10-Q 1 sj10-q.txt FORM 10-Q 06-30-2006 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to ____________ Commission file number 0-32013 SPEAR & JACKSON, INC. ----------------------------------------------------- (Exact name of registrant as specified in its charter) Nevada 91-2037081 ------------------------------- --------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 401 South Lasalle Street, Suite 201, Chicago, Illinois 60605 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 312-765-0680 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.001 per share Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]. Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]. Registrant had 5,735,561 shares of Common Stock, $.001 par value per share, outstanding as of August 14, 2006. Spear & Jackson, Inc. INDEX Page Number ------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) ............................ 1 Condensed Consolidated Statements of Operations - Three and Nine Months ended June 30, 2006 and 2005........... 1 Condensed Consolidated Balance Sheets - June 30, 2006 and September 30, 2005 (audited) ............................ 2 Condensed Consolidated Statements of Cash Flows - Nine Months ended June 30, 2006 and 2005 .................... 3 Notes to Condensed Consolidated Financial Statements......... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................... 22 Item 3. Quantitative and Qualitative Disclosures about Market Risk .. 56 Item 4. Controls and Procedures ..................................... 57 PART II. OTHER INFORMATION Item 1. Legal Proceedings ........................................... 57 Item 6. Exhibits .................................................... 60 SIGNATURES ........................................................... 61 Certifications of Acting Chief Executive Officer and Chief Financial Officer pursuant to Section 302 ..................... EX 31 Certifications of Acting Chief Executive Officer and Chief Financial Officer pursuant to Section 906 ..................... EX 32 ITEM I. FINANCIAL STATEMENTS SPEAR & JACKSON, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

~~For~~FOR ~~the~~THREE ~~Three~~MONTHS ~~Months~~FOR ~~Ended~~THE ~~For~~NINE ~~the~~MONTHS ~~Six~~ENDED ~~Months~~ENDED ~~Ended~~---------------------------- ~~March~~---------------------------- 31JUNE 30, ~~March~~JUNE 3130, ~~March~~JUNE 3130, ~~March~~JUNE 3130, 2006 2005 ~~2004~~2006 2005 ~~2004~~ ------------ ------------ ------------ ------------ Net sales .................................................. $ 2824,~~201~~647 $ 2725,~~427~~954 $ 5375,~~308~~145 $ 5078,~~409~~412 Cost of goods sold ......................................... 1816,~~916~~768 1817,~~721~~531 3551,~~900~~743 3452,~~528~~622 ------------ ------------ ------------ ------------ Gross profit ............................................... 97,~~285~~879 8,~~706~~423 1723,~~408~~402 1525,~~881~~790 Operating costs and expenses: Selling, general and administrative expenses .............. 89,~~130~~360 87,~~401~~889 1627,~~955~~783 1524,~~077~~431 ------------ ------------ ------------ ------------ Operating (loss) income .................................... (1,~~155~~481) ~~305~~534 ~~453~~(4,381) ~~804~~1,359 Other income (expense) Rental income ............................................. 37 39 46111 79118 82 Interest and bank charges (net) ........................... (1238) ~~(63)~~9 (4125) (~~141~~32) ------------ ------------ ------------ ------------ ~~Income~~(Loss) income from continuing operations before unusual or infrequent items and income taxes .............. (1,~~182~~482) ~~288~~582 ~~491~~(4,295) ~~745~~1,445 ~~Profit~~Unusual or infrequent items: Manufacturing reorganization costs ........................ (592) (269) (1,820) (269) Settlement of class action litigation ..................... (650) - (650) - Gain on sale of land and buildings, net of ~~related~~ reorganization costs .................................................... ~~2,503~~- - - 2,503 - ------------ ------------ ------------ ------------ ~~Income~~(Loss) income from continuing operations before income taxes .............................................. 3(2,~~685~~724) ~~288~~313 2(6,~~994~~765) ~~745~~3,679 ~~Provision~~Income ~~for~~tax (provision) benefit ............................. (41) (206) 272 (654) ----------- ----------- ----------- ----------- (Loss) income ~~taxes~~from continuing operations ................... (2,765) 107 (6,493) 3,025 ----------- ----------- ----------- ----------- Discontinued operations: Loss from discontinued operations (net of income taxes of $nil in 2006 and 2005)............ (~~491~~14) (~~356~~42) (~~448~~101) (~~532~~414) Adjustment to previously recorded loss on disposal of discontinued operations............................... 3 - 12 - ----------- ----------- ----------- ----------- Loss from discontinued operations .......................... (11) (42) (89) (414) ----------- ----------- ----------- ----------- Net ~~income~~ (loss) income .......................................... $ 3(2,~~194~~776) $ 65 $ (686,582) $ 2,~~546~~611 ~~$ 213~~ ============ ============ ============ ============ Basic and diluted ~~earnings~~ (loss) income per share: From continuing operations ................................. $ (0.2748) $ 0.02 $ (1.13) $ 0.31 From discontinued operations ............................... (0.00) (0.01) (0.02) (0.04) ----------- ----------- ----------- ----------- $ (0.2248) $ 0.0201 $ (1.15) $ 0.26 ============ ============ ============ ============ Weighted average shares outstanding ........................ 115,~~741~~735,~~122~~561 116,~~741~~197,~~122~~527 115,~~741~~735,~~122~~561 119,~~741~~893,~~122~~257 ============ ============ ============ ===========~~= The accompanying notes are an integral part of these financial statements. 1~~

The accompanying notes are an integral part of these financial statements. 1 SPEAR & JACKSON, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT SHARES)

AtAT ~~March~~JUNE 3130, AtAT ~~September~~SEPTEMBER 30, 2006 2005 ~~2004~~ ------------ ---------------- (~~Unaudited~~UNAUDITED) ASSETS Current assets: Cash and cash equivalents ..................................................... $ 96,~~924~~321 $ 57,~~090~~289 Trade receivables, net of allowance for doubtful accounts of $1,458 and $1,525 ....................................................... 2217,~~005~~074 1816,~~843~~448 Inventories ................................................................... 2623,~~636~~989 2124,~~988~~999 ~~Assets~~Foreign ~~held~~taxes ~~for~~recoverable ~~sale~~ ..................................................... 201 - ~~3,190~~ Deferred income tax asset, current portion .................................... 2,~~179~~843 2,~~128~~623 Other current assets .......................................................... 1,~~852~~168 1,~~310~~316 -------- -------- Total current assets ....................................................... 6251,596 52,~~549~~675 Property, plant and equipment, net ............................................ 2017,~~094~~674 2217,~~114~~568 Deferred income tax asset ..................................................... 1113,~~196~~753 1012,~~933~~690 Investments ................................................................... ~~168~~405 ~~160~~157 -------- -------- Total assets ............................................................... $ 9483,~~054~~428 $ 8583,~~756~~090 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable ................................................................. $ 8113 $ 68752 Trade accounts payable ........................................................ 98,~~574~~550 8,~~562~~103 Accrued expenses and other liabilities ........................................ 1412,~~063~~720 1211,~~948~~241 Foreign taxes payable ......................................................... 76153 2288 -------- -------- Total current liabilities .................................................. 2321,~~794~~436 2120,~~600~~184 Other liabilities .............................................................. ~~1,049~~756 ~~1,172~~749 Pension liability .............................................................. 3541,~~821~~324 3335,~~545~~954 -------- -------- Total liabilities .......................................................... 6063,~~664~~516 56,~~317~~887 -------- -------- Stockholders' equity: Common stock, 25,000,000 shares authorized $0.001 par value; 12,011,122 issued and 5,735,561 shares outstanding ....................................~~........................~~ 12 12 Additional paid in capital ..................................................... 51,590 51,590 Accumulated other comprehensive income (loss): Minimum pension liability ~~adjsutment~~adjustment, net of tax ........................... (3945,~~959~~744) (3843,~~030~~751) Foreign currency translation adjustment, net of tax ........................ 1514,~~706~~042 1211,~~429~~765 Unrealized gain (loss) on derivative instruments ..........................~~....~~ ~~(4)~~- (617) Retained earnings .............................................................. ~~6,585~~552 47,~~039~~134 Less: ~~270~~6,~~000~~275,561 common stock held in treasury, at cost ......................... (540) (540) -------- -------- Total stockholders' equity ........................................... 3319,~~390~~912 2926,~~439~~203 -------- -------- -------- -------- Total liabilities and stockholders' equity ........................... $ 9483,~~054~~428 $ 8583,~~756~~090 ======== ======== ~~The accompanying notes are an integral part of these financial statements. 2~~

The accompanying notes are an integral part of these financial statements. 2 SPEAR & JACKSON, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)

~~For~~FOR ~~the~~THE ~~Six~~NINE ~~Months~~MONTHS ~~Ended~~ENDED ~~March~~------------------------- 31JUNE 30, ~~March~~JUNE 3130, 2006 2005 ~~2004~~ --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income attributable to continuing and discontinued operations .........~~.......................................................~~ $ 2(6,~~546~~582) $ ~~213~~2,611 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Depreciation ................................................................... 1,~~523~~775 12,~~508~~225 Amortization of asset held for sale ............................................ 22 - ~~Profit~~16 Gain on sale of land and buildings ............................................. - (2,503) - Loss on sale of plant, property and equipment ..................................~~...~~ 2 11 14 Deferred income taxes .......................................................... ~~349~~(566) ~~470~~515 Changes in operating assets and liabilities~~, excluding the effects of acquisitions and dispositions~~: ~~Increase~~Decrease in trade receivables .................................................. ~~(2,186)~~104 ~~(3,232)~~256 Decrease (~~Increase~~increase) ~~decrease~~ in inventories ............................................. 1,681 (34,~~665~~374) 68Decrease ~~Increase~~(increase) in other current assets ....................................~~....~~ ~~(472)~~208 (~~291~~394) Contributions paid to pension plan ............................................. (12,~~456~~595) (15,~~424~~892) Increase in other non-current liabilities ...................................... 26,~~027~~181 ~~650~~3,028 Increase in trade accounts payable ............................................. ~~782~~109 ~~1,175~~160 ~~(Decrease)~~Increase ~~increase~~ in accrued expenses and other liabilities ............................. 1,144 721 (~~183~~Decrease) ~~674~~increase ~~Increase~~ in foreign taxes payable ...................................~~....~~ 46(108) 354 Decrease in other liabilities .................................................. (~~182~~26) (~~466~~284) ------- ------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES ...............................~~.......~~ 1,327 (3,~~341~~850) ~~(638)~~ ------- ------- INVESTING ACTIVITIES: Purchases of property, plant and equipment ...................................... (~~642~~1,213) (~~6,838~~942) Proceeds from sale of property, plant and equipment ~~net~~............................. of86 ~~costs~~8,616 Purchase of ~~disposal~~equity investment ..................................................... ~~8,631~~(229) - ------- ------- NET CASH ~~PROVIDED BY~~ (USED IN) PROVIDED BY INVESTING ACTIVITIES ............................... ~~7,989~~ (61,~~838~~356) 7,674 ------- ------- FINANCING ACTIVITIES: ~~Increase~~Decrease in overdraft ............................................................ 10(773) ~~1,844~~(67) ------- ------- NET CASH ~~PROVIDED~~USED BYIN FINANCING ACTIVITIES ........................................... 10(773) ~~1,844~~(67) ------- ------- Effect of exchange rate changes on cash and cash equivalents ..................... ~~176~~(166) ~~181~~(303) ------- ------- CHANGE IN CASH AND CASH EQUIVALENTS .............................................. ~~4,834~~ (~~5,451~~968) 3,454 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ................................. 7,289 5,090 ~~9,191~~ ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ....................................... $ 96,~~924~~321 $ 38,~~740~~544 ======= ======= SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest ........................................................ $ 6182 $ ~~197~~32 ======= ======= Cash paid for taxes ........................................................... $ 53402 $ 5985 ======= ======= ~~The~~NON-CASH ~~accompanying~~INVESTING ~~notes~~AND ~~are~~FINANCING anACTIVITIES ~~integral~~Common ~~part~~stock ofissued ~~these~~for ~~financial~~acquisitions ~~statements~~......................................... 3$ - $ - ======= =======

The accompanying notes are an integral part of these financial statements. 3 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS EXCEPT SHARES) NOTE 1 - BASIS OF PRESENTATION These condensed consolidated financial statements are expressed in U.S. dollars and have been prepared in accordance with accounting principles generally accepted in the United States. The condensed consolidated financial statements include the accounts of Spear & Jackson Inc. (the Company) and its wholly owned subsidiaries, Mega Tools Ltd., Mega Tools USA, Inc., Megapro Tools, Inc., S and J Acquisition Corp., Spear & Jackson plc and Bowers Group plc. Both Spear & Jackson plc and Bowers Group plc are sub-holding companies and their business is carried out by the following directly and indirectly owned subsidiaries: Bowers Metrology Limited, Bowers Metrology UK Limited, Coventry Gauge Limited, CV Instruments Limited, Eclipse Magnetics Limited, Spear & Jackson (New Zealand) Limited, James Neill Canada Inc., James Neill Holdings Limited, James Neill U.S.A. Inc., Spear & Jackson (Australia) Pty Ltd., Magnacut Limited, Neill Tools Limited, Spear & Jackson Garden Products Limited, Spear & Jackson Holdings Limited, Spear & Jackson France S.A., Societe Neill France S.A, CV Instruments Europe BV and Bowers Eclipse Equipment Shanghai Co. Limited. As further explained in note 4, below, the purchase of Spear & Jackson plc and Bowers Group plc by Megapro Tools, Inc. (now Spear & Jackson, Inc.), which was completed on September 6, 2002, was treated as a reverse acquisition. The results and assets of discontinued operations are presented in accordance with Statement of Financial Accounting Standards ("SFAS") 14. All significant intercompany accounts and transactions have been eliminated on consolidation. The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial statements pursuant to both the rules and regulations of the Securities and Exchange Commission and with instructions to Form 10-Q. Accordingly, certain information and footnote disclosures required for annual financial statements have been condensed or omitted. The Company's management believes that all adjustments necessary to present fairly the Company's financial position as of June 30, 2006 and September 30, 2005, and the results of operations for the three and nine month periods ended June 30, 2006 and June 30, 2005 and cash flows for the nine month periods ended June 30, 2006 and June 30, 2005 have been included and that the disclosures are adequate to make the information presented not misleading. The balance sheet at September 30, 2005 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's and Subsidiaries' annual report on Form 10-K for the year ended September 30, 2005. It is suggested that these financial statements be read in conjunction with the audited consolidated financial statements and related footnotes of the Company for the year ended September 30, 2005 included in the Company's annual report filed on Form 10-K for the period then ended. The condensed consolidated financial statements of Spear & Jackson, Inc. are denominated in US dollars. Changes in exchange rates between UK sterling, the Euro, the Australian dollar, the New Zealand dollar, the Chinese Yen and the US dollar will affect the translation of the UK, French, Dutch, Chinese, New Zealand and Australian subsidiaries' financial results into US dollars for the purposes of reporting the consolidated financial results. The process by which each foreign subsidiary's financial results are translated into US dollars is as follows: income statement accounts are translated at average exchange rates for the period; balance sheet asset and liability accounts are translated at end of period exchange rates; and equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner affects the stockholders' equity account, referred to as the accumulated other comprehensive income account. Management have decided not to hedge against the impact of exposures giving rise to these translation adjustments as such hedges may impact upon the Company's cash flow compared to the translation adjustments which do not affect cash flow in the medium term. The results of operations for any interim periods are not necessarily indicative of the results to be expected for the full year, or any subsequent periods. 4 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 1 - BASIS OF PRESENTATION - CONTINUED Certain reclassifications have been made to prior period amounts to conform to current period presentation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. NOTE 2 - RECENTLY ISSUED ACCOUNTING STANDARDS In March 2005, the FASB issued Interpretation ("FIN") No. 47, "Accounting for Conditional Asset Retirement Obligations--an Interpretation of FASB Statement No. 143." This Interpretation clarifies the timing of liability recognition for legal obligations associated with an asset retirement when the timing and (or) method of settling the obligation are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. We do not believe that the implementation of this statement will have a material impact on the Company's consolidated results of operation and financial condition. In March 2005, the SEC issued Staff Accounting Bulletin ("SAB") No. 107 regarding the Staff's interpretation of SFAS No. 123(R). This interpretation provides the Staff's views regarding interactions between SFAS No. 123(R) and certain SEC rules and regulations and provides interpretations of the valuation of share-based payments for public companies. The interpretive guidance is intended to assist companies in applying the provisions of SFAS No. 123(R) and investors and users of the financial statements in analyzing the information provided. We believe the adoption of this Statement will not have a material impact on our financial position or results of operations. In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections". SFAS 154 replaces APB Opinion No. 20, "Accounting Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle. SFAS 154 also requires that a change in method of depreciating or amortizing a long-lived non-financial asset be accounted for prospectively as a change in estimate, and correction of errors in previously issued financial statements should be termed a restatement. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005 which is effective with our first quarter of fiscal 2007. We intend to adopt the disclosure requirements upon the effective date of the pronouncement. We do not believe that the adoption of this pronouncement will have a material effect on our consolidated financial position, results of operations or cash flows. In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements ("EITF 05-6.") EITF 05-6 provides guidance on determining the amortization period for leasehold improvements acquired in a business combination or acquired subsequent to lease inception. The guidance in EITF 05-6 will be applied prospectively and is effective for periods beginning after June 29, 2005. Adoption of this standard is not expected to have a material impact on our consolidated financial position or results of operations. In October 2005, the FASB issued Staff Position No. 13-1, "Accounting for Rental Costs Incurred During a Construction Period" ("FSP No. 13-1"). FSP No. 13-1 is effective for the first reporting period beginning after December 15, 2005 and requires that rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense. We do not believe that adoption of FSP No. 13-1 will have a material impact on our financial statements. 5 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 2 - RECENTLY ISSUED ACCOUNTING STANDARDS - CONTINUED In November 2005, the Financial Accounting Standards Board (FASB) issued FSP No. 123(R)-3, "Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards." This pronouncement provides an alternative method of calculating the excess tax benefits available to absorb any tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R). The company has until November 2006 to make a one-time election to adopt the transition method. The company is currently evaluating FSP 123(R)-3; this one-time election will not affect operating income or net earnings. In February 2006, the Financial Accounting Standards Board issued Statement No. 155, Accounting for Certain Hybrid Financial Instruments, as an amendment to Statement No. 133, Accounting for Derivatives Instruments and Hedging Activities, and Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. Statement No. 155 amends Statement No. 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principle cash flows. Statement No. 155 amends Statement No. 140 to allow qualifying special purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative instrument. Statement No. 155 is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The Company does not believe that the adoption of Statement No. 155 will have a material impact on the Company's condensed consolidated financial statements. In March 2006, the Financial Accounting Standards Board issued Statement No. 156, Accounting for Servicing of Financial Assets as an amendment to Statement No. 140. Statement No. 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective for reporting periods beginning after September 15, 2006. We do not expect the adoption of SFAS 156 to have a material impact on our results of operations or financial condition. In June 2006, the Financial Accounting Standards Board ratified the consensus reached by the EITF on EITF Issue No. 05-01, Accounting for the Conversion of an Instrument That Becomes Convertible Upon the Issuer's Exercise of a Call Option ("EITF 05-01"). The EITF consensus applies to the issuance of equity securities to settle a debt instrument that was not otherwise currently convertible but became convertible upon the issuer's exercise of call option when the issuance of equity securities is pursuant to the instrument's original conversion terms. The adoption of EITF 05-01 is not expected to have a material impact on our results of operations or financial condition. In July 2006, Financial Accounting Standards Board issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes as an interpretation of Statement No. 109. This interpretation clarifies the application of Statement No. 109 by defining a criterion than an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise's financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. At this time, we have not completed our review and assessment of the impact of adoption of FIN 48. NOTE 3 - CRITICAL ACCOUNTING POLICIES A summary of our critical accounting policies is included in Note 2 to the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2005. Management believes that the application of these policies on a consistent basis enables the Company to provide useful and reliable financial information about the Company's operating results and financial condition. As disclosed in the annual report on Form 10-K for the fiscal year ended September 30, 2005, the discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements. These have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of the financial statements 6 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 3 - CRITICAL ACCOUNTING POLICIES - CONTINUED requires us to make estimates and assumptions and adopt accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses as disclosed in those financial statements. These judgements can be subjective and complex, and consequently actual results could differ from those estimates. Our most critical accounting policies relate to revenue recognition; foreign exchange risk; inventory, the computation of deferred income taxes, the recognition of deferred income tax assets and pension and other post retirement benefit costs. Since September 30, 2005, there have been no changes in our critical accounting policies and no significant changes to the assumptions and estimates related to them. NOTE 4 - NATURE OF BUSINESS The Company was incorporated in the State of Nevada on December 17, 1998 and was inactive until the acquisition of Mega Tools Ltd. and Mega Tools USA, Inc. via reverse acquisition on September 30, 1999. The Company was engaged in the manufacture and sale of a patented multi-bit screwdriver. The Company entered into an exclusive North American license agreement with the patent holder of a retracting cartridge type screwdriver. This license agreement gave the Company unrestricted use of the patent in Canada and the United States until November 8, 2005. The Company's wholly owned subsidiaries, Mega Tools USA, Inc. and Mega Tools Ltd. manufactured and marketed the drivers to customers in the United States and Canada. With effect from September 30, 2003 the Company exited its screwdriver operations following the sale of the trade and net assets of Mega Tools USA, Inc. and Mega Tools Ltd. The historical results of operations for this business have been reclassified to earnings (loss) from discontinued operations on the Company's Consolidated Statements of Operations. On September 6, 2002 the Company acquired the entire issued share capital of Spear & Jackson plc and Bowers Group plc. These companies, through their principal operating entities, as disclosed in note 1, manufacture and distribute a broad line of hand tools, lawn and garden tools, industrial magnets and metrology tools primarily in the United Kingdom, Europe, Australia, North and South America, Asia and the Far East. Following recommendations by the SEC, the acquisition of Spear & Jackson plc and Bowers Group plc ("S&J") by Megapro Tools, Inc. was accounted for as a reverse acquisition for financial reporting purposes. The reverse acquisition is deemed a capital transaction and the net assets of S&J (the accounting acquirer) were carried forward to Megapro Tools, Inc. (the legal acquirer and the reporting entity) at their carrying value before the combination. Although S&J was deemed to be the acquiring corporation for financial accounting and reporting purposes, the legal status of Megapro Tools, Inc. as the surviving corporation does not change. The relevant acquisition process utilizes the capital structure of Megapro Tools, Inc. and the assets and liabilities of S&J are recorded at historical cost. In these financial statements, S&J is the operating entity for financial reporting purposes and the financial statements for all periods presented represent S&J's financial position and results of operations. The equity of Megapro Tools Inc. is the historical equity of S&J retroactively restated to reflect the number of shares issued in the S&J acquisition. On 7 November 2002 the Company changed its name from Megapro Tools, Inc. to Spear & Jackson, Inc. Following formal approval by the SEC and the U.S. District Court for the Southern district of Florida of the settlement of the litigation captioned SEC v. Dennis Crowley, Spear & Jackson, Inc., International Media Solutions, Inc., Yolanda Velazquez and Kermit Silva (Case No: 04-80354-civ-Middlebrooks), the Company entered into a Stock Purchase Agreement with PNC Tool Holdings LLC ("PNC") and Dennis Crowley, the sole member of PNC. The Stock Purchase Agreement was effected on April 8, 2005. Under the Stock Purchase Agreement, the Company acquired, for $100, and other good and valuable consideration, 6,005,561 common shares of the Company held by PNC which represented approximately 51.1% of the outstanding common shares of the Company at December 31, 2004, and which constituted 100% of the common stock held by such entity. The parties also executed general releases in favor of each other subject to the fulfillment of the conditions of the Stock Purchase Agreement. 7 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 4 - NATURE OF BUSINESS - CONTINUED As a result of the stock purchase, the stockholders of the Company had their percentage stock interest increase correspondingly. Jacuzzi Brands, Inc. ("Jacuzzi"), which is a beneficial owner of 3,543,281 shares of common stock, had its interest in the Company increase to approximately 61.8% of the outstanding common stock. On April 21, 2005, Jacuzzi adopted a plan of disposition of the Company's common stock. On 23 March 2006, Jacuzzi Brands, Inc. ("Jacuzzi") and its subsidiary undertaking, USI American Holdings, Inc. ("USI" and together with Jacuzzi, the "Seller") entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with United Pacific Industries Limited ("UPI"), a Bermuda Corporation, to sell its entire holding of 3,543,281 shares of the common stock (the "Shares") of Spear & Jackson, Inc. ("SJI") to UPI for $1.40 per share for an aggregate purchase price of $4,960,593. Such shares constitute all of the shares of SJI owned by the Seller. The representations, warranties and covenants made by Jacuzzi and UPI are typical for this type of transaction, and include a covenant that restricts Jacuzzi from soliciting or negotiating with a third party between the signing date of the Stock Purchase Agreement and the closing date of the transaction. Jacuzzi has also agreed that in connection with the closing of the transaction, it will, among other things, cause UPI's designees and one designee of Jacuzzi to be elected to the Board of Directors of Spear & Jackson, Inc. and will use commercially reasonable best efforts so that such UPI designees are in sufficient numbers to give UPI a majority of the Board of Directors of the Spear & Jackson, Inc. UPI has also agreed that it or any of its affiliates will not purchase any additional Common Stock during the period from the signing date of the Stock Purchase Agreement through one year following the closing at a price less than $1.40 per share. The purchase of the Shares by UPI contemplated by the Stock Purchase Agreement is subject to the receipt of a number of closing conditions, including approval by UPI's shareholders and the United Kingdom Pensions Regulator, and the receipt of certain other regulatory approvals as well as other customary closing conditions. The Seller and UPI then announced that they had entered into Amendment No. 1 dated May 4, 2006, ("Amendment No. 1 to the Stock Purchase Agreement") to extend the date by which the Seller and UPI were required to lodge the clearance application with the UK Pensions Regulator. The Seller and UPI subsequently received a comfort letter dated July 5 2006, issued by the UK Pensions Regulator (the "Comfort Letter"). The Seller and UPI have agreed to waive the condition contained in the Stock Purchase Agreement for a clearance from the UK Pensions Regulator and to accept the Comfort Letter in satisfaction of that condition. The trustees of Spear & Jackson, Inc.'s UK Pension Plan confirmed by a letter dated July 6, 2006 their acceptance of the UK Pensions Regulator's determination. The Seller and UPI subsequently announced that they had entered into Amendment No. 2 dated July 10, 2006, ("Amendment No. 2 to the Stock Purchase Agreement") to waive their respective requirements for a clearance from the UK Pensions Regulator and to accept in its place the Comfort Letter which states the UK Pensions Regulator is of the view, based on the information supplied to him in connection with the clearance application, that the change of control as a result of the sale by the Seller of all of its shares of Spear & Jackson, Inc. to UPI is not detrimental to the UK pension plan and the UK Pensions Regulator believes that a clearance is not necessary for the transaction. In addition, pursuant to the terms of Amendment No. 2 to the Stock Purchase Agreement, UPI agreed, subject to the Closing having occurred, to indemnify the Seller and JBI Holdings Limited (the "Jacuzzi Indemnified Parties") should the UK Pensions Regulator, regardless of the Comfort Letter, require any of the Jacuzzi Indemnified Parties to make a contribution or provide financial support in relation to the potential pension plan liabilities of SJI or its subsidiaries. In addition, UPI has also agreed that for a period of twelve months from the Closing Date, UPI will not, and will use its best efforts to ensure that neither Spear & Jackson, Inc. nor any of its subsidiaries will, take any action or omit to take any action that causes the UK Pensions Regulator, as a result of such action or omission, to issue a contribution notice against the Jacuzzi Indemnified Parties in relation to any UK pension plan in which Spear & Jackson, Inc. or any subsidiary of Spear & Jackson, Inc. 8 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 4 - NATURE OF BUSINESS - CONTINUED is an employer. Further, UPI agreed that for a period of twelve months from the Closing Date, that it will not (and will use its best efforts to ensure that neither Spear & Jackson, Inc. nor any subsidiary of Spear & Jackson, Inc. will) engage in any action or inaction which in relation to any such UK pension plan would fall within the UK Pension Regulation clearance guidance note dated April 2005 as a 'Type A' event unless UPI procures that clearance is issued by the UK Pensions Regulator in relation to such event in terms which confirm that no Jacuzzi Indemnified Party shall be linked to a financial support direction or contribution notice in respect of such event. On July 28, 2006 the purchase was formally completed. On June 22, 2006, Jacuzzi and UPI filed a preliminary Form 14C with the SEC announcing notice of change in control and of a majority of directors pursuant to section 14(f) of the Securities Exchange Act of 1934 and Rule 14f-1 thereunder. The 14C indicated that three new directors would be designated by and elected to the Board of directors by UPI, to serve until the Company's next annual meeting. The 14C became effective on August 7, 2006, and the three new directors will replace the incumbent directors on about August 27, 2006. In the interim, the Board by resolution, appointed the three new directors--Lewis Hon Ching Ho, Andy Yan Wai Poon and Maria Yuen Man Lam--to the Board effective August 9, 2006. Brian C. Beazer, the Chairman of UPI, is a director of Jacuzzi and holds approximately 24.56% of the shares of UPI. David H. Clarke, the Chairman and Chief Executive Officer of Jacuzzi, is a director of UPI and holds approximately 22.88% of the shares of UPI. Mr. Clarke also holds approximately 28,350 shares of common stock of Spear & Jackson, Inc., representing approximately 0.49% of the shares of Spear & Jackson, Inc. but the shares of Spear & Jackson, Inc. owned by Mr. Clarke are not being purchased at the time of the sale of the Shares by the Seller to UPI. NOTE 5 - DISCONTINUED OPERATIONS The following table presents the results of the Company's operations that have been reclassified as discontinued and the (loss) income that has been recorded in connection with the disposal of these businesses:

~~For~~FOR ~~the~~THE ~~Three~~THREE ~~For~~MONTHS ~~the~~FOR ~~Three~~THE ~~For~~NINE ~~the~~MONTHS ~~Six~~ENDED ~~For~~ENDED ~~the~~---------------------------- ~~Six~~----------------------------- ~~Months~~June ~~Ended Months Ended Months Ended Months Ended March 31~~30, ~~March~~June 3130, ~~March~~June 3130, ~~March~~June 3130, 2006 2005 ~~2004~~2006 2005 ~~2004~~ -------------- -------------- -------------- -------------- Note (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) ~~Sevice~~Revenues ~~cost~~reclassified to discontinued operations: Thread gauge measuring division ..................~~...........~~ (a) $ ~~460~~- $ ~~387~~376 $ ~~916~~590 $ ~~762~~1,226 ~~Interest~~------- ~~cost~~------- ------- ------- $ - $ 376 $ 590 $ 1,226 ======= ======= ======= ======= Loss from discontinued operations: Loss from operations of thread gauge measuring division ........................... ~~2,570 2,289 5,114 4,507 Expected return on plan assets~~ ............... (~~2,704~~a) (~~2,779~~14) $ (~~5,378~~42) (~~5,473~~101) ~~Recognition~~$ of(414) ~~actuarial loss ........... 693 435 1,375 854~~ ------- ------- ------- ------- ~~Total~~$ ~~benefit~~(14) ~~cost~~$ (42) $ (101) $ (414) ======= ======= ======= ======= Adjustment to previously recorded loss on disposal of discontinued operations: Megapro screwdrivers division ...................... (b) 3 $ ~~1,019~~- 12 $ ~~332~~- ------- ------- ------- ------- $ ~~2,027~~3 $ ~~650~~- $ 12 $ - ======= ======= ======= ======= ------- ------- ------- ------- Total loss from discontinued operations net of taxes $ (11) $ (42) $ (89) $ (414) ======= ======= ======= =======

Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company's previously issued financial statements and notes have been reclassified to reflect the discontinued components detailed above. Accordingly, the assets, liabilities, net operations, and net cash flows of these business segments have been reported as "Discontinued Operations" in the accompanying condensed consolidated financial statements. 9 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 5 - DISCONTINUED OPERATIONS - CONTINUED (a) During the fourth quarter of fiscal 2005, the Company began marketing for sale certain assets associated with its Coventry Gauge thread gauge measuring business that is located in the United Kingdom. On February 28, 2006, the Company concluded the sale of these assets for a nominal consideration. The assets sold comprised plant and equipment, inventories and goodwill. The acquirer paid (pound)1 and assumed certain liabilities in respect of the leased premises from which the trade operates. The carrying values of the assets relating to this entity were written down to the lower of depreciated cost or estimated fair value after consideration of selling costs in the quarters ended March 31, 2005 and September 30, 2005. No further losses or gain on disposal are required to be recognized in the current period. The assets and liabilities of discontinued operations held for sale have not been reported separately in the consolidated balance sheets of the Company as the net book amounts involved are not considered material. (b) During the year ending September 30, 2003, the directors of Spear & Jackson, Inc. carried out a strategic review of the Company's loss making Megapro screwdriver division ("Megapro"). It was determined that the division was no longer a core activity of the group and various divestment strategies were considered. With effect from September 30, 2003, the trade and assets of the division's principal operating companies, Mega Tool USA, Inc. and Mega Tools Limited, were transferred by prior subsidiary management, and without prior authorization, at their net book value of $384 to the division's former managing director. The transfer proceeds were in the form of $284 of loan notes and other receivables and the discharge of a loan of $100 owed by the company to the Megapro managing director. Having considered the future financial position of Megapro, the directors of Spear & Jackson, Inc. provided $97 against the recoverability of the balance of the sales proceeds which was outstanding at September 30, 2003. A further $187 was provided against this debt in the year ended September 30, 2004. It has now been agreed with Megapro that it will pay Canadian $54 (approximately $41) in settlement of those debts and this is being repaid in monthly installments of Canadian $5 (approximately $4) of which $27 was received in the year ended September 30, 2005. A further $12 has been received in the nine months ended June 30, 2006. NOTE 6 - RETIREMENT BENEFIT PLAN The Company operates a contributory defined benefit pension plan covering certain of its employees in the United Kingdom based subsidiaries of Spear & Jackson plc. The benefits covered by the Plan are based on years of service and compensation history. Plan assets are primarily invested in equities, fixed income securities and Government Stocks. Pension costs amounted to $2,121 for the quarter ending June 30, 2006 and $1,001 for the same quarter last year. Pension costs for the nine months ending June 30, 2006 were $6,181 compared with $3,028 for the equivalent period last year. The net periodic costs include the following components:

~~Wednesbury~~FOR ~~Boca~~THE ~~Raton~~THREE ~~Total~~MONTHS ~~England~~FOR ~~Florida~~THE NINE MONTHS ENDED ENDED ------------------------------- ------------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2006 2005 2006 2005 -------------- -------------- -------------- -------------- (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) ~~Sale~~(IN ~~proceeds~~THOUSANDS) ~~net~~Service ofcost ~~selling, professional and other costs~~ ......................~~....................~~ $~~5,174~~ 546 $~~3,427~~ 453 $8 1,~~601~~595 ~~Less:~~$ ~~net~~1,369 ~~book~~Interest ~~value~~cost ..................... 2,720 2,526 7,929 7,640 Expected return on plan assets .... (2,568) (2,656) (7,493) (8,034) Recognition of actuarial loss .....~~.....~~ 21,~~223~~423 3678 4,~~168~~150 52,~~391~~053 ------- ------- ------- ~~Gross~~------- ~~profit~~Total onBenefit ~~disposal~~cost ................~~...............~~ $ 2,~~951~~121 ~~259~~$ 31,~~210~~001 ~~Less: related reorganisation costs (see below) ......... 707 - 707 ------ ------ ------~~ $2 6,~~244~~181 $ ~~259 $2~~3,~~503~~028 ======= ======= ======= =======

10 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 6 - RETIREMENT BENEFIT PLAN - CONTINUED The Company's funding policy with respect to the Plan is to contribute annually not less than the minimum required by applicable UK law and pension regulations. Amounts payable are determined on the advice of the Plan's actuaries. The Company has contributed $766 to the Plan in the quarter to June 30, 2006 (2005 $4,436) and $2,595 in the nine month period ended on that date (2005 $5,892). The Company anticipates that contributions of $3.3 million will be made in the year ending September 30, 2006 (2005 $10.2 million of which $3.0 million was in respect of annual ongoing employer contributions and $7.2 million related to a one-off special contribution into the Plan). Accounting standards require a minimum pension liability be recorded when the value of pension assets is less than the accumulated benefit obligation ("ABO") at the annual measurement date. As of September 30, 2005, our most recent measurement date for pension accounting, the value of the ABO exceeded the market value of investments held by the pension plan by approximately $35.95 million. In accordance with accounting standards, the charge against stockholders' equity will be adjusted in the fourth quarter to reflect the value of pension assets compared to the ABO as of the end of September 2006. If the level of pension assets exceeds the ABO as of a future measurement date, the full charge against stockholders' equity would be reversed. NOTE 7 - PROPERTY, PLANT AND EQUIPMENT, NET

~~For~~AT ~~the~~JUNE ~~Three For the Three For the Six For the Six Months Ended Months Ended Months Ended Months Ended March 31~~30, ~~March~~AT ~~31,~~SEPTEMBER ~~March 31~~30, ~~March~~2006 ~~31,~~ 2005 ~~2004 2005 2004~~ -------------- -------------- --~~------------~~ ~~--------------~~ (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) ~~(in~~Assets ~~thousands)~~held ~~(in~~and ~~thousands)~~used: ~~Current~~Land ~~tax~~and ~~(charge)/credit~~buildings, at cost ..................... $ ~~(51)~~16,646 $ 515,799 $Machinery, ~~(99)~~equipment $and ~~(62)~~vehicles, ~~Deferred~~at ~~tax~~cost ~~charge~~...... 31,860 35,331 Furniture and fixtures, at cost ................. 1,239 1,256 Computer hardware, at cost ...................... ~~(440)~~1,445 ~~(361)~~1,244 ~~(349)~~Computer software, at cost ...................... 318 342 Assets held under finance leases, at cost ....... (~~470~~a) 2,271 2,883 -------- -------- 53,779 56,855 Accumulated Depreciation ........................ (36,105) (39,287) -------- -------- ~~$(491)~~Net ~~$(356)~~...................................... $~~(448)~~ 17,674 $~~(532)~~ 17,568 ===== ===== ===== =====

(a) Included in property, plant and equipment at June 30, 2006 are capital leases with a net book value of $0.8 million (September 30, 2005 $0.9 million). The cost of these assets held under capital leases was $2.3 million (September 30, 2005 $2.9 million) and the accumulated depreciation relating to these assets was $1.5 million (September 30, 2005 $2.0 million). NOTE 8 - INVENTORIES

~~For~~AT ~~the~~JUNE ~~Three For the Three For the Six For the Six Months Ended Months Ended Months Ended Months Ended March 31~~30, ~~March~~AT ~~31,~~SEPTEMBER ~~March 31~~30, ~~March~~2006 ~~31,~~ 2005 ~~2004 2005 2004~~ -------------- -------------- ~~-------------- --------------~~ (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) ~~(in~~Finished ~~thousands)~~products ~~(in thousands) Tax at US federal statutory income tax rate $(1,290) $(101) $(1,048) $(373) Overseas tax at rates different to effective rate~~ .............................................. ~~165~~$ ~~(26)~~18,799 ~~122~~$ 8719,740 ~~Permanent~~In-process ~~differences~~products ..................... ~~(40) (36) (79) (75) Gain on sale of UK property covered by capital losses brought forward~~ ....................... ~~885~~4,577 -6,481 ~~885~~Raw -materials ~~Valuation allowance~~ ....................... ~~(211) (191) (328) (171) Miscellaneous~~ ........................... 5,671 5,320 Less: allowance for slow moving and obsolete inventories .... -(5,058) (26,542) - - ------- ----- ---~~----~~ ~~-----~~ $ ~~(491)~~23,989 $~~(356)~~ $24,999 ~~(448) $(532)~~ ======= =~~====~~ ======= =~~====~~

11 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 9 - UNUSUAL OR INFREQUENT ITEMS (a) GAIN ON SALE OF LAND AND BUILDINGS NET OF REORGANIZATION COSTS On January 28, 2005 the Company completed the sale of part of its industrial site at St. Paul's Road, Wednesbury, England, and on February 15, 2005 the Company also concluded the disposal of its warehouse and office facility in Boca Raton, Florida. Details of these sales are as follows:

~~For~~WEDNESBURY ~~the~~BOCA ~~Three~~RATON ~~For~~ENGLAND ~~the~~FLORIDA ~~Three~~TOTAL ~~For the Six For the Six Months Ended Months Ended Months Ended Months Ended March 31, March 31, March 31, March 31, 2005 2004 2005 2004~~ -------------- -------------- -------------- ~~--------------~~ (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) (inIN ~~thousands~~THOUSANDS) ~~(in~~Sale ~~thousands)~~proceeds ~~Total~~ net ~~income~~of ~~(loss)~~selling, professional and other costs ............................................ $5,174 $3,~~194~~427 $ ~~(68) $ 2~~8,~~546~~601 $Less: ~~213~~net ~~Other~~book ~~comprehensive~~value ~~income (loss) Additional minimum pension liability~~ .... ~~658 (758) (1,929) (3,133) Foreign currency translation adjustments (1,389) (1,183) 3,277 5,996 Unrealized gains on derivative instruments~~ ................................ 162,223 113,168 575,391 11 ------- ------- ------- ~~-------~~Gross ~~Total~~profit ~~comprehensive~~on ~~income~~disposal ................................ $ 2,~~479~~951 $259 ~~368~~3,210 $Less: 3related reorganization costs (see below)........... 707 - 707 ------ ------ ------ $2,~~951~~244 $ 3259 $2,~~087~~503 ======= ======= ======~~= =======~~

Following the sale of the surplus element of the Wednesbury facility, provision was made for costs to be incurred in connection with the consolidation of the current manufacturing operation into the smaller site. These costs principally comprised office and factory refurbishment, factory reorganization and departmental relocations within the site. (b) MANUFACTURING REORGANIZATION COSTS On January 25, 2006, the Company announced the closure of the remaining element of its manufacturing site at Wednesbury, England. All warehouse and distribution operations currently performed at this location will be transferred to the Company's principal UK manufacturing site in Sheffield. The manufacturing and assembly functions formally carried out at this site will now be out sourced to suppliers based outside the UK. The closure and relocation of the Wednesbury facility are to be completed by November 30, 2006 and the costs of this exercise are anticipated to be approximately $2.1 million. These costs include employee severance payments, site closure expenses, factory reorganization expenses, plant transfer costs and associated capital expenditure. In addition to the above, the Company announced in the current quarter that certain manufacturing operations carried out at its Atlas site in Sheffield ("Atlas") will also cease. Provision for employee severance costs in respect of the closure of these manufacturing operations has been made in the quarter ended June 30, 2006. As discussed, below, in footnote 14, "Subsequent Events", on July 27, 2006, Spear & Jackson, Inc.'s UK subsidiary, Spear & Jackson Garden Products Limited, completed the sale of the remaining element of the Wednesbury site for (pound)2.6 million sterling (approximately $4.7 million), excluding disposal costs, which will result in a gain on disposal of approximately $3.5 million.. Funds realized from the disposal are to be used to finance the closure costs with any excess sale proceeds being reinvested in other operational initiatives. The Wednesbury site closure and the production rationalization a Atlas form part of the Company's UK manufacturing reorganization program which has been initiated to regenerate and modernize key areas of the hand and garden tools business. The closures will enable the Company to consolidate its two UK hand and garden tool manufacturing sites and will allow the Company to develop a modern manufacturing, warehouse and distribution facility which will be well placed to meet the current and future needs of its customers. 12 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 9 - UNUSUAL OR INFREQUENT ITEMS - CONTINUED As explained above, a surplus element of the Wednesbury site was sold in 2005 and provision was made at March 31, 2005 for various site reorganization costs that were to be incurred as a result of that partial sale. Certain of these costs will not now be incurred following the decision to close the remainder of the site and market the property for resale and such excess provisions have been released in the prior quarter. Costs provided in respect of the Wednesbury closure and the Atlas reorganization as at June 30, 2006 and amounts credited in respect of the release of excess provisions from prior periods are as follows:

~~Sales~~THREE ~~Long-lived~~MONTHS ~~Assets~~NINE ~~(a)~~MONTHS ~~Sales~~ENDED ~~Long-lived~~ENDED ~~Assets~~JUNE ~~(a) ----------------------- --------------------- ----------------------- --------------------- Three Months Ended Six Months Ended March 31~~30, ~~March~~2006 ~~31,~~JUNE ~~March 31~~30, ~~March~~2006 ~~31, March 31, March 31, March 31, March 31, 2005 2004 2005 2004 2005 2004 2005 2004~~ --------- -----~~----~~ --------- -----~~----~~ ~~---------~~(IN ~~---------~~THOUSANDS) ~~---------~~(IN ~~---------~~THOUSANDS) ~~Hand~~Severance &costs ~~garden~~......................................... ~~tools~~ $ ~~20,891~~351 $ 211,~~033~~536 $Fixed ~~6,633~~asset $impairments ~~10,005~~................................. $ ~~39,315~~145 $ ~~38,151~~145 $Site ~~6,633~~closure $costs ~~10,005~~...................................... ~~Metrology~~96 ~~tools~~463 ~~4,383 4,104 2,601 2,932 8,400 7,687 2,601 2,932 Magnetic products 2,927 2,290 737 984 5,593 4,571 737 984 Corporate~~ - ~~10,123 13,298~~ - ~~10,123 13,298~~ -----~~----~~ --------- ~~---------~~592 ~~--------- --------- --------- --------- --------- Total $ 28~~2,~~201~~144 $Release ~~27,427~~of $excess ~~20,094~~provisions $accrued ~~27,219~~in $prior ~~53,308~~periods.... ~~$ 50,409 $ 20,094 $ 27,219 ========= ========= ========= ========= ========= ========= ========= ========= Depreciation Capital expenditure Depreciation Capital expenditure~~ -~~----------------------~~ --------------------- ----------------------- --------------------- Three Months Ended Three Months Ended Six Months Ended Six Months Ended March 31, March 31, March 31, March 31, March 31, March 31, March 31, March 31, 2005 2004 2005 2004 2005 2004 2005 2004 --------- --------- --------- --------- --------- --------- --------- --------- Hand & garden tools $ 483 $ 564 $ 294 $ 142 $ 945 $ 999 $ 572 $ 3,418 Metrology tools 172 121 10 16 285 220 66 161 Magnetic products 88 95 - 23 172 171 4 25 Corporate 63 47 - 3,232 121 118 - 3,234 --------- --------- --------- --------- --------- --------- --------- --------- Total $ 806 $ 827 $ 304 $ 3,413 $ 1,523 $ 1,508 $ 642 $ 6,838 ========= ========= ========= ========= ========= ========= ========= ========= Operating Income (Loss) Net Interest Operating Income (Loss) Net Interest ----------------------- --------------------- ----------------------- --------------------- Three Months Ended Three Months Ended Six Months Ended Six Months Ended March 31, March 31, March 31, March 31, March 31, March 31, March 31, March 31, 2005 2004 2005 2004 2005 2004 2005 2004 --------- --------- --------- --------- --------- --------- --------- --------- Hand & garden tools $ 850 $ 408 $ (58) $ (63) $ 153 $ 711 $ (103) $ (123) Metrology tools 311 351 (4) (5) 603 640 (7) (9) Magnetic products 318 270 (2) (3) 541 543 (5) (6) Corporate (324) ~~(724) 52 8 (844) (1,090) 74 (3)~~ --------- --------- ~~---------~~Net ~~---------~~reorganization ~~---------~~costs................................. ~~---------~~592 ~~--------- --------- Total $~~ 1,~~155~~820 ~~$ 305 $ (12) $ (63) $ 453 $ 804 $ (41) $ (141)~~ ========= =======~~== ========= ========= ========= ========= ========= ========= (a) Represents property, plant and equipment, net.~~

In addition to the net Wednesbury and Atlas reorganization costs of $1.8 million charged at June 30, 2006 it is anticipated that a further $0.1 million will be incurred in respect of the Wednesbury site closure on or before November 30, 2006 for which provision will be made in accordance with applicable financial reporting standards as and when liabilities for such charges crystallize. (c) SUMMARY OF PROVISIONS IN RESPECT OF THE UK MANUFACTURING AND REORGANIZATION PROGRAM As explained in footnote 4 (b) of the Company's consolidated financial statements included within the Company's Form 10-K for the year ended September 30, 2005, provisions totaling $1.7 million were set up in respect of a UK manufacturing reorganization program that was initiated during the course of that year. The provisions comprised the following: (i) As a result of the sale of the surplus element of the Company's manufacturing site at Wednesbury, England, the Company became contractually obliged to vacate office and warehouse facilities located on those parts of the site that had been sold. A provision of $0.5 million was made for costs in connection with this obligation. The provision principally related to office and factory refurbishment and reorganization expenses together with expenditure in respect of departmental relocations within the remainder of the site. Following the sale, elements of the Wednesbury manufacturing operation were closed or transferred and costs in connection with these initiatives are dealt with in (ii) and (iii) below. In the final quarter of the year ended September 30, 2005 the Company performed a review of its UK manufacturing operations and began implementation of a number of strategies to reduce its ongoing cost base. Costs provided in connection with the implementation of these initiatives relate to: (ii) $0.4 million of severance costs relating to the closure and down scaling of certain manufacturing processes at the Company's Sheffield and Wednesbury locations in the UK. (iii) $0.8million of impairment write-downs in respect of the plant and machinery involved in the restructured operations. 13 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 9 - UNUSUAL OR INFREQUENT ITEMS - CONTINUED As discussed in (b), above, $1.8 million was also provided in respect of the Wednesbury site closure and Atlas manufacturing reorganization at June 30, 2006. The Company also has a further provision of $1.8 million in respect of other UK manufacturing reorganization and relocation costs that was set up in periods prior to the year ended September 30, 2005. In the period ended June 30, 2006, $0.5 million has been spent in respect of employee severance costs and other reorganization expenses for which provision was made at September 30, 2005 and as noted above, additional provisions of $0.6 million have been made in the period relating to the closure of the Wednesbury site and the reorganization of the production facilities at Atlas. The following are summaries of the movements in the quarter and the nine months ended June 30, 2006. The movements in the liability balance showing the utilization and other changes to the provisions referred to above that have occurred between April 1, 2006 and June 30, 2006 are as follows:

~~Sales~~AT ~~(a)~~APRIL ~~Long-lived~~1, ~~Assets~~EXCHANGE ~~(b)~~AMOUNTS ~~Sales~~AMOUNTS ~~(a)~~AT ~~Long-lived~~JUNE ~~Assets~~30, ~~(b)~~2006 ~~-----------------------~~MOVEMENTS ~~---------------------~~PROVIDED ~~-----------------------~~PAID/UTILIZED 2006 --------------~~-------~~ ~~Three Months Ended Six Months Ended March 31, March 31, March 31, March 31, March 31, March 31, March 31, March 31, 2005 2004 2005 2004 2005 2004 2005 2004~~ --------- -----~~----~~ --------- ----~~-----~~ --------- ------~~---~~ --------- -----~~----~~ ~~United~~(IN ~~Kingdom~~THOUSANDS) $(IN ~~11,971~~THOUSANDS) $(IN ~~12,507~~THOUSANDS) $(IN ~~18,145~~THOUSANDS) $(IN ~~22,221~~THOUSANDS) $(a) ~~22,621~~Included $in ~~22,532~~Accrued $Expenses ~~18,145~~and $Other ~~22,221~~Liabilities: ~~Europe~~Other ~~7,035~~UK ~~6,234~~reorganization ~~1,272~~costs...................... 1,~~255~~655 ~~11,760~~109 ~~10,292~~- ~~1,272~~- 1,~~255~~764 ~~Australasia~~Wednesbury ~~3,404~~/ ~~3,927~~Atlas ~~677~~costs... ~~520 7~~1,~~402~~454 ~~8,746~~53 ~~677~~465 ~~520~~(298) ~~North America~~ 1,~~898~~674 ~~1,740~~Settlement -of ~~3,223~~class ~~3,519~~litigation................. ~~3,177~~ - ~~3,223 Other 3,893 3,019~~ - -650 ~~8,006 5,662~~ - -650 --------- --------- --------- --------- --------- ~~--------- --------- --------- Total~~ $ 283,~~201~~109 $ ~~27,427~~162 $ 201,~~094~~115 $ ~~27,219~~(298) $ 534,~~308~~088 ~~$ 50,409 $ 20,094 $ 27,219~~ ========= ========= ========= ========= ========= ~~=========~~(b) ~~=========~~Included ~~=========~~in Depreciation Capital expenditure Depreciation Capital expenditure ----------------------- --------------------- ----------------------- --------------------- Three Months Ended Three Months Ended Six Months Ended Six Months Ended March 31Property, ~~March~~Plant ~~31,~~and ~~March~~Equipment: ~~31,~~Asset ~~March~~impairments.......... ~~31, March 31, March 31, March 31, March 31, 2005 2004 2005 2004 2005 2004 2005 2004 --------- --------- --------- --------- --------- --------- --------- --------- United Kingdom~~ $ ~~707~~787 $ ~~699~~53 $ ~~269~~127 $ ~~159~~(68) $ ~~1,335~~899 $ 1,297 $ 368 $ 3,570 Europe 32 36 20 3 56 46 40 3 Australasia 67 76 15 19 132 147 234 31 North America - 16 - 3,232 - 18 - 3,234 --------- --------- --------- --------- --------- --------- --------- --------- Total $ 806 $ 827 $ 304 $ 3,413 $ 1,523 $ 1,508 $ 642 $ 6,838 ========= ========= ========= ========= ========= ~~=========~~Total...................... ~~=========~~$ ========= Operating Income (Loss) Net Interest Operating Income (Loss) Net Interest ----------------------- --------------------- ----------------------- --------------------- Three Months Ended Three Months Ended Six Months Ended Six Months Ended March 313,896 March 31, March 31, March 31, March 31, March 31, March 31, March 31, 2005 2004 2005 2004 2005 2004 2005 2004 --------- --------- --------- --------- --------- --------- --------- --------- United Kingdom $ ~~830~~215 $ ~~587 $ 26 $ (27) $ 506 $~~ 1,~~172~~242 $ ~~17 $~~ (75366) Europe 478 332 (61) (52) 355 197 (102) (99) Australasia 47 (217) 11 8 117 (70) 29 15 North America (200) (397) 12 8 (525) (495) 15 18 --------- --------- --------- --------- --------- --------- --------- --------- Total $ 14,~~155~~987 ~~$ 305 $ (12) $ (63) $ 453 $ 804 $ (41) $ (141)~~ ========= ========= ========= ========= =======~~== ========= ========= ========= (a) Sales are attributed to geographic areas based on the location of the customers. (b) Represents property, plant and equipment, net.~~

The movements in the liability balance between October 1, 2005 and June 30, 2006 are as follows:

~~Contractual~~AT ~~obligation~~OCTOBER ~~Total~~1, ~~Payments~~EXCHANGE ~~due~~AMOUNTS byAMOUNTS ~~period~~AT ~~($m)~~JUNE ~~Amount~~30, 12005 ~~year~~MOVEMENTS 1PROVIDED PAID/UTILIZED 2006 -3------------- 4-5------------- 5-------------- ~~years~~-------------- ~~Committed~~-------------- or(IN ~~less~~THOUSANDS) ~~years~~(IN ~~years~~THOUSANDS) or(IN ~~more~~THOUSANDS) ~~Capital~~(IN ~~lease~~THOUSANDS) ~~obligations~~(IN 1THOUSANDS) (a) Included in Accrued Expenses and Other Liabilities: Wednesbury move costs........ $ 444 $ (4) 0$ (324) $ (116) $ - Employee severance costs..... 402 (8) 0.6 -(394) - ~~Operating~~Other ~~leases~~UK ~~(note~~reorganization a)costs 7.~~1 0~~.9..................... 1.8,687 77 - - 1,764 Wednesbury / Atlas costs .7... - (6) 2,017 (337) 1,674 Settlement of class litigation.7................. - - 650 - 650 --- ---- --- ---- ~~8.5 1.7 2.4 1.7 2.7~~ --- ---- --- ---- ------- $ 2,533 $ 59 $ 2,343 $ (847) $ 4,088 ======= ======= ======= ======= ======= (b) Included in Property, Plant and Equipment: Asset impairments............ $ 803 $ 37 $ 127 $ (68) $ 899 ======= ======= ======= ======= ======= Total........................ $ 3,336 $ 96 $ 2,470 $ (915) $ 4,987 ======= ======= ======= ======= =======

14 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 9 - UNUSUAL OR INFREQUENT ITEMS - CONTINUED (c) SETTLEMENT OF CLASS ACTION LITIGATION As further explained, below, in footnote 13, "Legal Proceedings", on July 7, 2006, Spear & Jackson, Inc. entered into a Memorandum of Understanding whereby it agreed to pay $650,000 in settlement of the class action litigation, referred to in that note, in which it is a defendant. Provision has accordingly been made in the financial statements for the period ended June 30, 2006 for the payment of that sum. NOTE 10 - INCOME TAXES Spear & Jackson is subject to income taxes in the US and in the other overseas tax jurisdictions where its principal trading subsidiaries operate. The (provision)/ benefit for US and foreign income taxes arising on continuing operations consists of:

A reconciliation of the net benefit for income taxes compared with the amounts arising at the US federal rate is as follows:

The Company follows the provisions of SFAS No. 109, "Accounting for Income Taxes", which requires the Company to recognize deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns using the liability method. Under this method, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted rates in effect in the years in which the differences are expected to reverse. Deferred income tax expense or benefit is based on the changes in the asset or liability from period to period. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company reviews the recoverability of its deferred tax assets and, based on such periodic reviews, the Company could recognize a change in the valuation allowance relating to its deferred tax assets in the future should, for example, estimates of forecast taxable income be reduced or other favorable or adverse events occur. 15 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 10 - INCOME TAXES - CONTINUED In the quarter ended June 30, 2006, the income tax benefit relating to the Company's U.S. and non-U.S. subsidiary losses has been offset by a valuation allowance based upon an assessment by management of the Company's ability to realize such benefits. In assessing the Company's ability to realize its deferred tax assets, management considered the scheduled reversal of deferred tax liabilities, projected future taxable income and tax and other strategic planning initiatives. Future reversal of the valuation allowance will be achieved either when the tax benefit is realized or when it has been determined that it is more likely than not that the benefit will be realized through offset against future taxable income. NOTE 11 - COMPREHENSIVE INCOME Comprehensive income represents net income and other revenues, expenses, gains and losses that are excluded from net income and recognized directly as a component of stockholder's equity. Comprehensive income and its components comprise the following:

NOTE 12 - SEGMENT DATA The Company's principal operations relate to the manufacture and distribution of a broad line of hand tools, lawn and garden tools, industrial magnets and metrology tools. These operations are conducted through business divisions located primarily in the United Kingdom, France, the Netherlands, USA and Australasia. Given below are summaries of the significant accounts and balances by business segment and by geographical location, reconciled to the consolidated totals. In both periods, transactions and balances applicable to the Company's distribution companies in France, Australia and New Zealand have been aggregated with the hand and garden product businesses since these products represent the most significant proportion of the distribution companies' trades. Those transactions relating to the Company's distribution entities in the Netherlands and China have been included in the Metrology division disclosures. The summaries also provide an analysis of the accounts and balances between continuing and discontinued operations. The financial information of the segments is regularly evaluated by the corporate operating executives in determining resource allocation and assessing performance and is reviewed by the Company's Board of Directors. The Company's senior management evaluates the performance of each business segment based on its operating results and, other than general corporate expenses, allocates specific corporate overhead to each segment. Accounting policies for the segments are the same as those for the Company. The following is a summary of the significant accounts and balances (in thousands) by business segment, reconciled to the consolidated totals. 16 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES)

(a) Represents property, plant and equipment, net. 17 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) The following table presents certain data by geographic areas (in thousands):

(a) Sales are attributed to geographic areas based on the location of the customers. (b) Represents property, plant and equipment, net. 18 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 13 - LEGAL PROCEEDINGS On April 15, 2004, the US Securities and Exchange Commission filed suit in the U.S. District Court for the Southern District of Florida against the Company and Mr. Dennis Crowley, its then current Chief Executive Officer/Chairman, among others, alleging violations of the federal securities laws. Specifically with regard to the Company, the SEC alleged that the Company violated the SEC's registration, anti-fraud and reporting provisions. These allegations arise from the alleged failure of Mr. Crowley to accurately report his ownership of the Company's stock, and his alleged manipulation of the price of the Company's stock through dissemination of false information, allowing him to profit from sales of stock through nominee accounts. On May 10, 2004, the Company consented to the entry of a preliminary injunction, without admitting or denying the allegations of the SEC complaint. The SEC is continuing its investigation into pension issues. The Company is offering its full cooperation. As a further measure, the Court appointed a Corporate Monitor to oversee the Company's operations. In addition to Mr. Crowley consenting to a preliminary injunction the Court's order also temporarily barred Mr. Crowley from service as an officer or director of a public company, and prohibited him from voting or disposing of Company stock. Following Mr. Crowley's suspension the Board appointed Mr. J.R. Harrington, a member of its Board of Directors, to serve as the Company's interim Chairman. Mr. William Fletcher, a fellow member of the Company's Board of Directors, who, until October 27, 2004, was the Company's Chief Financial Officer, and who is a director of Spear & Jackson plc, based in Sheffield, is serving as acting Chief Executive Officer. Following extensive settlement negotiations with both the SEC and Mr. Crowley, the Company reached a resolution with both parties. On September 28, 2004, Mr. Crowley signed a Consent to Final Judgment of Permanent Judgment with the SEC, without admitting or denying the allegations included in the complaint, which required a disgorgement and payment of civil penalties by Mr. Crowley consisting of a disgorgement payment of $3,765,777 plus prejudgment interest in the amount of $304,014, as well as payment of a civil penalty in the amount of $2,000,000. In May 2005, the SEC applied to the Court for the appointment of an administrator for the distribution of these funds to the victims of Mr. Crowley's actions, pursuant to the Fair Funds provisions of the Sarbanes-Oxley Act of 2002. On November 18, 2004, the Company signed a Consent to Final Judgment of Permanent Injunction with the SEC pursuant to which the Company, without admitting or denying the allegations included in the Complaint filed by the Commission, consented to a permanent injunction from violation of various sections and rules under the Securities Act of 1933 and the Securities Exchange Act of 1934. Additionally, the Company entered into a Stock Purchase Agreement with PNC Tool Holdings LLC ("PNC") and Mr. Crowley, the sole member of PNC. Under the Stock Purchase Agreement, the Company acquired, for $100, and other good and valuable consideration, 6,005,561 common shares of the Company held by PNC, which represented approximately 51.1% of the outstanding common shares of the Company at December 31, 2004, and which constituted 100% of the common stock held by such entity. The parties also executed general releases in favor of each other subject to the fulfillment of the conditions of the Stock Purchase Agreement. The Stock Purchase Agreement was effected on April 8, 2005, following formal approval by the SEC on February 10, 2005 and, on February 15, 2005 by the U.S. District Court for the Southern District of Florida of the settlement of the litigation captioned SEC v. Dennis Crowley, Spear & Jackson, Inc., International Media Solutions, Inc., Yolanda Velazquez and Kermit Silva (Case No: 04-80354-civ-Middlebrooks). The Stock Purchase Agreement was further conditioned on, among other things, the disgorgement and civil penalty funds being paid by Mr. Crowley. These monies have now been received and are being administered for the benefit of the victims of the alleged fraud by a court appointed administrator pursuant to the fair funds provision of the Sarbanes-Oxley Act of 2002. With the return of the Spear & Jackson shares to the Company by PNC, the stockholders of the Company have had their percentage stock interest increase correspondingly. Jacuzzi Brands, Inc. ("Jacuzzi"), which is a beneficial owner of 3,543,281 shares of common stock, has had its interest in the Company increase to approximately 61.8% of the outstanding common stock. 19 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 13 - LEGAL PROCEEDINGS - CONTINUED Subsequent to the SEC action a number of class action lawsuits were initiated in the U.S. District Court for the Southern District of Florida by Company stockholders against the Company, Sherb & Co. LLP, the Company's former independent auditor, and certain of the Company's directors and officers, including Mr. Crowley, the Company's former Chief Executive Officer/Chairman, and Mr. Fletcher, the Company's former CFO and current acting Chief Executive Officer. These suits allege essentially the same claims as the SEC suit discussed above. These various class action suits were subsequently consolidated. Thereafter, the defendants filed certain Motions to Dismiss with regard to the Complaint and on October 19, 2005, the U.S. District Court for the Southern District of Florida in Re Spear & Jackson Securities Litigation entered its Order regarding these Motions. The Order denied the Company's motion as well as that of Mr. Crowley, the former Chief Executive Officer of Spear & Jackson. The Company is in the process of preparing its answer and defenses to the Complaint. The Court granted the Motion to Dismiss on behalf of Mr. Fletcher, the Company's interim Chief Executive Officer, and also granted the Motion to Dismiss on behalf of the Company's former independent auditor, Sherb & Co., LLP. The class plaintiff has since filed an appeal regarding the trial court's decision to dismiss the case against Sherb & Co., LLP, which appeal is presently pending. No appeal was filed with respect to the decision to dismiss the case against Mr. Fletcher. The Court denied the motion of Spear & Jackson's Monitor to abate the litigation for a six-month period pending the administration of the SEC's restitution fund. The Court also denied the Plaintiff's Motion for Clarification and established a new cut-off for discovery until December 19, 2005. The case was initially set on the Court's two-week calendar beginning March 6, 2006 but the trial date has since been reset for October 2006. On July 7, 2006 the US District Court for the Southern District of Florida issued a Memorandum of Understanding ("MOU") which confirmed that the plaintiffs and defendants in the class action had reached an agreement in principle for the settlement of this litigation, subject to Court approval. The MOU outlines the general terms of the settlement ("the Settlement") and is intended to be supplemented by a Stipulation and Agreement of Settlement that is to be issued at a later date. In settlement of the class action the defendants will pay a sum of $650,000 which is to be deposited by S&J into a Qualified Settlement Fund within thirty days of the date of the MOU. Following the execution of the MOU, the lead plaintiffs will commence discovery procedures to confirm the fairness and reasonableness of the Settlement. The plaintiffs retain the right to terminate the Settlement if such discovery reveals that the Settlement is not fair, reasonable and adequate. Subject to these discovery procedures confirming the adequacy of the Settlement, all parties have agreed to use their best efforts to finalize an appropriate Stipulation of Settlement and any other relevant documentation necessary to obtain approval by the Court of the settlement of this action. If the Settlement outlined in the MOU is not approved by the Court or, if subsequently terminated, the terms of the above Settlement will be without prejudice, any settlement amounts already paid will be returned and parties will revert to their litigation positions immediately prior to the MOU. On September 6, 2005, the Company was served with a Shareholder Derivative Complaint filed on June 1, 2004 in the Circuit Court for Palm Beach County, Florida (Case No. CA005068). The suit names, in addition to the Company, which is a nominal defendant, present and former directors and the Company's prior independent auditors, Sherb & Co. LLP., as defendants. The suit contains essentially the same factual allegations as the SEC suit, which was filed in April 2004 in the U. S. District Court for the Southern District of Florida, and the series of class actions claims initiated in the U.S. District Court, but alleges state law claims of breaches of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and lack of reasonable care by various or all the defendants. The Company will evaluate the Complaint and file its response at the appropriate time. In addition, the Company is currently in settlement discussions in an effort to resolve the matter. 20 SPEAR & JACKSON, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS EXCEPT SHARES) NOTE 13 - LEGAL PROCEEDINGS - CONTINUED Additionally, the Company is, from time to time, subject to legal proceedings and claims arising from the conduct of its business operations, including litigation related to personal injury claims, customer contract matters, employment claims and environmental matters. While it is impossible to ascertain the ultimate legal and financial liability with respect to contingent liabilities including lawsuits, the Company believes that the aggregate amount of such liabilities, if any, in excess of amounts accrued or covered by insurance, will not have a material adverse effect on the consolidated financial position or results of operations of the Company. With effect from September 30, 2003 the Company exited its screwdriver operations following the disposition of the trade and assets of Mega Tools Ltd and Mega Tools USA, Inc. The disposition of the screwdriver division was undertaken by Neil Morgan who was then heading up the division. The Company believes that no specific authorization was afforded to Mr. Morgan to undertake that disposition and, following review of the terms and circumstances of the purported sale, it is the intention of the Company to pursue claims against Mr. Morgan and the transferee. NOTE 14 - SUBSEQUENT EVENTS On July 27, 2006, Spear & Jackson, Inc.'s UK subsidiary, Spear & Jackson Garden Products Limited, completed the sale of the remaining element of its industrial site at St. Paul's Road, Wednesbury, England, for a price of (pound)2.6 million sterling (approximately $4.7 million), excluding disposal costs. On the same date Spear & Jackson Garden Products Limited entered into a lease agreement with the new owners of the Wednesbury property to rent, for a nominal peppercorn value, the premises until November 30, 2006, by which date the company is now required to vacate the site. The gain arising on the sale of the premises will amount to approximately $3.5 million. On July 28, 2006, the company's majority 61.8% shareholder, Jacuzzi Brands, Inc, completed the sale of its holding of 3,543,281 shares of the common stock of Spear & Jackson, Inc. to United Pacific Industries Limited, a Bermuda corporation. 21 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General ------- The following information should be read in conjunction with the consolidated financial statements and notes thereto and other information set forth in this report. Forward Looking Statements -------------------------- This report (including the information in this discussion) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties, including statements regarding the Company's capital needs, business strategy and expectations, and are being made pursuant to the safe harbor provisions and the Private Securities Litigation Reform Act of 1995. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. Terminology such as "may", "will", "should", "believes", "estimates", "plans", "expects", "attempts", "intends", "anticipates", "could", "potential" or "continue", the negative of such terms, or other comparable terminology, are intended to identify forward-looking statements. Risk Factors ------------ Historically, Spear & Jackson, Inc. ("Spear & Jackson", "the Company", "we") has achieved growth by the development of new products, strategic acquisitions and expansion of the Company's sales organization. There can be no assurance that Spear & Jackson, Inc. will be able to continue to develop new products, effect corporate acquisitions, or expand sales to sustain rates of revenue growth and profitability in future periods. Any future success that the Company may achieve will depend upon many factors including factors that may be beyond the control of the Company or which cannot be predicted at this time. Although we believe that our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations, actual results may differ materially from our expectations. Uncertainties and factors that could cause actual results or events to differ materially from those set forth or implied include: THE COMPANY IS SUBJECT TO A NUMBER OF SIGNIFICANT RISKS THAT MIGHT CAUSE THE COMPANY'S ACTUAL SALES TO VARY MATERIALLY FROM ITS FORECASTS, TARGETS, OR PROJECTIONS, INCLUDING: o achieving planned revenue and profit growth in each of the Company's business units; o changes in customer requirements and in the volume of sales to principal customers; o renewal of material contracts in the Company's business units consistent with past experience; o the timing of orders and shipments; o emergence of new competitors or consolidation of existing competitors; o continued absence of consolidation among key customers; o Industry demand fluctuations. 22 Our expectations for both short- and long-term future net revenues are based on our own estimates of future demand. Orders from our principal customers are ultimately based on demand from end-users and such prospective end-user demand can be difficult to measure. Low end-user demand, would negatively affect orders we receive from distributors and other principal customers and this would mean that our revenues in any fiscal period could be adversely impacted. If our estimates of sales are not accurate and we experience unforeseen variability in our revenues and operating results, we may be unable to adjust our expense levels accordingly and our profit margins will be adversely affected. A number of our products are sold through distributors and large retailers. No assurances can be given that any or all such distributors or retailers will continue their relationship with us. Distributors and other significant retail customers cannot easily be replaced and the loss of revenues and our inability to reduce expenses to compensate for the loss of revenues could adversely affect our net revenues and profit margins. With the growing trend toward retail trade consolidation, especially in the developed US, European and Australasian markets, certain of our product groups are sold to key retailers whose bargaining strength is growing. Accordingly, we face greater pressure from such significant retail trade customers to provide more favorable trade terms with, accordingly, the risk of margin dilution. We can also be negatively affected by changes in the policies of our material retail trade customers, particularly with regard to the reduction of trade inventory levels, access to shelf space, and other conditions. The market for certain of the Company's products is subject to economic conditions affecting the industrial manufacturing sector, including the level of capital spending by industrial companies and the general movement of manufacturing to low cost foreign countries where the Company may not have a competitive market presence. Accordingly, economic weakness in the industrial manufacturing sector may result in decreased demand for certain of the Company's products, which will impact negatively on the Company's trading performance. Economic weakness in the consumer market will also have a detrimental effect on the Company's profitability. In the event that demand for any of the Company's products declines significantly, the Company could be required to recognize certain costs as well as asset impairment charges on long-lived assets related to those products. RISKS ASSOCIATED WITH THE SUCCESSFUL AND TIMELY INTEGRATION OF ANY SIGNIFICANT BUSINESSES ACQUIRED BY THE COMPANY AND REALIZATION OF ANTICIPATED SYNERGIES: The Company has made, and in the future may make, acquisitions of, or significant investments in, businesses with complementary or aligned products and services or in new start up businesses. Acquisitions involve numerous risks, including but not limited to: (1) diversion of management's attention from other operational matters; (2) inability to complete acquisitions along anticipated timescales, or at all; (3) lack of success in realizing anticipated synergies from acquisitions and investments (4) weaknesses in acquired company's internal controls; (5) worse-than-expected performance of the acquired company or its product offerings; (6) unknown, underestimated and/or undisclosed commitments or liabilities; (7) failure to integrate and retain key employees; and (8) unsuccessful integration of operations. The Company's inability to effectively manage these risks could materially and adversely affect the Company's business, financial condition and results of operations. RISKS CONCERNING THE CONTINUING AVAILABILITY OF APPROPRIATE RAW MATERIALS AND FACTORED PRODUCTS: The Company's business units source raw materials, component parts and factored goods from a wide range of domestic and foreign suppliers. If the business units experience difficulties in obtaining sufficient supplies of such items as a result of component prices becoming unreasonable, interruptions in supply due to natural disaster, economic or political difficulties, changes in regulatory requirements and tariffs, quarantines or other restrictions, the Company would experience resultant delays in the shipping of its products to customers which would have a negative impact on our revenues. 23 RISKS CONCERNING THE MAINTAINING AND IMPROVEMENT OF CURRENT PRODUCT MIX: If we fail to appropriately manage our cost structure to reallocate resources to areas that will provide the best long-term benefits to our customers and shareholders, our reporting results will be adversely affected. For instance, we may experience unfavorable shifts in product mix or reductions in demand for a product that limits our ability to spread manufacturing costs over higher sales volume. RISKS RELATING TO INCREASING PRICE, PRODUCTS AND SERVICES COMPETITION: The markets for our products are characterized by intense competition and pricing pressures. We compete with businesses having substantially greater financial, research and development, manufacturing, marketing, and other resources. If we are not able to continually design, manufacture, and successfully introduce new or enhanced products or services that are comparable or superior to those provided by our competitors and at comparable or better prices, we could experience pricing pressures and reduced sales, profit margins, profits, and market share, each of which could have a materially adverse effect on the Company's sales and margins. RISKS IN CONNECTION WITH CHANGES IN COMPANY INVENTORY LEVELS: Our inventory is subject to risks of changes in market demand for particular products. Our inability to obtain critical parts and supplies or any resulting excess and/or obsolete inventory could have an adverse impact on our results of operations. RISKS CONCERNING THE TIMELY IMPLEMENTATION OF THE COMPANY'S RESTRUCTURING PROGRAMS AND FINANCIAL PLANS: The Company continues to evaluate plans to consolidate and reorganize some of its manufacturing and distribution operations. There can be no assurance that the Company will be successful in these efforts or that any consolidation or reorganization will result in revenue increases or cost savings to the Company. The implementation of these reorganization measures may disrupt the Company's manufacturing and distribution activities, could adversely affect operations, and could result in asset impairment charges and other costs that will be recognized if and when reorganization or restructuring plans are implemented or obligations are incurred. RISKS INHERENT IN OUR DEPENDENCE ON INTERNATIONAL SALES AND FOREIGN OPERATIONS: Our principal business locations are situated in the UK, France, the Netherlands, Australasia and China and we generate sales from many areas of the world involving transactions denominated in a variety of currencies. The Company is subject to currency exchange rate risk to the extent that its costs are denominated in currencies other than those in which its revenues are derived. In addition, since our financial statements are denominated in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies have had, and will continue to have, an impact on our earnings. Accordingly, we cannot be certain that currency exchange rate fluctuations will not adversely affect our future results of operations and financial condition. As explained above, a significant proportion of sales are made by our businesses, particularly those in the UK, into foreign export markets. We anticipate that the portion of our total revenue from international sales will continue to increase as we further enhance our focus on developing new products, establishing new business partners and strengthening our presence in key growth areas. These overseas interests will therefore be subject to various financial and operating risks that arise from conducting business internationally, including: o unexpected changes in, or the imposition of, additional legislative or regulatory requirements in the various geographical regions where the Company operates; o fluctuating exchange rates; 24 o tariffs and other barriers; o difficulties in staffing and managing foreign sales operations; o import and export restrictions; o greater difficulties in accounts receivable collection and longer payment cycles; o potentially adverse tax consequences; o potential hostilities and changes in diplomatic and trade relationships. RISKS CONCERNING THE CONTINUING DEVELOPMENT AND MAINTENANCE OF APPROPRIATE BUSINESS CONTINUITY PLANS FOR THE COMPANY'S PROCESSING SYSTEMS: Our results could be adversely affected if we are unable to implement improvements in our reporting systems without significant interruptions in our accounting, order entry, billing, manufacturing and other customer support IT functions. Additionally, should employee time and advisory costs to be incurred in respect of compliance with Section 404 of the Sarbanes-Oxley Act 2002 be higher than management's expectations, this may also have a negative impact on Company earnings. RISKS IN CONNECTION WITH ATTRACTING AND RETAINING QUALIFIED KEY EMPLOYEES: The success of the Company's efforts to grow its business depends on the contributions and abilities of key executive and operating officers and other personnel. The Company must therefore continue to recruit, retain and motivate management and operating personnel sufficient to maintain its current business and support its projected growth. A shortage of these key employees might jeopardize the Company's ability to meet its growth targets. RISKS RELATING TO MATERIAL BREACHES OF SECURITY OF ANY OF THE COMPANY'S SYSTEMS: The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect the Company's transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of the financial statements; providing reasonable assurance that receipts and expenditures of the Company's assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of the Company assets that could have a material effect on the financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of the Company's financial statements would be prevented or detected. Any failure to maintain an effective system of internal control over financial reporting could limit the Company's ability to report its financial results accurately and timely or to detect and prevent fraud. RISKS CONCERNING SIGNIFICANT INCREASES IN THE COST OF PROVIDING PENSION BENEFITS TO EMPLOYEES AND RETIREES: The Company has a defined benefit pension plan ("The Pension Plan", "The Plan") covering certain of its UK employees, former employees and retirees. Our Pension Plan assets are invested primarily in equity securities and fixed-income government and corporate securities. At present, the Pension Plan has pension liabilities that exceed its assets. Under applicable law, we are required to make cash contributions to an underfunded pension plan to the extent necessary to comply with minimum funding requirements imposed by regulatory demands. The amount of such cash contributions is based on an actuarial valuation of the Plan. 25 A number of statistical and other factors which attempt to anticipate future events are used by the actuaries in calculating the expense and liability related to the plan. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by us, within certain guidelines, and in conjunction with our actuarial consultants and auditors. Our actuarial consultants also use subjective factors such as withdrawal and mortality rates to estimate the expense and liability related to these plans. The actuarial assumptions used by us may differ significantly, either favorably or unfavorably, from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. The funding status of the Plan can therefore alter as a result of changes in the actuarial assumptions used, changes in market conditions and a number of other factors. We cannot provide assurance that the value of the Pension Plan assets, or the investment returns on those Plan assets, will continue to be sufficient in the future. It is therefore possible that we may be required to make significant additional cash contributions to the Plan which would reduce the cash available for other business requirements, or that we will have to recognize a significant pension liability adjustment which would decrease the net assets of the Company. RISKS RELATED TO RAW MATERIAL AND ENERGY COSTS: The prices of many of the Company's raw materials vary with market conditions. In addition, the price of many of the Company's finished goods, component parts and assemblies that are purchased from overseas' suppliers are impacted by changes in currency rates, freight costs and raw materials at the point of production. Gas, electricity and other utility prices have become increasingly volatile in the UK, where we have a significant manufacturing presence. This situation has been exacerbated by price increases for certain of our raw materials, particularly steel, cobalt and plastics. We do not generally engage in commodity hedging transactions for raw materials. Significant increases in the prices of raw materials, sourced components, finished goods or other commodities could require us to increase the prices of our products, which may reduce consumer demand for our products or make us more susceptible to competition. The Company's ability to pass these increases on to its customers varies depending on the product line, rate and magnitude of any increase. There may be periods of time during which increases in these costs cannot be recovered and our profitability will be adversely affected. RISKS ASSOCIATED WITH FOREIGN SUPPLIERS: We purchase a growing portion of our products from foreign suppliers based in India and the Far East. In line with the those risks, outlined above, associated with our foreign operations and international selling, our use of foreign suppliers also causes increased risk to our business due to: o increases in transportation costs; o new or increased import duties; o transportation delays; o foreign work stoppages; o potential war, terrorism and political unrest; o exchange rate fluctuations that could increase the cost of foreign manufactured goods. RISKS CONCERNING THE CONTINUED AVAILABILITY OF FINANCING, AND FINANCIAL RESOURCES ON THE TERMS REQUIRED TO SUPPORT THE COMPANY'S FUTURE BUSINESS STRATEGIES: We believe that our existing balances of cash, cash equivalents, our cash flow from operations, and the existing credit facilities negotiated for the Company's UK and other operations will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future. Although we expect existing debt financing arrangements and cash flows generated from operating activities to be sufficient to fund operations at the current and projected levels in the future, there is no assurance that our operating plan will be achieved. We may need to take actions to reduce costs and to seek alternative financing arrangements. 26 RISKS RELATING TO THE OUTCOME OF PENDING AND FUTURE LITIGATION AND GOVERNMENTAL OR REGULATORY PROCEEDINGS: As discussed in the footnotes to the condensed consolidated financial statements, we are involved in various pending litigation matters arising out of Derivative and Class Action claims and also from the ordinary routine conduct of our business, including, from time to time, litigation relating to such items as commercial transactions, contracts, and environmental matters. The final outcome of these matters, cannot always be determined with certainty and such actions may therefore have a material adverse effect on the Company's financial position and its results of operations or cash flows. RISKS ASSOCIATED WITH OUR ACCOUNTING POLICIES AND ESTIMATES THAT MAY HAVE A MATERIAL EFFECT ON THE COMPANY'S FINANCIAL RESULTS: Significant accounting policies and estimates have material effects on our calculations and estimations of amounts in our financial statements. Our operating results and balance sheets may be adversely affected either to the extent that actual results prove to be adversely different from previous accounting estimates or to the extent that accounting estimates are revised adversely. We base our critical accounting policies, including our policies regarding revenue recognition, reserves for returns, rebates, bad debt, deferred tax asset recognition, pension plan assumptions and inventory valuation, on various estimates and subjective judgments that we may make from time to time. The judgments made can significantly affect net income and our balance sheets. Our judgments, estimates and assumptions are subject to change at any time. In addition, our accounting policies may change at any time as a result of changes in GAAP as it applies to us or changes in other circumstances affecting us. Changes in accounting policy have affected and could further affect, in each case materially and adversely, our results of operations or financial position. RISKS ASSOCIATED WITH MAJORITY STOCKHOLDER As detailed in the footnotes to the condensed consolidated financial statements, on July 28, 2006, the Company's majority stockholder, Jacuzzi Brands, Inc. ("Jacuzzi"), completed the sale of its 61.8% stockholding in Spear & Jackson, Inc. to United Pacific Industries Limited, a Bermuda corporation, and its wholly-owned subsidiary Pantene Global Holdings Limited (collectively, "UPI"). This change in ownership and control of the Company may have a significant impact on its future strategy, the way that it conducts its operations and the size and composition of its earnings and net assets, since UPI can influence substantially all matters requiring stockholder approval, including the election of directors, the approval of significant corporate transactions, such as acquisitions, the ability to block an unsolicited tender offer and any other matter requiring a vote of shareholders. Additionally, based on its majority ownership, UPI is in position to complete a merger or other transaction involving the Company, subject to compliance with applicable regulatory requirements, which could result in the elimination of minority stockholders. UPI paid Jacuzzi $1.40 per share for its shares of common stock of the Company. UPI has agreed that for a one-year period following the closing of its acquisition of the majority interest in the Company, if UPI or any of its affiliates acquire any additional shares of the Company, the purchase price per share will not be less than $1.40. However, UPI is under no obligation to acquire any additional shares of the Company and the Company has no knowledge, of UPI's intention to in this regard. RISK FACTORS THAT MAY NEGATIVELY IMPACT OUR STOCK PRICE: Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors particular to the Company, its industry and the markets in which it operates. Not all of these factors are in our control. These factors may include: sales falling below anticipated levels because of the timing of orders or weakening demand; adverse sales mixes; regional economic and governmental conditions; raw material price volatility; and 27 benefits from restructuring initiatives falling below forecast. Such factors may therefore cause our operating results for future periods to be below the expectations of management and the Company's advisers and this may cause a decline in the price of our common stock. There has been no material change in our risk factors from those described on pages 12 to 16 in our Form 10-K for the fiscal year ended September 30, 2005 except as in respect of the recent change in control of the Company and the addition of new directors . In evaluating any forward-looking statements, you should consider various risk factors, including those summarized above, and, those described in the other sections of this report, in the other reports the Company files with the SEC and in the Company's press releases. Such factors may cause the Company's actual results to differ materially from any forward-looking statement. The Company disclaims any obligation to publicly update the statements, or disclose any difference between its actual results and those reflected in the statements. With respect to all such forward-looking statements, the Company seeks the protection afforded by the Private Securities Litigation Reform Act of 1995. CORPORATE ORGANIZATION OVERVIEW Spear & Jackson, Inc. currently conducts its business operations through its wholly owned subsidiaries, Spear & Jackson plc and Bowers Group plc, and, until September 30, 2003, Mega Tools Ltd and Mega Tools USA, Inc. A brief summary of our corporate organizational history is as follows: (a) Incorporation of Megapro Tools, Inc. The Company was incorporated under the name Megapro Tools, Inc., on December 17, 1998 under the laws of the State of Nevada. The Company was inactive until the acquisition of Mega Tools Ltd and Mega Tools USA, Inc., by means of a reverse acquisition, on September 30, 1999. (b) Incorporation of Mega Tools Ltd and Mega Tools USA, Inc. Mega Tools Ltd was incorporated in British Columbia, Canada, on January 7, 1994. Mega Tools USA Inc. was incorporated under the laws of the State of Washington on April 18, 1994. Prior to the acquisition by Megapro Tools, Inc., Mega Tools USA Inc. was operated as a subsidiary of Mega Tools Ltd. (c) The acquisition of Mega Tools Ltd and Mega Tools USA, Inc. by Megapro Tools, Inc. On September 30, 1999 Mega Tools Ltd was acquired from Mrs. Maria Morgan, Envision Worldwide Products Ltd, Mr. Robert Jeffrey, Mr. Lex Hoos and Mr. Eric Paakspuu in exchange for the issue of 6,200,000 restricted shares in the common stock of Megapro Tools, Inc. These shares were valued at $275 for accounting purposes, representing the total paid-in-capital of the Mega Tools Ltd shares acquired. Mega Tools USA, Inc. was acquired from Mega Tools Ltd in exchange for the payment of $340,000 which was satisfied by the issuance of a promissory note to Mega Tools Ltd. The acquisition of Mega Tools USA, Inc. was completed immediately prior to the acquisition of Mega Tools Ltd. Megapro Tools, Inc. had no business assets prior to the acquisition of the two companies. Prior to the acquisition of Mega Tools Ltd and Mega Tools USA, Inc., each of Mrs. Maria Morgan, Mr. Robert Jeffery, Mr. Lex Hoos and Mr. Eric Paakspuu were shareholders of Mega Tools Ltd. Neither Mrs. Maria Morgan, Mr. Robert Jeffery, Mr. Lex Hoos nor Mr. Eric Paakspuu was a director or officer of Mega Tools Ltd or Mega Tools USA and neither individual had any management role with Mega Tools Ltd or Mega Tools USA, either before or after the acquisition. Envision Worldwide Products Ltd owned 24.8% of the shares of Mega Tools Ltd prior to the acquisition of this interest by Megapro Tools, Inc. The former stockholders of Mega Tools Ltd acquired a proportionate interest in Megapro Tools, Inc. upon completion of the acquisition of Mega Tools Ltd and Mega Tools USA. Mr. Neil Morgan, husband of Mrs. Maria Morgan, was sole promoter upon inception. Other than the issue of stock to Mrs. Maria Morgan 28 upon the acquisition of Mega Tools Ltd, Mr. Morgan did not enter into any agreement with the Company in which he was to receive from or to provide to the company anything of value. Mr. Neil Morgan was the legal and beneficial owner of the interest in Mega Tools Ltd held by Mrs. Maria Morgan. Mrs. Morgan acquired the interest previously held by Mr. Morgan on April 16, 1999. Prior to the acquisition of Mega Tools Ltd and Mega Tools USA, Mr. Neil Morgan was the president and chief executive officer of Megapro Tools, Inc. and each of Mega Tools Ltd and Mega Tools USA. Mr. Morgan continued as president and CEO of Megapro Tools, Inc. upon completion of this acquisition. (d) The acquisition of Spear & Jackson plc and Bowers Group plc by Megapro Tools, Inc. On August 23, 2002, USI Mayfair Limited, a corporation organized under the laws of England and a wholly owned subsidiary of USI Global Corp., Megapro Tools, Inc. ("Megapro") and S and J Acquisitions Corp. (a company incorporated on August 22, 2002 under the laws of the State of Florida and a wholly owned subsidiary of Megapro Tools, Inc.) executed a Stock Purchase Agreement to acquire all of the issued and outstanding shares of Spear & Jackson plc and its affiliate, Bowers Group plc, owned by USI Mayfair Limited. The purchase price comprised 3,543,281 shares of common stock of Megapro and promissory notes in the principal amount of (pound)150,000 pounds sterling ($232,860) ("the Transaction"). The Transaction closed on September 6, 2002. Concurrently with the closing of the Transaction, and as a condition precedent thereto, Megapro closed a Private Placement pursuant to which it agreed to issue 6,005,561 shares of the common stock of Megapro to PNC Tool Holdings, LLC, a Nevada limited liability company ("PNC"), in consideration for $2,000,000 (the "Private Placement"). Mr. Dennis Crowley ("Crowley"), who became CEO of the company, was the sole owner of PNC. In connection with the closing of the Transaction, certain principal shareholders of Megapro, including Envision Worldwide Products, Ltd, Neil Morgan and Maria Morgan contributed an aggregate of 4,742,820 shares of their common stock of Megapro to the capital of Megapro, and agreed to a two year lock-up with respect to their remaining 192,480 shares of common stock of Megapro. The stockholders did not receive any consideration in connection with their contribution of shares. As a result of the closing of the Transaction and the Private Placement, and upon the effectuation of all post closing matters, Megapro had 12,011,122 shares of common stock outstanding, 6,005,561 shares of which were beneficially owned by PNC. The shares issued to PNC were subject to the terms of a Stockholder's Agreement and a Registration Rights Agreement. In the Stockholders' Agreement dated as of September 6, 2002 by and among Megapro Tools, Inc., USI Mayfair Limited, PNC and Crowley (the "Stockholders") it was agreed that, other than certain "unrestricted transfers", the parties involved would not transfer any Company securities for the two years beginning on September 6, 2002. On September 6, 2002, under an unrestricted transfer relating to the transfer of stock from a permitted affiliate, USI Mayfair Limited transferred all of the Company securities owned by it, along with all of its rights under the Stockholders' Agreement, to USI Global Corp. Since the date of the Transaction, the Company has not issued any shares of its stock except under a limited number of options and has not engaged in any financing using its stock. (e) Change of Name to Spear & Jackson, Inc. On October 1, 2002, the Board of Directors unanimously executed a written consent authorizing and recommending that the stockholders approve a proposal to effect the change of name to Spear & Jackson, Inc. On October 2, 2002, company stockholders holding a majority of the voting power of the Company executed a written consent authorizing and approving the proposal to effect the name change. The Board believed that the new name, Spear & Jackson, Inc., would reflect the change in business and would promote public recognition and more accurately reflect the Company's intended business focus. 29 On November 7, 2002, the name of the Company was changed from Megapro Tools, Inc. to Spear & Jackson, Inc. through the filing of a Certificate of Amendment to the Company's Articles of Incorporation with the Secretary of State of the State of Nevada. (f) Acquisition of Majority Interest by Jacuzzi Brands, Inc. On April 15, 2004, the US Securities and Exchange Commission filed suit in the U.S. District Court for the Southern District of Florida against the Company and Mr. Dennis Crowley, its then current Chief Executive Officer/Chairman, among others, alleging violations of the federal securities laws. Specifically with regard to the Company, the SEC alleged that the Company violated the SEC's registration, anti-fraud and reporting provisions. These allegations arise from the alleged failure of Mr. Crowley to accurately report his ownership of the Company's stock, and his alleged manipulation of the price of the Company's stock through dissemination of false information, allowing him to profit from sales of stock through nominee accounts. On May 10, 2004, the Company consented to the entry of a preliminary injunction, without admitting or denying the allegations of the SEC complaint. The SEC is continuing its investigation into pension issues. The Company is offering its full cooperation. As a further measure, the Court appointed a Corporate Monitor to oversee the Company's operations. In addition to Mr. Crowley consenting to a preliminary injunction the Court's order also temporarily barred Mr. Crowley from service as an officer or director of a public company, and prohibited him from voting or disposing of Company stock. Following Mr. Crowley's suspension, the Board appointed Mr. J.R. Harrington, a member of its Board of Directors, to serve as the Company's interim Chairman. Mr. William Fletcher, a fellow member of the Company's Board of Directors, who, until October 27, 2004, was the Company's Chief Financial Officer, and who is a director of Spear & Jackson plc, based in Sheffield, is serving as acting Chief Executive Officer. Following extensive settlement negotiations with both the SEC and Mr. Crowley, the Company reached a resolution with both parties. On September 28, 2004 Mr. Crowley signed a Consent to Final Judgment of Permanent Judgment with the SEC, without admitting or denying the allegations included in the complaint, which required a disgorgement and payment of civil penalties by Mr. Crowley consisting of a disgorgement payment of $3,765,777 plus prejudgment interest in the amount of $304,014, as well as payment of a civil penalty in the amount of $2,000,000. In May 2005, the SEC applied to the Court for the appointment of an administrator for the distribution of these funds to the victims of Mr. Crowley's actions, pursuant to the Fair Funds provisions of the Sarbanes-Oxley Act of 2002. On November 18, 2004 the Company signed a Consent to Final Judgment of Permanent Injunction with the SEC pursuant to which the Company, without admitting or denying the allegations included in the Complaint filed by the Commission, consented to a permanent injunction from violation of various sections and rules under the Securities Act of 1933 and the Securities Exchange Act of 1934. Additionally, the Company entered into a Stock Purchase Agreement with PNC Tool Holdings LLC ("PNC") and Mr. Crowley, the sole member of PNC. Under the Stock Purchase Agreement, the Company acquired, for $100, and other good and valuable consideration, 6,005,561 common shares of the Company held by PNC, which represented approximately 51.1% of the outstanding common shares of the Company at December 31, 2004, and which constituted 100% of the common stock held by such entity. The parties also executed general releases in favor of each other subject to the fulfillment of the conditions of the Stock Purchase Agreement. The Stock Purchase Agreement was effected on April 8, 2005, following formal approval by the SEC on February 10, 2005 and, on February 15, 2005 by the U.S. District Court for the Southern District of Florida of the settlement of the litigation captioned SEC v. Dennis Crowley, Spear & Jackson, Inc., International Media Solutions, Inc., Yolanda Velazquez and Kermit Silva (Case No: 04-80354-civ-Middlebrooks). The Stock Purchase Agreement was further 30 conditioned on, among other things, the disgorgement and civil penalty funds being paid by Mr. Crowley. These monies have now been received and are being administered for the benefit of the victims of the alleged fraud by a court appointed administrator, pursuant to the Fair Funds provisions of the Sarbanes-Oxley Act of 2002. With the return of the Spear & Jackson shares to the Company by PNC, the stockholders of the Company have had their percentage stock interest increase correspondingly. Jacuzzi Brands, Inc. ("Jacuzzi"), which is a beneficial owner of 3,543,281 shares of common stock, has had its interest in the Company increase to approximately 61.8% of the outstanding common stock. On April 11, 2005 Jacuzzi agreed to the termination of a previous letter agreement dated September 6, 2002, which supplemented the Stockholders' Agreement of the same date. The letter agreement required Jacuzzi to vote a substantial portion of its voting stock in the Company in proportion to the vote of other shareholders of the Company. At the time the letter agreement was executed, Jacuzzi was a principal, but a minority shareholder of the Company. As explained above, with the recent return to the capital of the Company of the majority shareholder interest previously held by PNC, Jacuzzi then held a majority capital stock interest in the company, and the continuation of the letter agreement was no longer considered necessary for the fulfillment of its original intent. Jacuzzi also provided a general release to the Company and its affiliates excepting Mr. Crowley and his spouse. (g) Disposal of Majority Interest by Jacuzzi to United Pacific Industries Limited On April 21, 2005, Jacuzzi adopted a plan of disposition of the Company's common stock. On March 23, 2006, Jacuzzi and its subsidiary undertaking, USI American Holdings, Inc. ("USI" and, together with Jacuzzi, "the Seller") entered into a Stock Purchase Agreement (the "Stock Purchase Agreement" with United Pacific Industries Limited ("UPI"), a Bermuda Corporation, whose shares are traded on the Hong Kong Exchange, to sell its entire holding of 3,543,281 shares of the common stock ("the Shares") of Spear & Jackson, Inc. to UPI for $1.40 per share for an aggregate purchase price of $4,960,593. The representations, warranties and covenants made by Jacuzzi and UPI are typical for this type of transaction, and include a covenant that restricts Jacuzzi from soliciting or negotiating with a third party between the signing date of the Stock Purchase Agreement and the closing date of the transaction. Jacuzzi has also agreed that, in connection with the closing of the transaction, it will, among other things, cause UPI's designees and one designee of Jacuzzi to be elected to the Board of Directors of Spear & Jackson, Inc. and will use commercially reasonable best efforts so that such UPI designees are in sufficient numbers to give UPI a majority of the Board of Directors of the Spear &Jackson, Inc. UPI has also agreed that neither it nor any of its affiliates will purchase any additional Common Stock during the period from the signing date of the Stock Purchase Agreement through one year following the closing at a price less than $1.40 per share. The purchase of the Shares by UPI contemplated by the Stock Purchase Agreement is subject to the satisfaction of a number of closing conditions, including approval by UPI's shareholders and the United Kingdom Pensions Regulator, and receipt of certain other regulatory approvals as well as other customary closing conditions. A copy of the Stock Purchase Agreement is on file with the SEC in connection with the filing by Jacuzzi of a Schedule 13D/A on March 27, 2006. The Seller and UPI entered into Amendment No. 1 dated as of May 4, 2006 ("Amendment No. 1 to the Stock Purchase Agreement") to extend the date by which the Seller and UPI were required to lodge the clearance application with the UK Pensions Regulator. The Seller and UPI subsequently received a comfort letter dated July 5, 2006 issued by the UK Pensions Regulator (the "Comfort Letter"). The Seller and UPI have agreed to waive the condition contained in the Stock Purchase Agreement for a clearance from the UK Pensions Regulator and to accept the Comfort Letter in satisfaction of that condition. The trustees of Spear & Jackson, Inc.'s UK Pension Plan confirmed by a letter dated July 6, 2006 their acceptance of the UK Pensions Regulator's determination. The Seller and UPI then entered into Amendment No. 2 dated as of July 10, 2006 ("Amendment No. 2 to the Stock Purchase Agreement") to waive their respective requirements for a clearance from the UK Pensions Regulator and to accept in its place the Comfort Letter which states the UK Pensions Regulator is of the view, based on the information supplied to him in connection with the clearance application, that the change of control as a result of the sale by the Seller of all of its shares of Spear & Jackson, Inc. to UPI is not detrimental to the UK pension plan and the UK Pensions Regulator believes that a clearance is not necessary for the transaction. 31 In addition, pursuant to Amendment No. 2 to the Stock Purchase Agreement, UPI agreed, subject to the Closing having occurred, to indemnify the Seller and JBI Holdings Limited (the "Jacuzzi Indemnified Parties") should the UK Pensions Regulator, regardless of the Comfort Letter, require any of the Jacuzzi Indemnified Parties to make a contribution or provide financial support in relation to the potential pension plan liabilities of SJI or its subsidiaries. In addition, UPI has also agreed that for a period of 12-months from the Closing Date, UPI will not, and will use its best efforts to ensure that neither Spear & Jackson, Inc. nor any of its subsidiaries will, take any action or omit to take any action that causes the UK Pensions Regulator, as a result of such action or omission, to issue a contribution notice against the Jacuzzi Indemnified Parties in relation to any UK pension plan in which Spear & Jackson, Inc. or any subsidiary of Spear & Jackson, Inc. is an employer. Further, UPI agreed that for a period of 12-months from the Closing Date, that it will not (and will use its best efforts to ensure that neither Spear & Jackson, Inc. nor any subsidiary of Spear & Jackson, Inc. will) engage in any action or inaction which in relation to any such UK pension plan would fall within the UK Pension Regulation clearance guidance note dated April 2005 as a 'Type A' event unless UPI procures that clearance is issued by the UK Pensions Regulator in relation to such event in terms which confirm that no Jacuzzi Indemnified Party shall be linked to a financial support direction or contribution notice in respect of such event. Closing occurred on July 28, 2006. On June 22, 2006, Jacuzzi and UPI filed a preliminary Form 14C with the SEC announcing notice of change in control and of a majority of directors pursuant to section 14(f) of the Securities Exchange Act of 1934 and Rule 14f-1 thereunder. The 14C indicated that three new directors would be designated by and elected to the Board of directors by UPI, to serve until the Company's next annual meeting. The 14C became effective on August 7, 2006, and the three new directors will replace the incumbent directors on about August 27, 2006. In the interim, the Board by resolution, appointed the three new directors--Lewis Hon Ching Ho, Andy Yan Wai Poon and Maria Yuen Man Lam--to the Board effective August 9, 2000. As previously reported by the Company, on July 28, 2006, Jacuzzi Brands, Inc., together with USI American Holdings, Inc., completed the sale of their shares of common stock of Spear & Jackson (representing a majority interest) to United Pacific Industries Limited, which shares are held by United Pacific Industries Limited's wholly-owned subsidiary Pantene Global Holdings Limited (collectively, "UPI"). On August 7, 2006, the Company filed with the Securities and Exchange Commission, and mailed to the Company's stockholders, an Information Statement pursuant to Sections 14(c) and 14(f) of the Securities Exchange Act of 1934, as amended, disclosing the intention of UPI to execute a written consent, as majority stockholder, electing to the Board of Directors the following UPI nominees: Lewis Hon Ching Ho; Andy Yan Ywai Poon; and Maria Yuen Man Lam. On August 9, 2006, the Board of Directors expanded the Board of Directors from three members to six members and elected as additional directors Messrs. Ho and Poon and Ms. Lam. Information concerning the backgrounds of the new Directors is included in the Information Statement under the heading "Information Regarding the Executive Officers and New Directors". The Board of Directors elected the new Directors as a means to facilitate the transition from the prior Board of Directors to the new Board of Directors. At the present time, Messrs. Harrington, Fletcher and Dinerman will continue to serve as Directors together with the newly elected Directors. No new officers have been elected as yet by the Company. Soneet Kapila will continue to serve as Corporate Monitor for the Company. Brian C. Beazer, the Chairman of UPI, is a director of Jacuzzi and holds approximately 24.56% of the shares of UPI. David H. Clarke, the Chairman and Chief Executive Officer of Jacuzzi, is a director of UPI and holds approximately 22.88% of the shares of UPI. Mr. Clarke also holds approximately 28,350 shares of common stock of Spear & Jackson, Inc., representing approximately 0.49% of the shares of Spear & Jackson, Inc. but the shares of Spear & Jackson, Inc. owned by Mr. Clarke are not being purchased at the time of the sale of the Shares by the Seller to UPI. FURTHER CHANGES TO CORPORATE ORGANIZATION During the year ended September 30, 2005 the Company set up a new sales and distribution facility, CV Instruments BV, in Maastricht, Holland. This new facility specializes in the distribution of portable hardness testing equipment manufactured in China and the sale of general engineers hand tools. Additionally, an allied manufacturing, quality control and distribution centre, Bowers Eclipse Equipment Shanghai Co. Limited, has been established in Shanghai, China and is expected to be fully operational as a distribution and manufacturing unit during the first quarter of fiscal 2007. 32 EXIT FROM SCREWDRIVER AND THREAD GAUGE MEASURING OPERATIONS With effect from September 30, 2003 the Company exited its screwdriver operations following the disposition of the trade and assets of Mega Tools Ltd and Mega Tools USA, Inc. The disposition of the trade and assets of the screwdriver division was undertaken by Neil Morgan who was then heading up the division. The Company believed that no specific authorization was afforded to Mr. Morgan to undertake that disposition. The disposition proceeds were in the form of $284,000 of loan notes and other receivables and the discharge of a loan of $100,000 owed by the Company to the managing director of the screwdriver division. Full provision was made in the Company's financial statements against the recoverability of these disposition proceeds. It has now been agreed with Megapro that it will pay Canadian $ 53,900 (approximately $41,000) in settlement of those debts and this is being paid in monthly installments of Canadian $5,000 (approximately $3,800).$27,000 was received in the year ended September 30, 2005 and a further $12,000 has been received in the nine months to June 30, 2006. During the fourth quarter of fiscal 2005, the Company began marketing for sale certain assets associated with its UK thread gauge measuring business. On February 28, 2006, the Company concluded the sale of these assets for a nominal consideration. The assets sold comprised plant and equipment, inventories and goodwill. The acquirer paid (pound)1 and assumed certain liabilities in respect of the leased premises from which the trade operates. The carrying values of the assets relating to this operation have been written down to estimated fair value and the net operations, cash flows and assets are presented as "Discontinued Operations" in accordance with SFAS 144. SUMMARY OF PRINCIPAL OPERATIONS Spear & Jackson, Inc., through its principal operating entities, as disclosed in footnote 1 to the condensed consolidated financial statements, manufactures and distributes a broad line of hand tools, lawn and garden tools, industrial magnets and metrology tools primarily in the United Kingdom, Europe, Australasia, North and South America, Asia and the Far East. These products are manufactured and distributed under various brand names including: * Spear & Jackson - garden tools; * Neill - hand tools; * Bowers - bore gauges and precision measuring tools; * CV - precision measuring instruments; * Robert Sorby - wood turning tools; * Moore & Wright - precision tools; * Eclipse - blades and magnetic equipment; * Elliot Lucas - pincers and pliers; and * Tyzack - builders' tools Until the disposition of the screwdriver division in September 2003, the Company also manufactured and sold a range of patented multi-bit screwdrivers under the "Megapro" brand name. The Company also manufactured and sold a range of thread gauge measuring equipment under the "Coventry Gauge" logo until the sale of the principal business assets of that business operation in February 2006. The Company's four principal business units and their product offerings can be summarized as: 1) NEILL TOOLS, which consists of Spear & Jackson Garden Tools and Neill Tools, manufactures, among other products, hand hacksaws, hacksaw blades, hacksaw frames, builders' tools, riveter guns, wood saws and lawn, garden and agricultural tools, all non-powered. In addition, Neill Tools has supplemented its UK manufactured products with factored products and bought in components from Far Eastern and Indian suppliers. Neill Tools product offering now includes a full range of hand power tools and, from January 1, 2005, Spear & Jackson Garden Tools' range has been supplemented by a portfolio of electric powered garden tools. 2) ECLIPSE MAGNETICS' key products are permanent magnets (cast alloy), magnetic tools, machine tools, magnetic chucks and turnkey magnetic systems. Products range from very simple low-cost items to technically complex high value added systems. In addition, Eclipse Magnetics engages in the trading of other 33 magnetic material, sourced from the Far East, both in the form of sales of complete factored items to end-customers as well as sales of component parts to UK manufacturers. Eclipse is also involved in applied magnetics and supplies many areas of manufacturing with products such as separators, conveyors, lifting equipment and material handling solutions. 3) The Company's metrology division comprises: MOORE & WRIGHT which manufactures a wide variety of products including: low technology measuring tools and hand held gauges for checking the threads, diameters and tapers of machined components. This division has supplemented its manufactured products with a range of factored items. BOWERS METROLOGY which is a manufacturer of high specification metrology instruments including precision bore gauges that measure the diameter of machined components. In addition to the core range of bore gauges, the Company also manufactures universal gauges and hardness testing equipment. In December 2004, the division secured the European distributorship rights for a range of premier portable hardness testers sourced from China. This distribution operation is operated through a specifically formed Dutch subsidiary company, CV Instruments Europe BV, based in Maastricht, Holland. An allied manufacturing, quality control and distribution centre, Bowers Eclipse Shanghai Equipment Limited, was established in Shanghai, China, during the year ended September 30, 2006. 4) ROBERT SORBY is a manufacturer of hand held wood working tools and complementary products. The products are handcrafted with strong aesthetic appeal. In addition, Spear & Jackson, Inc. has subsidiary companies in France (Spear & Jackson France SA) and Australasia (Spear & Jackson (Australia) Pty Limited and Spear & Jackson (New Zealand) Limited) which act as distributors for Spear & Jackson and Bowers manufactured products and complementary products sourced from third party suppliers. The Company's continuing operations can be analyzed into three business segments, hand and garden tools, magnetic products and metrology tools. For further detailed financial information by reportable segment, including sales, profit and loss, and total asset information, see Note 12 in the "Notes to the condensed consolidated financial statements" included within this Quarterly Report on Form 10-Q. Also included within Note 12 is a detailed geographical analysis including sales, profit and loss, and total asset information. The Company's product offering comprises both own-manufactured items and products sourced from third party suppliers as fully complete factored products or semi finished components. The Company's principal manufacturing sites can be summarized as: Name/Location Products Manufactured ------------- --------------------- A UK a) Neill Tools Hand tools Atlas Site, Sheffield b) Spear & Jackson Garden Products Garden tools Wednesbury, West Midlands c) Robert Sorby Wood turning tools Sheffield d) Eclipse Magnetics Magnetic products Vulcan Road, Sheffield e) Bowers Metrology Precision measuring tools Bradford B France a) Spear & Jackson Assembly of garden tools France 34 We currently sell our products to industrial, commercial and retail markets throughout the world, with a significant concentration in the United Kingdom, European Union, Australia, New Zealand and the Far East. These markets chiefly comprise: The non-powered hand tool industry in which the Company has hand tool, engineers' hand tool and garden tool business interests. These products are typically sold in industrial catalogs, hardware stores, garden centers and multiple retailers. This industry is highly mature with clearly defined traditional brand names being joined by a broad base of "house brands" typically supplied from third world manufacturers. The magnetic industry. This can be split into magnet manufacturers and magnetic integrators. The magnet users and integrators utilize the magnetic materials to produce products such as security sensors, electrical windows and magnetic filters and lifters. The metrology industry, which can be split into two main market segments: (i) low tolerance tools such as tape measures, rulers and protractors and (ii) surface roughness measuring equipment and laser measuring instruments, etc., used in the exact measurement of technologically precise machined components. The Company's Bowers Metrology Group presently operates in the latter market segment on a worldwide basis. The hobbyist and professional wood turning industry. This industry is relatively small and caters to individuals who have reasonable disposable income, often retirees, or who are professional wood turners producing craft products. Our strategy is to maintain and develop the revenues of our businesses through such methods as: (a) Maintaining and heightening the profile of our existing quality brand names. Such activity will comprise trade, general and TV advertising, extensive promotional work at trade shows, the development of corporate web sites, etc. (b) Continuous product improvement and innovation. (c) Increasing market share by offering highly competitive product offerings. (d) The launch of new and innovative product and product ranges. (e) Improving manufacturing efficiencies and continually reviewing other cost saving measures. The Company offers a comprehensive range of tools and equipment ranging from hacksaw blades to pliers, from secateurs to digging forks and from a simple magnet to a computer controlled materials handling system. The Company's policy is to support its core product offering with a pipeline of new products and range extensions. For example, in the current quarter, Bowers Metrology launched the new "Snapmatic" range of high precision snap gauges at the biennial MACH tradeshow in May 2006. The first major shipments are forecast in quarter four of the current financial year. 35 DISCUSSION OF CRITICAL ACCOUNTING POLICIES We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ significantly from those estimates under different assumptions and conditions. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 10-K filing for the year ended September 30, 2005 included a detailed discussion which addressed our most critical accounting policies. The quarterly financial statements for the period ended June 30, 2006, attached hereto, should therefore be read in conjunction with that discussion. These policies are those that are most important to the portrayal of our financial condition and results of operations and which require our most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies are those relating to revenue recognition, foreign exchange risk, inventory valuation, pension and post-retirement benefit obligations and accounting for deferred and current income taxes. Since September 30, 2005 there have been no changes in our critical accounting policies and no significant change to the assumptions and estimates related to them. OVERVIEW When compared to the equivalent periods last year, the results for the quarter and nine months ended June 30, 2006 show a decrease in both net sales and gross profit . Allied to this, increases in both selling, general and administrative expenses and charges in respect of unusual or infrequent items have resulted in a net loss for the periods under review. Sales of $24.65 million for the quarter ended June 30, 2006 show a decrease of $1.30 million (5.04%) when compared to sales of $25.95 million achieved in the comparable period last year. This decrease is primarily due to lower sales volumes, adverse currency exchange fluctuations, and increased sales rebates. Amongst the principal factors behind the decreased volumes were the disappointing UK and overseas sales in our Neill Tools and Robert Sorby divisions. For the nine months ended June 30, 2006, sales of $75.14 million were $3.27 million (4.14%) lower than sales of $78.41 million recorded in the nine months ended June 30, 2005, with the negative impact of adverse currency exchange fluctuations being only partially mitigated by sales volume increases. Gross profit was $7.88 million for the quarter ended June 30, 2006 compared to $8.42 million for the comparative period last year, a reduction of 6.41%. For the nine months ended June 30, 2006 gross profit was $23.40 million (2005: $25.79 million), a decrease of 9.27%. Direct costs are still being adversely affected by increases in prices for our principal raw materials of steel, plastic, cobalt and nickel and increases in utility costs. Margins were further diluted by the change in sales mix in the hand and garden division where higher sales of factored garden power tools were made at the expense of better margins on industrial hand tool product lines. 36 Selling, general and administrative expenses have increased by $1.47 million (18.65%) to $9.36 million in the three months ended June 30, 2006. In the nine month period under review, costs have increased by $3.35 million (13.72%)from $24.43 million in 2005 to $27.78 million in 2006. This is primarily due to increases in the non-cash FAS 87 pension charge of $1.12 million and $3.15 million, respectively, for the three and nine month periods ended June 30, 2006. Additionally, inflationary increases and increased selling and distribution expenses have further caused these costs to rise. Such increases have been partially offset, however, by the beneficial movement in the US$/Sterling cross rate, reduced head office legal costs and the effects of local reorganization and cost-cutting measures. While cost reduction programs will continue to be implemented to control the level of overhead expenses, administrative costs for the full year will show a significant increase over the prior year largely as a result of the $4.4 million increase in the FAS 87 pension charge. Additionally, while settlement of the Company's SEC litigation suit has resulted in decreases in administrative costs, head office legal expenses associated with the Class and Derivative Action litigation and the role of the Corporate Monitor will continue to be incurred until a resolution of those legal issues. Costs in respect of unusual and infrequent items of $1.24 million have been incurred in the quarter ended June 30, 2006 (2005: $0.27 million) and $2.47 million in the nine month period ended on that date (2005: credit of $2.23 million). In January 2006 the Company announced the closure of the remaining element of its manufacturing site at Wednesbury, England. A sale of this site was concluded on July 27, 2006 at a price of (pound)2.6 million (approximately $4.5 million). Additionally, the Company announced in the current quarter that certain manufacturing operations carried out at its Atlas site in Sheffield, England, will also cease. The site closure and Atlas reorganization form part of the Company's UK manufacturing restructuring program that has been initiated to regenerate and modernize key areas of the hand and garden tools business. Costs provided in respect of the site closure and reorganization for the quarter and nine month period ended June 30, 2006 were $0.59 million and $1.82 million, respectively. The charge for the nine months to June 30, 2006 is stated net of a credit of $0.33 million representing the release of certain provisions associated with a reorganization of the Wednesbury site that was initiated in March 2005. As a result of the closure of the site, these provisions are no longer required and they have accordingly been released. As further discussed, below, in Part II, Item 1, "Legal Proceedings", on July 7, 2006, Spear & Jackson, Inc. entered into a Memorandum of Understanding whereby it agreed to pay $0.65 million in settlement of the class action litigation, referred to in that note, in which it is a defendant. Provision has accordingly been made in the financial statements for the period ended June 30, 2006 for the payment of that sum. fThe results for the nine months ended June 30, 2005 benefited from the gain of $2.50 million arising on the disposal of part of the company's manufacturing site at Wednesbury, England. There is no comparable item in fiscal 2006. As a result of lower margins, higher overhead costs, manufacturing reorganization provisions, property disposal gains in 2005 that were not repeated in 2006 and litigation settlement costs, the Company's result from continuing activities before taxation has moved from an income of $0.31 million in the quarter to June 30, 2005 to a $2.72 million loss in the quarter to June 30, 2006. Likewise, a $6.77 million loss incurred in the nine months to June 30, 2006 compares to a $3.68 million profit in the same period last year. RESULTS OF OPERATIONS The following discussion provides a review of the results for the three and nine months ended June 30, 2006 versus the three and nine months ended June 30, 2005. 37 Summary Profit and Loss Account Data: Three Months Nine Months ended June 30 ended June 30 ---------------- --------------- 2006 2005 2006 2005 $m $m $m $m ------- ------ ------ ------ Net Sales ............................. 24.65 25.95 75.14 78.41 Cost of goods sold .................... (16.77) (17.53) (51.74) (52.62) ----- ----- ----- ----- Gross profit .......................... 7.88 8.42 23.40 25.79 Selling, general and administrative expenses ............. (9.36) (7.89) (27.78) (24.43) ----- ----- ----- ----- Operating (loss)income ................ (1.48) 0.53 (4.38) 1.36 Other income .......................... 0.00 0.05 0.08 0.09 ----- ----- ----- ----- (Loss)income from continuing operations before unusual and infrequent events.. (1.48) 0.58 (4.30) 1.45 Gain on sale of land and buildings ........................... - - - 2.50 Manufacturing reorganization costs .... (0.59) (0.27) (1.82) (0.27) Settlement of class litigation ........ (0.65) - (0.65) - ----- ----- ----- ----- (Loss)income from continuing operations before income taxes ........ (2.72) 0.31 (6.77) 3.68 Income tax (provision) benefit ........ (0.04) (0.20) 0.28 (0.65) ----- ----- ----- ----- Net (loss)income from continuing operations ......................... (2.76) 0.11 (6.49) 3.03 ----- ----- ----- ----- Net loss from discontinued Operations ............................ (0.01) (0.04) (0.09) (0.42) ----- ----- ----- ----- Net (loss)income ...................... (2.77) 0.07 (6.58) 2.61 ===== ===== ===== ===== Effective tax rate .................... (1.50%) 74.07% (4.08%) 20.00 ===== ===== ===== ===== Comparisons as a % of net sales: Gross profit .......................... 31.96% 32.45% 31.14% 32.89% Selling, general and Administration expenses ............. 37.97% 30.39% 36.97% 31.16% Operating (loss) income ............... (6.01%) 2.06% (5.83%) 1.73% (Loss)income from continuing operations before income taxes ...... (11.05%) 1.21% (9.00%) 4.69% Net (loss)income ...................... (11.26%) 0.25% (8.76%) 3.33% Note: The percentages and percentage change data shown above, and in other percentage data within this narrative have been calculated from the Consolidated Statements of Operations included in the Financial Statements attached hereto. The financial data shown in the Financial Statements is given in thousands rather than the millions presentation adopted in the table above. NET SALES Sales decreased by $3.27 million (4.17%) from $78.41 million in the nine months ended June 30, 2005 to $75.14 million for the nine months ended June 30, 2006. Sales of $24.65 million in the quarter ended June 30, 2006 were $1.3 million (5.04%) lower than sales of $25.95 million recorded for the comparable period last year. 38 These decreases are analyzed as follows: Nine Months Three Months ended ended June 30, June 30, 2006 2006 Note $m $m ----------- ------------ Effect of exchange rate movements .................... (a) (3.98) (0.53) Sales volumes movements ...... (b) 1.02 (0.74) Increased rebates ............ (c) (0.31) (0.03) ----- ----- (3.27) (1.30) ===== ===== Analyzed by principal business segment the net sales increase is as follows:- Nine Months Three Months ended ended June 30, June 30, 2006 2006 Note $m $m ---------- ----------- i) Hand and garden tools Effect of exchange rate movements ................. (a) (2.87) (0.34) Sales volume movements .... (b) (0.49) (1.04) Rebates ................... (c) (0.31) (0.03) ----- ----- (3.67) (1.41) ii) Metrology tools Effect of exchange rate movements ................. (a) (0.67) (0.14) Sales volume movements .... (b) 1.04 0.04 ----- ----- 0.37 (0.10) iii) Magnetic products Effect of exchange rate movements ................. (a) (0.44) (0.05) Sales volume increases .... (b) 0.47 0.26 ----- ----- 0.03 0.21 ----- ----- Total net sales increase .. (3.27) (1.30) ===== ===== Notes: (a) The functional currency of the majority of the group's revenues is sterling and the variation in the US$/(pound) cross rate in the three and nine month periods ending June 30, 2006 compared to the comparable periods last year has had a significant impact on the US dollar value of the group's sales. The average cross rates in the period under review can be summarized as: 39 Average Cross Rates ------------------------------- 2006 2005 % Movement ---- ---- ---------- 9 months ended June 30 1.774 1.871 -5.18% 3 months ended June 30 1.826 1.857 -1.67% (b) In general, business conditions in many of our markets remained challenging as a result of sluggish consumer demand and continuing intense competition from rival suppliers across a number of product ranges. Despite this however, there have been sales volume increases in certain of our operations. The Eclipse Magnetics division has experienced strong UK and overseas performance. Within the Metrology division, sales growth has been achieved through our selling and distribution facility in Maastricht and by a strong export performance in the US, our selling and distribution facility in Maastricht, together with a strong performance in the US. (c) The level of rebates has increased overall in 2006 by $0.03 million in the three month period and $0.31 million in the nine month period when compared to 2005. This is primarily due to increased rebates offered by our French and Australian divisions. SEGMENT REVIEW OF SALES REVENUES We aim to maintain and develop the revenues of our businesses through the launch of new products, the enhancement of existing items and the continued marketing of the Company's brands in order to retain and gain market share. Sales and revenue details on a segment basis are as follows: NEILL TOOLS Sales for the quarter ended June 30, 2006 of $10.76 million showed a decrease of $0.84 (7.27%) million over last year's sales of $11.60 million. This was attributable to decreased volumes of $0.81 million and adverse exchange movements of $0.19 million only partially offset by decreased sales rebates of $0.16 million. In the nine months ended June 30, 2006 sales of $32.78 million were $2.15 (6.17%) million less than last year's sales of $34.93 million. This decrease comprised adverse exchange movements of $1.79 million, decreased sales volumes of $0.42 million offset by reduced sales rebates of $0.06 million. Overall, the division's sales for the third quarter were 7.27% worse than last year and below forecast. Both home and export performances were disappointing. The UK market witnessed poor sales especially within the retail sector which, once again, is experiencing a down turn in consumer spending. Major retail outlets reported sales downturns of between 9% and 19%. This increasingly soft retail demand has a direct impact on our Hand & Garden sales in the UK and remains a cause for concern. Export sales were down on last year, mainly attributable to high stock levels held by our dealers in the Middle and Far East. Within the industrial tools business, export markets continue to be driven by demand for our hacksaw blades. Sales of these products now represent 60% of our industrial tools' revenues and strategies are being prepared to spread this sales concentration risk through the development of higher margin product ranges. Continued success within this sector will depend on increased brand presence and new product development. Gross margins were again depressed. The main drivers behind this reduction were a mix switch towards Garden Power products at the expense of the higher margin hacksaw blade ranges and increases of more than 50% in gas and electricity supply costs. Reductions in manufacturing costs continue to be the focus of management in order to improve competitiveness for penetration into new markets. As previously reported, in January 2006 the company announced the closure of the remaining element of its manufacturing site at Wednesbury, England. 40 The site closure forms another key part of the Company's UK manufacturing strategy to regenerate and modernize key areas of the hand and garden tools businesses. All warehouse and distribution operations currently performed at this location will be transferred to the Atlas site in Sheffield. The manufacturing and assembly functions formally carried out at this site will now be outsourced to suppliers based outside the UK. The transfer of operations from Wednesbury to Sheffield is scheduled to be completed in October and November 2006 and is progressing on time and in line with budgeted cost projections. When integrated, it will ensure that the UK hand and garden business will deliver improved customer service and satisfaction. Additionally, in the current quarter, the company announced that certain manufacturing operations carried out at its Atlas site will also cease. The main challenges for the business revolve around reducing the remaining manufacturing cost base and driving innovation and new product development in line with our core brands and competences. Quarter 4's forecast trading performance shows little sign of any up turn in sales revenues. The demand for the new Woodsaw range (Predator), however, continues to drive manufacturing as we look to improve our output to satisfy demand. New export markets are being targeted and new UK sales channels such as the electrical and grocery sectors are being evaluated as areas for future sales growth. ECLIPSE MAGNETICS Sales for the quarter showed a $0.21 million (7.55%) increase over last year's figures (2006 $2.97 million, 2005 $2.76 million) with increased volumes of $0.26 million only partially offset by adverse exchange rate variances of $0.05 million. For the nine months ended June 30, 2006 sales showed a marginal increase of $0.03 million (2006, $8.38 million, 2005, $8.35 million) attributable to improved volumes $0.47 million mitigated by adverse exchange variances of $0.44 million. Overall, sales volumes for the third quarter were higher than the comparable period last year. Sales into the UK market improved despite sales from the material handling section being 50% down on the comparable period last year as a result of a number of one-time projects buoying the 2005 results. Export sales were also better than last year, mainly due to the new filtration range, "Micromag", and an increasing market share for our permanent filters. Our US performance continued to prosper as we increased our US market share through the introduction of new products and by close key account management. The Engineered Magnetic Solutions business continued to see growth with new products and technologies being offered for bespoke industry solutions. Competition from the Far East remains the main threat, whether directly or through agents, as we continue to see the emergence of more and more companies in our trading markets offering high quality goods at low market price points. Gross margins were lower than in the equivalent period last year due to the mix in the Industrial sector and higher utility costs. Key primary materials, steel, nickel and cobalt remained stable during the period. Looking forward, the main challenge continues to be the distancing of rival Far East manufacturers from our key customer base. Our commodity-based business is under continued threat. To counter this, we continue to promote the attractiveness of our product by offering added value to our customers. Improvements in product sourcing and reductions in manufacturing costs continue to be the focus of the management to increase competitiveness in new markets. As part of this strategy, the division enhanced its presence in China in January 2006 when it paid $0.2 million for a 25% equity participation in a recently formed Chinese Venture and other initiatives are being evaluated. 41 In addition, management continues to follow a strategy of new product development as a further method to increase market share within key product segments. ROBERT SORBY Sales for the quarter decreased by $0.25 (19.65%) million when compared to last year (2006 $1.03 million, 2005 $1.28 million) as a result of sales volume decreases of $0.24 million and adverse exchange variances of $0.01 million. In the nine month period ending June 30, 2006, sales have decreased by $0.48 million (11.91%) from $4.03 million in 2005 to $3.55 million in 2006 primarily due to reduced volumes of $0.28 million and adverse exchange variances of $0.20 million. During the quarter Robert Sorby has continued to face a very challenging time with sales declining amid softening demand, especially in US markets. Reduced volumes in the quarter, when compared to last year, were almost entirely attributable to reduced sales volumes in the US. Comparative figures for 2005 also include a significant one-time order which was not repeated in 2006. Additionally, excess stocks held by one major US customer have had an adverse effect on the current quarter's sales demand. In the UK, sales were similar to last year, largely due to successes at wood working exhibitions and shows. The underlying trend, however, is one of a very subdued market place. A number of macro economic factors have contributed to this malaise. Our typical customer is a retiree on a fixed income. Recent significant increases in utility prices and gasoline have reduced levels of disposable income and discretional spend on hobby activities is one of the first areas of expenditure to be reduced. We have continued to switch our focus from dealer selling to consumer marketing, especially in-store demonstrations, woodworkers' club events and regional exhibitions. One innovation has been the introduction of a series of master classes in the UK and this concept is to be extended to the US in the first quarter of the next financial year. Such consumer focused initiatives have taken place in our principal markets of the USA, UK, Australia and Ireland. Business in these regions becomes ever more competitive, but the business remains focused on not sacrificing margins for short term sales gains. In the light of the sales shortfalls, a tight rein has been kept on manufacturing, product development and marketing expenditure. Towards the end of 2005 we suffered as a result of the dramatically escalating price of steel, which is our prime raw material. Those prices have now steadied and it is hoped that this will ease some of the pressure on margins. Looking forward, the business climate remains uncertain. UK retail sales, in general, remain soft and we continue to witness an increase in the number of competitive entry level turning tools from Asia that are now available in the market. As yet these have not gained a significant foothold in the market but we will monitor the market's appetite for these products and react accordingly. BOWERS METROLOGY In the quarter ended June 30, 2006, sales from continuing operations show a decrease of $0.10 million (2.54%) over last year ($4.11 million 2006, $4.21 million 2005) due to adverse exchange variances of $0.14 million being partially offset by increased sales volumes of $0.04 million. Cumulatively, sales have increased by $0.37 million (3.21%) from $11.76 million in 2005 to $12.13 million in 2006. This is attributable to increased volumes of $0.90 million and adverse exchange movements of $0.53 million. 42 Export sales continue to show steady growth, with Germany and USA leading the way. Of our other major export markets, both Italy and France remain depressed, although the former has begun to show initial signs of recovery. Demand in Eastern Europe is also strong, particularly with regard to the new testing instruments being sold via our Maastricht operation. Having our own facility in the Netherlands is improving sales in that region. Sales of the premium brand portable hardness testers that are imported from China continue to flourish and, with several new products coming on line, a further strong sales performance is anticipated from Maastricht in quarter 4. The UK remains the main concern, with the double threat of competition from low cost imports and a shrinking industrial market place. Continuing factory closures in the automotive market, including Rover and Peugeot, are, unfortunately, not being offset by expansion in other UK factories such as Honda, Nissan and Toyota. On a more optimistic note, however, MACH, the main biennial tradeshow, was held in May 2006, and witnessed a 9% increase in visitor numbers. Our new "Snapmatic" range of high precision snap gauges was launched at the show and the first major shipments are due to be made in Quarter 4. Additionally, several new products from key suppliers will be launched in the UK in Quarter 4. The Shanghai facility is now making regular shipments to our European distribution centre in Maastricht and commenced direct sales to the Asia region in the quarter. Further capital expenditure is expected during Quarter 4 enabling the first series of bench hardness testers to be produced in Shanghai. To supplement this activity, we are also applying for a trading license within China itself. When granted, this will then enable us to distribute the core Bowers 3-point bore gauge range directly through this market. SPEAR & JACKSON FRANCE Overall, sales for the third quarter of $2.49 million show a $0.08 million decrease (3.07%) over the comparable period last year with higher sales rebates levels of $0.15 partially offset by sales volume increases of $ 0.05 million and favorable exchange variances of $0.02 million. For the nine month period ended June 30, 2006 sales have decreased by $0.46 million (5.40%) from $8.46 million in 2005 to $8.0 million in 2006. Here, favorable volumes of $0.15 were exceeded by increased sales rebate levels of $0.15 million and adverse exchange movements of $0.46 million. On a macro economic level, the trends of previous quarters' continue. The French economy remains depressed with increased unemployment rates and the migration of manufacturing operations to low cost regimes overseas. Lower consumer confidence and reduced spending levels are also present in the run up to the 2007 presidential elections. Business conditions in the Company's markets have continued to reflect this depressed retail environment. Competition remains intense in the French market with a large proportion of garden product turnover being concentrated in a small number of retail outlets. This makes price negotiations difficult and can result in additional incentives, e.g. rebates being offered, as a matter of course, in order to secure orders. Sales rebate levels were particularly high in the period under review. We continue to feel the effects from the increasing flow of cheap Asian and Far Eastern imports which puts pressure on turnover and margins. This margin dilution could be further exacerbated by the opening of specialist cut-price garden stores by one of our major customers later in the year. The number of these stores could rise to over 100 over the next ten years. 43 In order to combat increased competition from cheap imports and to combat the negative effects of the seasonality of garden product sales, the Company concentrates on marketing activity to promote its principal brands and to secure new listings. The design and presentation of our three key brands (Spear & Jackson, Laurenty and Forges de Lavieu) have been revamped, a French S&J web set has been set up and various promotional activities initiated. In the last quarter the Company has extended a private range of cutting tools and revised other private range garden, wood and grass tools. To retain margins we have increased the amount of product sourced from Far Eastern and Indian suppliers and we continue to press suppliers for rebates as a condition of purchase. It is clear, however, that in order to retain our current levels of business and to increase the success of new product ranges, it is essential that we are able to offer quality products at lower price points and that we extend our sales routes to include mail order and internet options. AUSTRALASIA Sales for the quarter for Spear & Jackson Australia and Spear & Jackson New Zealand were $0.24 million (6.67%) lower than last year (2006 $3.30 million, 2005 $3.54 million), due to adverse exchange variances of $0.15 million, increased sales rebates of $0.06 million and decreased sales volumes of $0.03 million. Cumulatively for the nine months to June 30, 2006 sales have decreased by $0.58 million (5.33%) from $10.87 million in 2005 to $10.29 million in 2006. Adverse exchange movements of $0.41 million and increased rebates of $0.24 million were only partially compensated by increased volumes of $0.07 million. The Australian market recorded unexpected economic growth during the third quarter despite an increase in domestic interest rates in May 2006 and escalating fuel costs. The economy also recorded a 30 year low unemployment rate giving early evidence that the increase in interest rates had a less than anticipated impact on economic activity. There is strong speculation that the Reserve bank will be forced to increase interest rates again in Quarter 4 in order to curb inflationary pressures. This upturn in economic activity and associated consumer confidence came too late to have any impact on Australian revenues for the quarter. During the quarter industry and major retail customers reported declines in sales levels and a number of customers reduced their purchasing and inventory levels in advance of the Australian financial year end of June 30. Likewise, the New Zealand economy showed promising signs in the third quarter with economic data showing improved retail sales figures and a slightly better than expected business confidence reading. This upturn however, had little impact on New Zealand's sales for the quarter which continued to be affected by a slow down in consumer spending. Comparing current year sales performance in Quarter 3 with that of the prior year, sales reductions arising from business lost to cheap Asian import competition, declining price points, softening consumer demand and the decline in masonry, metals and garden divisions were partially offset by incremental sales gains within our air, hand tool and metals categories. In the nine month period ended June 30, 2006, increased sales in Australia across the air, hand tools and metals divisions, when compared to the comparable period last year, were mitigated by reduced sales in New Zealand as a result of the loss of business with a major retail group. The Australian and New Zealand markets continue to be extremely price competitive with many of our retail customers sourcing their "house brands" directly from Asia in direct competition with S&J. This practice has placed, and will continue to place, added pressure on our sales, margins and market share. Despite this, in Australia, we were still able to meet market price points across all core categories in order to maintain and grow market share. Margin dilutions were mitigated by improved product 44 sourcing, new product releases and a favorable AU$. In addition, although 2006 was negatively impacted by the loss of two major customers, these adverse movements were compensated by incremental gains arising from the introduction of new lines, improved ranges and increased promotional activity. In New Zealand, where the same competitive pricing pressures are felt, increased levels of sales promotions have been initiated to stimulate demand and slow moving inventories have been reduced. Furthermore, a new range of digging tools developed specifically for the New Zealand market has been accepted and "core-ranged" into the largest retail group in New Zealand and three other major accounts and this should improve margins and sales revenues in the final quarter of fiscal 2006 and beyond. Overall, sales to our major customers reflect the continued expansion and domination of the market by the major corporate retailers who continue to expand their market share at the expense of the traditional independent retail groups. As such, our sales mix reflects this trend with sales growth continuing in the corporate sector whilst sales within the independents continue to decline. Our objective going forward is to spread our exposure to the corporate sector by increasing our sales and market share in the independent and industrial markets. COSTS OF GOODS SOLD AND GROSS PROFIT Costs of goods sold decreased by 4.35% from $17.53 million in the three month period ended June 30, 2005 to $16.77 million in the three months ended June 30, 2006. In the nine month period under review, costs of goods sold decreased by 1.67% from $52.62 million in the nine months ended June 30, 2005 to $51.74 million in the nine months ended June 30, 2006. Headline information concerning costs of goods sold as a percentage of sales and gross profit margins in the periods under review is as follows: Three Months Ended Nine Months Ended -------------------- ------------------ June 30 June 30 June 30 June 30 2006 2005 2006 2005 ------- ------- ----- -------- Cost of goods sold as a % of sales ........... 68.04 67.55 68.86 67.11 Gross Profit Margin ....... 31.96 32.45 31.14 32.89 Margins have continued to suffer from competitive price pressures, adverse currency movements, unfavorable sales mixes, the adverse effects of raw material (principally steel) and utility price hikes together with increases in the cost of fuel used to operate our manufacturing processes. In the Neill Tools division a main driver behind decreased margins has been the mix switch towards factored garden power tools at the expense of better margins on industrial hand tool product lines. We continue to monitor and evaluate means of maintaining and improving current sales mixes and of further reducing costs of goods sold across all of our principal trading operations to avoid margin erosion. The highly price sensitive markets in which we operate make it prohibitive to pass on cost increases to certain of our customers. This, and the upward pressure on steel prices caused by strong demand from China, will continue to have an adverse influence on our margins in the short term. Improvements in manufacturing costs continue to be the focus of the management to improve competitiveness for new markets. The manufacturing reorganization program, initiated in the last quarter of 2005, and which has continued in the second and third quarters of fiscal 2006 with the announcement of the closure of our UK manufacturing site at Wednesbury and the reorganization of our Atlas manufacturing site in Sheffield, England, will have a beneficial effect on margins. The restructuring initiatives will result in own-manufactured product being progressively replaced with factored items sourced from overseas, thereby reducing costs and increasing profitability. 45 OPERATING COSTS AND EXPENSES Selling, general and administrative (SG&A) expenses increased by $1.47 million (18.65%) from $7.89 million in the three months ended June 30, 2005 to $9.36 million in the three months ended June 30, 2006. In the nine months ended June 30, 2006 costs of $27.78 million have increased by $3.35 million (13.72%) from $24.43 million in the nine months to June 30, 2005. The principal reasons for the changes in the levels of SG&A expenses in the three and nine month periods ended June 30, 2006 over their prior year comparatives can be summarized as follows: Increases Over Prior Year ------------------------------- Nine Months Three Months ended ended June 30, 2006 June 30, 2006 $m $m ------------- ------------- a) Impact of movements in average US$/sterling cross rates in the period .................. (1.14) (0.11) b) Increased FAS 87 pension costs ....... 3.15 1.12 c) Inflationary increases ............... 0.60 0.20 d) Decreased head office costs relating to legal and professional fees, monitor fees and associated costs ................................ (0.27) (0.01) e) One-time costs in setting up the Metrology Division's China facility .. 0.10 0.00 f) Other net increases including increases in variable selling and distribution costs associated with increase in March 2006 sales .... 0.91 0.27 ----- ---- Total increase in SG&A expenses ...... 3.35 1.47 ===== ==== OTHER INCOME AND EXPENSES Other income and expenses moved from a net credit of $0.05 million in the three months ended June 30, 2005 to $nil in the three months ended June 30, 2006. For the nine month period under review other income and expenses has moved from a $0.09 million credit in the nine months to June 30, 2005 to a $0.08 million credit in the nine months to June 30, 2006. This slight decline is attributable to higher 2006 lease asset interest charges and higher UK bank charges on bank accounts denominated in foreign currencies being only partially offset by higher bank interest credits in the Company's American businesses and lower bank interest charges in the French business. 46 INFREQUENT AND UNUSUAL ITEMS (a) MANUFACTURING REORGANIZATION COSTS Three Months Nine Months ended June 30 ended June 30 ----------------- ----------------- 2006 2005 2006 2005 $m $m $m $m Manufacturing reorganization costs (0.59) (0.27) (1.82) (0.27) ----- ----- ----- ----- In January 2006, the Company announced the closure of the remaining element of its manufacturing site at Wednesbury, England. All warehouse and distribution operations currently performed at this location will be transferred to the Company's principal UK manufacturing site in Sheffield. The manufacturing and assembly functions formally carried out at this site will now be relocated to suppliers based outside the UK. The closure and relocation of the Wednesbury facility are to be completed by November 30, 2006 and the costs of this exercise are anticipated to be approximately $2.1 million. These costs include employee severance payments, site closure expenses, factory reorganization expenses, plant transfer costs and associated capital expenditure. In addition to the above, the Company announced in the current quarter that certain manufacturing operations carried out at its Atlas site in Sheffield, England, ("Atlas") will also cease. Provisions for employee severance costs in respect of the closure of these manufacturing operations has been made in the quarter ended June 30, 2006. Subsequent to the quarter end, on July 27, 2006, Spear & Jackson, Inc.'s UK subsidiary, Spear & Jackson Garden Products Limited, completed, the contract for the sale of the remaining element of the Wednesbury site for (pound)2.6 million sterling (approximately $4.7 million), excluding disposal costs. Funds realized from this disposal will be used to finance the UK manufacturing reorganization program with any excess sale proceeds being reinvested in other operational initiatives. The Wednesbury site closure and the production rationalization at Atlas form part of the Company's UK manufacturing reorganization program which has been initiated to regenerate and modernize key areas of the hand and garden tools business. The closure will enable the Company to consolidate its two UK hand and garden tool manufacturing sites and will allow the Company to develop a modern manufacturing, warehouse and distribution facility which will be well placed to meet the current and future needs of its customers. Costs provided in respect of the Wednesbury site closure and the Atlas reorganization were $0.59 million for the quarter ended June 30, 2006 and $2.15 million for the nine month period ended June 30, 2006. In addition to these net Wednesbury and Atlas reorganization costs it is anticipated that a further $0.1 million will be incurred in respect of the Wednesbury site closure on or before November 30, 2006 for which provision will be made in accordance with applicable financial reporting standards as and when liabilities for such charges crystallize. As explained in (b), below, a surplus element of the Wednesbury site was sold in 2005 and provision was made at March 31, 2005 for various site reorganization costs that were to be incurred as a result of that partial sale. Certain of these costs will not now be incurred following the decision to close the remainder of the site and such excess provisions, amounting to $0.33 million, were released in the quarter ended March 31, 2006. 47 (b) PROFIT ON SALE OF LAND AND BUILDINGS On January 28, 2005 the Company completed the sale of part of its industrial site at St. Paul's Road, Wednesbury, England, and on February 15, 2005 the Company also concluded the disposal of its warehouse and office facility in Boca Raton, Florida. Details of these sales are as follows: Wednesbury England Boca Raton $m Florida Total (Part Sale) $m $m ---------- ---------- ----- Net sale proceeds .................. 5.2 3.4 8.6 Less net book value ................ (2.3) (3.1) (5.4) ---- ---- --- Gross profit on disposal ........... 2.9 0.3 3.2 Less related reorganization costs .. (0.7) 0.0 (0.7) ---- --- ---- Net profit on sale ................. 2.2 0.3 2.5 === === === Following the sale of the surplus element of the Wednesbury facility, provision was made for costs to be incurred in connection with the consolidation of the current manufacturing operation into the smaller site. These costs comprised factory refurbishment, factory reorganization and departmental relocations within the site. Certain of these provisions were no longer be required following the decision to close the remainder of the site and all excess provisions were accordingly released in the quarter ended March 31, 2006. (c) SETTLEMENT OF CLASS ACTION LITIGATION As further explained, below, in Part II Item 1 "Legal Proceedings", on July 7, 2006, Spear & Jackson, Inc. entered into a Memorandum of Understanding whereby it agreed to pay $0.65 million in settlement of the class action litigation, referred to in that note, in which it is a defendant. Provision has accordingly been made in the financial statements for the quarter to June 30, 2006 for the payment of that sum. (LOSS)INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES Our loss before income taxes in the three months ended June 30, 2006 amounted to $2.72 million compared to an income before taxes for the three months ended June 30, 2005 of $0.31 million. The loss before income taxes in the nine month period ended June 30, 2006 was $6.77 million compared to a $3.68 million profit last year. These adverse movements are attributable to: Nine Months ended Three Months ended June 30, 2006 June 30, 2006 $m $m ----------------- ------------------ Manufacturing reorganization costs ............................... (1.55) (0.32) Profit on sale of land and buildings in 2005 ................... (2.50) (0.00) Settlement of class litigation ...... (0.65) (0.65) Decreased gross margins ............. (2.39) (0.54) Increased pension costs ............. (3.15) (1.12) Other increases in SG&A costs ....... (0.20) (0.35) Decreased other income .............. (0.01) (0.05) ------ ----- Total adverse movements ............. (10.45) (3.03) ------ ----- 48 INCOME TAXES An income tax charge of $0.04 million arose in the three months ended June 30, 2006 compared to a $0.20 million income tax charge in the three months ended June 30, 2005. For the nine month period to June 30, 2006 an income tax benefit of $0.28 million arose compared to a $0.65 million charge in the comparative period last year. Income taxes were 1.50% of the loss before tax in the three months ended June 30, 2006 compared to 74.07% of the income before tax in the three months ended June 30, 2005. Income taxes were 4.08% of losses in the nine months ended June 30, 2006 compared to 20.00% of income in the comparable period last year. Differences between the effective rate and the statutory rate of taxation of 35% in the periods under review result from (a) income and losses in certain non-UK subsidiaries within the Spear & Jackson group being taxed at rates different from the effective rate, (b) the utilization of tax losses which are not recognized within the deferred tax computation and (c) permanent differences between accounting and taxable income as a result of non-deductible expenses and non-taxable income. Other specific factors behind the divergence in effective tax rates in the periods ended June 30, 2005 and June 30, 2006 were as follows: 1. Period Ended June 30, 2006 i) Valuation allowances of $1.22 million have been applied to the costs associated with the closure of the Wednesbury site and reorganization of the Atlas site and to losses incurred in certain UK and overseas divisions in the period. ii) A valuation allowance of $0.18 million has also been applied to the costs to be incurred in relation to the settlement of the class action. iii) Adjustments of $0.09 million in respect of the correction of prior period taxation provisions. 2. Period Ended June 30, 2005 i) Valuation allowances of $0.39 million have been applied to losses incurred in certain UK and overseas divisions in the period. ii) The taxation charge has been reduced by $0.89 million in respect of the utilization of prior period losses against the gain arising on the sale of UK land and buildings. (LOSS) INCOME FROM CONTINUING OPERATIONS Our loss from continuing activities was $2.76 million for the three months ended June 30, 2006 (2005: $0.11 million profit) and for the nine months ended June 30, 2006 it was a $6.49 million loss compared to a $3.03 million profit in the previous year. DISCONTINUED OPERATIONS Discontinued operations relate to the thread gauge measuring division of the Metrology Division based in the UK, and the Company's Megapro screwdriver division. During the fourth quarter of fiscal 2005, the Company began marketing for sale its thread gauge business located in the UK. The carrying values of the assets relating to this entity were initially written down to estimated fair value in the quarter ended March 31, 2005 and further write downs were made in September 2005. On February 28, 2006, the Company concluded the sale of these assets for a nominal consideration. 49 The Megapro screwdriver division was disposed of with effect from September 30, 2003 when the trade and assets of the principal Megapro companies were transferred at their net book value to a management buy-in team headed by the managing director of the Megapro business. In accordance with SFAS No 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company's previously issued Financial Statements have been reclassified to present separately the net operations, cash flows, assets and liabilities of these business segments, where material, as Discontinued Operations. Total losses attributable to discontinued operations were $0.01 million in the three months ended June 30, 2006 (2005: $0.04 million), and were $0.09 million in the nine months ended June 30, 2006 (2005: $0.42 million). FINANCIAL CONDITION Liquidity and Capital Resources Our cash and cash equivalents amounted to $6.32 million at June 30, 2006 ($7.29 million at September 30, 2005), working capital (excluding deferred taxes) totaled $27.32 million at June 30, 2006 ($29.87 million at September 30, 2005) and our stockholders' equity was $19.91 million at June 30, 2006 ($26.20 million at September 30, 2005). Net cash provided by operating activities in the nine month period ended June 30, 2006 was $1.33 million compared to a $3.85 million outflow in the nine months ended June 30, 2005. This increase in net cash of $5.18 million primarily arises from: o increased trading working capital inflows of $5.85 million (note a) o increase in net inflows from other assets and liabilities of $7.73 million (note b) Offset by: o the reduction in net income (adjusted for depreciation, and deferred taxes) of $8.40 million as explained in the commentary on trading results above. The reasons for these trade working capital variances and movements in other assets and liabilities are summarized below. a) Trade Working Capital Variances The net increase in inflows from trade working capital is attributable to: Note $million Increased inventory inflows ..................... (i) 6.05 Decreased trade payable inflows ................. (0.05) Reduced trade receivable inflows ................ (ii) (0.15) ----- Net increase in trade working capital inflows ... 5.85 ===== i) In the nine months ended June 30, 2006 inventory inflows increased by $1.68 million compared to a decrease of $4.37 million in the period ended June 30, 2005. Within most of the UK divisions, and especially in the UK hand tool division, the period to June 30, 2006 witnessed a rigorous inventory reduction program, whereas in the comparable period last year stock levels increased. In 2005 the UK hand tools division saw inventory increases in anticipation of new product launches and this has not been repeated in 2006. This trend was also mirrored in the Metrology, Magnetics and Australasian divisions. Such decreases were offset, however, by higher than usual seasonal inventory increases in our French business. 50 ii) Trade receivable inflows for the nine months to June 30, 2005 benefited by $0.7 million from customer receipts relating to increased sales levels in August and September 2004. As this trend was not repeated in August and September 2005, cash flows for the nine months to June 30, 2006 did not benefit to the same extent from the collection of receivables from prior period sales. b) Variances in Cash Flows attributable to Other Assets and Liabilities. With regard to the net inflows from other assets and liabilities, the main factors contributing to the $7.73 increased inflows are: i) An increase in the non-cash FAS 87 pension charge of $3.15 million; ii) The inclusion, at June 30, 2006, of a restructuring provision of $1.67 million in relation to the closure of the Wednesbury site and the reorganization of the Atlas site. iii) The inclusion, at June 30, 2006, of a provision of $0.65 million in relation to the settlement of then class action litigation. iv) While there has been an increase in annual employer contributions of $0.36 million to the UK pension scheme, in June 2005 there was a special contribution of $3.63 million made to the scheme and this was not repeated in June 2006. The beneficial effect of the above has been diluted by: i) Payments of $0.85 million in respect of the UK manufacturing reorganization program; Cash outflow from investing activities was $1.36 million in the period ended June 30, 2006 compared to an inflow of $7.67 million in the period ended June 30, 2005. The 2005 comparative period included receipts of $8.6 million relating to the net sale proceeds of the property at Boca Raton, Florida and to the partial sale of excess land at our Wednesbury manufacturing site. The 2006 figures include purchases of property, plant and equipment relating to the partial renewal of our UK motor fleet and start up capital expenditure in our newly formed Chinese operation. Additionally, the 2006 cash outflow also includes the purchase of a 25% equity participation in a recently incorporated Chinese magnetic products company. Net cash used by financing activities was $0.77 million in the period ended June 30, 2006 (2005: $0.07 million). The June 2006 increase represents the partial repayment of the UK bank overdraft facility which had been utilized at the end of September 2005 to meet the payment of special pension plan contributions totaling $7.2 million. BANK FACILITIES The UK subsidiaries of Spear & Jackson plc and Bowers Group plc maintain a line of credit of $8.32 million. This is secured by fixed and floating charges on the assets and undertakings of these businesses. Of the total facility, $5.55 million relates to bank overdrafts and $2.77 million is available for letters of credit. These facilities are denominated in British pounds. The overdraft carries interest at UK base rate plus 0.75%. At June 30, 2006 the Company had $0.01 million of borrowings outstanding under the overdraft line (September 30, 2005 $0.75 million) and had $0.23 million in outstanding letters of credit (September 30, 2005: $0.60 million). As a consequence of the special pension contribution of $7.2 million that was paid in two installments in June and September 2005, and the additional funding which will be required to finance the ongoing restructuring initiatives, an open-ended, on demand bridging loan of $5.55 million was also negotiated with the Company's UK bankers. The facility is denominated in British pounds 51 and is secured by a first legal charge over the Company's land and property at Wednesbury, England. It carries interest at UK base rate plus 1%. This facility has not yet been utilized and, following the receipt of funds relating to the sale of the remaining element of the Wednesbury site in July 2007, will now be cancelled. The French, Australian and New Zealand subsidiaries of Spear & Jackson plc maintain short-term credit facilities of $2.86 million denominated in Euros, Australian dollars and New Zealand dollars. The facilities comprise bank overdraft lines, with interest rates ranging from 6.8% to 12.6%, together with facilities for letters of credit and the discount of bills receivable. There was nil outstanding under the overdraft lines at June 30, 2006 (September 30, 2005: nil). At June 30, 2006 there was $0.89 million of letters of credit and bills were outstanding under these facilities (September 30, 2005: $0.9 million). The UK facilities were renewed in December 2005, the Australian facilities were renewed in October 2005, and the French facilities fall due for renewal at various dates in 2006. These lines of credit are subject to the Company's and its subsidiaries' continued credit worthiness and compliance with the applicable terms and conditions of the various facilities. Assuming that the Company maintains compliance with these conditions it is anticipated that all the facilities will be renewed on comparable terms and conditions. The Company's bank accounts held with the HSBC Bank plc by UK subsidiaries of Spear & Jackson plc and Bowers Group plc form a pooled fund. As part of this arrangement the companies involved have entered into a cross guarantee with HSBC Bank plc to guarantee any bank overdraft of the entities in the pool. At June 30, 2006 the extent of this guarantee relating to gross bank overdrafts was $23.29 million (September 30, 2005 $20.40 million). The overall pooled balance of the bank accounts within the pool at June 30, 2006 was an overdraft balance of $0.01 million (September 30, 2005 of $0.75 million). The bank overdraft and other facilities of Spear & Jackson Australia Pty. Limited have been guaranteed by its immediate parent, James Neill Holdings Limited and the bank overdraft and other facilities of Spear & Jackson France SA have been guaranteed by Spear & Jackson plc. Our business operations have been funded from net operating income supplemented, where necessary, by utilization of the UK, French and Australian banking facilities described above. We believe that we have sufficient capital resources, liquidity and available credit under our principal banking facilities supplemented, where necessary, by temporary increases to sustain our current business operations and normal operating requirements for the foreseeable future. As the Company continues to focus its efforts on improving the competitiveness of its worldwide operations, additional funding may be required to finance the restructuring of the non-profitable areas of the Company's divisions and to meet items of significant one-off expenditure. Such expenditure may include: costs associated with the closure and relocation of the Company's manufacturing facility in Wednesbury, England; investment in new capital equipment; further special contribution payments to reduce the pension plan deficit; further reorganization and set up costs, and investment in our business ventures in China; and any other expansion of the Spear & Jackson or Bowers operations. Funding of these initiatives may be obtained through the negotiation of increased bank lending facilities or the sale of surplus assets. OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS The Company makes a range of contractual obligations in the ordinary course of business. The following table summarizes the Company's principal obligations at June 30, 2006: 52 Contractual obligation Payments due by period ($m) -------------------------------------- Total Amount 1 year 1-3 4-5 5 years Committed or less years years or more --------- ------- ----- ----- ------- Capital lease obligations 0.89 0.50 0.39 - - Operating leases (note a) 6.21 1.04 1.98 1.62 1.57 ---- ---- ---- ---- ---- 7.10 1.54 2.37 1.62 1.57 ---- ---- ---- ---- ---- (a) Amounts represent the minimum rental commitments under non-cancelable operating leases. (b) Excluded from the above tables are the amounts payable by the Company to the UK defined benefit pension plan as future funding obligations cannot be accurately forecast beyond the short term. In the years ended September 30, 2006 and September 30, 2007, providing that certain criteria are met, the annual contributions will be fixed at (pound)1.9 million sterling (approximately $3.3 million). In subsequent years advice received from the actuaries to the pension plan indicates that the contributions could increase to (pound)4 million (approximately $7.6 million) per annum. (c) As at June 30, 2006, the Company had letters of credit of $0.40 million outstanding which are secured under the UK and Australian credit facilities. In addition, the Company's French subsidiary had discounted $0.72 million of bills of exchange with recourse. At June 30, 2006, the Company had no material off-balance sheet arrangements other than the non-debt obligations described in contractual obligations, above. OUTLOOK Current forecasts indicate that the Company will generate a net income from continuing operations before income taxes of approximately $0.9 million in the fourth quarter. This is stated after consideration of income and charges arising from unusual and infrequent items. Such forecasted financial performance information is subject to a number of factors and uncertainties as described in the "Forward Looking Statements" and "Risk Factors" sections of this report, above. Operating losses were incurred in quarters 1, 2 and 3 and this trend is anticipated to continue into quarter 4. As in previous quarters, the Company's base trading profit will be eliminated by the non-cash FAS 87 expense which has increased significantly over the comparable charge recognized in the period ended June 30, 2005. As previously explained, based on calculations provided by the Company's actuaries, the annual pension charge has risen by $4.4 million from $4.0 million in 2005 to $8.4 million in the year ended September 30, 2006 and this has had a material adverse effect on the Company's earnings. Base trading profit for the fourth quarter is currently anticipated to be approximately $0.5 million and after deduction of the quarter's pension charge of $2.2 million an operating loss (before unusual and infrequent items and taxation) of $1.7 million is forecast. Earnings in quarter four will also be negatively impacted by the provision of a further $0.9 million of costs in connection with the closure of the Company's manufacturing site in Wednesbury, England and other UK reorganization initiatives. The negative impact of these costs will, however, be offset by a gain of approximately $3.5 million arising on the disposal of the company's UK manufacturing site at Wednesbury that was completed in July 2006. The loss from continuing operations before taxation sustained in the nine months ended June 30, 2005 was $6.8 million and, after inclusion of the anticipated fourth quarter net income before taxation of $0.9 million, the Company therefore currently forecasts a loss before income taxes of $5.9 million for the year ended September 30, 2006. 53 The Company's core UK hand and garden business continued to experience difficult trading conditions in quarter three and this trend is expected to persist in quarter 4. Although certain elements of the business have performed encouragingly, the adverse effects of the general downturn in demand in the UK retail sector and the fierce competition from cheap foreign imports persist. Demand from our export markets, particularly the Far and Middle East, has also softened as the intensive purchasing activity resulting from building projects in the aftermath of the Iraqi conflict has declined. As previously discussed, in the light of these increasingly competitive market conditions, the Company performed a detailed review of its UK manufacturing operations in quarter four of 2005 to identify initiatives to combat declining sales performance and the increase in low price point imports from Far Eastern markets. The implementation of a number of strategies to reduce its ongoing cost base was started in that quarter. This has continued into quarter three of fiscal 2006 and will be further developed in quarter four and beyond. The closure and relocation of the Company's UK manufacturing facility at Wednesbury, England, are to be completed by the end of November 2006. The costs of this exercise, which are anticipated to amount to approximately $2.1 million, comprise employee severance payments, site closure expenses, factory reorganization expenses, plant transfer costs and associated capital expenditure. On July 27, 2006 Spear & Jackson, Inc.'s UK subsidiary, Spear & Jackson Garden Products Limited, completed the sale of the remaining element of the Wednesbury site for (pound)2.6 million sterling (approximately $4.7 million), excluding disposal costs, which will generate a gain on disposal of approximately $3.5 million. Funds realized from the disposal are to be used to finance the closure costs with any excess sale proceeds being applied to other operational initiatives. In addition, in quarter 3, the Company announced that certain manufacturing operations carried out at its Atlas site in Sheffield, England will also cease. The Wednesbury site closure and Atlas reorganization form part of the Company's UK manufacturing reorganization program which has been developed to regenerate and modernize key areas of the hand and garden tools business. The closure will enable the Company to consolidate its two UK hand and garden tool manufacturing sites and will allow the Company to develop a modern manufacturing, warehouse and distribution facility which will be well placed to meet the current and future needs of its customers. We will continue to look at further initiatives to rationalize underperforming areas of the business and to monitor operational infrastructures in the United Kingdom, particularly overhead costs, to ensure that these are as cost efficient as possible and at a level appropriate to the needs of the business. In conjunction with this, the inventory reduction program that has been implemented in quarters one to three will continue, although temporary increases in inventories will occur as a result of inventory builds that will be necessary during the closure of the Wednesbury manufacturing site. As with the Company's UK hand and garden tool businesses, our Australasian and French subsidiaries continue to experience difficult trading conditions because of flat retail demand, increased levels of competition from Far East imports, reduced consumer spending and the increasing trend of some retail groups to expand their own direct import programs. To counteract such factors, the management of these operations has developed and introduced a number of new and extended ranges and promotional programs. Going forward these ranges should deliver incremental sales and margin growth. Additionally, overhead reduction programs are ongoing as management continues to focus on the removal of all excess costs from the businesses. Within the Metrology division the new selling and distribution outlet in Maastricht is now fully operational, and incremental revenue growth is forecast for the rest of the fiscal year. In the future, this revenue and earnings growth will be enhanced by the division's quality control and distribution centre which has been established in Shanghai, China and which is expected to become fully functional in quarter one of fiscal 2007. In the short term, however, profitability will be negatively impacted by the one-time costs associated with the start up of the business. Looking forward, demand for low cost, own manufactured metrology hand tools will continue to face further pressure from the Far East. The Company therefore recognizes the need to focus its UK manufacturing sites on producing more high technology products and measuring solutions. In order to make the Company more competitive in the low technology sectors various, initiatives are being explored including the start up and establishment of its manufacturing and distribution centre in Shanghai. 54 Our businesses will again face the issues of increased costs and margin erosion as a result of raw material, fuel and other utility price increases, interest rate increases, the $4.4 million increase in the FAS 87 pension charge and a weak dollar. This will again put pressure on our margins and overhead costs, and wherever possible, these increases will be passed on though sales price increases. Any strengthening of the US dollar would impact favorably on the business as this would ease the pressure on margins and increase our competitiveness. Current trends, however, suggest a continued weakening which will place additional pressure on our sales into a number of export markets. The level of overhead expenses, particularly legal and professional costs, incurred by our US corporate head office has reduced following the settlement of the SEC suit during 2005. Significant professional costs have continued to be incurred, however, both in relation to the Class and Derivative Action lawsuits and in connection with the appraisal of offers from potential acquirers to purchase all, or part, of the Company's common stock. As discussed under Part II, Item 1, "Legal Proceedings", a Memorandum of Understanding is now in place for the settlement of the Class Action and the disposal of Jacuzzi Brands, Inc.'s majority shareholding in the company was completed on July 28, 2006. This should therefore reduce the ongoing level of legal and professional fees. In the forthcoming quarters we will continue to focus on improving cash generation. As explained above, on January 25, 2006 the Company announced the closure of the remaining element of its manufacturing site at Wednesbury, England. In addition, therefore, to normal trading cash requirements, in the next six months costs will be incurred in the relocation of the Wednesbury manufacturing operation and its consolidation into the Company's principal UK manufacturing site in Sheffield and elsewhere. These costs will be funded from existing core UK bank facilities and from the sale proceeds of approximately $4.7 million relating to the disposal of the Wednesbury manufacturing site. Further significant one-time expenditure will be incurred in August 2006 following the Company's agreement under a Memorandum of Understanding to pay $0.65 million in settlement of the Class Action litigation. This payment will be met from existing US funds. To restrict the pressure that the reorganization and litigation settlement costs will have on the Company's bank facilities, focus will be maintained on the working capital reduction program that has already been initiated. The benefits of this initiative can be seen in the favorable inventory movements in the quarter and emphasis will continue to be placed on strict working capital control in the forthcoming months. Going forward, the success factors critical to our business include sales growth through penetration in new and existing markets; the implementation of strategies to enable us to compete against suppliers based in low cost manufacturing regimes; emphasis on new product development activities so that we can exploit our brand equity and technical expertise to differentiate our product offerings from cheap "me-too" imports; emphasis on promotional campaigns and demonstration tours which focus on high margin product groups and on those high added value areas of the Metrology and Magnetics businesses; reorganization of our manufacturing and overhead bases so that they are as cost efficient as possible; the successful start up of new operations in China and elsewhere; and the maximization of cash resources and the negotiation of additional bank facilities, where required, so that we are able to fund new initiatives and take advantage of market opportunities. Much will also depend on the level of retail demand in our UK, French and Australasian markets. The results for quarters one, two and three were adversely affected by softening demand and a further deterioration in consumer confidence could significantly impact on our earnings levels in quarter four and subsequent periods. As previously reported, the formal resolution of the SEC legal action in fiscal 2005 enabled the Company to move forward so that both short and long term commercial strategies could be formulated and implemented. The stability of the company will be further enhanced by the settlement of the Class Action litigation and by the completion of the sale of Jacuzzi Brands, Inc.'s 61.8% majority shareholding in Spear & Jackson, Inc. to United Pacific Industries Limited ("UPI") on July 28, 2006. The development of detailed business strategies under our new ownership structure is, inevitably, still in its early stages but potential synergies and areas of specific market and commercial expertise have been identified which, going forward, are hoped to be of benefit to both Spear & Jackson, Inc. and UPI. Both UPI and Spear & Jackson, Inc. welcome the alliance which should lead to the formation of an association of size and products that will be able to compete effectively in the modern global trading world. 55 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The principal market risks to which the Company is exposed comprise interest and exchange rate fluctuation, changes in commodity prices and credit risk. INTEREST RATE RISK The Company is exposed to interest rate changes primarily as a result of interest payable on its bank borrowings and interest receivable on its cash deposits. At June 30, 2006 the Company had cash and cash equivalents of approximately $6.32 million and bank borrowings of $0.01 million. Given the current levels of borrowings, the Company believes that a 1% change in interest rates would not have a material impact on consolidated income or cash flows. Holding the same variables constant, a 10% increase in interest rates would again have a negligible effect on interest payable. The nature and amount of our debt and cash deposits may, however, vary as a result of future business requirements, reorganization programs, market conditions, and other factors. The definitive extent of our interest rate risk is not therefore quantifiable or predictable because of the variability of future interest rates and business financing requirements. EXCHANGE RATE RISK The Company has operations in the United Kingdom, France, the Netherlands, Australia, New Zealand and China. These operations transact business in the relevant local currency and their financial statements are prepared in those currencies. Translation of the balance sheets, income statements and cash flows of these subsidiaries into US dollars is therefore impacted by changes in foreign exchange rates. In the nine months ended June 30, 2006 compared to the equivalent period in 2005, the change in exchange rates had the effect of decreasing the Company's consolidated sales by $3.98 million, or 5.08%. Since most of the Company's international operating expenses are also included in local currencies, the change in exchange rates had the effect of decreasing operating expenses by $1.14 million or 4.67% for the nine months ended June 30, 2006 compared to the comparable prior year period. Additionally, our subsidiaries bill and receive payments from some of their foreign customers and are invoiced and pay certain of their overseas suppliers in the functional currencies of those customers and suppliers. Accordingly, the base currency equivalent of these sales and purchases is affected by changes in foreign currency exchange rate. We manage the risk and attempt to reduce such exposure by periodically entering into short term forward exchange contracts. At June 30, 2006 the Company held forward contracts in place to sell Australian and New Zealand dollars to buy approximately 0.54 million US dollars. 56 The contract values were not materially different to the period end value of the contracts. A 10% strengthening or weakening of the US$ against its Australian counterpart could, however, result in the Company suffering losses or benefiting from gains of approximately $0.05 million had no forward contracts been taken out. COMMODITY PRICE RISK The major raw materials that we purchase for production are steel, cobalt, nickel and plastic. We currently do not have a hedging program in place to manage fluctuations in commodity prices. CREDIT RISK Credit risk is the possibility of loss from a customer's failure to make payments according to contract terms. Prior to granting credit, each customer is evaluated, taking into consideration the borrower's financial condition, past payment experience, credit bureau information, and other financial and qualitative factors that may affect the borrower's ability to repay. Specific credit reviews are used in performing this evaluation. Credit that has been granted is typically monitored through a control process that closely monitors past due accounts and initiates collection actions when appropriate. In addition, credit insurance is taken out in respect of a substantial proportion of the Company's non UK receivables as a means of recovering outstanding debt where the customer is unable to pay. At June 30, 2006, the Company made an allowance of $1.46 million in respect of doubtful accounts which management believes is sufficient to cover all known or expected debt non-recoveries. ITEM 4. CONTROLS AND PROCEDURES We carried out an evaluation under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective for recording, processing and summarizing the information we are required to disclose in the reports we file under the Securities Exchange Act of 1934, within the time periods specified in the SEC's rules and forms. Our management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which by their nature can provide only reasonable assurance regarding management's control objectives. There were no significant changes in our internal control over financial reporting during the third quarter of 2006 identified in connection with the evaluation referred to above, that have materially affected, or are reasonably likely to materially effect, our internal control over financial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings On April 15, 2004, the US Securities and Exchange Commission filed suit in the U.S. District Court for the Southern District of Florida against the Company and Mr. Dennis Crowley, its then current Chief Executive Officer/Chairman, among others, alleging violations of the federal securities laws. Specifically with regard to the Company, the SEC alleged that the Company violated the SEC's registration, anti-fraud and reporting provisions. These allegations arise from the alleged failure of Mr. Crowley to accurately report his ownership of the Company's stock, and his alleged manipulation of the price of the Company's stock through dissemination of false information, allowing him to profit from sales of stock through nominee accounts. On May 10, 2004, the Company consented to the entry of a preliminary injunction, without admitting or denying the allegations of the SEC complaint. The SEC is continuing its investigation into pension issues. The Company is offering its full cooperation. 57 As a further measure, the Court appointed a Corporate Monitor to oversee the Company's operations. In addition to Mr. Crowley consenting to a preliminary injunction the Court's order also temporarily barred Mr. Crowley from service as an officer or director of a public company, and prohibited him from voting or disposing of Company stock. Following Mr. Crowley's suspension the Board appointed Mr. J.R. Harrington, a member of its Board of Directors, to serve as the Company's interim Chairman. Mr. William Fletcher, a fellow member of the Company's Board of Directors, who, until October 27, 2004, was the Company's Chief Financial Officer, and who is a director of Spear & Jackson plc, based in Sheffield, is serving as acting Chief Executive Officer. Following extensive settlement negotiations with both the SEC and Mr. Crowley, the Company reached a resolution with both parties. On September 28, 2004, Mr. Crowley signed a Consent to Final Judgment of Permanent Judgment with the SEC, without admitting or denying the allegations included in the complaint, which required a disgorgement and payment of civil penalties by Mr. Crowley consisting of a disgorgement payment of $3,765,777 plus prejudgment interest in the amount of $304,014, as well as payment of a civil penalty in the amount of $2,000,000. In May 2005, the SEC applied to the Court for the appointment of an administrator for the distribution of these funds to the victims of Mr. Crowley's actions, pursuant to the Fair Funds provisions of the Sarbanes-Oxley Act of 2002. On November 18, 2004, the Company signed a Consent to Final Judgment of Permanent Injunction with the SEC pursuant to which the Company, without admitting or denying the allegations included in the Complaint filed by the Commission, consented to a permanent injunction from violation of various sections and rules under the Securities Act of 1933 and the Securities Exchange Act of 1934. Additionally, the Company entered into a Stock Purchase Agreement with PNC Tool Holdings LLC ("PNC") and Mr. Crowley, the sole member of PNC. Under the Stock Purchase Agreement, the Company acquired, for $100, and other good and valuable consideration, 6,005,561 common shares of the Company held by PNC, which represented approximately 51.1% of the outstanding common shares of the Company at December 31, 2004, and which constituted 100% of the common stock held by such entity. The parties also executed general releases in favor of each other subject to the fulfillment of the conditions of the Stock Purchase Agreement. The Stock Purchase Agreement was effected on April 8, 2005, following formal approval by the SEC on February 10, 2005 and, on February 15, 2005 by the U.S. District Court for the Southern District of Florida of the settlement of the litigation captioned SEC v. Dennis Crowley, Spear & Jackson, Inc., International Media Solutions, Inc., Yolanda Velazquez and Kermit Silva (Case No: 04-80354-civ-Middlebrooks). The Stock Purchase Agreement was further conditioned on, among other things, the disgorgement and civil penalty funds being paid by Mr. Crowley. These monies have now been received and are being administered for the benefit of the victims of the alleged fraud by a court appointed administrator pursuant to the fair funds provision of the Sarbanes-Oxley Act of 2002. With the return of the Spear & Jackson shares to the Company by PNC, the stockholders of the Company have had their percentage stock interest increase correspondingly. Jacuzzi Brands, Inc. ("Jacuzzi"), which is a beneficial owner of 3,543,281 shares of common stock, has had its interest in the Company increase to approximately 61.8% of the outstanding common stock. Subsequent to the SEC action a number of class action lawsuits were initiated in the U.S. District Court for the Southern District of Florida by Company stockholders against the Company, Sherb & Co. LLP, the Company's former independent auditor, and certain of the Company's directors and officers, including Mr. Crowley, the Company's former Chief Executive Officer/Chairman, and Mr. Fletcher, the Company's former CFO and current acting Chief Executive Officer. These suits allege essentially the same claims as the SEC suit discussed above. 58 These various class action suits were subsequently consolidated. Thereafter, the defendants filed certain Motions to Dismiss with regard to the Complaint and on October 19, 2005, the U.S. District Court for the Southern District of Florida in Re Spear & Jackson Securities Litigation entered its Order regarding these Motions. The Order denied the Company's motion as well as that of Mr. Crowley, the former Chief Executive Officer of Spear & Jackson. The Court granted the motion to dismiss on behalf of Mr. Fletcher and also granted the motion to dismiss the former independent auditor, Sherb & Co LLP. The class plaintiff has since filed an appeal regarding the trial court's decision to dismiss the case against Sherb& Co. LLP, which appeal is presently pending. No appeal was filed with respect to the decision to dismiss the case against Mr. Fletcher. The Court denied the motion of Spear & Jackson's Monitor to abate the litigation for a six-month period pending the administration of the SEC's restitution fund. The Court also denied the Plaintiff's Motion for clarification and established a new cut-off for discovery until December 19, 2005. The case had initially been set on the Court's two-week calendar beginning 6 March 2006 but the trial date was then reset for October 2006. On July 7, 2006 the US District Court for the Southern District of Florida issued a Memorandum of Understanding ("MOU") which confirmed that the plaintiffs and defendants in the class action had reached an agreement in principle for the settlement of this litigation, subject to Court approval. The MOU outlines the general terms of the settlement ("the Settlement") and is intended to be supplemented by a Stipulation and Agreement of Settlement that is to be issued at a later date. In settlement of the class action the defendants will pay a sum of $650,000 which is to be deposited by S&J into a Qualified Settlement Fund within thirty days of the date of the MOU. Following the execution of the MOU, the lead plaintiffs will commence discovery procedures to confirm the fairness and reasonableness of the Settlement. The plaintiffs retain the right to terminate the Settlement if such discovery reveals that the Settlement is not fair, reasonable and adequate. Subject to these discovery procedures confirming the adequacy of the Settlement, all parties have agreed to use their best efforts to finalize an appropriate Stipulation of Settlement and any other relevant documentation necessary to obtain approval by the Court of the settlement of this action. If the Settlement outlined in the MOU is not approved by the Court or, if subsequently terminated, the terms of the above Settlement will be without prejudice, any settlement amounts already paid will be returned and parties will revert to their litigation positions immediately prior to the MOU. In addition to this class action, on September 6, 2005, the Company was served with a Shareholder Derivative Complaint filed on June 1, 2004 in the Circuit Court for Palm Beach County, Florida (Case No. CA005068). The suit names, in addition to the Company, which is a nominal defendant, present and former directors and the Company's prior independent auditors, Sherb & Co. LLP., as defendants. The suit contains essentially the same factual allegations as the SEC suit, which was filed in April 2004 in the U. S. District Court for the Southern District of Florida, and the series of class actions claims initiated in the U.S. District Court, but alleges state law claims of breaches of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and lack of reasonable care by various or all the defendants. The Company will evaluate the Complaint and file its response at the appropriate time. In addition, the Company is currently in settlement discussions in an effort to resolve the matter. 59 Additionally, the Company is, from time to time, subject to legal proceedings and claims arising from the conduct of its business operations, including litigation related to personal injury claims, customer contract matters, employment claims and environmental matters. While it is impossible to ascertain the ultimate legal and financial liability with respect to contingent liabilities including lawsuits, the Company believes that the aggregate amount of such liabilities, if any, in excess of amounts accrued or covered by insurance, will not have a material adverse effect on the consolidated financial position or results of operations of the Company. Item 6. Exhibits (a) Exhibits 31.1 Certification of acting Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d -14(c) of the Securities Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 350). 31.2 Certification of Chief Financial Officer pursuant to Rule 13a - 14(a) or Rule 15(d) - 14(c) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of acting Chief Executive Officer pursuant to Rule 13a - 14(b) or Rule 15d - 14(c) of the Securities Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.1350). 32.2 Certification of Chief Financial Officer pursuant to Rule 13a - 14(b) or Rule 15d - 14(c) of the Securities Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.1350). 60 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SPEAR & JACKSON, INC. August 14, 2006 /s/ John Harrington, Jr. ----------------------------- John Harrington, Jr. Interim Chairman August 14, 2006 /s/ William Fletcher ----------------------------- William Fletcher Acting Chief Executive Officer (Principal Executive Officer) August 14, 2006 /s/ Patrick J. Dyson ----------------------------- Patrick J. Dyson Chief Financial Officer (Principal Financial and Accounting Officer) 61

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