FINANCIAL HIGHLIGHTSHIGHLIGHTS (MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 2005 2004 CHANGE Closing market price per share $ 48.04 $ 48.99 (2%) Total return (share price change plus dividends) 1% 35% Net sales from continuing operations $ 3,285 $ 2,997 10% Operating income from continuing operations $ 445 $ 412 8% Percent of sales 13.5% 13.8% (30bp) Net earnings from continuing operations $ 272 $ 237 15% Per share from continuing operations $ 3.18 $ 2.81 13% Net earnings $ 270 $ 367 (27%) Per share $ 3.16 $ 4.36 (28%) Free cash flow* $ 294 $ 317 (8%) Return on capital employed from continuing operations 14.8% 14.8% – Dividends per share $ 1.14 $ 1.08 6% * REFER TO PAGE 38 OF MD&A FOR THE RECONCILIATION OF OPERATING CASH FLOW TO FREE CASH FLOW TABLE OF CONTENTS LONG-TERM FINANCIAL OBJECTIVES BUSINESS SECTION SALES GROWTH Letter to Shareowners page 2 3-5% Organic Growth The Scorecard page 7 8-12% Growth Including Acquisitions Business Overview page 8 FINANCIAL PERFORMANCE FINANCIAL SECTION Mid-teens percentage EPS Growth Management’s Discussion And Free Cash Flow greater than or equal to Net Income Analysis of Financial Condition ROCE In 12-15% Range And Results of Operations page 31 Financial Statements page 47 DIVIDEND Notes page 51 Continued Growth CORPORATE SECTION CREDIT RATINGS Investor and Shareowner LONG-TERM“Upper Tier” Investment FINANCIAL Grade OBJECTIVES Information page 76 Board of Directors and Executive Officers page 77 THE STANLEY WORKS, AN S&P 500 COMPANY, IS A WORLDWIDE SUPPLIER OF TOOLS, HARDWARE AND SECURITY SOLUTIONS FOR PROFESSIONAL, INDUSTRIAL AND CONSUMER USE. SWK OPERATES IN THREE BUSINESS SEGMENTS: CONSUMER PRODUCTS INDUSTRIAL TOOLS SECURITY SOLUTIONS HAND TOOLS FASTENING SYSTEMS AUTOMATIC DOOR SYSTEMS CONSUMER MECHANICS INDUSTRIAL AND AUTOMOTIVE MECHANICAL ACCESS SYSTEMS MECHANICS TOOLS TOOLS SYSTEMS INTEGRATION INDUSTRIAL AND AUTOMOTIVE CONSUMER STORAGE PERSONAL SECURITY SOLUTIONS STORAGE SYSTEMS HARDWARE INSTALLATION, SERVICE AND LASER LEVELING AND MAINTENANCE MEASURING TOOLS ASSEMBLY TOOLS AND SYSTEMS HYDRAULIC TOOLS SPECIALTY TOOLS The Stanley Works is evolving from a cost-focused building products company to a more growth-oriented diversified industrial, while continuing to strive for global cost competitiveness through the Stanley Fulfillment System (SFS). Our vision is to be the world’s biggest and best branded tools and hardware franchise, coupled with an attractive security solutions growth platform. We move into our 164th year with a legacy of quality and a future of growth. 2005 ANNUAL REPORT 1 163RD MANAGEMENT LETTER TO SHAREOWNERS TO OUR SHAREOWNERS We entered 2005 stating that “our company remains poised for further growth.” This was in fact the case as Stanley continued on its upward trajectory. Organic growth, achieved by delivering a superior value proposition to end users of our products and services, as well as strategic acquisitions contributed to our success. Overall revenue in- creased by 10% including organic growth of 4%. Earnings per share from continuing operations were up 13%, and free cash flow* (operating cash flow less capital investment) was 109% of net income. Return on Capital Employed (ROCE) was a robust 14.8%. In total, our financial performance was consistent with our long-term financial objectives. It was also a year of considerable strategic and enterprises for which they are responsible. progress both for the Company and for our indi- This forward-looking, fact-based approach led vidual businesses. The Stanley Works has a proud to the acquisition of Facom and National as well 163 year heritage. However, we are keenly aware as the acquisitions of six smaller security compa- that standing still is tantamount to moving back- nies with annual revenues totaling $140 million. wards during this era of ever intensifying global It also led to the decision during the year to competition. Consequently, we hold ourselves divest our activities in U.K. decorator tools and accountable to make and execute tough calls in appliance hinge manufacturing. These were regarding our portfolio of businesses and we hold product lines that had minimal long-term poten- each of our operating managers accountable for tial for either profitable growth or above average continuously strengthening the organizations returns. * REFER TO PAGE 38 OF MD&A FOR THE RECONCILIATION OF OPERATING CASH FLOW TO FREE CASH FLOW. THE STANLEY WORKS 2 2005 WAS THE THIRD CONSECUTIVE YEAR IN WHICH SALES INCREASED BY A DOUBLE-DIGIT PERCENTAGE, AND EARNINGS PER FULLY DILUTED SHARE FROM CONTINUING OPERATIONS HAS GROWN AN AVERAGE OF 39% ANNUALLY SINCE 2002. These moves position The Stanley Works to 3.2 pts during the same period despite our having reach the $4 billion mark in revenues in 2006 invested an additional $1 billion of capital to with a clear road map to achieve double-digit build out our portfolio. Our success has been a EPS growth over the next several years. As direct result of empowering our management industry consolidation has accelerated across our teams and in turn, their people, to pursue prof- segments, we have successfully capitalized on itable growth through three essential impera- our financial flexibility and acquisition integra- tives: 1) Strong and innovative customer value tion capabilities to create value. Moreover, these propositions that solve our customers’ problems moves have considerably strengthened each of and exceed their expectations; 2) Brand support; the company’s core franchises in tools, hardware and 3) Global cost competitiveness through the and security solutions while prospectively reduc- Stanley Fulfillment System (SFS). We are confi- ing dependence on any one customer to no more dent that we can earn above average returns and than 10% of revenues. achieve long-term vitality by owning and operat- ing businesses for which these factors are impor- During this year of lackluster U.S. equity market tant and encouraging our management teams to returns, the value of SWK shares decreased 2%, excel in these areas. closing at $48.04, approximately in-line with the overall market and our peer group. Total return CONSUMER PRODUCTS Our consumer hand and on shareowners’ investment was 1% in 2005, fol- mechanic’s tool business sets the standard for lowing 35% and 11% returns in 2004 and 2003, success as it relates to these imperatives. Our respectively. Dividends increased 6% to $1.14 per lineup of innovative tools, with product cues share. This was our 129th consecutive year of taken from the professional end user, is stronger paying a cash dividend and the 38th consecutive than ever. Brand awareness and vitality in the year it has been raised. We continue to view the U.S. is second to none and we believe we have dividend as an important part of our overall cost leadership or parity in most categories in return to shareholders. which we participate. Commercialization efforts have been broadened in recent years in an effort STATE OF THE BUSINESS 2005 was the third to reach the full spectrum of end users. consecutive year in which sales increased by a double-digit percentage, and earnings per fully As this letter goes to press, we are embarking diluted share from continuing operations has on the most ambitious new hand tools product grown an average of 39% annually since 2002. launch in our history: FatMax® Xtreme.™ This Return on Capital Employed (ROCE) has improved exciting new family of products, aimed squarely 2005 ANNUAL REPORT 3 at the professional and serious DIYer, will create While innovative, profitable and recently success- a new industry “gold standard” for design and ful, consumer storage competes in an industry performance. We are also intensifying our com- which has unfavorable structural aspects that mercialization efforts in the construction and suppress returns and thus is under constant DIY markets in Europe in 2006, with the inten- review. tion of achieving market success comparable to that we are currently enjoying in the Americas. INDUSTRIAL The Facom integration takes front One word, momentum, characterizes the state of and center stage in 2006. We like the company we our consumer hand and mechanic’s tool business. bought. We like the people, the brands and the value proposition. Facom, in combination with Consumer hardware, now almost $300 million our previously existing European business, estab- in annual revenues, is also in great shape as lishes The Stanley Works as the company with we enter 2006. The combined Stanley/National clear brand leadership and the strongest value franchises offer the broadest product line in the proposition across the various European geogra- industry, the best merchandising capabilities, phies and market segments. In time, with full the best service proposition through National’s access to Stanley’s resources, Facom will achieve fulfillment center and global cost leadership global cost competitiveness which in turn will through Stanley’s world-class low-cost country secure its role in our company as another center manufacturing and sourcing operations in con- of excellence for professional, industrial, automo- junction with SFS. One might think “a hinge is a tive and plumbing tool design for years to come. hinge,” and it is, but more importantly, consumer hardware is a service business with defensible Our Bostitch pneumatic fastening systems busi- advantages. Stanley/National will be well posi- ness offers a strong value proposition with the tioned to expand into adjacent product areas freshest line of corded pneumatic products in the and geographies after completing its integration industry, and a reputation as the quality choice activities in 2006. for the professional and industrial customer. Despite a diverse manufacturing footprint with Our plastic and metal consumer storage business facilities in Asia, Eastern Europe, Mexico and the (about 10% of the segment) remains a question U.S., Bostitch still has some work to do on its cost mark in this otherwise very strong segment. position, for which plans are being formulated.