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

Good morning, everybody. Thanks for joining us on day 2. We're going to keep things rolling with the team from Stanley Black & Decker. We have Stanley's new CFO, Patrick Hallinan, joining us as well as familiar face in Investor Relations. Everyone knows Dennis Lange. So Patrick, if you want to just kind of give us some opening remarks. I know you have some slides online, maybe with refer to folks at home can click along. But maybe give us a lay of the way in first, and then, we'll dive into some Q&A.

I think -- I've spent the morning here today, first time at this conference. A lot of the attendees probably know the company as well or better than I do at this point. But obviously, a company in the midst of a transition. Don and the Board streamlined the portfolio, focusing on two businesses, the tools and outdoor business, that's about 85% of our revenue, and Industrial business, that's about 15% of our revenue. Put in motion a cost transformation about a year ago, and the objective is to drive out of the business by the end of 2025, both to return the margin to where it should be and will be, but also to create the room to invest for growth [indiscernible] cost transformation journey. We've delivered, at this point in time, about $600 million of cost transformation since the program has started. We're running a bit ahead of schedule and have every confidence we're going to get to that $2 billion. We've also been driving a lot of inventory out of the business, it's about $1 billion, $1.4 billion in the last year or so. And once we get to the end of this year, we probably still have another $1 billion, $1.5 billion of inventory to take out of the business. And as we get the balance sheet cleaned up and the cost structure in place, you're going to see the focus on growth accelerate. It's not that we ever lost that focus, but certainly, now the supply chain is healed and the margin structure allows you to invest appropriately in SG&A, we'll be on a growth journey from this point forward.

Excellent. Maybe just if you could give us a bit of an update of what you're seeing out there? Obviously, demand environment has been pretty rich and nuance this year. I know for your own profitability and kind of the journey here, obviously, a lot of that more internally focused, but any observations externally in terms of customer demand or their own inventory levels or any categories as you point out?

Yes. I'll talk to first demand and the demand environment, then the channel inventory environment. I would say, consistent with the comments we made at the end of the second quarter and consistent with, I think, some of the big U.S. retailers at the end of their quarter or about a month later, we've seen the Pro very much engaged and probably stronger than we would have expected this year. And nothing is kind of wavered there. I'd say, on the consumer side of things, we certainly have seen more price sensitivity at higher price points. And I think that's consistent with what the retailers are experiencing. I don't think there's been kind of a new wrinkle in demand since our second quarter remarks. What I would say is we're expecting the macro to be about where it is. I mean central banks seem poised to be biased towards defense, and that's where they've been. I'd say, given that posture, this year has been better than we might have otherwise thought from just a pure avoidance of recession. We'll see if that still holds true, but I think we feel that the demand we're getting now is likely the demand we see for the balance of this year and into the front half of next year. For us, channel inventories are in a reasonable. I'd say, they're at the low end of what would be a normal range for us personally. And I'd say that, that's true, whether you're talking pro-centric channels or consumer-centric channels, whether you're talking the U.S. or other regions of the world. So we don't see a big channel inventory issue. We certainly have more inventory on our own balance sheet than we'd like to. Like I said, probably by the end of this year to the tune of $1 billion to $1.5 billion. But we're going to work that off slowly. We're not going to be using price as a lever to get after that. And we also have some production and distribution footprint changes that will be taking place in the U.S. and elsewhere over the next 1.5 years, 2 years. The part of the pacing of that inventory will be to ensure service levels as we make those transitions.

Understood. I think as categories go, there's probably one category that folks have noticed a bit more volatility on, on the outdoor side. I know that's an area that was a little bit of a headwind in 2Q. A lot of that may be attributable to weather, or at least early on. But any sort of normalization or inflection, deflection there to note?

Yes. I would say as this year has played out, our Tools demand has probably been better than we would have anticipated and outdoor softer. And whether that's due to the weather, in the first half of the year, or whether that is due to a little bit of COVID hangover, it's hard to discern at this point with any kind of precision. I would certainly say the winter season at the end of '22 was softer than anticipated. Both '22 and '23, spring/summer softer than anticipated. Again, I think part of that must be because it spans more than just any one couple of month period more than weather. It must be a little bit of that COVID overhang. I think we're prepared as we head into this winter for a little bit of that same dynamic to be playing out, where that consumer price sensitivity has the demand in the outdoor space dialed a little bit down from where we would otherwise desire. But hopefully, we exit '23 with most of the post-COVID dynamics playing out, and we can get into '24 and be kind of through kind of a COVID whipsaw on demand. But we're going to be gating our procurement and production with that in mind, both with the fact that channels seem to be poised to be conservative on inventory, and we're still trying to find our footing post-COVID.

Understood. If I think about the inventory destocking, the internal inventory destocking that you're going through, how should I think about sort of this return to normalized production that we're approaching versus the remaining inventory you'd still like to bring down? It seems like it would be a headwind to margins at some level. But I guess there's a little bit of a definitional question like, what does normalized production mean? Where do we ultimately see kind of the uplift when destocking is thoroughly done?

I think appropriately, Don and the team, over the last year, especially the back half of 2022 and the early part of '23, where we really pushed production way down to address both falling demand and the inventory that was on the balance sheet at the time, that -- when you're talking about many plants at 30% or sometimes even less than that level, off of normal production levels, that's a pretty dramatic effect. Definitely had an effect to the full year P&L this year. I think we're through most of that by the end of the first quarter. I mean -- I think next year, given where the macro is and given some of the outdoor dynamics, could we still have some softness in production? But nothing as dramatic as the second half of '22 or the early part of '23. And I don't see production curtailment as a main driver of the gross margin in '24. I think the drivers of the gross margin of the '24 are what's the macro? So are you getting kind of any volume leverage or not? What is deflation? And is our cost transformation on track? And so I don't think getting into the low-30 percentile by the end of '24 is very much in the cards, even if you have modest macro and even if you don't have a dramatic deflationary tailwind at your back. I think we're making that 35% gross margin by the end of 2025, largely a self-help journey that is not predicated on a big volume tailwind or a big deflationary tailwind. And we're going into next year expecting still this kind of muddled macro environment where defensively postured central banks, you have a war in Ukraine, and those things are weighing on demand as they are right now.

Understood. On the cost savings, you mentioned things were going there a little bit better than expected. Any particular areas of success that you'd want to point out?

I think two areas have been particularly quick to returns and particularly powerful, both strategic sourcing across our enterprise, but in particular, in the Tools & Outdoor business. And then lean and continuous improvement inside our facilities across the enterprise, but inclusive of and especially in the Industrial business. And then two of the more powerful levers. I think as the next 2 years play out, that's when we see not just those dynamics continue, but layered into the cost savings from taking out facilities, redundant facilities in both production and distribution.

Understood. I guess within that then, on the cost side, how should I think of maybe the other piece of that? So there's been, I'll call it, this acute cost environment for you guys, really even predates the wave of inflation and supply chain current going all the way back to tariffs. Some of those things are probably relaxed and maybe improved, like transportation, but how should I think about kind of the overall cost picture over the last several years or maybe the price cost picture? Because you've absorbed a lot of inflation. You did get some price. You did take some countermeasures. But are those still kind of a big kind of net headwind today or between deflation and countermeasures and price if you largely offset those?

And Dennis, you correct me if I misspeak here, I want to say cumulatively, including kind of our outlook for this year, you'd say a 3-, 4-year cumulative cost inflation in the $2 billion, $2.25 billion and kind of pricing to offset that in the $1.5 billion to $1.7 billion range. So you still have costs ahead of price. I'd say part of the cost journey we're on now from '23 through '25 to take the $2 billion of cost out of the business, part of that is an acknowledgment of we're not likely to be pushing meaningfully new price through the system. And so it's cost structure chain and it's structural cost structure change that re-heal the margin back up towards 35%. And I don't think while we've seen some very nice transportation savings, both ocean and ground, some of that was in our guidance, and some of that has been in the guidance updates we made this year. And we've seen, on the margin, some metals. We haven't seen a broad-based collapse in commodities. And we'll -- I don't expect that to be the case, unless there's a broad-based change to the macro. I think some things like copper and resins have been kind of surprisingly resilient through this part of the process. So we're expecting, as we go through the balance of this year and as we go into next year, just modest deflation, it's not a tailwind. We're expecting -- we're going to use self-help to reclaim the margin, and we don't expect big pricing dynamics up or down.

Got it. So sticking with kind of the cost side of the equation in the journey there. Nearshoring is something you guys were doing before it was popular and before we had all these new fancy terms for it like Friendshoring and Jersey shoring or whatever else we need to do. How is that calculus evolved over time? Clearly, more supply chain inflation probably drives more accretive actions on nearshoring. But technology has probably changed or improved. Like has your strategy around that really evolved as a function of what maybe that backdrop has changed since you started doing this, gosh, what, 7, 8 years ago now?

Yes. I don't know that I have all the history of the journey. I think as I've gotten up to speed in my 5 or so months, my understanding is we moved somewhere in the neighborhood of 5% to 10% of the volume from China to NAFTA, mostly Mexico. And we have a road map to continue that, especially in the next year around more Outdoor and Power Tools in Mexico. I look at that as that's a derisking of the supply chain. And also as you do more of it, you get the working capital benefits that come with it. But the pace at which it's moving is really the pace at which we can stand up and create the quality and capability of engineering capacity in Mexico and the supplier network in Mexico and Southern U.S. to replicate the strength of those things that were built over 2 or 3 decades in China. And so I think that pace will continue, but I think the pace will be modest. In that it's going to go at the pace at which you build up the engineering capability and the pace in which you build up the supplier network, which is -- it's a measured pace. I think you -- from a pure risk management perspective, you'd like it to be faster than it is. But if you just swung production over here and then got exposed to lower-quality suppliers, not supporting you in the way you can rely on, that's just a different form of risk. So I think we're kind of moving it at the pace at which engineering and supplier capability transitions.

Some of the supplier pieces of that are at least somewhat beyond your control. Like how much are you able to really influence that? Obviously, saying, "Hey, there's a bunch of business waiting for you at the end of this road once you ramp up capacity." Is that -- has it been a challenge or a more complicated discussion to help stand that up? Like do you have to help provide them some amount of either guaranteed business or help them with their capitalization. How does that discussion work?

It's certainly -- fortunately, you do have somewhat of an automotive base to build off of in certain commodity sectors. But you do end up much the way you do when you do strategic sourcing. You do a bit of supplier development because you're trying to create in the realm of strategic sourcing competition. And you're trying to get more equal competition and strong competition amongst suppliers. In places like Mexico, where you just don't have that, you end up with a supplier development capability that comes usually from your procurement orders. And you're -- sometimes you're having to get them up learning curves, and that's why it takes time. And then to your point, work with them to ship volumes in a guaranteed basis over time. But it's a gradual process. I'm less close to it at Stanley in my 5 months, but in my prior life, that's what we were doing. We had started to build a separate supplier development capability in Mexico to do just that.

Understood. Maybe pivoting over to growth, and I have a few kind of different areas I want to discuss in that regard. Maybe just starting with the macro overlay there. You mentioned that the Pro was a little stronger. I feel like I always try to put in context as I'm talking to folks that houses don't necessarily buy tools, the contractors do. And we certainly don't have an excess of contractors or folks that are going to be leaving the industry based on lack of activity for them to work on. How do I think about sort of the growth algorithm or growth potential in the Pro categories just given that contractor won't go down? They'll probably continue to go up maybe limited by the number of warm bodies. But how do you think about kind of that model as it influences the way you look at demand?

Yes. Yes. I think we feel like '24 macro aside, which I think we're going to be in '24 sorting through Central Bank war and oil inflation. But the medium, longer-term growth trajectory, given to your point that you have an undersupply of housing, you have reshoring of either production and/or distribution more in North America, and you have some infrastructure builds. I think we feel like there's very helpful tailwinds over the medium and long term. Then those macros then also get supported by -- as battery technology has allowed more applications of higher-powered tools, that allows battery-oriented tools to displace things that were driven by air compressor or other forms of energy. So there's that avenue. And then for us, we spent some years prior to the past, very focused on diversified industrial inorganic strategy. And we have to get back to some of our traditional focus of driving innovation, of driving field service and support and focus on brand level organic growth as opposed to a lot of M&A and a lot of integration M&A. So I think when we talk about Stanley Black & Decker growth, '24 and beyond, we're going to be talking about the macro. We're going to be talking about innovation, including expanding where battery gets used in Power Tools. And then we're going to be talking about getting back to some of our traditional operating models and brand growth model.

Are there initial targets for share gain that are clearly out in front of the rest, whether it's specific channels, customers, product categories and anything that really stands out as a day 1 initiative there?

Yes. I would say we have many, many brands in our portfolio. But I anticipate, as Chris Nelson, who's been on board as Head of our Tools & Outdoor business, works with Don, works with the Board of continuing Don's focus on, let's be much more focused and let's be much more streamlined. You can see probably Chris and the Tools & Outdoor team pick four to six of the biggest brands and really focus the innovation and the brand building and the field support on those four to six biggest brands across both Tools & Outdoor. And so I'd say it's going to be brand-led and innovation-led growth. Some of it will be an expansion of where battery plays and some of it's just going to be a reinvigoration of brands that maybe didn't get the attention over the last 3 to 5 years as we were doing so much M&A and integration work.

Understood. And I guess what does innovation look like in the tools business these days? I think in outdoor, it's sort of a clear like kind of gas to battery. But if I think about the major changes to Stanley's line card over the last several years. Clearly, FLEXVOLT was very game changing. You kind of cut the cord on a bigger piece of the portfolio. What are the big opportunities from here? It seems like batteries just getting smaller, lighter, more powerful. That's -- those are all good, but they sound more incremental. Is there anything, I guess, more game-changing that folks should think about as an opportunity if the technology would've come along?

Yes, I'll start and Dennis, you can add to it because you have a broader run time of where the innovation is played. But as I've been here in 5 months, and I've gotten through a couple of innovation sessions with the Tools & Outdoor team. I'd still say there's more room to run of where batteries can be impactful, whether they're replacing gas or compressors and in Pro Tools and both areas like concrete, in areas like handheld outdoor products that are beyond things like blowers and trimmers, where the battery has been playing out, but you're getting to the point where you have battery-powered chainsaws that can beat the top line engine-driven chainsaws. And you're getting to the point where you have concrete tools and nailers that are outperforming compressor driven equivalents. And so I think there's still more runway to go from that. And then we also have an opportunity inside our own portfolio, to increasingly platform. So when we're going about driving some level of innovation, how do you also drive the level of platforming that allows you to get a better cost basis and maybe more automation and assembly. So I think that there's avenues both on delighting the end user, and there's also avenues on improving the cost basis. But I don't know what you'd add to that, Dennis.

Yes, I mean if you think about the core model, it's going application by application and just making the existing contractor more efficient and effective at their job. And that saves time, saves money, et cetera, for the contractor. They see the value of that, but it also brings news to the category in a way that reinvigorates your brands. And then you have kind of the bigger swings that Pat was talking about. And this industry, power, run time and safety and economics has been important for our users. And while there's continued advances in all of the electronics, the motors, batteries, they continue to push forward in a way that you're taking out new applications that couldn't be done efficient or effectively in a cost-effective way with battery in the past, and we continue to see a lot of opportunity on that front.

And I guess, kind of marrying the two things we talked about thus for, the cost journey as well as the growth opportunity and some of the innovation, Tools & Outdoor sort of capture a few of those things. Obviously, a big area of electrification, you guys have made investments there as well with MTD. How would you characterize the level of competition, the level of customer uptake on electrified product maybe versus traditional? How's that journey gone?

Yes. I mean I think the competitive dynamics have been, at least from what I've been able to assess in my 5 months here, relatively stable, that we have very good, very capable competitors. So we're going to have to be at the top of our game to delight end users and delight channel partners, but we feel like we're equipped to do that. I think in terms of uptake, I'd say we made a big outdoor acquisition a couple of years ago. I'd say the handheld walk behind transition to electric, I'd say that's at or above the pace we would have anticipated in that outdoor equipment transition. I'd say when you're talking large format, like ride-on, whether it's for the consumer or for the Pro, I'd say that's slower than we would have anticipated. And I would expect it to kind of keep going at that pace and that the performance and cost basis that's going to appeal to the consumer for that larger format. I don't think the industry is there. I don't think that's just us, I think that's broadly, there's just not the cost benefit there yet. So I think it will happen. Just like more and more of automotive, we'll make that transition, but I think it's going to be at a much more measured pace than we or others would have anticipated a year or 2 ago.

Understood. Like putting all this together, you guys are -- as part of this journey kind of identified maybe where the landing zone is for '24 in that $4 to $5 range? Understanding the sort of this exit rate phenomenon that's taking place. I think for most folks, kind of the internal calculus from here is how much of that 4 to 5 is sort of a baseline, of which we resume normalized growth versus are there a lot more incremental discrete items that you would say, okay, never mind, the revenue is over the next few years, there's still x -- $100 million of costs being taken out. Any way to maybe thread the needle on define that a little bit more? Just what we could at least think about order of magnitude post '24?

Yes. Well, I'd say, as you referred to some of the expectations Don had half a year or a year ago, I still think that's very much in the ZIP code. I think next year will play out based on where the macro is on the margin, what our level of investment is and where deflation is and we'll kind of give you that update. But we're coming out of this year. This is consistent with the guidance we gave at the end of Q2 with a very kind of healthy trajectory, that kind of points to that ZIP code. I think beyond that, we still have $1 billion of cost out after the end of this year. And we have a lot of confidence in that. I would say, as Chris has come on board and as Chris and Tamer and I work under Don to take his vision forward, we're working to see, can we and should we be pushing that gross margin up from there? And what is the right long-term algorithm for this business? And I think we feel like if we set the right priorities and we stay focused on those priorities, we have every bit the ability to get the EBITDA margin to the high teens, if not into the low 20s, and that's where we're focused on. And with a really healthy gross profit margin, that's at least 35%, if not higher than that. I think you want to be at that level, if you're going to be able to invest in innovation and brand consistently throughout the cycle. And whether or not you go higher or lower than that is predicated on where do you see the growth opportunities, right? The more you see growth opportunities that might have your gross margin be on the lower side of the range. The more you see something like growth that's mid-single digits and thereabouts, you might push that margin up a little bit higher. But we're trying to drive the business to at least mid-single-digit growth, at least 35% gross profit margin. And to the extent we can push one or both of those higher, we will because we're trying to get to the business to high teens, low 20s EBITDA margin.

Understood. Crystal clear. And I see we're at time. So guys, I really appreciate you taking the time. Thanks for joining us. And we'll leave it there. Best of luck to you.

Well, thanks, Josh.

Thank you.