史丹利百得 (SWK) 2007 Q2 法說會逐字稿

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

Mr.Gould you may begin your conference.

Okay, thank you. Good morning everybody. On the call with me this morning are John Lundgren, our Chairman and CEO, Jim Loree, our Executive VP and CFO. We've had three press releases out, our third quarter dividend, annual dividend increase last Friday, the announcement of a new director yesterday and this morning our second quarter results and remainder of year guidance. All those press releases are on our website as well as the presentation that we will use the materials, the conference call charts. They're at stanleyworks.com in the investor relations web page. I will refer to these charts throughout the call and we put a PDF version of them out there about a half hour ago so it out there if you would like to projection it. John and Jim will review the results and we'll have the Q&A period. I think the call will last approximately an hour.

The replay will be available beginning at 1:00 p.m. this afternoon through the end of next week. The replay number is 800-642-1687 and you do need a code for the replay which is 677-3100 nub. After that, the link to the audio and the slides will remain on our Website. If there are any questions you can call me at (860)827-3833. We remind you that we issue our earnings guidance in the press release at the beginning of the quarter and we do not comment on it thereafter. If it were to change materially we would issue a press release and conduct a conference call. Secondly, 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'd like to turn the call over to John Lundgren.

Thanks, Gerry. Most of what's on the first chart in the document that we've posted on web is in the earnings release. Specifically, $1.01, up 12%, continuous operations, versus guidance of approximately $1. Within the quarter we were quite pleased with the performance of the portfolio in general with some relatively tough North American market conditions, particularly as it relates, as we all know, to domestic hong. Particularly encouraging was 160 basis-point increase in operating margin from 13% to 14.6%, and Jim will talk to the -- some more specifics on a segment-by-segment basis a little later. The tax rate was unchanged versus year ago, and our share count was up slightly as indicated in the earnings release, we bought back 1.8 million shares at an average price of $59.88. And basically share count at the end of June was where it was at the end of December. The purchase of that -- the purpose of the buyback of course was to minimize or mitigate the creep or the impact of option exercises due to our increased stock price as opposed to significantly lower the share count.

So performance overall slightly ahead of expectations with pretty good performance across the entire portfolio, and we're going to come on to that. In terms of revenues, 10% growth, and as you will remember, we do exclude currency changes when we're talking about organic growth. So it was a record quarter for Stanley in terms of revenues. That's primarily due to the inclusion of the HSM acquisition. Volume was up 1%, price up 2% for a total of 3% organic growth. We were helped 2% by currency and 5% by acquisitions. Within the segments, growth, organic growth, meaningful organic growth in all three segments. Construction and DIY, despite the market conditions, were up 3% organically, Bostitch was flat to down slightly, it will come on to that, but within construction and DIY 5% excluding Bostitch. So we're pleased with the performance of that segment and we're pleased with the progress we're making on Bostitch. Which we'll touch on in a minute. The industrial segment up 4% organically and security up 2% organically, of course with a big lift from HSM. So record revenue for the quarter in terms of the financial highlights per se.

Acquisitions added $56 million to our revenues, and hand tools were strong in Europe and from a small base in Asia led by new products, that's the Excel introduction in Europe, you'll recall that's about six months or one wave behind the Xtreme launch in the North American markets, and Bostitch was soft, but consistent with our expectations. Again, a lot of market headwind and we're making a lot of strategic decisions as to what kind of business we'd pursue in an effort to improve margins in that business. The industrial and automotive repair tools business as well as engineered solutions, engineered solutions with our primary business being hydraulics and Vidmar, they were strong in Europe as well as North America. Facom was another bright spot. In security, really strong performance in mechanical access, hardware, access technologies, as well as our mechanical locking business all did well. Partially offset by U.S. systems integration softness. In our USI business, our focus remains on shifting our mix away from primarily installation business to different portfolios of business with larger recurring revenue content, or quite frankly, the HSM model. And we're making progress in that area and we'll continue to make it as the year goes on. Operating margin of $164 million was up 24%.

As I said, we're quite pleased with 160 basis-point improvement. And no one specific factor contributed to that improvement. We had a great productivity achievement and the funnel remains full. We've done a good job with pricing, outpacing inflation for the second quarter in a row. And HSM, of course, added about $50 million worth of business at a healthy operating margin. Double-digit growth in earnings per share led by industrial and mechanical, as I said, acquisition-related accretion is what we talked about when we bought specifically National and Facom. That accretion is finding IT way into our earnings as committed and as predicted. And cash flow of about 100% of net income combined with a very strong, I believe it was a record first quarter cash flow, puts us in good shape cash flow-wise for the first half of the year, the next slide. You see cash flow from operations at 100 and -- $196 million, pretty much in line with our expectations and about where it was a year ago.

CapEx of $44 million, slightly behind a year ago, pretty much on pace to where we need to be with a lot of thoughtful spending going on across all the businesses as well as our IT platform. And it does put us on track for $400 million to $450 million of cash flow, as Jim guided to early in the year, and where we will stay in terms of our guidance. In terms of working capital turns, the turns were unchanged if we exclude the impact of HSM, which of course is a different business model, and we would expect it to favorably impact turns. If you look at the specific elements receivables, inventories, as well as payables, they're all up slightly, just quite frankly reflecting the fact we're a larger company than we were a year ago. Working capital turns remain at 4.1 which is neither, in our candid view, neither good or bad. What it does say with our (SFS) initiatives, we have considerable opportunity or improvement in increasing our working capital turns in the second half of the year as well as going forward on a longer term basis. The balance sheet, again, no surprises, recent financing has positioned us to maintain our upper tier investment grade debt ratings which is always an objective. It's a complicated chart, but I think it's just in looking at the pieces, the balance sheet as reported is on the left, we've talked a lot about our $450 million ETPS that we use to finance Facom where we received 50% equity credit from the rating agencies. Our most recent financing, 330 million equity units also includes a mandatory convertible offering for which we received in total about 75% equity credit from the rates agencies. So if you see simply as calculated, 50% debt-to-cap given the equity credit received from the agencies for those two recent financings, debt-to-cap at 35%, right in line with where we need to be to maintain our desired and targeted investment grade. I'm going to turn it over to Jim to talk a little bit about the segments and provide some guidance and then we're going to open it up for your questions.

Okay. Thank you, John. We'll start with the construction and DIY segment. All three segments had a, I think an impressive performance this quarter. We'll talk about industrial and security having a really outstanding profit growth story. Construction and DIY basically had some nominal profit growth on 6% revenue growth, 5% segment profit growth, and fortunately, and I think impressively in this environment, we're able to maintain our segment profit rate right around 15%. Within that story, you have hand tools and storage up 9%, particularly strong in Europe with a new product introductions going on over there. The U.S. was up 2%, a nice positive performance in a very difficult market environment. U.S. point of sale at the cash register is down modestly at minus 3%, it's deny down all year about 3%, first quarter, second quarter. And that's despite some very strong performance from the FatMax and FatMax Xtreme in the U.S. The rest of the world, excluding Americas, sales were up 17% as the new product introductions and the emphasis that we're placing on emerging markets and developed countries outside of the United States really pay excellent dividends this quarter, and fortunately that diversification enabled us to deliver an overall good sales performance in the hand tools and storage business. You can see the FatMax Xtreme and FatMax lines with point of sale up 10% at the North American retailers. Then under the heading of steady progress, Bostitch, sales were up 2%. If you take out acquisitions from that, they were down just nominally, I think a point or two. That is very encouraging in this very difficult, soft U.S. construction market.

And the Bostitch team is making great headway and very steady progress on their cost takeout initiatives, and in the last six months have begun a tool transition to our Besco, Taiwanese and Chinese plants and also successfully closed the Chihuahua, Mexico facility, one of the key elements of our Bostitch turnaround plan. The most encouraging thing of all about Bostitch relates to the revenue line, where at the point of sale, despite the -- some of the other construction and DIY lines being negative, the Bostitch 13-week point of sale is actually nominally positive and their four-week point of sale is up 4%. So it seems, knock on wood, that we have hit bottom in terms of the performance of that business from a revenue point of view, and that's stability, when combined with the profit improvement initiatives, should bode well for the future and certainly the Bostitch business delivered in the second quarter in excess of our expectations slightly. Moving on to industrial. Great story here, 5% revenue growth, 4% [X] currency, segment profit up 35% to $46 million and the rate, I think this is the first time we've really seen a 15% rate in the industrial segment profit, and that is very, very encouraging performance. There was broad-based strength in industrial.

The industrial and auto repair business, which includes Mac, Proto and Facom was up 4%, Proto is doing exceptionally well in the revenue line, their revenue up 10% aided by good strong industrial demand, exports, and petrochemical demand. Our engineered solutions businesses were also up 9% delivering an impressive performance there with Vidmar and hydraulic tools up greater than 10% and the Facom acquisition as John mentioned is performing well with sales up 7% transform the synergy realization, which at the time we announced the deal we communicated EUR35 million of synergies appears to be right on track, and one footnote on cash flow, we've been spending about $18 million a quarter on severance and restructuring cash for the Facom acquisition and that will subside at some point in the future. And that also bodes well for future cash flow realizations. We've been able to deliver that good cash flow performance despite the payout of the restructuring expenses to the ex-employees from the Facom acquisition. We had good pricing performance in industrial, very good inflation recovery and we had also a good productivity story. So overall, a really nice story with revenue growth, profit expansion and a great performance from that segment. Security was another bright spot in the second quarter with HSM as well as the strength in mechanical that John referenced providing us with excellent growth, 22% revenue growth up to $363 million revenue line, and so that segment now operating at a run rate of over $1.4 billion, segment profit was up 34% to $68 million and you can see the profit rate, all the way up to 18.6%, very, very encouraging performance. Mechanical access really strong across the board with the best locking business, the access technologies business and the hardware business all strong. Overall 9% sales growth, good order book, operating margin mechanical greater than 20%, able to recover the more than 100% of the inflation through price, good productivity gains, and very positive story in Mechanical.

Convergent is pretty much playing out just as we expected, the HSM acquisition is providing the recurring revenue and the operating margin expansion cementing the business model in a positive sense so we can now begin the expansion of that business. Before we do that, we have to get through the backlog of issues that we have in the Convergent legacy systems integration business. So the reverse integration that we talked about on the last call is proceeding on schedule, and we will continue to see progress there, I believe. We did have a negative 8% revenue in the United States systems integration business, so all the good story there in security could have been even better had it been for but for these issues. But I think we've got the solutions strategically now for Convergent so the next couple quarters should play out very well in that regard.

We were able to deliver the revenue growth in the organic, positive organic story in the second quarter once again, and this chart we've used it before, we have updated it for the second quarter, just kind of shows you the breakdown of the construction and DIY Americas where the market issues are really profound. And in that regard, the tools and storage Americas was up 2%, Bostitch in the Americas down 3% for a net of flat organic performance in that very tough market. And then the rest of the portfolio, industrial, security, and the non-americas CDIY business, up 4% in that all blends to the total organic growth that we communicated. So once again we have been able to withstand very difficult North American construction DIY markets and still deliver a good performance. Moving now to guidance, there's been a slight tweak to our guidance, it's really on the EPS line for the total year. We were at $4.00 to $4.10 last c all, we brought it down to $4.00 to $4.05, like everybody else we're dealing with an export, the repeal of the rebate for the export VAT in China, will cost us $0.05 in the second half, and so it sort of takes away the upside in our guidance but we're right on track for a $4 to $4.05 performance for the year. That would be earnings growth of 15 to 17%, not too shabby considering the 6 or 7-point tax rate headwind that we're dealing with. That headwind alone in the third quarter will cost us $0.09 to $0.12. As you can see, the rate in the third quarter of '06 was 20% and we'll be looking at a 26 to 28% tax rate this third quarter. So with that higher tax rate, we're expecting about $1.10 per share, that would be 1% earnings per share growth. If you backed out the tax rate headwind, we'd be right around 10%. So feeling pretty good about that.

The revenue guidance of 2% organic is consistent with a we've been saying all year. It looks like a 2% year. 2% in the previous quarters and I think we'll probably be there in the third and fourth quarter as well. That includes the headwind from the loss of the hardware business at Home Depot, which is significant. So as you can see, the organic growth underlying that is actually strengthening a bit in the third and fourth quarters, based on our forecast. With that, I'll turn it over to John, wrap it up.

Just one summary page and then we'll open it up to your questions. From the revenue perspective, it was a record quarter, as previously said, with earnings of $1.01, double-digit growth, and 160 basis points of operating margin improvement. Pleased with Proto, worked on our backlog, we've improved our margins, Vidmar remains a very, very strong well-performing strategic business, Facom we've talked about, we're achieving synergies as well as top line, in line or slightly ahead of where we'd predicted, and strength across the board in mechanical security. The Bostitch recovery is progressing well, both in terms of identifying the appropriate customer base going forward, as well as addressing the cost structure. We can spend more time on that in the Q&A to the extent it's desired. You'll recall at the end of last year we set our objective with Bostitch was 100 basis point a quarter on average of operating margin improvement to take us from low single digits to low double digits, we're actually on or ahead of that pace. And the team is pleased with that, as is -- as are Jim and I.

HSM, on track, the convergent securities solutions business has a lot going on with the reverse integration but the field rhythms are in place, four very strong regional Vice Presidents working for Tim Wall and Brett [Vontrager], really getting their hands around the combined business consolidations are where we expect them to be with a few more to come. So we're in a good place there. We're pleased that we grew in every region of the world. It's not easy to do. Particularly in light of what's the going on in the North American construction and DIY markets. Importantly, price and productivity more than offset unprecedented levels of inflation, particularly nonferrous metals for the second consecutive quarter. We've implemented both the central as well as business-specific pricing center of excellence that's really adding value.

Jim talked about the Chinese VAT rebate or cancellation of that, in fact. That was announced June 20th, and went into effect July 1st. So certainly in short to intermediate term guidance there's not much we can do to react to that, other than work on it over time. The portfolio diversification continues to reduce volatility, in terms of reduced construction on large U.S. retailers, construction in DIY markets and of course our European and industrial as well as security content really helped this quarter deliver some numbers in the face of what's going o n. Lastly, our share count's stable by virtue of having repurchased $100 million worth of stock or 1.7 million shares. Let's open it up to questions.

(OPERATOR INSTRUCTIONS) Your first question comes from Jim Lucas.

Thanks, good morning.

Hi Jim.

Two questions. One, with regard on the international front, very good color and one of the cleanest quarters we've seen from Stanley in quite some time, I should put that up front. But with regards to the international outlook, one, if you could give us a little bit of color on the emerging market, one of the things you talked about earlier this year is your emerging market strategy, and any color you could give us there, particularly on the industrial side. And secondly, with regards to new products, if you could just talk a little bit about what potentially is in the pipeline, if there's anything meaningful that you can talk about at this point, or if there's something that we might keep an eye out for later in the year?

Jim, it's John. I'm take both of those. First of all, you know, emerging markets is something we spend a lot of time thinking and talking about. We're in the midst of our strategic planning process, at least in terms of chronologically, where it fits in the year and a lot of focus on it. We include former central and Eastern Europe as well as most of the Asian markets in emerging markets, simply said, we're growing at a tremendous rate, albeit off a very low base. On the industrial side, as you know, we've spoken about this at analyst days, our strategy is to penetrate the emerging markets with our industrial business as opposed to develop the infrastructure to become a retail or consumer company, because that infrastructure simply doesn't exist. And ultimately, waterfall down to i.e. the construction and DIY markets or the retail markets. So the simple word there is great progress, huge percentage gains, the base is small, we're really pleased with the tracks traction we're gaining in Asia under the leadership of Jeff Chen, long-term Stanley employee, who's taken overhead of our Asian business within the last 12 months. And our productivity remains strong in both our Polish fastening and pneumatic tool plant, as well as [Tona] our plant in the Czech republic. So so far so good, but not enough to move the needle on a global Stanley basis and an area of tremendous focus for the future. On NPD, new product development, all I want to say at this stage is we just stick to a hard and fast rule that we're not going to talk to the media, or the investment community before we talk to our customers. Nothing has changed from our rhythm of spring and fall introductions of carefully selected SKUs and product categories, particularly in the construction and DIY market. We're two waves into what we've said would be at least a four-wave continuous flow, we're keeping that pipeline full. So the rhythm that you've seen from Stanley, expect it to continue, i.e. a spring and fall introduction of five to 20 strategic SkUs, a little more closely aligned on the timing with Europe and the U.S. as in the past because we've made some modest organizational changes to link the European construction and DIY market a little more closely with the North American black and yellow brand of Stanley model. But short of that, not much more we can say. No trojan horse or no hidden agendas. Steady flow keeping our vitality index up in the mid to high 20s where we want it to be and no deviation from what we've said in the past.

Okay. And max gross in the quarter, just for housekeeping here?

That was just up slightly.

Up slightly, okay. Thank you very much.

Your next question comes from Kenneth Zener.

Good morning. I'm interested in, two questions, with the restructuring, why did that come up lighter I guess versus your $0.08 to $0.10 guidance?

Excuse me, could you repeat the question?

Your restructuring charges about $0.06 this quarter compared to the $0.08 to $0.10 guidance you had last quarter. Could you kind of discuss the issues?

There's no issues, it's a 2-cent difference at the low end, there's no explanation required, we didn't spend as much as we did, we may spend more in the fourth quarter.

Okay. And then I'm just interested in the capital allocation during the quarterly, the $100 million of buybacks, I understand to avoid share creep and the three small acquisitions together could have been at $175 million a large perhaps down payment on an acquisition. Can you discuss the reasoning and what -- oh, I'm sorry.

We said consistently over the years that our goal is to, with respect to buybacks, buyback opportunistically, number 1, and secondly, to ensure that we could control the number of shares outstanding, particularly in times of significant share price appreciation that results in option-related dilution or which folks cash in options and the share count goes up, either of those two cases. So that, I would consider the first statement I made more strategic about the capital allocation related to buybacks in the second point that I made was more tactical, so we have a tactical practice of trying to keep the share count in line through buying back stock when it relates to share creep. And that's exactly what we did in the quarter. We did not do what I would consider an opportunistic buyback like we did last year or the other 400 million that we repurchased in the last five years. It was really more of a housekeeping item to control the share count. When folks exercise options, and there has been a fair amount of exercise activity from employees and ex--employees, the -- there is cash that comes into the company that is not operating cash flow but it's investing cash flow and it wouldn't show up as an operating cash flow. But that's what we basically use the majority of that, and the rating agencies, we've had that conversation with them, and we haven't had any pushback so we're -- that will continue to be our strategy as we go forward.

Ken, let me reiterate, to build on Jim's response, there's no change in our strategic allocation of free cash flow. Specifically, we're going to pay the dividend, the next primary fundamental use is strategic accretive acquisitions when, in fact, they're there to be made. And if they aren't, as long as we've maintained our debt ratings we will contemplate buying back stock or building the war chest for future acquisitions. So a lot of what we're looking at of material nature is in foreign markets. The, incubation period is longer and Jim has said the rest.

Okay. I guess related to the three small acquisitions for $75 million, how do you strike a balance between receiving cash for a very large opportunistic one as opposed to a smaller fish versus one big fish approach? Thank you very much.

We don't. In terms of trying to decide one versus the other. Each acquisition is looked at on its own merits. The three of those together did not add to a lot of money. Each was -- they were relatively small but each was extraordinarily strategic in its own space. We've added a logical security business to senior technologies when we love, we've added a great industrial storage business with a real focus on healthcare vertical, which is important. And we've just continued our strategy that we've been under the last three years of adding door distributors to fill our regional voids. So two in security, one in Vidmar, which is one of our highest performing and highest-return industrial tools businesses. Those are generally identified at the business level and vetted by the business development team as well as Jim and me for both strategic and financial return criteria. They were great opportunities and we'll happily make them to continue to grow our business. It does not preclude us from making larger acquisitions in the future if we needed to borrow money to do it, we'd do it. And they were there there for the taking, we've added them to the portfolio we're quite pleased to have bought three such strategic businesses at a weighted-average of less than seven times EBITDA in three different businesses that we love.

Thank you.

Your next question comes from Eric Bosshard.

From Cleveland Research, good morning. Can you talk a little bit, I was unclear on what you said about consumer U.S. in the quarter in regards to sell in and sell through, it seemed like you indicated that sell through had been perhaps stronger an sell-in in the POS, can you clarify what you're seeing there?

What I said was the U.S. POS in the hand tools and storage was down, has been down all year. And the number happens to be 3% and it's been fairly consistent all year. And it's -- the revenues in the hand tools and storage business were organically up 2% in the Americas. So-- and that's pretty much -- that's not an exact one for one comparison, but it's a very close and a very good directional comparison. Inventories are not out of line and in the Bostitch business, what I said was that we actually had positive point of sale for 13 weeks, and we had up 4 points of point of sale performance for the last four weeks, and that overall, excluding currency, organic revenues in Bostitch in the Americas were down 2%. So hand tools was up slightly at the sell-in, versus the sell-through, Bostitch was the opposite, and kind of net-net, I think the whole situation there is pretty much where we want it to be.

As you look into the second half and you've got a couple weeks in the into July in the third quarter, how do you think the sell-in versus simple-through behaves from a momentum standpoint, as in the first half of the sell through continues to be down and the sell in continue to be up or do we right-size that at some point in time?

Eric, we have no idea. All we do is manage it one week at a time, one month at a time. We are going into a very interesting environment right now with comps that, in theory, should be easier in the CDIY market in the U.S. Because as we all recall, the real issue in -- we started in the third quarter of last year, but there's no really indication of -- from an economic point of view or from a housing starts point of view or from a repair and remodeling perspective that anything dramatically positive or anything is even changing. So it would be a fool's game for us to try to predict what point-of-sale and sell-through and sell-in is going to do other than to say that we expect to continue to deliver the organic growth that we've committed to in the guidance.

Yeah, and just to add to know to what Jim said, we've got several hundred people in the field working very closely with our large customers to manage inventories, to try to ensure that the supply chain is consistent with demand, it's neither in our best interest or the customer's to build inventory. We tend to take a little longer perspective than next week or next month, and as Jim said, there's a lot going on out there. Inventories are in balance to the extent that they start to build, we'll have good -- we'll have far better and more productive and transparent conversations with our large customers than we've had in the past. I think thats all because we all realize the benefits of a smoothly functioning supply chain and the problems with huge spikes in demand, whether they're market-driven or simply inventory adjustment driven. So our perspective's a little longer term and I don't allow anybody at Stanley Works to spend a lot of time or burn a lot of brain cells worrying about next week or next months POS (inaudible) and thats for hedge funds to worry about.

I guess secondly on pricing it sound like you've done well on a price versus cost. How does that behave in the second half and also how do you think about the China VAT issue in regards to that?

Well, as I mentioned last call, our pricing was catching up with our inflation in the fourth quarter, as I communicated last call. And but for the China VAT issue, you know, that is still the case. So we're very close to 100% of our inflation realization, but if you include the impact of the VAT excise repeal, then we're still going to be playing a little catch-up. But we do intend to implement price increases to cover that particular issue, given that the supply base is virtually entirely Chinese and everybody has the same issue.

Eric to shed a little more light on that, as I mentioned, I don't know if you were on the call yet or not, that was announced on June 20th, went into effect July 1st. So certainly -- I think the team has done a really good job getting out ahead of the commodities increases in general, which is why two quarters in a row, the combination of productivity and pricing has offset the inflation. This one came upon us very quickly. As Jim said, the good news is there's no one who's not dealing with the same thing. The annualized impact for Stanley, if nothing changes, and it is a relatively fluid bit of legislation, is about $16 million, it's about $6 million for what we have purchased and $10 million for what we produce in our own factories, all of which come under the same legislation. Importantly, without spending too much time on certain product categories are not included, if they're highly technical in this legislation. So $16 million annualized obviously cut that in half, that's about 8. We have some -- we have some inventory to which that doesn't apply. It gets to be roughly $7 million or $0.05 a share in the second half of the year. We'll work real hard on recovering that in pricing because there's nowhere else to get it. It's just a question of lead times with customers that you're intimately familiar with various purchasing agreements. There's going to be -- there will be at least three months of slippage between when we can get any pricing and recover it, thus the inclusion of that headwind in the second half outlook.

Your next question comes from Stephen Kim from grue Citigroup -- Citigroup.

Hey guys, can you hear me.

Yes, you're all set.

Okay, great. First of all, I wanted to ask about the Facom operations. You just spent some time talking about the synergies and savings and it certainly looks like everything's gone on track there, as you've s aid. I was curious if you could talk a little bit about the selling opportunities you've been seeing and the opportunities for incremental sales growth from here, maybe some cross-selling opportunities. I remember a while back you talked about some potential opportunities on that front, I was curious if you could update us on that?

Sure. We're-- it's -- we based none of the acquisition economics or any of our internal or external commitments on, we call them revenue synergies because we think it would be not prudent to do that. We still see some, the potential for some maybe is a better way to say it. We've realized none to date. But there are several categories, particularly with Facom product and technology branded Facom, Stanley, Proto, something of that nature, sold to true professional North American channels, provides us some good opportunity. Less opportunity for U.S. black and yellow branded Stanley products sold through Facom channels in that those products were already in Europe and the channels are fairly -- were fairly w ell-understood. So the cross-selling opportunities are there, more Facom back to the U.S., small enough that we're not -- that we never had nor will we continue to put a lot of hope or faith in that in terms of organic growth but obviously we're going to continue to pursue them. And the back room synergies and the cost synergies remain on or ahead of schedule, that's what's thus far driving the economics.

Steve, I would add to that the real synergies that are associated from a revenue point of view with Facom, in my opinion, are yes, there are some there are skew/related or product-related, hopefully some day those will actually tum to fruition, but they won't change, move the needle so to speak. What will change the needle is the fact that we put a platform together. We now have one of two platforms out there truly global in nature in the industrial and automotive repair tools market. In that regard, that positions us very well for the emerging market opportunity, and the combination of brands and the scale that we have, and the products all give us what I would consider to be a very credible platform to go head-to-head with the other one out there, and that's really where the synergies from a revenue point of view will come from, will really unlock the opportunity for us to go after emerging markets in industrial and automotive repair tools.

Okay. Great. And I was wondering if you could talk a little bit more about the Bostitch sales. I know in response to Eric's question you had made some comments but I didn't catch the gist of what I was looking for, which is basically on the sales front, in Bostitch, it seemed that there were two slides on which you talked about the sales, you talked about on slide 8, sales were up 2% overall and then you said that on slide 11 you said Bostitch was down 3%, I assume that was just U.S. and I assume the difference was basically international but I wanted to make sure there wasn't something else I was missing and I was also wondering within that, if you could talk about any particular channels of distribution perhaps that were particularly strong, because you said you were somewhat positively surprised by the sales at Bostitch.

You're missing nothing,Steve, other than obviously organically we take out currency, we had a good quarter in Bostitch in Europe so it shows up in volume and in currency. The fact that North America was down I believe it was 2% was no surprise either. We were pleased with that. As you may or may not be a ware, six months ago we parted relationship with our largest industrial products distributor, and that was probably good for both of us. They'd elected to pursue a private-label strategy which was right for them, and as a consequence, when that -- their strategy and their focus, they will not be the most strategic or best partner for Bostitch, particularly in getting to the channel. There was plenty of inventory within that large customer, which is pretty much sold its way through. And Bostitch itself, through its own direct distribution channels, is looking to replace that business. So 2% down in North America was actually a little better than we'd anticipated. The Bostitch team felt good about that, as did we. We spent the entire day at Bostitch a week ago Friday and we felt that good progress was being made. And no other surprises at Bostitch. The numbers are exactly as you stated them, and other than you're not referencing currency is being one of the differences. Remember, we've got about $100 million Bostitch business in Europe, with the currency, that gave us some nice organic growth.

Your next question comes from Nigel Coe from Deutsche Bank.

Thanks, good morning. It sounds like you had a reasonably good quarter with Bostitch very encouraging. Could you talk about the where you are in the process of offshore and the manufacturing capacity? And at what point will that be complete?

Yeah, I'll talk about it to the extent I'm willing to. Publicly. It's right on schedule. Specifically, we said we were going to do several things and we've done them. Be bought Besco, who was a large supplier to Bostitch, it's now a wholly-owned subsidiary of The Stanley Works. So the process of moving more tools to Besco is not particularly difficult or challenging technically. Besco produces in both Taiwan and China, and obviously we're going to choose very carefully what we produce in Taiwan, which is the center of expertise, not terribly low cost for tools, compared to China. If it's a lower technology product it would waterfall down to China. In terms of what that has done in terms of North America, Jim referenced this, we are quite pleased with the progress on closing our Chihuahua fastening plant, normally it makes very little sense to close a Mexican plant and move production to the Northeast. In doing that, Chihuahua was an expensive place to ship raw steel and an even more expensive place to ship to our North American customers, so we've dramatically lowered the delivered product cost of fasteners to the Northeast U.S. market, but moving them from Chihuahua to East [Greenich], moving some of the best people along with it. What space where we normally produced tools in East Greenich, those are the tools that are moving overseas. It is on schedule and to say it will never be complete because every time we introduce a new high-tech. product we will value the risks and rewards versus producing it in North America versus Taiwan versus China and we'll take each one on a case-by-case basis. So it's in progress, obviously a much larger percentage is being produced in lower-cost countries than six months ago. That percentage will continue but it will never stop for the foreseeable future we will produce products in East Greenich, we'll produce some very high/tech. products that are ours and ours alone in Taiwan, and as the product become more commoditized they'll water fall to China.

And the change in the Chinese VAT export legislation doesn't impact materially what you're trying to achieve t here?

It doesn't Impact materially what, Nigel?

What you're trying to achieve with Bostitch.

It's impacts the cost it's just that the -- it actually impacts is a positive way if you think about it because the real competition for Bostitch fasteners at the margin is the generic nails and the generic nails are the preponderance of them are made in China. So now the generics have endured a cost increase of substantial proportions and we have three plants in three different continents, and so a much more diversified manufacturing base, which I have mentioned for a long time as being a competitive advantage. We were going through a period of time where it didn't seem like so much of an advantage but this VAT excise repeal I think helps the Bostitch business marginally in terms of its cost competitiveness.

Your next question comes from Peter Lisnic from Robert W. Baird.

Good morning, gentlemen. Can we just talk a little bit about security? I guess the U.S. integration business, and kind of where we're at there? It sounds like it was another relatively tough quarter there, just going through the quote/unquote restructuring process but can you give us a sense as to where we're at and whether or not other what kinds of progress we're seeing in terms of turning that business into more of an RMR, recurring monthly revenue kind of business?

Last call I did mention there would be several quarters, probably the remainder of the year of negative performance in terms of revenue growth anyway out of the USSI business. And we elected to pursue that path because of precisely for the reason that you mentioned, which is to build the recurring revenue base and change the business model. In doing that, we've had some sales force turnover, we've had compensation plans have been changed and there are certain sales folks that a have quickly grasped the new business model and we're seeing some early winds that are encouraging. And then there are some other sales reps who for whatever reason, are having more difficulty with it, and it's going to take them some time and if they ultimately don't get it, then they will probably not be with us for the long term. So that whole process is very consistent with what I stated before. We expect it to take about the rest of the year to kind of work its way through. And the HSM acquisition has helped the overall business operating margin and the management infusion from HSM has been very positive and we're expecting really good things from convergent security, but I think it's going to be 2008 before we really see the growth engine from convergent that we're looking for. In the meantime, mechanical's going great guns, if we can keep that going to the second half of the year, the security segment should be looking pretty good here as we go forward.

Okay. But it also sound like what you're also incurring is some, I guess maybe unidentifiable costs with sort of transitioning the business model.

Well, let me just, since you brought that up, let me just say that when your revenue goes down and you have a field organization, similar to a manufacturing situation, you have unabsorbed costs. And what we're trying to figure out is with this business model redefinition, what exactly is the right size for the business. And it's partially a function of what markets are we going after and what verticals, and it's partially a function of how many sales people do we have and are they effective and so forth. All of that is going on right now. So we're having a little resizing of the business, which we have to do before we start to get back on the growth track. And that's exactly what's happening.

Okay. And when you, just to scale it for us, I guess, when you look at that business from an RMR perspective, kind of where do you think it could get to when you look at it two, three, four years out? Is this --

Well, our stated objective -- yes, our stated objective for that business is 50% RMR, 50% install. That's what HSM was running when we bought it, and we're closer to 25, 30% right now. But over a two to three-year period we would hope to see that work its way up toward the 50%. And we'll see if we can make that happen. But that's the goal, and we're -- we think we have the right people in charge to make it happen.

Your next question comes from Seth Weber from Bank of America.

Good morning. A couple questions, sticking with the security business, the margin there was pretty well ahead of what we were looking for. Is there any seasonality to that -- to this quarter or to that business or is that sort of the run rate we should be thinking about from here? That's my first question.

Seth, fair question and I guess, you know, I know you're new to covering the company, we've spent a lot of time on this and we probably weren't as clear with you as we needed to be. There's a lot of seasonality in security in terms of margins, and second and third calendar quarters. Not so much in terms of revenue but in terms of margins. Specifically, second and third quarter, there's probably 2 to 300 basis points of goodness versus first and fourth quarter on the mechanical side. Two factors driving that. First, we have a tremendous position in the university and school market with our mechanical locking business, you change locks on campuses in June, July and August when the students aren't on campus and while that transcends two calendar quarters we get a tremendous amount of incremental business at very good margins. That's a plus. That works in the opposite direction of a negative in the first and fourth calendar quarters in our access business and it's specifically about site readiness. You show up to install an electric or a sliding door in a new hospital in a new retail outlet, and the weather's been bad, maybe it's flooding in California, maybe it's freezing in the Northeast, the site isn't ready, so not only do we not get the revenue, but the point Jim just made is we have our people, a fixed cost that's not absorbed. So we have a little bit of a revenue as well as a margin issue, working against us in access in the first and fourth quarter. We have the opposite effect in mechanical in the second and third quarters, so that in and of itself, could be two, maybe even 300 basis points of margin which we've seen over time. Anything beyond that is operational execution and arguably we're accountable for it. But there's some meaningful seasonality in that business.

Thanks for that clarification. Going over to the pricing and volume, is it possible for you to give us the disclosure that usually shows up in the Q or pricing and volume by segment?

No.

Or should we wait for that.

It's possible, we just as soon you wait for the Q for that because we've just decided it does -- it really doesn't -- in our view, doesn't help anybody understand the company any better and it raises more questions than it asks. When it shows up in the queue, off-line, if we can provide obviously clarity that we're able to provide without three more press releases, Gerry or Jim or I would be happy to do that. But we're really trying to spend a little less time on pricing. Because what happens, by no fault of anyone's, is that gets projected into quarterly margin predictions, which Jim and I are out of the business -- by segment, which Jim and I are out of the business of providing.

Okay, Mr. Lundgren, are there anymore closing remarks?

No, if we're finished with the questions, I'd just thank everybody obviously for their attention and interest, as always, Gerry is available for follow-up questions as are Jim and I as needed. And we will talk to you in October.

Thank you.

This concludes today's conference call, you may now disconnect.