史丹利百得 (SWK) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Stanley Works second quarter results conference call. [OPERATOR INSTRUCTIONS] Thank you. Mr. Gould, you may begin your conference.

Thank you very much. Good morning, everybody. On the call with me this morning are John Lundgren our Chairman and CEO; and Jim Loree, our Executive VP and CFO. Our earnings release including guidance and our dividend release went out yesterday. They're available on our website, StanleyWorks.com. They will be referred to at various points on the call. Again, this quarter, John and Jim will go over a PowerPoint presentation similar to the last couple of quarters and it is also up on our website under events and webcasts in the Investor Relations section. So you can follow along. And about 20 minutes ago, we put a PDF version up there so you can easily print it.

John and Jim will review the matters in the release and we will have a Q&A. In compliance with Reg FD we will discuss earnings guidance today at the outset of the quarter consistent with last night's release, and then we will not comment on it thereafter. If business conditions were to change materially, we would issue a press release. The call should last about an hour. There will be a replay available beginning two hours after the call ends and it will go through the end of the day Sunday. The replay number is 800-642-1687. And for that purpose, the code is 2803627. Thereafter, it will be on our website. You will be able to call me with any questions at 860-827-3833.

Finally, we remind you that certain statements contained in this discussion by the various Stanley 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 included in last night's release and included in today's Form 8-K. With that, I would like to turn the call over to John Lundgren.

Thanks, Gerry. I am going to go through the PowerPoint presentation. I think it is easier to take notes and follow. I will start and then turn it over to Jim.

Well, first and foremost, it was a real milestone for Stanley. It was our first $1 billion revenue quarter in our 163-year history. Obviously that's something we're proud of. Driven by 25% increase in revenues, driven primarily by acquisitions but healthy organic growth as well. Specifically, if you look at our sources of growth, volume contributed 3%. We got very little in terms of price. There were some pluses and minuses that we will talk to in the segments. But giving us 3% organic growth, no effective currency either positive or negative this quarter, or no material effect. Acquisitions contributing 22%. So in total, 25% increase in revenues versus first quarter of '05.

Looking within the segments, consumer products was up 27%. 5% of which was organic. And obviously the majority of that is due to the inclusion of National Hardware. Industrial tools was up 33%, primarily due to the inclusion of Facom. Organically, industrial tools was down 1%, and that was driven by quite a large decline in the fastening systems or Bostitch business offset by some really strong performance in mechanics, tools, storage, our Vidmar business, industrial storage and Mac. A little bit more on the individual businesses later.

We were quite pleased with security. 9% total growth for the couple, very small acquisition, but driven by 4% organic growth. Very strong quarter in Access, our electric door business, the model is working, good momentum in the system's integration business, and we love our mechanical business, we love the margins, we love the business, we love our market position, and one of our challenges is to make it grow faster. But solid, solid performance across the quarter, with the exception of Bostitch and we will come on to that in just a minute.

Looking at how that translates to earnings, we were up 17%, or $0.13 a share versus first quarter a year ago. We reported $0.90, that's versus our guidance of $0.80 to $0.85. You see, our 13% operating margin which was in our release in our share count. In the guidance, our tax rate was about 80 basis points higher. And basically, the results are -- helped about a $0.01 by a lower tax rate.

Operating margin was affected by geographical mix. The tax rate was also affected by geographical mix. We have a lower tax rate in Europe. Europe did well. And the operating margin was affected by both materials costs in the consumer segment, as well as good performance in the industrial segment, ex-Bostitch and industrial being larger, that being our lower segment.

Also included in the number, if you look to page -- if you flip to the next slide, is about $0.05 per share of charges, about 3 million of -- in inventory step-up charges and 2 million of other charges. As I'm sure you know, the inventory step-up charges are noncash. The other charges are primarily severance. And those are cash charges. But on an apples to apples basis, we had about $0.01 worth of similar charges in the first quarter '05. So EPS from continuing ops excluding the charges for those who care to look at it that way, were about $0.95 versus $0.78 the same period a year ago. Operating margin would have been about 30 basis points higher. Obviously, the tax rate is the same.

Looking to some of the financial highlights for the complete P&L, we've talked about revenues, acquisitions, adding nearly 180 million. Very strong performance in our consumer hand tools segment, led by both FatMax and FatMax Xtreme, the new introduction. I guess it is far too early to declare victory on Xtreme and FatMax but we have good news and better news in that Xtreme is meeting its expectations to date and we are thus far experiencing less cannibalization of the FatMax line than anticipated. So that's been a good story thus far. And when Jim talks about the guidance a little later on, we will talk about some of the future plans for that very important product line.

Within industrial, as previously mentioned, mechanics, tools, and storage, up 10%, in terms of revenue, with good margins, fastening, our Bostitch was weak compared to the same period a year ago. We are doing a lot of work to try to take some of the end of quarter spikes out of that business, level load our factories, and do a better job managing fill rates. It is a conscious effort. And we will come on to that a little later on in our presentation.

We are quite pleased with security. Second and third quarters historically are a little better in terms of margins and revenues due to some seasonality, but we had strong growth in Access as previously mentioned and the North American systems integration business is really gaining momentum. Operating income as previously mentioned, 13.3. Before the step-up charges, again, materials inflation, higher percentage of our mix now being industrial, which has some very strong businesses, but in total, that's our lowest margin segment of the three segments which -- in which we report. But all in, up 18%, we're pleased with that, EPS up 17%, and great quarter and great first half in terms of cash flow.

While there has been some looking at the quarter and saying, gee, in absolute terms the quarter was down X a receivables sale, we had 93 million of free cash flow in the second quarter. That included 41 million from the receivables sale. But I call your attention to the bottom right. We had a similar level of receivable sales in the first quarter of '05. So when you're looking at first half '06 to first half '05, both of which included 43, 44 million of receivable sales, we have got 164 million or roughly 53 million more cash flow, same period year to date this year as last year, so we're off to a real good start, and Jim is going to talk about our expectations for cash flow when we get to guidance.

Looking at our results versus our guidance for the second quarter, just a walk which we thought would be helpful, starting with the $0.77 from a year ago, earnings growth, it all came from earnings growth before charges, specifically earnings were up $0.18 versus our guidance we had earnings up about $0.09 to $0.12. Of the $0.18, that all came from operations with the exception of about $0.01 of the $0.95, or $0.01 of the over achievement, was due to an 80 basis point lower tax rate than included in our guidance. Step-up charges were as we projected. Restructuring charges were as we projected. So it gets to you GAAP earnings of $0.90, versus our guidance of $0.80 to $0.85 from continuing operations. So we were pleased from an operating perspective.

The next chart, I think is a very important one. Because something that we often discuss, but don't believe is very well understood is the relationship between Stanley's performance and home building, or more specifically residential home starts. Our stock tends to go up and down on the news when the data is published, if it is healthy, we will get a lift, if it is not, we will be penalized but in fact there is minimal or virtually no correlation between Stanley's operating performance and operating results and the home start data. One reason is, of course is when housing starts are down, remodeling efforts are up. And that reduces our hand tools volatility. And that's -- or cyclicality. And that's an important part. But I think more important is the fact that only a very small percentage of Stanley's revenues, and as a result, its operating income, is dependent on home starts.

Now, the chart that is on the screen perhaps does a better job of explaining what we've not been as effective in communicating as I think we need to be. If you start on the right-hand side of that chart, a lot of Stanley's businesses, security, Proto, Vidmar, Facom, Mac tools, assembly, hydraulics, supply and services, that accounts for more than 50% of our revenues, have zero relationship or correlation or dependence with home building. But if you go over to the businesses that one might conclude are dependent on, or closely related to home starts, we look at hardware, fastening, hand tools and laser tools. Now these are management estimates, but these are our percentages, and we think we understand our business as well as anybody, of what percentage of those businesses in fact are dependent on U.S. residential new construction. And specifically, hardware is about a $300 million business that combines Stanley National business of which 10%, or about 30 million is home start dependent.

Fastening is a $600 million business, but the largest customers and channels for our fastening business are furniture manufacturing, pallet production, pallet repair. But still, 15% plus or minus, or 90 to $100 million of fastening is clearly related to new construction and new home starts. The hand tools business, I talked about the offset between new construction and remodeling. But 10% of about a $1 billion dollar business or 100 to 125 million is clearly home center -- excuse me, home start dependent, and probably the most dependent business is our laser tool business.

We actually debated internally whether we should report laser tools within the consumer segment, or industrial. We currently report it within industrial. But about half of that $100 million business is dependent on new construction. That's what this business is about. So roughly, you get about 300 million out of our 4 billion that we can tie to home center starts, and that's not a significant percentage of our revenues.

Moving on, a second consideration that certainly we talk about is Stanley's exposure to U.S. consumer spending. Economic trends in general, but U.S. consumer spending in particular, because the Stanley brand is so well known and so strong. Well, there is no business, or no brand that is immune from changes up or down in consumer spending. But what this graphic and some of the logic is intended to show is starting with the -- only 33% of Stanley is consumer. And if you look at the right-hand side, of that -- of our consumer segment, as reported, just a little bit more than half of that is the U.S. Almost two-thirds is North America. When you add Canada. But 21% is Europe and 5% is Asia.

As we think about our business, and our consumer business, the majority of our consumer segment purchases are made by -- are made by professionals. We've got various estimates, the current number is 62%, give or take a few percentage, two-thirds of the purchases of Stanley hand tools are made by professionals. We are the go-to brand, the leading brand in terms of awareness, as everybody knows. And our hand tools are generally smaller ticket, nondurable nature compared to larger ticket items and for instance the Bostitch pneumatic nail gun, or some other items of that nature, or some of our peer groups products.

And just -- just an anecdote, but it will help you, the average quote consumer homemaker, homeowner, whatever, might buy one, possibly two hammers in their lifetime. A pro buys five to seven hammers a year, and it is the professional who is buying the Stanley hand tools, reusing the Stanley hand tools. They are our core.

Last but certainly not least, one way to grow the business regardless of the market in which we're competing is innovation in new products. FatMax Xtreme is off to a great start and we have got plans in both the U.S. and Europe to further the advancement of FatMax Xtreme.

And the counter cyclicality as I mentioned earlier between home building and home improvement is real, we've seen it over 163 years of history at Stanley, it is not a theory, it is a fact-based, data-driven conclusion, and we thought at least sharing those last two charts with you would help understand numerically to the extent possible why we believe so strongly we're less affected by, particularly home starts and some of the other things we're talking about. I'm going to turn it over to Jim who is going to get into some of the segment detail and walk through the guidance. I will come back for a summary and then we will take some questions.

Thank you, John. We have, as you know, three segments in Stanley and this quarter all three of them had double digit operating income growth. Let's start with consumer. We had 27% revenue growth and 21% operating income growth, our operating margin came in at 15.3%, down 80 basis points from the prior year. The National Hardware acquisition is progressing well. It is on track as per expectations.

The decline in the operating margin was a little bit of I think more of the timing than anything. We had some cost inflation in the quarter that wasn't recovered through price increases. That should be a lot better in the second half for the consumer business, as we've taken some pricing actions. Our innovation and our advertising support continue to stimulate excellent end user demand as the FatMax Xtreme product launch and the FatMax introduction into the mass merchant channel have both been very successful. And our second quarter North American hand tool sell-through is up in double digits. And so in total, the consumer product outlook is very encouraging. In the fall we will introduce another wave of these FatMax Xtreme products in the U.S., and we also have a wave of products coming into Europe. Europe has yet to see any of the FatMax Xtreme products. That will start in September.

Moving to the industrial segment, we had 19% operating income growth on 33% revenue growth. The operating margin was 9.8%, down 110 basis points from the prior year, as the fastening business weighed down the operating margin rate in that particular segment. It would have been 10.5% without the step-up charges, so considering the downward pressure from the fastening business, not too bad a performance. And that was driven by the Facom acquisition which remains on track as per expectations similar to National, things are going pretty well, we have a very robust monitoring process and the integration teams are doing their jobs very effectively. There was also good sales strength in mechanics tools, the Proto brand, storage, the Vidmar brand, and hydraulic tools.

As far as fastening goes, the second quarter was a stabilizing quarter for us. Even though sales were down 2 to 3 points, they were -- that was in the face of an 8% decline in the first quarter. So some improvement there. And frankly, the sales decline did not derive from market conditions as much as it derived from our own intentional actions to decrease -- to walk away from some business that was very price sensitive. So we could have been closer to flat to up a point in that business had it not been for that. The cost and price issues that we've had in the first quarter, although moderating to some extent, still resulted in operating margin down 5 million versus the prior year. And that was down 11 million versus the prior year in the first quarter.

Now, one of the really positive stories of the quarter, and one that I feel compelled to mention publicly here since I've been tough on this business in the past on these calls, but the Mac tools business had organic growth for the first time in a long time, and they had their first double digit operating margin quarter since 1997, if you can imagine that. So that business, albeit slowly and methodically is gaining some momentum, and the driver count was up sequentially in the quarter, the comp sales were up 4 to 5 points in the quarter so things are looking pretty good for the folks out in the Mac business.

Moving on to security, another double digit operating performance growth rate in this segment. Revenues up 9%. The operating income up 12%. The operating margin was up 40 basis points. Organic sales in Americas were up 5 points. Europe was flat ex-currency. And we continue to see this type of organic growth as we move into the back half of the year. We had real strength in the automatic door business, and really exceptional quarter from that business. The systems integration business had a strong growth quarter, with 9 or 10% organic growth. As John mentioned the mechanical business while it is very profitable had relatively slow growth in the quarter, although positive. And we do have a good order rate and a backlog building in this business, and we're seeing the benefits of some of the recent cost actions that we've taken. So we -- our outlook continues to be positive for security.

Cash flow, John hit the highlights earlier, basically, we're up, free cash flow, 53 million, versus the prior year, on a year to date basis, and 32 million in the quarter. As John mentioned, the quarterly performance was against a tough comp but included the $41 million receivable sale, but when you look at it on a year to date basis when you net out those receivable sales, very nice cash flow performance and it really positions us well to be able to meet and potentially exceed the $350 million target that we have had out there for a while.

Moving to the balance sheet, debt to capital ratio is in pretty good shape here, as we financially digesting the Facom, National, and the $200 million share repurchase that we did earlier in the year. You can see the adjusted debt to capital, when you adjust it for the hybrid financing that we did in the fourth quarter of last year, is now approaching the same point that it was a year ago, before we did those three very large capital consuming projects.

Okay. Let's move on to guidance now. Let's start with sales growth. And as you can see, in the third quarter, we're looking for a 4 to 6% growth organically. That will come from a continued strength in the consumer products segment, a rebound in the industrial tools segment, and 4 to 5% growth continuing in security. And then we layer on the acquisitions and so on, and we're looking at about 25% growth for the quarter. And we will move on to our view as far as inflation goes. Inflation is an issue for us, although not as much in the first half as it will be in the second half. So included in our guidance is an estimate of approximately $22 million of inflation for the back half of the year, versus only 7 in the first half. But the good news here is that the pricing actions that we have in place should allow us to offset about 70% of that inflation, although the offset will be stronger in the fourth quarter than it will in the third.

Then as far as the third quarter earnings per share guidance, that 4 to 6% organic growth should yield us earnings per share of $1.03 to $1.07, that will be up 14 to 19% versus the prior year, and that includes about a $0.03 additional charge for some restructuring in the third quarter of this year. The total year, we're still looking at a number that is well within the earlier range that we had, if you recall, we have, since January of this year, we have been predicting -- we had been predicting 3.45 to 3.65. We narrowed their range down to approximately 3.55. That will include $0.17 of step-up charges and $0.18 of -- $0.17 to $0.18 of restructuring and that will be about a -- well, it will be a low double digit growth performance for the year. So with that, I will turn it back over to John.

Just to summarize, I'm well into my third year at Stanley, and Jim is eight, and this is despite what is going on in the world around us, this is as encouraged as we've been about our business in quite a while. Obviously a milestone of 1 billion is more important to us than it is to the external world. It is the first time in our 163-year history. But it was accompanied by great cash flow, up 48% in the first half. Both integrations; they are very different businesses in different geographies but they're on track. We're pleased, we're quite pleased, as I said earlier, with both the performance of FatMax Xtreme on its own and the stability and continued strong performance of our base FatMax line as well as in the hand tools business.

Security rebounded nicely as we projected it would. The security business and Mac tools showed meaningful operation margin improvement. The cost reductions that we implemented early in the first quarter are falling to the bottom line. They're taking hold. They're offsetting a lot of the inflations that we're absorbing. And Jim talked about our view going forward. The Bostitch business has stabilized under new leadership and focused on the future. We brought back about $200 million worth of stuff, 24 million of that was in the second quarter. So we have reduced our share count. And as previously press released, we've completed the acquisition of Best, we actually haven't completed. We have a binding purchase agreement, shares are being tendered, we expect that to close at the end of July that gives us both a manufacturing foothold and arguably a competitive advantage for our pneumatic tool production business. So we're feeling very good about what we think was a productive quarter on both the operating and strategic benchmark front. Let's open it up to questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Kenneth Zener with Merrill Lynch.

Interested in looking at the top line. You guys have talked about organic growth in the second quarter of 5 to 7%, and it was 3%. I wonder if you could highlight where the volume came up lighter? Obviously, you guys had good operating leverage given Black & Decker is talking about inventory corrections at the bigger, large retailers. Thank you.

The primary area was Bostitch. As I said we intentionally walked away from some business there. And the other segments were in some cases, I guess about a point in both consumer and security we're a point lighter than we were expecting but nothing dramatic. There is a little bit of downdraft in the marketplace, from some of the external factors that are going on. But you can see they're just nominally affecting us and not really driving any severe contraction.

Right.

If you recall, Ken, most of the inventory correction, at least that affected Stanley took place in the first quarter, and we discussed it on that call. We saw a lot of it in late December, right through mid January, and we believe most of that is behind us, and some of the other categories, particularly in the home centers, probably did not experience it as early as we did. And are experiencing the same thing, perhaps just three months later in the calendar year, same types of corrections, just a question of timing by, quite frankly by department, in each and every home center.

Great. I guess with the fastening business, do you think you guys are going to have to right-size that business, if you guys are walking away from business is there something structural that finally happened in the $400 million fastening part as opposed to the 200 million product business which will result in lower nominal sales.

No. In terms of right-sizing, I will be very specific. Our fixed and structural costs are too high in that business. That's what we're addressing over time. This business is not dramatically smaller than it was. Again, it is -- some even outsourced business that we walked away from at low margins and at the end of the quarter that caused a spike to our system, tremendous over time, not reasonable cost production due to the loss of level loading of our factories. We've got a good geographical footprint, two production facilities, three in fact in North America, two in the northeast that are quite closely related, one in Mexico. A state of the art facility in Poland and a brand new state of the art facility in China.

We have the facilities in the right place. We need to start making the right products in the right place. We've taken a good step on tools. And we will get fastening -- we will get fastening correct over time, as we evaluate the options over the next 6 to 12 months. And in the meantime, we're focusing on processes, fill rates, and level loading our factories, but not reducing capacity in the fastening side of the business.

Your next question comes from Ivy Zelman with Credit Suisse.

Hey, guys. Thank you. Two questions. John, you mentioned that new construction is roughly 5 to 10%, or a small exposure, and that historically, that has been offset by the improvements in the business in home improvement. I guess with respect to what we're seeing right now, part of the weakness I think in your stock is related to concerns that home improvement is also going to slow given all of the equity extraction that basically funded home improvement growth. And just wondering how are you looking at that in terms of your forecast? Are you expecting home improvement to continue to grow and be a positive contributor? Or have you anticipated on that as well scaling back and expectations of the economy or home improvement will slow? That's the first question.

I am going to let Jim take it, Ivy. But I mean simply said, what is baked into our guidance is no dramatic change in the -- if you will, in the one offsetting the other. The correlations I talked about, Stanley's top line and Stanley's operating margins not being related to specifically what is going on going forward, but Jim's got some specifics that he will share with you.

I think the main point I want to make is that we couldn't be introducing the FatMax Xtreme and moving the FatMax into the mass merchant channel at a better time when you look at the fact that there potentially could be some market softness, and the way we're kind of thinking about it is that the positive share gain that comes -- is coming, and the average ticket increases that are coming from those moves and we've seen very little, if any cannibalization at this point in time in North America, plus the fact that our European business in consumer has been lackluster, over the last year or two, in terms of its new product introductions, and innovations. And now we have FatMax Xtreme being introduced in Europe, really covers, I think, a fair amount of terrain in terms of offsetting any potential weakness in the home improvement.

But at this point, I mean you're really not showing in your models or your forecasts any decline in home improvement?

Well, whether we do it in our models or whether we do it kind of conceptionally, it doesn't really matter. It is the same. And we're not assuming a big downturn in home improvement, it is true.

And I guess what we're saying is we obviously don't operate in a vacuum, but we're certainly getting more lift out of incremental FatMax with less than anticipated -- FatMax Xtreme with less than anticipated FatMax sales, what we're getting from that is more than offsetting any global or macro decline, and that's what we're benefiting from. That's when it is important to have the leading brand in hand tools, a lot of innovation, and advertising and merchandising support program that your large customers will get behind.

Okay. Thank you. I guess my second question relates to Ken's question, on sales guidance. Looking at I guess when you were at the end of the second quarter -- the first quarter, when you put out your guidance on 2Q, you notched it down the low end of the range for both consumer to now 4 to 6 compared to what you had indicated prior, it was a little bit higher, and same thing in the other businesses. Are you just concerned and being conservative, or do you think that the targets that you had originally looked at are still achievable? Just being more conservative?

You're talking consumer, Ivy in particular?

I'm talking all three segments, you notched down your full-year expectations.

Well, let's start with we started the year in January with a 3.45 to 3.65 earnings per share guidance and was consistent with a 2 to 4% revenue growth, organic revenue growth estimate at that time. In April, we bumped it up to 4 to 6%. This is really before some of the external concerns came about in terms of the consumer segment. But we also at the time improved our consumer outlook from 2 to 3% growth for the year to 5 to 7. We now have moderated that 5 to 7% consumer outlook to 4 to 6, and our total is down from 4 to 6 to 3 to 5. So these are not dramatic shifts in the organic growth estimate, it is just a little tempering, going from 4 to 6 to 3 to 5, the high end of now is the midpoint of what we had--.

No, I understand. And I'm not criticizing the move. I'm just trying to understand is it, because you just are concerned without having anything necessarily happening in the fundamental business today to suggest that you should do that, because you're just trying to be conservative, going out. Or do you see things in the market that would make you feel more concerned that you might be needing to notch it down?

We're just taking into account internal performance and external -- our view of the external marketplace is all it is. It is just an estimate.

Okay. Thank you.

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

Good morning, guys.

Hey, Margaret.

Jim, I don't know about anyone else but I can barely hear you. My questions are around the security solution and what should we be forecasting for organic growth?

For security solutions, what should you be forecasting? We're saying 4 to 5%, Margaret? Can you hear me now?

Not really.

It must be your line. But in any case, we will continue to forecast organic growth and try to get out of the business of forecasting margins. We're saying 4 to 5% organic, and remind you, and everyone else that we do think we see both top line and margin seasonality that favor the second and third quarter, over the first and fourth. Both due to business mix that we've talked about and higher mechanical than the summer months, particularly in the university or the education vertical. And we rarely, if ever, run into seasonality issues, i.e. site readiness issues due to weather in the third and fourth quarter, excuse me, second and third quarter in our access business, which we run into in the first and fourth. So we're saying 4 to 5 on the organic side for security.

And then relative to the organic growth, do you plan to supplement that with acquisitions and how is the pipeline at the moment?

Well, the acquisition growth that we have in our estimate right now for the year is 50 to $100 million. And we don't see anything dramatically in excess of that for this year. We're pacing ourselves this year with acquisitions. We're digesting what we have. But we certainly have a pipeline that we're working on for the future.

Okay. And then the last question is just do you plan any more divestitures before the end of this year?

Nope, none planned.

Okay. Thank you.

You're welcome.

The next question comes from Michael Rehaut with JP Morgan.

Hi, good morning.

Hi, Michael.

I guess you kind of cut me off at the pass in talking about trying to get out of the business in forecasting margins for the different segments, but with that being said, the consumer products businesses had anywhere from 12% to 19% margins over the last six quarters. This quarter is kind of right in the middle. It would seem that given the EPS guidance for the back half, that you are looking, though, for a better margin in consumer in the back half of the year, and can you comment if I'm thinking about that correctly? And what should be a normalized margin in that business?

I don't know that there is a -- any kind of a real accurate answer to the question, other than to say that the margins do vary for many different reasons, high volume, high volume quarters tend to have higher margin because there is more cost absorption and there is -- we have a lot of different variation with the timing of inflation, and then timing of our price recovery, and that drives margin variation, and so on and so there really is no way for us to give any more, concrete or granular guidance or advice on how to predict those margins other than to say they probably will be somewhere in the range that they have been historically.

I guess I will add to that, we are the undisputed brand leader, we intend to lead pricing where necessary to mitigate inflation, if we can do them in perfect lock-step remains to be seen, but obviously we've got some inflation headwind that we're trying to offset in terms of pricing and productivity. Last, but certainly not least we have got a stated strategy of improving our mix, through technology, through innovation, that's what extreme is about, it is a higher-priced product line, targeted at the pro. And as we continue to introduce Xtreme products and waterfall FatMax, that is a higher mix product line. If we successfully execute that strategy, that should protect, if not improve margins from their current level.

Now, certainly in the guidance, you do, I assume, have on your own internal estimates margin assumptions for the back half of the year for consumer. Is it just you're not willing to share that at this point? Or is it supposed to be somewhere around the 15, 16% range that you're currently hitting right now?

We do all of our estimates in ranges, Michael, so it would be -- I can't really share a point estimate with you, but I think you're in the ballpark. I can't say any more than that.

Okay. I appreciate it. And just one last thing. On the cost inflation by quarter chart, you said that you expect pricing in the second half would offset about 70%. I just wanted to clarify, was that 70% of the 22 million in the back half, or the overall $29 million number.

We're talking back half to back half, Michael.

Okay.

And what we're saying, it works with -- it is going to vary by segment, but with obviously price, lift, lead times, large customer leverage and things of that nature, we're a month or two away, any pricing that we haven't announced and negotiated we know we won't see the pricing and we'll be looking to next year. So we're saying 70% of the 22 in the second half is what we either feel that we have agreements from customers, or we are -- or we have enough leverage to go get that. Beyond that, we're going to have to get with productivity in our mix upgrades in order to maintain margin.

And just one last question if I could, the share count came down nicely in the quarter and you talked about that in the April call. What are your thoughts in terms of incremental share buyback? Is that something that you plan to remain active in the second half of the year?

We have no plans to remain active, specific plans. However, we have 4.1 million shares of authorization remaining on an 8 million authorization that the Board approved several years ago. And we have cash, we have capacity, and we will monitor the situation relative to our acquisition pipeline, and other factors, and it would not be out of the question for us to repurchase more shares in the back half.

Your next question comes from the line of Stephen Kim with Citigroup.

Thanks, guys. Good quarter.

Thanks, Steve.

I guess my question related to your consumer business. Your guidance range for the year is, even though it is only 4 to 6, that's still a big enough range, given for the fourth quarter, given that you've given the 3Q specifically, and it seems to span a range of anywhere from 4 to 10, I guess my question is, is what was easy comps there, what would cause you to sort of leave open the door to have organic sales and consumer only for 4 to 5% in the fourth quarter? Are you seeing something there that like makes you think that that might be prudent?

Let me say two things. The comps are easy in North America. They're less easy in Europe. I guess I'm reacting Steve to only to 4 to 5% which is 2 to 3 ex the market rate which means we're gaining share. We can't predict what the large North American customers will do. We are not anticipating the dramatic inventory correction or draw-down that was referenced earlier on this call, by Ken, at Merrill Lynch, but also, that started, you will recall, in the second half of December, last year. We're not anticipating it will happen, but if it does, it will have tremendous impact on our fourth quarter numbers. But simply said, 4 to 6% organic growth in consumer is 2 to 3 ex the market. We're not going to apologize for that.

No, absolutely. I was thinking that you might give us some inkling as to what we might be expecting in terms of the new product pipeline from consumer in the back half. Are you able to share some of that with us?

I will -- first of all, our policy is, and will remain, we will hold to it, specifics, until we can send you to a customer to see it on the shelf, we're not going to talk specifics. But strategically, what we've said, and I'm comfortable saying, we talked -- we've always talked about two ways, at least, of Xtreme introductions We only introduced about 22 SKUs and five product categories in North America this spring. Look for an introduction of that magnitude in the U.S. again late third, early fourth quarter, a similar number of product categories and SKUs. And remember, we've done nothing to date in Europe. And Europe is about 30% of our consumer hand tools business. And we're looking for and hoping for a lift there, but as I know, you're also familiar, it takes longer to get the products listed, to get them on the shelf, to get the POS pull-through in Europe. So think about a 5 to 10-product line, a 5 to 10-product line range in Europe, and say another 5 in the U.S., beginning to ship late September, early October, finding their way to retail hopefully in time for the Christmas season. But holiday purchases is not a big deal for FatMax Xtreme. These are pros buying these products and they're buying them every day.

Great. I guess my last question related to security. Can you give us some evidence or indications or anecdotes, whichever you prefer, that would help us see the cross-selling opportunities in that business, actually being realized?

What do you want, Steve? You want examples?

Whatever you feel comfortable sharing with us, just, there is obviously a lot of--.

Let's talk about LCTs, Jim and how those are--.

Yes, I think Steve, you're familiar with the LCT concept.

Sorry, folks, that's our acronym for local customer team.

And what they're doing, they're taking the various sales forces and they're actually organizing a kind of a group of -- they're having meetings every month, and sharing leads with each other, and the goal of that is for the electronic people to help the mechanical people generate sales for the access door people to help others generate sales. They're all calling on the same verticals, some more than others, and depending on the business. So in essence, that's the concept. And the benefits from that have not been earth shattering because it takes a long time for this kind of initiative to really take root. But they are staying at it, and we would invite any of our analysts who would like to go to an LCT meeting, to get with Gerry Gould, and arrange that and you can see or yourself firsthand, actually Gerry runs one of the LCTs in Phoenix and I think Steve, you probably have seen it up close and personal.

The only other thing -- this is John. The only other thing I would add to what Jim said, is the concept is working, the information is being shared but you're familiar with the three I'll say distinct businesses each run by a CLO within security, right now, in the field.

Our techs are -- they tend to be mechanical folks, or door folks, or systems integration folks, and until they're thoroughly cross trained and that takes a lot of time, right now, it takes two techs to call on a large institution, or a large vertical to do that cross-selling. Over time, the cross-training will take place that will allow far more lead sharing and far more informative selling on our behalf and on the part of the field tech than we're getting right now. But Jim said it best. It takes time. This was a $100 million business four years ago. It is 850 now and it is growing. And we're growing with it and we're learning every day.

Your next question comes from the line of Jim Lucas with Janney Montgomery and Scott.

Thanks, good morning. I hope you won't be offended if I don't ask a question on consumer.

Jim, we couldn't possibly be offended by any question you would ask.

I'm sure you will ask one on Mac, right?

I don't have to ask about Mac, so thank you on that one. So Facom integration, can you bring us up to date on not only the integration of Facom but what you're seeing on the European industrial landscape. And with regards to security in your prepared remarks you had talked about emphasizing the mechanical business more, and I was hoping you might be able to elaborate on that comment.

I will try to take them both, Jim, and then Jim Loree can obviously add on to that, and for Facom, what can we say? So far, so good. It is a very difficult legalistic arduous process. But as I think folks know, we announced what we call the European competitive plan on May 10, which requires tremendous consultation with employees, works councils, unions, government officials. So far, so good. Those are proceeding according to plan. Any time you announce a European competitive plan, it is almost a sure thing you end up in court two or three different times. We've had no unfavorable rulings relative to the Company and its position. We feel good about that.

We've had the anticipated push back protests and things of that nature, as you do when you close four distribution centers and two factories. But certainly, nothing out of the ordinary compared to my task, which is a lot of experience with such things and certainly the expectations of Jim, myself, and the European management team.

We are very pleased with the collaboration between the integration team, and the existing businesses. And of course, we're pleased with the Facom results to date. We think they are outperforming a market that is softening but not in terrible shape in terms of the European industrial and mechanics tools market.

My comment on security was such, it is just a business where margins are good, we've got a great brand, we would like to be growing 5 or 6% organically instead of two or three because it is just an obvious mix upgrade. Electronics growing faster. We all know that. We're both improving margins and growing our electronic business nicely the last two or three quarters. But it has a long, long way to go to get to mechanicals.

So when you've got a business where the margins are one 1.5 times line average, it is simply said via better specifying and commercial construction channels, a few other totally -- programs that are totally internal, i.e. up to us to develop and implement. I've got a business where the margin is that good I want to grow it more than 2% so we got to put some resources against it. There really was no silver bullet or no grand plan that we are about to reveal other than we've got a great business, let's make it bigger as opposed to maintain share.

Okay. And on security, are there any particular verticals that you're seeing any strengths or weaknesses in?

I would say no, not at this stage. We're so -- we're meaningfully positioned in three of the five verticals that we take seriously and are working hard to have meaningful positions in the other two. Of those three, we are skewed heavily towards retail. We see nothing either really positive or really negative in retail.

As it relates to education, it is seasonal. It is a good season. So nothing bad there. Health care, commercial, financial institutions, really nothing earth shattering at this stage, Jim, from the marketplace looking back. And as I said, didn't say, we had a record quarter with Access, that's a big piece of security, that business model is working, and -- but again, that is both new starts, and obviously re-dos, or remakes, or reinstallations with existing facilities. Both pieces of that business are in pretty good shape.

Okay. Thank you.

Your next question comes from the line of Sam Darkatsh with Raymond James.

Good morning, John. Good morning, Jim. Most of my questions were asked, but I just have three little ones. First off, Denise Nemchev was moved over to fastening and it looks like Bostitch is beginning to respond to her being moved over there. Has she been or has her former role been -- found someone for that over in the industrial section?

We're contemplating what we're going to do with that, Sam. Denise had a portfolio job. To refresh everyone's memory, Denise is a career Stanley person but her first P&L was assembly technologies. So OEM to the automotive distribution channel, and she inherited Proto and Vidmar after that. All three of those businesses, Proto, Vidmar, and assembly have general managers or acting COO's in place who had previously reported to Denise. They're now reporting directly to [Don McIlnay] who you all know who is an industry veteran. And by changing some of the scope of who reports to whom, and moving Jeff Ansell as a direct report to me, Don has freed up a lot of time to mentor and coach those three people.

We may or may not, and I would say we're unlikely to replace Denise's portfolio job with an individual as opposed to just elevate three folks who each have about $100 million P&L currently reporting directly to McIlnay and leave it that way. So in essence we've taken out a layer in the industrial tools group and elevate -- brought in one, and elevated two people to run the three P&Ls that Denise oversaw.

Got you. Two more quick questions. Not to belabor the inventory question at retail, but I'm not sure, John, Jim, who would address this, but do you have a sense of how many weeks of safety stock is at retail now versus normal time this year?

I have a sense, and this is all it is, I won't even -- I think this is normal time. It is not Father's Day, seasonal building of course is big, but I would expect -- let me just say that the large customers in general were carrying 12 weeks, said they wanted to get to 8, and my sense is can survive at 10 but can't at 8, and they're at about 10. That's purely my sense, and obviously, customer specific data, we won't talk about, and it is going to vary. But our sense is about two weeks, and we can all do that math, of inventory, has come out of the system, since last December.

We're cautiously optimistic that it will stay there, that it can't be drawn down much below that in late December, early January, as it has in the past. Or certainly in late December. But that tempers some of our optimism or bullishness around the fourth quarter, and obviously, raises some of the questions, gee, guys you have a long pot in the second half. Yes, we do. We do if there is further retail inventory adjustments, but we don't see it in hand tools. And I have to remind everybody, these are generally across the board reductions or mandates among the large customers, but the inventory situation is often dramatically different going into those.

What we got caught up in at the end of the year is we probably didn't have more than 10 weeks of inventory at retail or 12, and it got cut back to six or less, really hurt us. We're not anticipating that to happen again.

The cut down at the store level or was it behind the store level?

Sam, we don't distinguish if is at the store or in a customer central warehouse, they can get it to the store in a day. Obviously, if it is at the warehouse versus the store, you got out of stock issues. But the honest answer to your question is we don't distinguish and we don't have good data that would distinguish. We know it is has gotten to the customer's warehouse. We know when it goes through the cash register, but it is only our store walks just as you and a lot of your colleagues do. It is only at our store walks that tells us what is at retail versus what is in their warehouse and obviously if we speculate or think it is in the warehouse and we don't see it at retail and it hasn't come out of the cash register yet. That's what our merchandising and sales guys do in terms of trying to get the product out of the back room and on to the shelf.

Last one, and I will make it a quick one. I guess we've long been told that the security industry grows overall in the high single digits. And I'm guessing because of your mix of more mechanical versus electronic, that your addressable market probably grows a little slower than that so you're not actually losing share per se, it's just because of your mix per se? Am I looking at that correctly?

I think so. My guess, and of course the data isn't perfect, we get better at it every day as we meet new consultants and stay in this business longer, but my gut reaction to that would be you're absolutely correct. Our SI business is growing quickly. As I say, that mix is down, our margin, but that's where the growth is. We think we're maintaining share at best in mechanical, and we would like to grow our share in mechanical, and Access, we're at a minimum maintaining share of that piece of the business, but clearly, that's growing faster than electronic and some of the real high-tech pieces that are included in that global security business.

And your last question comes from Chitra Sundaram with Cardinal Capital.

Thank you. Congratulations on the quarter. It was very pleasant to get numbers. Just on the cost inflation, there are just two quick ones. Mainly raw materials, and its main culprit, steel. And secondly when you go back to the start of this recovery, the economic cycle, is there a way, or do you have the numbers cumulatively what has been the cost inflation, and where have you exact up in terms of recovering it from the price?

Yes, let me take those -- it is Jim. First of all, let's talk over a three-year span. If we go back to '04, and early '04, we got hit with a wave of steel inflation, and especially in the wire rod, but really throughout the continuum of different types of steel. And that year, we incurred about $70 million worth of inflation, and we recovered about two-thirds of that. Last year, we had closer to 35 million, we had some carry-over from '04 and then we had energy starting to kick in and also some inflation in finished goods and then nonferrous started to kick in near the end of the year. So we had less inflation in '05, and we recovered again 60 to 70% of that.

This year, what we really have experienced is dramatic increases in nonferrous metals. So aluminum, zinc, and the like. And they have -- a lot of our products use these nonferrous metals. So for instance, the tape rules, the knives and blades, a lot of our security products have utilization of these, hardware, and so on. So that's really what is -- that, and what I would call kind of an intermediate inflation that's working its way through the supply chain, and coming out in the form of finished goods, and purchased components. Starting to see more of that this year. We have a very good handle on the inflation as it occurs. We monitor it weekly. We review it monthly at the highest levels of the Company. We discuss our price recovery, our pricing strategies, by business, with the business leadership. And so on. So we're on top of it.

This year, I think we will end up with about 30 million of inflation, and we will recover about half of it, but we will have good momentum coming into -- from a price standpoint, coming into the year 2007. And so we will have to see what happens to inflation as we go forward. I think we're -- we're of the mind that inflation is here for at least the medium term, it is not going away any time soon, so we really have created a philosophy here of we need to recover our inflation through price increases, and then let -- at least some of the productivity drop through to margin growth.

An option of reduction in SKUs is not a good strategy, I would think, right because you want to increase choice at the retail level?

Yes, I didn't mean to imply that we were reducing our SKU count at all.

No, no, no, no, I'm just suggesting that -- was that correct?

That's correct.

Can I just quickly ask you, on the security solutions, at the end of the second quarter, I'm sorry, on the second quarter call, you all had talked about the ability over a couple of months of giving you comfort, when you were talking about Q2 guidance. When we look at Q3, I think it is the seasonality working in your favor that gives you the comfort, correct?

Well, that, and the security is a longer cycle business than the other businesses that we have, so we have a pretty good visibility into our next quarter pipeline through our backlog and we also have a reasonable amount of recurring revenue. So all of those things help us with our confidence.

Thank you.

Okay. Thank you.

There are no further questions. I will now turn it back over to Mr. Gould for closing remarks.

I think we have nothing to close. Obviously, thank you for your interest, attention and questions. We will talk to you again in October unless for some reason there is a material change in Stanley's business conditions, or a significant event. Thanks a lot.

Thank you for participating in Stanley Works second quarter results conference call. This call is available for replay beginning at 1:00 p.m. Eastern standard time today through midnight on July 30, 2006. The conference I.D. number for the replay is 2803627. Again, the conference ID number for the replay is 2803627. The number to dial for the replay is 1-800-642-1687 or 706-645-9291. Again, 1-800-642-1687 or 706-645-9291. You may now disconnect.