sales to large home center and mass merchant customers in North America due to the success of new product launches such as the Company's second generation of garage storage end items and consumer fastening products. Also, the Consumer Mechanics Tools business experienced increased demand in the U.S. due to increased promotional programs with home center and mass merchant customers. Volume contributed to 13% of the increase, while favorable pricing and currency contributed 1% each. Operating profit was $57 million, or 19.3% of net sales, for the third quarter of 2005, compared to $42 million, or 16.2% of net sales, in 2004 due primarily to volume leverage and reduced advertising spending which was concentrated during the first six months of 2005. On a year to date basis, Consumer Products net sales in 2005 were $826 million, a 6% increase from $777 million in 2004, reflecting volume increases of 4% along with favorable pricing and foreign currency impacts of 1% each. Year to date operating profit in 2005 was $141 million, or 17.1% of net sales, compared to $126 million, or 16.2% of net sales in 2004. The improvement in the year to date operating profit rate is related to the increase in third quarter sales volume partially offset by the drop in first quarter sales volume caused by inventory reduction programs entered into by several large retailers and the impact of commodity cost inflation as discussed above.
$96 million, or 15.6% of net sales, compared to $84 million, or 16.7% of net sales in 2004 primarily due to the factors discussed above pertaining to the third quarter results, offset by $2 million of increased consulting costs, and the negative impact of first quarter 2005 weather issues and acquisition impacts.
Restructuring
During the third quarter of 2005, the Company initiated a $1.8 million cost reduction program primarily at its Mechanical Access, Fastening and European operations. The action was comprised of the severance of 54 employees. Of this amount, $0.8 million has been utilized to date with $1.0 million of accrual remaining as of October 1, 2005. Approximately $0.7 million of such charge was recorded in the Security Solutions segment; $0.8 million was recorded in the Industrial Tools segment; and $0.3 million was recorded in the Consumer Products segment.
During the second quarter of 2005, the Company initiated a second phase of cost reduction activities at its Blick business, included in the Company's Security Solutions segment, of which $1.6 million was recorded to restructuring expense, with an additional charge of $0.5 million incurred during the third quarter in relation to stay bonus benefits offered to certain employees. This action was taken to streamline Blick's business model and primarily entailed the severance of approximately 50 employees. Of this amount, $1.5 million has been utilized to date with $0.5 million of accrual remaining as of October 1, 2005.
In connection with its second quarter acquisition of Precision, the Company recorded $0.7 million relating to severance costs to the initial purchase price allocation which has been fully utilized as of October 1, 2005. The Company plans to finalize its acquisition date integration plans for Precision during the fourth quarter of 2005.
In connection with its acquisitions of ISR and Security Group, the Company recorded $1.4 million of restructuring reserves in the purchase price allocation comprised of $1.1 million of severance and $0.3 million of lease exit costs. Of this amount, $0.7 million has been utilized to date with $0.7 million of accrual remaining as of October 1, 2005.
In addition to the above actions, $1.3 million of severance reserves associated with the "Operation 15" initiative and $0.2 million of reserves associated with the first quarter 2004 acquisitions remain. The Company expects the aggregate $3.7 million of restructuring reserves at October 1, 2005 to be substantially expended by the end of 2005. Refer to Note I for additional information.
FINANCIAL CONDITION
Liquidity, Sources and Uses of Capital: Operating cash flows were $75 million in the third quarter of 2005 compared to $99 million in the third quarter of 2004. Working capital reflects higher receivables associated with strong sales volume toward the end of the quarter and higher income tax payments occurred in 2005. On a year to date basis, operating cash flow of $212 million in 2005 decreased by $30 million from 2004 based on an increase in working capital, partly offset by the liquidation of certain financing lease receivables during the first quarter of 2005 which generated $43 million in cash.
In the third quarter of 2005, cash payments for acquisitions, principally Pinnacle and ABZ which were partially offset by favorable working capital purchase price adjustments received from the ISR and Precision former shareowners, totaled $4 million. Year to date acquisition spending was $110 million, reflecting the first and second quarter acquisitions of Security Group, Rolatape, Precision and Sielox, which was significantly lower than the $258 million outflow in the first nine months of 2004 when Blick, Frisco Bay and CST/Berger were acquired. Investing cash flows associated with the sales of businesses reflect the March 2004 disposal of the Residential Entry Door business which generated cash proceeds of $162 million, and income tax payments pertaining to the gain on sale of this business as well as the Home Décor business that was divested in December 2004. As part of the current profitable growth strategy, the Company will continue to assess and make acquisitions that increase shareowner value and diversify the risk associated with large customer concentrations. Capital expenditures for the third quarter and first nine months of 2005 were higher than the corresponding 2004 periods due to information system upgrades and plant investments in China and Thailand. The Company expects future capital expenditures to increase approximately in proportion to its sales growth.
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The Company incurred net cash outflows of $43 million from financing activities in the third quarter of 2005 versus net cash outflows of $46 million in 2004 primarily due to increased payments made on short-term borrowings, offset by higher proceeds received from stock option exercises. Year to date net cash inflows from financing activities of $51 million were $73 million higher than financing activities outflow in 2004 due to the factors discussed pertaining to the third quarter results along with the first quarter 2004 repayment of $120 million of long-term debt which matured on March 1, 2004.
As discussed, the Company announced that it has made firm offers to purchase Facom for 410 million euros (approximately $500 million) and National for $170 million in cash. Closing of these transaction are expected to occur by year-end 2005 or shortly thereafter pending satisfaction of regulatory approvals and other requirements. The Company expects to fund these acquisitions through existing cash resources and debt, with the intention of preserving its current upper-tier investment grade credit ratings. The Company is evaluating debt financing of $400 million - $500 million which is expected to occur during the fourth quarter of 2005.
In order to limit the U.S. dollar price related to the acquisition of Facom, the Company entered into a currency call option with a notional value of 150 million euros, and a scheduled expiration date of November 1, 2005. Under the terms of this call option, the Company paid a $2 million premium for the right (but not obligation) to purchase 150 million euros at an exchange rate of 1.31 to the U.S. dollar. Because this financial instrument pertains to a proposed acquisition, changes in fair value must be recorded in the results of operations. Other-net for the first nine months of 2005 reflects a $2.0 million loss for this call option comprised of the $2 million premium paid. The fair value of the instrument at the end of the period was nominal. The Company is not exposed to any loss beyond the premium paid for this call option, and would recognize a gain in the event that the market exchange rate for the euro exceeds 1.31 at the date the acquisition is consummated.
The Company will continue to assess the possibility of repurchasing some of its outstanding common stock. Such decision would be based on a number for factors including the level of acquisition activity, the market price of the Company's common stock and the current financial condition of the Company with an aim to maintain the Company's current upper-tier credit ratings. At this time, no plan to repurchase stock has been finalized.
MARKET RISK
On July 21, 2005 China announced it will let the Chinese RMB ("RMB") fluctuate ending its decade-old valuation peg to the U.S. dollar. Since the announcement, the RMB has remained stable, maintaining its 2% increase in value against the U.S. dollar. The Company sources significant products from China and other Asian low cost countries for resale in other regions. To the extent the RMB or these other currencies appreciate with respect to the U.S. dollar, the Company may experience cost increases on such purchases. While the present 2% appreciation of the RMB should not generate material cost increases for RMB denominated purchases, further appreciation of this or other currencies utilized for procurement could adversely affect profitability. In the event significant RMB or other currency appreciation occurs, the Company would initiate customer pricing or other actions in an effort to mitigate the related cost increases, but it is possible such actions would not fully offset the potential unfavorable impact.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no significant change in the Company's exposure to market risk during the third quarter of 2005. For discussion of the Company's exposure to market risk, refer to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, contained in the Company's Form 10-K for the year ended January 1, 2005.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including the Company's Chairman and Chief Executive Officer and its Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures, as of October 1,
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2005, pursuant to Rule 13a-15(e) of the Securities Exchange Act of 1934. Based upon that evaluation, the Company's Chairman and Chief Executive Officer and its Chief Financial Officer have concluded that, as of October 1, 2005, 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 has been no change in the Company's internal controls that occurred during the third quarter of 2005 that have materially affected or are reasonably likely to materially affect the registrant's internal control over financial reporting. During the fourth quarter of 2004 and the first nine months of 2005, the Company has invested approximately $147 million in the acquisition of businesses. Management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of these recently acquired businesses. As part of its ongoing integration activities, the Company is continuing to incorporate its controls and procedures into these recently acquired businesses.
CAUTIONARY STATEMENT
Under the Private Securities Litigation Reform Act of 1995
Certain statements in this Quarterly Report on Form 10-Q, including but not limited to those regarding the Company's ability to: (i) obtain the required approvals and satisfy the customary conditions necessary to complete and close the Facom and National acquisitions by year end 2005 or shortly thereafter; (ii) realize benefits related to the Facom acquisition including joint efforts in product sourcing and procurement; (iii) realize fully diluted EPS accretion from the proposed Facom acquisition amounting to approximately 10 cents per share in 2006 increasing to 65 cents per share in 2008 when 35 million euros ($42 million) in pre-tax synergies are expected to be realized; (iv) realize benefits from the National acquisition that will be nominally accretive to earnings in 2006 and accretive to fully diluted earnings per share by approximately 10 cents in 2007; (v) repatriate $245 million in foreign earnings and limit the tax liability related to the same to $14.9 million; (vi) finalize its acquisition date integration plans for Precision during the fourth quarter of 2005; (vii) substantially expend the aggregate $3.7 million of restructuring reserves at October 1, 2005 by the end of 2005; (viii) fund the Facom and National acquisitions through existing cash resources and debt, with the intention of preserving its current upper-tier investment grade credit ratings; (ix) continue to make acquisitions that increase shareowner value and diversify the risk associated with large customer concentrations; (x) keep future capital expenditure increases proportional to sales growth; (xi) limit full year commodity and energy cost inflation impact to approximately $40 – 45 million with an estimated additional $10 million of labor inflation; (xii) deliver price increases between $30 – 40 million for the total year; (xiii) limit the impact of Statement of Financial Accounting Standards ("SFAS") 154, 123R, 153 and 151 as well as Financial Accounting Standards Board Interpretation No. 47; (xiv) initiate and recognize the benefits of customer pricing (including, but not limited to price increases of $30 – 40 million for 2005) or other actions taken in an effort to mitigate commodity, energy, labor and other cost increases are forward looking and inherently subject to risk and uncertainty; and (xv) limit the fourth quarter 2005 direct cost impact associated with rising energy prices to approximately $5 million are forward looking and inherently subject to risk and uncertainty.
The Company's ability to deliver the results as described above (the "Results") is based on current expectations and involves 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 deliver the Results is dependent upon: (i) obtaining the approvals and clearances required to consummate the proposed Facom and National acquisitions; (ii) the ability of the Company to achieve the synergies anticipated as a result of the proposed Facom and National acquisitions; (iii) the success of the Company in identifying, negotiating and closing future acquisitions and integrating its recent (as well as future) acquisitions; (iv) the continued 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; (v) the need to respond to significant changes in product demand due to economic and other changes; (vi) continued improvements in productivity and cost reductions;
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(vii) the final geographic distribution of future earnings; (viii) the identification of overhead cost reduction opportunities and effective execution of the same; (ix) the Company's favorable settlement of routine tax audits; (x) the Company's ability to successfully limit to $14.9 million the costs incurred in order to repatriate $245 million cash pursuant to the American Jobs Creation Act of 2004; (xi) satisfactory payment terms under which the Company buys and sells goods, materials and products; and (xii) the success of the Company's efforts to promptly replace old equipment with more energy efficient and technologically superior equipment, enforce existing contracts relating to energy use and prices, manage energy use to maximize usage during lower cost periods and shift to lower cost sources of energy where appropriate and feasible.
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 and to maintain its customer base, including customers of acquired companies; (ii) the continued success of the Company's sales initiatives and 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 sales force to adapt to any changes made in the sales organization and achieve adequate customer coverage; (v) the ability of the Company to fulfill increasing demand for its products; (vi) the ability to continue successfully managing and defending claims and litigation; (vii) the absence or mitigation of increased pricing pressures from customers and competitors and the ability to defend market share in the face of competition; and (viii) the mitigation of any cost increases generated by, for example, continued increase in the cost of energy or significant RMB or other currency appreciation.
The Company's ability to achieve the Results will also be affected by external factors. These external factors include pricing pressure and other changes within competitive markets, the continued consolidation of customers particularly 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 and cash flow, the strength of the U.S. and global economies 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.
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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PART II – OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
The following table provides information about the Company's purchases of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act during the nine months ended October 1, 2005:
| | | | | | | | | | | | | | | | | | |
| 2005 | | (a)
Total
Number
Of Shares
Purchased | | Average
Price Paid
Per Share | | Total Number
Of Shares
Purchased As
Part Of A
Publicly
Announced
Program | | Maximum
Number Of
Shares That
May Yet Be
Purchased
Under The
Program |
| January 2 – February 5 | | | 2,241 | | | $ | 48.64 | | | | — | | | | — | |
| February 6 – March 5 | | | — | | | | — | | | | — | | | | — | |
| March 6 – April 2 | | | — | | | | — | | | | — | | | | — | |
| April 3 – May 7 | | | 189 | | | | 45.59 | | | | — | | | | — | |
| May 8 – June 4 | | | — | | | | — | | | | — | | | | — | |
| June 5 – July 2 | | | — | | | | — | | | | — | | | | — | |
| July 3 – August 6 | | | — | | | | — | | | | — | | | | — | |
| August 7 – September 3 | | | 84 | | | | 45.34 | | | | — | | | | — | |
| September 4 – October 1 | | | — | | | | — | | | | — | | | | — | |
| | | | 2,514 | | | $ | 48.30 | | | | — | | | | — | |
|
(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 taxes related to the vesting or delivery of a combination of restricted share units and long-term incentive shares.
ITEM 6. EXHIBITS
| | |
| 10 | (i) | Form of Change in Control Severance Agreement (incorporated by reference to Exhibit 10(i) to the Quarterly Report on Form 10-Q/A for the quarter ended June 28, 2003). |
| |
| (ii) | Schedule of Certain Executive Officers who are Parties to the Change in Control Severance Agreements in the forms referred to in Exhibit 10(i) (incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K dated August 22, 2005). |
| |
| 11 | Statement re Computation of Per Share Earnings (the information required to be presented in this exhibit appears in Note C to the Company's Condensed Consolidated Financial Statements set forth in this Form 10-Q) |
| | |
| 31 | (i) | (a) Certification by Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) |
| | |
| | (b) | 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. |
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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: October 28, 2005
| By: /s/ James M. Loree
James M. Loree
Executive Vice President
and Chief Financial Officer |
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