Stanley Black & Decker, Inc.
Q3 2007 Earnings Call Transcript

Published: 24 Oct 2007

[Operator:]

Good morning. My name is Valerie and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Stanley Works’ Third Quarter Conference Call. All lines have been placed onmute to prevent any background noise. After the speakers' remarks there will bea question-and-answer session. (Operator Instructions) Mr. Gould you may begin your conference.

[Gerry Gould:]

Okay. Thank you Valerie, and good morning everybody. On thecall with me this morning are John Lundgren, our Chairman and CEO and JimLoree, our Executive VP and CFO. We've issued three press releases in the lastfew days; our fourth quarter dividend last Friday; the announcement of a newdirector on Monday; and this morning our third quarter results and our fourthquarter and full-year guidance. They are all on our website on www.stanleyworks.comin the Investor Relations segment. There is a presentation also, on our website and some PowerPointand PDF versions of charts that we’ll refer to during the call. They went up byabout 60 minutes ago, so please refer to those. John and Jim will review the quarter’s results and thenwe’ll have a question-and-answer period following that. The call should last aboutan hour. Beginning at 1.00 pm this afternoon, we’ll have replayavailable through next Wednesday, the end of Wednesday the 31st. Thereplay number is 800-642-1687, and this quarter the code that you need for thereplay is 201-99629. After that comes down next Wednesday, both the replay andthe presentation will remain on our website. Any questions, call me at 860-827-3833. And we just have twobrief announcements, and we are ready to start. First, in accordance with Reg G,we issued our earnings guidance at the beginning of the quarter as we did today,and we cannot comment on it thereafter. If it were to change materially, wewould issue a press release and conduct a conference call. And finally, certain statements contained in this discussionby the various Stanleyparticipants are forward-looking statements, as such, they involve risks. Actualresults may differ materially from those expected or implied, so we direct youto the cautionary statements in form 8-K, which we filed with today's pressrelease this morning. With that, I would like to turn the call over to JohnLundgren.

[John Lundgren:]

Thank you Gerry,and I will provide an overview and then ask Jim Loree to look a little deeperinto some of the individual segment performances, as well as our fourth quarterguidance, which I will remind everybody, will be the last quarterly guidancethat we will issue. This is consistentwith our first quarter call 2007 we are beginning in January of '08. We willprovide an annual guidance and update that in the event of a material change. This quarter, in a large way validates the portfoliodiversification strategy that we initiated almost four year ago, and obviously wecontinue to pursue it today. Looking at the quarter, in summary, our CDIYbusiness and segment performed fairly well in a challenging domestic market,and the consequence of less dependence on some large US retailers didn't haveas large and adverse an impact that it might have, had our portfolio looked theway it looked four or five years ago. Strong CDIY performance in Europe, as well as our industrialtool group and our security segment, across the board, contributed to the goodresults in the quarter, which does enable us to re-affirm our full-year 2007sales EPS and free cash flow guidance that Jim can take you through in a lotmore detail. Quickly on the numbers, because you have them, it was arecord sales quarter for the Stanley Works, exceeding $1.1 billion. Pretaxincome was up 11%. Operating margins surpassed 15% and free cash-flow of $119million, was a 130% of net income. Strong performance in our industrial tool sector, across theboard, hydraulics Proto, Vidmar, Facom, all with very strong high-single orlow-double digit growth. Our mechanical security business had anextraordinarily strong quarter. Bostitch continues to recover, despite about50% of [DIY] markets being quite weak. Obviously the North American residentialsector is about 50% of what Bostitch does, it is industrial and is lessimpacted by market conditions. But that profit improvement program that we havediscussed in many occasions, remains on track. The HSM merger also is on track, and the legacy system integrationbusiness at Stanleyis still not performing at our expectations, but is clearly benefiting from thereverse integration into the HSM business model, which was one of primestrategic drivers behind that important acquisition. We grew across the board. All three regions of the worldshowed growth. And the combination of price and productivity more than offsetthe high inflation that we experienced during the quarter and this is the fifthconsecutive quarter, where that's taking place, which has an obvious positiveimpact on our margin achievement. Numbers in general, you see the $9, it was flat in line withour guidance of approximately $10. Operating margin, as I mentioned was up 100basis points, at 15.4% versus 14.4% a year ago. 700 basis points of increasedtax versus third quarter '06, which accounted for about $0.10 a share. The27.2% tax rate was only slightly or marginally above the midpoint of the rangewe provided in our guidance, but nonetheless 700 basis points up higher than ayear ago. Share count was not too different. It crept up 1.1 millionshares, as the performance of the stock over time has put more options in themoney, and the anticipated exercise of those options. So, EPS growth was constrainedby $0.10 in taxes, but all in all from an operating margin perspective, was agood quarter. Pre-tax income on operating margin both expanded. Pre-taxincome up 11%, operating margin up 20%, with a 15.4% operating margin, sodouble-digit growth in both of those key metrics were achieved. Looking at revenues in the next chart, and some of thevarious components, there was a 12% total increase in revenue, the biggestsingle contributor. About half of that was the HSM acquisition, but at $1.131 billion,these were record revenues for Stanley. Looking at the sources of growth, as most of you know, we donot include currency in our organic growth figures. It did add 2% to the total topline, butgrowth across the board volumes contributing to 2% positive price, which is agood thing. 1% for 3% organic then 2% currency, so this is the split up betweenour core activities or activities that have been with Stanley for more than 12months, and acquisitions was about equalleading to 12% growth in total. Looking at the segments, I won’t detract from what Jim isgoing to talk to you about in just a minute. But again, growth across the board

[Jim Loore:]

Thanks John. As we’ve said in the release, it really was astory of industrial insecurity. Really strong performances, but we had to holdon our own in CDIY segment to put it all together, and that's exactly what theydid. With revenues up 3% to $457 million, that included 3 points of currencybenefit, and we did that with a minus 8% organic growth in the Americas, whichwas very, very difficult market conditions, as John mentioned, and I think avery good performance and certainly some share gain going on there to achievethat in the US with a strong new product introductions that we have and thestrong execution. But the real story in CDIY, this quarter, was international,with double digit growth in Europe, Australia,Latin America, Asia, virtually everywhere, weare in markets around the world. We had strong growth and good growth in Canada,and it wasn't all currency, there was definitely some new product introductiongains in those major markets that we participated. That revenue performance allowed us to basically hold ourown with a modest decrease in segment profit down 5%, and a slight decline inthe segment profit rate, down to what I would consider a more normalized levelof about 16.8%. So all in all, an excellent performance for this segment in avery difficult market. Hand tools and storage was up 7%, and again the story wasthe strength internationally, and particular Europe, offsetting the weak Americas.The European folks in our Construction and DIY hand tools and storage business,were up 25% and that truly was an extraordinary performance driven by newproduct introductions and increased brand support. The margin decrease was alsoaffected by, and the overall segment was affected by some mixed stores,mechanic tools, and storage that we mentioned. Point of sale performance in the U.S. was down 5%, so sell-throughof the product down 5%. So actually inventories came down a little bit for thecustomers in the quarter and we note that in FatMax. And FatMax Xtreme point ofsell-through was up 7% at the North American retailers. That is a sample oflargest customers, the seven largest customers that we do business with, herein the Americas. The rest of the world, as I mentioned, the sales werestrong, up 23% and Bostitch sales were down slightly, nominally down 1% andagain the story was international with Europe up 12% and the U.S. was downabout 4% in Bostitch. And the profit and improvement initiatives in that businessremain on track. We said a couple of quarters ago, that we expected somesequential improvement, about a point a quarter, and they are holding to thatimprovement. So, the teams up there at East Greenwichare continuing to move that business in the right direction. So, moving on to industrial, it's truly a great story here.A strong, strong performance, revenue is 13% to $300 million, segment profit up46% to $42 million and 320 basis points of expansion in the segment profit rateto almost 14%. Industrial and automotive repair tools, which consist for thispurpose of Proto, MAC and Facom was up 8%, including 5% organic growthperformance. We had terrific strength in the Proto industrial business inthe America's up 11% and Facom was up 7% organically on strong new productintroductions and a solid integration continuing in that business. And as John mentioned, the engineered solutions businessesalso benefited from exchange, but had some really solid organic growth up 16%on total, and they were up almost 30%. And we had double-digit growth in thesmall business, the Vidmar high-end storage business, assembly technologies andthe hydraulics business. We had a good story on price realization, where favorablepricing more than offset our cost inflation in this segment and certainlyproductivity added to profits as well. And as I mentioned, the folks at Facomare doing a great job on the integration and not only are the revenues comingin as we expected, it got a little bit better. But the synergy realizationcontinues to be in line with expectations. Moving on now to security, another great story here, withrevenues up 24% to $374 million, segment profit up 34% to $69 million and otherexpansion in segment profit rate up a 130 basis points to 18.4%. The story here was twofold. First, an excellent performanceby the Mechanical Access business, which tends to be North American-centric. Wehad 7% sales growth in that business with strong orders and productivity in theautomatic doors business, but also good solid performances across the board inmechanical access solutions, including the old BEST Access, commercial locksand lock set business. Again, as the order book is strong in the business, theoperating margin is now north of 20%. The price realization and productivitygains are strong as well, and the non-ferrous metal inflation, is well though abatingsomewhat is still with us, but the price is more than offsetting there rightnow, and the productive is actually added to the margins. And then the other story in security is the ConvergentSecurity business where we had 62% sales growth, all of that driven by HSM, amodest decrease in the remaining part of the business, excluding HSM. Thatmodest decrease was driven by a sales decline in the United States SystemsIntegration business, which is, as we expected as we wean ourselves off theunprofitable types of business that we were working on previously there, andintegrating that business into the HSM business model. The team is in place to manage that integration, and it’sgoing well. And the good news there in the US Systems Integration business isthe operating margin was up $6 million on a sequential basis, which is movingin the right direction. And now turning to cash flow, another good story here. Asolid, solid quarter, $130 million in operating cash flow, $119 million in freecash flow, brings us to a year-to-date figure of $326 million for operating and$271 million for free cash flow, and that puts us solidly in position toachieve our forecast to $400 million to $450 million for the year. And we will expect to see some workingcapital improvements in the fourth quarter that are built into our thoughtprocess there. And then turning to the full-year and fourth quarterguidance, really nothing different here. We expect the fourth quarter to be inline with previous expectations and that's the full-year, 2% organic sales inthe fourth quarter, which is in line with what we have accomplished eachquarter this year. Acquisitions contributing 6 points total, 8 points of salesgrowth, the earnings per share of a $1.10 to a $1.15 that will give us a 6% to11% earnings per share growth with some significant tax headwind which you cansee on the chart there. It looks like about $0.15 to $0.18 headwind is still todeliver this earnings growth. The free cash flow $130ish to $180 million, will get us tothe 400 to 450, and when you step back and look at the year in light of thevery difficult United States Construction & DIY market, we expect toregister 15% to 17% earnings growth, and that goes to the strength of the portfoliothat we started this conversation at the beginning talking about, how thatportfolio has shifted. And if we go to the next chart here, the portfolioshift, you can see, back in 2002 when we were $2.6 billion, we had $1.7 millionof Construction & DIY. So the majority of the portfolio revenue base coming fromthat Construction & DIY segment back in ’02 now; today a very similarnumber, $1.8 billion coming from Construction & DIY, but we have grown thesecurity business from $300 million to $1.4 billion during that timeframe, andthe industrial from $600 million to $1.3 billion and as a consequence we have amuch more balanced portfolio. And then the other point that I would make here is thatbecause the Construction and DIY segment are mostly geographically diversesegments. And you saw that in the results today that we only have $1.1 billionof exposure to the United State Construction and DIY market and [.700 million]in the rest of world. So that geographic diversification within the Constructionand DIY segment has helped us this quarter and we think it will continue tohelp us as we go forward here. So we have a larger and more diverse revenue base, and thatreally did help us drive performance throughout the year and we'll expect tocontinue to see that in the fourth quarter. Moving to the next chart, you can see a pretty good yearwhen we step back and look at some other key variables such as free cashflow. It looks like about an 11% to 25%increase there, pretax income about a 25% increase. Operating cash flowconsistent increases as well there, and then EBITDA should grow about 25% thisyear. So on pretty much all fronts, including our earnings pershare with that 15% to 17% growth expectation, it looks like its going to be apretty good year and it looks like, despite the difficulties in the UnitedStates Construction and DIY housing related markets, that our portfolio iswithstanding them very well and we'll continue to do so as we go forward. With that we'll opening up for our questions.

[Operator:]

(Operator Instructions) Yourfirst question comes from Michael Rehaut.

[Ray Huang:]

Hi guys, this is actually RayHuang on for Mike. How are you doing?

[John Lundgren:]

Okay.

[Ray Huang:]

Just had a couple of questions,first on the price realization. You got to expect that to continue goingforward to the fourth quarter and into the next year and by how much?

[Jim Loree:]

Well, it will definitely goforward into the fourth quarter and it will help the fourth quarter. We arelooking at inflation in the total year of around $70 million now and we'llrecover about 80% of that in terms of our price realization. Price realizationhas grown to be a fairly good competency of the company over the past few yearsand certainly this year its been a pretty good year in that respect. Part of itthough, part of the higher percentage then will be typically, I mean typicallyhave been in the 60% to 65% realization range for the last couple of years. And I think the reason we aredoing a little bit better this year, is that the -- we are gaining somepositive effect from the non-ferrous inflation subsiding a bit as we go, tryingto go throughout the year and price increase, lag the inflation. So, we'rehaving a little bit of benefit from, of that lag effect, which we thought wouldcome soon or later, it looks likes it's coming. Nothing really significantthere, but I think in the fourth quarter we'll -- we should be, maybe the firstquarter where we are very close to a 100% price realization vis-à-vis our inflation. And when you look at it on asegment basis, its interesting, because we continue to -- that lag effect isclearly occurring in the Security business and in the Industrial business wherewe are recovering a little bit more than 100% of our inflation, but really justcatching up for inflation that we experienced in the past and in the CDIYsegment unfortunately due to the structural characteristics and difficulties inachieving price increases in that segment. The price realization percentage ismuch lower. We would be without that segmentkind of waiting the mix down, we would probably be right out around the 100maybe even slightly above 100% as we sit here today.

[Ray Huang:]

Okay, so you guys are stilltracking that 70 million in raw material inflation that you guys had previouslygiven.

[Jim Loree:]

Yes, no change from that and atleast based on the last 3 months worth of data.

[Ray Huang:]

Okay and then onto the follow-upon Bostitch, simply you guys are on-track there, but where you guys versus whatyour initial expectations were in a couple of quarters ago and how did thatprogressing over the next 12 months or so?

[John Lundgren:]

No, that’s fair. As Jim said weare at in fact slightly ahead and it's not going to be perfectly linear. Ithink we were pretty clear starting a year ago we said 100 basis points aquarter for 8 quarters, that gives you 800 basis points and takes margins fromvery low single-digits up to low double-digits. We are slightly ahead of it,it's not perfectly linear as mentioned. In terms of the key projects we cantalk about some things that weren't public at the time, but the key projectsare what’s driving a lot of the improvement, specifically our plant in Chihuahua, Mexicois closed, that’s been a very good thing. Fastening production is primarilybeen relocate, what’s been relocated at three different facilities as you know,and else don't travel very well, they are heavy. And we moved that productionprimarily to East Greenwich, Rhode Island. Secondarily thePoland and the Lung Fung, China, concurrent with that move we are making goodprogress on our tool transfer from East Greenwich Rhode Island to both Taiwanand China with recent Besco acquisition again a very important element in theprofit improvement program, with the transfer of some less proprietary tools tolower cost markets importantly we own the company, we own the facility, it isnot outsourced, it is a Stanley Works production facility primarily in Taiwan, secondarily in China. So, specific models, at thebeginning of that curve have been transferred and the products working and theproducts are moving back to the various domestic markets. So, simply said, on-track it'sthree quarter in a row, where we have achieved what we said we would and as Jimsuggested and we would suggest from our most recent review Bostitch business.We continue to track it very closely, and our plan and what's picked into thefourth quarter guidance at our plans for next year or it will continue withthat pace.

[Ray Huang:]

Okay, great. Thanks guys.

[Operator:]

Your next question comes from KenZener with Merrill Lynch

[Ken Zener:]

Good morning.

[Jim Loree:]

Good morning.

[John Lundgren:]

Good morning, Zen.

[Ken Zener:]

I am interested in the Industrialmargins, which while up year-over-year. I am just trying to understand the kindof sequential decline. I am just trying to see about the mix for industrialistquote which is 13.9 versus 15.2 in the second quarter of '07, is that just kindof normal seasonality or can you kind of explain that a little bit?

[John Lundgren:]

Sure, it's primarily one driver,and Jim who has got business specific detail in front of them. And I am notsure how much detail we want to go. The biggest single element is, August isnever a very high productivity month in France. We know how important Facomis. It's a third of the revenue and more than the third of the profit from thatbusiness. Last August of course we had tremendous synergies going on and theearliest synergy is hitting the bottom line. So, while the business with Facomremains extraordinarily healthy and wouldn't want to suggest anything to the contrary.August with vacation period etcetera, Europe in general, France in particular, is arelatively low productivity month usually results in under recovery of somefixed costs. And simply said, it didn't show up last year because theimprovements due to the synergies at Facom overwhelmed the lack of efficiencyor reduced efficiency. And importantly we still have eight French plans andmajor merging porter that all we need to do is plan it a little better andforecast at a little better. It is always existed. It just didn't show up lastyear because synergies overwhelmed the historical lack of fixed cost recoveryand French plans in August.

[Ken Zener:]

Okay, and then I guess on the SecurityIntegration. I believe last quarter you guys said it was the business was down8% the second quarter, and sounds like it's kind of down the low single digitsthis quarter. Is that correct?

[John Lundgren:]

That's correct. That's on the [electrophic]convergent fees, Ken.

[Ken Zener:]

Exactly.

[John Lundgren:]

Mechanical continues to do nicelywith low single-digit organic growth at improved margins. We would love to withall three businesses on the Mechanical side heading on most, if not allcylinders, but what we are speaking to is yes --

[Ken Zener:]

But there you also said thatprofit was up $6 million. Was that quarter-to-quarter?

[John Lundgren:]

That was sequential that Jimreferred to, second to third, and that’s primarily, you’ll recall, within theLegacy SI business, we had a tremendous backlog of best and profitable installationprojects, particularly in some corrections facilities around the world, wherewe didn’t do as good a job as we should have, in both, estimating cost toinstall and secondarily, bringing it in at the cost we estimated once weprovided an estimate that arguably was not competitive to begin with. We are Stanley, we are in thisbusiness for the long haul, we are going to honor those commitments to ourcustomers, that backlog at the end of the second quarter was dramaticallyreduced. We still have a few more and what we said on our second quarter callis they would be reduced. We are finished with them until the end of this year,but that’s the primary sequential driver. Quite frankly, continued strongperformance at HSM and fewer bad projects in the backlog to work through atLegacy Systems Integration.

[Operator:]

Your next question comes fromNigel Coe with Deutsche Bank.

[Nigel Coe:]

Thanks, good morning. Nicequarter by the way, I think you do admit some good numbers here, and it’s a verychallenging environment. Just want to focus on Industrial, particularly with EngineeredSolutions, 16% organic growth. Can you just talk about some of the drivers ofthat performance, and lot of my Industrials are talking about 4Q and 2008 beinga bit more challenging, could you maybe address that question as well.

[Jim Loree:]

Sure, engineered solutions is amixture of several small businesses, anywhere from $60 million to $150 millioneach; within those businesses each one participates in a niche market. So forinstance Vidmar is in the high end storage business for industrial customers,military customers and most recently hospitals in the healthcare industry withthe acquisition of InnerSpace. And assembly is in the Automotive OEM business.And hydraulics happens to be in the scrap recovery and demolishing segments ofthe market. So, to extrapolate anythingdramatic about the state of the overall industrial economy would be verydangerous and difficult. However, fortunately for us the markets that wehappened to in are vibrant right now, and the value propositions that we havewithin these businesses are very good and strong. And I think in all caseswe’re either maintaining or growing share within those businesses. So, it’s a combination ofindustrial strength within certain niches that we are in. And on top of thatsome good performance. Now the one notable exception to that in terms of marketstrength would be the assembly, you know the Automotive business. And there isa couple of things going on there. Number one, there Europeanperformance was very strong in the quarter. So despite, you know, again the US wasin the Automotive industry. They did it very well in that regard. They had arelatively easy comp on top of that because it’s been down for a while. Andbasically the combination of those two factors and some good new products havehelped propel into a positive performance as well. So, no one story there, buthaving said that, we don’t see any significant weakness at all on theindustrial economy across the board. I am talking more in a general sense now.And I think the exports in the USare certainly robust that’s helping drive the industrial economy and theinternational aspects of the Industrial business are very strong as well.

[John Lundgren:]

Nigel, let me just add one thingto Jim’s point because the segmentation is relatively new to the investmentcommunity. We have only been reporting this way, this is our third quarter andwithin Industrial. The largest distinction between what we call Industrial onAutomotive Repairs versus Engineered Solutions. Engineered Solutions representsabout 20% of our Industrial portfolio. That is they made to order versus a madeto stock business model. But all the businesses that Jimdiscussed, they tend to be larger ticket items, longer lead times and theinterest to simplification. More often than not it's going to come from the customer'scapital budget as opposed to his expense budget. Thus, we have a little longerlook into the future, in terms of open orders and things of that nature in thatbusiness. So, fundamental business modeldifference, made to order versus made to stock and beyond that obviously theyall compete in the same general environment. It's more an internal than anexternal thing, is why the Engineered Solutions segment showed more robustgrowth than Industrial in total.

[Nigel Coe:]

Got it, thanks for the colorthere and just a quick follow-on HSM, I know it's not part of organic growth,but can you just talk about the organic growth there for the quarter?

[Jim Loree:]

It's very consistent with what ithas been, the trend is in the right direction. It's in the 8% to 10% kind of arange and the good news about that business it has so much recurring revenuethat forecasting the revenue is a lot easier than say the CDIY segment nextweek. So in any event, business continues to be strong and trending in theright direction in HSM.

[Operator:]

Your next question comes fromEric Bosshard with Cleveland Research.

[Eric Bosshard:]

Good morning.

[Jim Loree:]

Hi Eric.

[Eric Bosshard:]

Two questions, first of all onthe Facom business, the 7% organic growth SFX seems like a heck of a number.What's going on in those markets and within market shares what’s driving thatand is that sustainable over what period of time?

[Jim Loree:]

Well, the market itself Eric isnot on fire, certainly stronger than usual, so its probably you get probably2.5% economic growth going on in Europe right now, and these markets tend totrack the economy fairly closely, but compared to how Europe has beencontinentally or been particularly has been performing over the past few yearsthat's a slightly stronger pulse than before. The real story at Facom islargely one of new product introductions and Facom prior to Stanley's ownership was owned by a financial,in effect the financial portfolio company, company they don't fetch in and thenItalian commercial furniture company. So they are now part of a global toolcompany and a global industrial in Automotive tools platform and we didn'treally bank on any revenue synergies or anything else when we put the dealtogether, nor do we really count on those, but we are definitely getting someand in addition to that we are getting some geographic expansion into Centraland Eastern Europe. So combination of factors, thequestion about sustainability who knows certainly new product introductiondoesn’t turn on one quarter in the Industrial business and turn off the next,so I think we should have some sustained performance for a period of time,whether it will be at the levels that we have this quarter will be anotherquestion, but certainly we see no reason to become pessimistic about organicgrowth at Facom at this time.

[John Lundgren:]

Yeah, Eric before you ask mesecond question because we now it works to get cut off in the queue. Just toexpand historically Facom's been outstanding at new product introduction. Ithink the internal improvements at Facom are simply our robust new productpipeline replaced all of the attrition from the core business thus the businesswas able to stay flat. What's happened with the Facom team that I think justimprovements that Jim talked about in their rhythm, in their metrics and howthey are managing the business is simply said, the new product introduction isnot 100% cannibalization or replacing lot business. So, they are maintaining alarger percentage of the core business and as a consequence, some of the newproduct introductions becomes net incremental and that’s really helping. Can wekeep doing that forever. It’s a long plan, but we like the way the business isgoing, we like the way it's managed and EQUIP AUTO which is largest Automotiveand Industrial show in Europe just took place.We were very pleased with the interest, the results with our position at EQUIPAUTO in Parisin late October. So, for the short-term future things look good at Facom.

[Eric Bosshard:]

And then lastly, it seems thatthis is your last quarterly guidance. Within the 4Q guidance, my number suggestthat you probably need to have some profit growth out of the CDIY which isdifferent than what you showed in the 3Q. Can you just give a little sense ofwhat you expect the profit comparison to be in that segment and 4Qyear-over-year and why?

[Jim Loree:]

Well, I will tell you, Eric. Wedon’t, we are not in the business of giving guidance by segment anyway eventhough we still give quarterly guidance. But what I will say is that, we expectthe fourth quarter to look and also lot like the third quarter in the sensethat CDIY will most likely be a kind of a strong base and not particularlystrong in terms of growth but solid in terms of not eroding. And thenIndustrial and Security we are expecting very strong quarters out of them aswell in the fourth quarter.

[Operator:]

Your next question comes fromPeter Lisnic with Robert W. Baird.

[Peter Lisnic:]

Good morning gentlemen.

[John Lundgren:]

Hi, Peter.

[Peter Lisnic:]

I guess first question would beon Security. If you look at the legacy Convergent portfolio, you mention thesequential profitability improvement. But can you give us a sense as to whatthat would mean on a year-over-year basis or where we were at in terms of justthe underlying margin in that business right now?

[John Lundgren:]

Yeah. I guess as Jim just said,Pete in all fairness, not only are we’re going to forecast or talk revenue andmargin by segment. We’re certainly not going to talk to it by sub-segment. Wehave no intention on an open conference call of talking Legacy Convergent,Security margins versus HSM versus anything else. What we’ve said we’ve been very-- about HSM is obviously mixing up Security in a meaningful way. A businessthat was certainly a drag on profitability, you know, round numbers it's 350million of the $600 million segment. So, you can do the math on what 6 millionin one quarter did. Going forward we see the reversed integration of the LegacySI business into the HSM model continuing to affect performance and that’swhat's build into our guidance. Importantly, the change wassimply we have a better with the help and one of the strategic justificationsof HSM a far better cost estimating tool, far better project managementcapabilities and the elimination of the backlog, you know, all of those aswe’ve said in the second quarter impacted the third quarter positively we’llcontinue to impact the fourth quarter. That’s why we bought HSM and right nowwe got 15% plus operating margin business and we continue to believe it's thereand can go up from there, but we just aren't in a position and it's not in ourbest interest to provide any more granularity than that.

[Peter Lisnic:]

No I understand that, I just wastrying to get a ballpark of whether or not you are seeing improvement and howmuch but second question. So thanks for that answer. Second question, in termsof the Mechanical Access business, I think I had the same question what Ericjust asked on Facom and that is it looks like 7% plus in the first half orfirst three quarters of the year. And Jim you mentioned strength on all threeof the businesses. Just can give us a bit more coloron how that's happening and do you expect that to continue and how?

[Jim Loree:]

We don't expect to continue at 7%for the intermediate term that's for sure because it's a 3% to 4% market growthstory. If we can get Mechanical to grow 3% or 4% the real growth in the futurefor this segment above line average will come from the Convergent business andMechanicals job is to grow 3% to 4% and generate a lot of profit and lot ofcash and help us fund the expansion, of the platform into other geographies andso forth. That said, there is lot of, a lotof good things going on in the organic growth area in Mechanical. We are verystrong in the Education and Healthcare markets. They both happen to be goodmarkets to be in right now. Where gaining some shares in the CommercialConstruction market because all of the fact, that we have more specifiers thanwe use to and that's gradually starting to have a positive impact and we alsohave a full product line and you recall that in the last few year we purchaseda few companies that have enabled us to round out our product line in Mechanicalaccess. And some of the competition prior to the fact that we have this, now wehave this full product line, but prior to that some of the competition wastaking advantage in their pricing strategies by looking at low (volume), wherewe were competing with them and then making their moneys on areas where we didn'thave products and they are winning bids that way. That is not happening to theextent that it did before and that certainly is helping. The other factor there is theautomatic door business which has just been a tremendous growth story over thepast five to seven years, started out five to seven years ago it was $100million business, today it's between $200 million and $300 million and most ofthat has been organic growth and they have had enormous share gain. That has todo, we believe, with the superior products that they have and they continue todevelop new products in that particular business and also has to do with ourdistribution strategy, which is go-direct strategy and that enables us to servethe national accounts extremely well and we have gained share as a result. So, all of those factors I think arecombing to give us strong performance. And the other thing, it's an intangiblebut I believe it has something to do with this, is that we split these businessesfrom management perspective about a year ago and as it turns out the Mechanicalfolks now are able to focus much more on the nuts and bolts of organic sharegain and productivity and other things in their business and they don't have toworry about estimating cost in the Electronic business and project management,the Electronic business. I am trying to figure out how to grow the recurringrevenue base in the Electronic business in all thing and the technology changesin the Electronic business, and everything else there was potentially a bit ofdistraction before. So, I think increased focus has also contributed to thestrong performance in Mechanical access

[John Lundgren:]

Pete, let me just add because youdidn't get everything you were looking for, I know in convergent, but infairness. Just, the third leg of course of our Mechanical Security Solutionsbusiness is builder's hardware. We talked about in February, talked about againin May, we lost a meaningful piece of business there and it is what clouds theoutlook and makes Jim or me hesitant to say yes of course, it will continuewith the rate. The good news is we lost thebusiness, we started to plan for it, that business has in fact wind down alittle slower than we thought and we've done a better job replacing the lostbusiness, and we gave ranges of what we thought that might mean in terms ofrevenue and income, and quite frankly we've lost the revenue a little bit andincome a little bit slower than we had anticipated in our outlook and we’rereplacing it with business that we know we can count on in the future a littlebit faster, still a lot of open books there. With the speed at which linereviews work and as Jim already talked about the architectural bidding process,and it's a little less than straight forward, but that too has contributed togreat performance of late, and it’s a little more difficult to predict theshort intermediate term future of that piece of the business. But all in, we'repleased with our decision to have split those businesses, fundamentallydifferent business models despite the great synergies between the two in termof install base.

[Operator:]

Your next question comes fromSteven Kim with Citigroup.

[Mark Montanan:]

Hi, this is Mark Montanan onbehalf of Steven. Regarding your recent acquisition, seems like you’re line upproduct offering on the Mechanical access is fairly complete, wondering isyou’re expecting to further add to your portfolio on the Mechanical side, orshould we expect more acquisitions coming on the convergent side going forward?And in particular are you still expecting to expand these future convergentacquisitions internationally. Thanks.

[John Lundgren:]

Yeah. Well, I guess it was March8 when we talked specifically about some of the different strategies in thegrowth platforms so we have in Security and Industrial and Automotive tools.But, we have three growth platforms of which two are security and each ofthose, one is Mechanical and one is Convergent. And the growth strategies aresomewhat different, especially as it relates to the M&A growth. And you’re right; I mean we havea relatively complete now product line in Mechanical in North America,certainly there is no, there is no burning platform need to buy anything elseas product related doesn’t mean that there won’t be possible nicheopportunities that come up from time to time within Mechanical in NorthAmerica. But the real opportunity in themanagement team is well aware and strongly pursuing it for growth for mergerand acquisition growth in Mechanical is outside the borders of the United States,and that’s where they are focused on. And I suspect you probably will see somedeals there and all likelihood over the coming years. And when you think aboutthe strength of this business and profitability and the growth profileetcetera, it’s a nice business and it’s equally as nice in Europe as it is inthe US.But the products in the USdon’t just translate like the tool business translates into Europe.You have to, they are subject to different standards and you have to have localproducts. So, it makes it more challengingand it really does require sort of M&A approach to the non-US growthstrategy. So that’s Mechanical. In convergent, convergent has the opportunityto grow through acquisition as well. But I would say their growth strategy willlikely be more focused on organic. Not to say that we won’t acquire there’scertainly a lot of commercial monitoring companies that we could consolidateinto our business in a very successful and cost effective manner and it'slikely that we will do that, and it's also possible that overtime, there maybesome businesses outside the borders, of the United States that are attractiveto us, that will to a large extent depend on how well, the team is executing inNorth America making sure that the US Systems Integration business isstabilized and so forth. So before we go venturing toofar, beyond our borders we are going to make that we totally certain, that wehave the equation right, in the United States and the only way you can betotally certain is to get some quarters under your belt and make sure that theperformance is there. Clearly, we are moving in the right direction, and wewould expect to continue to do that.

[Mark Montanan:]

Okay, great. And then a follow-upto previous question on the implications to the fourth quarter guidance andmargins holding up pretty fairy well. Is this, I am just wondering if this isparticularly due to the strong pricing that you mentioned earlier on theindustrial on Security segments? I know you said that CDIY is going to continueto be anchor there, are you expecting margins to really hold in place mainlydue to the pricing or is it something in particular of the time in anotheryear?

[John Lundgren:]

No, it's kind of what we arelooking at about 2% organic growth where we are looking at strong productivity.We are looking at price and inflation roughly off setting each other. That meancombination of factors, such as that are really driving the outlook forcontinued in a positive performance. Certainly the market conditionswere not betting on any improvement in any market conditions, I can assure youof that.

[Operator:]

Your next question comes fromSeth Weber with Banc of America.

[Seth Weber:]

Hi good morning, my questionshave all been asked and answered thank you.

[Jim Loree:]

Thanks Seth.

[John Lundgren:]

Thanks Seth.

[Operator:]

Your next question comes fromDavid McGregor with Longbow Research.

[David McGregor:]

Yes, good morning. Just on thetopics for organic growth at HSM. Can you talk about your plans for 2008 withrespect to opening new offices and how that could contribute to organic growth?

[John Lundgren:]

Yeah, there are David, three tosix regions where we feel we are not top cities, quite frankly, where we feelwe are not perfectly suited to compete. The best way to not make money or losemoney in this business, as I am sure you understand, is to how folks drive in threeor four hundred miles to service a commercial account. So I won’t name thecities, but three to six are on the radar screen for having enough critical mathbetween the Legacy Stanley Systems Integration business in HSM, to open anoffice there and as there is consequence to staff with two to four field techs,and that is quite frankly to eliminate the cut drive time from four hours toone hour to allow us to grow organically in that market. It probably overall would come,but we still have some redundancy in our field operations, as you might expectcombining the HSM locations with the Stanleylocations. We have done a really good job so far Brett Vontrager, Tim Wall andthe team. They have done a very good job in terms of choosing the rightlocation and the tough decisions, the best of the best in terms of the peoplewhere if you got two-ten person offices in a city that becomes a 15 personoffice. So, long answer to a simple question, look for three to six new citiesnext year, which we think will help contribute to the organic growth. We thinkit's necessary. We continue, the biggest help to organic growth of course iskeeping attrition at or below industry standard levels, where we are with HSM.That’s what Tim Wall and the team wake up every morning, not just looking fornew business, but working real hard to ensure that they retain every existingcustomer, that’s a profitable customer. And if there is any chance of losing itfor whatever reason, we work extra hard to keep that from happening, which iswhy attrition is well below our industry standards in that business and areworking hard to drive it even lower.

[David McGregor:]

And it's impressive as 8% to 10%growth is, is it possible that with these 3 to 6 openings that might be on thescreen of '08 that we could see organic growth moving higher from 8% to 10%next year.

[John Lundgren:]

David, anything is possible, isthat built into our guidance? The answer is no, as much as we would like to, wedon’t operate in a vacuum, there are people out there actually after those samecommercial accounts as we are. Some of whom are a lot bigger than we are, sothe simple answer is, that’s just part of our on-going practice. We think weneed to do that to keep up with the kind of growth we’ve experienced in thepast. It will naïve for us, you or anyone else to think that for whateverreason, consolidations of the customer base, that their wont be some attrition.And remember, when there is, whether it’s three or five or 8%, even if you areon the low end of that, 3% to 5% attrition means you need some new business inexciting markets or you need some new cities to back fill that before youbreakeven. The best part of the HSM model asJim suggested earlier, is the high base and increasingly high percentage of therevenue that’s recurring. When you get more than 50% of your revenue baserecurring, that is an annuity, and at least a year in advance that businesswill be with you, and that’s where our focus is, on HSM. But we will take anyupside that that team can deliver, they’ve done nothing but pleases with theconnectivity and their performance so far, but it would not be prudent for usto expect any more from and making a lot of things going on, and they’reoperating in an intensely competitive market.

[Operator:]

There are no further questions.I’ll turn it over to John Lundgren for final comments.

[John Lundgren:]

I want to thank, just nothingelse to say in terms of the numbers, they are out as always as Gerry isavailable for a follow-up if somebody didn’t get it. There is a lot going on inthe market this morning and a lot of calls coming out. So, thanks to all of you who tookthe time to listen in and for those who didn’t get to you know it’s a availablethis starting 1 o'clock this afternoon. Thanks a lot.

[Operator:]

This concludes today’s conferencecall. You may now disconnect.