Quarterly Report:
January 20, 1999
AMERICAN POWER CONVERSION CORPORATION (APCC)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS:
Revenues
Net sales were $327.4 million for the third quarter of 1998, an increase of 33.1% compared to $246.0 million for the same period in 1997. Net
sales for the first nine months of 1998 were $806.9 million compared to $621.7 million in 1997, an increase of 29.8%. The increase was
attributable to continued strong demand for the Company's uninterruptible power supply (UPS) and surge protection products. Third quarter
and nine month year-to-date net sales growth was strong worldwide with the Americas (North and Latin America) growing 32.1% and 30.0%,
respectively, EMEA (Europe, Middle East and Africa) growing 43.5% and 39.8%, respectively, and the Asia Pacific region growing 16.8%
and 9.6%, respectively, despite the economic downturn in that region. International net sales (excluding Canada) comprised 37% of total net
sales in each of the third quarter and first nine month periods of 1998 and 1997, respectively.
Cost of Goods Sold
Cost of goods sold was $183.1 million or 55.9% of net sales in the third quarter of 1998 compared to $132.5 million or 53.8% in the third
quarter of 1997. Cost of goods sold was $446.4 million or 55.3% of net sales in the first nine months of 1998 compared to $340.5 million or
54.8% in the same period of 1997. Gross margins declined by approximately 210 basis points and 50 basis points during the third quarter and
first nine months of 1998, respectively, over the comparable periods in 1997. Substantially all of the gross margin erosion was product mix
related as the Company's high end UPS business now accounts for a larger percentage of revenue, combined with seasonally strong desktop
unit volume growth of Back-UPSr products that were price reduced in the fourth quarter of 1997. Total inventory reserves at September 27,
1998 were $23.5 million compared to $19.3 million at December 31, 1997. The Company's reserve estimate methodology involves quantifying
the total inventory position having potential loss exposure, reduced by an amount reasonably forecasted to be sold, and adjusting its interim
reserve provisioning to cover the net loss exposure.
Operating Expenses
Operating expenses include marketing, selling, general and administrative (SG&A), and research and development (R&D) expenses.
SG&A expenses were $70.8 million or 21.6 % of net sales for the third quarter of 1998 compared to $55.7 million or 22.6% of net sales for
the third quarter of 1997. SG&A expenses were $189.8 million or 23.5% of net sales for the first nine months of 1998 compared to $145.0
million or 23.3% of net sales for the first nine months of 1997. The aggregate dollars of SG&A expenses have increased over last year due
primarily to costs associated with increased staffing of sales and administrative positions both domestically and internationally. However, the
slight decrease as a percentage of sales from third quarter 1997 to third quarter 1998 is attributable to certain fixed SG&A expenses spread over
a higher revenue base, as well as the Company's focused efforts to manage spending. The allowance for doubtful accounts at September 27,
1998 was 7.7% of accounts receivable, compared to 8.5% at December 31, 1997. The Company continues to experience strong collection
performance.
Excluding 1998 charges of $7.6 million for acquired R&D (see "Acquisition" below), R&D expenses were $8.0 million or 2.4% of net sales
and $6.2 million or 2.5% of net sales for the third quarters of 1998 and 1997, respectively, and R&D expenses were $24.7 million or 3.1% of
net sales and $15.8 million or 2.5% of net sales for the first nine month periods of 1998 and 1997, respectively. The increased R&D spending
primarily reflects increased numbers of software and hardware engineers and costs associated with new product development and engineering
support. Although the aggregate dollars of R&D expenses have increased as a result of continued product and process development, the slight
decrease as a percentage of sales from third quarter 1997 to third quarter 1998 is attributable to certain fixed R&D expenses spread over a
higher revenue base.
Other Income, Net and Income Taxes
Other income is comprised principally of interest income, which increased substantially from 1997 to 1998 due to higher average cash balances
available for investment during 1998.
Excluding 1998 non-tax deductible charges of $7.6 million for acquired R&D (see "Acquisition" below), the Company's effective income tax
rates were approximately 30.5% and 31.5% for the quarters ended September 27, 1998 and September 28, 1997, respectively. The decrease
from last year is due to the expected tax savings from an increasing portion of taxable earnings being generated from the Company's operations
in Ireland, a jurisdiction which currently has a lower income tax rate for manufacturing companies than the present U.S. statutory income tax
rate.
LIQUIDITY AND CAPITAL RESOURCES
Working capital at September 27, 1998 was $454.3 million compared to $426.8 million at December 31, 1997. The Company's cash position
decreased to $208.9 million at September 27, 1998 from $270.1 million at December 31, 1997, primarily due to the cash purchase of
approximately 77% of the share capital of Silcon A/S (see "Acquisition" below).
Worldwide inventories were $222.9 million at September 27, 1998 compared to $104.2 million at December 31, 1997. Inventories increased
during the first nine months of 1998 due to anticipation of increased demand patterns during the second half of the year which result from
typical seasonal factors, combined with $19 million of inventory purchased in the Silcon acquisition. During the third quarter of 1998,
inventories grew 11.6% over second quarter 1998 levels, compared to a 25.6% growth rate for third quarter 1998 net sales over second quarter
1998. Inventory levels were 68% as a percentage of quarterly sales in the third quarter of 1998, down from 77% in the second quarter of 1998.
At September 27, 1998, the Company had $50 million available for future borrowings under an unsecured line of credit agreement at a floating
interest rate equal to the bank's cost of funds rate plus .625% and an additional $15 million under an unsecured line of credit agreement with a
second bank at a similar interest rate. No borrowings were outstanding under these facilities at September 27, 1998. In connection with the
acquisition of Silcon (see "Acquisition" below), the Company acquired $24.8 million in bank indebtedness with interest rates ranging from 4%
to 8%. The Company repaid $9.8 million of this indebtedness during the third quarter of 1998. The Company had no
significant financial commitments, other than those required in the normal course of business, at September 27, 1998.
Capital investment for the first nine months of 1998 consisted primarily of manufacturing and office equipment, and buildings and
improvements. The nature and level of capital spending was made to improve manufacturing capabilities and to support the increased
marketing, selling, and administrative efforts necessitated by the Company's growth. Net capital expenditures were financed from available
operating cash. The Company had no material capital commitments, other than those required in the normal course of business, at September
27, 1998.
The Company has agreements with the Industrial Development Authority of Ireland ("IDA") under which the Company receives grant monies
for costs incurred for machinery, equipment, and building improvements for its Galway and Castlebar facilities equal to 40% and 60%,
respectively, of such costs up to a maximum of $13.1 million and $1.3 million, respectively. Such grant monies are subject to the Company
meeting certain employment goals and maintaining operations in Ireland until termination of the respective agreements. The total cumulative
amounts of capital grant claims submitted and received through September 27, 1998 for the Galway facility were approximately $12.6 million
and $8.9 million, respectively. The total cumulative amount of capital grant claims submitted through September 27, 1998 for the Castlebar
facility was $1.2 million; no capital grant claims had been received for the Castlebar facility. Under separate agreements with the IDA, the
Company receives direct reimbursement of training costs at its Galway and Castlebar facilities for up to $3,000 and $12,500, respectively, per
new employee hired. The total cumulative amounts of training grant claims submitted and received through September 27, 1998 for the
Galway facility were approximately $1.8 million and $1.3 million, respectively. The total cumulative amount of training grant claims
submitted through September 27, 1998 for the Castlebar facility was approximately $0.9 million; no training grant claims had been received
for the Castlebar facility.
During the first quarter of 1998, the Company began establishing a manufacturing operation in China. The Company is leasing a 50,000 square
foot facility in Suzhou and began manufacturing selected products at this facility during the third quarter of 1998. Capital expenditures for the
China expansion will be financed from operating cash. In August 1998, the Company purchased a third manufacturing facility in the
Philippines for approximately $750,000, financed from operating cash. The Company continues to evaluate international manufacturing
expansion including additional locations in the Far East and South America.
Management believes that current internal cash flows, together with available cash, available credit facilities or, if needed, the proceeds from
the sale of additional equity, will be sufficient to support anticipated capital spending and other working capital requirements for the
foreseeable future.
Acquisition
Early in the second quarter of 1998, the Company entered into a definitive agreement with the principal management shareholders of Silcon
A/S to acquire stock of Silcon, a Denmark-based manufacturer of three-phase UPSs up to 480 kVA, and the Company commenced a tender
offer for Silcon shares. In June 1998, the initial tender offer and purchase of stock from principal management shareholders was completed
enabling the Company to operate Silcon as a majority- owned subsidiary. During the third quarter of 1998, the Company increased its
ownership percentage to 77%. The Company's cash outlays of $56 million were financed from operating cash.
The purchase price was allocated to the net assets acquired and to acquired in- process research and development (acquired R&D). Acquired
R&D includes the value of products in the development stage and not considered to have reached technological feasibility. In accordance with
applicable accounting rules, acquired R&D is required to be expensed. Accordingly, $7.4 million of the acquisition cost was expensed in the
second quarter of 1998. An additional $.2 million was expensed in the third quarter of 1998 consistent with the Company's increased
ownership percentage. The remaining purchase price exceeded the fair value of the tangible net assets acquired by approximately $39 million,
which is being amortized on a straight-line basis over periods ranging from 10-20 years. The acquisition has been accounted for as a purchase
and, accordingly, Silcon's results of operations are included in the Company's consolidated financial statements from the date of acquisition.
Foreign Currency Activity
Financial statements for the Company's international subsidiaries for which the U.S. dollar is the functional currency are remeasured into U.S.
dollars using current rates of exchange for monetary assets and liabilities and historical rates of exchange for nonmonetary assets. Gains and
losses from remeasurement are included in other income, net.
The Company invoices its customers in Japan, Great Britain, Germany, and France, in their respective local currencies. At September 27, 1998
the Company's unhedged foreign currency accounts receivable, by currency, were as follows:
(In thousands) Foreign Currency U.S. Dollars
Japanese Yen 1,619,000 11,320
British Pounds 4,201 7,132
German Marks 19,723 11,810
French Francs 36,146 6,443
Total gross accounts receivable at September 27, 1998 was approximately $215.5 million. The Company had non-trade receivables of 4.1
million Irish Pounds (approximately US$6.2 million), as well as Irish Pound denominated liabilities of 4.4 million (approximately US$6.5
million). The Company also had liabilities denominated in various European currencies of US$14.7 million, as well as Yen denominated
liabilities of approximately US$1.9 million.
The Company continually reviews its foreign exchange exposure and considers various risk management techniques including the netting of
foreign currency receipts and disbursements, rate protection agreements with customers/vendors and derivatives arrangements, including
foreign exchange contracts. The Company presently does not utilize rate protection agreements or derivatives arrangements.
Recently Issued Accounting Standards
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information, which establishes standards for reporting information about operating segments in annual
and interim financial statements issued to shareholders. This Statement also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The Company will adopt this Statement at December 31, 1998 and is currently studying its
provisions.
The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. This Statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The adoption of this Statement is not expected to have a material
impact on the Company's financial position or results of operations.
The AICPA Accounting Standards Executive Committee recently issued Statement of Position ("SOP") 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. This SOP requires that certain costs related to the development or purchase of
internal-use software be capitalized and amortized over the estimated useful life of the software, and is effective for fiscal years beginning after
December 15, 1998. The SOP also requires that
costs related to the preliminary project stage and post
implementation/operations stage in an internal-use computer software development
project be expensed as incurred. The adoption of this SOP is not expected to
have a material impact on the Company's financial position or results of
operations.
The AICPA Accounting Standards Executive Committee recently issued Statement of Position ("SOP") 98-5, Reporting on the Costs of
Start-Up Activities. This SOP requires that costs incurred during start-up activities, including organization costs, be expensed as incurred, and
is effective for fiscal years beginning
after December 15, 1998. The adoption of this SOP is expected to have no impact on the Company's financial position or results of operations.
Year 2000 Readiness Disclosure Statement
Many computer systems were not designed to handle any dates beyond the year 1999 and, therefore, many companies will be required to
modify their computer hardware and software prior to the year 2000 in order to remain fully operational. During 1998, the Company
commenced a year 2000 readiness program to assess the impact of the year 2000 issue on the Company's operations and address necessary
remediation. A year 2000 program director reporting directly to senior management has been assigned to this project, which includes:
Assessment of the Company's products for year 2000 compliance. All of the Company's hardware products and accessories are year 2000
compliant, meaning that they have been tested to verify that where date fields are processed, dates are calculated and displayed accurately, and
that scheduled events such as shutdowns, self-tests, and run-time calibrations, and also the handling of unscheduled events, such as power
failures, are unaffected by the millenium and century change; provided that all other third party products (e.g., software, firmware, operating
systems, and hardware) properly exchange date data with the Company product and provided also that the Company products are used in
accordance with the product documentation. In addition, the Company's year 2000 compliant products recognize the year 2000 as a leap year.
The Company has also tested its software products and determined that these products are substantially year 2000 compliant, and the Company
intends to resolve any remaining year 2000 issues before the arrival of year 2000. Periodically updated information about the Company's
software products is available at the Company's Year 2000 Readiness Disclosure Web site (www.APCC.com). Information on this site is
provided to the Company's customers for the sole purpose of assisting in planning for transition to the year 2000. Such information is the most
currently available concerning the behavior of the Company's products in the next century and is provided "as is" without warranty of any
kind. In addition, to the extent the Company's hardware and software products are combined with the hardware and software products of other
companies, there can be no assurance that users of the Company's products will not experience year 2000 problems as a result of the
combination of the Company's hardware and software products with non-compliant products of other companies. The Company currently does
not anticipate material expenditures to remedy any year 2000 issues with its products and services.
Assessment of the Company's information technology ("IT") and non-IT systems for year 2000 compliance. The Company is currently in the
process of evaluating its IT systems for compliance. The Company's Oracle manufacturing and financial information systems were
implemented during 1998. The Company is currently evaluating the year 2000 compliance of these systems in accordance with Oracle's
recommendations. The Company has installed the most recent software patches available from Oracle and expects its initial testing of these
patches to be complete by the end of 1998. The Company does not consider the cost of the new hardware and software for the Oracle
implementations to be related to year 2000 readiness as these system replacements were already planned to satisfy the demands of expansion of
its worldwide operations and were not accelerated due to year 2000 issues. The Company is also currently in the process of evaluating its
non-IT systems for compliance. Additionally, the Company utilizes other third party software and equipment to distribute its products as well
as to operate other aspects of its business. The Company is reviewing such software and equipment. There can be no assurance that such
software and equipment is year 2000 compliant, that non-compliant software and equipment will be made compliant on a timely basis, or that
any such non-compliant software and equipment would not have a material adverse effect on the Company's systems and operations.
Evaluation of third parties with which the Company has a material relationship, including key suppliers, service providers, and strategic
partners. The Company's year 2000 readiness program includes identifying these third parties and determining, based on receipt of written
verification, review of publicly available financial statement disclosures, and other means, that such third parties are either in compliance or
expect to be in compliance prior to January 1, 2000. The Company is currently in the process of communicating with its significant vendors,
service providers, and certain strategic partners. Many enterprises, including the Company's present and potential customers, may be devoting a
substantial portion of their information systems spending to
resolving year 2000 issues, which may result in their spending being diverted from applications such as the Company's products, over the next
two years.
Development of contingency plans. The Company is currently not in a position to determine what would be its most reasonably likely worst
case year 2000 scenario or any plan for handling such scenario. To date, the Company has not completed a formal contingency plan for
non-compliance, however to the extent that further evaluation of its products, its IT and non-IT systems, or information obtained from the
third parties with which it has a material relationship suggests that there is a significant risk, contingency plans will be implemented. Such
contingency plans may include the development of alternative sources for the product or service provided by any non-compliant vendor.
It is the Company's policy to expense as incurred all costs associated with year 2000 readiness. To date, the Company has not identified a
separate budget for year 2000 issues. No IT projects have been deferred due to year 2000 efforts. Although the Company is not yet able to
estimate its total incremental cost for year 2000 issues, based on its preliminary review to date, the Company does not believe that the costs of
year 2000 issues will have a material adverse effect on the Company's business, operating results, or financial condition. Although the
Company is taking measures to address the impact, if any, of year 2000 issues, it cannot predict the outcome or success of its year 2000
readiness program, or whether the failure of third party systems or equipment to operate properly in the year 2000 will have a material adverse
effect upon the Company's business, operating results, or financial condition, or require the Company to incur unanticipated material expenses
to remedy any year 2000 issue.
The foregoing discussion regarding the Company's year 2000 readiness program's implementation, effectiveness, and cost, contains
forward-looking statements which are based on management's expectations, determined utilizing certain assumptions of future events including
third party compliance and other factors. However, there can be no guarantee that these expectations will be realized, and actual results could
differ materially from management's expections. Specific factors that might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area and other similar uncertainties, and the remediation success of the Company's suppliers,
service providers, and strategic partners.
Factors That May Affect Future Performance
Statements contained in this document that do not describe historical facts may constitute forward-looking statements. The Company makes
such forward-looking statements under the provisions of the "safe harbor" section of the Private Securities Litigation Reform Act of 1995. The
forward-looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties which
could cause actual results to differ from those projected. The factors that could cause actual results to differ materially include the following:
the ability of APC to operate Silcon as a less than wholly-owned subsidiary; APC's ability to successfully integrate Silcon's operations; the
review and revaluation of acquired R&D by the Securities and Exchange Commission (SEC); the timely development and acceptance of new
products such as the Symmetra Power Array; ramp up and expansion of manufacturing capacity; general worldwide economic conditions;
growth rates in the power protection industry and related industries, including but not limited to the PC, server, and networking industries;
competitive factors and pricing pressures; changes in product mix; changes in the seasonality of demand patterns; inventory risks due to shifts
in market demand; the effects of any other possible acquisitions; component constraints and shortages; risk of nonpayment of accounts
receivable; all risks associated with the year 2000 issue including, but not limited to, the impact on the Company's business due to internal
systems or systems of suppliers and other third parties adversely affected by year 2000 problems as previously discussed above; the uncertainty
of the litigation process including risk of an unexpected, unfavorable result of current or threatened litigation; factors associated with
international operations; and the risks described from time to time in the Company's filings with the SEC.
FORM 10-Q
September 27, 1998 |
