Stanley Black & Decker, Inc. (SWK) Q2 2008 Earnings Report, Transcript and Summary

Good morning, my name is Carlie and I will be your conference operator today. At this time, I would like to welcome everyone to the Stanley Works Second Quarter Results 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. I would now like to turn the call over to our host, Mr. Gary Waybright, Stanley Interim Vice President, Investor Relations. Sir, you may begin your conference.

Thanks, Carly. It is actually Greg, but I have been called worse, so, good morning to everyone. On the call in addition to myself is John Lundgren, our Chairman and CEO; Jim Loree, our Executive Vice President and CFO; and a special guest Tony Byerly who is the Chief Operating Officer of our North American Convergent Security business. Tony will talk to us about the Sonitrol acquisition during the presentation. There are a few recent press releases that I would like to mention. One relates to our second quarter results, which was issued last night. The others relate to our second-quarter dividend increase which was our 41st consecutive annual increase. The other releases speak to the completion of the Sonitrol and Xmark acquisitions and the announcement naming Bret Bontrager, our Corporate Executive Officer. These releases are available on our website. Today's presentation is also available on our site and we will refer to these charts during the call. John and Jim will review Stanley's second quarter results and Tony as I mentioned will speak to the Sonitrol acquisition, and then we will have a Q&A session. The entire call is expected to last approximately one hour. A replay of the call will be available beginning at 2:00 PM and the replaying number is 800-642-1687 and the access code which is in the press release is 45127121 and please feel free to call me with any questions at 860-827-3544. Just a couple of quick announcements before we proceed. One is a reminder that we issue and update earnings guidance on an annual basis and our press release at the beginning of each quarter and we can not comment on such guidance thereafter. If our guidance changes materially we will issue a press release and conduct a conference call. And secondly another reminder that certain statements made during today's discussion by the various Stanley participants are forward-looking statements. They are based on the assumptions of future events that may not prove to be accurate and as such they involve risks and uncertainties. Actual results may differ materially from those that are expected or implied, so we direct you to the cautionary statements in our Form 8-K, which we filed with yesterday's press release and in our current or our recent 34-F filings. I will now turn the call over to John Lundgren.

Thanks Greg, good morning everybody. First just a couple of highlights from a very busy second quarter at Stanley, earnings of a $1.05 were up 4%, excluding the portfolio charges and related business closures that amounted to about $0.10 that were detailed in the press release and set to walk between continued operations... continuing operations and discontinued operations is also contained within the press release. Revenues grew 5% on the basis of currency and acquisitions. We did experience reasonably good organic growth in Europe and in our security business excluding hardware, and we'll come on to that. That was offset by continued weakness in U.S. markets in general and residential construction markets in particularly... in particular. The gross margin was relatively flat consistent with the prior year. We have got good pricing and productivity to offset the inflation as well as the impact of the lower volume. Jim is going to give you a detailed walk, but right now we are estimating 2008 inflation at approximately $150 million for the year and prior to the year beginning that number was between 60 and 80 was our estimate. So that's the magnitude of the increase. We are doing better than in past years in recovering that inflation with price, we are estimating approximately 90% recovery, but that still does leave the gap that we need to fill with productivity improvements in order to ensure that margins don't suffer. Cash flow slightly ahead of prior years excluding the impact of the receivable securitization, facility termination, that was about $17 million understandably unwinding net debt arrangement. CDIY revenue all in was up 4%, Europe was 7% organically. Profit rate was maintained operating margin at 14.6%, and that's despite the inflation and the volume pressure we are experiencing around the world. And within our industrial segment, strong sales growth 12%, if they say security up 7%, profit rated 18.7% excluding hardware, but still quite profitable even including the impact of the lost hardware business was 60 basis point less than 18.1. Looking at the results on the next chart, specifically zeroing in on the earnings picture, virtually all of these number are contained in the press release on a continuing ops basis $0.98 to $0.95 on the basis on which we began the year and provided annual guidance growing a $1.01 up to a $1.05, so a 5% increase on top of a 6% increase in the first quarter. Operating margin down slightly. Tax rate up about 40 basis points, so a little bit of a head wind there and the share count reflects approximately $200 million of buybacks that took place between the fourth quarter '07 and January '08. So all in a 4% improvement in earnings on an apples-to-apples basis, highlighted there in the box as well as outlined in detail in our press release. Looking at revenue, 5% increase primarily in the benefit of acquisitions and foreign exchange. I see revenues that add $1.54 billion, up 58 million. The sources of growth in essence organic was flat as 3% volume declined on a global basis was offset by 3% price improvement; 4% from currency, 1% from acquisitions leading to the 5% that you see in two or three different places. Looking within the segments, organically you see CDI vied down 1% as 4% volume decline is almost fully mitigated by 3% price increase. The total 4% growth of course that's the difference between our organic and FX, which we do not include in our organic growth reporting. Industrial was up 2% organically. Volume flat on a global basis and price 2%, the rest being currency and security down 2% on a comparative basis with volume down 5%, price up 3%. Again importantly we've talked to the hardware. You will recall we discontinued business with one of our larger retail customers that was announced in the second quarter of '07. It will not anniversary until the fourth quarter of '08 and that's about $12.5 million to $15 million a quarter of revenue, negative headwind if you will. Excluding that good solid growth in security totaled 7% of which 4% was organic. Given the magnitude of that number we do think it's important to point it out because it was a conscious decision and a mutual decision with us and the large customer. So simply said, revenues were subdued by weak U.S. market conditions and we were flat in a down market. We think a pretty good accomplishment. Looking on a geographical basis, it's clear from the map that it's a busy chart but we think there is a lot of good important information on it that our diversification and the fact that it is significantly larger percentage of our revenues are out side the U.S. than as little as three years ago is having tremendous benefit. That being said perhaps not the benefit as much benefit as is perceived based on some of the conversations we've had with both analysts and investors in the last several weeks or months. Zeroing on the U.S., middle of the left in total down 2%. This is global Stanley, all businesses and organically down 4%, and that's... represents 56% of Stanley Works total volume. Canada is up 7%; it... sorry it's up 11% in total, organically 1%, and that's all currency... overwhelmingly currency of course and that's represents about 7% of total Stanley revenue. Latin America strong on an organic basis as well as the total basis, it represents only 3% as Stanley's volume, but good volume growth as well as volume growth price achievement in Latin America. Europe, very interesting and I am going to give you a little more granularity in a minute on Europe, but in total up 15%, organically 3%, and that represents about 30% of our total revenues; Asia up 40%, 32% of which is organic of a low base, but we are gaining tremendous traction in the Asian markets in general and Mainland China in particular; and Australia relatively flat on an organic basis down 1%, total up 12% and Australia represents 2% of Stanley's volume. So Europe is about twice as big in terms of absolute terms as it was three years ago and it's growing nicely as well as Latin America and Asia up significantly from a lower base, which is really helping our results and in the sense validating the focus on geographic as well as business mix shift in our portfolio. The next chart is something you haven't seen from us in the past, but recent dialogue that Jim and I and Greg, in fact have had with both analysts and investors is focused a lot on state of the European economy in general as well as our European business in particular. So, we thought it would be helpful to put together this chart or just some information all on one page, and it's virtually all available from public sources. But just starting at the top left, you see the last four quarters of European... Western European GDP growth, that between 2% and 3%. 2.9%, 2.9% falling to 2.5%, following to 2.3%. So not a mediocre decline, but certainly far from robust. The colored chart, if you will are just various geographies, what's shaded in green, call them emerging former Eastern European markets, where GDP growth is above 3%. Those markets in total represent only 3% of Stanley's revenues. The yellow shaded areas are markets that are, I'll say traditional Western European markets with a few exceptions in red that are growing at 1-3% and those markets, as you see them primarily France, Spain, UK, Germany represent about 23% of Stanley's revenues. And they're growing at less than 3% per year in terms of GDP up until most recently. And then the areas in red Hungary, Italy, Ireland, Portugal and others, representing 4% of our revenues are growing at less than 1%. Over on the right, those are not randomly selected. Germany of course is one of the larger economies in Europe but it is not a large contributor to Stanley revenues. Those are Stanley's four largest markets in Europe. Now just take a look at the state of those markets; housing in the UK structured down 27% year-to-date. It's the worst market since 1945. The DIY business, the large home centers varies not dissimilar to the home center businesses in the U.S. are down 3% to 4%. So a third to half the rate that U.S. home centers that are thus far reported are down and auto industrial in the UK are flat to slightly down. In France the economy is holding up better than most western European countries. Construction's solid but it is slowing, DIY down about half the rate of the UK and about a fifth the rate of the U.S. Auto repair flat to down slightly. And industry at this stage remains positive that plus low single digit but its flattening. Italy less healthy with construction down, DIY flat; industrial is flat as well, automotive down about 10%, and I think no surprise that if there was a construction boom in Europe, most of it was in the south western part of Europe, particularly Spain. Construction permits are down 44% year-to-date in Spain. Automotives down as well GDP basically flat. So simply said the thought of European markets being buoyant is anything but true. They have been relatively soft, although not as soft as the U.S. for the last six to nine months and we are faring fairly well in those conditions. The next chart is a look at the Stanley business within Europe that we thought would be helpful to overlay one on the other. This is information we normally wouldn't provide on a call or wouldn't get into this level of detail but we think there is enough diversity of opinion out in the world in terms of how we are doing in Europe, relative to the rest of the world and how important Europe is. We put it on our two quarter rolling average basis just to take some of the lumpiness out of the numbers. On the left is total Europe and if you go back to third quarter '06 or fourth quarter '06, you see high... mid-to-high single digit volume growth in the black and prices being relatively flat. Of late you see that the volume growth is flat and it hasn't gone negative, but it's basically zero or flat with price offsetting some of the volume declines or the volume flattening. So as an example, in the most recent quarter volume and total up to two-tenths of 1%, price up 1.3% that would translate on that basis to 1.5% growth. A subset of total Europe is to the right, which is European construction, CDIY and you see the volatility. If you go back to the same time period, high single or low double digit volume growth, flat pricing has since turned to negative volume growth although low single digits mitigated by some price. So an obvious question is how and why have we held up in market conditions that I think are far less robust than perhaps is the perception. There were a lot of factors going on, first and foremost new product innovation continues to accelerate, simultaneous introduction of products on a global basis instead of Europe trailing the U.S. by six to nine months has had a tremendous is that a tremendous impact. We continue to support our brand in all major markets. Facom had its new catalog in March '08, that has been very well received, celebrating the 90-year anniversary of the company. And there are revenue synergies from the Facom acquisition that are now fully embedded. We have had two and half years of collaboration among the legacy Stanley and Facom teams; they are all under one management team in one place. And that too is having an impact relative to the conditions out there. So our conclusion is continuing to operate well in a weakening market that may get weaker, that being said, we want to make it very, very clear, the European market relative to history has been anything but robust in the last six months. Let's go back to a more traditional look if you will at our segments the way that we've typically talked to you about them on this call. Most of this has been said. Construction in DIY revenues are up 4% driven by Europe. You see the operating margins flat and our segment profit up $3 million or 4% in absolute terms. Sales up 4% outside the U.S.; you saw that on the maps on chart 5. U.S. is obviously impacted by the weak residential construction market although we're encouraged by the results given the volume softness within the U.S. retail channel. We are clearly gaining share as our volume is down about one-third or less the level of the market in general, and that's just simple arithmetic. We know we're gaining shares of consequence. And encourage that the segment profit rate is held at 14.6% despite the significant inflation and volume pressure. Jim is going to show you some numbers and be a little more granular on what's in our press release. But that number has gone up to about 150 million annually. About two thirds of Stanley's inflation always is steel and about two-thirds of our inflation is in the... the steel inflation is in the construction in DIY segment. So this segment holding a 14.6 given the magnitude of inflation in general, steel inflation in particular, and the high steel content within the Bostitch business to consumer tools and storage business is a good achievement in terms of both product innovation mix upgrades and price recovery. Moving on to industrial, double digit revenue growth would actively extend at the expense of 220 basis points of margin. Simply said industrial and automotive tools revenues did grow 10%, 1% of which was organic from a very large business there in Europe and a lot of currency effect. Facom continues to do extremely well; revenue is up 20% and 4% organically certainly inline with the market if not slightly ahead. So we continue to be pleased with the performance of that business and the Americas down. Engineered solutions were up 20%, more than half of that is from the recent Innerspace acquisition that we have talked about. That's our intelligent part focused on healthcare channels. Solid organic growth and the remainder of the engineered storage business specifically Vidmar, the hydraulics business remains strong in terms of volume and Assembly Tech is holding pretty well given its focus in automotive. Segment profit is down, steel inflation, product mix, as well strategic investments and just to give you a little more light on that proto and hydraulics in particular within these segment extraordinary high steel content. They will behind through the third quarter and we can catch up by the fourth quarter in terms of ability to recover via pricing the steel inflation that they've absorbed. And we continue to invest in emerging markets in our industrial channels both in the Mid-East as well as Asia. It's an engine on a platform for future growth. And we think this is... would be the worst time to take off the accelerator in those markets. Last, but not... certainly not least is security. What it shows you on a total basis is revenue is up 1%. That being said, 7% without the hardware headwind that we talked about. Segment profits flat on a similar basis as well as the profit rate, flat without hardware, down 60 basis points including the loss of the hardware business. We're very pleased with the performance of the Convergent Security business and just to refresh everyone's memory that's the legacy systems integration business at Stanley, it's HSM on international basis, it is the Blick business in the UK, the Frisco Bay business in Canada, and this is where Sonitrol will fit and Tony will talk to you about that a little later on in the presentation. Net sales growth up 9%, 5% of which was organic. We're getting operating leverage that we'd hoped for with HSM. And a greater importance to this is our U.S. systems integration margins continue to expand from the successful reverse integration of the legacy Stanley SI business into HSM. Mechanical access which consist of our access technologies business, mechanical and electro-mechanical locking, personal security which is our senior technologies in Bedcheck [ph] business as well as builder's hardware up 6%, 2% organically excluding the hardware and this quarter was about 18 million down due primarily to the loss of the business and a large retailer that as I said early will anniversary in the fourth quarter. And if nothing else the comps will get easier but maintaining that business where it is in light of that orchestrated withdrawal from about $50 million on an annual basis piece of business is holding up pretty well. Profit remains high at 18.7%, extra hardware but I don't think we need to apologize for 18.1% as stated and as reported. Now working capital management and cash generation remain a focus particularly in this environment and we're making progress in both areas. I'm going to turn it over to Jim who's going to take you through some of that as well as talk to you about our look going forward for the rest of the year.

Okay, thank you John. First of all inventories were a great story with an 8 day decrease in light of the volume issues; the physical volume reductions that we are encountering which we will talk about in a few minutes. It's really difficult to bring inventories down like that and it can't be done in a haphazard way that's to be done through process and methodical process improvements and that's exactly what's going on with the Stanley fulfillment system as it relates to inventories. So we can look for more progress in inventories as the year goes on and I think that will continue to be a good story. Receivables were up quite a bit and 12% to be specific. We are not terribly concerned about that because the vast majority of that was related to... in the administrative calendar, a calendar issue which had to do with where the month closed and that should take care of itself by the fourth quarter, may continue into the third quarter, but should be out of that by the fourth quarter. So receivables, we have no material delinquency creep that we have analyzed very carefully and haven't... don't have any real issue there, and payables continues to be a very good story. So we are able to improve the turns from 4.5 to 4.8, and we expect to close out the year well over five turn, so good progress there. The cash flow and the company's cash generating capability continues to be an excellent story with good solid cash flow for the quarter. It would have been even better had it not been for the fact that we terminated a $17 million receivable, securitization facility, and no longer need that facility given that we have $800 million in liquidity outlines out there right now, so we decided... left to determinate that cost of $17 million in the quarter. But we continue to believe that receivables will generate cash in 2008. So on a year-to-date basis, we are at about $138 million of free cash flow compared with 152 last year, down 14. If you take way the effect of the terminated facility in effect, we are tracking to last year's levels, which is we are very high or highest ever. Moving onto price and inflation; this has been a really incredible phenomenon in 2008 like nothing we have seen since John and I have been here. It's certainly probably hard to inspect the 70s, when we as a country experienced this kind of inflation. Our estimate started the year if you recall back at the February analyst meeting, we indicated that we thought inflation would be about $75 million. Today that number is 2X the 75, and basically at $150 million. We could have had a $0.70 per share negative impact from that inflation had we not responded in a very crisp, robust way. So our price recovery continues to highlight the company's strong inflation forecasting and also just price recovery discipline. And you can see that we are expecting to recover 80% back in the initial timeframe. We upgraded that to 90% on last earnings call. And we still, despite the fact that we are going to have $150 million of inflation, we still believe that we will recover 90%. We've already taken most of the actions that are required to accomplish that. And in this environment, you really need a robust price recovery mechanism in order to preserve the margins and the latest culprit in the inflationary trend area is not surprisingly steel, and the steel companies have gotten very aggressive with tearing up contracts and not honoring commitments and so forth, resin, purchased products also factors. But now steel is really the big culprit there. Moving onto guidance, the 2008 guidance that we issued in January of 420-440 assumed organic sales of roughly flat to up 1% and price about $60 million which was near 80% of the 75 million inflation that I just talked about. So price would have been about a point of sales, 1.2% to be exact. So at the time in order to get to 0% to 1% organic sales, we were assuming that physical volume would be essentially down a point roughly and I will come back to that in a minute. If we take now the effect of the discontinued operations which primarily involve the sale of CST, but also some smaller product lines totaling about $60 million which we announced in mid-June as well as the recently closed Sonitrol acquisition which has a $0.02 dilutive effect in 2008. On an adjusted basis that guidance would look more like 410 to 430. Now as we indicated in the last call, we were suspecting that the second half economic environment could be difficult and it certainly has fulfilled that expectation. So we put in place a contingency plan which provided for $0.20 benefit in '08, net of $15 million of restructuring and as it turns out, the volume impact is now going to be about $0.50 a share which is what we suggested it might be last time, if the economic difficulties were to continue. So we've implemented those contingency plans subsequent to the last conference call and as a result of that proactive action are able to preserve the earnings base. So the 3.90 that you see here relates to $3.88 continuing operations number for last year and we now believe that organic growth will be down 1%, but the fact that the price is now up about two points, really means that volume is down 3 to 4 points. So the physical volume impact from the recessionary conditions in some of our markets is really severe and I would like to think in terms of the ability to draw down inventory with a 3% to 4% reduction and still preserve an earnings base. It means that there is a lot of good work going on in the productivity area in the company as well. We'll move on now to significant 2Q events. Pleased to announce that the Brett Bontrager, our Vice President of Business development and our President of our Stanley Convergent Security Solutions was named an Executive Officer by our Board that press release as Greg mentioned had been issued and we congratulate Brett on that achievement. We also agreed to sell our CST/Berger Laser leveling and measuring unit which was about 80 million in revenues. We announced that in mid-June, hope to close that shortly, next couple of weeks. We were able to achieve a selling price of $205 million and we also at that same time announced plans to divest about $60 million in revenue of some smaller non-strategic businesses during the year. And worthy of note, the CST/Berger business have become non-strategic, because it was getting... it had a competitors from the high-end that were coming down and competitors from the low-end that were kind of coming up; it was in the middle. When we bought that company back in 2004, we were envisioning that it could become a growth platform if we were able to acquire some of the other companies on the higher-end. As it turned out for various reasons, none of those were available for acquisition and we were really left with no degrees of freedom. So the decision to sell that business was made this year, and we were able to achieve a very healthy $205 million for something we paid about $64 million, four years ago. We also announced the acquisition of Xmark for approximately $50 million. It's located in Ottawa, Canada. It develops and markets RFID based systems to identify and protect people on assets in the healthcare market. Its principal products focus on infant protection in hospitals and wander protection for Alzheimer's patients and the like. As many of you know, we have a small kind of fledgling business, but extremely a high growth and profitable business in the security segment that specializes in healthcare type security like this. And then we also announced the acquisition of Sonitrol for $276 million. A very exciting and meaningful acquisition, and as Greg mentioned, we have Tony Byerly, COO of the North American Convergent Security business here to share some highlights. Tony would you please talk about Sonitrol?

Thanks Jim. As Jim mentioned, these are exciting times in electronic security industry. I have been in the security industry for nearly 20 years, and I have seen only a handful of industry defining moments. One such moment began roughly one and a half years ago with the acquisitions of HSM by the Stanley Works and then combining of it with the Stanley System's integration business creating Stanley Convergent Security Solutions. That moment really has fully evolved now with the Sonitrol acquisition. The combining of Stanley CSS with Sonitrol creates the third largest electronics security monitoring company in the U.S. based on total revenue. Now Sonitrol will help both the direct and the franchise network go-to-market approach also about 125,000 customers and Sonitrol is best know for its industry leading audio verification technology; and as a result, reports the industry's highest apprehension rates and lowest dispatch and false alarm rates making it a law enforcement trend. Sonitrol's revenue is broken down by 53% coming from monitoring and service, 34% from installation, 8% from equipment and product sales, and 5% franchise growth. The combining of Staley CSS and Sonitrol not only creates a third largest overall provider as I mentioned, but also solidifies Stanley CSS as the second largest commercial security monitoring provider. Now the company reports $110 million in total revenues and through its audio verification technology reports one of the most stable customer bases in the industry with low attrition rates and an average customer life of 12 years. There are numerous strategic benefits to the Sonitrol acquisition. First it increases the overall CSS global platform to over 700 million and the Stanley Security solutions platform to over 1.6 billion. As previously reported the acquisition will be $0.02 dilutive in 2008 as Jim mentioned, $0.04 accretive in 2009 increasing by an incremental $0.05 each year thereafter. There are also numerous similarities between the two businesses. Both are commercially focused. Both drive an RMR, a reoccurring revenue business model, both are known for quality and high customer satisfaction and both have a solid national account program. The acquisition certainly brings increased skills of operations in national accounts towards the organization overall. In addition this allows us to really focus in on specific vertical markets for example the education market. Sonitrol is a leader in the K through 12 market and Stanley Securities Solutions is well positioned in the higher education market. Now in addition to Sonitrol's audio verification and intrusion alarms which they are very well known for, the company also offers a full range of suite of services as well as security systems including access control, video surveillance or CCTV, fire alarm detection and other security equipment products such as video monitoring and online access control management. Now with the close of Sonitrol behind us on Friday and as with previous D&A acquisitions, the integration is already in progress and has been carefully planned. I am very pleased to have Todd Leggett, who is actually Sonitrol's former Senior Vice-President of operations to join our team as our Vice-President, General Manager of Sonitrol operation. Todd has a considerable amount of experience in the industry and specifically at Sonitrol. Now joining Todd and leading our integration efforts will be Jim Coplain, [ph] who is one of our most seasoned leaders and who has a considerable amount of acquisition simulation experience as well. Of course Todd and Jim are joined by the entire team and we'll go through the many years of experience on this call. We don't have the time. But all integration activities will be carefully monitored and controlled and we're excited to have Sonitrol as part of the Stanley's CSS platform. I'm going to turn back to Jim. He's going to talk about transition.

Thank you, Tony. We're pleased to have Tony and his team in-charge of integrating Sonitrol. They did a great job with the reverse integration of HSM. So the same team that led that. Now working the Sonitrol acquisition and we're looking forward to great results there. As we look at the portfolio transition, this is truly remarkable metamorphosis over the last few years, from '02 to '08, where with $2.6 billion company with 65% of our revenues in construction and DIY in 2002, with the largest customer totaling 22% of our revenues. By last year, we had built the security business up to about 31% of the total revenues, construction DIY was down to 40%, and industrial had grown to 29%, and we were $4.5 billion. So close to double in size. And then as we now adjust for the divestiture of CST and the acquisitions of Sonitrol and Xmark, you can see that the various portfolio moves that we announced in the last quarter have had a notable effect on the portfolio composition. So you can see the security business would now account for about 35% of the revenues, rapidly approaching the size of the construction and DIY business, which is 37%; and of course the industrial is roughly the same. So in general, continued progress in the tough environment... tough operating environment, but some of the challenges in this environment are also creating opportunities for us, and we continue to take advantage of those. Just a very, very brief refresher on the growth platforms. We continue to allocate our capital into three... our three major growth platforms industrial and automotive tools, mechanical security, and convergent security. So here you've seen a number of acquisitions that are more focused on the convergent business in the last year or so, but would not be at all surprised to see some progress in one or two of these other growth platforms over the next coming months. And I'll wrap it up now. We took a little bit longer than we usually do with the overview, where we had a lot of content. Needless to say, the inflationary conditions have accelerated. We've implemented the strong recovery actions, price management we talked about the rigorous process that we have enabling 90% recovery. Good news also is that we are able to recover price in CDIY much more effectively than we have in past years. We are looking to recover close to 80% this year of our inflation in construction and DIY. So, with the Chinese inflation and so forth have helped that out, and competitive dynamics are such that that we are able to do that. We will encounter a lag in the price inflation recovery in the third quarter. So for those folks that are modeling, please factor that in. We've quantified that in the press release, so that should be easy to do. We're also going to provide a schedule for those of you, who are interested later today that will break out the quarters for '07 on a recast basis, which will reflect the discontinued operations. So, I will caveat that by saying that that will change from quarter-to-quarter here, and we will continue to provide that on an ongoing basis this year. It will change as some of the $60 million transactions that we talked about are close than they actually are removed from continuing operations. So it will be a challenge to keep up with it, but we'll will provide as much information as possible to make it easy. The markets themselves are offering no sign of rebound, we talked the length about that. So the organic growth forecast is now down 1% to 2% for the year. The volume was even steeper volume decreased. John talked at length about Europe. Contingency cost actions have been implemented. We expect to be able to preserve our earnings and cash flow base amidst these weak markets and we absolutely should be well positioned for a successful '09 regardless of what the conditions might be with strong price momentum with carry over from the cost reduction actions coming into '09. The hardware loss will anniversary in the middle of the fourth quarter and we will have a substantial amount of restructuring in the base... in the '08 base, and the Stanley fulfillment system is gaining traction. So, as I said a minute ago, we are taking advantage of the market conditions performing well, but also taking advantage of this opportunity to advance the portfolio. And we will turn it over for Q&A at this point.

ey Carlie, at this time, we will turn it back to you for the Q&A session. Question And Answer

[Operator Instructions]. Your first question comes from Peter Lisnic with Robert Baird.

Good morning. It's actually John on for Pete. Can you guys just talk about with M-CSS, the 5% organic growth was recurring revenue kind of growing at that rate also and kind of as a reverse integration that you've done, is that fully impact now?

Yeah. John, this is John; I'll take it although. Tony could probably take it even better. The simple answer is yes; the percentage of recurring revenue was actually increasing although that's what we modeled. As you'll recall HSM recurring revenue was dramatically higher than the Legacy Convergent Stanley business. So in total, the weighted average is increasing and in fact the percent of the proportions, excuse me, of reoccurring is increasing a little faster than the rates in general. At this stage, 18 months in, it's a little premature to declare victory, but all I can say is we are pleased beyond our initial expectations and we were cautiously or highly optimistic upon acquiring HSM. The team is still in place, and I think the best indication to that is we've just gone and made another $275 million acquisition in similar space and empowered the HSM team and former HSM team and Brett Bontrager to integrate that business. And without over simplifying, the process worked extraordinarily well with HSM, and Tony and his team along with Todd Leggett from Sonitrol, who is an industry veteran, we hope to apply the exact same type of methodology with Sonitrol and get the same kind of initial success and maintain the momentum as we did with HSM.

Okay and then my follow up; just the free cash flow generation has stayed really strong kind of relative to everything else. What are your uses of kind of that free cash flow looking forward?

Well it... as we have said all along historically two-thirds of our free cash flow has gone to strategic acquisitions, one-third has been returned to the shareholders and equally split between dividends and buy backs. Going forward, you could expect that to continue. I mean we think Stanley stock is a good buy right now. That being said that's a one time opportunity and it doesn't advance our portfolio strategically. The acquisition pipeline is robust with strategic acquisitions within the reach of our own cash flows. You'll recall we did announce a modest increase to our dividend the 41st consecutive year. So I think it is fair to say $500 million in cash flow on an ongoing basis going forward. I think the two thirds of it will be used for strategic acquisitions and a third will be returned to the shareholders primarily via dividend, opportunistic buyback when and if the pipelines are not full or we feel that our stock is so depressed, while it is not strategically advancing our portfolio, it's the best short term use of cash.

Okay. Thank you.

Our next question comes from Jim Lucas with Janney Montgomery.

Thanks, good morning guys.

James good morning.

Impressed with the good color on the conference call today. Two questions. One, on the industrial margins. Could you give us a little bit more color on how much of that is the pricing gap versus mix and any additional color specifically on the mix. And secondly just following up on the last question about the cash flow usage on the robust acquisition pipeline. Can you talk a little bit about what you are seeing in the various growth platforms. What type of... where may be any type of color that you can give on the tools versus security what you are seeing out there and domestic versus international?

Sure, Jim will... Jim will take both of those, Jim and I'll add on it if need be.

We are looking for international acquisitions in the security business there with some success in the pipeline. And as far as the tool industry, the tool industry is supposed to consolidate at some point in time. I have being waiting nine years since I have been here for it to happen. I would suggest that this maybe a fairly opportune time for that, simply because of the stresses and pressures on the cash flow and the earning statements of certain tool companies that are sort of in the middle. Similar to how we were with CST. They're not private label and they're not the world's best brand at hand tool company, they are somewhere in between and they are getting squeezed. So there's some of that going on and I suspect this industry will likely consolidate at some point in time and I don't know whether it will be this year but if it does, we'll be in a good position to be a participant in that. So that's really the growth platforms. As far as the industrial profit margin of 220 basis points, I'd say it's about a third of each. I mean the strategic investments where we did a fairly substantial amount of consulting work in product simplification and complexity reduction to help us with our inventory reduction in a Stanley Fulfillment Systems initiatives, and that was about a third of the issue and then product mix is, we're finding particularly in the automotive repair business in industrial, a little more tendency to avoid the big ticket items and of course the financing state of the financing markets hasn't helped since many of those credits that when they sell tool boxes and so forth to end users are... they tend to be sub prime or close to sub prime in nature and the availability of financing is constrained at this time obviously. So, there tends to some of the higher margin storage type business in the automotive repairs is being stressed a little bit. And we just add some other mix issues here and there throughout the portfolio in industrial but are probably less structural and it's temporary in nature. And then the other third is this price gap that you talked about when you end up with... and the industrial business in particular; they tend to be on a little slower pace as far as the industry goes, recovering price because they have catalogs and things like that. That's all changing in this environment but sometimes it takes a little time to change behavior patterns and so our businesses are working hard to change those patterns and they range from businesses like hydraulics, which I think is implemented something like 6 price increases this year to proto which has implemented 1 and is now about to implement another one and everything in between. But with the recent spike in inflation they got caught little bit more than the other businesses with unanticipated, unrecovered inflation but it will be temporary.

And back to your acquisition commentary. Have you seen any changes in the multiples out there or was it still that sellers premium that's out there?

No Jim since... glad you asked. I was going to add on time permitting. The good assets, obviously there is very little private equity competition for those assets. That being said, there has been very little price capitulation on the good assets. I think it would be a tough time to sell poorly performing assets or assets without a great growth profile or opportunity for growth with some synergies, but if you look at businesses that we've just sold as well as businesses that we've acquired, the numbers aren't crazy, but the good businesses continue to sell at a rich premium reflecting their growth and income potential, and I think as long as those are the types of businesses being sold that's our expectation for the next 6 to 12 months. Full and fair prices for the good assets.

Okay. Thanks again for the color today.

Your next question comes from Michael Rehaut with JP Morgan.

Hi, good morning.

Good morning, Mike.

The first question just on the raw material and offsetting actions; if the raw materials were to sort of stabilize here, which unfortunately doesn't look likely, but what would that 150 be in terms of carry over into '09. And am I to assume also that the actions that you've taken, you are expecting an incremental 40 million benefit on the cost savings?

Yeah. Want to try? What was the second part of the question?

The 40--

Is this the offsetting... what would flow through on the raw material side?

Yeah, we've been playing catch up; when you are chasing inflation, you are playing catch up. So if inflation stops, price exceeds inflation when it stops. So we are not the... the cost actions are not for price recovery. And you are right, it's a hypothetical question, because in reality, we are not expecting the inflation to stop, and we are not expecting our price actions to stop as inflation increases. So it's very hypothetical. What we are girding against with these cost actions is a continuation of an economic slow down. And we don't know whether that's going to happen just like we didn't know whether the second half was going to be as bad as it is, but we are prepared with a $40 million carryover and $30 million of restructuring in the 2007 base, which we may or may not use next year depending on circumstances. We are prepared to weather whatever kind of storm comes our way with quick solid earrings and cash flow performance.

Okay. And just I guess secondly, where would you expect over the next two, three years to see your product mix continue to go? I mean would you see security getting up into the... in the 40s? How would you think about consumer DIY? Are you comfortable at the size it is today or do you think you can see that shrink a little further?

Yeah, I guess it depends on whether it's an absolute terms, Mike or as percent of total. As Jim showed, when we call--

Percent of total.

Yeah, I understood. As we closed '07, we're going to be close to a third of third of third. That was our interim objective. We said for a long time we'd like security to be 50% of the total in five years. That's probably slowed down a little bit. We said that three years ago and we continue to grow. Our objective with CDIY, with the sales of CST, there are two good businesses within CDIY and they are big. We think we can grow them organically at a rate slightly above the market, keep them at about the 1.7 billion, where they are currently growing at low to mid single digits, which means they will decline as a percent of total. We don't have a problem with CDIY businesses in general, it's the home center dependency we are trying to stay away from. So if I had to speculate, they... you said two to three years, they probably could go down to as low as 25% of the business while the combination of security and industrial would be 75 with security growing at a little faster rate than industrial borrowing any of the major consolidations that Jim talked about.

Okay, great.

We don't want to shrink any of our businesses in absolute terms however. Jeff Ansell's team is doing a great job growing a CDIY businesses with innovation, mix, and pricing in a market that's down high single or low double digits.

Okay, great.

And your next question comes from Eric Bosshard with Cleveland Research. Eric, your line is open. If your line is on mute please unmute your line. There is no response from Eric's line. We'll continue with the next question from Nigel --

We will try someone else, we'll go back to him later.

Okay. Your next question comes from Nigel Coe with Deutsche Bank.

I have some questions on Nigel's behalf. Within CDIY, I was hoping you could give some color on Bostitch and the consumer tool business.

What you are looking for related to Bostitch and consumer tools?

Just some additional color on how those business are performing.

They are both performing consistent with expectations. In fact consumer tools and storage is performing maybe better than we would expect given the market. And Bostitch is about where we hoped it would be. It's a little bit frustrating, but not discouraging. Specifically we've taken $50 million worth of cost out of the Bostitch business. We've inherited... we've absorbed a lot of inflation. We've got almost $50 million of prize with the Bostitch business to do and in doing all that margins have remained about where they were in the last two quarters. We need little bit of help from the market place on Bostitch to get margins back up to the high single low double digits, where it's been historically and where is our target. But if there is a perception that Bostitch is losing money, it's simply not the case. It's making money, its making money in the low single digit operating income for couple of quarters in a row. Doing a great job internally with price, manufacturing restructuring, and tremendous SG&A constraint weathering a market that's down. About 50% of the Bostitch business is CDIY and 50% is industrial. Neither of which are terribly strong and about 25% of the Bostitch business is outside the U.S., that business is very healthy. So Bostitch is running really-really hard to stay in place and with a little bit more pricing which the market, I think is ready for and a little bit of help through the market, I think we will get it back to where we want it to be and where it rightfully should be at this stage of the process.

Okay and then going to the restructuring, where specifically are you guys looking to restructure?

Well restructuring is broad based. It means marginal facilities, SG&A cuts people not as opposed to spending for which we reserve. It's pervasive across the company. Obviously we would across all businesses across the company. Obviously we do less restructuring and our highest potential growth there is for fear of cutting that growth. So basically what it is, is getting certain businesses that are facing marketplace headwinds downsized so their infrastructure is more in line with the reduced size of the business and that applies to every business in Stanley whose volumes and revenues aren't up.

Okay great. And then one last quick one if you don't mind, are you guys currently paying full spot prices for steel?

No. We'd like to think with our global sourcing capabilities we're at or below market but it depends on what one does call... what one is establishing and agreeing to be the spot price. We'd like to think we're doing a good job leveraging our global sourcing capabilities. What we do know is our prices are going up as fast as everyone else's, its just from which base we are talking. So the magnitude of the increase from the base is unprecedented. We would like to think we are paying a little bit below full spot prices because we are buying ahead to the extent we can and that has given us a bit of benefit.

Great, thank you.

Our next question comes from Anna Stromberg with NAV Capital. I am sorry; the next question comes from Ted Hover [ph] with Stanopoint [ph].

Good morning. Just going back to the cost recovery question. I guess I wanted to, I don't know if you would actually kind of break this out but what percent of your cost inflation is primarily attributable to steel. Just trying to get a sense so we can kind of see what's going on with steel price.

Yeah.

And how much is actually driving that and my second kind of... second... my follow up question would be what type of price recovery do you need to get across your product line to be able to get your targeted 9% price recovery?

Well, the second one is going to be very difficult to answer, the first one is easy; I talked to it earlier. Roughly, two-thirds of all of our inflation is steel, the rest in order of descending priority is resin, nonferrous metals, and of course there is no... there is little bit more stability in non-ferrous metals right now and steel, last year nonferrous metals in fact were greater, cause of inflation and steel. So roughly two thirds of our cost inflation is steel, followed by resin, nonferrous metals and then various other inputs. What kind of price we have to get, I mean it's simply arithmetic, it's 90% of our $150 million is about $135 million, you need 135 million on a $4 billion revenue base. So globally across Stanley that's 3% to 4% on an annualized basis for the year. That's going to vary dramatically by business where some are up 20 and some are flat. But simply said, we need $135 million on $4.5 billion, which is 3% to 4% on an annual basis with tremendous discrepancies or variations across the Stanley businesses. I hope that answers your question; if not, for more granularity, Greg can walk you through that offline.

Okay, thanks.

And this concludes the Q&A session for today's call. John, do you have any closing remarks?

This obviously was a very busy quarter. And we feel good about the results given the environment that's out there. We've got a lot of work to do on pricing. We think we have the right people in place to do it. And borrowing any major news, we will talk to you again on October. Thanks for your interest this morning.

Thank you for participating in today's conference call. You may now disconnect.