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| SWK > SEC Filings for SWK > Form 10-K on 25-Feb-2008 | All Recent SEC Filings |
25-Feb-2008
Annual Report
The financial and business analysis below provides information which the Company believes is relevant to an assessment and understanding of its consolidated financial position, results of operations and cash flows. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes.
The following discussion and certain other sections of this Annual Report on Form 10-K contain statements reflecting the Company's views about its future performance that constitute ''forward-looking statements'' under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which the Company operates and management's beliefs and assumptions. Any statements contained herein (including without limitation statements to the effect that The Stanley Works or its management ''believes'', ''expects'', ''anticipates'', ''plans'' and similar expressions) that are not statements of historical fact should be considered forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. There are a number of important factors that could cause actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth, or incorporated by reference, below under the heading ''Cautionary Statements''. The Company does not intend to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.
BUSINESS OVERVIEW
The Company is a diversified worldwide supplier of tools and engineered solutions for professional, industrial, construction, and do-it-yourself (''DIY'') use, as well as engineered solutions and security solutions for industrial and commercial applications. Its operations are classified into three business segments: Construction & DIY (''CDIY''), Industrial and Security. The CDIY segment manufactures and markets hand tools, storage systems, fasteners, and electronic leveling and measuring tools, as these products are principally utilized in construction and do-it-yourself projects. These products are sold primarily to professional end users and distributed through retailers (including home centers, mass merchants, hardware stores, and retail lumber yards). The Industrial segment manufactures and markets: professional mechanics and storage systems, plumbing, heating, air conditioning and roofing tools, assembly tools and systems, hydraulic tools and specialty tools (Stanley supply and services). These products are sold to industrial customers and distributed primarily through third party distributors as well as direct sales forces. The Security segment is a provider of access and security solutions primarily for retailers, educational, financial and healthcare institutions, as well as commercial, governmental and industrial customers. The Company provides an extensive suite of mechanical and electronic security integration systems, software, related installation, maintenance, and a variety of security services including security monitoring services, electronic integration systems, software, related installation and maintenance services, automatic doors, door closers, exit devices, hardware and locking mechanisms.
For several years, the Company has pursued a diversification strategy to enable profitable growth. The strategy involves industry, geographic and customer diversification, as exemplified by the expansion of security solution product offerings, the growing proportion of sales outside the U.S., and the deliberate reduction of the Company's dependence on sales to U.S. home centers and mass merchants. Execution of this strategy has entailed approximately $2.2 billion of acquisitions since the beginning of 2002, several divestitures, and increased brand investments. Additionally, the strategy reflects management's vision to build a growth platform in security while expanding the valuable branded tools platform. Over the past several years, the Company has generated strong free cash flow and received substantial proceeds from divestitures that enabled a transformation of the business portfolio.
Free cash flow, as defined in the following table, was $457 million in 2007, $359 million in 2006, and $294 million in 2005, considerably exceeding net earnings. Management considers free cash flow an important indicator of its liquidity, as well as its ability to fund future growth and provide a dividend to shareowners. Free cash flow does not include deductions for mandatory debt service, other borrowing activity, discretionary dividends on the Company's common stock and business acquisitions, among other items.
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(Millions of [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Dollars) 2007 2006 2005 Net cash provided by operating [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] activities $ 544 [[Image Removed]] $ 439 [[Image Removed]] $ 362 [[Image Removed]] Less: capital [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] expenditures [[Image Removed]] (66 ) [[Image Removed]] (60 ) [[Image Removed]] (53 ) Less: capitalized [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] software [[Image Removed]] (21 ) [[Image Removed]] (20 ) [[Image Removed]] (15 ) |
The Company strives to reinvest its free cash flow in high return businesses in order to generate strong return on assets and improve working capital efficiency.
Significant areas of tactical emphasis related to execution of the Company's diversification strategy, as well as events impacting the Company's financial performance in 2007 and 2006, are discussed below.
Continued Growth of Security Business
During 2007, the Company further advanced its strategy of becoming a global
market leader in the commercial security industry. Annual revenues of the
Security segment have grown to $1.433 billion, or 32% of 2007 sales, up from
$216 million, or 10% of 2001 sales. Key events pertaining to the growth of this
segment in the past year include the following:
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• HSM Electronic Protection Services, Inc.
(''HSM'') was acquired in January 2007 for
$546 million in cash. HSM, based near Chicago,
Illinois, provides security alarm monitoring
services and access control systems to
commercial customers via a central monitoring
hub station and a network of branch locations
across the U.S. HSM combines world class
service and installation capabilities with a
broad customer base. It is the fourth largest
electronic security company and second largest
commercial monitoring company in North
America. The acquisition is enabling more
efficient utilization of our extensive network
of field technicians thus enhancing overall
profitability, as the Company is in the
process of a reverse integration of the
pre-existing electronic security business into
HSM. The addition of monitoring enables
longer-term customer relationships involving
value-added services and recurring revenues,
which aids the repositioning of electronic
security as a higher profit and higher growth
business for Stanley. HSM contributed
approximately $220 million in sales and 4
cents of diluted earnings per share in 2007;
the relatively low contribution to net
earnings reflects $36 million of non-cash
intangible asset amortization, primarily for
acquired monitoring service contracts, as well
as interest expense on borrowings necessary to
fund the acquisition.
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• Upon the January 16, 2007 acquisition of HSM,
the Company realigned to report three new
segments effective in the first quarter of
2007: CDIY, Industrial and Security. These new
segments more clearly convey the Company's
growth strategies and reflect management's
view of its businesses with the inclusion of
HSM. Also, the Company is now presenting
segment results before corporate overhead
expenses, which are not allocated to the
segments.
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• In June, 2007 Bed-Check Corporation (''Bed
Check'') was acquired for $20 million in cash.
Bed-Check is a leading U.S.-based manufacturer
of non-restrictive patient fall-monitoring
systems used by caregivers in hospitals and
other facilities. It increases the scale and
expands the distribution channels of the
Company's existing personal security business.
A wireless key-lock manufacturer and various
other small but strategic acquisitions in the
security segment were completed throughout
2007 for $21 million in cash.
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The above acquisitions complement the existing Security segment product offerings, increase its scale and strengthen the value proposition offered to customers as industry dynamics favor multi-solution providers that offer ''one-stop shopping''. The Company continues to focus on integrating the acquired
businesses as it expands the suite of its security product and service offerings. Various process improvement initiatives were initiated including integration of overlapping field service organizations and implementation of certain common back office systems. These integration efforts will continue in 2008, particularly the reverse integration of the legacy electronic security business into HSM.
While diversifying the business portfolio through expansion into Security is important, management also recognizes that the branded construction & do-it-yourself products and industrial businesses are the foundations on which the Company was established and provide strong growth and cash flow generation prospects. Management is committed to growing these strong and profitable businesses through innovative product development, brand support and relentless focus on global cost competitiveness to foster vitality over the long term. Acquisition-related growth will also be pursued where appropriate. The following matters affected the branded tool and storage businesses:
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• The Company has focused on innovation in order
to enhance its product development pipeline
and reduce commercialization cycle time. In
2007, new product roll-outs included over 250
hand tool and storage products. In 2006, the
largest new hand tools product introduction in
the Company's history was successfully
launched. The FatMax®Xtreme™ product line
commenced shipping at the end of March 2006
and was supplemented by a second phase
roll-out initiated in September 2006, which
included the initial launch of FatMax®XL™
products in European markets.
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• In July, 2007 the Company acquired Innerspace
Products Corporation (''Innerspace''), which
has a strong presence in the growing
healthcare storage market and offers
made-to-order storage solutions for medical
facilities across the U.S. Innerspace provides
a strong strategic fit for the Company's
existing Vidmar storage business and reported
2006 sales of $22 million.
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• In January 2006, the Company completed the
acquisition of Facom S.A. (''Facom'') for
407 million euros ($480 million) which was
financed with a combination of cash on hand
and debt issuance. Facom, based in France, is
a leading European manufacturer of hand and
mechanics tools with annual revenues
approximating $475 million. Facom designs,
manufactures and markets the majority of its
tool product offerings to professional
automotive and industrial end users with its
well-known industrial tool brands: Facom®,
Virax® and USAG®. Facom operates primarily
within the premium industrial and automotive
tools sector in Europe, while the Company's
pre-existing European customer base is focused
mainly on the construction and DIY channels.
As a result, the two businesses complement
each other and benefit from joint efforts in
areas such as product sourcing and
procurement. Facom is profitable and has
experienced a long history of success in
professional markets in Europe, especially in
France and Italy. Nonetheless, many of its
products are subject to competitive forces
that required a significant reformation of its
cost structure and that of existing Stanley
Europe. This reformation has enhanced the
long-term competitiveness and should help to
preserve the Facom and Stanley tool franchises
in Europe. The restructuring program reduced
costs by rationalizing manufacturing,
logistics, sales and support organizations. It
has resulted in the closure of six facilities
and the severance of approximately 450 people
since commencing in the latter part of 2006.
While the actions were completed during 2006
and 2007, $18 million in cash payments will
continue into 2008.
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• In July 2006, the Company acquired
approximately 67% of the outstanding shares of
Besco Pneumatic Corporation (''Besco''), a
leading Asian manufacturer of pneumatic tools
for $38 million in cash. Each year until 2011,
the Company will have the option to increase
its ownership by up to 15% to an ultimate
ownership of 82%. Besco, which is
headquartered in Taiwan, possesses
state-of-the-art research and development
capabilities and efficient production
facilities. Besco was historically a supplier
to Stanley fastening systems as well as third
parties. The acquisition was a key step in
reducing the fastening systems business' cost
structure.
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The Stanley® brand is recognized as one of the world's great brands and is one of the Company's most valuable assets. Brand support was increased over the past several years, including television advertising campaigns associated with new product roll-outs, continued NASCAR racing sponsorships as well as more print and web-based advertising that generated approximately one billion brand impressions annually. These advertising and marketing campaigns yielded strong results as evidenced by various hand tools metrics during 2007: web traffic increase of 20%; sales lead increase of 30%; and brand awareness increase of 34% versus 2006.
The Company continued to practice the operating disciplines encompassed by the Stanley Fulfillment System (''SFS''), which is a continuous operational improvement process committed to increasing customer and shareowner value. The SFS core disciplines consist of striving for perfect quality, service excellence, optimal cost, and environmental health & safety. The Company applies SFS to many aspects of its business including procurement, maximizing customer fill rates, and acquisition integration. The SFS program helped to mitigate the impact of material and energy price inflation that was experienced in recent years. SFS was instrumental in the reduction of inventories during 2007 and the related improvement in working capital turnover. In 2008 and beyond, the Company plans to further leverage SFS to achieve higher working capital turns, decreased cycle times, reduced complexity in operations and increased customer satisfaction.
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Aside from the strategic commentary above, four other matters having a significant impact on the Company's results were inflation, currency exchange rate fluctuations, share repurchases and stock option expensing.
The Company has been negatively impacted by inflation, primarily commodity and freight, which has increased costs by an estimated $165 million over the past three years. During this period, approximately two-thirds of the cost increase was recovered through pricing actions, and the remainder was largely offset through various cost reduction initiatives. The Company expects the negative impact of inflation affecting production and distribution costs during 2008 will be in the range of $75 - $80 million, inclusive of new tariffs on fasteners imported from Asia. Management plans to recover the majority of this impact through customer pricing, and offset the remainder through plant productivity actions.
In recent years, the strengthening of foreign currencies had a favorable impact on the translation of foreign currency-denominated operating results into U.S. dollars. The favorable impact of foreign currency translation, including acquired companies, contributed an estimated $.19, $.05 and $.04 of diluted earnings per share from continuing operations in 2007, 2006 and 2005, respectively. Fluctuations in foreign currency exchange rates relative to the U.S. dollar may have a significant impact, either positive or negative, on future earnings.
During 2007 and 2006, the Company executed share repurchases of 3.6 million and 4.0 million outstanding shares of its common stock, respectively, for $200 million in each year. The stock repurchases were accretive to diluted earnings per share by 6 cents in 2007, and 13 cents in 2006. The 2007 stock buy-backs occurred later in the year than the related 2006 activity; accordingly, the benefit of the 2007 repurchase activity will not be fully reflected in weighted average shares outstanding used to compute earnings per share until 2008. The share repurchase benefit was partially offset by the issuance of 4.4 million shares of common stock under various employee plans over the two year period, and also by higher interest expense associated with short-term borrowings made to finance the share repurchases. In January 2008 the Company repurchased an additional 2.2 million of shares.
In 2006, the Company adopted Financial Accounting Standards Board Statement No.
123 (revised 2004), ''Share-Based Payment'' (''SFAS 123R''), which requires all
share-based payments, including grants of employee stock options, to be
recognized as an expense in the Consolidated Statement of Operations based on
their fair values as they are earned by the employees under the vesting terms.
Pursuant to the adoption of SFAS 123R, the Company recognized $9 million of non-cash, pre-tax stock option compensation expense in both 2007 and 2006, which reduced diluted earnings per share by 7 cents in each year compared to 2005. Refer to Note A Significant Accounting Policies of the Notes to the Consolidated Financial Statements for further discussion of the adoption of SFAS 123R.
RESULTS OF OPERATIONS
Below is a summary of the Company's operating results at the consolidated level, followed by an overview of business segment performance. The terms ''organic'' and ''core'' are utilized to describe results aside from the impact of acquisitions during their initial 12 months of ownership. This ensures appropriate comparability to operating results of prior periods.
Net Sales: Net sales from continuing operations were $4.484 billion in 2007, as compared to $4.019 billion in 2006, a 12% increase. Acquisitions, principally HSM, contributed 7% in higher sales. Organic volume and pricing both increased 1%, while favorable foreign currency translation in all regions increased sales 3% versus the prior year. Strong performance in the Industrial segment, particularly by the hydraulic and mechanics tools businesses, was supplemented by more modest gains in the CDIY and Security segments. CDIY achieved robust growth internationally that was partially offset by weakness in the U.S. associated with housing market declines. In the Security segment, solid gains by the automatic door and mechanical lock businesses, as well as overall pricing actions, more than compensated for lower sales in the legacy electronic security integration business as it shed unprofitable equipment installations.
Net sales from continuing operations were $4.019 billion in 2006, as compared to $3.285 billion in 2005, a 22% increase. Acquisitions contributed 21% or $689 million of the sales increase. Organic sales increased 1% driven by a slight increase in volume and relatively consistent pricing levels and foreign currency impact compared to the prior year. The organic increase was generated by share gains achieved in the consumer hand tools and automatic doors businesses offset by price and volume declines experienced in the fastening . . .
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