史丹利百得 (SWK) 2003 Q2 法說會逐字稿

Good afternoon. My name is Melissa, and I will be your conference facilitator. At this time, I would like to welcome everyone to The Stanley Works Second Quarter Earnings Conference Call.

Mr. Gould, you may begin your conference.

Thank you, Melissa, and thank you all for joining us today. With me are John Trani, Chairman and CEO, and Jim Loree, CFO. Before we begin, I'd like to call your attention to the Second Quarter Earnings Release we issued this morning, and also two press releases we issued last Tuesday, the 15th, about our dividend and a new Director on our board.

If you need to reference those releases, they're at our website www.stanleyworks.com under the investor relations section. Jim will open the presentation in a minute with a short review of the releases and a few remarks and then Jim will highlight several financial matters in the release and we will turn it back to Melissa who will explain the Q and A procedure.

We remind you that to comply with (inaudible) our earnings guidance will be given at the outset of each quarter as we'll do today, and we won't comment on it afterwards. If business conditions change our guidance materially for example more than 10% either way, we will issue a press release and conduct a conference call at that time. We've logged an hour for the call. We expect it to conclude at about 3:00 p.m. The call is recorded for replay which will be available to anyone who wants to listen beginning at 4:00 Eastern time today through the end of the day Saturday, the 26th. If you'd like to listen to today's call, it's available at 1-800-642-1687, using the code 172-1273. And then after Saturday, it will be available in the investor relation section of our website. No password will be required for either replay. If you have any questions, call me after the call at 860-827-3833.

Finally, two reminders. First, that in this discussion as well as our press release, reported earnings are supplemented with related amounts and percentages excluding restructuring cost, impairment charges and certain other costs, and we believe these supplemental measures provide useful information, removing the effective variances in reported results that are not indicative of fundamental changes in our company's earning capacity. So full reconciliations with the reported amounts are included in the press release and have been posted to our website.

And secondly, certain statements contained in this discussion by the various Stanley participants are forward-looking and may differ materially from what's expected or implied. We direct you to the cautionary statement in form 8-K that we filed with the release today. With that, I'll turn the teleconference over to John.

Good afternoon, everyone. Today we reported second quarter earnings of 14 cents per fully diluted share versus 72 cents last year. The results include pre-tax restructuring, asset impairment and other charges totaling $48 million, or 38 cents per share. The rest of our comments will exclude these charges and accordingly earnings of 52 cents or at the upper end of our forecasted range of 48 to with 52 cents. That's down 20 cents from last year, and clearly reflects the marketplace difficulty being encountered.

Sales decline organically reflecting the weak economy. Asset utilization in the U.S. continues at about 68% in durable goods, and that is partially due to the increased globalization of production. The exit of the Mac Direct business and the Home Depot entry doors loss in the fourth quarter of last year all contributed to the decline. The good news is that the rest of our business other than Mac and entry doors experienced a slight increase in the quarter.

While second quarter free cash flow was below last year, the $116 million of operating cash flow in the first half was about 11% higher than 2002, and free cash flow before dividends is already over $100 million, about 37% ahead of last year's record pace. Regarding operation 15, all planned actions were carried out. Mac Direct was exited in May, and the anticipated work force reduction of 1,000 people is 80% complete. With the 300 person reduction in the first quarter, our employment is down over at 1,100 people year-to-date, with about 2 to 300 more likely in the later of the year. No one likes these actions, but that's the reality of the markets we're currently operating in.

The result was 250 basis points of sequential operating margin improvement, just shy of the 12% target. Looking forward, we are hopeful but cautious regarding the very real monetary and fiscal stimuli recently enacted. Nonetheless, low capacity utilization in the prior spending bubble will take time in our view to correct themselves. Given retail run rates and their conservative purchases born of significant overall inventory levels, primarily in private label products, the sales picture is cloudy at best. With continuing carryover of the Home Depot doors loss and the Mac Direct unwinding, we expect sales ex-best Access to continue to be difficult for the remainder of the year. While the elements of operation 15 will be delivered, absent a stronger sales outlook than we currently see, further operating margin rate progress will be made, but the 15% target will not be reached this year. Jim Loree will cover the financial details of today's announcements including operation 15. This year reduction trades action and the outlook for earnings for the rest of this year. Following Jim's comments, I'll review a few other events from the second quarter and we'll take your questions. Jim?

Okay. Thank you, John. Starting with sales, sales increased to 8% in total. Aside from best sales declined 2% including the 4% increase from currency. May 8th guidance for sales was to be flat aside from Best Access and Mac, in fact sales on this basis were flat. We also guided to a slight uptick in gross margins versus the first quarter rate. The actual rate was 33.5% in the second quarter versus 33.3 in the first, again consistent with our guidance. On a sequential basis comparing second quarter to first quarter of 2003, SG&A was $174 million before charges, and decreased $8 million. This reflects the benefit from operation 15 and other actions as anticipated. We were hoping for slightly better, but we encountered some unfavorable exchange as well as higher than planned executive relocation expenses. Net interest increased to $7 million versus $6 million in the second quarter of last year due to higher debt levels from funding the best acquisition in the first piece of the equity hedge settlement.

However, sequentially net interest expense declined from $8 million in the first quarter due to overall lower rates on our floating debt. Other net increased to $8 million versus a credit of $3 million in 2002. This is attributable to a loss incurred upon the sale of assets versus a gain of $3 million in the prior year, as well as the impact of amortizing intangibles acquired and lower profitability of the MAC Advantage financing program. We recorded 48 million of charges in the second quarter as follows. 3 million in cost of sales for impairment of Mac Direct inventories, $20 million in SG&A, $12 million mostly from Mac Direct receivables included in that 12 million in SG&A and $8 million of CEO retirement cost. $25 million of charges were incurred below operating income, including $9 million of operation 15 severance, and 13 million related to Mac Direct and 3 million of other impairments, all related to the operation 15 initiative. A table is shown within the relief depicting the charge components and the reconciliation on page 8 clarifies their geography within the income statement. We will continue to evaluate the Mac Direct assets and develop plans for the remaining operation-15 actions that could and likely will be further charges throughout 2003 as anticipated, and this is highlighted in our GAAP guidance.

I might add that the CEO retirement costs represent the accrual of the components of John's severance in the contract from mid 2000. These costs are essentially for two years salary and bonus and pension benefits agreed upon at that time. We added $213 million of debt upon the April and June settlements of our equity hedge positions. Additionally, we repatriated $3 million of cash from Europe and together with $34 million of free cash flow after dividends generated in the second quarter, we repaid $55 million of debt.

Although debt increased by a $158 million in the quarter, our debt to cap ratio is 53.8, up 10.7% from March and up 11.7% from year-end 2002, and we expect to deploy free cash flow to debt reduction in coming quarters. The effect upon our share count was a reduction of 8.4 million shares so the fully diluted share amount is now 82 million, down from essentially 90 million at the beginning of the quarter.

Inventories grew 10 million versus the first quarter and working capital consumed $26 million of cash. The inventory increase has resulted in excellent fill rates. We are serving customers well and are prepared to continue that, even if the third quarter demand outlook improves. We've adjusted third quarter production rates downward and hand tools, mechanics tools and fastening, where most of the inventory growth has occurred and we also intensifying efforts to turn slow-moving stock.

Moving to cash flow, cash from operations was $64 million versus $84 million in the same quarter last year, reflecting the working capital usage halfway through the year, free cash flow before dividends was $100 million versus $73 million a year ago. Across Stanley, capital expenditures were only $8 million versus $13 million a year ago.

Our decapitalization plans are on track and we expect a net cash benefit from them in 2003. When we issued our press release on May 8th with full year guidance, we indicated an expectation that second half sales would be down 1 to 2% versus prior year aside from best, then we ran out gross margin at then current rates, figured out how much cost we needed to take out to get back to 15% exiting the year. That was the origin of the actions comprising operation-15. Since then, the actions John noted have been executed. The costs are coming out. The remaining actions will be diligently pursued, and the operation-15 cost reductions are on schedule to deliver the expected $100 million of annual savings.

Second half sales as John mentioned, however, do not appear to be on track to deliver expected levels, although Best is clearly and solidly on track to do their part. Accordingly, we indicated in our release today that we expect to earn 60 to 63 cents per fully diluted share aside from operation-15 related charges and impairments, and further, we indicated that the current First Call consensus of $2.20 per share on the same basis appears reasonable as an approximation of this year's earnings.

To summarize, we continue to respond to a difficult environment. Today's outlook arises primarily from a lower sales picture in the second half, and now the mission of our sales teams is to prove us wrong and outperform. And now I will turn it back over to John.

Thank you, Jim. In summary, the weak economy, customer inventory reductions that are continuing, and higher commodity costs continue to weigh upon earnings, but we're taking decisive actions and generating strong cash flows. And it's beginning to become apparent that we made one terrific acquisition in Best Access.

I'd like to mention a few reasons for optimism. On the last call, we stated that our Wal-Mart share and average bill were increasing in expected double-digit sales growth for at least the next two years. POS is up at a double digit rate at Wal-Mart, and the company continues to reduce its weeks of stock on hand, unfortunately.

Today consumer walking into a Wal-Mart store will see a dramatic increase in the presence of our mechanics tools sets under the recently launched Stanley Pro line. Tool sets account for about 70% of industry sales, and Wal-Mart has added an eight-foot bay of our tool sets. Their quality is above that of comparable nationally branded mechanics tools. Merchandising plans are currently being finalized for early September deployment to ensure that consumers are informed about this new line. Our efforts with Wal-Mart are working. In just two years, Wal-Mart has jumped on to the screen as one of the top three destinations for hand tools in the eyes of the consumers we surveyed.

Second, the dividend was increased last week for the 36th consecutive time as we told you in May. That record places Stanley among the top 15 of the S&P 500 in the longevity of dividend increases, our approximate 3.5% cash dividend yield is nearly double that of the S&P 500.

Third, the Access Solutions Group had an excellent quarter and continues to justify its place as a significant growth vehicle. Access Technologies had another double digit sales increase, primarily due to share gains in the retail marketplace from contract wins. With the only direct national service system, Access has a unique position to leverage. Best, our largest acquisition ever, had a record operating margin rate and built its backlog, which had been reduced from the middle of 2002 until the first quarter of this year. It grew its sales force during the quarter and continues to put in place those processes to build a great business.

Mac Tools post the exit of Mac Direct was solidly profitable in June. Conversions from direct to traditional were better than anticipated. In addition the net of new traditional distributors added equaled 51, the highest in several years and the third quarter outlook here is positive as well.

Some of you may be aware of Jesse James who has a program called "Monster Garage," one of the top rated shows on the Discovery Channel seen by an estimated 9 million viewers weekly. Mac Tools has signed a five-year marketing agreement with Jesse and intends to have a signature series with his name across a wide breadth of products. For our traditional Mac distributors, this is also a benefit. They too will have rights to distribute Jesse James tools as well as both Jesse James branded and Jesse James Mac co-branded apparel, and other merchandise.

Finally, the industrial channel had a slight glimmer of hope with POS for Stanley at Granger positive for the first time this year in June. As you know, Stanley will be Granger's sole mechanics tools supplier in the premium end of the market next year. The back half marketing program this year will create 2 million exposures through a variety of direct mail vehicles. For example, each of Granger's 1,200 salespeople will have to set up three new Stanley Proto customers to qualify for a sales contest, so we've been invited to train all their salespeople at 10 regional seminars in August. We're very happy to announce the election of Virgis Colbert to our Board of Directors next week, a senior executive with Miller Brewing in Milwaukee. He brings years of experience and a wealth of knowledge in plan operations, logistics, distribution and materials management: There will be ample and immediate opportunity for Virgis to make a positive impact here. Lastly on May 20th, I announced my retirement from Stanley at the end of the year. The rationalization phase of the company's transformation has been completed. Earnings are improving. Cash flow is strong. The organization simplified and a capable management team is in place.

The next phase, the expansion phase, began in earnest with last year's combination of businesses to form the tools group and with the addition of Best Access leading to the formation of the Access Solutions business. With these steps in place, the transition of the portfolio away from home center dependence and the transfer of our company's culture to acquisitive growth are well underway. The opportune time to transition to a new CEO. As you know, the board has formed a search committee, engaged a search firm, and expects to name a successor CEO by the end of the year. It's early in the process, and there's nothing more to report on this subject today. Until that time, I plan to oversee advancement of the portfolio transition that we discussed in May in completion of operation 15 actions. Those are the priorities. With that, I'll turn it over to the operator and take your questions.

At this time, I would like to remind everyone, if you would like to ask a question, please press "*" then the number 1 on your telephone keypad. At the company's request, you are only allowed to ask one question and one follow-up question. After that, if you have any further questions, you must press "*1" again to go back into queue. Please hold while we wait for your first question. Your first question comes from Joseph Sroka with Merrill Lynch.

Good afternoon, everyone.

Hi, Joe.

I guess either John or Jim, in the sales for the quarter, could you sort of give an indication of the impact of units versus price and then my follow-up would be, how is that units versus price incorporated into your second half expectations?

Okay, well, basically you have some currency effect, as I mentioned, you know, excluding Best, we were down to -- we have some currency effect of about four points, so you know can get kind of the feel for, you know, the physical volume. Price was not a huge negative. You know, so that gives you a feel for it. I'd say what we've got in store -- and remember, some of this includes the loss of Mac Direct and so on, and the doors weakness, you know the loss of the region, but as we look at the back half, we're looking for a deterioration -- not looking for it but that's what we have built into the numbers of some you know three points or so.

And because of price or units?

Mostly units. In fact, all are units.

Okay, I was trying to find out if you thought the pricing environment was more stable.

The pricing environment is not more stable, Joe. I would say that the pricing environment is totally contingent upon new product development and substitution of products more than it is that prices are stabilizing, if you will.

Accept except that we expect in the back half some benefit from operation 15 price, about $10 million or so.

Ok, but I guess ex-currency, ex-Best, you're thinking it's all units?

For your purposes, yes.

Fair enough. Thank you, sir.

You're welcome.

Your next question comes from Eric Bosshard with Midwest Research. Mr. Bosshard, your line is open.

Sorry about that. In terms of sales growth, can you better define -- I guess you're talking about the core business excluding currency and Best down 6% in the second quarter, you're now saying you expect that to be down 9% in the second half, is that correct?

Well, yeah, approximately.

What is eroding at a 9% rate? I mean, is this across the portfolio? Have you seen --

No, the big issues that were already built into the thought process were the entry doors and the Mac. Nothing has basically changed there except entry doors maybe a little bit weaker. But Mac is, you know, performing as expected. And then the only difference in the outlook that we had before and the outlook we have now is really in the consumer and mechanics tools areas, there seems to be, you know, a fair amount of caution on the part of customers. It's not an issue necessarily with the point of sale, but we're not going to put in, you know, a higher number until we see them start to buy again.

What you've got, Eric, if you wanted to think about it, I think, is ex-entry doors and Mac, basically it's flat. Down 2%, Jim?

Yeah.

Down two.

And that turns into down five in the second half based on what you see in consumer -

No, what I'm talking about is basically the second half, what I just gave you.

Have you seen market share erosion or is it simply just looking at retail inventories and reorder levels?

Well, we look at and we do have and get now weeks of stock in POS, and it's not POS, although that kind of is a little bit sporadic, but still POS is relatively solid. What we see is inventory contraction. And we don't know how far that's going to go, and we don't know generally how much retailers have of private label and other goods, which may be taking up the open to buy.

My follow-up question, in terms of margins, you made 250 basis points of progress from 1Q. It sounds like in the second half, 3Q versus 2Q and 4Q versus 3Q, can you talk about the margin progression implied in the numbers you are talking about now and why it looks different than we thought 60 days ago?

We expect the third quarter to start with a 13, ok? That's -- and we never really shared, you know, a number on May 8th, but it's reasonably consistent from slightly lower, but still more or less in the same ballpark as the rate we expected on May 8th. And then we'll see about the fourth quarter, but, you know, the fourth quarter should see some further sequential progression as these benefits from operation 15 are realized. But the volume is the wild card, and unfortunately, it's not helping us right now. And it may. We just -- what we have in the numbers is not robust.

Thank you.

You're welcome.

Your next question comes from Mark Nambran with Barrow Hanley.

Can you do me a favor and kind of frame the inventory issue a little bit so that I can understand it better and talk about your expectations as to how you're going to improve or potentially just maintain some level of inventory change here over the remainder of the year?

You're talking about our inventories, I take it, right?

I'm talking about yours, but know, how they relate obviously to your customers also.

Right. Well, we were building some inventory as you know primarily in the mechanics tools, hand tools and fastening businesses to kind of ramp up for what we were hopefully expecting to be a fairly robust third quarter, and it appears it's not going to happen. If it does happen, we're well positioned to serve, as you can see. However, what we've done is we've adjusted manufacturing rates in those three businesses by some 20 to 30% downward in the third quarter. That's already done. And so we expect inventories to come back into line in the third quarter. As a result of that, as I mentioned in my remarks, the fill rates are as good as they've been as long as I've been with Stanley, and the customers are definitely feeling it in a positive way and are not making a big issue out of it as it has been in the past. So that is a very positive side effect of the situation, but in order to get the inventories down and make sure that we don't compromise the fill rate, there's a lot of detail work that's been going on at the SKU level by all the business general managers, making sure we have the right stuff in stock and make sure we're trying to move in turn the slower-moving stuff and that I can take that out of stock permanently so we don't fill up inventories with slower-moving stuff. So that's kind of a summary of what's going on there.

Just so I can get a sense for that then, you would say that inventories themselves will no longer be a drain on working capital or cash flow in the second half of the year or to reach some point in which it stabilizes?

We expect it to be a positive in the back half.

Thank you.

Your next question comes from David Gerow with T. Rowe Price.

How many operators get your name right?

Did they get it right?

No?

Sixth call today and no one's got it right yet so I didn't even listen for it. Just a couple quick questions. Can you give us the best organic revenue growth? I mean, how much were they up in the quarter on an organic basis?

2%.

And second, can you talk a little about the inventory situation, you sort of built in towards Q2 even though revenues are down a little bit, and now in Q3 you're going to have an issue because you're taking inventories down faster than sales growth. Can you just talk about the margin pressure that you'll face in Q3 I guess more in the tools group relative to Q2, where you have a little bit of a benefit probably on the gross margin line?

We've got -- that is true. You know, the statement that you make about inventory reductions causing "liquidation" issues is real. Observe On the other side, we've got a whole bunch of new products coming in here whose margin mix should be better, and Best as a percentage of the total will be going up, so we would -- which has better margins. So when you mix it all together, we think what Jim said will occur. And to put it in financial terms, I suppose, the growth margins will db -- should increase more than nominally as they did in the second quarter, even though we will have some negative drag from, you know, lower manufacturing levels, we expect the manufacturing reductions to have significant implications as it relates to employment, and that will help balance it, of course there's always the fixed costs or the structural costs that don't go away, and that's already been factored into that equation.

Is Best strongest seasonally in Q3?

It's the highest quarter of the year.

Ok. That's great. Thank you very much.

You're welcome.

Your next question comes from Ivy Zelman with CSFB.

Good afternoon, gentlemen. Can you talk about specifically the fastening business, you know, I look at that business today and I see lots of secular challenges, three of your major end markets, pallets, I guess the customers don't really want brand, they're using generics in the U.S., you've got mobile homes manufacturing housing as sort of a dying industry and then furniture moving to outsourcing. How are you going to grow that business and how do you stop the bleeding?

Well, you're right, Ivy. There are struck structural problems clearly in the fastening business. Having said that, it appears the fastening intensity of use seems to be going up. The market grew last year overall, and we think there are a bunch of new products that are coming that should give us some advantage going forward, and so despite the fact that you do have the generics and so on, we actually see the tone of our fastening business improving a little bit sequentially.

As part of the same question, was that business flat in Q2?

Essentially, yeah. It was maybe down a point or flat.

Ok. And then my follow-up question really pertains to a bigger issue of you claimed earlier in your statements, John, about the globalization of manufacturing which has resulted in low utilization rates, which I think is prevalent for many industries in the U.S. today. What I wonder is what's going to stop once you do relocate manufacturing to low cost countries and reconfigure your footprint and reduce your head count from the deflationary pressure going to continue and the any margin improvement that you may have realized from not seeing that margin improvement being eroded subsequent to realizing, you know, the benefits of the lower cost manufacturing, ie, Husky. What's going to stop it after you realize the gains?

From?

The gains from the restructuring. You're moving everything to low-cost manufacturing.

That's right.

But I think once you do that, I mean I'm not convinced, and maybe you can convince me that the deflationary pressures go away, because now you're competitive.

No. They don't go away. They are here to stay. We have a situation where we have a permanency of excess capacity, and I would argue for virtually everything, and so, therefore, the game is outlet expansion, product development, and raising the average bill in one way, shape or form. And that is what we're trying to do with the organization solutions effort that we talked about in raising peg storages average bill at Home Depot by 3X. We hope over a period of time. And so on and so on and so on, why we did sets, and why sets are 70% of the market in mechanics tools, and trying to get the unit to price level up there and get Wal-Mart's average ticket rising, so all of those things are part of the equation. It is certainly not the end of capacity utilization issues. We -- my belief is that that is permanent, a permanent structural change that will go on, has gone on as it has in many other markets and will continue. I don't see any changes.

I guess, my only question then in response to that, realizing that you're very much aware of the structural challenges and you know obviously trying to combat them with product innovation, et cetera. Why would you put your neck out with operation 15 and really try to, number one, assume like right now you basically talked the street down again. You know you told us in May you were going to get to 15% operating margin by the fourth quarter, and I understand why you're not going to get there now, but why do you feel at this point, like for example, I think you also stated you're going to raise prices and if some of the industrial customers or who you're raising prices don't like it, you know too bad type of thing. I just wonder, why do you feel you can raise prices in order to get to your goal of operation 15 as one component, and as you just admitted, the structural environment that you're challenged with?

Well, we are -- you're absolutely right on. We are challenged with the structural environment. Having said that, you have to be able to balance price and cost. If you you're just giving price away, and we have done this before, without commensurate volume offset, you just kind of go into a very quickly in your gross margin rate, and so the game has to be to try to sustain the volume without dropping the price down to your knickers, and the only way to do that is through new product development and you've got to change the mix of the business. And that is the reason that the portfolio, as we stated in May, over time will look maybe entirely different, but certainly substantially different than it does currently for exactly the reasons that you mentioned, which is a continuing price pressure by very large customers and the desire and the wherewithal because of the cash generation to be able to change that portfolio structure. We do not have that kind of intensity going on in the Access Solutions business, for example.

Right, so can you get the -

Let me finish. We don't have the intensity going on in Europe in that frame, nor in Asia actually. So our job is to try to take the composition of the businesses we have and start to gradually -- and in certain cases rapidly - shift the portfolio mix. That's the only way out, Ivy, that I see. And so the pricing that was put in was due to commodity prices rising at a very substantial and rapid rate, and so we pass that on to our distributors, and presume that they're going to pass it on to the end user because the product is better in the industrial markets in particular.

Your next question comes from Jim Lucas with (inaudible) Montgomery Scott.

Congratulations, gentlemen. One in a row. You've got to start somewhere. Couple of questions here. If we kind of -

Jim you know, I got a tan in the backyard; I'm feeling pretty good.

If we stay on the big picture theme here, one of the issues from a productivity standpoint that you know clearly is the mix has switched more to the consumer side here in the near term where the growth has been coming from, every quarter, it seems, for several quarters now, we keep hearing about inventory correction, it's hard to get the information from the customers -

No, we have the information now. We have the information. We can see what is going on.

Ok.

In the major retailers. And what's going on is they are taking down the inventory.

And so does that mean now from a demand-scheduling standpoint, you're getting the visibility?

Yes.

Is the first part, and second, as you begin to take

your manufacturing more and more to these low-cost countries, how much flexibility do you really have in terms of building that inventory when you have that 10,000-mile pipeline, and what does that do to your inventory management longer term?

Well, I'll tell you something. You know, to be honest with you, and we we'll show you these charts when we all get together again, but the fundamental goes like this. The POS level at retail does not change very much unless there's a promotion from week to week. This is not, you know, the toy business or the ice cream business or whatever where you get spikes when the heat comes or Christmas comes and that's it. This is basically a day-to-day, week-to-week kind of business, and while we're trying to get the retailers to do is frankly give us the keys to the kingdom in terms of ordering because what you see is a very different pattern of ordering than the POS would imply, for whatever reason. And when you jerk that number up and down in ordering pattern, you do all kinds of crazy stuff to the production schedules or at least attempt to because factories, as you know, do not go up 50% and down 50% week to week, or month to month. So what people then do is guess.

We don't have to guess very much anymore because we are getting the POS by SKU from the larger retailers, and that should allow us to schedule properly, and given the fact that the POS data, the levels do not fluctuate very much from week to week, or month to month, we should be seeing a better match of their POS to what's going on in the factory. And that is the goal, to shrink the number of weeks in the overall chain so their (inaudible) goes out and our inventory doesn't. And we think there's plenty of slop in here as we're looking at the data and the numbers. The critical question is, will we be able to convince the retailer to change the ordering patterns in a way that gives them better inventory. For example, we did a little study inside one of the major retailers that showed that in certain locations, they were extremely heavy in inventory, and other locations, extremely light in inventory, so this average really meant very little. And so again, we're trying to get them to change the ordering pattern and give us the kind of a vendor-managed inventory opportunity. We'll see.

Ok. And then you made the comment about the portfolio continuing to evolve over time. You know, clearly with closing this equity hedge, the debt has been increased here. Can you talk about potential divestitures? Are you examining the portfolio, is there something in the couple of quarters and, in several quarters? Just talk a little bit to the portfolio a little bit more.

Other than what I told new May, nothing, Jim. And my job is not to sit here and conjecture. I just told you guys in May strategically what we're trying to do, and I think over time, over years, you will see the complexion change fairly significantly. Because we will continue to generate the cash.

Your next question comes from Greg Nejmeh with Deutsche Banc.

Good afternoon, John, Jim. I guess a question related to this transformation. One of the strategic initiatives that you've mentioned several times, John, is to distance yourself, so to speak, from the big box retailers, and when I think about that imperative, I think about your pursuing acquisitions that will enable you to serve industrial channels of distribution more readily, and yet those are precisely the distribution channels where jobs are seemingly migrating away from or out of U.S. on a more or less permanent basis. So I guess the question really becomes are those opportunities as plentiful as you believe them to be, or, you know, is Best Access kind of a unique asset and perhaps those opportunities aren't as meaningful as you've concluded?

Well, Greg, I'd offer you as a strategist multiple things. Number one, the markets in which the access solutions group participates are as large as the markets collectively that Stanley globally participates in. So $25 billion plus. So there's enormous opportunity. Number two is that these markets that we're dealing with in that arena have very large service content and, more importantly, very large install bases. So to the extent that we can be direct as opposed to going through some intermediary, a distributor or whatever, we will capture a good part of the value chain, control the end customer, and be able to deliver a full boat of product solutions to that end customer. And this is more in the region of systems than it is in products, which gives us all kinds of wonderful margin opportunities which, as I expressed in May, this market is what I would call a favored market for all the reasons I laid out there, including the fact that all of the participants are profitable, which is a wonderful thing, and there are some underlying dynamics because of that. Second, I did not confine the remarks that I made to Ivy were about in terms of the hollowing out of the United States in particular and so on going on in manufacturing, that is not the case in Europe yet, and we still have a very large market in Europe, and one where in a very great number of products that we have, we have no participation. Hardware being one of them, which is a solid business for Stanley today, but we have no participation in Europe, which is a market as large if not larger than the United States. So there are a lot of opportunities to place the cash in relatively sanguine and healthy markets without having to fight either the big box domination or the capacity issues and the migration issues of manufacturing that are going on in the United States.

Great. Thank you.

You're welcome.

Your next question comes from Sam Darkatsh with Raymond James.

Good afternoon. You talked about -- John, you talked about in the second half, how entry doors may be get ago little bit weaker, your expectations, at least. If I'm not mistaken, we're beginning to anniversary against your losing share at Home Depot. Are the trends getting weaker because of the individual category at your retailer or is it because of a run rate of share losses that seems to be continuing year-over-year?

It's late fourth Q that it anniversaries, just to give you a frame. We may have announced it and told you about it when we knew about it, but the actuality and the reality of it did not come until then. So we still have to fight through what we think is the third quarter, and then the fourth quarter should see a narrowing, a significant narrowing of that issue.

So then I'll rephrase the question. Is the underlying growth in the category X the lost share in the territories, can you characterize that growth rate?

I would say it's positive, it's reasonable, but it's not robust.

And the second question, if I might. Demand and/or the inventory levels at the retail still seems to be sluggish and may need to be kick-started, I guess. Can you talk either broadly or specifically about your marketing spend and the trends within SG&A along those lines?

I guess the question I'm trying to succinctly kind of paraphrase it, what is going on with our marketing spending relative to the SG&A trends?

Yes, sir.

Ok. There have been no major reductions in marketing spend. In fact, what we're looking at in the third quarter is perhaps for the first time maybe a slight increase. First time in a while.

From the third quarter?

Yeah.

And that should be a sustainable strategy or is it just a one quarter out kind of thing?

We'll see if it pays back.

Okay. Thank you, gentlemen.

Your next question comes from Chet Hollister with All American Research.

Yeah, I have a question about the vitality index. You talked about that being an important performance metric in the past.

Yes.

My question is, what was it kind of at the end of CEO Mr. Trani's first year?. My understanding from some prior research reports was it was maybe 27, 28%, and now it's tough to estimate, but my sense it it's probably trending less than 25%.

Well, let me just stop you right there, okay? Because we will show you charts historically that say we're at 12 or below where Mr. Trani took over, unless you're at 30. The data comes out every year, and we show it every year when we have our meetings, and if you'd like a copy of the historical ones, Jerry Gould can certainly provide them to you.

How about current vitality index? Would that be the same as what it was last year or would it be lower.

It will be about 25%. We established a goal when I first came here of 25%, and we would anticipate that that would be the rate going forward.

Okay. Thank you.

You're welcome.

Your next question comes from David Gerow with T. Rowe Price.

Hi. Can you give us any commentary on sort of how much money or the progression with Mac Direct, I mean, how much did Mac Direct lose in Q1, Q2, and now with Mac Direct sort of gone, how does that look sort of Q3?

We had a loss in the first quarter. In the second quarter, we had a positive operating margin in May and a slightly higher margin rate in June, all right, so as we said, solidly profitable, David. I'm not going to go into the specific number. But it's above 2%. It's not 10%. Which is the longer-term goal.

Ok. One follow-up question as well.

Sure.

Just a very minor thing. Interest expense, it looked like it declined and debt went up. Is that just all interest rate -- was there anything unusual or should that number sort of be constantly going forward as well?

God bless Mr. Greenspan. It's all rate-driven.

Ok. Thank you.

Ok.

Your next question comes from Margaret Whelan with UBS.

Hey, guys, I'm jumping on for Margaret. Question, can you just talk about what the net impact on SG&A we should expect the net impact on SG&A to be after Mac Direct has been exited, and then is sort of just the Mac traditional business and then the Best Access business is accounted for? Presumably the access solutions has a higher SG&A run rate? Can you comment on that at all?

Sure. Yeah. I mean, it does have a higher -- Best does have a higher SG&A as a percent of sales. You know, it tends to run perhaps as much as 10 points higher than the rest of the portfolio, but it has absolutely great gross margin so it's not a problem.

It's the way the industry operates.

The operating margin for that business is north of 20%, so it's a good solid business equation.

Which is the target -- a couple months ago, your target for SG&A was to get to 18%?

That was back in February of 02, I guess it was, and it still is our target. But that would exclude Best. Obviously we didn't have Best at the time, that structural difference, so excluding Best, you know, today we're -- I'd say in the third quarter, year we're going to be in the 20 to 21% kind of a range, which, you know, is finally getting back to a place where 18% sounds like it might be achievable with a little sales growth before the last couple quarters when we were running 23 and more, you know, 18 looked like a long shot, but we've never departed from the 18% goal, and getting Mac Direct out of the equation to your early earlier point will help a lot. We had an $8 million sequential improvement in SG&A, at least half of that if not more was driven by Mac Direct, and we're going to get more similar kinds of numbers in the third quarter from Mac.

Is it possible to improve to 21% and then maybe 20 in the fourth quarter?

You know, I won't say, you know -- I won't say that I agree with that necessarily. We can all take a shot at it, but what I can tell you, it largely depends on volume, and when you put the kind of volume numbers on the page that we have, you know, it's going to be -- we'll see.

Can you also comment on the traditional Mac business? How would you say the performance was on first a year-over-year basis and relative to your expectations? Were you surprised by anything?

Actually we weren't surprised by anything. The traditional business is healthy, it's growing at double-digit rates and revenue, and it is earning good profit. It performed exactly in accordance with our expectation.

And frankly, the folks out in Columbus, which is where Mac is headquartered, did a great job in unwinding of the direct business in increasing the conversions above the numbers that we -- conversions from direct to traditional that we mentioned to you in May, remove 30% of the structure out of the head quarters, and continue to ship and reduce the backlog all at the same time, which had the highest net additions to the group X the conversions that we've had in at least three or four years, so you put that all together, they did a very, very good job in a very, very short amount of time in getting out of this thing, and now it's kind of like getting over a cold and now they're ready to go and see if they can drive some volume.

Well, they have a business model that should work now. So that's good.

Yeah.

That is good.

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

John, could you just bring us up to date on the current count at Mac now that we're back to talking about one unified front at Mac of where you stand from a dealer count and what the total conversions ended up being?

The conversions were about 160, 160 conversions. We were originally targeting 100, and we added 51 net to the base, Jim, and I think we're up just shy of 1,500.

Ok. And before -- just -- my memory is fading. Prior to direct, where was the Mac count?

I want to say slightly less, maybe around 1,300.

Ok. Thank you.

You're welcome.

Your next question comes from Jason Putman with CSFB.

Hi, guys.

Good afternoon, Jason.

I was just wondering, can we just review quickly the restructuring charges? It looks like to me that so far year-to-date, operation-15 is $54 million pre-tax, and I thought before you said it was going to be $60 million total. Are we still on track for that $60 million-type number? Is it going to run a little bit over, and kind of what are the other non-recurring charges that you're going to have in the second half of the year?

Hold on one second. We got a little scramble going on here. We may have to get back to you on that.

It just looked like the numbers that you were projecting as far as reported earnings for the back half of the year just looked a little bit bigger than -

Oh, I know what that is, Jason. There is -- originally we were projecting something like 72 to 107 all in, and there's a couple of things, we still think that related to the scope that we discussed on May 8th, that that's a reasonable range more likely in the higher end of that range than lower based on our impairments in the Mac receivables. However, kind of the new twist, if you will, is that we're contemplating the sale of our Mac Advantage Financing Program, and our estimate provides a certain amount of funds for doing that.

It will be a huge positive for the company, if that is executed, and we think there's a reasonable probability that we will execute it, assuming we can come to terms with the financial institutions we're talking to, but basically it would take all that risk out of the company, it would take something that loses money and was one of the other expense part of the income statement drag versus prior year, it would take that away, and we would not have to worry anymore about collecting receivables, financing receivables, which are essentially sub-prime in nature for the most part. So we're pretty excited about that if we can make it happen. We're trying not to put too much fanfare or specific quantification behind it right now because we're in the middle of a negotiation and we don't know, but that will be a positive if we pull that off.

But that would result in a loss if that occurs?

It could. Depends on -- you know, that's what we put into the guidance there was a little provision for that. Which is the difference between May 8th and current.

At this time, there are no further questions. Mr. Trani, are there any closing remarks?

No, you know, obviously it was a difficult quarter from a sales perspective. We continue to believe we will have a difficult revenue environment until it turns. The second half of some year it will be up, maybe this one, but certainly the economists are better at calling it than we have collectively been, so until we see it at retail or in the industrial marketplace, we're certainly not going to call it, but having said that, I think you'll see continued progress here, and who knows, as Jim said, maybe we'll wind up with a little bit higher revenue and, therefore, a little bit better result. With that, I wish everyone a good summer, and we'll talk to you in the fall. Thank you.

Thank you for participating in today's The Stanley Works Second Quarter Earnings Conference Call. You may now disconnect.