(Jan. 31, 2000) -- Wow! The story at American Power Conversion (Nasdaq: APCC) keeps getting better and better. Of course, I'm biased, as I share this holding with the Boring Port, but I think even an objective observer would have to be impressed.


Last Thursday, APC reported Q4 and full-year 1999 earnings, capping an amazing decade for the company -- one in which the stock compounded at 53.7% annually (for perspective, only 15 stocks in Value Line's 5,000-stock database did better). In the fourth quarter, relative to the same quarter last year, revenues grew 21.9% (a nice rebound from last quarter's aberration of 8.7% year-over-year growth), and gross margins increased sharply from 45.2% to 48.1%. This offset slightly higher operating expenses, resulting in operating income jumping 35.0%. Net margins soared from 14.9% to 17.1%, triggering a 40.1% increase in net income. The result was EPS of $0.34, two cents better than analysts' estimates and 38.5% higher than last year. It was the 16th consecutive quarter that APC met or beat consensus estimates.

For the full year (excluding a one-time charge in 1998 for acquired R&D), revenues grew 18.8%, gross margins increased from 44.8% to 46.0%, and operating expenses declined from 26.0% to 25.1%, resulting in operating income jumping 31.7%. Net margins jumped from 13.8% to 15.4%, resulting in a 33.0% and 31.3% increase in net income and EPS, respectively. Note that APC's performance is accelerating, as growth and margins were all stronger in Q4 than for the full year.

But as strong as the income statement was, the story on the balance sheet was even better -- a more important consideration in my opinion, as I've discussed in my previous writings on APC (see below for links).

The company remains essentially debt-free and is sitting on $456.3 million of cash, equal to 8.6% of its $5.3 billion market capitalization. Cash increased 107.5% year over year and $125.4 million in Q4 alone. Given that APC's net income in Q4 was only $66.5 million, the company's cash profitability was nearly twice as high as its reported profitability.

This was due to balance sheet improvements. While revenue grew 9.2% compared to Q3, accounts receivable fell 10.2% (and days sales outstanding fell two days to 54 days), while inventories fell 11.1%. APC's days of inventory is now 89.1 days -- the second-lowest level in the past 20 quarters and a dramatic improvement from the 134.4 days a year ago and 104.2 days in Q3. Not surprisingly, the flow ratio improved to 2.29 versus 2.55 and 2.70 in Q3 and year over year, respectively. All of these factors generated an abundance of cash.

The net result of the income statement and balance sheet improvements is that return on invested capital for the quarter increased to 46% versus 35% a year ago and 42% last quarter. (I calculate the figure slightly differently, but agree that ROIC is very high and increasing.)

New Product Developments

With the acquisition of Silcon in 1998, APC is now pushing aggressively into the high end of the market with its Silcon and Symmetra product lines, which showed greater than 60% and 40% unit growth, respectively, and now account for approximately 10% of APC's sales.

APC also announced that they partnered with Microsoft (Nasdaq: MSFT) to build the UPS (uninterruptible power supply) tab in the Windows 2000 UPS management control panel. This tab provides improved basic support for most manufacturers' UPS's, but Microsoft has included a more advanced driver for enhanced management of APC's UPS's. This gives APC an edge in selling to customers who use Windows 2000.

CEO's Concluding Remarks

APC's CEO, Rodger Dowdell, concluded the conference call with analysts (click here to read my notes from the call) by saying:

"We have entered the year 2000 with the broadest product and service offering in our history. Equally important, the company is by far in the strongest financial position it has ever been in. The IT market's focus on availability, the rapid growth of the Internet and the technology to support it, as well as the continued proliferation of devices over networks are all very favorable trends for APC. Additionally, as you may have read in The Wall Street Journal earlier this month, power quality continues to be an issue, even here in the U.S. The U.S. Energy Department recently concluded that the reliability of North America's electricity supply systems during peak usage periods has been considerably eroded due to the strong economy and the impact of deregulation. In that the U.S. utilities grid is among the best in the world, it is clear there remains a very real need for the assurance of reliable power.

"Finally, in respect to our business outlook, we believe the company can meet the existing consensus estimate of $0.24, representing 33% year-over-year growth, and meet or exceed the full-year estimate of $1.24 [which would be 18.1% growth]."


I could find no warts on this blowout quarter, and APC's future looks exceptionally bright. I will continue next week with some thoughts on APC's valuation before resuming my series on Beating the Market.

--Whitney Tilson

Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous guest columns in the Boring Port and other writings, click here.

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