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.
In the third quarter of 2004, the Company entered into a new financing arrangement under which an independent third party will provide revolving credit to Mac Tools distributors' end customers for product purchases. In connection with this transaction, existing accounts receivable related to the Company's Mac Advantage financing program of $47 million were sold.
In October 2004, the Company announced it has entered into a definitive agreement to sell its home décor business. This business unit supplies mirrored closet doors, closet organization products and wall decor products primarily though large retailers in North America and Europe. The transaction is expected to close in the fourth quarter of 2004. Annual sales of the home décor business are approximately $150 million. The business unit is an element of the Company's Consumer Products segment. Combined after-tax net proceeds from the transaction are expected to approximate $65 million. A net after-tax gain of approximately $30 million, or 35 cents per fully diluted share, will be realized upon completion of the transaction.
The Mac Advantage receivables and home décor business unit sale transactions provide important sources of cash for use toward achieving the Company's deleveraging objectives in 2004, as well as the pursuit of the Company's strategic objectives of redeploying capital toward expansion of the Tools and Security Solutions businesses over the long-term, which provide higher than average growth and returns.
Net sales from continuing operations were $791 million in the third quarter of 2004 as compared to $666 million in the third quarter of 2003, representing an increase of 19%. Excluding the $59 million net sales from acquisitions, organic sales increased 10% driven by 4% volume growth, improved pricing and favorable foreign currency impact. The volume growth is due to increased industrial tool demand from favorable market conditions and improved execution in several businesses; strong demand continued from home center and mass merchant customers; and Security Solutions revenues increased primarily due to share gains in the access technology business. Favorable foreign currency translation, primarily European and Asian, increased net sales by 3%. The impact of pricing resulted in a net sales increase of 3%. Double-digit percentage organic sales growth was achieved in the Company's Industrial Tools business segment and Consumer Hand Tools business unit. Year to date net sales from continuing operations in 2004 were $2,365 million as compared to $1,950 million in 2003, an increase of 21%. Acquisitions contributed $166 million, or an 8% increase, of net sales. Organic sales increased due to volume increases of 7%, favorable foreign currency translation which increased sales by 3%, and pricing increases of 3%. The factors resulting in the Company's nine month performance are primarily the same items discussed previously pertaining to the third quarter results.
The Company reported gross profit from continuing operations of $288 million, or 36% of net sales, in the third quarter of 2004, compared to $227 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, 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 nine months of 2004. The Company has actively pursued price increases in many business channels to partially offset this negative impact. Steel cost and other inflation increases, partially offset by price increases, will continue to have a substantial impact on the Company in the fourth quarter and beyond. The effect of commodity inflation, including freight increases, is now expected to total $70-75 million in the year 2004, of which approximately 60% is projected to be offset with related price increases. Year to date gross profit from continuing operations in 2004 was $850 million, or 36% of net sales, compared to $661 million, or 34% of net sales through the comparable period in 2003. Excluding the favorable impact of acquisitions, gross profit improved $112 million as compared with the nine months ended September 2003 due primarily to the same factors as in the third quarter, as well as inventory losses in 2003 related to the termination of the MacDirect distribution model.
Selling, general and administrative expenses ("SG&A") from continuing operations, inclusive of the provision for doubtful accounts, were $179 million, or 23% of net sales in the third quarter of 2004, compared to $144 million, or 22% of net sales, in the prior year. The increase of $35 million was primarily attributed to: acquired businesses that increased costs by $16 million, increased business portfolio SG&A spending levels in connection with the 10% organic sales increase, increased funding for brand support, Sarbanes-Oxley compliance costs, and foreign currency translation. Year to date SG&A from continuing operations was $529 million, or 22% of net sales, compared to $480 million, or 25% of net sales in 2003. The factors resulting in the Company's nine month performance are primarily the same items discussed previously pertaining to the third quarter results, however, the incremental cost of acquisitions was $44 million. Additional factors impacting this comparison were accounts receivable losses of $21 million which related to the exiting of the MacDirect distribution model and $8 million of costs related to the retirement of the Company's former CEO which were both recorded in 2003.
Net interest expense from continuing operations in the third quarter was $8 million, an increase of $1 million over the third quarter of 2003. Year to date interest expense was $25 million in 2004, an increase of $3 million over the same period in 2003. The increase was from higher borrowings primarily for acquisitions, partially offset by lower interest rates.
Other, net from continuing operations represented $11 million of expense, a decrease of $3 million over expense of $14 million in the third quarter of 2003. This decreased expense in other, net is primarily the result of a $6 million loss associated with the MacDirect exit on the sale of the Mac Tools distributor receivable portfolio in 2003, partially offset by incremental amortization of acquired intangibles and unfavorable currency. Other, net year to date was $35 million expense, an increase of $3 million from expense of $32 million for year to date 2003, driven by higher intangible amortization and unfavorable currency.
The Company's effective income tax rate from continuing operations was 29% in the third quarter this year compared to 28% in the prior year's quarter. Year to date, the income tax rate for 2004 was 30% as compared to 29% during the same time period in 2003. On October 22, 2004, the "American Jobs Creation Act of 2004" (the "Jobs Act") was enacted into law. This legislation implements a one-year reduced income tax rate on repatriation of foreign earnings, a phased-in tax reduction on profits from domestic manufacturing activity, and a phased-in repeal of credits from the extraterritorial taxation of income (ETI) exclusion. The Company is currently evaluating the Jobs Act to determine the impact.
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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 $296 million in the third quarter of 2004 represented a 6% increase from $279 million in the third quarter of 2003, driven by the aforementioned favorable currency impacts in Europe and strength in home center and mass merchant channels in the U.S. Pricing represented 2% of the sales increase, currency 3% and volume 1%. Operating profit was $44 million, or 15% of net sales, for the third quarter of 2004, compared to $39 million, or 14% 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, partially offset by the previously mentioned commodity cost inflation. On a year to date basis, Consumer Products net sales in 2004 were $901 million, a 14% increase from $791 million in 2003. Year to date operating profit in 2004 was $132 million, or 15% of net sales, compared to $99 million, or 12% of net sales in 2003. The improvement in sales and operating profit for the nine month period is due to the same factors discussed previously pertaining to the third quarter results.
Industrial Tools sales of $323 million in the third quarter of 2004 represented a 22% increase from $264 million in the third quarter of 2003. Excluding the CST/Berger acquisition, organic sales increased 17% to $309 million. This organic improvement was the result of improved economic conditions and strong execution in fastening systems, industrial mechanics tools, hydraulic tools, specialty tools and assembly tools businesses. Mac Tools revenues increased 2% in the second quarter, as traditional distributor additions and higher route average sales completely offset the anticipated decline from last year's MacDirect exit. Operating profit was $35 million, or 11% of net sales, for the third quarter of 2004. In the third quarter of 2003, the Industrial Tools segment reported $19 million operating profit, or 7% of net sales. The increase in the third 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 as a result of the carryover benefits from prior year restructuring programs, as well as the inclusion of CST/Berger. These favorable factors were partially offset by the previously mentioned commodity cost inflation. On a year to date basis, Industrial Tools net sales in 2004 were $961 million, an 18% increase from $812 million in 2003. Year to date operating profit in 2004 was $101 million, or 11% of net sales. Through the first nine months of 2003, the Industrial Tools segment reported operating profit of $18 million. The significant improvement is due to non-recurring charges in 2003 of $32 million due mainly from receivable and inventory losses associated with the MacDirect exit, as well as the same factors discussed previously pertaining to the third quarter results.
Security Solutions sales increased 40% to $171 million in the third quarter of 2004. Excluding acquisitions, Security Solutions organic sales increased 4% to $127 million, on strength in the supply and service of automatic commercial door systems in access technologies. Best Access Systems sales volume was virtually unchanged from third quarter 2003 levels, while incoming orders increased 10%, reflecting a shift in mix toward longer order cycle electronic access systems. Operating margin decreased to 18% versus 21% last year, due primarily to the impact of slightly lower margins related to the 2004 acquisitions. On a year to date basis, Security Solutions net sales in 2004 were $503 million, a 45% increase from $347 million in 2003 due to both organic and acquisition growth. Year to date operating profit in 2004 was $88 million, or 17% of net sales, compared to $65 million, or 19% of net sales in 2003. The improvement in sales and decrease in operating profit as a percentage of net sales for the nine month period is primarily attributable to the same factors discussed previously pertaining to the third quarter results, as well as increased commodity inflation and negative field productivity.
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Restructuring, Asset Impairment 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 and $11 million in restructuring and asset impairment charges in the second and third quarters of 2003, respectively, for the Operation 15 initiative. Of this charge, $5 million related to the Consumer Products segment, $22 million related to the Industrial Tools segment and the remaining $6 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 MacDirect retail channel, $10 million for severance and related benefits for Operation 15 initiative headcount reductions, $11 million of asset impairments and $2 million of other exit costs pertaining to other Operation 15 initiatives. The $16 million of asset impairments generally relates to assets designated as held for use which are idle as a result of the Operation 15 initiatives and accordingly their book value has been written off. The second and third quarter charges for headcount reductions resulted in a net employment reduction of approximately 800 manufacturing, selling and administrative people.
The exit of MacDirect required the liquidation of certain assets and lease obligations. In the first three quarters of 2003, the Company recognized $21 million of receivable losses, $7 million of inventory losses and $20 million of other costs ($11 million related to trucks and other items and $9 million related to write-offs on the Mac financing portfolios) associated with the MacDirect exit.
In 2004, $5 million of 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.
At October 2, 2004, the restructuring and asset impairment reserve balance was $7 million. A summary of the Company's restructuring reserve activity from January 3, 2004 to October 2, 2004 is as follows (in millions):
| | | | | | | | | | | | | | | | | | |
| | | 01/03/2004 | | Acquisitions | | Usage | | 10/02/04 |
| Acquisitions | |
| Severance | | $ | — | | | $ | 5 | | | $ | (4 | ) | | $ | 1 | |
| Operation 15 | |
| Severance | | | 3 | | | | | | | | (3 | ) | |
| Asset impairments | | | 9 | | | | | | | | (4 | ) | | | 5 | |
| Other | | | 3 | | | | | | | | (2 | ) | | | 1 | |
| Prior to 2003 | |
| Other | | | 1 | | | | | | | | (1 | ) | | | | |
| | | $ | 16 | | | $ | 5 | | | $ | (14 | ) | | $ | 7 | |
|
The Company expects the above restructuring and asset reserve balances to be fully expended by mid 2005.
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.
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FINANCIAL CONDITION
Liquidity and Sources of Capital
Operating cash flow of $100 million in the third quarter of 2004 decreased $51 million from the prior year's third quarter principally as a result of working capital levels that increased due to higher receivables from timing of sales in the third quarter and inventory increases in preparation for timing of sales in the fourth quarter (i.e. first half of quarter higher than second half). On a year to date basis, operating cash flow of $243 million in 2004 decreased by $23 million from 2003 due primarily to the factors discussed previously pertaining to the third quarter results, and timing of tax payments in 2004 versus 2003.
In the first quarter of 2004 the Company received $162 million in cash from the sale of the entry door business. In the second and third quarters of 2004 $22 million and $10 million, respectively, of related income taxes were paid, and approximately $18 million of remaining income taxes will be disbursed in later quarters.
In the third quarter of 2004, the Company entered into a new financing arrangement under which an independent third party will provide revolving credit to Mac Tools distributors' end customers for product purchases. This new program will lower the Company's risk and working capital requirements, while providing Mac Tools' end customers with increased financing flexibility. In connection with this transaction, existing accounts receivable related to the Company's Mac Advantage financing program were sold. Of the $47 million total proceeds, approximately $35 million were used to reduce amounts outstanding under the Company's receivables securitization facility. The remaining $12 million was applied to reduction of outstanding debt. The effect of this transaction on third quarter 2004 operating cash flow is a positive $12 million.
Cash payments for acquisitions amounted to $258 million year-to-date.
Aside from normal debt service payments, the Company repaid $120 million of long-term debt which matured on March 1, 2004, and cash inflows for the nine months ended October 2, 2004 from short-term borrowings, principally commercial paper, amounted to $170 million. Overall net cash inflows of $24 million from borrowing activities were realized in the nine months ended October 2, 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 the current portion of long-term debt.
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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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
| | | | | | |
| | 4 | (i) | | $400,000,000 Credit Agreement dated as of October 14, 2004 with the Lenders named therein, Citibank, N.A. as Administrative Agent, Citigroup Global Markets, Inc. as Lead Arranger and Book Runner, and Fleet National Bank, BNP Paribas and UBS Securities as Co-Syndication Agents |
| | 10 | (i) | | Schedule of Certain Executive Officers who are Parties to Change in Control Severance Agreements, which agreements are incorporated by reference to Exhibit 10(i) to the Company's Quarterly Report on Form 10-Q/A for the quarterly period ending June 28, 2003 |
| | 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 |
|
(b) Reports on Form 8-K
| | |
| (i) | The Company filed a current report on Form 8-K dated July 26, 2004 with respect to the Company's press release reporting the Company's results for the second quarter 2004 and providing guidance for the third quarter and full year 2004 and for the full year 2005. |
CAUTIONARY STATEMENT
Certain statements contained in this Quarterly Report on Form 10-Q, including but not limited to those regarding the Company's ability to (i) achieve its deleveraging goals in 2004 and to capitalize on further acquisition opportunities over the longer term; (ii) limit the effects of commodity inflation to $70-$75 million in the year 2004 and offset approximately 60% thereof with related price increases; (iii) complete restructuring activities within existing restructuring and asset impairment reserve by mid 2005 and (iv) consummate the expected sale of its home décor business and realize after tax net proceeds of approximately $65 million and a net after tax gain of approximately $30 million; 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.
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The Company's ability to deliver the results as described above (the "Results") is dependent upon (i) the success of the Company in identifying, negotiating and closing future acquisitions and integrating its recent (as well as future) 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; (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; and (v) the satisfaction or waiver of the remaining contingencies under the aforementioned agreement to sell its home décor business including but not limited to purchaser financing, customary clearances and consents from third parties and regulators and the finalization of customary documentation to permit the sales of the business' assets in France, Italy and other non-U.S. jurisdictions.
The Company's ability to deliver the Results is also dependent upon (i) the continued success of the Company's marketing and sales efforts, including the Company's ability to recruit and retain an adequate sales force; (ii) 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; (iii) the success of recruiting programs and other efforts to maintain or expand overall Mac Tools truck count versus prior years; (iv) the ability of the Company to fulfill increasing demand for its products; (v) the ability to continue successfully managing and defending claims and litigation; (vi) 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 (vii) the identification of overhead cost reduction opportunities and effective execution of the same.
The Company's ability to achieve the Results will also be affected by external factors. These external factors will 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 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 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: November 12, 2004
| By: /s/ James M. Loree |
| James M. Loree
Executive Vice President
and Chief Financial Officer |
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