The Company has embarked on a growth strategy and continues to alter its portfolio of businesses. This growth strategy encompasses acquisitions and the reduction of risk associated with certain large customer concentrations. The Company believes this strategy will improve the overall profitability of operations. In the first quarter of 2004, the Company completed the sale of its entry door business and the acquisitions of Chicago Steel Tape Co. ("CST/Berger"), Blick plc ("Blick") and Frisco Bay Industries Ltd ("Frisco Bay"). The entry doors business has been reported as a discontinued operation for all periods presented and the year to date 2004 net earnings from discontinued operations are $95 million, or $1.13 per fully diluted share, which consists primarily of the after-tax gain from the sale.
Net sales from continuing operations were $795 million in the second quarter of 2004 as compared to $653 million in the second quarter of 2003, representing an increase of 22%. Excluding the $59 million net sales from acquisitions, organic sales increased 13% driven primarily by 8% volume growth as strong demand continued from home center and mass merchant customers; industrial tool demand benefited from favorable market conditions and improved execution in several businesses; Security Solutions revenues increased primarily due to share gains in the access door business; and both Europe and Asia benefited from currency translations. Favorable foreign currency translation, primarily European and Asian, increased net sales by 2%. The impact of pricing resulted in a net sales increase of 3%. Double-digit percentage organic sales growth was achieved in all three business segments – Consumer Products, Industrial Tools and Security Solutions. Year to date net sales from continuing operations in 2004 were $1,573 million as compared to $1,285 million in 2003, an increase of 22%. Acquisitions contributed $107 million, or an 8% increase, of net sales. Organic sales increased due to volume increases of 9%, favorable foreign currency translation which increased sales by 3%, and pricing increases of 2%. The factors resulting in the Company's six month performance are primarily the same items discussed previously pertaining to the second quarter results.
The Company reported gross profit from continuing operations of $283 million, or 36% of net sales, in the second quarter of 2004, compared to $220 million, or 34% of net sales, in the prior year. The businesses acquired increased gross profit by $27 million. The remaining increase was primarily attributed to increased sales volume and gross profit rate improvement. The gross profit rate improvement was attributable to the carryover benefit of 2003 restructuring programs, volume leverage, inventory losses in the second quarter of 2003 related to the termination of the Mac Direct distribution model, favorable pricing and improved product mix. These benefits were partially offset by higher steel costs and other inflation. The Company continued to experience a significant impact from unusually high levels of commodity price inflation (particularly steel) in the first six months of 2004. The Company continues to actively pursue price increases in many business channels to partially offset this negative impact. Steel cost and other inflation increases will continue to have a substantial impact on the Company in the third quarter and beyond while several partially offsetting price increases will phase in during the third quarter. The effect of commodity inflation, including freight increases, is now expected to total $70-80 million in the year 2004, of which approximately two-thirds is projected to be offset with related price increases. Year to date gross profit from continuing operations in 2004 was $562 million, or 36% of net sales, compared to $434 million, or 34% of net sales through the comparable period in 2003. Excluding the favorable impact of acquisitions, gross profit improved $79 million as compared with the six months ended June 2003 due to the same factors as in the second quarter.
Selling, general and administrative expenses (SG&A) from continuing operations, inclusive of the provision for doubtful accounts, were $178 million, or 22% of net sales in the second quarter of 2004, compared to $169 million, or 26% of net sales, in the prior year. The increase of $9 million was primarily attributed to: acquired businesses that increased costs by $16 million; receivable losses in
2003 which related to the exiting of the Mac Direct distribution model of $11 million; $8 million of 2003 costs related to the retirement of the Company's former CEO; increased business portfolio SG&A spending levels by 8% in connection with the 13% organic sales increase; and increased funding for brand support. Year to date SG&A from continuing operations was $350 million, or 22% of net sales, compared to $337 million, or 26% of net sales. The factors resulting in the Company's six month performance are primarily the same items discussed previously pertaining to the second quarter results, however, the incremental costs of acquisitions was $28 million and Mac Tools accounts receivable losses in 2003 were $21 million.
Interest-net from continuing operations in the second quarter was $9 million, an increase of $2 million over the second quarter of 2003. Year to date interest-net from continuing operations was $17 million in 2004, an increase of $2 million over the same period in 2003. The increase was from higher borrowings primarily for acquisitions.
The Company's effective income tax rate from continuing operations was 29% in the second quarter this year compared to 27% in the prior year's quarter, reflecting a favorable impact from refunds of prior year tax assessments in the 2003 rate. Year to date, the income tax rate for 2004 was 30% as compared to 29% during the same time period in 2003. The sequential decline in the second quarter of 2004 reflects a reduction in the year-to-date tax rate to 30%, from 31% in the first quarter of 2004, due to increased earnings in foreign locations with lower tax rates, a recent favorable tax law change in a foreign country and other tax planning activities.
Business Segment Results
In April 2004, the Company announced a change to its segment reporting to align with the portfolio changes resulting from the divestiture and acquisitions in the first quarter of 2004. The Company reports the following three segments: Consumer Products, Industrial Tools and Security Solutions. The Consumer Products segment includes hand tools, consumer mechanic tools and storage units, hardware, and home décor. Industrial Tools is comprised of Mac Tools, Proto mechanic tools, pneumatic tools, storage systems, specialty tools, assembly technologies, hydraulic tools and CST/Berger. The Security Solutions segment includes access technologies, Best Access, and newly acquired Blick and Frisco Bay. The Company's reportable segments are an aggregation of businesses that have similar products and services, among other factors. The Company assesses the performance of its reportable segments using operating profit and return on capital. Segment operating profit excludes interest income, interest expense, other-net, restructuring charges and asset impairments, as well as income tax expense.
Consumer Products sales of $298 million in the second quarter of 2004 represented a 15% increase from $260 million in the second quarter of 2003, driven by the aforementioned strength in home center and mass merchant channels in the U.S. and favorable currency impacts in Europe. Pricing represented 2% of the sales increase, currency 3% and volume 10%. Operating profit was $41 million, or 14% of net sales, for the second quarter of 2004, compared to $28 million, or 11% of net sales, in 2003. The improvement in operating profit is primarily attributable to favorable price and product mix combined with operating leverage from higher sales volumes and the absence of $4 million in 2003 Operation 15 charges. On a year to date basis, Consumer Products net sales in 2004 were $604 million, an 18% increase from $513 million in 2003. Year to date operating profit in 2004 was $89 million, or 15% of net sales, compared to $59 million, or 12% of net sales in 2003. The improvement in sales and operating profit for the six month period is primarily attributable to the same factors discussed previously pertaining to the second quarter results.
Industrial Tools sales of $322 million in the second quarter of 2004 represented a 16% increase from $276 million in the second quarter of 2003. Excluding the CST/Berger acquisition, organic sales increased 11% to $306 million. This organic improvement was the result of improved economic conditions in the fastening systems, industrial mechanics tools, and hydraulic tools businesses. Mac Tools revenues were essentially flat, a strong performance as traditional distributor additions and higher route average sales offset the decline from last year's MacDirect exit. Operating profit was $37 million, or 11% of net sales, for the second quarter of 2004. In the second quarter of 2003, the
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Industrial Tools segment reported a $2 million operating profit due to $18 million of charges for receivable and inventory losses associated with the MacDirect exit and an allocated portion of the costs associated with the retirement of the Company's former CEO. The remaining increase in the second quarter 2004 operating profit and margin rate was due to higher sales volume, substantial improvement in the margin performances of Mac Tools and industrial mechanics tools (i.e. Proto) as a result of the carryover benefits from prior year restructuring programs, as well as the inclusion of CST/Berger. On a year to date basis, Industrial Tools net sales in 2004 were $638 million, a 16% increase from $548 million in 2003. Year to date operating profit in 2004 was $67 million, or 10% of net sales. In the first half of 2003, the Industrial Tools segment reported a $1 million operating loss due to $32 million of charges mainly from receivable and inventory losses associated with the MacDirect exit. The improvement in operating profit is primarily attributable to the same factors discussed previously pertaining to the second quarter results.
Security Solutions sales increased 50% to $175 million in the second quarter of 2004. Excluding Blick and Frisco Bay Industries, acquired in the first quarter, Security Solutions organic sales increased 15% to $134 million, on strength in the supply and service of automatic commercial door systems in access technologies. In addition, Best Access delivered 5% organic sales volume growth. Operating margin decreased to 16% versus 19% last year, due to high commodity inflation, acquisition related severance, business mix, and negative field productivity related partially to a temporary change in the geographic mix of the business. On a year to date basis, Security Solutions net sales in 2004 were $331 million, a 48% increase from $224 million in 2003. Year to date operating profit in 2004 was $57 million, or 17% of net sales, compared to $39 million, or 17% of net sales in 2003. The improvement in sales and operating profit for the six month period is primarily attributable to the same factors discussed previously pertaining to the second quarter results.
Restructuring and Other Charges
In the first quarter of 2003, the Company recorded $3 million in restructuring reserves for new initiatives, pertaining to the further reduction of its cost structure, primarily for severance-related obligations. These reserves were fully expended by the end of 2003.
The Company recorded $22 million in restructuring and asset impairment charges in the second quarter of 2003. Of this charge, $5 million related to the Consumer Products segment, $14 million related to the Industrial Tools segment and the remaining $3 million related to centralized corporate functions. These charges consisted of $5 million of asset impairments and $5 million of other exit costs related to the exit of the Company's Mac Direct retail channel; $9 million for severance and related benefits for Operation 15 initiative headcount reductions; and $3 million for asset impairments pertaining to other Operation 15 initiatives. The $8 million of asset impairments generally relates to assets designated as held for use, which are idle as a result of Operation 15 initiatives, and accordingly their book value has been written-off. The second quarter charge for headcount reductions resulted in a net employment reduction of approximately 700 manufacturing, selling and administrative personnel.
The exit of MacDirect required the liquidation of certain assets and lease obligations. In the first two quarters of 2003, the Company recognized $24 million of receivable losses and $7 million of inventory losses associated with the MacDirect exit.
In 2004, $5 million of restructuring reserves were established in purchase accounting for the Blick and Frisco Bay acquisitions primarily pertaining to headcount reductions associated with the integration of these businesses.
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At July 3, 2004, the restructuring and asset impairment reserve balance was $11 million. A summary of the Company's restructuring reserve activity from January 3, 2004 to July 3, 2004 is as follows (in millions):
| | | | | | | | | | |
| | | 01/03/2004 | | Acquisitions | | Usage | | 07/03/04 |
| Acquisitions | | | | | | | | | | | | | | | | |
| Severance | | $ | — | | | $ | 5 | | | $ | (4 | ) | | $ | 1 | |
| Other | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | |
| Operation 15 | | | | | | | | | | | | | | | | |
| Severance | | | 3 | | | | — | | | | (2 | ) | | | 1 | |
| Asset impairments | | | 9 | | | | — | | | | (1 | ) | | | 8 | |
| Other | | | 3 | | | | — | | | | (2 | ) | | | 1 | |
| | | | | | | | | | | | | | | | | |
| Prior to 2003 | | | | | | | | | | | | | | | | |
| Other | | | 1 | | | | — | | | | (1 | ) | | | — | |
| | | $ | 16 | | | $ | 5 | | | $ | (10 | ) | | $ | 11 | |
|
The Company expects the above restructuring and asset reserve balances to be fully expended by the end of 2004.
In the second quarter of 2003, the Company recognized $8 million in charges related to compensation payable to its former Chairman and Chief Executive Officer, John Trani, who announced his retirement effective December 31, 2003. Such retirement expenses were comprised of severance and pension as specified in an employment contract entered into in 2000.
FINANCIAL CONDITION
Liquidity and Sources of Capital
Operating cash flow of $91 million in the second quarter of 2004 increased $27 million from the prior year's second quarter principally as a result of working capital levels being closely managed during this period of strong sales volume growth, as well as lower cash outflows related to restructuring. On a year to date basis, operating cash flow of $143 million in 2004 increased by $27 million from 2003 due primarily to the same factors discussed previously pertaining to the second quarter results.
In the first quarter of 2004 the Company received $162 million in cash from the sale of the entry door business. In the second quarter of 2004 $22 million of related income taxes were paid, and approximately $28 million of the remaining income taxes will be disbursed in later quarters. Cash payments for acquisitions amounted to $255 million year-to-date. Thus, the net cash outflow pertaining to acquisition and divestiture activity was $115 million, about half of which was paid with existing cash resources and the remainder was financed with commercial paper borrowings. Aside from normal debt service payments, the Company repaid $120 million of long-term debt which matured on March 1, 2004, and cash inflows from short-term borrowings, principally commercial paper, amounted to $187 million. Overall net cash inflows of $50 million from borrowing activities were realized in the first half of 2004.
The Company assumed $29 million of debt in the Blick and Frisco Bay acquisitions. In addition the remaining $22 million Blick purchase price obligation is reflected in current portion of long-term debt. In total debt increased $96 million in the first half of 2004.
In December 2003, the Company announced that it was evaluating the sale of as much as $175 million of equity-linked securities as a possible longer-term funding alternative for recent acquisitions. As a result of the Company's recent cash flow levels and a continued commitment to the near-term divestiture of certain small non-core activities, management announced on July 26, 2004 the sale of equity-linked securities will not be required at this time. Changing circumstances could lead to a re-evaluation of the need for equity-linked securities or other forms of financing.
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ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, under the supervision and with the participation of management, including the Company's Chairman and Chief Executive Officer and its Executive Vice President and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. Based upon that evaluation, the Company's Chairman and Chief Executive Officer and its Executive Vice President and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in its periodic Securities Exchange Commission filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.
PART 2 – OTHER INFORMATION
| |
| ITEM 2. | CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES |
| | | | | | | | | | |
| Period | | (a)
Total Number
of Shares
Purchased | | Average Price
Paid per Share |
| January 4 – February 7, 2004 | | | 3,558 | | | $ | 39.08 | |
| February 8 – March 6, 2004 | | | 97 | | | | 38.95 | |
| March 7 – April 3, 2004 | | | 9,034 | | | | 42.92 | |
| April 4 – May 8, 2004 | | | 8,645 | | | | 44.58 | |
| May 9 – June 5, 2004 | | | — | | | | — | |
| June 6 – July 3, 2004 | | | — | | | | — | |
| Total for period ended July 3, 2004 | | | 21,334 | | | $ | 42.94 | |
|
| |
| (a) | This column includes repurchasing of shares for the deemed surrender to the Company by plan participants of shares of common stock to satisfy the exercise price or taxes related to the exercise of employee stock options and delivery of restricted shares. |
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting was held on April 23, 2004.
| |
| (i) | The following directors were elected at the meeting: |
|
| | | | | | | | | | | | | | |
| | | Shares Voted For | | Shares Withheld | | Broker Non-Votes |
| John G. Breen | | | 66,361,370 | | | | 10,032,281 | | | | 0 | |
| Virgis W. Colbert | | | 70,386,986 | | | | 6,006,665 | | | | 0 | |
| John F. Lundgren | | | 70,888,879 | | | | 5,504,772 | | | | 0 | |
|
| |
| (ii) | Ernst & Young LLP was approved as the Company's independent auditors by the following vote: |
|
| | | | | | | | | | | | | | |
| FOR: | | | 66,609,018 | | | AGAINST: | | 8,929,902 |
| ABSTAIN: | | | 854,731 | | | BROKER NON VOTES: | | 0 |
|
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| |
| (iii) | A shareholder proposal urging the Board of Directors to take the necessary steps to require that all members of the Board of Directors be elected annually was approved by the following vote: |
|
| | | | | | | | | | | | | | |
| FOR: | | | 46,588,846 | | | AGAINST: | | | 16,316,235 | |
| ABSTAIN: | | | 1,238,200 | | | BROKER NON VOTES: | | | 12,250,370 | |
|
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
| |
| (10) (iii) | The Stanley Works Restricted Stock Unit Plan for Non-Employee Directors* |
| |
| (31) (i) | Certification by Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) |
| |
| (ii) | Certification by Executive Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) |
| |
| (32) (i) | Certification by Chairman and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
| (ii) | Certification by Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* Compensation plan or arrangement
(b) Reports on Form 8-K
| |
| (i) | The Company filed a current report on Form 8-K dated April 5, 2004 publishing additional information the Company was asked to provide to Institutional Shareholder Services ("ISS") about tax fees that the Company reported in its March 29, 2004 Proxy Statement for its 2004 Annual Meeting of Shareholders. |
| |
| (ii) | The Company filed a current report on Form 8-K dated April 9, 2004 with respect to the Company's press release announcing the completion of its acquisition of Frisco Bay Industries Ltd. |
| |
| (iii) | The Company filed a current report on Form 8-K dated April 26, 2004 with respect to the Company's press release reporting the Company's results for the first quarter of 2004 and providing guidance for the second quarter and full year 2004. |
CAUTIONARY STATEMENT
Certain statements contained in this Quarterly Report on Form 10-Q, including the statements regarding the Company's ability (i) to improve the overall profitability of the Company's operations; (ii) to limit the effect of commodity inflation, including freight increases, to approximately $70-80 million; (iii) to offset approximately two-thirds of anticipated commodity price inflation with price increases; (iv) to complete restructuring activities within existing restructuring and asset impairment reserves by the end of 2004; and (v) to maintain cash flow levels and divest certain small non-core activities such that the sale of equity-linked securities is not required are forward looking and are based on current expectations and involve inherent risks and uncertainties, including factors listed below and other factors that could delay, divert or change any of them, and could cause actual outcomes and results to differ materially from current expectations.
The Company's ability to achieve the results described above is dependent on; (i) the success of the Company's efforts in integrating its recently announced acquisitions; (ii) the success of the Company's efforts to raise prices in order to, among other things, offset the impact of steel and other commodity and material price inflation, including freight charges; (iii) the need to respond to significant changes in product demand due to economic and other changes; (iv) continued improvements in productivity and cost reductions; (v) the continued success of the Company's marketing and sales efforts, including
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the Company's ability to recruit and retain an adequate sales force; (vi) the continued success of The Home Depot, Lowe's and Wal-Mart sales initiatives as well as other programs to stimulate demand for Company products; (vii) the success of recruiting programs and other efforts to maintain or expand overall Mac Tools truck count versus prior years; (viii) the ability of the Company to fulfill increasing demand for its products; (ix) the ability to continue successfully managing and defending claims and litigation; (x) the absence or mitigation of increased pricing pressures from customers and competitors and the ability to defend market share in the face of price competition; and (xi) the continued ability of the Company to access credit markets under satisfactory terms.
The Company's ability to achieve the objectives discussed above will also be affected by external factors. These external factors may include pricing pressure and other changes within competitive markets, the continued consolidation of customers in consumer channels, inventory management pressures on the Company's customers, increasing competition, changes in trade, monetary, tax and fiscal policies and laws, inflation, currency exchange fluctuations, the impact of dollar/foreign currency exchange and interest rates on the competitiveness of products and the Company's debt program, the strength of the U.S. economy and the impact of events that cause or may cause disruption in the Company's distribution, financial and sales networks such as war, terrorist activities, political unrest and recessionary or expansive trends in the economies of the world in which the Company operates.
Unless required by applicable federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date hereof.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
THE STANLEY WORKS
Date: August 4, 2004 By: /s/ James M. Loree
| James M. Loree
Executive Vice President
and Chief Financial Officer |
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