April 03, 2000
POWER ONE INC (PWER)
Annual Report (SEC form 10-K)
ITEM 7-- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION IN CONJUNCTION WITH OUR FINANCIAL
STATEMENTS AND THE RELATED NOTES. IN ADDITION TO HISTORICAL INFORMATION, THE
FOLLOWING DISCUSSION AND OTHER PARTS OF THIS ANNUAL REPORT CONTAIN
FORWARD-LOOKING INFORMATION THAT INVOLVES RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY FORWARD-LOOKING
INFORMATION DUE TO FACTORS DISCUSSED UNDER "RISK FACTORS," "BUSINESS" AND
ELSEWHERE IN THIS ANNUAL REPORT.
GENERAL
We are a leading designer and manufacturer of more than 2,500 high-quality brand name power supplies. We sell our products both to OEMs and distributors who value quality, reliability, technology and service. We have more than 10,000 customers in the communications, industrial, automatic/semiconductor test equipment, transportation, medical equipment and other electronic equipment industries.
We were founded in 1973 as a manufacturer of AC/DC power supplies and until 1981 operated solely from our Southern California facility. During the 1980s, we established additional operations in Puerto Rico and Mexico to take advantage of certain labor, manufacturing and, in Puerto Rico, tax efficiencies. Between 1994 and 1996, we moved most of our Puerto Rico manufacturing operations to the Dominican Republic to capitalize on certain labor benefits. In September 1995, Stephens Group, Inc., an affiliate of Stephens Inc., and our management purchased Power-One from its previous owners and formulated a more aggressive growth strategy, which included a plan to grow through acquisitions.
In August 1998, we increased our international presence and our product offerings by acquiring Melcher for $53 million, including debt assumed. In January 1999, we further broadened our DC/DC product offerings by acquiring IPD for $32 million, including certain capitalized lease obligations and other indebtedness of IPD.
All references herein to Power-One and to operating data for 1998, include four months of Melcher's operations. For 1999, financial results are consolidated to include both Melcher and, for 11 months, IPD.
The years ended December 31, 1997 and 1998 represent 52-week years and the year end December 31, 1999 represents a 53-week year. The following table sets forth, for the periods indicated, certain Consolidated Statements of Operations data as a percentage of net sales for the periods presented:
1997 1998 1999
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Net sales.............................................. 100.0% 100.0% 100.0%
Cost of goods sold..................................... 59.6 61.9 58.5
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Gross profit........................................... 40.4 38.1 41.5
Selling expense........................................ 8.8 11.5 10.7
General and administrative............................. 7.3 8.1 8.3
Engineering expense.................................... 4.2 6.1 7.1
Quality assurance expense.............................. 2.2 1.9 1.8
Amortization of intangibles............................ 2.2 2.6 3.0
In process research and development.................... 0.0 0.0 1.6
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Income from operations................................. 15.7 7.9 9.0
Interest income........................................ 0.4 1.4 0.4
Interest expense....................................... (3.4) (0.8) (1.5)
Other income (expense)................................. (0.0) (0.6) 0.1
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Income before income taxes............................. 12.7 7.9 8.0
Income taxes........................................... 3.8 2.3 3.1
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Net income............................................. 8.9 5.6 4.9
Preferred stock accretion and dividends................ 1.7 0.0 0.0
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Net income to common stockholders...................... 7.2% 5.6% 4.9%
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YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31, 1998.
NET SALES. Net sales increased $102.9 million, or 100.4%, to $205.4 million for 1999 from $102.5 million for 1998. Included in net sales for 1999 are $43.6 million from Melcher, and $61.3 million from IPD. The main contributors to the $102.9 million increase in net sales were DC/DC power supplies which contributed $85.0 million, low-range power supplies, which contributed $12.2 million, custom power supplies, which contributed $5.2 million, and high-range power supplies, which contributed $3.9 million. These increases were partially offset by declines in our linear power supplies of $4.0 million. Most of the growth in the DC/DC business was derived from strong order flow from the communications market, which includes datacommunications and network equipment manufacturers such as Cisco, Nortel, Lucent Technologies and Newbridge Networks who are among our top customers. On the AC/DC side, the automatic/semiconductor test equipment market continued to expand with key customers such as Teradyne rebounding during 1999. We also experienced solid growth in other key markets such as industrial and transportation.
Net sales to OEMs for 1999 were $159.1 million, or 77.5% of net sales, an increase of $97.3 million or 157.4% over the comparable period in 1998, when net sales to OEMs represented 60.3% of net sales. Net sales to Cisco represented 16.0% of net sales in 1999. Cisco was the only customer that exceeded 10% of net sales in 1999. Net sales through distributors for 1999 were $46.3 million, or 22.5% of net sales, an increase of $5.6 million or 13.8% compared to the same period in 1998, when such net sales represented 39.7% of net sales. The lower percentage of net sales through distributors in 1999 is primarily due to the change in the mix of our customer base which, compared to last year, has shifted more toward OEM customers in the communications market.
Our recent acquisition of IPD has significantly broadened our customer base by increasing net sales to key OEMs and adding new OEMs in the communications market.
Net sales by markets for the years ended December 31, 1998 and 1999 were:
1998 1999
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Communications.............................................. 21% 49%
Industrial.................................................. 27% 18%
Automatic/Semiconductor test equipment...................... 19% 11%
Transportation.............................................. 4% 7%
Medical equipment........................................... 11% 6%
Computer, Retail and Other.................................. 18% 9%
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Total....................................................... 100% 100%
The changes in the percentage of our net sales by market are primarily due to a significantly larger concentration of net sales to the communications and transportation markets.
During 1999, demand for our products increased significantly, especially in the second half of the year. Our combined backlog on December 31, 1999 was $58.0 million, an increase of 125.0%, compared to backlog of $25.8 million on December 31, 1998. Pro forma backlog, which assumes IPD's backlog was in place at December 31, 1998, increased 90.8% at the end of December 1999 as compared to year-end 1998. For the quarter ended December 31, 1999 we experienced a strong bookings trend with $62.9 million in new orders taken. Much of this growth comes from strong demand in the communications market, which is primarily driven by datacommunications and network equipment manufacturers, as well as increased demand of our high-power product line, which are typically sold to the automatic/ semiconductor test equipment market.
GROSS PROFIT. Gross profit increased $46.1 million, or 118.1%, to $85.2 million for 1999 from $39.1 million for 1998. As a percent of net sales, gross profit increased to 41.5% for 1999 from 38.1% for the same period in 1998. The increase in gross profit margin primarily resulted from the inventory write-up related purchase accounting adjustments due to the Melcher acquisition which negatively impacted the prior year period. Excluding the non-recurring adjustments related to our acquisitions of IPD in 1999 and Melcher in 1998, our gross profit margin would have been approximately 41.8% in 1999 and 40.9% in 1998. The improved profit margin in 1999 is primarily due to the increase in net sales which allowed us to better leverage our fixed manufacturing expenses.
SELLING EXPENSE. Selling expense increased $10.2 million, or 86.4%, to $21.9 million for 1999 from $11.8 million for 1998. As a percent of net sales, selling expense decreased slightly from 11.5% in 1998 to 10.7% in 1999. The increase of $10.2 million was primarily due to the additional selling expense related to Melcher and IPD of $3.9 million and $4.9 million, respectively. Excluding Melcher and IPD, Power-One's core selling expense increased $1.4 million primarily due to higher employee costs of $322,000, and increased freight and travel expense aggregating $693,000, to support the increase in business growth during 1999.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased $8.7 million, or 104.7%, to $17.0 million for 1999 from $8.3 million for 1998. As a percent of net sales, general and administrative expense increased slightly to 8.3% in 1999 from 8.1% in 1998. The increase of $8.7 million was due to additional administrative expense related to Melcher and IPD of $1.9 million and $2.5 million, respectively, as well as an increase of $4.3 million in our core administrative expense. The increase in our core administrative expense of $4.3 million was primarily due to higher employee costs of $1.8 million related to an increase in staff, employee performance bonuses and temporary help; increased depreciation expense of $835,000 primarily related to the Oracle ERP project and other capital expenditures; higher professional fees of $521,000; increased insurance expense of $242,000; and increases in other general operating expenses such as travel, utilities and office supplies expenses.
ENGINEERING EXPENSE. Engineering expense increased $8.2 million, or 131.3%, to $14.5 million for 1999 from $6.3 million for 1998. The increase of $8.2 million was primarily due to Melcher's and IPD's additional engineering expense of $3.0 million and $4.2 million, respectively. In addition, Power-One's core engineering expenses increased $1.0 million primarily due to a $751,000 increase in employee costs and a $108,000 increase in product development expenses. As a percent of net sales, engineering expense increased to 7.1% for 1999 from 6.1% for 1998. This increase is directly attributable to our commitment to make strategic investments in support of our future growth.
QUALITY ASSURANCE EXPENSE. Quality assurance expense increased $1.8 million, or 88.4%, to $3.8 million for 1999 from $2.0 million for 1998. As a percent of net sales, quality assurance expense decreased slightly from 1.9% in 1998 to 1.8% in 1999. The increase of $1.8 million was primarily due to additional quality assurance expense related to Melcher and IPD of $378,000 and $710,000, respectively, as well as an increase of $687,000 in our core quality assurance expense primarily related to increased employee costs.
AMORTIZATION EXPENSE. The amortization of intangibles increased $3.6 million, or 136.6%, to $6.2 million for 1999 from $2.6 million for 1998. As a percent of net sales, amortization of intangibles increased to 3.0% for 1999 from 2.6% for 1998. The increase is attributable to a $1.0 million charge taken to write-off the unamortized balance of the intangible asset value of a technology and licensee agreement related to substantially similar product technology acquired as a result of the IPD acquisition. The balance of the increase is due to 11 months of amortization of intangibles initially recorded upon the acquisition of IPD on January 29, 1999 totaling approximately $1.6 million, as well as an additional $1.1 million of amortization of intangibles related to the Melcher acquisition.
IN-PROCESS RESEARCH & DEVELOPMENT. In connection with the IPD acquisition, we recorded a one time charge of $3.3 million for purchased in-process technology that had not reached technological feasibility.
INCOME FROM OPERATIONS. As a result of the above factors, income from operations increased $10.4 million, or 128.1%, to $18.5 million, or 9.0% of net sales, for 1999 from $8.1 million, or 7.9% of net sales, for 1998. Excluding non-recurring items totaling approximately $5.1 million in 1999 consisting of inventory fair market value write-up of $0.8 million, in-process research and development charge of $3.3 million and write-off of $1.0 million technology and license agreement, all of which were related to the IPD acquisition, and $2.9 million in 1998 for the inventory fair market value write-up related to the Melcher acquisition, income from operations would have been $23.5 million, or 11.5% of net sales, in 1999 and $11.0 million, or 10.7% of net sales, in 1998.
INTEREST INCOME. Interest income decreased $0.6 million, or 42.5%, to $0.8 million for 1999 from $1.4 million for 1998. This decrease was primarily related to the reduction in short-term, interest bearing financial instruments as a result of the available cash used for the Melcher acquisition in the third quarter of 1998. This decrease was partially offset by interest earned on proceeds from the sale of our stock in September and October 1999 which were invested in short-term, interest bearing financial instruments.
INTEREST EXPENSE. Interest expense increased $2.3 million, or 282.9%, to $3.1 million for 1999 from $0.8 million for 1998. The increase was primarily due to advances under our credit facilities to finance the IPD acquisition, as well as additional investments in facilities and capital equipment to increase our capacity to support the rapid growth of our business. This increase was partially offset by the repayment of $54.1 million of outstanding debt under our credit agreement with Bank of America, N.A. using the proceeds from the sale of our stock in September and October 1999.
OTHER INCOME (EXPENSE), NET. Other income increased $934,000, to $307,000 for 1999, from other expense of $627,000 for 1998, and is primarily due to gains on foreign currency transactions partly offset by net losses on disposals of fixed assets.
INCOME TAXES. The provision for income taxes increased $4.1 million, to $6.5 million for 1999, from $2.3 million for 1998. The effective tax rate of 39.1% in 1999 is significantly higher than the 28.9% in 1998. This is primarily attributable to the $3.3 million charge for in-process research and development and $1.6 million amortization of goodwill related to the IPD acquisition, both of which are not deductible for tax purposes.
YEARS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997.
NET SALES. Net sales increased $9.5 million, or 10.2%, to $102.5 million for 1998 from $93.1 million for 1997. The increase in net sales resulted primarily from a $18.8 million contribution from Melcher since the date of acquisition, as well as strong growth in unit shipments of standard and modified standard power supplies, particularly in high-range power configurations, during the first half of 1998. Including Melcher's results, the principal contributors to the $9.5 million increase in net sales were DC/DC power products, which contributed $14.1 million in net sales, and low-range power products, which contributed $4.4 million. These increases were offset by declines in linear and custom power products of $3.4 million and $3.9 million, respectively, and decreases in all other product lines of $1.7 million, net. Excluding Melcher, our net sales decreased $9.4 million, or 10.1%, to $83.7 million in 1998 from $93.1 million in 1997. This was primarily due to the general slowdown in demand for products within the electronics industry, as well as domestic inventory reductions at OEMs, including some of our customers, in the second half of 1998.
Net sales to OEMs for 1998 were $61.8 million, or 60% of net sales, an increase of $9.9 million or 19.0% over the comparable period in 1997, when net sales to OEMs represented 56% of net sales. Net sales through distributors for 1998 were $40.7 million, or 40% of net sales, a decrease of $0.4 million or 1.0% compared to the same period in 1997, when such net sales represented 44% of net sales. As a result of the Melcher acquisition, our OEM net sales to the communications and transportation markets increased $7.1 million and $3.6 million, respectively.
Our total backlog on December 31, 1998 was $25.8 million, which is comprised of Power-One's backlog of $13.4 million and Melcher's backlog of $12.4 million. Power-One's backlog stood at $32.2 million on December 31, 1997.
Beginning in the three month period ended June 30, 1998, demand for products slowed significantly within the electronics industry. This was the result of a softening trend in capital equipment markets, which in turn has been negatively influenced by weak demand due to the business recessions in various Asian economies, as well as an overall slowing in global economic activities. Demand for our products was further weakened by domestic inventory reduction initiatives at OEMs and distributors, including some of our customers. The contribution of Melcher, which sells primarily into the European market, more than offset the decline in our North American business. We expect that the Melcher acquisition will continue to have a positive impact on our overall business growth, particularly in data communications and telecommunications.
To counter the impact of the soft business climate in 1998, management pursued action steps to position us for increased growth in 1999. Some of these initiatives included actively pursuing new business synergies with Melcher in the areas of sales and cost reductions; aggressively pursuing acquisitions which culminated in the acquisition of IPD on January 29, 1999; and providing for additional investment in research and development. Additionally, we made significant progress to further upgrade our core business systems with the implementation of a new Oracle ERP system. Although this fully integrated Oracle ERP system is Year 2000 certified, the key reasons for implementing the new system are to further enhance our technical infrastructure by providing to management the tools available in a
new generation of systems and software to speed information retrieval; to position us for business growth; to facilitate business integration of acquired companies; and to provide a clearer audit trail for the source of information.
GROSS PROFIT. Gross profit increased $1.5 million, or 4.0%, to $39.1 million for 1998 from $37.6 million for 1997, which is primarily due to the inclusion of Melcher's gross profit since the date of the acquisition. As a percent of net sales, gross profit decreased to 38.1% for 1998 from 40.4% for the same period in 1997. The decline in gross profit margin primarily resulted from the inventory write-up related purchase accounting adjustments related to the Melcher acquisition. Excluding the Melcher related inventory fair market value purchase write-up adjustments, gross profit margin would have been 40.9% in 1998 and 40.4% in 1997.
SELLING EXPENSE. Selling expense increased $3.6 million, or 43.6%, to $11.8 million for 1998 from $8.2 million for 1997. The increase of $3.6 million is primarily due to the inclusion of Melcher's selling expense of $3.6 million since the date of acquisition. Excluding Melcher, selling expense was unchanged at $8.2 million compared to the prior year. As a percent of net sales, selling expense increased to 11.5% in 1998 from 8.8% for 1997, which is primarily due to our decision to maintain our sales resources intact during the business downturn in the latter portion of 1998, and due to the addition of Melcher which had proportionately higher selling expense on a stand-alone basis.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased $1.5 million, or 22.6%, to $8.3 million for 1998 from $6.8 million for 1997. As a percent of net sales, general and administrative expense increased to 8.1% in 1998 from 7.3% in 1997. The increase of $1.5 million is primarily due to higher public company expenses of $268,000, higher travel costs primarily related to pursuing other acquisitions of $149,000, higher depreciation expense of $244,000, higher general office expenses of $291,000, other expenses aggregating $385,000 and the inclusion of Melcher's general and administrative expenses of $748,000 since the date of acquisition. These increases are partially offset by decreases in salaries of $270,000 and bad debt expense of $315,000.
ENGINEERING EXPENSE. Engineering expense increased $2.3 million, or 58.9%, to $6.3 million for 1998 from $3.9 million for 1997. As a percent of net sales, engineering expense increased to 6.1% for 1998 from 4.2% for 1997. The increase is primarily due to higher employee costs of $484,000, increased product development expense of $109,000, and the inclusion of Melcher's engineering expenses of $1.7 million since the date of acquisition.
QUALITY ASSURANCE EXPENSE. Quality assurance expense remained flat at $2.0 million for both 1998 and 1997. As a percent of net sales, quality assurance expense decreased to 1.9% for 1998 from 2.2% from 1997. Excluding Melcher, quality assurance expense decreased $153,000, or 7.5%, to $1.9 million in 1998 compared to $2.0 million in 1997. This decrease is primarily attributable to a decrease in salary expense.
AMORTIZATION EXPENSE. The amortization of intangibles increased $596,000, or 29.4%, to $2.6 million for 1998 from $2.0 million for 1997. As a percent of net sales, amortization of intangibles increased to 2.6% for 1998 from 2.2% for 1997. The increase is directly attributable to four months of amortization of intangibles initially recorded upon the acquisition of Melcher on August 31, 1998.
INCOME FROM OPERATIONS. As a result of the above factors, income from operations decreased $6.5 million, or 44.6%, to $8.1 million for 1998 from $14.6 million for 1997. As a percent of net sales, income from operations decreased to 7.9% for 1998 from 15.7% for 1997. Excluding the charge to cost of sales of $2.9 million for the Melcher-related inventory fair market value purchase write-up adjustments, income from operations would have been $11.0 million in 1998 compared to $14.6 million in 1997.
INTEREST INCOME. Interest income increased $1.0 million, or 287.4%, to $1.4 million for 1998 from $0.4 million for 1997. This increase is primarily due to the interest income derived from investment of a portion of the net proceeds from our initial public offering, or IPO, in short-term, interest-bearing investment-grade financial instruments.
INTEREST EXPENSE. Interest expense decreased $2.4 million, or 74.7%, to $0.8 million for 1998 from $3.2 million for 1997. This decrease is primarily the result of the repayment of all bank borrowings under our existing bank credit facility using the net proceeds from our IPO completed in the fourth quarter of 1997.
OTHER INCOME (EXPENSE), NET. Other expense increased $609,000, to $627,000 for 1998, from $18,000 for 1997, and is primarily due to foreign currency translation losses of $455,000 related to Melcher since the date of acquisition and other expenses aggregating $154,000.
INCOME TAXES. The provision for income taxes decreased $1.2 million, to $2.3 million for 1998, from $3.5 million for 1997. Income taxes as a percent of net sales decreased to 2.3% in 1998 from 3.8% in 1997. The decrease is due to a $721,000 reduction in tax provision related to the $7.2 million write-up of assets to fair value as a result of purchase accounting adjustments made for the Melcher acquisition. The remainder is attributable to a $122,000 tax credit related to a pre-tax loss incurred by our U.S. operations in the third quarter of 1998, as well as a decrease in the overall effective tax rate due to a relatively lower portion of operating income generated in the second half of 1998, primarily as a result of lower net sales of high-power products.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents balance increased $52.8 million, or 489.8% from $10.8 million at December 31, 1998 to $63.6 million at December 31, 1999. This increase in cash is primarily due to $118.3 million in net proceeds from our sale of 4,975,000 shares of common stock in September and October 1999. Prior to the sale of our stock, our primary source of cash, other than cash from operations, consisted of borrowings from credit facilities of $55.8 million. The primary uses of cash in 1999 consisted of $67.0 million for repayment of credit facility borrowings, $28.3 million for the purchase of IPD and $1.2 million of related transaction costs, and $27.1 million for the acquisition of property and equipment.
Cash provided by operating activities in 1999 was $0.5 million and was primarily attributable to cash earnings from operations of $27.9 million (net income plus depreciation, amortization, in-process research and development charge and loss on disposal of fixed assets) offset by $27.4 million used for working capital. The $27.4 million use of working capital was primarily due to an increase in accounts receivable and inventories of $18.9 million and $18.5 million, respectively, offset by an increase in accounts payable and accrued expense of $3.8 million and $6.3 million, respectively.
The $27.1 million to acquire property and equipment included approximately $5.6 million for hardware, software and implementation support related to our Oracle ERP system conversion, $4.3 million to purchase IPD's manufacturing facility, $5.9 million to acquire surface-mount technology equipment, and the balance for additional property, plant and capital equipment expenditures consistent to support our growth plans.
In 1999 we restructured our credit agreement to provide for more flexibility and to increase our credit limits. We now have a $65 million revolving line of credit, which bears interest on amounts outstanding payable quarterly based on our leverage ratio and one of the following rates as selected by us: LIBOR plus 1.25% to 2.50%, or the bank's base rate plus 0% to 1.25%. The credit agreement (a) provides for restrictions on additional borrowings, leases and capital expenditures; (b) prohibits us, without prior approval, from paying dividends, liquidating, merging, consolidating or selling our assets or business; and (c) requires us to maintain a specified net worth, minimum working capital and certain
ratios of current liabilities and total debt to net worth. At December 31, 1999, amounts outstanding under our line of credit were $2.5 million all of which was borrowed by Melcher. Borrowings are collateralized by substantially all of our assets.
As a result of the Melcher acquisition, we have various credit facilities with banks in Switzerland and Germany which can be drawn upon in the form of term loans. The aggregate credit limit for all such credit facilities is approximately $13.2 million. Melcher's credit facilities in Switzerland bear interest on amounts outstanding payable at various time intervals and market rates based on Swiss LIBOR plus a margin ranging from 1.25% to 2.00%. Some of Melcher's credit agreements require Melcher to maintain certain financial covenants and to provide certain financial reports to the lenders, none of which materially restricts Melcher. At December 31, 1999, short-term (including current portion of long-term debt) and long-term amounts outstanding under Melcher's credit facilities were $5.5 million and $3.1 million, respectively.
At December 31, 1999, short-term (including current portion of long-term debt) and long-term amounts outstanding under all credit facilities with banks were $8.0 million and $3.1 million, respectively.
We currently anticipate that our total capital expenditures for 2000 will be approximately $23.1 million, of which approximately $1.9 million represents costs related to the implementation of our Oracle ERP system at P-E, as well as continued enhancements and upgrades at our Camarillo and Mexico locations, approximately $7.3 million represents investments in surface-mount technology automation and approximately $9.6 million represents investments in manufacturing improvements. The amount of these anticipated capital expenditures will frequently change duri |
