** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**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 June 25, 2006**                                              |
|               | ** **                                                                                    |
|               | **or**                                                                                        |
|               | ** **                                                                                    |
| o                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **         | **For the transition period from  _____________to_____________**                              |

 

**CommissionFile 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 ISLAND02892**

**401-789-5735**

(Address and telephone number of principal executiveoffices)

 

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. YES   x   NO   o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

 

| Large accelerated filer   x |   | Accelerated  filer   o |   | Non-accelerated  filer   o |
|---------------------------------------|--------|----------------------------------|--------|--------------------------------------|

 

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). YES   o   NO   x

 

Registrant’s Common Stock outstanding, $0.01 parvalue, at July 27, 2006 —190,481,000 shares

 

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** **

**AMERICANPOWER CONVERSION CORPORATION**

**INDEX**
|                                        | ** ** | **Page No.**                                                                                                                    | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Part I—Financial Information:** |       |                                                                                                                                 |       |
| ** **                             |       |                                                                                                                                 |       |
| Item  1.                               |       | Consolidated  Condensed Financial Statements:                                                                                        |       |   |   |
|                                   |       | Consolidated Condensed Balance Sheets—June 25, 2006  and December 31, 2005 (Unaudited)                                          |       | 3 - 4 |   |
|                                   |       |                                                                                                                                 |       |   |   |
|                                   |       | Consolidated Condensed Statements of Income—  Three Months and Six Months Ended June 25, 2006 and June 26, 2005 (Unaudited)     |       | 5 |   |
|                                   |       |                                                                                                                                 |       |   |   |
|                                   |       | Consolidated Condensed Statements of Cash Flows—  Three Months and Six Months Ended June 25, 2006 and June 26, 2005 (Unaudited) |       | 6 |   |
|                                   |       |                                                                                                                                 |       |   |   |
|                                   |       | Notes to Consolidated Condensed Financial Statements (Unaudited)                                                                     |       | 7 - 14 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item 2.                                |       | Management’s Discussion and Analysis of Financial ondition  and Results of Operations                                           |       | 15 - 28 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item 3.                                |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                          |       | 29 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item 4.                                |       | Controls and Procedures                                                                                                              |       | 29 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| **Part  II—Other Information:**   |       |                                                                                                                                 |       |
| ** **                             |       |                                                                                                                                 |       |
| Item  1.                               |       | Legal  Proceedings                                                                                                                   |       | 29 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item  1A.                              |       | Risk  Factors                                                                                                                        |       | 30 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item 2.                                |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                         |       | 31 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item 4.                                |       | Submission of Matters to a Vote of Security Holders                                                                                  |       | 31 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| Item 6.                                |       | Exhibits                                                                                                                             |       | 32 |   |
|                                   |       |                                                                                                                                 |       |   |   |
| **Signatures**                         |       | 33                                                                                                                                   |       |
| ** **                             |       |                                                                                                                                 |       |
| **Exhibit  Index**                     |       | 34                                                                                                                                   |       |

 

2

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**PART I—CONSOLIDATEDCONDENSED FINANCIAL STATEMENTS**

**ITEM1.  FINANCIAL STATEMENTS**

**AMERICAN POWER CONVERSIONCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

***Inthousands except per share amount***

***(Unaudited)***

**ASSETS**
| ** **                                                                                                     | ** ** | **June 25,  2006** | ** **    | **December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------|---------------|-----------------------------|------------|
| Current assets:                                                                                                | ** ** | ** **              |          |                        |       |
| Cash and cash  equivalents                                                                                     | ** ** | **$**                   | **202,078**   |                        | $          | 262,414 |   |
| Short term  investments (Note 3)                                                                               | ** ** | **336,667**             |          | 511,181                     |       |
| Accounts  receivable, less allowance for doubtful accounts of $14,146 in 2006 and  $14,995 in 2005   | ** ** | **395,887**             |          | 374,694                     |       |
| Inventories:                                                                                                   | ** ** | ** **              |          | ** **                  | ** ** |
| Raw materials                                                                                                  | ** ** | **241,751**             |          | 215,260                     |       |
| Work-in-process and finished goods                                                                             | ** ** | **365,810**             |          | 326,563                     |       |
| Total  inventories                                                                                             | ** ** | **607,561**             |          | 541,823                     |       |
|                                                                                                           | ** ** | ** **              |          |                        |       |
| Prepaid expenses  and other current assets                                                                     | ** ** | **62,701**              |          | 59,181                      |       |
| Deferred income  taxes                                                                                         | ** ** | **68,600**              |          | 60,139                      |       |
|                                                                                                           | ** ** | ** **              |          |                        |       |
| Total current  assets                                                                                          | ** ** | **1,673,494**           |          | 1,809,432                   |       |
|                                                                                                           | ** ** | ** **              |          |                        |       |
| Property, plant and  equipment:                                                                                | ** ** | ** **              |          |                        |       |
| Land, buildings and improvements                                                                               | ** ** | **91,934**              |          | 75,549                      |       |
| Machinery and equipment                                                                                        | ** ** | **243,057**             |          | 229,768                     |       |
| Office equipment, furniture and fixtures                                                                       | ** ** | **106,659**             |          | 101,144                     |       |
| Purchased software                                                                                             | ** ** | **61,078**              |          | 53,275                      |       |
|                                                                                                           | ** ** | **502,728**             |          | 459,736                     |       |
| Less accumulated  depreciation and amortization                                                                | ** ** | **309,588**             |          | 293,692                     |       |
| Net property,  plant and equipment                                                                             | ** ** | **193,140**             |          | 166,044                     |       |
|                                                                                                           | ** ** | ** **              |          |                        |       |
| Long term  investments (Note 3)                                                                                | ** ** | **564**                 |          | 562                         |       |
| Goodwill (Note  4)                                                                                             | ** ** | **17,951**              |          | 15,781                      |       |
| Other  intangibles, net (Note 4)                                                                               | ** ** | **29,503**              |          | 36,115                      |       |
| Deferred income  taxes                                                                                         | ** ** | **43,820**              |          | 42,427                      |       |
| Other assets                                                                                                   | ** ** | **3,919**               |          | 5,101                       |       |
|                                                                                                           | ** ** | ** **              |          |                        |       |
| Total assets                                                                                                   | ** ** | **$**                   | **1,962,391** |                        | $          | 2,075,462 |   |

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

3

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**AMERICAN POWER CONVERSIONCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED BALANCE SHEETS (CONTINUED)**

***Inthousands except per share amount***

***(Unaudited)***

**LIABILITIESAND SHAREHOLDERS’ EQUITY**
| ** **                                                                                                                            | ** ** | **June 25,  2006** | ** **    | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|---------------|-----------------------------|------------|
| Current liabilities:                                                                                                                  | ** ** | ** **              |          |                        |       |
| Accounts payable                                                                                                                      | ** ** | **$**                   | **162,288**   |                        | $          | 176,345 |   |
| Accrued compensation                                                                                                                  | ** ** | **51,519**              |          | 41,798                      |       |
| Accrued sales and  marketing programs                                                                                                 | ** ** | **52,573**              |          | 47,826                      |       |
| Accrued warranty (Note  5)                                                                                                            | ** ** | **13,348**              |          | 13,272                      |       |
| Other accrued expenses                                                                                                                | ** ** | **59,651**              |          | 60,013                      |       |
| Deferred revenue                                                                                                                      | ** ** | **44,976**              |          | 41,793                      |       |
| Income taxes payable                                                                                                                  | ** ** | **34,644**              |          | 39,755                      |       |
|                                                                                                                                  | ** ** | ** **              |          |                        |       |
| Total current  liabilities                                                                                                            | ** ** | **418,999**             |          | 420,802                     |       |
|                                                                                                                                  | ** ** | ** **              |          |                        |       |
| Deferred tax liability                                                                                                                | ** ** | **11,344**              |          | 14,911                      |       |
|                                                                                                                                  | ** ** | ** **              |          |                        |       |
| Total liabilities                                                                                                                     | ** ** | **430,343**             |          | 435,713                     |       |
|                                                                                                                                  | ** ** | ** **              |          |                        |       |
| Shareholders’ equity  (Notes 6, 7, 8 and 9):                                                                                     | ** ** | ** **              |          |                        |       |
| Common stock, $0.01 par  value; authorized 450,000 shares in 2006 and 2005; issued 190,179 shares in  2006 and 195,778 shares in 2005 | ** ** | **1,902**               |          | 1,958                       |       |
| Additional paid-in  capital                                                                                                           | ** ** | **22,671**              |          | 131,862                     |       |
| Retained earnings                                                                                                                     | ** ** | **1,504,625**           |          | 1,504,093                   |       |
| Accumulated other  comprehensive income                                                                                               | ** ** | **2,850**               |          | 1,836                       |       |
|                                                                                                                                  | ** ** | ** **              |          |                        |       |
| Total shareholders’  equity                                                                                                      | ** ** | **1,532,048**           |          | 1,639,749                   |       |
|                                                                                                                                  | ** ** | ** **              |          |                        |       |
| Total liabilities and shareholders’ equity                                                                                       | ** ** | **$**                   | **1,962,391** |                        | $          | 2,075,462 |   |

 

* *

* *

*Seeaccompanying notes to consolidated condensed financial statements.*

4

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**AMERICAN POWER CONVERSIONCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED STATEMENTS OF INCOME**

***Inthousands except earnings per share***

***(Unaudited)***
| ** **                                      | ** ** | **Six months ended** | ** **    | **Three months ended** | ** ** |
|-------------------------------------------------|------------|--------------------------------|---------------|----------------------------------|------------|
| ** **                                      | ** ** | **June 25,**              | ** **    | **June 26,**                | ** ** | **June 25,** | ** ** | **June 26,** | ** ** |
| ** **                                      | ** ** | **2006**                       | ** **    | **2005**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Net sales (Note  10)                            | ** ** | **$**                          | **1,038,778** |                             | $          | 888,609 | ** ** | **$** | **559,985** |   | $ | 480,606 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Cost of goods  sold                             | ** ** | **692,365**                    |          | 545,893                          | ** ** | **371,360** |   | 302,341 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Gross profit                                    | ** ** | **346,413**                    |          | 342,716                          | ** ** | **188,625** |   | 178,265 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Operating expenses:                             |       |                           |          |                             |       |   |   |   |   |
| Marketing,  selling, general and administrative | ** ** | **257,821**                    |          | 206,198                          | ** ** | **135,837** |   | 105,619 |   |
| Research and  development                       | ** ** | **48,362**                     |          | 42,975                           | ** ** | **25,827** |   | 22,736 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Total operating  expenses                       | ** ** | **306,183**                    |          | 249,173                          | ** ** | **161,664** |   | 128,355 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Operating income                                | ** ** | **40,230**                     |          | 93,543                           | ** ** | **26,961** |   | 49,910 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Other income,  net                              | ** ** | **10,352**                     |          | 8,983                            | ** ** | **4,918** |   | 5,189 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Earnings before  income taxes                   | ** ** | **50,582**                     |          | 102,526                          | ** ** | **31,879** |   | 55,099 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Income taxes                                    | ** ** | **11,381**                     |          | 24,606                           | ** ** | **7,173** |   | 13,224 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Net income                                      | ** ** | **$**                          | **39,201**    |                             | $          | 77,920 | ** ** | **$** | **24,706** |   | $ | 41,875 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Basic earnings  per share                       | ** ** | **$**                          | **0.20**      |                             | $          | 0.40 | ** ** | **$** | **0.13** |   | $ | 0.22 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Basic weighted  average shares outstanding      | ** ** | **193,083**                    |          | 192,955                          | ** ** | **191,648** |   | 193,438 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Diluted earnings  per share                     | ** ** | **$**                          | **0.20**      |                             | $          | 0.39 | ** ** | **$** | **0.13** |   | $ | 0.21 |   |
|                                            |       |                           |          |                             |       |   |   |   |   |
| Diluted weighted  average shares outstanding    | ** ** | **195,981**                    |          | 199,036                          | ** ** | **194,342** |   | 199,742 |   |

 

 

*Seeaccompanying notes to consolidated condensed financial statements.*

5

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**AMERICAN POWER CONVERSIONCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS**

***Inthousands***

***(Unaudited)***
| ** **                                                                         | ** **   | **Six months ended** | ** **   | **Three months ended** | ** **   |
|------------------------------------------------------------------------------------|--------------|--------------------------------|--------------|----------------------------------|--------------|
| ** **                                                                         | ** **   | **June 25,  2006**        | ** **   | **June 26,  2005**          | ** **   | **June 25,  2006** | ** ** | **June 26,  2005** | ** ** |
| ***Cash  flows from operating activities***                                        | * *     | * *                       | * *     | * *                         | * *     | * * | * * | * * | * * |
| Net income                                                                         | ** **   | **$**                          | **39,201**   |                             | $            | 77,920 | ** ** | **$** | **24,706** |   | $ | 41,875 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |         |                           |         |                             |         |   |   |   |   |
| Depreciation and  amortization of property, plant and equipment                    | ** **   | **20,968**                     |         | 18,390                           | ** **   | **10,327** |   | 9,736 |   |
| Gain on sale of  property, plant and equipment                                     | ** **   | **(739**                       | **)**        | ** **                       | ** **   | **(739** | **)** | ** ** | ** ** |
| Amortization of  other intangibles                                                 | ** **   | **6,612**                      |         | 5,895                            | ** **   | **3,307** |   | 2,947 |   |
| Provision for  doubtful accounts                                                   | ** **   | **1,355**                      |         | 658                              | ** **   | **829** |   | 123 |   |
| Provision for  inventories                                                         | ** **   | **15,128**                     |         | 3,321                            | ** **   | **10,349** |   | 2,561 |   |
| Share-based  compensation expense                                                  | ** **   | **8,123**                      |         | 5,692                            | ** **   | **4,012** |   | 2,625 |   |
| Deferred income  taxes                                                             | ** **   | **(13,421**                    | **)**        | (4,429                           | )            | **2,141** |   | (1,024 | ) |
| Other non-cash  items, net                                                         | ** **   | **1,014**                      |         | (905                             | )            | **846** |   | (501 | ) |
| Changes in operating  assets and liabilities:                                      |         |                           |         |                             |         |   |   |   |   |
| Accounts receivable                                                                | ** **   | **(22,548**                    | **)**        | (31,320                          | )            | **(30,163** | **)** | (30,622 | ) |
| Inventories                                                                        | ** **   | **(80,866**                    | **)**        | (7,950                           | )            | **(28,347** | **)** | 9,675 |   |
| Prepaid expenses and other current assets                                          | ** **   | **(3,520**                     | **)**        | (8,471                           | )            | **(2,239** | **)** | (3,965 | ) |
| Other assets                                                                       | ** **   | **(988**                       | **)**        | (2,174                           | )            | **972** |   | (259 | ) |
| Accounts payable                                                                   | ** **   | **(14,057**                    | **)**        | 3,287                            | ** **   | **(11,267** | **)** | 8,410 |   |
| Accrued expenses                                                                   | ** **   | **17,365**                     |         | (3,004                           | )            | **15,797** |   | 2,657 |   |
| Income taxes payable                                                               | ** **   | **(5,111**                     | **)**        | 9,959                            | ** **   | **(9,743** | **)** | (11,911 | ) |
| Net cash (used  in) provided by operating activities                               | ** **   | **(31,484**                    | **)**        | 66,869                           | ** **   | **(9,212** | **)** | 32,327 |   |
|                                                                               |         |                           |         |                             |         |   |   |   |   |
| ***Cash  flows from investing activities***                                        | * *     | * *                       | * *     | * *                         | * *     | * * | * * | * * | * * |
| Purchases of  held-to-maturity securities                                          | ** **   | **—**                     |         | (624,844                         | )            | **—** |   | (266,230 | ) |
| Maturities of  held-to-maturity securities                                         | ** **   | **5,000**                      |         | 648,297                          | ** **   | **5,000** |   | 303,748 |   |
| Purchases of  available-for-sale securities                                        | ** **   | **(2,566,140**                 | **)**        | (925,525                         | )            | **(1,266,037** | **)** | (486,075 | ) |
| Sales of  available-for-sale securities                                            | ** **   | **2,735,652**                  |         | 911,030                          | ** **   | **1,349,967** |   | 447,231 |   |
| Capital  expenditures                                                              | ** **   | **(48,562**                    | **)**        | (15,315                          | )            | **(31,671** | **)** | (10,328 | ) |
| Proceeds from  sale of property, plant and equipment                               | ** **   | **1,237**                      |         | —                           | ** **   | **1,237** |   | — |   |
| Net cash  provided by (used in) investing activities                               | ** **   | **127,187**                    |         | (6,357                           | )            | **58,496** |   | (11,654 | ) |
|                                                                               |         |                           |         |                             |         |   |   |   |   |
| ***Cash  flows from financing activities***                                        | * *     | * *                       | * *     | * *                         | * *     | * * | * * | * * | * * |
| Purchases of  common stock                                                         | ** **   | **(129,493**                   | **)**        | —                           | ** **   | **(59,216** | **)** | — |   |
| Proceeds from  issuances of common stock                                           | ** **   | **10,114**                     |         | 27,507                           | ** **   | **5,301** |   | 18,775 |   |
| Tax effect of  stock options                                                       | ** **   | **2,009**                      |         | —                           | ** **   | **1,056** |   | — |   |
| Dividends paid  on common stock                                                    | ** **   | **(38,669**                    | **)**        | (38,621                          | )            | **(19,141** | **)** | (19,366 | ) |
| Net cash used in  financing activities                                             | ** **   | **(156,039**                   | **)**        | (11,114                          | )            | **(72,000** | **)** | (591 | ) |
|                                                                               |         |                           |         |                             |         |   |   |   |   |
| Net change in  cash and cash equivalents                                           | ** **   | **(60,336**                    | **)**        | 49,398                           | ** **   | **(22,716** | **)** | 20,082 |   |
| Cash and cash  equivalents at beginning of period                                  | ** **   | **262,414**                    |         | 72,721                           | ** **   | **224,794** |   | 102,037 |   |
| Cash and cash  equivalents at end of period                                        | ** **   | **$**                          | **202,078**  |                             | $            | 122,119 | ** ** | **$** | **202,078** |   | $ | 122,119 |   |
|                                                                               |         |                           |         |                             |         |   |   |   |   |
| ***Supplemental  cash flow disclosure***                                           | *** *** | *** ***                   | *** *** | *** ***                     | *** *** | *** *** | *** *** | *** *** | *** *** |
| Cash paid during the  period for:                                                  |         |                           |         |                             |         |   |   |   |   |
| Income taxes (net of  refunds)                                                     | ** **   | **$**                          | **27,839**   |                             | $            | 13,983 | ** ** | **$** | **13,675** |   | $ | 20,265 |   |

 

* *

* *

*See accompanying notes to consolidated condensedfinancial statements.*

6

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**AMERICAN POWER CONVERSION CORPORATION ANDSUBSIDIARIESNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS*(Unaudited)***

**1.****              ManagementRepresentation**

The accompanyingunaudited consolidated condensed financial statements should be read inconjunction with the consolidated financial statements included in the AmericanPower Conversion Corporation (APC) Annual Report on Form 10-K for the yearended December 31, 2005. In the opinion of management, the accompanyingunaudited consolidated condensed financial statements contain all adjustments(consisting of only normal recurring accruals) necessary to present fairly theconsolidated financial position and the consolidated results of operations andcash flows for the interim periods. The results of operations for the interimperiods are not necessarily indicative of results to be expected for the fullyear.

**2.****              Principles ofConsolidation**

The accompanyingconsolidated condensed financial statements include the financial statements ofAmerican Power Conversion Corporation and its wholly-owned subsidiaries. Allsignificant intercompany accounts and transactions are eliminated inconsolidation.

**3.****              Investments**

APCclassifies as short term its investments with original maturities greater thanthree months and less than or equal to one year, and as long term itsinvestments with remaining maturities greater than one year. APC has noinvestments with maturity dates greater than one year except for auction ratesecurities and variable rate demand obligations. Held-to-maturity securitiesare carried at amortized cost. Available-for-sale securities are recorded atfair value with net unrealized gains and losses reported, net of income taxes,in other comprehensive income. Management determines the appropriateclassification of securities at the time of purchase and re-evaluates suchdesignation as of each balance sheet date. Securities are classified asheld-to-maturity when APC has the positive intent and ability to hold suchsecurities to maturity. APC invests its excess cash principally in auction ratesecurities and variable rate demand obligations which have long-term underlyingmaturities, however the market is highly liquid and the interest rates resetfrequently.

At June 25, 2006, APC had no held-to-maturityinvestments. At December 31, 2005, APC’s held-to-maturity investments included$5.0 million with contractual maturities of one year or less; APC had noheld-to-maturity investments with contractual maturities longer than one year.At June 25, 2006 and December 31, 2005, APC’s available-for-sale auction ratedebt securities (ARS’s) included $224.0 million and $364.5 million,respectively, with contractual maturities between approximately one to 37years. In addition, at June 25, 2006, APC’s available-for-sale ARS’s included$5.5 million that had underlying equity investments. At June 25, 2006 andDecember 31, 2005, APC’s available-for-sale variable rate demand obligations(VRDN’s) included $107.2 million and $136.7 million, respectively, withcontractual maturities between 13 and 33 years. Both the ARS’s and VRDN’sresemble short-term instruments because they contain features (i.e., interestrate reset and put options, respectively) that allow for the sale of theinstrument on a predetermined schedule of seven to 49 days depending on thetype of instrument and its particular features.

Proceeds from the salesof investment securities available-for-sale were $1.350 billion and $447million in the second quarters of 2006 and 2005, respectively, and were $2.736billion and $911 million in the first six months of 2006 and 2005,respectively.

7

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| ** **                         | ** ** | **Amortized  Cost**       | ** **  | **Gross Unrealized  Holding Gains** | ** ** | **Gross Unrealized  Holding Losses** | ** ** | **Fair  Value** | ** ** |
|------------------------------------|------------|---------------------------|-------------|-----------------------------------------------|------------|------------------------------------------------|------------|-----------------|------------|
| ** **                         | ** ** | **(In thousands***)* | ** **  |
| **At June 25, 2006**               | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| ** **                         | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| **Available-for-sale**             | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| Auction rate  securities           | ** ** | **$**                     | **229,487** | ** **                                    | **$**      | **—**                                     | ** ** | **$**           | **—** | ** ** | **$** | **229,487** | ** ** |
| Variable rate  demand obligations  | ** ** | **107,180**               | ** **  | **—**                                    | ** ** | **—**                                     | ** ** | **107,180**     | ** ** |
| Equity  investments                | ** ** | **510**                   | ** **  | **54**                                        | ** ** | **—**                                     | ** ** | **564**         | ** ** |
|                               | ** ** | **$**                     | **337,177** | ** **                                    | **$**      | **54**                                         | ** ** | **$**           | **—** | ** ** | **$** | **337,231** | ** ** |
| **At December 31, 2005**           | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| ** **                         | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| **Available-for-sale**             | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| Auction rate  securities           |       | $                         | 369,481     |                                          | $          | —                                         |       | $               | —     |   | $ | 369,481 |   |
| Variable rate  demand obligations  |       | 136,700                   |        | —                                        |       | —                                         |       | 136,700         |       |
| Equity  investments                |       | 481                       |        | 81                                            |       | —                                         |       | 562             |       |
|                               |       | 506,662                   |        | 81                                            |       | —                                         |       | 506,743         |       |
| **Held-to-maturity**               | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
| U.S. government  agency securities |       | 5,000                     |        | —                                        |       | (28                                            | )          | 4,972           |       |
|                               |       | 5,000                     |        | —                                        |       | (28                                            | )          | 4,972           |       |
| ** **                         | ** ** | ** **                | ** **  | ** **                                    | ** ** | ** **                                     | ** ** | ** **      | ** ** |
|                               |       | $                         | 511,662     |                                          | $          | 81                                             |       | $               | (28        | ) | $ | 511,715 |   |

 

**4.****              Goodwill and OtherIntangible Assets**

At each of June 25, 2006 and December 31, 2005, goodwill of $15.9 millionand $15.8 million, respectively, was associated with the Small Systems segment.At June 25, 2006, goodwill of $2.1 million was associated with the LargeSystems segment and originated during the first quarter of 2006 from a paymentof escrowed purchase price consideration. Amortized intangible assets were asfollows:
| ** **                         | ** ** | ** **                                  | ** ** | **June 25, 2006** | ** **  | **December 31, 2005** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|-----------------------------|-------------|---------------------------------|------------|
| **Amortized  Intangible  Assets**  | ** ** | **Weighted  Average  Amortization  Period** | ** ** | **Gross  Carrying  Amount** | ** **  | **Accumulated  Amortization**   | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                         | ** ** | **($ in thousands)**                   | ** ** |
|                               |       |                                        |       |                        |        |                            |       |   |   |   |   |
| Technology                         |       | 8 years                                     | ** ** | **$**                       | **87,319**  | ** **                      | **$**      | **61,505** |   | $ | 87,319 |   | $ | 55,958 |   |
| Customer lists                     |       | 9 years                                     | ** ** | **11,100**                  | ** **  | **8,393**                       |       | 11,100 |   | 7,610 |   |
| Tradenames                         |       | 9 years                                     | ** ** | **3,957**                   | ** **  | **2,975**                       |       | 3,957 |   | 2,693 |   |
| Total amortized  intangible assets |       | 8 years                                     | ** ** | **$**                       | **102,376** | ** **                      | **$**      | **72,873** |   | $ | 102,376 |   | $ | 66,261 |   |

 

Aggregateamortization expense related to APC’s other intangible assets for the secondquarters of 2006 and 2005 was $3.3 million and $2.9 million, respectively, andfor the first six months of 2006 and 2005 was $6.6 million and $5.9 million,respectively. Estimated aggregated amortization for each of the next fivesucceeding fiscal years is $13.2 million for 2006, $11.1 million for 2007, $6.6million for 2008, $2.6 million for 2009, and $1.2 million for 2010. There areno expected residual values related to these intangible assets.

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**5.****              WarrantyLiability**
| ** **           | ** ** | **Product  Warranty  Liability at  Beginning  of Quarter** | ** ** | **Accruals for  Product  Warranties  Issued During  the Quarter** | ** ** | **Adjustments  to Accruals  for Preexisting  Warranties** | ** ** | **Warranty  Payments** | ** ** | **Product  Warranty  Liability at  End of  Quarter** | ** ** |
|----------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------------------|------------|----------------------------------------------------------------|------------|
| ** **           | ** ** | **(In thousands)**                                              | ** ** |
| Second Quarter  2006 | ** ** | **$**                                                                | **13,229** | ** **                                                                       | **$**      | **11,388**                                                          | ** ** | **$**                  | **—** | ** **                                                     | **$**      | **(11,269** | **)** | **$** | **13,348** | ** ** |
| First Quarter  2006  | ** ** | **$**                                                                | **13,272** | ** **                                                                       | **$**      | **7,315**                                                           | ** ** | **$**                  | **—** | ** **                                                     | **$**      | **(7,358** | **)** | **$** | **13,229** | ** ** |
|                 |       |                                                                 |       |                                                                             |       |                                                                |       |                   |       |                                                           |       |
| Second Quarter  2005 |       | $                                                                    | 12,012     |                                                                             | $          | 9,189                                                               |       | $                      | —     |                                                           | $          | (9,518 | ) | $ | 11,683 |   |
| First Quarter 2005   |       | $                                                                    | 13,092     |                                                                             | $          | 5,334                                                               |       | $                      | —     |                                                           | $          | (6,414 | ) | $ | 12,012 |   |

 

**6.****              Earnings Per Share**

Basic earnings per shareis computed by dividing net income by the weighted average number of commonshares outstanding during the period. Diluted earnings per share is computed bydividing net income by the weighted average number of common shares anddilutive potential common shares outstanding during the period. Under thetreasury stock method, the unexercised options are assumed to be exercised andthe unvested restricted stock units are assumed to be vested at the beginningof the period or at issuance, if later. The assumed proceeds are then used topurchase common shares at the average market price during the period. Potentialcommon shares for which inclusion would have the effect of increasing dilutedearnings per share (i.e., antidilutive) are excluded from the computation.
| ** **                                                                                                                     | ** ** | **Six months ended** | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                     | ** ** | **June 25,  2006**        | ** ** | **June 26,  2005**          | ** ** | **June 25,  2006** | ** ** | **June 26,  2005** | ** ** |
| ** **                                                                                                                     | ** ** | **(In thousands)**        | ** ** |
| Basic weighted  average shares outstanding                                                                                     | ** ** | **193,083**                    |       | 192,955                          | ** ** | **191,648** |   | 193,438 |   |
| Net effect of  dilutive potential common shares outstanding based on the treasury stock  method using the average market price | ** ** | **2,898**                      |       | 6,081                            | ** ** | **2,694** |   | 6,304 |   |
| Diluted weighted  average shares outstanding                                                                                   | ** ** | **195,981**                    |       | 199,036                          | ** ** | **194,342** |   | 199,742 |   |
| Antidilutive potential  common shares excluded from the computation above                                                      | ** ** | **2,439**                      |       | 588                              | ** ** | **2,490** |   | 197 |   |

 

**7.****              Shareholders’ Equity**

***Common Stock and Paid-in Capital.***  In February 2006, APC’s Board of Directorsapproved a stock repurchase program which authorizes up to $200 million torepurchase outstanding shares of APC’s common stock. The purchases would bemade on the open market based on market and business factors. The duration ofthe repurchase program is two years but may be suspended or discontinued at anytime without prior notice. APC commenced the repurchase of its common stock inFebruary 2006.

The decrease in commonstock and paid-in capital during the second quarter of 2006 reflected APC’ssecond quarter repurchase on the open market of approximately 3.0 millionshares of its common stock, at an average price of $20.21 per share, totaling$59 million. The decrease in common stock and paid-in capital during the firstsix months of 2006 reflected APC’s first half repurchase on the open market ofapproximately 6.4 million shares of its common stock, at an average price of$20.30 per share, totaling $129 million. Such shares have been deemedauthorized but not issued. These decreases were partially offset by stockissuances relating to stock-based employee benefit programs, as well as to thefinancial statement recognition of the tax benefit afforded to APC as a resultof the disposition of option shares by APC employees. Accounting rules requirethis corporate tax benefit to be recorded as an increase in paid-in capital.

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***Dividends.*** Dividends of $0.10 per share were declared and paid in each of the firstand second quarters of 2006 and 2005. It is the intention of the Board ofDirectors to pay a comparable quarterly dividend on a going forward basiscontingent upon continued capital availability and a determination that cashdividends continue to be in the best interests of APC and its shareholders.

**8.****             ****Comprehensive Income**

The components of comprehensive income, net of tax, are as follows:
| ** **                                               | ** ** | **Six months ended** | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------|------------|--------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **June 25,  2006**        | ** ** | **June 26,  2005**          | ** ** | **June 25,  2006** | ** ** | **June 26,  2005** | ** ** |
| ** **                                               | ** ** | **(In thousands)**        | ** ** |
| Net income                                               | ** ** | **$**                          | **39,201** |                             | $          | 77,920 | ** ** | **$** | **24,706** |   | $ | 41,875 |   |
| Other comprehensive  income (loss), net of tax:          |       |                           |       |                             |       |   |   |   |   |
| Change in foreign currency translation adjustment        | ** ** | **1,041**                      |       | (905                             | )          | **891** |   | (501 | ) |
| Net unrealized loss on investments, net of income  taxes | ** ** | **(27**                        | **)**      | —                           | ** ** | **(45** | **)** | — |   |
| Other comprehensive income (loss)                        | ** ** | **1,014**                      |       | (905                             | )          | **846** |   | (501 | ) |
|                                                     |       |                           |       |                             |       |   |   |   |   |
| Comprehensive income                                     | ** ** | **$**                          | **40,215** |                             | $          | 77,015 | ** ** | **$** | **25,552** |   | $ | 41,374 |   |

 

**9.****              Share-Based Payments**

Effective January 1,2006, APC adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards No. 123 (revised 2004), *Share-BasedPayment*, using the modified-prospective transition method. Underthis transition method, compensation cost recognized in the first quarter offiscal 2006 includes compensation cost for all share-based payments grantedthrough January 1, 2006, but for which the requisite service period had notbeen completed as of January 1, 2006, based on the grant date fair valuesestimated in accordance with the original provisions of SFAS 123. Compensationcost for all share-based payments granted subsequent to January 1, 2006 will bebased on grant date fair values estimated in accordance with the provisions ofSFAS 123R. Compensation cost for grants during the second quarter ended June25, 2006 were not material. There were no grants during the first quarter endedMarch 26, 2006. Results for prior periods have not been restated.

As a result of theadoption of SFAS 123R, APC’s income before income taxes for the second quarterand first six months ended June 25, 2006 were $1.0 million and $2.0 millionlower, respectively, and net income for the second quarter and first six monthsended June 25, 2006 were $0.8 million and $1.6 million lower, respectively,than if APC had continued to account for share-based compensation under APBOpinion No. 25. APC recognized a total of $4.0 million and $8.1 million ofshare-based compensation cost for the second quarter and first six months endedJune 25, 2006. APC did not record a cumulative effect of change in accountingprinciple related to forfeitures of stock-based awards since such forfeitureswere not material. As of June 25, 2006, there was $20.4 million of totalunrecognized compensation cost related to outstanding share-based compensationarrangements. That cost is expected to be recognized over a remainingweighted-average period of 1.8 years. APC utilizes a FASB Interpretation No. 28attribution model for the timing of the recognition of compensation expense.

Prior to the adoption ofSFAS 123R, APC presented all tax benefits of deductions resulting from theexercise of stock options as operating cash flows in APC’s ConsolidatedCondensed Statements of Cash Flows. SFAS 123R requires the cash flows resultingfrom tax deductions in excess of the compensation cost recognized for thosestock options (excess tax benefits) to be classified as financing cash flows.

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The following tableillustrates the effect on net income and earnings per share as if APC hadapplied the fair value recognition provisions of SFAS 123 for the secondquarter and first six months ended June 26, 2005:
| ** **                                                                                                                                    | ** ** | ** **  | ** ** | **Six months  ended**                                           | ** ** | **Three months  ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                    | ** ** | ** **  | ** ** | **June 26,  2005**                                              | ** ** | **June 26,  2005**      | ** ** |
| ** **                                                                                                                                    | ** ** | ** **  | ** ** | **(In thousands except per share amounts)** | ** ** |
| Net income                                                                                                                                    |       | As reported |       | $                                                                    | 77,920     |                         | $          | 41,875 |   |
| Add:  Compensation expense recognized during the period, net of related tax effects                                                           |       |        |       | 4,326                                                                |       | 1,995                        |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | Pro forma   |       | (7,239                                                               | )          | (3,505                       | )          |
| Net income                                                                                                                                    |       | Pro forma   |       | $                                                                    | 75,007     |                         | $          | 40,365 |   |
|                                                                                                                                          |       |        |       |                                                                 |       |                         |       |
| Basic earnings  per share                                                                                                                     |       | As reported |       | $                                                                    | 0.40       |                         | $          | 0.22 |   |
|                                                                                                                                          |       | Pro forma   |       | $                                                                    | 0.39       |                         | $          | 0.21 |   |
|                                                                                                                                          |       |        |       |                                                                 |       |                         |       |
| Diluted earnings  per share                                                                                                                   |       | As reported |       | $                                                                    | 0.39       |                         | $          | 0.21 |   |
|                                                                                                                                          |       | Pro forma   |       | $                                                                    | 0.38       |                         | $          | 0.20 |   |

 

For all of APC’sstock-based compensation plans, the fair value of each grant was estimated atthe date of grant using the Black-Scholes option pricing model. Black-Scholesutilizes assumptions related to volatility, the risk-free interest rate,dividend yield, and employee exercise behavior. Expected volatilities utilizedin the model are based on the historical volatility of APC’s stock price. Therisk-free interest rate is derived from the U.S. Treasury yield curve in effectat the time of grant. The model incorporates exercise and post-vestingforfeiture assumptions based on an analysis of historical data. The expectedlife of fiscal 2006 grants has been derived from historical information andother factors.

At June 25, 2006, APC hadone active stock-based compensation plan, the 2004 Long-Term Incentive Plan(2004 LTI Plan), and an employee stock purchase plan (ESPP), which aredescribed more fully below. At June 25, 2006, there were 9.6 million sharesavailable for future grants under the 2004 LTI Plan.

On June 10, 2004, APC’sshareholders approved APC’s LTI Plan, which replaced APC’s 1997 Stock OptionPlan (1997 Plan). The 2004 LTI Plan will enable APC to utilize sharespreviously not distributed under the 1997 Plan. No further grants will be madefrom the 1997 Plan. Awards under the 2004 LTI Plan may be in the form ofincentive stock options, non-qualified stock options, restricted stock,restricted stock units, performance restricted stock, performance restrictedstock units, or any other equity-based interests as the Compensation Committeeof APC’s Board of Directors shall determine. The number of shares of commonstock that may be delivered in satisfaction of awards granted under the 2004LTI Plan shall be equal to (a) the number of shares of common stock that remainavailable for grant under the 1997 Plan as of June 10, 2004, plus (b) anyshares of common stock underlying outstanding awards under the 1997 Plan thatafter June 10, 2004 expire or terminate without being exercised or that wouldotherwise again become available for issuance under the 1997 Plan, and in noevent shall exceed an aggregate of 15 million shares.

On April 21, 1997, APC’sshareholders approved the 1997 Stock Option Plan and on June 19, 1987 approvedthe 1987 Stock Option Plan (collectively the 1997 and 1987 Plans). The 1997 and1987 Plans authorized the grant of options for up to 12.0 million shares and21.6 million shares, respectively, of common stock. On June 11, 2002 and May 7,1999, APC’s shareholders authorized an additional 9.5 million shares and 12.0million shares, respectively, under the 1997 Stock Option Plan, resulting in anaggregate of 33.5 million shares available for grant under the 1997 StockOption Plan.

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Options granted under APC’sstock-based compensation plans are either (a) options intended to constituteincentive stock options (ISOs) under the Internal Revenue Code of 1986 (theCode) or (b) non-qualified options. Incentive stock options may be grantedunder the Plans to employees or officers of APC. Non-qualified options may begranted to consultants, directors (whether or not they are employees),employees or officers of APC.

ISOs granted under APC’sstock-based compensation plans may not be granted at a price less than the fairmarket value of the common stock on the date of grant (or 110% of fair marketvalue in the case of employees or officers holding 10% or more of the votingstock of APC). The aggregate fair market value of shares, for which ISOsgranted to any employee are exercisable for the first time by such employeeduring any calendar year (under all stock option plans of APC and any relatedcorporation), may not exceed $100,000. Non-qualified options granted under thePlan may not be granted at a price less than the lesser of (a) the book valueper share of common stock as of the end of the fiscal year of APC immediatelypreceding the date of such grant, or (b) 50% of the fair market value of thecommon stock on the date of grant.

Options granted under the1997 and 1987 Plans before December 1, 1995 vested 25% at the end of the firstyear and 12.5% at the end of each six month period thereafter. Options grantedafter December 1, 1995 and before February 14, 1997 vested 20% at the end ofthe second year and 20% at the end of each year thereafter. Options grantedafter February 14, 1997 vest 25% at the end of the first year and 12.5% at theend of each six month period thereafter. Options granted under the 2004 LTIPlan generally vest 25% at the end of each year.

On April 21, 1997, APC’sshareholders approved the 1997 Non-employee Director Stock Option Plan and onMay 20, 1993 approved the 1993 Non-employee Director Stock Option Plan(collectively the Director Plans). The 1997 and 1993 Director Plans authorizedthe grant of options for up to 400,000 shares and 80,000 shares of commonstock, respectively. In the first six months of 2006 and 2005, all non-employeedirectors were entitled to participate in the 1997 Non-Employee Director StockOption Plan, with each receiving no option grants during those quarters.

Options granted under the1997 Director Plan, and the options granted on August 9, 2001 under the 1997Stock Option Plan, vest 25% at the end of the second year and 9.375% at the endof each six month period thereafter. Options granted under the 1993 DirectorPlan vested 25% at the end of the first year and 25% annually thereafter.

Options granted under allstock-based compensation plans after January 1, 1993 expire not more than tenyears from the date of grant (five years in the case of ISOs granted to tenpercent shareholders). The outstanding options at June 25, 2006 expire atvarious dates through 2016. Options granted terminate within a specified periodof time following termination of an optionee’s employment or position as adirector or consultant with APC.

A summary of the status of stock options outstandingunder APC’s stock-based compensation plan as of June 25, 2006, and changesduring the first six months ending on that date is presented below. APC has apolicy of issuing new shares to satisfy stock option exercises.
| ** **                      | ** ** | **Options**                                                                              | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **(In thousands except years and per share amounts)** | ** ** |
|                            |       |                                                                                     |       |                                   |       |                                                |       |                            |       |
| Outstanding at  January 1, 2006 |       | 11,757                                                                                   |       | $                                      | 15.69      |                                                |       |                            |       |   |
| Granted                         |       | 162                                                                                      |       | $                                      | 18.98      |                                                |       |                            |       |   |
| Exercised                       |       | (698                                                                                     | )          | $                                      | 12.41      |                                                |       |                            | $          | 3,283 |   |
| Terminated                      |       | (231                                                                                     | )          | $                                      | 19.82      |                                                |       |                            |       |   |
| Outstanding at  June 25, 2006   |       | 10,990                                                                                   |       | $                                      | 15.86      |                                                | 4.3 years  |                            | $          | 48,537 |   |
|                            |       |                                                                                     |       |                                   |       |                                                |       |                            |       |
| Exercisable at June 25,  2006   |       | 9,623                                                                                    |       | $                                      | 15.53      |                                                | 3.8 years  |                            | $          | 33,199 |   |

 

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***StockPurchase Plan.***  OnApril 21, 1997, APC’s shareholders approved an Employee Stock Purchase Plan(the Plan) to provide substantially all employees an opportunity to purchaseshares of its common stock through payroll deductions, in an aggregate amountup to 10% of eligible compensation. Semiannually, participant account balancesare used to purchase shares of stock at the lesser of 85% of the fair marketvalue of shares on the grant date or the exercise date. The aggregate number ofshares purchased by an employee may not exceed 3,000 shares annually (subjectto limitations imposed by the Internal Revenue Code). The employee stockpurchase plan expires on February 11, 2017. A total of 3.0 million shares are authorizedfor purchase under the Plan. During the second quarters of 2006 and 2005, underthe Plan, 72,604 shares were issued at $18.47 per share and 69,214 shares wereissued at $16.78 per share, respectively. No shares were issued under the Planduring the first quarters of 2006 and 2005.

***Restricted Stock Units.***  Also under theaforementioned 2004 LTI Plan, APC’s Compensation and Stock Option Committee ofthe Board of Directors approved the award of restricted stock units (RSU’s). Asummary of the status of RSU’s as of June 25, 2006 and changes during the firstsix months then ended is presented below:

|                                | ** ** | **Number  of RSU’s**      | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|--------------------------------|------------|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                     | ** ** | **(Shares in thousands)** | ** ** |
| Non-vested at  January 1, 2006 |       | 1,137                               |       | $                                                  | 19.82      |   |
| Granted                        |       | 483                                 |       | $                                                  | 18.98      |   |
| Terminated                     |       | (65                                 | )          | $                                                  | 21.75      |   |
| Non-vested at June 25,  2006   |       | 1,555                               |       | $                                                  | 19.47      |   |

 

Under the 2004 LTIPlan, if APC awards a dividend on its common stock prior to the vesting date ofan RSU, the holder of the restricted stock unit would be entitled to receive onthe vesting date a dividend equivalent payment. Dividend equivalents arerecognized as compensation expense when the dividend is declared. The RSUawards will vest, and the underlying common stock will concurrently issue,ratably over four years, whereby the units granted will vest 25% on June 30 inthe year following the date approved, and 25% on June 30 of each yearthereafter.

**10.****       Operating SegmentInformation**

***Basis for presentation. ***APC operates primarily within one industryconsisting of three reportable operating segments by which it manages itsbusiness and from which various offerings are commonly combined to develop atotal solution for the customer. These efforts primarily incorporate thedesign, manufacture, and marketing of power protection equipment and relatedsoftware and accessories for computer, communications, and related equipment.APC’s three segments are: Small Systems, Large Systems, and “Other.” Each ofthese segments address global markets.

***Small Systems.***  TheSmall Systems segment develops power devices and accessories for servers andnetworking equipment commonly used in local area and wide area networks and forpersonal computers and sensitive electronics. Major product offerings includethe Back-UPS®, Smart-UPS®, and Symmetra® Power Array® single-phase family ofUPSs. Also included are SurgeArrest® surge suppressors as well as cabling andconnectivity products. Additional accessories and software products are offeredto enhance the management of these networks, including APC’s PowerChute®software and NetShelter® server enclosures. Products are sold to home andcommercial users primarily through an indirect selling model consisting ofcomputer distributors and dealers, value-added resellers, mass merchandisers,catalog merchandisers, E-commerce vendors, and strategic partnerships.

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***Large Systems.***  TheLarge Systems segment provides systems, products and services that primarilyprovide back-up power, power distribution and cooling for data centers,facilities, and communications equipment for both commercial and industrialapplications. Product offerings include major components of InfraStruXure®systems, Silcon® UPSs, precision cooling equipment, DC and broadband powersystems, Gutor® industrial UPS systems and APC Global Services. Products aresold to commercial users through both a direct and indirect selling modelconsisting of value-added resellers and strategic partnerships. Additionally,APC utilizes manufacturer representatives to identify and secure projects.

***“Other” Segment.***  TheOther segment consists principally of mobile accessories and replacementbattery products. The distribution model of products in the Other segment isconsistent with that of the Small Systems segment.

APC measures theprofitability of its segments based on gross margin. Segment gross marginsexclude certain expenses which are managed outside the reportable segments.Costs excluded from segment profit are operating expenses, primarily consistingof R&D, selling and corporate expenses, and income taxes. Expenditures foradditions to long-lived assets are not tracked or reported by the operatingsegments, although depreciation expense is allocated to and reported by theoperating segments.

Summary operating segment information is as follows:
| ** **                         | ** ** | **Six months ended** | ** **    | **Three months ended** | ** ** |
|------------------------------------|------------|--------------------------------|---------------|----------------------------------|------------|
| ** **                         | ** ** | **June 25,  2006**        | ** **    | **June 26,  2005**          | ** ** | **June 25,  2006** | ** ** | **June 26,  2005** | ** ** |
| ** **                         | ** ** | **(In thousands)**        | ** **    |
| **Segment  net sales**             |       |                           |          |                             |       |   |   |   |   |
| Small Systems                      | ** ** | **$**                          | **750,480**   |                             | $          | 663,692 | ** ** | **$** | **399,587** |   | $ | 356,231 |   |
| Large Systems                      | ** ** | **246,590**                    |          | 185,549                          | ** ** | **139,484** |   | 104,876 |   |
| Other                              | ** ** | **33,091**                     |          | 33,692                           | ** ** | **15,590** |   | 16,359 |   |
| Total segment  net sales           | ** ** | **1,030,161**                  |          | 882,933                          | ** ** | **554,661** |   | 477,466 |   |
| Shipping and  handling revenues    | ** ** | **8,617**                      |          | 5,676                            | ** ** | **5,324** |   | 3,140 |   |
| Total net sales                    | ** ** | **$**                          | **1,038,778** |                             | $          | 888,609 | ** ** | **$** | **559,985** |   | $ | 480,606 |   |
| ** **                         | ** ** | ** **                     | ** **    | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Segment  profits**               | ** ** | ** **                     | ** **    | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Small Systems                      | ** ** | **$**                          | **310,617**   |                             | $          | 307,497 | ** ** | **$** | **165,830** |   | $ | 160,989 |   |
| Large Systems                      | ** ** | **43,210**                     |          | 36,635                           | ** ** | **25,871** |   | 19,188 |   |
| Other                              | ** ** | **18,057**                     |          | 19,510                           | ** ** | **8,602** |   | 9,244 |   |
| Total segment  profits             | ** ** | **371,884**                    |          | 363,642                          | ** ** | **200,303** |   | 189,421 |   |
| Shipping and  handling net costs   | ** ** | **25,471**                     |          | 20,924                           | ** ** | **11,678** |   | 11,155 |   |
| Other indirect  operating expenses | ** ** | **306,183**                    |          | 249,175                          | ** ** | **161,664** |   | 128,356 |   |
| Other income,  net                 | ** ** | **10,352**                     |          | 8,983                            | ** ** | **4,918** |   | 5,189 |   |
| Earnings before income  taxes      | ** ** | **$**                          | **50,582**    |                             | $          | 102,526 | ** ** | **$** | **31,879** |   | $ | 55,099 |   |

 

**11.****       Litigation**

APC is involvedin various claims and legal actions arising in the ordinary course of business.While management currently believes that resolving all pending legal matters,individually or in aggregate, will not have a material adverse impact on APC’sfinancial position, litigation and claims are subject to inherentuncertainties, including the risk of an unfavorable outcome, and management’sview of these matters may change in the future. An unfavorable outcome couldinclude monetary damages or, in cases where injunctive relief is sought, aninjunction prohibiting certain activities. Were an unfavorable final outcome tooccur, there exists the possibility of a material adverse impact on APC’sfinancial position, cash flows and results of operations for the period inwhich the effect becomes reasonably estimable.

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**ITEM 2.**                    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS

We beginManagement’s Discussion and Analysis of Financial Condition and Results ofOperations (MD&A) with a discussion of our business outlook for the secondhalf of 2006. We also provide a discussion of our Results of Operations for thesecond quarter and first six months of 2006 compared to the second quarter andfirst six months of 2005. This discussion includes an overview of our operatingresults and the directions in which our markets, segments, and geographies aremoving. We then provide a Liquidity and Financial Resources discussion of thesignificant changes in our balance sheet during the second quarter and firstsix months of 2006, and cash flows for the second quarter and first six monthsof 2006 compared to the second quarter and first six months of 2005, as well asour contractual obligations and foreign currency activity. This is followed bya discussion of the Critical Accounting Policies that we believe are importantto our business operations and understanding of our results of operations.

This MD&Ashould be read in conjunction with the other sections of this report, including“Item 1. Financial Statements” and also our Annual Report on Form 10-K for theyear ended December 31, 2005, including “Item 1. Business;” “Item 6. SelectedFinancial Data;” “Item 8. Financial Statements and Supplementary Data;” and “Item9A. Controls and Procedures.”

Inaddition to historical consolidated financial information, the followingdiscussion contains forward-looking statements that reflect our plans,estimates and beliefs. Our actual results could differ materially from thosediscussed in the forward-looking statements. Factors that could cause orcontribute to these differences include those discussed below and elsewhere inthis Form 10-Q.

**BUSINESS OUTLOOK**

We are pleased with APC’stop line performance during the first half of 2006, but have identifiedopportunities for improvement. Our performance continues to reflect strongdemand across geographies and major operating segments and extended our doubledigit year-over-year revenue growth streak to twelve consecutive quarters. Weare confident that the strong year-over-year revenue growth can be attributedto what we believe is a healthy macro-economic environment for IT spending andis the result of our continued investments in research and development, salesand marketing activities and the growing adoption of APC’s network-criticalphysical infrastructure, or NCPI, architecture. APC has pioneered integratedsystems for NCPI, which is the foundation upon which Information Technology(IT) and telecommunication networks reside. It is the “backbone” of a business,as its elements provide the power, cooling, physical housing, cabling and otherelements which allow the IT systems to function. The investments we havecontinued to make to educate the market and drive adoption of the technology,we believe, are being well received as customers embrace the modular, standardizedapproach APC has pioneered.

As strong as our revenueresults were in the first and second quarter, our operating performance has notproduced similar results. Through the streamlining of operations, supply chaininitiatives and pricing actions, we are taking steps to improve our grossmargin, while maintaining investments in innovation, sales and marketingprograms to drive awareness and adoption of APC’s NCPI solutions globally.Despite continued progress in our operations and supply chain initiatives, theyear-over-year trends remain unfavorable although less so than previousquarters. Additionally, year-over-year margins were also negatively impacted inthe quarter by segment and product mix as well as pricing. From the firstquarter, top line growth that outpaced spending growth coupled with grossmargin improvement resulted in operating income more than doubling in thesecond quarter versus the first quarter 2006.

Developing and managingthe internal capabilities necessary to meet the supply and order fulfillmentrequirements of two distinct business models, that is, a transaction-orientedproducts business and a customer-focused systems solutions business, is acomplicated and difficult task. To support these two businesses, we are workingto lower manufacturing costs and improve product delivery to our globalcustomer base. This includes transitioning more Large Systems manufacturingoverseas and populating global distribution centers with a broader portfolio ofproducts. While we are generating some savings from transitioning theseproducts overseas, particularly related to material cost savings, we haveincurred incremental costs and suffered from product availability disruptions.Additionally, revamping our distribution model has generated incrementallogistics costs. During the second quarter 

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we continued to makestrides to improve our order fulfillment process and reduce our reliance onexpedited shipping methods, particularly related to air freight. We saw ourgross margin stabilize and increase slightly from the first quarter, howeverour freight and logistics costs remain at levels higher than they were prior tothe recent transitions of Large Systems product manufacturing overseas.

As we look forward to theremainder of 2006, we will continue to aggressively implement our plans tocontinue transforming APC into a lean, ambidextrous, customer-centricenterprise. To accomplish this, we will need to: (1) optimize operationalefficiency, (2) deploy and improve distribution capabilities in all regionsglobally, (3) accelerate the responsiveness of the supply chain to minimizeavailability issues for the more complex solutions, (4) improve demand tosupply signaling capabilities to support both business models, and (5) build aproducts and professional services business needed for successfully pursuingdatacenter opportunities. Some of these initiatives, during implementation, mayresult in our incurring incremental costs prior to achieving the desiredoutcomes. Additionally, these initiatives will take time, some more thanothers, to implement, but we are committed to making significant, meaningful,and timely progress.

We recently announcedplans for the consolidation of Irish manufacturing operations in our Castlebar,Ireland facility and the redeployment of certain customer-facing positions tolocations in the Europe, Middle East and Africa region in closer proximity tocustomers. The company currently intends to retain select sales, informationtechnology, research and development and business support functions in itsexisting Galway, Ireland facility. APC has begun discussions with its workforcein Ireland with the objective of reducing approximately 200 to 250 positionswithin Ireland, primarily in the manufacturing, operations and customer supportareas.  The estimated range of costs inconnection with this plan is approximately $4.0 million to $5.0 million,consisting primarily of one-time employee severance costs, which will berecognized in the third quarter 2006. The company anticipates completing theplan in the first quarter of 2007 and that all of the expected costs will befinanced from available operating cash.

We believe that we arewell positioned competitively, financially and strategically. We will continueto be focused on empowering IT professionals with the knowledge, tools andsolutions they need to effectively design, build and manage network-criticalphysical infrastructure. Our objective is for APC to become a trusted, globalpartner for the long term, committed to solving our customers’ NCPI problems oftoday and helping them anticipate their challenges of tomorrow, therebyallowing our customers to focus on their core competencies. Experts now predictthat powering and cooling the data center will soon become more expensive than purchasingthe IT equipment to populate it.  Theimportance of properly managing and maximizing the performance of NCPI hasnever been higher.  APC anticipated thismarket need and is helping customers prepare for this reality with an entirelynew approach to design, build and operate data centers.  Today, we are committed to arm data centerprofessionals with a solution that enables them to manage their complex powerand cooling challenges. We believe that we can accomplish these objectives bydramatically reducing our customers’ level of complexity and their total costof ownership involved in designing, building, and managing the network-criticalphysical infrastructure that is at the very core of maintaining businesscontinuity, application availability, and network reliability.

Additionally, we continueto plan for revenue growth in all three of our reportable segments: SmallSystems, Large Systems and “Other.” As in recent quarters, we expect the rateof revenue growth of our Large Systems segment to be greater than the growthexpected for Small Systems due to the assumed continued success of our overallstrategy and the acceptance of our products in specific market segments.

Overall gross margins for2006 are currently expected to continue to be impacted on a year-over-yearbasis by increased operational costs and a shift in product mix toward thefaster-growing, lower-margin Large Systems products. Gross margins,particularly for Small Systems products, are expected to continue to beimpacted by our response to a competitive pricing environment, but we have madesingle-digit price increases on select Small Systems products to help offsetrising commodity price trends. While we expect to continue to strive forfavorable component pricing arrangements with our material suppliers, therecent rising trends of commodity prices, particularly for steel, copper andlead, are expected to put upward pressure on our product materials costs. Inaddition to price increases in the Small Systems segment, we also expect partialoffset from material cost reductions, particularly for Large Systems products,typically seen after transitioning to low-cost factories.

Increased operationalcosts, including freight and warehousing, are associated with the management ofour supply chain. These costs are tied to fulfilling customer orders andreducing overall long-term costs through the stocking of 

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global third-partydistribution centers, expediting of product to meet customer demand, and thetransition cost of shifting production to lower cost manufacturing locations.We expect this could continue in the near term, however ultimately it isexpected these transitions will allow for lower manufacturing costs. In theshort-term, each transition is the equivalent of a new product introduction toa facility and comes with a learning curve and initial supply chaininefficiencies. Operational cost improvement initiatives, including redesign ofour supply chain processes and elimination of redundant manufacturing costs,are expected to cause incremental costs in the short-term, but ultimatelyresult in long-term gross margin improvement.

Gross margin variabilitycould continue to result from changing revenue levels, which are dependent onunit volumes, prices and currency trends as well as the mix of products sold,unit costs and yield issues associated with production at our factories,transfers of production to our low cost facilities, excess manufacturingcapacity, costs to comply with new and existing environmental regulations(including, but not limited to, the European Union’s directive on wasteelectrical and electronic equipment (WEEE) and directives relating torestriction of hazardous substances (RoHS)), excess inventory, supply chaininefficiencies, inventory obsolescence (including potential exposure from WEEEand RoHS compliance) and variations in inventory valuation.

We have dedicated effortsto optimize our overall manufacturing capacity and locations over recent yearsand we will continue to plan for future capacity requirements based on theassumed continued acceptance and demand for our products in the specific marketsegments they were designed to address. We currently expect that capitalspending will be between $80 million and $100 million in 2006, compared to $49million in 2005. We expect that most of our incremental capital spending for2006 will go toward acquiring and expanding a building for a customerTechnology Learning Center, to be based in St. Louis, Missouri, andmaintaining, upgrading, and expanding our current manufacturing capacity, aswell as investments to upgrade current hardware and software officetechnologies. During the second quarter, we acquired the land and building inSt. Louis for approximately $14 million from available cash on-hand.

We are committed tosustaining our R&D efforts to meet the future needs of our customers acrossall segments and potentially expanding into emerging, high-growth areas. Wecontinue to advance our NCPI systems in addition to ensuring our end-to-endoffering is the best in the industry. We will remain focused on aggressivelydriving the growth of our network-critical physical infrastructure solutions,which will require sustaining and increasing our operating expense investmentsin sales and marketing, including increased personnel and investments in globalcustomer education initiatives.

In February 2006, APC’sBoard of Directors approved a stock repurchase program which authorizes up to$200 million to repurchase outstanding shares of APC’s common stock. Thepurchases would be made on the open market based on market and businessfactors. APC commenced the repurchase of its common stock in February 2006 and,as of the end of the second quarter, had repurchased approximately 6.4 millionshares on the open market at an average price of approximately $20.30 pershare, totaling $129 million. The duration of the repurchase program is twoyears but may be suspended or discontinued at any time without prior notice.

We currently expect ourtax rate to be approximately 21 - 23% for the full year 2006. The estimatedeffective tax rate is based on current tax law and the current expected income.The tax rate may be affected by the jurisdictions in which profits aredetermined to be earned and taxed, our ability to successfully implementadditional tax savings planning opportunities and our ability to realizedeferred tax assets.

We are currently a partyto various legal proceedings and claims. We currently do not believe that theultimate outcome of current legal proceedings and claims will have a materialadverse effect on our financial position or overall trends in results ofoperations. However, litigation is subject to inherent uncertainties, includingthe risk of an unfavorable outcome, and management’s view of these matters maychange in the future. An unfavorable outcome could include monetary damages or,in cases where injunctive relief is sought, an injunction prohibiting certainactivities. If an unfavorable outcome were to occur in any specific period,there exists the possibility of a material adverse impact on the results ofoperations of that period or future periods. We believe that, given our currentliquidity and cash and investment balances, even an adverse judgment in currentlegal proceedings and claims would not have a material impact on cash andinvestments or liquidity.

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**RESULTSOF OPERATIONS**

**COMPARISON OF THE THREE AND SIX MONTH PERIODS ENDED JUNE 25,2006 AND JUNE 26, 2005**

**Revenues**

Net sales were$560.0 million for the second quarter of 2006, an increase of 16.5% compared to$480.6 million for the comparable period in 2005. Net sales for the first sixmonths of 2006 were $1.039 billion, an increase of 16.9% compared to $888.6million for the same period in 2005. Each of our major geographies andprincipal operating segments reported very healthy top line second quarter andfirst half growth. We are confident that the strong year-over-year growth canbe attributed to what we believe continues to be a healthy macro-economicenvironment for IT spending and is the result of our continued investments insales and marketing activities and the growing adoption of APC’snetwork-critical physical infrastructure, or NCPI, architecture.

Each of ouroperating segments contributed to the strong top line performance. The LargeSystems segment, which is a focus of our data center initiatives andincorporates 3-phase UPS products, cooling, services and other relatedproducts, again posted the strongest gains for APC. We continued to makeinvestments in supporting our efforts in these network-critical physicalinfrastructure markets and our top line advances highlight the resulting strongperformance. Led by solid growth in our online Smart-UPS products, Back-UPSfamily and InfraStruXure related products, the Small Systems segment also continuesto produce strong results that reflect APC’s position as a preferred partner inthe mid-market and consumer power protection markets. For further informationabout revenues by segment, refer to the *Segment Results*section below.

***Revenues by Geography.**** *The following table summarizes our revenues on a geographic basis for thesecond quarter and six months ended June 25, 2006 and June 26, 2005.

 
| ** **                                 | ** ** | **Six months ended** | ** **  | **Three months ended** | ** ** |
|--------------------------------------------|------------|--------------------------------|-------------|----------------------------------|------------|
| ** **                                 | ** ** | **June 25,  2006**        | ** **  | **% of  Total**             | ** ** | **June 26,  2005** | ** ** | **% of  Total** | ** ** | **June 25,  2006** | ** ** | **% of  Total** | ** ** | **June 26,  2005** | ** ** | **% of  Total** | ** ** |
| ** **                                 | ** ** | **(In millions)**         | ** **  |
| North and Latin America (the Americas)     | ** ** | **$**                          | **552.0**   | ** **                       | **53.1**   | **%** | $ | 462.0 |   | 52.0 | % | **$** | **304.8** | ** ** | **54.4** | **%** | $ | 257.8 |   | 53.6 | % |
| Europe, the Middle East, and Africa (EMEA) | ** ** | **299.3**                      | ** **  | **28.8**                         | **%**      | 256.9 |   | 28.9 | % | **162.3** | ** ** | **29.0** | **%** | 140.2 |   | 29.2 | % |
| Asia                                       | ** ** | **187.5**                      | ** **  | **18.1**                         | **%**      | 169.7 |   | 19.1 | % | **92.9** | ** ** | **16.6** | **%** | 82.6 |   | 17.2 | % |
| Total Net Sales                            | ** ** | **$**                          | **1,038.8** | ** **                       | **100.0**  | **%** | $ | 888.6 |   | 100.0 | % | **$** | **560.0** | ** ** | **100.0** | **%** | $ | 480.6 |   | 100.0 | % |

 

TheAmericas’ net sales increased 18.2% in the second quarter of 2006 over thesecond quarter of 2005, and increased 19.5% in the first six months of 2006over the first six months of 2005. EMEA’s net sales increased 15.7% in thesecond quarter of 2006 over the second quarter of 2005, and increased 16.5% inthe first six months of 2006 over the first six months of 2005. Asia’s netsales increased 12.4% in the second quarter of 2006 over the second quarter of2005, and increased 10.3% in the first six months of 2006 over the first sixmonths of 2005.

Inaddition, we believe that constant currency information is useful for anunderstanding of our operating results. Revenues on a constant currency basisdiffer from revenues presented in accordance with accounting principlesgenerally accepted in the United States.

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**Constant Currency Revenues**

*($ in millions)*

 
| ** **      | ** ** | **Three Months Ended  June 25, 2006** | ** ** | **Three Months Ended  June 26, 2005** | ** ** |
|-----------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **      | ** ** | **Constant $  Revenue**                              | ** ** | **Constant $  Impact**                               | ** ** | **Constant $  % Change** | ** ** | **Constant $  Revenue** | ** ** | **Constant $  Impact** | ** ** | **Constant $  % Change** | ** ** |
|            |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| The Americas    | ** ** | **$**                                                     | **303.9**  | ** **                                                | **$**      | **0.8** | ** ** | **17.9** | **%** | $ | 256.8 |   | $ | 1.0 |   | 21.7 | % |
| EMEA            | ** ** | **162.3**                                                 | ** ** | **—**                                                | ** ** | **15.7** | **%** | 136.0 |   | 4.2 |   | 14.1 | % |
| Asia            | ** ** | **95.1**                                                  | ** ** | **(2.1**                                                  | **)**      | **15.0** | **%** | 80.8 |   | 1.8 |   | 23.4 | % |
| Total Net Sales | ** ** | **$**                                                     | **561.3**  | ** **                                                | **$**      | **(1.3** | **)** | **16.7** | **%** | $ | 473.6 |   | $ | 7.0 |   | 19.7 | % |

 
| ** **      | ** ** | **Six Months Ended  June 25, 2006** | ** **  | **Six Months Ended  June 26, 2005** | ** ** |
|-----------------|------------|---------------------------------------------------------|-------------|---------------------------------------------------------|------------|
| ** **      | ** ** | **Constant $  Revenue**                            | ** **  | **Constant $  Impact**                             | ** ** | **Constant $  % Change** | ** ** | **Constant $  Revenue** | ** ** | **Constant $  Impact** | ** ** | **Constant $  % Change** | ** ** |
|            |       |                                                    |        |                                                    |       |   |   |   |   |   |   |   |   |
| The Americas    | ** ** | **$**                                                   | **550.2**   | ** **                                              | **$**      | **1.9** | ** ** | **19.1** | **%** | $ | 460.8 |   | $ | 1.2 |   | 22.9 | % |
| EMEA            | ** ** | **305.6**                                               | ** **  | **(6.3**                                                | **)**      | **19.0** | **%** | 249.4 |   | 7.5 |   | 8.6 | % |
| Asia            | ** ** | **194.3**                                               | ** **  | **(6.9**                                                | **)**      | **14.3** | **%** | 166.9 |   | 2.8 |   | 17.0 | % |
| Total Net Sales | ** ** | **$**                                                   | **1,050.1** | ** **                                              | **$**      | **(11.3** | **)** | **18.1** | **%** | $ | 877.1 |   | $ | 11.5 |   | 17.3 | % |

 

EMEA’srevenues on a constant currency basis principally reflect fluctuations in theEuro and British pound.

Asia’srevenues on a constant currency basis principally reflect fluctuations in theJapanese yen and Australian dollar.

**Costof Goods Sold**

Costof goods sold was $371.4 million or 66.3% of net sales in the second quarter of2006 compared to $302.3 million or 62.9% of net sales in the second quarter of2005. Cost of goods sold was $692.4 million or 66.7% of net sales in the firstsix months of 2006 compared to $545.9 million or 61.4% of net sales in thefirst six months of 2005. Gross margins for the second quarter of 2006 were33.7% of net sales, approximately 340 basis points lower than in the secondquarter of 2005. Gross margins for the first six months of 2006 were 33.3% ofnet sales, approximately 530 basis points lower than in the first six months of2005. The lower second quarter and first half 2006 gross margins wereattributable to a segment mix shift toward our Large Systems segment, combinedwith pricing and mix shifts within our principal segments.

Additionally,approximately one percentage point of the decline was attributable to higher operationalcosts, primarily freight and logistics costs, resulting from production shiftsto lower-cost locations and distribution center transitions and, to a lesserdegree, manufacturing cost inefficiencies caused by redundant capacity.Although we continued to reduce our reliance on expedited shipment methodsduring the quarter, particularly air freight, overall freight and logisticscosts remain higher than prior year levels. Going forward, we will continue tofurther improve our processes and efficiencies.

For further informationabout gross margins by segment, refer to the *SegmentResults* section below.

***Inventory Reserves.***  Totalinventory reserves at June 25, 2006 were $62.4 million compared to $48.6million at December 31, 2005. The increase in total inventory reservesreflected routine provisioning that was necessary as a result of applying APC’sinventory reserve methodology throughout the quarter, offset by the physicaldisposition of inventories covered by APC’s inventory reserves. APC’s reserve estimatemethodology involves quantifying the total inventory position having potentialloss 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 exposureis the result of combining the cost of inventories specifically identified ashaving little or no opportunity for sale or use (thus available for physicaldisposition) plus the cost of inventories having a high risk of no future saleor use based upon an analysis of on-hand quantities compared to historical andanticipated future sale or use. APC maintains an on-going business process forthe 

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physicaldisposition of inventories previously identified. Inventory write-offs occur atthe time of physical disposition. Inventories, once reserved, are not writtenback up as such reserve adjustments are considered to be a permanent decreaseto the cost basis of the excess or obsolete inventory.

**Segment Results**(Alsorefer to Note 10 of Notes to Consolidated Financial Statements in Item 1 ofthis report for important information regarding APC’s reportable segments)

***Small Systems.***  Net sales for products in the Small Systemssegment, which provides power protection, UPS and management products for thePC, server and networking markets, increased in the second quarter of 2006 by12.2% over the second quarter of 2005, and increased in the first six months of2006 by 13.1% over the first six months of 2005. Demand for our online, singlephase, Smart-UPS solution, the Smart UPS RT, summer demand for Back-UPS desktopUPS, and InfraStruXure related products, including racks and device management,bolstered sales for this segment.

Second quarter and first half 2006 gross margins forthe Small Systems segment of 41.5% and 41.4%, respectively, declined 370 basispoints and 490 basis points, respectively, from the comparable periods in 2005.In addition to the aforementioned higher freight and logistics costs, pricingand mix shifts were factors in the year-over-year decline.

***Large Systems.***  Net sales for products in theLarge Systems segment, consisting primarily of 3-phase UPS, services, precisioncooling and ancillary products for data centers, facilities and communicationapplications, increased in the second quarter of 2006 by 33.0% over the secondquarter of 2005, and increased in the first six months of 2006 by 32.9% overthe first six months of 2005. Year-over-year growth in InfraStruXure relatedsolutions, including Symmetra 3-Phase UPS, helped drive growth in this segment.In total, InfraStruXure revenue grew approximately 30% year-over-year andsequentially. Additionally, our new Smart UPS VT, which replaces lower-kVAlegacy Silcon products and APC’s broadband products also contributed to thestrong top line performance of this segment.

Second quarter and firsthalf 2006 gross margins for the Large Systems segment of 18.5% and 17.5%,respectively, increased 20 basis points and decreased 220 basis points, respectively,from the comparable periods in 2005. While the aforementioned higher freightand logistics costs contributed to the downward pressure on margins in thissegment, product mix, particularly related to the growth of lower marginofferings in our broadband family, also impacted the year-over-year margincomparison. Continuing material cost savings partially offset these unfavorablefactors.

*** “Other” Segment.***  Netsales for products in the Other segment, consisting principally of mobileaccessories and replacement batteries, decreased in the second quarter of 2006by 4.7% over the second quarter of 2005, and decreased in the first six monthsof 2006 by 1.8% over the first six months of 2005 as sales of mobileaccessories were down year-over-year in both periods and replacement batterysales were down in the second quarter.

Secondquarter and first half 2006 gross margins for the Other segment of 55.2% and54.6%, respectively, decreased 130 basis points and 330 basis points,respectively, from the comparable periods in 2005. Pricing and material costsnegatively impacted this segment’s gross margins.

## **Operating Expenses**

***Marketing, Selling, General, andAdministrative (SG&A) Expenses.*** SG&A expenses inthe second quarter of 2006 were $135.8 million or 24.3% of net sales comparedto $105.6 million or 22.0% of net sales in the second quarter of 2005. SG&Aexpenses in the first six months of 2006 were $257.8 million or 24.8% of net salescompared to $206.2 million or 23.2% of net sales in the first six months of2005. We continue to support our data center initiatives, with a focus onincreasing the awareness of our existing and prospective customers,particularly in relation to our InfraStruXure architecture. Our investmentsremain concentrated on driving InfraStruXure and data center-relatedinitiatives, including sales and service staffing, education, and salesgeneration. The investments we are making in these areas are essential tobranding the data center, and establishing APC as a leader in the network-

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critical physicalinfrastructure market. We also recorded nearly $3 million in incremental costsyear-over-year associated with the newly acquired Netbotz business, includingamortization of intangibles ($6 million during the first half). Additionally,pursuant to our adoption of SFAS 123R, we recorded approximately $1 million inincremental stock-based compensation during the quarter ($2 million during thefirst half) for a total equity compensation expense of $4 million ($8 millionduring the first half) when combined with costs associated with restrictedstock units; the majority of these costs were classified in operating expenses.

The allowance for bad debts was 3.4% of gross accounts receivable at June25, 2006, substantially unchanged from 3.8% at December 31, 2005. Accountsreceivable balances outstanding over 60 days represented 14.1% of totalreceivables at June 25, 2006 compared to 12.7% at December 31, 2005. A majorityof U.S. and international customer balances continue to be covered byreceivables insurance. We continue to experience strong collection performance.Write-offs of uncollectable accounts represent less than 1% of net sales forboth periods.

***Research and Development(R&D).***  R&D expenditures were $25.8 million or4.6% of net sales in the second quarter of 2006, up from $22.7 million or 4.7%of net sales in the second quarter of 2005. R&D expenditures were $48.4million or 4.7% of net sales in the first six months of 2006, up from $43.0million or 4.8% of net sales in the first six months of 2005. We are committedto sustaining our R&D efforts to meet the future needs of our customersacross all segments and potentially expanding into emerging, high-growth areas.We continue to advance our NCPI systems in addition to ensuring our end-to-endoffering is the best in the industry. We believe that continued productinnovation through development is necessary for our existing products to remaincompetitive in our markets, as well as creating opportunities from new productintroductions. The increases in total R&D spending primarily reflectincreased numbers of software and hardware engineers and costs associated withnew product development and engineering support.

**OtherIncome, Net and Income Taxes**

***Other Income, Net.***  Otherincome is comprised principally of interest income which decreased during thesecond quarter of 2006 due principally to lower average cash balances availablefor investment during 2006. Interest income increased during the first sixmonths of 2006 as a result of the favorable impact of rising interest ratescompared to the first six months of 2005.

At June 25, 2006,APC had $539.3 million of total cash and investments, down from $774.2 millionat December 31, 2005. We manage APC’s cash and investment balances to preserveprincipal and liquidity while maximizing our return on the total investmentportfolio. We diversify our investment portfolio by investing in multiple typesof investment-grade securities with multiple investment brokers. Based on APC’sinvestment portfolio and interest rates, at June 25, 2006, a 100 basis pointincrease or decrease in interest rates would have resulted in an increase ordecrease of approximately $5 million in our annual interest income.

***Income Taxes.**** *Our effective income tax rate wasapproximately 22.5% for the second quarter and first six months ended June 25,2006 and was approximately 24.0% for the second quarter and first six months ofJune 26, 2005. The decrease in 2006 from 2005 is due to the tax savings from anincreasing portion of taxable earnings anticipated to be generated from APC’soperations in jurisdictions currently having lower income tax rates than thepresent U.S. statutory income tax rate. This shift resulted partially from ourproduct transitions to lower cost, lower tax, manufacturing locations. APC hastax holidays in China and India which reduce or eliminate the income taxes paidin those countries. Although this could have the effect of increasing APC’sforeign taxes, we expect APC’s effective income tax rate to remain considerablylower than the U.S. statutory federal corporate tax rate of 35%.

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**LIQUIDITYAND CAPITAL RESOURCES**

**Working Capital**

Working capital at June 25, 2006 was $1.254billion compared to $1.389 billion at December 31, 2005. Our total cash, cashequivalents, and short-term investments decreased to $539.3 million at June 25,2006 from $774.2 million at December 31, 2005.

***Stock Repurchase Program****.*  InFebruary 2006, APC’s Board of Directors approved a stock repurchase programwhich authorizes up to $200 million to repurchase outstanding shares of APC’scommon stock. The purchases would be made on the open market based on marketand business factors. The duration of the repurchase program is two years butmay be suspended or discontinued at any time without prior notice. APCcommenced the repurchase of its common stock in February 2006. The first half2006 decrease in our cash, cash equivalents, and short-term investmentsposition reflected APC’s first half repurchase on the open market ofapproximately 6.4 million shares of its common stock, at an average price of$20.30 per share, totaling $129 million.

In addition, APC’s continued positiveoperating results allowed us to pay a quarterly dividend and continue tointernally finance the capital investment, R&D, sales and marketingspending required to expand our operations.

**Cash Flows**

The table below summarizes our cash flows forthe second quarters and first six months ended June 25, 2006 and June 26, 2005.
| ** **                                           | ** ** | **Six months ended** | ** **  | **Three months ended** | ** ** |
|------------------------------------------------------|------------|--------------------------------|-------------|----------------------------------|------------|
| ** **                                           | ** ** | **June 25,  2006**        | ** **  | **June 26,  2005**          | ** ** | **June 25,  2006** | ** ** | **June 26,  2005** | ** ** |
| ** **                                           | ** ** | **(In thousands)**        | ** **  |
| Net cash (used in)  provided by operating activities | ** ** | **$**                          | **(31,484** | **)**                            | $          | 66,869 | ** ** | **$** | **(9,212** | **)** | $ | 32,327 |   |
|                                                 | ** ** | ** **                     | ** **  |                             | ** ** | ** ** |   |   |   |
| Net cash provided by  (used in) investing activities | ** ** | **127,187**                    | ** **  | (6,357                           | )          | **58,496** |   | (11,654 | ) |
|                                                 | ** ** | ** **                     | ** **  |                             | ** ** | ** ** |   |   |   |
| Net cash used in  financing activities               | ** ** | **(156,039**                   | **)**       | (11,114                          | )          | **(72,000** | **)** | (591 | ) |
|                                                 | ** ** | ** **                     | ** **  |                             | ** ** | ** ** |   |   |   |
| Net change in cash and  cash equivalents             | ** ** | **(60,336**                    | **)**       | 49,398                           | ** ** | **(22,716** | **)** | 20,082 |   |
| Cash and cash  equivalents at beginning of period    | ** ** | **262,414**                    | ** **  | 72,721                           | ** ** | **224,794** |   | 102,037 |   |
| Cash and cash equivalents at end of period           | ** ** | **$**                          | **202,078** | ** **                       | $          | 122,119 | ** ** | **$** | **202,078** |   | $ | 122,119 |   |

 

***Cash Flows from OperatingActivities****.*  Ourcash flows from operations for the second quarter and first six months of 2006funded increased inventory as discussed below. Our cash flows from operationsfor the second quarter of 2005 and first six months of 2005 reflectedhigher profit levels. In addition, bothyears reflected increased accounts receivable balances as a result of highersecond quarter and first half sales.

***Cash Flows from InvestingActivities****.*  Ourinvesting activities cash flows in the second quarter and first six months of2006 reflected the impact of the aforementioned share repurchase program, andin the second quarter and first six months of 2005 reflected the purchase ofavailable-for-sale securities. Both periods included the impact of capitalspending, principally manufacturing and office equipment, purchased softwareapplications, and building improvements. Our investment approach and thecomposition of our investment portfolio remained relatively constant overallwith no investments having maturity dates greater than one year, except for ourauction rate securities and variable rate demand obligations. Capital spending in the second quarters andfirst six months of 2006 and 2005 focused on funding additional equipment needsand improving existing factories, principally in the U.S., India, and thePhilippines, as well as continuing investment in information technologies.

***Cash Flows from FinancingActivities****.*  Our cash flows from financing activitiesincluded the afore-mentioned share repurchases in the second quarter and firstsix months of 2006, as well as the payment of common stock dividends ofapproximately $19.1 million and $19.4 million during the second quarters of2006 and 2005, respectively, and $38.7 million and $38.6 million during thefirst six months of 2006 and 2005, respectively. These outflows were partiallyoffset by proceeds from issuances of common stock relating to employee stockplans during each of the periods presented.

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** **

**Inventories**

Worldwideinventories were $607.6 million at June 25, 2006, up from $541.8 million atDecember 31, 2005. Our inventory typically increases in the first half due toseasonal anticipation of summer demand patterns as a result of power outagesand interruptions. Also, higher levels of on-hand finished goods were requiredto ensure product availability as we navigate our aforementioned supply chainissues, and to meet increasing current and anticipated demand, particularlyInfraStruXure demand, as well as to manage the requirements associated withcontinuing transfers of production of a wide range of Small and Large Systemsproducts to and among our low cost manufacturing regions. In addition, weincreased our inventory levels strategically to support in-region lead timeinitiatives, as well as to support continuing new product introductions.Despite increasing inventory levels, our inventory days on hand improved to 147days in the second quarter of 2006, down from 161 days in the first quarter of2006, reflecting our strong second quarter 2006 net sales performance, andapproximated 144 days in the second quarter of 2005. There were no inventorycharges, other than APC’s standard provisioning, during the second quarters andfirst six months of 2006 and 2005.

**ContractualObligations**

The following tablesummarizes our significant contractual obligations at June 25, 2006, and theeffect such obligations are expected to have on our liquidity and cash flows infuture periods. This table excludes amounts already recorded on our balancesheet as current liabilities at June 25, 2006.
| ** **                   | ** ** | **Payments Due By Period** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| ** **                   | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                   | ** ** | **(In millions)**                    | ** ** |
| Operating Lease  Obligations |       | $                                         | 27.4       |   | $ | 4.7 |   | $ | 13.6 |   | $ | 6.4 |   | $ | 2.7 |   |
|                              |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

APC’s non-cancelable operating leases, primarily forwarehousing and office space, expire at various dates through 2011. Theseleases contain renewal options for periods ranging from one to seven years andrequire APC to pay its proportionate share of utilities, taxes, and insurance.APC is not able to determine the aggregate amount of purchase orders thatrepresent contractual obligations for the purchase of goods and services, assuch purchase orders may represent authorizations to purchase rather thanbinding agreements. For the purposes of this disclosure, contractualobligations for the purchase of goods and services are defined as agreementsthat are enforceable and legally binding on APC and that specify allsignificant terms, including: fixed or minimum quantities to be purchased;fixed, minimum, or variable price provisions; the approximate timing of thetransaction, and contain no provisions allowing for cancellation withoutsignificant penalty. Our purchase orders for raw materials or purchasedfinished products are based on our current manufacturing needs and/or demandforecasts and are fulfilled by our vendors within short time horizons. We donot have significant agreements for the purchase of raw materials or finishedproducts specifying minimum quantities or set prices that exceed our expectedrequirements for three months.

**Capital Expenditures and Capital Commitments**

During the secondquarters of 2006 and 2005, our capital expenditures, net of capital grants,amounted to approximately $31.7 million and $10.3 million, respectively. Duringthe first six months of 2006 and 2005, our capital expenditures, net of capitalgrants, amounted to approximately $48.6 million and $15.3 million,respectively. Our capital spending during the second quarters and first sixmonths of 2006 and 2005 consisted primarily of manufacturing and officeequipment, purchased software applications, and building improvements, withspending focused on funding additional equipment needs and improving existingfactories, principally in the U.S., India, and the Philippines, as well ascontinuing investment in information technologies. Substantially all of APC’snet capital expenditures were financed from available operating cash.

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We have dedicated effortsto optimize our overall manufacturing capacity and locations over recent yearsand we will continue to plan for future capacity requirements based on theassumed continued acceptance and demand for our products in the specific marketsegments they were designed to address. We currently expect that capitalspending will be between $80 million and $100 million in 2006, compared to $49million in 2005. We expect that most of our incremental capital spending for2006 will go toward acquiring and expanding a building for a customerTechnology Learning Center, to be based in St. Louis, Missouri, andmaintaining, upgrading, and expanding our current manufacturing capacity, aswell as investments to upgrade current hardware and software officetechnologies. During April 2006, we acquired the leased facility currentlyoccupied in St. Louis for $14.3 million as the first major step toward ourTechnology Learning Center. The purchase price was paid from available cash.

We had no material capital commitments during the second quarters andfirst six months of 2006 and 2005, or at June 25, 2006 and December 31, 2005.

APChas an agreement with the Industrial Development Authority of Ireland,otherwise known as the IDA. Under this agreement, we receive grant monies forcosts incurred for machinery, equipment, and building improvements for ourGalway facility. These grants are equal to 40% of such costs up to a maximum of$13.1 million. Such grant monies are subject to APC meeting certain employmentgoals and maintaining operations in Ireland until termination of the agreement.By an amendment agreement dated June 26, 2006, APC and the IDA agreed to (1)reduce the aggregate required employment goals for our Galway facility subjectto maintaining certain minimum target employment levels in our Galway andCastlebar facilties and  the impositionof monetary penalties should aggregate employment levels in the two facilitiesfall below 405 employees, (ii) reduce by 30% over two years APC’s contingentgrant liability in the event that APC breaches the agreement, and (iii) extendthe term of the underlying agreement from 2008 to 2012. Under a separateagreement with the IDA, we receive direct reimbursement of training costs atour Galway and Castlebar facilities for up to $3,000 and $12,500, respectively,per new employee hired. Also refer to Note 15 of Notes to ConsolidatedFinancial Statements in Item 8 of American Power Conversion Corporation’sAnnual Report on Form 10-K for the year ended December 31, 2005.

APC also has an agreement with the IDA for a research and developmentgrant towards the costs of a project for the development of software products.The availability of the grant is contingent on meeting certain milestones inthe progress of the project as well as meeting certain employment goals on theproject within the Galway facility. The amount of grant assistance available onsatisfaction of all conditions is 28% of the eligible expenditure to a maximumof €714,588. At June 25, 2006, no grant claims had been claimed or received.

**Borrowing Facilities and Financial Commitments**

APChad no borrowing facilities or significant financial commitments, other thanthose required in the normal course of business, during the second quarters andfirst six months of 2006 and 2005, or at June 25, 2006 and December 31, 2005.

**Off-Balance-Sheet Arrangements**

APChad no significant off-balance sheet arrangements during the second quartersand first six months of 2006 and 2005, or at June 25, 2006 and December 31,2005.

**Quarterly Cash Dividends**

Dividends of $0.10per share were declared and paid in each of the first and second quarters of2006 and 2005. It is the intention of the Board of Directors to pay acomparable quarterly dividend on a going forward basis contingent uponcontinued capital availability and a determination that cash dividends continueto be in the best interests of APC and its shareholders.

APChas historically generated annual cash flows from operating activities as aresult of strong operating results and, at times, improvement in workingcapital. We believe that current internal cash flows together with availablecash, available credit facilities or, if needed, the proceeds from the sale ofadditional equity, will be sufficient to support anticipated capital spending,dividend payments, and other working capital requirements for the foreseeablefuture.

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##  

## **Foreign Currency Activity**

We invoice our customers in various currencies.Realized and unrealized transaction gains or losses are included in the resultsof operations and are measured based upon the effect of changes in exchangerates on the actual or expected amount of functional currency cash flows.Transaction gains and losses were not material to the results of operations inthe second quarters or first six months of 2006 and 2005.

The table belowsummarizes information on balances that are sensitive to foreign currencyexchange rates and presents such amounts in U.S. dollar equivalents.

|                                  | ** ** | **June 25, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **Accounts  Receivable**    | ** ** | **Liabilities**       | ** ** | **Accounts  Receivable** | ** ** | **Liabilities** | ** ** |
| ** **                       | ** ** | **(In millions)**      | ** ** |
| U.S. dollar  functional currency | ** ** | **$**                       | **87.6**   | ** **            | **$**      | **104.5** |   | $ | 98.6 |   | $ | 93.8 |   |
|                             |       |                        |       |                  |       |   |   |   |   |
| Swiss franc functional  currency | ** ** | **$**                       | **18.5**   | ** **            | **$**      | **4.8** |   | $ | 14.4 |   | $ | 5.8 |   |

 

APC also had non-tradereceivables denominated in Euros of approximately U.S.$0.9 million and U.S.$1.4million at June 25, 2006 and December 31, 2005, respectively.

We continually review ourforeign exchange exposure and consider various risk management techniques,including the netting of foreign currency receipts and disbursements, rateprotection agreements with customers/vendors and derivatives arrangements,including foreign exchange contracts. We presently do not utilize rate protectionagreements or derivative arrangements.

**CRITICALACCOUNTING POLICIES**

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. The U.S.Securities and Exchange Commission has defined critical accounting policies asthose that are both most important to the portrayal of our financial conditionand results and which require our most difficult, complex or subjectivejudgments or estimates. Based on this definition, we have identified thepolicies below as critical to our business operations and the understanding ofour results of operations. The impact and any associated risks related to thesepolicies on our business operations is discussed throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations wheresuch policies affect our reported and expected financial results. For allfinancial statement periods presented, there have been no materialmodifications to the application of these critical accounting policies. For adetailed discussion on the application of these and other accounting policies,also refer to Note 1 of Notes to Consolidated Financial Statements in Item 8 ofAmerican Power Conversion Corporation’s Annual Report on Form 10-K for the yearended December 31, 2005.

On an on-going basis, weevaluate 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 valuationallowances, restructuring reserves and contingencies, and litigation. We baseour estimates on historical experience and on various other assumptions thatare believed to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Materiallydifferent results in the amount and timing of our actual results for any periodcould occur if we made different judgments or utilized different estimates.Actual results may differ from those estimates.

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Our criticalaccounting policies are as follows:

***RevenueRecognition. ***Wefollow very specific and detailed guidelines in measuring revenue; however,certain judgments affect the application of our revenue policy. Revenue resultsare difficult to predict, and any shortfall in revenue or delay in recognizingrevenue could cause our operating results to vary significantly from quarter toquarter. In general, revenue is recognized when title has passed at the time ofdelivery of product for all of our operating segments as stipulated by thedelivery terms for the sales transactions. In addition, prior to revenuerecognition, we require persuasive evidence of the arrangement, that the priceis fixed or determinable, and that collectibility is reasonably assured. Thisrequires us to assess at the point of delivery whether these criteria have beenmet. When management determines that such criteria have been met, revenue isrecognized. Installation is not applicable for a majority of Small Systems andall “Other” segment products based on the nature of the products sold.Generally, revenue associated with Large Systems sales is also recognized atthe time of delivery and/or installation pursuant to the delivery and/orinstallation terms. 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)). We record estimatedreductions to revenue for customer programs and incentive offerings, includingspecial pricing agreements, price protection, co-operative advertising andother volume based discounts at the time of sale.

Revenue from sales ofthird-party vendor products or services is recorded on a gross basis when APCis a principal to the transaction, and is recorded net of costs should APC actas an agent between the client and vendor. Generally, APC does not act asagent. Several factors are considered to determine whether APC is an agent orprincipal, most notably whether APC is the primary obligor to the client, hasinventory risk or adds meaningful value to the vendor’s products or service.Consideration is also given to whether APC was involved in the selection of thevendor’s product or service, has latitude in establishing the sales price, orhas credit risk.

Our arrangements do notgenerally include acceptance clauses. However, if an arrangement includes acustomer specified acceptance provision, acceptance can occur at our factoryprior to delivery or at the customers’ site. Revenue recognition will occurupon management’s determination of acceptance by the customer consistent withthe agreed-upon delivery terms for the sale. As we continue to introduce newproducts and enter into new product and service arrangements with customers, weanticipate that installation and customer acceptance provisions may become morecommon, and therefore increasingly significant for determining delivery andperformance and consequently our entitlement to recognize revenue.

Certain LargeSystems product lines and, at times, one product line included in the SmallSystems segment, require electrical hardwire installation or duct installationwhich is performed by the customer or their contracted licensedcontractor/electrician. Where we do not perform such installation, revenuerecognition at the time of delivery is proper as customer acceptance of theunit is not required. Also, payment by the customer is not contingent uponinstallation of the product.

We offer additionalservices to customers depending on the type of product the customer haspurchased, including product-based and professional services. Revenue isrecognized at the time services are provided or is deferred and recognized overthe service period (where applicable). The fair value of these services arebased upon the rates that we charge customers in separately negotiatedtransactions and such services are not essential to the functionality of thedelivered product.

For all sales, exceptthose completed over the Internet, we use a binding purchase order as evidenceof an arrangement. For sales over the Internet, we use a credit cardauthorization as evidence of an arrangement. Sales through certain customersare evidenced by a master agreement governing the relationship together withbinding purchase orders on a transaction by transaction basis.

***EstimatingValuation Allowances and Accrued Liabilities — Allowances for Sales Returns,Doubtful Accounts, Inventory Obsolescence and Product Recall, and Assessment ofthe Probability of the Outcome of our Current Litigation. ***Significant managementjudgments that affect the application of our revenue policy also includeestimates of potential future product returns related to current period productrevenue. We analyze historical returns, current economic trends, and channelinventories when evaluating the adequacy of the sales returns and otherallowances. Significant management judgments and estimates must be made andused in connection with establishing 

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the sales returnsand other allowances in any accounting period. Material differences may resultin the amount and timing of our revenue for any period if management madedifferent judgments or utilized different estimates.

We provide limited rightsof return to distributors and retailers for our Small Systems product lines. Weprovide appropriate reserves for returns at the time that related revenue isrecognized, based on historical patterns of returns and contractual provisionsin accordance with the provisions of Statement of Financial AccountingStandards No. 48, *Revenue Recognition WhenRight of Return Exists*, and U.S. Securities and Exchange CommissionStaff Accounting Bulletin No. 104. Returns of Large Systems products generallydo not occur. Historically, returns have represented approximately 3% of grosssales and have not differed significantly from prior estimates.

Similarly, we mustmake estimates of the uncollectability of our accounts receivable. Managementspecifically analyzes accounts receivable balances in view of customercredit-worthiness, customer concentrations, historical bad debts, currenteconomic trends, and changes in our customer payment terms when evaluating theadequacy of the allowance for doubtful accounts. A majority of U.S. and international customer balances continue to becovered by receivables insurance. Historically, write-offs of uncollectable accounts have represented less than 1%of net sales.

Our inventoryreserve estimate methodology involves quantifying the total inventory positionhaving potential loss exposure. Loss exposure generally results from severalbusiness factors, including product or component discontinuance, unplannedchanges in demand, product design changes, and factory transitions. Quantifyingsuch loss exposure is the result of combining the cost of inventoriesspecifically identified as having little or no opportunity for sale or use(thus available for physical disposition) plus the cost of inventories having ahigh risk of no future sale or use based upon an analysis of on-hand quantitiescompared to historical and anticipated future sale or use. We maintain anon-going business process for the physical disposition of inventoriespreviously identified. Inventory write-offs occur at the time of physicaldisposition. Inventories, once reserved, are not written back up as suchreserve adjustments are considered to be a permanent decrease to the cost basisof the excess or obsolete inventory. If actual market conditions are lessfavorable than those projected by management, additional inventory write-downsmay be required.

We are, and may in thefuture become, involved in litigation involving our business, products oroperations. For pending claims for which there is an estimable range of lossgreater 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 theminimum estimated liability. Because of uncertainties related to theidentifiable range of loss on any pending claims, we may be unable to make areasonable estimate of the liability that could result from an unfavorableoutcome. As additional information becomes available, we assess the potentialliability related to our pending claims and revise our estimates. Suchrevisions in our estimates of the potential liability could materially impactour results of operation and financial position. The litigation process isinherently uncertain and includes the risk of an unexpected, unfavorableresult. We may be materially adversely impacted by any such litigation.

***Valuation ofLong-lived Tangible and Intangible Assets including Goodwill. ***We assess theimpairment of long-lived tangible and intangible assets on an ongoing basis andwhenever events or changes in circumstances indicate that the carrying valuemay not be recoverable. Should our assessment of long-lived and amortizableintangible assets suggest impairment, we would determine recoverability basedon an estimate of future undiscounted cash flows resulting from our use of theasset and its eventual disposition.

Factors weconsider that could trigger an impairment review include the following:

·                  significantunderperformance relative to expected historical or projected future operatingresults;

·                  significantchanges in the manner of our use of the acquired assets or the strategy for ouroverall business;

·                  significantnegative industry or economic trends; and

·                  significanttechnological changes, which would render equipment or manufacturing processesobsolete.

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We evaluate eachof our reporting units with goodwill during the fourth quarter of each fiscalyear or more frequently if impairment indicators arise. Impairment losses aredetermined based upon the excess of carrying amounts over discounted expectedfuture cash flows of the underlying business.

***Accounting forIncome Taxes. ***Aspart of the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. This process involves estimating our actual current tax exposuretogether with assessing temporary differences resulting from differingtreatment of items, such as deferred revenue, for tax and accounting purposes.These differences result in deferred tax assets and liabilities, which areincluded within our consolidated balance sheet. We must then assess thelikelihood that our deferred tax assets will be recovered from future taxableincome. Expectations about future taxable income incorporate numerousassumptions about actions, elections and strategies to minimize income taxes infuture years. Our ability to take such actions, make preferred elections andimplement tax-planning strategies may be adversely impacted by enacted changesin tax laws and/or tax rates, as well as successful challenges by taxauthorities resulting from differing interpretations of tax laws andregulations.

APC is routinelyunder audit by federal, foreign, state, or local authorities in the areas ofincome taxes and the remittance of sales and use taxes. These audits includequestioning the timing and amount of deductions, the nexus of income amongvarious tax jurisdictions and compliance with federal, foreign, state, andlocal tax laws. In evaluating the exposure associated with various tax filingpositions, we often accrue for probable exposures. To the extent APC were toprevail in matters for which accruals have been established or were to berequired to pay amounts in excess of reserves, APC’s effective tax rate in agiven financial statement period could be materially affected.

To the extent we believethat recovery of deferred tax assets is not likely, we must establish a valuationallowance. To the extent we establish a valuation allowance or increase thisallowance in a period, we must include an expense within the tax provision inthe consolidated statements of income. Significant management judgment isrequired in determining our provision for income taxes, our deferred tax assetsand liabilities and any valuation allowance recorded against our net deferredtax assets. At June 25, 2006 and December 31, 2005, we provided a valuationallowance on certain of our deferred tax assets, primarily consisting of netoperating losses generated in 2001 through the second quarter of 2006 for thestart up and continuing operations of Brazilian operations, because ofuncertainty regarding their realizability. The valuation allowance is based onour estimates of taxable income by jurisdiction in which we operate and theperiod over which our deferred tax assets will be recoverable. In the eventthat actual results differ from these estimates or we adjust these estimates infuture periods we may need to establish an additional valuation allowance whichcould materially impact our financial position and results of operations.

## **RECENTLYISSUED ACCOUNTING STANDARDS**

We have determinedthat there are no recently issued accounting standards expected to have amaterial impact on APC’s consolidated financial position or results ofoperations.

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**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

We, in the normal courseof business, are exposed to market risks relating to fluctuations in foreigncurrency exchange rates. The information required under this section related tosuch risks is included in the *ForeignCurrency Activity* section of Management’s Discussion and Analysis ofFinancial Condition and Results of Operations in Item 2 of this report and isincorporated herein by reference.

We, in the normal courseof business, are also exposed to market risks relating to fluctuations ininterest rates and the resulting rates of return on investments in marketablesecurities. The information required under this section related to such risksis included in the *Other Income, Net*section of Management’s Discussion and Analysis of Financial Condition andResults of Operations in Item 2 of this report and is incorporated herein byreference.

**ITEM4.  CONTROLS AND PROCEDURES**

**(A)      Evaluationof disclosure controls and procedures**

As of theend of the period covered by this report, management carried out an evaluation,under the supervision and with the participation of APC’s Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of disclosurecontrols and procedures as defined in Rule 13a-15(e) of the Securities ExchangeAct of 1934, as amended. Based on such evaluation, the Chief Executive Officerand Chief Financial Officer have concluded that as of the end of the periodcovered by this report, APC’s disclosure controls and procedures were effectivein timely alerting them to material information required to be included in APC’speriodic filings with the U.S. Securities and Exchange Commission.

**(B)      Changesin internal control over financial reporting**

There were no changes in ourinternal control over financial reporting during APC’s last fiscal quarter thathave materially affected, or are reasonably likely to materially affect, APC’sinternal control over financial reporting.

***Limitations Inherent in all Controls*****.**APC’s management, including ourChief Executive Officer and our Chief Financial Officer, recognize that ourdisclosure controls and our internal controls (discussed above) cannot preventall error or all attempts at fraud. Any controls system, no matter how well craftedand operated, can only provide reasonable, and not absolute, assurance ofachieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Because of the inherent limitations in anycontrol system, no evaluation or implementation of a control system can providecomplete assurance that all control issues and all possible instances of fraudhave been or will be detected.

**PART II -OTHER INFORMATION**

**ITEM1.  LEGAL PROCEEDINGS**

APC is involved in claimsand legal actions arising in the ordinary course of business. While managementcurrently believes that resolving all pending legal matters, individually or inaggregate, will not have a material adverse impact on APC’s financial position,litigation and other claims are subject to inherent uncertainties, includingthe risk of an unfavorable outcome, and management’s view of these matters maychange in the future. An unfavorable outcome could include monetary damages or,in cases where injunctive relief is sought, an injunction prohibiting certainactivities. Were an unfavorable final outcome to occur, there exists thepossibility of a material adverse impact on APC’s financial position, cash flowsand results of operations for the period in which the effect becomes reasonablyestimable.

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**ITEM1A.  RISK FACTORS**

## **FACTORS THAT MAY AFFECT FUTURE RESULTS**

This document containsforward-looking statements that involve risks and uncertainties, particularlyin the *Business Outlook* sectionof Management’s Discussion and Analysis of Financial Condition and Results ofOperations in Item 2 of this report. You can identify forward-lookingstatements by the use of forward-looking terminology including “believes,” “expects,”“may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “proforma,” “estimates,” or “anticipates” or the negative of these words andphrases or other variations of these words and phrases or comparableterminology. Our actual results could differ materially from those anticipatedin these forward looking statements as a result of certain factors, includingthe risks faced by us described below and elsewhere in this document.

We caution readersnot to place undue reliance on any such forward-looking statements, which speakonly as of the date they are made. We disclaim any obligation to publiclyupdate or revise any such statements to reflect any change in our expectationsor in events, conditions, or circumstances on which any such statements may bebased, or that may affect the likelihood that actual results will differ fromthose set forth in the forward-looking statements.

The factors thatcould cause actual results to differ materially include the following: APC’sability to improve the execution of its operations processes and eliminateoperational waste and excess expense; depending on market circumstances, APCmay not complete its previously approved stock repurchase program; the impactof increasing competition which could adversely affect APC’s revenues andprofitability; the impact of foreign currency exchange rate fluctuations; theimpact on demand, component availability and pricing, and logistics, and thedisruption of manufacturing operations that result from labor disputes, war,acts of terrorism or political instability; ramp up, expansion, transfer andrationalization of global manufacturing capacity, including successfullyconsolidating APC’s Irish manufacturing operations in Castlebar, Ireland andredeploying certain customer-facing positions within the Europe, Middle Eastand Africa region; APC’s ability to effectively align operating expenses andproduction capacity with the current demand environment; the potential impactof complying with changing environmental regulations; impact on ordermanagement and fulfillment, financial reporting and supply chain managementprocesses as a result of APC’s reliance on a variety of computer systems; thediscovery of a latent defect in any of APC’s products; general worldwide economicconditions, and, in particular, the possibility that the PC and related marketsdecline; growth rates in the power protection industry and related industries;product mix changes and the potential negative impact on gross margins fromsuch changes; changes in the seasonality of demand patterns; inventory risksdue to shifts in market demand; component constraints, shortages, pricing andquality; risk of nonpayment of accounts receivable; the uncertainty of thelitigation process including risk of an unexpected, unfavorable result ofcurrent or future litigation; and the risks described from time to time in APC’sfilings with the Securities and Exchange Commission.

For a discussionof these and other risk factors, please refer to “Item 1A. Risk Factors”included in our Annual Report on Form 10-K for the year ended December 31,2005.

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**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS.**

The following tablesummarizes information relating to purchases made by APC of shares of our commonstock during the first six months ended June 25, 2006.

**ISSUER PURCHASES OF EQUITY SECURITIES**
| **Period**                             | ** ** | **Total  Number  of Shares  Purchased**                         | ** ** | **Average  Price  Paid per  Share** | ** ** | **Total Number  of Shares  Purchased as  Part of  Publicly  Announced  Plans or  Programs** | ** ** | **Approximate  Dollar Value  of Shares  that May Yet  Be Purchased  Under the  Plans or  Programs** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **(In thousands except per share amounts)** | ** ** |
| January 1, 2006 to January 22, 2006    |       | —                                                               |       | $                                        | —     |                                                                                                                 | —     |                                                                                                                                   | $          | — |   |
| January 23, 2006  to February 19, 2006 |       | 970                                                                  |       | $                                        | 20.20      |                                                                                                                 | 970        |                                                                                                                                   | $          | 180,389 |   |
| February 20,  2006 to March 26, 2006   |       | 2,474                                                                |       | $                                        | 20.46      |                                                                                                                 | 2,474      |                                                                                                                                   | $          | 129,723 |   |
| March 27, 2006  to April 23, 2006      |       | —                                                               |       | —                                   |       | —                                                                                                               |       | $                                                                                                                                      | 129,723    |   |
| April 24, 2006  to May 21, 2006        |       | 1,420                                                                |       | $                                        | 20.80      |                                                                                                                 | 1,420      |                                                                                                                                   | $          | 100,137 |   |
| May 22, 2006 to  June 25, 2006         |       | 1,507                                                                |       | $                                        | 19.64      |                                                                                                                 | 1,507      |                                                                                                                                   | $          | 70,507 |   |
| Total                                  |       | 6,371                                                                |       | $                                        | 20.30      |                                                                                                                 | 6,371      |                                                                                                                                   |       |   |

 

In February 2006, APC’sBoard of Directors approved a stock repurchase program which authorizes up to$200 million to repurchase outstanding shares of APC’s common stock. Thepurchases would be made on the open market based on market and businessfactors. APC commenced the repurchase of its common stock in February 2006 andas of the end of the first six months of 2006, had repurchased approximately6.4 million shares on the open market at an average price of approximately $20.30per share (compared to a volume weighted average price of $20.31 per share),totaling $129 million. The duration of the repurchase program is two years butmay be suspended or discontinued at any time without prior notice.

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

The Annual Meetingof Shareholders was held on June 9, 2005 at which APC’s shareholders approvedthe following:

(i)                         bya vote of 167,360,353 shares in favor, 6,120,801 opposed, and 1,158,632abstaining, the number of directors was fixed at six.

(ii)                      thefollowing persons (with vote results) were elected to serve another term asDirectors of APC:

|                         | ** ** | **For**     | ** ** | **Withheld** | ** ** |
|-------------------------|------------|-------------|------------|--------------|------------|
| Rodger B.  Dowdell, Jr. |       | 159,139,884 |       | 15,499,902   |       |
| Neil E.  Rasmussen      |       | 158,975,236 |       | 15,664,550   |       |
| Ervin F. Lyon           |       | 150,307,776 |       | 24,332,010   |       |
| James D. Gerson         |       | 162,150,990 |       | 12,488,796   |       |
| John G.  Kassakian      |       | 171,648,506 |       | 2,991,280    |       |
| Ellen B. Richstone      |       | 171,673,487 |       | 2,966,299    |       |

(iii)                   by a vote of170,216,591 shares in favor, 3,248,209 opposed, and 1,174,986 abstaining, theratification of the appointment of APC’s independent auditors, KPMG LLP, wasapproved.

(iv)                  bya vote of 145,206,159 shares in favor, 4,904,948 opposed, 2,480,647 abstaining,and 22,048,032 broker non-votes, the Amended and Restated 1997 Employee StockPurchase Plan was approved.

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**ITEM6.  EXHIBITS**

Exhibit No. 3.01                                Articlesof Organization of APC, as amended, previously filed as an exhibit to APC’sQuarterly Report on Form 10-Q for the fiscal quarter ended June 27, 1999 andincorporated herein by reference (File No. 1-12432)

Exhibit No. 3.02                                By-Lawsof APC, as amended and restated, previously filed as an exhibit to APC’s CurrentReport on

                                                                                                                  Form 8-Kdated as of October 29, 2004 and incorporated herein by reference (File No.1-12432)

Exhibit No. 10.1                                Agreementbetween APC and Paul Thomas Goldman III, previously filed as an exhibit to APC’sCurrent Report on Form 8-K dated May 26, 2006 and incorporated herein byreference (File No. 1-12432)

Exhibit No. 10.2                                Amendment,dated June 26, 2006, to Agreement, dated February 16, 1994, between theregistrant and Industrial Development Agency (Ireland) (filed herewith)

Exhibit No. 31.1                                Certification of RodgerB. Dowdell, Jr., Chief Executive Officer, pursuant to Rules 13a-14(a) and15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant toSection 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

Exhibit No. 31.2                                Certificationof Richard J. Thompson, Chief Financial Officer, pursuant to Rules 13a-14(a)and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant toSection 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

Exhibit No. 32.1                                Certification of RodgerB. Dowdell, Jr., Chief Executive Officer, pursuant to Rules 13a-14(b) and15d-14(b) of the Securities Exchange Act of 1934, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

Exhibit No. 32.2                                Certificationof Richard J. Thompson, Chief Financial Officer, pursuant to Rules 13a-14(b)and 15d-14(b) of the Securities Exchange Act of 1934, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

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SIGNATURES

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

**AMERICANPOWER CONVERSION CORPORATION**

Date:  August 4, 2006

/s/ Richard J.Thompson

Richard J. Thompson

*Chief Financial Officer*

*(Principal Accounting AndFinancial Officer)*

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**AMERICAN POWER CONVERSION CORPORATION ANDSUBSIDIARIESEXHIBIT INDEX**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                              | ** ** | **Page  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 Current  Report on Form 8-K dated as of October 29, 2004 and incorporated herein by  reference (File No. 1-12432)                                     |       |          |       |
|            |       |                                                                                                                                                                                                                                         |       |          |       |
| 10.1            |       | Agreement  between APC and Paul Thomas Goldman III, previously filed as an exhibit to  APC’s Current Report on Form 8-K dated May 26, 2006 and incorporated herein  by reference (File No. 1-12432)                                     |       |          |       |
|            |       |                                                                                                                                                                                                                                         |       |          |       |
| 10.2            |       | Amendment,  dated June 26, 2006, to Agreement, dated February 16, 1994, between the  registrant and Industrial Development Agency (Ireland) (filed herewith)                                                                                 |       | 35-36         |       |
|            |       |                                                                                                                                                                                                                                         |       |          |       |
| 31.1            |       | Certification  of Rodger B. Dowdell, Jr., Chief Executive Officer, pursuant to Rules  13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) |       | 37            |       |
|            |       |                                                                                                                                                                                                                                         |       |          |       |
| 31.2            |       | Certification  of Richard J. Thompson, Chief Financial Officer, pursuant to Rules 13a-14(a)  and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)    |       | 38            |       |
|            |       |                                                                                                                                                                                                                                         |       |          |       |
| 32.1            |       | Certification  of Rodger B. Dowdell, Jr., Chief Executive Officer, pursuant to Rules  13a-14(b) and 15d-14(b) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) |       | 39            |       |
|            |       |                                                                                                                                                                                                                                         |       |          |       |
| 32.2            |       | Certification  of Richard J. Thompson, Chief Financial Officer, pursuant to Rules 13a-14(b)  and 15d-14(b) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)    |       | 40            |       |

 

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