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 third quarters of 2004 and 2003 are as follows:
* Percent amount represents corresponding dollar amount as a percent of total revenue.
** Percent amount represents percentage increase or decrease relative to the three months ended September 27, 2003.
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Total revenue in the third quarter of 2004 increased $43.2 million, or 8.2%, over prior-year levels. Of the year-over-year increase in total revenues, $16.6 million was attributable to currency translation and $17.9 million resulted from the consolidation of SOC, previously accounted for under the equity method, and Snap-on’s wholly owned financial services subsidiaries. Sales also increased $8.7 million, or 1.7%, year over year on higher sales of handheld diagnostics tools worldwide, increased sales in the domestic and international dealer businesses, and increased sales of equipment worldwide, partially offset by lower sales of industrial tools in North America. In Europe, commercial and industrial tool sales were essentially flat.
Gross profit (defined as net sales less cost of goods sold) increased $17.6 million, or 130 basis points (100 basis points equals 1.0 percent) to 43.5% of net sales. The impact of higher sales, $10.7 million in lower year-over-year continuous improvement action costs, $5.9 million of currency translation and $2.3 million in cost savings achieved from the closure and relocation of two U.S. hand-tool plants in March 2004 was partially offset by $7.7 million from lower LIFO benefits and other inventory costs, $5.7 million of costs associated with production inefficiencies and other manufacturing variances associated with the relocation of production from the two U.S. hand-tool plants and a $3.5 million impact from increases in steel costs.
Operating expenses in the third quarter of 2004 increased $20.1 million, or 60 basis points as a percentage of total revenue, from the third quarter of 2003, including $10.5 million from the consolidation of SOC, previously accounted for under the equity method, and Snap-on’s wholly owned financial services subsidiaries. Foreign currency translation contributed $5.1 million to the year-over-year operating expense increase. Operating expenses during the third quarter of 2004 were impacted by the higher sales, as well as $1.8 million of higher freight costs, reflecting increased freight rates and smaller, but more frequent, shipments to dealers and $1.0 million associated with the company’s expansion of its distribution system and operating presence in Asia.
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Highlights of Snap-on’s results of operations for the first nine months of 2004 and 2003 are as follows:
** Percent amount represents percentage increase or decrease relative to the nine months ended September 27, 2003.
Total revenue in the first nine months of 2004 increased $163.3 million, or 10.0%, over prior-year levels. Of the year-over-year increase in total revenues, $65.3 million was attributable to currency translation and $59.9 million resulted from the consolidation of SOC, previously accounted for under the equity method, and Snap-on’s wholly owned financial services subsidiaries. Sales increased $38.1 million, or 2.3%, year over year on improved worldwide sales of industrial tools, equipment and diagnostics, as well as higher worldwide sales in the dealer business.
Gross profit increased $31.3 million, but decreased 80 basis points to 42.9% of net sales. The impact of higher sales and $24.2 million of currency translation was partially offset by $12.4 million from lower LIFO benefits and other inventory costs, $6.9 million of higher expenses from production inefficiencies and other manufacturing variances associated with the relocation of production from the two U.S. hand-tool plants and a $4.1 million impact from increases in steel costs.
Operating expenses in the first nine months of 2004 increased $70.0 million, or 40 basis points as a percentage of total revenue, from the first nine months of 2003, including $32.0 million from the consolidation of SOC, previously accounted for under the equity method, and Snap-on’s wholly owned financial services subsidiaries. Foreign currency translation contributed $19.8 million to the year-over-year operating expense increase. Operating expenses during the first nine months of 2004 also included the impact of higher sales, higher freight expense of $4.3 million, reflecting increased freight rates and smaller, but more frequent, shipments to dealers, $3.6 million of costs associated with the settlement of two U.S. General Services Administration ("GSA") contract audits and start-up costs of $3.5 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 and equipment repair services 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 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 to the Consolidated Financial Statements for further discussion of SOC and the company’s adoption of FIN No. 46R.
During the third quarter of 2004, Snap-on realigned certain of its business units within its reportable business segments. The primary realignments included Snap-on’s Equipment Solutions (facilitation) business moving from the Commercial and Industrial Group to the Diagnostics and Information Group and Snap-on’s EquiServ (equipment services) business moving from the Diagnostics and Information Group to the Commercial and Industrial Group. Prior year financial data by segment has been restated to reflect these reportable business segment realignments.
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 segment 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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* Percent amount represents corresponding dollar amount as a percent of total segment revenue.
Total segment revenue in the third quarter of 2004 increased $11.0 million, or 4.4%, over prior-year levels due to a $6.3 million increase in worldwide sales, primarily due to $5.4 million from higher price realization, and $4.7 million of currency translation. In the United States, sales were 1.5% higher year over year, despite a sales decline in the Southeastern United States, believed to be primarily caused by the impact from the widespread hurricane activity during the third quarter. The average number of dealer vans in operation during the third quarter of 2004 was down year over year primarily due to a lower level of new dealer additions in 2004. During the first quarter of 2004, Snap-on tightened eligibility requirements for its franchise dealer expansion and enhancement initiative and the recruitment standards for prospective dealers, aimed at improving the strength of its franchised dealer network. 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 mid-single-digit rate. In the company’s international dealer businesses, third quarter segment revenue increased $7.9 million year over year, including $4.8 million from currency translation.
Segment gross profit for the third quarter of 2004 increased $6.5 million, or 70 basis points as a percentage of total segment revenue, from the same period last year primarily due to the impact of $11.2 million in lower year-over-year continuous improvement activity costs, $2.5 million from higher sales, $2.0 million in cost savings achieved from the closure and relocation of the two U.S. hand-tool plants and $1.7 million of currency translation, partially offset by $4.9 million of costs associated with production inefficiencies and other manufacturing variances associated with the relocation of production from the two U.S. hand-tool plants, $3.4 million from lower LIFO benefits and other inventory costs and a $3.0 million impact from increases in steel costs. Operating expenses for the Snap-on Dealer Group increased $3.0 million year over year, but decreased 50 basis points as a percentage of total segment revenue. The $3.0 million increase in operating expenses primarily reflects $1.7 million in higher freight costs, reflecting increased freight rates and smaller, but more frequent, shipments to dealers and $1.4 million of currency translation, partially offset by a $2.1 million reduction in bad debt expense. As a result of these factors, segment operating earnings in the third quarter of 2004 increased $3.5 million, or 120 basis points as a percentage of total segment revenue, as compared to the third quarter of 2003.
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Total segment revenue for the first nine months of 2004 increased $20.5 million, or 2.6%, over prior-year levels due to $17.9 million of currency translation and a $2.6 million increase in worldwide sales. In the United States, sales were 0.3% lower year over year. The average number of dealer vans in operation during the first nine months of 2004 was down year over year primarily due to a lower level of new dealer additions in 2004. During the first quarter of 2004, Snap-on tightened eligibility requirements for its franchise dealer expansion and enhancement initiative and the recruitment standards for prospective dealers, aimed at improving the strength of its franchised dealer network. For the first nine 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. In the company’s international dealer businesses, segment revenue for the first nine months of 2004 increased $21.7 million year over year, including $19.3 million from currency translation.
Segment gross profit for the first nine months of 2004 decreased $3.5 million, or 160 basis points as a percentage of total segment revenue, from the same period last year, primarily due to $7.8 million of costs associated with production inefficiencies and other manufacturing variances associated with the relocation of production from the two U.S. hand-tool plants, $3.6 million of lower LIFO benefits and other inventory costs and a $3.5 million impact from increases in steel costs. These higher costs were partially offset by $6.8 million of currency translation and $5.0 million in lower year-over-year continuous improvement activity costs. Operating expenses for the Snap-on Dealer Group increased $4.0 million year over year, but decreased 50 basis points as a percentage of total segment revenue. The $4.0 million increase in operating expenses primarily reflects $5.4 million of currency translation and $4.3 million of higher freight expense, reflecting increased freight rates and smaller, but more frequent, shipments to dealers, partially offset by $5.5 million of lower bad debt expense and lower year-over-year continuous improvement costs of $1.6 million. As a result of these factors, segment operating earnings in the first nine months of 2004 decreased $7.5 million, or 110 basis points as a percentage of total segment revenue, as compared to the first nine months of 2003.
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Total segment revenue in the third quarter of 2004 increased $11.9 million, or 4.9%, over prior-year levels due to $10.0 million of currency translation and $1.9 million of improved sales. Higher sales of vehicle-service equipment worldwide and a slight increase in sales of tools in Europe and Asia were partially offset by a decline in sales of hand and power tools used in industrial applications in North America.
Segment gross profit for the third quarter of 2004 increased $1.2 million, but decreased 110 basis points as a percentage of total segment revenue. Benefits realized from higher sales and $3.4 million of currency translation were partially offset by a $2.8 million year-over-year impact from lower LIFO benefits and other inventory costs, $1.1 million of increased freight costs, reflecting increased freight rates and $1.0 million costs associated with production inefficiencies and other manufacturing variances associated with the relocation of production from the two U.S. hand-tool plants. Operating expenses for the Commercial and Industrial Group increased $6.0 million, or 90 basis points as a percentage of total segment revenue. The increase in operating expenses reflects the impact of higher sales, $3.0 million of currency translation, $1.7 million in higher bad debt expense and $1.0 million of start-up costs associated with the company’s investment to expand its distribution and operating presence in Asia, partially offset by a $1.7 million gain from a facility sale. Operating expenses were also impacted by $1.0 million in higher year-over-year continuous improvement actions, including costs for the consolidation of three European manufacturing facilities. As a result, segment operating earnings in the third quarter of 2004 decreased $4.8 million as compared to the third quarter of 2003.
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Total segment revenue for the first nine months of 2004 increased $73.9 million, or 9.8%, over prior-year levels due to $41.8 million of currency translation and $32.1 million in higher sales. Demand for tools in the first nine months of 2004 improved in both North America and Europe despite a decline in sales of hand and power tools used in industrial applications in North America in the third quarter, 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 nine months of 2004 increased $15.2 million, but decreased 120 basis points as a percentage of total segment revenue. Benefits realized from higher sales and $14.9 million of currency translation were partially offset by $8.5 million of lower LIFO benefits and other inventory costs, $4.2 million of higher year-over-year continuous improvement activity costs, $2.0 million of increased freight costs, reflecting increased freight rates and $1.6 million in higher expenses from production inefficiencies and other manufacturing variances associated with the relocation of production from the two U.S. hand-tool plants. Operating expenses for the Commercial and Industrial Group increased $33.7 million, or 120 basis points as a percentage of total segment revenue. The increase in operating expenses reflects the impact of higher sales, $12.1 million of currency translation, $4.0 million in higher bad debt expense, $3.6 million of costs associated with the GSA contract audits settlement and a $1.9 million year-over-year increase in continuous improvement costs, partially offset by a $1.7 million gain from the sale of a facility. Operating expenses were also impacted by $3.5 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 nine months of 2004 decreased $18.5 million as compared to the first nine months of 2003.
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Total segment revenue in the third quarter of 2004 increased $19.9 million, or 20.3%, over prior-year levels primarily due to $17.7 million in higher sales, primarily attributable to growth in Snap-on® handheld diagnostics, in particular the launch of the Snap-on® SOLUSTMScannerTM diagnostics tool through the U.S. dealer business. Currency translation of $2.2 million also contributed to the year-over-year increase in segment revenue.
Segment gross profit for the third quarter of 2004 increased $10.1 million, or 240 basis points as a percentage of total segment revenue, from the same period last year, largely reflecting the growth in sales and benefits from prior continuous improvement activities. Operating expenses for the Diagnostics and Information Group were essentially flat year over year, but improved 390 basis points as a percentage of total segment revenue, primarily reflecting the impact of higher sales. As a result, segment operating earnings in the third quarter of 2004 increased $9.3 million, or 630 basis points as a percentage of total segment revenue, as compared to the third quarter of 2003.
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Total segment revenue for the first nine months of 2004 increased $32.7 million, or 11.1%, over prior-year levels primarily due to $25.7 million in higher sales, principally sales of handheld diagnostics, as well as $7.0 million of currency translation.
Segment gross profit for the first nine months of 2004 increased $19.8 million, or 270 basis points as a percentage of total segment revenue, from the same period last year largely reflecting the growth in sales of handheld diagnostics and information products, $4.3 million of benefits from prior continuous improvement activities and $2.5 million of currency translation. Operating expenses for the Diagnostics and Information Group were essentially flat, but decreased 270 basis points as a percentage of total segment revenue, reflecting $2.3 million of currency translation partially offset by $1.1 million of lower bad debt expense. As a result, segment operating earnings in the first nine months of 2004 increased $19.3 million, or 540 basis points as a percentage of total segment revenue, as compared to the first nine months of 2003.
Segment operating results for Financial Services for the three and nine months ended October 2, 2004, are as follows:
Segment operating earnings for the third quarter and the first nine months of 2004 were $7.4 million and $27.9 million. Net finance income was $10.0 million and $31.7 million in the third quarter and first nine months of 2003. Operating earnings for the third quarter and the first nine months of 2004 decreased year over year primarily due to lower loan originations and higher market interest rates. Snap-on believes the decline in loan originations is primarily due to sales mix in the Snap-on Dealer Group and a reduced level of dealer borrowings resulting from the strengthening fiscal health of dealers, combined with the introduction of the extended trial franchise program.
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Interest expense was $6.1 million in the third quarter of 2004, up $0.3 million from $5.8 million in the third quarter of 2003. For the first nine months of 2004, interest expense of $17.4 million was down $0.8 million from $18.2 million in the prior year. The year-over-year increase in the third quarter primarily reflects higher average interest rates, partially offset by lower average debt levels. For the first nine months of 2004, the year-over-year decline primarily reflects the impact of lower average debt levels due to cash flow from operating activities, partially offset by higher average interest rates.
Other income (expense) – net was an expense of $0.8 million for the third quarter of 2004, as compared to an expense of $2.4 million in the comparable prior-year period. This line item includes the impact of all non-operating items such as interest income, minority interest, hedging and currency exchange rate transaction gains and losses, and other miscellaneous non-operating items. Other expense decreased $1.6 million in the third quarter of 2004 over the prior-year level largely due to lower foreign exchange losses. Other income (expense) – net was an expense of $3.6 million for the first nine months of 2004, as compared to an expense of $6.5 million in the comparable prior-year period. Other expense decreased $2.9 million in the first nine months of 2004 over the prior-year level primarily due to $4.2 million of lower foreign exchange losses, partially offset by a $1.1 million increase in minority interests.
Snap-on’s effective tax rate of 23.0% and 22.7% for the third quarter of 2004 and 2003 both benefited from the conclusion of prior-year’s tax matters. For the first nine months of 2004 and 2003, Snap-on’s overall effective tax rate was 30.7% and 31.9%. Snap-on anticipates that its effective tax rate for the fourth quarter of 2004 will approximate 35%.
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 restructuring 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 balance sheet affords the company the financial flexibility to respond to both internal growth opportunities and those available through acquisitions.
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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 operational decisions. As of October 2, 2004, working investment (defined as accounts receivable – net of allowances plus inventories less accounts payable) of $672.0 million was down $36.2 million from the $708.2 million as of year-end 2003. The following represents the company’s working investment position as of October 2, 2004, and January 3, 2004.
Accounts receivable at the end of the third quarter of 2004 was $527.5 million, down $19.3 million from year-end 2003 levels, including a decrease of $1.3 million from currency translation. At the end of the third quarter of 2004, days sales outstanding improved to 86 days from 88 days at January 3, 2004.
Inventories totaled $345.3 million at the end of the third quarter of 2004, down $5.8 million from year-end 2003 levels, including a decrease of $1.5 million from currency translation. Inventories accounted for using the first-in, first-out (FIFO) method as of October 2, 2004, and January 3, 2004, approximated 63% and 69% of total inventories, respectively. 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 October 2, 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 October 2, 2004, were 3.6 turns, as compared to 3.5 turns at year-end 2003.
Total notes payable and long-term debt was $331.8 million at the end of the third quarter of 2004, as compared to $333.2 million at year-end 2003. Cash and cash equivalents were $153.3 million as of October 2, 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.
Borrowings under commercial paper programs totaled $25.0 million at both the end of the third quarter of 2004 and at year-end 2003. On July 27, 2004, Snap-on entered into a five-year $400 million multi-currency revolving credit facility that will terminate on July 27, 2009. This $400 million facility replaced the $408 million of multi-currency revolving credit facilities that served to back the company’s commercial paper programs, including a $200 million, 364-day revolving credit facility that terminated on July 30, 2004, and a five-year $208 million revolving credit facility that would have terminated on August 20, 2005. 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 date of this document, Snap-on believes it is in compliance with all covenants of this revolving credit facility.
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At October 2, 2004, Snap-on also had $20 million of unused committed bank lines of credit, of which $10 million expires on July 31, 2005, and $10 million expires on August 31, 2005.
The following discussion focuses on information included in the accompanying Consolidated Statements of Cash Flows.
Cash flow provided from operating activities was $134.2 million in the first nine 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. In the third quarter of 2004, Snap-on made a $10.0 million payment to the U.S. Department of Justice pursuant to an agreement to resolve a government audit relating to two contracts with the GSA. Cash flow from operating activities in 2003 was $140.0 million, including a $14.0 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 $25.9 million in the first nine months of 2004 were up from the $18.7 million expended in the first nine 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 $35 million to $40 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 the company believes market conditions are favorable. Snap-on repurchased 900,000 shares of common stock for $29.4 million under its previously announced share repurchase programs during the first nine months of 2004. As of the end of the third quarter of 2004, Snap-on has remaining availability to repurchase up to an additional $125.1 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. The company intends to continue to buy, and has bought, additional shares in the fourth quarter of 2004, such that full year repurchases have exceeded its fiscal 2004 repurchase target of 1,000,000 shares that was publicly announced by press release dated January 21, 2004.
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Snap-on has paid consecutive quarterly cash dividends, without interruption or decline, since 1939. Cash dividends paid totaled $43.4 million for the first nine months of 2004, as compared to $43.6 million in the first nine 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.
Employees:
On August 27, 2004, Snap-on and approximately 70 employees at the company's Natick, Massachusetts, facility ratified a new collective bargaining agreement. The terms of the agreement were not materially different from the previous agreement.
Approximately 125 employees at the company’s Johnson City, Tennessee, facility are covered under a collective bargaining agreement that will expire in December 2004. At this time the company cannot predict the outcome of these negotiations.
American Jobs Creation Act of 2004:
On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law. The company is currently assessing the impact the Act will have on its future effective tax rates and cash tax payments.
Snap-on’s disclosures of its critical accounting polices, which are contained in its Annual Report on Form 10-K for the year ended January 3, 2004, have not materially change since that report was filed.
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Snap-on expects full-year 2004 reported earnings to be in the range of $1.35 to $1.45 per diluted share, which is anticipated to include $0.26 per share for continuous improvement costs.
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; and make effective improvements in machine maintenance, plant productivity and manufacturing line set-up and change-over practices; as well as uncertainties related to 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; and its ability to weather disruption arising from planned facility closures, or other labor interruptions. These risks also include uncertainties related to Snap-on’s ability to withstand external negative factors including terrorist disruptions on business; potential 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; the impact on approximately ten percent of the dealer network and on the company’s sales from hurricane activity in the Southern and Eastern coastal regions of the United States and the related impact of decreased sales on the operating income from financial services; 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, particularly in North America and Europe. 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 fluctuations in currency exchange rates 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 to the Consolidated Financial Statements.
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 to the Consolidated Financial Statements.
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 October 2, 2004, was$0.7 million on interest rate-sensitive financial instruments and $0.8 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 October 2, 2004, $9.5 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 $10.6 million as of October 2, 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.
There were no changes in internal control over financial reporting that occurred during the quarter ended October 2, 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 third 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 the company believes 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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These repurchases are being made pursuant to the three Board authorizations discussed above. During the first nine months of 2004, the company repurchased 900,000 shares of common stock in connection with this announcement. The company intends to continue to buy, and has bought, additional shares in the fourth quarter of 2004, such that full year repurchases have exceeded its fiscal 2004 repurchase target of 1,000,000 shares that was publicly announced by press release dated January 21, 2004.
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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
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