Wolseley believes the Group has adequate facilities and working capital to meet its current requirements. As of July 31, 2004, net debt amounted to £941.4 million, compared to £826.7 million at July 31, 2003 and £545.6 million at July 31, 2002. Net debt includes both short-term and
long-term borrowings less cash and current asset investments but excludes borrowings in respect of the construction loan portfolio, as disclosed in Note 29 of the Consolidated Financial Statements on page F-31. The principal reason for the increase in debt in fiscal 2004 was attributable
to acquisitions and the principal reason for the increase in debt in fiscal 2003 as compared to the prior year was attributable to the PBM acquisition in July 2003. The Group seeks a balance between certainty of funding and a flexible, cost-effective borrowings structure. The overall policy
is to ensure that, at a minimum, all projected net borrowing needs are covered by committed facilities arranged by the corporate office, supplemented where appropriate by locally arranged overdraft facilities. The principal source of funds to the Group is committed bank debt.
During the 2004 fiscal year, the Group entered into 14 new bilateral facilities, seven of which were denominated in Euros and six of which were denominated in US dollars, the remaining facility being sterling denominated; at the fiscal year-end exchange rates, the sterling value of these
facilities was £348 million. In addition, SBS entered into a syndicated loan with four banks for US$400 million, the principal purpose of which is to finance SBS’s construction loan receivables. This approach has enabled Wolseley to adjust its funding profile to match more precisely
its investment profile and strengthen its relationship with its core banks.
The year-end maturity profile of Wolseley’s centrally managed facilities at July 31, 2004, was as follows:
Maturity Date
Facility
amount
£m
Less than 1 year
579
1-2 years
28
2-3 years
400
3-4 years
330
4-5 years
66
5-6 years
59
Total
1,462
Cash Flows from Operations
Net cash flow from operating activities decreased from £607.7 million to £325.2 million, due to a net absorption of working capital of £401.9 million. Group inventory levels increased by £274.3 million during the year as a
result of the rapid growth in sales of the North American operations, the effects of opening an additional distribution center in the US Plumbing and Heating Distribution business, an increase in US
inventory levels in response to the market shortage of copper and steel products and the effects of inflation on the value of items carried. Creditors increased by £108.6 million during the year,
compared with an increase of £123.0 million in the previous year. Debtors increased by £236.3 million, compared with an increase of £32.9 million in the prior year, driven by the growth in sales. As
the rate of sales growth outpaced that of working capital, the working capital to sales ratio showed a further improvement from 15.4 per cent to 15.2 per cent. Wolseley’s targeted working capital ratio
remains 15 per cent.
Borrowings
Net borrowings excluding construction loan borrowings as set out in Note 29 of the Consolidated Financial Statements, increased during fiscal year 2004 by £114.7 million to £941.4 million from £826.7 million at July 31, 2003. The increase in borrowings was primarily due to
expenditure on acquisitions of £123.5 million. During fiscal year 2003 net borrowings, excluding construction loan borrowings, increased by £281.1 million to £826.7 million at July 31, 2003. The increase in net borrowings during fiscal 2003 was primarily due to expenditure on
acquisitions of £512.5 million. Construction loan borrowings relating to the US Building Materials Distribution segment increased to £187.7 million at July 31, 2004 from £176.2 million at July 31, 2003 having increased from £171.4 million at July 31, 2002. These loans relate to
construction loan receivables, which increased to £187.7 million at July 31, 2004 from £176.1 million at July 31, 2003 having increased from £171.4 million at July 31, 2002. The construction loan receivables are funded from separately identifiable bank facilities; accordingly, it is
considered appropriate that this specific funding should be separately identified from the Group’s general borrowing on the balance sheet. In addition, this funding is excluded from the calculation of Wolseley’s gearing figures. See Note 41 of the Consolidated Financial Statements for an
additional description and maturity profile of borrowings. The Group’s borrowings are not significantly affected by seasonality.
Financial Instruments and Treasury Policy
For a discussion of the Group’s financial instruments and treasury policies, see Note 33 of the Consolidated Financial Statements.
Capital Expenditure
Capital expenditure, net of asset disposal proceeds, increased by £27.4 million (25.3 per cent) on the prior year to £135.6 million reflecting Wolseley’s policy of continued investment in the business, including the new Richland distribution center in the US, the new head office in
France, the initial investments in the new head office for Wolseley UK and the common information technology platform. Capital expenditure increased by 11.8% during the fiscal year 2003 from £96.8 million to £108.2 million. The fluctuation during the fiscal years was due to
additional investment in distribution centers in the US during fiscal 2003. At July 31, 2004, capital expenditure commitments amounted to £62.1 million. These commitments will be financed through borrowings and primarily relate to the expansion of the branch network and additional
distribution centers in both Europe and the US.
Exchange Rate Fluctuations
Wolseley earns a significant proportion of its sales and profits in foreign currencies, principally the US dollar and to a lesser extent the Euro and Canadian dollar. The average US dollar to sterling exchange rate weakened against the pound by 9.0% during the fiscal year 2004, compared
to a weakening of 8.7% and 0.7% during the fiscal years 2003 and 2002, respectively. The effect of this currency fluctuation was to reduce reported turnover and trading profits for the North American Plumbing and Heating Distribution segment and the US Building Materials
Distribution segment by approximately these percentage amounts in fiscal years 2004 and 2003. During the fiscal year 2004 the Euro strengthened against the pound by 2.8%. The effect of this movement was to increase the reported profits and turnover of the European Distribution
segment by 1.0% and 0.8%, respectively. The Euro strengthened against the pound by 7.0% during the fiscal year 2003. The effect of this currency fluctuation was to increase reported turnover and trading profits for the European Distribution segment for the full year ended July 31, 2003
by approximately 2.5% and 1.9%, respectively.
Under current European legislation, the Group will be required to adopt International Financial Reporting Standards (“IFRSs”) and International Accounting Standards (“IASs”) in the preparation of its financial statements from August 1, 2005 onwards. Wolseley’s internal project task
force to manage the transition of financial reporting from UK GAAP to international accounting has completed an initial assessment of the impact on the accounts of the Group, and work is underway to ensure full compliance for the fiscal year ending July 31, 2006.
Based on the initial assessment, the areas of greatest impact for the Group are changes in respect of the accounting treatment for goodwill, intangible assets, property leases, share based payments, pensions, deferred tax and dividends. The presentation of the financial statements will also
be affected; management is currently assessing the full impact of the changes in presentation.
The abstract, UITF abstract 38 – Accounting for ESOP Trusts, changes the presentation of an entity’s own shares held in an employee share trust from requiring them to be recognised as assets to requiring them to be deducted in arriving at shareholders’ funds. It also has consequential
changes to UITF 17 requiring that the expense to the profit and loss account should be the difference between the fair value of the shares at the date of award and the amount that an employee may be required to pay for the shares (i.e. the ‘intrinsic value’ of the award). The adoption of
UITF 38 did not result in a material impact to Wolseley’s consolidated balance sheets or income statements.
New Accounting Developments under US GAAP
In December 2003, the FASB issued a revised SFAS No. 132, “Employers’ Disclosures About Pensions and Other Postretirement Benefits.” Wolseley has adopted the revised disclosure requirements of this pronouncement.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). In December 2003, FIN 46 was revised (FIN 46R) to clarify some of the provisions of FIN 46 and exempt certain entities from its requirements. Application of FIN 46R is
required in financial statements of public entities that have interests in structures that are commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities for all other types of variable interest entities is required in financial
statements for periods ending after March 15, 2004. The adoption of FIN 46R did not result in a material impact to Wolseley’s consolidated balance sheets or income statements.
In March 2004, the Emerging Issues Task Force (EITF) of the FASB issued EITF Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share” (EITF 03-6). This issue addressed changes in the reporting calculation and
requirements of earnings per share, providing the method to be used when a company has granted to holders of any form of security, rights to participate in the earnings of Wolseley along with the participation rights of common stockholders. Wolseley has reviewed the contractual rights
granted for stock options and concluded that EITF 03-6 does not affect Wolseley’s reporting and disclosure requirements.
In June 2004, the EITF issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). The Issue is to determine the meaning of other-than-temporary impairment and its application to debt and equity
securities within the scope of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”), certain debt and equity securities within the scope of SFAS No. 124, and equity securities that are not subject to the scope of SFAS 115 and not accounted
for under the equity method of accounting. The impairment methodology for various types of investments accounted for in accordance with the provisions of APB Opinion 18, “The Equity Method of Accounting for Investments in Common Stock” and SFAS 115 is predicated on the
notion of “other than temporary” that is ambiguous and has led to inconsistent application. The Task Force reached a consensus that the application guidance in EITF 03-1 should be used to determine when an investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-
temporary impairments. Management is in the process of determining the impact of EITF 03-1 on Wolseley’s business, results of operations, financial position, and liquidity, and will adopt the recognition and measurement guidance of EITF 03-1, when applicable.
Wolseley did not incur any costs exceeding £1 million on product research and development expenditure during the fiscal years 2004, 2003 or 2002. For a discussion related to patents and licenses, see “Item 4 – Information on the Group, paragraph B, – Business Overview, Patents and
Trademarks”.
Critical Accounting Estimates
The Group’s principal accounting policies are set out on pages F-7 to F-9 of the consolidated financial statements and conform with accounting principles generally accepted in the United Kingdom (“UK GAAP”). The preparation of financial statements in accordance with UK GAAP
requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related footnotes. The most sensitive estimates affecting the financial statements are in the areas of assessing the
recoverability of receivables, the net realizable value of inventory, the impairment of goodwill and long-lived intangible assets, the reserves in respect of self-insured insurance and the consideration received from vendors.
Allowance for Doubtful Accounts
Provision is made against accounts that in the estimation of management are irrecoverable. Within each of the businesses assessment is made locally of the recoverability of accounts receivable based on a range of factors including the age of the receivable and the creditworthiness of the
customer. The provision is assessed monthly with a detailed formal review of balances and security being conducted at the full year and half year. Determining the recoverability of an account involves estimation as to the likely financial condition of the customer and their ability to
subsequently make payment. If we are overly cautious as to the financial condition of the customer we may provide for accounts that are subsequently recovered. Similarly if we are overly optimistic as to the financial condition of the customer we may not provide for an account that is
subsequently determined to be irrecoverable. Furthermore, while Wolseley has a large geographically dispersed customer base, a slowdown in the markets in which Wolseley operates may result in higher than expected uncollectible amounts and therefore higher (or lower) than
anticipated charges for irrecoverable receivables. In recent years Wolseley has not experienced significant variation in the amount charged to the income statement in respect of doubtful accounts, when compared to sales.
Wolseley held allowances for doubtful debts totaling £42.3 million, £46.2 million and £35.9 million at July 31, 2004, 2003 and 2002, respectively.
Inventories
For financial reporting purposes Wolseley evaluates its inventory to ensure it is carried at the lower of cost or net realizable value. Provision is made against slow moving, obsolete and damaged inventories. Damaged inventories are identified and written down through our inventory
counting procedures conducted within each business. Provision for slow moving and obsolete inventories is assessed by each business as part of their ongoing financial reporting. Obsolescence is assessed based on comparison of the level of inventory holding to the projected likely future
sales. Future sales are assessed based on historical experience and adjusted where the manufacturer has indicated that they will no longer continue to manufacture the particular item. To the extent that future events impact the salability of inventory these provisions could vary
significantly. For example changes in specifications or regulations may render inventory, previously considered to have a realizable value in excess of cost, obsolete and requiring to be fully written off. Wolseley held allowances in respect of inventory balances totaling £83.6 million and
£108.2 million at July 31, 2004 and 2003, respectively.
Impairment of long-lived assets
Wolseley periodically evaluates the net realizable value of long-lived assets, including goodwill, other intangible assets and tangible fixed assets, relying on a number of factors, including operating results, business plans and projected future cash flows.
In its UK GAAP financial statements, Wolseley amortizes purchased goodwill arising since August 1, 1998 over its estimated economic life subject to a maximum of 20 years. Unexpected future events may evidence an economic life less than this period in which circumstances a higher
amortization charge would be made in those
future financial statements as a result of this shorter life. Tangible fixed assets are depreciated over their useful lives. Where there is evidence of a potential impairment to the carrying value of either
goodwill or tangible fixed assets, Wolseley undertakes an estimation of the fair value of that asset in accordance with the approach set out in Financial Reporting Standard 11. The fair value is in most
cases based on the discounted present value of the future cash flows expected to arise from the business unit to which the goodwill relates, or from the individual asset or asset group. Estimates are used
in deriving these cash flows and the discount rate. For US GAAP purposes, following the adoption of SFAS 142 “Goodwill and Intangible Assets” on August 1, 2002, all pre-existing goodwill and
indefinite-lived intangible assets are no longer subject to amortization but are reviewed annually for impairment. The Group completed the required impairment tests during 2004, which indicated no
charge was required (2003: nil).
Where there is evidence of a potential impairment to the carrying value of tangible fixed assets, impairment is assessed on the basis of the anticipated undiscounted future cash flow from the relevant assets. If the net present value of estimated cash flows are lower than the carrying value
of the asset, an impairment loss is recognized. Wolseley has not experienced any impairments during the periods presented in the consolidated financial statements.
The complexity of the estimation process and issues related to the assumptions, risks and uncertainties inherent with the application of our intangible and tangible fixed asset accounting policies affect the amounts reported in the financial statements. In particular, if different estimates of
the projected future cashflows or a different selection of an appropriate discount rate were made, these changes could materially alter the projected value of the cash flows of the asset and as a consequence materially different amounts would be reported in the financial statements.
Self-insured insurance
Wolseley operates a captive insurance company, Wolseley Insurance Limited, which is registered and operational in the Isle of Man. This company provides reinsurance exclusively to certain companies within the Wolseley Group. Provision is made based on actuarial assessment of the
liabilities arising from the insurance coverage provided. The actuarial assessment of the reserve for future claims necessarily includes estimates as to the likely trend of future claims costs and the estimates as to the emergence of further claims subsequent to the year end. An actuarial
review of claims is performed annually. The loss development factors derived from this review are used each quarter to revise the provision based on the most recent claims experience. To the extent that actual claims differ from those projected the provisions could vary significantly. As
of July 31, 2004, the provision for claims arising from this insurance was £33.4 million (2003: £32.1 million).
Consideration received from vendors
At the beginning of each calendar year, Wolseley enters into agreements with many of its vendors providing for inventory purchase rebates primarily upon achievement of specified volume purchasing levels. For certain agreements the rebate rises as a proportion of purchases as higher
quantities or values of purchases are made. Wolseley accrues the receipt of vendor rebates as part of its cost of sales for products sold, taking into consideration cumulative purchases of inventory to date and projected purchases through the end of the qualifying period. Rebates are
accrued for each reporting period with an extensive reassessment of the rebates earned being performed at the end of the fiscal year and half way through the fiscal year. Wolseley has agreements with numerous and geographically dispersed suppliers, but a slow down in the markets in
which Wolseley operates, or a significant change in the profile of products purchased may result in purchases for the remainder of the year differing significantly from those projected. Consequently the rebate actually received may vary from that accrued in the financial statements.
Off balance sheet arrangements
As at July 31, 2004, the Group had no material off-balance sheet arrangements.
Contractual obligations and commercial commitments
The following table sets forth the aggregate maturities of the Group’s debt, operating leases and other long term obligations for the five fiscal years subsequent to July 31, 2004 and thereafter.
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