UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

 

 

 

 

                          (860) 225-5111                          

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No  o

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o   No x

 

79,076,109 shares of the registrant’s common stock were outstanding as of April 28, 2009

 

TABLE OF CONTENTS

 

 

See notes to condensed consolidated financial statements.

 

See notes to condensed consolidated financial statements.

 

See notes to condensed consolidated financial statements.

 

See notes to condensed consolidated financial statements.

THE STANLEY WORKS AND SUBSIDIARIES
NOTES TO (UNAUDITED) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
APRIL 4, 2009

 

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (hereafter referred to as “generally accepted accounting principles”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations for the interim periods have been included and are of a normal, recurring nature. For further information, refer to the consolidated financial statements and footnotes included in The Stanley Works and Subsidiaries’ (collectively, the “Company”) Form 10-K for the year ended January 3, 2009.

 

The prior year financial statements have been adjusted to reflect the adoption of new accounting standards FSP APB 14-1 and SFAS 160 which required retrospective application as described in Note B. Certain prior year amounts have been reclassified to conform to the current year presentation.

 

 

Implemented:   In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position Accounting Principles Board (“APB”) 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”). FSP APB 14-1 applies to convertible debt instruments that have a “net settlement feature” permitting settlement partially or fully in cash upon conversion. The guidance requires issuers of such convertible debt securities to separately account for the liability and equity components in a manner that reflects the issuer’s nonconvertible, unsecured debt borrowing rate. The FSP requires bifurcation of a component of the debt into equity, representative of the approximate fair value of the conversion feature at inception, and the amortization of the resulting debt discount to interest expense in the Consolidated Statement of Operations. FSP APB 14-1 is effective for the Company beginning in January 2009 and has been applied retrospectively, as required. The impact of adoption of this FSP at the March 2007 issuance date of the $330.0 million of Convertible Notes was a $54.9 million decrease in Long-term debt and a $20.9 million increase in associated deferred tax liabilities pertaining to the interest accretion, and a $0.3 million reclassification of debt issuance costs, net of tax, related to the conversion option feature of the Convertible Notes, totaling a $33.7 million increase to equity. As described more fully in Note I Long-term Debt and Financing Arrangements of the Company’s 2008 Form 10K, in November 2008, the Company repurchased and thereby extinguished $10 million of the Convertible Notes. As a result of this November 2008 $10 million partial extinguishment of the Convertible Notes, the debt discount was reduced by $1.2 million and equity decreased $0.7 million net of tax. The remaining $53.7 million debt discount is being amortized to interest expense using the effective interest method through the Convertible Notes maturity in May 2012. Interest accretion recognized under the FSP in each year is as follows: $7.7 million in 2007; $10.3 million in 2008; $10.2 million in 2009; $10.6 million in 2010; $11.0 million in 2011; and $3.9 million in 2012. The net earnings impact of the interest accretion recognized in accordance with the FSP was $1.6 million, or 2 cents per diluted share, in each of the three month periods ended April 4, 2009 and March 29, 2008. Refer to Note I Convertible Notes for further details.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.”(“SFAS 157”). SFAS 157 establishes a single definition of fair value and a framework for measuring fair value, sets out a fair value hierarchy to be used to classify the source of information used in fair value measurements, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. SFAS 157 indicates that an exit value (selling price) should be utilized in fair value measurements rather than an entrance value, or cost

basis, and that performance risks, such as credit risk, should be included in the measurements of fair value even when the risk of non-performance is remote. SFAS 157 also clarifies the principle that fair value measurements should be based on assumptions the marketplace would use when pricing an asset whenever practicable, rather than company-specific assumptions. In February 2008, the FASB issued Staff Positions (“FSPs”) No. 157-1 and No. 157-2, which, respectively, removed leasing transactions from the scope of SFAS 157 and deferred its effective date for one year relative to nonfinancial assets and nonfinancial liabilities except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Accordingly, in fiscal 2008 the Company applied SFAS 157 guidance to: (i) all applicable financial assets and liabilities; and (ii) nonfinancial assets and liabilities that are recognized or disclosed at fair value in the Company’s financial statements on a recurring basis (at least annually). In January 2009, the Company applied this guidance to all remaining assets and liabilities measured on a non-recurring basis at fair value. The adoption of SFAS 157 for these items did not have a material effect on the Company. Refer to Note M Fair Value Measurements for disclosures relating to SFAS 157.

 

In June 2008, the FASB issued FASB Staff Position Emerging Issues Task Force (“EITF”) No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). Under the FSP, unvested share-based payment awards with rights to receive nonforfeitable dividends (whether paid or unpaid) are participating securities that must be included in the two-class method of computing EPS. The Company adopted FSP EITF No. 03-6-1 as of January 3, 2009 and calculated basic and diluted earnings per share under both the treasury stock method and the two-class method for all periods presented. There was no difference in the earnings per share under the two methods for the three months ended April 4, 2009 and March 29, 2008, and the treasury stock method continues to be reported as detailed in Note C Earnings Per Share.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition), establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed, and requires the acquirer to disclose the information needed to evaluate and understand the nature and effect of the business combination. This statement applies to all transactions or other events in which the acquirer obtains control of one or more businesses, including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. For new acquisitions made following the adoption of SFAS 141(R), significant costs directly related to the acquisition including legal, audit and other fees, as well as most acquisition-related restructuring, must be expensed as incurred rather than recorded to goodwill as is generally permitted under SFAS 141. Additionally, contingent purchase price arrangements (also known as earn-outs) must be re-measured to estimated fair value with the impact reported in earnings. With respect to all acquisitions, including those consummated in prior years, changes in tax reserves pertaining to resolution of contingencies or other post acquisition developments will be recorded to earnings rather than goodwill. SFAS 141(R) was applied to the Company’s business combinations completed during the first quarter of 2009. The adoption of SFAS 141(R) did not have a material impact on the Company in the first quarter of fiscal 2009, but may have a significant impact in future periods.

 

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 requires reporting entities to present non-controlling (minority) interests as equity (as opposed to a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and non-controlling interests. SFAS 160 has been applied beginning in fiscal 2009 as required by the Statement and the presentation and disclosure requirements have been applied retrospectively as required for all periods presented. As a result of the implementation of SFAS 160, $19.2 million and $18.5 million relating to non-controlling interests as of April 4, 2009 and January 3, 2009, respectively, have been recast from Other liabilities to Noncontrolling interests within Equity.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS 161”) effective for fiscal years and interim periods beginning after November 15, 2008. This pronouncement requires enhanced disclosures but does not impact the accounting for derivative instruments. The Company adopted SFAS 161 in January 2009 and the related disclosures are in Note G Derivative Financial Instruments.

 

In June 2008, the FASB issued EITF Issue No. 07-5, Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock (“EITF 07-5”), which is effective for the Company in January, 2009. EITF 07-5 requires an entity to reevaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including consideration of the contingent exercise and settlement provisions in such instruments. The Company has several instruments that are in scope of the EITF, all of which were reassessed and continue to be classified in equity. As a result, the adoption of EITF 07-5 had no impact on the Company.

 

Not Yet Implemented:   In December 2008, the FASB issued FSP SFAS No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” This FSP amends SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on disclosures about plan assets of defined benefit pension and other postretirement benefit plans. The FSP requires disclosures about how investment allocation decisions are made, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs and significant concentrations of risk within plan assets. The FSP is effective for fiscal years ending after December 15, 2009, with prospective application. The FSP requires enhanced disclosures but does not change the accounting for pensions. Accordingly, the FSP will not have any impact on the Company’s results of operations, financial condition or liquidity.

 

In April 2009, the FASB issued FSP SFAS No. 107-1 and APB Opinion No. 28-1, Interim Disclosures About Fair Value of Financial Instruments, requiring fair value disclosures for financial instruments that are not reflected in the Condensed Consolidated Balance Sheets at fair value. Prior to the issuance of this FSP, the fair values of those assets and liabilities were required annually but will now be required on a quarterly basis. In addition, quantitative and qualitative information about fair value estimates for all financial instruments not measured in the Condensed Consolidated Balance Sheets at fair value is required. The FSP will be effective for interim reporting periods that end after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The Company will implement the disclosure requirements under this FSP in the second quarter of 2009.

 

 

The following table reconciles the weighted average shares outstanding used to calculate basic and diluted earnings per share for the three months ended April 4, 2009 and March 29, 2008:

 

The following weighted-average stock options and warrants to purchase the Company’s common stock were outstanding during the three months ended April 4, 2009 and March 29, 2008, but were not included in the computation of diluted shares outstanding because the effect would be anti-dilutive:

 

 

 

The components of inventories at April 4, 2009 and January 3, 2009 are as follows (in millions):

 

 

 

During 2008, the Company completed fourteen acquisitions for an aggregate value of $576.6 million. These acquisitions were accounted for as purchases in accordance with SFAS 141. During the first quarter of 2009 the Company completed two minor acquisitions for a combined purchase price of $6.0 million. These two acquisitions were accounted for as purchases in accordance with SFAS 141(R) which was adopted by the Company at the beginning of the current fiscal year. The purchase price allocations for the 2008 acquisitions are largely complete but preliminary with respect to deferred taxes and certain other items. The purchase price allocations for the minor 2009 acquisitions are preliminary with respect to intangible asset valuation, income taxes and other matters. Changes to the purchase price allocation recorded during the first quarter of 2009 primarily relate to income tax adjustments and the finalization of certain integration plans.

 

Changes in the carrying amount of goodwill by segment are as follows (in millions):

 

 

At April 4, 2009, the Company’s restructuring reserve balance was $65.1 million. The Company expects to utilize a majority of these reserves in 2009 and estimates approximately 30% will be expended in 2010 depending upon the timing of actions in Europe as discussed below. A summary of the restructuring reserve activity from January 3, 2009 to April 4, 2009 is as follows (in millions):

 

 

2009 Actions:   In response to further sales volume declines associated with the economic recession, the Company initiated various cost reduction programs in the first quarter of 2009. Severance charges of $8.3 million were recorded during the quarter relating to the reduction of approximately 480 employees. In addition to severance, $0.7 million in charges was recognized for asset impairments. The asset impairments pertain to production and distribution assets written down as a result of the decision to move certain manufacturing activities to lower cost countries and the closure of several small distribution centers. Facility closure costs totaled $0.1 million. Of the amounts charged in the first quarter, $2.0 million has been utilized to date, with $7.1 million of reserves remaining as of April 4, 2009. Of the charges recognized in the first quarter of 2009: $4.2 million pertains to the Security segment, $1.6 million to the Industrial segment; $2.9 million to the CDIY segment; and $0.4 million to non-operating entities.

 

Pre-2009 Actions:   During 2008, the Company initiated cost reduction initiatives in order to maintain its cost competitiveness. A large portion of these actions were initiated in the fourth quarter as the Company responded to deteriorating business conditions resulting from the U.S. economic weakness and slowing global demand, primarily in its CDIY and Industrial segments. Severance charges of $70.0 million were recorded relating to the reduction of approximately 2,700 employees. In addition to severance, $13.6 million in charges were recognized pertaining to asset impairments for production assets and real estate, and $0.7 million for facility closure costs. Of the $85.5 million full year 2008 restructuring and asset impairment charges, $13.8 million, $29.7 million, $35.6 million, and $6.4 million pertained to the Security, Industrial, CDIY, and Non-operating segments, respectively. Also, $1.2 million in other charges stemmed from the termination of service contracts. During 2007, the Company also initiated $11.8 million of cost reduction actions in various businesses entailing severance for 525 employees and the exit of a leased facility. As of January 3, 2009 the reserve balance related to these prior actions totaled $55.3 million. The amount utilized in the first quarter of 2009 totaled $9.9 million. The remaining reserve balance of $44.3 million predominantly relates to actions in Europe under review with the European Works Council process.

Acquisition Related:   During the first quarter of 2009, $2.4 million of reserves were established for an acquisition closed in the latter half of 2008 related to the consolidation of security monitoring call centers. Of this amount $0.8 million was for the severance of approximately 90 employees and $1.6 million related to the closure of a branch facility, primarily from remaining lease obligations. The Company utilized $1.0 million of the restructuring reserves during the first quarter of 2009 established for previous acquisitions and as of April 4, 2009, $13.7 million in acquisition-related accruals remain. The remaining balance primarily relates to approximately $7 million for Facom for which the timing of payments depends upon the actions of certain European governmental agencies as well as the call center consolidation expected to occur in the later quarters of 2009.

 

 

The Company is exposed to market risk from changes in foreign currency exchange rates, interest rates, stock prices and commodity prices. As part of the Company’s risk management program, it uses a variety of financial instruments such as interest rate swap and currency swap agreements, purchased currency options and foreign exchange contracts to mitigate interest rate and foreign currency exposure. Generally, commodity price exposures are not hedged with derivative financial instruments and instead are actively managed through customer pricing initiatives, procurement-driven cost reduction initiatives and other productivity improvement projects. Financial instruments are not utilized for speculative purposes. If the Company elects to do so and if the instrument meets the criteria specified in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended (SFAS 133), management designates its derivative instruments as cash flow hedges, fair value hedges or net investment hedges.

 

A summary of the fair value of the Company’s derivatives recorded in the Consolidated Balance Sheets are as follows (in millions):

 

 

The counterparties to all of the above mentioned financial instruments are major international financial institutions. The Company is exposed to credit risk for net exchanges under these agreements, but not for the notional amounts. The risk is limited to the asset amounts noted above. The Company limits its exposure and concentration of risk by diversifying financial institutions and does not anticipate non-performance by any of its counterparties. Further, as more fully discussed in Note M Fair Value Measurements, the Company considers non-performance risk of its counterparties at each reporting

period and adjusts the carrying value of these assets accordingly. The risk of default is considered remote.

 

CASH FLOW HEDGES

 

For derivative instruments that are so designated at inception and qualify as cash flow hedges, the Company records the effective portions of the gain or loss on the derivative instrument in Accumulated other comprehensive income, a separate component of Shareowners’ Equity, and subsequently reclassifies these amounts into earnings in the period during which the hedged transaction is recognized in earnings. The ineffective portion of the gain or loss, if any, is immediately recognized in the same caption where the hedged items are recognized in the Consolidated Statements of Operations, generally Other-net. The Company measures hedge effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item, both of which are based on forward rates. For interest rate swaps designated as cash flow hedges, the Company measures the hedge effectiveness by offsetting the change in the variable portion of the interest rate swap with the change in the expected interest flows due to fluctuations in the LIBOR based interest rate.

 

There is a $3.2 million and $4.8 million after-tax gain reported for cash flow hedge effectiveness in Accumulated other comprehensive income as of April 4, 2009 and January 3, 2009, respectively. Of this amount $2.3 million is expected to be reclassified to earnings as the hedged transactions occur or as amounts are amortized within the next 12 months. The ultimate amount recognized will vary based on fluctuations of the hedged currencies through the maturity dates. The table below details pre-tax amounts reclassified from Accumulated other comprehensive income into earnings during the periods in which the underlying hedged transactions affected earnings; due to the effectiveness of these instruments in matching the underlying on a net basis there was no significant earnings impact.

 

 

The impact of de-designated hedges was a pre-tax gain of $0.6 million in the first quarter of 2009. The hedged items impact to the income statement for the first quarter of 2009 was a loss of $2.9 million to Cost of sales and a loss of $6.4 million to Other-net. There was no impact related to the interest rate contracts hedged items.

 

Interest Rate Contracts

 

The Company enters into interest rate swap agreements in order to obtain the lowest cost source of funds within a targeted range of variable to fixed-rate debt proportions. At April 4, 2009, the Company has outstanding contracts fixing the interest rate on its $320.0 million floating rate convertible notes (LIBOR less 350 basis points) at 1.43%.

 

Foreign Currency Contracts

 

Forward contracts:   Through its global businesses, the Company enters into transactions and makes investments denominated in multiple currencies that give rise to foreign currency risk. The Company and its subsidiaries regularly purchase inventory from its non-United States dollar subsidiaries that creates volatility in the Company’s results of operations. The Company utilizes forward contracts to

hedge these forecasted purchases of inventory. Gains and losses reclassified from Accumulated other comprehensive income for the effective and ineffective portions of the hedge as well as any amounts excluded from effectiveness testing are recorded to Cost of sales. As of April 4, 2009 the notional values of the hedge contracts is as follows (includes $36.7 million which is de-designated):

 

 

Currency swaps:   The Company and its subsidiaries have entered into various inter-company transactions whereby the notional values are denominated in currencies other than the functional currencies of the party executing the trade. In order to better match the cash flows of its inter-company obligations with cash flows from operations, the Company enters into currency swaps. The notional value of the United States dollar exposure and the related hedge contracts outstanding as of April 4, 2009 is $150.0 million.

 

FAIR VALUE HEDGES

 

For derivative instruments that are so designated at inception and qualify as fair value hedges, the Company records the changes in the fair value of the derivative instrument as well as the hedged item in the income statement within the same caption. The Company measures effectiveness by comparing the cumulative change in the hedged contract with the cumulative change in the hedged item, both of which are based on forward rates.

 

Interest Rate Risk

 

In an effort to optimize the mix of fixed versus floating rate debt in the Company’s capital structure, the Company enters into interest rate swaps. In January 2009, the Company entered into interest rate swaps with notional values which equaled the Company’s $200.0 million 4.9% notes due 2012 and $250.0 million 6.15% notes due 2013. The interest rate swaps effectively converted the Company’s fixed rate debt to floating rate debt based on LIBOR, thereby hedging the fluctuation in fair value resulting from changes in interest rates. A summary of the fair value adjustments relating to these swaps for the first quarter of 2009 are as follows (in millions):

 

 

In addition to the amounts in the table above, the net swap settlements that occur each period and amortization of terminated swaps are also reported in interest expense, and amounted to a $3.0 million gain for the first quarter of 2009. Interest expense for the period was $6.4 million on the underlying debt.

 

NET INVESTMENT HEDGES

 

Foreign Exchange Contracts

 

The Company utilizes net investment hedges to offset the translation adjustment arising from remeasurement of its investment in the assets, liabilities, revenues, and expenses of its foreign subsidiaries. For derivative instruments that are designated at inception and qualify as net investment hedges, the Company records the effective portion of the gain or loss on the derivative instrument in Accumulated other comprehensive income. The Company measures effectiveness by comparing the cumulative change in the hedged contract with the cumulative change in the hedged item, both of which are based on forward rates. The total after-tax amount in Accumulated other comprehensive income was a loss of $2.4 million and $6.6 million at April 4, 2009 and January 3, 2009, respectively. In December 2008 the Company entered into a foreign exchange contract to hedge its net investment in euro assets, as detailed in the pre-tax amounts below (in millions).

 

 

 

The income statement impacts related to derivatives not designated as hedging instruments under SFAS 133 for the first quarter of 2009 is as follows (in millions):

 

In January 2009, a Great Britain pound currency swap matured, resulting in a cash payment of $10.5 million.

 

 

In January 2009, the Company purchased from financial institutions over the counter 15-month capped call options on 3 million shares of its common stock for an aggregate premium of $16.4 million, or an average of $5.47 per option. In accordance with EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” the premium paid was recorded as a reduction to equity. The gain or loss on the option will depend on the actual market price of the Company’s stock on exercise dates which occur in March 2010. The contracts for each of the three series of options generally provide that the options may, at the Company’s election, be cash settled, physically settled or net-share settled (the default settlement method). Each series of options has various expiration dates within the month of March 2010. The options will be automatically exercised if the market price of the Company’s common stock on the relevant expiration date is greater than the applicable lower strike price (i.e. the options are “in-the-money”). If the market price of the Company’s common stock at the expiration date is below the applicable lower strike price, the relevant options will expire with no value. If the market price of the Company’s common stock on the relevant expiration date is between the applicable lower and upper strike prices, the value per option to the Company will be the then-current market price less that lower strike price. If the market price of the Company’s common stock is above the applicable upper strike price, the value per option to the Company will be the difference between the applicable upper strike price and lower strike price. The aggregate fair value of the options at April 4, 2009 was $13.9 million.

 

 

 

FSP APB 14-1 applies to the Company’s $320.0 million in outstanding convertible notes (the “Convertible Notes”) that were issued on March 20, 2007 and are due May 17, 2012. At maturity, the Company is obligated to repay the principal in cash, and may elect to settle the conversion option value, if any, as detailed further below, in either cash or shares of the Company’s common stock. The Convertible Notes bear interest at an annual rate of 3-month LIBOR minus 3.5%, reset quarterly (but never less than zero), and initially set at 1.85%. Interest is payable quarterly commencing August 17, 2007. At the March 20, 2007 issuance date the estimated market rate of interest for the Convertible Notes would have been 5.13% (the non-convertible or “straight-debt” borrowing rate) without the conversion option feature. The FSP requires the Company to record non-cash interest accretion to reflect the straight-debt borrowing rate on the Convertible Notes and to recast prior periods for comparability. The Convertible Notes are unsecured general obligations and rank equally with all of the Company’s other unsecured and unsubordinated debt. The Convertible Notes were issued as a component of the Company’s Equity Units and are pledged as collateral to secure the holders’ obligations to purchase common stock under the terms of the Equity Purchase Contract component of these units, as described more fully in Note I Long-Term Debt and Financing Arrangements in the Company’s 2008 Form 10-K.

 

The Company is obligated to remarket the Convertible Notes commencing on May 10, 2010 to the extent that holders of the Convertible Note element of an Equity Unit or holders of separate Convertible Notes elect to participate in the remarketing. Holders of Equity Units may elect to have the Convertible Note element of their units not participate in the remarketing by the following means: create a Treasury Unit (replace the Convertible Notes with zero-coupon U.S. Treasury securities as collateral to secure their performance under the Equity Purchase Contracts); settle the Equity Purchase Contracts early; or settle the Equity Purchase Contracts in cash prior to May 7, 2010. Upon a successful

remarketing of the Convertible Notes, the proceeds will be utilized to satisfy in full the Equity Unit holders’ obligations to purchase the applicable amount of the Company’s common stock under the Equity Purchase Contracts on May 17, 2010. In the event the remarketing of the Convertible Notes is not successful, the holders may elect to pay cash or to deliver the Convertible Notes to the Company as consideration to satisfy their obligation to purchase common shares under the Equity Purchase Contract.

 

The conversion premium for the Convertible Notes is 19.0%, equivalent to the initial conversion price of $64.80 based on the $54.45 value of the Company’s common stock at the date of issuance. Upon conversion on May 17, 2012 (or in respect of a cash merger event), the Company will deliver to each holder of the Convertible Notes $1,000 cash for the principal amount of each note. Additionally at conversion, to the extent, if any, that the conversion option is “in the money”, the Company will deliver, at its election, either cash or shares of the Company’s common stock based on an initial conversion rate of 15.4332 shares (equivalent to the initial conversion price set at $64.80) and the applicable market value of the Company’s common stock. The ultimate conversion rate may be increased above 15.4332 shares in accordance with standard anti-dilution provisions applicable to the Convertible Notes or in the event of a cash merger. For example, an increase in the ultimate conversion rate will apply if the Company increases the per share common stock dividend rate during the five year term of the Convertible Notes; accordingly such changes to the conversion rate are within the Company’s control under its discretion regarding distributions it may make and dividends it may declare. Also, the holders may elect to accelerate conversion, and “make whole” adjustments to the conversion rate may apply, in the event of a cash merger or “fundamental change”. Subject to the foregoing, if the market value of the Company’s common shares is below the conversion price at conversion, (initially set at a rate equating to $64.80 per share), the conversion option would be “out of the money” and the Company would have no obligation to deliver any consideration beyond the $1,000 principal payment required under each of the Convertible Notes. To the extent, if any, that the conversion option of the Convertible Notes becomes “in the money” in any interim period prior to conversion, there will be a related increase in diluted shares outstanding utilized in the determination of the Company’s diluted earnings per share in accordance with the treasury stock method prescribed by SFAS No. 128, Earnings Per Share. At April 4, 2009, the conversion option is out of the money and accordingly the Company does not have any obligation beyond the $320.0 million of outstanding convertible notes.

 

The principal amount of the Convertible Notes was $320.0 million at both April 4, 2009 and January 3, 2009. The net carrying value and unamortized discount of the Convertible Notes was $286.8 million and $33.2 million, respectively, at April 4, 2009 and $284.3 million and $35.7 million, respectively, at January 3, 2009. The remaining unamortized balance will be recorded to interest expense through the Convertible Notes maturity in May 2012. The equity component carrying value was $32.9 million at both balance sheet dates.

 

No interest expense was recorded for the contractual interest coupon on the Convertible Notes for the periods presented because it would be less than a zero interest rate based upon the applicable 3-month LIBOR minus 3.5% rate in these periods. The Company has outstanding derivative contracts fixing the interest rate on the $320.0 million floating rate Convertible Notes (3-month LIBOR less 350 basis points) at 1.43% and recognized $1.2 million of interest expense pertaining to these interest rate swaps in each of the three month periods ending April 4, 2009 and March 29, 2008. The non-cash interest expense accretion related to the amortization of the liability balance as required under the FSP totaled $2.5 million for both the first quarter of 2009 and the first quarter of 2008. The interest expense recognized on the $320.0 million of Convertible Notes reflecting both the fixed interest rate swaps and the interest accretion required under the FSP represented an effective interest rate of 5.1% for the first quarter of 2009 and 5.2% for the first quarter of 2008.

 

In order to offset the common shares that may be deliverable pertaining to the previously discussed conversion option feature of the Convertible Notes, the Company entered into Bond Hedges with certain major financial institutions. The Company paid the financial institutions a premium of $49.3 million for the Bond Hedge which was recorded, net of $14.0 million of anticipated tax benefits,

as a reduction of Shareowners’ Equity. The terms of the Bond Hedge mirror those of the conversion option feature of the Convertible Notes such that the financial institutions may be required to deliver shares of the Company’s common stock to the Company upon conversion at its exercise in May 2012. To the extent, if any, that the conversion option feature becomes “in the money” during the five year term of the Convertible Notes, diluted shares outstanding will increase accordingly. Because the Bond Hedge is anti-dilutive, it will not be included in any diluted shares outstanding computation prior to its maturity. However, at maturity of the Convertible Notes and the Bond Hedge in 2012, the aggregate effect of these instruments is that there will be no net increase in the Company’s common shares.

 

J. Commitments and Contingencies

 

The Company is involved in various legal proceedings relating to environmental issues, employment, product liability and workers’ compensation claims and other matters. The Company periodically reviews the status of these proceedings with both inside and outside counsel, as well as an actuary for risk insurance. Management believes that the ultimate disposition of these matters will not have a material adverse effect on the Company’s operations or financial condition taken as a whole.

 

The Company’s policy is to accrue environmental investigatory and remediation costs for identified sites when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. As of April 4, 2009 and January 3, 2009, the Company had reserves of $28.4 million and $28.8 million, respectively, primarily for remediation activities associated with company-owned properties as well as for Superfund sites. The range of environmental remediation costs that is reasonably possible is $18.9 million to $52.0 million which is subject to change in the near term.

 

 

The Company’s financial guarantees at April 4, 2009 are as follows (in millions):

 

 

The Company has guaranteed a portion of the residual value arising from its synthetic lease and U.S. master personal property lease programs. The lease guarantees aggregate $53.8 million while the fair value of the underlying assets is estimated at $63.7 million. The related assets would be available to satisfy the guarantee obligations and therefore it is unlikely the Company will incur any future loss associated with these lease guarantees. The Company has issued $35.1 million in standby letters of credit that guarantee future payments which may be required under certain insurance programs. The Company provides various limited and full recourse guarantees to financial institutions that provide financing to U.S. and Canadian Mac Tool distributors for their initial purchase of the inventory and truck necessary to function as a distributor. In addition, the Company provides limited and full recourse guarantees to financial institutions that extend credit to certain end retail customers of its U.S. Mac Tool distributors. The gross amount guaranteed in these arrangements is $15.0 million and the $13.6 million carrying value of the guarantees issued is recorded in debt and other liabilities as appropriate in the consolidated balance sheet.

 

The Company provides product and service warranties which vary across its businesses. The types of warranties offered generally range from one year to limited lifetime, while certain products carry no warranty. Further, the Company at times incurs discretionary costs to service its products in connection

with product performance issues. Historical warranty and service claim experience forms the basis for warranty obligations recognized. Adjustments are recorded to the warranty liability as new information becomes available.

 

The changes in the carrying amount of product and service warranties for the three months ended April 4, 2009 are as follows (in millions):

 

 

 

Following are the components of net periodic benefit cost for the three months ended April 4, 2009 and March 29, 2008 (in millions):

 

 

 

SFAS 157 defines, establishes a consistent framework for measuring, and expands disclosure requirements about fair value. SFAS 157 requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

 

Level 1 — Quoted prices for identical instruments in active markets.

 

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs and significant value drivers are observable.

 

Level 3 — Instruments that are valued using unobservable inputs.

 

The Company holds various derivative financial instruments that are employed to manage risks, including foreign currency and interest rate exposures. These financial instruments are carried at fair value and are included within the scope of SFAS 157. The Company determines fair value of derivatives through the use of matrix or model pricing, which utilize verifiable inputs such as market interest and currency rates. When determining the fair value of these financial instruments for which Level 1 evidence does not exist, the Company considers various factors including the following: exchange or

market price quotations of similar instruments, time value and volatility factors, the Company’s own credit rating and the credit rating of the counter-party.

 

The following table presents the fair value and the hierarchy levels, for financial assets and liabilities that are measured at fair value (in millions):

 

 

The Company recorded $0.7 million in restructuring related asset impairments during the first quarter, as discussed in Note F Restructuring. Fair value for impaired production assets was based on the present value of discounted cash flows. This included an estimate for future cash flows as production activities are phased out as well as auction values (prices for similar assets) for assets where use has been discontinued or future cash flows are minimal. The assumptions represented Level 3 inputs.

 

 

During 2008, the Company sold its CST/berger laser leveling and measuring business to Robert Bosch Tool Corporation, for $196.7 million in cash and recorded an $83.2 million after-tax gain as a result of the sale. The Company sold three other smaller businesses during 2008 for total cash proceeds of $7.9 million and a total after-tax loss of $0.2 million. The divestitures of these businesses were made pursuant to the Company’s growth strategy which entails a reduction of risk associated with certain large customer concentrations and reallocation of capital resources to increase shareowner value.

 

CST/berger, which was formerly in the Company’s CDIY segment, manufactures and distributes surveying accessories as well as building and construction instruments primarily in the Americas and Europe. Two of the small businesses that were sold were part of the Security segment, while the third minor business was part of the Industrial segment.

 

In accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the results of operations of CST/berger and the three small businesses have been reported as discontinued operations. The operating results of the four divested businesses are summarized as follows (in millions):

 

 

There were no assets or liabilities classified as held for sale in the Consolidated Balance Sheets at April 4, 2009 and January 3, 2009.

 

 

On May 1, 2009, the Company committed to repurchase $103.0 million of its junior subordinated debt securities issued in November 2005 for $58.7 million in cash. The Company expects the transaction will result in a pretax gain of approximately $44 million. The cash settlement of the transaction will occur on May 6, 2009.

 

 

OVERVIEW

 

The Company is a diversified worldwide supplier of tools and engineered solutions for professional, industrial, construction, and do-it-yourself (“DIY”) use, as well as engineered and security solutions for industrial and commercial applications. Its operations are classified into three business segments: Security, Industrial and Construction & DIY (“CDIY”). The Security segment is a provider of access and security solutions primarily for retailers, educational, financial and healthcare institutions, as well as commercial, governmental and industrial customers. The Company provides an extensive suite of mechanical and electronic security products and systems, and a variety of security services. These include security integration systems, software, related installation, maintenance, monitoring services, healthcare solutions, automatic doors, door closers, exit devices, hardware and locking mechanisms. Security products are sold primarily on a direct sales basis and in certain instances, through third party distributors. The Industrial segment manufactures and markets: professional industrial and automotive mechanics tools and storage systems; assembly tools and systems; plumbing, heating and air conditioning tools; hydraulic tools and accessories; and specialty tools. These products are sold to industrial customers and distributed primarily through third party distributors as well as direct sales forces. The CDIY segment manufactures and markets hand tools, consumer mechanics tools, storage systems, pneumatic tools and fastener products which are principally utilized in construction and do-it-yourself projects. These products are sold primarily to professional end users as well as consumers, and are distributed through retailers (including home centers, mass merchants, hardware stores, and retail lumber yards).

 

Over the past several years, the Company has generated strong free cash flow and received substantial proceeds from divestitures that enabled a transformation of the business portfolio. Beginning with the first significant security acquisitions in 2002, Stanley has consummated $2.8 billion in acquisitions and pursued a diversification strategy to enable profitable growth. The strategy involves industry, geographic and customer diversification, as exemplified by the expansion of security solution product offerings, the growing proportion of sales outside the U.S., and the deliberate reduction of the Company’s dependence on sales to U.S. home centers and mass merchants. Sales outside the U.S. represented 41% of the total in 2009, up from 29% in 2002. Sales to U.S. home centers and mass merchants have declined from a high point of approximately 40% in 2002 to 14% in 2009. The reallocation of capital to higher growth businesses and attendant diversification of the revenue base helped position Stanley to weather the current challenging economic times. In the near term, management will concentrate primarily on debt reduction, driving operating efficiencies through the Stanley Fulfillment System disciplines, and the integration of acquisitions to achieve further synergies. Management continues to monitor markets for attractive acquisition targets. In the medium term the Company intends to pursue further growth opportunities in security solutions, industrial tools, healthcare markets and emerging markets while maintaining focus on the valuable branded tools and storage businesses. Refer to the “Business Overview” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2009 for additional strategic discussion.

 

First Quarter 2009 Cost Actions and Outlook

 

The global economic downturn deepened during the first quarter as evidenced by a 19% decline in sales unit volumes versus the prior year. A contingency cost reduction plan was developed early in the year to protect earnings and cash flow in the event estimated full year 2009 volume declines were greater than 10-12%. Management elected to implement this plan as the quarter progressed and projections evolved to indicate that full year sales volume declines were more likely to be between 13-15%, with smaller volume declines in the back half of the year as comparisons become easier.

The Company estimates that full year diluted earnings per share will be in the range of $2.00 to $2.50 based on the following assumptions: