UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Registrant's telephone number, including area code: (262) 656-5200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [_]
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Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
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See Notes to Consolidated Financial Statements.
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The Financial Accounting Standards Board (“FASB”) issued interpretation (“FIN”) No. 46R, “Consolidation of Variable Interest Entities (an interpretation of ARB No. 51)” in December 2003, which became effective for Snap-on at the beginning of its 2004 fiscal year. FIN No. 46R provides consolidation guidance regarding the identification of variable interest entities (“VIE”) for which control is achieved through means other than through voting rights. FIN No. 46R provides guidance in determining if a business enterprise is the primary beneficiary of a VIE and whether or not that business enterprise should consolidate the VIE for financial reporting purposes.
Based on the company’s analysis of FIN No. 46R, the company concluded that Snap-on would consolidate Snap-on Credit LLC (“SOC”) as of January 4, 2004, the beginning of Snap-on’s 2004 fiscal year. Snap-on previously accounted for SOC, a 50%-owned joint venture with The CIT Group, Inc. (“CIT”), using the equity method. Snap-on has consolidated SOC on a prospective basis and, as such, has not restated previously issued financial statements. The impact of the consolidation of SOC on Snap-on’s consolidated balance sheet was not significant. As a result of the consolidation of SOC in fiscal 2004, Snap-on is reporting the results of its finance operations as a new business segment, “Financial Services.” Refer to Notes 2 and 14 to the Consolidated Financial Statements for further discussion of SOC and Snap-on’s business segments.
Highlights of Snap-on’s results of operations for the second quarters of 2004 and 2003 are as follows:
Total revenue in the second quarter of 2004 increased $46.9 million, or 8.3%, over prior-year levels. Of the year-over-year increase in total revenues, $15.5 million was attributable to favorable currency
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translation and $20.8 million resulted from the consolidation of SOC, previously accounted for under the equity method, as well as related reclassifications of Snap-on’s wholly owned financial services subsidiaries to be consistent with the presentation of SOC effective with the beginning of fiscal 2004. Organic sales (defined as net sales, excluding the impact of acquisitions, divestitures and currency translation and used to illustrate growth on an operating basis) increased $10.6 million, or 1.9%, year over year on improved worldwide sales of industrial tools, equipment and diagnostics, which more than offset a sales decline in the worldwide dealer business.
Gross profit (defined as net sales less cost of goods sold) increased $9.8 million, but decreased 20 basis points (100 basis points equals 1.0 percent) to 43.3% of net sales. The impact of higher organic sales and $5.8 million of favorable currency translation was partially offset by $3.6 million of higher year-over-year continuous improvement costs included in cost of goods sold.
Operating expenses in the second quarter of 2004 increased $19.3 million, or 20 basis points as a percentage of total revenue, from the second quarter of 2003, including $11.2 million from the consolidation of SOC, as well as related reclassifications of Snap-on’s wholly owned financial services subsidiaries to be consistent with the presentation of SOC. Additionally, $4.7 million of the operating expense increase was attributable to unfavorable foreign currency translation. Operating expenses during the second quarter of 2004 also included $3.6 million of costs associated with the settlement of two U.S. General Services Administration (“GSA”) contract audits, $2.0 million in higher year-over-year costs associated with compliance under the Sarbanes-Oxley Act of 2002 and $1.0 million associated with the company’s expansion of its distribution system and operating presence in Asia. These increases in operating expenses were partially offset by $4.1 million of lower bad debt expense and $1.7 million of lower year-over-year pension, other retirement and insurance costs.
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Highlights of Snap-on’s results of operations for the first six months of 2004 and 2003 are as follows:
Total revenue in the first six months of 2004 increased $120.1 million, or 10.8%, over prior-year levels. Of the year-over-year increase in total revenues, $48.7 million was attributable to favorable currency translation and $42.0 million resulted from the consolidation of SOC, previously accounted for under the equity method, as well as related reclassifications of Snap-on’s wholly owned financial services subsidiaries to be consistent with the presentation of SOC effective with the beginning of fiscal 2004. Organic sales increased $29.4 million, or 2.5%, year over year on improved worldwide sales of industrial tools, equipment and diagnostics, which more than offset a sales decline in the worldwide dealer business.
Gross profit increased $13.7 million, but decreased 170 basis points to 42.6% of net sales. The impact of higher organic sales and $18.3 million of favorable currency translation was partially offset by $10.4 million of higher year-over-year continuous improvement costs, inventory adjustments of $5.2 million and $3.5 million of additional costs associated with manufacturing inefficiencies and other variances arising from the relocation of production from two U.S. hand-tool plants, which were closed on March 31, 2004.
Operating expenses in the first six months of 2004 increased $49.9 million, or 20 basis points as a percentage of total revenue, from the first six months of 2003, including $21.5 million from the consolidation of SOC, as well as related reclassifications of Snap-on’s wholly owned financial services subsidiaries to be consistent with the presentation of SOC. Additionally, $14.7 million of the operating expense increase was attributable to unfavorable foreign currency translation. Operating expenses during the first six months of 2004 also included $3.6 million of costs associated with the settlement of two GSA contract audits, higher freight expense of $3.1 million and start-up costs of $2.5 million associated with the company’s expansion of its distribution system and operating presence in Asia.
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Snap-on’s business segments are based on the organization structure used by management for making operating and investment decisions and for assessing performance. Snap-on’s reportable business segments include: (i) the Snap-on Dealer Group; (ii) the Commercial and Industrial Group; (iii) the Diagnostics and Information Group; and (iv) Financial Services. The Snap-on Dealer Group consists of Snap-on’s business operations serving the worldwide franchised dealer van channel. The Commercial and Industrial Group consists of the business operations providing tools and equipment products to a broad range of industrial and commercial customers worldwide through direct, distributor and other non-franchised distribution channels. The Diagnostics and Information Group consists of the business operations providing diagnostics equipment, vehicle-service information, business management systems, equipment repair services and other solutions for vehicle service to customers in the worldwide vehicle service and repair marketplace. Financial Services is a new business segment, beginning in fiscal 2004, consisting of the business operations of SOC, a consolidated 50%-owned joint venture between Snap-on and CIT, and Snap-on’s wholly owned finance subsidiaries in those international markets where Snap-on has dealer operations. Prior year segment disclosures have not been restated to include the Financial Services segment due to the prospective adoption of FIN No. 46R. See Note 2 for further discussion of SOC and the company’s adoption of FIN No. 46R.
Snap-on evaluates the performance of its operating segments based on segment revenues and operating earnings. Segment revenues are defined as total revenues, including both external customer revenue and intersegment revenue. Segment operating earnings are defined as revenues less cost of goods sold and operating expenses. Snap-on accounts for intersegment sales and transfers based primarily on standard costs with reasonable mark-ups established between the segments. Snap-on allocates shared services expenses to those segments that utilize the services based on a percentage of either cost of goods sold or segment revenues, as appropriate.
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Total segment revenue in the second quarter of 2004 decreased $6.6 million, or 2.3%, over prior-year levels due to $11.1 of lower organic sales, partially offset by $4.5 million of favorable currency translation. In the United States, organic sales were 2.3% lower year over year. The average number of dealer vans in operation during the second quarter of 2004 was down 2.9% year over year primarily due to a lower level of new dealer additions in 2004. The company believes that the decline in dealer additions during the second quarter of 2004 contributed to the lower year-over-year sales, and results from the company’s tightening of recruitment standards, as well as the introduction of a new franchise program for prospective dealers. The company believes that the new franchise program offers starting dealers an opportunity to grow their franchise, while developing appropriate operating practices through greater discipline and regular quarterly performance reviews. For the quarter, sales by Snap-on U.S. franchised dealers to their customers (as reported to Snap-on by its dealers) continued to grow, increasing at a low-single-digit rate.
Segment gross profit for the second quarter of 2004 decreased $2.2 million, but increased 30 basis points as a percentage of total segment revenue, from the same period last year primarily due to the impact of lower organic sales and $1.2 million of higher year-over-year continuous improvement activity costs, partially offset by $1.9 million of favorable currency translation and $0.5 million of lower expense for pension, other retirement and insurance. Operating expenses for the Snap-on Dealer Group decreased $3.5 million year over year, or 40 basis points as a percentage of total segment revenue. The $3.5 million decrease in operating expenses primarily reflects the impact of lower organic sales, $3.9 million of lower bad debt expense, lower year-over-year continuous improvement costs of $0.8 million and $0.6 million of lower expense for pension, other retirement and insurance, partially offset by $1.4 million of higher freight expense, reflecting increased freight rates and smaller, but more frequent, shipments to dealers and $1.5 million of unfavorable currency translation. As a result of these factors, segment operating earnings in the second quarter of 2004 increased $1.3 million, or 70 basis points as a percentage of total segment revenue, from the second quarter of 2003.
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Total segment revenue for the first six months of 2004 increased $8.4 million, or 1.5%, over prior-year levels due to $13.2 million of favorable currency translation, partially offset by $4.8 million of lower organic sales. In the U.S. marketplace, organic sales were 1.2% lower year over year. During the first six months of 2004, the average number of dealer vans in operation was down 1.8% year over year primarily due to a lower level of new dealer additions in 2004. The company believes that the decline in dealer additions during the second quarter of 2004 contributed to the lower year-over-year organic sales, and results from the company’s tightening of recruitment standards, as well as the introduction of a new franchise program for prospective dealers. For the first six months of 2004, sales by Snap-on U.S. franchised dealers to their customers (as reported to Snap-on by its dealers) continued to grow, increasing at a mid-single-digit rate. Excluding currency translation, international operations sales were essentially flat year over year.
Segment gross profit for the first six months of 2004 decreased $9.3 million, or 240 basis points as a percentage of total segment revenue, from the same period last year primarily due to lower organic sales, $6.2 million of higher year-over-year continuous improvement activity costs and $2.9 million of higher production expenses due to production inefficiencies and other manufacturing variances associated with the relocation of production from the two hand-tool plants, which were closed on March 31, 2004. These higher costs were partially offset by $5.1 million of favorable currency translation. Operating expenses for the Snap-on Dealer Group increased $1.4 million year over year, but decreased 40 basis points as a percentage of total segment revenue. The $1.4 million increase in operating expenses primarily reflects $4.0 million of unfavorable currency translation and $2.7 million of higher freight expense, reflecting increased freight rates and smaller but more frequent shipments to dealers, partially offset by $3.4 million of lower bad debt expense and lower year-over-year continuous improvement costs of $1.5 million. As a result of these factors, segment operating earnings in the first six months of 2004 decreased $10.7 million, or 200 basis points as a percentage of total segment revenue, from the first six months of 2003.
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Total segment revenue in the second quarter of 2004 increased $26.3 million, or 9.3%, over prior-year levels due to $17.1 million of improved organic sales and $9.2 million of favorable currency translation. Demand for tools improved in both North America and Europe, with increased sales of hand and power tools used in industrial and commercial applications. In addition, higher sales of vehicle-service equipment were achieved worldwide, partially offset by a decline in sales in Snap-on’s facilitation business for new-vehicle dealerships.
Segment gross profit for the second quarter of 2004 increased $7.0 million, but decreased 50 basis points as a percentage of total segment revenue. Benefits realized from higher organic sales and favorable currency translation were partially offset by $2.5 million of higher year-over-year continuous improvement activity costs. Operating expenses for the Commercial and Industrial Group increased $9.4 million, or 30 basis points as a percentage of total segment revenue. The increase in operating expenses reflects the impact of higher organic sales, $3.6 million of costs associated with the GSA contract audits settlement, $2.6 million of unfavorable currency translation and $0.6 in higher bad debt expense. Operating earnings were also reduced by $1.0 million for start-up costs associated with the company’s investment to expand its distribution and operating presence in Asia. As a result, segment operating earnings in the second quarter of 2004 decreased $2.4 million as compared to the second quarter of 2003.
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Total segment revenue for the first six months of 2004 increased $63.5 million, or 11.4%, over prior-year levels due to $31.8 million of favorable currency translation and $31.7 million from improved organic sales. Demand for tools improved in both North America and Europe, with increased sales of hand and power tools used in industrial and commercial applications. In addition, higher sales of vehicle-service equipment were achieved in both North America, through the company’s Technical Automotive Group (“TAG”) distribution channel, and in Europe.
Segment gross profit for the first six months of 2004 increased $13.6 million, but decreased 120 basis points as a percentage of total segment revenue. Benefits realized from higher organic sales and $11.5 million of favorable currency translation were partially offset by inventory adjustments of $6.3 million, $4.2 million of higher year-over-year continuous improvement activity costs and higher expenses due to production inefficiencies and other manufacturing variances associated with the relocation of production from the two hand-tool plants of $0.6 million. Operating expenses for the Commercial and Industrial Group increased $25.2 million, or 80 basis points as a percentage of total segment revenue. The increase in operating expenses reflects the impact of higher organic sales, $9.1 million of unfavorable currency translation, $3.6 million of costs associated with the GSA contract audits settlement, $2.1 million in higher bad debt expense and a $0.9 million year-over-year increase in continuous improvement costs. Operating earnings were also reduced by $2.5 million of start-up costs associated with the company’s investment to expand its distribution and operating presence in Asia. As a result, segment operating earnings in the first six months of 2004 decreased $11.6 million as compared to the first six months of 2003.
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Total segment revenue in the second quarter of 2004 increased $6.3 million, or 8.3%, over prior-year levels primarily due to $4.6 million of organic sales growth, principally in information products, heavy-duty diagnostics and other handheld products, as well as $1.7 million of favorable currency translation.
Segment gross profit for the second quarter of 2004 increased $5.0 million, or 330 basis points as a percentage of total segment revenue, from the same period last year largely reflecting the growth in organic sales of handheld diagnostics and information products and benefits from prior continuous improvement activities. Operating expenses for the Diagnostics and Information Group increased $2.2 million, or 40 basis points as a percentage of total segment revenue, primarily reflecting the impact of higher organic sales and $0.6 million of unfavorable currency translation. As a result, segment operating earnings in the second quarter of 2004 increased $2.8 million, or 290 basis points as a percentage of total segment revenue, from the second quarter of 2003.
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Total segment revenue for the first six months of 2004 increased $10.2 million, or 6.7%, over prior-year levels primarily due to $5.4 million of organic sales growth, principally in information products, heavy-duty diagnostics and other handheld products, as well as $4.8 million of favorable currency translation. In 2003, intersegment revenue included approximately $5 million related to the production of certain European equipment products that was subsequently transferred to the Commercial and Industrial Group.
Segment gross profit for the first six months of 2004 increased $9.4 million, or 350 basis points as a percentage of total segment revenue, from the same period last year largely reflecting the growth in organic sales of handheld diagnostics and information products and benefits from prior continuous improvement activities. Operating expenses for the Diagnostics and Information Group increased $1.8 million, but decreased 80 basis points as a percentage of total segment revenue, reflecting the impact of higher organic sales, $1.6 million of unfavorable currency exchange, partially offset by $1.4 million of lower bad debt expense. As a result, segment operating earnings in the first six months of 2004 increased $7.6 million, or 430 basis points as a percentage of total segment revenue, from the first six months of 2003.
Segment operating results for Financial Services for the three and six months ended July 3, 2004, are as follows:
Segment operating earnings for the second quarter and first six months of 2004 were $9.6 million and $20.5 million; CIT’s minority interest in SOC for the second quarter and first six months of 2004 of $0.1 million of expense and $0.7 million of expense is included in “Other income (expense) – net” on the accompanying Consolidated Statement of Earnings. Net finance income was $11.2 million and $21.7 million in the second quarter and first six months of 2003. Operating earnings for the second quarter and the first six months of 2004 decreased year over year primarily due to higher market interest rates.
Interest expense was $5.7 million in the second quarter of 2004, down $0.3 million from $6.0 million in the second quarter of 2003. For the first six months of 2004, interest expense of $11.3 million was down $1.1 million from $12.4 million in the prior year. The year-over-year decline in both the second quarter and year-to-date periods primarily reflects the impact of lower average debt levels due to cash flow from operating activities, partially offset by higher average interest rates.
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Other income (expense) — net was an expense of $0.9 million for the second quarter of 2004, as compared to an expense of $0.4 million in the comparable prior-year period. This line item includes the impact of all non-operating items such as interest income, minority interests, hedging and exchange rate transaction gains and losses, and other miscellaneous non-operating items. Other expense increased $0.5 million in the second quarter of 2004 over the prior-year level largely reflecting a $0.7 million increase in minority interests, primarily reflecting the consolidation of SOC beginning in fiscal 2004. This was partially offset by $0.4 million of lower foreign exchange losses. Other income (expense) – net was an expense of $2.8 million for the first six months of 2004, as compared to an expense of $4.1 million in the comparable prior-year period. Other expense decreased $1.3 million in the first six months of 2004 over the prior-year level primarily due to $1.9 million of lower foreign exchange losses, partially offset by a $1.2 million increase in minority interests.
Snap-on’s effective income tax rate was 35.0% for the second quarter and first six months of 2004 and 2003.
For a discussion of Snap-on’s exit and disposal activities, refer to Note 5 of the Consolidated Financial Statements.
Snap-on’s growth has historically been funded by a combination of cash provided by operating activities and debt financing. Snap-on believes that its cash from operations, coupled with its sources of borrowings, are sufficient to fund its anticipated requirements for working capital, capital expenditures and continuous improvement activities, acquisitions, common stock repurchases and dividend payments. Due to Snap-on’s credit rating over the years, external funds have been available at a reasonable cost. As of the date of the filing of this Form 10-Q, Snap-on’s long-term debt and commercial paper was rated A2 and P-1 by Moody’s Investors Service and A and A-1 by Standard &Poor’s. Snap-on believes that the strength of its financial position affords the company the financial flexibility to respond to both internal growth opportunities and those available through acquisitions.
The following discussion focuses on information included in the accompanying Consolidated Balance Sheets.
Snap-on has been focused on improving asset utilization by making more effective use of its investment in certain working capital items. Termed “working investment,” the company uses this measure to assess management’s operating performance and effectiveness relative to those components of working capital that are more directly impacted by operating decisions. As of July 3, 2004, working investment (defined as accounts receivable – net of allowances plus inventories less accounts payable) of $696.0 million was down $12.2 million from the $708.2 million as of year-end 2003. The following depicts the company’s working investment position as of July 3, 2004, and January 3, 2004.
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Accounts receivable at the end of the second quarter of 2004 was $556.9 million, up $10.1 million from year-end 2003 levels, while days sales outstanding improved to 85 days from 88 days at January 3, 2004.
Inventories totaled $344.3 million at the end of the 2004-second quarter, down $6.8 million from year-end 2003 levels. Inventories accounted for using the first-in, first-out (FIFO) method as of July 3, 2004, and January 3, 2004, approximated 66% and 69% of total inventories. All other inventories are generally accounted for using the last-in, first-out (LIFO) cost method. The company’s LIFO reserve declined from $81.8 million at January 3, 2004, to $80.7 million at July 3, 2004. Inventory turns (defined as the current quarter’s cost of goods sold annualized, divided by the average of the last four quarter-end’s inventory balances) at July 3, 2004, were 3.8 turns, as compared to 3.5 turns at year-end 2003.
Total notes payable and long-term debt was $330.6 million at the end of the second quarter of 2004, as compared to $333.2 million at year-end 2003. Cash and cash equivalents were $126.6 million as of July 3, 2004, and $96.1 million at the end of fiscal 2003. The increase in cash and cash equivalents from year-end levels was primarily due to cash flows from operating activities and proceeds from stock purchase and stock option plans.
Borrowings under commercial paper programs totaled $25.0 million at both the end of the second quarter of 2004 and at year-end 2003. At July 3, 2004, Snap-on had $408 million of multi-currency revolving credit facilities that served to back its commercial paper programs, including a $200 million, 364-day revolving credit facility with a one-year term-out option that would terminate on July 30, 2004. The term-out option would have allowed Snap-on to elect to borrow under the credit facility for an additional year after the termination date. In addition, Snap-on had a five-year, $208 million revolving credit facility that would terminate on August 20, 2005. At July 3, 2004, Snap-on was in compliance with all covenants of these revolving credit facilities and there were no borrowings under either revolving credit commitment. The financial covenant under these facilities required that Snap-on maintain a ratio of total debt to the sum of total debt plus shareholders’ equity of not greater than 0.60 to 1.00. The company’s ratio of total debt to the sum of total debt plus shareholders’ equity was 0.252 to 1.00 at July 3, 2004, as compared to 0.248 to 1.00 at year-end 2003. This ratio may vary from time to time as the company issues commercial paper to fund seasonal working capital requirements and to the extent that the company uses debt to fund acquisitions. At July 3, 2004, Snap-on also had an unused committed $20 million bank line of credit that would expire on August 1, 2004.
On July 27, 2004, subsequent to the end of the second quarter, Snap-on entered into a new five-year $400 million multi-currency revolving credit facility that terminates on July 27, 2009. This $400 million facility replaces the $408 million of multi-currency revolving credit facilities discussed above. The $400 million revolving credit facility’s financial covenant requires that Snap-on maintain a ratio of total debt to the sum of total debt plus shareholders’ equity of not greater than 0.60 to 1.00. As of the filing date of this document, Snap-on believes it is in compliance with all covenants of this revolving credit facility.
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Also on July 27, 2004, Snap-on renewed its committed bank line of credit. Under the terms of the renewal, the committed $20 million bank line of credit reduces to $10 million on September 1, 2004, and expires on July 31, 2005.
The following discussion focuses on information included in the accompanying Consolidated Statements of Cash Flows.
Cash flow provided from operating activities was $91.0 million in the first six months of 2004, including a $10.7 million net income tax refund, primarily resulting from a $78.2 million voluntary U.S. pension contribution made in the fourth quarter of 2003. Cash flow from operating activities in 2003 was $55.6 million, including a $10.0 million pension plan contribution. The consolidation of SOC as of January 4, 2004, did not have a material impact on cash flow.
Capital expenditures of $17.3 million in the first six months of 2004 were up from the $13.0 million expended in the first six months of 2003. Investments primarily included new product-related, quality and cost reduction capital investments, as well as ongoing replacements of manufacturing and distribution facilities and equipment. Snap-on anticipates fiscal 2004 capital expenditures will be in the range of $40 million to $45 million, of which approximately two-thirds is expected to be used for investments relating to new products, quality enhancement or cost reduction. Capital expenditures for the full year of fiscal 2003 totaled $29.4 million.
In the second quarter of 2004, Snap-on sold, at book value, its 70% interest in Texo s.r.l., a European manufacturer and developer of vehicle lifts, for approximately $0.6 million.
Snap-on has undertaken stock repurchases from time to time to offset dilution created by shares issued for employee and dealer stock purchase plans, stock options, and other corporate purposes, as well as to repurchase shares when market conditions are favorable. Snap-on repurchased 750,000 shares of common stock for $24.6 million under its previously announced share repurchase programs during the first six months of 2004. As of the end of the second quarter of 2004, Snap-on has remaining availability to repurchase up to an additional $127.9 million in common stock pursuant to the Board of Directors’ authorizations. The purchase of Snap-on common stock is at the company’s discretion, subject to prevailing financial and market conditions. On January 21, 2004, the company publicly announced that it expected to accelerate its planned 2004 full-year share repurchases, and repurchase approximately 750,000 to 1,000,000 shares of common stock in 2004.
Snap-on has paid consecutive quarterly cash dividends, without interruption or decline, since 1939. Cash dividends paid totaled $29.0 million for the first six months of 2004, as compared to $29.1 million in the first six months of 2003.
Government Contract Matters: On July 23, 2004, Snap-on reached an agreement with the U.S. Department of Justice to resolve the government audit, previously discussed in the company's Annual Report and Form 10-K, relating to two contracts with the U.S. General Services Administration ("GSA"). Snap-on agreed to settle the claims over the interpretation and application of the price reduction and billing provisions of these two contracts for sales from March 1996 through the July 23, 2004, settlement date for $10 million. Snap-on incurred a pretax charge of $3.6 million, or $0.04 per diluted share, in the second quarter of 2004 for costs not previously accrued. Snap-on remitted the $10 million cash settlement to the U.S. Department of Justice on August 5, 2004.
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As noted in the company’s 2003 Annual Report and Form 10-K, Snap-on has government contracts with federal departments and agencies, two of which were under audit by the GSA. The two contracts involve sales from March 1996 through February 2001, and sales since February 2001. The primary focus of these audits concerned the interpretation and application of the price reduction provisions. On March 2, 2004, the government provided Snap-on with a claim estimate of approximately $12 million relating to the audited contract periods from July 1997 through May 2002. Additional amounts could have been claimed by the government for contract periods not covered by these audits.
The settlement releases Snap-on from civil claims and penalties under the price reduction and billing provisions of the contracts for the full contract periods through the settlement date. The settlement does not preclude the government from pursuing any administrative remedies that it would have as a normal right to pursue under any contract. Snap-on cooperated with the audit and investigation and agreed to the settlement in order to resolve these matters and avoid protracted litigation.
Throughout the audit resolution period, Snap-on has continued to sell to the government. Snap-on intends to negotiate with the GSA new or amended contract terms in an effort to avoid similar matters.
Snap-on’s disclosures of its critical accounting policies, which are contained in its Annual Report on Form 10-K for the year ended January 3, 2004, have not materially changed since that report was filed.
Snap-on expects the earnings benefits from its continuous improvement actions to exceed such continuous improvement costs in the second half of 2004, leading to enhanced operating margin. Along with improving signs for continued sales demand in its more cyclical commercial and industrial businesses, Snap-on continues to expect reported net earnings to exceed prior-year levels for the remainder of 2004. However, some of the anticipated margin enhancement is expected to be partially offset in the near term as the company continues to work to improve manufacturing processes associated with recently relocated production that has resulted in inefficiencies and higher costs. Additionally, Snap-on expects to incur continuous improvement costs of approximately $6 million during the third quarter and an additional $4 million during the fourth quarter of 2004, bringing full-year estimated costs up to a revised total of approximately $26 million.
As a result of its six-month results, including the previously noted charge of $0.04 per diluted share associated with the settlement related to the two GSA contracts, and the expected performance during the remainder of 2004, Snap-on expects its full-year 2004 reported earnings to be in the range of $1.72 to $2.00 per diluted share, including the estimated full-year cost of $0.28 to $0.30 per diluted share for continuous improvement costs.
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Safe Harbor: Statements in this document that are not historical facts, including statements (i) that include the words “expects,” “targets,” “plans,” “estimates,” “believes,” “anticipates,” or similar words that reference Snap-on or its management; (ii) specifically identified as forward-looking; or (iii) describing Snap-on’s or management’s future outlook, plans, estimates, objectives or goals, are forward-looking statements. Snap-on or its representatives may also make similar forward-looking statements from time to time orally or in writing. Snap-on cautions the reader that any forward-looking statements included in this document that are based upon assumptions and estimates were developed by management in good faith and that management believes such assumptions and estimates to be reasonable as of the date of this document. However, these statements are subject to risks, uncertainties or other factors, including some events that may not be within the control of the company, that could cause (and in some cases have caused) actual results to differ materially from those described in any such statement.
These risks and uncertainties include, without limit, uncertainties related to estimates, assumptions and projections generally, and the timing and progress with which Snap-on can continue to achieve savings from cost reduction, continuous improvement and other Operational Fitness initiatives; make improvements in supply chain efficiencies; the company’s capability to retain and attract dealers, effectively implement new programs, capture new business, introduce successful new products and other Profitable Growth initiatives; its ability to weather disruption arising from planned facility closures; Snap-on’s ability to withstand external negative factors including terrorist disruptions on business; changes in trade, monetary and fiscal policies, regulatory reporting requirements, laws and regulations, or other activities of governments or their agencies, including military actions and such aftermath that might occur; and the absence of significant changes in the current competitive environment, inflation, interest rates, legal proceedings, and energy and raw material supply and pricing (including steel), supplier disruptions, currency fluctuations, or the material worsening of economic and political situations around the world.
In addition, investors should be aware that generally accepted accounting principles prescribe when a company should record an allowance for particular risks, including litigation exposures. Accordingly, results for a given reporting period could be significantly affected if and when an allowance is established for a major contingency. Reported results, therefore, may appear to be volatile in certain accounting periods.
These factors may not constitute all factors that could cause actual results to differ materially from those discussed in any forward-looking statement. Snap-on operates in a continually changing business environment and new factors emerge from time to time. Snap-on cannot predict such factors nor can it assess the impact, if any, of such factors on Snap-on’s financial position or its results of operations. Accordingly, forward-looking statements should not be relied upon as a prediction of actual results or regarded as a representation by the company or its management that the projected results will be achieved. Snap-on disclaims any responsibility to update any forward-looking statement provided in this document.
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Market risk is the potential economic loss that may result from adverse changes in the fair value of financial instruments. Snap-on is exposed to market risk from changes in both foreign currency exchange rates and interest rates. Snap-on monitors its exposure to these risks and attempts to manage the underlying economic exposures through the use of financial instruments such as forward exchange contracts and interest rate swap agreements. Snap-on does not use derivative instruments for speculative or trading purposes. Snap-on’s broad-based business activities help to reduce the impact that volatility in any particular area or related areas may have on its operating earnings as a whole. Snap-on’s management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks.
FOREIGN CURRENCY RISK MANAGEMENT: Snap-on has significant international operations and is subject to certain risks inherent with foreign operations that include currency fluctuations and restrictions on movement of funds. Foreign exchange risk exists to the extent that Snap-on has payment obligations or receipts denominated in currencies other than the functional currency. To manage these exposures, Snap-on identifies naturally offsetting positions and then purchases hedging instruments in an attempt to protect the residual net exposures. Snap-on’s financial position and results of operations have not been materially affected by such events to date. For additional information, see Note 7.
INTEREST RATE RISK MANAGEMENT: Snap-on’s interest rate risk management policies are designed to reduce the potential volatility of earnings that could arise from changes in interest rates. Through the use of interest rate swaps, Snap-on aims to stabilize funding costs by managing the exposure created by the differing maturities and interest rate structures of Snap-on’s assets and liabilities. For additional information, see Note 7.
Snap-on utilizes a Value-at-Risk (“VAR”) model to determine the potential one-day loss in the fair value of its interest rate and foreign exchange-sensitive financial instruments from adverse changes in market factors. The VAR model estimates were made assuming normal market conditions and a 95% confidence level. Snap-on’s computations are based on the inter-relationships among movements in various currencies and interest rates (variance/co-variance technique). These inter-relationships were determined by observing interest rate and foreign currency market changes over the preceding quarter.
The estimated maximum potential one-day loss in fair value, calculated using the VAR model, at July 3, 2004, was$0.9 million on interest rate-sensitive financial instruments and $0.5 million on foreign currency-sensitive financial instruments. The VAR model is a risk management tool and does not purport to represent actual losses in fair value that will be incurred by Snap-on, nor does it consider the potential effect of favorable changes in market factors.
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CREDIT RISK: Credit risk is the possibility of loss from a customer’s failure to make payments according to contract terms. Prior to granting credit, each customer is evaluated, taking into consideration the borrower’s financial condition, collateral, debt-servicing capacity, past payment experience, credit bureau information, and other financial and qualitative factors that may affect the borrower’s ability to repay. Specific credit reviews and standard industry credit scoring models are used in performing this evaluation. Loans that have been granted are typically monitored through an asset-quality-review process that closely monitors past due accounts and initiates collection actions when appropriate. In addition to its direct credit risk exposure, Snap-on also has credit risk exposure for certain SOC loan originations with recourse provisions against Snap-on. At July 3, 2004, $11.0 million of loans originated by SOC have a recourse provision to Snap-on if the loans become more than 90 days past due. For additional information on SOC, see Note 2.
ECONOMIC RISK: Economic risk is the possibility of loss resulting from economic instability in certain areas of the world. Snap-on continually monitors its exposure in these markets. Snap-on’s Commercial and Industrial Group includes a hand-tool manufacturing facility in Argentina with net assets of approximately $10.5 million as of July 3, 2004. Due to economic instability in Argentina, Snap-on resized its operations there in 2001 and will continue to assess Argentina’s economic situation to determine if any future actions or impairment write-downs are warranted.
As a result of the above market, credit and economic risks, net income and revenues in any particular period may not be representative of full-year results and may vary significantly from year to year and from quarter to quarter. Inflation has not had a significant impact on the company.
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Quarterly Controls Evaluation and Related CEO and CFO Certifications
Snap-on conducted an evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (“Disclosure Controls”) as of the end of the period covered by this Quarterly Report. The controls evaluation was done under the supervision and with the participation of management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”).
Attached as exhibits to this Quarterly Report are certifications of the CEO and the CFO, which are required in accordance with Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This Controls and Procedures section includes information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
Definition of Disclosure Controls
Disclosure Controls are controls and other procedures designed to reasonably assure that information required to be disclosed in reports filed or submitted under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Disclosure Controls include components of internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. To the extent that components of internal control over financial reporting are included within the Disclosure Controls, they are included in the scope of the company’s quarterly evaluation of Disclosure Controls.
Limitations on the Effectiveness of Controls
The company’s management, including the CEO and CFO, does not expect that the company’s Disclosure Controls or its internal control over financial reporting will prevent all error or fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must consider the benefits of the controls in relation to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
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Scope of the Controls Evaluation
The evaluation of the company’s Disclosure Controls included a review of the controls’ objectives and design, the company’s implementation of the controls and the effect of the controls on the information generated for use in this Quarterly Report. In the course of the controls evaluation, management sought to identify data errors, controls problems or acts of fraud and confirm that appropriate corrective action, including process improvements, were being undertaken. This type of evaluation is performed on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning controls effectiveness can be reported in the company’s Quarterly Reports on Form 10-Q and to supplement the company’s disclosures made in its Annual Report on Form 10-K. Many of the components of the Disclosure Controls are also evaluated on an ongoing basis by the company’s Internal Audit Department and by other personnel in the Finance organization, as well as by independent auditors who evaluate them in connection with determining their auditing procedures related to their report on Snap-on’s annual financial statements and not to provide assurance on controls. The overall goals of these various evaluation activities are to monitor Disclosure Controls, and to modify them as necessary; management’s intent is to maintain the Disclosure Controls as dynamic systems that change as conditions warrant.
Among other matters, management also considered whether its evaluation identified any “significant deficiencies” or “material weaknesses” in internal control over financial reporting, and whether the company had identified any acts of fraud involving personnel with a significant role in internal control over financial reporting. This information was important both for the controls evaluation generally, and because item 5 in the certifications of the CEO and CFO requires that the CEO and CFO disclose that information to the company’s Audit Committee of the Board of Directors and to the company’s independent auditors. In the professional auditing literature, “significant deficiencies” are referred to as “reportable conditions,” which are deficiencies in the design or operation of controls that could adversely affect the company’s ability to record, process, summarize and report financial data in the financial statements. Auditing literature defines “material weakness” as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and the risk that such misstatements would not be detected within a timely period by employees in the normal course of performing their assigned functions. Management also sought to address other controls matters in the controls evaluation, and in each case if a problem was identified, management considered what revision, improvement and/or correction to make in accordance with its ongoing procedures.
Conclusions
Based upon the controls evaluation, Snap-on’s CEO and CFO have concluded that, subject to the limitations noted above, as of the end of the period covered by this Quarterly Report, that the company’s Disclosure Controls were effective to provide reasonable assurance that material information relating to Snap-on and its consolidated subsidiaries is made known to management, including the CEO and CFO.
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There were no changes in internal control over financial reporting that occurred during the quarter ended July 3, 2004, that have materially affected, or are reasonably likely to materially affect, Snap-on’s internal control over financial reporting.
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Please refer to Note 13 of the Consolidated Financial Statements for more information regarding legal proceedings.
The following chart discloses information regarding the shares of Snap-on’s common stock repurchased by the company during the second quarter of fiscal 2004, all of which were purchased pursuant to Board of Directors’ authorizations that the company has publicly announced. Snap-on has undertaken stock repurchases from time to time to offset dilution created by shares issued for employee and dealer stock purchase plans, stock options, and other corporate purposes, as well as to repurchase shares when market conditions are favorable. The repurchase of Snap-on common stock is at the company’s discretion, subject to prevailing financial and market conditions.
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The company also publicly announced by press release dated January 21, 2004, that it expected to accelerate its planned 2004 full-year share repurchases, and repurchase approximately 750,000 to 1,000,000 shares of common stock in 2004. These repurchases are being made pursuant to the three Board authorizations discussed above. During the first six months of 2004, the company repurchased 750,000 shares of common stock in connection with this announcement. Assuming a price per share of $33.60 (the closing price on the last business day preceding the end of the second quarter), the value of shares that the company may repurchase in 2004 after the second quarter in connection with this announcement is $8.4 million.
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Snap-on held its Annual Meeting of Shareholders on April 22, 2004. The shareholders (i) elected four members of Snap-on’s Board of Directors, whose terms were up for reelection, to serve until the Annual Meeting in the year 2006 and (ii) ratified the Audit Committee’s selection of Deloitte & Touche LLP as the company’s independent auditor for 2004. There were 63,034,018 outstanding shares eligible to vote. The persons elected to the Corporation’s Board of Directors, the number of votes cast for and the number of votes withheld with respect to each of these persons are set forth below:
The proposal to ratify the Audit Committee’s selection of Deloitte & Touche LLP as the company’s independent auditor for 2004 received the following votes:
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During the second quarter of 2004, Snap-on reported on Form 8-K the following:
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Pursuant to the requirements of the Securities Exchange Act of 1934, Snap-on Incorporated has duly caused this report to be signed on its behalf by the undersigned duly authorized person.
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EXHIBIT INDEX
Exhibit No. Exhibit
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