史丹利百得 (SWK) 2007 Q1 法說會逐字稿

Good morning. My name is Celeste and I will be your conference operator today. At this time I would like to welcome everyone to the Stanley Works first quarter results conference call. All lines have been placed to mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (OPERATOR INSTRUCTIONS)

I would now like to turn the conference over to Mr. Gerry Gould, Stanley Works Vice President Investor Relations. Mr. Gould, you have the floor.

Thank you, Celeste. Good morning, everybody and thank you for joining us this morning. On the call with me are John Lundgren, our Chairman and CEO, Jim Loree, Executive VP and CFO, and Craig Douglas our VP and Treasurer.

There are two press releases that we'll refer to, or that are out there, the first being our second quarter dividend release that was out yesterday and the second being our first quarter '07 results and guidance that we issued last night. They're both on our web site, stanleyworks.com in the Investor Relations section. Also, the PowerPoint presentation we referred to in the release that we will be using this morning is on our web site. We'll refer to these charts as we go through. A PDF version was placed out there about 15 minutes ago if you want to download and print it. What will happen here is Jim and John will review the results and then we'll have a Q&A period. The whole call should last about an hour.

There will be a replay available starting at 1 p.m. this afternoon through the end of the 30th, Monday the 30th of April. The replay number is 800-642-1687, and you do need a code for that which is 5156943 and the link to it and the charts will remain on our web site after that. If there are any questions you can call me at 860-827-3833.

Two reminders. The usual two reminders, we issue our earnings guidance in the press release at the beginning of the quarter, and we cannot comment on it thereafter, so if there is anything material that changes, we would issue a release and conduct a conference call at that time. And then secondly, a reminder that certain statements contained in this discussion by the various Stanley participants are forward-looking statements. As such, they involve risk, actual results may differ materially from those expected or implied, so we direct you to the cautionary statements in Form 8K which we filed with today's press release.

With that, I would like to turn the call over to Jim Loree.

Thank you, Gerry. Last night we reported earnings per share from continuing operations of $0.80, up 78% over the first quarter '06 when it was $0.45. We had net earnings of 68 million versus 38 million a year ago. The $0.80 performance was right in line with our guidance of $0.80 which we reaffirmed at our March 8th Analyst Meeting. Operating margins were 12.8%. That was a 300 plus basis point improvement over the prior year, and the tax rate was about 300 basis points higher than the 24% it was a year ago. To paraphrase one of our south side analysts in one of his reports this morning, it was a solid quarter and it was further enhanced by a very flattering comp, so it was an easy comp but a very good performance.

Turning to revenues, revenues were up in double-digits, up 10% driven by the HSM acquisition, primarily. On the left-hand side of the chart you can see the sources of growth, if we build up from the 10% we had 5 points from acquisitions, 3 points from currency, and very strong European currencies and generally currencies around the world. 2% organic growth, right in line with our guidance, and that 2% organic growth consisted of price. It was a big quarter for price as we made good progress offsetting a very big inflation quarter with excellent price realization, especially in the industrial and security segments.

You look at the right side of the page. As you can see the three segments there, the new segment that we introduced at the Analyst Meeting on March 8th, construction and DIY was up 3%, that was flat organically, but that flat organic performance included a very solid performance in the hand tools business, despite the fact that we have the weak residential construction housing markets in the U.S. The industrial segment was the power house segment of the quarter, with revenues up 9%, 6% organic growth, excellent broad based strength there. John will comment further on that.

And security had growth of 20%, which was driven entirely by the HSM acquisition. Within that story, though, it is a very, very strong double-digit performance in the best mechanical business, the most profitable segment with our subsegment within security, and some retrenchment in terms of revenues and the electronic business, and John will also shed more color on that. In any event we achieved record revenues despite the weak market conditions in the U.S. housing related markets.

Moving to financial highlights. We talked about the revenues, acquisitions added 57 million, we talked hand tools being strong outside the U.S., Bostitch was soft. Organically they were down significantly. That was expected with their tough market conditions. The industrial business was, as I said, strong across the board. Auto repair tools was especially strong in Europe. Back home is doing very, very well from a growth point of view, and we're very pleased with that acquisition. I mentioned the security growth in mechanical access, which was very encouraged from a mixed point of view and offset in large part by the U.S. systems integration business.

Operating margin up over 300 basis points, but 130 basis points when you take out the noise from the step-up charges and other items, and within that we had all segments up versus the prior year as the price inflation story was -- recovery story was strong, as I mentioned, and then productivity got us over the top, along with some help from mix in the security business to get us that positive performance in every segment on a year-over-year margin rate accretion bases. The earnings were strong double-digit growth, and as I said, pretty much strength across all the segments, and the cash flow was equal to 100% of net income, right on the money so to speak.

Focusing a little bit more on cash flow on the next page, it was a record cash flow performance for our first quarter for The Stanley Works for operating cash flow. You can see the strong net income performance and then the growing depreciation and amortization, which is largely driven by amortization associated with acquisitions, in particular this quarter we had something on the record of approximately $8 million of amortization associated with the HSM acquisition that we added in the first quarter.

Working capital. We had a modest build in working capital, which is not unexpected for the first quarter, driven mainly by inventory increases, preparing for the second quarter, selling season. And the free cash flow is also a good story of $68 million, and you can see the CapEx was significantly higher than what we typically will see in a first quarter. That has more to do with the balancing of CapEx spending across the quarters. That strong productivity that got us the margin accretion is being driven largely by accelerated projects and the timing of projects that are happening earlier in the year, and that bodes well for the remainder of the year, and we can expect to see that CapEx remain in line with expectations. In general, free cash flow was strong, and on track -- we're on track to meet our current year free cash flow forecast of some 400 to $450 million.

Let's take a look at the balance sheet now. The balance sheet is in very good shape considering the $2 billion plus acquisitions that we made since 2002 including the most recent addition of HSM. We've conducted two financings in the last year, year-and-a-half, one major one to cover Facom in late '05, that was the ETPS, of which the rating agencies give us 50% credit for -- equity credit for that financing due to its nature, and then the most recent equity units, the $330 million issuance, which was recently completed to finance HSM on a permanent basis. So those two adjustment that is you see on that page bring us to an adjusted debt to capital ratio of about 34%, and we're marching towards the territory that we want to be in to maintain the upper tier investment grade ratings that we have, and we're maintaining our discipline -- balance sheet discipline in this growth environment.

With that I will turn it over to John who will shed some more color on the segments and then talk about other matters of importance.

Thanks, Jim. This is the first time we've spoken to you in terms of our new segmentation. I think it reveals quite a bit, so we'll spend a little bit of time on it. In our construction and DIY segment, which, which to remind everyone is primarily our consumer tools and storage business, formerly our CST Berger Laser Leveling business and the Stanley Bostitch fastening business, so the primary components within that segment. Revenues globally were up 3%, our operating income from the segment up 8%, and 70 basis points of improvement in our margin. A lot of strength here.

The hand tools plus 10% with continued good performance from our FatMax Xtreme rollouts in the U.S., and as it starts to accelerate in Europe with the XL line and new product sales. U.S. POS, which is retail sell-through, is lagging a little bit prior to -- relative to prior years, and that's despite good performance in our FatMax line as well as Xtreme. It does reflect the soft market conditions in the North American retail markets. That being said we've seen sequential improvement fourth quarter to first quarter. We have got a pretty good pipeline of new product introductions planned for later in the year, so primarily market driven in North America. We feel good about our position.

Europe and the rest of the world has done extraordinarily well. Sales were up 23%, and as we say offset by the weaker U.S. construction markets, and retail sell-through remained strong as well, as I said, particularly with our new Xtreme line in North America, less cannibalization than we anticipated on the base FatMax line. And as mentioned in the press release the XL, which is the Xtreme branding in Europe, is just reaching the shelves now, so we expect to see nice sell-through, but timed that well supported introduction as well.

Bostitch, our Stanley fastening system sales were down 4% primarily driven by the soft U.S. construction and industrial markets. We've talked about our profit improvement initiatives at our Analyst Day on March 8th. That program remains on track. The business team is focused on it. A lot of help from the corporate business development team, as Jim and Denise Nemchev reported on that for those of you who were with us on March 8th. We're managing that program with the rigor, discipline, of an acquisition integration, and we have a lot of confidence that we'll achieve its objectives. Within the sales number there is a modest impact from some conscious exiting of some lower margin businesses, which will continue throughout the year as we get better on our pricing, on our margins by business. But all in, Bostitch achieved its internal expectations with the modest reduction in its top line and income performance, about in line with where we expected it to be on track to recovery.

Tremendous story in our industrial group, both in North America and abroad, with strong sales in operating margin growth virtually across the board. Revenues up 9%, significant increase doubling of the segment profit, and in terms of the margin, 670 basis point increase. And Jim referenced some of the step-up charges that is have gone away, but nonetheless very, very strong performance even if you exclude the step-up charges in the first quarter of '06, tremendous 330 basis point improvement.

Strength every where. Industrial and automotive tools is about 9% up, of which a piece of that was currency, about 4%. Recall that Facom, which is a terrific business, up about 450 million in revenues in Europe -- 100% of its revenues are coming from Europe. Obviously weak dollar, so we got a nice currency lift. That being said, there is still strong, strong unit volume growth within industrial tools and automotive. And the smaller piece of that segment, engineered solutions, again, nice 10% revenue growth. Facom, as mentioned extraordinarily strong on the top line, some of which is currency, but the European markets are stronger than they've been in recent years. We're seeing great vitality in continental Europe, particularly in the automotive repair and aftermarket, which of course is helping our business and our synergies are starting to kick in, which is helping both top line and margin.

Jim touch on the progress we've made on pricing and productivity, more than offsetting inflation. It is really a big story. It is a big story across the board of particular value in both industrial tools and in the securities segment, where we're achieving a lot of non-ferrous, unprecedented levels of non-ferrous metal inflation. We're doing better at both forecasting inflation in the raw materials, but also getting out ahead of the curve, in both keeping our productivity project funnels full and active, as well as more surgical pricing to go after the specific SKUs that are strategic where we're encountering these unprecedented levels of inflation. That comment applies to industrial as well as the mechanical piece of the security business, that Jim touched on, and it has been a huge help to us in the first quarter.

Moving onto security, it continues to grow primarily on the strength of the HSM acquisition. Revenues were up 20%, significant improvement in segment profitability, as well as the profit rate, and the profit rate is still up 50 basis points even excluding step-up charges from the prior year.

Looking at the two pieces within that business, very strong performance in mechanical access solutions. 5% sales growth despite some of the issues with our builders hardware business that we talked about on March 8th, as well as we're moving the majority of our distribution for builders hardware from our North American distribution center in Canapolis to Rock Falls, where we have a dramatically better capability to fill small orders, and that transitions in place without too, too much difficulty, but it has had an impact on the hardware top line. Orders are encouraging, backlog is good as we enter the second quarter, strong operating margin, and again, we got good price in productivity to offset levels of inflation that we've never seen in our many years of being in this business at Stanley.

On the Convergent Security side, 52% sales growth that's driven all by HSM, which is been a good story thus far. Operating margin of about 8% in the segment with HSM being a little less than 1/3 of that segment posting very strong first quarter operating margins of 25%. As you know, the acquisition was completed in January. Financing is in place, and we're beginning the integration of the two management teams with senior management visits by Brett [Bontrager], Tim [Walb], (Inaudible) more than 50 field locations already selecting the best and brightest from both teams and moving forward. And again, I think we actually believe that acquisition integration is becoming a core competency at Stanley, if it isn't already. We've got a good team focused on it.

And where we are today and where we are in the first quarter, for me, helps validate, first of all the strategy of the down stream integration and Convergent Security by buying a world class monitoring company. Second, validates the quality of the assets we bought, both in terms of its business mix, its portfolio, and the management team that comes with it, so we're off to a good start. Synergies are yet to come between HSM and Stanley Convergent Security business.

Moving on, I think this next chart does begin to show the benefit of the portfolio transition that Jim and I have been talking to you about for the last three years. American construction markets were weak. There is no way around it. It is clear as can be from everything we read and see, and that's impacting about 25% of our revenues. If you look on the left-hand side, you see the construction and DIY within the Americas, which is obviously not the entire construction and DIY segment, hand tools were flat. If you think about hand tools growing 7% globally, that business is booming, and it is maintaining year ago levels despite a lot of head wind from the marketplace.

Fastening was down 10%, and as a consequence when you add the other businesses in the segment, organic sales were down 7% in construction and DIY within the Americas, which is about 25% of Stanley's revenues. If you look at the remainder of the portfolio, industrial, security and construction and DIY in Europe and Asia, very strong sales performance up 5%, and it does begin to show the impact of the diversified portfolio with a reasonably good organic sales growth profile despite the softness in the North American retail markets.

Moving onto guidance, Jim normally does this because it is extremely complicated, and he is better at it than I am. He delegated up today because it is not much of a change, in all seriousness, from where we've been on both the quarter and the year. Looking -- we're looking at organic growth in the neighborhood of 2% in the second quarter, another 6% from acquisitions for a total top line growth of about 8%. Those numbers will carry through to the year, which bring us to EPS guidance of approximately $1 a share in the second quarter, which is an 11% improvement on a year-on-year basis.

We're maintaining our $4 to 4.10, which is where we've been both in January when we spoke with you, March when we spoke to you, and we're maintaining that guidance today, which is a 15 to 18% increase as well, as Jim reported, based on our good first quarter achievement we feel comfortable with our 400 to $450 million range for free cash flow. No changes, no significant changes in the tax rate. Importantly, the second quarter guidance includes a tax rate of 26% to 28% in that guidance, up marginally from the 26% that we saw in the second quarter '06, and the same for the year, 26 to 28% tax rate, and as we talked about on many occasions, that's up a lot from the 21% that we experienced in '06.

So to summarize, before we open it up for questions and answers, record quarter in terms of sales at 1.05 billion, earnings at $0.80 were up 78%, operating margin of 13% up 320 basis points. Probably the largest and among the most significant acquisitions in Stanley's history is closed, financed, and the integration is moving very, very rapidly within our Convergent Securities Solutions business. We grew in all major regions of the world. It is the first time we've done that. We've often had good performances in North America offset by flatness in either Asia or Europe, positive growth in all three of the major regions of the world.

Price and productivity, as Jim and I have both said, more than offsetting high levels of inflation, and it is good to be out in front of that curve. And last but certainly not least the benefit of the portfolio diversification, reducing the volatility in our earnings despite some tough market conditions in the North American retail business. We are less dependent on the large U.S. retailers and the currently weak U.S. construction and DIY markets, and higher percentage of our revenues coming from Europe, industrial, and security, allowed us to post a very, very solid quarter despite some pretty weak conditions in 25% of our business.

At this stage I think we'll open it up to questions, if we can get back to the operator.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Michael Rehaut with JPMorgan.

Thanks. Good morning.

Hey, Mike.

The first question I had was on the CSS segment. If you could break out, and by the way, the detail on the slides were really helpful. Thank you. If you could just possible break out what CSS did excluding HSM or on an organic basis on a sales, and also on an operating margin, it seems like perhaps the 8% that you said was a combined margin? What was that ex HSM?

The answer, the 8% is a combined margin. We're not going to break it out. We're spending too much of our time providing our competitors with information on the Stanley Works that I wish I had on them. And we've got a $1.4 billion segment that we're going to break into mechanical and convergent and talk to about it that way. HSM was a great quarter.

Your math is correct on both a sales and margin basis, call it the Legacy Systems Integration Business that Stanley was down, kind of our rule of thumb going forward, because I think sometimes we create problems for ourselves by micro managing Mac Tools and Best Locks and things of that nature. It's not a 500 or $600 million business, we are not going to get granular on margins. We think it is a disservice to us, to Stanley, and its shareowners, and doesn't necessarily provide you and the investment community with any more information on the Company that helps you judge and -- judge our performance and value our business. So Legacy Stanley security was down, both sequentially and versus 1Q '06. HSM performed better than we expected, and that's the level of the detail we will go into publicly on a subsegment of our securities sector.

And maybe a little color on why it is down would be useful to the analyst community. We are in the process of restructuring our -- restructuring is a bad word for this, but in the progress of reshaping our strategy in this business which we talked about in length in our December conference call, when we did the HSM announcement, and we have been in the process of doing that for about six months. This is a medium cycle business.

You can imagine that as we drive this business more towards recurring revenue, the old ways of going out there and just doing installation projects are going by the way side, and the sales folks are having to concentrate more on finding deals with recurring revenue. It is not a market driven issue at all. It's more internally strategically driven where we're not accepting the standard installation project business mix that we used to. We're driving the mix more towards recurring revenue, and in doing that we're going to go through a couple quarters of compression in the electronics business. Now the good news is we don't make a whole lot of money on the installation projects that we're not doing. So it is not a big deal from a margin point of view. That's why we mixed up in the quarter in security. However, you will see over the next few quarters, probably two quarters or so, some negative performance from the Legacy Systems Integration business, and some, we think, good performance from the HSM more than offsetting that.

What Jim just said is very important, without getting more granular than we intend to on that business. You'll recall we've always had an objective of a higher recurring revenue content within our security business in general and convergent in particular. Our number preHSM was low in the 15 to 25% range in a good quarter or in a good year, and as Jim said, a lot of installation business that wasn't necessarily as profitable as we initially believed and not enough recurring revenue. HSM of course was at the high-end of the -- A, due to the business that it is in, commercial monitoring, and, B, due to its business model, never accepting an installation that isn't profitable on its own and doesn't come with a meaningful amount of recurring revenue. So as we work very hard to reduce the pure installation revenue, which basically is starting at 0 every day and trying to do it again, and improve the percentage and increase the percentage of revenue that it that's recurring we'll see some softness in the Legacy side. That being said we're looking at the combination of the two. It is why we bought HSM and why we don't want to get any more granular, Mike, on the particular pieces of it going forward.

Okay. Thank you for that. Just one second question and then I am done. You mentioned that you broke out the North America, CDIY Americas, which was down or on an organic basis about 7% and that the remainder was up 5%. I was wondering if you had an -- if you could give us an idea what industrial -- what the industrial segment was, because you also said later in the presentation that you had growth in all three major regions of the world, which would imply growth in the Americas but yet you said that on an organic basis huge part of your Americas were down 7%, so I just wanted to be able to reconcile that.

The Americas down 7% is construction DIY. In the Americas. Remember, in total, Mike, that's the consumer tools and storage business, CST Berger and Stanley Bostitch. Industrial was up mid-single digits or more across the board in all three regions, the Americas, Europe and Asia.

So the industrial growth was able to offset the decline in hand tools and fastening and still allow Americas to grow on an organic basis?

Industrial is a different segment, but on an organic basis Americas would be up.

Okay. Thank you.

Your next question comes from the line of Peter Lisnic with Robert Baird.

Good morning, it's actually John [Helsaltron] for Pete. Just one, I had a question kind of on Facom. It looks like you guys are really not cover off the ball there on the sales front, and I assume the cost restructuring efforts that you are doing are working. Are you guys kind of revising upward your estimate for accretion to come?

No, we're not, John. At this stage obviously we're a year plus into owning Facom. We got a really nice lift in the first quarter, because if you think about it, we had no cost synergies in the first quarter a year ago. And the simple answer to your question is, the upward lift in top line we're delighted with the volume, but remember it is about half currency in the quarter. It is about seven and seven round numbers. But two things are going on at Facom, the new product pipeline is robust. Historically for Facom they've had a new product pipeline that's been robust and it's been about 100% cannibalization, or said differently, they've needed a 20% plus [vitality] index to maintain a flat top line due to attrition in the base business and relatively weak markets. What we've seen the last couple quarters from Facom is much less -- let me say it differently, much more of the new product pipeline has been incremental, so that's the lift on the top line.

A lot of the cost synergies which are on schedule and we're pleased with our restructuring plans, it is just a question on timing. We did get a little bit more in the first quarter than we might have from Facom, and that attests to the strong margins. The same programs are in place. It is a question of when we achieve them. And what we said, I guess we didn't put it in the press release, but what we are thinking is we are confident that we will get the accretion that we committed to when we made the acquisition. At this stage we're not in a position to revise it upwards. I think there was tremendous skepticism that we could get to where we are, excuse me, to where we committed, and all we're doing at this stage is saying we will deliver those commitments, and we're well on track to doing it, and as you know because you and Pete follow us closely, it is a three-year commitment, and we're on or slightly ahead of schedule in timing, I don't think we're ahead of schedule in terms of total realization.

Okay. Just a follow-up, Bostitch, that kind of 4% decline, how much of that was walking away from business that was lower margin?

Very small. It is why I mentioned it in my word count, John, but we didn't mention it on the -- in the text per se if you will. Less than 1 of the 4%. We're getting better on a customer by customer, and of course we don't name specific customers on this call, that's in no one's best interest, but that's quite a fragmented business. Its largest customers are 30 to 40 million as opposed to the consumer tools and storage business where they're hundreds of millions. We're just getting more granular on the business we take and the business we walk away from. But, as I say, I mention it as an aside, that's less than 25% of the decline, and we'll continue to do that as we refine our mix and that could result in a slightly smaller business. Overwhelmingly, though, it is the market in which it is doing business, let's say 3 to 1 or 4 to 1 over conscious business decisions.

I'd like to add a comment on that one as well. I noticed in some of the preliminary reports there was some allusions to Stanley having lost its largest distributor in this business in the construction segment, and while it is true that Stanley has elected not to do business with this customer any longer, we have -- it is part of an overt strategy on our part to redirect our distribution to more favorable -- through a more favorable channels, and it is not anything that was unanticipated or a surprise to us.

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

Hi. This is Mark [Montanan] on the line for Steve Kim.

Hi, there.

Good morning. Just wanted to get a little clarity on the other expense line item. The ramp-up year-over-year predominantly I know is due to the amortization associated with HSM. Is that a sustainable level going forward for the next few quarters, and is that what is modeled into your current EPS estimates?

Pretty much. I will take that one, Mark, and the answer is yes. Predominantly that's what it is, and there is no change from anything we've committed or communicated previously.

Okay. No incremental change there?

No.

Secondly, should we expect the same margin trajectory now with the new break up of the segmented reporting results in construction, do it yourself, and security should probably peak margin wise in the third quarter. Do you expect that to continue going forward?

I don't think we're going to make any predictions about seasonality of the new segments until we have a few years under our belt, so we did that last time. We introduced the new segmentation and learned along with everybody else, so I think this time we'll just avoid making any progress prognostications in that regard.

I think, I think, Jim has said it all, the building season being second and third quarter and those tending to be good seasonal quarters for our security business won't change. You can do the math as well as we can, but as my colleague, Mr. Loree, said, we've gotten out of the business of predicting our quarterly margins by segment and asking to be held accountable to it. It is just not the way we run our business, and it is again, as I said in response to Mike Rehaut's question, we've concluded, we do ourselves a tremendous disservice by trying to provide information to help the folks on the other end of the phone evaluate Stanley, and we just have to be more common sense and more pragmatic about it going forward.

Great. Thank you.

Your next question comes from the line of Eric Bosshard with Cleveland Research.

This is actually Mark stepping in for Eric. First, on security and the slightly softer sequential growth, is that a function of a softer industry or is it primarily the CSS piece of it? And where should we be looking for that growth number to be going forward?

Well, I believe I addressed the direction of the question anyway in an earlier response. A convergent business is going through a period of strategic, [Bostitch] strategic redirection more towards recurring revenue. The market is strong. The market consists of both installations and recurring revenue, both elements of the market are strong. We are reshaping our strategy to go after recurring revenue. There is a hiatus period where there is adjustments being made in the sales force, to compensation plan,s to training, et cetera for the Legacy sales folks, and so we're going to go through a period of a couple quarters of somewhat softer volume in the Legacy Systems Integration business in the U.S., and it is not market related.

Once you're through these integration issues or rephasing issues, how should we think about security growth going forward?

Well, what we said in the March 8th analyst meeting was that the mechanical subsegment of security is in about a 3 to 4% growth market, and we would expect at least maintain share in that particular market. The convergent business is in a market that grows somewhere between 5 and 10%, depending on the year, so I think those are your kind of market growth rates. We have -- when we finally get going in convergent we're going to have an excellent growth platform, excellent sales force, service, et cetera, and we certainly should be able to maintain share in that market as well. Whether we'll achieve 5 to 10% growth, who knows, there could be lots of different things that could affect that, but right now that's the opportunity in front of us.

Remember, the three elements, if you will, of convergent are the Legacy Stanley systems integration business, which is as much about install as it was about recurring revenue, the new HSM business, and then a meaningful business in Europe, the former Blick business. They're not all equal, but none accounts for less than 25 or more than 40% of that new segment that's about 600 million in revenues. So, several moving pieces, but as Jim suggests, we'll get our act together on the North American convergent side, which is a third of the revenues, and then we think we've got some pretty good market in which to do business when we get our model the way that we intend to operate it going forward.

Secondly, in terms of commodity costs today, maybe relative to 90 days ago, can you talk a little bit about where you're making the pricing progress and how we should think about the commodity cost environment for your businesses going forward, where the pressure will be, and where you'll be able to offset with price?

We're making progress in all segments. On a relative basis we're doing better in industrial and security on a percentage of inflation recovery. As you know the construction and DIY market with its industry profile is a tougher market to achieve pricing increases, although we have had some success in that segment as well. The outlook that we provided for inflation in the last conference call and the environment today are very similar, so there is really no significant change in our inflationary outlook. That's good news because inflation for the last few years has been sort of a creeping, kind of growing phenomenon, and seemed that from quarter to quarter it generally would tend to get worse as opposed to better, and obviously we've been in the process of implementing price increases to offset that, and there is a timing impact and such.

But the plan for this year, for instance, was to achieve or to experience approximately 20 million of inflation in the first quarter, and that's basically what happened to us, and so 1/3 -- and the total was 60 so 1/3 of the inflation is already behind us in the first quarter. We have a very good visibility into inflation that is already out there for the coming quarters. Now, what we don't know is what new inflation will come. If it remains stable, as it has been for the last 90 to 180 days, then we're in a position where as we get towards the end of the year, the carry over from the price increases actually will exceed by the fourth quarter, the, modestly exceed probably approximate 100% of the inflation, and we should be in a neutral situation. Now, that's all else equal, and you just never know what's going to change, competitive environment, commodity, various commodities that might go up or down, and so forth, but right now it is pretty much as billed in the previous quarter, and we're very appreciative that that's the situation because it certainly makes the earnings forecasting and the performance that much more predictable.

Just to add a little bit of granularity to what Jim said, you track Stanley very closely so you know for us it is normally all about steel, and steel has been a little more predictable. The only issue with steel is the discrepancy between Chinese steel and steel elsewhere is as large as it has ever been in recent history. That's less of an impact on us because we're pretty large steel users on three continents, and globally the inflation is about where we thought it would be.

It is the non-ferrous metals, of course, that are keeping everybody up at night. Many non-ferrous metals are at historical highs and they have gotten there very, very rapidly between the third and first quarter, and Jim has said the rest. That's the bad news. The good news is we saw is coming. I alluded to it. We have some processes in place between the gross margin call, productivity calls, looking hard at inflation to ensure that we're on the same page with our business heads on where this is going, and the combination of price and productivity, what we do -- what we need to do to maintain our margins. Which is why I think we took some satisfaction in seeing our margins where they were in the first quarter given the unprecedented levels of inflation, and Jim has said the rest. There is nothing in the second quarter that says that should get worse, and with a little luck from the marketplace it could turn itself around by the fourth quarter.

Your next question comes from the line of Kenneth Zener with Merrill Lynch.

Good morning.

Hey, Ken.

I am just interested in the first quarter you guys had 0 organic and 2% price. For your fiscal year guidance of organic growth 2%, is that all price or is it going to be 1/2?

We have a little bit of a semantics issue there. Price is included in organic growth. The only thing that's excluded are acquisitions and currency.

I understand that. For the organic, are you guys breaking that out assuming flat volume in your organic 2% rate?

We don't break out between price and volume. If the price trend is maintained, and it was 2% in the first quarter, it would not be surprising if it was close to 2% in the second quarter, and then if our guidance is 2% organic, then I would suggest that maybe by interpolation that you might be close to right there.

I guess, realizing you guys aren't going to be micro managing margin comments on your distinct businesses, which I agree with, could you comment on, given a competitor's strong results earlier this week on the Mac and Proto business, and given that that's been an evolving story for you guys over the past couple of years, can you give some recent comments within the current quarter and a competitor's strong performance? Thank you.

Yes. I will keep them very general because the particular competitors to whom you're referring, that's all they do, and Mac represents about 2.5% of Stanley's revenues. So Mac is continuing to do extremely well on both -- on three fronts, and it is how we look at it. We're bringing on distributors at a much faster rate than attrition. The third or perhaps fourth consecutive quarter of net distributor adds, that's a really good thing for us. Obviously there is a direct correlation between that and top line. Retention is far better than it has been in the past, and you'll recall we talked a lot about a span of control at the district manager level. We've done a lot of quantitative analysis. We think we're beginning to find the sweet spot in terms of what's the right span of control for a district manager in terms of minimizing or optimizing SG&A, but maximizing the amount of training and what have you that he can give to the distributors. So, the third or fourth consecutive quarter of positive growth on Mac, we're feeling pretty good about it.

Proto, our issues are in the supply chain, no issue at all with product, how it is doing, the market is booming, and we're working rapidly to improve our fill rates in Proto back to historical levels, but the business itself is one that we're confident in, tremendous opportunity for it, not just in North America but in the merging middle eastern and Asian markets, and it remains a very strategic business for us. In, I would say, very working in a very favorable market.

And when we say supply chain issues in Proto, we're referring to unprecedented growth and the strain that puts on the supply chain.

On our ability to honor our commitments to 95 to 98% fill rate at a minimum. It is a high class problem when you're a manufacturer when demand exceeds your ability to supply. That being said, it is not one that your customers can tolerate very long, and that's our short intermediate term focus in Proto.

As you can see from the operating margin performance within the segment, the operating margin for both of those businesses, and taking in the aggregate as well, is a good story on a year-over-year basis operating margin rate accretion.

Right. I saw that. I guess just the other comment, realizing those businesses were quite small, but for the HSM, which, with (Inaudible) presence in the Company now for a couple months, and you're in [no breast] discussions with them prior to the acquisition, have there been some further upside, or surprises in the deal either to the upside or to the downside that you guys would like to kind of highlight? Because I know in the past seasonality, your margins had been surprises in some of the acquisitions, but now that he has been there, any further comments? Thank you very much.

The only thing that surprised us, if there have been surprises with respect to HSM, have been positive surprises relating to the quality of the management, the depth of the management, the business model, the common sense associated with the business model and when you compare it to the installation oriented model that we have in the Legacy business, and the opportunity for us to do what is in effect very close to a reverse integration of our own systems integration business into HSM, with the best and brightest from both sides but clearly the business model prevails in terms of HSM. So that's been the surprise. They have got good operating momentum in that business, as good if not better than what we thought it was, and it is all positive.

Just to add to what Jim said, if you think about it, every business management would say in a perfect world I would like to understand this business but start with a clean piece of paper, that's basically what Tim and his team did when they split off from Honeywell several years ago, brand new state of the art call center, extraordinarily modern and effective systems in terms of analytics to give Tim's team what they need every day to know where they stand on margins, where they stand on customer satisfaction, et cetera. So if you think about it, you have a squeaky clean new system to support the business that's less than three years old. That's almost a perfect world, and it is designed specifically for that business, so we knew that when we bought HSM. What we really didn't know is how much value that had the potential to add to the Legacy Stanley SI business. So as I say, it validates the strategy, validates the quality of the assets, and we've only owned them a quarter, so we're the net of Legacy Stanley and HSM. We'll end up a little too early to tell, but we're cautiously optimistic it is going to end up where we said it would in terms of accretion and growth.

Thank you.

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

With regards to the strength that you're seeing globally, Europe and Asia in particular, could you give a little additional color from specific geographies within Europe, and Asia, and product lines, just trying it get a better feel for how broad based this is and if there is anything in particular that stands out more than one any other business?

Yes. Jim, quite a few questions there, obviously excluding security. Two segments, lots of businesses, three geographies. Hopefully, I'll do it justice. Let me start with Asia because it is easy. It is booming in terms of revenue and percentage increases, but you know Stanley extraordinarily well. It is booming from a low base, so we're really getting traction. It is all industrial in Asia. Our strategy is to penetrate at the top end of the market and waterfall down. We have Jeff Chen on the ground over there, who is one of our most accomplished and seasoned executives. We have Don [McElmay] helping with the strategy and several people on the ground growing that business dramatically as we add distributors, as we add retail site from a low base in Asia. That's not going to move the needle for Stanley 100% increases are 50 to 100% increases off that low a base. It is going to be a while until that shows up globally on the top line.

Europe is I will say from strength to strength. On the industrial side I think we talked enough about Facom we don't need to dwell on it. Legacy Stanley way up. It is a combination of three things. Good market continues, robust new product pipeline, as they say, the Xtreme line in the states is the XL line in Europe. It is at retail in U.K. It is now moving to retail on continental Europe, so we're getting the pipeline benefit of that.

And then last, but certainly not least,, and it is a little different than how I might have thought the model would work best. The connectivity on the consumer or retail construction DIY piece of the business with the U.S. is better than ever, and there is a lot more commonality from a product development perspective than I might have thought two or three years ago. The connection between Jeff Ansell's team in North America and the folks he has on the ground in Europe is as good as it has been in my history at Stanley. Those three things are really contributing to growth in both the industrial and the consumer segments, or the industrial and retail businesses in Europe, which as you know are about equally sized, and they're both one is growing double-digits. They're both growing double-digits with currency, but one high single digits and one -- but both high single digits without currency.

With regard to your third point, the commonality you're seeing, are there any specific examples you can sight there of where you're seeing that?

Sure. It is primarily in the commercialization effort. Product development historically has been, hey, it works in North America, try it in Europe. There is much better discovery teamwork going on, joint collaboration through what we call our PRB process with Ansell's team and the European sales marketing organization, in customizing the innovations to make them specific to the European market. Certain products are a direct transfer that have been successful. Others, there is customization taking place, and we're getting out ahead of that. I think a maybe greater importance, we've never had an issue with innovation being robust. We've had an issue with the commercialization of the efforts and the activities. We're advertising in Europe because we've got the distribution. We've straightened out our supply chain, where we're getting the products to the marketplace so we're not advertising the empty shelves, so we stepped up the -- we're far better coordinated in the commercialization effort from the sell-in to the merchandising and advertising support behind the retail brand, which is obviously helping sell-through. All of that in a good market, Europe is as good as it has been in a long time for Stanley.

Your next question is from the line of David Leibowitz with Burnham.

Good morning. A few questions. One, which is of your divisions right now, or brands would you say is responding the least well to your efforts to improve it?

We don't have divisions. We have segments. Within those segments we have a variety of businesses. Probably to try to answer your question, the business that's facing the most head wind is probably our very small assembly technology business. It is OEM primarily to the North American automotive industry. That's not a particularly good business to be in right now. So we're focusing on maintaining SG&A, maintaining our customers, improving our quality, but there is a lot of head wind in that business. It is -- that's the bad news. The good news is it is a $70 million business, and it is not going to dramatically affect our organic growth rate.

Second, your emphasis on maintaining your credit rating, would that preclude a large acquisition over the next 10 to 12 months?

The simple answer, preclude? No -- I will let our CFO answer the question, but the simple answer, wouldn't preclude it, it would obviously influence our thinking in terms of how we financed it.

Our priorities, which I stated at our March 8th Analyst Meeting right now are for debt reduction for the current year we'll probably do a small quantity of acquisitions, maybe 50, 100 million, something like that, nothing dramatic. Now if something big and attractive were to come along that would be in our strategic sweet spot, would we look at it, yes. If it was really compelling economically, strategically, and we had the capacity to integrate it, would we consider it, yes, we would. But, I mean, obviously, we would do it with our strategy in place of maintaining our upper tier investment grade ratings, and so it is not likely that anything like that is going to happen any time in the near future. We're certainly not working on anything like that right now. That makes it even less likely.

Your final question comes from the line of Chitra Sundaram with Cardinal Capital.

Thanks for taking my question. Can we discuss the apparent dicotamy within the U.S. between the industrial business and the residential -- the DIY segment, because when we kind of look at a macro level there seems to be a slowing on the manufacturing side as well, but perhaps there is a different segment that your industrial business is focused on?

It is not really a dicotamy, Chitra, if you think about our industrial business is broad based, it is industrial tools, automotive repair, don't forget LaBounty, which is a very important business, it's doing extraordinarily well. Take the U.S. -- we all read the Home Starts data, we read Residential Construction. That is all in that segment. While there is not tremendous tail wind in the U.S. industrial economy, it is also not bad, and we have a diverse portfolio of businesses that service that economy. Excuse me, that service those various end markets and various channels with a portfolio of businesses. Jim talked about Proto. We have demand exceeding our ability to supply it right now. That's a good thing. We talked about Mac Tools, that's 90% domestic. So the U.S. automotive after-market and repair market is quite strong, and much of our industrial segment in North America sells into that business. To your point as well as into factories. Modest tail wind there, and we're probably gaining share in some of our businesses, and the head wind is in residential construction.

And with the dollar where it is, the exports are booming, so, I think the U.S. industrial economy is pretty strong right now, and we all know, as John pointed out, the housing related markets are incredibly weak. The only dicotamy we have is one's strong, one's weak, and when you put them together, it is relatively stable.

This concludes our Q&A session. Mr. Lundgren, do you have any closing remarks?

No. I think it has been a good session. We appreciate your questions. We appreciate your being with us, and we'll talk to you again in July, unless we have a major event between now and then.

This concludes today's conference call. You may now disconnect.