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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended May 31, 2004

OR

Commission File No. 1-11288

ACTUANT CORPORATION

(Exact name of registrant as specified in its charter)

6100 NORTH BAKER ROAD

MILWAUKEE, WISCONSIN 53209

Mailing address: P. O. Box 3241, Milwaukee, Wisconsin 53201

(Address of principal executive offices)

(414) 352-4160

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

The number of shares outstanding of the registrant’s Class A Common Stock as of June 30, 2004 was 23,755,791.

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FORWARD LOOKING STATEMENTS AND CAUTIONARY FACTORS

This quarterly report on Form 10-Q contains certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. The terms “may,” “should,” “could,” “anticipate,” “believe,” “estimate,” “expect,” “objective,” “plan,” “project” and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to inherent risks and uncertainties that may cause actual results or events to differ materially from those contemplated by such forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with such statements, factors that may cause actual results or events to differ materially from those contemplated by such forward-looking statements include, without limitation, general economic conditions and market conditions in the recreational vehicle, truck, automotive, industrial production, and construction industries in North America, Europe and, to a lesser extent, Asia, market acceptance of existing and new products, successful integration of acquisitions, operating margin risk due to competitive pricing and operating efficiencies, supply chain risk, material or labor cost increases, foreign currency risk, interest rate risk, commodity risk, the impact of geopolitical activity on the economy, the length of economic downturns in the Company’s markets, the resolution of contingent liabilities related to APW Ltd. and other litigation matters, the Company’s ability to access capital markets, the Company’s debt level, and other factors that may be referred to or noted in the Company’s reports filed with the Securities and Exchange Commission from time to time.

When used herein, the terms “Actuant,” “we,” “us,” “our,” and the “Company” refer to Actuant Corporation and its subsidiaries.

Actuant Corporation provides free-of-charge access to its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments thereto, through its website, www.actuant.com, as soon as reasonably practical after such reports are electronically filed with the Securities and Exchange Commission.

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PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

ACTUANT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands, except per share amounts)

(Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements

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ACTUANT CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

See accompanying Notes to Condensed Consolidated Financial Statements

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ACTUANT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

Note 1. Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements of Actuant Corporation (“Actuant,” or the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial reporting and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The Condensed Consolidated Balance Sheet data as of August 31, 2003 was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. The Company’s significant accounting policies are disclosed in its fiscal 2003 Annual Report on Form 10-K/A. For additional information, refer to the consolidated financial statements and related footnotes in the Company’s fiscal 2003 Annual Report on Form 10-K/A.

In the opinion of management, all adjustments considered necessary for a fair presentation of financial results have been made. Except as discussed otherwise, such adjustments consist of only those of a normal recurring nature. Operating results for the nine months ended May 31, 2004 are not necessarily indicative of the results that may be expected for the entire fiscal year ending August 31, 2004.

Prior year financial statements have been reclassified where appropriate to conform to current year presentations.

Note 2. Acquisitions

Fiscal 2004

On September 3, 2003, the Company acquired certain assets and assumed certain liabilities of Kwikee Products Company, Inc. (“Kwikee” or the “Kwikee Acquisition”) for $28.2 million of cash. Kwikee, headquartered in Cottage Grove, Oregon, is a leading provider of retractable step systems and storage tray systems for the North American recreational vehicle (“RV”) market and is included in our Engineered Solutions segment. The purchase agreement allows for additional payments to the sellers aggregating no more than $1.0 million, contingent on the Company achieving targeted earnings before interest, income taxes, depreciation, and amortization in the fiscal years ended August 31, 2004 through 2008. This transaction was funded through borrowings under the Company’s senior secured credit agreement. Kwikee was an attractive acquisition candidate because it holds leading market positions in retractable step systems and storage tray systems and increases the Company’s content per vehicle in the important motorhome segment of the RV industry. In addition, Kwikee’s brand name, experienced management, and track record of profitable growth were all attractive factors in evaluating the acquisition. The transaction was accounted for using the purchase method of accounting; therefore, the results of operations are included in the accompanying Condensed Consolidated Financial Statements since the acquisition date. The preliminary purchase price allocation resulted in goodwill of $19.9 million and intangible assets of $3.1 million, consisting of patents, trademarks, and customer relationships.

On December 30, 2003, the Company acquired 100% of the outstanding capital stock of Dresco B.V. (“Dresco” or the “Dresco Acquisition”) for $31.9 million of cash (net of $0.8 million of cash acquired). Dresco, headquartered in Wijchen, Netherlands, is a leading distributor of electrical, plumbing and other supplies to the Benelux (Belgium, the Netherlands, and Luxembourg) home center market and is included in our Tools & Supplies segment. The purchase agreement allows for additional payments to the sellers aggregating no less than €1.75 million and no more than €10.0 million, contingent on the Company achieving targeted net sales in the calendar years ended December 31, 2004 through 2006. The aggregate minimum payment of €1.75 million has been recorded as a liability in the preliminary purchase price allocation. Dresco was an attractive acquisition candidate because of its market leadership, the synergistic opportunities with Kopp (our German electrical home center supplier), and its logistics competencies. Dresco’s Benelux customer base provides the Company with geographic expansion opportunities for markets beyond those covered by Kopp in Germany, Austria, and Eastern Europe, and it’s non-electrical products, such as plumbing, expand the Tools & Supplies business product offering. A portion of the proceeds from the Company’s 2% Convertible Senior Subordinated Debentures offering in November 2003 were used to fund the transaction. The transaction was accounted for using the purchase method of accounting; therefore, the results of operations are included in the accompanying Condensed Consolidated Financial Statements since the acquisition date. The preliminary purchase price allocation resulted in goodwill of $24.4 million and intangible assets of $2.5 million, consisting of trademarks, a non-compete agreement, and customer relationships.

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The following unaudited pro forma results of operations of the Company for the three and nine months ended May 31, 2004 and 2003 give effect to the Kwikee and Dresco acquisitions as though the transactions had occurred at the beginning of fiscal 2003.

The comparability of net earnings between the periods presented is impacted by the net of tax charges for the early extinguishment of debt of $6.8 million during the three months ended May 31, 2004 and $18.1 million and $1.3 million during the nine months ended May 31, 2004 and 2003, respectively. Additionally, a net of tax (benefit) charge of $(0.5) and $4.2 million was recorded during the three and nine months ended May 31, 2003, respectively, for litigation matters associated with divested businesses.

Fiscal 2003

On September 3, 2002, the Company acquired approximately 80% of the outstanding capital stock of Heinrich Kopp AG (“Kopp” or the “Kopp Acquisition”). Kopp, headquartered in Kahl, Germany, is a leading provider of electrical products to the German, Austrian, and Eastern European retail home center markets and is included in our Tools & Supplies segment. In the transaction, the Company paid approximately $15.8 million (including the assumption of debt and deferred purchase price of $1.6 million, less acquired cash) for 80% of the capital stock of Kopp. During the first quarter of fiscal 2004, the Company paid the deferred purchase price and exercised its option to acquire the remaining 20% of the outstanding capital stock for $3.3 million by utilizing borrowings available under its senior secured credit agreement. The transactions were accounted for using the purchase method of accounting; therefore, the results of operations are included in the accompanying Condensed Consolidated Financial Statements since the respective acquisition dates. There was no goodwill recorded, as the purchase price in each step of the acquisition was less than the fair value of the acquired assets and liabilities. Accordingly, the book value of the acquired long-lived assets has been reduced as required under generally accepted accounting principles.

The Company committed to integration plans to restructure portions of Kopp’s operations during the first quarter of fiscal 2003. These plans were designed to reduce administrative and operational costs and resulted in a $9.3 million restructuring reserve being recorded in the Kopp purchase price allocation. Of the reserve, $2.6 million relates to the closure of Kopp’s manufacturing facility in Ingolstadt, Germany, with the balance primarily representing other employee severance costs to be incurred in connection with the transfer of certain production out of Germany to lower cost locations and general reductions in the workforce. During the third quarter of fiscal 2004, the Company revised its estimate of the total cost of restructuring Kopp, due to lower than anticipated severance costs. This adjustment resulted in a reduction in the restructuring reserve of $2.4 million which was recorded as a reduction in the recorded value of the acquired long-lived assets as required by generally accepted accounting principles. As of May 31, 2004, the Ingolstadt, Germany facility had been closed, three leased warehouses in Germany had been vacated, and German employment had been reduced by over 200 employees, or 30%.

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A rollforward of the restructuring reserve follows:

Note 3. Accounts Receivable Financing

During fiscal 2001, the Company established an Accounts Receivable Securitization Program whereby it sells certain of its trade accounts receivable to a wholly owned, bankruptcy-remote special purpose subsidiary which, in turn, sells participating interests in its pool of receivables to a third-party financial institution (the “Purchaser”). The Purchaser receives an ownership and security interest in the pool of receivables. New receivables are purchased by the special purpose subsidiary and participation interests are resold to the Purchaser as collections reduce previously sold participation interests. The Company has retained collection and administrative responsibilities on the participation interests sold. The Purchaser has no recourse against the Company for uncollectible receivables; however, the Company’s retained interest in the receivable pool is subordinate to the Purchaser and is recorded at fair value. Due to a short average collection cycle of approximately 60 days for such accounts receivable and the Company’s collection history, the fair value of the Company’s retained interest approximates book value. The retained interest recorded at May 31, 2004 and August 31, 2003 is $19.6 million and $17.7 million, respectively, and is included in accounts receivable in the accompanying Condensed Consolidated Balance Sheets. The securitization program has a final maturity in May 2006, subject to renewal by the Purchaser. The total credit capacity under the program is approximately $35 million, with trade accounts receivables sold and being serviced by the Company totalling $27.0 million and $23.9 million at May 31, 2004 and August 31, 2003, respectively.

Sales of trade receivables from the special purpose subsidiary to the Purchaser totaled $52.7 million and $148.4 million for the three and nine months ended May 31, 2004, respectively, and $47.2 million and $148.4 million for the three and nine months ended May 31, 2003, respectively. Cash collections of trade accounts receivable balances in the total receivable pool totaled $84.1 million and $237.3 million for the three and nine months ended May 31, 2004, respectively, and $70.5 million and $223.0 million for the three and nine months ended May 31, 2003, respectively.

The Accounts Receivables Securitization Program is accounted for as a sale in accordance with FASB Statement No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities – a Replacement of FASB Statement No. 125.” Sales of trade receivables are reflected as a reduction of accounts receivable in the accompanying Condensed Consolidated Balance Sheets and the proceeds received are included in cash flows from operating activities in the accompanying Condensed Consolidated Statements of Cash Flows.

The table below provides additional information about delinquencies and net credit losses for trade accounts receivable subject to the Accounts Receivable Securitization Program.

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Accounts receivable financing costs of $0.1 million for both the three months ended May 31, 2004 and 2003, and $0.4 million for both the nine months ended May 31, 2004 and 2003, are included in net financing costs in the accompanying Condensed Consolidated Statements of Earnings.

Note 4. Inventories, Net

The nature of the Company’s products is such that they generally have a very short production cycle. Consequently, the amount of work-in-process at any point in time is minimal. In addition, many parts or components are ultimately either sold individually or assembled with other parts making a distinction between raw materials and finished goods impractical to determine. Other locations maintain and manage their inventories using a job cost system where the distinction of categories of inventory by state of completion is also not available.

As a result of these factors, it is neither practical nor cost effective to segregate the amounts of raw materials, work-in-process or finished goods inventories at the respective balance sheet dates, as segregation would only be possible as the result of physical inventories which are taken at dates different from the balance sheet dates.

Note 5. Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill for the nine months ended May 31, 2004 are as follows:

The gross carrying amount and accumulated amortization of the Company’s intangible assets that have defined useful lives and are subject to amortization as of May 31, 2004 and August 31, 2003 are as follows:

The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of May 31, 2004 and August 31, 2003 are $4.8 million and $2.5 million, respectively. These assets are comprised of acquired tradenames.

Amortization expense for intangible assets was $0.6 million and $1.7 million for the three months and nine month ended May 31, 2004, respectively, and $0.5 million and $1.8 million for the three and nine months ended May 31, 2003, respectively. Total fiscal 2004 amortization expense is estimated to be $2.2 million. Amortization expense for future years is estimated to be as follows: $2.1 million in fiscal 2005, $2.0 million in fiscal 2006, $1.9 million in fiscal 2007, and $1.8 million in fiscal 2008.

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Note 6. Accrued Product Warranty Costs

The Company recognizes product warranty costs at the time of sale. The amount recognized is based on historical claims rates and current claim cost experience. The following is a reconciliation of the changes in accrued product warranty for the nine months ended May 31, 2004:

Note 7. Debt

In February 2004, the Company entered into a $250 million five-year senior revolving credit facility (the “Revolver”). All outstanding borrowings under the Revolver can be repaid at any time without premium or penalty. The Revolver is not secured by the Company’s assets, but provides for guaranties and stock pledges by certain of the Company’s significant subsidiaries. The interest rates on outstanding borrowings are at LIBOR plus a spread. At May 31, 2004, the 6-month LIBOR was 1.58%. A non-use fee is payable quarterly on the average unused credit line under the Revolver. At May 31, 2004, the non-use fee was 0.35%. Borrowings and non-use fees under the Revolver are subject to a pricing grid, which can result in further increases or decreases in the borrowing spread and non-use fees depending on the Company’s leverage ratio. As a result of the reduction in the Company’s leverage ratio for the twelve months ended May 31, 2004, the borrowing spread for the fiscal 2004 fourth quarter will be reduced from 1.50% to 1.38% and the non-use fee will be reduced from 0.35% to 0.30%. The unused and available credit line under the Revolver at May 31, 2004 was approximately $221 million. The Revolver contains customary limits and restrictions concerning investments, sales of assets, liens on assets, fixed charge coverage ratios, maximum leverage, acquisitions, dividends and other restricted payments. As of May 31, 2004, the Company was in compliance with all debt covenants.

During March 2004, the Company initiated a commercial paper program (“Commercial Paper”) with two financial institutions that provides for an aggregate maximum borrowing capacity of $50 million. At May 31, 2004, there was $26.4 million of Commercial Paper outstanding, all of which had original maturity terms of 31 days or less and were at an average interest rate of 1.64%, including issuance fees. The Revolver acts as a liquidity backstop for outstanding Commercial Paper, meaning the combined outstanding balance of the Revolver and Commercial Paper cannot exceed $250 million.

The Revolver replaces the senior secured credit agreement, which had a final maturity of June 2006. All borrowings outstanding under the senior secured credit agreement were repaid in February 2004 and the Company was released from any remaining obligations. The early extinguishment resulted in a non-cash, pre-tax charge of approximately $2.3 million in the second quarter of fiscal 2004, representing the non-cash write-off of remaining capitalized debt issuance costs.

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In November 2003, the Company sold $150.0 million aggregate principal amount of Convertible Senior Subordinated Debentures (“2% Convertible Notes”) due November 15, 2023. The 2% Convertible Notes bear interest at a rate of 2.00% annually which is payable on November 15 and May 15 of each year. Beginning with the six-month interest period commencing November 15, 2010, holders will receive contingent interest if the trading price of the 2% Convertible Notes equals or exceeds 120% of their underlying principal amount over a specified trading period. If payable, the contingent interest shall equal 0.25% of the average trading price of the 2% Convertible Notes during the five days immediately preceding the applicable six-month interest periods.

The Company has the right to repurchase for cash all or part of the 2% Convertible Notes on or after November 20, 2010. The holders have the right to require the Company to purchase all or a portion of the 2% Convertible Notes on November 15, 2010, November 15, 2013 and November 15, 2018 or upon certain corporate events. The purchase price for these repurchases shall equal 100% of the principal amount plus accrued and unpaid interest. The 2% Convertible Notes are jointly and severally guaranteed by certain of the Company’s domestic subsidiaries on a senior subordinated basis. These guarantees will be released when the Company has no 13% Notes outstanding; provided that if the Company issues other senior subordinated debt that is guaranteed by one or more of the Company’s subsidiaries, then such subsidiaries will be required to guarantee the 2% Convertible Notes on an unsecured senior subordinated basis.

The 2% Convertible Notes are convertible into shares of the Company’s common stock at a conversion rate of 25.0563 shares per $1,000 of principal amount, which equals a conversion price of approximately $39.91 per share (subject to adjustment) only under the following conditions: (i) during any fiscal quarter commencing after November 30, 2003, if the closing sale price of the Company’s common stock exceeds $47.89 (120% of the conversion price of $39.91) for at least 20 trading days in the 30 consecutive trading day period ending on the last trading day of the preceding fiscal quarter, (ii) during any period in which the Company’s senior subordinated debt credit rating falls below certain thresholds, (iii) if a 2% Convertible Note has been called for redemption and has not yet been redeemed, the holder may convert prior to the close of business on the last business day prior to the redemption date, or (iv) if specified corporate transactions occur.

Net proceeds from the issuance of the 2% Convertible Notes were $145.0 million. The Company used $63.9 million of the net proceeds to fund the repurchase of $49.4 million of 13% Notes through open market and negotiated purchases, including premium payments and accrued interest. As a result of these repurchases the Company recorded a pre-tax charge of $15.1 million during the first quarter of fiscal 2004, consisting of bond redemption premium payments and the non-cash write-off of the associated debt discount and debt issuance costs. In addition, the net proceeds were used to repay $28.2 million of borrowings under the senior secured credit agreement related to the acquisition of Kwikee, and $3.3 million for the remaining 20% interest in Kopp, as well as $1.6 million for the Kopp deferred purchase price. The Company also made optional repayments on the term loan under the senior secured credit agreement and the Euro-denominated term loans totaling $17.3 million. The remaining net proceeds were used to fund the $31.9 million net cash purchase price of the Dresco acquisition.

The Company repurchased an additional $31.5 million of its 13% Notes in the third quarter of fiscal 2004 through a negotiated purchase, and recorded a pre-tax charge of $9.9 million consisting of a premium payment to the bondholders and the non-cash write-off of the associated debt discount and debt issuance costs.

During the first quarter of fiscal 2003, the Company retired $9.4 million of its 13% Notes acquired through open market and negotiated purchases. The Company recorded a pre-tax charge of $2.0 million consisting of bond redemption premium payments and the non-cash write-off of the associated debt discount and debt issuance costs.

The 13% Notes include fair value adjustments of $(1.1) million and $(0.4) million at May 31, 2004 and August 31, 2003, respectively, related to interest rate swap contracts that convert fixed rates to variable rates. See Note 10, “Derivatives” for further information.

Note 8. Stock Option Plans

The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations to account for stock option plans. Accordingly, no compensation expense has been recognized for its stock option plans. The following table illustrates the effect on net earnings and earnings per share had the Company adopted the fair value based method of accounting for stock-based employee compensation for all periods presented.

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During the second quarter of fiscal 2003, the Company adopted the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” which had no impact to the Company’s condensed consolidated statements of earnings or balance sheets.

Note 9. Distribution of Electronics Segment

On July 31, 2000, the Company effected the spin-off of APW Ltd., a Bermuda company organized to own and operate its former Electronics Business. In conjunction with the spin-off and as is customary in these types of transactions, APW agreed to indemnify the Company for certain claims and liabilities. However, as a result of APW’s bankruptcy filing discussed below, APW was released from its obligation to indemnify the Company for income tax matters relating to the spin-off and periods prior to the spin-off. Accordingly, the Company is or may be subject to substantial liabilities of APW. In particular, the Company remains liable for tax obligations associated with the spin-off and related corporate restructuring transactions as well as APW’s and its potential tax obligations for periods prior to the spin-off.

During the third quarter of fiscal 2002, APW and one of APW’s wholly owned indirect subsidiaries, Vero Electronics, Inc., commenced prepackaged bankruptcy cases in the United States Bankruptcy Court for the Southern District of New York. On July 31, 2003, APW and Vero Electronics emerged from bankruptcy. Pursuant to the bankruptcy proceedings, APW rejected certain agreements entered into between APW and the Company at the time of the spin-off that governed a variety of indemnification matters between the parties. These agreements included the Tax Sharing and Indemnification Agreement, or TSA, in which APW agreed to indemnify the Company for income tax liabilities in excess of $1.0 million which could arise from any audit or other administrative or judicial proceedings resulting in adjustments to the separate taxable income of APW or any of its subsidiaries which were included in the Company’s consolidated group for periods prior to the spin-off, as well as all taxes related to the spin-off and related corporate restructuring transactions. The Internal Revenue Service has commenced an audit of the Company’s tax return for fiscal 2000, which was the year in which the spin-off and related corporate restructuring transactions occurred. If any audit adjustments were to result in a tax liability, such liability would be payable by the Company. The amount of such additional tax liabilities may be substantial and could have a material adverse effect on the Company’s financial condition and results of operations.

On August 6, 2002, the Company and APW entered into an agreement which provides, among other things, that the right of offset asserted by the Company with respect to approximately $23.8 million of funds (the “Offset Funds”) which it held on behalf of APW is an allowed secured claim which is unimpaired by the APW bankruptcy proceeding; and, further, that the Company may retain possession of the Offset Funds and may use such Offset Funds to, among other things, reimburse it for certain estimated costs of approximately $4.9 million and any tax adjustments arising from the Company’s spin-off of APW. In the event that such costs and adjustments exceed the Offset Funds, the Company will be responsible for any shortfall, and such excess amount could result in a materially adverse impact upon its financial position and results of operations. Pursuant to the agreement with APW, the Company will be required to pay an estimated $18 to $19 million of the Offset Funds to APW or other third parties as spin-off related contingencies are resolved. The Company estimates that these payments will be made sometime before the end of fiscal 2007 although there can be no assurance as to the actual date these payments will be made. The Offset Funds have been recorded in “Other Long-term Liabilities” and totaled $18.9 million as of May 31, 2004 and August 31, 2003.

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Prior to the spin-off, the Company, in the normal course of business, entered into certain real estate and equipment leases or guaranteed such leases on behalf of its subsidiaries, including those in the Electronics Business segment. In conjunction with the spin-off, the Company assigned its rights in the leases used in the Electronics Business segment to APW, but was not released as a responsible party from all such leases by the lessors. As a result, the Company remains contingently liable for such leases. The discounted present value of future minimum lease payments for such leases, assuming no offset for sub-leasing, totals approximately $15.8 million at May 31, 2004. The future undiscounted minimum lease payments for these leases are as follows: $2.4 million in the balance of calendar 2004; $3.1 million in calendar 2005; $2.4 million in calendar 2006; $2.4 million in calendar 2007; $2.5 million in calendar 2008; and $9.1 million thereafter. The parties to these leases, include both subsidiaries of APW and certain former APW subsidiaries that have been acquired by third parties. The Company remains contingently liable for those leases if these entities are unable to fulfill their obligations thereunder. A future breach of these leases by these APW subsidiaries or their successors could, therefore, potentially have a material adverse impact upon the Company’s financial position and results of operations.

Note 10. Derivatives

All derivatives are recognized on the balance sheet at their estimated fair value.

Fair Value Hedges

At May 31, 2004, the Company was party to the following interest rate swap contracts that convert fixed rate debt to variable rate debt:

At August 31, 2003, the Company was party to only Swap #1 and the notional amount was $25 million. During the third quarter of fiscal 2004, the Company terminated $21 million of the notional amount of Swap #1 by paying cash of $1.1 million, representing the fair value of this portion of the swap contract, to the counterparty. This portion of the swap contract was terminated because the underlying debt that was being hedged by this contract was no longer outstanding due to the retirement of 13% Notes through open market and negotiated purchases. This termination fee was recorded within the Charge for Early Extinguishment of Debt in the Condensed Consolidated Statements of Earnings during the three months ended May 31, 2004. Swap #2 was entered into during the third quarter of fiscal 2004 prior to the 13% Notes retirement that occurred during the third quarter of fiscal 2004.

No net gain or loss has been recorded in earnings related to changes in the fair value of these swap contracts since the contracts are considered to be “effective” as the terms of the contracts exactly match the terms of the underlying debt. The fair value of these contracts were recorded as a $1.1 million and as a $1.8 million long-term liability at May 31, 2004 and August 31, 2003, respectively, with the offset recorded as fair value adjustments to the 13% Notes. The six-month LIBOR rate at May 31, 2004 was 1.58%.

During the third quarter of fiscal 2003 the Company terminated an interest rate swap contract that had a notional amount of $25 million, which converted fixed rate debt of 13% to variable rate debt. The Company received a cash settlement of $1.6 million, representing the fair value of the swap contract, from the counterparty. Prior to the termination, hedge accounting treatment was used since the contract was considered to be “effective” as the terms of the contract exactly matched the terms of the underlying debt. Hedge accounting treatment resulted in no net gain or loss being recorded in earnings related to changes in the fair value of the contract. Because the swap was terminated, hedge accounting was also discontinued. The $1.6 million cash settlement was treated as a premium to the outstanding 13% Notes (the underlying debt) and was being amortized to net financing costs over the original remaining life of the contract. The unamortized premium for this terminated swap contract was $1.4 million at August 31, 2003. The 13% Notes that were the underlying debt for this swap contract have since been retired through open market and negotiated purchases during fiscal 2004. As a result, the entire unamortized premium balance of $1.2 million has been recognized within the Charge for Early Extinguishment of Debt on the Condensed Consolidated Statements of Earnings during the third quarter of fiscal 2004.

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Cash Flow Hedges

At August 31, 2003, the Company was a party to an additional interest rate swap contract to convert variable rate debt to a fixed rate with a notional value of $25 million. This contract matured on September 5, 2003. Unrealized gains, net of income taxes, of less than $0.1 million for the nine months ended May 31, 2004, and $0.2 million and $0.4 million for the three and nine months ended May 31, 2003, respectively, were recorded in other comprehensive income to recognize the fair value of interest rate swap contracts to convert variable rate debt to a fixed rate.

Note 11. Earnings Per Share

The reconciliations between basic and diluted earnings per share are as follows:

The 2% Convertible Notes discussed in Note 7, “Debt,” had no impact on the Company’s earnings per share calculations for the periods presented because conditions under which the notes may be converted had not been satisfied. If these conditions had been satisfied, common shares outstanding would be increased by 3,758,445 and net of tax annual interest expense on the 2% Convertible Notes of $1.9 million would have been added back to net earnings for purposes of calculating diluted earnings per share. See Note 7, “Debt,” for a complete discussion of conditions that must be met for the 2% Convertible Notes to be converted.

Note 12. Employee Benefit Plans

The Company provides defined benefit pension and other postretirement benefits to certain employees of its domestic businesses. The defined benefit pension plans consisted of two domestic plans, which cover certain employees and executives of a business acquired in 1997. The domestic plans are frozen and as a result plan participants no longer earn future benefits.

Certain former employees of acquired domestic businesses who retired before February 1, 1994 (and their dependents) have the option of being covered under the Company’s postretirement medical plans. In addition, retiree life insurance is available to certain employees hired before 1988. Most individuals receiving postretirement health care benefits under the above programs are required to make monthly contributions to defray a portion of the cost. Retiree contributions are adjusted annually. The accounting for retiree health care benefits assumes retirees will continue to contribute toward the cost of such benefits. Retirees currently do not contribute toward the cost of life insurance.

The Company also maintains defined benefit pension plans for certain employees in various foreign countries. The defined benefit pension plans primarily consisted of a number of separate plans that cover a limited number of foreign employees. Future benefits are earned with respect to the foreign plans.

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Components of net periodic benefit costs were as follows: