** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

** **

**Washington,D.C. 20549**

 

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**FORM 10-Q**

** **

| **(Mark One)** |
|----------------|
| **ý**     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|           | **For the quarterly period ended March 28,  2004** |
|           |
| or             |
|           |
| **o**          | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           | **For the transition period from  ____________________ to ____________________** |

 

**Commission File Number: 1-12432**

 

**AMERICANPOWER CONVERSION CORPORATION**

(Exact name of registrant asspecified in its charter)

 

 

| **MASSACHUSETTS**                                                |   | **04-2722013**                         |
|------------------------------------------------------------------|--------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |   | (I.R.S.  employer  identification no.) |

 

**132FAIRGROUNDS ROAD, WEST KINGSTON, RHODE ISLAND 02892401-789-5735**

(Address and telephone numberof principal executive offices)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 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 ý |   | NO o |
|------------|--------|------|

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

| YES ý |   | NO o |
|------------|--------|------|

 

Registrant’s Common Stock outstanding, $0.01par value, at April 28, 2004 – 200,185,000 shares

 

 

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**AMERICANPOWER CONVERSION CORPORATION**

 

**INDEX**

 
| **Part I - Financial Information:** |                                                                                        |
|-------------------------------------|---------------------------------------------------------------------------------------------|
|                                |                                                                                        |   |
| Item 1.                             | Consolidated Condensed Financial Statements:                                                |   |
|                                | Consolidated Condensed Balance Sheets -                                                     |   |
|                                | March 28, 2004 and December 31, 2003 (Unaudited)                                  | 3 - 4 |
|                                |                                                                                        |   |
|                                | Consolidated Condensed Statements of Income  -                                              |   |
|                                | Three Months Ended                                                                          |   |
|                                | March 28, 2004 and March 30, 2003  (Unaudited)                                    | 5 |
|                                |                                                                                        |   |
|                                | Consolidated Condensed Statements of Cash  Flows -                                          |   |
|                                | Three Months Ended                                                                          |   |
|                                | March 28, 2004 and March 30, 2003  (Unaudited)                                    | 6 |
|                                |                                                                                        |   |
|                                | Notes to Consolidated Condensed Financial  Statements                                       |   |
|                                | (Unaudited)                                                                                 | 7 - 13 |
|                                |                                                                                        |   |
| Item 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 13 - 25 |
|                                |                                                                                        |   |
| Item 3.                             | Quantitative and Qualitative Disclosures  About Market Risk                                 | 25 |
|                                |                                                                                        |   |
| Item 4.                             | Controls and Procedures                                                                     | 25 |
|                                |                                                                                        |   |
| **Part II - Other Information:**    |                                                                                        |
|                                |                                                                                        |   |
| Item 1.                             | Legal Proceedings                                                                           | 26 |
|                                |                                                                                        |   |
| Item 6.                             | Exhibits and  Reports on Form 8-K                                                           | 27 |
|                                |                                                                                        |   |
| **Signatures**                      |                                                                                        | 28 |
|                                |                                                                                        |   |
| **Exhibit Index**                   |                                                                                        | **29** |

 

2

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**PART I - CONSOLIDATED CONDENSED FINANCIALSTATEMENTS**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

***In thousands exceptper share amount***

***(Unaudited)***

 

**ASSETS**

 
|                                                                                               |   | **March 28,  2004** |          | **December 31,****2003** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------------|---------------|-------------------------------|--------|
| Current  assets:                                                                                   |   |                     |          |                          |   |
| Cash and cash equivalents                                                                          |   | **$**                    | **253,387**   | ** **                    | $      | 252,114 |   |
| Short term investments (Note 4)                                                                    |   | **526,548**              | ** **    | 496,209                       |   |
| Accounts receivable, less allowance for  doubtful accounts of $19,046 in 2004  and $18,987 in 2003 |   | **256,508**              | ** **    | 264,718                       |   |
| Inventories:                                                                                       |   |                     | ** **    |                          |   |
| Raw materials                                                                                      |   | **205,819**              | ** **    | 185,431                       |   |
| Work-in-process and finished goods                                                                 |   | **234,309**              | ** **    | 216,791                       |   |
| Total inventories                                                                                  |   | **440,128**              | ** **    | 402,222                       |   |
|                                                                                               |   |                     | ** **    |                          |   |
| Prepaid expenses and other current assets                                                          |   | **26,192**               | ** **    | 25,296                        |   |
| Deferred income taxes                                                                              |   | **60,234**               | ** **    | 57,638                        |   |
|                                                                                               |   |                     | ** **    |                          |   |
| Total current assets                                                                               |   | **1,562,997**            | ** **    | 1,498,197                     |   |
|                                                                                               |   |                     | ** **    |                          |   |
| Property, plant and equipment:                                                                     |   |                     | ** **    |                          |   |
| Land, buildings and improvements                                                                   |   | **71,238**               | ** **    | 71,206                        |   |
| Machinery and equipment                                                                            |   | **207,528**              | ** **    | 207,506                       |   |
| Office equipment, furniture and fixtures                                                           |   | **86,608**               | ** **    | 85,474                        |   |
| Purchased software                                                                                 |   | **35,308**               | ** **    | 35,074                        |   |
|                                                                                               |   | **400,682**              |          | 399,260                       |   |
| Less accumulated depreciation and  amortization                                                    |   | **243,068**              | ** **    | 235,309                       |   |
| Net property, plant and equipment                                                                  |   | **157,614**              | ** **    | 163,951                       |   |
|                                                                                               |   |                     | ** **    |                          |   |
| Long term investments (Note 4)                                                                     |   | **47,497**               | ** **    | 58,525                        |   |
| Goodwill (Note 5)                                                                                  |   | **6,679**                | ** **    | 6,679                         |   |
| Other intangibles, net (Note 5)                                                                    |   | **47,395**               | ** **    | 50,292                        |   |
| Deferred income taxes                                                                              |   | **25,928**               | ** **    | 25,994                        |   |
| Other assets                                                                                       |   | **2,391**                | ** **    | 2,328                         |   |
|                                                                                               |   |                     | ** **    |                          |   |
| Total assets                                                                                       |   | **$**                    | **1,850,501** | ** **                    | $      | 1,805,966 |   |

 

3

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**LIABILITIESAND SHAREHOLDERS’ EQUITY**

 
|                                                      |   | **March 28,  2004** |          | **December 31,****2003** |   |
|-----------------------------------------------------------|--------|--------------------------|---------------|-------------------------------|--------|
| Current liabilities:                                      |   |                     |          |                          |   |
| Accounts payable                                          |   | **$**                    | **119,163**   | ** **                    | $      | 102,800 |   |
| Accrued compensation                                      |   | **33,820**               | ** **    | 39,366                        |   |
| Accrued sales and marketing programs                      |   | **34,041**               | ** **    | 29,947                        |   |
| Accrued warranty (Note 6)                                 |   | **12,001**               | ** **    | 11,709                        |   |
| Other accrued expenses                                    |   | **28,328**               | ** **    | 34,146                        |   |
| Deferred revenue                                          |   | **26,440**               | ** **    | 24,330                        |   |
| Income taxes payable                                      |   | **46,488**               | ** **    | 38,428                        |   |
|                                                      |   |                     | ** **    |                          |   |
| Total current liabilities                                 |   | **300,281**              | ** **    | 280,726                       |   |
|                                                      |   |                     | ** **    |                          |   |
| Deferred tax liability                                    |   | **15,205**               | ** **    | 14,357                        |   |
|                                                      |   |                     | ** **    |                          |   |
| Total liabilities                                         |   | **315,486**              | ** **    | 295,083                       |   |
|                                                      |   |                     | ** **    |                          |   |
| Shareholders’ equity (Notes 7, 8, 9 and  10):        |   |                     | ** **    |                          |   |
| Common stock, $0.01 par value;                            |   |                     | ** **    |                          |   |
| authorized 450,000 shares in 2004 and 2003;               |   |                     | ** **    |                          |   |
| issued 200,423 shares in 2004 and 199,982  shares in 2003 |   | **2,004**                | ** **    | 2,000                         |   |
| Additional paid-in capital                                |   | **186,757**              | ** **    | 182,566                       |   |
| Retained earnings                                         |   | **1,345,418**            | ** **    | 1,326,733                     |   |
| Treasury stock, 250 shares, at cost                       |   | **(1,551**               | **)**         | (1,551                        | )      |
| Accumulated other comprehensive income                    |   | **2,387**                | ** **    | 1,135                         |   |
|                                                      |   |                     | ** **    |                          |   |
| Total shareholders’ equity                           |   | **1,535,015**            | ** **    | 1,510,883                     |   |
|                                                      |   |                     | ** **    |                          |   |
| Total liabilities and shareholders’ equity           |   | **$**                    | **1,850,501** | ** **                    | $      | 1,805,966 |   |

 

*See accompanying notes to consolidatedcondensed financial statements.*

 

4

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED STATEMENTS OF INCOME**

***In thousands exceptearnings per share***

***(Unaudited)***

 
|                                            |   | **Three  months ended**  |        |
|-------------------------------------------------|--------|--------------------------|-------------|
|                                            |   | **March 28,  2004** |        | **March 30,  2003** |   |
|                                            |   |                     | ** **  |   |   |
| Net sales (Note 11)                             |   | **$**                    | **351,751** | ** ** | $ | 308,975 |   |
|                                            |   |                     | ** **  |   |   |
| Cost of goods sold                              |   | **202,659**              | ** **  | 183,061 |   |
|                                            |   |                     | ** **  |   |   |
| Gross profit                                    |   | **149,092**              | ** **  | 125,914 |   |
|                                            |   |                     | ** **  |   |   |
| Operating expenses:                             |   |                     | ** **  |   |   |
| Marketing, selling, general and  administrative |   | **86,184**               | ** **  | 72,380 |   |
| Research and development                        |   | **18,403**               | ** **  | 14,520 |   |
| Total operating expenses                        |   | **104,587**              | ** **  | 86,900 |   |
|                                            |   |                     | ** **  |   |   |
| Operating income                                |   | **44,505**               | ** **  | 39,014 |   |
|                                            |   |                     | ** **  |   |   |
| Other income, net                               |   | **1,732**                | ** **  | 2,508 |   |
|                                            |   |                     | ** **  |   |   |
| Earnings before income taxes                    |   | **46,237**               | ** **  | 41,522 |   |
|                                            |   |                     | ** **  |   |   |
| Income taxes                                    |   | **11,559**               | ** **  | 11,543 |   |
|                                            |   |                     | ** **  |   |   |
| Net income                                      |   | **$**                    | **34,678**  | ** ** | $ | 29,979 |   |
|                                            |   |                     | ** **  |   |   |
| Basic earnings per share                        |   | **$**                    | **0.17**    | ** ** | $ | 0.15 |   |
|                                            |   |                     | ** **  |   |   |
| Basic weighted average shares outstanding       |   | **199,903**              | ** **  | 196,397 |   |
|                                            |   |                     | ** **  |   |   |
| Diluted earnings per share                      |   | **$**                    | **0.17**    | ** ** | $ | 0.15 |   |
|                                            |   |                     | ** **  |   |   |
| Diluted weighted average shares outstanding     |   | **206,106**              | ** **  | 199,765 |   |

 

*See accompanying notes to consolidatedcondensed financial statements.*

 

5

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS**

***In thousands***

***(Unaudited)***

 
|                                                                                         |   | **Three  months ended**  |        |
|----------------------------------------------------------------------------------------------|--------|--------------------------|-------------|
|                                                                                         |   | **March 28,  2004** |        | **March 30,  2003** |   |
| ***Cash flows from  operating activities***                                                  |   |                     | ** **  |   |   |
| Net income                                                                                   |   | **$**                    | **34,678**  | ** ** | $ | 29,979 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |   |                     | ** **  |   |   |
| Depreciation and amortization of property,  plant and equipment                              |   | **9,645**                | ** **  | 8,995 |   |
| Amortization of other intangibles                                                            |   | **2,897**                | ** **  | 2,965 |   |
| Provision for doubtful accounts                                                              |   | **—**               | ** **  | 622 |   |
| Provision for inventories                                                                    |   | **1,476**                | ** **  | 1,000 |   |
| Deferred income taxes                                                                        |   | **(1,682**               | **)**       | 3,447 |   |
| Other non-cash items, net                                                                    |   | **1,252**                | ** **  | 1,446 |   |
| Changes in operating assets and  liabilities:                                                |   |                     | ** **  |   |   |
| Accounts receivable                                                                          |   | **8,210**                | ** **  | (89 | ) |
| Inventories                                                                                  |   | **(39,382**              | **)**       | (33,022 | ) |
| Prepaid expenses and other current assets                                                    |   | **(896**                 | **)**       | (2,548 | ) |
| Other assets                                                                                 |   | **(63**                  | **)**       | 130 |   |
| Accounts payable                                                                             |   | **16,363**               | ** **  | (4,373 | ) |
| Accrued expenses                                                                             |   | **(4,868**               | **)**       | (9,567 | ) |
| Income taxes payable                                                                         |   | **8,060**                | ** **  | (9,626 | ) |
| Net cash provided by (used in) operating  activities                                         |   | **35,690**               | ** **  | (10,641 | ) |
|                                                                                         |   |                     | ** **  |   |   |
| ***Cash flows from  investing activities***                                                  |   |                     | ** **  |   |   |
| Purchases of held-to-maturity securities                                                     |   | **(676,526**             | **)**       | (686,102 | ) |
| Maturities of held-to-maturity securities                                                    |   | **657,215**              | ** **  | 726,332 |   |
| Purchases of available-for-sale securities                                                   |   | **—**               | ** **  | (233 | ) |
| Capital expenditures, net of capital grants                                                  |   | **(3,308**               | **)**       | (3,469 | ) |
| Net cash (used in) provided by investing  activities                                         |   | **(22,619**              | **)**       | 36,528 |   |
|                                                                                         |   |                     | ** **  |   |   |
| ***Cash flows from  financing activities***                                                  |   |                     | ** **  |   |   |
| Proceeds from issuances of common stock                                                      |   | **4,195**                | ** **  | 2,506 |   |
| Dividends paid on common stock                                                               |   | **(15,993**              | **)**       | — |   |
| Net cash (used in) provided by financing  activities                                         |   | **(11,798**              | **)**       | 2,506 |   |
|                                                                                         |   |                     | ** **  |   |   |
| Net change in cash and cash equivalents                                                      |   | **1,273**                | ** **  | 28,393 |   |
| Cash and cash equivalents at beginning of  period                                            |   | **252,114**              | ** **  | 209,322 |   |
| Cash and cash equivalents at end of period                                                   |   | **$**                    | **253,387** | ** ** | $ | 237,715 |   |
|                                                                                         |   |                     | ** **  |   |   |
| ***Supplemental cash  flow disclosures***                                                    |   |                     | ** **  |   |   |
| Cash paid during the period for:                                                             |   |                     | ** **  |   |   |
| Income taxes (net of refunds)                                                                |   | **$**                    | **4,566**   | ** ** | $ | 16,298 |   |

 

*See accompanying notes to consolidatedcondensed financial statements.*

 

6

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**NOTESTO 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, 2003. In the opinion of management, the accompanyingunaudited consolidated condensed financial statements contain all adjustments (consistingof only normal recurring accruals) necessary to present fairly the consolidatedfinancial position and the consolidated results of operations and cash flowsfor the interim periods. The results of operations for the interim periods arenot necessarily indicative of results to be expected for the full year.

 

**2.****              Principlesof Consolidation**

 

The accompanying consolidated condensed financial statements includethe financial statements of American Power Conversion Corporation and itswholly-owned subsidiaries. All significant intercompany accounts andtransactions are eliminated in consolidation.

 

**3.****              Restructuring**

 

In early 2002, APCannounced global headcount reductions which impacted personnel worldwide,principally in the U.S., U.K., Ireland, and the Philippines, throughout a broadrange of functions within the organization. The majority of these terminationswere the result of APC’s decision to consolidate its Philippines-basedmanufacturing operations, resulting in the closing of APC’s manufacturing facilityin the province of Laguna. Such restructuring actions were announced during thefirst quarter of 2002 and substantially completed by the end of 2002.

 

In the firstquarter of 2002, APC recorded $7.3 million of related restructuring costs ofwhich $4.8 million and $2.5 million were classified in cost of goods sold andoperating expenses, respectively. These costs included the effects ofapproximately 941 employee terminations, principally 54% in manufacturing, 14%in sales and 13% in research and development, based on severance agreements, aswell as facilities closures in the Philippines, U.S. and U.K., and the relatedimpairment of tangible assets, principally buildings and manufacturingequipment, based on management’s assessment of market data. These costs werenot allocated to APC’s operating segments, but rather were classified asindirect operating expenses for segment reporting consistent with APC’sclassification for its internal financial reporting; also refer to Note 11.

 

In connection withAPC’s decision to consolidate its Philippines-based manufacturing operations,APC closed manufacturing facilities located in the Philippines province ofLaguna, in Maryland, and also in the U.K. APC marketed its Philippines propertywith an intent to sell these assets in 2003. However, APC was unable tocomplete this sale as a result of an unfavorable real estate market. Inaccordance with the provisions of Statement of Financial Accounting StandardsNo. 144, *Accounting for the Impairment orDisposal of Long-Lived Assets*, in the second quarter of 2003 thePhilippines building and equipment were reclassified at their fair values,which aggregated $3.0 million, to held-for-use property, plant, and equipmentand depreciation re-commenced. APC sold a building in Maryland to a third partyin October 2002. Also, in connection with the closure of a leased facilityin the U.K., APC recognized a lease liability during the first quarter of 2002;this lease will expire in 2005.

 

7

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A summary of therelated 2002 restructuring liabilities during the first quarters of 2004 and2003 is outlined below. APC expects all such restructuring liabilities atMarch 28, 2004 to be fully paid in cash by the end of 2005.

 

**2002 Restructuring Plans**

 
| **In  thousands**         |   | **Restructuring********Liabilities  at********Beginning********of Quarter** | ** ** | **Total********Charges** | ** ** | **Non-cash********Charges** | ** ** | **Cash  Payments** | ** ** | **Restructuring  Liabilities at  End of  Quarter** | ** ** |
|---------------------------|--------|-----------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|--------------------|------------|----------------------------------------------------|------------|
| **First Quarter 2004**    |   |                                                                        |       |                     |       |                        |       |               |       |                                               |       |
| Employee terminations     |   | **$**                                                                       | **25**     | ** **               | **$**      | **—**                  | ** ** | **$**              | **—** | ** **                                         | **$**      | **—** | ** ** | **$** | **25** | ** ** |
| Termination of U.K. lease |   | **414**                                                                     | ** ** | **—**               | ** ** | **—**                  | ** ** | **(94**            | **)**      | **320**                                            | ** ** |
|                      |   | **$**                                                                       | **439**    |                     | **$**      | **—**                  | ** ** | **$**              | **—** | ** **                                         | **$**      | **(94** | **)** | **$** | **345** | ** ** |
| **First Quarter 2003**    |   |                                                                        |       |                     |       |                        |       |               |       |                                               |       |
| Employee terminations     |   | $                                                                           | 25         |                     | $          | —                      |       | $                  | —     |                                               | $          | — |   | $ | 25 |   |
| Termination of U.K. lease |   | 775                                                                         |       | —                   |       | —                      |       | (158               | )          | 617                                                |       |
|                      |   | $                                                                           | 800        |                     | $          | —                      |       | $                  | —     |                                               | $          | (158 | ) | $ | 642 |   |

 

**4.****              Investments**

 

APC classifies as short term its investmentswith original maturities greater than three months and less than or equal toone year, and as long term its investments with remaining maturities greaterthan one year and less than or equal to two years. APC has no investments withmaturity dates greater than two years. Held-to-maturity securities are carriedat amortized cost. Available-for-sale securities are recorded at fair valuewith net unrealized gains and losses reported, net of income taxes, in othercomprehensive income. Management determines the appropriate classification ofsecurities at the time of purchase and re-evaluates such designation as of eachbalance sheet date. Securities are classified as held-to-maturity when APC hasthe positive intent and ability to hold such securities to maturity. There wereno sales of investment securities in the first quarters of 2004 and 2003.

 
| **In thousands**                  |   | **Amortized  Cost** |        | **Gross  Unrealized  Holding  Gains** |       | **Gross  Unrealized  Holding  Losses** |       | **Fair  Value** |       |
|-----------------------------------|--------|---------------------|-------------|---------------------------------------|------------|----------------------------------------|------------|-----------------|------------|
| **At  March 28, 2004**       |   |                |        |                                  |       |                                   |       |            |       |
| **Held-to-maturity**              |   |                | ** **  |                                  | ** ** |                                   | ** ** |            | ** ** |
| Certificates of deposit           |   | **$**               | **267,841** | ** **                            | **$**      | —                                 | ** ** | **$**           | —     | ** ** | **$** | **267,841** | ** ** |
| Corporate bonds                   |   | **61,805**          | ** **  | **118**                               | ** ** | **—**                             | ** ** | **61,923**      | ** ** |
| Municipal bonds and notes         |   | **208,959**         | ** **  | **32**                                | ** ** | **—**                             | ** ** | **208,991**     | ** ** |
| U.S. government agency securities |   | **35,000**          | ** **  | **17**                                | ** ** | **—**                             | ** ** | **35,017**      | ** ** |
|                              |   | **573,605**         |        | **167**                               | ** ** | **—**                             | ** ** | **573,772**     | ** ** |
| **Available-for-sale**            |   |                |        |                                  |       |                                   |       |            |       |
| Equity investments                |   | **440**             | ** **  | **—**                            |       | —                                 | ** ** | **440**         | ** ** |
|                              |   | **$**               | **574,045** |                                  | **$**      | **167**                                | ** ** | **$**           | —     | ** ** | **$** | **574,212** | ** ** |
| **At  December 31, 2003**    |   |                |        |                                  |       |                                   |       |            |       |
| **Held-to-maturity**              |   |                | ** **  |                                  | ** ** |                                   | ** ** |            | ** ** |
| Certificates of deposit           |   | $                   | 209,814     |                                  | $          | —                                 |       | $               | —     |   | $ | 209,814 |   |
| Corporate bonds                   |   | 236,873             |        | 237                                   |       | —                                 |       | 237,110         |       |
| Municipal bonds and notes         |   | 66,607              |        | 67                                    |       | —                                 |       | 66,674          |       |
| U.S. government agency securities |   | 41,000              |        | 5                                     |       | (16                                    | )          | 40,989          |       |
|                              |   | 554,294             |        | 309                                   |       | (16                                    | )          | 554,587         |       |
| **Available-for-sale**            |   |                |        |                                  |       |                                   |       |            |       |
| Equity investments                |   | 440                 |        | —                                |       | —                                 |       | 440             |       |
|                              |   | $                   | 554,734     |                                  | $          | 309                                    |       | $               | (16        | ) | $ | 555,027 |   |

 

8

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**5.****              Goodwilland Other Intangible Assets**

 

At each of March 28, 2004 andDecember 31, 2003, goodwill of $6.7 million was associated with the SmallSystems segment. Amortized intangible assets were as follows:

 
| **In thousands**                  |   |                                        |       | **March 28,  2004**    |       | **December 31,  2003**   |   |
|-----------------------------------|--------|---------------------------------------------|------------|-----------------------------|------------|-------------------------------|--------|
| **Amortized  Intangible  Assets** |   | **Weighted  Average  Amortization  Period** |       | **Gross  Carrying  Amount** |       | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
|                              |   |                                        |       |                        |       |                          |   |   |   |   |   |
| Technology                        |   | 6 years                                     | ** ** | **$**                       | **80,043** | ** **                    | **$**  | **37,679** |   | $ | 80,043 |   | $ | 35,239 |   |
| Customer lists                    |   | 5 years                                     | ** ** | **8,900**                   | ** ** | **5,201**                     |   | 8,900 |   | 4,864 |   |
| Tradenames                        |   | 5 years                                     | ** ** | **3,157**                   | ** ** | **1,825**                     |   | 3,157 |   | 1,705 |   |
| Total amortized intangible assets |   | 6 years                                     |       | **$**                       | **92,100** | ** **                    | **$**  | **44,705** |   | $ | 92,100 |   | $ | 41,808 |   |

 

Aggregateamortization expense related to APC’s other intangible assets for each of thefirst quarters of 2004 and 2003 was $2.9 million and $3.0 million,respectively. Estimated aggregated amortization for each of the next fivesucceeding fiscal years is $11.6 million for 2004, $11.6 million for 2005,$11.6 million for 2006, $9.4 million for 2007, and $5.0 million for 2008. Thereare no expected residual values related to these intangible assets.

 

**6.****              WarrantyLiability and Product Recall**

 
| **In thousands**       |   | **Product****Warranty****Liability at********Beginning********of Quarter** |       | **Accruals for****ProductWarrantiesIssued Duringthe Quarter** |   | **Adjustments****to Accrualsfor PreexistingWarranties** |       | **Warranty****Payments** |   | **Product********Warranty********Liability at********End of********Quarter** |   |
|------------------------|--------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------|--------|---------------------------------------------------------|------------|--------------------------|--------|------------------------------------------------------------------------------|--------|
|                   |   |                                                                       |       |                                                          |   |                                                    |       |                     |   |                                                                         |   |
| **First Quarter 2004** |   | **$**                                                                      | **11,709** | ** **                                                    | **$**  | **6,291**                                               | ** ** | **$**                    | — | ** **                                                                   | **$**  | **(5,999** | **)** | **$** | **12,001** | ** ** |
|                   |   |                                                                       |       |                                                          |   |                                                    |       |                     |   |                                                                         |   |
| **First Quarter 2003** |   | $                                                                          | 27,183     |                                                          | $      | 6,965                                                   |       | $                        | — |                                                                         | $      | (13,402 | ) | $ | 20,746 |   |

 

In early 2003, APC announced a product recall of Back-UPS® CS 350 and500 models, due to potential safety issues. Prior to announcing the recall, APCreceived eight reports worldwide of units overheating, resulting in the meltingof the unit’s outer casing, six of which occurred in the United States. Threeof the reported incidents resulted in minor property damage; no injuries havebeen reported. The total number of affected devices recalled worldwide isapproximately 2.1 million with approximately 900,000 devices recalled in theUnited States. The recall is limited to two specific models in APC’s Back-UPSCS product line, the Back-UPS CS 350 and the Back-UPS CS 500, in both 120-voltand 230-volt models. The affected units were manufactured betweenNovember 2000 and December 2002 and were sold primarily throughcomputer and electrical distribution, catalog and retail outlets worldwide. Inthe fourth quarter of 2002, APC accrued a current liability and recognizedadditional warranty expense, classified in cost of goods sold, of $19.6million. Based upon repair cost and return rate experience to-date as well ascurrent estimates of remaining costs to be incurred, APC expects the aggregatecosts for the recall to be less than originally estimated. To reflect thischange, cost of goods sold was reduced by $5.5 million in the third quarter of2003. As of March 28, 2004, APC had incurred approximately 81% ofcurrently estimated total recall costs. Our estimation of remaining recallcosts of $2.7 million, comprised of $1.0 million for the U.S. and $1.7 millionfor international geographies, continues to be subject to actual return ratesand per unit repair costs which can vary by country. We expect that futureamounts will not differ materially from our current estimates.

 

9

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**7.****              EarningsPer Share**

 

Basic earnings per share is computed by dividing net income by theweighted average number of common shares outstanding during the period. Dilutedearnings per share is computed by dividing net income by the weighted averagenumber of common shares and dilutive potential common shares outstanding duringthe period. Under the treasury stock method, the unexercised options areassumed to be exercised at the beginning of the period or at issuance, iflater. The assumed proceeds are then used to purchase common shares at theaverage market price during the period. Potential common shares for whichinclusion would have the effect of increasing diluted earnings per share (i.e.,antidilutive) are excluded from the computation.

 
|                                                                                                                          |   | **Three  months ended**  |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|
| **In thousands**                                                                                                              |   | **March 28,  2004** |   | **March 30,  2003** |   |
|                                                                                                                          |   |                     |   |   |   |
| Basic weighted average shares outstanding                                                                                     |   | **199,903**              |   | 196,397 |   |
| Net effect of dilutive potential common shares  outstanding based on the treasury stock method using the average market price |   | **6,203**                |   | 3,368 |   |
| Diluted weighted average shares outstanding                                                                                   |   | **206,106**              |   | 199,765 |   |
|                                                                                                                          |   |                     |   |   |   |
| Antidilutive potential common shares  excluded from the computation above                                                     |   | **602**                  |   | 5,679 |   |

 

**8.****              Shareholders’Equity**

 

Changes in paid-in capital for the periods presented represent theissuances of common stock resulting from the exercise of employee stockoptions.

 

OnJune 18, 2003, APC’s Board of Directors approved initiation of a quarterlycash dividend of $0.08 per share of common stock. Dividends of $0.08 per sharewere declared and paid in each subsequent quarter including on February 9,2004, payable on March 17, 2004 to shareholders of record as ofFebruary 25, 2004. 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.

 

**9.****              Comprehensive Income**

 

The components of comprehensive income, net of tax, are as follows:

 
|                                                     |   | **Three  months ended**  |       |
|----------------------------------------------------------|--------|--------------------------|------------|
| **In thousands**                                         |   | **March 28,  2004** |       | **March 30,  2003** |   |
|                                                     |   |                     | ** ** |   | ** ** |
| Net income                                               |   | **$**                    | **34,678** |   | $ | 29,979 |   |
| Other comprehensive income, net of tax:                  |   |                     |       |   |   |
| Change in foreign currency translation  adjustment       |   | **1,252**                |       | 1,482 |   |
| Net unrealized loss on investments, net of  income taxes |   | **—**               |       | (36 | ) |
| Other comprehensive income                               |   | **1,252**                |       | 1,446 |   |
| Comprehensive income                                     |   | **$**                    | **35,930** |   | $ | 31,425 |   |

 

10

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**10.****       Stock-Based Compensation**

 

At March 28, 2004, APC had four stock option plans and an employeestock purchase plan, which are described more fully in Note 11 of Notes toConsolidated Financial Statements in Item 8 of APC’s Form 10-K for the yearended December 31, 2003. As permitted by Statement of Financial AccountingStandards No. 123 as amended by No. 148, *Accountingfor Stock-Based Compensation*, APC accounts for those plans under therecognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations. No stock-based employee compensation cost isreflected in net income, as all options granted under those plans had anexercise price equal to the market value of the underlying common stock on thedate of grant. The following table illustrates the effect on net income andearnings per share if APC had applied the fair value recognition provisions ofStatement 123 to stock-based employee compensation:

 

 
|                                                                                                                                          |   |        |       | **Three  months ended**  |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|------------|--------------------------|------------|
| **In thousands except per share  amounts**                                                                                                    |   |        |       | **March 28,  2004** |       | **March 30,  2003** |   |
|                                                                                                                                          |   |        |       |                     |       |   |   |
| Net income                                                                                                                                    |   | As reported | ** ** | **$**                    | **34,678** |   | $ | 29,979 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | Pro forma   | ** ** | **(2,324**               | )          | (5,457 | ) |
| Net income                                                                                                                                    |   | Pro forma   | ** ** | **$**                    | **32,354** |   | $ | 24,522 |   |
|                                                                                                                                          |   |        |       |                     |       |   |   |
| Basic earnings per share                                                                                                                      |   | As reported | ** ** | **$**                    | **0.17**   |   | $ | 0.15 |   |
|                                                                                                                                          |   | Pro forma   |       | **$**                    | **0.16**   |   | $ | 0.12 |   |
|                                                                                                                                          |   |        |       |                     |       |   |   |
| Diluted earnings per share                                                                                                                    |   | As reported | ** ** | **$**                    | **0.17**   |   | $ | 0.15 |   |
|                                                                                                                                          |   | Pro forma   |       | **$**                    | **0.16**   |   | $ | 0.12 |   |

 

**11.****       OperatingSegment Information**

 

***Basisfor presentation***

 

APC operates primarily within one industry consisting of three reportableoperating segments by which it manages its business and from which variousofferings are commonly combined to develop a total solution for the customer.These efforts primarily incorporate the design, manufacture, and marketing ofpower protection equipment and related software and accessories for computer,communications, and related equipment. APC’s three segments are:  Small Systems, Large Systems, and Other.Each of these segments address global markets. The Small Systems segmentdevelops power solutions for servers and networking equipment commonly used inlocal area and wide area networks and for personal computers and sensitiveelectronics; additional accessories and software products are offered toenhance the management of these networks. The Large Systems segment produceslarge system products and services that provide power and availabilitysolutions for data centers, facilities and communications equipment. The Othersegment principally consists of notebook computer accessories andreplacement batteries.

 

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 research and development, selling and corporate expenses, and income taxes.Expenditures for additions to long-lived assets are not tracked or reported bythe operating segments, although depreciation expense is allocated to andreported by the operating segments.

 

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During the fourthquarter of 2003, gross margin was determined to be the most reliable andmeaningful measure of segment profitability for the purpose of executivemanagement’s allocating resources to and assessing the performance of APC’soperating segments for 2003 and future periods. Prior period amounts have beenrestated on this basis in accordance with the requirements of Statement ofFinancial Accounting Standards No. 131, “*Disclosuresabout Segments of an Enterprise and Related Information.”*

 

Summary operatingsegment information is as follows:

 
|                               |   | **Three  months ended**  |        |
|------------------------------------|--------|--------------------------|-------------|
| **In thousands**                   |   | **March 28,  2004** |        | **March 30,  2003** |   |
|                               |   |                     | ** **  |   | ** ** |
| **Segment net sales**              |   |                     | ** **  |   | ** ** |
| Small  Systems                     |   | **$**                    | **275,094** |   | $ | 242,526 |   |
| Large  Systems                     |   | **58,321**               |        | 47,593 |   |
| Other                              |   | **16,169**               |        | 17,337 |   |
| Total  segment net sales           |   | **349,584**              |        | 307,456 |   |
| Shipping  and handling revenues    |   | **2,167**                |        | 1,519 |   |
| Total net  sales                   |   | **$**                    | **351,751** |   | $ | 308,975 |   |
|                               |   |                     |        |   |   |
| **Segment profits**                |   |                     |        |   |   |
| Small  Systems                     |   | **$**                    | **137,466** |   | $ | 114,565 |   |
| Large  Systems                     |   | **8,271**                |        | 7,907 |   |
| Other                              |   | **10,549**               |        | 10,234 |   |
| Total  segment profits             |   | **156,286**              |        | 132,706 |   |
| Shipping  and handling net costs   |   | **7,194**                |        | 6,809 |   |
| Other  indirect operating expenses |   | **104,587**              |        | 86,883 |   |
| Other  income, net                 |   | **1,732**                |        | 2,508 |   |
| Earnings  before income taxes      |   | **$**                    | **46,237**  |   | $ | 41,522 |   |

 

**12.****       Litigation**

 

OnJanuary 10, 2003, Powerware Corporation filed in the United StatesDistrict Court for the Eastern District of North Carolina (the “Court”) acomplaint alleging infringement of three United States patents. On May 7, 2003,Powerware Corporation filed with the Court an amended complaint modifying itsallegations of infringement regarding the Powerware Patents. APC was servedwith the amended complaint on May 9, 2003. Powerware Corporation is seekingunspecified damages and injunctive relief. On May 28, 2003, APC filed itsanswer to the amended complaint and on June 17, 2003 APC filed its firstamended answer and counterclaims alleging infringement by Powerware Corporationof three United States patents owned by APC. On July 3, 2003, PowerwareCorporation filed its answer to counterclaims. On March 18, 2004,Powerware Corporation amended its complaint to add an additional patent to thelitigation.

 

As previously reported in APC’s Form 10-K for the fiscal year endedDecember 31, 2003, on February 5, 2004, Liebert Corporation andZonatherm Products, Inc., Liebert’s sales representative firm in the Chicagoarea, filed a lawsuit in the Circuit Court of Cook County, Illinois, ChanceryDivision (the “Court”) against APC, Aerico, LLC, a sales representative firmformed by former employees of Zonatherm Products, and the former employees ofZonatherm Products who formed Aerico, LLC. The lawsuit alleges willfulviolation of the Illinois Trade Secrets Act, tortuous interference withcontract, tortuous interference with prospective economic advantage, civilconspiracy and conspiracy to breach fiduciary duties. Liebert and Zonatherm areseeking compensatory and punitive damages and injunctive relief. OnFebruary 18, 2004, the Court denied plaintiffs’ motion for a temporaryrestraining order.

 

In addition, APC is involved in various other claims and legal actionsarising in the ordinary course of business.

 

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While management currently believes that resolving all pending legalmatters, individually or in aggregate, will not have a material adverse impacton APC’s financial position, the litigation and other claims noted above aresubject to inherent uncertainties, including the risk of an unfavorableoutcome, and management’s view of these matters may change in the future. Anunfavorable outcome could include monetary damages or, in cases whereinjunctive relief is sought, an injunction prohibiting certain activities. Werean unfavorable final outcome to occur, there exists the possibility of amaterial adverse impact on APC’s financial position, cash flows and results ofoperations for the period in which the effect becomes reasonably estimable.

 

**13.****       SubsequentEvents**

 

On March 29, 2004, APC returned its 250,000 treasury shares to anauthorized but not issued status.

 

In April 2004, APC’s Board of Directors declared a quarterlydividend, payable on June 16, 2004 to shareholders of record as of May 26,2004. It is the intention of the Board of Directors to pay a comparable quarterlydividend on a going forward basis contingent upon continued capitalavailability and a determination that cash dividends continue to be in the bestinterests of APC and its shareholders.

 

**ITEM2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

We beginManagement’s Discussion and Analysis of Financial Condition and Results ofOperations (MD&A) with a discussion of our Results of Operations for thefirst quarter of 2004 compared to the first quarter of 2003. This discussionincludes an overview of our operating results and the directions in which ourmarkets, segments, and geographies are moving. We then provide a Liquidity andFinancial Resources discussion of the significant changes in our balance sheetduring the first quarter of 2004, and cash flows for the first quarter of 2004compared to the first quarter of 2003, as well as our contractual obligationsand foreign currency activity. We also provide a discussion of our businessoutlook. This is followed by a discussion of the Critical Accounting Policiesthat we believe are important to our business operations and understanding ofour results of operations. We conclude with information about factors that mayaffect our future results.

 

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, 2003, including “Item 1. Business;” “Item 6.Selected Financial Data;” and “Item 8. Financial Statements and SupplementaryData.”

 

**RESULTS OF OPERATIONS**

 

**COMPARISON OF THE THREE MONTH PERIODS ENDED MARCH 28,2004 AND MARCH 30, 2003**

 

**Revenues**

Net sales in thefirst quarter of 2004 were $351.8 million, an increase of 13.8% compared to$309.0 million for the comparable period in 2003, attributable to strength inour major product segments, the Small and Large System segments, as well asgrowth across our major geographies, particularly Asia. Our coreuninterruptible power supply (UPS) offerings grew, and management believes thatincreasingly APC solutions, particularly our InfraStruXureTM architecture, arebeing specified for network-critical physical infrastructure (NCPI)requirements. For furtherinformation about revenues by segment, refer to the *Segment Results*section below.

 

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*Revenues byGeography. *The following table summarizes our revenueson a geographic basis for the first quarters ended March 28, 2004 andMarch 30, 2003.

 
|                                       |   | **Three  months ended**  |       |
|--------------------------------------------|--------|--------------------------|------------|
| **In millions**                            |   | **March 28,  2004** |       | **% of  Total** |   | **March 30,  2003** |   | **% of  Total** |   |
| North and Latin America (the Americas)     |   | **$**                    | **164.0**  | ** ** | **46.6** | % | $ | 151.4 |   | 49.0 | % |
| Europe, the Middle East, and Africa (EMEA) |   | **110.6**                | ** ** | **31.4** | % | 99.5 |   | 32.2 | % |
| Asia                                       |   | **77.2**                 | ** ** | **22.0** | % | 58.1 |   | 18.8 | % |
| Total Net Sales                            |   | **$**                    | **351.8**  | ** ** | **100.0** | % | $ | 309.0 |   | 100.0 | % |

 

In the first quarter of 2004, netsales of the Americas increased 8.4% over the first quarter of 2003. EMEAincreased 11.1% in the first quarter of 2004 over the first quarter of 2003 andAsia increased 32.9% in the first quarter of 2004 over the first quarter of2003. In the first quarter of 2004, on a constant currency basis, EMEAincreased 1.4% and Asia increased 22.2% over the first quarter of 2003. In thefirst quarter of 2004, on a constant currency basis, EMEA’s revenues would havebeen lower by $9.6 million, principally due to strengthening of the Euro andBritish pound, and Asia’s revenues would have been lower by $6.2 million,principally due to strengthening of the Japanese yen and Australian dollar. Webelieve constant currency information is useful for an understanding of ouroperating results. Revenues on a constant currency basis differ from revenuespresented in accordance with accounting principles generally accepted in theUnited States.

 

**Cost of Goods Sold**

Cost of goods sold was $202.7 million or57.6% of net sales in the first quarter of 2004 compared to $183.1 million or59.2% of net sales in the first quarter of 2003. Gross margins for the firstquarter of 2004 were 42.4% of net sales, approximately 160 basis points higherthan in the first quarter of 2003. The first quarter 2004 gross marginimprovement was associated with the favorable pricing impact of a weakeningU.S. dollar, particularly in Europe, as well as cost reductions,particularly in the Small Systems segment, from declining material costs andselect product transitions to low costmanufacturing locations, partially offset by the impact of pricingactions. For further informationabout gross margins by segment, refer to the *Segment Results*section below.

 

*Inventory Reserves.* Total inventory reserves at March 28, 2004 were $39.6 millioncompared to $38.8 million at December 31, 2003. This increase was dueprimarily to routine provisioning that was necessary as a result of applyingAPC’s inventory reserve methodology throughout the year. 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 physical disposition of inventories previously identified. Inventorywrite-offs occur at the time of physical disposition. Inventories, oncereserved, are not written back up as such reserve adjustments are considered tobe a permanent decrease to the cost basis of the excess or obsolete inventory.

 

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**Segment Results**(Alsorefer to Note 11 of Notes to Consolidated Financial Statements in Item 1 ofthis report for important information regarding APC’s reportable segments)

 
|                              |   | **Three  months ended**  |      |
|-----------------------------------|--------|--------------------------|-----------|
| **In millions**                   |   | **March 28,  2004** |      | **March 30,  2003** |   |
| **Segment net sales**             |   |                     |      |   |   |
| Small Systems                     |   | **$**                    | **275.1** |   | $ | 242.6 |   |
| Large Systems                     |   | **58.3**                 |      | 47.6 |   |
| Other                             |   | **16.2**                 |      | 17.3 |   |
| Total segment net sales           |   | **349.6**                |      | 307.5 |   |
| Shipping and handling revenues    |   | **2.2**                  |      | 1.5 |   |
| Total net sales                   |   | **$**                    | **351.8** |   | $ | 309.0 |   |
| **Segment profits**               |   |                     |      |   |   |
| Small Systems                     |   | **$**                    | **137.5** |   | $ | 114.6 |   |
| Large Systems                     |   | **8.3**                  |      | 7.9 |   |
| Other                             |   | **10.5**                 |      | 10.2 |   |
| Total segment profits             |   | **156.3**                |      | 132.7 |   |
| Shipping and handling net costs   |   | **7.2**                  |      | 6.8 |   |
| Other indirect operating expenses |   | **104.6**                |      | 86.9 |   |
| Other income, net                 |   | **1.7**                  |      | 2.5 |   |
| Earnings before income taxes      |   | **$**                    | **46.2**  |   | $ | 41.5 |   |

 

*SmallSystems.*  Net salesfor products in the Small Systems segment, which provides power protection,UPS, and management products for the PC, server, and local area networkingmarkets, increased in the first quarter of 2004 by 13.4% over the comparableperiod in 2003. The improvement in the first quarter of 2004 over the prioryear was driven by demand for APC’s Smart-UPS® families combined with increasedsales of management solutions. Grossmargins for the Small Systems segment improved in the first quarter of 2004over the comparable period in 2003. The first quarter improvement in 2004 over the prior year levelreflected strong growth from server related UPS sales within the segment,favorable currency trends, and cost reductions, partially offset by the impactof pricing actions. APC’s Small Systems cost reductions were achieved through acombination of product transitions to low cost manufacturing locations andmaterial cost reductions from APC’s supplier base. Our product cost reductionsaccounted for approximately 280 basis points of the gross margin improvementsin the first quarter of 2004 in the Small Systems segment and were drivenprincipally by material cost improvements.

 

*Large Systems.*  Netsales for products in the Large Systems segment, consisting primarily of3-phase UPS, DC-power systems, precision cooling products and services for datacenters, facilities, and communication applications, increased 22.5% in thefirst quarter of 2004 over the comparable period in 2003. Continued salesgrowth of our Symmetra 3-phase, the UPS component of our InfraStruXuresolution, and continued growth of ourservice revenue drove the first quarter 2004 improvement over the comparableperiod in 2003. Also contributing to the first quarter 2004 improvement was solidgrowth of our ancillary products and precision cooling solutions. Gross marginsfor the Large Systems segment decreased in the first quarter of 2004 comparedto the first quarter of 2003. As our InfraStruXure architecture gains inpopularity, we are experiencing positive margin trends from InfraStruXurerelated products, particularly the Symmetra 3-phase. However, at the same time,the migration to InfraStruXure is resulting in an unfavorable margin impact tothe traditional Silcon product line. Additionally, aggressive pricing in theprecision cooling product category also negatively impacted year-over-yeargross margins in the Large Systems segment.

 

*“Other” Segment.*  Netsales for products in the Other segment, consisting principally of notebookcomputer accessories, replacement batteries and Web-based services, decreased6.7% in the first quarter of 2004 over the comparable period in 2003. Webelieve that order timing and softness following the Christmas 2003buying season contributed to thedecrease. Gross margins for the Other segment improved in the first quarter2004 from the

 

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comparable prior year level, drivenprincipally by a favorable mix shift within the segment toward higher marginreplacement batteries, material cost reductions, and favorable year-over-year currencytrends. APC’s Other segment cost reductions were achieved through a combinationof product transitions to low cost manufacturing locations and material costreductions from APC’s supplier base. Our product cost reductions accounted forapproximately 620 basis points of the gross margin improvements in the firstquarter of 2004 in the Other segment and were driven principally by materialcost improvements.

 

## **Operating Expenses**

## ** **

*Marketing, Selling, General, and Administrative(SG&A) Expenses.*SG&A expenses in the first quarter of 2004 were $86.2 million or 24.5% ofnet sales compared to $72.4 million or 23.4% of net sales in the first quarterof 2003. We continue to commit resources to support our sales and marketingobjectives, with a primary focus on increasing the awareness of our existingand prospective customers, particularly in relation to our InfraStruXurearchitecture. The increase in total spending in the first quarter of 2004reflected ongoing sales and promotional efforts which involve expanding oursales and support teams, developing new channels such as manufacturerrepresentatives and engineering contractors, and increasing sales and marketingsupport of our core reseller channels, as well as funding our educationalefforts through high-level customer and partner events.

 

The allowance for bad debts was 6.9% of gross accounts receivable atMarch 28, 2004 compared to 6.7% at December 31, 2003. Accountsreceivable balances outstanding over 60 days represented 11.3% of totalreceivables at March 28, 2004 compared to 13.5% at December 31, 2003.This increase reflects a growing portion of our business originating in areaswhere longer payment terms are customary, including a growing contribution frominternational markets. We continue to experience strong collection performance.Write-offs of uncollectable accounts represent less than 1% of net sales. Amajority of international customer balances continue to be covered byreceivables insurance.

 

*Research and Development (R&D).* R&D expenditures were $18.4 million or 5.2% of net sales in thefirst quarter of 2004 and $14.5 million or 4.7% of net sales in the firstquarter of 2003. We continue to commit resources to support our investment inresearch and development with a primary focus on driving product innovationthrough increasing engineering efforts. 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.

 

**Other Income, Net and Income Taxes**

 

*Other Income, Net.* Other income is comprised principally of interest income partiallyoffset by a $0.4 million foreign exchange loss related to settlement of anintercompany balance. Although average cash balances available for investmentrose during the first quarter of 2004, the decrease in interest income from thecomparable prior year level was related to the strategic purchase of additionaltax-exempt securities in a weak coupon market as well as an overall decline inthe bond market.

 

At March 28, 2004, APC had $827.4 million of total cash andinvestments, up from $806.8 million at December 31, 2003, all of which arestated at fair value. We manage APC’s cash and investment balances to preserveprincipal and liquidity while maximizing our return on the total investment portfolio.We diversify our investment portfolio by investing in multiple types ofinvestment-grade securities with multiple investment brokers. Based on APC’sinvestment portfolio and interest rates at December 31, 2003, a 100 basispoint increase or decrease in interest rates would have resulted in an increaseor decrease of approximately $8 million in our annual interest income.

 

*Income Taxes.*  Our effective income tax rates for the first quarters of 2004 and2003 were approximately 25.0% and 27.8%, respectively. The decrease in thefirst quarter of 2004 compared to the first quarter of 2003 is due to the taxsavings from an increasing portion of taxable earnings anticipated to begenerated from APC’s operations in jurisdictions currently having lower incometax rates than the present U.S. statutory income tax rate. This shift resultedpartially from our product transitions to lower cost, lower tax, manufacturinglocations. APC has tax

 

16

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holidays in China, India, and the Philippines,which reduce or eliminate the income taxes paid in those countries. Asubstantial portion of APC’s tax holiday in the Philippines expired in thethird quarter of 2003. Although this will have the effect ofincreasing APC’s foreign taxes, APC’s effective income tax rate will remainconsiderably lower than the U.S. statutory federal corporate tax rate of 35%.

 

**LIQUIDITY ANDFINANCIAL RESOURCES**

 

Working capital at March 28, 2004 was $1.263 billion compared to$1.217 billion at December 31, 2003. APC has been able to increase itsworking capital position as the result of continued positive operating resultsand despite internally financing the capital investment required to expand itsoperations as well as sales and marketing spending. Our cash, cash equivalents,and short-term investments position increased to $779.9 million atMarch 28, 2004 from $748.3 million at December 31, 2003. Theimprovement during the first quarter of 2004 was offset in part by increasedinvestment in working capital, particularly inventories, as well as a firstquarter 2004 quarterly cash dividend payments of eight cents per share, orapproximately $16.0 million.

 

Cash flows provided by operating activities were $35.7 million in thefirst quarter of 2004, compared to cash flows used by operating activities of$10.6 million in the first quarter of 2003. The improvement in the firstquarter of 2004 in our cash flows from operating activities reflected adecrease in accounts receivable, due principally to increased collectionefforts, partially offset by increased investment in working capital,particularly inventories. Cash flows used in investing activities were $22.6million, compared to cash flows provided by investing activities of $36.5million in the first quarter of 2003. Our investing activities cash flows wereused mainly for the purchase of held-to-maturity securities and for capitalspending, principally manufacturing and office equipment, purchased softwareapplications, and building improvements. Cash available from operationsresulted in net purchases of investments in the first quarter of 2004,including the purchase of additional tax-exempt securities. Our investmentapproach and the composition of our investment portfolio remained relativelyconstant overall with no investments having maturity dates greater thantwo years. Cash flows used infinancing activities were $11.8 million in the first quarter of 2004, comparedto cash flows provided by financing activities of $2.5 million in the firstquarter of 2003. Cash flows from financing activities in the first quarters of2004 and 2003 resulted from proceeds from issuances of common stock relating toemployee stock plans, and were more than offset during the first quarter of2004 by the payment of approximately $16.0 million of common stock dividends.

 

Worldwide inventories were $440.1 million at March 28, 2004, up from$402.2 million at December 31, 2003. Our inventory typically increases inthe first quarter due to seasonally lower revenue in the first quarter. Also,on-hand raw materials and finished goods increased during the first quarter of2004 to support current and anticipated demand for our three phase systemsincluding InfraStruXure and other related products, as well as the in-housemanufacture of select products previously manufactured by a third partysubcontractor. In addition, raw materials and finished goods increased toprovide additional levels of inventories in order to minimize the potentialsupply disruptions relating to transfers of production of a wide range of Smalland Large Systems products to low cost manufacturing regions in 2004. There were no inventory charges, other thanAPC’s standard provisioning, during the first quarters of 2004 and 2003.Inventory levels as a percentage of quarterly sales were 125% in the firstquarter of 2004, up from 93% in the fourth quarter of 2003 and 114% in thefirst quarter of 2003. This increase was due in part to the typicalfirst quarter 2004 inventory build combined with the typical seasonal declinein net sales from the fourth quarter to the sequential first quarter of thefollowing year.

 

In early 2003, we announced a product recallof Back-UPS CS 350 and 500 models, due to potential safety issues. Prior toannouncing the recall, APC received eight reports worldwide of unitsoverheating, resulting in the melting of the unit’s outer casing, six of whichoccurred in the United States. Three of the reported incidents resulted inminor property damage; no injuries have been reported. The total number ofaffected devices recalled worldwide is approximately 2.1 million withapproximately 900,000 devices recalled in the United States. The recall islimited to two specific models in APC’s Back-UPS CS product line, the Back-UPSCS 350 and the Back-UPS CS 500, in both 120-volt and 230-volt models. Theaffected units were manufactured between November 2000 andDecember 2002 and were sold primarily through computer and electricaldistribution, catalog and retail outlets worldwide. In the fourth quarter of2002, APC accrued a current liability and recognized additional warrantyexpense, classified in cost of goods sold, of $19.6 million. Based upon repaircost and return rate experience to-date as well as current estimates

 

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of remaining costs to be incurred, APCexpects the aggregate costs for the recall to be less than originallyestimated. To reflect this change, cost of goods sold was reduced by $5.5million in the third quarter of 2003. As of March 28, 2004, APC hadincurred approximately 81% of currently estimated total recall costs. Ourestimation of remaining recall costs of $2.7 million, comprised of $1.0 millionfor the U.S. and $1.7 million for international geographies, continues to besubject to actual return rates and per unit repair costs which can vary bycountry. We expect that future amounts will not differ materially from ourcurrent estimates.

 

*Contractual Obligations.*  The following table summarizes our significant contractual obligations atMarch 28, 2004, and the effect such obligations are expected to have onour liquidity and cash flows in future periods. This table excludes amountsalready recorded on our balance sheet as current liabilities at March 28,2004.

 
|                        |   | **Payments  Due By Period** |   |
|-----------------------------|--------|-----------------------------|--------|
| **In millions**             |   | **Total**                   |   | **Less  than 1  year** |   | **1-3  years** |   | **3-5  years** |   | **More  than 5  years** |   |
|                        |   |                        |   |   |   |   |   |   |   |   |   |
| Operating Lease Obligations |   | $                           | 25.6   |   | $ | 5.7 |   | $ | 10.0 |   | $ | 5.0 |   | $ | 4.9 |   |
|                             |        |                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

## **APC’s non-cancelable operating leases, primarily forwarehousing and office space, expire at various dates through 2012. Theseleases contain renewal options for periods ranging from one to nine 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 first quarters of 2004 and 2003, our capital expenditures,net of capital grants, amounted to approximately $3.3 million and $3.5 million,respectively, consisting primarily of manufacturing and office equipment,purchased software applications, and building improvements. Capital spending inthe first quarter of 2004 focused on funding additional equipment needs andimproving existing factories, principally in the U.S., the Philippines, andIndia, as well as continuing investment in information technologies.Substantially all of APC’s net capital expenditures were financed fromavailable operating cash.

 

We have dedicated significant efforts to rationalize our overallmanufacturing capacity over the past three years and we will continue to planfor future capacity requirements based on the assumed continued acceptance anddemand for our products in the specific market segments they were designed toaddress. We currently expect that capital spending will be between $20 millionand $30 million in 2004, compared to $21.6 million in 2003. We expect that mostof the capital spending for 2004 will go toward maintaining, upgrading, andexpanding current manufacturing capacity, as well as investing to upgradecurrent hardware and software office technologies. We are also planning onbuilding product demonstration sites in selected locations around the world insupport of our present strategy.

 

We had no material capital commitments during the first quarters of 2004and 2003, or at March 28, 2004 and December 31, 2003.

 

APC has agreements with the IndustrialDevelopment Authority of Ireland, otherwise known as the IDA. Under theseagreements, we receive grant monies for costs incurred for machinery,equipment, and building improvements for our Galway and Castlebar facilities.These grants are equal to 40% and 60%, respectively, of such costs up to amaximum of $13.1 million for Galway and $1.3 million for Castlebar. Such grantmonies are subject to APC meeting certain employment goals and maintainingoperations in Ireland until termination of the respective agreements.

 

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*Borrowing Facilitiesand Financial Commitments.*  At March 28, 2004 andDecember 31, 2003, we had available for future borrowings $65.0 millionunder an unsecured line of credit agreement at a floating interest rate equalto the bank’s cost of funds rate plus 0.625% and an additional $6.0 millionunder an unsecured line of credit agreement with a second bank at similarinterest rates. No borrowings were outstanding under these facilities duringthe first quarters of 2004 and 2003, or at March 28, 2004 andDecember 31, 2003. APC had no significant financial commitments, otherthan those required in the normal course of business, during the first quartersof 2004 and 2003, or at March 28, 2004 and December 31, 2003.

 

*Off-Balance-SheetArrangements.*  APC had no significant off-balance sheetarrangements during the first quarters of 2004 and 2003, or at March 28,2004 and December 31, 2003.

 

*Quarterly CashDividends.*  On June 18, 2003, APC’s Board ofDirectors approved initiation of a quarterly cash dividend of $0.08 per shareof common stock. Dividends of $0.08 per share were declared and paid in eachsubsequent quarter including on February 9, 2004, payable onMarch 17, 2004 to shareholders of record as of February 25, 2004. InApril 2004, a quarterly dividend was declared, payable on June 16,2004 to shareholders of record as of May 26, 2004. It is the intention of theBoard of Directors to pay a comparable quarterly dividend on a going forwardbasis contingent upon continued capital availability and a determination thatcash dividends continue to be in the best interests of APC and itsshareholders.

 

APC has historically generated annual cash flows from operatingactivities as a result of strong operating results and, at times, improvementin working capital. We believe that current internal cash flows together withavailable cash, available credit facilities or, if needed, the proceeds fromthe sale of additional equity, will be sufficient to support anticipatedcapital spending, dividend payments, and other working capital requirements forthe foreseeable future.

 

## ***Foreign Currency Activity***.  We invoice our customers invarious currencies. Realized and unrealized transaction gains or losses areincluded in the results of operations and are measured based upon the effect ofchanges in exchange rates on the actual or expected amount of functionalcurrency cash flows. Transaction gains and losses were not material to theresults of operations in the first quarters of 2004 and 2003.

## ** **

AtMarch 28, 2004, APC’s unhedged foreign currency accounts receivable, bycurrency, were as follows:

 
| **In thousands** |   | **Foreign  Currency** |   | **U.S.  Dollars** |   |
|------------------|--------|-----------------------|--------|-------------------|--------|
|             |   |                  |   |              |   |
| European Euros   |   | 35,178                |   | $                 | 42,679 |   |
| Japanese Yen     |   | 3,180,471             |   | $                 | 29,491 |   |
| British Pounds   |   | 9,039                 |   | $                 | 16,487 |   |
| Swiss Francs     |   | 20,961                |   | $                 | 16,421 |   |

 

APCalso had non-trade receivables denominated in European Euros of approximatelyU.S.$0.9 million, liabilities denominated in various European currencies ofapproximately U.S.$53.6 million, and liabilities denominated in Japanese Yen ofapproximately U.S.$10.9 million.

 

Wecontinually review our foreign exchange exposure and consider various riskmanagement techniques, including the netting of foreign currency receipts anddisbursements, rate protection agreements with customers/vendors andderivatives arrangements, including foreign exchange contracts. We presently donot utilize rate protection agreements or derivative arrangements.

 

**BUSINESS OUTLOOK**

 

We are very pleased to start the year with such a healthy first quarterperformance, including net income growth that exceeded revenue growth. Weentered 2004 in as strong a competitive and financial position as ever before,and we are leveraging this strength throughout our business. It is evident thatAPC solutions are resonating with customers across their networks as weexperienced growth in our major business segments. Not only have our core UPS

 

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offerings grown, but increasingly APC solutions, specifically ourInfraStruXure architecture, are being specified for network-critical physicalinfrastructure (NCPI) requirements. As customers implement adaptable, on-demandinformation technology (IT) systems, APC’s products are supporting NCPI needsmore quickly and more cost-effectively than ever before.

 

As we look ahead to 2004, we are currentlyplanning for growth in annual revenue in all three of our reportable segments:Small Systems, Large Systems and Other. We expect the rate of growth of ourLarge Systems products to be greater than the growth expected for Small Systemsdue to the assumed continued success of our overall strategy and the acceptanceof our products in specific market segments.

 

Overall gross margins for 2004 are currentlyexpected to be impacted by a shift in product mix toward the faster-growing,lower-margin Large Systems products. Gross margins, particularly for Small Systemsproducts, are expected to be impacted by planned price reductions which areexpected to be offset by the favorable impact of the expected reduction of theunit costs of our products, particularly material costs, as a result of assumedunit volume growth and our continued efforts to improve manufacturing costefficiencies, as well as expected favorable pricing arrangements with oursuppliers. Gross margin variability could result from changing revenue levels,which are dependent on unit volumes and prices as well as the mix of productssold, unit costs and yield issues associated with production at our factories,excess manufacturing capacity, excess inventory, inventory obsolescence andvariations in inventory valuation.

 

We have dedicated significant efforts torationalize our overall manufacturing capacity over the past three years and wewill continue to plan for future capacity requirements based on the assumedcontinued acceptance and demand for our products in the specific marketsegments they were designed to address. We currently expect that capitalspending will be between $20 million and $30 million in 2004, compared to $21.6million in 2003. We expect that most of the capital spending for 2004 will gotoward maintaining, upgrading, and expanding current manufacturing capacity, aswell as investing to upgrade current hardware and software office technologies.We are also planning on building product demonstration sites in selectedlocations around the world in support of our present strategy.

 

Weare committed to sustaining our R&D efforts to meet the future needs of ourcustomers across all segments and potentially expanding into emerging,high-growth areas. We continue to dedicate resources to support our investmentin research and development with a primary focus on driving product innovationthrough increasing engineering efforts. We believe that continued productinnovation through development is necessary for our existing products to remaincompetitive in our markets, as well as to create opportunities from new productintroductions, including our InfraStruXure architecture.

 

Wewill remain focused on aggressively driving the growth of our network-criticalphysical infrastructure solutions such as InfraStruXure, which will requiresustaining and increasing our operating expense investments in sales andmarketing. A primary focus is increasing the awareness of existing andprospective customers, particularly in relation to our InfraStruXurearchitecture. Overall we are expanding sales and support teams, developing newchannels such as manufacturer representatives and engineering contractors,funding our educational efforts through high-level customer and partner events,as well as increasing sales and marketing support of our core reseller channels.

 

We currently expect our tax rate tobe approximately 25% for 2004. The estimated effective tax rate is based oncurrent tax law and the current expected income. The tax rate may be affectedby the jurisdictions in which profits are determined to be earned and taxed,our ability to successfully implement additional tax savings planningopportunities, the outcome of tax audits, and our ability to realize deferredtax assets.

 

We are currently a party to various legalproceedings and claims, including a claim alleging patent infringement. As aresult of expected costs related to the defense of such matters, we expect 2004legal costs to exceed 2003 legal costs. We currently do not believe that theultimate outcome of these 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

 

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specific period, there exists the possibilityof a material adverse impact on the results of operations of that period orfuture periods. We believe that, given our current liquidity and cash andinvestment balances, even an adverse judgment would not have a material impacton cash and investments or liquidity.

 

**CRITICAL ACCOUNTING POLICIES**

 

The discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. The U.S. Securities and Exchange Commission has definedcritical accounting policies as those that are both most important to theportrayal of our financial condition and results and which require our mostdifficult, complex or subjective judgments or estimates. Based on thisdefinition, we have identified the policies below as critical to our businessoperations and the understanding of our results of operations. The impact andany associated risks related to these policies on our business operations isdiscussed throughout Management’s Discussion and Analysis of FinancialCondition and Results of Operations where such policies affect our reported andexpected financial results. For all financial statement periods presented,there have been no material modifications to the application of these criticalaccounting policies. For a detailed discussion on the application of these andother accounting policies, also refer to Note 1 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, 2003.

 

On an on-going basis, we evaluate the judgments and estimatesunderlying all of our accounting policies, including those related to revenuerecognition, product returns, bad debts, inventories, impairment of long-livedassets, deferred tax valuation allowances, restructuring reserves andcontingencies, and litigation. We base our estimates on historical experienceand on various other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Materially different results in the amount and timing ofour actual results for any period could occur if we made different judgments orutilized different estimates. Actual results may differ from those estimates.

 

Our criticalaccounting policies are as follows:

 

***Revenue Recognition***

We follow veryspecific and detailed guidelines in measuring revenue; however, certainjudgments affect the application of our revenue policy. Revenue results aredifficult 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.Installation is not applicable for Small Systems and Other segment productsbased on the nature of the products sold. Generally, revenue associated withLarge Systems sales is also recognized at the time of delivery pursuant to thedelivery terms, as we do not perform installation. Delivery terms vary, butoften include origin-based terms (e.g., FOB Shipping Point and Ex-works) anddestination-based terms (e.g., DDU/DDP (delivered duty unpaid/delivered dutypaid)).

 

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. Since we do not perform the 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 additional services to customers depending on the type ofproduct the customer has purchased, including on-site services, installationconsulting services, remote monitoring services, power audit services, andnetwork integration services. Revenue is recognized at the time services areprovided or is deferred and recognized over the

 

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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,except those completed over the Internet, we use a binding purchase order asevidence of 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.

 

Our arrangements do not generally include acceptance clauses. However,if an arrangement includes a customer specified acceptance provision,acceptance generally occurs at our factory prior to delivery. As we continue tointroduce new products in 2004, we anticipate that installation and customeracceptance provisions may become more common, and therefore increasinglysignificant for determining delivery and performance and consequently ourentitlement to recognize revenue.

 

***Estimating Valuation Allowances and Accrued Liabilities –Allowances for Sales Returns, Doubtful Accounts, Inventory Obsolescence andProduct Recall, and Assessment of the Probability of the Outcome of our CurrentLitigation***

Significantmanagement judgments that affect the application of our revenue policy alsoinclude estimates of potential future product returns related to current periodproduct revenue. We analyze historical returns, current economic trends, andchannel inventories when evaluating the adequacy of the sales returns and otherallowances. Significant management judgments and estimates must be made andused in connection with establishing the sales returns and other allowances inany accounting period. Material differences may result in the amount and timingof our revenue for any period if management made different judgments orutilized different estimates.

 

We provide limited rights of return to distributors and retailers forour Small Systems product lines. We provide appropriate reserves for returns atthe time that related revenue is recognized, based on historical patterns ofreturns and contractual provisions in accordance with the provisions ofStatement of Financial Accounting Standards No. 48, *Revenue Recognition When Right of Return Exists*, and U.S.Securities and Exchange Commission Staff Accounting Bulletin No. 104. Returnsof Large Systems products generally do not occur. Historically, returns haverepresented 3% of gross sales and have not differed significantly from priorestimates.

 

Similarly, we mustmake estimates of the uncollectability of our accounts receivables. 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 internationalcustomer balances are covered by receivables insurance. Historically, bad debtshave been 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.

 

In early 2003, we announced a product recall of Back-UPS CS 350 and 500models, due to potential safety issues. Prior to announcing the recall, APCreceived eight reports worldwide of units overheating, resulting in the meltingof the unit’s outer casing, six of which occurred in the United States. Threeof the reported incidents resulted in minor property damage; no injuries havebeen reported. The total number of affected devices recalled worldwide isapproximately 2.1 million with approximately 900,000 devices recalled in theUnited States. The recall is limited to two specific models in APC’s Back-UPSCS product line, the Back-UPS CS 350 and the Back-UPS CS 500, in both

 

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120-volt and 230-volt models. The affected units were manufacturedbetween November 2000 and December 2002 and were sold primarilythrough computer and electrical distribution, catalog and retail outletsworldwide. In the fourth quarter of 2002, APC accrued a current liability andrecognized additional warranty expense, classified in cost of goods sold, of$19.6 million. Based upon repair cost and return rate experience to-date aswell as current estimates of remaining costs to be incurred, APC expects theaggregate costs for the recall to be less than originally estimated. To reflectthis change, cost of goods sold was reduced by $5.5 million in the thirdquarter of 2003. As of March 28, 2004, APC had incurred approximately 81%of currently estimated total recall costs. Our estimation of remaining recallcosts of $2.7 million, comprised of $1.0 million for the U.S. and $1.7 millionfor international geographies, continues to be subject to actual return ratesand per unit repair costs which can vary by country. Actual return rates mayvary significantly among different geographies. The most significant risksassociated with our return rate assumptions include varying degrees of productrecall regulation by geography as well as varying consumer awareness levels andaccess to timely recall information. Actual per unit repair cost includesprincipally transportation costs which will be influenced by the proximity ofcustomer locations to the service center location as well as the priority levelof delivery requirements. We expect that actual future amounts will not differmaterially from our current estimates.

 

We are, and may inthe future become, involved in litigation involving our business, products oroperations. For pending claims for which there is an estimatable 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 isuncertain and includes the risk of an unexpected, unfavorable result. We may bematerially adversely impacted by any such litigation.

 

***Valuation of Long-lived Tangible and Intangible Assetsincluding Goodwill***

We assess theimpairment of long-lived tangible and intangible assets including goodwill onan ongoing basis and whenever events or changes in circumstances indicate thatthe carrying value may not be recoverable. Should our assessment suggestimpairment, we would determine recoverability based on an estimate of futureundiscounted cash flows resulting from our use of the asset and its eventualdisposition. Factors we consider that could trigger an impairment reviewinclude 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 and manufacturing process,obsolete.

 

We evaluate eachof our reporting units with goodwill during the fourth quarter of each fiscalyear or more frequently if impairment indicators arise.

 

***Accounting for Income Taxes***

As part of theprocess of preparing our consolidated financial statements, we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves estimating our actual current tax exposure together withassessing temporary differences resulting from differing treatment of items,such as deferred revenue, for tax and accounting purposes. These differencesresult in deferred tax assets and liabilities, which are included within ourconsolidated balance sheet. We must then assess the likelihood that ourdeferred tax assets will be recovered from future taxable income. Expectationsabout future taxable income incorporate numerous assumptions about actions,elections and strategies to minimize income taxes in future years. Our abilityto take such actions, make preferred elections and implement tax-planningstrategies may be adversely impacted by enacted changes in tax laws and/or taxrates, as well as successful challenges by tax authorities resulting fromdiffering interpretations of tax laws and regulations.

 

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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 cash flows and effectivetax rate in a given financial statement period could be materially affected. Inlate 2003, the Internal Revenue Service began an examination of APC’s 2002 taxyear. Although the outcome of tax audits is always uncertain, managementbelieves that adequate amounts of tax have been reserved for any adjustmentsthat are expected to result from this examination.

 

To the extent we believethat recovery of deferred tax assets is not likely, we must establish avaluation allowance. To the extent we establish a valuation allowance orincrease this allowance in a period, we must include an expense within the taxprovision in the consolidated statements of income. Significant managementjudgment is required in determining our provision for income taxes, ourdeferred tax assets and liabilities and any valuation allowance recordedagainst our net deferred tax assets. At March 28, 2004 andDecember 31, 2003, we provided a valuation allowance on certain of ourdeferred tax assets, primarily consisting of net operating losses generated in2001 through 2004 for the start up and continuing operations of Brazilianoperations, because of uncertainty regarding their realizability. The valuationallowance is based on our estimates of taxable income by jurisdiction in whichwe operate and the period over which our deferred tax assets will berecoverable. In the event that actual results differ from these estimates or weadjust these estimates in future periods we may need to establish an additionalvaluation allowance which could materially impact our financial position andresults of operations.

 

## **RECENTLY ISSUEDACCOUNTING 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.

 

## **FACTORS THAT MAYAFFECT FUTURE RESULTS**

 

This document contains forward-looking statements that involve risksand uncertainties. Our actual results could differ materially from thoseanticipated in these forward looking statements as a result of certain factors,including the risks faced by us described below and elsewhere in this document.

 

The factors that could cause actual results to differ materiallyinclude the following: costs incurred by APC for the product recall of selectBack-UPS CS models are greater than or less than currently anticipated; coststo comply with the provisions of the Sarbanes-Oxley Act of 2002 are greaterthan currently anticipated; impact on order management and fulfillment,financial reporting and supply chain management processes as a result of APC’sreliance on a variety of computer systems, including Oracle 11i which wasimplemented in the first quarter 2001 and is periodically upgraded; the impactof increasing competition which could adversely affect APC’s revenues andprofitability; the impact of foreign currency exchange rate fluctuations whichcould decrease revenue and/or increase operating costs; the impact on demand,component availability and pricing, and logistics, and the disruption of Asianmanufacturing operations that result from labor disputes, war, acts ofterrorism or political instability; ramp up, expansion and rationalization ofglobal manufacturing capacity; the discovery of a latent defect in any of APC’sproducts; APC’s ability to effectively align operating expenses and productioncapacity with the current demand environment; general worldwide economicconditions, and, in particular, the possibility that the PC and related marketsdecline; growth rates in the power protection industry and related industries,including but not limited to the PC, server, networking, telecommunications andenterprise hardware industries; competitive factors and pricing pressures;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 inAPC’s filings with the Securities and Exchange Commission.

 

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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.

 

For a discussionof these and other risk factors, please refer to Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded in our Annual Report on Form 10-K for the year ended December 31,2003.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We, in the normal course of business, are exposed to market risksrelating to fluctuations in foreign currency exchange rates. The informationrequired under this section related to such risks is included in the *Foreign Currency Activity* section ofManagement’s Discussion and Analysis of Financial Condition and Results ofOperations in Item 2 of this report and is incorporated herein by reference.

 

We, in the normal course of business, are also exposed to market risksrelating to fluctuations in interest rates and the resulting rates of return oninvestments in marketable securities. The information required under thissection related to such risks is included in the *Other Income, Net* section ofManagement’s Discussion and Analysis of Financial Condition and Results ofOperations in Item 2 of this report and is incorporated herein by reference.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

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

 

Our chief executive officer andour chief financial officer, after evaluating the effectiveness of APC’s“disclosure controls and procedures” (as defined in the Securities Exchange Actof 1934 Rules 13a-15(e) and 15d-15(e)) as of a date (the “Evaluation Date”) asof the end of the period covering this quarterly report, have concluded that asof the Evaluation Date, our disclosure controls and procedures were adequateand designed to ensure that material information relating to us and our consolidatedsubsidiaries would be made known to them by others within those entities.

 

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

 

There were no significant changes in our internal controls overfinancial reporting or, to our knowledge, in other factors that couldsignificantly affect our internal controls over financial reporting subsequentto the Evaluation Date.

 

There were nosignificant deficiencies or material weaknesses identified in the evaluationand, therefore, no corrective actions were taken.

 

*Limitations Inherent in all Controls*.****APC’smanagement, including our chief executive officer and our chief financialofficer, recognize that our disclosure controls and our internal controls(discussed above) cannot prevent all error or all attempts at fraud. Anycontrols system, no matter how well crafted and operated, can only providereasonable, and not absolute, assurance of achieving the desired controlobjectives, and management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Because of the inherent limitations in any control system, no evaluation orimplementation of a control system can provide complete assurance that allcontrol issues and all possible instances of fraud have been or will bedetected.

 

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**PART II - OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

OnJanuary 10, 2003, Powerware Corporation filed in the United StatesDistrict Court for the Eastern District of North Carolina (the “Court”) acomplaint alleging infringement of three United States patents. On May 7, 2003,Powerware Corporation filed with the Court an amended complaint modifying itsallegations of infringement regarding the Powerware Patents. APC was servedwith the amended complaint on May 9, 2003. Powerware Corporation is seekingunspecified damages and injunctive relief. On May 28, 2003, APC filed itsanswer to the amended complaint and on June 17, 2003, APC filed its firstamended answer and counterclaims alleging infringement by Powerware Corporationof three United States patents owned by APC. On July 3, 2003, PowerwareCorporation filed its answer to counterclaims. On March 18, 2004,Powerware Corporation amended its complaint to add an additional patent to thelitigation.

 

As previously reported in APC’s Form 10-K for the fiscal year endedDecember 31, 2003, on February 5, 2004, Liebert Corporation andZonatherm Products, Inc., Liebert’s sales representative firm in the Chicagoarea, filed a lawsuit in the Circuit Court of Cook County, Illinois, ChanceryDivision (the “Court”) against APC, Aerico, LLC, a sales representative firmformed by former employees of Zonatherm Products, and the former employees ofZonatherm Products who formed Aerico, LLC. The lawsuit alleges willfulviolation of the Illinois Trade Secrets Act, tortuous interference withcontract, tortuous interference with prospective economic advantage, civilconspiracy and conspiracy to breach fiduciary duties. Liebert and Zonatherm areseeking compensatory and punitive damages and injunctive relief. OnFebruary 18, 2004, the Court denied plaintiffs’ motion for a temporaryrestraining order.

 

In addition, APC is involved in various other claims and legal actionsarising 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,the litigation and other claims noted above 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, an injunctionprohibiting certain activities. Were an unfavorable final outcome to occur,there exists the possibility of a material adverse impact on APC’s financialposition, cash flows and results of operations for the period in which theeffect becomes reasonably estimable.

 

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**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

 

**(A)****       Exhibits**

 
| Exhibit No. 3.01 |   | Articles of Organization of APC, as amended,  previously filed as an exhibit to APC’s Quarterly Report on Form 10-Q for the  fiscal quarter ended June 27, 1999 and incorporated herein by reference  (File No. 1-12432)                     |
|------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                                   |
| Exhibit No. 3.02 |   | By-Laws of APC, as  amended and restated, previously filed as an exhibit to APC’s Annual Report  on Form 10-K for the fiscal year ended December 31, 1998 and  incorporated herein by reference (File No. 1-12432)                           |
|             |   |                                                                                                                                                                                                                                                   |
| Exhibit No. 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)      |
|             |   |                                                                                                                                                                                                                                                   |
| Exhibit No. 31.2 |   | Certification of Donald  M. Muir, 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)              |
|             |   |                                                                                                                                                                                                                                                   |
| Exhibit No. 32.1 |   | Certification of Rodger B. Dowdell, Jr., Chief  Executive Officer, pursuant toRules 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) |
|             |   |                                                                                                                                                                                                                                                   |
| Exhibit No. 32.2 |   | Certification of Donald  M. Muir, 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)       |

 

**(B)****       Reports on Form 8-K**

 

None.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| **AMERICAN POWER CONVERSION CORPORATION**      |
|------------------------------------------------|
|                                           |
| Date:   May 7, 2004                       |
|                                           |
|                                           |
|                                           | /s/ Donald M. Muir |   |
|                                           |
| Donald M. Muir                                 |
| *Chief Financial Officer*                      |
| *(Principal Accounting And Financial Officer)* |

 

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**EXHIBIT INDEX**

 

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                               |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                          |
| 3.01                |   | Articles of Organization of APC, as amended,  previously filed as an exhibit  to  APC’s Quarterly Report on Form 10-Q for the fiscal quarter ended  June 27, 1999 and incorporated herein  by reference (File No. 1-12432)                |
|                |   |                                                                                                                                                                                                                                                          |
| 3.02                |   | By-Laws of APC, as  amended and restated, previously filed as an exhibit to APC’s Annual Report  on Form 10-K for the fiscal year ended   December 31, 1998 and incorporated herein by reference (File No.  1-12432)                           |
|                |   |                                                                                                                                                                                                                                                          |
| 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) |
|                |   |                                                                                                                                                                                                                                                          |
| 31.2                |   | Certification of Donald  M. Muir, 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)        |
|                |   |                                                                                                                                                                                                                                                          |
| 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) |
|                |   |                                                                                                                                                                                                                                                          |
| 32.2                |   | Certification of Donald  M. Muir, 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)        |

 

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