-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Fxdx8j+bbMNT3knnES46F7pnv+wgwtTLQego1mMNoayDykpHkH6oDl/4854PbHV1 x2ltS0fQPm+WodzEPxigyw== 0000835910-03-000011.txt : 20030514 0000835910-03-000011.hdr.sgml : 20030514 20030514171539 ACCESSION NUMBER: 0000835910-03-000011 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20030330 FILED AS OF DATE: 20030514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN POWER CONVERSION CORPORATION CENTRAL INDEX KEY: 0000835910 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRICAL INDUSTRIAL APPARATUS [3620] IRS NUMBER: 042722013 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-12432 FILM NUMBER: 03700106 BUSINESS ADDRESS: STREET 1: 132 FAIRGROUNDS RD CITY: WEST KINGSTON STATE: RI ZIP: 02892 BUSINESS PHONE: 4017895735 MAIL ADDRESS: STREET 1: 132 FAIRGROUNDS ROAD CITY: WEST KINGSTON STATE: RI ZIP: 02892 10-Q 1 tenq103.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ___________________ FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 30, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________to_____________ Commission File Number: 1-12432 AMERICAN POWER CONVERSION CORPORATION (Exact name of Registrant as specified in its charter) MASSACHUSETTS 04-2722013 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 132 FAIRGROUNDS ROAD, WEST KINGSTON, RHODE ISLAND 02892 401-789-5735 (Address and telephone number of principal executive offices) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [ X ] NO [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES [ X ] NO [ ] Registrant's Common Stock outstanding, $0.01 par value, at May 6, 2003 - 196,593,000 shares 1 FORM 10-Q March 30, 2003 AMERICAN POWER CONVERSION CORPORATION INDEX Page No. Part I - Financial Information: Item 1. Consolidated Condensed Financial Statements: Consolidated Condensed Balance Sheets - March 30, 2003 and December 31, 2002 (Unaudited) 3 - 4 Consolidated Condensed Statements of Income - Three Months Ended March 30, 2003 and March 31, 2002 (Unaudited) 5 Consolidated Condensed Statements of Cash Flows - Three Months Ended March 30, 2003 and March 31, 2002 (Unaudited) 6 Notes to Consolidated Condensed Financial Statements (Unaudited) 7 - 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 - 22 Item 3. Quantitative and Qualitative Disclosures About Market Risk 23 Item 4. Controls and Procedures 23 Part II - Other Information: Item 1. Legal Proceedings 24 Item 6. Exhibits and Reports on Form 8-K 24 Signatures 25 Certifications of Chief Executive Officer and Chief Financial Officer 26 - 27 Exhibit Index 28 2 FORM 10-Q March 30, 2003 PART I - CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ITEM 1. FINANCIAL STATEMENTS AMERICAN POWER CONVERSION CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS In thousands except per share amount (Unaudited) ASSETS
March 30, December 31, 2003 2002 Current assets: Cash and cash equivalents $237,715 $209,322 Short term investments (Note 5) 394,260 430,986 Accounts receivable, less allowance for doubtful accounts of $18,604 in 2003 and $17,855 in 2002 236,546 237,079 Inventories: Raw materials 198,002 175,079 Work-in-process and finished goods 153,991 144,892 Total inventories 351,993 319,971 Prepaid expenses and other current assets 27,093 24,545 Assets held-for-sale (Notes 4 and 7) 3,033 3,033 Deferred income taxes 48,506 51,606 Total current assets 1,299,146 1,276,542 Property, plant and equipment: Land, buildings and improvements 64,314 64,190 Machinery and equipment 197,360 195,076 Office equipment, furniture and fixtures 78,760 78,388 Purchased software 32,348 32,513 372,782 370,167 Less accumulated depreciation and amortization 203,380 195,239 Net property, plant and equipment 169,402 174,928 Long term investments (Note 5) 53,022 56,293 Goodwill (Note 6) 6,679 6,679 Other intangibles, net (Note 6) 58,292 61,257 Deferred income taxes 25,774 26,354 Other assets 2,397 2,527 Total assets $1,614,712 $1,604,580
See accompanying notes to consolidated condensed financial statements. 3 FORM 10-Q March 30, 2003 AMERICAN POWER CONVERSION CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (CONTINUED) In thousands except per share amount (Unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY
March 30, December 31, 2003 2002 Current liabilities: Accounts payable $95,610 $99,983 Accrued compensation 27,689 33,029 Accrued warranty (Note 8) 20,746 27,183 Accrued sales and marketing programs 25,374 22,405 Other accrued expenses 28,642 30,301 Deferred revenue 20,035 19,135 Income taxes payable 35,778 45,404 Total current liabilities 253,874 277,440 Deferred tax liability 14,855 15,088 Total liabilities 268,729 292,528 Shareholders' equity (Notes 9, 10, 11 and 12): Common stock, $0.01 par value; authorized 450,000 shares; issued 196,756 shares in 2003 and 196,496 shares in 2002 1,968 1,965 Additional paid-in capital 134,330 131,827 Retained earnings 1,211,542 1,181,563 Treasury stock, 250 shares, at cost (1,551) (1,551) Accumulated other comprehensive loss (306) (1,752) Total shareholders' equity 1,345,983 1,312,052 Total liabilities and shareholders' equity $1,614,712 $1,604,580
See accompanying notes to consolidated condensed financial statements. 4 FORM 10-Q March 30, 2003 AMERICAN POWER CONVERSION CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF INCOME In thousands except earnings per share (Unaudited)
Three months ended March 30, March 31, 2003 2002 Net sales (Note 13) $308,975 $296,712 Cost of goods sold 183,061 194,411 Gross profit 125,914 102,301 Operating expenses: Marketing, selling, general and administrative 72,380 66,152 Research and development 14,520 14,801 Total operating expenses 86,900 80,953 Operating income 39,014 21,348 Other income, net 2,508 1,831 Earnings before income taxes and cumulative effect of accounting change 41,522 23,179 Income taxes 11,543 6,606 Earnings before cumulative effect of accounting change 29,979 16,573 Cumulative effect of accounting change, net of income taxes of $15,459 (Note 3) -- 34,500 Net income (loss) $29,979 $(17,927) Basic earnings (loss) per share: Basic earnings per share before cumulative effect of accounting change $0.15 $0.08 Cumulative effect of accounting change, net of tax -- 0.17 Basic earnings (loss) per share $0.15 $(0.09) Basic weighted average shares outstanding 196,397 195,828 Diluted earnings (loss) per share: Diluted earnings per share before cumulative effect of accounting change $0.15 $0.08 Cumulative effect of accounting change, net of tax -- 0.17 Diluted earnings (loss) per share $0.15 $(0.09) Diluted weighted average shares outstanding 199,765 197,388
See accompanying notes to consolidated condensed financial statements. 5 FORM 10-Q March 30, 2003 AMERICAN POWER CONVERSION CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS In thousands (Unaudited)
Three months ended March 30, March 31, 2003 2002 Cash flows from operating activities: Net income (loss) $29,979 $(17,927) Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: Depreciation and amortization of property, plant and equipment 8,995 10,964 Amortization of goodwill and other intangibles 2,965 2,951 Provision for doubtful accounts 622 1,979 Provision for inventories 1,000 4,082 Deferred income taxes 3,447 (14,392) Cumulative effect of accounting change -- 49,959 Restructuring charges -- 3,877 Other non-cash items, net 1,446 (108) Changes in operating assets and liabilities: Accounts receivable (89) 26,224 Inventories (33,022) 11,977 Prepaid expenses and other current assets (2,548) (3,604) Other assets 130 (101) Accounts payable (4,373) 4,096 Accrued expenses (9,567) 2,434 Income taxes payable (9,626) 4,893 Net cash (used in) provided by operating activities (10,641) 87,304 Cash flows from investing activities: Purchases of held-to-maturity securities (686,102) (129,156) Maturities of held-to-maturity securities 726,332 25,395 Purchases of available-for-sale securities (233) (10,228) Capital expenditures, net of capital grants (3,469) (4,248) Net cash provided by (used in) investing activities 36,528 (118,237) Cash flows from financing activities: Proceeds from issuances of common stock 2,506 1,276 Net cash provided by financing activities 2,506 1,276 Net change in cash and cash equivalents 28,393 (29,657) Cash and cash equivalents at beginning of period 209,322 288,210 Cash and cash equivalents at end of period $237,715 $258,553 Supplemental cash flow disclosures Cash paid during the period for: Income taxes (net of refunds) $16,298 $(584)
NON-CASH TRANSACTIONS: In the first quarter of 2002, APC recorded a restructuring charge that included a non-cash component of $3,877 (Note 4). See accompanying notes to consolidated condensed financial statements. 6 FORM 10-Q March 30, 2003 AMERICAN POWER CONVERSION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. Management Representation The accompanying unaudited consolidated condensed financial statements should be read in conjunction with the consolidated financial statements included in the American Power Conversion Corporation, APC, Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion of management, the accompanying unaudited consolidated condensed financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the consolidated financial position and the consolidated results of operations and cash flows for the interim periods. The results of operations for the interim periods are not necessarily indicative of results to be expected for the full year. 2. Principles of Consolidation The accompanying consolidated condensed financial statements include the financial statements of American Power Conversion Corporation and its wholly- owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. 3. Change in Accounting Principle On January 1, 2002, APC adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Statement 142 requires that companies no longer amortize goodwill and other intangible assets with indefinite lives, but instead test goodwill impairment at least annually or more frequently if impairment indicators arise. Statement 142 also requires completion of a two-step transitional goodwill impairment test. In connection with completion of the first step of its transitional analysis, APC identified two reporting units with goodwill, Large Systems and Small Systems; these reporting units are also reportable segments. APC then determined the carrying value of each reporting unit by assigning the assets and liabilities, including existing goodwill and other intangible assets, to these reporting units as of the date of adoption. Completion of the first step of APC's analysis indicated impairment in the carrying amount of its goodwill. APC's goodwill was primarily associated with its Large Systems segment which consists primarily of uninterruptible power supply (UPS), DC-power systems, and precision cooling products for data centers, facilities, and communication applications. Conditions contributing to the goodwill impairment included the ongoing softness in IT and communications market segments coupled with lower corporate investment for these types of applications. In connection with completion of the second step of its transitional analysis, APC compared the carrying amount of reporting unit goodwill with the implied fair value of reporting unit goodwill, both of which were measured as of the date of adoption. The implied fair value of goodwill was determined by allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation, in accordance with the provisions of Statement of Financial Accounting Standards No. 141, Business Combinations. The residual fair value after this allocation was the implied fair value of the reporting unit goodwill. Based on this second step, APC recorded a non-cash charge equal to the goodwill balance associated with APC's Large Systems segment of approximately $50 million (approximately $35 million on an after-tax basis). This charge was recognized as the cumulative effect of a change in accounting principle net of income taxes, included in APC's results as of January 1, 2002, and had no effect on APC's liquidity. APC's remaining goodwill is associated with its Small Systems segment. APC evaluates each of its reporting units with goodwill during the fourth quarter of each fiscal year or more frequently if impairment indicators arise. 7 4. Restructuring In early 2002, APC announced global headcount reductions which impacted personnel worldwide throughout a broad range of functions within the organization, principally in the U.S., U.K., Ireland, and the Philippines. The majority of these terminations were the result of APC's decision to consolidate its Philippines-based manufacturing operations, resulting in the closing of APC's manufacturing facility in the province of Laguna. Such restructuring actions were announced during the first quarter of 2002 and substantially completed by the end of 2002. APC anticipates the final settlements of these restructuring actions to be completed by the end of 2003. In the first quarter of 2002, APC recorded $7.3 million of related restructuring costs of which $4.8 million and $2.5 million were classified in cost of goods sold and operating expenses, respectively. These costs included the effects of approximately 941 employee terminations, principally in the manufacturing area, facilities closures and the related impairment of tangible assets. These costs were not allocated to APC's operating segments, but rather were classified as indirect operating expenses for segment reporting consistent with APC's classification for its internal financial reporting; also refer to Note 13. A summary of the related 2002 restructuring liabilities during the first quarters of 2003 and 2002 is outlined below. APC expects all such restructuring liabilities at March 30, 2003 to be fully paid in cash by the end of 2003. 2002 Restructuring Plans
In thousands Restructuring Restructuring Liabilities at Liabilities at Beginning Total Non-cash Cash End of of Quarter Charges Charges Payments Quarter First Quarter 2003 Employee terminations $25 $ -- $ -- $ -- $25 Facilities closures 775 -- -- (158) 617 $800 $ -- $ -- $(158) $642 First Quarter 2002 Employee terminations $ -- $2,550 $ -- $(968) $1,582 Facilities closures -- 4,717 (3,877) -- 840 $ -- $7,267 $(3,877) $(968) $2,422
8 5. Investments APC classifies as short term its investments with original maturities greater than three months and less than or equal to one year, and as long term its investments with remaining maturities greater than one year and less than or equal to two years. APC has no investments with maturity dates greater than two years. Available-for-sale securities are recorded at fair value with net unrealized gains and losses reported, net of income taxes, in other comprehensive income. Held-to-maturity securities are carried at amortized cost. Management determines the appropriate classification of securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Securities are classified as held-to-maturity when APC has the positive intent and ability to hold such securities to maturity. There were no sales of investment securities in the first quarters of 2003 or 2002.
In thousands Gross Gross Unrealized Unrealized Amortized Holding Holding Fair Cost Gains Losses Value At March 30, 2003 Available-for-sale: Bond funds $31,441 $167 $(528) $31,080 Equity investments 405 -- -- 405 31,846 167 (528) 31,485 Held-to-maturity: Certificates of deposit 130,334 -- -- 130,334 Corporate bonds 207,849 89 (17) 207,921 Municipal bonds and notes 40,443 -- (3) 40,440 U.S. government agency securities 37,171 155 (10) 37,316 415,797 244 (30) 416,011 $447,643 $411 $(558) $447,496 At December 31, 2002 Available-for-sale: Bond funds $31,233 $114 $(449) $30,898 Equity investments 398 -- -- 398 31,631 114 (449) 31,296 Held-to-maturity: Certificates of deposit 134,602 -- -- 134,602 Corporate bonds 153,501 78 -- 153,579 Municipal bonds and notes 120,845 -- (6) 120,839 U.S. government agency securities 47,035 203 (20) 47,218 455,983 281 (26) 456,238 $487,614 $395 $(475) $487,534
9 6. Goodwill and Other Intangible Assets At each of March 30, 2003 and December 31, 2002, goodwill of $6.7 million was associated with the Small Systems segment. Amortized intangible assets were as follows:
In thousands March 30, 2003 December 31, 2002 Weighted Amortized Average Gross Gross Intangible Amortization Carrying Accumulated Carrying Accumulated Assets Period Amount Amortization Amount Amortization Technology 6 years $80,642 $29,209 $80,642 $26,702 Customer lists 5 years 8,900 3,856 8,900 3,519 Tradenames 5 years 3,157 1,342 3,157 1,221 Total amortized intangible assets 6 years $92,699 $34,407 $92,699 $31,442
Aggregate amortization expense related to APC's other intangible assets for each of the first quarters of 2003 and 2002 was $3.0 million and $3.0 million, respectively. Estimated aggregated amortization for each of the next five succeeding fiscal years is $11.9 million for 2003, $11.4 million for 2004, $11.4 million for 2005, $11.4 million for 2006, and $9.3 million for 2007. There are no expected residual values related to these intangible assets. 7. Long-lived Assets In early 2002, APC announced its decision to consolidate its Philippines-based manufacturing operations resulting in the closing of APC's manufacturing facility in the province of Laguna. In the first quarter of 2002, in connection with this action as well as the closure of manufacturing facilities in the U.S. and U.K., APC recorded $3.9 million of asset impairment charges related to buildings and equipment of which $3.4 million and $0.5 million were classified in cost of goods sold and operating expenses, respectively. These impairment charges were not allocated to APC's operating segments, but rather were classified as indirect operating expenses for segment reporting consistent with APC's classification for its internal financial reporting. At March 30, 2003, a building and equipment held-for-sale, with an aggregate value of $3.0 million, are stated at the lower of their fair values less estimated selling costs or carrying amounts and depreciation is no longer recognized. We continue to market this property with an intent to sell these assets in 2003. However, the current real estate market has not been favorable and has not allowed us to complete this sale as quickly as we had originally expected. 8. Warranty Liability and Product Recall
In thousands Product Accruals for Product Warranty Product Adjustments Warranty Liability at Warranties to Accruals for Liability at Beginning Issued During Preexisting Warranty End of of Quarter the Quarter Warranties Payments Quarter First Quarter 2003 $27,183 $6,965 $ -- $(13,402) $20,746 First Quarter 2002 $6,846 $6,115 $ -- $(5,270) $7,691
In early 2003, APC announced a product recall of Back-UPSr CS 350 and 500 models, due to potential safety issues. Prior to announcing the recall, APC received eight reports worldwide of units overheating, resulting in the melting of the unit's outer casing, six of which occurred in the United States. Three of the reported incidents resulted in minor property damage; no injuries have been reported. The total number of affected devices being recalled worldwide is approximately 2.1 million with approximately 900,000 devices recalled in the United States. 10 The recall is limited to two specific models in APC's Back-UPS CS product line, the Back-UPS CS 350 and the Back-UPS CS 500, in both 120-volt and 230-volt models. The affected units were manufactured between November 2000 and December 2002 and were sold primarily through computer and electrical distribution, catalog and retail outlets worldwide. In the fourth quarter of 2002, APC accrued a current liability and recognized additional warranty expense, classified in cost of goods sold, of $19.6 million. As of March 30, 2003, APC had incurred approximately one third of total estimated recall costs. Actual amounts may differ materially from APC's current estimates. 9. Earnings Per Share Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares and dilutive potential common shares outstanding during the period. Under the treasury stock method, the unexercised options are assumed to be exercised at the beginning of the period or at issuance, if later. The assumed proceeds are then used to purchase common shares at the average market price during the period. Potential common shares for which inclusion would have the effect of increasing diluted earnings per share (i.e., antidilutive) are excluded from the computation.
In thousands Three months ended March 30, March 31, 2003 2002 Basic weighted average shares outstanding 196,397 195,828 Net effect of dilutive potential common shares outstanding based on the treasury stock method using the average market price 3,368 1,560 Diluted weighted average shares outstanding 199,765 197,388 Antidilutive potential common shares excluded from the computation above 5,679 6,481
10. Shareholders' Equity Changes in paid-in capital for the periods presented represent the issuances of common stock resulting from the exercise of employee stock options. 11. Comprehensive Income The components of comprehensive income, net of tax, are as follows:
In thousands Three months ended March 30, March 31, 2003 2002 Net income (loss) $29,979 $(17,927) Other comprehensive income (loss), net of tax: Change in foreign currency translation adjustment 1,482 (83) Net unrealized loss on investments, net of income taxes (36) (25) Other comprehensive income (loss) 1,446 (108) Comprehensive income $31,425 $(18,035)
11 12. Stock-Based Compensation At March 30, 2003, APC had four stock option plans and an employee stock purchase plan, which are described more fully in Note 13 of Notes to Consolidated Financial Statements in Item 8 of APC's Form 10-K for the year ended December 31, 2002. As permitted by Statement of Financial Accounting Standards No. 123 as amended by No. 148, Accounting for Stock-Based Compensation, APC accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if APC had applied the fair value recognition provisions of Statement 123 to stock-based employee compensation:
In thousands except per share amounts Three months ended March 30, March 31, 2003 2002 Net income (loss) As reported $29,979 $(17,927) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects Pro forma (5,457) (6,121) Net income (loss) Pro forma $24,522 $(24,048) Basic earnings (loss) per share As reported $0.15 $(0.09) Pro forma $0.12 $(0.12) Diluted earnings (loss) per share As reported $0.15 $(0.09) Pro forma $0.12 $(0.12)
The weighted average fair value of stock options granted during each of the first quarters of 2003 and 2002 was $11.07 and $8.79, respectively. APC estimates the fair value of each option as of the date of grant using the Black- Scholes pricing model with the following weighted average assumptions used for grants in each of the first quarters of 2003 and 2002:
Three months ended March 30, March 31, 2003 2002 Expected volatility 69% 74% Dividend yield -- -- Risk-free interest rate 1.2% 3.2% Expected life 6 years 6 years
APC accounts for its non-employee stock-based compensation awards in which goods or services are the consideration received for the equity instruments issued based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. Compensation cost recognized for non-employees under these plans in the accompanying consolidated condensed financial statements is not material. 12 13. Operating Segment Information Basis for presentation APC operates primarily within one industry consisting of three reportable operating segments by which it manages its business and from which various offerings are commonly combined to develop a total solution for the customer. These efforts primarily incorporate the design, manufacture and marketing of power protection equipment and related software and accessories for computer, communications and related equipment. APC's three segments are: Small Systems, Large Systems and Other. Each of these segments address global markets. The Small Systems segment develops power solutions for servers and networking equipment commonly used in local area and wide area networks and for personal computers and sensitive electronics; additional accessories and software products are offered to enhance the management of these networks. The Large Systems segment produces large system solutions that provide power and availability solutions for data centers, facilities and communications equipment. The Other segment principally consists of notebook computer accessories, replacement batteries and Web-based services. APC measures the profitability of its segments based on direct contribution margin. Direct contribution margin includes R&D, marketing and administrative expenses directly attributable to the segments and excludes certain expenses which are managed outside the reportable segments. Costs excluded from segment profit are indirect operating expenses, primarily consisting of selling and corporate expenses, and income taxes. In addition, our 2002 restructuring charges were not allocated to our operating segments, but rather were classified as indirect operating expenses for segment reporting consistent with our classification for our internal financial reporting. Expenditures for additions to long-lived assets are not tracked or reported by the operating segments, although depreciation expense is allocated to and reported by the operating segments. Summary operating segment information is as follows:
In thousands Three months ended March 30, March 31, 2003 2002 Segment net sales: Small Systems $242,526 $242,562 Large Systems 47,593 40,000 Other 17,337 12,597 Total segment net sales 307,456 295,159 Shipping and handling revenues 1,519 1,553 Total net sales $308,975 $296,712 Segment profits: Small Systems $103,800 $97,230 Large Systems (1,524) (10,637) Other 10,234 6,881 Total segment profits 112,510 93,474 Shipping and handling net costs 6,809 3,483 Restructuring charges -- 7,267 Other indirect operating expenses 66,687 61,376 Other income, net 2,508 1,831 Earnings before income taxes $41,522 $23,179
13 14. Litigation APC is involved in various claims and legal actions arising in the ordinary course of business. APC does not believe that the ultimate disposition of these matters will have a material adverse effect on its consolidated financial position or results of operations or liquidity. In addition, on January 10, 2003, Powerware Corporation filed in the United States District Court for the Eastern District of North Carolina (the "Court") a complaint alleging infringement of three United States patents (the "Patents"). On May 7, 2003, Powerware Corporation filed with the Court an amended complaint modifying its allegations of infringement regarding the Patents. APC was served with the amended complaint on May 9, 2003. Powerware Corporation is seeking unspecified damages and injunctive relief. APC is evaluating the allegations in the amended complaint and APC is due to respond to the amended complaint by May 29, 2003. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTH PERIODS ENDED MARCH 30, 2003 AND MARCH 31, 2002 Revenues Net sales were $309.0 million for the first quarter of 2003, an increase of 4.1% compared to $296.7 million for the same period in 2002. This increase was attributable principally to higher first quarter 2003 net sales of our Large and "Other" segments. Net sales of our Small Systems segment remained unchanged year-over-year overall. In addition, the first quarter 2003 improvement over the comparable quarter last year was assisted by the favorable pricing impact of a weakening U.S. dollar, particularly in Europe, offset by the cumulative effect of pricing actions over the course of the past year. Strong first quarter 2003 net sales of our Large Systems segment, consisting primarily of uninterruptible power supply (UPS), DC-power systems, and precision cooling products for data centers, facilities, and communication applications, reflected sales of InfraStruXure as well as strengthening in services and our industrial UPS business, partially offset by weakness in our communications market segment. First quarter 2003 net sales of our "Other" segment, consisting principally of notebook computer accessories, replacement batteries and Web-based services, were also strong due mainly to organic growth of existing products as well as growth from new mobile accessory products. Although positive growth trends were seen in our rack, power distribution and high end Smart-UPSr products, first quarter 2003 net sales of our Small Systems business, which provides power protection, UPS, and management products for the PC, server, and local area networking markets, remained at first quarter 2002 levels due principally to continued weakness in spending on IT equipment served by APC's Small Systems solutions. On a geographic basis, the Americas (North and Latin America) represented 49.0% of first quarter 2003 revenues, decreasing 9.9% year-over-year. Europe, the Middle East and Africa (EMEA) represented 32.2% of revenues, increasing 33.5% from the first quarter of 2002. Finally, Asia represented 18.8% of revenues, increasing 7.3% year-over-year. On a constant currency basis, EMEA was up 19.0% and Asia remained unchanged versus the first quarter of 2002. Cost of Goods Sold Cost of goods sold was $183.1 million or 59.2% of net sales in the first quarter of 2003 compared to $194.4 million or 65.5% in the first quarter of 2002. First quarter 2003 gross margin was 40.8% of sales, approximately 630 basis points higher than the comparable period in 2002. The first quarter 2003 gross margin improvement was associated with gross margin improvements in both the Small and Large System segments. The first quarter 2003 gross margin improvement in the Small Systems segment over the first quarter of 2002 was primarily attributable to product cost reduction efforts. These cost reductions were achieved through a combination of product transitions to low cost manufacturing locations and material cost reductions from APC's supplier base. Partially offsetting this improvement was unfavorable mix, primarily in our Back-UPS and surge consumer products. The first quarter 2003 gross margin improvements in the Large Systems and "Other" segments over the first quarter of 2002 was primarily the result of a continual lowering of product costs achieved through factory consolidations and ongoing capacity rationalization efforts. In addition, to a lesser extent, the first quarter 2003 improvement over the comparable quarter last year was assisted by the favorable pricing impact of a weakening U.S. dollar, particularly in Europe, offset by the cumulative effect of pricing actions over the course of the past year. 14 Additionally, first quarter 2002 gross margins included the effects of restructuring costs of $4.8 million associated with our first quarter 2002 global headcount reductions. These actions impacted personnel worldwide throughout a broad range of functions within the organization, principally in the U.S., U.K., Ireland, and the Philippines. The majority of these terminations were the result of our decision to consolidate our Philippines- based manufacturing operations resulting in the closing of our manufacturing facility in the province of Laguna. These restructuring costs were the result of events or assessments that occurred during the first quarter of 2002 and included the effects of employee terminations, facilities closures, and the related impairment of tangible assets. These costs have not been allocated to our operating segments, but rather have been classified as indirect operating expenses for segment reporting consistent with our classification for internal financial reporting; also refer to Note 13 of Notes to Consolidated Condensed Financial Statements in Item 1 of this Report. Our 2002 restructuring actions were announced and substantially completed during 2002. We anticipate the final settlements of our 2002 restructuring actions to be completed by the end of 2003. Due to the timing of the facilities closures and contractual or regulatory obligations to certain workers, the financial benefits of these actions did not commence until the second quarter of 2002 with most of the full benefit being realized by the close of 2002. Also refer to Note 4 of Notes to Consolidated Condensed Financial Statements in Item 1 of this Report. Total inventory reserves at March 30, 2003 were $36.1 million compared to $37.2 million at December 31, 2002. There were no inventory charges, other than our standard provisioning, during the first quarters of 2003 and 2002. Our reserve estimate methodology involves quantifying the total inventory position having potential loss exposure. Loss exposure generally results from several business factors, including product or component discontinuance, unplanned changes in demand, product design changes, and factory transitions. Quantifying such loss exposure is the result of combining the cost of inventories specifically identified as having little or no opportunity for sale or use (thus available for physical disposition) plus the cost of inventories having a high risk of no future sale or use based upon an analysis of on-hand quantities compared to historical and anticipated future sale or use. We maintain an on-going business process for the physical disposition of inventories previously identified. Inventory write-offs occur at the time of physical disposition. Inventories, once reserved, are not written back up as such reserve adjustments are considered to be a permanent decrease to the cost basis of the excess or obsolete inventory. Segment Results (Also refer to Note 13 of Notes to Consolidated Condensed Financial Statements in Item 1 of this Report for important information regarding APC's reportable segments) Net sales in the first quarter of 2003 for products in the Small Systems segment, which provides power protection, UPS, and management products for the PC, server, and local area networking markets, approximated first quarter 2002 levels. Net sales remained unchanged due principally to continued weakness in spending on IT equipment served by APC's Small Systems solutions. Profits for the Small Systems segment improved in the first quarter of 2003 over the comparable quarter in 2002, primarily reflecting product cost reduction efforts. These cost reductions were achieved through a combination of product transitions to low cost manufacturing locations and material cost reductions from APC's supplier base. Partially offsetting this improvement was unfavorable mix, primarily in our Back-UPS and surge consumer products. Net sales for products in the Large Systems segment, consisting primarily of UPS, DC-power systems, and precision cooling products for data centers, facilities, and communication applications, increased 19.0% in the first quarter of 2003 compared to the first quarter of 2002. The strong first quarter 2003 net sales were due principally to sales of InfraStruXure as well as strengthening in services and our industrial UPS business, partially offset by weakness in our communications market segment. Losses for the Large Systems segment declined in the first quarter of 2003 reflecting a continual lowering of product costs achieved through factory consolidations and capacity rationalization efforts that were begun in late 2001. First quarter 2003 net sales for products in the "Other" segment, consisting principally of notebook computer accessories, replacement batteries and Web- based services, were also strong due mainly to organic growth of existing products as well as growth from new mobile accessory products. The first quarter 2003 gross margin improvement in the "Other" segment over the first quarter of 2002 was primarily the result of our transitioning products to lower cost manufacturing facilities. 15 Operating Expenses Operating expenses include marketing, selling, general and administrative (SG&A) and R&D expenses. SG&A expenses were $72.4 million or 23.4% of net sales for the first quarter of 2003 compared to $66.2 million or 22.3% of net sales for the first quarter of 2002. The increase in total spending in the first quarter of 2003 reflects additional investments in sales and marketing promotions as well as personnel to support new markets and products, combined with increased investment in administrative support. The allowance for doubtful accounts at March 30, 2003 was 7.3% of accounts receivable, compared to 7.0% at December 31, 2002. Accounts receivable balances outstanding over 60 days represented 11.5% of total receivables at March 30, 2003, down slightly from 11.7% at December 31, 2002. This decrease reflects an increased collection effort, offset in part by a growing portion of our business originating in areas where longer payment terms are customary, including a growing contribution from international markets. We continue to experience strong collection performance. Write-offs of uncollectable accounts represent less than 1% of net sales. A majority of international customer balances continue to be covered by receivables insurance. R&D expenses were $14.5 million or 4.7% of net sales and $14.8 million or 5.0% of net sales for the first quarters of 2003 and 2002, respectively. Total R&D spending decreased slightly as our focused efforts to control costs combined with the effect of restructuring expenses recorded in the first quarter of 2002 offset the impact of increased numbers of software and hardware engineers and other costs associated with new product development and engineering support in the first quarter of 2003. Other Income, Net and Income Taxes Other income in the first quarters of 2003 and 2002 is comprised principally of interest income. Interest income increased substantially in the first quarter of 2003 over the comparable prior year level due principally to average cash balances available for investment that were higher in the first quarter of 2003 than in the first quarter of 2002, partially offset by lower short term interest rates during the first quarter of 2003. At March 30, 2003, APC had $685.0 million of total cash and investments. We manage APC's cash and investment balances to preserve principal and liquidity while maximizing our return on the total investment portfolio. We diversify our investment portfolio by investing in multiple types of investment-grade securities with multiple investment brokers. Based on APC's investment portfolio and interest rates at March 30, 2003, a 100 basis point increase or decrease in interest rates would have resulted in an increase or decrease of approximately $1.7 million in our annual interest income. Our effective income tax rate was approximately 27.8% and 28.5% for the first quarters ended March 30, 2003 and March 31, 2002, respectively. The decrease from 2002 to 2003 is due to the tax savings from an increasing portion of taxable earnings being generated from APC's operations in jurisdictions currently having lower income tax rates than the present U.S. statutory income tax rate. This shift resulted partially from our product transitions to lower cost, lower tax, manufacturing locations. LIQUIDITY AND CAPITAL RESOURCES Working capital at March 30, 2003 was $1.045 billion compared to $999.1 million at December 31, 2002. APC has been able to increase its working capital position as the result of continued positive operating results and despite internally financing the capital investment required to expand its operations. Our cash, cash equivalents and short-term investments position decreased to $632.0 million at March 30, 2003 from $640.3 million at December 31, 2002, due to increased investment in working capital, particularly inventories, as well as funding first quarter 2003 expenses related to our recent product recall. 16 Worldwide inventories were $352.0 million at March 30, 2003 compared to $320.0 million at December 31, 2002. The first quarter 2003 inventory build was primarily related to anticipation of increased demand patterns during the second half of the year which result from typical seasonal factors and, to a lesser extent, increased on-hand inventories needed to support the in-house manufacture of select products previously manufactured by a third party subcontractor. There were no inventory charges, other than APC's standard provisioning, during the first quarters of 2003 and 2002. Inventory levels as a percentage of quarterly sales were 114% in the first quarter of 2003, up from 89% in the fourth quarter of 2002. This increase was due in part to the typical first quarter 2003 inventory build combined with the typical seasonal decline in net sales from the fourth quarter to the first quarter of each year. We announced a product recall of Back-UPS CS 350 and 500 models in early 2003 due to potential safety issues. Prior to announcing the recall, APC received eight reports worldwide of units overheating, resulting in the melting of the unit's outer casing, six of which occurred in the United States. Three of the reported incidents resulted in minor property damage; no injuries have been reported. The total number of affected devices being recalled worldwide is approximately 2.1 million with approximately 900,000 devices recalled in the United States. The recall is limited to two specific models in APC's Back-UPS CS product line, the Back-UPS CS 350 and the Back-UPS CS 500, in both 120-volt and 230-volt models. The affected units were manufactured between November 2000 and December 2002 and were sold primarily through computer and electrical distribution, catalog and retail outlets worldwide. Our methodology for estimating costs associated with this product recall involved estimating future costs to be incurred to replace the recalled products based on expected returns and the costs to conduct the recall, particularly repair and transportation costs. Our repair and transportation cost estimates include costing for component parts and inside labor; we also obtained third party cost quotes for outside labor and freight. The expected percentage of units to be returned out of the total population of units is an important assumption. Our current assumption is that approximately 40% of domestic units in the hands of end-users and approximately 20% of international units will be exchanged. To help understand the relative impact of the return rate assumption, a 10 percentage point increase in the worldwide return rate would increase the estimated recall costs from $19.6 million to $25 million. In the fourth quarter of 2002, we accrued a current liability and recognized additional warranty expense which is classified in cost of goods sold. As of March 30, 2003, we had incurred approximately one third of total estimated recall costs. We expect APC's cash outlays associated with this product recall to be financed from operating cash. Actual amounts may differ materially from our current estimates. At March 30, 2003 and December 31, 2002, we had available for future borrowings $65.0 million under an unsecured line of credit agreement at a floating interest rate equal to the bank's cost of funds rate plus 0.625% and an additional $6.0 million under an unsecured line of credit agreement with a second bank at similar interest rates. No borrowings were outstanding under these facilities during the first quarters of 2003 and 2002, or at March 30, 2003 and December 31, 2002. APC had no significant financial commitments, other than those required in the normal course of business, during the first quarters of 2003 and 2002, or at March 30, 2003 and December 31, 2002. During the first quarters of 2003 and 2002, our capital expenditures, net of capital grants, amounted to approximately $3.5 million and $4.2 million, respectively, consisting primarily of manufacturing and office equipment, buildings and improvements, and purchased software applications. Our capital spending remains focused on funding additional equipment needs and existing factories as well as continuing investment in information technologies. The decrease in capital spending in the first quarter of 2003 from comparable prior year levels, reflected our continued efforts to control and reduce capital spending and rationalize our overall production capacity which included our first quarter 2002 decision to consolidate our Philippines based manufacturing operations in the province of Cavite. Substantially all of APC's net capital expenditures were financed from available operating cash. We had no material capital commitments during the first quarters of 2003 and 2002, or at March 30, 2003 and December 31, 2002. We have agreements with the Industrial Development Authority of Ireland, otherwise known as the IDA. Under these agreements, we receive grant monies for costs incurred for machinery, equipment and building improvements for our Galway and Castlebar facilities. These grants are equal to 40% and 60%, respectively, of such costs up to a maximum of $13.1 million for Galway and $1.3 million for Castlebar. Such grant monies are subject to our meeting certain employment goals and maintaining operations in Ireland until termination of the respective agreements. 17 We believe 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. Foreign Currency Activity We invoice our customers in various currencies. Realized and unrealized transaction gains or losses are included in the results of operations and are measured based upon the effect of changes in exchange rates on the actual or expected amount of functional currency cash flows. At March 30, 2003, our unhedged foreign currency accounts receivable, by currency, were as follows:
In thousands Foreign US Currency Dollars European Euros 41,077 $43,899 Japanese Yen 3,049,560 $25,403 British Pounds 9,402 $14,807 Swiss Francs 19,386 $14,028
We also had non-trade receivables denominated in Irish Pounds of approximately US$0.9 million, liabilities denominated in various European currencies of approximately US$44.6 million, and liabilities denominated in Japanese Yen of approximately US$6.6 million. We continually review our foreign exchange exposure and consider 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. We presently do not utilize rate protection agreements or derivative arrangements. CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations are based upon the accompanying consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The U.S. Securities and Exchange Commission has defined critical accounting policies as those that are both most important to the portrayal of our financial condition and results and which require our most difficult, complex or subjective judgments or estimates. Based on this definition, we have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies. For a detailed discussion on the application of these and other accounting policies, also refer to Note 1 of Notes to Consolidated Condensed Financial Statements in Item 8 of this Report. On an on-going basis, we evaluate the judgments and estimates underlying all of our accounting policies, including those related to revenue recognition, product returns, bad debts, inventories, impairment of long-lived assets, deferred tax valuation allowances, restructuring reserves and contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Materially different results in the amount and timing of our actual results for any period could occur if we made different judgments or utilized different estimates. Actual results may differ from those estimates. 18 Our critical accounting policies are as follows: Revenue Recognition We follow very specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter. In general, revenue is recognized when title has passed at the time of delivery of product for all of our operating segments as stipulated by the delivery terms for the sales transactions. In addition, prior to revenue recognition, we require persuasive evidence of the arrangement, that the price is fixed or determinable, and that collectibility is reasonably assured. Installation is not applicable for Small Systems and Other segment products based on the nature of the products sold. Generally, revenue associated with Large Systems sales is also recognized at the time of delivery pursuant to the delivery terms, as we do not perform installation. Delivery terms vary, but often include origin-based terms (e.g., FOB Shipping Point and Ex-works) and destination-based terms (e.g., DDU/DDP (delivered duty unpaid/delivered duty paid)). Certain Large Systems product lines and, at times, one product line included in the Small Systems segment require electrical hardwire installation or duct installation which is performed by the customer or their contracted licensed contractor/electrician. Since we do not perform the installation, revenue recognition at the time of delivery is proper as customer acceptance of the unit is not required. Also, payment by the customer is not contingent upon installation of the product. We offer additional services to customers depending on the type of product the customer has purchased, including on-site services, installation consulting services, remote monitoring services, power audit services, and network integration services. Revenue is recognized at the time services are provided or is deferred and recognized over the service period (where applicable). The fair value of these services are based upon the rates that we charge customers in separately negotiated transactions and such services are not essential to the functionality of the delivered product. For all sales, except those completed over the Internet, we use a binding purchase order as evidence of an arrangement. For sales over the Internet, we use a credit card authorization as evidence of an arrangement. Sales through certain customers are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction by transaction basis. Our arrangements do not generally include acceptance clauses. However, if an arrangement includes a customer specified acceptance provision, acceptance generally occurs at our factory prior to delivery. As we introduce new products in 2003, we anticipate that installation and customer acceptance provisions may become more common, and therefore increasingly significant for determining delivery and performance and consequently our entitlement to recognize revenue. Estimating Valuation Allowances and Accrued Liabilities - Allowances for Sales Returns, Doubtful Accounts, Inventory Obsolescence and Product Recall, and Assessment of the Probability of the Outcome of our Current Litigation Significant management judgments that affect the application of our revenue policy also include estimates of potential future product returns related to current period product revenue. We analyze historical returns, current economic trends, and channel inventories when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates. We provide limited rights of return to distributors and retailers for our Small Systems product lines. We provide appropriate reserves for returns at the time that related revenue is recognized, based on historical patterns of returns and contractual provisions in accordance with the provisions of Statement of Financial Accounting Standards No. 48, Revenue Recognition When Right of Return Exists, and U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 101. Returns of Large Systems products generally do not occur. Historically, returns have represented approximately 3% of gross sales and have not differed significantly from prior estimates. 19 Similarly, we must make estimates of the uncollectability of our accounts receivables. Management specifically analyzes accounts receivable balances in view of customer credit-worthiness, customer concentrations, historical bad debts, current economic trends, and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. A majority of international customer balances continue to be covered by receivables insurance. Our inventory reserve estimate methodology involves quantifying the total inventory position having potential loss exposure. Loss exposure generally results from several business factors, including product or component discontinuance, unplanned changes in demand, product design changes, and factory transitions. Quantifying such loss exposure is the result of combining the cost of inventories specifically identified as having little or no opportunity for sale or use (thus available for physical disposition) plus the cost of inventories having a high risk of no future sale or use based upon an analysis of on-hand quantities compared to historical and anticipated future sale or use. We maintain an on-going business process for the physical disposition of inventories previously identified. Inventory write-offs occur at the time of physical disposition. Inventories, once reserved, are not written back up as such reserve adjustments are considered to be a permanent decrease to the cost basis of the excess or obsolete inventory. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. In early 2003, we announced a product recall of Back-UPS CS 350 and 500 models. Our methodology for estimating costs associated with this product recall involved estimating future costs to be incurred to replace the recalled products based on expected returns and the costs to conduct the recall, particularly repair and transportation costs. Our repair and transportation cost estimates include costing for component parts and inside labor. We also obtained third party cost quotes for outside labor and freight. The expected percentage of units to be returned out of the total population of units is an important assumption. Our current assumption is that approximately 40% of domestic units in the hands of end-users and approximately 20% of international units will be exchanged. To help understand the relative impact of the return rate assumption, a 10 percentage point increase in the worldwide return rate would increase the estimated recall costs from $19.6 million to $25 million. In the fourth quarter of 2002, we accrued a current liability and recognized additional warranty expense which was classified in cost of goods sold. As of March 30, 2003, we had incurred approximately one third of total estimated recall costs. Actual amounts may differ materially from our current estimates. We are, and may in the future become, involved in litigation involving our business, products or operations. For pending claims for which there is an estimable range of loss greater than zero, we record the best estimate of liability within the range. If no point within the range is considered the best estimate, we record the minimum estimated liability. Because of uncertainties related to the identifiable range of loss on any pending claims, we may be unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, we assess the potential liability related to our pending claims and revise our estimates. Such revisions in our estimates of the potential liability could materially impact our results of operation and financial position. The litigation process is uncertain and includes the risk of an unexpected, unfavorable result. We may be materially adversely impacted by any such litigation. Valuation of Long-lived Tangible and Intangible Assets including Goodwill We assess the impairment of long-lived tangible and intangible assets including goodwill on an ongoing basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Should our assessment suggest impairment, we would determine recoverability based on an estimate of future undiscounted cash flows resulting from our use of the asset and its eventual disposition. Factors we consider that could trigger an impairment review include the following: -- significant underperformance relative to expected historical or projected future operating results; -- significant changes in the manner of our use of the acquired assets or the strategy for our overall business; -- significant negative industry or economic trends; and -- significant technological changes, which would render equipment and manufacturing process, obsolete. 20 On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. With the adoption of Statement 142, we implemented the necessary reclassifications in order to conform to the new criteria in Statement of Financial Accounting Standards No. 141, Business Combinations, for recognition of intangible assets apart from goodwill. Statement 142 requires that companies no longer amortize goodwill and other intangible assets with indefinite lives, but instead test goodwill impairment at least annually or more frequently if impairment indicators arise. Statement 142 also requires completion of a two-step transitional goodwill impairment test. In connection with completion of the first step of our transitional analysis, we identified two reporting units with goodwill, Large Systems and Small Systems; these reporting units are also reportable segments. We then determined the carrying value of each reporting unit by assigning the assets and liabilities, including existing goodwill and other intangible assets, to these reporting units as of the date of adoption. Completion of the first step of our analysis indicated impairment in the carrying amount of our goodwill. Our goodwill was primarily associated with our Large Systems segment which consists primarily of uninterruptible power supply (UPS), DC-power systems, and precision cooling products for data centers, facilities, and communication applications. Conditions contributing to the goodwill impairment included the ongoing softness in IT and communications market segments coupled with lower corporate investment for these types of applications. In connection with completion of the second step of our transitional analysis, we compared the carrying amount of reporting unit goodwill with the implied fair value of reporting unit goodwill, both of which were measured as of the date of adoption. The implied fair value of goodwill was determined by allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation, in accordance with the provisions of Statement 141. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Based on this second step, we recorded a non-cash charge equal to the goodwill balance associated with our Large Systems segment of approximately $50 million (approximately $35 million on an after-tax basis). This charge was recognized as the cumulative effect of a change in accounting principle net of income taxes, included in APC's results as of January 1, 2002, and had no effect on our liquidity. Our remaining goodwill is associated with our Small Systems segment. We evaluate each of our reporting units with goodwill during the fourth quarter of each fiscal year or more frequently if impairment indicators arise. Accounting for Income Taxes As part of the process of preparing our consolidated condensed financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. Expectations about future taxable income incorporate numerous assumptions about actions, elections and strategies to minimize income taxes in future years. Our ability to take such actions, make preferred elections and implement tax-planning strategies may be adversely impacted by enacted changes in tax laws and/or tax rates, as well as successful challenges by tax authorities resulting from differing interpretations of tax laws and regulations. To the extent we believe that recovery of deferred tax assets is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the consolidated statements of income. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. At March 30, 2003 and December 31, 2002, we provided a valuation allowance on certain of our deferred tax assets, primarily consisting of net operating losses generated for the start up of Brazilian operations, because of uncertainty regarding their realizability. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations. 21 RECENTLY ISSUED ACCOUNTING STANDARD In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. This consensus addresses several issues including how to determine when a multiple arrangement exists and the proper accounting treatment. The guidance in this consensus is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Adoption of the guidance in this consensus is not expected to have a material impact on our consolidated financial position or results of operations. FACTORS THAT MAY AFFECT FUTURE RESULTS This document contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this document. The factors that could cause actual results to differ materially include the following: costs incurred by APC for the recent product recall are greater than or less than currently anticipated; impact on order management and fulfillment, financial reporting and supply chain management processes as a result of APC's reliance on a variety of computer systems, including Oracle 11i which was implemented in the first quarter 2001; the effect on our business, our suppliers, our customers, or the economy resulting from travel, supply-chain or general business disruptions from Severe Acute Respiratory Syndrome (SARS); the impact on demand, component availability and pricing, and logistics, and the disruption of Asian manufacturing operations that result from labor disputes, war, acts of terrorism or political instability; ramp up, expansion and rationalization of global manufacturing capacity; the discovery of a latent defect in any of APC's products; APC's ability to effectively align operating expenses and production capacity with the current demand environment; general worldwide economic conditions, and, in particular, the possibility that the PC and related markets decline more dramatically than currently anticipated; growth rates in the power protection industry and related industries, including but not limited to the PC, server, networking, telecommunications and enterprise hardware industries; competitive factors and pricing pressures; product mix changes and the potential negative impact on gross margins from such changes; changes in the seasonality of demand patterns; inventory risks due to shifts in market demand; component constraints, shortages and quality; risk of nonpayment of accounts receivable; the uncertainty of the litigation process including risk of an unexpected, unfavorable result of current or future litigation; and the risks described from time to time in APC's filings with the Securities and Exchange Commission. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date they are made. We disclaim any obligation to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements. For a discussion of these and other risk factors, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2002. 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We, in the normal course of business, are exposed to market risks relating to fluctuations in foreign currency exchange rates. The information required under this section related to such risks is included in the Foreign Currency Activity section of Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of this Report and is incorporated herein by reference. We, in the normal course of business, are also exposed to market risks relating to fluctuations in interest rates and the resulting rates of return on investments in marketable securities. The information required under this section related to such risks is included in the Other Income, Net section of Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of this Report and is incorporated herein by reference. ITEM 4. CONTROLS AND PROCEDURES (A) Evaluation of disclosure controls and procedures Our chief executive officer and our chief financial officer, after evaluating the effectiveness of APC's "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a date (the "Evaluation Date") within 90 days before the filing date of this quarterly report, have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities. (B) Changes in internal controls There were no significant changes in our internal controls or, to our knowledge, in other factors that could significantly affect our internal controls subsequent to the Evaluation Date. 23 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS APC is involved in various claims and legal actions arising in the ordinary course of business. APC does not believe that the ultimate disposition of these matters will have a material adverse effect on its consolidated financial position or results of operations or liquidity. In addition, on January 10, 2003, Powerware Corporation filed in the United States District Court for the Eastern District of North Carolina (the "Court") a complaint alleging infringement of three United States patents (the "Patents"). On May 7, 2003, Powerware Corporation filed with the Court an amended complaint modifying its allegations of infringement regarding the Patents. APC was served with the amended complaint on May 9, 2003. Powerware Corporation is seeking unspecified damages and injunctive relief. APC is evaluating the allegations in the amended complaint and APC is due to respond to the amended complaint by May 29, 2003. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits Exhibit No. 3.01 Articles of Organization of APC, as amended, previously filed as an exhibit to APC's Quarterly Report on Form 10-Q for the fiscal quarter ended June 27, 1999 and incorporated herein by reference (File No. 1-12432) Exhibit No. 3.02 By-Laws of APC, as amended and restated, previously filed as an exhibit to APC's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 and incorporated herein by reference (File No. 1-12432) Exhibit No. 99.1 Certification of Rodger B. Dowdell, Jr., Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * Exhibit No. 99.2 Certification of Donald M. Muir, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * * American Power Conversion Corporation has the originally signed certificate and will provide it to the Securities and Exchange Commission upon request. (B) Reports on Form 8-K On January 15, 2003, APC filed a Current Report on Form 8-K with the Securities and Exchange Commission which reported, pursuant to Items 7 and 9, APC's two January 14, 2003 press releases announcing a voluntary recall of two models in its Back-UPS(R) CS uninterruptible power supply line and also separately announcing the anticipated financial impact of the special charge associated with its product recall as well as providing an update on anticipated financial results for the fourth quarter of 2002. 24 FORM 10-Q March 30, 2003 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN POWER CONVERSION CORPORATION Date: May 14, 2003 /s/ Donald M. Muir Donald M. Muir Chief Financial Officer (Principal Accounting And Financial Officer) 25 CERTIFICATION I, Rodger B. Dowdell, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of American Power Conversion Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Rodger B. Dowdell, Jr. Rodger B. Dowdell, Jr. Chairman, President and Chief Executive Officer 26 CERTIFICATION I, Donald M. Muir, certify that: 1. I have reviewed this quarterly report on Form 10-Q of American Power Conversion Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Donald M. Muir Donald M. Muir Senior Vice President, Finance and Administration, Treasurer and Chief Financial Officer 27 FORM 10-Q March 30, 2003 AMERICAN POWER CONVERSION CORPORATION AND SUBSIDIARIES EXHIBIT INDEX
Exhibit Page Number Description No. 3.01 Articles of Organization of APC, as amended, previously filed as an exhibit to APC's Quarterly Report on Form 10-Q for the fiscal quarter ended June 27, 1999 and incorporated herein by reference (File No. 1-12432) 3.02 By-Laws of APC, as amended and restated, previously filed as an exhibit to APC's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 and incorporated herein by reference (File No. 1-12432) 99.1 Certification of Rodger B. Dowdell, Jr., Chief Executive 29 Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * 99.2 Certification of Donald M. Muir, Chief Financial Officer, 30 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
* American Power Conversion Corporation has the originally signed certificate and will provide it to the Securities and Exchange Commission upon request. 28 Exhibit 99.1 CERTIFICATION In connection with the Quarterly Report of American Power Conversion Corporation (the "Company") on Form 10-Q for the period ending March 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Rodger B. Dowdell, Jr., Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Rodger B. Dowdell, Jr. Rodger B. Dowdell, Jr. Chairman, President and Chief Executive Officer May 14, 2003 The foregoing certification is being furnished solely pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code) and is not being filed as part of a separate disclosure document. 29 Exhibit 99.2 CERTIFICATION In connection with the Quarterly Report of American Power Conversion Corporation (the "Company") on Form 10-Q for the period ending March 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Donald M. Muir, Senior Vice President, Finance and Administration, Treasurer and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Donald M. Muir Donald M. Muir Senior Vice President, Finance and Administration, Treasurer and Chief Financial Officer May 14, 2003 The foregoing certification is being furnished solely pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code) and is not being filed as part of a separate disclosure document. 30 -----END PRIVACY-ENHANCED MESSAGE-----