Welcome to the Third Quarter 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 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 2022 third quarter webcast. On the webcast, in addition to myself, Don Allan, President and CEO; and Corbin Walburger, Vice President and Interim CFO. On our earnings release, which was issued earlier this morning and a 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 third quarter 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 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 in our most recent '34 Act filing. I'll now turn the call over to our President and CEO, Don Allan.

Thank you, Dennis, and good morning, everyone. As you saw from today's release, we made tangible progress during the third quarter towards our strategy around focusing our business and transforming our supply chain. We are building positive momentum as we deliver improved customer fill rates, deployed a new organizational structure, implemented cost controls and actively reduced our inventories. In addition, we made significant progress reducing debt, utilizing $3.3 billion in proceeds from our strategic divestitures. All key priorities we set out heading into the third quarter. All of this is not yet apparent in the financials, but we are encouraged by a few items. One, our headcount reductions are largely complete. Two, inventory is coming down. Three, cash generation was positive in September, and we believe this can continue in the fourth quarter and next year. And four, gross margin will be the last to turn as we face the high cost of destocking, but we expect to be through that and pivot to better performance by the middle of next year. While the macroeconomic environment remains challenging, notably softer North America consumer and European markets, combined with stubborn cost inflation, there were relative bright spots with continued strength in Professional Construction and Industrial customer demand, as well as incremental progress unlocking global supply chain constraints. Our actions to alleviate semiconductor constraints are progressing as expected and are contributing to results through our improved fill rates as well as slightly better organic revenue performance in Q3. Third quarter revenue was $4.1 billion, up 9%, driven by our Outdoor Equipment acquisitions. Organic revenue declined 2%, which was an improvement over what we delivered in the first half, due to increased professional power tool supply and a solid performance by the Industrial business as organic growth was up 14%. Price realization sequentially…

Thank you, Don, and good morning, everyone. Let me walk through the details of our third quarter business segment performance. Beginning with Tools & Outdoor, revenue grew 10% to $3.5 billion as the MTD and Excel outdoor acquisitions contributed nearly $600 million of revenue or approximately 18% growth, and price realization contributed 7%. These factors were partially offset by a 12% decline in volume and a negative 3% impact from currency. On an organic basis, we were down low single digits in emerging markets in North America and down 12% in Europe. U. S. retail point-of-sale was supported by professional demand and remained consistent with levels exiting the second quarter of 2022. Aggregate weeks of inventory in these channels remain below 2019 levels. The European results were impacted by retail market pressure due to high levels of customer inventory and inflation as recessionary concerns and the war in Ukraine continue to weigh on consumer spending, particularly in the Northern region. Adjusted operating margin for the segment was 6.8%. Excluding charges and acquisitions, margin was 140 basis points better at 8.2%, however, still below the 15.5% level from the same period last year as the benefit from price realization was more than offset by commodity inflation, higher supply chain costs, production curtailment costs and lower volume. Consistent with normal seasonality, the MTD and Excel outdoor businesses deliver only about 40% of full year volume in the back half at operating margin substantially below the annual average as margins in the first half of the year are typically bolstered by peak outdoor seasonal volume leverage. Across the North American channels, organic sales in retail and e-commerce were down versus 2021 levels, with moderate strength in Commercial and Industrial. However, as compared to a pre-pandemic 2019 baseline, organic sales performance was up double…

Thank you, Corbin. So in summary, a lot of progress was made in our first 90 days and these benefits will become even more apparent within the financials in the coming quarters. Our headcount reductions are largely complete. Inventory is now coming down. Cash generation was positive in September, and we believe this will continue in the fourth quarter and next year. Gross margin will be the last to turn as we face the high cost of destocking but we expect to be through that and pivot to better performance by the middle of next year. And we will continue to focus on debt reduction, further strengthening the balance sheet. All as we continue our commitment to return value to our shareholders through cash dividends. As we move forward, we have a clear strategy, vision and execution plan. And we are laser-focused on optimizing what is within our control. The macroeconomic environment will definitely continue to be choppy and 2023 will clearly bring new challenges. However, we 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?

Okay. Thanks. Shannon, we can now open the call to Q&A, please.

[Operator Instructions] Our first question comes from the line of Julian Mitchell with Barclays. Your line is open.

For my question, I'd just like to circle back to Slide 9, which was very helpful, and completely agree with the effort to get cash flow up even if it means near-term earnings are down. But I guess two related questions on that. One is the free cash flow was still negative $500 million in Q3. You've got the plus $400 million to $500 million in Q4. So really just trying to test the conviction in that tailwind on free cash given that it was, I think, worse than expected in the third quarter. And then secondly, when you look at that gross margin chart sort of bottoming in Q1 next year, just wondered what you're assuming for the macro on that point. Because I guess the risk would be that as you keep trying to lower inventories, the macro rolls and they stay kind of stubbornly high, so extra on the production is needed. So just trying to test sort of what are you assuming on the macro, on the pro channel for early next year when looking at that gross margin recovery slope?

Thank you, Julian, for the question, and so we'll give you a little more color in response to that. But as I think through the -- you're right with your opening comment, this is really a heavy focus on cash flow right now. And I was very pleased to see that we generated some solid cash flow in the month of September. Our conviction related to the fourth quarter is very strong. I feel like that we've done all the right things to ensure that our inventory continues to go down. We took additional steps in the third quarter to lower production even further, which is obviously having a bigger impact on Q4 versus Q3. We made that decision as we started to get a little more insight into what we needed to produce in the first half of next year, what the inventory levels were going to be. And we looked at a variety of different scenarios: growth scenarios, flat scenarios and declining scenarios. And we utilized all those scenarios to help, what we feel is the best decision we can make related to production at this stage. The chart is a depiction at a high level of what we believe the gross margin rates will be when you blend all those different centers together and you look at all the possible outcomes. Could there be a scenario where we have a deeper decline in revenue and we have to pullback production even further? Yes, that could play out over 2023, but we'll see how that -- we'll see how things evolve as we get deeper into the end of this year into early next year. The focus for us, though, continues to be, as I mentioned at the start of this commentary, our top priority is cash flow.…

Thank you. Our next question comes from the line of Tim Wojs with Baird. Your line is open.

Maybe if you could just talk a little bit, Don, about some of the improvements in some of the market-facing metrics that you kind of talked about on the call in terms of where are fill rates today versus where they might have been kind of early part of this year and what the progress on that looks like. And then just as you're talking with your customers, how are they kind of thinking about promotional activity and pricing as you move into '23?

Yes. Thanks, Tim, for that question. Yes, I'm really pleased with the team's progress in fill rates over the last 90 days. It's not 95% or above, so we still have more opportunity in front of us. But depending on the product category, we've made anywhere from 300 basis point improvement to 600 basis point improvement in the last 90 days. And so that's a great accomplishment by the team in a very short period of time. Now a large part of it is triggered by the supply constraint that we were dealing with in semiconductors, that now is pretty much behind us at this stage. And therefore, we feel like we can really focus on making sure that we're meeting the demand that our customers have. Another metric that we've looked at is what is the on-shelf percentage of all our products within our major customers. And those numbers are actually very good, 95-plus percent when you look at our products on the shelves -- those products are on the shelf. We have very little out-of-stock situations at this point in time. The third thing that I looked at is we actually did a really sizable promotion set of shipments to many customers in September and here in the month of October. A substantial amount of promotional activity is something that we haven't seen in well over a year, and so we're very pleased to be able to get back kind of at the end cap, get into some of the off-shelf areas within our major customers and begin to really drive some of that promotional activity and share gain in those particular circumstances. So, all three of those things are what we're looking at to really say, hey, we're making progress and we're getting back to a nice mix of core business and promotional activity, which is really, what makes the Tools and the Outdoor business successful over the midterm and the long term. As far as 2023, at this point, our customers are very excited about the upcoming year and the opportunities they see. They still believe that professional will continue to be strong. As I mentioned earlier, we are preparing a variety of different scenarios that could be a healthy environment or could be a significant decline that we have to manage through. And so therefore, we think given the amount of inventory we have, we have the ability to meet the needs of the customers, both core and promotional activities. And hence, why we continue to cut back production to ensure that we do actually lower our levels of inventory over the next 12 months.

Our next question comes from the line of Nigel Coe with Wolfe Research. Your line is open.

So Don, a question on inventory, you might be shocked by that. So obviously, no surprise, I'm just wondering if maybe you could quantify the actual -- you've called out the $0.82 of incremental production penalty to the guide, but where does that stand for the full year? I mean, how much are you absorbing maybe on an annualized basis so we can try and gauge the opportunity when inventory does eventually normalize? And then secondly, just kind of second part of that question is you talked about promotional activity, which obviously is top part of the business, but do you have to promote and discount to shift that inventory over the next couple of quarters?

Yes. Thanks, Nigel. Yes, I would say that we've seen obviously a pretty significant impact on our margins [Technical Difficulty] year due to basically heavy pullback in production. And we've done it probably almost -- we had to make three to four different adjustments as the year has gone on. As we got into late May and June, we had to make an adjustment based on what we're seeing with the slower consumer demand. We did it again in the early July time frame to prepare for our back half. And then we did -- we're doing it again here in the late stages of the third quarter into the fourth quarter for the early part of next year. So the impact to the P&L is probably around $400 million. It's a pretty substantial number for us in 2022. So that would equate to well over $2 of EPS, probably higher than that given our tax rate is very low. So, it's substantial. And so that, in my view, obviously, is a temporary situation that we have to navigate through and really figure out what that impact would be as things start to come back in a positive way. What was the second question, Nigel, I forgot?

Discounting.

Discounting, yes, on the inventory. So right now, I think we're being very balanced in our approach on how we liquidate inventory. We're looking at promotional activities. We're looking at alternative channels. The interesting part of the situation is that this is not old inventory. This is inventory that's been created in the last 15 to 18 months, that is very healthy inventory that we should be able to sell at reasonable price points. The question is time, how long do we want to take for the liquidation to occur. So I think we're going to strike the right balance between pursuing promotional discount activities and really just pursuing it more through normal core activity at normal price points.

Thank you. Our next question comes from the line of Nicole DeBlase with Deutsche Bank. Your line is open.

Just maybe we could talk a little bit about pricing. I think that's also an important variable as we all kind of think through the puts and takes for 2023. So with demand now moving into negative territory and now that we're seeing some refreshing declines in commodity prices. What's the conviction that you guys can stick the price increases that you've taken so far? And maybe what is your view of what's going on from a competitive perspective as well?

Yes. I think when I look -- when I think about this situation, it obviously is something that's very unusual. We can't go back in time and look at anything in Stanley Black & Decker and say we had a period of time where we had 10% to 12% price increases. That just hasn't been part of any history here within the Company, at least recent history. And so therefore, you have to look at it a little bit differently. That being said, we all have to remember there's been a period of time leading up to this where we had no price increase of any substance, and we were incurring substantial impact in our P&L from the inflation back in 2021. And so we can't forget that. We have to recognize that that's a dynamic that we went through. And then when the tail end of this happens and we're recovering the commodity deflation that we're now experiencing, which actually won't hit our P&L until the later stages of 2023, we have to be vigilant with the price increases and recognize that just because the commodity indices have changed, it does not mean we can lower our prices, because we have the high-cost inventory in our system that has to flow through and be sold to our customers and eventually the end users over some period of time, which is probably at least nine to 12 months at a minimum. And therefore, I think the tail, we will continue to be disciplined about this. We always are looking at what's happening with our competitors in the market. At this stage, we feel like our price points are very consistent with their price points across virtually every category. So, we don't see anything unusual happening there. And we do know there are some competitors that are still putting some price increases into the market even today. So there's going to be a tail here that we're going to have to navigate through. I believe the impact of deflation and what happens with price over the next two years will still be a substantial positive for Stanley Black & Decker's P&L.

Thank you. Our next question comes from the line of Chris Snyder with UBS. Your line is open.

So I just wanted to ask more about the decision to have higher production curtailments versus what the Company expected three months ago. Because back half demand is trending as expected versus the July update, so does this reflect a softer outlook on demand into 2023? Or just more urgency around bringing working capital down and generating cash, maybe after that working capital winds down that the Company expected in the September quarter?

Thank you. Maybe, Corbin, you can provide that -- give some color to that question.

No, I don't think that our view in North America is pretty consistent as we -- we're seeing levels of demand that were consistent with how we exited the second quarter. Obviously, we're seeing weaker demand in Europe. But the production curtailments are really, to your point, about generating cash and that's really what's been driving it. So, that as Don said, we've been through three or four of these. And as we look at the desire to get the inventory out, there are a few ways to do it. But the quickest way for us was to reduce our production, which we've done throughout the last three or four months.

Yes. I think I'll just add to that, that when I made some comments in response to the first question, we have looked at a variety of different scenarios. And one of the scenarios is a continued retraction of demand as the housing market continues to slow and potentially construction slows down for a period of time. And therefore, we're factoring that into our decision as well. So it's a combination of what Corbin said, but it's also looking at what we think are potential scenarios for next year, and being thoughtful about what our production should be today. We have to remember that our supply chain is fairly lengthy. So things that we're producing today, we're selling -- something we produce this month, we're probably selling in the month of March and April of next year. And so that's really the decision we're making. And we're trying to strike the right balance and reducing the inventory, as Corbin was describing, and being as proactive and aggressive about that to continue to drive a healthy cash flow performance going forward. And then two, making sure we meet the needs of our customers and not have a retraction in our fill rates. And I think based on the decision we've made around production, we are striking the proper balance in that particular area.

Thank you. Our next question comes from the line of Michael Rehaut with JPMorgan. Your line is open.

Just wanted to try and get a sense, obviously, a lot of near-term disruption. And just trying to -- I guess, in two ways, number one, kind of zero in on the next couple of quarters, I guess, 4Q, for example, is going to be low digit margins in Tools & Storage. How much of that margin level is what you'd consider to be relatively temporary primarily, I think, driven by the inventory reductions? And how much is kind of a reset versus expectations 90 days ago? And I guess, ultimately, where I'm going with this is, I think in your most -- in Slide 9, you're talking about a high 20s gross margin by the end of the year. Potentially, it could -- the opportunity for low 30s, but it does look like that's a little bit of a reset versus also 90 days ago. And what type of headwinds are you seeing today compared to getting to, I believe, you kind of threw out like that $7 per share run rate by the end of 2023? It looks like there's a few more moving pieces or headwinds that might take that number down by $1 or $2 even.

Well, so I'll -- there was a lot in that, Michael. So I'll start with the first question you had around fourth quarter margins and how much they may be being impacted by these pullback in production decisions. The impact in the fourth quarter is about 5 points or 500 basis points. So it's substantial, clearly. So we're also dealing with the last stages or the middle stages of the high-cost inventory from the big inflation wage that we've had that are in our inventory now, and that we're starting to sell that through. So that's another factor that's pushing down margins that will take time to work through. Because even when you get 90% or 100% price recovery when you go to these actions, you still have an impact in your margin rate that's substantial. And in this case, the differential in our margin rate is about 300 basis points just from the difference of inflation, dollar and price dollar, because it's not a one-for-one offset. The only way you're going to offset it completely in your margin rate is going to be if you get like 120%, 130% recovery on inflation through price. And so you got a bit of a double impact that's impacting the margins right now in Q4. And so I think that's something that we just have to be thoughtful about as we analyze the view of Q4. We're not going to give a ton of color on 2023. What we're trying to do is help people understand that there's a path to get our gross margins back to the high 20s and eventually to 35-plus percent. The path is really about eliminating some of these temporary things, because these things are temporary in the sense of pulling back on production will eventually get…

Thank you. Our next question comes from the line of Adam Baumgarten with Zelman & Associates. Please go ahead.

I'm just wondering if you could run through some of the point-of-sale trends that you saw in U.S. retail throughout the quarter and maybe into October, if you saw any deceleration. It sounded like it was relatively stable, but any nuance would be helpful as we enter the fourth quarter.

Sure. Do you want to take that, Corbin?

Yes. As we said earlier, we really did not see a big difference in the third quarter from what we exited in the second quarter. So in some ways, particularly around power tools, they've held up pretty well. Hand tools obviously was down a little bit. But in general, I think the POS sales in the U. S. have held up somewhat surprisingly well third quarter. Hard to tell what's going to happen in the fourth quarter and next year, as Don mentioned. But in the third quarter, we were relatively -- on a relative basis, pleased with what we saw.

Thank you. Our last question comes from David MacGregor with Longbow Research. Your line is open.

Yes, I think we got a pretty good handle on inventory and gross margins at this point. Let me just ask about the outdoor acquisitions and you talked about slower consumer demand and the seasonal patterns, which I guess we understand is probably comes as a surprise to anyone. The seasonal pattern, was it consistent or was there something changing there? And just talk about margin contribution expectations and the progress on integration. And how do you avoid not being distracted by everything you're focusing on with inventory and gross margins and keep an appropriate level of focus on the integration and the achievement of value for the steel?

That's a great question. We've actually integrated or folded in the integration process of MTD and Excel into the transformation plan in all the rhythms and rigors that we have around that. I mean we spend a lot of time every day, every week, focusing on these different things that we're talking about over the last hour. And so we have created a set of processes and rhythms that allow us to really polish these different things, make decisions related to a variety of different items and folding in the integration of MTD and Excel into that has actually been a bit of an efficiency for us to make sure that we don't lose sight of the importance of those acquisitions and effectively integrating them into the Stanley Black & Decker operating system. I think -- when I think about the outdoor business, yes, it was a rough outdoor season this year for sure due to weather primarily. And then, there was a bit of a consumer impact at the tail end of it as well as consumers started shifting their dollars to other areas. That being said, as you talk to our customers, they -- as usual, they're very bullish about the upcoming outdoor season and early next year. I think it will be a good season if the weather cooperates. Again, I think we've planned for a variety of different scenarios that could play out, whether it's a flat scenario or an up scenario or a down scenario, will be determined. But our production levels have been focused on those different scenarios because we are producing product in the fourth quarter for the upcoming season. So, it's difficult to know where that season is going to go. But if you listen to our customers, they're very excited about it. We're taking a balanced point of view on it to make sure that we effectively meet the needs of our customers and ensure that we don't get stuck with a lot of extra inventory if something unusual plays out. Maybe Corbin, you might want to talk a little bit about where we are with margin profile, how the integration is going and provide a little more color on that.

Yes. The integration, I think, has gone very well. And the colleagues that joined from MTD and Excel have been fantastic, and it's great to have them as target team, and the very innovative right now. Given the seasonal weakness that we saw in the spring and summer, obviously, margin rates were hit probably more than we expected because of the weaker season. However, as we go forward, we don't -- our view hasn't changed in where we think the business can get to over time. And we're generally very strong on hitting our synergy targets and getting the margins of our acquisitions to where we want, and we feel the same for both MTD and Excel on this one.

Thank you. I would now like to hand the conference 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. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.