史丹利百得 (SWK) 2003 Q3 法說會逐字稿

Good morning. My name is Leslie, and I'll be your conference facilitator today.

At this time, I would like to welcome everyone to the Stanley Works third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, please press star, then the number 2.

I would now like to introduce Mr. Gerry Gould, Vice President of IR. Thank you, Mr. Gould, you may begin.

Okay, thank you, Leslie. Thank you all for joining us this morning. With me today are John Trani, Chairman and CEO, and Jim Loree, Chief Financial Officer.

Before we begin, I would like to call your attention to the third quarter press release we issued this morning on earnings, and in addition to the one we issued a week ago on the dividend, our fourth quarter dividend. If you need the references, they've been posted to our web site, stanleyworks.com. We'll open the presentation with a short review of the releases and brief comments.

John will open the presentation in a moment with a short review of news releases and brief comments, and after his remarks, Jim will highlight several of the financial matters in the release, and then we will turn it back over to the operator who will explain the Q&A procedure.

We remind you that to comply with Reg FC, our fourth quarter earnings guidance will be given in the call today, and then we will not be able to comment on it thereafter. If business conditions change the guidance materially, for example by more than 10% in either direction, we would issue a press release and do a conference call at the time.

We've allotted about an hour for the call. This teleconference is being recorded for replay which will be available to anybody who wants to listen beginning two hours after the call ends through the end of the day, Saturday the 25th. The recall number is 800-642-1687 with the pass code 3208500. After that it will be available at our web site and it will require no access code. If you have any questions, call me after the call at 860-827-3833.

Two more reminders. In this discussion, as well as the press release, our reported earnings are supplemented with related amounts and percentages that exclude restructuring costs, impairment charges, certain other costs. We believe these supplemental measures provide useful information, removing the effects of variances in the reported results that are not indicative of fundamental changes in our company's earnings capacity. So, full reconciliation with the reported amounts have been provided, both within the release and on our web site.

And finally, certain statements contained in this discussion by the various Stanley participants are forward-looking statements, and actual results may differ materially from those expected or implied. We direct you to the cautionary statements in Form 8-K which we are filing with today's release.

With that, I'll turn the conference over to John.

Thank you, Gerry. Good morning, everyone.

Today we're reporting third quarter earnings of 51 cents of fully diluted share versus 62 cents last year. Those results include pretax restructuring, asset impairment, and other charges totaling $17 million or 14 cents a share. The rest of our comments, Jim's and mine will exclude these charges, and accordingly, earnings of 65 cents were above our forecasted range of 60 to 63 cents per share and up 5% from last year.

Sales per client 1%, excluding both the positive effects of the Best Access acquisition and the negative impact of exiting Mac Direct, reflecting the continued weak economy, at least in the manufacturing sector.

Capacity utilization in the U.S. continues in the low to mid 70% range in durable goods, due in part to the increased globalization of production as we've discussed over the years. The Home Depot entry doors loss in the fourth quarter last year also contributed, as that has not anniversaried yet.

The good news is two-fold. First, other than Mac Direct and the lost Home Depot entry doors region, sales increased 2% with September being the best month, following a slight gain in the second quarter. And second, sales were several percentage points better than expected coming into the quarter.

This was easily the best cash flow quarter our company has ever had, as those of you who received the chart that Gerry sent out can see, based upon the 20-year performance. Operating cash flow of $151 million was up 45% over last year, and on a year-to-date basis, $267 million of cash from operations is a 28% increase over last year.

Free cash flow before dividends of $138 million was up 48%, and at $239 million, year-to-date free cash flow has already surpassed the total for the full year of 2002, which was itself a record year. These amounts include $26 million from selling Mac financing receivables in the quarter, but also includes $69 million in last year's third quarter when we got a past pension cash reversion.

There are several reasons for the strong cash flow. First, we reduced inventories. Second, Best Access is generating more free cash than anticipated. Third, capital expenditures are being carefully controlled. And finally, our tax and treasury functions are doing an outstanding job.

The second real encouragement was our operating margins, specifically Operation 15 actions that were carried out, the Mac Direct exit in May, various production productivity programs, and the organizations streamlining reduced our employment by over 1100 people in the first half, and that was felt in the third quarter. These actions, together with improvements elsewhere, increased the operating margin another 130 basis points. Our operating margins, which were 9% in the first quarter, climbed to 11.5% in the second and to 12.8% in the third. On a year-over-year basis, the third quarter was 12.8% versus 11.5% in 2002.

Looking forward, we remain hopeful but cautious. The stimulation of retail from economic policies is real and being felt. Our expectation is that promotional activity for Stanley will be sequentially above the normal seasonal pattern in the fourth quarter.

However, inventory reduction and private label emphasis are facts of life at certain retailers. While we track and now know the weeks of stock on hand at major retailers, the extent of further inventory contraction is unknown, although it seems to be stable in several segments. Our hope is that we do not enter the POS 'doom loop', as I've described it to all of you. The planned promotional activity should mitigate that problem.

We're still impacted by the carryover of the late 2002 Home Depot doors loss and the recent Mac Direct unwinding, so sales, X Best Access, will continue to be difficult for the remainder of the year. Nonetheless, sales will grow at a solid rate in 2003 overall for the first time in several years. The elements of Operation 15 are being delivered. Further operating margin rate progress will be made. And the 15% operating margin target is in our sights.

Jim will cover the financial details of today's announcements and the outlook for earnings for the rest of the year. Following those comments, I'll review a few other items from the third quarter, and then we'll take your questions.

Okay, thanks, John.

Sales increased 8%, aside from Best and the impact of exiting Mac. As John said, sales were down 1%. Currency added 2 points. Weak entry door volume caused 3 points of unfavorability versus prior year. Without this issue, the company's revenues would have been up in a double digit percentage.

Our July 22nd guidance was for sales aside from Best to be down about 6% in the second half of this year. In fact, sales in this basis were down only 3% in the third quarter, which is a positive sign. We also had an encouraging increase in gross margins to 33.4% versus 31.5% a year ago, as Op 15 volume leverage in the favorable mixin of Best Access sales contributed to this result.

For SG&A, comparing third quarter to second, SG&A expenses of $148 million before charges decreased by $7 million. This follows an $8 million reduction in the second quarter versus the first, for a total reduction of $15 million since the first quarter, or approximately $60 million annually. This reflects the benefits we are realizing from Operation 15 and other actions, despite currency headwinds.

Net interest expense increased to $7 million versus $5 million in the third quarter of last year, due to higher debt levels from both the Best acquisition and the equity hedge related share repurchase, which reduced our outstanding shares by 9%.

Other net increased to $9 million versus a credit of $1 million in 2002. This was attributable to the impact of amortizing intangibles acquired, primarily with Best's $3 million, a lower profitability from the Mac advantage financing program that was worth about $1.5 million of negative, the absence of a prior year environmental settlement cost us $2 million on a comparable basis, and the absence of a land sale gain for another $2 million which benefited our last year third quarter results.

We recorded $17 million of charges in the third quarter as follows: $6 million in other net for impairment of Mac financing assets and $11 million of other. A table is shown in the release depicting these components and the reconciliations on pages nine and ten clarify their geography within the quarterly and nine month income statements.

We will continue to liquidate selected Mac assets and to execute plans for the remaining Operation 15 actions. There could, and likely will, be further charges in the fourth quarter and the first half of '04. I'll talk a little bit more about them in a minute. The fourth quarter affect is highlighted in our GAAP guidance.

Now, on to cash. A fabulous story. With $117 million of free cash flow after dividends generated in the third quarter, we repaid $77 million of debt and our cash balance increased by $42 million. Our debt-to-capital ratio is $50.6%, down from 53.8% in June, still up 8.5% over year end '02. We expect to deploy free cash flow, as well as part of our cash balance to further debt reduction in coming quarters.

Inventories declined $20 million versus second quarter, and working capital generated $24 million worth of cash. The inventory decrease occurred while maintaining excellent fill rates. We are serving our customers well and prepared to continue to do so, even if the demand outlook improves. We're also intensifying our efforts to turn slow moving stock, and, in fact, sold several million dollars of such inventory in the quarter.

As John indicated our free cash flow so far in 2003 is $237 million, more than we generated in all of 2002, itself a record year. And across Stanley, nine months cap ex, we're only $28 million versus $42 a year ago, and $12 million in the third quarter versus $11 in last year's third quarter. Our decapitalization plans are on track and we expect a net cash benefit from them in 2003. All in all, we were quite pleased with the execution in the quarter.

Last quarter we indicated that Operation 15 was on track to deliver the planned $100 million of savings. However, at the time, we said that the 15% rate would likely not be achieved as we exit the year, and the primary reason for the shortfall was revenue-related with some cost growth unrelated to Operation 15, a secondary cause.

The third quarter result of near 13% operating margin was very encouraging. We expect to achieve at or near that level in the fourth quarter, as well. Within the spending confines of the Operation 15 program, we do see a road map to get close to, if not at, 15% within a few quarters.

There is much execution ahead. However, the achievement of the original goal of the program is within our sights, if not exactly within the desired time frame.

And now, as far as guidance for the fourth quarter, we expect fourth quarter earnings to be 61 to 64 cents, aside from Operation 15 related charges and impairments. The current first call consensus of $2.15 per share for the full year on the same basis appears reasonable. And we currently expect sales to be up 6% to 7%, all in and up slightly excluding Best in this quarter, in the fourth quarter.

We also increased our 2003 full-year GAAP guidance, in effect, indicating the positive execution of the Mac repositioning and related asset liquidations will enable us to take less extensive charges related to Operation 15 and those indicated in our July guidance. The total cost of Operation 15 is expected to be approximately $100 million to $110 million, with about $15 to $25 million spilling over into the first half '04. The program implementation and charges should be complete by mid '04, and these outlays are consistent with the overall amounts that we indicated in the original Operation 15 program.

Our cash flow outlook remains strong, and we expect free cash flow before dividends to approximately $340 million this year. We are confident, with cash flow approximating at least $100 million to be generated in the fourth quarter alone, that at $340 million, the year will end up, at least, 46% higher than the record $233 million we generated in 2003.

Already, as of today, our debt is well below $800 million, and we expect to see it approach $700 million as we close out the year. And debt to capital should move down to 47%, or thereabouts, by the end of the year.

In summary, our expected 61 cent to 64 cent fourth quarter, when added to our 65 cent third quarter, means that we expect $1.26 to $1.29 per fully diluted share in the second half of 2003, up 21% to 24% over the second half of '02. Earnings issues that began with a flawed Dallas/ Wichita Falls plant consolidation in mid 2002 have been put behind us, and in addition, the free cash is flowing. The debt to cap is decreasing and the actions to execute a significant portfolio shift are under way.

The management team is energized and committed to a successful CEO transition, and as John prepares to turn over the mantle, he leaves a company that is performing well, a company that has done an enormous amount of heavy lifting during his tenure, and one that is making key strategic moves for a bright future.

So, thanks, John, for your leadership, and I'll now turn it back to you.

Thanks, Jim, for the kind words.

In summary, the weak economy and customer inventory reductions continue to weigh upon earnings, but we've taken decisive actions and are generating encouragingly strong cash flows. It is becoming ever clearer that we made one terrific acquisition in Best Access.

There are a few other topics I would like to mention briefly. The Access Solutions group had an excellent quarter and continues to be a significant growth vehicle. Access Technologies had a number of -- another double digit sales increase, up 16% versus last year, primarily due to share gains in the retail marketplace from contract wins. With the only direct national service system, Access has a unique position to leverage.

Best Access had mid single digit orders growth and another record operating margin rate. We expect mid single digit sales growth and a double digit orders increase in the fourth quarter, coming off a weak 2002 when the business was in the process of being sold.

Cash flow has been very strong and our return on capital here already exceeds our cost of capital. A number of business development activities are being pursued to assure sustained growth in 2004 and beyond.

Our hardware program at the Home Depot has been very successful, and as a result, we have been given an opportunity in the peg storage category. Our organization solutions business is off and running. It is being tested at 417 Home Depot stores with the objective of offering end user organization solutions while raising the average bill of the category 57%. The impact is being felt already with the category average selling price in those stores rising by a double digit percentage.

After four quarters in a row with operating losses, Mac Tools had positive operating margin this quarter. We continue to add traditional distributors, and their third quarter comp increase was encouraging. This was the first quarter in memory with a double digit sales increase X Mac Direct. Our goal is to achieve a double digit operating margin rate by the middle of next year.

Our POS, point of sales, at Granger has been positive sequentially, that is versus prior month, in absolute terms for four consecutive months now, and up double digit in September, as our contract win, enhanced field sales structure, and some excellent programs are taking hold. Similarly, at MSC, our number two MRO, or maintenance repair and operating supply company distributor in the country, we've had, at this company, we've had a double digit POS increase so far in 2003.

Overall, our Proto business saw its order rate up by mid single digit percent in the third quarter. Fill rates are very high, and backlog at an all-time low.

Shipments to Granger and MSC both increased modestly over the second quarter, but lag the POS considerably as inventory reductions continue in response to our improved service levels. We'll begin shipping the initial product for the 2004 program, Proto and Blackhawk by Proto, to Granger, MSC, and other authorized Stanley/Proto distributors in November, and eventually, our shipments will respond to the POS growth.

On recent calls, we indicated that our Wal-Mart share and average bill are increasing, and cited a dramatic increase in the presence of our mechanic's tools sets under the recently launched Stanley Pro line. Wal-Mart added an eight foot bay of our mechanic's tool sets this summer. Their features and quality are above those of comparable nationally-branded mechanics tools. Combined with great pricing, this offers the consumer a demonstrable new value equation.

Merchandising plans have been finalized and began to roll out in early September to ensure that consumers are informed about this new line. Perhaps you've seen Wal-Mart's advertisement for Stanley mechanic's tool sets in last week's issue of "Sports Illustrated", and full page ads in "USA Today" recently, as part of an integrated marketing plan with TV ads.

These ads direct our target audience to the stanleytools.com internet web site where the traffic has increased dramatically. If you visit the web site you can see details of the product features, as well as the print and TV ad for yourself. Sell through has accelerated since these ads began to run.

The holidays should be a natural selling season for these mechanic's tool sets, and that appears to be the case. Do It Best and Menard's have ordered a few of the sets. Look for the 20 Plus 3 bonus pack in Do It Best retail outlets. Some of the sets have already shipped.

Under our five-year marketing agreement with Jesse James of the Discovery Channel's top-rated "Monster Garage "show, we began shipping toolbox/tool set combinations for holiday season promotion, and depending upon its success, have a signature series across a wide breadth of products shortly thereafter. A higher-featured Jesse James toolbox will be sold by our traditional Mac distributors, and in addition, an expanded signature series set to professionals, and one to consumers will be made before the end of the year.

The sales and earnings guidance that Jim discussed includes a modest level of promotional activity consistent with the prior two years. However, the early activity around such promotions is encouraging. If some of them materialize, they could provide some revenue boosts in the fourth quarter, not counted, but being pursued. For example, at the Home Depot, we anticipate that fourth quarter tools promotions could equal the year-to-date levels.

While three weeks do not make a quarter, sales for the first three weeks of October have been excellent. Also, there is virtually no doubt that Stanley will enter 2004 at a much higher EPS run rate than was the case this year, and with high cash generation. The virtuous circle mentioned in May is being executed, and this is just the beginning.

Finally, the Board expects to name a successor CEO by the end of the year. The process is moving forward. And there is nothing more to report on that subject today.

With that, I'll turn it over to the operator -- to Leslie and take your questions.

Thank you. At this time, I would like to remind everyone if you would like to ask a question, please press star, then the number 1 on your telephone key pad. In the interest of time, we ask that you please limit your questions to one question and one follow-up. We'll pause for a moment to compile the Q & A roster.

Your first question comes from Jason Putman, CSFB.

Hi. Good morning.

Good morning, Jason.

Just a question on the asset acquisition that you noted in the press release, $30 million. Can you just give us a little bit more detail on that?

We're in the process of doing a partnership arrangement with a company in Israel, which will give us a much better position in the plastic storage business. It is a bolt-on deal, has arrangements in it which we'll discuss if it all passes through the Israeli antitrust authorities, and go from there.

Ok. So, this would be an acquisition then.

Well, it's not quite an acquisition. It deals with product lines and sharing arrangements on supplier buys and distribution arrangements on the other side, so it's much more -- I would use the word complicated, but a little bit more complex than just the straight buy/sell.

And we should just get some more details on that shortly? Or -- ?

Well, as soon as we have the -- we're in the antitrust authority right now seeking approval. As soon as that's made, then we'll give you some more clarity.

Ok. And then, next question is really, kind of related to margins, a good margin quarter. And I'm just wondering, specifically, I guess, with the segment margins, doors performed very well. But what -- is there an upper limit, you know, when you think about the 15%, how do you think about the breakdown between tools and doors? Is it, you know, 20% for doors and, you know, maybe 13% for tools, or is there a rough range that you can provide us with?

Well, the doors segment, Jason, has, as you know, the entry doors business and it has our Access Solutions business in that. And included in the entry doors is the mirror doors and the home decor and items of that nature. That particular business is never going to be, in our opinion anyway, a 15% to 20% margin business without a lot of heavy lifting, and so forth, which, you know, probably is not going to be undertaken by us.

So, on the other hand, the securities solutions, and including Best and the Access divisions, is easily a 20% operating margin, and so to the extent that we grow the -- you know, that side of the business and the other side stays the same, it mixes up. The practical limit is 20% to 25%, you know, probably, for that type of business that we see today. But that's where we're going with the door segment.

And then just lastly, is there any update on your divestiture possibilities? I know you had mentioned it, you know, previously. Are you thinking, you know, the doors business has been one that's been mentioned? Is there any other -- ?

I don't think we ever mentioned it, but the -- you know, we're analyzing all of our aspects of our portfolio for its fit relative to the strategic and financial return parameters that are -- we require. And we are committed to enriching the portfolio as we discussed at the May analysts meeting, and that process is moving along, and as soon as we have something to announce, we'll announce it.

Ok, great. Thanks.

Remember, we talked about the right-hand side of the chart. The one chart I told you is, that if you had to take one chart away from that May presentation on Stanley, it was the chart with the circles that showed the 46%, I believe, at the time of sales, moving from the right-hand side and generating cash to the left-hand side, and we said we would monitor those assets, either ourselves or else or -- in one fashion or another, and that process is ongoing.

Your next question comes from Jim Lucas, Janney Montgomery Scott.

Thanks a lot. Good morning, guys.

Good morning, Jim.

First, a housekeeping question. From a tax rate perspective, Jim, where do you see the tax rate, going forward?

Well, I think, Jim, you know, over the intermediate to long-term as we grow the European business, it will be able to, probably, come down a little bit. But the reality is, to the extent that we're in the U.S., you know, our tax rate is, statutory tax rate is 35%, and then we have state tax on top of that for a couple of points so we're up against like a 38% tax rate. And there's ways to, you know, mitigate that to some extent, but the practical limit today, you know, with the mix we have today, is probably somewhere between 30% and 32%.

Ok. And looking at the balance sheet, if we could look at two lines in particular. One, the increase in receivables. I know that some of that has to do with the sales gains at Best, but if you could comment on what's happening in receivables, but more notably, the increase in the accrued expenses. Can you talk about where -- what has gone into that bucket this year?

Well, there are a number of things that have, obviously, affect the accrued expenses, but if you just look at September '03 versus September '02, the accrued expenses are up like $50 million, or so. And of that, 30 is related to the purchase of Best. So, the rest of it, there is a big -- whole series of different accounts.

And it's not, you know, as if one stands out. We have everything from sales commissions to co-op expense and all types of accruals, tax accruals, as you can possibly imagine. It is not as though there's one other thing that stands out. Just a whole series of things.

Right. That cloudiness is why I asked the question. On the receivables?

Well, what is the question on the receivables?

Well, they're down year-over-year, but the sequential increase, is that just normal seasonality?

No. Actually, the receivables generated cash if you look at the cash flow statement in the quarter, so, you know, how could the receivables go up and receivables generate cash? Interesting question.

But we actually moved about $35 million of the Mac -- of the distributor financing receivables that were in long-term assets, and they were moved up to receivables. That did not create a cash flow event. So the real underlying performance of the receivables was very strong. In fact, much stronger than normal for this type of -- end of third quarter, typically, is a build in receivables.

Ok. And the size of the Mac Advantage portfolio right now?

The size of the Mac Advantage portfolio is approximately $50 million right now.

All right. Thanks a lot.

Your next question comes from Mark Giambrone, Barrow Hanley.

Good morning, fellas.

Good morning, Mark.

Hi, Mark.

Couple of questions. First, can you give us the sales and margins just for Access on a sequential basis?

No.

-- increased sequentially, and what's the absolute level?

No.

Ok.

Can't do that. I don't blame you for asking.

Second thing I wanted to ask you is why do you say on a margin basis that the fourth quarter margins aren't going to have much of an improvement over the third quarter?

If you look at history, we study history a lot here because it helps to try to understand the dynamics. What goes on in the fourth quarter with the holidays and everything has a tendency to suppress the gross margins. And typically, the fourth quarter, at least in recent years, has been slightly, you know, less robust than the third quarter on a sequential volume basis, as well.

So you'll end up with a slight negative volume leverage effect, and then you -- on top of that, you have higher costs in the manufacturing plants. And it's the combination of those two things that typically will knock the fourth quarter gross margins and operating margins down by, you know, 50 to 100 basis points. So staying the same sequentially actually is indicative of continuous sequential improvement.

Ok. An then flowing into the first and second quarter next year is where we'll really see the improvement again in terms of the absolute improvement?

Yeah. I would expect it to see continued improvement as we get into the first half, especially the second quarter. The second and third quarters are the, you know, the biggest quarters of the year, sales-wise, and that's where you'll really see the expansion.

I'm not going to make a prediction on the first quarter yet because it is too early, but you know, the first quarter tends to look more like the fourth quarter than -- without the holiday problem. From a volume point of view.

And how about a debt to cap target? Do you have a sense of where that's going to be? I'm sorry if you've already told us that and I forgot.

I think I mentioned that by the end of the year we expect to be around 47, but we would like to get down to sub-40 levels by the end of next year.

Ok. Thank you.

Your next question comes from Eric Bosshard, Midwest Research.

Good morning.

Hi, Eric.

Couple of things. In terms of the Operation 15, I think when we started this, you had hoped to exit 2003 at a 15% margin run rate. Is the expectation now that you're going to achieve that at some point in 2004, and is there the expectation that you can have a 15% margin for all of 2004? Can you just give us some definition on that?

Yeah, I would say no. In terms of all of 2004. I would say that we will get sequentially better, as Jim mentioned, through 2004, and a lot of it will have to do with the mix of the businesses that we've got, Eric, and, to be frank about it, the business development activity that may go on over the period of time here.

Because we are mixing into higher margin rate, operating margin rate entities in our -- if you will, our funnel of activity of business development activities. In the acquisition side of the equation, all will generate above the current operating margin rate out of the box. So, it will depend upon that as well as the mix going forward. But we don't have a -- we have not gone through the operating plan process for next year. But my guess is we will not see an overall 15% rate for the year.

I don't think we'll see an overall 15% rate for the year. We do have enough benefits coming out of Operation 15 to yield about 100 basis point improvement just in the first half.

So, the question is, you know, A, how good is the execution on that? And you know, that's still to come. Some of that is still to come. And then, you know, the second question is getting from 14 to 15. There is a lot of moving parts that need to happen. A lot of the portfolio shift items.

However, having said that, you know, there is a -- there is a road map to get there. We're not going to commit, you know, to do it, because last time we committed to get from 9 to 15 and we only got to 13 and people expressed a lot of disappointment -- yeah, despite the fact that we had a 400 basis point improvement and almost $100 million of savings in the run rate.

So we're not going to commit to do that because we understand some people, you know, don't accept that, and if you commit they want the number committed to, and we want the number committed to. So we are going to commit to some improvement, we just don't know how much at this point.

And the biggest change from what you said now versus what was said six months ago at the analysts meeting, before that, before -- when Operation 15 was rolled out, I mean, what changed in terms of the ability to get there?

Three things. The first is volume, and we expected to be flat, excluding Best in the second half, and as it turns out, it looks like we'll be closer to about minus 2%. So, we lost some is volume leverage. That also hurt us from a absorption point of view.

We got hit with more currency headwind on the SG&A, and then on top of that, some of the projects that were scheduled for the second half now look to be more like first half in nature, in timing. So, it is a combination of factors.

Ok. And then just one follow-up question. In terms of the sales momentum, and John, it's been a while since I've heard you say sales trends are excellent -- where, specifically, or across the board, are you seeing improvement in sales momentum, which is obviously demand-driven?

We're seeing -- I see several things. Number one, we're seeing sequential improvement in the industrial -- parts of the industrial market. Not all, but spotty.

Secondly, we're seeing sequential improvement in Mac, frankly, in terms of the fact that over time, we will see the impact of the Mac Direct lessen, simply because it was lessening before it was finally bulletized, so to speak.

And third, we're starting to see some realization of retail that, perhaps, promoting hand tools is not such a bad thing. And if we wind up with that happening, we should see some improvement against what we've had sequentially go on. I mentioned that we're hopeful that the fourth quarter's level of promotions with the large retailers will equal the whole year through the first three quarters. That would be a very positive impact.

The other thing, Eric, is that, as I said, the first three weeks don't make the quarter, but October is a very important month, as Jim mentioned, because of the holidays, in the back end, and so on. So, October, in terms of a quarterly look, is an important month in the fourth quarter. Particularly for a business with half of its business in the consumer side. So, what we're seeing over the first three weeks is encouraging.

And above what -- we plot every day the sales level against the pattern and look at the pattern over a five-year period. And make, as you might imagine, predictions day by day by day. As those days get closer to the end, you get a narrower band between the max and the min and all the median, so we kind of do a little bit of a distribution. And thus far, the first three weeks, that number is tracking above what we would have expected on a seasonal basis between, if you will, September and October, and between the third quarter and the fourth quarter, and so we're encouraged.

To be honest with you, we haven't seen that in years. So, you're right about my tone being positive, and you know, I consider myself to be a fairly sober guy, but we do look at the analytics, and they are positive right now.

Your next question comes from Steve Fockens, Lehman Brothers.

Hi, good morning, guys. Just one quick question. Of the $267 million in operating cash year-to-date, and $114 of that is changes in other operating assets and liabilities, what are the major components of that?

Hold on one second, Steve.

Well, there's a whole series of things. Just like when Jim Lucas asked the question, it's not as if one thing is driving it. We're clearly doing, you know, much better on our cash tax payments this year. Our inventory and receivables provisions are both up. The prepaids are down. The restructuring payments are down considerably from where they were. And then there's, just again, you know, probably five or ten other lines. A couple million apiece. It's just -- a lot of things went in the proper direction to generate cash.

I'm presuming that next year, most of those are -- I mean, obviously, it's nice to have this year, but most -- that's probably not repeatable next year?

No, I -- the way I would look at it is as follows: The -- you know, the -- of the $340 million that we're projecting for the year, probably $50 million, or so, is what I would call non repeatable items, just as a rough estimate, rough order of magnitude. So, somewhere in the $275 to $300 million kind of level is about where I think we would be. That's all consistent with what we basically said at the analyst's meeting for our three-year outlook.

No, actually, it's a little bit higher, to be honest with you. We told you $250, okay, and now, frankly, the cash generating capacity of the company looks to be a little bit higher. So, we'll see as we go, here. But you know, I would say we're on the upper end of the -- the $250 guidance that we gave you in May looks to be solid, going forward, and we think that it could be higher

And part of it is Best, which is generating better cash than we thought, and we seem to be getting our heads around the inventory situation a little bit more than we had heretofore, that some of you have been screaming about for years. And we're finally making some dents here in that situation, which I think you'll see continue.

But interestingly, the working capital for the year is not going to be a major generator of cash related to the $340. So one of the reasons I think we are in a more sustainable, you know, the high $200s kind of a place, is that, you know, as the working capital will gradually come down. We no longer will have the drain on working capital that we've had year in and year out from the Mac business because of the exit of the Mac Financing, our division of distributor financing. And we continue to work on selling the Mac Advantage portfolio, as well. So there's -- a lot of factors contributing to that.

Your next question comes from Joseph Sroka,Merrill Lynch.

Good morning, everyone.

Hi, Joe.

John, you have described, and you're still describing, sort of a multiquarter, multiyear profit improvement and portfolio realignment program. Shall we be concerned or unconcerned that there could be a strategic shift with whoever your successor winds up being, or is this something that the Board has bought into and is sort of making a condition of your successor to stick with the game plan?

Well, I would say this, Joe. You're going to wind up with -- when any new individual walks into a situation, they're going to put their own particular spin on what you see and what you do and so on. I think, however, that we're all business people and that individual, when he looks at the portfolio and looks at the changes that have been already made and those that are under way, and hopefully will conclude in a reasonably -- on a recently near term basis, I think he will be favorably disposed to continue the strategy that has been laid out.

I can tell you that the Board is extremely supportive of the strategy that we laid out actually a year ago -- a year and a half ago now, close to it. And has been with us every step of the way, and has not -- has asked a lot of questions but, really, not questioned the movement pending CEO changes and so on, which frankly, they could have easily done.

They could have said well, let's wait for the new guy before we make any of these moves and so on. But they have not done that. They've essentially said full steam ahead and get done what you can get done as rapidly as possible because we understand the portfolio situation. We understand the customer concentration issues that you're facing, and the sooner this company mitigates those, that force and that reality, the better off we'll all be.

So, we're in the hunt to do that, and frankly, we're very encouraged by the cash generation which gives us enormous flexibility to carry out that mandate. So, that's where we are on that, Joe. I think, you know, it's basically, we know where we are. We know what we have to do.

Jim mentioned some road maps that we have and how to get the operating margin rate up. And to a sustainable level. And not dependent upon people's whim in knocking one, two, or three points off of the sales level and crushing the earnings because they got a different buy in China, or whatever.

Ok. Fair enough. Thank you, sir.

Thank you, Joe.

Your next question comes from Stephen Kim, Smith Barney.

Thanks very much. Just had a couple of quick ones left here. Number one, I guess on the Op 15 restructuring program, you talked about the fact that, you know, some of the initiatives you had initially planned for this year pushed off into '04. Can you be a little more specific in terms of what sorts of things, you know, have been moved out, and maybe the reasons for them?

Mainly they are plant and distribution projects, and projects that are more complicated than the first phase that we executed, which was done very crisply. And projects are dependent on a number of factors, and the feasibility of projects and the timing of projects is subject to change, sometimes, as new facts become known.

And frankly, you know, when we put the Operation 15 plan in place, we told people that it had to be -- the projects had to be fundamentally complete by the middle of '04, because we didn't want to continue on with a restructuring program beyond that and wanted to kind of get into a pay-as-you-go. So, when the projects were put on the table, a few of those were put on the table that really should -- more likely take longer, so we've had to go back in a few cases and reprioritize projects that we -- other projects that we had, and the ones that could be done sooner. So that process has occurred in the last 90 days.

The other thing, Steve, to tell you the truth, we had a process here in the last, actually within the last few weeks, where we had a two-day, probably 100 person group of plant managers, distribution center leaders, product development people, the overall business leaders, and so on, come together to develop programs for 2004 that would generate substantial productivity. And we'll see how all of that goes.

But it was a very productive couple of days, and some of what Jim is talking about emanated from that discussion, where one thing substituted for another, as well. And it was decided that those had greater returns, and therefore, should be pursued versus what we had on the docket already.

Ok, great. The next one is just pretty much to a housekeeping issue. Jim, you had talked about a couple of items which were sort of making the prior year -- the year ago third quarter, non-comparable, and I know there was a, what, $5.5 million tax credit? I know there was part of an environmental gain that was embedded in that quarter, and you mentioned something about a land sale? I thought you said $2 million or -- could you run through those quickly again?

There was about $2 million for an environmental settlement that we had related to a transaction that occurred, you know, a long time ago. There was the sale of some land in the Dallas area adjacent to our plant. That was like $1.5 million.

There was an effective tax rate adjustment in the quarter, last third quarter. We normally adjust our affected tax rate throughout the year as we get closer to the end of the year. We have a better estimate of what the effective tax rate is going to be. It was a bigger adjustment in the third quarter of last year. Bigger favorable adjustment than it was in the third quarter of this year.

Did I miss anything? I guess that's it.

Your next question comes from Margaret Whelan, UBS.

Good morning, guys.

Good morning, Margaret.

You started off, I think, John, in your prepared comments you said your capacity utilization is about 70% right now? Is that right?

No, no, I said that capacity utilization that -- this is a -- the conference board comes out with -- says we're in the mid 70s right now in overall U.S. capacity utilization.

Can you tell us what it is at Stanley?

It varies all over the place. All the way from 50% to 100%.

By --

Plant.

I know, but in terms of, maybe, the different product groups?

I don't have the information in all of the product groups, Margaret, to be honest with you.

Well, what we could say about the product groups though is that the industrial-oriented businesses have typically had a lower capacity utilization than the consumer. So, for instance, the mechanic's tools, and the fastening, you know, which has a big industrial component, as well. Both of those have a lot of excess capacity.

And then, Jim, with your 15% operating margin goal, does that assume you're going to close some of these factories?

None of the big ones.

And what about moving some of them, or moving some capacity over to the U.S. or as your sales grow, kind of opening new factories outside of the U.S.?

There will be likely -- there may be a bolt-on to one factory that we're looking at of moving stuff out of the U.S. But the migration out of the U.S. continues.

Can you just remind us how -- what percent of your sales is being manufactured overseas now?

I think it's roughly about 40%.

Ok. Thank you.

You're welcome. Margaret, I should correct myself there, as Gerry said. It's in the low cost country area. Obviously, we manufacture more than that, given the plants in Europe, and so on.

Thanks.

Overseas. Okay.

At this time, there are no further questions.

Mr. Trani, are there any closing remarks?

Yes, thank you.

There is substantially -- a substantial portfolio repositioning activity under way at Stanley. From our strong current and anticipated free cash flow, you should expect the portfolio shift cited in May to continue apace. Our success with Best gives us confidence that acquisitions here can be integrated successfully.

Moreover, as a company, our run rate, I'll reiterated it again entering 2004, should be the best ever. Go take a look at the earnings performance in the first half and the second half of the years on average, and it will give you an idea of where we think we are and will be exiting in 2004.

Finally, I would like to say thanks to everyone. To the detractors, on the phone and prior to being on this phone call, you've been right several times over the last few years. And frankly, I've learned from my mistakes.

To our supporters, your understanding has been invaluable. There are always bumps in the road. You felt them with us and for us, but stayed the course. Your faith will be rewarded.

And to our owners, your investment is in good hands and your dividend is extremely secure. We know why you own Stanley and we'll continue to provide you with a balanced return.

When entering Stanley almost seven years ago, I stated our vision was to become a great brand. We're not there by any means -- yet, by any means. It's been a journey, and the destination has not been reached, but perhaps the road is clearer than ever before on how to get there, and the team never better.

My expectation is that a new, faster-growing, more predictable Stanley will emerge over the next 24 months. Perhaps sooner. It will be fun to watch that happen, albeit as a share owner, not an active participant.

Thanks again, and to you and your families, a blessed holiday season. Bye-bye.

Thank you for participating in this Stanley Works third quarter earnings conference call. You may now disconnect.