Stanley Black & Decker, Inc. (SWK) Earnings Call Transcript & Summary

Good afternoon. I'm Sam Darkatsh. On behalf of Raymond James, we'd like to welcome you to the Stanley Black & Decker presentation. With us today from the company, Don Allan, Executive [Audio Gap] Investor Relations; Cort Kaufman is back there in the back, Director of Investor Relations. I think the presentation, you said prepared remarks for about 20 minutes or so, which would leave us plenty of time, 5, 10 minutes or so for questions. And without any further ado, Don, welcome. The floor is yours.

Thank you, Sam. Good afternoon, everybody. So as Sam said, I'd like to spend maybe 20 minutes going through a few slides, and then we'll open it up to Q&A. So maybe just to start with a bit of a refresher on our company. And so last year, we were about $14.5 billion in revenue. Market cap as of today is just over $22 billion. And you can see our cash dividend yield, which continues to be a great part of our story as it has been for many decades. We -- when you look at the company and you look at the geographic split of Stanley Black & Decker, you can see the United States makes up about 60% of our total company. Similar factors for each one of our segments, a little bit different for Industrial and Security is slightly smaller than that 60%. And then obviously, we have a very significant European presence as well as solid emerging market presence. For the last 3 to 4 years, when Jim Loree became our CEO, we laid out a vision of getting to a revenue number of $22 billion by 2022. And we were very clear that was an aspirational goal, that was not something that we were determined to get to. But if the circumstances were right through M&A and organic growth, we felt there was a reasonable path to achieve that. And we still, today, feel like there has been potential for us to achieve that. But what went along with it was 3 other kind of important pillars. One, we wanted to be a company that had been known for innovation for a long time, but really want to be known for innovation outside of our industry and the markets that we compete in. So continuing to invest in that important part of our company. Continue our top quartile performance. Financially, when you look at our TSR and making sure the track record that we've had for the last 15 to 20 years continues on the journey going forward. And then really doubling down our commitment to social responsibility as well. And we do believe we've created some outstanding franchises that are world-class and have the attributes, as you see in the upper left hand corner, with world class brands. Very attractive growth platforms, have the ability to grow organically 4% to 6%. Scalable and defensible franchises. And then, of course, have the ability to differentiate themselves through some type of innovation, whether that's product innovation or service innovation, depending on what the business is or a combination of both. And so therefore, these businesses really have become strong innovation-driven platforms that are very diverse and across global markets. And for those of you who have followed our story for the last 15-plus years, you know that we put an operating system in place or an operating model that for many years we referred to as the Stanley Fulfillment System, and then it became the Stanley Fulfillment System 2.0. And with our annual report this -- for last year and our 10-K that was recently filed, we announced that we're evolving that operating model a little bit and are very much focused on 4 different areas that are centered around technology and people. For us to be successful, obviously, we need to continue to attract talent, and we need to continue to invest in technology to make us efficient and effective in everything we do. Those 4 pillars include extreme innovation, which you've heard of breakthrough innovation, that's just another way of saying that. Also it's looking at -- it sounds good, extreme versus breakthrough, extreme innovation. The other thing is looking at evolving to a world-class customer experience. How do we make sure that our customers continue to have the outstanding experience they have with us and make sure that's maintained at a world-class level. The third area is looking at just what we call core operating supply chain, which is really just driving efficiency across our supply chain like we have for many, many decades. And then the fourth area is focused on the pillar of -- performance resiliency, thank you, Dennis, which is really how do we maintain our resiliency in an environment that is so volatile such as the one we've experienced for the last 3 years, where we've had tariffs, we've had commodity inflation, we've had currency pressure. Now we have things like the virus we have to deal with. How do we make sure that we're able to offset these different things and continue to grow our earnings at the level that we would like to over the midterm, the short term and, of course, the long term. Applying all those different principles to our businesses allows us to really achieve the long-term financial objectives that we've laid out there, as you see over to the right and the middle of the page, which is 4% to 6% organic growth; 10% to 12% total revenue growth, which clearly includes the inorganic or M&A activity; and then 10% to 12% EPS growth, getting the right operating leverage on the organic growth over time. And of course, free cash flow exceeding net income. We had a great free cash flow performance last year. It was a nice bounce back from the previous 2 years, where we hadn't achieved 100-plus percent of free cash flow conversion on net income. And we were very pleased with that outcome in 2019 as it was a great thing to achieve, as it's been something as part of our track record for a very long time. 10 working capital turns or better. And then our CFROI would be somewhere in the range of 12% to 15%, where it currently sits about 13.5%, 14% today. If we hit those long-term financial objectives using our operating model against the existing platforms, that allows us to really be able to fund what we believe is an investor-friendly capital allocation, with half of that money going back to the shareholders, either in a dividend or the opportunistic share repurchase where that makes sense; and the other half going into M&A and reinvesting in those platforms, in those franchises, so they can continue to grow and make sure they have the right assets to be successful and differentiate themselves over time. So a little bit of reality in today's world. I'd like to spend a little bit of time on China and the coronavirus or COVID-19 as it's being called now. So I think what I would like to do is maybe just start and give you a little bit of information about our China operation and our China manufacturing footprint and supply base. So as you can see, if you count it up, the plants, we have 10 major plants in China, 6 of them are Tools plants and 4 of them Industrial. The existing local business in China is about $250 million in annual revenue, with about 80% of that being made up of our Industrial business and the remaining $60 million to $70 million is our Global Tools & Storage business. Throughout the first quarter, we really have not seen much revenue being generated in the local Chinese business, as you might expect. And that probably will be the case through the remainder of the first quarter. But probably the bigger question you have in your mind is our supply chain. Our supply chain in China serves 40% of our capacity across the company. And so $2.5 billion of sourcing happens from China, whether that's vendors that provide parts and components to the U.S. and the European region, so manufacturing and assembly can happen there, or we're making the products in China and we ship them into different markets like the U.S., Europe, et cetera. About $2 billion of the $2.5 billion in sourcing is manufactured in China and shipped into those countries I mentioned. The other $0.5 billion are parts and components that are sent to those parts of the world where they're manufactured in those geographies. As many of you know, we've had a strategy for quite some time to continue to localize our manufacturing and get closer to our customer. We've been doing that. And in the United States, about 40% of what we sell in the U.S. is made in the U.S. In Europe, that number is about 30%. Our objective over the next 3 years is to get that number closer to 75% to 80% in those 2 major markets. We currently have very detailed plans to do that. And the combination of the tariffs and, obviously, the virus just add to the desire and the incentive to want to move forward with that plan and execute on it. As it relates to the virus and where we are on China as far as our manufacturing capabilities as of today, we shut down these 10 plants for the 2 weeks of the holiday season around Chinese New Year. The week after that, these plants began to open up and the production capabilities and utilization got to about 50%, 60% on average across those plants sometime last week. We're continuing to make progress on that, and those numbers continue to improve as we sit here today. And we're continuing to focus on getting more employees back to work, that's one of the challenges we have right now, where all the employees have not returned to the plants. We have a process that we need to go through with every employee before they get into the plant around checking for fever and other symptoms that are visible and then, obviously, wearing masks within the plant to try to protect our employees as much as possible in that environment. We do believe it will take another 2 or 3 weeks probably to get to 100% utilization in these plants. And that obviously is assuming that the virus doesn't worsen in China, that it stabilizes and begins to -- to begin to go -- retract or go backwards. If that happens to get worse, then obviously those numbers could change. But right now, that's what our plans are, and we believe that's achievable based on where we are today. This will cause some pressure for us in March and April from a revenue perspective. So we see that revenue in the last 2 weeks of March will probably be pressured based on these capacity challenges we're having and also in the month of April. We do believe it's more of a timing-related matter at this stage. But obviously, that's very dependent on where the virus goes and how significant it is. If things stabilize and we don't see a dramatic worsening, we think that's probably where we are. We have a timing issue we have to work through for the first half of the year and the full year as well. As usual, we always go through a process of really trying to find different levers and establish contingency plans to offset these types of headwinds like we've done for the last 2 or 3 years. Last year, we had $445 million of headwinds related to tariffs, commodity inflation and currency. Through margin resiliency, restructuring, pricing actions, et cetera, we were able to offset that and still achieve earnings growth in an environment with that many headwinds. We will continue to take that approach. That doesn't mean that in a given quarter, we may have some timing issues and we can't completely offset headwinds like in the first or the second quarter of this year, but our objective is to have a contingency plan through margin resiliency. I said on the January earnings call that, that was $100 million to $150 million for this year. That plan is still rock-solid and in place, and we will continue to execute on it, whether this virus becomes more significant or not. The idea was to always have a contingency plan available for headwinds. But what you really would like to do is have that contingency plan there to help you outperform. And so we'll see how the year plays out. So what I would like to do is maybe spend a little bit of time talking about margin resiliency as I wrap up my comments, and then talk a little bit about some of the great growth catalysts we still have in our company that allow us to gain share as a company from a revenue perspective. So first with was margin resiliency. We believe there's $300 million to $500 million of margin opportunity for the next 3 years that we can capture through these different initiatives and programs by utilizing advanced data analytics and other technologies to drive value in the pricing area and margin excellence; next-generation procurement, which is really going after additional opportunities through our supply chain to help our vendors become more efficient in how they operate, but also capturing deflationary opportunities around commodities as well as that opportunity continues to evolve for us in a positive way here in 2020. Looking at Industry 4.0 and the technologies of automation as well as digitizing our plants. And so the automation piece is something that is clearly defined using robotics for certain types of manufacturing techniques that will create value in our manufacturing plants and allow us to be more efficient from a cost perspective, but also gives us more flexibility to move our manufacturing production among plants into different geographies as we see fit and as we see appropriate, especially along that strategy of trying to get closer to our customer. And the fourth one is how we become even more efficient with our functions and our indirect spend. And so this is an initiative that's been underway for about 18 months. We've created value last year in this initiative. We see more value over the next 3 years to become even more efficient with our costs in those particular areas. We're using technology. We're using outsourced partners in some cases to really make this is a scalable framework that ultimately creates sustainable value, not onetime value but sustainable value over the long term. There occasionally will be onetime value things created to this program, but the vast majority of the value that will be created will be permanent and sustainable. It helps us offset headwinds, but more importantly, what it does over the long term is it allows us to get our gross margins heading in the right direction again. If you look at what happened to our gross margins as a company, we've lost 300 to 400 basis points in our gross margins over the last 3 years because of all these headwinds. So we're sitting at about 33% gross margin here, and we believe we should be a 36%, 37% gross margin company, which we were 4 years ago or 3 years ago. That opportunity still exists to get back to those levels. And these are the levers that are going to help us get there as well as operating leverage as we grow organically going forward in addition to this. So that leads me to my last bit of comments, which is really thinking about and focusing on how well positioned we are to continue to gain share. So we've had a wonderful rollout of Craftsman into Lowe's and Amazon and NAPA Auto Parts last year going into this year. It's been incredibly successful, and we see that as a $1 billion annual program by 2021. But also things like Stanley and Stanley FatMax in a much robuster way within Home Depot and the success that we're seeing there and we will continue to see, launching FLEXVOLT and expanding the product offering there. There's more runway, 3 to 5 products each year, still rolling out under the FLEXVOLT program. And then last year, we added the technologies of the DEWALT XTREME and DEWALT ATOMIC, which are smaller, more powerful tools that can be used in small, confined locations and places. That continues to grow, and it's another growth catalyst for us as we head into 2020 and 2021. And then LENOX and IRWIN. Revenue synergies and, of course, e-commerce continues to be a great opportunity for us. And eventually, they'll be something related to the Black & Decker brand on this page as we revitalize that brand and begin to launch something most likely in 2021 and that opportunity there. So a lot of exciting opportunities organically for us to continue to go after even in this world of volatility and turbulence, as we're seeing, that's causing some pressure to our margins. And then there's an inorganic pipeline, which has been strong as well as we think about some of the more significant platforms we want to keep building upon for M&A, such as outdoor products, Tools & Storage and our Industrial businesses of engineered fastening and infrastructure. And you see some of the acquisitions that we've done recently. The IES acquisition with Paladin and Pengo brands. The CAM acquisition that we've recently announced here in the first quarter gets us in the aerospace engineered fastening. And then, of course, our minority stake in MTD for outdoor products. And we have the ability to purchase the remaining 80% starting in July of 2021. So there's a nice pipeline of things that have happened there that can continue to happen and, certainly, the other opportunities that are not on the page for future acquisitions. There's still a fairly robust pipeline in those 3 categories I just mentioned. We feel like we've positioned the company to continue to operate very well in a difficult environment like we're in today and be able to achieve the objectives we laid on around organic growth, earnings growth, strong cash flow and hopefully, maybe by 2022, achieve our revenue objective of $22 billion. But again, that's aspirational versus something we're obsessed about. So that's my prepared comments and remarks, and what I will do is we'll open it up to Q&A, Sam.

Terrific. Thank you. I'll start, Don, with a few questions and then we'll open it up for the group here. First off, you've talked about how -- the Chinese supply chain pressures, what that might look like for late March and April. And you said, we're anticipating some significant pressures. You don't necessarily have to quantify this, but I'm trying to get a sense of the materiality of that pressure, particularly knowing that the spring selling season is pretty critical in a lot of your tooling businesses -- your Tools business?

Yes. So as I said, probably the last couple of weeks of March are what we're concerned about right now. And if you think about how our business functions, all of us in the industry really lower our inventories at the end of December and the end of January because our year-end is end of December, it's one of our lowest selling quarters and the first 2 months of the first quarter. And so we get to very low inventory levels as well as our customers do as well because their year-ends are the end of January and that's a slow season for them. And then in February, a dramatic ramp-up occurs in production. And then in March and April and early May is when we really start selling our product into our major customers around the globe for the spring selling season, especially in the Northeast or the northern part of the globe. That has been hindered somewhat by what I described in China this year, where that ramp-up in February has been very slow. And so we're going to see a bit of delay of product getting into there. But we're looking at alternatives to assist our customers by doing certain things in Mexico to try to offset that. But I think right now, we feel like there's some pressure to that 6- to 7-week time frame that I mentioned. But I don't think it's something that's massive. I think it's something that's manageable as a timing issue for the first half of the year or the full year at this stage. Obviously, these things can change as the virus worsens. But we think it's something that we can manage through that doesn't cause a major disruption to our customers.

At Stanley, you've been quite playing that Security is "on the clock" and it's a large part of your business but you're still trying to determine how critical or core that business is to the overall enterprise. How does -- the benefit of having Security in the portfolio is that it's a very steady business, particularly in turbulent times elsewhere. How does the virus or any other sorts of angst that you're seeing in the other parts of your business potentially affect your decision-making as to how Security fits in the overall portfolio? Might you delay the decision to make a decision or at least to announce a decision, or perhaps now increasingly look to retain it within your portfolio?

Yes, it's a great point and question. Because if you look at the last 2.5, 3 years for us, we've had all the things I mentioned for headwinds: currency, tariffs, commodity inflation, now a virus that's impacting our supply chain and our local Chinese business. Through all that, our Security business hasn't been impacted by any of those things because of the way it's structured, because of the type of service and products that it provides. And therefore, it does kind of resonate how stable it can be in a very volatile environment. That being said, it hasn't performed financially the way that it needs to. So what we did is we put it on the clock about 1.5 years plus ago, 18 months ago to 20 months or so. And the objective was, we need to see consistent organic growth, which we're starting to see now over the last couple of quarters. We need to see continued improvement in the profitability of the business. The cash flow and the working capital has always been good, so that's not something we necessarily needed to work on. But it's making very good progress the last couple of quarters, and this year and I believe in the first quarter that will continue to be the case. And so we'll see what the ultimate decision is in the second quarter as that's when the 2-year clock kind of ends, but it's pretty much done everything we asked it to do. And it's, therefore, creating value to our company. And it is a stabilizing force through periods like this. So no decision has been made, but it wouldn't be shocking if we decided to maybe look at this for another year or so and continue to make progress in its transformation.

You talked about how demand in China was obviously very weak. But talk about -- have you seen any instances or evidence of demand weakness elsewhere, be it in Europe, be it at POS in the United States? What are you seeing demand wise? Cost and supply constraint, sure, but I mean, are you seeing it in demand or no?

Yes, it's a good question. We're not seeing it in demand right now. We actually -- our POS continues to be strong in the U.S. at our major customers. The European markets continue to perform at the same level they were performing last year. Obviously, those are not high-growth markets as far as GDP. But for us, it's been an opportunity for us to gain share. And so those markets have been performing in line with expectations. And then emerging markets, I would say, are kind of performing in line with expectations, too, although they are weak and they have been weak for a while. There's nothing unusual happening there. At this stage, it just feels like the only pressure we have is to our revenue, which is more related to the supply chain. And we don't really see market-related revenue challenges currently. But obviously, we're watching that very, very closely because as the virus spreads, that could change. But at this point, we're not seeing it.

The CAM acquisition, fairly sizable. Also notable that it gets you into aerospace, which long term is a very attractive growth business. Talk about the strategic and the financial rationale of that acquisition, particularly in light of what we're obviously seeing with Boeing who -- which is a large customer, as you mentioned.

I think the -- if you had followed us for the last 10-plus years since Stanley and Black & Decker came together, whenever we talked about the engineered fastening business, we would always talk about we would love to get into aerospace fasteners because it had very similar traits to the automotive industry, which is where we're heavily invested today with fasteners. With one difference, it had a much better growth trajectory and profile and had less kind of volatility to it that you see in the automotive space. And 10 years later, we finally found the asset that we think is a great fit to this business, and that's CAM. Now there is a short-term issue that we all know about, which is the 737 MAX and getting that back online, and that is a sizable portion of the CAM revenue. However, we do believe that's a short-term issue to work through and the ultimate positive long-term nature of this asset will read through to our performance. And we will be able to benefit from the strong growth in this particular industry over the next 3 to 5 years and beyond. We just have to work through this time frame. Now the good news is, as we negotiated the transaction. We did some things that protect us. And so that if the MAX doesn't get recertified for some reason, which is probably a pretty low probability, there would be a price reduction. And if other things happen after that as far as production levels of the MAX don't achieve certain levels, that will be another opportunity for price reduction, assuming the certification happens. So we think we've protected ourselves from that point of view. And the other thing is, when we look at this industry, it's got great profitability and it has a growth profile that's solid for the next 8 to 9 years. And so we love the asset. We love the management team that came with it, who is very seasoned in aerospace fastening in particular and has a long track record of working in that industry. And so although those little things like -- not little things, there are things we're concerned about related to Boeing, we kind of put that in the category of short-term risk, let's protect ourselves on the purchase price side as much as feasible. And it's a good strategic asset, and that's why we went forward with the transaction.

Any questions in the room. Here. A question here, yes.

Wanted to [indiscernible].

The question was about Techtronic and some of the things that they're doing with lithium-ion battery technology and what that may mean to our particular business. I think we've done an outstanding job with battery technology at Stanley Black & Decker with things like FLEXVOLT, where we are the only one that has a system that is a battery technology that can go back and forth between 20-volt tools, 60-volt tools and 120-volt tool when you use 2 of those 60 battery -- 60 voltage battery packs. No competitor has that particular technology. They may have 60, 70, 80-volt battery packs to run certain tools, but that's a different battery system that you have to maintain for bigger tools versus a smaller battery system for other tools. Our benefit is, we get to go flexing back and forth for those types of tools. So you don't have to maintain multiple battery systems. And therefore, we think our innovation and technology is still better than some of those innovations that are coming up.

I think we're out of time here. We will continue this in the breakout. Thank you very much.

Thank you, everybody.