Kristyn Hutzell – IR
Richard Thompson – CEO
Jeff Kyle – CFO
Todd Cooper – Stephens Inc.
Power-One, Inc. (PWER) Q2 2008 Earnings Call Transcript July 24, 2008 5:00 PM ET
Good day ladies and gentlemen and welcome to the Power-One second quarter 2008 teleconference. At this time all participants are in a listen-only mode. We’ll facilitate a question-and-answer session towards the end of today’s conference. If at any time during the call you require assistance, please key star followed by zero and a coordinator will be happy to assist you. I would now like to turn the presentation over to your host for today’s conference, Miss Kristyn Hutzell with Investor Relations. Please proceed.
Good afternoon, everyone. Thank you for joining us today to discuss Power-One's 2008 second quarter results. Joining me today are Richard Thompson, Chief Executive Officer and Jeff Kyle, 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 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 results as discussed or information provided in the forward-looking statements. We refer you to the company's reporting documents 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, Rich.
Thank you, Kristyn. Good afternoon and thank you for joining Power-One for our second quarter 2008 financial results conference. I will begin this call with a review of the company's performance during the quarter and then provide an update on recent developments and the progress we are making in our recovery plans.
After my remarks Jeff Kyle, our Chief Financial Officer will provide greater detail on the financial results for the second quarter and our outlook for the third quarter and full year. We'll then be happy to address your questions.
Today we reported net sales of $149 million for the second quarter 2008, up 21% versus a year ago and a net loss of $0.04 per share, which represents a significant narrowing of our loss of $0.13 in the year-ago quarter, which included $0.03 in restructuring and impairment charges. The results exceeded the guidelines we provided at the end of the last quarter and reflect higher-than-expected demand and the impact of our first steps in our recovery plans.
During the second quarter growth was strong across our core markets with higher sales in networking, telecommunications and server customers and significantly higher sales of our renewable energy products. We saw strong turns business and also shipped approximately $4 million in net past due orders. During the quarter there was approximately $5 million in new project ramp-up revenues, which was higher than our normal expectations for product launches. Booking during the quarter remained relatively strong particularly in renewable energy, however we are seeing some softness from specific North American customers.
Second quarter gross margin improved 240 basis points from Q1, this increase resulted from higher volumes as well as component cost savings we realized during the quarter. Adversely impacting the gross margin were continued operating inefficiencies and expedite cost to ship past due orders. Our margins are moving in the right direction but we have a lot of work in front of us. Jeff will step through the P&L in detail later in the call and I will now give you a progress report on our profitability initiatives.
On our conference call last quarter I outlined four key initiatives that we are implementing to improve operational and financial performance. I will now discuss the six-month goal and let you know how we are going to achieve them.
Our first initiative is to grow revenues faster than the market and our goal is to increase revenue by 8% to 10% this year. While the economic environment in North America is impacting some of our customers’ expectations, we continued to see strength in many areas and we are taking actions internally that are expected to boost revenue growth. Key to the higher growth are our efforts to reshape the company’s market focus. Specific actions include exit slow growth markets, increasing the profitability of low margin products or pealing [ph] them out of product offerings, greatly improving customer service and converting our leading-edge technology and the best-in-class solutions for our customers’ power needs.
During the quarter we took actions to exit the white goods market, which includes our digital motor control products. We will honor our current contractual commitments but will no longer seek new business in similar applications. This action will free up production capacity to address customer demand in the computer and office equipment market, largely in file servers and storage applications. Additionally, we are exiting lower margins, lower growth industrial markets. We will continue to address these markets with standard and in some cases modified standard products through alternative channels.
In the second quarter, we continued to introduce products that offer higher efficiency and they are lower the user’s cost of operations geared to the growing worldwide demand for greener solutions. We enjoy technology advantages in the high efficiency products and continue to make the investment to stay in the lead. We introduced leading edge, front end AC to DC products with best-in-class efficiencies specifically aimed at storage and server markets. We also launched the next-generation rectifier platform with very high efficiency for network carriers.
To better serve the high growth renewable energy market, we launched five new inverters in the Aurora product family. Our new 10kW and 12kW photovoltaic string inverters, which we expect to significantly ramp up in Q3 will complete a full range of products from 1.5kW to 300kW. We are seeing significant interest in these products in Central Europe as they are well suited to fill a sweet spot in the current residential and small business markets. In addition we are designing inverters for use in wind applications and expect to introduce these products next year. Our increased focus on renewable energy markets should continue to drive topline growth.
Our second initiative is to significantly improve gross margin and our goal is to achieve gross margin in the mid 20s by year end. The 240 basis point improvement in Q2 is the beginning of profitability improvements from the implementation of our initiatives to address operating inefficiencies and higher manufacturing costs. We believe we are on track to achieve this goal this year. We are working to position China as our high volume factory, utilize Asian manufacturers when appropriate and better utilize our high mix low-volume plant in the Dominican Republic.
During the quarter our efforts to transfer production to China was delayed by approval process of some of our customers. This is taking longer than we originally thought but we expect to catch up in the second half of the year. We continue to consolidate our material spend with fewer vendors through the vendor reduction program which was implemented at the beginning of the quarter. Additionally, we are reducing sole source components to help reduce our material spend and improve on-time delivery. We also reviewed our vendor relationships, increased efforts to qualify vendors closer to our manufacturing plants. This will help to reduce shipping and handling expenses while significantly improving component availability and reducing inventory. We are working hard towards our goal to have all our vendors within 100-mile range of our China plant. Longer term, our goal is to reduce the number of components we use from over 40,000 to less than 10,000 over the next few years with initial progress as early as Q4 this year.
Our third initiative is to improve on-time delivery to our customers and during the second quarter we continued to implement specific actions. While we made progress shipping past due orders during the quarter, we felt only modest improvement in our ability to ship to our customers on time. We remain however committed to our goal of quickly improving on-time delivery to 90% or higher. This is one of our most difficult challenges due to the multiple corrective actions required. New supplier manage inventory programs are targeted in Asia during the third and fourth quarters to support the ramp up in China. In the area of demand planning, we initiated an (inaudible) process on limited scope in July which will enhance our demand management and supply planning processes and expect to integrate this process throughout Power-One in Q4. In order to improve master scheduling we are implementing features in Oracle to allow level loading and balance capacity through all of our four plants and on our EMS partners. Our goal is to operate each plant of 85% of capacity in order to create flexibility to address unforecasted customer demand. Corrective actions to the supply chain which we outlined in our gross margin discussion will also help improve on-time delivery.
Our final initiative is to increase working capital efficiency. Jeff will review changes in working capital in detail. During the quarter our working capital investment measured in days working capital improved to 90 days from 104 days in Q1. We made progress on our receivable collection efficiency, which drove a modest improvement in the quality and ageing of our receivables. We also saw inventory turns improve slightly but our investment in inventory remains unacceptably high. We are changing our business processes to actively manage these areas to generate cash to support our initiatives and strengthen our balance sheet.
Additionally we announced in June a $75 million convertible notes offering. The note proceeds were used to repay in full our previous existing long-term debt and effectively lowered our interest rate while increasing terms from 2 to 5 years. Jeff will explain why we chose to refinance now as well as outline the general terms of the deal and its impact on the P&L and balance sheet.
Now, let’s discuss the increasing opportunity we are seeing in the renewable energy inverter market. While this market is still in its infancy, it is estimated that total available market for solar inverters will be $1.3 billion in 2008 and currently growing over 30% a year. Additionally inventers in the wind market are expected to be $1.1 billion. At the current time the market for our products is largely in Europe where governments are driving adoption of alternative energy by offering subsidies and putting into effect a variety of regulations that are stimulating the adoption of greener power. We continue to broaden our reach in many European countries including Germany, Italy and Spain. During the quarter, we strengthened our renewable energy sales and service team in Germany in order to address a growing market demand for our products in that country. Our ability to be flexible and scale our operations in this market allows us to quickly implement product innovations. Our products range from 1.5kW to 300kW are both grid and off-grid and address both solar and wind while most companies in the market address either solar or wind but generally not both. As I discussed earlier, this quarter we introduced five new products in renewable energy. We plan to introduce more products including 100kW to 300kW products for the commercial market in the US. Our inverters deliver over 96% efficiency over an extremely wide operating range and we have a very broad product portfolio.
Power-One currently has a small market share in inverters for renewable energy. We estimate it as under 5% of the worldwide market for solar and wind which we regard as an enormous opportunity. By making investments in engineering and infrastructure and also through strategic partnerships, we believe we will double this business each year for the next several years. We expect that this market at the end of 2008 will have a revenue run rate of more than 10% of our sales and sales in 2009 will surpass the $100 million mark.
In the digital power market, we are now actively working to monetize our IP and secure additional second sources for our technology as we discussed last quarter. Our digital technology is incorporated in most of the topologies that we use in our existing product line. While we have every intention to continue to actively pursue this market, in order for our products to be successful we must first have a strong second source partner. There is still significant progress to be made in our strategic initiatives but our processes to improve the operational performance and drive long-term growth and profitability are in place. We believe we are on track to recovery and look optimistically towards continued improvements in Q3.
I will now turn the call over to Jeff for a detailed discussion of Q2 financials and guidance for Q3 and the full-year 2008.
Thank you Rich. During the second quarter of 2008, we recorded revenue of a $149.3 million, an increase of 21% from last year's Q2 revenue of $123.8 million and a loss of $0.04. These results were above our original guidance at a range of $130 million to $135 million with a loss of $0.05 to $0.08. The better-than-expected results were driven by strength in most of our markets with particular strength in the renewable energy market as well as some unanticipated demand from certain customers. We also fulfilled from past due orders which further contributed to the strong results.
Sales to the communication market were $59 [ph] million or 47% of sales compared with $61 million or 49% of sales during Q2 of last year, up approximately 14% year over year. Instrumentation and industrial market sales were $21 million or 14% of sales compared with $28 million or 23% of sales in the same period last year down 24%. This is not a target market for us and we are not presenting new business in most of the areas that make up this market. Sales to the server, storage and computer market were $17 million or 12% of sales compared with $17 million or 14% of sales during the same quarter last year, up approximately 4%. Other markets were $41 million or 27% of sales compared with $18 million or 14% of sales during Q2 of last year, up approximately 132% year over year driven primarily by renewable energy. Sales to OEMs in Q2 were $110 million or 74% of total sales compared with last year’s Q2 sales of $94 million or 76% of total sales. The top 10 OEM customers in Q2 accounted for $64 million or 43% of total sales. No customer during Q2 was greater than 10% of sales. Sales to service providers were $10 million or 6% of sales compared to $7 million or 6% of sales in Q2 of last year. Sales to distributors were $29 million or 20% of sales, an increase from $23 million or 18% of sales during the same quarter last year.
By geography Q2 sales were as follows, 26% in North America, 49% Europe, and 25% Asia versus 32%, 43% and 25% respectively in Q2 2007. Europe was up 42% year over year, Asia 17% and North America was down 4%. Our 90-day backlog at the end of Q2 was $107 million an approximately 16% increase from Q2 2007 90-day backlog of $92 million. Net bookings for the quarter came in at $149.3 million an 18% increase over last year's second quarter bookings of $126.9 million.
Our consolidated gross profit in Q2 was approximately 20.5% of sales, a slight decrease from the gross profit margin of 20.8% for last year's second quarter. While the gross margin improved from the first quarter 2008, it continued to be impacted by operating inefficiencies and high manufacturing costs as Rich discussed.
SG&A expenses of $18.8 million were roughly flat with SG&A in the second quarter of last year and were 13% of sales versus 15% of sales in last year’s Q2.
Engineering and quality assurance expenses for the quarter decreased 6% year over year to 8% of sales from last year’s Q2 levels of 10% due to our restructuring efforts implemented during 2007.
We recorded approximately $3.2 million in interest expense versus $1.8 million in the year-ago quarter. This quarter included interest charges of approximately $0.9 million to write off unamortized debt issue cost and SG&A included $0.2 million of fees related to the refinancing. The effective interest rate on the notes we issued during the second quarter is 9.3%. For the second half of 2008, our total interest expense per quarter would be approximately $2.2 million. Let me note that these numbers may fluctuate with debt balances, interest rates and other factors.
Other income expenses was an expense of approximately $1 million versus income of approximately $0.5 million in Q2 ’07. Included in the other expense was approximately $1.2 million of charges related to the write-off of certain investments offset by approximately $0.3 million gains related to foreign currency fluctuations. Our consolidated tax position for the quarter was approximately $0.2 million primarily related to our profitable European locations. Dividend income and equity in earnings related to our Asian joint venture were $0.9 million after tax.
Net loss for Q2 was $3.9 million or $0.04 per share versus $11.1 million or $0.13 per share which included $0.03 of restructuring and impairment charges in the same quarter a year ago. CapEx was approximately $2 million included investments in manufacturing, engineering equipment and IT infrastructure. Our cash and investment balance was $38 million at the end of Q2 compared with a balance of $26 million at the end of Q1.
Now I would like to discuss working capital. As you know, one of our initiatives is to improve working capital and we have a number of projects currently running at lower cash used of the working capital. This quarter we made slight progress on days receivables and inventory turns. DSOs were approximately 90 days down from 94 days in Q1. This was a net improvement of 4 days despite a significant increase in sales in Europe and Asia where payment terms are approximately 30 days higher on average. Our inventory balance at the end of Q2 was $124 [ph] million roughly flat with a $119.7 million at the end of Q1 and turns improved very modestly from 3.4 to 3.9. We were not able to significantly improve our turns this quarter due to inventory required to support new product introductions for our customers in the renewable energy and service storage market as well as material and work in progress that was delayed transferring to China.
We believe that as we achieve manufacturing efficiencies and execute various supply chain initiatives, turns will improve to a much greater extent. Payables at the end of Q2 were $121 million versus $107 million at the end of Q1 and are consistent with timing and level of purchases during the quarter. As you know in June, we announced the pricing of $75 million worth of convertible senior notes. After fees and repayment of $50.3 million to PWER Bridge for principal and interest, the net proceeds from the offering were approximately $20 million. The balance will be used for working capital and ongoing corporate expenses. You can see this transaction reflected on the long-term debt line of our balance sheet, which at the end of Q2 was $76 million versus $50 million at the end of Q1.
Now, I would like to offer you guidance for the third quarter and full year 2008. We expect that our Q3 2008 revenue will be in the range of $140 million to $145 million, lower than our second quarter revenues primarily due to what we anticipate will be weaker demand from some of our North American customers, no significant repeating ramp ups and seasonal softness in Europe. Based on our continued implementation of profit improvement actions, despite the lower revenues we forecasted our loss will narrow slightly from Q2 to a range of breakeven to $0.03 loss per share.
For full year 2008, we continue to estimate revenue around 8% to 10% as compared to 2007. We expect that our key initiatives will continue to benefit gross margin, reduce operating expenses and lead to a profitable second half of 2008. We continue to expect that the net loss for 2008 will be in a range of $12 million to $20 million.
At this time we would be glad to answer your questions.
(Operator instructions) Your first question comes from the line of Todd Cooper with Stephens Inc. Please proceed.
Todd Cooper – Stephens Inc
Yes, good afternoon Rich and Jeff.
Good afternoon Todd.
Todd Cooper – Stephens Inc
Did you release or give the backlog and book-to-bill numbers?
Yes, the numbers should be actually in the press release on the wire.
The backlog was at $107 million, that is a 90-day backlog compared to $92 million a year ago Todd. Book-to-bill was 1 to 1.
Todd Cooper – Stephens Inc
Okay. What is the Asian JV that is on the income statement?
Yes, sure Todd. The Asian JV is part of a prior business acquisition in 1999. The company acquired the JV as part of purchase of another company and the JV is supporting both Power-One products and outside products. The JV has been accounted for on the equity message since the inception in the ’99 timeframe that we have been writing off the income associated with that due to concerns about the quality of the product and other issues around the JV. During last quarter we actually received a declaration of dividend and changed the accounting that we were practicing on the JV and we stopped writing off our share of the income. So, last quarter we recognized $1.2 million that went through the income statement and this quarter income is a function of dividend last year for all of 2007 and our share of the equity income year to date for 2008.
Kyle, let me just add a bit, the JV is with a Chinese government agency. We are a 49% holder. Basically the product going through there from Power-One is mid volume AC to DC and DC to DC products. So, it’s been a very successful relationship as of late for us certainly and it is flexible capacity. We’re approximately 30% of the JV’s volume, so there are quite a few other folks in there and as I said earlier it appears to be a better [ph] relationship as we go forward.
Todd Cooper – Stephens Inc
But it is in China, it is not a facility in Malaysia?
No, it is in China. The Malaysian facility is a contract manufacturer called BCM. They do our DC to DC products as well.
Todd Cooper – Stephens Inc
Okay. Let me switch to alternative energy. How does the margin profile of those products compare to your other products?
Right, we have not disclosed that but I think the margins are substantially higher in the renewable energy as you would expect for an embryo industry. So, the profile is quite good. We manufacture those products in Europe which is close to the market where we are delivering them and it is quite a different product as you can imagine. Our main products are either board matter or shoe box size AC to DC with the exception of the power systems that go into the carriers. These are very large products and very different manufacturing skills required.
Todd Cooper – Stephens Inc
You started out with just residential offering and I know you have added a commercial, so is the demand you are seeing coming from both or is it skewed more towards residential than commercial?
Well, it’s both Todd. Those products as you know, particularly the ones we recently announced 10kW and 12kW, they are meant for both residential and small businesses, obviously stringing them together we can go up to 300kW which would be larger businesses. Today our revenue profile is about 40% business and about 60% residential. We would expect over time that particularly through the subsidies the government offer that that would change slightly that residential would actually become more important to us. That’s why our road map was targeted more at those residential inverters early on.
Todd Cooper – Stephens Inc
With the way that that piece of the business is growing, I know you are targeting 25% type gross margin by the end of the year, does that raise your longer term goal for gross margins substantially?
Well, it certainly does. We haven’t forecasted 2009 or given a forecast to our investors Todd but that would make sense obviously, the logic behind it is higher percentage of our revenue stream i.e., with the higher gross margins the tide would lift the whole boat. So, we are very enthusiastic about this. We do expect at some time in the future to have more a price competition but we don’t see that in the market today and we don’t expect to see significant price competition for quite a few quarters out.
Todd Cooper – Stephens Inc
Okay, thanks and good job. It was nice for the upside surprise this afternoon.
Well thank you very much. As you know, one of our key initiatives are what is driving our activities today in the company and we expect those to help us deliver more consistent results to our investors over time.
Todd Cooper – Stephens Inc
Okay, that’s been a challenge in the past. So, let’s see another one next quarter.
Okay, thank you for the encouragement.
Thank you Todd.
You have no further questions at this time.
Okay, great. Thank you and we hope to have all of our investors on the call in the next quarter. Thank you very much.
Thank you for your participation in today’s conference. This concludes the presentation, you may now disconnect. Good day.