidance. Why do that? why not just execute and hit the numbers and show that, rather than give this guidance today?

Richard Thompson

Well there is a lot of different approaches you can take into management. I think being bold with our statements and putting expectations on the organization is not anything that's bad, obviously. We are trying to drive ourselves to better performance. Having a stated goal in front of our investors is certainly, requires more of a commitment from our team. As to the comment about this sounds like a replay of some of the items in the past, I will just say that we're certainly better organized as I shared with you earlier, we looked at root causes this time. We had extensive work behind it. We had two extensive meetings where we got the team together, went through identification of root causes, where we were, how did we get here? Where do we want go and how are we going to get there? We spent a lot of management time with a grass roots organization from the bottom of the organization all the way through middle management and to top management.

So, these are not just pushed down directives, they come from the shop floor. They come from the salesman in the street. They come from the engineer on the design board. So, we believe we have a very committed organization and we believe we have the processes identified and frankly, now it's execution. That's an easy few syllable word but it's very hard to accomplish. And that's what the men and women at Power-One are now about.

Amit Daryanani - RBC Capital Market

Fair enough. Best of luck.

Richard Thompson

Thank you very much.

Operator

(Operator Instructions).

Richard Thompson

Okay. Without any more questions, I want to thank you for listening to our call and asking those questions. We'll certainly do our best to perform. That's what we're getting paid for. And we hope to be able to announce in the next call progress to each one of these goals. Thank you for your investment and thank you for your time.

Operator

This concludes today's conference. You may now disconnect.

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Source: Power-One Q1 2008 Earnings Call Transcript
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