Welcome to the Third Quarter 2020 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.

Thank you, Shannon. Good morning, everyone. And thanks for joining us for Stanley Black & Decker's 2020 second quarter conference call. On the call in addition to myself is Jim Loree, President and CEO and Don Allan, Executive Vice President and CFO. Our earnings release which issued earlier this morning and the supplemental presentation which we will refer to during the call are available on the IR section of our website. A replay of this morning's call will also be available beginning at 11 AM today. The replay number and the access code are in our press release. This morning, Jim and Don will review our 2020 third quarter results and various other matters followed by a Q&A session. Consistent with prior calls, 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 on 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, they involve risk and uncertainty. It's therefore possible that the actual results may materially differ from any forward-looking statements that we might make today. We direct you to the cautionary statements in the 8-K that we filed with our press release and our most recent 34 Act filing. I will now turn the call over to our President and CEO, Jim Loree.

Thank you, Dennis. Good morning, everyone. What an eventful year it has been thus far. Going into 2020, we expected some volatility and uncertainty. However, no one could have anticipated the ups and downs and the twists and turns this year would take, and there's still two months ago. As you saw from this morning's press release, our team is doing an impressive job managing through the trials and tribulations of this era. And I want to thank every one of our 54,000 plus associates who contributed to those results. I'm happy to say that we nailed what was perhaps one of the best quarters in our history. Pick your metric – gross margin, operating margin, free cash flow, the list goes on. For me, the most gratifying is the operating margin rate of 17.7%. We've proven over the decades since the Black & Decker merger that we can produce organic growth at a reasonably consistent 4% to 6%. However, our goal has always been to marry that up with relatively consistent operating margin rate accretion, with a goal of breaking through that 15% ceiling at some point. That has been elusive until now. In late 2017, we entered what turned out to be a three-year period of significant external headwinds caused by tariffs, cost inflation and FX pressures, all totaling approximately $1 billion of unfavorable margin impact. With a lot of work and a strong constitution, we were able to offset those headwinds and generate a 6% EPS CAGR during that era. We also bought Irwin, Lenox and Craftsman, among others, and utilized those acquisitions to cement incredibly strong strategic partnerships with our two major home center partners in the US, as well as building a thriving e-commerce business, including a partnership with North America's largest e-commerce player. And…

Thank you, Jim. And good morning, everyone. I will now take a deeper dive into our business segment results for the third quarter. Tools & Storage delivered excellent revenue growth, volume up 10% and price contributing 1 point. The segment organic growth for the third quarter was impacted by the timing of promotional volume that ended up shipping in October versus our previous expectation of September. This represented approximately $100 million to $125 million for 4 to 5-point impact versus the 3Q revenue planning assumption we communicated in late August. As many of you know, there is a significant amount of volume that goes into the channel for the fourth quarter holiday promotions during the September through October timeframe. You will see this timing shift included in the Q4 planning assumptions that I will review later. The third quarter operating margin rate was outstanding and clearly a record performance at 21.5% for Tools & Storage, up 490 basis points versus the prior year as volume, productivity, cost control and price delivered the strong margin rate expansion. As volume growth accelerated, we experienced excellent operating leverage due to the significant adjustments to our cost base over the last six months in response to the pandemic. Now, let's take a look at some of the geographies within Tools & Storage. North America was up 11% organically. US retail delivered 16% organic growth, driven by strong DIY and improving professional demand, along with continued momentum within the e-commerce platforms. POS remained very robust throughout the quarter as we experienced an average growth in the low 20s percentile over the entire third quarter. The US retail store inventory levels, although up slightly from the beginning of the quarter, remained significantly lower than last year. The North American commercial and industrial tool channels continued to…

Okay. Thank you, Don. Like I said before, no one could have anticipated the ups and downs and the twists and turns this year would take and it looks like it's going to be a great outcome. Look, we've covered a lot of ground already. And so, I'll just take a few more minutes to highlight our growth catalysts. The Craftsman brand rollout remains a key element of our growth strategy and the surge in DIY outdoor and positive trends in e-commerce have further accelerated this opportunity. By the end of the year, we expect to deliver $900 million of cumulative growth from this program since acquisition and about $100 million dollars ahead of our latest plan. And with more Craftsman growth opportunities on the horizon, we can reiterate our commitment to achieve the $1 billion revenue targets six years earlier than we committed during our initial acquisition announcement. We can now start to evaluate how much further we can go beyond $1 billion over the course of time, especially with the potential addition of outdoor power equipment through MTD. The MTD opportunity gives us an option beginning in the middle of the next year to acquire the remaining 80% of one of the great American outdoor power equipment companies at an all-in multiple that will be in the 7 to 8 times EBITDA range. We continue to be encouraged by their product development pipeline as well as their progress on improving profitability. That category is experiencing similar benefits from the consumers' reconnection with the home. And we continue to be excited about the runway for growth by leveraging brand, technology and channel synergies. This combination has the potential to generate significant shareholder value by expanding our presence in this $20 billion plus market. And everybody understands how the pandemic…

Great. Thanks, Jim. Shannon, we can now open the call to Q&A please. Thank you.

[Operator Instructions]. Our first question is from Jeff Sprague with Vertical Research.

A bunch of questions. I guess I'll trust those behind me will ask the ones I don't. I want to focus in on margins a little bit more, if we could. And just understand if there was anything really unusual in the Tools margin in the quarter. And then just thinking about what you're suggesting for organic growth, it looks like it would put Tools revenues in Q4 similar, maybe up slightly from Q3. So, maybe you could just give us a little additional color on margins specifically in Tools & Storage from Q3 into Q4. Thank you.

The third quarter margins, as we mentioned, were really outstanding at 21.5%. And there was nothing unusual in there or one time in nature. It was really a demonstration of the significant amount of costs that we took out very quickly back starting in March and April timeframe of this year. A lot of that was temporary. Then we did a very quick pivot – do you remember back in June and July? – to convert a large portion of that to permanent cost actions and make it sustainable going forward because we recognize the volatility of the situation and we're really starting to see the benefit of those cost actions flowing through the margins and maintaining our cost base at this level as we see the strong top line growth and get outstanding operating leverage as a result. Let me just be clear that, for those of you wondering if we're just cranking up the plants, and that's resulting in some unusual benefits to margins, that's not the case. The way that accounting works, it actually gets hung up on your balance sheet for almost six months and you don't really see that benefit till later on down the road. So, we're not seeing that benefit because I know that's probably a question some of you have. It's really just what I mentioned. It's really focused on the cost actions we took and the benefit of operating leverage associated with that. On the organic growth part of your question, yeah, I would say we're probably looking at a similar Q4 to what we just experienced in Q3 for Tools, and, frankly, for the company as well, overall. And we'll see how that plays out. We've had a great start to the fourth quarter. We really feel positive about the performance in the month of October. But we also know that, in the fourth quarter, the heavy revenue month, really the biggest one is October and then the beginning of November is pretty strong too. So, it's great to have that start at the beginning of the quarter.

And our next question comes from Deepa Raghavan with Wells Fargo Securities.

I'll stick with the margin theme here too. Don, you noted Tools & Storage margins have stepped up higher. Can you talk about how much of that structural lift in margin sticks over the medium term? That is, how much higher than the 17% T&S margins we should be expecting on a go-forward basis here? Also, a quick clarification on 2021 margin resiliency measures of $100 million to $150 million. Will that be pulled only if things deteriorate versus your plan? Or will that be layered in irrespective? Thank you.

On your first question, we really are very focused right now on how do we take this step change in margin rates for Tools and do our best to make a large part of it sustainable. And I really think when you see the Q4 result, and actually when you do the math and you start to think through the models, you're going to see that the margin rate in Q4 is going to be – although not as high as Q3 because we do have a normal tick down due to some holiday mix factors that occur in the fourth quarter, but still will be around 20%. It will be a very strong margin rate for the fourth quarter for Tools & Storage. When I think about going forward into next year, we are now looking at this business as being a very high teens margin business, and we want to be able to maintain that going forward. And so, that's our view at the stage. They will exit the year around 18% for the full year for margins. And we would expect them to continue to be somewhere between 18% and 20% next year, barring any unusual things that – headwinds or things like that, that we're not expecting at this stage. As far as margin resiliency, we're going after that number no matter what. So, these are these are things associated with Industry 4.0, commercial pricing excellence, some of the plant moves we're doing around the world to streamline our operations, et cetera, and so we will aggressively go after that $300 million to $500 million over the next three years, the $100 million to $150 million for 2021. And so, it sets up a nice contingency if we need it. And as I said in my script, if we don't need it, they'll help us either make some investments or have an outperformance or a mix of both.

Our next question comes from Josh Pokrzywinski with Morgan Stanley.

I'll just shift over to growth. And, Don, one comment you made about the lack of contemplated inventory replenishment. I know we're kind of talking about percentages of percentages, given that it's really just a phenomenon that precedent in US retail. But I think some of Jim's earlier comments dating back to other points in the third quarter suggest there's maybe four or five weeks of inventory that could use replenished at some point. My math would say that, on the totality of Tools & Storage, that's still kind of a mid to high-single digit percentage of any given quarters of growth potential. Is that something that we see stretching out here into the first half of 2021? And is that kind of the right order of magnitude to think about what that restock means in terms of segment organic growth?

It's Jim. I know you directed it towards Don, but I feel lonely because everybody wants to talk about margins, and I'm not an expert – I know how to make them expand, but I'm not an expert on the details of the margins. So, I'll take that one. And we've had a lot of customer contact with our partners who have these inventories that are not where they want them to be. And the fill rates are not exactly where they want them to be, although I think we're doing reasonably well in relation to their typical suppliers. So, there is this replenishment of – and I think you're in the right zone, about four weeks or so of inventory that we would all – customers and us would all like to replenish. But keeping up with the POS, I feel humbled to say that right now is really a challenge. So, yes, I think you've got it right, in the sense that it's not going to be solved in the fourth quarter and the customers are very, very clear about, it must be solved in the in the first quarter. And we hope to be able to do that and to fulfill their needs. Thank you.

Our next question comes from Julian Mitchell with Barclays.

Apologies, Jim. Maybe one more question on margins. Looking at it – maybe two parts, I suppose. In 2021, understand that the margin resiliency and the carryover sort of net of temporary actions, but should we expect much in the way of things like outright new selling costs coming back or R&D perhaps stepping up or are those sort of all included when you talk about a reinstatement of actions? And also, beyond 2021, broad thoughts on incremental margins in Tools? What do you think your entitlement is there when you consider competition the channel, but also your margin resiliency efforts?

I would say that, you look at the back half of this year for Tools & Storage margins, we're clearly benefiting from some amazing operating leverage that most likely we will not get that magnitude of operating leverage next year because we will do some of the things you mentioned, we will continue to invest in growth, and so we may not have 21.5% or 20% margins like we're going to have in the back half of this year. But we believe we're going to have margins that, as I said, are somewhere between 18% and 20%. So, pretty robust margins as we make some of those investments, which means our operating leverage will still be very, very strong, probably somewhere between 30% and 40%, leaning more towards the 40% next year and pretty robust. And so, I think we've positioned our cost base, we're positioning our manufacturing footprint as we continue to make changes to that as well as expand some capacity in certain areas around distribution and manufacturing to allow us to make sure that we continue to have that type of leverage as we're able to benefit from this significant growth environment, which has the potential to continue for much longer than the first three to six months of next year. We'll see how that plays out. And whether there's certain factors like US stimulus and other things that continue to drive that type of performance. But there's a lot of activity, as you know, a focus around the home that Jim touched on and e-commerce as well. And so, we're really trying to prepare ourselves for that type of environment that may continue for maybe 12 to 18 months. And as a result, I expect to see very strong margins throughout next year in the range that I mentioned.

Our next question comes from Michael Rehaut with JP Morgan.

I just wanted to get a finer understanding on the promotional sales shift, number one, in Tools & Storage. Looked like it was expecting another 4 to 5 points of growth in the third quarter, but now that shifts into the fourth quarter. However, I'd be surprised if you were to say – excluding that – if that normal shift had occurred or the sales were in September, I'd be hard pressed to say you would be looking for a mid-single digit organic growth range. So, just want to try to understand how that kind of works through and also if it has different – if those sales have different margins being promotional sales. And lastly, I'd just love to get some additional comments in terms of the growth opportunity you see for the company over the next couple of years in e-commerce?

I'll take the latter part of your question and Don will take the former part.

If we go back to the Tools shift from Q3 to Q4, about 4 to 5 points, as I mentioned and you mentioned as well. So, yeah, when you think about the dynamics of what's happening in the fourth quarter, we're getting a really strong surge here in October of some things that shifted from the month of September to October. And when you look at the performance for the full quarter, it's going to be a similar type result as what we experienced in Q3. So, if that 4 or 5 points that shifted into Q3, we'd be kind of looking at mid to high-single digits performance in Tools & Storage for the full quarter. But that factors in a lot of different things. You have to recognize that, although POS in North America is strong and we're assuming it's somewhere between mid-teens to low 20 percentile, other things – the growth is decelerating in certain parts, like the European markets, the emerging markets. We saw some inventory kind of stocking and restocking in those geographies that will not repeat itself here in the fourth quarter. So, although we see growth, it won't be of the same magnitude we saw there. And then, we still have some portions of the business that are retracting, although retracting at slightly lower percentages than what we saw in Q3. We still have that as a factor as well. So, when you pull that all together, that's kind of how you get to that net result at the end of the day. Jim?

On e-commerce, obviously, we're very excited about this topic because when it was not very popular, we were kind of a couple of yards and a cloud of dust, just workman like going after it, building it, zero – almost zero in 2010. And today, we're knocking on the door of $2 billion in e-commerce and the profitability is good. It's not something that you can worry about negative mix. The profitability is good. The cost to serve is actually reasonable vis-à-vis other channels and gross margins are excellent. So, today, we have a vast network of partnerships around the world with major e-commerce players. And we're very pleased with that and proud of that, ranging from Alibaba to Amazon to some of the regional players and so forth. It's all B2B2C as opposed to D2C, which is okay for us. It's worked well. And, frankly, our competition has more or less shied away, have not really made it a strategic focus in general. So, we sit here today in a very good place with strength. And so, we're not naive to think that the competition is not going to jump in. Of course, they are. But we are going to double down in this area and have already constructed a $75 million worth of investments over the next year or two to strengthen our position in e-commerce. And one of the big initiatives is the Black & Decker brand revitalization. It's probably a little-known fact. But the Black & Decker brand plays extremely well with the younger generations. And of course, younger generations are the core of the e-commerce of growth in the future. So, with Jeff Ansell running this Black & Decker revitalization initiative in partnership with a major e-commerce player in North America is kind of one of our elements of the strategy. And then, we also have significant investments in the core, so strengthening the core e-commerce that we have as well with additional resources, additional focus on content creation and market development. And also, initiatives, pretty significant initiatives in Germany, China and India, all D2C. So, areas where our share is not where we're under indexed, if you will, from an existing channel perspective. Going D2C in those markets because we have very little to lose, especially in China and India, and really excited about this. I think e-commerce is going to be a major, major growth driver for many years to come.

And our last question comes from Joe Ritchie with Goldman Sachs.

Wanted to maybe stick on growth for my one question. When you guys issued your 8-K intra quarter in 3Q, I think you guys were calling for high teens T&S growth and recognized the promotional activity was 4 to 5 points. And so, I was wondering if you could maybe just elaborate what else changed relative to your expectations earlier in the quarter? And then, specifically, I've heard you call out international decelerating and inventory levels. Just any more color around on around that specifically would be helpful. Thank you.

I would say that, when we did the announcement back in late August, we said in Q3, for Tools, we see kind of a high teens performance for organic and we talked about the reasons why it's different. We also communicated that we expected Q4 to have kind of low single-digit growth. So, we're indicating that the back half would probably grow somewhere around 7%, 8%, in that range. We're now looking at a back half that's going to grow around 10%. And potentially a little bit better if some of the trends continue here in Q4 that we saw in October. So, we're seeing a better growth profile for the back half of the year in total versus what we thought about a month and a half ago or so for the Tools & Storage business. And a large part of that is the continued strength of North American retail and what we're seeing there with POS. And although we do have some de-selling in Europe and the growth number will be lower, but still very good versus Q3 because Q3 was pretty robust and kind of mid-teens number for growth, we'll probably see something that's closer to half of that in our European markets. And that factors in some of the inventory stocking that we saw in Q3. So, the things that have really shifted are that we were able to recognize how much inventory was built in our customers throughout the third quarter. And there was a significant amount in some of the international markets and very little in the North American retail channel. And then, here in the fourth quarter, we see the dynamic of not having – as I said, we're not really putting any inventory build in the fourth quarter. At the end of the day, could there be a little bit in the North American retail channel when we're done? Maybe, but it's probably going to be pretty modest to the point that Jim made when he answered this question earlier. The bigger part of the adjustment is going to happen in Q1.

Thank you. This concludes the question-and-answer session. I'd now like to turn the call back over to Dennis Lange for closing remarks.

Shannon, thanks. We'd like to thank everyone again for calling in this morning and for your participation on the call. Obviously, please contact me if you have any further questions. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.