Stanley Black & Decker, Inc. (NYSE:SWK) Q4 2022 Earnings Call Transcript

Stanley Black & Decker, Inc. (NYSE:SWK) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Welcome to the Fourth Quarter and Full Year 2022 Stanley Black & Decker Earnings Conference Call. My name is Shannon, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to the Vice President of Investor Relations, Dennis Lange. Mr. Lange, you may begin.

Dennis Lange: Thank you, Shannon. Good morning, everyone, and thanks for joining us for Stanley Black & Decker’s 2022 Fourth Quarter and Full Year Webcast. On the webcast in addition to myself, Don Allan, President and CEO; and Corbin Walburger, Vice President and Interim CFO. Our earnings release, which was issued earlier this morning and the supplemental presentation, which we will refer to, are available on the IR section of our website. A replay of this morning’s webcast will also be available beginning at 11 a.m. today. This morning, Don and Corbin will review our 2022 fourth quarter and full year results and various other matters followed by a Q&A session. Consistent with prior webcast, we are going to be sticking with just one question per caller.

And as we normally do, we will be making some forward-looking statements during the call based on our current views. Such statements are based on assumptions of future events that may not prove to be accurate and, as such, involve risk and uncertainty. It’s therefore possible that the actual results may materially differ from any forward-looking statements that we may make today. We direct you to the cautionary statements in the 8-K that we filed with our press release and in our most recent 34-F filing. I’ll now turn the call over to our President and CEO, Don Allan.

Don Allan: Thank you, Dennis, and good morning, everyone. Our fourth quarter performance marked another meaningful step forward on our journey to streamline and optimize Stanley Black & Decker. Building on our number one worldwide market position in Tools & Outdoor, as well as our leading Industrial business, we continue to focus on advancing our simplification and transformation strategy. Across the second half of 2022, we improved customer fill rates significantly, reduced inventories by $800 million and realized $200 million in efficiency benefits from our leaner organizational structure as well as enhanced cost control in the back office and the supply chain. These actions generated more than $500 million of free cash flow in the fourth quarter, which supported a corresponding similar amount of reduction in our debt, a key objective of our capital allocation plan in the second half of 2022.

Overall, we are making progress, and I am confident that our strategy and priorities are positioning the company for a strong, sustainable, long-term growth, cash flow generation, profitability enhancement and shareholder return. This transformation journey has just started, and significant efforts are still ahead of us. Our success will be dependent on staying agile while maintaining a disciplined approach, which ensures we stay focused on our key set of priorities. Our team has seen significant changes over the second half of 2022, and they will lead us through the next phase of the transformation in 2023. I would like to take a moment to thank all of our leaders and employees across the globe and recognize them for their focus, commitment and hard work, especially over the last 7 months to 8 months.

Our 2022 full year revenue reached $16.9 billion, up 11% versus a record of 2021, led by the outdoor power equipment acquisitions as well as 9% organic growth in the Industrial segment, and a 7% improvement in price realization. However, these top line growth drivers were partially muted by significant retractions in consumer and DIY demand, as well as certain supply chain constraints we experienced in early 2022. Our margins were significantly impacted by inflation, and when we chose to prioritize inventory reductions by lowering manufacturing production levels in this last four to five months of 2022, this was to allow us to generate solid free cash flow as we experienced in the fourth quarter. These negative profitability impacts resulted in a full year adjusted diluted earnings per share being down year-over-year to $4.62.

For the fourth quarter, revenues were in line with the prior year at $4 billion. Demand from our professional end markets remained healthy. With our differentiated offerings and improved product availability, we successfully executed our promotional plans in support of the holiday season for our retail partners. Adjusted EPS for the period was a loss of $0.10, a result of our planned prioritization efforts around inventory reduction and cash generation. Notably, we lowered inventory by $500 million as compared to the end of the third quarter. We entered 2023 prepared to navigate a challenging macroeconomic backdrop as interest rate hikes begin to yield their intended effects. That said, we are committed to advancing our transformation. While there is more work to be done, we have a clear road map forward.

We are watching the demand environment and global economic dynamics very closely. Although, current demand remains consistent with levels experienced in the back half of last year, we are planning for all scenarios, which balance the potential continuation of the current trends with the prospect of a further demand slowdown due to intensifying macro pressures. While changes in demand are difficult to predict, our base case or midpoint of guidance assumes a decline in volume versus 2022 as we believe markets will continue to be challenged during 2023 as new housing starts are projected to decline 15% to 25% and repair and remodel activity will decline modestly year-over-year, we are also prepared to respond if revenue impacts are worse or better than our base case to ensure we appropriately manage the risks and opportunities that could arise.

This guidance will have a P&L loss in the front half, which is impacted by our strategic choice to continue to reduce our inventory levels. For the full year, we are guiding an adjusted EPS range of zero up to $2. Our free cash flow guidance is much stronger at $500 million up to $1 billion in 2023, well ahead of net income as we drive another $750 million up to $1 billion of inventory reduction during the year. As you have heard me say many times over the past year, we believe the long-term view for the industries, which our products serve is very positive with powerful generational shifts in the housing, more time at home due to hybrid work, an aging housing stock that needs repair and remodel, the continued improvement in aerospace demand and the acceleration of electrification within the automotive markets.

We also have powerful secular drivers in Tools & Outdoor from the shift to cordless power tools and electric powered outdoor equipment as we leverage our brands and innovation to gain market share. Our priorities in 2023 will continue to be aligned with our messaging over the last six months; one, strong focus on cash flow through inventory reduction to assist with ongoing debt deleveraging; two, sequential improvement in our gross margins as we drive further supply chain transformation initiatives; and three, get back to gaining market share in all major categories of our Tools & Outdoor business. Our 2023 guidance base case is planning for an improved profitability performance in the back half of the year as we see more benefits from the transformation program.

We believe our annualized EBITDA will achieve a run rate of close to $1.5 billion in the back half. That will be a major step forward in returning our company back to 2019 EBITDA levels, which were just above $2 billion. Given the significant benefits expected to be realized beyond 2023 from our supply chain transformation program, there appears to be a very reasonable glide path to exceed 2019 levels for EBITDA. Our teams around the world remain focused on executing our primary areas of long-term strategic focus, continuing to advance innovation, electrification, and global market penetration to achieve organic growth of two to three times the market growth, streamlining and simplifying the organization as well as shifting resources to prioritize investments that we believe have a positive and more direct impact for our customers and end users; accelerating the operations and supply chain transformation to return gross margins to historical 35% plus levels, while improving fill rates to better match inventory with customer demand; and then prioritizing cash flow generation and inventory optimization.

We are making deliberate strategic investments in our businesses to position the company to fully capitalize on these long-term opportunities to gain share within the industries that we serve and to accelerate our organic growth. With that in mind, last year, we invested approximately $350 million in research and development, up over 25% versus 2021 and well ahead of our total sales growth. This increase in R&D will ensure we continue to fund incremental investments beyond our core and breakthrough innovation, electrification across the portfolio, and market leadership, including digital and end user activation. This is an area where we have a long legacy of key investments to maintain our market-leading innovation ecosystem. We clearly took another step forward in 2022 and we will again in 2023.

Our business transformation remains on track and we are building momentum towards delivering approximately $1 billion in annualized savings by the end of 2023. That will support both gross and operating margin expansion once our inventory destock is complete. Let’s spend some time on the topic of innovation. We are continuing to release new products and bring advancements and innovation to our industries. Today, I will highlight a few exciting launches. As it relates to outdoor electrification, we are introducing new CRAFTSMAN and DEWALT outdoor offerings. For the 2023 season, CRAFTSMAN will carry a new range of lithium-ion electric ride-on mowers and an expansion of our 20-volt CRAFTSMAN Outdoor Essentials, notably new brushless string trimmers and blowers as well as a new cordless pressure washer.

For the PRO, we are continuing to expand the DEWALT FLEXVOLT 20-volt MAX system, including the addition of a new pruning chainsaw that is lightweight and compact with an 8-inch bar and a high-efficiency brushless motor. Shifting to professional job site products and solutions, this is another key area for long-term growth. We recently debuted a range of revolutionary tools, accessories, and storage solutions for pros in the commercial concrete and construction industries as we continue to electrify the job site. We are expanding the FLEXVOLT product family with the launch of the world’s first cordless in-line SCS MAX Chipping Hammer and Cordless Hexbreaker Hammer. We are also introducing the most powerful cordless DEWALT large angle grinder.

All three of these new cordless tools include Perform and Protect safety features as well. Additionally, we have a new DEWALT ToughSystem Solution for storing, charging, and transporting DEWALT 20-volt and FLEXVOLT batteries. And lastly, our DEWALT product team partnered with CONVERGE, a leading concrete material and operations optimization company, to develop and unveil new concrete DNA compatible sensors. This new product allows DEWALT pros to begin work sooner as users can directly measure concrete hardening using advanced artificial intelligence rather than relying on estimations. In addition, this product helps reduce cement consumption by tailoring the exact amount needed. Together with CONVERGE, we are helping to tackle the challenge of reducing carbon emissions through our product innovation.

As the worldwide leader in tools and outdoor, these are prime examples of the types of core and breakthrough innovations that we expect to continue to introduce to our customers and deliver for our end users. Now, diving a bit deeper into our business transformation. The team has made great progress. We realized $200 million of savings in the second half of 2022 from efficiency benefits, including our organizational changes, as well as indirect cost savings. We expect to deliver cumulative SG&A savings of $500 million by the end of 2023, covering simplification of the corporate structure, streamlined leadership spans of controls and organizational layers and the reduction of indirect spend. Our new organizational structure is now in place, and the teams are activating our priorities.

As you saw in our recent announcements, we have brought on two new business leaders who are critical for our transformation. Patrick Hallinan was named our incoming Chief Financial Officer. Patrick is a seasoned executive who has led global high-performing finance functions across top consumer brands. Patrick joins us in April from Fortune Brands Innovations, where he currently serves as their CFO, and is the ideal candidate for the next leader of our finance function. John Lucas joined us as our new CHRO and brings a highly distinguished track record with world-class experience in organizational and human capital management. John will be instrumental to enabling our culture and values and to the long-term success of our business. I want to thank Corbin Walburger and Deborah Wintner for their leadership and significant contributions during this critical transformation period for the company.

I look forward to continuing to work with them as key Stanley Black & Decker leaders. Turning to our supply chain transformation. We have line of sight to deliver cumulative savings of $500 million by the end of 2023 and $1.5 billion by 2025. Building off the momentum from last quarter, we activated our transformation with a sense of urgency to optimize our operations, which better serve our customers while also being efficient and agile with our footprint and cost structure. After approving and initiating action on our SKU reductions, we now have approximately 50,000 SKUs that we are no longer manufacturing and are approved for decommission. Throughout 2023, we will work to transition our customers to the products that deliver the most value for our end users.

As we shared last quarter, the strategic sourcing team activated quick wins. We are pleased to share that, this early traction has already generated $40 million in savings. Wave one is now fully activated and addresses approximately $2 billion of spend, which is covered by 20 RFPs that are due back this quarter. We also successfully advanced our facility optimization and distribution network planning. The detailed feasibility analysis nearing completion this quarter, with execution of the plan to follow shortly thereafter. Lastly, we have heightened our focus on manufacturing excellence, reemphasizing SBD Kaizen and Lean manufacturing practices at our factories. Activation at four plants will be complete this quarter. And in March, we will initiate the next wave.

We have exited the acute phase of pandemic-driven supply constraints. And as such, refocusing our plans on continuous improvement rigor will enable the acceleration of value across the network. You can expect us to continue to take strides forward, and we will provide you with updates towards achieving our cumulative $1 billion of savings by the end of 2023 on our path to delivering total program savings of $2 billion by 2025. I will now pass it to Corbin, who will take you through more detailed commentary on the fourth quarter and full year performance as well as our 2023 guidance. Corbin?

Corbin Walburger: Thank you, Don, and good morning, everyone. Let me walk through the details of our business segment performance. Beginning with Tools & Outdoor, fourth quarter revenues were in line with last year at $3.4 billion, benefiting from a 7% improvement from price actions and an eight-point contribution from the MTD and Excel outdoor acquisitions. Both of these acquisitions are now a part of organic growth beginning in December. These factors were offset by a 12% decline in volume and a negative 3% impact from currency. From a full year perspective, Tools & Outdoor achieved record revenue of $14.4 billion, driven by a 7% improvement from price actions, and 21% growth contributed by our outdoor acquisitions, which was offset by softer consumer demand and currency.

Looking at the regions, Latin America achieved 4% organic growth. Although Europe declined 3% organically, performance improved sequentially from the third quarter, and we believe the more significant impacts from UK channel destocking are now behind us. North America was down 7% as a result of lower consumer and DIY market demand, as well as the third quarter carrying heavier holiday promotional shipments compared to last year. US retail point of sale was supported by price increases and professional demand. Compared to a pre-COVID 2019 baseline, the fourth quarter POS growth was consistent with the growth levels experienced in the third quarter of 2022. Aggregate weeks of supply in these channels ended 1.5 weeks below 2019 levels. Adjusted operating margin for the segment was 1% in the quarter as the benefit from price realization was more than offset by commodity inflation, higher supply chain costs, planned production curtailments and lower volume.

For the year, operating margin was 8.4%, down versus prior year. Turning to the strategic business units. For the full year, Power Tools declined 5% organically due to weakness in consumer and DIY and front half constraints related to electronic components. These volume impacts were partially offset by the benefits of our price increases and the continued performance of our strong DEWALT cordless innovation across our FLEXVOLT, ATOMIC and XTREME product families as well as our new and differentiated power stack battery packs. Hand tools declined 5% organically in the year. Consumer related headwinds were partially offset by price realization as well as new product innovation, notably the DEWALT Impact Connect, which consists of accessories that attach to an impact driver, allowing up faster cutting than standard hand tools.

We also benefited from innovation in storage solutions such as mobile tool storage within the DEWALT Tough system and the CRAFTSMAN Premium S2000 metal storage platform. The Outdoor business declined 7% organically on a pro forma basis for 2022 due to the difficult outdoor season outlined earlier in the year. The fourth quarter marked the one-year anniversary of the MTD and Excel acquisitions, and we’re pleased with the progress made to advance the outdoor platform integration. We now have a combined dealer channel sales team and launched one go-to-market approach to grow share. We’ve activated a brand portfolio strategy, leveraging DEWALT, Cub Cade,t and Hustler in the Pro and high-end resi market segment while targeting CRAFTSMAN, Troy-Bilt, WolfGarden, and Black & Decker for the residential end user.

I want to acknowledge and thank the entire team for their dedication to this process and ongoing commitment to delivering the best products for our customers. Now, shifting to Industrial, which had another strong quarter, recording 10% organic growth and double-digit adjusted operating margin. Segment revenue declined 1% versus last year as nine points of price realization and one point of volume were offset by five points from currency and six points from the oil and gas divestiture. The team leveraged the price increases and volume growth to overcome commodity inflation and higher supply chain costs to deliver adjusted operating margin of 11.5%, up sequentially 40 basis points and up 220 basis points versus last year. Looking within the segment, Engineered Fastening organic revenues were up 9% in the quarter, led by aerospace growth of 37% and auto growth of 14%, which were partially offset by industrial markets.

Aerospace fasteners delivered its sixth consecutive quarter of sequential revenue improvement as the recovery in commercial OEM production continues. The auto fasteners’ strong quarter, demonstrated by the business’ ability to gain share in a dynamic environment and outpaced global light vehicle production in the quarter and for the full year. Attachment tools organic revenues were up 18%, driven by strategic pricing actions. While orders particularly from our dealer channel partners have been moderating, our backlog remains above 2019 levels. We continue to make progress with our inventory reduction in the fourth quarter, taking out nearly $500 million and resulting in a total second half inventory reduction of $775 million. Our production curtailment actions have been successful, helping to reduce DSI by approximately 20 days in the quarter and it was good to see the significant inventory reduction in the second half translate into free cash flow generation in the fourth quarter.

As we look to the front half of 2023, we are targeting another $500 million reduction with the majority of this progress to be made in the second quarter. Although we typically see a seasonal inventory build as we prepare for the outdoor and spring selling season, we have the ability to work down our input materials and components as well as drive commercial actions to sell through finished goods. Our full year 2023 inventory reduction target is $750 million to $1 billion, which will drive significant cash flow generation that will be used to pay down debt and further strengthen our balance sheet. The timing of this reduction is demand-dependent. In a few moments, I’ll cover how these assumptions impact the 2023 guidance range. Turning to gross margins.

We expect the impact of planned production curtailments and higher cost inventory liquidations will continue to weigh on margins through the first half of 2023, resulting in margins in the low 20s. Production curtailments in the fourth quarter were down approximately 30% versus the long-term average and impacted gross margins by approximately six to seven points in the quarter. In our base case, we expect to improve from these levels but not fully eased production curtailments until the third quarter of 2023, which should support a gross margin recovery into the mid to high 20s in the back half. The normalized production and better gross margins could potentially shift earlier or later in the year depending on the overall demand environment and the speed of destocking.

We have the teams focused on inventory reduction, cash generation, and balance sheet health as we work to drive gross margins to our historical 35% plus target level in 2025. I’ll now walk through how the company is planning for three demand scenarios for our 2023 guidance as the macroeconomic outlook remains dynamic. Our base case scenario assumes a modestly unfavorable market demand environment, compared to what we experienced during the second half of last year. In this scenario, we are assuming total organic growth to be down low single digits with the first quarter being the toughest comp. Tools & Outdoor total organic revenue, inclusive of positive price is expected to be down low single digits, while Industrial is planned for low single-digit growth.

Specifically, for Tools & Outdoor, this would imply a full year volume decline of approximately 5%, ahead of our forecast for the market. For the second half, volume is expected to be down 3% to 3.5%. In this base case, we would maintain our production curtailments with the goal of returning to normalized levels in the third quarter. As a result, the under absorption of fixed manufacturing costs would continue to constrain first half 2023 operating margins to low single digits. As production returns to normalized levels in the back half of the year, we expect operating margin rate to improve to the mid to high single-digit range. While our teams are aggressively focused on capturing deflation, this scenario does not include moderating commodity prices benefiting the P&L until late 2023 after the destock, and can be a positive driver heading into 2024.

As we monitor the demand environment, we will be measured in the timing and magnitude of our investments, reinvesting into our businesses at the point of impact as part of our transformation strategy, and our base case scenario includes approximately $125 million of annualized reinvestment targeted at commercial leadership, driving innovation and complexity reduction. Shifting to our second half acceleration scenario. This contemplates the possibility of a stronger demand environment supporting organic growth in the second half of 2023. Total organic growth would be relatively flat for the year. To support the improved second half demand, production levels would normalize towards the end of the second quarter. This scenario would position us to deliver high single-digit operating margins in the second half as well as an elevated level of reinvestment to accelerate our transformation.

Lastly, we are preparing a downside case that reflects a deceleration of demand due to elevated recessionary pressures. In this case, we expect full year organic revenues to decline by mid-single digits with volume declines in both the tools and outdoor and industrial segments. If this were to occur, our production curtailments would likely continue through the end of 2023, extending the time line of our gross margin recovery. Under this scenario, we would opt to conservatively meter the level of reinvestment until we had more clarity on the extent and duration of the macro impacts and economic cycle. Overall, we feel it’s prudent to consider this range of potential 2023 demand possibilities production and reinvestment levels as we continue to prioritize inventory reduction and cash generation.

As such, we are guiding full year adjusted earnings per share in the range of zero to $2. On a GAAP basis, we expect the earnings per share range to be negative $1.65 to positive $0.85, inclusive of one-time charges from the global supply chain optimization and the remaining outdoor integration-related expenses. The current pre-tax estimate for one-time charges is approximately $225 million to $325 million with $50 million to $100 million in non-cash charges. Now some added quarterly context from our base case. For the first quarter, we’re expecting similar levels of operating profit to what we delivered in the fourth quarter. However, we do not expect the discrete tax benefits to repeat, resulting in a first quarter adjusted loss of $0.75 per share at the midpoint.

We believe profitability can improve sequentially into the second quarter, resulting in a stronger performance. In total, we expect our actions but will translate to positive first half free cash flow driven by $500 million of inventory reduction, most of which will come in the second quarter. As we get through the first half destock, we expect earnings to inflect positively in the second half of the year, generating an annualized EBITDA run rate of approximately $1.3 billion to $1.7 billion. We view this as a jumping off point to further improve with our transformation. Our guidance calls for $500 million to $1 billion of free cash flow in 2023, primarily from inventory reduction. We’re focused on our key priorities; number one, generate strong cash flow through inventory reduction to assist with ongoing debt deleveraging; number two, sequential improvement in our gross margins as we drive further supply chain transformation initiatives; and number three, focus on gaining market share in all major categories.

We’re planning for the dynamic operating environment to continue and feel we have the strategy in place to successfully navigate our path forward as we remain focused on driving above market long-term organic growth. With that, I will now turn the call back over to Don.

Don Allan: Thank you, Corbin. So in summary, we successfully advanced our cost reduction and business transformation strategy over the last quarter and made meaningful progress on a number of key objectives, including inventory reduction, cash generation, debt reduction and streamlining our organizational structure and supply chain. We have given you an indication today of what annualized EBITDA could be on the first step of this journey. We believe we can build from 2023’s back half as our supply chain savings continue to accrue and contribute to the restoration of our gross margin to the 35% plus level. As we look ahead, we aim to get our levels of EBITDA back to 2019 levels and beyond as we continue to transform our business.

While the macroeconomic environment is uncertain and 2023 will clearly bring us challenges, we are prepared to navigate forward and believe our actions to reshape, focus and streamline our organization, as well as reinvest in our core businesses will enable us to deliver strong shareholder value over the long-term via robust organic growth and enhanced profitability. With that, we are now ready for Q&A. Dennis?

Dennis Lange: Great. Thanks, Don. Shannon, we can now start Q&A, please. Thank you.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Julian Mitchell with Barclays. Your line is now open.

Julian Mitchell: Hi, good morning.

Don Allan: Good morning.

Julian Mitchell: Good morning. Maybe just my question would be around — I guess, two quick parts. One would be, it looks like you’re guiding for positive price, I think, in Tools this year, maybe the conviction in that given what seems to be a lot of inventory kind of out there at customers and competitors. And then also, the second part would just be I heard what you said on the annualized EBITDA run rate. Are we still assuming a sort of $7 plus or so of EPS potential at Stanley in the medium-term based off that, or has that view changed?

Don Allan : Yes. So I’ll start and then Corbin probably will add a little color too on both of those topics. But I would say that our price model has about 1.5 to 2 points in it for the year for 2023. And based on where we are now with commodity prices, which you’ve seen some improvement or reduction, but overall, when you look at the basket of commodities for us, we really don’t see any significant deflation and a little bit of inflation here in the first half of the year. So we still see based on that, that we can maintain price throughout the year. Now your question on the angle of there’s a lot of inventory in the channel, and therefore, we’re going to have to take specific promotional actions that might be unusual to drive inventory out of the channel, which, therefore, would impact our price.

We don’t really see that in our plan today. So we see normal promotional activity in the spring and the Father’s Day season and then, of course, in the later stages around Thanksgiving and other holidays at the end of the year. And so at this point, we do not believe there’s a need to do anything unusual around pricing activities to push things to the channel. One thing I’ll just point out related to inventory levels in the channel. For us specifically, we actually feel where the inventory is in our customers is pretty reasonable at this point, and it’s actually down a little bit from 2019 levels. And so probably about a week to two weeks down from those levels, which is a good place to be. And we feel like we’ve gone into the year with the adequate amount of inventory in their stores.

And what we’re dealing with is higher levels of inventory in our own distribution network that we have to work through during 2023 and probably some early stages of 2024. But the vast majority of that reduction is going to happen this year in 2023. The second question was related to

Corbin Walburger : Long-term EPS, medium-term.

Don Allan : Long-term EPS and the $7 and some commentary around that. So I think as you start to dissect the guidance we’re providing at the midpoint, you’ll see that the back half is getting itself close to a couple of dollars EPS for this year. And if you annualize that and factor in seasonality from the outdoor season that happens in the first half of the year primarily, you’re probably trending something for 2024 that’s closer to $5. And now that assumes that we deal with an environment that we have guided here, which is the midpoint is pretty muted from a volume perspective. We — as you heard from Corbin in his presentation, the back half is assuming for the Tools & Outdoor business that the organic performance will be down about three points.