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STANLEY BLACK & DECKER, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion contains statements reflecting the Company's views about its future performance that constitute "forward-looking statements" under the Private Securities Litigation Act of 1995. There are a number of important factors that could cause actual results to differ materially from those indicated by such forward-looking statements. Please read the information under the caption entitled "Cautionary Statement under the Private Securities Litigation Reform Act of 1995." Throughout this Management's Discussion and Analysis ("MD&A"), references to Notes refer to the notes to the (unaudited) condensed consolidated financial statements in Part 1 Item 1 of this Form 10-Q, unless otherwise indicated. BUSINESS OVERVIEW Strategy Stanley Black & Decker Inc. is a diversified global provider of power and hand tools, mechanical access solutions (i.e. automatic doors, commercial and residential locking systems), electronic security and monitoring systems and products and services for various industrial applications. The Company is continuing to pursue a diversification strategy that involves industry, geographic and customer diversification to foster sustainable revenue, earnings and cash flow growth. The Company has four growth platforms: Security (both electronic and mechanical), Engineered Fastening, Infrastructure and Healthcare Solutions. The Company intends to focus on organic growth across all of its businesses, with the majority of the acquisition-related investments being within the four growth platforms. Execution of this diversification strategy has entailed approximately $5.3 billion of acquisitions since 2002 (aside from the Black & Decker merger) and increased brand investment, enabled by strong cash flow generation. Refer to the "Strategic Objectives" section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Form 10-K for the year ended December 31, 2011 for additional strategic discussions. Capital Allocation The Company announced a 20% increase of the quarterly cash dividend to $0.49 per common share on July 18, 2012, marking the 45th consecutive annual dividend increase for the Company. The Board of Directors also authorized the repurchase of up to 20 million shares of the Company's common stock. These repurchases will be made over time at management's discretion. These actions are consistent with the Company's commitment to achieve its long term capital allocation objectives of deploying free cash flow, which includes returning approximately 1/3 of free cash flow to shareowners through continued dividend growth and opportunistic share buybacks. Segments The Company classifies its business into three reportable segments, which also represent its operating segments: Construction & Do It Yourself, Security, and Industrial. CDIY The CDIY segment is comprised of the Professional Power Tool and Accessories business, the Consumer Power Tool business, which includes outdoor products, plumbing (Pfister) and the Hand Tools, Fasteners & Storage business. The segment sells its products to professional end users, distributors and retail consumers. The majority of sales are distributed through retailers, including home centers, mass merchants, hardware stores, and retail lumber yards. Revenues in the CDIY segment were $3.991 billion for the first nine months of 2012, representing 48% of the Company's total revenues. The Professional Power Tool and Accessories business sells professional grade corded and cordless electric power tools and equipment including drills, impact wrenches and drivers, grinders, saws, routers and sanders. The business also sells power tool accessories which include drill bits, router bits, abrasives and saw blades. The Hand Tools, Fasteners & Storage business sells measuring and leveling tools, planes, hammers, demolition tools, knives, saws and chisels. Fastening products include pneumatic tools and fasteners including nail guns, nails, staplers and staples. Storage products include tool boxes, sawhorses and storage units. The Consumer Power Tool business sells corded and cordless power tools sold under the Black & Decker brand, lawn and garden products and home products. Lawn and garden products include hedge trimmers, string trimmers, lawn mowers, edgers, and related accessories. Home products include hand held vacuums, paint tools and cleaning appliances. 36-------------------------------------------------------------------------------- Table of Contents The Plumbing Products business sells plumbing fixtures primarily for residential use. Security The Security segment is comprised of the CSS and the Mechanical Access Solutions businesses. Revenues in the Security segment were $2.345 billion for the first nine months of 2012, representing 29% of the Company's total revenues. The CSS business designs, supplies and installs electronic security systems and provides electronic security services, including alarm monitoring, video surveillance, fire alarm monitoring, systems integration and system maintenance. Purchasers of these systems typically contract for ongoing security systems monitoring and maintenance at the time of initial equipment installation. The CSS business also sells healthcare solutions, which includes medical carts and cabinets, asset tracking solutions, infant protection, pediatric protection, patient protection, wander management, fall management, and emergency call products. The CSS business sells to consumers, retailers, educational, financial and healthcare institutions, as well as commercial, governmental and industrial customers. Products are sold predominantly on a direct sales basis. The Mechanical Access Solutions business sells and installs automatic doors, residential and commercial hardware, locking mechanisms, electronic keyless entry systems, keying systems, tubular and mortise door locksets. The Mechanical Access Solutions business sells to both residential and commercial customers, with distribution through direct sales, through retailers (including home centers) and, through third party distributors. Industrial The Industrial segment is comprised of the Industrial and Automotive Repair, Engineered Fastening and Infrastructure businesses. Industrial segment revenues were $1.918 billion for the first nine months of 2012, representing 23% of the Company's total revenues. The Industrial and Automotive Repair business sells hand tools, power tools, and engineered storage solution products. The business sells to industrial customers in a wide variety of industries and geographies. The products are distributed through third party distributors as well as a direct sales force. The Engineered Fastening business primarily sells engineered fastening products and systems designed for specific applications. The product lines include stud welding systems, blind rivets and tools, blind inserts and tools, drawn arc weld studs, engineered plastic fasteners, self-piercing riveting systems and precision nut running systems. The business sells to customers in the automotive, manufacturing, and aerospace industries, amongst others, and its products are distributed through direct sales forces. The Infrastructure business consists of the CRC-Evans business, and the Company's Hydraulics business. The business's product lines include custom pipe handling machinery, joint welding and coating machinery, weld inspection services and hydraulic tools and accessories. The business sells to the oil and natural gas pipeline industry and other industrial customers. The products and services are primarily distributed through a direct sales force. AcquisitionsPending Acquisition On July 23, 2012, the Company announced that it has entered into a definitive agreement to acquire Infastech, a global manufacturer and distributor of specialty engineered fastening technology based in Hong Kong for approximately $850 million. The acquisition of Infastech is expected to be approximately $0.15 accretive to the Company's diluted earnings per share in the first year and over $0.35 accretive to diluted earnings per share by Year 3. The transaction is subject to customary closing conditions and is expected to close, at the earliest, in the fourth quarter of 2012. The business would be integrated into the Company's current Engineered Fastening business, within the Industrial segment. 2012 Acquisitions In August 2012, the Company acquired Tong Lung Metal Industry ("Tong Lung") for $103 million, net of cash acquired, and assumed $20 million of short term debt. Tong Lung manufactures and sells commercial and residential lock sets and is included within the Security segment. In June 2012, the Company acquired AeroScout for $239 million, net of cash acquired. AeroScout is the market leader in Real-Time Location Systems (RTLS) for healthcare and certain industrial customers and is being integrated into the Security and Industrial segments. 37-------------------------------------------------------------------------------- Table of Contents In May 2012, the Company acquired Powers Fasteners ("Powers") for $221 million, net of cash acquired. Powers is a distributor of several complementary product groups, including: mechanical anchors, adhesive anchoring systems and powered forced-entry systems, such as powder-actuated and gas-fastening systems. Powers is being integrated into the CDIY segment and is expected to increase CDIY's penetration into commercial construction and increase independent channel distribution across the globe. In January 2012, the Company acquired Lista North America ("Lista") for $90 million, net of cash acquired. Lista's storage and workbench solutions complement the Industrial & Automotive Repair division's tool, storage, RFID, and specialty supply product and service offerings. Lista is being integrated into the Company's Industrial segment. The acquisitions of Tong Lung, AeroScout, Powers, and Lista will be relatively neutral to 2012 earnings and will have a modest accretive impact to the Company's 2013 earnings. 2011 Acquisitions In September 2011, the Company obtained a controlling share of Niscayah Group AB for a total purchase price of $984.5 million. The Company purchased the remaining shares of Niscayah during the second quarter of 2012 for $11.3 million, bringing total purchase price to $995.8 million. Niscayah is one of the largest access control and surveillance solutions providers in Europe. Niscayah's integrated security solutions include video surveillance, access control, intrusion alarms and fire alarm systems, and its offerings include design and installation services, maintenance and repair, and monitoring systems. The acquisition expands and complements the Company's existing security product offerings and further diversifies the Company's operations and international presence. Management believes the acquisition of Niscayah will result in approximately $80 million in cost synergies by the end of 2013. Additionally, the acquisition is expected to provide a benefit of approximately $0.45 of earnings per diluted share (excluding expected acquisition-related charges of $60 million to $80 million) by 2014, with $0.20 in 2012. In September 2011, the Company acquired AlarmCap for $59 million, net of cash acquired. AlarmCap is one of the leading security alarm service providers in Canada, serving more than 79,000 residential and commercial customers. It offers customers a full suite of security and related monitoring products and services, including intrusion, smoke detection and environmental services. AlarmCap and Niscayah are being integrated into the Company's Security segment. In January 2011, the Company acquired InfoLogix for $60 million, net of cash acquired. Infologix is a leading provider of enterprise mobility solutions for the healthcare and commercial industries and adds an established provider of mobile workstations and asset tracking solutions to the Company's existing healthcare solutions platform, which operates under the Company's Security segment. Divestitures HHI and Tong Lung Divestiture On October 8, 2012 the Company entered into a definitive agreement to sell its Hardware & Home Improvement business ("HHI") to Spectrum Brands Holdings, Inc. for $1.4 billion in cash. HHI is a provider of residential locksets, residential builders hardware and plumbing products marketed under the Kwikset, Weiser, Baldwin, Stanley, National and Pfister brands. HHI had 2011 annual revenues of $940 million, approximately 90% of which are derived in North America, with over 50% of its sales to U.S. home centers. With the exception of the Pfister product line, which is reported within the Company's CDIY segment, HHI is reported within Stanley's Security segment. The divestiture of the HHI business is part of the continued diversification of the Company's revenue streams and geographic footprint. Included with the sale of HHI is a portion of the previously mentioned Tong Lung business, which was acquired by the Company during the third quarter of 2012. The portion included in the sale of HHI manufactures and sells residential locksets. This portion, as well as the remaining portion of Tong Lung that manufactures and sells commercial locksets, is reported within the Company's Security segment. The sale is subject to customary closing conditions including required regulatory approvals. The closing would happen in two stages with the HHI closing occurring first, followed by a second closing for the Tong Lung business. The Company will use the proceeds to repurchase shares, partially fund the pending acquisition of Infastech, and for modest deleveraging to protect senior debt ratings. 2011 Divestitures 38-------------------------------------------------------------------------------- Table of Contents The Company sold three small businesses for total cash proceeds of $27 million. The largest of these businesses was part of the Company's Industrial segment, with the other two businesses being part of the Company's Security segment. Net sales associated with these businesses were $16.6 million and $55.7 million for the three and nine months ended September 29, 2011, respectively. These businesses were sold as the related product lines provided limited growth opportunity or were not considered part of the Company's core offerings. The operating results of these three businesses have been reported as discontinued operations in the Consolidated Statements of Operations and Comprehensive Income for 2011. Certain Items Impacting Earnings Throughout MD&A, the Company has provided a discussion of the outlook and results both inclusive and exclusive of merger and acquisition-related and other charges. Merger and acquisition-related charges related primarily to the Black & Decker merger and Niscayah acquisition while other charges related to the 2012 cost actions and the loss on debt extinguishment. The amounts and measures, including gross profit and segment profit, on a basis excluding such charges are considered relevant to aid analysis and understanding of the Company's results aside from the material impact of charges; the measures are utilized internally by management to understand business trends, as once the aforementioned anticipated cost synergies from merger and acquisitions are realized, such charges are not expected to recur. The charges are as follows: Third Quarter and Year-To-Date 2012 Merger and Acquisition-Related and Other Charges The Company reported $161 million and $324 million in pre-tax charges in the third quarter and year-to-date 2012 periods, respectively, pertaining to merger and acquisition-related and other charges which were comprised of the following: • $12 million and $26 million for the third quarter and year-to-date 2012 periods, respectively, reducing Gross Profit pertaining mainly to facility closure-related charges; • $39 million and $101 million for the third quarter and year-to-date 2012 periods, respectively, in SG&A primarily for integration-related administrative costs, consulting fees, and employee related matters; • $12 million and $38 million for the third quarter and year-to-date 2012 periods, respectively, in Other, net primarily for deal transaction costs; • $45 million for the third quarter and year-to-date 2012 periods, in Loss on debt extinguishment, associated with the loss on extinguishment of $900.0 million of debt maturities; and • $53 million and $114 million for the third quarter and year-to-date 2012 periods, respectively, in restructuring charges primarily for Niscayah-related restructuring charges and costs containment actions associated with the severance of employees. The tax effect on the above charges during the third quarter of 2012 was a $44 million tax benefit, resulting in after-tax merger and acquisition-related and other charges of $117 million, or $0.71 per diluted share. On a year-to-date basis, the tax effect on the above charges, some of which were not tax deductible, was a $78 million benefit, resulting in an after-tax charge of $246 million, or $1.46 per diluted share. Third Quarter and Year-To-Date 2011 Merger and Acquisition-Related Charges The Company reported $86 million and $173 million in pre-tax charges in the third quarter and year-to-date 2011 periods, respectively, pertaining to the merger and acquisition-related charges which were comprised of the following: • $15 million and $26 million for the third quarter and year-to-date 2011 periods, respectively, reducing Gross Profit primarily to facility closure-related charges; • $22 million and $56 million for the third quarter and year-to-date 2011 periods, respectively, in SG&A primarily for integration-related administrative costs, consulting fees, and employee related matters; • $34 million and $44 million for the third quarter and year-to-date 2011 periods, respectively, in Other, net for deal transaction costs; and • $15 million and $47 million for the third quarter and year-to-date 2011 periods, respectively, in restructuring charges for severance and charges associated with the closure of facilities. The tax effect on the above charges during the third quarter of 2011 was a $22 million provision, resulting in after-tax charges of $64 million, or $0.37 per diluted share. On a year-to-date basis, the tax effect on the above charges, some of which were not tax deductible, was $26 million, resulting in an after-tax charge of $147 million, or $0.86 per diluted share. The year-to-date tax effect of $26 million is also impacted by the inclusion of $18 million of uncertain tax positions related to ongoing operational and legal entity integrations. 2012 Outlook 39-------------------------------------------------------------------------------- Table of Contents This outlook discussion is intended to provide broad insight into the Company's near-term earnings and cash flow generation prospects. The Company expects full year diluted earnings per share to approximate $3.65 in 2012, inclusive of $350 million merger and acquisition related and other charges consisting of restructuring and related costs associated with severance of employees and facility closure and certain compensation charges, advisory and consulting fees, as well as the charges associated with the 2012 cost actions and the charges associated with the July 2012 extinguishment of debt. Excluding such charges, 2012 earnings per diluted share is expected to approximate $5.25. The Company expects full year free cash flow, excluding merger & acquisition-related charges and payments, to approximate $1.2 billion. The 2012 outlook assumes that organic net sales will increase 1% on a pro-forma basis (assumes Niscayah was owned for the full year 2011); the Company will continue to execute on Black & Decker cost and revenue synergies, along with the cost synergies associated with the Niscayah integration; and the Company will deliver on proactive cost containment actions in addition to integration driven cost synergies. The Company's has decided to intensify it's focus on increasing organic growth and is concentrated in six major areas: (1) increase presence in emerging markets in the Power Tools, Hand Tools and Commercial Hardware businesses, (2) create a "smart" tools and storage market using radio frequency identification (RFID) and real time locating system (RTLS) technology, (3) leverage the AeroScout RTLS capability into the electronic security market including the acute care vertical within the Company's Healthcare Solutions business, (4) expand the Company's market penetration with U.S. government customers in the Healthcare, Security, and Industrial verticals, (5) grow offshore oil and gas pipeline service revenue in the Company's CRC-Evan's business, and (6) continue to identify and realize revenue synergies associated with the Black & Decker Merger. Over the next three years the Company will invest approximately $150 million ($100 million of recurring operating expense and $50 million of capital) to support these initiatives, including $15 million of operating expenses in the fourth quarter of 2012. The Company expects that investment and achievement in these growth areas will generate $800 to $900 million of incremental revenue over the same three year period. RESULTS OF OPERATIONS Terminology: 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 were $2.787 billion in the third quarter of 2012 compared to $2.620 billion in the third quarter of 2011, representing an increase of $167.0 million, or 6%. Organic growth remained relatively flat, acquisitions provided a 9% increase in net sales, while the unfavorable effects of foreign currency translation caused a 3% decrease. The CDIY segment grew 4% organically, in comparison to the corresponding 2011 period, which was driven by the success of new product development and market share gains. In the Industrial segment, organic sales fell approximately 2% relative to the third quarter of 2011, as strength in the Engineered Fastening business was more than offset by IAR exposure to weakening European markets and declines in the Infrastructure business due to the slow large diameter onshore pipeline market as well as declining scrap steel prices. Organic net sales in the Security segment decreased approximately 3% relative to the third quarter of 2011, due to European exposure and weakness within the MAS business in the US tied to slow commercial construction, soft National Account spending and a product gap within the commercial mechanical lock business. From a geographic standpoint, Europe declined 3% organically, while North America remained relatively flat. The Company succeeded in achieving growth in targeted emerging markets, led by 15% organic growth in emerging Asia, followed by 12% growth in Latin America. On a year-to-date basis, net sales totaled $8.254 billion, up 9% compared to $7.585 billion of net sales in the first nine months of 2011. Organic growth provided a 2% increase in net sales and acquisitions provided an additional 10% increase, while unfavorable effects of foreign currency translation resulted in a decrease of 3% of net sales. The primary driver of growth for first nine months of 2012 was the CDIY segment, adding 4% organic growth. Additionally, the Industrial segment achieved 2% organic growth, as strong Engineered Fastening growth was largely offset by weakness in the IAR and Infrastructure businesses. Organic growth within the Security segment contracted 3%, primarily due to weak vertical markets and European exposure. Gross Profit: Gross profit was $1.010 billion in the third quarter of 2012, compared to $968.3 million in the third quarter of 2011, or 36.2% and 37.0% of net sales for each quarter, respectively. Merger and acquisition-related charges, which reduced gross profit, were approximately $12 million in the third quarter of 2012 and $15 million in the third quarter of 2011. Excluding these charges, gross profit was 36.6% of net sales in 2012 and 37.5% of net sales in 2011. The decrease in the profit rate year over year reflects positive impacts from productivity projects and cost synergies, both of which were more than offset by inflation and negative mix driven by higher revenues in CDIY, which has lower profit margins than Security and Industrial. Year-to-date gross profit was $3.018 billion or 36.6% of net sales, compared to $2.809 billion or 37.0% of net sales for the nine month periods ended September 29, 2012 and October 1, 2011, respectively. Merger and acquisition-related charges, which 40-------------------------------------------------------------------------------- Table of Contents reduced gross profit, were approximately $26 million in both the first nine months of 2012 and 2011. Excluding these charges, gross profit was 36.9% of net sales in 2012 and 37.4% of net sales in 2011. The year-to-date decrease in the profit rate is due to the same factors which impacted the third quarter. SG&A Expenses: SG&A, inclusive of the provision for doubtful accounts, was $655.7 million, or 23.5% of net sales, in the third quarter of 2012 compared to $639.7 million, or 24.4% of net sales, in the third quarter of 2011. Within SG&A, merger and acquisition-related compensation costs and integration-related expenses totaled approximately $39 million and $22 million, respectively, for the third quarter of 2012 and 2011. Excluding these merger and acquisition-related charges, SG&A was 22.1% of net sales in 2012 compared to 23.6% of net sales in the prior year. On a year-to-date basis, SG&A, inclusive of the provision for doubtful accounts, was $2.005 billion or 24.3% of net sales in 2012 compared to $1.872 billion or 24.7% of net sales in 2011. Excluding merger and acquisition-related charges of approximately $101 million and $56 million, respectively, during the first nine months of 2012 and 2011, SG&A was 23.1% and 23.9% of net sales, respectively. The favorable SG&A rate, for the third quarter and on a year-to-date basis, primarily reflects sales volume leverage and continued cost containment efforts. Distribution center costs (i.e., warehousing and fulfillment facility and associated labor costs) are classified within SG&A. This classification may differ from other companies who may report such expenses within cost of sales. Due to diversity in practice, to the extent the classification of these distribution costs differs from other companies, the Company's gross profits may not be comparable. Corporate Overhead: The corporate overhead element of SG&A, which is not allocated to the business segments, amounted to $61.8 million in the third quarter of 2012 and $55.3 million in the third quarter of 2011, or 2.2% of net sales in both periods. Excluding merger and acquisition-related charges, the corporate overhead element of SG&A was $39.3 million and $36.4 million in the third quarter of 2012 and 2011, respectively, or 1.4% of net sales in 2012 and 1.3% of net sales in 2011. On a year-to-date basis, the corporate overhead element of SG&A amounted to $184.7 million in 2012, compared to $172.4 million in 2011, both of which represent 2.2% of net sales in the corresponding periods. Excluding merger and acquisition-related charges, the corporate overhead element of SG&A was $127.0 million and $122.1 million for the first nine months of 2012 and 2011, respectively, or 1.5% of net sales in 2012 and 1.6% of net sales in 2011. Other, net: Other, net expense amounted to $77.0 million in the third quarter of 2012 versus $89.6 million in 2011. Excluding merger and acquisition-related and other charges, Other, net was $65.1 million and $55.8 million in the third quarter of 2012 and 2011, respectively. The quarter-to-date fluctuation is largely due to incremental amortization expense from intangible assets associated with the Niscayah acquisition and other 2012 acquisitions. On a year-to-date basis, Other, net expense was $248.7 million in 2012 as compared with $201.7 million in 2011. Excluding merger and acquisition-related and other charges, Other, net was $211.3 million and $158.1 million in first nine months of 2012 and 2011, respectively. The increase is primarily attributable to increased amortization expense as well as unfavorable impacts of foreign currency. Loss on debt extinguishment: As discussed in Note H, Long Term Debt and Financing Arrangements, in the third quarter of the 2012 the Company recorded a net pre-tax loss of $45 million associated with the extinguishment of $900.0 million of debt maturities. Interest, net: Net interest expense in the third quarter of 2012 was $34.1 million versus $26.8 million in 2011. On a year-to-date basis, net interest expense was $97.6 million compared to $83.2 million in the prior year. The increase in interest expense, net, for both quarter to date and year-to-date mainly relates to lower interest income stemming from lower cash balances. Income Taxes: The Company recognized income tax expense of $28.8 million and $116.7 million for the three and nine month periods ended September 29, 2012 respectively, resulting in an effective tax rate of 20.0% and 23.0% for the respective periods. The effective tax rate differs from the U.S. statutory tax rate for the three and nine month periods ended September 29, 2012, primarily due to a portion of the Company's earnings realized in lower-taxed foreign jurisdictions, the favorable settlement of certain tax contingencies, and the realization of a foreign deferred tax asset attributable to the reduction of a valuation allowance for certain net operating losses. The income tax expense for the three and nine month periods ended October 1, 2011, were $35.1 million and $86.0 million, respectively, resulting in an effective tax rate of 17.8% and 14.3% for the respective periods. The effective tax rate differs from the statutory tax rate for the three and nine month periods ended October 1, 2011 primarily due to a portion of the Company's earnings realized in lower-taxed foreign jurisdictions, the realization of benefits attributable to the reduction of certain foreign jurisdiction valuation allowances and the resolution of certain tax positions pertaining to prior years. The income tax expense for the nine month period includes tax benefits of $69.2 million for the favorable settlement of certain tax contingencies partially offset by the inclusion of $17.5 million of uncertain tax positions related to ongoing operational and legal entity 41-------------------------------------------------------------------------------- Table of Contents integrations. Business Segment Results The Company's reportable segments are aggregations of businesses that have similar products, services and end markets, amongst other factors. The Company utilizes segment profit (which is defined as net sales minus cost of sales and SG&A aside from corporate overhead cost), and segment profit as a percentage of net sales to assess the profitability of each segment. Segment profit excludes the corporate overhead expense element of SG&A, other-net (inclusive of intangible asset amortization expense), restructuring charges, interest income, interest expense and income tax expense. Corporate overhead is comprised of world headquarters facility expense, cost for the executive management team and the expense pertaining to certain centralized functions that benefit the entire Company, but are not directly attributable to the businesses, such as legal and corporate finance functions. Refer to Note N, Restructuring and Asset Impairments, of the Notes to the Condensed Consolidated Financial Statements for the amount of restructuring charges attributable to each segment. As discussed previously, the Company's operations are classified into three reportable segments, which also represent its operating segments: CDIY, Security, and Industrial. CDIY: Third Quarter Year-to-Date (Millions of Dollars) 2012 2011 2012 2011 Net sales $ 1,376.1 $ 1,337.6 $ 3,991.5 $ 3,912.8 Segment profit $ 200.3 $ 169.8 $ 564.6 $ 516.9 % of Net sales 14.6 % 12.7 % 14.1 % 13.2 % CDIY net sales increased $38.5 million, or 3% in 2012 compared to third quarter 2011. CDIY grew 4% organically, reflective of successful new product launches, revenue synergies and market share gains. Market share gains stemmed from strength in the Company's Hand and Power Tool businesses in the U.S., U.K., and in emerging markets. The segment overcame European weakness through growth in global markets including 13% organic growth in Latin America. The successful execution of revenue synergy plans led growth within hand tools, which has enabled this part of the business to grow significantly in the emerging markets. Acquisitions contributed an additional 3% of sales growth, which was offset by a 4% decline due to unfavorable changes in foreign currency translation. On a year-to-date basis, net sales increased $78.7 million or 2% in the first nine months of 2012 compared to the first nine months of 2011. Organic growth contributed 4%, complemented by an additional 1% from acquisitions, partially offset by 3% of unfavorable currency translation. Organic sales increases were driven by the same factors impacting the third quarter and also the ongoing success of the DEWALT hand tool launch which commenced in the second quarter of 2011. Segment profit amounted to $200.3 million, or 14.6% of net sales, for the third quarter of 2012, compared to $169.8 million or 12.7% of net sales in 2011. Excluding $17.2 million in merger and acquisition-related charges, segment profit totaled $217.5 million, or 15.8% of net sales for the third quarter of 2012 which compares to segment profit of $176.5, or 13.2% of net sales in the third quarter of 2011 (excluding $6.7 million in merger and acquisition-related charges). Segment profit rose 260 basis points to its highest level since the Black & Decker merger due to cost synergies and volume leverage. Year-to-date segment profit for CDIY was $564.6 million or 14.1% of net sales, compared to $516.9 million or 13.2% of net sales for the corresponding 2011 period. Excluding $31.0 million in merger and acquisition-related charges, segment profit amounted to $595.6 million, or 14.9% of net sales in 2012, compared to $530.2 million or 13.6% in 2011 (excluding $13.3 million in merger and acquisition-related charges). Gross margin improved on a year-to-date basis due to the same factors which impacted the third quarter. Security: Third Quarter Year-to-Date (Millions of Dollars) 2012 2011 2012 2011 Net sales $ 789.7 $ 648.2 $ 2,344.7 $ 1,811.2 Segment profit $ 120.2 $ 107.3 $ 319.2 $ 283.8 % of Net sales 15.2 % 16.6 % 13.6 % 15.7 % Security net sales increased $141.5 million, or 22% in the third quarter of 2012 from $648.2 million in the third quarter of 2011, primarily driven by the Niscayah acquisition, which increased sales by 26%. Unfavorable foreign currency translation 42-------------------------------------------------------------------------------- Table of Contents reduced net sales by 1% and organic revenue declined 3% as volume decreases were partially offset by pricing increases. From a geographic standpoint, volume decline in Europe was partially offset by stronger end markets in the U.S. and Canada. CSS experienced mild declines due to anticipated weakness in European markets offsetting gains in the legacy CSS North America business driven by backlog conversion. The commercial lock business continued to be affected by weakness in the U.S retrofit market while the Access Technologies business had similar challenges due to reductions in capital spend by its largest customer. Healthcare organic revenue declined due to lower hospital capital expenditures. These declines were partially offset by growth in the Company's residential hardware business. On a year-to-date basis, net sales increased $533.5 million or 29% in the first nine months of 2012, from the first nine months of 2011. The Niscayah acquisition contributed 34% of the increase over the comparable 2011 period. Organic revenue declined 3% and unfavorable currency translation reduced net sales by 2%. The year-to-date organic revenue decline continues to be driven by the same factors which impacted the third quarter. Segment profit for the quarter was $120.2 million or 15.2% of net sales, compared to $107.3 million or 16.6% of net sales in 2011. Excluding Niscayah, as well as merger and acquisition-related charges of $10.2 million, segment profit amounted to 18.8% of net sales in the third quarter of 2012, compared to 19.2% of net sales in the third quarter of 2011(excluding Niscayah and $11.1 million in merger and acquisition-related charges). The slight quarter to date margin decline is reflective of pressure from volume declines which was largely offset by cost containment actions. On a year-to-date basis segment profit was $319.2 million or 13.6% of net sales in the first nine months of 2012, compared to $283.8 million or 15.7% of net sales in the first nine months of 2011. Excluding merger and acquisition-related charges of $34.7 million, segment profit amounted to $353.9 million or 15.1% of net sales in the first nine months of 2012, compared to segment profit of $301.5 million or 16.6% of net sales in the first nine months of 2011 (excluding $17.7 million in merger and acquisition-related charges). Year-to-date margin declines are primarily attributable to absorption pressure from volume declines in Europe. Industrial: Third Quarter Year-to-Date (Millions of Dollars) 2012 2011 2012 2011 Net sales $ 620.9 $ 633.9 $ 1,917.6 $ 1,860.5 Segment profit $ 95.1 $ 106.8 $ 314.1 $ 308.7 % of Net sales 15.3 % 16.8 % 16.4 % 16.6 % Industrial sales amounted to $620.9 million in the third quarter of 2012, down 2% from $633.9 million in the third quarter of 2011. Net sales declined 1% organically and 4% due to unfavorable currency exchange. Acquisitions provided 3% growth. Organic sales declines are primarily attributable to weakness in European end markets, especially in IAR and portions of the Engineered Fastening businesses. The Infrastructure business was negatively impacted by the weak large diameter onshore pipeline market and depressed scrap metal prices which negatively impact the Hydraulics business. Partially offsetting these declines was a strong performance by the Engineered Fastening business, which continues to post solid organic growth and gain market share despite weak automotive end markets. Year-to-date sales were $1.918 billion, a 3% increase from 2011 sales of $1.861 billion. The segment grew 2% organically, primarily though increased volume. The impact of acquisitions provided an additional increase of 4%, which was partially offset by a 3% reduction from unfavorable currency translation. Net sales growth has been primarily driven by continued strong organic growth in the Engineered Fastening business, growth in the Mac Tools mobile distribution channel and the offshore pipeline business. Year to date increases have been partially offset by overall weakness in the European markets. Industrial segment profit for the third quarter of 2012 was $95.1 million, or 15.3% of net sales, compared to $106.8 million or 16.8% of net sales in the third quarter of 2011. Excluding $0.6 million in merger and acquisition-related charges, segment profit was $95.7 million, or 15.4% of net sales in the third quarter of 2012 and $107.3 million, or 16.9% of net sales in the third quarter of 2011 (excluding $0.5 million in merger and acquisition-related charges). Engineered Fastening continued to produce strong automotive results and drove its operating margin significantly higher by fueling top-line growth while keeping operating expenses flat to last year, reflective of cost containment actions. IAR and Infrastructure faced strong operating margin headwinds as cost containment actions were insufficient to offset volume declines. On a year-to-date basis Industrial profit totaled $314.1 million or 16.4% of net sales in the first nine months of 2012, compared to $308.7 million or 16.6% of net sales in the first nine months of 2011. Excluding merger and acquisition-related charges of $3.6 million, Industrial profit amounted to $317.7 million, or 16.6% of sales in the first nine months of 2012 and $309.5 million, or 16.6% of net sales, in the first nine months of 2011 (excluding $0.8 million in merger and acquisition-related 43-------------------------------------------------------------------------------- Table of Contents charges). The profit rate remained consistent, attributable to sales volume leverage within Engineered Fastening and the success of cost containment measures offset by volume and cost absorption issues in IAR and Infrastructure businesses. RESTRUCTURING ACTIVITIES A summary of the restructuring reserve activity from December 31, 2011 to September 29, 2012 is as follows (in millions): 12/31/2011 Additions, net Usage Currency 9/29/2012 2012 Actions Severance and related costs $ - $ 91.5 $ (56.1 ) $ 0.5 $ 35.9 Facility closures - 15.2 (10.1 ) - 5.1 Asset impairments $ - $ 10.8 $ (10.8 ) $ - $ - Subtotal 2012 actions $ - $ 117.5 $ (77.0 ) $ 0.5 $ 41.0 Pre-2012 Actions Severance and related costs $ 82.4 $ (5.9 ) $ (25.8 ) $ 0.3 $ 51.0 Facility closures 1.7 2.5 (0.2 ) - 4.0 Subtotal Pre-2012 actions 84.1 (3.4 ) (26.0 ) 0.3 55.0 Total $ 84.1 $ 114.1 $ (103.0 ) $ 0.8 $ 96.0 2012 Actions: In the first nine months of 2012, the Company continued with restructuring activities associated with the Black & Decker merger, Niscayah and other acquisitions, and recognized $59.2 million of restructuring charges related to activities initiated in the current year. Of those charges, $37.5 million relates to severance charges associated with the reduction of approximately 500 employees, $10.9 million relates to facility closure costs, and $10.8 million relates to asset impairment charges. For the three months ended September 29, 2012, the Company recognized $28.6 million of restructuring charges related to activities initiated in the current year. Of those charges, $16.6 million relates to severance charges associated with the reduction of approximately 150 employees, $1.2 million relates to facility closure costs, and $10.8 million relates to asset impairment charges. In addition, the Company has initiated cost reduction actions in the first nine months of 2012 that were not associated with any merger and acquisition activities, resulting in severance charges of $54.0 million pertaining to the reduction of approximately 1,000 employees, and $4.3 million of facility closure costs. For the three months ended September 29, 2012, the Company recognized severance charges of $23.8 million pertaining to the reduction of approximately 500 employees, and $1.3 million of facility closure costs. Of the $41.0 million of reserves remaining as of September 29, 2012 the majority are expected to be utilized in 2012. Pre-2012 Actions: In the first nine months of 2012, the Company released $5.9 million of the severance reserve related to remaining liabilities for prior year initiatives, with $2.5 million of this reserve being released in the third quarter. The Company also recorded $2.5 million of facility closure costs associated with prior year initiatives in the first nine months of 2012, with $2.2 million recorded in the third quarter. The vast majority of the remaining reserve balance of $55.0 million relating to pre-2012 actions is expected to be utilized in the fourth quarter of 2012 and the first half of 2013. Segments: The $114.1 million of charges recognized in the first nine months of 2012 includes: $28.8 million pertaining to the CDIY segment; $33.6 million pertaining to the Security segment; $47.2 million pertaining to the Industrial segment; and $4.5 million pertaining to Corporate charges. During the third quarter of 2012, the Company recognized $53.4 million of charges including $8.1 million pertaining to the CDIY segment; $10.7 million pertaining to the Security segment; $31.6 million pertaining to the Industrial segment; and $3.0 million pertaining to Corporate charges. FINANCIAL CONDITION Liquidity, Sources and Uses of Capital: The Company's primary sources of liquidity are cash flows generated from operations and available credit under the Company's credit facilities. Operating Activities: Cash flow provided by operations was $151 million in the third quarter of 2012 compared to cash flow provided by operations of $156 million in the third quarter of 2011. The cash flows from operations were negatively impacted by merger and acquisition-related charges and payments of $84 million and $73 million in 2012 and 2011, respectively. Working capital outflows were $175 million as compared to $14 million in the third quarter of the prior year, with the increase driven primarily by higher accounts receivables caused by timing of sales within the quarter. Other cash outflows in 2011 were largely attributable to one-time retirement plan contributions which did not re-occur in 2012. 44-------------------------------------------------------------------------------- Table of Contents Year-to-date cash flow provided by operations was $418 million in the first nine months of 2012, compared to $456 million in the corresponding period of 2011. The cash flows from operations were negatively impacted by merger and acquisition-related charges and payments of $212 million and $154 million in 2012 and 2011, respectively. Working capital outflows were $286 million in the first nine months of 2012, compared with outflows of $72 million in the 2011 period, up primarily due to accounts receivable and accounts payable balances which were affected by the timing of sales and cash disbursements within the quarter. Other cash outflows in 2011 were largely attributable to one-time retirement plan contributions which did not re-occur in 2012. Free Cash Flow: Free cash flow, as defined in the following table, was $62 million in the third quarter of 2012 compared to $98 million in the corresponding 2011 period. Free cash flow on a year-to-date basis was $158 million in 2012, compared to $260 million in 2011. 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. Quarter to Date Year-to-Date (Millions of Dollars) 2012 2011 2012 2011Net cash provided by operating activities $ 151 $ 156 $ 418 $ 456 Less: capital expenditures (89 ) (58 ) (260 ) (196 ) Free cash flow $ 62 $ 98 $ 158 $ 260 When merger and acquisition-related charges and payments of $107 million and $304 million for the three and nine months ended September 29, 2012, respectively, are added back to the Company's free cash flow, the resulting amounts are free cash flows of $169 million and $463 million, respectively. When merger and acquisition-related charges and payments of $79 million and $191 million for the three and nine months ended October 1, 2011, respectively, are added back to the Company's free cash flow, the resulting amounts are free cash flows of $176 million and $450 million, respectively. Based on its demonstrated ability to generate cash flow from operations, as well as its strong balance sheet and credit position at September 29, 2012, the Company believes over the long term it has the financial flexibility to deploy capital to its shareowners' advantage through a combination of potential share repurchases, dividends and acquisitions. Investing Activities: Cash flow used in investing activities was $188 million in the third quarter of 2012 compared to $1,053 million in the third quarter of 2011. Year-to-date cash flows used in investing activities were $934 million and $1,401 million in the first nine months of 2012 and 2011, respectively. Capital and software expenditures were $89 million (inclusive of $23 million for merger and acquisition-related capital expenditures) in the third quarter of 2012, compared to $59 million (inclusive of $6 million for merger and acquisition-related capital expenditures) of capital expenditures in 2011. Year-to-date capital and software expenditures were $260 million (inclusive of $92 million for merger and acquisition-related capital expenditures) and $196 million (inclusive of $37 million for merger and acquisition-related capital expenditures) in the first nine months of 2012 and 2011, respectively. The Company will also continue to invest in productivity and cost structure improvements, as well as achieving merger and acquisition-related cost synergies while ensuring that such investments provide an appropriate return on capital employed. Cash outflows from business acquisitions were $106 million in the third quarter of 2012, primarily relating to the purchase of Tong Lung. For the nine months ended September 29, 2012 cash outflows from business acquisitions were $695 million, which includes the purchase of Powers, AeroScout, Tong Lung, Lista, and the remaining outstanding shares of Niscayah. Cash outflows for business acquisitions in 2011 were $1.013 billion and $1.178 billion for the three and nine months ended October 1, 2011, respectively. The 2011 acquisition outflows relate primarily to the purchase of Niscayah. Financing Activities: Cash flow provided by financing activities was $209 million in the third quarter of 2012 compared to $122.7 million used by financing activities in the third quarter of 2011. Year-to-date proceeds from financing activities were outflows of $374 million in 2012 and $42 million in 2011. Repayments on long-term debt, including premium paid on debt extinguishment, were $992 million in the third quarter of 2012 compared to $2 million for the third quarter of 2011. As described more fully in Note H, Long-Term Debt and Financing Arrangements, the Company repurchased three debt instruments with total outstanding principal of $900 million, and paid a premium on extinguishment of $91 million. On a year-to-date basis, repayments on long-term debt were $1.222 billion and $403 million in 2012 and 2011, respectively. Proceeds from long-term borrowings were $729 million in the third quarter of 2012 compared to $1 million for the third quarter of 2011. As more fully described in Note H, Long-Term Debt and Financing Arrangements, the Company issued junior 45-------------------------------------------------------------------------------- Table of Contents subordinated debentures and received $729 million of net proceeds as part of the issuance. Net proceeds from short-term borrowings under the Company's commercial paper program amounted to $527 million and $69 million in the third quarter of 2012 and 2011, respectively. On a year to date basis, net proceeds from short-term borrowing under the Company's commercial paper program amounted to $1.316 billion and $556 million in 2012 and 2011, respectively. Cash proceeds from the issuance of common stock were $27 million and $17 million for the third quarter of 2012 and 2011, respectively. On a year to date basis, cash proceeds from the issuance of common stock were $103 million and $102 million for the first nine months of 2012 and 2011, respectively. Cash proceeds from the issuance of common stock primarily relate to the exercise of employee stock options. Cash dividends were $83 million in the third quarter of 2012 compared to $69 million in the third quarter of 2011. On a year to date basis, cash dividends were $221 million and $207 million in 2012 and 2011, respectively. Increases in dividend payments are reflective of the Company's higher year over year dividend rate. On a year to date basis purchases of common stock totaled $218 million and $6 million in 2012 and 2011, respectively. During the second quarter of 2012 the Company repurchased approximately three million shares of common stock for $200 million. In the first nine months of 2012, the Company received $36 million from the termination of interest rate swaps, and paid $56 million related to the termination of a forward starting interest rate. Credit Ratings & Liquidity: The Company maintains strong investment grade credit ratings from the major U.S. rating agencies on its senior unsecured debt (average A-) as well as its short-term commercial paper borrowings. There have been no changes to any of the ratings during 2012. Failure to maintain strong investment grade rating levels could adversely affect the Company's cost of funds, liquidity and access to capital markets, but would not have an adverse effect on the Company's ability to access committed credit facilities. In March 2011, the Company entered into a new four year $1.2 billion committed credit facility (the "Credit Agreement"), which replaced all formerly existing credit facilities. Borrowings under the Credit Agreement may include U.S. Dollars up to the $1.2 billion commitment or in Euro or Pounds Sterling subject to a foreign currency sublimit of $400.0 million and bear interest at a floating rate dependent upon the denomination of the borrowing. Repayments must be made on March 11, 2015 or upon an earlier termination date of the Credit Agreement, at the election of the Company. In July 2011, in connection with the Niscayah acquisition, the Company entered into a $1.25 billion 364 day credit facility ("Facility"). The Facility decreased to $750 million (as per the terms of the agreement) in December 2011 and was terminated in July 2012 with the concurrent execution of a new $1.0 billion 364 day committed credit facility. The new facility contains a 1 year term-out provision and borrowings under the Credit Agreement may include U.S. Dollars up to the $1.0 billion commitment or in Euro or Pounds Sterling subject to a foreign currency sublimit of $400.0 million and bear interest at a floating rate dependent upon the denomination of the borrowing. Repayments must be made by July 12, 2013 or upon an earlier termination date of the Credit Agreement, at the election of the Company, unless the term-out provision is exercised. The Company has not drawn on either of the commitments provided by the Facilities. These credit facilities are designated to be liquidity backstops for the Company's $2.0 billion commercial paper program. As discussed in Note J, Equity Arrangements, in the third quarter of 2011, the Company entered into a forward share purchase contract on its common stock which obligates the Company to pay $350 million to the financial institution counterparty not later than August 2013, or earlier at the Company's option, for the 5,581,400 shares purchased. Cash and cash equivalents totaled $770 million as of September 29, 2012, which is predominantly held in foreign jurisdictions. Concurrent with the Black & Decker merger, the Company made a determination to repatriate certain legacy Black & Decker foreign earnings, on which U.S. income taxes had not previously been provided. As a result of this repatriation decision, the Company has recorded a related deferred tax liability. Current plans and liquidity requirements do not demonstrate a need to repatriate other foreign earnings. Accordingly, all other undistributed foreign earnings of the Company are considered to be permanently reinvested, or will be remitted substantially free of additional tax, consistent with the Company's overall growth strategy internationally, including acquisitions and long-term financial objectives (as demonstrated by the recent acquisition of Niscayah). No provision has been made for taxes that might be payable upon remittance of these undistributed foreign earnings. However, should management determine at a later point to repatriate additional foreign earnings, the Company would be required to accrue and pay taxes at that time. On July 25, 2012, the Company issued $750 million of junior subordinated debentures maturing on July 25, 2052 with fixed 46-------------------------------------------------------------------------------- Table of Contents interest payable quarterly in arrears at a rate of 5.75% per annum. The Company, may at its election, redeem the debentures in whole or in part, at par on or after June 25, 2017. The debentures' subordination, long tenor and interest deferral features provide significant credit protection measures for senior creditors and as a result the debentures were awarded a 50% equity credit by S&P and Fitch, and a 25% equity credit by Moody's. The net proceeds of $729 million from the offering was used for general corporate purposes, including the repayment of short term debt and the refinancing of recent and near term debt maturities. In the third quarter of 2012 the Company repurchased $900 million of its long term debt via open market tender and exercise of its right under the redemption provision of each notes (as further described in footnote H. Long-Term Debt and Financing Arrangements). The initial funding of the repurchased debt was accomplished by utilizing excess cash on hand and the issuance of Commercial Paper. The Company intends on refinancing a portion of its outstanding Commercial Paper through the issuance of Long Term Debt in an amount similar to the amount of notes repurchased. OTHER MATTERS Critical Accounting Estimates: There have been no significant changes in the Company's critical accounting estimates during the third quarter of 2012. Refer to the "Other Matters" section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Form 10-K for the year ended December 31, 2011 for a discussion of the Company's critical accounting estimates. |