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

So our next fireside chat, we're really happy to have Stanley Black & Decker here. We have Pat Hallinan, EVP and Chief Financial Officer; as well as Dennis Lange, who runs Investor Relations. Pat, I think you had some prepared comments, you want to go through a little bit of a presentation, and then we'll get into Q&A.

These are the same slides?

Same slides. That's good. It's all kind of...

On the slide, Joe. So we feel -- we definitely -- we brought 3 slides. We had an Investor Day right before Thanksgiving. And a big part of Investor Day was 2 things. One, talking about where we are in our transformation journey, which we expect to be substantively done with by the end of '25. And what are some of the financial objectives we have beyond '25 and our pivot to growth? So certainly, as we've gone through the transformation since the latter part of '22, we've come out of a much more focused portfolio. We have a tools business that's a bit more than $13 billion in revenue and a fasteners business that is a bit more than $2 billion in revenue. We've really set the business up for growth from this point. And that's where our investors -- our investments are. We certainly have a bit more work to do on the margin journey, but we feel like we're making the progress we want to make, especially given the lack of volume we've seen. And we think there's very exciting opportunity as we go forward to combine growth with margin in our business, along with a very disciplined capital deployment. The long-term financial objectives we shared at our Investor Day, and these are beyond '27, are return to mid-single-digit growth, which we think is around 200-plus basis points over a low single-digit market. Our kind of underlying market is real GDP, especially real durables GDP; a margin profile that's above 35%, targeting -- trying to get back towards 37% plus, but certainly above 35%. Annual operating leverage, so annual growth of pretax operating income at about 20% to 25% of annual net sales gains. And then EBITDA margins in the high teens. CFROI margins, mid-teens are better, and cash conversion around 100% of net income, plus or minus 10 percentage points. And then getting our leverage back down to more traditional levels, which are kind of 2.0 to 2.5x net debt to EBITDA. And we're excited about where we're going. I mean obviously, I think, like many of us, we kind of wish the macro environment was a bit more of a speeding elixir, but we really feel like we're getting the brand well positioned for growth. While we have work to do on the margin, we know what that work is, and we're excited about combining those 2 to really generate a lot of value creation and then be very disciplined on how we allocate that capital. I thought that would be kind of a set up and then turn the Q&A back to you.

Yes. No, appreciate that. And we can probably keep it on the long-term financial framework. But one of the slides that you guys had at your Investor Day was really like the path to 2027 and basically, the implied EBITDA was about $2.5 billion by 2027. So maybe just talk to us about the levers, like how important is getting to 3% organic growth in terms of being able to achieve those targets? And what you think the key levers are to get there?

I think -- I mean, I think the -- on the growth -- because obviously, we're making some SG&A investments as we go down that journey, right? So if you're thinking over that time horizon, $300-plus million of SG&A investments, you're probably talking the gross amount of contribution margin has to be kind of $1.3 billion plus or minus $100 million, probably about at least $1.3 billion. And I'd say it's -- so half to more than half is going to be purely gross margin and then the balance is growth. So growth is a meaningful portion, but it's not predicated solely on growth. That's not like we're sitting here kind of fingers-crossed to a market dynamic. And I would even say, inclusive of that 35%, while volume would certainly be helpful to the 35% journey we're committed to getting to 35%, kind of irrespective of the volume environment. In fact, what we said at Investor Day was, as long as the volume declines can stop, the 35% journey is something we have a lot of confidence in.

That's great to hear. And just to be clear, the path to 35%, the expectation is 35% exiting next year. And as you think about the path, part of it, you guys had also said you're increasing your inventories this year. When you say that you've got a lot of confidence, just talk us through the key levers to get us from exiting this year at 31% and change to 35%?

35%. Yes. We're still focused as a team working towards that 35% by the fourth quarter of next year. We did talk about both at the Investor Day and the third quarter earnings call. We're probably chasing somewhere in the $100 million to $150 million of incremental savings to make that happen just given the lack of volume and the lack of deflation we've seen over the last couple of years. And so if it doesn't happen in the fourth quarter of '25, we would expect it to happen sometime in the early or middle part of '26. It's still a focus. And I'd say, Joe, the main levers are about half incremental strategic sourcing and the other half is the combination of additional footprint rationalization and in-plant lean in the facilities that remain. And I'd say they each contribute roughly 50-50, that other 50% is a combination of the footprint rationalization and the lean.

Okay. Great. That's super helpful. And then maybe just going back to the longer-term comments. Now you're hoping for 35% to 37% or greater than 35%, talked about network optimization and operational excellence, can you just maybe step us through what that actually means in practice?

Yes. I mean, we have 3 things going on simultaneously. Probably the one that requires the most in terms of moving things around is footprint rationalization. So as we've done that, I think there's one on the production side and one on the distribution side. Production-wise, it's getting capacity out of the system. And it's also doing some things that are the result of kind of finally getting to the full integration of the businesses we acquired, which is getting to centers of excellence by product categories, sometimes 1, sometimes 2. And that has been pretty significant. We're -- we've been over the period of '22 to '23, probably in kind of 1 to 3 major facility closures a year. We'll probably be at least kind of in the 2 or 3 perspective for the next couple of years. And then on the distribution side of things, it's again been a capacity, but it's also been reorienting our hubs and spokes to simultaneously take capacity out, but improve service levels. And I want to say this year, just within '24, for example, there's probably 40-plus rooftops having some type of effect on them, whether that's a closure of a production facility, opening a new part of the distribution or moving a value chain out of one facility or another. So quite a lot of activity, obviously, because fixed costs aren't our biggest cost, that's why it's not the biggest driver because materials are about 60% of our cost base, that's why sourcing is the biggest driver. And so these things are all going on simultaneously. So we'll continue on the path of strategic sourcing. It will continue to be our biggest contributor in the latter innings, just like it was in the early innings because of the composition of materials in our COGS. And then in-plant lean is kind of getting globally standardized manufacturing processes that are optimized. And that is working in parallel with whether it's a facility move or an existing facility that just needs to be optimized.

So a lot of stuff going on.

Yes, a lot of stuff going on...

A lot of stuff going on. And look, arguably, a great time to be doing it, just given that the environment has been tepid for your business. If things were to turn on a dime, right, and the business would -- starts accelerating, let's say, in the first half of next year, I'm not saying that that's going to happen, but let's...

Let's hope it does.

Yes. So do you have too much going on? Or would you be able to deliver to a better growth environment when the environment turns?

Yes. I think we welcome growth. I mean, yes, we have a lot going on, but none of it is being pursued in a way where we kind of tie a hand or 2 behind our back if growth were to inflect positively. Growth would help us quite a bit, and we would welcome that quite a bit.

Can we talk about the SG&A investments that you're making because I think you mentioned $300 million earlier. Some of it is putting just more feet on the street. And just maybe how are you thinking about toggling those investments with the fact that you structurally want to lower your SG&A over time as well?

Yes. I would say, when we talk about, and you're probably referring to the Investor Day going from kind of 21% to 22% more to like 20% to 21%. And I'd say that as much about a surge of investment to drive innovation and growth improvement. And then it planes out of the water a little bit as you start getting that revenue growth, right? It starts to moderate what percentage of sales it is. Two things will be going on. One is Chris Nelson and his team have really been focused on putting that incremental investment towards innovation and towards brand building and feet on the street, and the early innings were a lot around innovation. And as he's gotten that running, increasingly, you've seen this year and the latter part of last year, increasingly feet on the street and brand building. And I think that will continue to be kind of probably at a higher level than will be the permanent level for a while until we get the organic growth engine back to the market-beating growth of level will perform. But we'll also always be challenging our functional spend back office. My finance function will have to get more efficient. And I think that's pretty stereotypical for at-scale branded goods companies, where we're going to be driving efficiency in finance, HR, IT and legal to continually fuel growth going forward. But I think a little bit what you're seeing in the financial targets we layered in is eventually, once the growth algorithm is humming, we can kind of moderate that a little bit, and it will look as a percentage of sales to be more like 20%, 21%.

Helpful. I want to -- in kind of thinking about your key competitor in the space, like one of the core tenets to their strategy was a larger field presence, right? As you kind of think about your own field presence relative to Tektronix, how much catch up do you have to do to have something that is comparable?

I think it's a manageable amount of catch-up. We've probably put, I think, in the last 12 to 15 months, like 400 people in the field. I think it's a manageable amount of catch-up. I think what we hear loudly from our channel partners is, we're talking about pro oriented channel partners. They want manufacturers helping them drive sales, and they want a manufacturer who's supporting their product in market. And that's where our resource dollars are going. And we maybe got a bit behind of where our -- even our own history was. But I think the level of catch-up is manageable. And we're just being thoughtful as we layer the investments in that we're tracking them against specific objectives, and that we're making the progress that we expected and the progress that's reasonable to the rate of investments, and we're not just throwing it out there kind of Willy Nilly. So when you talk about the field resources, you're talking about very specific geographies and very specific channel partnering.

And just contextualizing that number, the $400 million, like how does that compare to what the field organization was about a year ago?

Joe, I think it's a pretty significant increase if you think about geographies. And to Pat's point, what we've tried to do is be really thoughtful about where are the priority markets, how do you do it with people, but how do you also wrap around the other initiatives that we've talked about, be it grow the trades, flowing more marketing behind our brands and really kind of having a holistic approach as you go into regions or if you go into other geographies around the world.

That's helpful. And then Pat, you mentioned earlier, sourcing being the biggest opportunity. You guys have made a lot of progress on your cost reduction program, still heading towards like roughly $1.5 billion by the end of this year with an extra $500 million coming next year. When you mentioned earlier that you were still needed to chase roughly $100 million to $150 million, is that all in the context of what the $2 billion expectation is?

It's probably going to put us beyond that. We kind of haven't like announced a new goal because I don't want to confuse people. But we expected certain volume and deflationary dynamics over these last 3 years that haven't played out. They haven't been growth years, and there hasn't been substantive deflation. And so we're probably going to have to probably get closer to 1.6% or 1.7% to get to the 35% in a reasonable time frame. And that's -- as a leadership team and as an operating team, that's what we're focused on, is accelerating some additional savings in the absence of volume and in the absence of deflation gets to the same gross margin outlook.

I'm going to turn it to the audience in a second, see if there's any questions. But one of the things that you guys talked a lot about at the Investor Day was around platforming. It seems like a big fundamental change to how you guys operate. So maybe just discuss what's happening on that front.

Yes. I think innovation broadly and platforming is part of that. One of the things Chris Nelson did, or I'd say 2 very important things they did and strategic and organizational change in the business was go to a brand-led structure, where brands have equal, if not greater, billing than sales. There are always an important mix of marketing and sales, but we kind of had a sales-dominated structure for a long time. And then the second was to centralize all the engineering resources under a Chief Technology Officer. And the reason why those things are really critical is we wanted to drive innovation really backwards, not just from -- we were always very good at driving innovation backwards from user dynamics, but the combination of where do we see opportunity to innovate for users, but also against the biggest growth factors. So we're being really focused on the innovation is towards the biggest growth opportunities. And then how do you centralize the way you do innovation? See you're creating product libraries around engines and transmissions and electronics and batteries, so that every product developer, because we had a highly decentralized product development approach, it doesn't feel like they have a degree of freedom to just go out and create a lot of uniqueness that maybe isn't adding value to the end user. It might be interesting, and it might be on the margin, something that's new, but isn't particularly impactful and really hone in the degree of differentiation in components and subassemblies. And that's already been underway. Ricardo Munoz, who's our Chief Technology Officer in our Tools and Outdoors business, has been starting this journey. It will take us at least 2 to 4 years. So this is kind of a meaningful chunk of the SKU base just because it takes time to roll it out, but he is already going through each of these component categories in creating standardized libraries. And given his ability to manage the innovation process and the engineering base, keep people disciplined around that library.

That's helpful. I'll go to the audience and see if there's any questions. Could you just wait for the mic real quick. Thank you.

Could you talk about the innovation pipeline that can drive 2025 organic growth?

Yes. I think there's a number of things in the innovation pipeline, in particular, DEWALT around concrete and plumbing and electrical. But I -- what Chris and team have been focused on is innovation across all 3 of the big brands. In DEWALT, you're talking about 4 to 5 really targeted areas of trade groups globally. In Stanley Black & Decker, they're really focused on both productivity enhancing and industrial design, enhancing performance in STANLEY. And then in CRAFTSMAN, it's around getting that COGS base styled in for the DIY price points. And so all that's going on. I'd say for '25, it's mostly going to be around the concrete stuff and plumbing and electrical for DEWALT. You have things like the Construction Jack for STANLEY and some other like items, like there's a heavy lifter device called GRABO for STANLEY that helps construction workers grab heavy items on their own and be more productive as individuals. And then in CRAFTSMAN, it's mostly around outdoor products.

Helpful. Any other questions from the audience? I'm surprised that first question wasn't on tariffs. So I'll ask you on tariffs. Okay. So you laid out at a conference in November, what your expectations would be a potential additional $200 million tariff expectations if we did see tariffs go to 60%. Help us understand how that actually works mathematically, right? Because I think you've got a COGS base. It's like roughly $6 billion. 20% to 25% of your COGS, I believe, is in China. Like -- so how does that mathematically only result in a $200 million impact?

Yes, yes. So you're speaking, and Joe speaking to some information we put out before Investor Day and then reiterated on Investor Day, so you could see it online. Our U.S. P&O COGS base is about $6 billion. Our global COGS base is about double that, but that's the U.S. COGS base. And there's a pie chart that kind of illustrates of that U.S. COGS base, where's the predominant geographic origin of the COGS base. And it is about 20%, 25% China. So first of all, it's -- we already have 25% tariffs on stuff from China. And so the list -- the 301 tariffs, List 1, 2, 3 and 4A that were enacted over the period of mostly 2017 and 2018. And most of those, not all of them, but most of them in simplifying terms are at 25%. Those tariffs still exist today. When they originally came out, they resulted in more than $300 million of exposure to our business. Through supply chain moves, we've gotten that exposure down below $100 million. So what we were pointing to is if on those same items, things went up an incremental 35 points, roughly speaking, that's where that $200 million comes from. And if that were a scenario that played out, we would start with pricing actions, and then we'd be quickly bringing in supply chain actions to attack it similarly. The reason we pointed to that scenario because we would acknowledge like, one, we don't have any specific information. We don't know what will happen any more so than anybody else does, and you can come up with many different permutations. It's twofold. One is that's a pretty expedient action for the administration to take. They already have a framework out there. It's been legally challenged, so they can -- they could do it and sustain it. The second thing is, I think just geopolitically, we're going to have to continue reducing our U.S. market exposure to the China market. And so kind of irrespective of what administration came in, we were going to be on this journey. You're going to -- this administration might accelerate the pace, but reducing U.S. market exposure to China was probably going to be on the long-term strategy, right? It certainly was on our long-term strategy road map, no matter what. And so that's why we pointed to that strategy. We also illustrated our other source of COGS, 40% to -- 45% to 50% of which is U.S. and the balance is rest of world. So people want to kind of run their own permutations, they can kind of run their own permutations.

Yes. Helpful. And when you talked about all the rooftop reductions that you were doing, the footprint changes that you're making, is that already contemplating less in China?

Yes. Our global supply chain team, and we kind of have a strategy part of our global supply chain team was, okay, we want to take out at least $1.5 billion of COGS and part of that is going to be footprint-oriented. We want it to be going directed to a long-term supply chain vision. And so the -- where do we feel like it's going to be most likely to be geopolitically safe to operate? Where do you have a supplier universe? Where can you build both an engineering workforce and a production workforce? And so they were all swimming towards these objectives. Absent a government intervention, you kind of get it -- it gets paced by the rate at which you can develop suppliers or get your suppliers to move with you and build your engineering base. If you end up having the effects of tariffs, you end up just having to kind of accelerate those dynamics as best you can is really what you end up doing.

Yes. That makes sense. And then just from a -- I know it's still early stages, and I think we're still trying to figure out how this is all going to shake out, but have you started having conversations with your channel partners regarding pricing? And how do those dynamics work? And...

Yes. I feel -- we definitely are in a very important margin journey, and we're very committed to that margin journey. And supply chain moves tend to take 12 to 10 -- 12 to 24 months. So the lever to pull before the supply chain is priced. And so as soon as the election result was known, we started to have conversations with major channel partners about, hey, we don't know what's going to happen, but we want to communicate to you our approach, should some things that seem reasonable happen, which it does seem like there's likely to be tariffs, and it does seem likely to be -- some of them will be China, and those might be the more enduring. And so we started those conversations. Obviously, we haven't given out a specific, like here's the list price change on this date because we don't know yet, and we'll enact it when there's better and more information. But we certainly wanted to be working in a very proactive and transparent and forthright manner with our channel partners. We wanted -- we felt like maybe the last time, as I said, the supply chain we were very effective with moving and moving pretty quickly. We went from 40%, 45% China down to 20%, 25%, but we probably could have been more proactive with price, and we want to be more proactive with price this time.

Unlike last time, this isn't the first tariff rodeo. So is -- what I'm hearing from you is it seems like there's -- because there's a playbook to have those pricing discussions, maybe pricing happens quicker...

That's our objective, and that's what we're working with our channel partners. And we've already gotten to the point where our teams are probably 4-plus months into where are the competitive dynamics and the elasticities by SKU and product family, more conducive to pricing and where are they less conducive? How do you get across a portfolio of thousands of SKUs, the right price coverage to deal with the tariff burden, but also acknowledging elasticities as reasonable a way as you can.

Makes sense. I want to turn it over to the portfolio. At the Investor Day, you highlighted divesting a business for roughly about $0.5 billion in proceeds, noncore assets. It seems like you're targeting the Aero business. I'm just curious, like, have you already seen interest from prospective buyers?

I'd say Aero is among. I'd say we have a small number in each side of our house, which the Tools & Outdoor and the Industrial side, that could be candidates. I'd say we haven't started a process, and I'd say any process would be -- we'd have to see, is the business ready? Where is the M&A interest? But yes, I mean, we have not just in that business, but in some of our other businesses, people come in to talk with us. I certainly -- it feels like the M&A markets are getting on the margin healthier, the back part of this year. And we're doing certain things to position assets to be ready. We'll see kind of what, if any, kind of tariff scenario comes out of the front half of next year. And given that knowledge, our business readiness and the particularly strength of any one part of the M&A market versus another, we'll make a call on what that asset is.

You guys have done a lot from a portfolio perspective over the past decade. You really have grown your Tools & Outdoor business, you've divested some noncore assets with the Security business, now like divesting potentially the Aero business. Why not more holistically look at the Engineered Fastening assets as a potential divestiture candidate and just become a stand-alone pure-play focused tools company?

Yes. I think our first and our foremost, our objective to all of our stakeholders is to maximize value creation. And if that was ever kind of the thing to maximize value creation, we'd have to consider that as stewards of financial returns. Right now, we feel like there's opportunity to get the fastener business to a different performance level. And the way we see the way the market is valuing that, at this moment in time, as best we can kind of decipher from the dialogues we have and the strategic work we do is we do better for our stakeholders, driving the growth and performance of most of that business, even if part of like something like Aero were to go away, creates more value for our shareholders. If that dynamic change, then we would consider something different. There are some synergies between these businesses and that some of our fastener product lines use tools that are driven by the product platforms we have in the T&O business, but we always challenge ourselves on that. If we felt like that was a value maximizing thing at this point in time, we'd be considering it. We don't think it is. And it's not -- we don't need something of that order of magnitude to really kind of navigate our balance sheet dynamics.

Let's talk about free cash flow. And so you've given us targets to 2027. You've given us longer-term targets beyond that. How do you think about normalized free cash flow? Because we're going through this like strange period, right...

Yes. Very strange. With the combination of spending a lot of cash on transformation, but then taking a lot of cash off the balance sheet from working capital, there's some very sizable -- last year was about $1 billion of inventory reduction and a couple of hundred million dollars of transformation cash. This year, we'll have kind of $400-ish million or so of inventory reduction, but still another couple of hundred million dollars of transformation cash. Yes, I'd say the longer-term objective is to be about 100% cash conversion of net income, plus or minus 10 percentage points depending where we are in a PP&E cycle. And we're probably 2 to 3 years away from that. I'd say 2.5 or minus a half year away from that.

That's fair. Last question for me. We talked a little bit about the 2025 framework, at least the 35% gross margins. You're really not banking on a lot of growth, at least in the first half of the year. Are there any other parts of the framework you want to highlight or elaborate on at this point?

No, I think next year, we are working to make it a growth year. I think the markets will tell us that. I think if there's not some kind of macro shock from geopolitics, it has a very good chance to be a growth year. I don't think it will be a lights-out kind of growth year. That would be a pleasant surprise if it happened. But I think if it's a growth year, it's kind of a low single-digit growth year. We're working hard to get to that 35%. I'd say, again, absent a big tariff shock, we certainly expect to finish the year somewhere in the 32%, 33-ish percent gross margin range. And we're still going to be prioritizing transformation, sustaining the dividend and deleverage for our capital deployment. And we'll probably be, again, not knowing any tariff scenario, $300 million to $500 million of working capital reduction, mostly around inventory. I don't want to give specific '25 guidance, not with those kind of broad strokes. Those are consistent with what we need to be true to kind of deliver on our multiyear framework. And I think that those are, again, absent an unpredictable dynamic from an administration, that's kind of what we're focused on.

Perfect. Pat, Dennis, really good to see you. Thank you for coming...

Thank you for having us, and thank you for the interest. Thank you.