史丹利百得 (SWK) 2005 Q2 法說會逐字稿

Good morning, my name is Shatina 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. [Operator instructions]. I would now like to turn the conference over to Gerry Gould, please go ahead sir.

Thank you Shatina. Good morning everybody. On the call this morning with me are John Lundgren, our Chairman and CEO, and Jim Loree, our Executive VP and CFO. We had a flurry of press releases that are all out there, our earnings and guidance press release last night. We declared a dividend yesterday, named a new director, we had an election of a corporate officer, all those press releases are out there as well as the security contract with NASA. So they're all on our web site and they'll all be mentioned at various points in the call.

Secondly, little bit of a change this quarter, Jim and John will go over a PowerPoint presentation similar to what we did last Monday with the acquisition announcement. It's up on our Web site. It's at stanleyworks.com in the Investor Relations section so you can follow along. And 15 minutes ago we put a PDF version up there in case you want to print it. So Jim and John will review the matters in the releases and then we will go to a Q&A period. And the operator will explain how it works.

In accordance with Reg FD, as we usually do, we'll give earnings guidance today at the outset of the quarter consistent with yesterday's release and we will not comment thereafter, but we will pre-release if business conditions where it to change materially.

The call should last about an hour. There will be a replay available two hours after the call through the end of the day Saturday at midnight. The call number is 800-642-1687, and the code is 7901230, and thereafter it will be on our Web site. You can call me with any questions.

One reminder, and then we'll get started, certain statements contained in this discussion by the various participants are forward-looking statements. As such, they involve risks. 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 releases. With that, I would like to turn the call to John Lundgren.

Thanks Gerry. As you saw on our press release yesterday, we reported record results in the second quarter, starting with revenues of $824 million, up $70 million or 9% over the second quarter of 2004. The sources of growth were fairly evenly distributed. We grew organically about 5%, as you see on the chart, and our recent acquisitions, all of which we'll touch on a little later on, added 4% for a total of 9%. Within our organic growth, 2% of that was volume, 2% price, and 1% the debt of foreign currency translation.

Within the segments, we will talk little bit more about that later on in this morning's presentation, but Consumer Products grew a total of 4%. That was all organic, as we've made no acquisitions in the consumer product segment within the last 12 months. Similar situation for Industrial Tools, 8%, all organic, and Security Solutions grew about 20% in total, of which 1% was organic, the rest due to acquisitions. And Jim and I will later on will try to drill down a little bit more about security growth in general and Access in particular. So a total of 9% growth, 5% organic.

Looking at the Financial results in terms of EPS, we reported $0.78, slightly above our guidance. You'll recall that our guidance when Jim and I gave it at the last quarter was $0.72 to $0.76. The $0.78 is an 11% increase over the same period a year ago. Net earnings of $59 million in Q2 04 increased to $66 million in the second quarter of '05.

Not on the chart but in our release, we achieved a gross margin of 36.7%. That was roughly 50 basis points ahead of the same quarter a year ago, translating to 13.7% operating margin, about 20 basis points above a year ago.

Our tax rate was 28%, which was a percentage point lower than we estimated. Jim will give you a lot more detail or direction at least as best we can looking forward. That added a penny to earnings, and we have about 85 million shares outstanding. This was our seventh consecutive quarter with double digit EPS increase.

Some of the highlights for the second quarter, a little more detail on what I just showed you. In our consumer segment, our U.S. tool business was extremely strong. Hardware was flat, modest declines in our toolbox and small storage business. In the industrial segment, Bostitch or fastening, laser, mechanics, and hydraulics tools were all extremely strong. Great quarters from a top line perspective and we benefited accordingly with earnings.

In security, mechanical, and electronic access gained, offset by automatic doors decline, so automatic doors declined as was in our press release, and as Jim will talk about a little more, we're in fact just comp affected and we feel good about our security business in the second quarter and really everything about it. And when I go through the segments, Jim will drill down a little bit more on security in particular.

Operating income of $113 million, up 11% over the same quarter a year ago. I said on the same previous chart, OM of 13.7% up 20 basis points. That includes $189 million of SG&A, or 22.9% of sales versus $171 million of SG&A or 22.7% of sales a year ago. The $18 million increase in SG&A came from a variety of sources. It's flat as a percent of sales, but we feel that the money's being a lot better spent.

Specifically, $6 million came from acquisitions, $2 million integration costs, $3 million more advertising over an already healthy level in the same quarter a year ago, and then the last $7 million expansion of the core business. So, we look really hard, not just with SG&A in absolute terms, but the mix of where and how we are spending the SG&A. We feel that mix is getting richer every quarter.

So to translate, EPS was $0.78 as I said, which included $0.03 in restructuring - that's exactly the number that Jim gave you when we provided second quarter guidance in April. That's what we incurred. There is additional $0.02 of transaction costs relaing to the Facom offer that we put forward on the 18th of July. The lower tax rate, as I said earlier, added $0.01 to the guidance. Free cash flow was $61 million, and we had higher cash earnings and we had more working capital needs. Jim, again, will comment in more detail on cash flow, both achievements to date, some of the movements, and our forecast for the year.

Looking at our segments, we had a terrifically strong quarter and we're entering the third quarter with great momentum in Consumer Products. Again, revenues increased 4%, and that was 100% organic. Operating income increased 8%, so we're getting really good leverage off the volume and sales increases. And operating margin increased a healthy 15.3% a year ago to 16% in the second quarter of '05. We were quite pleased with the performance of this business.

In terms of the highlights, sales accelerated after our first quarter customer inventory correction. We had strength in hand tools, but the UK was weak, and ZAG was relatively weak, as I said earlier, oil prices obviously impact cost and the need to raise prices impacted volume. Hardware was relatively flat.

In the first quarter, when we gave our guidance and talked about our business, we told you that our primary large retail customers were adjusting their inventories and the POS was exceeding orders and process sell-through would take place and that is exactly what happened. The sell-through to the top six US customers are up plus 5%, which is similar to the first quarter '05 increase.

But as we enter the second quarter, our third quarter, excuse me, we're feeling very good about our open order situation. We have good programs, strong programs in place, and they're rolling out in the summer making us feel really good about the second half of '05. We had very strong advertising support around Father's Day in the second quarter. That will continue to stimulate end user demand.

And for perspective, to refresh your memories, what Jim reported in the first quarter, orders were down 4% versus the same quarter '04, despite, and partially due to the trade inventory corrections. In the second quarter, orders were up 8%, which has given us a lot of confidence as we enter the third quarter -- program driven and reflecting the strength of our brand.

In the Industrial Tools segment, we had solid revenue and operating income and they both continued to grow. Revenues were up 8% to $348 million. Operating income up 7%, so slightly less than revenue. We still have some steel inflation, most of that's in Bostitch. And as a consequence operating margin was down 10 basis points but still comfortably in the double digits in what can be a relatively cyclical business.

Sales strength continues in hydraulic tools, a record quarter in the LaBonte business, our hydraulic business. Fastening had a strong quarter. Our photomechanics tools business and our industrial storage business all had great quarters.

The steel cost reductions were actually minimal, due to a combination of two things - the type of steel we use, particularly in our fastening business, primarily rod, as well as the time required to pull lower cost steel through our production system and have it reflected in inventory and ultimately in cost of goods sold. There was an unfavorable mix and some production inefficiencies in the fastening business which led to margins declining ever so slightly, and that is primarily the backlog of our triple credit galvanized nail product doing very well, as we worked that backlog down and dramatically improved our service situation and our customer service measurement. It was a negative mix impact with less galvanized and more standard product.

Laser tools continues to be a bright spot. Sales of approximately $25 million, including $4 million in the consumer segment, up about 50%. Operating margin above 20%, and a good strong performance in Europe which we're pleased with.

And finally in the Industrial Segment, MAC Tools sales were flat, but operating margins were up 70 basis points to 9%. Remember this business has a very low capital base so 9% OM leads to a pretty good return on capital employs. We continue to work on our distributor accounts, it's up on a sequential basis, and again, industrial tools orders were up at the end of the first quarter only 1%, they were up 9% at the end of the second quarter.

Finally in security, this is perhaps the brightest spot from our perspective on the quarter. Our margins are back on track. Jim, Justin Boswell and the team explained in May to many of you what we thought was going on in the first quarter, what we thought would happen in the second quarter, and in fact that's exactly what happened. Revenues increased 20%, operating income 21%, margins versus same period a year ago were up 20 basis, but sequentially, as we said at our press release, they were up from 13% to 15.6%. Jim is going to take you back through those numbers of the May 6 walk in just a minute, to be sure there's clarity around what happened and in fact it's what we predicted would happen.

Organic sales in the Americas were good. Mechanical access was up 5%, electronic access up 7%, automatic doors were down, due primarily to $9 million less revenue received from a major customer in an '04 retrofit contract. Excluding the impact of that non-recurring comp, sales were up 6% organically in the automatic door business. Third quarter, we'll expect 3 to 5% organic growth with consistent or even better margins. And as Gerry mentioned, we press released win of a key access control and integration contract with NASA, which is obviously a premier account and a prestige customer.

Looking at orders, if you recall the first quarter, orders at the end of the first quarter were down 3% over a comparable basis at the end of the second quarter. At the end of the third quarter they are up 9%. So again, we feel very good about the momentum behind the security business.

Now I will turn it over to Jim who is going to give you a little more detail on second quarter net income, talk about the outstanding performance in the Security segment, some more detail on cash flow, and then we'll get back to some questions.

Okay. What we have up on the Internet now is an income statement which shows the second quarter of '05 versus the second quarter of '04. I'd focus on the right hand side of the chart that has the V percents, revenues up 9%, as John said, operating income up 11%. So some operating leverage, perhaps not as much as we would like, but I think we're going to get more as we go forward with our SG&A under firm control and continued organic revenue growth.

Not to much happening in the interest and other lines, at least when you look at it on a year versus prior year basis. The 11% growth in operating income netting out $2 million in restructuring which we had anticipated in the April call led to a 10% increase in pre-tax income and the tax rate was slightly favorable to the 29% that we had a year ago and came in at around 28%. So the net income was up 12%. The shares are at 85 million, led to an EPS growth of 11%.

But the story of the quarter, as John mentioned, is Security, and particularly, the operating margin rates. The charge you're looking at right now on the Internet is a flashback to the May 6 analyst meeting that we had in New York, and this was a chart that Chris Offel (ph) who is the CFO of our security business put up and told everybody how we were going to get back to a 15% operating margin from the low point of 13% that we experienced in the first quarter. And the elements that were included in that or involved in that were no inventory charge. We had in inventory charge in the first quarter at an acquired company.

We expected our auto door business, which had a tough quarter in terms of installation delays, to recover nicely by 1.6 points. We expected our electronics business in security, which is one of our growth engines in that portfolio, to improve the total operating margin by 5 points. And then volume, sequential volume from the first to the second quarter, was expected to contribute 4 points. And then we had a hedge of a point, just in case something went wrong somewhere along the line. That got us to the 15% operating margin, and then we knew we had this acquisition integration charge up in SG&A coming, so we expected it to be at 14% operating margin in the quarter and we were viewing that as a significant accomplishment.

What actually happened, if we turn to the next page now, was in the second quarter was we didn't get the inventory charge, obviously, as expected. The auto door recovery was expected, generating 2 points of margin improvement. And then the electronic profitability initiatives and the volume leverage both happened as expected, and that got us to a 16.3% 0M. And you'll note that we did not consume or use the hedge of 1 point that we had on the prior page. We did have the acquisition integration charge right around the same level we were expecting in total got us with a 15.6% OM. Very exciting for us and the security team I think and our shareholders as well.

And let me make a note as well on the security business as it relates to organic growth, because some of those folks who were so fixated on margin degradation over the last couple of quarters had also mentioned organic growth as an issue, and we haven't had much organic growth in the security business in recent quarters, although the acquired growth has been terrific. So as an example, the organic growth in security was in the third quarter of '04, was 4%, and then it dwindled down to - minus 1% in the fourth quarter. It was flat in the first quarter of '05, and it was up 1% in the second quarter.

So a number of factors have contributed to this lack of organic growth, but the single biggest factor has been this contract that we have with -- in the access automatic door business with our largest customer. And this contract was a complete remodeling of -- a very expensive remodeling of their automatic doors and reconditioning as well as some new doors that were put in some existing stores. This contract was significant in the sense that in the third quarter of '04, it was about $10 million of business with this customer, and in the prior year, the same time period, it was about $10 million. The business has stayed around that $10 million range, but the costs it was facing in the third quarter were $13 million, the fourth quarter was $19 million, and the fourth quarter was $19 million.

And the net result of all that was that the Security segment sales were due to that comp issue were depressed in the third quarter by 1 point. And in the fourth quarter by 3 points, and in the first quarter by 4 points, and in the second quarter by 5 points. So that lackluster performance, had it not been for this comp issue, would have looked more like a consistent 4% growth. Not exactly what we're looking for, but certainly a far sight better than the kind of numbers like minus 1, 0, flat, and so forth.

Going forward in that segment, we are expecting a recovery in the organic growth. We are predicting 3% for the third quarter, and the issue with this largest customer in the comp -- pretty much it goes away in the fourth quarter. It's nominal in the third quarter. It is about a point.

And the last thing I'll note on that is that the automatic door business is just performing terrifically. Without this customer comparison issue, the rest of the business in automatic doors has been up double digits now for three consecutive quarters. So the team in automatic doors is responding to that -- has responded to the comp issue which could have been actually even worse than it was. So I think we feel pretty good about the organic growth situation in security.

Now I'll now move on to some items of note. These are just details associated with the results. We had restructuring charges, as I mentioned, of $0.02 in the quarter. They were related to our UK security business and the further integration of that business. We had some charges in SG&A associated with acquisition integration also on the security business. They were $0.01 a share, or about $1.5 million.

We had $0.02 of costs embedded in the overall results associated with the Facom due diligence and an offer that we recently made, so our results actually would have been $0.02 EPS better had it not been for those costs that were expensed. And as I mentioned earlier, we did have the income tax reduction rate versus the April guidance and also versus prior year.

Moving on to cash flow. A good quarter for cash flow. It could have been better for cash flow had the working capital been a bit better, and we did have some growth in receivables which we -- about $10 million or so growth in receivables, which would be slightly unusual for this quarter. And that really related to the fact that we had started out with a very strong April and then in May -- we had a weak May, we had a very weak May. June was very strong. So it's purely timing and nothing to be concerned about for the long term.

The cash flow came out at $61 million, free cash flow, and that was versus 78 a year ago. If you look at it from a year- to-date basis, the right side of the chart, we're at 111 at this point in the year. And that positions us very well to hit our $300 million plus number for the total year. We're quite confident about that.

The next chart just shows the history of second quarter. We like to look at cash flow in a long-term context. That 61 is right in the zone of where it needs to be to meet our expectations. And then the balance sheet. The story here is that the cash is up $90 million, the debt is down $74 million, the equity is up $252 million, and the debt to cap is squarely in the mid-30s, at 35.6, down from 43.1 a year ago. And we are in very good shape to digest financially the Facom acquisition with cash and debt. And a A-ratings after assessment by the rating agencies were reaffirmed by both Moody's and S&P recently.

Moving on to guidance. The guidance is unchanged for 2005 so it's $3.20 a share to $3.30 after a $0.05 restructuring charge. That's slightly different because in the prior guidance we had about a $0.03 restructuring charge. So the guidance before the restructuring charge is slightly higher than it was before. That would be about 12 to 16% earnings growth. I mentioned the cash flow at $300 million plus. Organic sales for the year, 4 to 6%, and acquisitions should contribute about 4%.

For the third quarter, we're looking at organic sales in the 3% to 5% range. We feel really good about consumer. We think consumer is going to surge forward in the third quarter. We don't have the issues at the home centers or mass merchants outside of a few isolated issues that John already mentioned. And the acquisition growth should contribute another 5 -- total should be the 8 to 10% range.

Operating EPS of $0.81 to $0.83 -- the restructuring charge of $0.03, and a total net of that of $0.78 to $0.80, which would be 8% to 11% growth. Obviously, we're hoping for the higher end of that range, and if we can get it, it will be our eighth consecutive double digit quarter. With that, I'll turn to John.

Just in closing before we open it to questions, Gerry touched on it. We've had a very, very busy quarter. We made an offer to acquire Facom's Tools from Fimalac for $494 million. That offer was made on July 18, and the process for employee groups and various regulatory approval began the next day. We're delighted the Larry Zimmerman, the Chief Financial Officer of Xerox, has joined -- was elected and joined the Stanley board at our board meeting yesterday. Larry will attend his first board meeting in October.

We announced our 38th consecutive annual cash dividend increase. The dividend that Stanley has and will continue to be a very important element in terms of our total shareholder return. We hired Holly Ceredes two weeks prior, Holly Langsten (ph). Holly was married in the last month, that's why I mention both her maiden name and married name. Holly is president of our specialty tools business, replacing Bridget Marnaca (ph), who as you will recall, for those of you who were with us in May, has moved to Stanley Security Solutions as head of field operations and added a tremendous skill and talent to Justin Boswell's team.

Last, but certainly not least, we've elected Justin Boswell, President of Stanley Security Solutions, as an officer of the company. That reflects both Justin's past contributions in building the Security Solutions business from $100 million when he joined the company a little more than five years ago to $800 million today as well as the obvious importance of Security Solutions in our future.

So it was a really active quarter in terms of programs, and it was an outstanding quarter in terms of results. With that, Jim and I'll take your questions.

[Operator Instructions]. Your first question comes from the line of Steve Fockens with Lehman Brothers.

Hello?

Hi Steve.

Actually this is Andrew Keller. I have a couple of questions. Regarding your purchasing with your supply base. A lot of your competitors were last year implementing some new strategic initiatives to reduce their raw material and commodity costs, opening up a better line of communications with their suppliers. Could you provide some color today on the call on what you are planning to do to reduce your raw material costs and opening up a better line of communications with your supplier basis?

We have an excellent line of communication with our supply base and we have been that at that now for at least five years to seven years and possibly more. There's really - that's an ongoing effort at Stanley. We typically have generated between $50 and $80 million of productivity a year of which 60% or 70% of that typically has been material productivity. And that did not come from simply beating up suppliers and insisting on price increases, it's been a cooperative effort. Obviously with all the inflation activity, we're even ramping up our efforts further in this area. For us, it's going to be more business as usual in this area.

I will add to what Jim said. That one of the reasons, at least our estimation and our analysis of the numbers in 2004 is we recovered a far higher percentage of the unprecedented materials inflation in general and steel in particular last year than most of our peer group, which is one of the reasons we were able to grow margins in the course of the year. And just to echo what Jim said, a very active global sourcing organization coordinated across three continents, run by consummate professionals who all are long- term, long serving Stanley executives. And I'm quite pleased with both the numerical progress that has happened as well as the collaboration with our major suppliers.

I've been following your companies over the last couple of years, quality has always been a huge issue, a huge initiative for your organization. Is your global purchasing team working with their supplier base? Are the score carding them? How are they making sure that your supply team, supplier base is actually keeping up with quality metrics that only Stanley needs?

Well, the trend in industry, as I'm sure you know, is to do little or no incoming inspections. If we have to inspect raw materials quality coming, they won't be a supplier of The Stanley Works very long. We have our Stanley fulfillment System, it includes Lean Six Sigma and a whole lot of other things. We're a producer as well as a purchaser. In terms of supplying or our sourcing of finished goods, we have a well-established supply base of world-class manufacturers.

In terms of our supply of raw materials, we have a broad based of supplies of various materials, the overwhelming majority of whom have served Stanley for a long period of time and adheres to pecifications within our own plants with the implementation of the Stanley fulfillment system, enabled by Lean Six Sigma continues to improve every day under the guidance of Jeff Chen, who is head of global operations.

Thank you. Your next question comes from the line of Michael Rehaut with JP Morgan.

Good morning.

Hey Michael.

Just a couple of questions. First on the industrial tool margins. I guess you're still fighting through the higher raw material costs, which I guess continued to offset some of the volume leverage that you're getting. I was wondering if you could walk through at what point do you expect those higher material costs to be anniversaried where you might be looking forward to some leverage? Then I have a follow-up.

Well he fourth quarter was -- what I mentioned last time when we expected the higher cost to be anniversaried. The real question will be what happens with competitive conditions and can we hold the price that would allow us to pull through some operating leverage. That's a one day at a time kind of situation.

But setting that aside, I think that the issue - I think what we're going to see talking about the segments for a minute, to put industrial in perspective, I think we're going to see the consumer segment get some nice operating leverage in coming quarters because of its - I think it's, as I said earlier, going to have a surge in growth. John mentioned the programs that they're rolling out. I have never been more excited about what we're doing in the marketplace, and a lot of that you haven't seen yet but you will shortly.

And in the security segment, we're going to get some margin expansion over time, that we talked about in the May meeting. It may even be slightly faster than we thought. Certainly, it was in the second quarter, the jury's still out in the third quarter, but it certainly, I would say, has a positive bias to it. On the other hand, I think the industrial segment is approaching perhaps kind of a peak in terms of its run, and not just for us but for others. I expect that we'll see some slowdown in organic growth in the industrial. So if I were predicting, and we don't guide segment organic growth, but if I were predicting, I would say - would suggest that the consumer segment will probably outgrow the industrial segments in the third and fourth quarters of this year.

Therefore, I don't know that we have a huge opportunity for operating leverage in the industrial segment, although I will say that the fastening team is a pretty agile business team and they're looking at profitability improvement initiatives in the business as well as - we're doing the same in the MAC business. That's probably the most likely source of any operating margin expansion that we might have in industrial, notwithstanding the potential acquisition of Facom which will be accretive to the margins.

Jim, let me just add before Mike asks his follow-up, and I am sure he and many on the line are familiar with the numbers, but Bostitch and Stanley fastening systems is more than 40% of our industrial segment. And he overwhelming majority of the Bostitch sales, as you'll recall, are fasteners and nails, not the tools, per say. That is rod, which has not moved down nearly to the extent of flat steel. So to the extent that that continues to stay stable, we're less able to predict or see a raw materials decline. But what's far more important, with the point Jim made, is that the challenge will be holding a price increases that we worked so hard to drive through the beginning in the second quarter last year.

Okay, that was great. Thank you. Just as a follow-up, you mentioned in the press release that you've completed three smaller bolt-on acquisitions. I was wondering, we have heard different things from your expectations for the pace of acquisitions over the last 12 months, what are your expectations over the balance of this year and into '06 in terms of what the opportunities are out there and what might you think acquisitions add to be business in terms of sales and split between security and industrial? What are you looking at in terms of a pipeline and what might add to the results?

We have a very active pipeline. The reality is that when we're about to complete the largest acquisition in the company's history, we're not going to go out and go crazy buying up other things, until we are absolutely convinced that this is firmly in house. Now having said that, small security acquisitions like the ones that we just announced, are opportunistic and in some cases, even strategic, despite their small size. Like, for instance, the acquisition of Precision, which is exit devices and closers and fill outs a very important product line in the mechanical access business. One where our lack of that has led to some competitive issues over time, whether it be pricing or whether it be just the availability of the product. So that's is an important acquisition. You'll see acquisitions like that continue.

I would't expect to see too much in security, maybe $10 million, $20 million at the most this year. But we are totally committed to building out the security platform, like we've said before, and we expect in the ensuing year or years that we will make some significant security acquisitions and fulfill the vision that we've been developing here over the course of time in that business.

And then as it relates to tools, we will keep our eye on the consolidation of the industry. Obviously, timing will be regulated in accordance with our operational and financial capacity. Bu there are other properties out there. We are very interested in industrial properties or even consumer properties that don't have exposure to large home centers, so that would be kind of the focus of that particular acquisition program.

Mike, the only thing that I would add to what Jim said is we certainly don't feel capital constrained given our cash flows and given our balance sheet. We are going to be prudent, as we have been over time. But importantly, as it relates to looking at opportunities in security, whether it's to keep the pipeline full, vetting large acquisitions for the future or bringing small ones on board. With the possible exception of the two people on this call, the reason we would shy from an acquisition is organizational capacity to absorb. With the possible exception of Jim and myself, the folks integrating those acquisitions it's a different team. Justin Boswell has a very capable team in mechanical as well as electronic access. And Don McIlnay's tools group folks has done a great job integrating their small acquisitions. So it's a different talent pool and it just draws on a different part of the organization.

Thank you. Your next question comes from the line of Stephen Kim with Smith Barney.

Thanks. My first question relates to - really is a following on to Mike's question about security. In the past, you've talked about how you're going to focus domestically on integrating what you've already acquired and that perhaps we might see incremental acquisitions more of an international flavor. We saw one of those today, I guess, with Siloc (ph). And I gather that later this year you're probably will be a little judicious about how much you require internationally, but it sounds like in 2006 and 2007 that is on the table.

I wanted to see that if you could describe for us how you are approaching the international acquisitions in the security business. Do you have, for example, a short list of countries that you are seeking to enter, and vetting only acquisitions in those countries? Or are you rather casting more of a wider net and just simply seeking out the best companies on a set of sort of operational metrics and approaching your international strategy in security in that way?

Yes, Steve. I guess the latter is clearly the direction we're taking. It makes little or no difference where a company is headquartered. What makes the difference is where it does business. And if they're of any consequence, if they're European or Asian, they're doing business all over those continents. Our objective is to be among the first, if not the first, integrator with a direct model global footprint. There are a number of good companies out there that would move us quite quickly or more quickly in that direction, and that's our focus. Good companies doing business on a global basis, or on a Pan-continental basis, that would allow us to follow our large, primarily retail, secondarily other commercial customers, to other parts of the world.

And Justin Boswell's promotion to - or that you recently announced. Is that in any way related to your international strategy? How you see the promotion of Justin affecting your ability to implement your longer term strategy globally?

We see -- Justin from a day-to-day perspective has the exact same responsibilities he had two days before. This recognizes two things. It recognizes a long serving Stanley executive who has been a key member and leader of the team that's built a business from $100 million to $800 million with above line average margins, and also the fact that Justin will continue to lead that team going forward.

I don't think we have been even remotely evasive about the fact that Security Solutions will be a huge part of our future growth, and Justin is the guy that's going to lead that team. And he has built a terrific team with a combination of internal Stanley folks and acquired managers and executives. The message there is security is really important. Justin's our leader and he's doing a great job.

Thank you. Your next question comes from the line of Margaret Whelan with UBS.

Hi. Good morning guys.

Hi Margaret.

Hi Margaret Good morning.

Margaret Whelan. Would you say Justin is long serving or long suffering?

Both.

I'm just trying to figure out - I recognize that you do have this big account on the security services business and that's making your sales pattern more lumpy, do you have a sense for your backlogs and where the organic growth might shape up there? It just seems as if it is coming in different to our expectations. Just so we can a have a better idea of how to forecast?

It's been an evolving situation in terms of how do we forecast it much less how you forecast it. What's happening with backlogs in both access -- automatic doors and the two best businesses, the electronic and mechanical. Backlog is increasing in all three segments, and so what we are struggling with is mechanical is pretty straightforward, it's relatively short cycle. In the electronic business, we just announced this large NASA order. That's going to take a long time to install. And so we're going to have to put in better mechanisms for forecasting our lumpy revenue. And that's just one example out of hundreds if not thousands.

And then the automatic door business. I mean, we've been in this business since the 1930's and we've never won any contract like the one we have with our largest customer in that business. And so that was an aberration. They're still a very substantial company and a very healthy one for us. The kind of business we were doing, almost -- in some cases almost double our typical run rate and $9 million or $10 million higher. That is just something that -- while we knew it was coming, we were enjoying it when it was here, and we did a pretty good job trying to offset the decline but it was just impossible to do. We never really gave anybody a long-term forecast for the automatic doors business, and maybe in the future of we have some kind of similar program we will do that.

That might make it easier for us. The second part of the question on the same subject is that as far as I know you're still doing the acquisitions and then giving the acquired companies 12 months before you actually consolidate as part of your corporate overhead. Is that right?

Not in what we report externally. Margaret. We measured Justin and his team without that burden for 12 months. I may have confused you earlier in a one-on-one for which I apologize. But any numbers that we report externally include the overhead burden.

They do. Okay. So the 100 basis points then that you're referring to this quarter was separate to that again?

That's correct.

Okay, I got it. Thanks so much.

Okay Margaret.

Thanks Margaret.

Thank you. Your next question comes from the line of Eric Bosshard with Midwest Research.

Good morning. The consumer business improved nicely in the second quarter from the first quarter and it sounds like the order patterns and the expectations are for the second half to be materially better still on the top half and bottom line. Can you give us a little more explanation why you expect the improvement in the second half?

Yes. I guess two things. As I said, we entered the quarter with orders up 8%, which is twice what our revenue grew in the second quarter. And as I said, we are getting back to where we think orders and sales are going to start to level out. As you know, the retail customers worked off inventory in the first quarter somewhere between two and six weeks depending on the customers. We had the sales, we didn't have the orders. The orders bounced back in the second quarter, and for now they continue to be robust. That's just the analytics.

I think from a program perspective, we're planning a lot of advertising. The pipeline is full of new products. We've been in front of our largest retail customers with some line reviews and we're doing very well. A lot of those things are not in the marketplace yet, and as a consequence we're not in a position to talk about them on this call - something I was going to close with. We are going to be in a position on October 26, we think, to confirm our optimism and the book to be a whole lot more granular and a whole lot more specific about which specific categories, product lines, and even customers, once they're in the marketplace. So I hope that helps you, but that's about all we can say at the end of July.

Secondly, in the security business the improvement in the second quarter, and Jim, it was helpful for you to go from 1Q to Q2 But is there any one or two silver bullets that are allowing you to see better results? Obviously, the automatic door comparison helps in the second half, but anything structurally or from a demand standpoint or from how you're packaging the business to the end market that is allowing the results to return to what we'd hoped for when he started to grow this business?

Well, there is a tremendous amount of activity going on in the security business. When they refocused themselves, and we helped refocus them on the basics of the business about six months ago, it slowed down most of their acquisitions. Although we have done a few, but nothing really substantial or nothing really large. They basically put together a profit improvement initiative, which quarter by quarter by quarter will increase, hopefully, their operating margin if they're successful. It involves multiple elements.

Much of it just comes from integrating all the various businesses that they bought successfully with a common field organization, common systems, creating the value proposition for the customer, getting purchasing leverage, focusing on price realization, price management, in -- especially in the electronic business where the margins are lower, getting the second phase of the planned integration implemented. I mean, these are substantial programs. My view is that over a two-year period they could be worth as much as 5 points of margin in the second.

Yes, Eric, I would just like to reinforce what Jim said. I agree with everything he said. It is an area where we think we have a proven capability or competency at Stanley. But specifically, security in general, not necessarily for Stanley, it's been a business that's had reasonable margins based on growth and based on technology, which quite often, I'll say, compensated for relatively sloppy execution or inefficient operations. The only negative we have going for us in security is as electronic grows, as you know, it's a lower margin business than mechanical. So we've got a, if you will, a mix downgrade working against it.

More than offsetting that, though, is applying the Stanley performance system to that business. We've been the hand tools business for 160 years. We lose a couple percent of top line every year. If we don't get 3% in productivity, our margins will then strength, and our margins aren't shrinking. It's in our DNA. We acquire a security company. Some of the structural costs come out early, and then over the next 12 to 18 months, we get them under the same operating rhythm rigor as the hand tools business, on the same score card, and so far that's been a big piece, probably half of the margin enhancement from acquiring companies in the high single digits and getting them into the mid to high teens. And that will continue with Justin's leadership and with help from Jeff Chen, who runs our global operations.

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

Thanks, good morning. I just wanted to clarify two issues. Firstly, on industrial tools, I mean, you commented that you didn't expect to see too much more price leverage and too much more margin upside. I wanted to just check what you're saying, because Bostitch has a historic peak margin of probably around 12%, and I believe last year it was only at about 8%. So are you sort of saying you don't expect them to get back to peak margin in that business?

Jim LoreeL I'm not saying that at all. I think doing it through -- purely through operating leverage is probably not going to happen anytime soon because things are going to slow down a little bit, in my view, in the industrial segment and possibly in Bostitch. I think where they're going to get their margin expansion is through some business model changes, mostly related to their manufacturing footprint. And that's going to be a two to three year project. But there's more to come on that. And I wouldn't expect anything in the near future, unless we get a significant further decline in steel prices and the price that they have been able to achieve is better as a whole.

Okay, thanks. The second question is on your gross sort of guidance in the security business. If you compare the impact of the doors contract, Q2 '05 growth was about 6%. And you're saying that had 1% impact for Q3, so you would be looking at something like 4% to 6%. So, if anything, you may be looking at slightly lower gross in Q3. I am wondering how much of this is because the US FX is now probably going to be against you in the third and fourth quarter? I was wondering if you could give any organic growth guidance excluding the impact of currency?

Jim will perhaps shed even a better light on it, but there is very little impact of currency in our security business in that only about 15% of it is outside North America. We have round numbers, $800 million business on an annual basis, of which $125 million is outside North America. So FX is almost insignificant in the growth of security. So what you're seeing is pure organic, and it's businesses that are already on board.

Thank you. Your next question comes from the line of Ivy Zelman with Credit Suisse

Good morning, guys. In terms of your comment, I was taken a little taken aback by your indication that you would actually now consider buying companies within the consumer business. At least from the discussions we've had, it was definitely not an area that you had considered buying companies in.

Ivy, either we misspoke or you misinterpreted our comment. We said we'll continue to participate in the consolidation of the tools business, which would be focused in industrial, as Facom was and as CST Berger (ph) was, and we're going -- obviously, Securities is a growth platform. If we said we were going to acquire in the consumer business, we misspoke.

What we said was we would potentially even consider acquiring in the consumer business where there was no home center content, and those are extremely isolated types of situations. But where we could do that to strengthen the business we might consider it.

I'm glad Jim said that, because that's where you picked up that sound bite. Which is true. Remember, our strategy is to reduce our dependence on the big box retailers. In the last two years, our largest customer has gone from 22% of sales to 12% of sales. On a pro-forma basis with Facom, that'll be below 10. We could consider something in consumer that wouldn't affect that ratio negatively.

And just one more question related to the margins in securities. You had indicated earlier, John, just now, that your electronic access margins are obviously lower so you've got that headwind against you. When we last spoke in detail, we talked about those margins being 7% to 9% range. Looking at the margin improvement you enjoyed this quarter, did you see an improvement in electronic or was it more driven by the mechanical? And can you give us a breakdown on how that performance is doing?

Both. It was across the board. Both businesses improved, though, arguably, 150 basis points. If you think of our three platforms, roughly it's one-third, one-third, one-third access, automatic doors, and mechanical. We got a nice lift in access and about 150 basis points each in both of those businesses.

We normally don't, as you know, forecast or report margins by segment, and this -- these are businesses within a segment. But the simple answer to your question is that lift was broad based. And we're just a little -- the electronic business is a little bit newer to us than, obviously, the mechanical and, obviously, the access. Bridget Marnaca who is focusing on field ops is doing a terrific job identifying the opportunities, consolidating things in the back room. We see it as a slow, steady continuous improvement opportunity. We won't change the dynamics of the market in which we compete against - in which we compete. So we are encouraged by the progress, and we got a nice across the board lift in 2Q.

Thank you. I would now like to turn the call back over to John Lundgren for closing remarks.

I just wanted to thank everybody. We had great attendance on this morning's call, and maybe a $500 million acquisition had something to do with it, maybe a good quarter. Thank you very much for your attendance and just to remind everyone that we had, I think, a productive day in May where we focused on the security business. We hope to have an equally productive day both from our perspective in communicating our story and your perspective in understanding where this company's going on October 26, where we will have a second Analyst Day in New York., while we will touch on all of Stanley and of course its progress in 3Q performance and things of that nature the focus will be on our tools business. The consumer programs I have alluded to, what we're able to say about the Facom, and the progress on closing the deal or integration at the time and a lot of other good news. So we look forward to seeing you then.

Thank you. This now concludes today's Stanley Works second quarter earnings conference call. You may now disconnect.