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

Right. Hello, everybody. So for our next presenters, we're excited to have Stanley Black & Decker here with us. We've got Pat Hallinan, CFO. Pat, you wanted to kind of start off with some initial remarks. So why don't I turn it over to you?

Yes. I'll say a few things and then turn it over to you, Joe, for some questions. Obviously, for manufacturers, especially manufacturers with long supply chains especially those that extend to Asia. It's been quite an interesting year. And I would just start off saying that while this has been a year of dealing with a number of challenges and headwinds, as a team, we're quite confident that we stay on our long-term trajectory about a year ago this time we had a Capital Markets Day, laid out a number of markers of getting to mid-single-digit top line growth, 35-plus percent gross margin and EBITDA margin in the high teens or better. And we still think those are the right targets for the business. Tariffs probably put us 12 or so months behind that pace. But we've taken enough price to offset the tariffs. And then we're going to be pursuing mitigation that is well underway and throughout next year, that kind of gets the margin back on the volume impacted by tariffs, and we feel very confident with the path we're on. We would certainly welcome a calmer environment or a more construction products friendly environment, but we are confident in the things that we control.

Makes a ton of sense, Pat. And so I know Chris isn't here, but still, it's early days for him as the CEO. Just any thoughts on just changes in strategic priorities or playbook is in place and expect to kind of...

Yes, I would say for those of you who aren't familiar with us, we hired Chris Nelson, about 2.5 years ago, he sat in the Chief Operating Officer chair for the better part of those 2.5 years and took over the CEO reins in October. And I would say his approach will be evolutionary, not revolutionary. We are going to stay very focused on the financial metrics we laid out a year ago and very focused on the strategy that he really helped design over the last year, 1.5 years of being a branded products-oriented company where we're really for the near to medium term, myopically and aggressively focused on organic growth and margin expansion as opposed to M&A. And the same brands, DEWALT, STANLEY and CRAFTSMAN will remain the same priority brands. I'd say we'll do some very modest portfolio tightening. So again, I'd say it's -- it's more evolutionary than revolutionary. And the thing that I'd emphasis at this stage of our journey and it's unfortunate the tariff disruption of get to the 35% gross margin so that the focus is disproportionately on growth, right? Because that's kind of the next big -- I think, the next big chapter of the same story.

Got it. So let's talk about the long-term targets, and you referenced the fact that the same target still exist, but maybe because of the tariffs, they've been pushed out about 12 months. But let's talk about gross margin specifically. So the 35-plus percent gross margin target you now see it being achieved in the fourth quarter of 2026. Just talk about some of the levers that you need to pull in 2026 to achieve it. And then also, I know we'll get to growth, but what kind of level of like market stability do you need in order to get.

To growth? I can talk about both. I'd say gross margin. So I'd say the good news this year in a crazy year of a point in time when Liberation Day tariffs were 100% of our EBITDA. And obviously, and thankfully, those tariffs came down to maybe more like 35% of our EBITDA, but still a significant headwind. We really only had tariffs kind of knock us off forward margin trajectory for 1 quarter, the second quarter of this year, right? We took price quickly. And by the third quarter, we were back to margin progress. We finished this year, probably the fourth quarter of this year, around 31% gross margin for the full year and 33% for the quarter. Obviously, there's a little seasonality with our gross margin because we have outdoor products in the front half of the year that put some weight on it. But we expect to get to 35% next year. And I'd say Joe, the levers are -- we've been pursuing, as you know, about $500 million a year of gross COGS improvement each year. Next year is probably more like $350 million, $375 million of what I'll call like type gross margin improvement, whether that's strategic sourcing, platforming, continuous improvement in the plants and a few more plant activities. We probably get a few more footprint nodes out of the system next year. But then complementing that is $200-plus million of tariff mitigation, which is by the planned movement of SKUs out of China, whether that's to Mexico or elsewhere in Asia and then the SKUs that go to Mexico, getting USMCA compliant, that effectively lowers the tariff bill by $200 million to $300 million. So it's a combination. It's a modestly lower amount of gross traditional COGS savings complemented by about $200-plus million of tariff mitigation.

Okay. Great. And then just on the growth aspect, as you look into next year, getting to that, call it, 35% plus gross margin by the end of next year, does it contemplate a certain amount of growth.

I mean obviously, we would welcome growth and growth can provide leverage on the margin, and it can provide some leverage headwinds if it doesn't materialize. But when you think of our cost structure, our PP&E is about 2% to 4% of net sales. So there's not a big fixed asset issue around growth. It's really how we're leveraging the people in our plants issue. And so when the growth doesn't come, we have to rightsize the head count in the plants and when the growth does come, we can leverage it up to a point until we need to add a shift or something like that. So next year, I don't -- I'm not here today to kind of call next year's macro, but we probably aren't going to prepare for a robust macro. We will prepare for kind of a like noisy flattish or thereabouts kind of macro. And we're going to make that 35% margin progress kind of irrespective of that. It will force us -- if that is kind of closer to flat than to up, that forces us just to be tighter on our headcount, and we would certainly welcome the macro should it improve. I mean I think -- and I think there's a chance of that in the sense that this has been a year where because of tariffs, people have been very lean on inventories, hasn't been -- with all the immigration enforcement, it hasn't been a terribly friendly year for construction labor. And so if next year, just those things stabilize or don't get any worse, and there's any kind of midterm pressure on rates, then I think there's some chance for upside. But that's the kind of stuff that it would take to get, I think, macro upside.

Makes sense. Do you want to just spend a minute or so talking about the -- what you're seeing in the Pro versus DIY channel?

Yes. I would say this year, like the last few, the Pro has stayed stronger. I'd say, both have kind of been fits and starts. I'd say, obviously, the Pro has been more robust throughout all of this. And the takeaway from this year is you have some SKUs because we took quite a bit of price this year. And while the elasticity across the total portfolio is roughly 1 point of price up, 1 point of volume down. Obviously, that's not true everywhere at the SKU level. There's some that are more favorable and less favorable than that. When you really see truly, truly, truly only Pro SKUs, things for like hammer drills or saws for cutting concrete, you're seeing much less elasticity than you are in DIY SKUs. So the Pro has stayed stronger. I do think, though, that all have felt a lot of pressure from price and from immigration this year. And so the backdrop has been more challenging in '25 in total than in '24, still with the Pro ahead of the DIY, but both with some pressure. But the Pro is still willing to pay for performance, safety and durability, and the DIY is still on the margin spending only when they need to.

Makes sense. So we typically talk a lot about the gross margin line when it relates to your company, but the reality is that you're also doing things on the SG&A side as well. I guess talk a little bit about some of the investments that you're making in SG&A, but then -- and then balancing that with trying to structurally have lower SG&A over time?

Yes. And I would -- what I would say structurally, we've kind of had SG&A on a global basis as a percentage of net sales in the 21%, 22% range. As you know, Joe, sometimes it's kind of been 22-plus slight amount. Sometimes it's been lower. I would say, if you're thinking of next year, I'd say somewhere very much in between those 2. But inside of SG&A in a year like '25 here where sales is roughly going to be flat, we're pulling about $100 million plus out of the back office in order to put $100 million into the front office. And for '25, much like '24, the preponderance of that investment has been in product and in field resources, be it field sales or field support. I'd call it pretty modest changes in '24 and '25 around digital capabilities or just pure brand advertising because we were over these last couple of years, we've been a little bit refreshing our brand strategies and dialing in which targets we're going after most. I think as we go into '26, you're going to see a year that's somewhat similar where we're creating the capacity to invest by being lean in the back office. The investment will be similar kind of in that $70 million to $100 million range. And it will be similar, but I think we feel we're at a stage digital infrastructure-wise and brand strategy wise with DEWALT, CRAFTSMAN and STANLEY where you'll start to see maybe a different balance of what I'll call just pull marketing, be it digital marketing or more traditional media for brand advertising in addition to more feet on the street, but it won't be kind of all that. And I think it will be -- and that's just a reflection of the evolution of the brand turnaround.

Got it. You referenced earlier the $350 million to $375 million in platforming manufacturing footprint, sourcing kind of being like the primary levers. You're also on the cusp of concluding a very large program, a $2 billion cost reduction program. One of the questions we get frequently is how is there still room for them to cut costs? Like so how -- so how does the $350 million to $375 million that you referenced, how is that different from the actions that you've already taken over the last couple of years to drive out a pretty significant cost out?

Yes, I'd say on the margin, platforming and in-plant improvement, which platforming was barely at all in the last 3 years. and in-plant, which is -- which was a smaller part of it are growing, but I'd still say the preponderance is in strategic sourcing. But what I would tell you is like any company where you kind of have a living, breathing marketplace you're dealing with and performance execution, the pipeline we have right now of ideas to chase the $350 million, $375 million next year and the fruit that they're bearing in the early days is on a proportional basis like the pipeline we've had. So the way we govern it is we have -- at any given time, we have a set of 4 big work streams going, whether it's in-plant improvement, sourcing, platforming or taking nodes out of the network. And there's a game plan and there's kind of a high side, low side and what's the monthly and quarterly estimates of those and how much fruit are we getting along the way. And we're on a trajectory right now that would tell us proportionately, we could deliver the $350 million, $375 million next year. And then on the tariff mitigation, we have -- every Friday morning, we're together with a by-SKU where is it moving from country A to country B and how much USMCA. So it's -- you can imagine it's an intense project management process, but it's the requirement for us to get to 35%, you -- you've been part of this journey even before I came on board. And when Don laid out this game plan in the middle of '22, it was predicated on volume growth being mid-single digits. And so what we've had to do is get to the same endpoint with higher tariffs and with basically a volume decline. And so we've had to gin up more ideas and pursue them more aggressively.

So it's interesting. In a hypothetical scenario where tariffs maybe not go away, but they're a lot lower than they are today. You've done a lot to your supply chain to change the supply chain. How does that ultimately affect your P&L if we were in a much lower tariff environment than what you're experiencing today?

Yes. I mean I think you're getting to the -- is some of this regrettable -- or is it [indiscernible] some complexity or all these kinds of things. And I think like any manufacturer, we haven't, as a country, provided a very stable backdrop of policy to the good or the bad, right? I mean it's been a lot of whipsawing and I think what we've concluded, we're a global player is at least our U.S. COGS have to be minimized in China because whether we went under Democratic regimes or Republican, there's enough friction there. Sometimes it's just pure geopolitical friction, sometimes it's very trade-centric geopolitical friction. But I think that's something we must do and as long as we execute places like Mexico, Vietnam, Thailand efficiently, we -- first of all, over time, we can definitely get them to China levels efficiently. It will take some time to get that. But we feel like we're going to end up -- where we were a company that probably had 3 big centers of gravity manufacturing-wise, we're probably going to be more like 4 or 5. China doesn't go away. I mean we still have a European business and Asian business and a Latin American business that gets serviced from China but that node shrinks a bit and probably 2 other nodes grow a bit. Would you rather have 3 than 5 from an inventory perspective? For sure. But I think that's just the world we're going to be living in. And we feel like it gives us the flexibility that as different forces play out over time, we can kind of adapt over time.

Yes. And just for those that are not familiar, your expectation is still to have less than 5% of your COGS that you're sourcing into the U.S. from China?

Correct. Yes. We started this year around 15%, and we probably finished '26 below 5%.

Yes. Pretty incredible change there. Also for the folks that don't understand or don't know much about your platforming strategy. Do you want to explain the strategy and then ultimately, why now is the time for you to embark on it?

Yes. I mean -- there was a very big part of Stanley Black & Decker for a long time, where there was a highly decentralized engineering and product development process. And that's only changed in the last 2 or so years where Chris Nelson brought in a Chief Technology Officer. We centralized all engineering and new product development off of 1 central group. And in the old world, I think to the benefit of the company and 1 thing we've tried to hold on to is we were very close to end users and what they valued. And so our product developers knew intimately what they needed to do to drive value to end buyers. But they also had full license and really no good infrastructure to share. So they went off and they did everything in a very bespoke manner. I mean if they were innovating the next impact ranch, they specified their own engine. They specified their own transmission. And there was nobody overseeing it to harness it, that's a miss on our part. We now have the org structure and the incentives in place that and just the governance in place that people have to use set libraries for key components. And also that we have the expertise to make sure we're offering up the quality library to do things. And so I think now is the time, it's a huge. I came from a business where we use platforming to a great extent. So did Chris. I came from Fortune Brands, Chris from Carrier. And it's super powerful. It is a very big cultural change because people have to give up a degree of freedom and they have to see enough value in speed and cost to give up the degree of freedom because they are making trade-offs. But I think it's going to be a very powerful lever for us. I don't -- I think it's a modest piece of what gets us to 35%. I think it is an unlock beyond 35%.

And the measurable impact is going to be the cost efficiency and cost savings and the productivity associated with it.

And inventory longer term. I mean I think it's -- right, you can imagine a world where if sales were flat, we would like to get another $800 million to $1 billion of inventory out of the system. I think that becomes -- we'll make about $200 million of progress next year. That will become easier once we get through some tariff mitigation because you can imagine there's a lot of inventory builds and drawdowns as we go through tariff mitigation. But if we're going from a world with 3 big manufacturing centers as we just talked about to 5, that's a work against inventory. So if we're going to get inventory net down over time, we're going to need efficiency and efficiency is going to be better sales and ops planning, but also from things like platforming.

So we've talked about some of the pieces for 2026. Do you want to elaborate on maybe -- you mentioned inventory, that's a piece that people will be paying close attention to. We talked about the gross margins as well. Do you want to provide like any other thoughts around an initial framework for next year?

Yes, I certainly want to stray from strong form guidance because I think we're still trying to figure out exactly where the consumer and the market will be. So I kind of leave it to the wise people in the audience to kind of make your own kind of market predictions. I think and this is consistent with both the third quarter and some of the Q&A that is filed, right? We'll be aiming to hit 35% gross margins by the end of next year. We'll be there or very close. Certainly, our goal as a team to aim for 35%. We're probably going to finish this year with an average of 31%. It will be 33% in the fourth quarter. That's a pretty seasonally strong gross margin quarter for us. I think next year is probably going to be an average of somewhere in the 32%, 33% range with 35% being the endpoint. I think SG&A will be somewhere in that 21%, 22% range. Tax, about 20%. And we'll probably try beyond the cash that would flow out of that normal operating income chase about $200 million of inventory reduction. And I think until we talk to you about our market expectation at the end of January, beginning of February, that's a framework to put up against your own market expectations.

That's helpful. And your comment on seasonally strong in the fourth quarter. That is something that we've witnessed and experienced before. So gross margins stepping down sequentially but still up year-over-year, probably starting at the low 30s, to start is probably the right way to think about it.

Yes. I'd say that's the case. I mean I'm still waiting to see. We do have -- we talked about it on the third quarter call that as we went through tariffs this year and some of the pricing we decided as a leadership team, hey, let's not be too dollar on the elasticity, let's keep some capacity in our plants in case it's better than 1:1. So we're kind of working now to get that capacity out of our plants that will have a little bit of a headwind into next year because, as you know, those under absorption gets capitalized and rolls off the balance sheet in the first half. But I think you're right in that we'll make some progress sequentially, but you'll drive that average of 32% to 33% off the back half of the year.

Makes sense. So you referred to pricing just now. I mean, pricing has been strong, partly driven by the tariff environment that we've been in. How -- what's the kind of right way to think about pricing into next year?

Next year? We're not -- I mean our industrial business, which is 15% of our revenue is always doing some pricing on the margin, but that's very targeted and very unique to that business because they're engineered products for customers. And we're always doing a little bit internationally for FX in our tools business, but we don't have any big tools and outdoor pricing for next year. We did a second wave as we talked about doing, and we've executed it and finished that all up with our customers. And so unless there's some significant shift in the tariffs, we don't anticipate a big pricing event next year. Now you will have carry-in pricing that's pretty material, right? Because we -- this year, we took $800 million of annualized pricing but really, we got half a year of it roughly. And so you do have the front half of next year, that pricing coming in. So in your reconciliation, you'll see pricing, but we don't have a big new price increase coming next year. And right now, as you look at the things that tend to affect our business, metal pricing, resins and transportation, there's maybe a little bit of upward pressure in some metal categories that you're familiar with, but I'd say logistics are net favorable. And so you kind of look at, I don't want to say 0 inflation for next year, but pretty benign inflation, and we'll be leaning on cost of goods sold improvements to kind of offset that.

Okay. Great. I know we haven't touched on it yet, but we should. The fact that you're kind of changing your strategy within tools and outdoors to be much more brand focused versus sales-oriented. Talk about what that actually means for the 3 brands that you're really honing in on? And then also what it means to the brands that are not part of DEWALT, STANLEY and CRAFTSMAN?

Like anything, I mean, it's -- I'll get in more detail to that last part, but more it's -- our biggest brands between DEWALT, STANLEY and CRAFTSMAN, that's over $9 billion of our $13 billion of revenue. So it was a little bit of we need to get that right. Otherwise, what are we doing kind of thing. But what it really means to be brand-led. I mean a lot of what we were doing before was we were innovating product and then after the fact really figuring out which brand is most effective for the -- or most applicable to the product. And we weren't being disciplined enough of the trade segments we were chasing or which types of DIY customers we were chasing. And so it was a lot of product push and a lot of focus on channel exclusivities or at least some differentiators across channel and probably not enough focus and discipline on end buyers back. And so shifting to brand-led is really which end users did each brand target with what level of priority. And then what does that mean for the product road map? And then what does that mean for which channel partners and geographies and then where do we place our dollars from there. And so over the last 2 years, under Chris' leadership, we've really gone through as we've done our annual strategic planning, working end user back and focusing much more discipline on specific trades or specific segments of the DIY market. much more disciplined on what that means for our product road map and the product road map being uniquely brand-driven. And then where are the geographies where that's going to give us the most amount of growth. And it's been a big change for the company because it was kind of a product push instead of an end-user pull type company, and that's been the change we've been going through as we've navigated this.

So the second part of that question was, what does it mean for the other -- the other parts.

The other brands, we have had general managers where -- and I've been part of turnarounds prior, you don't say, "Hey, we don't care about these other brands, which for those of you who don't know, would be things like Black & Decker and Lennox and Irwin and Proto and there's a whole host of brands, Mac Tools, it's more with very limited resources and very limited senior leadership attention. How do you kind of hold water because we needed just to kind of hold in there. And so they have to get very focused on -- there's very few things they can do because they have very few degrees of freedom. And then also a little bit is then and if you really would have paid attention to third quarter disclosure, there were some brands we bought and we stretched too wide, probably just to the liking of our channel partners, but it wasn't sustainable for either of us like Lennox, which has long been a cutting tools brand. We started making Lennox screw drivers and tape measures, and we did the same with Irwin, which used to be a woodworking brand, not very sustainable for us or our channel partners. We've gone back and we've refocused those brands on where their core strengths are greatest, and that's been a part of what they've done.

So it begs the question whether there's potential addition by subtraction in some of the brands that you're talking about, but then there's also been discussion that we've had historically about within the Engineered Fastening business, potentially pieces of that portfolio.

Yes. I mean I think we still have a leverage issue out there. And we've been reasonably explicit if there's a part of the industrial fastener business, most likely our aerospace business, where if you followed the aerospace M&A sector, it's been a pretty hot sector. And that's a business where we have a good business, but it's a relatively small part of our business. It's about $400 million of revenue out of $15.25 billion. And as you know, we're not going to be on an M&A path in aerospace. That's the most likely asset we sell, and I think that gets to our leverage issue. I think other portfolio changes will be small things on the margin. I think it's -- there will be some other small things that happen just because they probably don't have the growth and margin potential we're looking for in the total portfolio. I think more to if we had a clean sheet of paper, would we have as many of these brands as we have now, maybe we wouldn't design it that way with a clean sheet of paper. But I think on a tools brand wise, we're more likely to focus those other brands than we are to jettison them just because we probably couldn't get paid enough relative to the value of focusing them.

Makes sense. One last question. So you're targeting about $600 million or so in free cash flow for this year. That assumes -- I know that fourth quarter tends to be seasonally stronger, but it does assume a pretty significant step up. So maybe just kind of walk through how you're thinking about that and what that's...

I mean again, those of you who don't know, seasonally, we do about the last quarter or 1/3 of the year is a bulk of our net cash flow. This year is probably even more so, again, because of some of the inventory builds and other expenses we faced in the middle of the year tariff-wise. The fourth quarter route to full year $600 million is about like $150 million, $160 million of net income, probably like $130 million, $140 million of D&A and then over $500 million of working capital improvement, predominantly from receivables and inventory and it will be a mix of all 3, but those are typically the heavy ones in the fourth quarter.

And still on track.

We're still on track.

Okay. Great. Pat, thanks so much for being here with us today. Great. Great to see you.

Yes. Thank you.