10-K 1 file001.htm FORM 10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
ANNUAL REPORT

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 X  EXCHANGE ACT OF 1934

For the fiscal year ended January 1, 2005

COMMISSION FILE 1-5224

THE STANLEY WORKS
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


 
CONNECTICUT 06-0548860
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
(I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
1000 STANLEY DRIVE
NEW BRITAIN, CONNECTICUT
06053
(ADDRESS OF PRINCIPAL
EXECUTIVE OFFICES)
(ZIP CODE)

860 225-5111
(REGISTRANT'S TELEPHONE NUMBER)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


TITLE OF EACH CLASS NAME OF EACH EXCHANGE
ON WHICH REGISTERED
Common Stock--$2.50 Par Value per Share New York Stock Exchange Pacific Stock Exchange

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:    NONE

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 and (2) has been subject to such filing requirements for the past 90 days.

Yes  X    No    

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [X].

Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12-b of the Act).

Yes  X    No    

As of July 3, 2004, the aggregate market values of voting common equity held by non-affiliates of the registrant was $3,742,976,480 based on the New York Stock Exchange closing price for such shares on that date. On March 2, 2005, the registrant had 82,618,222 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the end of the registrant's fiscal year are incorporated by reference in Part III.




FORM 10-K

PART I

ITEM 1.    BUSINESS

1(a)    GENERAL DEVELOPMENT OF BUSINESS

(i)    General.    The Stanley Works ("Stanley" or the "Company") was founded in 1843 by Frederick T. Stanley and incorporated in 1852. Stanley is a worldwide producer of tools for professional, industrial and consumer use and security products. Stanley® is a brand recognized around the world for quality and value.

In 2004, Stanley had net sales of $3.0 billion from continuing operations and employed approximately 14,100 people worldwide. The Company's principal executive office is located at 1000 Stanley Drive, New Britain, Connecticut 06053 and its telephone number is (860) 225-5111.

(ii)    Restructuring Activities.    Information regarding the Company's restructuring activities is incorporated herein by reference to the material captioned "Restructuring Activities" in Item 7 and Note O Restructuring and Asset Impairments of the Notes to the Consolidated Financial Statements in Item 15.

1(b) FINANCIAL INFORMATION ABOUT SEGMENTS    Financial information regarding the Company's business segments is incorporated herein by reference to the material captioned "Business Segment Results" in Item 7 and Note P Business Segments and Geographic Areas of the Notes to the Consolidated Financial Statements in Item 15.

1(c)    NARRATIVE DESCRIPTION OF BUSINESS

The Company's operations are classified into three business segments: Consumer Products, Industrial Tools, and Security Solutions.

Consumer Products

The Consumer Products segment manufactures and markets hand tools, consumer mechanics tools and storage units, and hardware. These products are sold to customers and distributed directly to retailers (including home centers, mass merchants, hardware stores, and retail lumber yards) as well as through third party distributors.

Hand tools include measuring instruments, planes, hammers, knives and blades, screwdrivers, saws, chisels, boring tools, masonry, tile and drywall tools, as well as electronic stud sensors, levels, alignment tools and elevation measuring systems. The Company markets its hand tools under the Stanley®, FatMax®, Powerlock®, IntelliTools(TM) and Goldblatt® brands, as well as under certain retailer's private label brands.

Consumer mechanics hand tools include wrenches, sockets and tool boxes which are marketed under the Stanley®, Husky® and ZAG® brands, as well as under certain retailer's private label brands.

Industrial Tools

The Industrial Tools segment manufactures and markets professional mechanics tools, pneumatic tools and fasteners, hydraulic tools and accessories, assembly tools and systems, and electronic measuring tools. These products are sold to customers and distributed primarily through third party distributors as well as through direct sales forces.

Professional mechanics tools include wrenches, sockets, electronic diagnostic tools, tool boxes and high-density industrial storage and retrieval systems. Professional mechanics tools are marketed under the Stanley®, Proto®, Mac®, Jensen®, Vidmar® and Blackhawk(TM) by Proto® brands.

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Pneumatic tools and fasteners include Bostitch®, Atro® and Stanley ® fastening tools and fasteners (nails and staples) used for construction, remodeling, furniture making, pallet manufacturing and other applications involving the attachment of wooden materials.

Hydraulic tools include Stanley® hand-held hydraulic tools and accessories used by contractors, utilities, railroads and public works as well as LaBounty® mounted demolition hammers and compactors designed to work on skid steer loaders, mini-excavators, backhoes and large excavators.

Assembly tools and systems include electric and pneumatic assembly tools marketed under the Stanley® brand (these are high performance, precision tools, controllers and systems for tightening threaded fasteners used chiefly by vehicle manufacturers).

Electronic measuring tools include laser and optical leveling and measuring devices utilized primarily by contractors, surveyors, engineers and other professionals and do-it-yourself individuals. These products are marketed under the CST/Berger® and David White® brands.

Security Solutions

The Security Solutions segment is a provider of access and security solutions primarily for retailers, educational and healthcare institutions, government, financial institutions, and commercial and industrial customers. The company provides an extensive suite of mechanical and electronic security products and systems, and a variety of security services. The company manufactures and markets automatic doors, door locking systems, commercial hardware and security access control systems. Products in the Security Solutions segment include security integration systems, software, related installation and maintenance services, automatic doors, and locking mechanisms. Security products are marketed under the Stanley®, Blick®, Frisco Bay®, PAC®, ISRTM, WanderGuard® , StanVisionTM and BEST® brands and are sold primarily on a direct sales basis as well as, in certain instances, through third party distributors.

Competition

The Company competes on the basis of its reputation for product quality, its well-known brands, its commitment to customer service and strong customer relationships, the breadth of its product lines and its emphasis on product innovation.

The Company encounters active competition in all of its businesses from both larger and smaller companies that often offer the same or similar products and services or that produce different products appropriate for the same uses. The Company has a large number of competitors; however, aside from a small number of competitors in the consumer hand tool and consumer hardware business, who produce a range of products somewhat comparable to the Company's, the majority of its competitors compete only with respect to one or more individual products or product lines within a particular line. The Company believes that it is one of the largest manufacturers of hand tools in the world featuring a broader line than any other toolmaker. The Company also believes that it is a leader in the manufacture and sale of pneumatic fastening tools and related fasteners to the construction, furniture and pallet industries as well as a leading manufacturer of hand-held hydraulic tools used for heavy construction, railroads, utilities and public works. The Company also believes that it is among the largest security integration service providers in North America.

Customers

A substantial portion of the Company's products in the Consumer Products and Industrial Tools segments are sold through home centers and mass merchant distribution channels in the U.S. In 2004, sales to The Home Depot were 12% of the Company's consolidated sales from continuing operations. A consolidation of retailers both in North America and abroad has occurred over time. While this consolidation and the domestic and international expansion of these large retailers provide the Company with opportunities for growth, the increasing size and importance of individual customers creates a certain degree of exposure to potential volume loss. The loss of the customer referred to above as well as certain of the other larger home centers as customers would have a material adverse

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effect on each of the Company's business segments until either such customers were replaced or the Company made the necessary adjustments to compensate for the loss of business.

Despite the trend toward customer consolidation, the Company has a diversified customer base and has decreased this potential risk over the past years as sales from continuing operations in markets outside of the home center and mass merchant distribution channel have grown at a greater rate through a combination of efforts to broaden the customer base primarily in the Security Solutions and Industrial Tools segments.

Raw Materials

The Company's products are manufactured of steel, aluminum and other metals, as well as wood and plastic. The raw materials required are available from a number of sources at competitive prices and the Company has annual contracts with some of its key suppliers. The Company has occasionally experienced difficulties in obtaining supplies in recent periods mainly for steel products. Certain commodity prices, particularly steel, may increase in 2005, but the Company does not anticipate difficulties with respect to adequate supplies of raw materials.

Backlog

Due to short order cycles and rapid inventory turnover in many of the Company's businesses, backlog is generally not considered a significant indicator of future performance. At February 6, 2005, the Company had approximately $279 million in unfilled orders compared with $284 million in unfilled orders at March 6, 2004. All of these orders are reasonably expected to be filled within the current fiscal year. Most customers place orders for immediate shipment and as a result, the Company produces primarily for inventory, rather than to fill specific orders.

Patents and Trademarks

No business segment is dependent, to any significant degree, on patents, licenses, franchises or concessions and the loss of these patents, licenses, franchises or concessions would not have a material adverse effect on any of the business segments. The Company owns numerous patents, none of which are material to the Company's operations as a whole. These patents expire at various times over the next 20 years. The Company holds licenses, franchises and concessions, none of which individually or in the aggregate is material to the Company's operations as a whole. These licenses, franchises and concessions vary in duration but generally run from one to 20 years.

The Company has numerous trademarks that are used in its businesses worldwide. The STANLEY® and STANLEY in a notched rectangle design trademarks are material to all three business segments. These well-known trademarks enjoy a reputation for quality and value and are among the world's most trusted brand names. The Company's tagline, "Make Something Great(TM)" is the centerpiece of the brand strategy for all segments. In the Consumer Products and Industrial Tools segments, the Bostitch®, Powerlock®, Tape Rule Case Design (Powerlock), FatMax®, LaBounty®, MAC®, Proto®, Jensen®, Goldblatt®, Husky®, Vidmar®, CST® and Zag® trademarks are also material to these segments. In the Security Solutions segment, the BEST®, Blick, Frisco Bay® and ISR(TM) trademarks are also material to this segment. The terms of these trademarks vary from one to 20 years, with most trademarks being renewable indefinitely for like terms.

Environmental Regulations

The Company is subject to various environmental laws and regulations in the U.S. and foreign countries where it has operations. Future laws and regulations are expected to be increasingly stringent and will likely increase the Company's expenditures related to environmental matters.

The Company is a party to a number of proceedings before federal and state regulatory agencies relating to environmental remediation. Additionally, the Company, along with many other companies, has been named as a potentially responsible party ("PRP") in a number of administrative proceedings for the remediation of various waste sites, including ten active Superfund sites.

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Current laws potentially impose joint and several liabilities upon each PRP. In assessing its potential liability at these sites, the Company has considered the following: the solvency of the other PRP's, whether responsibility is being disputed, the terms of existing agreements, experience at similar sites, and the fact that its volumetric contribution, if any, at these sites is relatively small.

The Company's policy is to accrue environmental investigatory and remediation costs for identified sites when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. The amount of liability recorded is based on an evaluation of currently available facts with respect to each individual site and includes such factors as existing technology, presently enacted laws and regulations, and prior experience in remediation of contaminated sites. The liabilities recorded do not take into account any claims for recoveries from insurance or third parties. As assessments and remediation progress at individual sites, the amounts recorded are reviewed periodically and adjusted to reflect additional technical and legal information that becomes available. As of January 1, 2005, the Company had reserves of approximately $13.6 million, primarily for remediation activities associated with Company-owned properties as well as for Superfund sites, for losses that are probable and estimable.

The amount recorded for identified contingent liabilities is based on estimates. Amounts recorded are reviewed periodically and adjusted to reflect additional technical and legal information that becomes available. Actual costs to be incurred in future periods may vary from the estimates, given the inherent uncertainties in evaluating environmental exposures. Subject to the imprecision in estimating future environmental costs, the Company does not expect that any sum it may have to pay in connection with environmental matters in excess of the amounts recorded will have a materially adverse effect on its consolidated financial position, results of operations or liquidity.

Employees

At January 1, 2005, the Company had approximately 14,100 employees, nearly 7,500 of whom were employed in the U.S. Approximately 765 U.S. employees are covered by collective bargaining agreements negotiated with 14 different local labor unions who are, in turn, affiliated with approximately 6 different international labor unions. The majority of the Company's hourly-paid and weekly-paid employees outside the U.S. are not covered by collective bargaining agreements. The Company's labor agreements in the U.S. expire in 2005, 2006, 2007 and 2008. With the exception of an eleven day strike in New Britain and Farmington, Connecticut, in 2003 there have been no significant interruptions or curtailments of the Company's operations in recent years due to labor disputes. The Company believes that its relationship with its employees is very good.

1(d) FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS Financial information regarding the Company's geographic areas is incorporated herein by reference to Note P Business Segments and Geographic Areas of the Notes to the Consolidated Financial Statements in Item 15.

1(e) AVAILABLE INFORMATION The Company's website is located at http://www.Stanleyworks.com. (This URL is intended to be an inactive textual reference only. It is not intended to be an active hyperlink to our website. The information on our website is not, and is not intended to be, part of this Form 10-K and is not incorporated into this report by reference.) Stanley makes its Forms 10-K, 10-Q, 8-K and amendments to each available free of charge on its website as soon as reasonably practicable after filing them with the U.S. Securities and Exchange Commission.

ITEM 2.    PROPERTIES

As of January 1, 2005, the Company and its subsidiaries owned or leased material facilities (facilities over 50,000 square feet) for manufacturing, distribution and sales offices in 16 states and 14 foreign countries. The Company believes that its material facilities are suitable and adequate for its business.

Certain properties are utilized by more than one segment and in such cases the property is reported in the segment with highest usage. Material facilities owned by the Company and its subsidiaries follow:

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Consumer Products

New Britain, Connecticut; Cheraw, South Carolina; Pittsfield, Vermont; Richmond, Virginia; Smiths Falls, Canada; Guang Dong, Peoples Republic of China; Besancon Cedex, France; Wieseth, Germany; Puebla, Mexico and Taichung Hsien, Taiwan.

Industrial Tools

Phoenix, Arizona; Clinton, Connecticut; Shelbyville, Indiana; Dallas and Wichita Falls, Texas; Two Harbors, Minnesota; Hamlet, North Carolina; Columbus, Georgetown and Sabina, Ohio; Allentown, Pennsylvania; East Greenwich, Rhode Island; Chihuahua, Mexico; Wroclaw, Poland; Daxing, Peoples Republic of China; Pecky, Czech Republic and Amphur Bangpakong, Thailand.

Security Solutions

Farmington, Connecticut; Indianapolis, Indiana.

Corporate Offices

New Britain, Connecticut

Material facilities leased by the Company and its subsidiaries follow:

Consumer Products

New Britain, Connecticut; Miramar, Florida; Kannapolis, North Carolina; Somerton, Australia; Mechelen, Belgium; Oakville and Smiths Falls, Canada; Hellaby, Ecclesfield, Northampton, England; Karmiel, Israel.

Industrial Tools

Covington, Georgia; Watseka, Illinois; Fishers, Indiana; Highland Heights and Columbus, Ohio; Milwaukie, Oregon; Biassono, Italy

Security Solutions

None

The aforementioned material facilities not being used by the Company include:

Consumer Products

Wichita Falls, Texas (owned); Richmond, Virginia (owned); and Ecclesfield, England (leased).

Industrial Tools

Hamlet, North Carolina (owned)

Security Solutions

None

ITEM 3.    LEGAL PROCEEDINGS

In the normal course of business, the Company is involved in various lawsuits, claims, including product liability, environmental and distributor claims, and administrative proceedings. The Company does not expect that the resolution of these matters will have a materially adverse effect on the Company's consolidated financial position, results of operations or liquidity.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted during the fourth quarter of 2004 to a vote of security holders.

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PART II

ITEM 5.    MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED
                    STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company's common stock is listed and traded on the New York and Pacific Stock Exchanges under the abbreviated ticker symbol "SWK," and is a component of the S&P 500 Composite Stock Price Index. The Company's high and low quarterly stock price on the NYSE for the years ended January 1, 2005 and January 3, 2004 follow:


  2004 2003
  High Low Dividend
Per
Common
Share
High Low Dividend
Per
Common
Share
QUARTER:
First $ 43.75   $ 36.42   $ 0.26   $ 36.06   $ 23.97   $ 0.255  
Second $ 46.08   $ 39.50   $ 0.26   $ 28.59   $ 21.00   $ 0.255  
Third $ 45.90   $ 40.17   $ 0.28   $ 30.53   $ 27.45   $ 0.26  
Fourth $ 49.33   $ 40.69   $ 0.28   $ 37.87   $ 29.47   $ 0.26  
Total             $ 1.08               $ 1.03  

As of January 1, 2005 there were 13,238 holders of record of the Company's common stock.

The Company made no repurchases of common shares during the fourth quarter of 2004.

ITEM 6.    SELECTED FINANCIAL DATA

The following selected financial information should be read in conjunction with the Consolidated Financial Statements and related Notes appearing in Item 15 of this Form 10-K. The information below excludes the Residential Entry Door, Home Décor and German paint roller businesses, which are classified as discontinued operations as disclosed in Note T Discontinued Operations in Item 15, unless otherwise noted (in millions, except per share amounts):


  2004 2003 ** 2002 ** 2001 ** 2000 **
Continuing Operations:                              
Net sales $ 3,043   $ 2,531   $ 2,234   $ 2,233   $ 2,371  
Net earnings $ 240   $ 91   $ 157   $ 137   $ 172  
Basic earnings per share:                              
Continuing operations $ 2.93   $ 1.08   $ 1.82   $ 1.59   $ 1.97  
Discontinued operations $ 1.54   $ 0.20   $ 0.32   $ 0.25   $ 0.25  
Total basic earnings per share $ 4.47   $ 1.28   $ 2.14   $ 1.85   $ 2.22  
Diluted earnings per share:                              
Continuing operations $ 2.85   $ 1.07   $ 1.78   $ 1.56   $ 1.97  
Discontinued operations $ 1.50   $ 0.20   $ 0.32   $ 0.25   $ 0.25  
Total diluted earnings per share $ 4.36   $ 1.27   $ 2.10   $ 1.81   $ 2.22  
                               
Percent of net sales:                              
Cost of sales   63.4   66.1   66.5   63.5   62.7
Selling, general and administrative*   22.8   24.3   22.6   23.8   24.5
Interest, net   1.1   1.1   1.1   1.2   1.1
Other, net   1.5   1.6   (0.4 )%    (0.6 )%    0.8
Earnings before income taxes   10.8   4.8   10.2   9.1   11.0
Net earnings   7.9   3.6   7.0   6.1   7.3

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  2004 2003 ** 2002 ** 2001 ** 2000 **
                               
Balance sheet data:                              
Total assets*** $ 2,851   $ 2,424   $ 2,418   $ 2,056   $ 1,885  
Long-term debt $ 482   $ 514   $ 563   $ 197   $ 249  
Shareowners' equity $ 1,221   $ 869   $ 994   $ 843   $ 747  
                               
Ratios:                              
Current ratio***   1.7     1.6     1.8     1.4     1.5  
Total debt to total capital   32.4   43.6   41.7   37.0   38.0
Income tax rate — continuing operations   27.0   25.9   30.8   32.7   33.8
Return on average equity   23.0   9.8   17.1   18.6   26.2
                               
Common stock data:                              
Dividends per share $ 1.08   $ 1.03   $ 0.99   $ 0.94   $ 0.90  
Equity per share at year-end $ 14.82   $ 10.69   $ 11.45   $ 9.96   $ 8.77  
Market price — high $ 49.33   $ 37.87   $ 52.00   $ 46.85   $ 31.88  
Market price — low $ 36.42   $ 21.00   $ 27.31   $ 28.06   $ 18.44  
Average shares outstanding (in 000's):                              
Basic   82,058     84,143     86,453     85,761     87,407  
Diluted   84,244     84,839     88,246     87,467     87,668  
                               
Other information:                              
Average number of employees   13,625     12,505     12,262     13,168     14,774  
Shareowners of record at end of year   13,238     13,915     14,053     15,290     16,014  
* Inclusive of provision for doubtful accounts.
** The results have been restated from earlier published amounts to reflect reclassification of the Residential Entry Door, Home Décor and German paint roller businesses as discontinued operations, as discussed in Note T Discontinued Operations of the Notes to the Consolidated Financial Statements in Item 15.
*** Item includes discontinued operations.
    Note: The Company made significant acquisitions in 2002 and 2004, as discussed in Note F Acquisitions of the Notes to the Consolidated Financial Statements in Item 15. Refer to the Significant Charges and Credits section of Management Discussion and Analysis in Item 7 for other matters affecting the comparability of results.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The financial and business analysis below provides information which the Company believes is relevant to an assessment and understanding of its consolidated financial position, results of operations and cash flows. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes.

The following discussion and certain other sections of this Report contain statements reflecting the Company's views about its future performance and constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which the Company operates and management's beliefs and assumptions. Any statements contained herein (including without limitation statements to the effect that The Stanley Works or its management "believes", "expects", "anticipates", "plans" and similar expressions) that are not statements of historical fact should be considered forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth below under the heading "Cautionary Statements." The Company does not intend to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.

BUSINESS OVERVIEW

The Company has continued to focus on a profitable growth strategy and to alter its portfolio of businesses. This strategy encompasses acquisitions and the reduction of risk associated with certain large customer concentrations. The Company believes this strategy will improve the overall profitability of operations over the long term. Over the next several years the Company anticipates more acquisitions will be made, particularly in the Industrial Tools and Security Solutions segments. The following events/matters (including acquisitions and divestitures related to this strategy) had a significant impact on the Company's financial performance in 2004 and 2003:

•  In 2004, the acquisitions of Blick plc, CST/Berger, Frisco Bay Industries Ltd., ISR Solutions Inc., and one small security business were completed at the total cost of $322 million. Blick is a leading U.K. integrator of security systems, communication and time management solutions for the commercial and industrial sectors. CST/Berger is a designer and manufacturer of laser and optical leveling and measuring equipment. Frisco Bay is a leading Canadian provider of security systems and equipment for financial institutions, government agencies and major corporations. ISR is a North American electronic security integrator providing the U.S. federal government and commercial customers with access security systems design, installation and maintenance services.
•  The Company sold its Home Décor business during the fourth quarter of 2004 for $87 million, and, therefore, this business was reported as a discontinued operation for all periods. The after-tax gain recorded on this transaction was $24 million. The Home Décor business contributed $0.13, $0.07, and $0.15 of diluted earnings per share in 2004, 2003, and 2002, respectively. Additionally, a small German business with annual sales of approximately $20 million, which manufactures primarily European private label paint rollers, was included in discontinued operations. The EPS impact of this business to the Company prior to divestiture was nominal.
•  The Company experienced an unfavorable impact from unusually high levels of commodity price inflation (particularly steel) in 2004 and actively pursued price increases across its channels. These price increase efforts gradually gained acceptance throughout the year with the Company's customers. The effect of commodity inflation, and freight cost increases, was $75 million in 2004, of which approximately 60% was offset with related price increases to customers. Steel cost and other inflation impacts, partially offset by price increases, will

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  continue to have a substantial impact on the Company in 2005 and potentially beyond. The Company estimates the carryover impact in 2005 of this inflation at $40-45 million, of which approximately 80-85% will be offset with the aforementioned price increase carryover impact. These 2005 estimates assume no change in existing commodity price levels or the related customer price levels.
•  The Company acquired several businesses, primarily Best Access which was completed in November 2002, which had a significant favorable impact on the Company's 2003 performance. The total cost of these acquisitions was $340 million.
•  The Company entered into a definitive agreement during December 2003 to sell its Residential Entry Door business and, therefore, this business was reported as a discontinued operation for all periods. The $161 million sale was completed in the first quarter of 2004 and the after-tax gain recorded was $95 million. The Residential Entry Door business contributed $0.13 and $0.17 of diluted earnings per share in 2003, and 2002, respectively. The impact in 2004 aside from the gain on the sale was nominal.
•  The Company announced restructuring plans in April 2003 to improve the profitability of certain struggling businesses ("Operation 15"). The restructuring was completed in 2003 and included a workforce reduction of over 1,000 people, the exit from the Mac Tools retail channel ("MacDirect"), and the impairment of certain fixed assets and inventories related primarily to the future consolidation of two distribution facilities.
•  The Company recognized $8 million in charges related to compensation payable to the former Chairman and Chief Executive Officer, John M. Trani, pertaining to his retirement effective December 31, 2003. These retirement costs were comprised of severance and pension as specified in an employment contract entered into in 2000.

In 2004, the Company implemented a change to its segment reporting in response to the divestiture and acquisition activity which arose from the aforementioned strategy. The Company's operations are now classified into three business segments: Consumer Products, Industrial Tools, and Security Solutions. The Consumer Products segment manufactures and markets hand tools, consumer mechanics tools and storage units, and hardware. These products are sold to customers and distributed directly to retailers (including home centers, mass merchants, hardware stores, and retail lumber yards). The Industrial Tools segment manufactures and markets professional mechanic tools and storage systems, pneumatic tools and fasteners, assembly tool systems and specialty tools, hydraulic tools and electronic leveling tools. These products are sold to customers and distributed either directly or through third party distributors. The Security Solutions segment manufactures and markets automatic doors, door locking systems, commercial hardware and security access control systems, primarily through various direct sales forces.

During 2004 and 2003, the strengthening of the Euro and other foreign currencies had a significant favorable impact on the translation of foreign currency-denominated operating results into U.S. dollars. It is estimated that the favorable impact of foreign currency translation, including acquired companies, contributed $0.12 and $0.13 of continuing operations diluted earnings per share in 2004 and 2003, respectively. Fluctuations in foreign currency exchange rates relative to the U.S. dollar may have a significant impact on future earnings.

RESULTS OF OPERATIONS

The Company has provided below a summary of its operating results at the consolidated level, followed by an overview of its business segment performance.

Net Sales:    Net sales from continuing operations were $3,043 million in 2004, as compared to $2,531 million in 2003, a 20% increase. Excluding 2004 acquisitions, organic sales increased 11% driven by 6% volume growth, improved pricing and favorable foreign currency impact. The volume growth is due to: increased industrial tool demand from favorable market conditions; improved order fulfillment and execution in several businesses; strong consumer hand and mechanics tool demand from home center and mass merchant customers; and increased Security revenues primarily due to share gains in

10




automated door products. The 2004 net sales volume performance was significant considering the Company had a 52-week 2004 reporting period versus a 53-week reporting period last year. Favorable foreign currency translation, primarily European, increased net sales by 2%. The impact of pricing resulted in a net sales increase of 3%, mainly as a result of the Company actively pursuing price increases to offset commodity inflation. Other pricing actions associated with more effective price management routines resulted in an additional $20-$25 million of benefit.

Net sales from continuing operations were $2,531 million for 2003, as compared to $2,234 million in 2002, a 13% increase. Acquisitions contributed $266 million, or a 12% increase of net sales. Overall, organic sales volume declined 2%, offset by favorable foreign currency translation of 3% due primarily to the movement in European currencies. Organic sales volume declined mainly due to the termination of the MacDirect program under the Operation 15 initiative combined with customer inventory corrections in the industrial and consumer channels in the first half of 2003. These sales declines were partially offset by strong fourth quarter 2003 demand in U.S. hand and mechanics tools, and expanding service operations and share gains at national accounts in the automated doors operation.

Significant Charges and Credits:    In 2004, the Company recorded $4 million of pre-tax restructuring costs in connection with specific personnel actions to streamline/reposition certain organizations, $4 million of impairment charges primarily associated with a 2004 information system strategy decision, and a $2 million provision for recent litigation. Additionally, an $8 million credit to income taxes was recorded as a result of favorable resolutions of tax audits, increased utilization of foreign net operating loss carry forwards and specific acquisition tax-planning activities.

In 2003, the Company recorded $108 million of pre-tax restructuring costs, impairment charges, and other exit costs in connection with the Operation 15 initiative. Certain expenses totaling $8 million related to the retirement of the Company's former Chairman and CEO were recorded in addition to Operation 15 charges. In the first quarter of 2003, the Company recorded $3 million in restructuring reserves for initiatives pertaining to the further reduction of its cost structure, primarily for severance-related obligations. A summary of the pre-tax charges recorded in 2003 related to these matters is as follows:


  (Millions of Dollars)
Operation 15      
Mac Direct exit      
Inventory losses $ 7  
Receivable losses   25  
Other   21  
Distribution facilities   13  
Other   42  
Total Operation 15 $ 108  
Other severance   3  
CEO retirement   8  
Total $ 119  

These charges were classified within the 2003 Consolidated Statement of Operations as follows: (i) Cost of sales — $20 million; (ii) SG&A and Provision for doubtful accounts — $37 million; (iii) Other-net — $10 million; and (iv) Restructuring and asset impairment charges — $52 million. Additionally, the 2003 income taxes reflect favorable foreign tax developments that resulted in a credit of $2 million.

In 2002, the Company reported a second quarter U.S. pension settlement pre-tax gain of $18 million. Also in the second quarter, the Company incurred $8 million in severance and related expenses associated with selling, general and administrative cost reductions. In the third quarter, the Company reported a $6 million credit to income taxes related to a favorable foreign tax development. In the fourth quarter, the Company recorded $22 million in non-cash charges for increased inventory and

11




receivable loss provisions and for specific manufacturing equipment impairments related to the following: (1) a reassessment of Mac Tools inventory and accounts receivable valuations, as a result of a then new retail control system; (2) an inventory valuation adjustment in Fastening Systems associated with cost estimation process improvements; and (3) impairment of certain fixed assets related primarily to the Wichita Falls and Dallas, Texas plants consolidation. Also in the fourth quarter the Company recorded $5.6 million of accounting corrections. These corrections relate primarily to expense capitalization and depreciation. Other significant credits in 2002 include $11 million in environmental income arising from a settlement with an insurance carrier recognized in the third and fourth quarters. These credits and charges were classified within the 2002 Consolidated Statement of Operations as follows: (i) Net sales — $1 million charge; (ii) Cost of sales — $17 million charge; (iii) SG&A expenses — $10 million charge; (iv) Other-net — $21 million credit; and (v) Income taxes — $6 million credit.

Gross Profit:    The Company reported gross profit from continuing operations of $1,112 million, or 36% of net sales, in 2004, compared to $858 million, or 34% of net sales, in the prior year. The businesses acquired increased gross profit by $105 million. The remaining $149 million improvement was primarily attributed to increased sales volume discussed previously, gross profit rate improvement, and $20 million of inventory losses recorded in 2003 related to the termination of the MacDirect distribution model and the planned consolidation of two major distribution facilities in conjunction with Operation 15. The gross profit rate improvement was attributable to the carryover benefit of 2003 restructuring programs, volume leverage, favorable pricing and improved product mix. These benefits were partially offset by higher steel costs and other inflation. The Company experienced a significant impact from unusually high levels of commodity price inflation (particularly steel) in 2004. The Company has actively pursued price increases in many business channels to partially offset this negative impact. The effect of commodity inflation and freight increases was $75 million in 2004, of which approximately 60% was offset with related price increases to customers. Steel cost and other inflation increases, partially offset by price increases, will continue to have a substantial impact on the Company in 2005 and potentially beyond.

The Company reported gross profit from continuing operations of $858 million, or 34% of net sales, in 2003, compared to $748 million, or 33% of net sales, in 2002. Excluding the $128 million favorable impact of acquisitions, gross profit declined slightly as compared with 2002 primarily due to organic sales volume declines discussed previously, $20 million of inventory losses recorded in conjunction with Operation 15, and higher retirement plan costs. These negatives were partially offset by favorable material and other efficiency variances.

SG&A expenses:    Selling, general and administrative expenses from continuing operations, inclusive of the provision for doubtful accounts, were $694 million, or 23% of net sales in 2004, compared to $616 million, or 24% of net sales, in the prior year. The increase of $78 million was primarily attributed to acquired businesses that increased costs by $62 million, higher business portfolio SG&A spending levels in connection with the strong organic net sales increase, increased funding for brand support, Sarbanes-Oxley compliance costs, and foreign currency translation. Additional factors impacting this comparison were accounts receivable losses of $25 million which related to the exiting of the MacDirect distribution model and $8 million of costs pertaining to the retirement of the Company's former CEO which were both recorded in 2003.

Selling, general and administrative expenses from continuing operations, inclusive of the provision for doubtful accounts, were $616 million, or 24% of net sales in 2003, compared to $505 million, or 23% of net sales, in the prior year. The increase relates to $70 million of incremental expenses from acquisitions, $25 million of receivable losses associated with the MacDirect exit, $8 million of costs related to the retirement of the Company's former CEO, higher retirement plan costs, and the negative impact from foreign currency translation.

Interest and Other-net:    Net interest expense from continuing operations in 2004 was $34 million, an increase of $6 million over 2003. The 2003 net interest expense from continuing operations represents a $4 million increase from the $24 million in 2002. The three year trend of increases was driven by higher borrowings due to the acquisitions discussed previously, partially offset by lower interest rates.

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Other-net from continuing operations represented $47 million of expense in 2004, an increase of nearly $8 million from expense of $39 million in 2003. The increase is primarily the result of increased intangible amortization expense of $10 million associated with recent acquisitions. Additionally, there was a significant cost increase and decrease which offset one another – a $10 million increase in currency losses from 2003 levels was offset by reduced losses on the MacAdvantage finance program in 2004 versus 2003.

Other-net from continuing operations was $39 million in expense for 2003 compared to $9 million in income for 2002. The increase in costs is primarily the result of an $18 million gain in 2002 from the U.S. pension settlement, $12 million of higher losses in 2003 related to the Company's MacAdvantage financing program, a $6 million loss on the sale of the Mac Tools distributor receivable portfolio (an Operation 15 initiative) in 2003, increased intangible amortization expense of $10 million in 2003 associated with acquisitions, and $11 million in income from an environmental settlement with an insurance carrier in 2002, which was slightly offset by a $2 million increase in other environmental expense.

Income Taxes:    The Company's effective income tax rate from continuing operations for 2004 was 27% as compared to 26% for 2003 and 31% for 2002.

The tax rate for the past two years reflects the continued benefit of a higher percentage of taxable income in countries with lower statutory rates, primarily in Europe and the Far East. Additionally, an $8 million credit to income taxes was recorded in 2004 as a result of favorable resolutions of tax audits, increased utilization of foreign net operating loss carry forwards and specific acquisition tax-planning activities. The 2003 effective income tax rate was affected further by the tax benefit from the Operation 15 charges which were predominately U.S. based. Additionally, the 2003 and 2002 income taxes reflect favorable foreign tax developments that reduced income taxes by $2 million and $6 million, respectively. The 2002 favorable development was offset by the impact of non-deductible excise tax associated with the termination of a defined benefit pension plan.

Business Segment Results:    The Company utilizes operating profit, which is defined as net sales minus cost of sales and SG&A, inclusive of the provision for doubtful accounts, and its percentage of net sales as measurements to evaluate the profitability of each segment. Segment operating profit excludes interest income, interest expense, other-net, restructuring charges and asset impairments, as well as income tax expense.


Consumer Products
(Millions of Dollars)
2004 2003 2002
Net sales from continuing operations $ 1,073   $ 958   $ 911  
Operating profit from continuing operations $ 175   $ 149   $ 130  
% of Net sales   16.3   15.6   14.3

Consumer Products net sales from continuing operations in 2004 represented a 12% increase from 2003, driven by the aforementioned strength in home center and mass merchant channels in the U.S. and favorable currency impacts in Europe. Of this 12% increase, volume represented 7% which was driven by growth in hand tools, consumer mechanics tools and storage units as a result of improved order fulfillment, increased brand support, and higher market demand, which was partially offset by volume declines in hardware products. Currency represented 4% and pricing 1% of the net sales increase. Operating margin improved 70 basis points primarily due to improved operating leverage from higher sales volumes, pricing and favorable product mix; however these factors were partially offset by the previously mentioned commodity cost inflation (primarily steel and resin), increased brand support and Sarbanes-Oxley compliance costs. Additionally, 2003 consumer products operating profit was impacted by $3 million in Operation 15 charges previously mentioned.

Consumer Products net sales from continuing operations in 2003 increased 5% as compared to 2002. The sales increased primarily from favorable foreign currency translation due mainly to European currencies. The volume increased slightly as a result of strong fourth quarter 2003 demand in the U.S. Hand Tools business which was offset partially by consumer channel customers inventory corrections in the first half of 2003. Consumer products operating profit was impacted by the charges previously mentioned totaling $3 million in 2003 and $6 million in 2002. The remaining $16 million increase in

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operating profit is primarily due to improved shift in business mix and favorable material and productivity variances, partially offset by higher retirement plan costs and further price erosion in 2003 versus 2002.


Industrial Tools
(Millions of Dollars)
2004 2003 2002
Net sales $ 1,292   $ 1,098   $ 1,111  
Operating profit $ 132   $ 17   $ 69  
% of Net sales   10.2   1.5   6.2

Industrial Tools net sales increased 18% from 2003. Excluding the CST/Berger acquisition, organic sales increased 12%. Volume represented 6% of the organic sales increase; and price and currency were 4% and 2%, respectively. This organic volume improvement was the result of better economic conditions, improved management execution in several businesses and improved order fulfillment related to industrial mechanic tool, assembly tool, specialty tool, and hydraulic tool products. Mac Tools net sales decreased 4% as sluggish market conditions impacted this business in the fourth quarter of 2004 combined with traditional distributor additions and higher route average sales only partially offsetting the anticipated decline from last year's MacDirect exit. The majority of the price increase was due to the Company's actions in response to commodity inflation as previously discussed. The significant improvement in the 2004 operating profit and margin rate is the result of charges in 2003 totaling $52 million mainly from receivable and inventory losses associated with the MacDirect exit, as well as higher sales volume, substantial improvement in the margin performances of Mac Tools and industrial mechanics tools as a result of the carryover benefits from prior year restructuring programs, and the acquisition of CST/Berger. These favorable factors were partially offset by the previously mentioned commodity cost inflation, as approximately two-thirds of the total company's commodity inflation (net of price recovery) impacted this segment, and Sarbanes-Oxley compliance costs.

Industrial Tools net sales in 2003 decreased 1% as compared to 2002. The sales volume decreased as a result of declining sales from the termination of the MacDirect program under the Operation 15 initiative and industrial channel customers inventory corrections in the first half of 2003, offset partially by strong fourth quarter 2003 demand in the U.S. mechanics tools business and favorable foreign currency translation due primarily to the European currencies. Industrial Tools operating profit was impacted by the charges previously mentioned totaling $52 million in 2003 and $21 million in 2002. The remaining $21 million decrease in 2003 operating profit is primarily due to significant price erosion and lack of manufacturing productivity (primarily in the fastening business), unfavorable shifts in business mix, and higher retirement plan costs.


Security Solutions
(Millions of Dollars)
2004 2003 2002
Net sales $ 678   $ 474   $ 212  
Operating profit $ 111   $ 76   $ 43  
% of Net sales   16.3   16.0   20.3

Security Solutions sales increased 43% in 2004. Excluding the acquisitions (primarily Blick plc, Frisco Bay Industries Ltd., and ISR Solutions Inc.), organic sales increased 6%. Sales volume represented 4% of the organic increase and price was 2%. The organic volume improvement was due to strength in the supply and service of automatic commercial door systems in access technologies. Best Access sales volume was virtually unchanged compared to 2003 levels while incoming orders increased, reflecting a shift in mix toward longer order cycle electronic access systems. The operating profit increase is primarily attributed to the impact of 2004 acquisitions. Operating margin was relatively flat versus 2003, primarily attributable to favorable business mix and pricing actions with customers; these favorable impacts were offset by increased commodity inflation, field productivity issues at Best Access, Sarbanes-Oxley compliance costs and key strategic consulting expenditures.

Security Solutions sales increased by $262 million in 2003. Excluding the impact of acquisitions (primarily Best Access) totaling $255 million, Security Solutions organic sales increased 3% and volume generated the majority of this increase. The organic volume improvement was due to strength

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in the supply and service of automatic commercial door systems in access technologies, partially offset by market share declines in the commercial hardware product line. Operating profit increased significantly primarily as a result of acquisitions.

RESTRUCTURING ACTIVITIES

In the fourth quarter of 2004, the Company recorded $8 million of restructuring and asset impairment charges — $4 million of restructuring costs in connection with specific personnel actions to streamline/reposition certain organizations primarily in the consumer and industrial segments; and $4 million of asset impairment charges primarily associated with a 2004 information system strategy decision.

In 2003, the Company recorded $49 million in restructuring and asset impairment charges for the Operation 15 initiative. These charges consisted of $12 million for severance, $26 million of asset impairments and $11 million of other exit costs related to the exit from the Company's MacDirect retail channel. The asset impairments generally relate to assets which are idle mainly as a result of restructuring initiatives and accordingly their book value has been written down to fair value.

In 2003, the Company also recorded $3 million in restructuring charges for initiatives pertaining to the further reduction of its cost structure, primarily for severance-related obligations. As of January 3, 2004, no accrual remained as all of the severance had been expended.

At January 1, 2005, the restructuring and asset impairment reserve balance was $5 million, which the Company expects to be fully expended by the end of 2005. A summary of the Company's restructuring reserves for the years ended January 3, 2004 to January 1, 2005 is as follows:


  2003 Charges Usage 2004
(Millions of Dollars)        
Q4 2004                        
Severance $   $ 4   $ (3 $ 1  
Asset impairments       4     (4    
                         
Operation 15                        
Severance   3         (1   2  
Asset impairments   9         (7   2  
Other   3         (3    
                         
Pre 2003                        
Other   1         (1    
  $ 16   $ 8   $ (19 $ 5  

For the three years ended January 1, 2005, 21 facilities have been closed as a result of restructuring initiatives. In 2004, 2003 and 2002, approximately 160, 1,100 and 1,000 employees have been terminated as a result of restructuring initiatives, respectively. Severance payments of $4 million, $18 million and $26 million and other exit costs of $4 million, $10 million and $4 million were made in 2004, 2003 and 2002, respectively. Write-offs of impaired assets were $11 million, $18 million and $6 million in 2004, 2003 and 2002, respectively.

Integration of certain acquisitions requires reduction of redundant personnel, closure of facilities, and other restructuring actions related to the acquired businesses. In such cases, a restructuring accrual is recorded for actions identified in integration strategy plans initially developed by the Company as of the acquisition date, with a resulting increase to goodwill. As integration strategies are executed, the Company monitors the previously established restructuring accruals and makes adjustments to such accruals to the extent actual expenditures differ from the estimated accruals. Adjustments recorded to previously established restructuring accruals until the time integration plans are fully executed, not to exceed one year from date of original acquisition, are reflected in the final goodwill amount included in the purchase price allocation. Adjustments made subsequent to the finalization of integration

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strategies, or after one year from the date of original acquisition, are reflected in the Company's results of operations. The Company recorded $5 million in restructuring reserves, primarily for severance, in connection with its first quarter 2004 acquisitions. Restructuring reserves pertaining to the 2002 Best acquisition were $6 million, comprised of $5 million for severance and $1 million in exit costs primarily for non-cancelable leases. All but $0.3 million of these acquisition related reserves were expended by January 1, 2005.

FINANCIAL CONDITION

Liquidity, Sources and Uses of Capital:    The Company's primary sources of liquidity are cash flows from operations and borrowings under various credit facilities.

The Company has historically generated strong cash flows from operations. In 2004, cash flow from operations was $372 million, as compared to $464 million in 2003. Working capital improvements were $45 million higher in 2003 as compared with 2004. In addition, in 2003 there were favorable impacts of $57 million for income tax deferrals and refunds, as well as approximately $40 million in cash proceeds from the sale of the Mac Tools distributor financing portfolio which did not reoccur in 2004. These items were partially offset by improved net earnings from continuing operations and lower cash payments related to restructuring and other charges in 2004 versus 2003.

In 2003, cash flow from operations was $464 million, as compared to $285 million in 2002. The increase is the result of working capital improvements of $32 million as compared to 2002 improvements, primarily from receivables and inventories, cash proceeds of approximately $40 million from the sale of the Mac Tools distributor financing portfolio, income tax payment deferrals and refunds aggregating $57 million, and $17 million in lower cash payments related to restructuring and other charges in 2003 versus 2002.

Capital expenditures were $55 million in 2004, $39 million in 2003, and $52 million in 2002. The Company incurred higher capital expenditures in 2004 for investment in various plants including manufacturing productivity projects, movement of production to low cost countries, and increased costs for software development and acquisitions as the Company continues to improve the infrastructure of its systems.

Free cash flow, as defined in the table below, was $317 million in 2004 and $425 million in 2003, considerably exceeding net earnings from continuing operations in a period of continued strong sales volume growth. The Company believes free cash flow is an important measure of its liquidity, as well as its ability to fund future growth and provide a return to the shareowners.


  2004 2003 2002
(Millions of Dollars)      
Net cash provided by operating activities $ 372   $ 464   $ 285  
Less: capital expenditures   (48   (31   (37
Less: capitalized software   (7   (8   (15
Free cash flow $ 317   $ 425   $ 233  

The Company received net proceeds from sales of the Residential Entry Door and Home Décor businesses of $205 million in 2004, and disbursed $301 million for business acquisitions. Additionally, as a result of the previously mentioned strong free cash flow from operations, the Company made $133 million in net payments on borrowings resulting in a 2004 year end 32.4% debt to capital ratio. This ratio was 43.6% at the end of 2003. The Company believes it has achieved its deleveraging goals and is well-positioned for capitalizing on future acquisition opportunities.

During 2003, the Company made $260 million in payments on borrowings. In the second quarter 2003, the Company repurchased 3.9 million shares of common stock and agreed to settle the remainder of its equity hedge through the repurchase of 4.1 million shares over the next four years. The 3.9 million share repurchase was made with $100 million of cash and increased commercial paper borrowings while the 4.1 million share repurchase involved $113 million of term debt. No open market purchase

16




of shares occurred. These repurchases of shares under the equity hedge contract, repayment of debt and currency fluctuation, resulted in a $20 million decrease in the Company's short-term and long-term borrowings.

In 2002, the Company received $338 million in net proceeds from issuance of long-term debt, and disbursed $356 million for business acquisitions. The Company made $154 million in payments on borrowings.

In 2004, the Company took advantage of favorable market conditions by refinancing its 364 day and long term (multi-year) credit arrangements, creating a long term credit facility with several U.S. banks to borrow up to $400 million at the lower of prime or money market rates. This long term credit facility matures in October 2009. In addition, the Company has short-term lines of credit with numerous foreign banks aggregating $161 million, of which $120 million was available at January 1, 2005. Short-term arrangements are reviewed annually for renewal. Of the $561 million aggregate credit lines, $400 million is available to support the Company's commercial paper program. In addition to these lines of credit, the Company maintains a facility designed for the securitization of certain trade accounts receivable for purposes of additional liquidity. As of January 1, 2005, the Company's maximum available funds under this arrangement were $122 million, of which $12 million was utilized.

In 2003, the Company filed a Shelf Registration in the amount of $900 million. This filing represents a prospectus which, if accompanied by a prospectus supplement, would allow the Company to offer, issue and sell, together or separately, debt, equity and other securities.

The Company also has numerous assets, predominantly vehicles and equipment, under a one-year term renewable U.S. master personal property lease. Residual value obligations, which approximate the fair value of the related assets, under this master lease were $24 million at January 1, 2005. The Company does not anticipate any material liabilities associated with these transactions.

Contractual Obligations:    The following summarizes the Company's significant contractual obligations and commitments that impact its liquidity.


  Payments Due by Period
  Total < 1 Year 2-3 Yrs 4-5 Yrs > 5 Yrs
(Millions of Dollars)          
Long-term debt $ 537   $ 55   $ 270   $ 7   $ 205  
Operating leases   97     22     32     18     25  
Deferred compensation   34     3     8     6     17  
Material purchase commitments   54     9     18     18     9  
Outsourcing and other obligations   34     15     16     3      
Total contractual cash obligations $ 756   $ 104   $ 344   $ 52   $ 256  

Other Commercial Commitments:


  Amounts of Commitments Expiration Per Period
  Total < 1 Year 2-3 Yrs 4-5 Yrs > 5 Yrs
(Millions of Dollars)          
U.S. lines of credit $ 400   $   $   $ 400   $  
International lines of credit   161     161              
Total commercial commitments $ 561   $ 161   $   $ 400   $  

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Short-term borrowings, long-term debt and lines of credit are explained in detail within Note I Long Term Debt and Financing Arrangements; and operating leases and other commercial commitments are explained in detail in Note R Commitments and Guarantees of the Notes to the Consolidated Financial Statements in Item 15.

The Company believes that its dividend is an important factor in generating returns for the shareowners. The Company's long term policy is to increase dividends by up to one-half of the Company's earnings growth rate, ultimately reaching a payout ratio of 25% of net earnings. Dividend increases are determined periodically in light of this policy and other considerations. Dividends increased 4.9% in 2004, 4.0% in 2003 and 5.3% in 2002. The Company plans to use a significant portion of free cash flow after dividends (operating cash flow less dividends and capital expenditures) to fund future acquisitions in commercial and industrial markets.

MARKET RISK

Market risk is the potential economic loss that may result from adverse changes in the fair value of financial instruments. The Company is exposed to market risk from changes in foreign currency exchange rates and interest rates. Exposure to foreign currency risk results because the Company, through its global businesses, enters into transactions and makes investments denominated in multiple currencies. The Company's predominant exposures are in European, Canadian and Asian currencies, including the Chinese RMB. Certain cross-currency trade flows arising from sales and procurement activities are consolidated and netted prior to obtaining risk protection, primarily purchased options. The Company is thus able to capitalize on its global positioning by taking advantage of naturally offsetting exposures to reduce the cost of purchasing protection. At times, the Company also enters into forward exchange contracts and purchased options to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables, predominately affiliate transactions. Gains and losses from these hedging instruments offset the gains or losses on the underlying net exposures, assets and liabilities being hedged. Management determines the nature and extent of currency hedging activities, and in certain cases, may elect to allow certain currency exposures to remain unhedged. The Company has also entered into several cross-currency interest rate swaps, to provide a partial hedge of the net investments in certain subsidiaries and better match the cash flows of operations to debt service requirements. Sensitivity to foreign currency exposure risk from these financial instruments at the end of 2004 would have been immaterial based on the potential loss in fair value from a hypothetical 10% adverse movement in all currencies. The Company generally does not hedge commodity price exposures.

The Company's exposure to interest rate risk results from its outstanding debt obligations, short-term investments, and derivative financial instruments employed in the management of its debt portfolio. The debt portfolio is managed to achieve capital structure targets and reduce the overall cost of borrowing by using a combination of fixed and floating rate debt as well as interest rate swaps and cross-currency swaps. The Company's primary exposure to interest rate risk comes from its floating rate debt in the U.S. and Europe and is fairly represented by changes in LIBOR rates. At January 1, 2005, the result of a hypothetical two percentage point increase in short-term LIBOR rates would not have resulted in a material impact on the pre-tax profit of the Company.

Fluctuations in the fair value of the Company's common stock affect ESOP expense as discussed in the U.S. Pension and ESOP section of Management Discussion and Analysis.

Sales to The Home Depot amounted to 12% of 2004 consolidated net sales from continuing operations. The Company has other significant customers, particularly home centers and major retailers, though individually there are no others that exceed 10% of consolidated sales. The loss or material reduction of business from any such significant customer could have a material adverse impact on the Company's results of operations and cash flows, until either such customers were replaced or the Company made the necessary adjustments to compensate for the loss of business.

The Company has access to financial resources and borrowing capabilities around the world. There are no material instruments within the debt structure that would accelerate payment requirements due to a change in credit rating, and no significantly restrictive covenants. The Company believes that its

18




strong financial position, operating cash flows and borrowing capacity provide the financial flexibility necessary to continue its record of annual dividend payments, to invest in the routine needs of its businesses, to make strategic acquisitions and to fund other initiatives encompassed by its growth strategy.

OTHER MATTERS

Income Taxes:    In October 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into law. The Act creates a temporary incentive for U.S. corporations to repatriate undistributed foreign earnings by providing an 85 percent dividends received deduction. As of January 1, 2005, the Company has not provided for U.S. income and foreign withholding taxes on $324 million of undistributed foreign earnings that are considered to be invested indefinitely outside the United States. The Company may elect to repatriate some amount up to $324 million resulting in recognition of a tax liability of up to $42 million. The Company is awaiting the issuance of further regulatory guidance and statutory corrections with respect to certain provisions in the Act in order to determine the amounts it may repatriate, and expects to be in a position to finalize its assessment during 2005.

Environmental:    The Company incurs costs related to environmental issues as a result of various laws and regulations governing current operations as well as the remediation of previously contaminated sites. Future laws and regulations are expected to be increasingly stringent and will likely increase the Company's expenditures related to routine environmental matters.

The Company accrues for anticipated costs associated with investigatory and remediation efforts in accordance with appropriate accounting guidelines which address probability and the ability to reasonably estimate future costs. The liabilities are reassessed whenever circumstances become better defined or remediation efforts and their costs can be better estimated. Subject to the imprecision in estimating future environmental costs, the Company believes that any sum it may pay in connection with environmental matters in excess of the amounts recorded will not have a materially adverse effect on its financial position, results of operations or liquidity. Refer to Note S Contingencies of the Notes to the Consolidated Financial Statements in Item 15 for further information on environmental liabilities and related cash flows.

U.S. Pension and ESOP:    In 2002, the Company recorded an $18 million pre-tax pension settlement gain in Other-net. This involved the termination and settlement of the primary U.S. salaried employee plan as well as settlement of most of the liabilities in the ongoing plan for hourly employees. In addition to the settlement gain, the Company recorded $8 million of operating income related to these plans in 2002, whereas in 2003 and 2004 the ongoing hourly plan resulted in approximately $2 million of expense.

As detailed in Note M Employee Benefit Plans of the Notes to the Consolidated Financial Statements in Item 15, the Company has an Employee Stock Ownership Plan (ESOP) under which the ongoing U.S. defined contribution and (401K) plans are funded. Overall ESOP expense is affected by the market value of Stanley stock on the monthly dates when shares are released. In 2004, the market value of shares released averaged $43.20 per share and the net ESOP expense was $2 million. In 2003, the market value of shares released averaged $29.30 per share and the net ESOP expense was $9 million. ESOP expense may vary in the future as the market value of the Company's common stock fluctuates.

The Company provides a 5% guaranteed rate of return on participant contributions made to the tax deferred savings plan (401K) prior to July 1998 when all contributions were invested in Stanley common stock. The value of the shares participants purchased prior to July 1998 along with the 5% cumulative guaranteed rate of return on Stanley common stock is known as an Investment Protection Account (IPA). Beginning in July 1998 the investment options for plan participant contributions were enhanced to include a variety of investment funds in addition to the Company's common stock, and there is no guaranteed rate of return to participants on any contributions made after that time. The IPA guarantee is included in the actuarial valuation of the ongoing U.S. pension plan. Payments related to the IPA guarantees, if they have any value, would be made to participants over a period of many years generally as they retire. In the event the market value of Stanley common stock declines

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below $43.59 (which is the stock price at which there was a settlement of this liability) additional costs may be triggered by the IPA benefit guarantee.

NEW ACCOUNTING STANDARDS

Refer to Note A Significant Accounting Policies of the Notes to the Consolidated Financial Statements in Item 15 for a discussion of new accounting pronouncements and the potential impact to the Company's consolidated results of operations and financial position.

CRITICAL ACCOUNTING ESTIMATES

Preparation of the Company's financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Significant accounting policies used in the preparation of the Consolidated Financial Statements are described in Note A Significant Accounting Policies in Item 15. Management believes the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters with inherent uncertainty. The most significant areas involving management estimates are described below. Actual results in these areas could differ from management's estimates.

Allowance for Doubtful Accounts:    Stanley's estimate for its allowance for doubtful accounts related to trade receivables is based on two methods. The amounts calculated from each of these methods are combined to determine the total amount reserved. First, the Company evaluates specific accounts where information indicates the customers may have an inability to meet financial obligations, such as bankruptcy. In these cases, the Company uses its judgment, based on the best available facts and circumstances, to record a specific reserve for those customers against amounts due to reduce the receivable to the amount expected to be collected. These specific reserves are reevaluated and adjusted as additional information is received. Second, a reserve is established for all customers based on a range of percentages applied to receivables aging categories. These percentages are based on historical collection and write-off experience. If circumstances change, for example the occurrence of higher than expected defaults or a material adverse change in a major customer's ability to meet its financial obligation to the Company, estimates of the recoverability of receivable amounts due could be reduced.

Inventories – Lower of Cost or Market, Slow Moving and Obsolete:    U.S. inventories are predominantly valued at the lower of LIFO cost or market. The calculation of LIFO reserves, and therefore the net inventory valuation, is affected by inflation and deflation in inventory components. The Company ensures all inventory is valued at the lower of cost or market, and continually reviews the book value of discontinued product lines and stock-keeping-units (SKUs) to determine that these items are properly valued. The Company also continually evaluates the composition of its inventory and identifies obsolete and/or slow-moving inventories. Inventory items identified as obsolete and/or slow-moving are evaluated to determine if reserves are required. The Company identifies these inventories and assesses the ability to dispose of them at a price greater than cost. If it is determined that cost is less than market value, then cost is used for inventory valuation. If market value is less than cost, then the Company writes down the related inventory to that value. If a write down to the current market value is necessary, the market value cannot be greater than the net realizable value, or ceiling (defined as selling price less costs to sell and dispose), and cannot be lower than the net realizable value less a normal profit margin, also called the floor. If the Company is not able to achieve its expectations regarding net realizable value of inventory at its current value, reserves would have to be adjusted accordingly.

Goodwill and Intangible Assets:    The Company completed acquisitions in 2004 and 2003 valued at $322 million and $23 million, respectively. The assets and liabilities of acquired businesses are recorded under the purchase method at their fair values at the date of acquisition. Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. The Company had recorded goodwill of $640 million and $79 million of indefinite-lived tradenames at January 1, 2005.

20




In accordance with SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment testing. The identification and measurement of goodwill and unamortized intangibles impairment involves the estimation of the fair value of reporting units. The estimates of fair value of reporting units are based on the best information available at the date of assessment, which primarily incorporate management assumptions about future cash flows. Future cash flows can be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities. While the Company has not recorded intangibles impairment losses in several years, it is possible impairments may occur in the future in the event expected cash flows change significantly. Specifically, the Specialty Tools and Fastening Systems reporting units had experienced operating profit and margin rate declines in 2003 and 2002 due to the depressed technology industry and intensified competition, respectively. In 2004, however, both Fastening Systems and Specialty Tools operating profits and margin rates increased due to improved market conditions and strong execution by management. Specialty Tools and Fastening Systems had $73 million and $41 million, respectively, of recorded goodwill at January 1, 2005. There is potential for future goodwill and intangible impairment losses if projected profits and cash flows significantly decline from current estimates. See Note G Goodwill, Customer Relationships and Other Intangible Assets of the Notes to the Consolidated Financial Statements in Item 15 for further discussion.

Property, Plant and Equipment (PP&E):    The Company generally values PP&E at historical cost less accumulated depreciation. Impairment losses are recorded when indicators of impairment, such as plant closures, are present and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount. The impairment loss is quantified by comparing the carrying amount of the assets to the weighted average discounted cash flows, which consider various possible outcomes for the disposition of the assets (i.e. sale, leasing, etc.). Primarily as a result of plant rationalization, certain facilities and equipment are not currently used in operations. The Company has recorded impairment losses related to unused assets and additional such losses may occur in the future.

Risk Insurance:    To some extent, the Company self insures for various business exposures. For domestic workers' compensation and product liability, the Company generally purchases outside insurance coverage only for severe losses ("stop loss" insurance). The two risk areas involving the most significant accounting estimates are workers' compensation and product liability (liability for alleged injuries associated with the Company's products). Actuarial valuations performed by an outside risk insurance expert form the basis for workers' compensation and product liability loss reserves recorded. The actuary contemplates the Company's specific loss history, actual claims reported, and industry trends among statistical and other factors to estimate the range of reserve required. Risk insurance reserves are comprised of specific reserves for individual claims and additional amounts expected for development of these claims as well as for incurred but not yet reported claims. The specific reserves for individual known claims are quantified by third party administrator specialists (insurance companies) for workers' compensation and by in-house legal counsel in consultation with outside attorneys for product liability. The cash outflows related to risk insurance claims are expected to occur over approximately 8 to 10 years, and the present value of expected future claim payments is reserved. The Company believes the liability recorded for such risk insurance reserves as of January 1, 2005 is adequate, but due to judgments inherent in the reserve process it is possible the ultimate costs will differ from this estimate.

Income Taxes:    The future tax benefit arising from net deductible temporary differences and tax carryforwards is $56 million at January 1, 2005 and $84 million at January 3, 2004. The Company believes earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future income tax benefits. For those jurisdictions where the expiration date of tax carryforwards or the projected operating results indicate that realization is not likely, a valuation allowance is provided. The valuation allowance as of January 1, 2005 amounted to $37 million.

In assessing the need for a valuation allowance, the Company estimates future taxable income, considering the feasibility of ongoing tax planning strategies and the realizability of tax loss

21




carryforwards. Valuation allowances related to deferred tax assets can be impacted by changes to tax laws, changes to statutory tax rates and future taxable income levels. In the event the Company were to determine that it would not be able to realize all or a portion of its deferred tax assets in the future, the unrealizable amount would be charged to earnings in the period in which that determination is made. By contrast, if the Company were to determine that it would be able to realize deferred tax assets in the future in excess of the net carrying amounts, it would decrease the recorded valuation allowance through a favorable earnings adjustment in the period in which that determination is made.

The Company periodically assess its liabilities and contingencies for all tax years still under audit based on the most current available information. When it is deemed probable that an adjustment will be asserted, the Company accrues its best estimate of the tax liability, inclusive of related interest charges. See Note Q Income Taxes of the Notes to the Consolidated Financial Statements in Item 15 for further discussion.

OFF-BALANCE SHEET ARRANGEMENTS

The Company's off-balance sheet arrangements include the following:

Receivable Securitizations:    The Company has agreements to sell, on a revolving basis, pools of accounts and notes receivables to a Qualified Special Purpose Entity (QSPE), which qualifies to be accounted for as an unconsolidated subsidiary. The entity is designed to facilitate the securitization of certain trade accounts receivable. Assets and related debt off-balance sheet were both $12 million at January 1, 2005. The Company is responsible for servicing these accounts while the QSPE bears the risk of non-collection. There were no sales of eligible receivables in 2004, as the securitization was reduced by $42 million during the year.

In 2003 the Company acquired a third party's interest in a Special Purpose Entity (SPE) which supported the Mac Tools extended financing programs. As a result, the entity became non-qualifying and the net assets which consisted primarily of notes receivable of $56.4 million at January 3, 2004 were consolidated in the Company's balance sheet. No gains or losses related to sales to the SPE were recorded. During 2003, the Company sold $39 million of receivables in this portfolio to a third party. In 2004, the majority of the remaining portfolio was sold without recourse for $50 million, and the SPE was dissolved. The Company has outsourced both of the Mac Tools extended financing programs to third parties and has thus reduced its exposure to future credit losses.

Synthetic Leases:    The Company is a party to synthetic leasing programs for two of its major distribution centers. The programs qualify as operating leases for accounting purposes, such that only the monthly rent expense is recorded in the Statement of Operations and the liability and value of the underlying assets are off-balance sheet. These lease programs are utilized primarily to reduce overall cost and to retain flexibility. As of January 1, 2005, the estimated fair value of assets and remaining obligations for these two properties were $50 million and $42 million, respectively.

CAUTIONARY STATEMENTS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements contained in this Annual Report to shareowners, including the statements regarding the Company's ability: (i) to improve the overall profitability of the Company's operations; (ii) to limit the carryover impact of steel cost and other inflation increases in 2005 to $40-45 million and to offset 80-85% of that impact through the carryover impact of price increases; (iii) to capitalize on future acquisition opportunities and fund other initiatives; (iv) to invest in the routine needs of its business; and (v) to continue its record of annual dividend payments and to increase such dividends are forward looking and are based on current expectations and involve inherent risks and uncertainties, including factors listed below and other factors that could delay, divert or change any of them, and could cause actual outcomes and results to differ materially from current expectations.

The Company's ability to achieve the results described above (the "Results") is dependent on: (i) the success of the Company's efforts to efficiently and promptly integrate its recently announced (as well

22




as future) acquisitions; (ii) the success of the Company's efforts to hold freight costs, steel and other commodity costs down; (iii) the success of the Company's efforts to sustain or increase prices in order to, among other things, offset the impact of steel cost and other inflation increases; (iv) continued improvements in productivity and cost reductions; (v) the identification of overhead cost reduction opportunities and effective execution of the same; (vi) the Company's successful settlement of routine tax audits; (vii) the ability of the Company to generate earnings sufficient to realize future income tax benefits during periods when temporary differences become deductible; (viii) the continued ability of the Company to access credit markets under satisfactory terms; and (ix) satisfactory payment terms under which the Company buys and sells goods, materials and products.

The Company's ability to deliver the Results also is dependent upon: (i) the continued success of the Company's marketing and sales efforts, including the Company's ability to recruit and retain an adequate sales force; (ii) the continued success of The Home Depot, Lowe's and Wal-Mart sales initiatives as well as other programs to stimulate demand for company products; (iii) the success of recruiting programs and other efforts to maintain or expand overall Mac Tools truck count versus prior years; (iv) the ability of the sales force to adapt to any changes made in the sales organization and achieve adequate customer coverage; (v) the ability of the Company to fulfill increasing demand for its products; (vi) the ability to continue successfully managing and defending claims and litigation; and (vii) the absence or mitigation of increased pricing pressures from customers and competitors and the ability to defend market share in the face of price competition.

The Company's ability to achieve the Results will also be affected by external factors. These external factors include pricing pressure and other changes within competitive markets, the continued consolidation of customers particularly in consumer channels, inventory management pressures on the Company's customers, increasing competition, changes in trade, monetary, tax and fiscal policies and laws, inflation, currency exchange fluctuations, the impact of dollar/foreign currency exchange and interest rates on the competitiveness of products and the Company's debt program, the strength of the US economy and the impact of events that cause or may cause disruption in the company's distribution and sales networks such as war, terrorist activities, political unrest and recessionary or expansive trends in the economies of the world in which the Company operates.

Unless required by applicable federal securities laws, the Company undertakes no obligation to publicly update or revise any forward looking statements to reflect events or circumstances that may arise after the date hereof.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company incorporates by reference the material captioned "Market Risk" in Item 7 and the material in Note J Financial Instruments of the Notes to Consolidated Financial Statements in Item 15 of this Form 10-K.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Item 15 for an index to Financial Statements and Financial Statement Schedules. Such Financial Statements and Financial Statement Schedules are incorporated herein by reference.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.  CONTROLS AND PROCEDURES

The management of The Stanley Works is responsible for establishing and maintaining an adequate system of internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally

23




accepted accounting principles in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management has assessed the effectiveness of The Stanley Works' internal control over financial reporting as of January 1, 2005. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission in Internal Control – Integrated Framework. Management concluded that based on its assessment, The Stanley Works' internal control over financial reporting was effective as of January 1, 2005. Management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of ISR Solutions, Inc., a company acquired in December 2004, with total assets of approximately $50 million as reflected in the Consolidated Balance Sheet and a nominal earnings impact. Ernst & Young LLP, the auditor of the financial statements included in this annual report on Form 10-K, has issued an attestation report on management's assessment of internal controls, a copy of which appears on page 33.

There has been no change in The Stanley Works' internal control over financial reporting during the fiscal quarter ended January 1, 2005 that has materially affected, or is reasonably likely to materially affect, The Stanley Works' internal control over financial reporting.

Within the 90-day period prior to the filing of this report, under the supervision and with the participation of management, including the Company's Chief Executive Officer and Chairman and its Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-15(e) of the Securities Exchange Act of 1934. Based upon that evaluation, the Company's Chief Executive Officer and Chairman and its Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in its periodic Securities Exchange Commission filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

ITEM 9B.  OTHER INFORMATION

On October 13, 2004, the Compensation and Organization Committee approved the issuance of stock options to the Company's named executive officers and others. The terms of those options are set forth in the Company's Form of Stock Option Certificate, a copy of which is filed herewith as Exhibit 10(iii)(b).

24




PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information required by Items 401 and 405 of Regulation S-K, except for Item 401 with respect to the executive officers as described below, is incorporated herein by reference to the information set forth in the Company's definitive proxy statement (which will be filed pursuant to Regulation 14A under the Exchange Act within 120 days after the close of the Company's fiscal year) under the headings "Information Concerning Nominees for Election as Directors," "Information Concerning Directors Continuing in Office," "Board of Directors," and "Section 16(a)—Beneficial Ownership Reporting Compliance." In addition to Business Conduct Guidelines that apply to all Directors and Employees of the Company, the Company has adopted a Code of Ethics that applies to the Company's Chief Executive Officer and all senior financial officers, including the Chief Financial Officer and principal accounting officer. A copy of the Company's Code of Ethics is available on the Company's website, www.stanleyworks.com.

The following is a list of the executive officers of the Company as of March 1, 2005:


Name, Age
(as of 1/1/2005)
Birth date
Office Elected to Office
J.F. Lundgren (53)
(09/03/51)
Chairman and Chief Executive Officer, March 1, 2004. Joined Stanley March 1, 2004. President, European Consumer Products, Georgia-Pacific Corporation (2000); President, European Consumer Products, Fort James Corporation (1997).   03/01/04  
B.H. Beatt (52)
(07/24/52)
Vice President, General Counsel and Secretary. Joined Stanley October 2000; Vice President, General Counsel and Secretary, Dexter Corporation (1991).   10/09/00  
Hubert Davis, Jr. (56)
(08/28/48)
Vice President, Chief Information Officer. Joined Stanley as Chief Information Officer and e-commerce Leader June 2000. Vice President—Worldwide Operations and Business, The Limited, Inc. and prior to that Vice President/Chief Information Officer, Mast Industries, a subsidiary of The Limited, Inc. (1995).   5/25/04  
J.H. Garlock Jr. (50)
(06/05/54)
Vice President, Stanley, October 2002. President, Stanley Fastening Systems. Joined Stanley September 2000 as President, Stanley Doors; President, Porter Cable Corporation (1997).   10/28/02  
W.D. Hill (55)
(09/18/49)
Vice President, Engineering and Technology—Tools Group. Joined Stanley August 1997 as Vice President, Engineering.   09/17/97  
P.M. Isabella (49)
(10/14/55)
Senior Vice President—Global Operations. Joined Stanley May 1999 as Vice President, Operations.   10/18/01  
J.M. Loree (46)
(06/14/58)
Executive Vice President, September 2002, and Chief Financial Officer. Joined Stanley July 1999 as Vice President Finance and Chief Financial Officer.   07/19/99  
M.J. Mathieu (52)
(02/20/52)
Vice President, Human Resources. Joined Stanley September 1997.   09/17/97  
D.R. McIlnay (54)
(06/11/50)
President, Tools Group. President, Doors business from April 2003 through December 2004. Joined Stanley October 1999 as President, Consumer Sales Americas; President & Chief Executive Officer, The Gibson-Homans Company (1997).   10/04/99  

25




ITEM 11.    EXECUTIVE COMPENSATION

The information required by Item 402 of Regulation S-K is incorporated herein by reference to the information set forth under the section entitled "Executive Compensation" of the Company's definitive proxy statement, which will be filed pursuant to Regulation 14A under the Exchange Act within 120 days after the close of the Company's fiscal year.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by Items 201(d) and 403 of Regulation S-K, except for the equity compensation plan information that follows, is incorporated herein by reference to the information set forth under the sections entitled "Security Ownership" and "Executive Compensation" of the Company's definitive proxy statement, which will be filed pursuant to Regulation 14A under the Exchange Act within 120 days after the close of the Company's fiscal year.

EQUITY COMPENSATION PLAN INFORMATION

Compensation plans under which the Company's equity securities are authorized for issuance at January 1, 2005 follow:


  (A) (B) (C)
Plan category Number of securities to
be issued upon exercise
of outstanding options
and restricted stock
shares
Weighted-average
exercise price of
outstanding options and
restricted stock shares
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (A))
Equity compensation     plans approved by     security holders 10,507,908 $32.46 20,677,528
Equity compensation     plans not approved
    by security holders
(a) (a) (a)
Total 10,507,908 $32.46 20,677,528
(a) There is a non-qualified deferred tax savings plan for highly compensated salaried employees which mirrors the qualified plan provisions but was not specifically approved by security holders. U.S. employees are eligible to contribute from 1% to 15% of their salary to a tax deferred savings plan as described in the Employee Stock Ownership Plan (ESOP) section of Item 15 Note M Employee Benefit Plans to the Consolidated Financial Statements of this Form 10-K. The Company contributes an amount equal to one-half of the employee contribution up to the first 7% of their salary, of which fifty-percent is invested in Stanley common stock for qualified employees. The investment of the remaining fifty-percent is controlled by the employee participating in the plan. The same matching arrangement is provided for highly compensated salaried employees in the "non-qualified" plan, except that the arrangement for these employees is outside of the ESOP, and is not funded in advance of distributions. Shares of the Company's common stock may be issued at the time of a distribution from the plan. The number of securities remaining available for issuance under the plan at January 1, 2005 is not determinable, since the plan does not authorize a maximum number of securities.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

26




ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 9(e) of Schedule 14A is incorporated herein by reference to the information set forth under the section entitled "Fees of Independent Auditors" of the Company's definitive proxy statement, which will be filed pursuant to the Regulation 14A under the Exchange Act within 120 days after the close of the Company's fiscal year.

PART IV

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)  Index to documents filed as part of this report:

1. and 2. Financial Statements and Financial Statement Schedules.

The response to this portion of Item 15 is submitted as a separate section of this report beginning with an index thereto on page 29.

3. Exhibits

See Exhibit Index in this Form 10-K on page 70.

(b)  See Exhibit Index in this Form 10-K on page 70.
(c)  The response in this portion of Item 15 is submitted as a separate section of this Form 10-K with an index thereto beginning on page 29.

27




SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

THE STANLEY WORKS

By /s/ John F. Lundgren
John F. Lundgren, Chairman
and Chief Executive Officer

March 7, 2005


/s/ John F. Lundgren   /s/ James M. Loree
John F. Lundgren, Chairman
and Chief Executive Officer
  James M. Loree, Executive Vice President and Chief Financial Officer
/s/ Donald Allan Jr.   *
Donald Allan Jr., Vice President, Corporate Controller   John G. Breen, Director
*   *
Stillman B. Brown, Director   Virgis W. Colbert, Director
*   *
Emmanuel A. Kampouris, Director   Eileen S. Kraus, Director
*
Kathryn D. Wriston, Director

*By: /s/ Bruce H. Beatt
Bruce H. Beatt
(As Attorney-in-Fact)

28




FORM 10-K
ITEM 15(a) (1) AND (2)
THE STANLEY WORKS AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

  Schedule II—Valuation and Qualifying Accounts of The Stanley Works and subsidiaries is included in Item 15 (page 30).

Management's Report on Internal Control Over Financial Reporting (page 31)

Report of Independent Registered Public Accounting Firm – Internal Control (page 32)

Report of Independent Registered Public Accounting Firm – Financial Statement Opinion (page 33)

  Consolidated Statements of Operations—fiscal years ended January 1, 2005, January 3, 2004, and December 28, 2002 (page 34).

Consolidated Balance Sheets—January 1, 2005 and January 3, 2004 (page 35).

  Consolidated Statements of Cash Flows—fiscal years ended January 1, 2005, January 3, 2004, and December 28, 2002 (page 36).
  Consolidated Statements of Changes in Shareowners' Equity—fiscal years ended January 1, 2005, January 3, 2004, and December 28, 2002 (page 37).

Notes to Consolidated Financial Statements (page 38).

All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.

29




Schedule II - Valuation and Qualifying Accounts
The Stanley Works and Subsidiaries
Fiscal years ended January 1, 2005, January 3, 2004 and December 28, 2002
(Millions of Dollars)


    ADDITIONS
Description Beginning
Balance
Charged to
Costs and
Expenses
(b)
Charged
To Other
Accounts
(a)
Deductions
Ending
Balance
Allowance for Doubtful Accounts:                                          
Year Ended 2004                                          
Current $ 38.4   $ 10.7 (c)  $ 7.5   $ 29.2   $ 27.4  
Non-current   10.4     2.3 (c)    (9.9       2.8  
Year Ended 2003:
Current   24.9     49.2 (c)    2.4     38.1     38.4  
Non-current   1.2     10.9 (c)    5.3     7.0     10.4  
Year Ended 2002:
Current   30.3     6.5     2.3     14.2     24.9  
Non-current   1.4         (0.2       1.2  
 
Tax Valuation Allowance:
Year Ended 2004: $ 33.1   $ 8.1   $   $ 4.5   $ 36.7  
Year Ended 2003:   24.5     12.3         3.7     33.1  
Year Ended 2002:   24.7     2.1         2.3     24.5  
 
Inventory Reserves:
Year Ended 2004: $ 59.1   $ 37.4   $ 5.7   $ 41.5   $ 60.7  
Year Ended 2003:   72.6     52.4     0.1     66.0     59.1  
Year Ended 2002:   54.9     44.7     2.1     29.1     72.6  
 
(a) Represents doubtful accounts charged-off, less recoveries of accounts previously charged-off.
(b) Represents foreign currency translation impact, acquisitions, and net transfers to / from other accounts.
(c) In 2003 the Company acquired a third party's interest in a special purpose entity which supports the Mac Tools extended financing programs. As a result, the entity became non-qualifying and the net assets, which consisted of net notes receivable of $56.4 million at January 3, 2004, have been consolidated in the Company's balance sheet. Other-net in the 2003 Consolidated Statement of Operations reflects $24.5 million of financing receivable losses for these programs, including $9.7 million pertaining to the exit from the Mac Tools retail channel. The related allowance for doubtful accounts of $14.8 million at January 3, 2004 for the Mac Tools extended financing programs is comprised of $5.6 million current and $9.2 million long-term reserves. In 2004 the majority of the remaining Mac Tools extended financing receivables was sold for $50 million.

30




MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of The Stanley Works is responsible for establishing and maintaining an adequate system of internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management has assessed the effectiveness of The Stanley Works' internal control over financial reporting as of January 1, 2005. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission in Internal Control – Integrated Framework. Management concluded that based on its assessment, The Stanley Works' internal control over financial reporting was effective as of January 1, 2005. Management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of ISR Solutions, Inc., a company acquired in December 2004, with total assets of approximately $50 million as reflected in the Consolidated Balance Sheet and a nominal earnings impact. Ernst & Young LLP the auditor of the financial statements included in this annual report on form 10-K, has issued an attestation report on management's assessment of internal controls, a copy of which appears on page 32.

/s/ John F. Lundgren
John F. Lundgren, Chairman and Chief Executive Officer

/s/ James M. Loree
James M. Loree, Executive Vice President and Chief Financial Officer

31




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareowners of The Stanley Works

We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that The Stanley Works maintained effective internal control over financial reporting as of January 1, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Stanley Works' management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying Management's Report on Internal Control Over Financial Reporting; management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of ISR Solutions, Inc., a company acquired in December 2004, which is included in the 2004 consolidated financial statements of The Stanley Works and constituted total assets of approximately $50 million at January 1, 2005 and an immaterial impact on net earnings for the year then ended.

In our opinion, management's assessment that The Stanley Works' maintained effective internal control over financial reporting as of January 1, 2005 is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, The Stanley Works' maintained, in all material respects, effective internal control over financial reporting as of January 1, 2005 based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of The Stanley Works and subsidiaries as of January 1, 2005 and January 3, 2004, and the related consolidated statements of operations, changes in shareowners' equity, and cash flows for each of the three fiscal years in the period ended January 1, 2005 and our report dated February 25, 2005 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

February 25, 2005

32




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareowners of The Stanley Works

We have audited the accompanying consolidated balance sheets of The Stanley Works and subsidiaries as of January 1, 2005 and January 3, 2004, and the related consolidated statements of operations, changes in shareowners' equity, and cash flows for each of the three fiscal years in the period ended January 1, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Stanley Works and subsidiaries at January 1, 2005 and January 3, 2004, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended January 1, 2005, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of The Stanley Work's internal control over financial reporting as of January 1, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2005 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Hartford, Connecticut
February 25, 2005

33




CONSOLIDATED STATEMENTS OF OPERATIONS

Fiscal years ended January 1, 2005, January 3, 2004
and December 28, 2002
(In Millions of Dollars, except per share amounts)


  2004 2003 2002
Net Sales $ 3,043.4   $ 2,530.6   $ 2,234.4  
Costs and Expenses                  
Cost of sales $ 1,931.1   $ 1,673.0   $ 1,486.7  
Selling, general and administrative   685.7     579.9     498.5  
Provision for doubtful accounts   8.6     35.6     6.5  
Interest income   (4.2   (6.2   (4.0
Interest expense   38.6     34.1     28.1  
Other-net   46.8     39.4     (8.7
Restructuring charges and asset impairments   7.7     52.2      
  $ 2,714.3   $ 2,408.0   $ 2,007.1  
Earnings from continuing operations before income taxes   329.1     122.6     227.3  
Income taxes   88.9     31.7     70.1  
Net earnings from continuing operations $ 240.2   $ 90.9   $ 157.2  
Earnings from discontinued operations before income taxes (including $180.7 million gain on 2004 divestitures)   195.9     28.2     45.3  
Income taxes on discontinued operations   69.2     11.2     17.5  
Net earnings from discontinued operations $ 126.7   $ 17.0   $ 27.8  
Net Earnings $ 366.9   $ 107.9   $ 185.0  
Basic earnings per share of common stock:            
Continuing operations $ 2.93   $ 1.08   $ 1.82  
Discontinued operations   1.54     0.20     0.32  
Total basic earnings per share of common stock $ 4.47   $ 1.28   $ 2.14  
Diluted earnings per share of common stock:            
Continuing operations $ 2.85   $ 1.07   $ 1.78  
Discontinued operations   1.50     0.20     0.32  
Total diluted earnings per share of common stock $ 4.36   $ 1.27   $ 2.10  

See Notes to Consolidated Financial Statements.

34




CONSOLIDATED BALANCE SHEETS

January 1, 2005 and January 3, 2004
(Millions of Dollars)


  2004 2003
Assets            
Current Assets            
Cash and cash equivalents $ 250.0   $ 204.4  
Accounts and notes receivable   582.0     462.8  
Inventories   413.4     361.6  
Deferred taxes   7.9     23.6  
Prepaid expenses   74.3     73.6  
Assets held for sale   44.3     110.1  
Total Current Assets   1,371.9     1,236.1  
Property, Plant and Equipment   398.9     392.5  
Goodwill   639.5     422.1  
Customer Relationships   144.9     110.2  
Other Intangible Assets   143.8     100.3  
Other Assets   151.6     162.6  
Total Assets $ 2,850.6   $ 2,423.8  
Liabilities and Shareowners' Equity            
Current Liabilities            
Short-term borrowings $ 47.1   $  
Current maturities of long-term debt   55.4     157.7  
Accounts payable   300.4     222.2  
Accrued expenses   415.9     314.3  
Liabilities held for sale       62.5  
Total Current Liabilities   818.8     756.7  
Long-Term Debt   481.8     513.6  
Deferred Taxes   90.0     81.6  
Other Liabilities   238.7     202.8  
Commitments and Contingencies (Notes R and S)            
Shareowners' Equity            
Preferred stock, without par value:            
Authorized and unissued 10,000,000 shares            
Common stock, par value $2.50 per share:            
Authorized 200,000,000 shares; issued 92,343,410 shares in 2004 and 2003   237.7     237.6  
Retained earnings   1,496.3     1,212.6  
Accumulated other comprehensive loss   (55.2   (84.2
ESOP debt   (166.9   (173.8
    1,511.9     1,192.2  
Less: cost of common stock in treasury (9,936,347 shares in 2004 and 11,066,589 shares in 2003)   290.6     323.1  
Total Shareowners' Equity   1,221.3     869.1  
Total Liabilities and Shareowners' Equity $ 2,850.6   $ 2,423.8  

See Notes to Consolidated Financial Statements.

35




CONSOLIDATED STATEMENTS OF CASH FLOWS

Fiscal years ended January 1, 2005, January 3, 2004
and December 28, 2002
(Millions of Dollars)


  2004 2003 2002
Operating Activities:            
Net earnings $ 366.9   $ 107.9   $ 185.0  
Adjustments to reconcile net earnings to cash provided by operating activities:                  
Depreciation and amortization   95.0     86.5     71.2  
Provision for doubtful accounts   8.6     36.0     6.7  
Restructuring and asset impairments   7.7     53.2      
Reclassify net proceeds from sales of businesses to investing activities   (204.9        
Other non-cash items   56.0     38.1     29.4  
Changes in operating assets and liabilities:                  
Accounts and notes receivable   (18.3   62.3     29.0  
Inventories   (43.5   24.1     (8.4
Accounts payable   54.8     (8.9   (14.3
Accrued Expenses   2.2     29.4     17.7  
Income taxes   33.8     16.5     (49.1
Other   13.2     19.2     17.9  
Net cash provided by operating activities   371.5     464.3     285.1  
Investing Activities:            
Capital expenditures   (47.6   (31.4   (37.2
Capitalized software   (7.2   (8.0   (15.1
Proceeds from sales of assets   3.0     4.7     11.5  
Business acquisitions   (301.2   (22.3   (355.9
Net proceeds from sales of businesses   204.9          
Other   11.2     5.0     1.2  
Net cash used in investing activities   (136.9   (52.0   (395.5
Financing Activities:            
Payments on long-term debt   (154.4   (18.1   (115.0
Proceeds from long-term borrowings   0.6     3.3     352.5  
Net proceeds (repayments) on short-term borrowings   20.4     (140.8   (39.3
Debt issuance costs   (1.3   (0.3   (15.0
Equity hedge settlement       (101.0    
Proceeds from issuance of common stock   27.7     4.3     17.4  
Cash dividends on common stock   (89.4   (86.1   (85.6
Net cash (used in) provided by financing activities   (196.4   (338.7   115.0  
Effect of exchange rate changes on cash   7.4     9.1     1.9  
Increase in cash and cash equivalents   45.6     82.7     6.5  
Cash and cash equivalents, beginning of year   204.4     121.7     115.2  
Cash and cash equivalents, end of year $ 250.0   $ 204.4   $ 121.7  

See Notes to Consolidated Financial Statements.

36




CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY

Fiscal years ended January 1, 2005, January 3, 2004
and December 28, 2002
(Millions of Dollars, except per share amounts)


  Common
Stock
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
ESOP
Debt
Treasury
Stock
Shareowners'
Equity
Balance December 29, 2001 $ 230.9   $ 1,195.4   $ (138.9 $ (187.7 $ (256.9 $ 842.8  
Comprehensive income:                              
Net earnings         185.0                       185.0  
Currency translation adjustment and other               17.8                 17.8  
Minimum pension liability               (2.3               (2.3
Total comprehensive income                                 200.5  
Cash dividends declared-$0.99 per share         (85.6                     (85.6
Issuance of common stock         (5.1               27.8     22.7  
Equity hedge shares delivered         (41.6               41.6      
Tax benefit related to stock options         3.0                       3.0  
ESOP debt decrease and tax benefit         4.0           6.9           10.9  
Balance December 28, 2002   230.9     1,255.1     (123.4   (180.8   (187.5   994.3  
Comprehensive income:                                    
Net earnings         107.9                       107.9  
Currency translation adjustment and other               49.7                 49.7  
Minimum pension liability               (3.8               (3.8
Total comprehensive income