史丹利百得 (SWK) 2007 Q4 法說會逐字稿

Good morning, my name is Matthew and I'll be your conference Operator today. At this time I'd like to welcome everyone to the Stanley Works Fourth Quarter Earnings Release 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) I would now like to introduce Gerry Gould, VP of Investor Relations, and turn the call over to him at this time. Thank you. Mr. Gould, you may begin your conference.

Okay, thank you, Matthew. Good morning. Everybody on the call this morning with me are John Lundgren, our Chairman and CEO; Jim Loree, our Executive VP and CFO. We have two Press Releases out that I'd refer to, the 4Q update and initial '08 guidance we issued on January 7 and then the Fourth Quarter results and '08 guidance we issued this morning. They're both on our website. Also, our PowerPoint presentation is on the website and we'll refer to these charts as we go along. We put a PDF version out there about 20 minutes ago. John and Jim will review the results and then we'll have a Q&A period that follows. The entire call should last about an hour. There will be a replay available beginning at 1:00 P.M. today through the end of the day Saturday, which is February 2nd. The replay number is 800-642-1687. You do need a code for the replay, which is 30996408. Thereafter, it will remain on our site. You can call me with questions at 860-827-3833.

And then we have two quick announcements. The first regarding Reg G, we issue and update our earnings guidance on an annual basis in our Press Release at the beginning of each quarter and we cannot comment upon it thereafter. If it changes materially, we would issue a Press Release and conduct a call. And secondly, certain statements contained in this discussion by the various Stanley participants are forward-looking statements. They're based on assumptions of future events that may not prove to be accurate. As such, they involve risks and uncertainty. Actual results may differ materially from those expected or implied, so we direct you to the Cautionary Statements in Form 8-K which we filed with today's release and in our recent 34 Act filings. With that, I'd like to turn the call over to John Lundgren.

Thanks, Gerry. Good morning, everybody. What I'm going to do is touch on some of the 2007 full year as well as Fourth Quarter highlights and then turn it over to Jim Loree. And Jim is going to go through some of our progress on cash flow, provide a little more detail, drill a little deeper into the segments, and then talk about some of our recent repurchase activity as well as 2008 guidance. 2007 in general and the Fourth Quarter in particular, I think, provided some pretty good evidence on the merits of our ongoing portfolio diversification. As you know, that started arguably five years ago, certainly started to gain traction about four years ago and it continues to reduce our volatility that enabled us to achieve sales earnings as well as cash flow growth due in part to the higher European industrial and security content and the obvious lower dependence on the Construction and DIY Markets which we've heard for the last six months are fairly weak in North America.

Looking quickly, revenues $4.5 billion, up 12%. 26% increase in operating margin and Jim is going to get into the drivers of that. 15% EPS growth, 25% growth in EBITDA. We're quite pleased with our cash flow, both from an operating cash flow perspective as well as free cash flow. All of these numbers on this page are in the release and in the appended financial statements, but to say the least, we were far from disappointed. In fact, we are quite pleased with these results in light of the market conditions, particularly in North America where we competed throughout 2007.

Looking at the Fourth Quarter financial results, good solid revenue growth and I'm going to provide more detail on it in the next slide. But revenue growth of 15%, earnings per share of $1.04 in Fourth Quarter '06 increasing to $1.11, a 7% increase, 16% increase without the tax headwind that I'm going to touch on in a minute. Just as it relates to guidance, we normally don't spend a lot of time talking about how we perform versus guidance, but in October of '07, we were out with $1.10 to $1.15. Given some of the much of the uncertainty out in the market, we did provide updated guidance even though there was not a material change in our business, which historically is not our custom, but we updated our guidance to $1.06 to $1.11 as Gerry suggested in early January. The $0.04 was simply a reflection of $0.04 of settlements of some legal issues for which at the time we saw no offsets. And as you can see from the results, we came in at the very top end of our revised guidance, or in fact right in the middle of our initial guidance. So throughout the volatility, very little changed. Really, attesting to the strength at least in our view of where we are.

Nice accretion in operating margin of 600 basis points in the quarter. The tax rate up to 21.3%. That was within our guidance range but that was about $0.09 worth of EPS headwind versus prior year. Our share count on average was about the same in the quarter, down 600,000 shares but as Jim will touch on later, we did repurchase about $100 million worth of stock in the Fourth Quarter, and another $100 million in the First Quarter not included in this share count. So earnings growth was consistent with our guidance that we provided in October as well as updated in early January.

Looking at a little more detail at Fourth Quarter revenues, again, the 15% improvement, the sources of growth are pretty straightforward. Volume was 1% globally, price was 1% for 2% organic growth and I'm going to talk a little bit more about that on the next slide. But in terms of the price, that 1% gave us about 75% inflation recovery for the year, where early on in the year in our calls and our annual guidance which was $4, and that's where we finished. We assumed about $60 million of commodities inflation. Our best estimate at the end of the year, we absorbed about $67 million, so it was a pretty accurate estimate. The difference between the $60 million and $67 million was -- the overwhelming majority of that difference was the elimination of value-added tax rebate reductions from China and the resulting increase. So we had a pretty good handle on that at the beginning of the year. There were obviously some puts and calls. But the good news is of the $67 million that we felt that we absorbed, pricing covered three quarters of it, so more of our productivity could fall to the bottom line and lead to our margin expansion. Currency added 5%. About 35% of our revenues are outside the U.S. The majority of that is in Europe. And acquisitions added another 8%, the biggest single piece there was HSM.

Looking real quickly at the segments, you see Construction DIY flat on an organic basis, up 5% in total for the fourth quarter. That's primarily the inclusion of Besco Pneumatic, our strategic Taiwanese and Chinese tool manufacturer that we purchased mid year. Really strong performance in our industrial segment, both from an organic perspective -- Jim is going to provide more detail on that -- but both automotive repair, automotive and industrial tools as well as our engineered solutions businesses performed well, 15% in total, the difference being primarily attributable to our InnerSpace acquisition. That's industrial storage included from mid year on. Security, 1% organic in total, as strong performance in the mechanical business offset some negative growth in the legacy Convergent security solutions business. And of course the inclusion of HSM added a lot.

So we achieved record revenues despite the domestic CDIY Markets and I think it's apparent on the next slide entitled "Benefits of our portfolio strategy on the transformation". Looking at organic growth on a quarter by quarter basis, this is all versus prior year. You see CDIY in the Americas, which is our consumer tools and storage business, the biggest piece of that of course is Stanley Bostitch and our CST laser leveling business. Three out of four quarters were down versus prior year flat in the Second Quarter but the minus 7 flat, minus 9, minus 4, roughly about 5% decline on an organic basis versus the year. Now, within that, that would imply some modest share gain at least through three quarters. Most of our research shows the customer base, or the Markets in which we sold those products, were down 7% to 8%, perhaps even a little more in the Fourth Quarter. We don't have all of the market data yet. But a 5% organic decline, if you will, in CDIY Americas would imply share gain. The rest of our business, 76% of our revenues consisting of CDIY in Europe and Asia, that's roughly about $600 million of revenue. Industrial and security combined for a nice mid single digit gains each and every quarter resulting in a nice consistent 2% to 3% organic growth throughout the year.

But as we've said on many earlier calls, as a Company, we've spent a meaningful amount of time and effort in streamlining our processes and in an effort to reduce the complexity in our business through our Stanley fulfillment system. I think the most tangible evidence of this at least in the Fourth Quarter as well as for the year is in the progress we're making on working capital. So I'm going to turn it over to Jim to talk specifically about that and about our cash flow.

Thank you, John. Well, as John alluded to, working capital is an excellent story for 2007, in particular the Fourth Quarter, and a key element of our excellent cash flow performance in the Fourth Quarter. As you can see, the turns improved from 4.5 to 5.1, 4.5 at the end of last year to 5.1. And that's a record for Stanley in the nine or so years I've been here and probably before as well. And the improvement was significant for several reasons. First, it was the first as John said manifestation of material improvement from our revitalized efforts that we're placing on the Stanley fulfillment system which has taken place really over the last 12 months or so. We talked about it briefly in the March 8 Analyst meeting. Second, the leaner inventory position that we have now comes at an excellent time given the uncertain economic outlook in the slowing world economy. Thirdly, the improvements are based on process improvement and not some sort of tactical or kneejerk reaction to bringing inventories down, and they do not come at the expense of Customer Service levels, which is very important. And then finally the extra cash that we generated from our Fourth Quarter working capital improvement totaled $86 million and that helped fund our ability to do another $100 million share repurchase in the first few weeks of 2008.

So moving on to the cash flow statement, as I discussed, working capital clearly was one of the key catalysts in the Fourth Quarter. You can see the $86 million there. We were also aided by strong depreciation and amortization of strong net income. We had a total operating cash flow of $218 million and free cash flow of $186 million. On the right hand side for the total year, free cash flow was a record $457 million. This is a big story here in addition to working capital was depreciation and amortization. And this is increasingly becoming a huge cash generator for us. All that intangible amortization that's come from the four or five years of acquisitions now totals about $160 million a year that we add to the net income. And then on top of that, we had a good working capital improvement of $31 million for the year given the sales growth that we experienced. And what you don't see on the page here is about $60 million of cash out which would be in that Other line related to severance and mostly from the Facom acquisition, a good portion of which is not likely to recur in '08 and that should help us on a prospective basis. All of that yielded a record free cash flow which exceeded our forecast of $400 million to $450 million which we introduced on March 8 back in New York, and the $457 million gives us a good, solid platform to go into '08 with.

When you look at cash flow from a more, from a longer term perspective, clearly, the '07 performance caps a string of really strong cash flow performances over the last 10 years or so. And this performance has really been a result of the portfolio transformation that John talked about in recent years. And interestingly the transformation itself has both been an enabler of ongoing growth as well as kind of a manifestation of that portfolio shift. So it's a virtuous circle, so to speak, and as we look at '08, our expectation is for $500 million plus of free cash flow and a continuation of this strong performance. And as I said, it should be doable because we have good strong net income and lower restructuring. And then the benefits of Stanley Fulfillment System should continue to appear in the cash flow statement. So very, very strong position going into '08 from a cash perspective.

Just a brief comment or two on the portfolio shift. We covered this before, but we have been able to achieve 16% average annual growth since '02, growing the revenues from $2.6 billion to $4.5 billion, and the Company is no longer dominated by the Construction and DIY market. In fact, the U.S. portion is about 25% versus 50% just five years ago, and as John indicated, this certainly is fortuitous for us in this weak United States Construction DIY market environment. And what we have here is a Company that also, their largest, our largest customer is only 8% of revenues today versus 22% a few years ago and our dependence on the U.S. home centers and mass merchants is greatly reduced down to below 20% from about 40% in 2002. We have a larger more diverse Company and a stronger Company to stand up to some of the pressures that we're encountering from an external perspective.

Now, we'll go through the segments in a little more detail as John indicated. The Construction and DIY segment had an okay performance from a revenue perspective and a good one when you consider the degree of difficulty in the environment. Segment profit was down 8% and our segment profit rate was down 190 basis points. Now, notably, $3 million of the $5 million segment profit decline is associated with the legal matters that John discussed in the quarter. So that would be kind of a one off if you will, but clearly, the U.S. was adversely impacted by the residential Construction market issues. In fact the U.S. Construction DIY was down about 4%. But the rest of the world was a great story. The sales were up 19%, continued to be strong in the wake of a strong Third Quarter performance and here, we had some benefits from an ongoing wave of new product introductions in Europe, Canada, Australia, Latin America and Asia and outstanding execution in those areas and a little help from decent economic environments in most of those places.

The segment profit rate as I mentioned in addition to the $3 million decline related to the legal matters was also somewhat suppressed by unfavorable product mix within the consumer tools and storage business. And therein, we had a mix towards consumer storage, both plastic and metal storage and you can imagine plastic and metal storage, the plastic being affected by the resin prices related to oil and the metal being affected by the strong Canadian currency as we ship those products from Canada into the U.S. And there was also a currency benefit significant in this segment; however, the Construction and DIY business also had a significant inventory reduction. So this is true for the total Company but it's also true for Construction and DIY segment. The benefits of currency in the quarter were significant and total for the Company was $7 million and it was a couple million for the CDIY segment. But the inventories coming down from a P&L perspective basically offset that, so there's really no significant impact from currency when you factor in the inventory reductions.

Moving on to Industrial. Here, we have a terrific story. Revenues up 15% as John indicated, the segment profit up double that -- 31% with almost 200 basis point increase in the segment profit rate. When you break it down into the subsegments if you will, the industrial and automotive repair tools part of it which is your Facom, Mac, Proto piece -- that was up 11%, of which 5% was organic. Proto had a terrific quarter, up 17% in revenues, without any acquisitions. There was some share gain, there were some customers buying ahead of price increases, a price increase effective in January of 3%, and there was also some good market strength, as in particular the petrochemical demand continues playing into one of our strengths in Proto. And Facom, although it was a little bit less in terms of organic growth than they encountered in the third quarter, still had a strong organic performance, netting out currency. They were up 2%. Engineered Solutions, terrific quarter, up 15% organic and up almost 30% with the acquisition of InnerSpace. We encountered double digit growth in all three of the elements -- industrial storage, assembly and hydraulics, each driven by good gains in product innovation as well as decent end markets.

And then the segment profit rate within industrial increased as well. And here, we saw the results of what I would consider excellent execution in the area of price realization and productivity with price offsetting inflation and then productivity basically falling through. And in Stanley, we have a very robust process for tracking inflation and making sure that the price increases are implemented on or about at the same pace. And the idea here is to try to offset the inflation with pricing, try to stay ahead of the curve as much as possible. And we have very good market intelligence from our sourcing organization about when those inflationary costs are coming through, how much they are. And the sourcing people and the operations people work hand in hand with the marketing folks to make sure they're armed with the data to go to their customers in realtime and implement price increases. It's easier in industrial than it is in Construction and DIY. That's why our price inflation recovery is about 100%, slightly above in industrial in the Fourth Quarter, whereas it was much much lower in Construction and DIY, say less than 50%. But still, we have that process throughout the Company, and you can see the benefits clearly in industrial.

Security also had a fantastic quarter with revenues up 30% on the strength of the HSM acquisition. Segment profit was up 44% and our profit rate was again up almost 200 basis points. Mechanical Access really strong, 8% revenue growth despite a Home Depot hardware loss. Of that 8%, 4% was organic, the other 4% were smaller acquisitions. The hardware loss in Home Depot cost us $10 million of revenue in the quarter. As John said, we had benefited from a delay in the loss of that business during the previous quarters. It really hit us in the Fourth Quarter. We expected it -- that was the good news. But it had a 5 point impact on organic growth in mechanical and a couple of points on the total segment. Convergent HSM performed very well. HSM had an 11% organic growth performance, if you consider that on a pro forma basis as if we owned HSM in the Fourth Quarter of last year even though we didn't, so they executed well. We continued to have the negative pressure from our business model change that was taking place in the U.S. Systems integration business. But this is a very good thing because we're shedding unprofitable business and it cost us 15% negative organic growth in the legacy USSI business in the quarter. However, we have basically one or two more quarters to go, we'll anniversary out of that and the business we're taking on today is very profitable business, much more similar to HSM's business with a nice recurring revenue content as well. The segment profit increase was also driven by price realization, as well as the realization of the HSM synergies and good strong productivity projects within the Mechanical Access business.

So, all of that goodness allowed us to become a little bit more active in terms of repurchasing shares. As you know, in November and December of '07, we repurchased 2 million. In May of '07 we repurchased 1.7 million, and with the depressed price levels in the early days of January of this year, we repurchased another 2.2 million. So in the last 12 months or so, we've spent now $300 million on share repurchases at an average price of $51.70 a share. With this most recent repurchase, the shares outstanding have dipped slightly below 80 million fully diluted shares. Our total debt at the end of the year was about $1.5 billion. If we take the $100 million we spent on the share repurchases, probably now closer to about $1.6 billion as we sit here today, and at $47 a share or so, the Company is trading for an enterprise value of about $5.3 billion, with '07 EBITDA of about $694 million. That would be about 7.6 times trailing EBITDA. So when you look at the value inherent that we see in the stock, hence the attractiveness of buying back shares at this time.

As we move now to 2008 guidance, this is nothing new here. This is all reaffirmation of what we introduced in the early days of January, when we pre-announced our Fourth Quarter as well as updated our '08 guidance, and as most folks on the call know, we are no longer providing quarterly guidance. We announced that over a year ago. And so this is the annual guidance for 2008 and the organic growth has been tempered to flat to up 1%. We're anticipating a very mild and short lived recession, by definition, and that would be in the U.S. By definition that would mean two quarters of negative GDP growth in the U.S. However, we do not expect it to go beyond that level of recession because the monetary and apparently the fiscal stimulus will be fairly strong coming into this year. So hopefully, this will be short lived. And so that 0 to 1% growth would be consistent with how we performed in past recessions. We've done some work looking at it typically. We will be flattish to maybe up or down 1 point during a recession and we might have two quarters of negative -- or a couple quarters of negative growth during a year where that organic growth where that occurred.

As far as other assumptions related to sales growth, we're looking for -- to do some acquisitions, we haven't built anything into the guidance obviously. We're looking for a share count of about 82 million shares, which anticipates nominal share creep and no new repurchases, although we're not ruling repurchases out at this point in time. We have our free cash flow expectation of around $500 million. We have about $100 millionish kind of a dividend and there's $400 million to work with to keep within our ratings -- roughly to keep within our ratings profile. We've spent $100 million of it, so there's $300 million left to spend, and we'll be looking at acquisitions, we'll be looking at share repurchases and we'll make whatever informed judgments that we deem appropriate at the time.

As far as inflation goes, we had a very consistent track record in '07 of predicting inflation. We certainly anticipate that to continue into '08. We're looking for about $75 million of inflation including currency, EVRR, all those sorts of things. We'll get about 80% of that [back] and recovered in price. We believe at this time, similar to our '07 performance, we expect to generate another $70 million or so in productivity. Our SG&A would probably be a slight increase in dollars versus '07 and a slight, very slight increase perhaps in percent of sales if that sales forecast comes to fruition, as it will increase slightly faster in all likelihood than the sales growth with this tempered sales outlook. And I mentioned free cash flow already, and the tax rate, we're looking for a similar tax rate in '08 that we experienced in '07. And I think we're very well positioned for some earnings growth despite a very challenging market environment. And with that, I'll turn it back over to Q&A.

Matthew? We're ready to take questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Peter Lisnic with Robert W. Baird.

Pete?

Can you hear me?

Yes, we can hear you now.

Oh, sorry. Jim, I was intrigued I guess by your comments on Facom with the growth slowing. It's looks like you're in kind of the mid to high single digits for the past couple quarters and then down to 2. Can you give us a sense as to what your expectations for the European economy might look like for '08? Is the slowing growth of Facom something that we ought to be incrementally concerned about or just kind of what's the thought there?

No, I think Facom growth was not an -- earlier in the year, was not a direct result of any economic boom over in Europe. And clearly, there was 1 point higher of GDP growth than we typically had been experiencing in Europe over the last X number of years. And Facom and GDP would be expected to track fairly closely. So I think the growth was more a function of the Facom folks joining a company that was willing to fund new product introductions and was a real tool company and there were some revenue synergies that we talked about that we didn't anticipate in our financial forecast for Facom when we bought the Company. And all of those things were positive. But the comps are getting tougher and yes, I think the likelihood of the economy maintaining that slightly higher than historical GDP growth in the context of a U.S. slowdown is not very high. And so we've tempered our growth outlook on a prospective basis for Facom. We're looking at probably something closer to flat to up 1 point or so for Facom as we go forward.

Okay, great. Thanks on that one, and then the follow-up question I guess, the working capital obviously was quite strong in the Fourth Quarter. I'm just wondering, how sustainable is this working capital improvement through the Fulfillment System? And I guess a way of asking the question might be do you have a longer term target or is there something there we could put our teeth around to say that this is sustainable, this is where Stanley is going in terms of working capital?

Yes, Pete, I'm going to start and Jim will take it. We would like to think that it's sustainable and we're not going to put a specific longer term target out there other than to say the Stanley Fulfillment System is all about continuous improvement. We've been working -- I don't want to say quietly behind the scenes, but working very hard focusing each and every one of our business unit leaders on, among other things, working capital efficiency and working capital improvement. And as you're probably aware, a meaningful piece of every P&L owner's compensation is based on measurable improvement in working capital turns on an annual basis. At the corporate level we're measuring it on cash flow and at the business unit level, it is on working capital turns. So simply said, it will be continuous improvement. We've been working at it awhile. I think the Fourth Quarter we really began to gain some traction and saw the first tangible results of that. Jim, you might want to add something.

Yes, I think that's very consistent with what I would say as well. The only thing I would add is that inventories were the star of the show in the Fourth Quarter and will continue to put upward pressure on the working capital turns through our process improvements from the Stanley Fulfillment System. What we would like to see in '08 and beyond is a continuation of the inventory improvements, continuation of the payables improvements which have been now in place for about two years and then the beginning of some improvements in receivables as well. And that would be something that we're working on very diligently and I believe that there is some opportunity there. Receivables are $800 million -- north of $800 million and clearly, there's some process improvement opportunities there. Perhaps not as much as in inventories because they're dictated by terms and terms have to be negotiated and there are economic trade offs that one makes. But there's a lot of waste in receivables in any Company that doesn't have fully standardized processes and a process focus. And Stanley's history with all of its acquisitions and everything has certainly left some opportunity on the table. So I think we'll see a broader based working capital improvement as we go through '08, but we certainly won't let up on inventories or payables.

Great. Thank you very much.

Your next question comes from the line of Richard Radbourne with Atlantic Equities.

Hello?

Hi, Richard.

Yes, this is actually Joe Herrick with Gutterman Research. Couple of questions, you guys talked about continuous improvement a while ago --

What firm?

Hello?

What firm are you with?

Joe Herrick with Gutterman Research. You guys talked earlier about continuous improvement initiatives. Regarding your operational initiatives, what are you guys doing regarding lean manufacturing TP and the Six Sigma and how do you expect them to affect your bottom line?

The end of your question was how to what about the bottom line?

How are you looking at lean manufacturing, Six Sigma, within your operational plans and how do you expect them to --

We've reviewed that at great lengths on previous calls. Lean Six Sigma, etc. are tools. They aren't processes within themselves that contribute to improve working capital efficiency as well as margin accretion. And we'll take that offline to the extent we need to, but we've got 19 people in the queue and don't want to spend any more time on that on this particular call.

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

Good morning, Ken.

If you could update us on the status of Bostitch, given that it's such a large business, I know the margins you guys had expected them to go up roughly 100 basis points sequentially in '07 and into '08. Could you tell us where we were, or refresh us, at the beginning of '06, end of '07 and what your expectations are?

Yes. Basically, Ken, as we've said, on several occasions, Bostitch was in terms of margins and performance, the business was shrinking due to a combination of market and us consciously shedding unprofitable business, up to 5%, even arguably approaching 10% of revenues although some of that we'll get back. They were low to mid single digit operating margins at the end of the year, by the end of '06. What we said we would like to do is march from about 4 to 12 in the course of eight quarters on average 100 basis points a quarter. I mean that's just eight quarters times 100 basis points, gets us to 12. And what we also said is it wouldn't be perfectly linear. We can say by the end of the year without providing more detail than we intend to for all of '07, they made a nice sequential improvement. Fourth Quarter was a bit of a setback.

That being said, there were three -- two things going on that are really difficult to isolate. As you know, we had about a $3.7 million charge that hit the Bostitch P&L, that's easy to isolate, an unfavorable product liability litigation but it did show up in the Bostitch numbers. We had the preliminary implications of the anti-dumping legislation that in some cases increased costs but the flip side of that gave the opportunity to improve prices, no telling where that will settle out in the short-term, but it was two offsetting factors for Bostitch. And then third, the business is 75% in North America and at least half of that is residential Construction related. And that's a tough business, so they got a lot of market headwind. Long answer to a simple question, we're happy with where we are in manufacturing restructuring, we have our Besco Pneumatic that we've purchased, we very successfully closed our Chihuahua plant, ramping up in Langfang. We have world class production on three continents, North America, Poland, and China, and we're still cautiously optimistic about the future of that business but there are tremendous marketplace uncertainties that are tempering our optimism.

That reminds me, there's one additional clarification on the guidance I wanted to make relative to the anti-dumping decision that was made by the Department of Commerce. And that is that the inflation in the price information that I actually gave you excludes the anti-dumping impact because it's been happening in realtime, happened last week, late last week in terms of the decision. And we haven't had an opportunity to fully vet it, although we believe it's going to be essentially a neutral to a slight positive, very slight positive for us for the year from a financial perspective. So we're not excluding it because it's a negative or anything like that. We're simply excluding it because we don't have accurate numbers for the price and inflation impact related to it. And you could imagine it's a 30, 29 point something, 29.6% I think it is tariff on many of our nails that we import from China as well as all of the other nails that are imported from China ranging anywhere from in the low teens percentage up to 110%. And so our competitors are going to experience in many cases the same type of impact if not worse.

And from a strategic perspective, it really I think is a positive for us, a very big positive for the Bostitch business because this business has really had to compete in a very very unfair environment over the last couple of years as the Chinese start ups have been dumping these nails into our country and certainly, the punitive tariffs that were put in place, especially the ones that are north of 30%, are really going to change and they are going to level the playing field, we hope. And on top of that, we have the most diverse manufacturing base of nail manufacturing of all of our competitors with manufacturing in Eastern Europe, North America, and China, and we have the flexibility to move production around from place to place as the economics of producing -- the cost economics of producing change. So we actually hail the advent of this anti-dumping issue, and I think it's going to be kind of a real positive for the business on a go forward basis.

Do you have a follow-up, Ken?

I do, I appreciate the expansion of that as well, Jim. The consumer margins, just to focus on this because I think that's where a lot of people do have this concern, though obviously your other 60% plus of businesses are operating very well -- the consumer business you talked about the 190 basis point margin drop year-over-year, related to U.S. mix and absence of price recovery. Can you talk about the mix A), and B) why we see better pricing outside the U.S. relative to the U.S? Thank you very much.

Well, first of all, we need to make sure that everyone understands the $68 million going to $63 million is a $5 million decrease in profit rate, of which 60% of which is related to non-recurring items, the legal matters. I don't know if that was entirely clear when I said it, but make sure that we understand that. And so if we added the $3 million back to the $63 million, we would be at $66 million divided by [459], just doing math in realtime here, we would be at 14.3 instead of 13.7. So we would be 130 basis point decline, so that's a piece of it. The mix issue itself in the quarter is simply one of -- we were doing some refreshing of some product lines in both ZAG and our consumer storage business and it just so happens those are our lowest margin businesses in Construction and DIY. And unfortunately, that's just what happened. That would be a big piece of the remainder of the negative there, and we don't see an inherent profitability issue in this segment on a go forward basis, especially with Bostitch recovering and with Construction and DIY being so strong outside the country. Now, there is pricing power outside the U.S. -- is actually a bit higher than it is in the U.S., although not dramatically higher, and that results from the fact that we are playing in many fragmented markets, much more fragmented markets from a customer perspective outside of the U.S., whether it's in Latin America or Europe or Australia, whatever. That said, there's some very large customers that wield a very significant amount of power.

There's been a lot of talk about China inflation and so forth as well in our business and other businesses that were affected by China inflation. And there's a lot of people getting exercised about inflation from China and how that might negatively impact these types of businesses, in particular these segments. And in fact we look again at China inflation as more of a positive than a negative for us because the single largest competitor for Stanley Works is not another branded tool company; it's private label in the aggregate. Private label in the aggregate buys 80% to 100% of their product from China and with prices going up, the retailers are facing unprecedented price increases and pressure from China. And that just simply is a positive for us because on a comparable basis, it means that we're more competitive with our non-China manufacturing and that we're on a level playing field from a China perspective.

Thank you.

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

Two questions on the acquisition integration side, please. First, could you bring us up-to-date? You talked a little bit about Facom's end markets. But in terms of the overall European industrial strategy both from a manufacturing standpoint as well as going to market of combining the Facom and Stanley brands -- if you could just give us a quick update there. And secondarily, with regards to the Convergent business, you had alluded to it in the opening remarks in terms of as the strategy there evolves. But in terms of the older lower margin business that you have been purposely changing the portfolio from, how far along are we on that and just overall, how do you feel about how that Convergent strategy is coming together?

Yes, Jim. It's John. I'll take them both and Jim will add on if need be. First of all, in Europe on the integration, I think there's two important integrations going on if you will, back room and front room. The strength -- or customer-facing. From the back room perspective, if it doesn't face a customer or an end-user, we're trying to do it in one place, one way. We're making I'd say great progress there, including a seamless transition in leadership on the Facom side of the business. But importantly, we have no intention to combine the Stanley and Facom brands other than in emerging markets where we don't have the structure and the scale to have, if you will, a dedicated salesforce. So in markets where we're spread a little thin, you do have one individual reporting jointly to the Facom and Stanley side. But in general, and you know this well, Facom is an iconic brand for professional automotive repair and industrial tools. Stanley brand in Europe is overwhelmingly Construction and DIY and we intend to keep them that way, so we're quite pleased with the integration in terms of cost synergies. The organizations are working better, very well together, better than in fact we had hoped for. And all we can say on that one is now we're 24 months into it, so far so good, and the two businesses are working well together.

The other point that Jim made on Facom I think is an important one to the first caller, to Pete Lisnic's question. The improvement in Facom revenues is a combination of great new product vitality, which has always been the case, but less attrition or cannibalization from the existing business, and I think that is the strength of the combination. Real quickly to touch on Convergent and security. Jim suggested we probably have two more quarters before some of, I'll say the bad legacy business primarily installation driven at low margins is going to filter through the system. In terms of the two organizations, again, we're as pleased as we could be at this point with how well they're working together. I think everyone understands. On the Stanley side it was a little bit difficult to say wait a minute, we've just bought HSM, we're doing a reverse integration. But the margins speak for themselves. The business processes speak for themselves, the percent of recurring revenue speaks for themselves and I think by now, they're starting to, they really are starting to behave as one team. We've got the majority of the office consolidation behind us. Leadership is aligned and we're, on both those fronts, we're certainly not complacent but we're on or ahead of schedule in terms of the integration and looking for some margin improvement on the legacy Stanley side going forward.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Eric Bosshard, with Cleveland Research.

Two questions for you. First of all, the mechanical side you commented of the improved growth out of that business it sounds like almost 10% excluding the hardware. What's driving that and what's the sustainability of that?

Well, there's a number of factors driving it, and I'd say they're more related to execution than anything else. The first is I think as I mentioned last quarter, there's a real intangible benefit to having split the mechanical and the electronic businesses. I think in reality, they're quite different businesses and the issues that one has to deal with in transforming an electronic business model are very distracting to someone who is trying to go or to a business that's trying to go out and gain share in the electronic, I mean the mechanical business. That said, I think over the last few years we have assembled a very broad based product line that covers virtually all of the important elements of a full fledged mechanical product line.

And why is this important? Because in the past, we were losing bids in mechanical and losing business occasionally. When competition had products in certain areas -- an example would be exit devices and closers, and so forth, and another example which we have yet to plug but hope to some day would be hollow metal doors -- where they would underbid one element and overbid another element of the proposal to win the business and we couldn't compete in the areas where we didn't have the business. That's virtually behind us. We have one remaining hole now which is hollow metal doors as I mentioned. Another benefit to the mechanical business has been the tremendous strength of the access technologies business, the automatic door business. And that particular business basically put together a value proposition to the customer which is predicated on a national footprint with 24/7 service and a service contract type of mentality where it's a service based business and they pull through a lot of mechanical product. Justin has actually been talking about this for years and gradually and methodically putting together that service value proposition and that's certainly paying off in spades. So then the final thing is we've added specifiers. We've added specifiers in the mechanical business, the old Best Access legacy business, if you will, and the combination of all of those factors has contributed to good, solid, building momentum in that particular business.

So understanding those are structural factors, is it reasonable to think that you can see sustained better growth like we saw in the Fourth Quarter?

Well, I think the thing that we have to be realistic about in mechanical is we're going to encounter some market headwinds and I don't think they're going to be dramatic like they are in the residential side, but there is a small piece of security. It's probably 30% of security roughly that is a commercial Construction related business. When you have, I think we all expect to see some pull back in commercial Construction, I don't know how much various people expect, but in our case, we expect to see some pullback but not to go negative like we saw in residential Construction. And I think that's probably going to weight down the Mechanical Access performance a bit lower than it has in the last couple of quarters. But that said, the strong momentum that we have in the fundamentals there is going to help us continue to have a very good '08 we would think, even though we expect to see some market slowdown. All of that has been built into the overall guidance for the Company.

And then a follow-up, I know Bostitch -- things are changing pretty rapidly right now in regards to the cost side of the equation, but can you talk about the expectation of getting to this 12% margin over eight quarters? Should we be thinking about a different schedule at this point or do you do anything different to ensure that you do stay on schedule?

Yes, that's really fair, Eric, and there's enough uncertainty in the marketplace. Let me just say we're not thinking about it any differently. We think -- and the reason being we think we have as much to gain as we do to lose with the pricing follow on to the anti-dumping legislation, but it's going to take us three to six months for Denise and her team to see where that settles out in the marketplace. In terms of everything we can do internally, we think we've done it. It's on track. It's really good to see it. We are producing tools in both Taiwan and China. That's very, very encouraging, so long answer to a simple question is we're not backing off that yet and if something goes on in the marketplace or executionally that would allow us to do that, we'll be the first to raise our hands. But we're still looking at, we're hoping and targeting a double digit run rate exiting 2008 for that business, in terms of operating margin.

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

Good morning, gentlemen.

Hi, Sam.

A couple real quick questions here. Jim, restructuring actions in '08, what are your expectations there?

Well, at the moment, what we are looking at is something that's going to be I think fairly similar to '07, so that would be something in the midteens. If the recession gets deeper, we could do more but if we do more, it will be, it should be relatively neutral to earnings because the benefits from those restructurings would be reflected in at least partially in the current year '08 P&L.

Second question, I think I heard you say share count assumption for '08 will be 82 million shares, but right now with the actions that were taken earlier this month, it's actually under 80 million. Option creep is that much? Or I mean, I'm confused as to why you wouldn't just assume an 80 million or 81 million share count?

Well, when the stock goes back up to $64, we'll lose a couple million shares or add a couple million shares of outstandings. So that's, the game plan here is to execute, be rewarded by higher stock price and then we'll go from there. So it's a bit of a tongue-in-cheek response. But the Company is undervalued right now, our expectation is the price will go up. That will create share creep and the last thing we want to do is have that impact our ability to deliver the earnings. So that's the reason for the guidance being constructed that way.

I'll be sure to put that in my model. Last quick question, John, this is for you. Could you go through Europe, looking at it broadly from 30,000 foot on a consumer industrial combined basis, where you're seeing changes in growth rates on a country by country basis? I mean, France is where your biggest exposure is, but are you starting to see things weaken or are there, is it looking to be pretty steady and stable at this point?

Sam, this is John. Jim and I are obviously in daily contact with all the key regional leaders, even country by country, you're absolutely right. France and the UK provide the overwhelming majority of our business. We've seen no softening on the industrial or consumer side at this stage. Germany is booming, which is an opportunity for us. We don't have a lot of business in Germany, but the growth from a low base. And I can't underemphasize the extent to which the opportunity to grow in -- I'll call them emerging former Central European Markets is filling in a lot of holes. Remember, we've got good production in Poland. We've got teams on the ground there and that's filling a lot of the -- we call it former western European gap or potential softness. So we're cautiously optimistic on the European outlook and maybe for the first time, in my career, Europe for a variety of reasons isn't going to follow the U.S. one way or another. At least you've read as much about that as we have. So the simple answer to your question is we're all over it in terms of staying current. We're not building much of a slump into our assumptions.

Your next question comes from the line of Nicole [Delevase] with Deutsche Bank.

Yes, I am asking questions on behalf of Nigel Coe today. How are you?

Good, Nicole.

Quick question for you on FatMax. Where are you guys on the rollout both in the U.S. and international?

Well, FatMax is -- I don't want to say yesterday's news but that's, that at this stage is one step behind what we call FatMax Xtreme in the U.S. and XL in Europe. And simply said, Nicole, we're where we said we've been and we will continue. We are two-thirds of the way through a previously announced sequential rollout. That's roughly two waves of new product introductions per year in the Spring and Fall which are the best selling seasons for relatively low price consumer hand tools. And we've had tremendous success in terms of the shipments of those products in two areas. The POS for the retail takeaway for the XL and for the Xtreme is up mid single to low double digit rates with less FatMax cannibalization than we had seen in the past. So looking forward what you can expect is until we say something differently or get further ahead of ourselves in terms of announcements, another two waves in 2008. The only difference being we'll do it simultaneously in the U.S. and Europe -- historically we've trailed in Europe but we think we have our supply chain to the point now where we can do them simultaneously. And we're looking for another $20 million to $30 million of growth from those product, new product introductions. And the question will be, can we keep the cannibalization of the base FatMax line as low as it's been so the overwhelming majority of that becomes incremental.

Your next question comes from the line of Michael Rehaut with JPMorgan.

Hi, thanks, good morning.

Good morning, Mike.

First question just on CDIY. Can you just break out what was the rest of the world excluding FX?

Yes, 5% less than -- you want the quarter or the year?

Quarter, please.

19%.

19%.

So that was, okay that was excluding the benefits. And also, what was the benefit on the margin line from the currency?

Probably 100 basis points, but I don't have it at the top of my head. We actually, you'd think it would be a pro rata percentage but I don't have that number off the top of my head. Jim might be able to give you a better estimate.

The 19% is half currency and half organic growth, just to clarify.

Okay.

And I missed the second part of your question because I was busy researching.

No, actually, I think that was my fault. I think you did say previously it was a $1 million to $2 million currency benefit.

Right.

The second question, just on '08, you'd mentioned that you're expecting a kind of a decent backdrop. It's a little bit in contrast to some economists that are looking for a little bit of a slowdown. And in the housing market to the extent that certainly, you're a lot less exposed to the housing market, but particularly driven by housing market down 5% on average in terms of completions across a lot of G7 type nations. So is your outlook or your game plan in Europe mostly end market tied or do you also have a new product share gain initiatives that would bolster your confidence of Europe?

Well, based on performance in the U.S, it down 10 to 20%, us down 5, we operate the same business model in Europe. On the CDIY side as I just said, in response to Nicole's question, we've got two more waves of XL coming in Europe. They've been extraordinarily successful. So we think the fact that our new product vitality on the consumer side, that's what's allowing us to gain share in a down market. Because a very high percentage thus far, 60 to 80 of it has been incremental, not a lot of cannibalization from the base business. And Jim made a very important point earlier why we're far from bullish, Mike. But while we're cautiously optimistic, despite the weakness of the dollar, the strengthening of -- if you will the Chinese currency relative to the dollar relative to Europe is going to have a big impact. Private label is a big piece in Europe. Whether it's generic or private label with the European home centers, the cost of those products will go up dramatically. We're number one or two in the market in every product category where we compete and with a lot of experience and a variety of branded products in situations like this, the market leader is quite often the one who gains as SKUs are rationalized, etc. We have, I think, a chance to gain as much as we have to lose. That's what provides, if you will, a floor to our belief that despite some market headwind, we think we can grow a little bit and maintain our margins even in the European market.

Okay, and just one last question. You kind of highlighted your ability to recover some of the cost inflation this year pretty effectively at least on the industrial side, a little bit more competitive on the CDIY side. I was wondering if you could give us your outlook for '08 in that as well, what's baked in and in terms of incremental raw material cost inflation. And if you're -- given that would likely to be up, have you already started to bake in certain pricing initiatives in your different businesses?

The answer is yes. Jim touched on it. I'm going to turn it over to him but we're looking at slightly more raw materials inflation and about the same percentage of recovery in the same place, but I think Jim can give you a little more granularity on that. I think it's important that you have it looking out at our guidance, because we'll update it if it changes.

Yes, the numbers, those are the numbers. And of the $75 million or so that I mentioned when we did the guidance page, about $50 million or so was actually materials. A lot of those materials are sourced from China, so we're having the currency impact, we're having the EVRR impact. We're having the wage inflation impact, and we had pretty good visibility, we have a centralized sourcing operation which has very good written contracts with these big suppliers, etc. And we kind of know where we are. We have a lot of our contracts have been finalized for '08 and we have some freight inflation, some wage inflation, and some energy inflation on top of that and that accounts for the $75 million.

Your next question comes from the line of Seth Weber with Banc of America Securities.

Hi, good morning.

Hi, Seth.

Back on the security business, on the last call, you guys talked about I think adding somewhere between or targeting three to six new cities for the HSM business and that kind of contributing to pretty robust organic growth rates. Is that still the case and can you talk about whether the competitive, the pricing environment in that business has changed here with the economic outlook?

Yes and no. We still continue, we are targeting between three to six or roughly one a quarter cities to add as we get confident we can have the scale to run a profitable operation. The no is that -- that is not the primary contributor to the HSM growth. That's, with 70 field offices, these are going to be much much smaller offices. The primary contributor to our growth is continuing to execute the reverse integration that Jim described in quite a bit of detail and continue the trend to increase the percentage of recurring revenue, i.e. the service piece of the business that comes along with the installation, executing I'll say the HSM model where it's unlikely if not inconceivable that we would do an installation without the monitoring and/or service contract that came with it. That's what's the driver of the organic growth.

Okay, and any change to the pricing environment in that business and can you also just going back to the Home Depot situation, should we expect another quarterly differential in this quarter and when will that kind of stop?

Well, let's take them one at a time. The Home Depot situation which relates to the hardware business is in mechanical and that is roughly a $40 million impact in total and a $30 million impact in '08, and it will anniversary after the third quarter is complete. So the Fourth Quarter we'll have completely anniversaried that issue and you can expect it to be -- hardware is a vending machine business. So in theory, so it's pretty evenly spread throughout the first three quarters.

You want to do the other part of the question? Just repeat the other part of your question?

The second part. Oh, Seth won't be able to.

Okay. I think it was the pricing, sorry, the pricing environment on --

HSM.

Quite frankly, no is the simple answer. It's a service business. It's a very small part of an operator's cost and the cost of failure is so high compared to the cost of doing it right, and I think by maintaining the current reputation we have as the premier service provider in the industry -- it's obviously a competitive business but we do not see tremendous competitive pricing pressure, particularly on the service side of that business.

Your last question comes from Robert Wertheimer with Morgan Stanley.

I'll try to be brief. On CDIY, just wanted to ask about margins by geography stripping out Bostitch. Is there any material, in other words are margins higher or lower overseas versus the U.S?

No. A lot of businesses they are, but in ours, margins are quite similar and we anticipate to see the same going forward. The team works hard to keep it that way. We manage it as a global business from a Product Development and a pricing perspective, so that in and of itself is part of the reason, but the simple answer to your question is no. They're very consistent.

Thank you very much and then the second question I'm just curious whether the economic uncertainty has an impact on your acquisition strategy. You have a lot of cash to deploy, especially -- I guess you're taking a slightly more positive view on Europe. And does that uncertainty reduce or change your appetite for acquisitions, new ones?

Go ahead, Jim.

Well, we look at this both tactically and strategically, and strategically there is no difference whatsoever. Our strategy remains as we presented it on March 8 and supplemented it in discussions in various Conference Calls afterwards. From a tactical perspective, there's always a trade off that one has to make in our positions when looking at buying oneself versus buying or spending the next $100 million to buy an acquisition. And as I said we're trading at 7.6 times EBITDA and that's a fairly compelling valuation on a historical basis, on an intrinsic basis, on almost any basis you can derive. So we're not saying that we're out of the acquisition hunt, because we're not, but yet when we look at the shares trading at the levels they have been trading, it's very difficult to get really excited about spending 9 or 10 times EBITDA doing all of the work to take out the costs and everything to get it so that you're buying it at basically 8 times EBITDA when you can buy yourself at really with buying exactly -- knowing exactly what you're buying, so we'll see. This year we may not do any major acquisitions. We may focus purely on share buybacks. But if some really compelling acquisition were to come around and when we contrasted the two, it looked like it was a smart move and strategically consistent, then we would definitely go in that direction. So we're keeping our options open and we're staying flexible and we'll see where we go. There are no further questions at this time. I'd now like to turn the call back over to John for any closing remarks.

Yeah, thanks, Matthew. Two things. Just very briefly. We ran over, but we wanted to get virtually everybody in the queue. One point I just wanted to make -- numerous companies on calls earlier last week and earlier this week have had impostors calling in and I abruptly dismissed the second caller, which was not Richard Radbourne from Atlantic Securities. We know Richard well. He follows the Company and we simply removed his line because he signed on for someone he wasn't. So for anybody who thought that somebody was dismissed rather abruptly, he was. And in the future, if they'd like to sign on as to who they are, we'll get them in the queue and if we don't get to it during the Q&A, Gerry is available, so I just want to make that clarification. Second, just a couple milestones before I close. Jim talked about the terrific performance of our Industrial Group, in general the Engineered Solutions in particular. We had our first shipments of our System 100 RFID Enabled Industrial Storage Unit, really, really strategic important product that we're very excited about in terms of our entrance into the healthcare segment. On the Hydraulics side, good market strength. The business continues to grow. This business is almost twice as big as it was three or four years ago, and after a lot of joint development effort, our assembly technologies business has received its first orders from Toyota Motors. And as you know, a lot of those decisions are initially made in Japan before they cascade to the U.S. So we're real pleased with some of those, I will say small but strategically important milestones within our industrial storage business. Thanks for your interest on a call that we extended just so we could try to address everyone's concerns and we'll talk to you next quarter.

Thank you.

This concludes today's Stanley Works Conference Call. You may now disconnect.