** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

** **

**(MarkOne)**
| **ý**                           | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|--------------------------------------|------------|------------------------------------------------------------------------------------------------|
| ** **                           | ** ** | **For the quarterly period ended March 27, 2005**                                              |
| ** **                           | ** ** | ** **                                                                                     |
| **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 ofregistrant as specified in its charter)

 

| **MASSACHUSETTS**                                                          | ** ** | **04-2722013**                        |
|----------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)            |       | (I.R.S. employer  identification no.) |
|                                                                       |       |                                  |
| **132  FAIRGROUNDS ROAD, WEST KINGSTON, RHODE ISLAND 02892  401-789-5735** |
| (Address and  telephone number of 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 the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

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

 

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

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

 

Registrant’sCommon Stock outstanding, $0.01 par value, at April 29, 2005 –192,912,000shares

 

 

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FORM 10-Q

March 27, 2005

 

**AMERICANPOWER CONVERSION CORPORATION**

 

**INDEX**

 
| ** **                          | ** **                                                                                                            | **Page No.** |
|-------------------------------------|-----------------------------------------------------------------------------------------------------------------------|--------------|
|                                |                                                                                                                  |         |
| **Part I - Financial Information:** |                                                                                                                  |
|                                |                                                                                                                  |         |
| Item 1.                             | Consolidated Condensed Financial Statements:                                                                          |         |
|                                | Consolidated  Condensed Balance Sheets -  March 27, 2005 and December 31, 2004 (Unaudited)                            | 3 - 4        |
|                                |                                                                                                                  |         |
|                                | Consolidated  Condensed Statements of Income -  Three Months Ended  March 27, 2005 and March 28, 2004 (Unaudited)     | 5            |
|                                |                                                                                                                  |         |
|                                | Consolidated  Condensed Statements of Cash Flows -  Three Months Ended  March 27, 2005 and March 28, 2004 (Unaudited) | 6            |
|                                |                                                                                                                  |         |
|                                | Notes  to Consolidated Condensed Financial Statements  (Unaudited)                                                    | 7  - 15      |
|                                |                                                                                                                  |         |
| Item 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                           | 15 - 29      |
|                                |                                                                                                                  |         |
| Item 3.                             | Quantitative  and Qualitative Disclosures About Market Risk                                                           | 30           |
|                                |                                                                                                                  |         |
| Item 4.                             | Controls  and Procedures                                                                                              | 30           |
|                                |                                                                                                                  |         |
| **Part II  - Other Information:**   |                                                                                                                  |
|                                |                                                                                                                  |         |
| Item 1.                             | Legal  Proceedings                                                                                                    | 31           |
|                                |                                                                                                                  |         |
| Item 6.                             | Exhibits                                                                                                              | 32           |
|                                |                                                                                                                  |         |
| **Signatures**                      |                                                                                                                  | 33           |
|                                |                                                                                                                  |         |
| **Exhibit Index**                   | ** **                                                                                                            | **34**       |

 

2

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**PART I****-CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

 

**ITEM 1****.****          FINANCIALSTATEMENTS**

 

**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

***Inthousands except per share amount***

***(Unaudited)***

 

**ASSETS**

 
| ** **                                                                                         | ** ** | **March 27,  2005** | ** **    | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------|---------------|------------------------|------------|
| Current assets:                                                                                    |       |                |          |                   |       |
| Cash and cash  equivalents                                                                         | ** ** | **$**               | **102,037**   |                   | $          | 72,721 |   |
| Short term  investments (Note 4)                                                                   | ** ** | **632,593**         |          | 642,853                |       |
| Accounts  receivable, less allowance for doubtful accounts of $16,599 in 2005 and  $16,180 in 2004 | ** ** | **327,710**         |          | 327,547                |       |
| Inventories:                                                                                       | ** ** | ** **          | ** **    | ** **             | ** ** |
| Raw materials                                                                                      | ** ** | **208,108**         |          | 212,883                |       |
| Work-in-process  and finished goods                                                                | ** ** | **274,684**         |          | 253,044                |       |
| Total  inventories                                                                                 | ** ** | **482,792**         |          | 465,927                |       |
|                                                                                               |       |                |          |                   |       |
| Prepaid expenses  and other current assets                                                         | ** ** | **43,800**          |          | 39,294                 |       |
| Deferred income  taxes                                                                             | ** ** | **52,697**          |          | 57,018                 |       |
|                                                                                               |       |                |          |                   |       |
| Total current  assets                                                                              | ** ** | **1,641,629**       |          | 1,605,360              |       |
|                                                                                               |       |                |          |                   |       |
| Property, plant  and equipment:                                                                    |       |                |          |                   |       |
| Land, buildings  and improvements                                                                  | ** ** | **69,840**          |          | 69,371                 |       |
| Machinery and  equipment                                                                           | ** ** | **218,493**         |          | 217,462                |       |
| Office equipment,  furniture and fixtures                                                          | ** ** | **93,174**          |          | 92,452                 |       |
| Purchased  software                                                                                | ** ** | **41,852**          |          | 40,817                 |       |
| ** **                                                                                         |       | **423,359**         |          | 420,102                |       |
| Less accumulated  depreciation and amortization                                                    | ** ** | **272,175**         |          | 265,251                |       |
| Net property,  plant and equipment                                                                 | ** ** | **151,184**         |          | 154,851                |       |
|                                                                                               |       |                |          |                   |       |
| Long term investments  (Note 4)                                                                    | ** ** | **5,518**           |          | 5,542                  |       |
| Goodwill (Note  5)                                                                                 | ** ** | **7,179**           |          | 7,179                  |       |
| Other  intangibles, net (Note 5)                                                                   | ** ** | **36,647**          |          | 39,627                 |       |
| Deferred income  taxes                                                                             | ** ** | **36,279**          |          | 28,687                 |       |
| Other assets                                                                                       | ** ** | **4,573**           |          | 2,626                  |       |
|                                                                                               |       |                |          |                   |       |
| Total assets                                                                                       | ** ** | **$**               | **1,883,009** |                   | $          | 1,843,872 |   |

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

3

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

***Inthousands except per share amount***

***(Unaudited)***

 

**LIABILITIESAND SHAREHOLDERS’ EQUITY**

 
| ** **                                                                                                                            | ** ** | **March 27,  2005** | ** **    | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|---------------|------------------------|------------|
| Current  liabilities:                                                                                                                 |       |                |          |                   |       |
| Accounts payable                                                                                                                      | ** ** | **$**               | **127,090**   |                   | $          | 132,213 |   |
| Accrued  compensation                                                                                                                 | ** ** | **40,009**          |          | 43,869                 |       |
| Accrued sales  and marketing programs                                                                                                 | ** ** | **39,021**          |          | 43,209                 |       |
| Accrued warranty  (Note 6)                                                                                                            | ** ** | **12,012**          |          | 13,092                 |       |
| Other accrued  expenses                                                                                                               | ** ** | **48,517**          |          | 46,929                 |       |
| Deferred revenue                                                                                                                      | ** ** | **37,401**          |          | 35,522                 |       |
| Income taxes  payable                                                                                                                 | ** ** | **32,813**          |          | 11,330                 |       |
|                                                                                                                                  |       |                |          |                   |       |
| Total current  liabilities                                                                                                            | ** ** | **336,863**         |          | 326,164                |       |
|                                                                                                                                  |       |                |          |                   |       |
| Deferred tax  liability                                                                                                               | ** ** | **15,315**          |          | 15,449                 |       |
|                                                                                                                                  |       |                |          |                   |       |
| Total  liabilities                                                                                                                    | ** ** | **352,178**         |          | 341,613                |       |
|                                                                                                                                  |       |                |          |                   |       |
| Shareholders’  equity (Notes 7, 8, 9 and 10):                                                                                    |       |                |          |                   |       |
| Common stock,  $0.01 par value; authorized 450,000 shares in 2005 and 2004; issued 192,821  shares in 2005 and 192,137 shares in 2004 | ** ** | **1,928**           |          | 1,921                  |       |
| Additional  paid-in capital                                                                                                           | ** ** | **72,260**          |          | 60,081                 |       |
| Retained  earnings                                                                                                                    | ** ** | **1,454,481**       |          | 1,437,691              |       |
| Accumulated  other comprehensive income                                                                                               | ** ** | **2,162**           |          | 2,566                  |       |
|                                                                                                                                  |       |                |          |                   |       |
| Total  shareholders’ equity                                                                                                      | ** ** | **1,530,831**       |          | 1,502,259              |       |
|                                                                                                                                  |       |                |          |                   |       |
| Total  liabilities and shareholders’ equity                                                                                      | ** ** | **$**               | **1,883,009** |                   | $          | 1,843,872 |   |

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

4

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED STATEMENTS OF INCOME**

***Inthousands except earnings per share***

***(Unaudited)***

 
| ** **                                      | ** ** | **Three months ended** | ** **  |
|-------------------------------------------------|------------|------------------------|-------------|
| ** **                                      | ** ** | **March 27,  2005**    | ** **  | **March 28,  2004** | ** ** |
|                                            |       |                   |        |   |   |
| Net sales (Note  11)                            | ** ** | **$**                  | **408,003** |   | $ | 351,751 |   |
|                                            |       |                   |        |   |   |
| Cost of goods  sold                             | ** ** | **243,552**            |        | 202,659 |   |
|                                            |       |                   |        |   |   |
| Gross profit                                    | ** ** | **164,451**            |        | 149,092 |   |
|                                            |       |                   |        |   |   |
| Operating  expenses:                            |       |                   |        |   |   |
| Marketing,  selling, general and administrative | ** ** | **100,579**            |        | 86,184 |   |
| Research and  development                       | ** ** | **20,239**             |        | 18,403 |   |
| Total operating  expenses                       | ** ** | **120,818**            |        | 104,587 |   |
|                                            |       |                   |        |   |   |
| Operating income                                | ** ** | **43,633**             |        | 44,505 |   |
|                                            |       |                   |        |   |   |
| Other income,  net                              | ** ** | **3,794**              |        | 1,732 |   |
|                                            |       |                   |        |   |   |
| Earnings before  income taxes                   | ** ** | **47,427**             |        | 46,237 |   |
|                                            |       |                   |        |   |   |
| Income taxes                                    | ** ** | **11,382**             |        | 11,559 |   |
|                                            |       |                   |        |   |   |
| Net income                                      | ** ** | **$**                  | **36,045**  |   | $ | 34,678 |   |
|                                            |       |                   |        |   |   |
| Basic earnings  per share                       | ** ** | **$**                  | **0.19**    |   | $ | 0.17 |   |
|                                            |       |                   |        |   |   |
| Basic weighted  average shares outstanding      | ** ** | **192,422**            |        | 199,903 |   |
|                                            |       |                   |        |   |   |
| Diluted earnings  per share                     | ** ** | **$**                  | **0.18**    |   | $ | 0.17 |   |
|                                            |       |                   |        |   |   |
| Diluted weighted  average shares outstanding    | ** ** | **198,258**            |        | 206,106 |   |

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

5

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS**

***Inthousands***

***(Unaudited)***

 
| ** **                                                                         | ** ** | **Three months ended** | ** **  |
|------------------------------------------------------------------------------------|------------|------------------------|-------------|
| ** **                                                                         | ** ** | **March 27,  2005**    | ** **  | **March 28,  2004** | ** ** |
| ***Cash  flows from operating activities***                                        |       |                   |        |   |   |
| Net income                                                                         | ** ** | **$**                  | **36,045**  |   | $ | 34,678 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                   |        |   |   |
| Depreciation and  amortization of property, plant and equipment                    | ** ** | **8,654**              |        | 9,645 |   |
| Amortization of  other intangibles                                                 | ** ** | **2,948**              |        | 2,897 |   |
| Provision for  doubtful accounts                                                   | ** ** | **535**                |        | — |   |
| Provision for  inventories                                                         | ** ** | **760**                |        | 1,476 |   |
| Compensation  expense – restricted stock units                                | ** ** | **3,067**              |        | — |   |
| Deferred income  taxes                                                             | ** ** | **(3,405**             | )           | (1,682 | ) |
| Other non-cash  items, net                                                         | ** ** | **(404**               | )           | 1,252 |   |
| Changes in  operating assets and liabilities:                                      |       |                   |        |   |   |
| Accounts  receivable                                                               | ** ** | **(698**               | )           | 8,210 |   |
| Inventories                                                                        | ** ** | **(17,625**            | )           | (39,382 | ) |
| Prepaid expenses  and other current assets                                         | ** ** | **(4,506**             | )           | (896 | ) |
| Other assets                                                                       | ** ** | **(1,915**             | )           | (63 | ) |
| Accounts payable                                                                   | ** ** | **(5,123**             | )           | 16,363 |   |
| Accrued expenses                                                                   | ** ** | **(5,661**             | )           | (4,868 | ) |
| Income taxes  payable                                                              | ** ** | **21,870**             |        | 8,060 |   |
| Net cash  provided by operating activities                                         | ** ** | **34,542**             |        | 35,690 |   |
|                                                                               |       |                   |        |   |   |
| ***Cash  flows from investing activities***                                        |       |                   |        |   |   |
| Purchases of  held-to-maturity securities                                          | ** ** | **(358,614**           | )           | (78,026 | ) |
| Maturities of  held-to-maturity securities                                         | ** ** | **344,549**            |        | 30,365 |   |
| Purchases of  available-for-sale securities                                        | ** ** | **(439,450**           | )           | (863,475 | ) |
| Sales of  available-for-sale securities                                            | ** ** | **463,799**            |        | 844,025 |   |
| Capital  expenditures, net of capital grants                                       | ** ** | **(4,987**             | )           | (3,308 | ) |
| Net cash  provided by (used in) investing activities                               | ** ** | **5,297**              |        | (70,419 | ) |
|                                                                               |       |                   |        |   |   |
| ***Cash  flows from financing activities***                                        |       |                   |        |   |   |
| Proceeds from  issuances of common stock                                           | ** ** | **8,732**              |        | 4,195 |   |
| Dividends paid  on common stock                                                    | ** ** | **(19,255**            | )           | (15,993 | ) |
| Net cash used in  financing activities                                             | ** ** | **(10,523**            | )           | (11,798 | ) |
|                                                                               |       |                   |        |   |   |
| Net change in  cash and cash equivalents                                           | ** ** | **29,316**             |        | (46,527 | ) |
| Cash and cash  equivalents at beginning of period                                  | ** ** | **72,721**             |        | 141,214 |   |
| Cash and cash  equivalents at end of period                                        | ** ** | **$**                  | **102,037** |   | $ | 94,687 |   |
|                                                                               |       |                   |        |   |   |
| ***Supplemental  cash flow disclosures***                                          |       |                   |        |   |   |
| Cash paid during  the period for:                                                  |       |                   |        |   |   |
| Income taxes  (net of refunds)                                                     | ** ** | **$**                  | **(6,282**  | ) | $ | 4,566 |   |

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

6

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**AMERICANPOWER CONVERSION CORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED 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, 2004. In the opinion of management, the accompanyingunaudited consolidated condensed financial statements contain all adjustments(consisting of only normal recurring accruals) necessary to present fairly theconsolidated financial position and the consolidated results of operations andcash flows for the interim periods. The results of operations for the interimperiods are not necessarily indicative of results to be expected for the fullyear.

 

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

 

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

 

**3.****     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 manufacturingfacility in the province of Laguna. Such restructuring actions were announcedduring the first quarter of 2002 and substantially completed by the end of2002.

 

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,as well 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. In connection with APC’sdecision to consolidate its Philippines-based manufacturing operations, APCclosed manufacturing facilities located in the Philippines province of Laguna,in Maryland, and also in the U.K. In connection with the closure of a leasedfacility in the U.K., APC recognized a lease liability during the first quarterof 2002. All related restructuring liabilities were fully settled during thefirst quarter ended March 27, 2005.

 

7

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**4.****     Investments**

 

APCinvests its excess cash principally in certificates of deposit, corporate andmunicipal bonds and notes, U.S. government agency securities, and auction ratesecurities. APC classifies as short term its investments with originalmaturities greater than three months and less than or equal to one year, and aslong term its investments with remaining maturities greater than one year andless than or equal to two years. APC has no investments with maturity datesgreater than two years, except for auction rate securities. Auction ratesecurities have long-term underlying maturities, however the market is highlyliquid and the interest rates reset every seven, 28 or 35 days. APC classifiesits auction rate securities as short term available-for-sale securities.Management determines the appropriate classification of securities at the timeof purchase and re-evaluates such designation as of each balance sheet date.Securities are classified as held-to-maturity when APC has the positive intentand ability to hold such securities to maturity. Held-to-maturity securitiesare carried at amortized cost. Available-for-sale securities are recorded atfair value with net unrealized gains and losses reported, net of income taxes,in other comprehensive income.

 

At March 27, 2005 and December 31, 2004, APC’s held-to-maturityinvestments included $454.4 million and $440.3 million, respectively, withcontractual maturities of one year or less, and $5.5 million and $5.5 million,respectively, with contractual maturities between one to two years; APC’savailable-for-sale auction rate securities included $77.3 million and $95.0million, respectively, with contractual maturities between approximately 14 to40 years.

 

Proceedsfrom the sales of investment securities available-for-sale were $463.8 millionand $844.0 million in the first quarters of 2005 and 2004, respectively.

 
| ** **                         | ** ** | **Amortized  Cost** | ** **  | **Gross Unrealized  Holding Gains** | ** ** | **Gross Unrealized  Holding Losses** | ** ** | **Fair  Value** | ** ** |
|------------------------------------|------------|---------------------|-------------|-------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                         | ** ** | **(In thousands)**  | ** **  |
| **At  March 27, 2005**             |       |                |        |                                |       |                                 |       |            |       |
|                               |       |                |        |                                |       |                                 |       |            |       |
| **Held-to-maturity**               | ** ** | ** **          | ** **  | ** **                          | ** ** | ** **                           | ** ** | ** **      | ** ** |
| Certificates of  deposit           | ** ** | **$**               | **163,595** | ** **                          | **$**      | **—**                           | ** ** | **$**           | **—** | ** ** | **$** | **163,595** | ** ** |
| Corporate bonds  and notes         | ** ** | **244,284**         | ** **  | **—**                          | ** ** | **—**                           | ** ** | **244,284**     | ** ** |
| Municipal bonds  and notes         | ** ** | **22,000**          | ** **  | **—**                          | ** ** | **—**                           | ** ** | **22,000**      | ** ** |
| U.S. government  agency securities | ** ** | **30,000**          | ** **  | **—**                          | ** ** | **(108**                             | **)**      | **29,892**      | ** ** |
| ** **                         | ** ** | **459,879**         | ** **  | **—**                          | ** ** | **(108**                             | **)**      | **459,771**     | ** ** |
| **Available-for-sale**             |       |                |        |                                |       |                                 |       |            |       |
| Auction rate  securities           | ** ** | **177,750**         | ** **  | **—**                          | ** ** | **—**                           | ** ** | **177,750**     | ** ** |
| Equity  investments                | ** ** | **482**             | ** **  | **—**                          |       | —                               | ** ** | **482**         | ** ** |
| ** **                         | ** ** | **178,232**         | ** **  | **—**                          | ** ** | **—**                           | ** ** | **178,232**     | ** ** |
| ** **                         | ** ** | ** **          | ** **  | ** **                          | ** ** | ** **                           | ** ** | ** **      | ** ** |
| ** **                         | ** ** | **$**               | **638,111** | ** **                          | **$**      | **—**                           | ** ** | **$**           | **(108**   | **)** | **$** | **638,003** | ** ** |
| **At  December 31, 2004**          |       |                |        |                                |       |                                 |       |            |       |
|                               |       |                |        |                                |       |                                 |       |            |       |
| **Held-to-maturity**               | ** ** | ** **          | ** **  | ** **                          | ** ** | ** **                           | ** ** | ** **      | ** ** |
| Certificates of  deposit           |       | $                   | 127,241     |                                | $          | —                               |       | $               | —     |   | $ | 127,241 |   |
| Corporate bonds  and notes         |       | 283,573             |        | 6                                   |       | (1                                   | )          | 283,578         |       |
| U.S. government  agency securities |       | 35,000              |        | —                              |       | (106                                 | )          | 34,894          |       |
|                               |       | 445,814             |        | 6                                   |       | (107                                 | )          | 445,713         |       |
| **Available-for-sale**             |       |                |        |                                |       |                                 |       |            |       |
| Auction rate  securities           |       | 202,075             |        | —                              |       | —                               |       | 202,075         |       |
| Equity  investments                |       | 506                 |        | —                              |       | —                               |       | 506             |       |
|                               |       | 202,581             |        | —                              |       | —                               |       | 202,581         |       |
|                               |       |                |        |                                |       |                                 |       |            |       |
|                               |       | $                   | 648,395     |                                | $          | 6                                    |       | $               | (107       | ) | $ | 648,294 |   |

 

8

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

 

Ateach of March 27, 2005 and December 31, 2004, goodwill of $7.2 million wasassociated with the Small Systems segment. Amortized intangible assets were asfollows:

 
| ** **                         | ** ** | **Weighted**     | ** ** | **March 27, 2005**  | ** ** | **December 31, 2004** | ** ** |
|------------------------------------|------------|------------------|------------|---------------------|------------|-----------------------|------------|
| **Amortized**                      | ** ** | **Average**      | ** ** | **Gross**           | ** ** | ** **            | ** ** | **Gross** | ** ** | ** ** | ** ** |
| **Intangible**                     | ** ** | **Amortization** | ** ** | **Carrying**        | ** ** | **Accumulated**       | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| **Assets**                         | ** ** | **Period**       | ** ** | **Amount**          | ** ** | **Amortization**      | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| ** **                         | ** ** | ** **       | ** ** | **(In  thousands)** | ** ** |
| Technology                         |       | 6 years          | ** ** | **$**               | **81,007** | ** **            | **$**      | **47,561** |   | $ | 81,040 |   | $ | 45,071 |   |
| Customer lists                     |       | 5 years          | ** ** | **8,900**           | ** ** | **6,546**             |       | 8,900 |   | 6,210 |   |
| Tradenames                         |       | 5 years          | ** ** | **3,157**           | ** ** | **2,310**             |       | 3,157 |   | 2,189 |   |
| Total amortized  intangible assets |       | 6 years          | ** ** | **$**               | **93,064** | ** **            | **$**      | **56,417** |   | $ | 93,097 |   | $ | 53,470 |   |

 

Aggregateamortization expense related to APC’s other intangible assets for each of thefirst quarters of 2005 and 2004 was $2.9 million and $2.9 million,respectively. Estimated aggregated amortization for each of the next fivesucceeding fiscal years is $11.8 million for 2005, $11.8 million for 2006, $9.6million for 2007, $5.2 million for 2008, and $1.2 million for 2009. There areno expected residual values related to these intangible assets.

 

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

 
| ** **              | ** ** | **Product  Warranty  Liability at  Beginning  of Quarter** | ** ** | **Accruals for****Product****Warranties  Issued During  the Quarter** | ** ** | **Adjustments  to Accruals  for Preexisting  Warranties** | ** ** | **Warranty  Payments** | ** ** | **Product  Warranty  Liability at  End of  Quarter** | ** ** |
|-------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|
| ** **              |       | **(In  thousands)**                                        |       |
| **First Quarter  2005** | ** ** | **$**                                                      | **13,092** | ** **                                                            | **$**      | **5,334**                                                 | ** ** | **$**                  | **—** | ** **                                           | **$**      | **(6,414** | **)** | **$** | **12,012** | ** ** |
|                    |       |                                                       |       |                                                                  |       |                                                      |       |                   |       |                                                 |       |
| **First  Quarter 2004** |       | $                                                          | 11,709     |                                                                  | $          | 6,291                                                     |       | $                      | —     |                                                 | $          | (5,999 | ) | $ | 12,001 |   |

 

***Product Recall.***  In early 2003, APC 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 and December 2002 andwere sold primarily through computer and electrical distribution, catalog andretail outlets worldwide. In the fourth quarter of 2002, APC accrued a currentliability and recognized additional warranty expense, classified in cost ofgoods sold, of $19.6 million. Based upon repair cost and return rate experienceto-date as well as then-current estimates of remaining costs to be incurred,APC projected that aggregate costs for the recall would 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 27, 2005, APC had incurredapproximately 90% of currently estimated total recall costs. Our estimation ofremaining recall costs of $1.4 million, comprised of $0.9 million for the U.S.and $0.5 million for international geographies, continues to be subject toactual return rates and per unit repair costs (which can vary by country) aswell as estimates for other recall-related costs expected to be incurred. Weexpect that future amounts will not differ materially from our current estimates.

 

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

 

Basic earnings per shareis computed by dividing net income by the weighted average number of commonshares outstanding during the period. Diluted earnings per share is computed bydividing net income by the weighted average number of common shares anddilutive potential common shares outstanding during the period. Under thetreasury stock method, the unexercised options are assumed to be exercised andthe unvested restricted stock units are assumed to be vested at the beginningof the period or at issuance, if later. The assumed proceeds are then used topurchase common shares at the average market price during the period. Potentialcommon shares for which inclusion would have the effect of increasing dilutedearnings per share (i.e., antidilutive) are excluded from the computation.

 

| ** **                                                                                                                     | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                     | ** ** | **March 27,  2005**    | ** ** | **March 28,  2004** | ** ** |
| ** **                                                                                                                     | ** ** | **(In thousands)**     | ** ** |
|                                                                                                                           |       |                   |       |   |   |
| Basic weighted  average shares outstanding                                                                                     | ** ** | **192,422**            |       | 199,903 |   |
| Net effect of  dilutive potential common shares outstanding based on the treasury stock  method using the average market price | ** ** | **5,836**              |       | 6,203 |   |
| Diluted weighted  average shares outstanding                                                                                   | ** ** | **198,258**            |       | 206,106 |   |
|                                                                                                                           |       |                   |       |   |   |
| Antidilutive  potential common shares excluded from the computation above                                                      | ** ** | **2,607**              |       | 602 |   |

 

**8.****     Shareholders’Equity**

 

***Paid-inCapital.***  Theincrease in paid-in capital during the first quarter of 2005 reflected stockissuances relating to stock-based employee benefit programs, as well as to thefinancial statement recognition of the tax benefit afforded to the company as aresult of the disposition of option shares by APC employees. Accounting rulesrequire this corporate tax benefit to be recorded as an increase in paid-incapital.

 

***RestrictedStock Units.***  Inaddition, under APC’s 2004 Long-Term Incentive Plan, on October 25, 2004, APC’sCompensation and Stock Option Committee of the Board of Directors approved theaward of 951,825 restricted stock units (RSU). The weighted average fair valueof such units granted during the fourth quarter of 2004 was $16.25 per unit.Under the recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedInterpretations, approximately $3.1 million of stock-based employeecompensation cost was reflected in net income and paid-in capital for suchunits in the first quarter of 2005. The RSU awards will vest, and theunderlying common stock will concurrently issue, ratably over four years,whereby one-fourth of the shares will vest on each of June 30, 2005, June 30,2006, June 30, 2007, and June 30, 2008.

 

***Dividends.***  Dividends of $0.08 per share were declaredand paid in the first and second quarters of 2004. In June 2004, APC’s Board ofDirectors approved a 25% increase in its quarterly cash dividend raising thepayout to $0.10 per share. Dividends of $0.10 per share were declared and paidin each subsequent quarter through the first quarter of 2005. It is theintention of the Board of Directors to pay a comparable quarterly dividend on agoing forward basis contingent upon continued capital availability and adetermination that cash dividends continue to be in the best interests of APCand its shareholders.

 

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**9.****     ComprehensiveIncome**

 

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

 
| ** **                                         | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **March 27,  2005**    | ** ** | **March 28,  2004** | ** ** |
| ** **                                         | ** ** | **(In thousands)**     | ** ** |
| Net income                                         | ** ** | **$**                  | **36,045** |   | $ | 34,678 |   |
| Other  comprehensive income, net of tax:           |       |                   |       |   |   |
| Change in  foreign currency translation adjustment | ** ** | **(404**               | )          | 1,252 |   |
| Comprehensive  income                              | ** ** | **$**                  | **35,641** |   | $ | 35,930 |   |

 

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

 

On June 10, 2004, APC’sshareholders approved APC’s 2004 Long-Term Incentive Plan (2004 LTI Plan),which replaced the 1997 Stock Option Plan. At March 27, 2005, APC had oneactive stock-based compensation plan, the aforementioned 2004 LTI Plan, and anemployee stock purchase plan (ESPP), which are described more fully in Note 10of Notes to Consolidated Financial Statements in Item 8 of APC’s Form 10-K forthe year ended December 31, 2004. As permitted by Statement of FinancialAccounting Standards 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 forStock Issued to Employees, and related Interpretations. No stock-based employeecompensation cost related to stock options is reflected in net income, as alloptions granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant. The following tableillustrates the effect on net income and earnings per share if APC had appliedthe fair value recognition provisions of Statement 123 to stock-based employeecompensation:

 
| ** **                                                                                                                                    | ** ** | ** **  | ** ** | **Three months ended**                       | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | ** **  | ** ** | **March 27,  2005**                          | ** ** | **March 28,  2004** | ** ** |
| ** **                                                                                                                                    | ** ** | ** **  | ** ** | **(In thousands except  per share amounts)** | ** ** |
| Net income                                                                                                                                    |       | As reported | ** ** | **$**                                        | **36,045** |   | $ | 34,678 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | Pro forma   | ** ** | **(1,403**                                   | )          | (2,324 | ) |
| Net income                                                                                                                                    |       | Pro forma   | ** ** | **$**                                        | **34,642** |   | $ | 32,354 |   |
|                                                                                                                                          |       |        |       |                                         |       |   |   |
| Basic earnings  per share                                                                                                                     |       | As reported | ** ** | **$**                                        | **0.19**   |   | $ | 0.17 |   |
|                                                                                                                                          | ** ** | Pro forma   |       | **$**                                        | **0.18**   |   | $ | 0.16 |   |
|                                                                                                                                          |       |        |       |                                         |       |   |   |
| Diluted earnings  per share                                                                                                                   |       | As reported | ** ** | **$**                                        | **0.18**   |   | $ | 0.17 |   |
|                                                                                                                                          | ** ** | Pro forma   |       | **$**                                        | **0.18**   |   | $ | 0.16 |   |

 

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***RestrictedStock Units. ***Alsounder the aforementioned 2004 LTI Plan, on October 25, 2004, APC’s Compensationand Stock Option Committee of the Board of Directors approved the award of951,825 restricted stock units (RSU). The weighted average fair value of suchunits granted during the fourth quarter of 2004 was $16.25 per unit. Under therecognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedInterpretations, approximately $3.1 million of stock-based employeecompensation cost was reflected in net income and paid-in capital for suchunits in the first quarter of 2005. Dividend equivalents are recognized ascompensation expense when the dividend is declared. The RSU awards will vest,and the underlying common stock will concurrently issue, ratably over fouryears, whereby one-fourth of the shares will vest on each of June 30, 2005,June 30, 2006, June 30, 2007, and June 30, 2008.

 

APC accounts for itsnon-employee stock-based compensation awards in which goods or services are theconsideration received for the equity instruments issued based on the fairvalue of the consideration received or the fair value of the equity instrumentsissued, whichever is more reliably measurable. Compensation cost recognized fornon-employees under these plans in the accompanying consolidated financialstatements is not material.

 

***Share-BasedPayment.****** ***In December2004, the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 123 (revised 2004), *Share-BasedPayment*, which is a revision of Statement No. 123 as amended by No.148, *Accounting for Stock-Based Compensation*.Statement No. 123(R) supercedes APB Opinion No. 25. Generally, the approach inStatement 123(R) is similar to the approach described in Statement 123.However, Statement 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values at the date of grant. Pro forma disclosureis no longer an alternative. The U.S. Securities and Exchange Commission hasextended this Statement’s effective date to the beginning of a company’s nextfiscal year, beginning after June 15, 2005. This Statement is effective for APCbeginning with the first quarter of 2006.

 

Statement 123(R) permitspublic companies to adopt its requirements using one of two methods. The “modifiedprospective” method requires compensation cost to be recognized beginning withthe Statement’s effective date (a) based on the requirements of Statement123(R) for all share-based payments granted after the effective date and (b)based on the requirements of Statement 123 for all awards granted to employeesprior to the effective date of Statement 123(R) that remain unvested on theeffective date. The “modified retrospective” method includes the requirementsof the modified prospective method described above, but also permits entitiesto restate based on the amounts previously recognized under Statement 123 forpurposes of pro forma disclosures either (a) all prior periods presented or (b)prior interim periods of the year of adoption.

 

In April 2005, the U.S.Securities and Exchange Commission issued Staff Accounting Bulletin No. 107.The Bulletin confirms the latitude in Statement 123(R)’s provisions onselecting models for valuing share options and clarifies other positions onaccounting and disclosure for share-based-payment arrangements. In addition,the Bulletin permits registrants to choose from different models to estimatethe fair value of share options, provides guidance on developing assumptionsused in the models, and addresses the interaction between Statement 123R andother SEC literature.

 

APC has yet to determinewhich method to use in adopting Statement 123(R). As permitted by Statement123, APC currently accounts for share-based payments to employees using APBOpinion No. 25’s intrinsic value method and, as such, generally recognizes nocompensation cost for employee stock options. Accordingly, the adoption ofStatement 123(R)’s fair value method will have a significant impact on APC’sresults of operations, although it will have no impact on APC’s overallfinancial position. APC is evaluating Statement 123(R) and has not yet determinedthe amount of stock option expense which will be incurred in future periods.

 

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

 

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

 

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

 

***Large Systems.***  TheLarge Systems segment provides systems, products and services that primarilyprovide back-up power, power distribution and cooling for data centers,facilities, and communications equipment for both commercial and industrial applications.Product offerings include major components of InfraStruXureTM systems, Silcon®UPSs, NetworkAIR® precision cooling equipment, DC and broadband power systems,and services. Products are sold to commercial users through both a direct andindirect selling model consisting of value-added resellers and strategicpartnerships. Additionally, APC utilizes manufacturer representatives toidentify and secure projects.

 

***“Other” Segment.***  TheOther segment principally consists of desktop and notebook computer accessoriesand replacement batteries. The distribution model of products in the Othersegment is consistent with that of the Small Systems segment.

 

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

 

Summary operatingsegment information is as follows:

 
| ** **                         | ** ** | **Three months ended** | ** **  |
|------------------------------------|------------|------------------------|-------------|
| ** **                         | ** ** | **March 27,  2005**    | ** **  | **March 28,  2004** | ** ** |
| ** **                         | ** ** | **(In thousands)**     | ** **  |
| **Segment  net sales**             | ** ** | ** **             | ** **  | ** ** | ** ** |
| Small Systems                      | ** ** | **$**                  | **307,461** |   | $ | 275,094 |   |
| Large Systems                      | ** ** | **80,673**             |        | 58,321 |   |
| Other                              | ** ** | **17,333**             |        | 16,169 |   |
| Total segment  net sales           | ** ** | **405,467**            |        | 349,584 |   |
| Shipping and  handling revenues    | ** ** | **2,536**              |        | 2,167 |   |
| Total net sales                    | ** ** | **$**                  | **408,003** |   | $ | 351,751 |   |
|                               |       |                   |        |   |   |
| **Segment  profits**               |       |                   |        |   |   |
| Small Systems                      | ** ** | **$**                  | **146,507** |   | $ | 137,466 |   |
| Large Systems                      | ** ** | **17,447**             |        | 8,271 |   |
| Other                              | ** ** | **10,266**             |        | 10,549 |   |
| Total segment  profits             | ** ** | **174,220**            |        | 156,286 |   |
| Shipping and  handling net costs   | ** ** | **9,769**              |        | 7,194 |   |
| Other indirect  operating expenses | ** ** | **120,818**            |        | 104,587 |   |
| Other income,  net                 | ** ** | **3,794**              |        | 1,732 |   |
| Earnings before  income taxes      | ** ** | **$**                  | **47,427**  |   | $ | 46,237 |   |

 

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**12.****  Litigation**

 

On January 10, 2003, Powerware Corporationfiled in the United States District Court for the Eastern District of NorthCarolina (the “Court”) a complaint alleging infringement of three United Statespatents. On May 7, 2003, Powerware Corporation filed with the Court an amendedcomplaint modifying its allegations of infringement regarding the Powerware Patents.APC was served with the amended complaint on May 9, 2003. Powerware Corporationis seeking unspecified damages and injunctive relief. On May 28, 2003, APCfiled its answer to the amended complaint and on June 17, 2003 APC filed itsfirst amended answer and counterclaims alleging infringement by PowerwareCorporation of three United States patents owned by APC. On July 3, 2003,Powerware Corporation filed its answer to counterclaims. On March 18, 2004,Powerware Corporation amended its complaint to add an additional patent to thelitigation. On or about October 27, 2004, Powerware Corporation changed itscorporate name to Eaton Power Quality Corporation. On January 31, 2005, theCourt issued a Markman ruling construing the patent claims at issue in thecase.

 

On December 23, 2004, APC filed a patentinfringement suit against Eaton Power Quality Corporation in the United StatesDistrict Court for the District of Delaware charging Eaton Power QualityCorporation with infringement of one United States patent. On January 26, 2005,Eaton Power Quality Corporation filed a motion to dismiss APC’s complaint onprocedural grounds. On February 9, 2005, APC filed an answering brief inopposition to Eaton Power Quality Corporation’s motion to dismiss.

 

As previously reported in APC’s Form 8-Kdated March 2, 2005, on February 24, 2005, Eaton Power Quality Corporation andits parent corporation, Eaton Corporation (collectively “Eaton”), entered intoa binding  memorandum of understandingwith APC to settle the two patent infringement suits pending in the UnitedStates District Court for the Eastern District of North Carolina and the UnitedStates District Court for the District of Delaware. In addition to settling alloutstanding patent litigation, APC and Eaton agreed to cross-license multiplepatents that were involved in the litigation. APC and Eaton also agreed to aten-year covenant prohibiting the companies from filing against each other anyadditional patent infringement suits related to products of the other that arebased on U.S. patent claims which are directed to electronic hardware thatperforms double conversion for power electronics. On May 4, 2005, APC and Eatonentered into a definitive settlement agreement consistent with the termsoutlined above. Neither party will pay the other any monetary compensation inconnection with the settlement.

 

As previously reported in APC’s Form 10-Qfor the quarter ended September 26, 2004, on February 5, 2004, LiebertCorporation and Zonatherm Products, Inc., Liebert’s sales representative firmin the Chicago area, filed a lawsuit in the Circuit Court of Cook County,Illinois, Chancery Division (the “Court”) against APC, Aerico, LLC, a salesrepresentative firm formed by former employees of Zonatherm Products, and theformer employees of Zonatherm Products who formed Aerico, LLC. The lawsuitalleged willful violation of the Illinois Trade Secrets Act, tortiousinterference with contract, tortious interference with prospective economicadvantage, civil conspiracy and conspiracy to breach fiduciary duties. Liebertand Zonatherm are seeking compensatory and punitive damages and injunctiverelief. On February 18, 2004, the Court denied plaintiffs’ motion for atemporary restraining order. On July 16, 2004, the Court dismissed withoutprejudice all claims except the Illinois Trade Secret Act claim. On August 6,2004, plaintiffs filed a second amended complaint reasserting the claimsdismissed by the Court on July 16, 2004. On August 20, 2004, the Court deniedplaintiffs’ motion for preliminary injunction as to violation of the IllinoisTrade Secrets Act. On September 21, 2004, plaintiffs filed a Notice of Appealof the August 20, 2004 ruling with the Illinois Appellate Court. On January 12,2005, the Court dismissed without prejudice all claims against APC except theIllinois Trade Secret Act claim. On March 1, 2005 the Illinois Appellate Courtissued an opinion on the appeal pursuant to which it affirmed the Court on theissue of non-trade secret nature of plaintiff’s customer lists, and remandedthe matter for the Court to enter an injunction against one of the individualformer employees of Zonatherm from using certain pricing books. On March 16,2005, plaintiffs filed a third amended complaint reasserting claimssubstantially similar to those dismissed by the Court in its January 12, 2005ruling.

 

In addition, APC is involved in variousother claims and legal actions arising in the ordinary course of business.

 

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While management currently believes thatresolving all pending legal matters, individually or in aggregate, will nothave a material adverse impact on APC’s financial position, the litigation andother claims noted above are subject to inherent uncertainties, including therisk of an unfavorable outcome, and management’s view of these matters maychange in the future. An unfavorable outcome could include monetary damages or,in cases where injunctive relief is sought, an injunction prohibiting certainactivities. Were an unfavorable final outcome to occur, there exists thepossibility of a material adverse impact on APC’s financial position, cashflows and results of operations for the period in which the effect becomesreasonably estimable.

 

**ITEM 2.****          MANAGEMENT’SDISCUSSION AND ANALYSIS 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 business outlook for 2005. Wealso provide a discussion of our Results of Operations for the first quarter of2005 compared to the first quarter of 2004. This discussion includes anoverview of our operating results and the directions in which our markets,segments, and geographies are moving. We then provide a Liquidity and FinancialResources discussion of the significant changes in our balance sheet during thefirst quarter of 2005, and cash flows for the first quarter of 2005 compared tothe first quarter of 2004, as well as our contractual obligations and foreigncurrency activity. This is followed by a discussion of the Critical AccountingPolicies that we believe are important to our business operations andunderstanding of our results of operations. We conclude with information aboutfactors that may affect 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, 2004, including “Item 1: Business;” “Item 6: SelectedFinancial Data;” “Item 8: Financial Statements and Supplementary Data;” and “Item9A: Controls and Procedures.”

 

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

 

**BUSINESS OUTLOOK**

 

While there continues tobe uncertainty around interest rate levels, energy costs and, in general,macroeconomic conditions and their potential impact on corporate investment andconsumer spending, we maintain a cautious but optimistic outlook for ourbusiness. We are also pleased with APC’s performance during our first quarterof 2005. For the seventh consecutive quarter APC’s year-over-year revenuegrowth was in double-digits. We are confident that the strong year-over-yeargrowth is the result of our continued investments in sales and marketingactivities and the growing adoption of APC’s network-critical physicalinfrastructure, or NCPI, architecture. The commitment we have made to educatethe market and drive adoption of the technology we believe is paying off ascustomers are embracing the modular, standardized approach APC has pioneered innetwork-critical physical infrastructure.

 

Against this background,we are planning for continued growth in annual revenue and increasing grossprofit and operating profit dollars in 2005. We believe that we are very wellpositioned competitively, financially and strategically continuing into 2005.We will continue to be focused on empowering IT professionals with theknowledge, tools and solutions they need to effectively design, build and managenetwork-critical physical infrastructure. Our objective is for APC to become atrusted, global partner for the long term, committed to solving our customers’network-critical physical infrastructure problems of today, and helping themanticipate their challenges of tomorrow, thereby allowing them to focus ontheir core competencies. We believe that we can accomplish this by dramaticallyreducing our customers’ level of complexity involved in designing, building,and managing the network-critical physical infrastructure that is at the verycore of maintaining business continuity, application availability, and networkreliability.

 

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As we look ahead furtherinto 2005, we are currently planning for growth in annual revenue in all threeof our reportable segments: Small Systems, Large Systems and “Other.” Similarto 2004, we expect the rate of growth of our Large Systems segment to begreater than the growth expected for Small Systems due to the assumed continuedsuccess of our overall strategy and the acceptance of our products in specificmarket segments.

 

Overall gross margins for2005 are currently expected to be impacted by a shift in product mix toward thefaster-growing, lower-margin Large Systems products. Gross margins,particularly for Small Systems products, are expected to be impacted by plannedprice reductions which we anticipate will be partially offset by the favorableimpact of the expected reduction of the unit costs of our products,particularly material costs, as a result of assumed unit volume growth and ourcontinued efforts to improve manufacturing cost efficiencies. We also expect,albeit to a lesser degree than in 2004, favorable pricing arrangements with oursuppliers. Gross margin variability could result from changing revenue levels,which are dependent on unit volumes, prices and currency trends as well as themix of products sold, unit costs and yield issues associated with production atour factories, excess manufacturing capacity, excess inventory, inventoryobsolescence and variations in inventory valuation.

 

We have dedicatedsignificant efforts to optimize our overall manufacturing capacity andlocations over recent years and we will continue to plan for future capacityrequirements based on the assumed continued acceptance and demand for ourproducts in the specific market segments they were designed to address. Wecurrently expect that capital spending will be between $30 million and $40million in 2005, compared to $29.3 million in 2004. We expect that most of thecapital spending for 2005 will go toward the maintaining, upgrading andexpansion of current manufacturing capacity, as well as investments to upgradecurrent hardware and software office technologies.

 

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

 

In 2004 alone we trainednearly one hundred thousand customers and partners on InfraStruXure,significantly more than we trained in 2003 and our goals for 2005 continue tobe even higher. Our investment posture remains intact and we are firmlycommitted to supporting the level of sales and marketing spending necessary toeducate customers and channel partners on the inherent performance and totalcost of ownership benefits of a modular, standardized solution such asInfraStruXure.

 

We currently expect ourtax rate to be approximately 24% for 2005, excluding the potential tax impactof the repatriation of offshore earnings discussed below. The estimatedeffective tax rate is based on current tax law and the current expected income.The tax rate may be affected by the jurisdictions in which profits aredetermined to be earned and taxed, our ability to successfully implementadditional tax savings planning opportunities and our ability to realizedeferred tax assets.  In October 2004,the American Jobs Creation Act of 2004 was enacted. This Act repealed the taxcode’s extraterritorial income (ETI) exclusion in response to the World TradeOrganization’s challenge that the ETI exclusion was a prohibited tax subsidy.The repeal will be phased in through 2006. The Act replaced the ETI exclusionwith a 3% domestic deduction for domestic production activities effective forAPC’s 2005 tax year. The Act also provides for an elective tax-favoredrepatriation of offshore earnings, provided that the dividends are invested inthe United States under a properly approved domestic reinvestment plan. Theelection to apply an 85% dividends-received deduction against cash dividendsmade by APC’s offshore subsidiaries can be made in 2005. We are currentlyreviewing the Act to determine its impact on APC. APC expects to determine theamounts and sources of foreign earnings to be repatriated, if any, during thethird quarter of fiscal 2005.

 

We are currently a partyto various legal proceedings and claims. The expected costs to litigate suchmatters were significant in 2004 and we expect such costs in 2005 to be lessthan the levels incurred during the prior year, as a result of our settling twopatent infringement suits. We currently do not believe that the ultimate outcomeof these legal proceedings and claims will have a material adverse effect onour financial position or overall trends in results of operations. However,litigation is subject to inherent uncertainties, including the risk of anunfavorable outcome, and management’s view of these matters may change in thefuture. An unfavorable outcome could include monetary

 

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damages or, in caseswhere injunctive relief is sought, an injunction prohibiting certainactivities. If an unfavorable outcome were to occur in any specific period,there exists the possibility of a material adverse impact on the results ofoperations of that period or future periods. We believe that, given our currentliquidity and cash and investment balances, even an adverse judgment would nothave a material impact on cash and investments or liquidity.

 

The statements below donot include any impact related to the expensing of stock options according toStatement of Financial Accounting Standards No. 123R, *Share-BasedPayment*, which will be effective for APC beginning with the firstquarter of 2006. The pro forma earnings impact of expensing of stock options onour results of operations for the first quarters of 2005 and 2004 is describedin Note 10 of Notes to Consolidated Financial Statements in Item 1 of thisreport.

 

**RESULTS OF OPERATIONS**

 

**COMPARISON OF THE THREE MONTHPERIODS ENDED MARCH 27, 2005 AND MARCH 28, 2004**

 

**Revenues**

Net sales in thefirst quarter of 2005 were $408.0 million, an increase of 16.0% compared to$351.8 million for the comparable period in 2004, attributable to strength inour major product segments, the Small and Large System segments, as well asgrowth across our major geographies, particularly North America.

 

Led by a nearly90% year-over-year increase in InfraStruXure revenue, APC’s Large Systemssegment set the pace for total company growth. We continued to make investmentsin supporting our efforts in these network-critical physical infrastructuremarkets and our top line advances highlight the resulting strong performance.Our Small Systems segment also reported solid performance. Led by solid growthin our Back-UPS desktop UPSs and our Smart-UPS server family, this segmentcontinues to produce strong results that reflect APC’s position as a preferredpartner in the mid-market and consumer power protection markets. Managementbelieves that increasingly APC solutions, particularly our InfraStruXurearchitecture, are being specified for network-critical physicalinfrastructure  requirements. For further information aboutrevenues by segment, refer to the *Segment Results*section below.

 

***Revenues by Geography.**** *The following table summarizes our revenues on a geographic basis for thefirst quarters ended March 27, 2005 and March 28, 2004.

 
| ** **                                  | ** ** | **Three months ended**   | ** ** |
|---------------------------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | **March 27,  2005**      | ** ** | **% of  Total** | ** ** | **March 28,  2004** | ** ** | **% of  Total** | ** ** |
| ** **                                  | ** ** | **($ in millions)** | ** ** |
| North and Latin  America (the Americas)     | ** ** | **$**                    | **204.2**  | ** ** | **50.0** | **%** | ** ** | $ | 164.0 |   | 46.6 | % |   |
| Europe, the  Middle East, and Africa (EMEA) | ** ** | **116.7**                | ** ** | **28.6** | **%** | ** ** | 110.6 |   | 31.4 | % |   |
| Asia                                        | ** ** | **87.1**                 | ** ** | **21.4** | **%** | ** ** | 77.2 |   | 22.0 | % |   |
| Total Net Sales                             | ** ** | **$**                    | **408.0**  | ** ** | **100.0** | **%** | ** ** | $ | 351.8 |   | 100.0 | % |   |

 

In thefirst quarter of 2005, net sales of the Americas increased 24.5% over the firstquarter of 2004. EMEA increased 5.5% in the first quarter of 2005 over thefirst quarter of 2004 and Asia increased 12.8% in the first quarter of 2005over the first quarter of 2004.

 

In thefirst quarter of 2005, on a constant currency basis, EMEA increased 2.6% andAsia increased 11.5% over the first quarter of 2004. In the first quarter of2005, on a constant currency basis, EMEA’s revenues would have been lower by$3.2 million, principally due to strengthening of the Euro and British pound,and Asia’s revenues would have been lower by $1.0 million, principally due tostrengthening of the Japanese yen and Australian dollar. In total, the impactof currency exchange rate changes worldwide added $4.5 million and $16.3million to net sales in the first quarters of 2005 and 2004, respectively. 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.

 

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**Costof Goods Sold**

Cost of goods sold was$243.6 million or 59.7% of net sales in the first quarter of 2005 compared to$202.7 million or 57.6% of net sales in the first quarter of 2004. Grossmargins for the first quarter of 2005 were 40.3% of net sales, approximately210 basis points lower than in the first quarter of 2004. The lower firstquarter 2005 gross margin was driven by a decline in manufacturing costefficiencies relating to higher incurred costs, including the requiredlogistics to facilitate meeting strong demand, particularly in the LargeSystems segment, as well as price discounting in the Small Systems segment.These negative factors were partially offset by favorable currency trends,particularly in Europe. Mix within each of our segments was also favorable toAPC’s overall gross margins, but was partially offset by an overall segment mixshift towards the Large Systems segment. For further information aboutgross margins by segment, refer to the *Segment Results*section below.

 

***Inventory Reserves.***  Totalinventory reserves at March 27, 2005 were $39.6 million compared to $39.4million at December 31, 2004. Total inventory reserves remained substantiallyunchanged and reflected routine provisioning that was necessary as a result ofapplying APC’s inventory reserve methodology throughout the year, substantiallyoffset by the physical disposition of inventories covered by APC’s inventoryreserves. APC’s reserve estimate methodology involves quantifying the totalinventory position having potential loss exposure. Loss exposure generallyresults from several business factors, including product or componentdiscontinuance, unplanned changes in demand, product design changes, andfactory transitions. Quantifying such loss exposure is the result of combiningthe cost of inventories specifically identified as having little or noopportunity for sale or use (thus available for physical disposition) plus thecost of inventories having a high risk of no future sale or use based upon ananalysis of on-hand quantities compared to historical and anticipated futuresale or use. APC maintains an on-going business process for the physicaldisposition of inventories previously identified. Inventory write-offs occur atthe time of physical disposition. Inventories, once reserved, are not writtenback up as such reserve adjustments are considered to be a permanent decreaseto the cost basis of the excess or obsolete inventory.

 

**Segment Results**(Also refer toNote 11 of Notes to Consolidated Financial Statements in Item 1 of this reportfor important information regarding APC’s reportable segments)

 

| ** **                         | ** ** | **Three months ended** | ** ** |
|------------------------------------|------------|------------------------|------------|
| ** **                         | ** ** | **March 27,  2005**    | ** ** | **March 28,  2004** | ** ** |
| ** **                         | ** ** | **(In millions)**      | ** ** |
| **Segment  net sales**             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Small Systems                      | ** ** | **$**                  | **307.5**  |   | $ | 275.1 |   |
| Large Systems                      | ** ** | **80.7**               |       | 58.3 |   |
| Other                              | ** ** | **17.3**               |       | 16.2 |   |
| Total segment  net sales           | ** ** | **405.5**              |       | 349.6 |   |
| Shipping and  handling revenues    | ** ** | **2.5**                |       | 2.2 |   |
| Total net sales                    | ** ** | **$**                  | **408.0**  |   | $ | 351.8 |   |
| ** **                         |       |                   |       |   |   |
| **Segment  profits**               |       |                   |       |   |   |
| Small Systems                      | ** ** | **$**                  | **146.5**  |   | $ | 137.5 |   |
| Large Systems                      | ** ** | **17.4**               |       | 8.3 |   |
| Other                              | ** ** | **10.3**               |       | 10.5 |   |
| Total segment  profits             | ** ** | **174.2**              |       | 156.3 |   |
| Shipping and  handling net costs   | ** ** | **9.8**                |       | 7.2 |   |
| Other indirect  operating expenses | ** ** | **120.8**              |       | 104.6 |   |
| Other income,  net                 | ** ** | **3.8**                |       | 1.7 |   |
| Earnings before  income taxes      | ** ** | **$**                  | **47.4**   |   | $ | 46.2 |   |

 

***Small Systems.***  Net sales for products in the Small Systemssegment, which provides power protection, UPS and management products for thePC, server and networking markets, increased in the first quarter of 2005 by11.8% over the comparable period in 2004. This segment benefited from stronggrowth in Back-UPS, solid gains from the Smart-UPS family, and growth in theInfraStruXure-related products, such as Racks and Power Distribution. Duringthe first quarter of 2005, approximately 30% of InfraStruXure revenue wasreported in the Small Systems segment.

 

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First quarter 2005 gross margins for the Small Systems segment of 47.7%declined 230 basis points from the comparable period in 2004. The year-over-year decline was the resultof the impact of price discounting and declines in manufacturing cost efficienciespartially offset by currency trends and favorable mix within the segment.

 

***Large Systems.***  Netsales for products in the Large Systems segment, consisting primarily of3-phase UPS, services, precision cooling and ancillary products for datacenters, facilities and communication applications, increased 38.3% in thefirst quarter of 2005 over the comparable period in 2004. The improvement wasdriven by InfraStruXure-related products, including our Symmetra3-phase, the UPS component of our InfraStruXure solution, and ancillary products. During the firstquarter of 2005, approximately 70% of InfraStruXure revenue was reported in theLarge Systems segment. Additionally, our engineered-to-order industrial systemsposted strong year-over-year growth rates as did our cooling solutions.

 

First quarter 2005 gross margins for the Large Systemssegment of 21.6% increased 740 basis points over the comparable period in 2004.As a result of year-over-year InfraStruXure sales growth, this segment isexperiencing positive margin trends from a favorable shift to these highergross margin product lines, particularly the Symmetra 3-phase. We alsoexperienced improved year-over-year gross margins in our industrial UPSbusiness and service business.

 

***“Other” Segment.***  Netsales for products in the Other segment, consisting principally of mobileaccessories and replacement batteries, increased 7.2% in the first quarter of2005 over the comparable period in 2004. The improvement was mainlyattributable to organic growth of existing products across the segment.

 

First quarter 2005 grossmargins for the Other segment of 59.2% decreased 600 basis points from thecomparable prior year level, driven principally by an unfavorable mix shifttoward lower gross margin mobile accessories, as well as a charge for costsassociated with the anticipated resolution of a vendor matter.

 

## **Operating Expenses**

 

***Marketing, Selling,General, and Administrative (SG&A) Expenses.*** SG&A expenses in the first quarter of2005 were $100.6 million or 24.7% of net sales compared to $86.2 million or24.5% of net sales in the first quarter of 2004. We continue to support ourdata center initiatives, with a primary focus on increasing the awareness ofour existing and prospective customers, particularly in relation to ourInfraStruXure architecture. The increase in total spending in the first quarterof 2005 reflected ongoing sales and promotional efforts which involve expandingour sales 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. In addition, theyear-over-year increase in operating expenses included incremental compensationcosts associated with restricted stock units awarded during the fourth quarterof 2004.

 

The allowance for bad debts was 4.8% of gross accounts receivable atMarch 27, 2005 compared to 4.7% at December 31, 2004. Accounts receivablebalances outstanding over 60 days represented 15.9% of total receivables atMarch 27, 2005 compared to 11.7% at December 31, 2004. This increase is due inpart to a growing portion of our business attributable to sales where longerpayment terms are customary combined with timing of certain first quarter 2005collections in Europe. A majority of U.S. and international customer balancescontinue to be covered by receivables insurance. We continue to experiencestrong collection performance. Write-offs of uncollectable accounts representless than 1% of net sales.

 

***Research andDevelopment (R&D).***  R&D expenditures were $20.2million or 5.0% of net sales in the first quarter of 2005 and $18.4 million or5.2% of net sales in the first quarter of 2004. We continue to commit resourcesto support our investment in research and development with a primary focus ondriving product innovation through increasing engineering efforts. We believethat continued product innovation through development is necessary for ourexisting products to remain competitive in our markets, as well as creatingopportunities from new product introductions. The increases in total R&Dspending primarily reflect increased numbers of software and hardware engineersand costs associated with new product development and engineering support.

 

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**OtherIncome, Net and Income Taxes**

 

***Other Income, Net.***  Otherincome is comprised principally of interest income which increased during thefirst quarter of 2005 due principally to higher average cash balances availablefor investment as well as rising interest rates.

 

At March 27, 2005, APC had $740.1 million of total cash and investments,up from $721.1 million at December 31, 2004. We manage APC’s cash andinvestment balances to preserve principal and liquidity while maximizing ourreturn on the total investment portfolio. We diversify our investment portfolioby investing in multiple types of investment-grade securities with multipleinvestment brokers. Based on APC’s investment portfolio and interest rates, atMarch 27, 2005, a 100 basis point increase or decrease in interest rates wouldhave resulted in an increase or decrease of approximately $7 million in ourannual interest income.

 

***Income Taxes.***  Our effective income tax ratesfor the first quarters of 2005 and 2004 were approximately 24.0% and 25.0%,respectively. The decrease in the first quarter of 2005 compared to the firstquarter of 2004 is due to the tax savings from an increasing portion of taxableearnings anticipated to be generated from APC’s operations in jurisdictionscurrently having lower income tax rates than the present U.S. statutory incometax rate. This shift resulted partially from our product transitions to lowercost, lower tax, manufacturing locations. APC has tax holidays in China and India which reduce or eliminate theincome taxes paid in those countries. We expect APC’s effective incometax rate to remain considerably lower than the U.S. statutory federal corporatetax rate of 35%.

 

***American Jobs Creation Act of 2004 — Repatriation of Foreign Earnings.***  InOctober 2004, the American Jobs Creation Act of 2004 was enacted. This Actrepealed the tax code’s extraterritorial income (ETI) exclusion in response tothe World Trade Organization’s challenge that the ETI exclusion was aprohibited tax subsidy. The repeal will be phased in through 2006. The Actreplaced the ETI exclusion with a 3% domestic deduction for domestic productionactivities effective for APC’s 2005 tax year. The Act also provides for atemporary 85% dividends received deduction on certain foreign earningsrepatriated during a one-year period. The deduction would result in anapproximate 5.25% federal tax rate on the repatriated earnings. To qualify for thededuction, the earnings must be reinvested in the United States pursuant to adomestic reinvestment plan established by a company’s chief executive officerand approved by its board of directors. Certain other criteria in the Jobs Actmust be satisfied as well. The maximum amount of APC’s foreign earnings thatqualify for the temporary deduction is $500 million. For APC, the one-yearperiod during which the qualifying distributions can be made is 2005. Noqualifying distributions were made during 2004.

 

APCis in the process of evaluating whether it will repatriate any foreign earningsunder the repatriation provisions of the Jobs Act and, if so, the amount thatit will repatriate. The range of reasonably possible amounts that APC isconsidering for repatriation, which would be eligible for the temporarydeduction, is zero to $500 million. APC is awaiting the issuance of furtherregulatory guidance and passage of statutory technical corrections with respectto certain provisions in the Jobs Act prior to determining the amounts it willrepatriate. If such regulatory guidance or technical corrections are favorable,APC is likely to repatriate amounts in the high end of our range. APC expectsto determine the amounts and sources of foreign earnings to be repatriated, ifany, during the third quarter of fiscal 2005. Use of the funds will be governedby a domestic reinvestment plan, as required by the Jobs Act.

 

Repatriationof the maximum amount eligible for the temporary deduction, which is $500million, could result in additional United States federal income tax expense,which APC currently estimates to be between zero and $38.2 million, in fiscal2005. Repatriation also would substantially increase liquidity in the UnitedStates, although use of the additional liquidity would be restricted by thedomestic reinvestment plan. There would be a corresponding reduction inliquidity at APC’s foreign subsidiaries. Some foreign subsidiaries may berequired to borrow in order to repatriate their earnings to the U.S.

 

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**LIQUIDITY AND FINANCIAL RESOURCES**

 

**WorkingCapital**

Working capital at March 27, 2005 was $1.305 billion compared to $1.279billion at December 31, 2004. Our cash, cash equivalents, and short-terminvestments position increased to $734.6 million at March 27, 2005 from $715.6million at December 31, 2004. APC’s continued positive operating resultsallowed us to pay a quarterly dividend and continue to internally finance thecapital investment, R&D, sales and marketing spending required to expandour operations.

 

**CashFlows**

The table below summarizes our cash flows for the first quarters endedMarch 27, 2005 and March 28, 2004.

 

| ** **                                           | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **March 27,  2005**    | ** ** | **March 28,  2004** | ** ** |
| ** **                                           | ** ** | **(In millions)**      | ** ** |
| Net cash  provided by operating activities           | ** ** | **$**                  | **34.5**   | ** ** | $ | 35.7 |   |
| Net cash  provided by (used in) investing activities | ** ** | **5.3**                | ** ** | (70.4 | ) |
| Net cash used in  financing activities               | ** ** | **(10.5**              | **)**      | (11.8 | ) |
| **Net  change in cash and cash equivalents**         | ** ** | **29.3**               | ** ** | (46.5 | ) |
| Cash and cash  equivalents at beginning of year      | ** ** | **72.7**               | ** ** | 141.2 |   |
| Cash and cash  equivalents at end of year            | ** ** | **$**                  | **102.0**  | ** ** | $ | 94.7 |   |

 

***Cash Flows from OperatingActivities****.*  Ourcash flows from operations for the first quarters of 2005 and 2004 reflectedhigher profit levels, partially offsetby increased inventory as discussed below.

 

***Cash Flows from InvestingActivities****.*  Ourinvesting activities cash flows were used mainly for the purchase ofavailable-for-sale and held-to-maturity securities and for capital spending,principally manufacturing and office equipment, purchased softwareapplications, and building improvements. Our investment approach and thecomposition of our investment portfolio remained relatively constant overallwith noinvestments having maturity dates greater than two years, except for ourauction rate securities.

 

***Cash Flows from FinancingActivities****.*  Ourcash flows from financing activities included the payment of common stockdividends of approximately $19.3 million and $16.0 million during the firstquarters of 2005 and 2004, respectively. These outflows were partially offsetby proceeds from issuances of common stock relating to employee stock plansduring each of the periods presented.

 

**Inventories**

Worldwide inventories were $482.8 million at March 27, 2005, up from$465.9 million at December 31, 2004. Our inventory typically increases in thefirst quarter due to seasonally lower revenue in the first quarter. Also,higher levels of on-hand finished goods were required during the first quarterof 2005 to meet increasing current and anticipated demand, particularlyInfraStruXure demand, as well as to manage the supply chain requirementsassociated with continuing transfers of production of a wide range of Small andLarge Systems products to and among our low cost manufacturing regions. Inaddition, we increased our inventory levels strategically to support in-regionlead time initiatives, as well as to support continuing new productintroductions. Inventory levels as a percentage of quarterly sales were 118% inthe first quarter of 2005, up from 91% in the fourth quarter of 2004, and downfrom 125% in the first quarter of 2004.The first quarter increase over the comparable quarter last year was duein part to the typical first quarter 2005 inventory build combined with thetypical seasonal decline in net sales from the fourth quarter to the sequentialfirst quarter of the following year. There were no inventory charges, otherthan APC’s standard provisioning, during the first quarters of 2005 and 2004.

 

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**Contractual Obligations**

The following tablesummarizes our significant contractual obligations at March 27, 2005, and theeffect such obligations are expected to have on our liquidity and cash flows infuture periods. This table excludes amounts already recorded on our balancesheet as current liabilities at March 27, 2005.

 
| ** **                   | ** ** | **Payments Due By Period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| ** **                   | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                   | ** ** | **(In millions)**          | ** ** |
| Operating Lease  Obligations |       | $                          | 28.0       |   | $ | 6.3 |   | $ | 12.3 |   | $ | 7.8 |   | $ | 1.6 |   |
|                              |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

## **APC’snon-cancelable operating leases, primarily for warehousing and office space,expire at various dates through 2011. These leases contain renewal options forperiods ranging from one to seven years and require APC to pay itsproportionate share of utilities, taxes, and insurance. APC is not able todetermine the aggregate amount of purchase orders that represent contractualobligations for the purchase of goods and services, as such purchase orders mayrepresent authorizations to purchase rather than binding agreements. For thepurposes of this disclosure, contractual obligations for the purchase of goodsand services are defined as agreements that are enforceable and legally bindingon APC and that specify all significant terms, including: fixed or minimumquantities to be purchased; fixed, minimum, or variable price provisions; theapproximate timing of the transaction, and contain no provisions allowing forcancellation without significant penalty. Our purchase orders for raw materialsor purchased finished products are based on our current manufacturing needsand/or demand forecasts and are fulfilled by our vendors within short timehorizons. We do not have significant agreements for the purchase of raw materialsor finished products specifying minimum quantities or set prices that exceedour expected requirements for three months.**

## ** **

**Capital Expenditures and Capital Commitments**

During the first quarters of 2005 and 2004, our capital expenditures, netof capital grants, amounted to approximately $5.0 million and $3.3 million,respectively, consisting primarily of manufacturing and office equipment,purchased software applications, and building improvements. Capital spending inthe first quarters of 2005 and 2004 focused on funding additional equipmentneeds and improving existing factories, principally in the U.S., India,Ireland, and the Philippines, as wellas continuing investment in information technologies. Substantially all of APC’snet capital expenditures were financed from available 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 $30 millionand $40 million in 2005, compared to $29.3 million in 2004. We expect that mostof the capital spending for 2005 will go toward maintaining, upgrading, andexpanding current manufacturing capacity, as well as investing to upgradecurrent hardware and software office technologies.

 

We had no material capital commitments during the first quarters of 2005and 2004, or at March 27, 2005 and December 31, 2004.

 

APChas agreements with the Industrial Development Authority of Ireland, otherwiseknown as the IDA. Under these agreements, we receive grant monies for costsincurred for machinery, equipment, and building improvements for our Galway andCastlebar facilities. These grants are equal to 40% and 60%, respectively, ofsuch costs up to a maximum of $13.1 million for Galway and $1.3 million forCastlebar. Such grant monies are subject to APC meeting certain employmentgoals and maintaining operations in Ireland until termination of the respectiveagreements. Under separate agreements with the IDA, we receive directreimbursement of training costs at our Galway and Castlebar facilities for upto $3,000 and $12,500, respectively, per new employee hired. Also refer to Note16 of Notes to Consolidated Financial Statements in Item 8 of American PowerConversion Corporation’s Annual Report on Form 10-K for the year ended December31, 2004.

 

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APCalso has an agreement with the IDA for a research and development grant towardsthe costs of a project for the development of software products. Theavailability of the grant is contingent on meeting certain milestones in theprogress of the project as well as meeting certain employment goals on theproject within the Galway facility. The amount of grant assistance available onsatisfaction of all conditions is 28% of the eligible expenditure to a maximumof €714,588. At March 27, 2005, no grant claims had been claimed or received.

 

**Borrowing Facilities and Financial Commitments**

AtMarch 27, 2005 and December 31, 2004, APC had available for future borrowings$65.0 million under an unsecured, non-committed line of credit agreement at afloating interest rate equal to the bank’s cost of funds rate plus 0.625%. Noborrowings were outstanding under this facility during the first quarters of2005 and 2004, or at March 27, 2005 and December 31, 2004.

 

APChad no significant financial commitments, other than those required in thenormal course of business, during the first quarters of 2005 and 2004, or atMarch 27, 2005 and December 31, 2004.

 

**Off-Balance-Sheet Arrangements**

APChad no significant off-balance sheet arrangements during the first quarters of2005 and 2004, or at March 27, 2005 and December 31, 2004.

 

**American Jobs Creation Act of2004 — Repatriation of Foreign Earnings**

In October 2004, theAmerican Jobs Creation Act of 2004 was enacted. This Act repealed the tax code’sextraterritorial income (ETI) exclusion in response to the World TradeOrganization’s challenge that the ETI exclusion was a prohibited tax subsidy.The repeal will be phased in through 2006. The Act replaced the ETI exclusionwith a 3% domestic deduction for domestic production activities effective forAPC’s 2005 tax year. The Act also provides for a temporary 85% dividendsreceived deduction on certain foreign earnings repatriated during a one-yearperiod. The deduction would result in an approximate 5.25% federal tax rate onthe repatriated earnings. To qualify for the deduction, the earnings must bereinvested in the United States pursuant to a domestic reinvestment planestablished by a company’s chief executive officer and approved by its board ofdirectors. Certain other criteria in the Jobs Act must be satisfied as well.The maximum amount of APC’s foreign earnings that qualify for the temporarydeduction is $500 million. For APC, the one-year period during which thequalifying distributions can be made is 2005. No qualifying distributions weremade during 2004.

 

APC is in the process ofevaluating whether it will repatriate any foreign earnings under therepatriation provisions of the Jobs Act and, if so, the amount that it willrepatriate. The range of reasonably possible amounts that APC is consideringfor repatriation, which would be eligible for the temporary deduction, is zeroto $500 million.  APC is awaiting theissuance of further regulatory guidance and passage of statutory technical correctionswith respect to certain provisions in the Jobs Act prior to determining theamounts it will repatriate. If such regulatory guidance or technicalcorrections are favorable, APC is likely to repatriate amounts in the high endof our range. APC expects to determine the amounts and sources of foreignearnings to be repatriated, if any, during the third quarter of fiscal 2005.Use of the funds will be governed by a domestic reinvestment plan, as requiredby the Jobs Act.

 

Repatriation of themaximum amount eligible for the temporary deduction, which is $500 million,could result in additional United States federal income tax expense, which APCcurrently estimates to be between zero and $38.2 million, in fiscal 2005.Repatriation also would substantially increase liquidity in the United States,although use of the additional liquidity would be restricted by the domesticreinvestment plan. There would be a corresponding reduction in liquidity at APC’sforeign subsidiaries. Some foreign subsidiaries may be required to borrow inorder to repatriate their earnings to the U.S.

 

**Quarterly Cash Dividends**

Dividends of $0.08per share were declared and paid in the first and second quarters of 2004. InJune 2004, APC’s Board of Directors approved a 25% increase in its quarterlycash dividend raising the payout to $0.10 per share. Dividends of $0.10 pershare were declared and paid in each subsequent quarter through the firstquarter of 2005. It is the intention of the Board of Directors to pay acomparable quarterly dividend on a going forward basis contingent uponcontinued capital availability and a determination that cash dividends continueto be in the best interests of APC and its shareholders.

 

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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 in various currencies.Realized and unrealized transaction gains or losses are included in the resultsof operations and are measured based upon the effect of changes in exchangerates on the actual or expected amount of functional currency cash flows. Transactiongains and losses were not material to the results of operations in the firstquarters of 2005 and 2004.**

 

Thetable below summarizes information on balances that are sensitive to foreigncurrency exchange rates and presents such amounts in U.S. dollar equivalents.

 
| ** **                       | ** ** | **March 27, 2005**      | ** ** | **December 31, 2004** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **Accounts Receivable** | ** ** | **Liabilities**       | ** ** | **Accounts Receivable** | ** ** | **Liabilities** | ** ** |
| ** **                       | ** ** | **(In millions)**       | ** ** |
| U.S. dollar  functional currency | ** ** | **$**                   | **83.2**   | ** **            | **$**      | **96.2** |   | $ | 97.6 |   | $ | 101.9 |   |
| Swiss franc  functional currency | ** ** | **$**                   | **14.9**   | ** **            | **$**      | **5.3** |   | $ | 17.2 |   | $ | 8.4 |   |

 

APCalso had non-trade receivables denominated in Euros of approximately U.S.$1.0million and U.S.$0.8 million at March 27, 2005 and December 31, 2004,respectively.

 

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.

 

**CRITICALACCOUNTING POLICIES**

 

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. The U.S.Securities and Exchange Commission has defined critical accounting policies asthose that are both most important to the portrayal of our financial conditionand results and which require our most difficult, complex or subjectivejudgments or estimates. Based on this definition, we have identified thepolicies below as critical to our business operations and the understanding ofour results of operations. The impact and any associated risks related to thesepolicies on our business operations is discussed throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations wheresuch policies affect our reported and expected financial results. For allfinancial statement periods presented, there have been no materialmodifications to the application of these critical accounting policies. For adetailed discussion on the application of these and other accounting policies,also refer to Note 1 of Notes to Consolidated Financial Statements in Item 8 ofAmerican Power Conversion Corporation’s Annual Report on Form 10-K for the yearended December 31, 2004.

 

On an on-going basis, weevaluate the judgments and estimates underlying all of our accounting policies,including those related to revenue recognition, product returns, bad debts,inventories, impairment of long-lived assets, deferred tax valuationallowances, restructuring reserves and contingencies, and litigation. We baseour estimates on historical experience and on various other assumptions thatare believed to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Materially differentresults in the amount and timing of our actual results for any period couldoccur if we made different judgments or utilized different estimates. Actualresults may differ from those estimates.

 

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Our criticalaccounting policies are as follows:

 

***RevenueRecognition. ***Wefollow very specific and detailed guidelines in measuring revenue; however,certain judgments affect the application of our revenue policy. Revenue resultsare difficult to predict, and any shortfall in revenue or delay in recognizingrevenue could cause our operating results to vary significantly from quarter toquarter. In general, revenue is recognized when title has passed at the time ofdelivery of product for all of our operating segments as stipulated by thedelivery terms for the sales transactions. In addition, prior to revenuerecognition, we require persuasive evidence of the arrangement, that the priceis fixed or determinable, and that collectibility is reasonably assured. Installationis not applicable for Small Systems and “Other” segment products based on thenature of the products sold. Generally, revenue associated with Large Systemssales is also recognized at the time of delivery and/or installation pursuantto the delivery and/or installation terms. Delivery terms vary, but ofteninclude 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. Where we do not perform such installation, revenuerecognition at the time of delivery is proper as customer acceptance of theunit is not required. Also, payment by the customer is not contingent uponinstallation of the product.

 

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

 

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

 

Our arrangements do notgenerally include acceptance clauses. However, if an arrangement includes acustomer specified acceptance provision, acceptance generally occurs at ourfactory prior to delivery. As we continue to introduce new products in 2005, weanticipate that installation and customer acceptance provisions may become morecommon, and therefore increasingly significant for determining delivery andperformance and consequently our entitlement to recognize revenue.

 

***EstimatingValuation Allowances and Accrued Liabilities – Allowances for Sales Returns,Doubtful Accounts, Inventory Obsolescence and Product Recall, and Assessment ofthe Probability of the Outcome of our Current Litigation. ***Significant managementjudgments that affect the application of our revenue policy also includeestimates of potential future product returns related to current period productrevenue. We analyze historical returns, current economic trends, and channelinventories when evaluating the adequacy of the sales returns and otherallowances. Significant management judgments and estimates must be made andused in connection with establishing 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 rightsof return to distributors and retailers for our Small Systems product lines. Weprovide appropriate reserves for returns at the time that related revenue isrecognized, based on historical patterns of returns and contractual provisionsin accordance with the provisions of Statement of Financial AccountingStandards No. 48, *Revenue Recognition WhenRight of Return Exists*, and U.S. Securities and Exchange CommissionStaff Accounting Bulletin No. 104. Returns of Large Systems products generallydo not occur. Historically, returns have represented approximately 3% of grosssales and have not differed significantly from prior estimates.

 

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Similarly, we mustmake estimates of the uncollectability of our accounts receivable. Managementspecifically analyzes accounts receivable balances in view of customercredit-worthiness, customer concentrations, historical bad debts, currenteconomic trends, and changes in our customer payment terms when evaluating theadequacy of the allowance for doubtful accounts. Commencing in August 2004, we expanded APC’s receivables insurancecoverage to include U.S.-based sales. A majority of U.S. and internationalcustomer balances continue to be covered by receivables insurance.Historically, bad debts have 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 ofBack-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 and December 2002 andwere sold primarily through computer and electrical distribution, catalog andretail outlets worldwide. In the fourth quarter of 2002, APC accrued a currentliability and recognized additional warranty expense, classified in cost ofgoods sold, of $19.6 million. Based upon repair cost and return rate experienceto-date as well as then-current estimates of remaining costs to be incurred,APC projected that aggregate costs for the recall would 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 27, 2005, APC had incurredapproximately 90% of currently estimated total recall costs. Our estimation ofremaining recall costs of $1.4 million, comprised of $0.9 million for the U.S.and $0.5 million for international geographies, continues to be subject toactual return rates and per unit repair costs (which can vary by country) aswell as estimates for other recall-related costs expected to be incurred. Themost significant risks associated with our return rate assumptions includevarying degrees of product recall regulation by geography as well as varyingconsumer awareness levels and access to timely recall information. Actual perunit repair cost includes principally transportation costs which will beinfluenced by the proximity of customer locations to the service centerlocation as well as the priority level of delivery requirements. We expect thatactual future amounts will not differ materially from our current estimates.

 

We are, and may in thefuture 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 isinherently uncertain and includes the risk of an unexpected, unfavorableresult. We may be materially adversely impacted by any such litigation.

 

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

 

•      significantunderperformance relative to expected historical or projected future operatingresults;

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

•      significantnegative industry or economic trends; and

•      significanttechnological changes, which would render equipment 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. Impairment losses aredetermined based upon the excess of carrying amounts over discounted expectedfuture cash flows of the underlying business.

 

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

 

***American Jobs Creation Act of2004 — Repatriation of Foreign Earnings. ***In October 2004, the American Jobs Creation Act of 2004 was enacted.This Act repealed the tax code’s extraterritorial income (ETI) exclusion inresponse to the World Trade Organization’s challenge that the ETI exclusion wasa prohibited tax subsidy. The repeal will be phased in through 2006. The Actreplaced the ETI exclusion with a 3% domestic deduction for domestic productionactivities effective for APC’s 2005 tax year. The Act also provides for a temporary85% dividends received deduction on certain foreign earnings repatriated duringa one-year period. The deduction would result in an approximate 5.25% federaltax rate on the repatriated earnings. To qualify for the deduction, theearnings must be reinvested in the United States pursuant to a domesticreinvestment plan established by a company’s chief executive officer andapproved by its board of directors. Certain other criteria in the Jobs Act mustbe satisfied as well. The maximum amount of APC’s foreign earnings that qualifyfor the temporary deduction is $500 million. For APC, the one-year periodduring which the qualifying distributions can be made is 2005. No qualifyingdistributions were made during 2004.

 

APC is in the process of evaluating whether itwill repatriate any foreign earnings under the repatriation provisions of theJobs Act and, if so, the amount that it will repatriate. The range ofreasonably possible amounts that APC is considering for repatriation, whichwould be eligible for the temporary deduction, is zero to $500 million.  APC is awaiting the issuance of furtherregulatory guidance and passage of statutory technical corrections with respectto certain provisions in the Jobs Act prior to determining the amounts it willrepatriate. If such regulatory guidance or technical corrections are favorable,APC is likely to repatriate amounts in the high end of our range. APC expectsto determine the amounts and sources of foreign earnings to be repatriated, ifany, during the third quarter of fiscal 2005. Use of the funds will be governedby a domestic reinvestment plan, as required by the Jobs Act.

 

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Repatriation of the maximum amount eligiblefor the temporary deduction, which is $500 million, could result in additionalUnited States federal income tax expense, which APC currently estimates to bebetween zero and $38.2 million, in fiscal 2005. Repatriation also wouldsubstantially increase liquidity in the United States, although use of theadditional liquidity would be restricted by the domestic reinvestment plan.There would be a corresponding reduction in liquidity at APC’s foreignsubsidiaries. Some foreign subsidiaries may be required to borrow in order torepatriate their earnings to the U.S.

 

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

 

To the extent we believethat recovery of deferred tax assets is not likely, we must establish 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 27, 2005 and December 31, 2004,we provided a valuation allowance on certain of our deferred tax assets,primarily consisting of net operating losses generated in 2001 through thefirst quarter of 2005 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 ISSUED ACCOUNTING STANDARDS**

## ** **

***Accounting for Conditional Asset Retirement Obligations. ***In March 2005, the Financial Accounting Standards Board issuedInterpretation No. 47, *Accounting for ConditionalAsset Retirement Obligations*. This Interpretation clarifies that theterm “conditional asset retirement obligation” as used in Statement No. 143, *Accounting for Asset Retirement Obligations*, refers to alegal obligation to perform an asset retirement activity in which the timingand (or) method of settlement are conditional on a future event that may or maynot be within the control of the entity. This Interpretation also clarifieswhen an entity would have sufficient information to reasonably estimate thefair value of an asset retirement obligation. This Interpretation is effectiveno later than the end of fiscal years ending after December 15, 2005 (December31, 2005, for calendar year enterprises). This Statement is effective for APCbeginning with the fourth quarter of 2005. Adoption of the guidance in this consensus is not expected to have amaterial impact on our consolidated financial position or results ofoperations.

 

***Share-BasedPayment.***  InDecember 2004, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), *Share-BasedPayment*, which is a revision of Statement No. 123 as amended by No.148, *Accounting for Stock-Based Compensation*.Statement No. 123(R) supercedes APB Opinion No. 25. Generally, the approach inStatement 123(R) is similar to the approach described in Statement 123.However, Statement 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values at the date of grant. Pro forma disclosureis no longer an alternative. The U.S. Securities and Exchange Commission hasextended this Statement’s effective date to the beginning of a company’s nextfiscal year. This Statement is effective for APC beginning with the firstquarter of 2006.

 

Statement 123(R) permitspublic companies to adopt its requirements using one of two methods. The “modifiedprospective” method requires compensation cost to be recognized beginning withthe Statement’s effective date (a) based on the requirements of Statement123(R) for all share-based payments granted after the effective date and (b)based on the requirements of Statement 123 for all awards granted to employeesprior to the effective date of

 

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Statement 123(R) that remain unvested on the effective date. The “modifiedretrospective” method includes the requirements of the modified prospectivemethod described above, but also permits entities to restate based on theamounts previously recognized under Statement 123 for purposes of pro formadisclosures either (a) all prior periods presented or (b) prior interim periodsof the year of adoption.

 

In April 2005, the U.S.Securities and Exchange Commission issued Staff Accounting Bulletin No. 107.The Bulletin confirms the latitude in Statement 123(R)’s provisions onselecting models for valuing share options and clarifies other positions onaccounting and disclosure for share-based-payment arrangements. In addition,the Bulletin permits registrants to choose from different models to estimatethe fair value of share options, provides guidance on developing assumptionsused in the models, and addresses the interaction between Statement 123R andother SEC literature.

 

APC has yet to determinewhich method to use in adopting Statement 123(R). As permitted by Statement123, APC currently accounts for share-based payments to employees using APBOpinion No. 25’s intrinsic value method and, as such, generally recognizes nocompensation cost for employee stock options. Accordingly, the adoption ofStatement 123(R)’s fair value method will have a significant impact on APC’sresults of operations, although it will have no impact on APC’s overallfinancial position. APC is evaluating Statement 123(R) and has not yetdetermined the amount of stock option expense which will be incurred in futureperiods.

 

## **FACTORS THAT MAY AFFECTFUTURE RESULTS**

## ** **

This document containsforward-looking statements that involve risks and uncertainties. Our actualresults could differ materially from those anticipated in these forward lookingstatements as a result of certain factors, including the risks faced by usdescribed below and elsewhere in this document.

 

The factors that couldcause actual results to differ materially include the following: costs tomaintain compliance with the provisions of the Sarbanes-Oxley Act of 2002 aregreater than currently anticipated; the impact of increasing competition whichcould adversely affect APC’s revenues and profitability; the impact of foreigncurrency exchange rate fluctuations; the impact on demand, componentavailability 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 potential impact of complying with changingenvironmental regulations; 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 isperiodically upgraded; 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 in APC’sfilings with the Securities and Exchange Commission.

 

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 31,2004.

 

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**ITEM 3.****          QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

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

 

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

 

**ITEM 4.****         ****CONTROLS AND PROCEDURES**

 

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

 

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

 

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

 

There were no changes inour internal control over financial reporting during APC’s last fiscal quarterthat have materially affected, or are reasonably likely to materially affect,APC’s internal control over financial reporting.

 

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

 

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**PART II****- OTHERINFORMATION**

 

**ITEM 1.****          LEGAL****PROCEEDINGS**

 

On January 10,2003, Powerware Corporation filed in the United States District Court for theEastern District of North Carolina (the “Court”) a complaint alleginginfringement of three United States patents. On May 7, 2003, PowerwareCorporation filed with the Court an amended complaint modifying its allegationsof infringement regarding the Powerware Patents. APC was served with theamended complaint on May 9, 2003. Powerware Corporation is seeking unspecifieddamages and injunctive relief. On May 28, 2003, APC filed its answer to theamended complaint and on June 17, 2003 APC filed its first amended answer andcounterclaims alleging infringement by Powerware Corporation of three UnitedStates patents owned by APC. On July 3, 2003, Powerware Corporation filed itsanswer to counterclaims. On March 18, 2004, Powerware Corporation amended itscomplaint to add an additional patent to the litigation. On or about October27, 2004, Powerware Corporation changed its corporate name to Eaton PowerQuality Corporation. On January 31, 2005, the Court issued a Markman rulingconstruing the patent claims at issue in the case.

 

On December 23,2004, APC filed a patent infringement suit against Eaton Power QualityCorporation in the United States District Court for the District of Delawarecharging Eaton Power Quality Corporation with infringement of one United Statespatent. On January 26, 2005, Eaton Power Quality Corporation filed a motion todismiss APC’s complaint on procedural grounds. On February 9, 2005, APC filedan answering brief in opposition to Eaton Power Quality Corporation’s motion todismiss.

 

As previouslyreported in APC’s Form 8-K dated March 2, 2005, on February 24, 2005, EatonPower Quality Corporation and its parent corporation, Eaton Corporation(collectively “Eaton”), entered into a binding memorandum of understanding with APC to settle the two patentinfringement suits pending in the United States District Court for the EasternDistrict of North Carolina and the United States District Court for theDistrict of Delaware. In addition to settling all outstanding patentlitigation, APC and Eaton agreed to cross-license multiple patents that wereinvolved in the litigation. APC and Eaton also agreed to a ten-year covenantprohibiting the companies from filing against each other any additional patentinfringement suits related to products of the other that are based on U.S.patent claims which are directed to electronic hardware that performs doubleconversion for power electronics. On May 4, 2005, APC and Eaton entered into adefinitive settlement agreement consistent with the terms outlined above. Neitherparty will pay the other any monetary compensation in connection with thesettlement.

 

As previouslyreported in APC’s Form 10-Q for the quarter ended September 26, 2004, onFebruary 5, 2004, Liebert Corporation and Zonatherm Products, Inc., Liebert’ssales representative firm in the Chicago area, filed a lawsuit in the CircuitCourt of Cook County, Illinois, Chancery Division (the “Court”) against APC,Aerico, LLC, a sales representative firm formed by former employees ofZonatherm Products, and the former employees of Zonatherm Products who formedAerico, LLC. The lawsuit alleged willful violation of the Illinois TradeSecrets Act, tortious interference with contract, tortious interference withprospective economic advantage, civil conspiracy and conspiracy to breachfiduciary duties. Liebert and Zonatherm are seeking compensatory and punitivedamages and injunctive relief. On February 18, 2004, the Court deniedplaintiffs’ motion for a temporary restraining order. On July 16, 2004, theCourt dismissed without prejudice all claims except the Illinois Trade SecretAct claim. On August 6, 2004, plaintiffs filed a second amended complaintreasserting the claims dismissed by the Court on July 16, 2004. On August 20,2004, the Court denied plaintiffs’ motion for preliminary injunction as toviolation of the Illinois Trade Secrets Act. On September 21, 2004, plaintiffsfiled a Notice of Appeal of the August 20, 2004 ruling with the IllinoisAppellate Court. On January 12, 2005, the Court dismissed without prejudice allclaims against APC except the Illinois Trade Secret Act claim. On March 1, 2005the Illinois Appellate Court issued an opinion on the appeal pursuant to whichit affirmed the Court on the issue of non-trade secret nature of plaintiff’scustomer lists, and remanded the matter for the Court to enter an injunctionagainst one of the individual former employees of Zonatherm from using certainpricing books. On March 16, 2005, plaintiffs filed a third amended complaintreasserting claims substantially similar to those dismissed by the Court in itsJanuary 12, 2005 ruling.

 

In addition, APCis involved in various other claims and legal actions arising in the ordinarycourse of business.

 

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**ITEM 6.****          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 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) |
|             |   |                                                                                                                                                                                                                                         |
| 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)         |

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| **AMERICAN  POWER CONVERSION CORPORATION**      |
|-------------------------------------------------|
|                                            |
| Date: May 6,  2005                              |
|                                            |
|                                            |
|                                            | /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**                                                                                                                                                                                                                                        |   | **Page  No.** |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|
|                |   |                                                                                                                                                                                                                                                   |   |          |
| 3.01                |   | Articles of  Organization of APC, as amended, previously filed as an exhibit to APC’s  Quarterly Report on Form 10-Q for the fiscal quarter ended June 27, 1999 and  incorporated herein by reference (File No. 1-12432)                          |   |          |
|                |   |                                                                                                                                                                                                                                                   |   |          |
| 3.02                |   | By-Laws of APC,  as amended and restated, previously filed as an exhibit to APC’s 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) |   | 35            |
|                |   |                                                                                                                                                                                                                                                   |   |          |
| 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)                   |   | 36            |
|                |   |                                                                                                                                                                                                                                                   |   |          |
| 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)           |   | 37            |
|                |   |                                                                                                                                                                                                                                                   |   |          |
| 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)                   |   | 38            |

 

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