史丹利百得 (SWK) 2005 Q1 法說會逐字稿

Good morning. My name is Marcus and I will be your conference facilitator today. At this time I would like to welcome everyone to the The Stanley Works first quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS]. I would now like to introduce Mr. Jerry Gould, Vice President of Investor Relations. Sir, you may begin your conference.

Thank you, Marcus. Good morning, everybody. On the call with me today is John Lundgren, our Chairman and CEO. And Jim Loree, our Executive VP and CFO. We issued four press releases yesterday; our earnings and ongoing guidance last night; our dividend declaration; the results of yesterday's annual meeting; and the naming of a new VP of Operations. And they're all up on our website. John and Jim will discuss the quarter and then we'll move on to a Q&A. In compliance with Reg FD we will give earnings guidance as we did in the release yesterday. We'll comment on it today and then we can't comment on it after that. And we would prelease if conditions changed materially. We expect this call to go about an hour, and at noon there will be a replay available two hours after the call ends through midnight Saturday night. The replay number is 800-642-1687. And the code for that replay is 5537924. And you can call me with any questions at 860-827-3833.

A few quick administrative-type reminders before we start. Some of the statements contained in this discussion by the various Stanley participants are forward-looking statements, as such they involve risk. Actual results may differ materially from those expected or implied, so we direct you to the cautionary statements in Form 8-K which we filed with yesterday's press release. Secondly, in this discussion, as well as in our press release, our second quarter guidance is supplemented with amounts and percentages that exclude $0.03 of charges we plan to take in the second quarter. We believe these supplemental measures provide useful information removing that effect as it's not indicative of our Company's earnings capacity. And a reconciliation with the applicable GAAP numbers is right within yesterday's release. Finally, Friday May 6th, a week from tomorrow is our Analyst Conference at the Saint Regence Hotel in New York City. We'll focus on our security business and also provide considerable insights and details and we'll provide an overall company update, as well as a tools update, but the may focus will be security. If you did not receive our notice invitation by e-mail, please call us for details and we hope to see you there for a deeper dive into our security business. With that I'd like to turn it over to John Lundgren.

Good morning, everybody. Last night we reported first quarter earnings of $0.78 a share. Included in this number is $0.06 from the tax rate being 6 points lower than we expected in the quarter. The significant element of our recent -- 6.4 within the quarter. A significant element of our recent tax rates reductions are systemic resulting from well-designed and executed tax planning strategies that have been enormously successful. Jim is going to discuss these in a little more detail later on in the call. But these are real cash savings and they do benefit our shareowners. Our earnings exceeded guidance of 70 to $0.74 per share and both sales and operating earnings were right in-line with our guidance. These earnings compare with $0.66 last year from continuing operations. So EPS of $0.78 was up 18% over $0.66 from continuing operations last year.

Sales grew 10% in total and 4% organically, comprised of 1% from volume, 1% from currency, and 2% from price. Passthrough of material cost increases was reasonably successful and right in-line with our expectations. And cost inflation stabilized during the last several quarters. We incurred $21 million of commodity and freight cost inflation in the quarter, versus the prior year quarter. And that was essentially the carryover effect of 2004 cost increases. The carryover effect of price passthrough was $16 million. Though we incurred a net $5 million negative P&L impact in the first quarter of this year. First quarter operating cash flow of $61 million and free cash flow of 50 million were 9 million and 6 million higher than the same quarter a year ago. Both included 43 million cash received from the monetization of certain U.K. lease portfolio assets. Even setting aside these proceeds, both operating and free cash flow were positive and that's encouraging given the seasonally high level of sales in March and April. As a consequence, we're modestly increasing our projection and now believe that free cash flow will approximate $300 million in 2005.

Looking at the segments, our Consumer Products segment sales were flat with prior year levels, but average sell through of Stanley products by major U.S. retailers was up 9% in the quarter, and again 8% in April. Though clearly our sales were negatively impacted by inventory corrections in the mass merchant and home center channels. We're encouraged by the prospects for growth and the remainder of the year as we have an impressive series of new products, share gains, and promotional programs lined up, which should help with sales as we go forward. Markets for our products have shown some weakness in Europe, in general, and particularly, in the U.K., which is a situation we'll monitor closely going forward. We look forward to sharing some of these developments with you at our upcoming analyst conference in May and October, especially at the latter, which as Jerry said we'll focus on the tools growth platform.

Again this quarter, as in the third quarter '04 and the fourth quarter '04, we had the most significant year-over-year improvement in our industrial tools segment. Strong markets contributed to higher volume levels and we leveraged a lower cost base and improved execution in our largest businesses, fastening and Mac Tools. This was another solid growth quarter for our largest industrial business, family Fastening Systems and its Bostitch brand. For the fifth consecutive quarter that business grew sales over 10%, excluding the positive affects of currency. Strength was in the home center, construction supply, and industrial channels in the U.S. as unit volume growth, aside from currency and price, was up a double-digit percentage in the U.S. Proto Industrial Mechanic Tools which we described as a business in turnaround last year had another exceptional performance in both sales and operating margin. This business which achieved only single-digit operating profit in 2003 is now posting low mid-teens operating margins on a regular basis.

Our Mac Tools business had a mixed quarter. On the positive side, distributor route averages were up 4%. But as reported elsewhere in the industry, turnover caused its number of distributors to decline 9% from a year ago. A new distributor recruiting manager has been added. Training and evaluation of new distributors has increased and we're making a concerted effort to bolster our recruiting and retention programs. In addition, the phasing in of the new Mac Card Financing Program which we announced last fall continues to take hold with our distributor base and the results of that program were encouraging in the first quarter. Total Mac sales did decline due to these factors. It's encouraging, however, that traditional distributor route averages have increased or at a minimum have been sustained year-over-year in eight consecutive quarters. And Mac Tools was profitable for the seventh consecutive quarter, a clear sign that the retool business model which relies on independent distributors is the right way to go market. This business has come a long, long way in a very short period of time.

Hydraulics tools with continuing benefits from strong steel recovery market and a successful mobile share new product launch delivered very strong double-digit percentage sales growth and further margin improvement again in this quarter. And finally, CST/Berger, our newest commercial industrial growth business delivered $17 million in sales and high teens percentage operating margins and was accretive to earnings per share again for the quarter. A $50 million business when we acquired it only a year ago. That business has now grown to an excess of an $80 million annual run rate.

Securities solutions revenues increased 24%, due to acquisition growth. This segment did $194 million in sales this quarter and is on track to exceed $800 million for the year. Aside from acquisitions, sales were flat. Weather problems affected automatic door installations and our European security business was relatively weak. It's important to understand several things about Stanley Security Solution's first quarter. First, after numerous quarters of building backlog, our North American Electronic Access Controls business had a strong double-digit percentage sales increase. At the same time, we had a modest single-digit percentage sales increase in the North American Mechanical Access business. We've long awaited concurrent growth in these two components of the Stanley Security segment, and they've now occurred. In addition, some important contracts were signed for high profile jobs and we're quite encouraged by these developments.

Second important event to understand, is that the North American Automatic Doors business had about an 8% decline in sales, but at the same time it's backlog grew significantly. Part of the sales decline came as no surprise. In the first quarter 2004 we were actively engaged in the upgrade program for all of Wal-Mart's automatic doors and that program has come to an end. You don't simply replace a program of that magnitude overnight, but we came close with a number of important orders from various retail, education, and healthcare customers. The other part of the sales decline was unexpected, temporary and led to part of the backlog increase. In January and February the rains in the Southwest and the snow in the Northeast caused severe commercial construction delays. Entire job schedules were pushed out and the automatic doors we expected and planned to install in the first quarter were delayed. The weather-related issues should be behind us and we end the rest of the year with the highest backlog in our history.

Considering the prior year first quarter sales of all of our security businesses, that would include ISR and the Security Group's first quarter '04 sales, even though we did not own them, pro forma sales growth was 4% in the first quarter. And that's reasonably good performance, given the aforementioned tough automatic door comps and the weather-related delays in that business. Operating margins which we previously forecasted to be in the low-teens percentage range this quarter, were 13%. This is largely attributable to the lower margins of ISR Solutions and Security Group which we recently acquired, the greater-than-expected shift in mix from higher margin mechanical access to lower marginal electronic access revenues within the quarter, and the end recovered fixed cost in the automatic door business.

With the weather-related issues in the past and the large backlog of orders, many of the first quarter issues are already resolved. For these reasons we're quite bullish on the near-term prospects for organic growth in the security platform. Moreover, we're continuing to build a unique and valuable Security Solutions business which will serve us well for years to come. With that, I'd like to ask Jim Loree to review some of the financial matters in the release, which includes our guidance for the second quarter and for the year.

Okay. Thank you, John. Let's start with the first quarter. The first quarter ended up to be about where we thought it would be as it relates to the operating performance. We did predict the sales and earnings before the tax benefit quite accurately and our team performed and delivered in-line with our expectations. All in we delivered $0.78, including the $0.06 tax benefit. That's plus 18% versus the prior year. And up 9% if you look at it excluding that tax item. When discounting $0.78 to $0.72 in order to try to figure out how we did versus expectations, please note that our guidance was 70 to $0.74. And we were right at the mid point of the guidance. More importantly, we performed within our projected range of organic growth despite the issues that we had with automatic doors and retailer inventory corrections. Both of which should be temporary timing issues. We raised the low-end of our '05 earnings guidance $0.05 and at the same time funded $0.03 for acquisition integration costs. Thus, reaffirming a positive outlook for the remainder of the year.

I want to talk in some detail about the security margins, the segment margins. First of all, we continue to believe that 15 to 20% operating margin and 5 to 7% organic growth are attainable in this segment. Next quarter we expect to be at about 15% before a 100 basis point acquisition integration charge. That should improve sequentially from there. One of the reasons I feel this way, we ended at 13% this quarter. The issues that Access contributed about 150 basis points of the sequential deterioration. We did not expect that. And, again, they were mostly weather-related delays, that ended up causing production inefficiencies, as well as unrecovered fixed field costs.

Some of the factors that we did anticipate were the initial impact of the recent acquisitions ending. The electronic -- the growing mix in electronic access. That cost us about 130 basis points versus the prior year and about half that versus the prior quarter. And then in addition to that we had the sale of the Blick financing lease portfolio, which was a very good thing to do from a capital management perspective. That cost us 50 basis points versus the prior year. All of which, and then some, was offset in the "other" category down below operating margin. So we did not anticipate the automatic door weather problems and all the ills that came with them and, hence, we ended up at 13% instead of the 14 to 15% that we expected to be. The Access problems cost us, as I mentioned, and we would not expect that to repeat in the second quarter. In addition to that, you should know that we have a very specific set of plans and programs to return this segment to 15 to 20% operating margin. We intend to go through them in some detail at next Friday's analyst meeting and look forward to doing that.

Let me talk a little bit now about the sale of the Blick financing receivables. You'll remember in the fourth quarter perhaps that we obtained about $7 million in cash proceeds from the initial sale of that portfolio and then we followed it up as expected in the first quarter with another $43 million. So in total, this monetization has returned to Stanley $50 million of the 178 million that we paid initially to acquire Blick. And that brings our invested capital down to about 130 million, and of course, we'll ultimately yield a higher return on capital for that acquisition. It also frees up capital that can be deployed elsewhere, and as I mentioned, we did record a gain, a $1.5 million gain, with the completion of that transaction. But it did cost us about a million dollars in margin in the quarter. And will continue to do so as we go forward.

As far as cash generation goes, we did generate $50 million of free cash flow in the first quarter. That compares to 44 million last year, and 44 million the year before. It was our highest free cash flow first quarter ever. However, it did include, as many have noted, $43 million from monetizing this leased portfolio. So if you excluded that, we would have generated free cash flow of about $7 million, which from our perspective, is in-line with what we would have expected, considering that in eight of the previous 10 years before 2003, free cash flow was negative and some quarters considerably, some first quarter considerably negative. And that results from a number of factors. First of all, there's a normal inventory build that we undertake in the first quarter typically, especially when we expect a strong second quarter. And we also in this particular case, had a relatively weak January and a much stronger finish, which resulted in higher receivable balances in the first quarter. They should take care of themselves through the normal seasonal cycles.

Our debt-to-capital ratio is right at our 35% median single A target. And our free cash flow for the year, we're modestly upgrading our outlook such that we believe it will approximate $300 million, or about 1.05 to 1.1 times our net income. Talking about the tax benefit for a moment, the tax rate was 23% versus the 29% we forecasted. This benefit arose largely from successful tax strategies, enabling us to utilize some existing NOLs in Europe. The '05 guidance reflects a 27% rate, this is at the lower end of the 27 to 28% range we previously indicated. However, as I mentioned last quarter, we're likely to see considerable quarter-to-quarter volatility in the tax rate as the year goes on. The SWK tax rate in 1996 was 38%. And it began to drop. By 1999 it was 35. By 2001, 32. By 2003, 30. And in '04 it was 27%. So you've seen some fairly steady progress over the last decade in bringing the effective tax rate down. This is not coincidental. Our tax department is focused on creating economic value through tax optimization and their track record speaks for itself.

On commodity inflation, the raw material inflation, primarily steel, nothing grammatic or new in this area, as previously mentioned it was 21 million in the quarter of which 16 was recovered in the form of price. That's about 75 basis points of net P&L effect. But certainly in the range we expected. And our outlook for the full year is unchanged. In earnings, as it relates to earnings guidance, our second quarter guidance calls for 4 to 6% organic sales growth over the second quarter of '04 and another 3 points for acquisition on top of that. The organic basically consists of about 3 points of volume, 1 point of currency and 1 point of price, all kind of plus or minus. 75 to $0.79 per share is the EPS outlook, versus $0.70 from last year from continuing operations. And then track $0.03 for the cost of acquisition integration, so net-net, we should see our guiding to a 72 to $0.76 range. Income taxes are expected to be 29%, approximately in the quarter. And for the total year '05, organic sales growth of 4 to 6%, and earnings of $3.20 to $3.30 per share are expected up 12 to 16% over the 285 from continuing operations last year. In this regard the bottom of the range has been increased by $0.05 and we've also covered the $0.03 of second quarter '05 charges as well in this new guidance.

Our cash balance is high at $310 million, and that reflects a number of years of higher foreign earnings, and as well as the cash from the Blick transaction. The opportunity is there for us under the American Jobs Creation Act of 2004 to pursue the repatriation of significant amounts of this cash. Our plans have yet to be finalized, and we intend to work on this project as we go through the year here. And hopefully the Act will result in some cash repatriation to the Company.

In summary, we're look forward to the analyst meeting that's upcoming on Friday, May 6th, in New York. And although the focus will be on the security growth platform, John and I will cover several topics of interest relating to the total company. This is an exciting and interesting time for us as we're now in our third year of building out our tools and security growth platforms and repositioning Stanley as a company with a sharp focus on discipline growth and building a more diverse portfolio with less dependence on large customers with short order cycles. In the almost six years I've been here, I have never been more positive about the prospects in front of us. And now I'll turn it back over to John.

Thanks, Jim. Let me just close by reviewing a few of the in processing coming second quarter developments. Our success with large contracts in the security business is encouraging. We recently renewed our service contract with one of our major U.S. retail customers for two years, and we've been expanding our presence with a key U.K. retailer as well. In addition, recent contract wins at airports in Memphis, Chicago, and Bangkok; at hospitals in the U.K. and the U.S.; and universities in the U.S. are verifying the value proposition that we're putting forth. We'll have a lot more to say about this on May 6th.

Most of you know, our branch support has been strong over the past 12 months. We're encouraged by the results driven by last fall's campaign and we're just starting our spring campaign. Three days ago, specifically last Monday, and running through July, we launched a campaign airing three new television commercials that will run 400 spots nationally across the U.S. Two of these commercials are new, and you'll see them on May 6th, if you've not already seen them on television. In addition, we've begun a series of bold new print ads to go along with our NASCAR program and our ongoing skills USA support.

Stanley Innovation and Design Team recently won five design awards for graphics and branding excellence from Graphic Design USA. Stanley received 14 packaging and graphic branding awards in 2004 and with the addition of these five new awards we're off to a great start in 2005. This is a very important part of our brand support, equally as important as advertising. Our Specialty Tools business received and filled a $1.4 million GSA day order in March. This is the largest government order it's ever received in its history. Also significant advances were made by our Bostitch Fastening Systems in the implementation and advancement of the Stanley Fulfillment System. Sell rates reached 95% Bostitch at the end of the first quarter. Past due orders declined to only a third of their beginning of quarter balance and nearly all eight of the fastening systems plants are in the top half of our operations quality ranking. This is great progress at Bostitch.

And finally, we announced that Jeff Chen was promoted to Vice President of Global Operations, filling an opening created when Paul Isabella left the Company two weeks earlier. Jeff's implemented the elements of the Stanley Fulfillment System, with fantastic results in Asia. And he's earned this opportunity through 22 years of operations success at Stanley. I hope you will all get to meet Jeff soon, I know he looks forward to getting to know you. Our bench is deep at Stanley and I'm pleased that we have the talent right within our company to quickly fill this key position.

We started the year 2005 with an in-line quarter achieving the sales and earnings growth we expected coming in. We expected and saw tough comps and strengthened security margins as we're in the midst of assimilating recently acquired acquisitions into our portfolio. We had greater industrial strength than anticipated, but customer inventory corrections on the consumer side and weather-related issues on the security side adversely affected results. All-in-all, those issues were addressed, cost inflation was again managed, and we delivered in-line with our estimates. Our optimism for the remainder of the year stems from recent share gains, productivity programs we've started, the Stanley Fulfillment System, taking hold rapidly, and a business development pipeline that's very likely to generate tangible results very soon. At this point, I'd like to turn it over to Marcus, our Operator, and we'll take your questions.

Thank you. [OPERATOR INSTRUCTIONS]. Your first questions comes from Margaret Whelan with UBS.

Good morning, everyone. Two questions. The first one, John, you said in your prepared comments that you had a record backlog at the security business, would you just give us a sense for what kind of growth we should expect there? And organically versus acquisitive for the next couple of quarters based on that backlog?

Sure, Margaret. I'll give you an overview and Jim will give you a little more granularity. We had reasonable effect in the first quarter. We will manage the extent to which we fill it all in the second quarter versus the remainder of the year based on cost efficiencies. To get it all back in the second quarter you could create enough overtime and things of that nature that it wouldn't be the best business decision. We expect to haul it back all in the course of the year. And Jim will give you some specifics.

First of all, the weather-related sales issue was in the neighborhood of like $4 million in the quarter. They expect to get back at least two of that, and maybe four of that in the second quarter. What was actually more difficult about it was not so much the loss of revenue, but the actual inefficiency that came with that, because they were overstaffed in both the field and headquarters for installations and there were a lot of idle people standing around. So that was addressed in the middle of the quarter as they realized this was happening. But because of the way the inventory accounting works, the efficiencies from that improvement were not realized in the quarter and hopefully will be -- and should be in the second quarter.

Now, as far as the growth itself goes, the Access business is up against very, very difficult comps in the first half, so the first quarter and the second quarter. Last year one of America's largest retailers, which they have a very extensive contract with did a major upgrade program which was in full swing in the first half of last year. So in the second quarter we would expect flat to slightly positive growth, even with a $2 million to $4 million recovery. And then from there on out, it should be pretty good growth for the Access business.

Okay. And the second question that I have is just regarding the tax rate. When you gave us the guidance for the quarter, you had expected it to be 29 and it came in at 23. At what point in the quarter did you realize that?

We were working on a project throughout the quarter, Margaret, on the utilization of these NOLs that I talked about and we really didn't know until we got into the latter part of the quarter whether it was actually going to prove fruitful or not. So it was late in the quarter.

And should we expect any more in the next three? I know you said again 29%.

The guidance for the year is 27% on the tax rate. I think we -- let me put it this way, we don't know how much the jobs creation act is going to cost us. And that was excluded from our previous guidance and from this guidance. But I would say the 27% is a very conservative estimate for the tax rate, excluding the jobs creation, potential costs from the jobs creation act.

It is conservative?

Yes.

Okay. Thanks.

Your next question comes from Stephen Kim with Stephen Kim.

Good morning. This is actually Vishnu for Steve who apparently has his own firm now.

[Laughter] It was news to us.

First question is on the security business, what was the foreign exchange impact on the security business in terms of sales?

Almost insignificant. Only a 100 -- on an annualized basis, only 125 million, or 15% of security is outside North America. So it's roughly 1%.

Okay. And the integration costs related to the acquisitions and security that you're citing for the second quarter. Can you just give us a little bit more color on what sorts of actions you're taking there, and as well, once those acquisition costs are done, will the margin recovery just be the fact that there's no more drag from the integration costs or do you expect those, the integration actions to result in an organic increase in the margins?

When we do acquisitions, particularly European ones, quite often it takes several years of rationalization to get all the costs out that we expected, expect to get out. So we had a plan and this relates specifically to the Blick acquisition. But we had a plan when we did the acquisition for a reduction in force the first 90 days that we owned it, which we successfully executed. And then we had another plan which we called Phase II, which involved more of a streamlining of the organization from a series of silos to a more unified organization, keeping in mind that this is a $120 million business and it's not -- it doesn't need to have six to eight different $20 million, $15 million P&Ls.

So this is kind of a streamlining to make it more unified. And that is in progress as we speak. It's a reduction in force of some 60 people or so. And the purpose of doing it is to keep the acquisition on track as it relates to its board commitments that we made when we did the deal. And the cost not only will not repeat, but there will be cost savings associated with these actions and the cost savings will be in the neighborhood of 4 million to $5 million.

So should we expect to see then, similar acquisition costs related to let's say Security Group and ISR as well?

Let me answer that by both adding on to what Jim said relating to Europe and addressing your question relating to ISR and the Security Group. In general, we have a history, it's tested and proven and you'll see more of it in terms of our projections, of buying businesses with low to mid single-digit operating margins and doubling them in the course of 18 months to get them to where they are today. The same will apply to ISR and Security Group, or at least that's our plan. Of our four -- of our 500 to even 1,000 basis point increase in these acquisitions over 18 months, roughly half those charges come out in the first 90 days, or certainly in the first six months. And often there are charges associated with doing that, which is built into our guidance.

But of equal or greater importance, the second half of 50% of the margin improvement that comes out over time is by applying the Stanley Fulfillment System to the Securities Solutions business. Specifically, Security Solutions within Stanley, as well as the industry as a whole, has done well based on technology and a lot of growth, which in many cases masks relatively inefficient operations. But by getting the security field ops, as well as the plants on the same rhythm, rigor, score card as the rest of the Stanley tools plants we've had tremendous success in margin enhancement overtime. It's in our D&A. We're in a tools business that over time prices have deteriorated 1 to 2% a year. So we have a model that gets 2 to 3% of the cost, [indiscernible] out every year in order to allow us to maintain margins. Applying that same model to security is what's going to generate the margin enhancement over time, without a lot of unexpected charges going forward.

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

Thanks. First question, could you talk -- you'll probably go into this next Friday. But the margin differential between the electronic and mechanical controls, could you provide a little color on what you're doing to close that gap?

Well, Jim, the margin difference is, electronic today is in the mid single-digits and the mechanical is probably close to 20%. We don't expect to ever close the gap entirely. We expect the electronic business to reach some kind of an equilibrium right around 12 to 15%. And as far as the specifics on how we're getting there it's a very comprehensive program which we've been working on now. Because this electronic business is almost like a startup from our perspective in the sense that we're creating a business model and then we're building it out through acquisition and organically.

But we have a very comprehensive profit improvement program for the Electronic Access business that we will execute over the next year. And time will tell. If we achieve this objective of 12 to 15%, this will be a terrific growth engine for Stanley, because the electronic market is growing substantially and we're putting the pieces together to make it into a real growth vehicle. So I'd rather wait, we'd all rather wait until we get a chance for Justin Boswell and Chris [Eppel] the CFO of the Security business to articulate the specifics of the plan. But it is a very substitutive and very comprehensive plan.

And that will be covered next Friday?

Absolutely.

Okay. And switching gears, diving a little bit more into Europe, we've heard from a lot of companies over the last two weeks that the European environment in general has been soft, and I think your comments in general echo that. Could you talk about what you're seeing over there from an end market standpoint and then as well from an acquisition pipeline, both security and industrial tools, talk about any type of evaluations or opportunities you see over there?

Yes. I'll take those, Jim. First of all, Europe's a big place, and the overwhelming majority of our softness and our read is on the market in general, the last two quarters was focused on the U.K. and with a lot of experience in that area historically, U.K. follows the U.S. and continental Europe follows that. But we haven't seen the softness, as much softness in continental Europe, obviously offset by currency, and we haven't seen the softness in the U.S. So the U.K., quite frankly, is a bit of a dilemma for us. It seems to be across most retail segments. And as you correctly noted, it's not unique to Stanley.

In terms of the BD pipeline and what's going on, we obviously don't comment on opportunities until they're there. But there are tremendous opportunities for consolidation in industrial and consumer in Europe. It's a tremendously fragmented market from that perspective. And our focus will continue to be security solutions, industrial tools, without a tremendous -- any business that's not tremendously reliant on the big box retailers, the B&Q, Castorama, et cetera, there, would be in our wheel house and they would be things that we would consider, provided they pass our strategic screen. That we've been quite public about what it is and that they reach our economic and financial return criteria, which we've also been pretty public about what they are.

And if there was a lot of weakness in Germany, we wouldn't necessarily feel it. Because we have almost no activity in Germany.

That's a good point. Our sense is Germany is quite weak, but it's such a small percentage of our European turnover that that would not adversely impact us. We are disproportionately skewed towards the U.K., both through Blick and through our tools business in the U.K.

Thank you. Your next question comes from David MacGregor with Longbow Research.

Good morning. Looks like there's some recovery taking place here in your industrial business that looks impressive. But I was wondering if you could just walk us through the remaining drags on margin performance there? Give us some sense of how imminent a turnaround may actually be or how imminent margin improvements might actually be?

I think that's a very fair question. Jim's going to give you a little bit of granularity. But importantly, industrial segment is less of a pure segment than consumer, which is quite clear in security, which is quite clear. Quite frankly, it's a grouping of our other businesses, the biggest of which is Stanley Fastening Systems or Bostitch about 600 million in annual revenue, and then the second being Mac Tools. All-in-all, it's 1.3 billion of which the two largest businesses comprise almost 900 million of that.

Also importantly, understand within that 1.3 billion segment, Mac Tools, which is about 250 million, and Speciality, which is about 100 million, at relatively modest operating margins can have an incredibly high return on capital employed. They are distribution businesses with very small -- virtually no fixed assets and not a lot of working capital. Jim can touch on -- and we'll touch on a couple of those pieces.

Okay. Well, with that as sort of a backdrop, if you went back into history and looked at the margin performance of this segment, you would find something like 6 to 7% with sort of -- probably the low water marker, or at least kind of the average typical performance of the segment over the last few years. And about two years ago we undertook a turnaround plan for two of our larger businesses in this segment, the Mac business and the Proto business. In the Mac business we exited a direct model and we went to purely independent distribution and took out an enormous amount of cost and ultimately took to that end capital and took that business from a losing kind of 10 to 12% performance to a plus, you know, mid single-digits where it is right now. So that's one of the great stories over the last few years in terms of margin improvement for industrial. But it's also one of the anchors as it relates to a company line average type of a margin performance.

We also have in that the largest, in the Proto business, which John talked about in his comments being about half the size of Mac, slightly larger than that, but in that range. And that business is -- has made a tremendous turnaround from about breakeven two years ago to where we are today in the kind of mid to low double-digits in the teens. So that leaves the smaller businesses, which are really performing well, hydraulics, assembly, there's a Vidmar storage business, the speciality business, these are all performing extremely well with market tailwind and good internal execution.

And that kind of takes us to the last piece of this, which is the fastening business. The pneumatic fastening business. The pneumatic fastening business has some great momentum in the market place, and a terrific business team, which is on top of its game. The only issue with the fastening folks is they got hit with a huge part of the inflation that we had last year, about 60% of our total 70 -- mid 75 million or so, inflation was associated with the fastening business. And they got a lot of that back in price, but they didn't get it all. So a lot of their improvements, which were taking them from like a 6% up to a -- we hoped to like a 12% operating margin, ultimately they got to around 9. We expect them for the first time in a long time to be able to get into the 10%, maybe even slightly above range in the second quarter. Because of the inflation anniversarying and productivity beginning to fall through, as well as a few more price increases that are catching up.

So to step back from all that. And then we have the CST/Berger business, delays are measuring a leveling business, which is a really high growth business with 20% type operating margins, and that should provide some benefit for the segment as we go forward. So when you step back from it all, we're pretty bullish on the segment. The one question mark that we have to resolve is can we get Mac up above the profitability where it is today? It does have a lower relative market share dramatically than its larger competitor, but it also competes with Danaher's Matco and they do better than we do from a margin perspective. So we think it can be done. But in all honesty we haven't quite cracked the code on getting there yet.

Good. Thanks for that walk-through. [indiscernible] mindful again that it is a more diverse grouping of businesses. But I was just trying to get some sense of whether the improvement -- the top line improvements are being driven by share gains or whether you're seeing an upturn in spending overall? It's kind of a high level question, but could you just talk a little about the extent to which you are seeing broader spending improvements?

I think it's mixed. I think it's clear and only fair to say that a portion, maybe up to half of our positive improvement particularly in fastening, which is the biggest business, and several others, is a little bit of market tailwind. That being said, clearly at least half is due to internally driven programs, specifically, just a terrific product introduction with triple coated nails where for a long time demand has succeeded our ability to supply. It's hard to get excited about nail technology, unless quite frankly, unless you saw it compared to the competitive product, which created a terrific demand exceeding supply situation.

So we've got some product innovation within that segment in Bostitch. As I said in my earlier comments, and Jim alluded to, we've got tremendous top line growth and great margin on CST/Berger, which is a very high tech, high margin business. So it's a bit of a cop-out to say it's 50/50, but it's a lot of each.

Thank you. Your next question comes from Ivy Zellman with Credit Suisse First Boston.

Good morning, guys. If you can talk a little bit about your goals to 15 to 20% operating margins in security? It seems rather difficult, given the electronic mix issue with the mechanical differential and those margins. And then secondly, with respect to the Blick management changes, can you talk about, if any changes in strategy is a result of those management departures?

Okay, Ivy, I'll take the first part of your question and John will take the second. As it relates to the margins, the first thing I want to make clear, when you read the press release and you look at the 13%, there's initial knee jerk reaction without full information that anyone would have be, "Oh, my God, what's happening?" And this is your growth platform -- or one of your growth platforms and a big part of your future, et cetera. And if you're only going to do 13% then what's so exciting about it?

But in reality the 15% that we were at in the fourth quarter, and the 13% that we're at in the second quarter, the major difference is the deterioration of the Access business, which is -- there's nothing systemic about it. It was a blip on the radar screen. So that's 150 basis points or so. Then the other 50 basis points is an acquisition charge where we had to write up the inventories in the Security Group acquisition and take them all as higher costs in the first 90 days of ownership as we liquidate those inventories. That's a pure function of purchase accounting. So 200 basis points of the sequential decline are items that will not repeat themselves in all likelihood. Certainly the acquisition won't. We feel strongly that the Access business is steadily on its way to delivering a good quarter.

So 15 to 20 that, gets you to 15. And then from there, as I mentioned earlier, we have a whole series of profit improvement initiatives for the security business that the team Justin Boswell and Chris Eppel and his operating team are working on. And we are going to go through those in considerable depth on May 6th. And that will be one of the highlights of the meeting is allowing people to get their -- to fully understand what we're trying to accomplish here with the profit improvement initiative in security.

As it relates to the second part of your question, we think things are in, I'll say in pretty good shape with Blick. We have an experienced, well-respected Blick executive with primarily sales and marketing background managing Blick today. And I'll kind of take that one to heart, because Blick was acquired just as I came on board, and as we were in the midst of aggressively executing a tested, proven, and successful Stanley integration model, I slowed the team down. And I actually felt we were making too many changes a little bit too fast and we were risking some top line growth. And as a consequence, Jim mentioned we did real well with Phase I of the integration of Blick and the second one lost some momentum. And I think that was a mistake on my part.

As we just relook at the situation, we have a phenomenally strong market position, customer base and pretty good technology. I've asked Justin and his team to stay very engaged in terms of the strategy and the objectives. But at the same time on getting the cost out, they're getting a tremendous amount of help from our European operations team. And that's a group we basically had held back for about a year to let Blick get integrated. So we have a great, we actually call it a "reintegration" program in place. It's gotten a lot of attention from Jim, from Justin, from myself. And we think Blick is -- we still think it was a great acquisition, giving us a real strong foothold in the U.K. as well as some of the other -- I'll call them "former" colonial markets. And we see it doing nothing but getting back on track in a very short period of time.

John, isn't the strategy, or wasn't the strategy for the overall securities solutions segment part of the big picture was that the real margin opportunity was in the OEM side and not being the -- just the integrator and part of the strategy, therefore, was to take the software that the U.K. Blick organization has and basically offer that software on an OEM basis to the U.S. and that's a higher margin business? Was that the original strategy in a big picture way? And is that currently still being in the same exact way originally thought being implemented in the U.S. going forward with the management changes that occurred at Blick?

You'll see a press release in the next couple of days announces that whole program in the U.S., Ivy. It is very important. The software works really well and it's very effective for the mid range and kind of lower end of the smaller customers in that segment of the market. It's not going to replace the enterprise software that companies like Casi Rusco, and Linnel, and Nexwatch, and so forth sell and have installed bases in. But for what we do in best, it's a very good fit, because a lot of our customers are not these big enterprise customers, but they're the more medium size segment of the market. So we're looking forward to that. It's been initially received very well by the sales force in Indianapolis or in the best business. And we should see some good dividends from that as expected.

Thank you. Your next question comes from Brendan Hartman with Cramer Rosenthal.

Good morning, guys. Jim, can you give us a walk through on the raw materials inflation in terms of what price increases have been put in place and how the timing impacts that throughout the year? And then what your outlook is particularly on the steel and the resin side and just put some numbers around that?

Sure. Our total year, the last time we said we thought the first quarter was going to be about 20 to 25, and we thought we'd get about 15 to 18 in price. It actually came in at 21 and we got 16 in price. So that was pretty much what we expected. We also said we thought the total year was going to be 40 to 50 total inflation, with about 30 in price. The view now is that the total year of the number will probably be a little closer to 50, but the price will be a smidgen higher and the difference between the two will remain the same. Everything is pretty stable there.

Now, the way this works through the various quarters is while this quarter it cost us say approximately $5 million of unrecovered margin because of the 21 versus the 16. In the second quarter on a year-over-year basis, we should have about parity between the inflation and the price. About 12 of each, inflation and price for the quarter. Then we would expect as the year goes on both the price and the inflation to become much smaller numbers. So our total year guidance is about right. But 33 of the inflation that we said was going to be between, or about 50, will be incurred through the first half.

Brendan, let me add to that. You talked about various commodities and resins. When you think of inflation and you think about Stanley, think steel. Obviously, petroleum is up, and the only business that's really affected, unlike some of our competitors, is our ZAG storage business which is $125 million business. Obviously, our freight rates, which affects everyone else.

But a $10 increase per barrel in oil is 3 to 5 million a year for Stanley, depending on how you calculate and the ripple effect and things of that nature. You just need to be focused overwhelmingly on steel. We've seen modest mitigation in steel price in the first quarter in the last few weeks. We track it very closely in the U.S., but none in Asia. So it just kind of reaffirms -- we've been pretty good at predicting this through the first quarter, and borrowing unforeseen volatility in that market in particular. We're pretty confident that we've got the brains tight around price and inflation as Jim just described it.

So does your forecast include additional price increases that have not yet been announced?

Nothing material.

No, nothing material. And that's given the fact that we see nothing in steel, so we think we've got it pretty much in balance for the remainder of the year.

There are some businesses where we have price increases on a regular basis, like some of the industrial businesses in Europe -- but most of that, it tends to be quite small in the overall scheme of things, and really doesn't affect the price of inflation discussion that much.

Thank you. Your next question comes from Richard Dalton with Atlantic Equities.

Good morning, everyone. I was wondering if you could just comment on two things. Firstly, on consumer. Can you just give us an idea of your expectations for the second quarter in terms of growth and margins, particularly because you're up against another tough comparison on the growth side? And also just can you split out for each segment the first quarter volume and price impact?

Okay. The consumer segment in the second quarter as far as the operating margin goes, we would expect to be fairly stable. In fact, that would also be true for the industrial segment. No big improvements in either one.

Is that year-on-year?

Yes. I'm talking sequentially. I haven't really looked at it year-on-year. Just in terms of vis-a-vis the first quarter. And there will be, we think, margin accretion for the operating margin accretion for the company sequentially, but it will come from the higher security margins more than anything. And as far as you want a price volume and so forth by segment, was that your question?

Yes. Yes, please.

Why don't we go on and we'll come back to you in a minute, Richard, or maybe you could give us a call?

Okay. That's fine.

We'll send you an e-mail. Because we'll have to dig it out.

Okay.

Thank you. Your next question comes from Armando Lopez with Morgan Stanley.

Good morning, guys. Just a couple of quick questions on security business. You mentioned you had won a number of big contracts in the quarter. Can you just talk a little bit about what your success rate is or what your hit rate is in terms of contracts you've bid on versus contracts you're winning?

We'd love to, Armando, and maybe with the real experts in the room, Justin and his team, they can give you some direction on that. I'd rather just defer it as opposed to guess in terms of -- because I just am not, don't have a grasp of the number of bids versus number of successes on new contracts. What I can tell you is we have an extraordinarily high retention rate on the service contracts, and that's of equal or greater importance to us. But it be best to defer the first one until we get Justin and a couple of his team members on the line.

We'll give them a heads-up, too, so they can look into that and be able to answer your question if you're there on the 6th.

Okay. Great. And then just a quick second one. You talked about retailers pulling down some inventory in the channel. How do you see inventory levels currently? Is there still further pulldown to come, do you think, or are they about average levels now?

Armando, our read is they've got to be average. We were surprised at the level of pulldown. As you'll recall from my opening comments, we track our, six of our largest customers that account for 70% of our retail sales. So we've got a pretty good grasp on it. And while we saw our shipments and our IV flat, take-away was up 8 and 9% for the quarter and month respectively. That's a lot of inventory pulldown. And quite frankly, we didn't sense they were stuffed at the end of the year. So that's a long way of saying we don't have perfect forward vision on it. But none of our guidance and our sales plans and our estimates reflect further inventory pulldown at the customer level.

Okay. All right. Great. Thanks, guys.

Thank you.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. I will now turn the call over to Mr. John Lundgren for any closing remarks.

Thanks Marcus. Let me just close by mentioning again the two analyst dates, May 6th and October 26th. And we will address some of the questions that have come up today in more granularity. We will also update you on some important programs and initiatives within the Company with a focus in May on Security and in October on Tools. We have a tremendous number of developments to discuss in security, and as a consequence, after a lot of internal discussion, we decided that giving that growth platform its own day just made a lot of sense for those of you who track Stanley as well as for us.

But our tools business, especially on the consumer side, has a business cycle that features the introduction in new products and the rollout of new share building programs in the summer. And most of that activity about which we're really excited simply can't be discussed with you in advance of its summer rollout. So we also look forward to the opportunity to demonstrate, again, the tools is very much a growth platform at Stanley. But competitive concerns and, obviously, our customer relations require that we do wait until after we've rolled this out in the summer to do so. We are privileged to have two growth platforms and we're really looking forward to reviewing both of them with you. Thanks a lot.

This conclude's today's Stanley Work's first quarter results conference call. You may now disconnect.