Stanley Works Q4 2008 Earnings Call Transcript

Jan.28.09 | About: Stanley Black (SWK)

Stanley Works (NYSE:SWK)

Q4 2008 Earnings Call

January 28, 2009 10:00 am ET


Kate White – Director of Investor Relations

John F. Lundgren – Chairman and Chief Executive Officer

James M. Loree – Executive Vice President and Chief Operating Officer

Donald Allan Jr. – Vice President and Chief Financial Officer


James Lucas

[Unidentified Analyst]

Eric Bosshard

Sam Darkatsh

Nigel Coe

Seth Weber

Michael Rehaut

Kenneth Zener


Good morning. My name is Jennifer and I will be your conference operator today. At this time I’d like to welcome everyone to Stanley Works fourth quarter 2008 results conference call. (Operator Instructions) And now I’d like to turn the call over to Miss White. You may begin your conference.

Kate White

Thank you very much Jennifer. Good morning everyone. My name is Kate White, Director of Investor Relations for The Stanley Works. Thank you all very much for joining us on the call this morning. On the call in addition to myself is John Lundgren, Stanley’s Chairman and CEO; Jim Loree, Stanley’s Executive Vice President and COO; and Don Allan, Stanley’s Vice President and CFO.

I would like to point out that our fourth quarter earnings release, which was issued this morning, and a presentation supplementing today’s call which we will refer to during the call are available on the Investor Relations portion of our website which is This morning Jim, John and Don will review Stanley’s fourth quarter and full year 2008 results and various other topic matters, followed by a Q&A session.

The entire call is expected to last approximately one hour and a replay of the call will be available beginning at 2:00 PM today. The replay number and access code are in our press release which again is on our website.

And as always, please feel free to contact me with any follow-up questions after today’s call at 860-827-3833 or Corbin Walburger at 860-827-3937. We will be making some forward-looking statements during this call. Such calls are based on assumptions of future events that may not prove to be accurate and as they involve in risk and uncertainty. It is therefore possible that actual results may differ materially from any forward-looking statements that we might make today, and we direct you to the cautionary statements in Form 8-K which we have filed with today’s press release.

With that I will now turn it over to our CEO, John.

John F. Lundgren

Thanks Kate. Good morning everybody. Thanks for listening, phoning in. Let me start with just I think what we spent a lot of time talking about internally. I know you’re interested in just an overview of the state of Stanley, as well as some fourth quarter and annual highlights.

Our fourth quarter earnings results were in line with previously communicated estimates. You will recall we had a prerelease on December 11, 2008. Those results were $0.66 in the fourth quarter ’08 translating to $3.41 for the year, excluding the fourth quarter restructuring charge which we communicated in our December 11 release and that Don Allan will talk a little bit more about later this morning.

It was a very good story in terms of cash flow. Free cash flow of $419 million and that’s despite an unplanned and unanticipated increase in capital spending of about $25 million due to the cancellation of several previously existing lease arrangements.

Working capital turns again a good story and a great source of cash increased by 0.6 of a turn to 5.9 despite the unprecedented volume decline that we experienced during the fourth quarter. And Jim’s going to talk about some of the sources both of cash as well as the programs driving the improved turns. It was particularly encouraging in the fourth quarter, the improvement in turns.

Price realization continues to be encouraging as we virtually offset the overwhelming majority of our inflation headwinds. For the last two years we’ve averaged about 85% and I have a slide that will give you a little more granularity on that, but we’re making a lot of progress via our pricing center of excellence.

The high point certainly for us in the quarter was the performance and for the year was the performance of our convergent Security Solutions business. Revenues grew 21% for the year, 32% for the quarter and operating margin expanded significantly. And again Jim will get into some more detail when we talk about the segments and give you a little bit more granularity on what’s taking place inside our Security segment.

And finally, the Security segment currently makes up the largest portion or made up the largest portion of our fourth quarter sales at 38% as our portfolio transition proceeds and Security thus far has been less adversely affected by the macroeconomic conditions.

Moving on to a closer look at revenues, revenues of $1.86 billion were down 5% from fourth quarter ’07. As you know there’s not a lot of seasonality in this family business, and the primary factor contributing to the revenue decline was the 10% volume decline as you see on the bottom left. And importantly that followed a 7% unit volume decline in the third quarter, and the 10% Don will talk to you a little bit more later on. That’s not inconsistent with the outlook for the first half of the year where we’re looking at or assuming 12% of volume decline for the foreseeable future.

Price was a good story, as we realized a 4% net price increase year-on-year resulting in a 6% decline in organic revenues. Currency was a negative, as the dollar strengthened against the euro, the British pound as well as the Australian and Canadian dollars, those four currencies making up the overwhelming majority of our foreign currency exposure.

And acquisitions primarily and securities, secondarily in our Engineered Solutions business, contributed about 6% to our top line. So the net result is a 5% decline in revenue, with a 10% unit volume decline.

Looking briefly at the segments, as I suggested Security performed well. The CDIY business was off 16% in total, 10% of which was organic. And Industrial was off 10%, 9 of which was organic.

Moving on to margin, we were pleased with our ability to hold gross margin rate for the year despite the decline in volume. You see gross margin holding steady at 37.8% as a result of a business mix towards the higher margin portfolio, as well as the realization of many of the planned costs synergies from recent acquisition.

You see that operating margin did decline 140 basis points. And the difference between flat gross margin performance and the 140 basis point decline in operating margin is primarily attributable to the volume decline, which of course was the catalyst for our announced fourth quarter initiatives.

Looking at pricing, I alluded to in the highlights you see at the top a history of our recovery of all our inflation, 81% in 2005, a 45% in 2006 although it was against the lower base, but then 83 and 88% the last two years.

We’ve talked about this on earlier calls, but several years ago we established a corporate pricing center of excellence which is really gaining traction. That has evolved in addition to the corporate center with a subset of pricing center of excellence or expert attached to each major business unit, and that’s really starting to gain some traction. So we’re pleased with our ability to thus far, at least the last two years, compensate for the overwhelming majority of materials inflation that we’ve received and we anticipate that to continue going forward.

Looking quickly at inflation, because it’s moving very quickly and there’s tremendous volatility, on the left hand side it’s clear commodity prices have declined significantly in recent months, yet we’ve still absorbed a tremendous amount of inflation. The materials inflation accounts for 60 to 75% of Stanley’s [cogs] inflation, depending on the quarter. And then depending on spot prices, 50 to 75% of Stanley’s material inflation is normally steel.

So you see the quarterly walk of materials inflation and all of our cost of goods inflation on the left hand side, where we’re continuing to absorb in excess of $40 million a quarter. Looking at the right, because steel is the single most prominent element in our cogs inflation, you see first quarter ’08 Stanley paid on average $660 for steel. In the fourth quarter that was up to $940, with the average for the year being $826. And that’s the average that was included in the chart on the previous page.

Looking forward into the first quarter, we’re anticipating an average cost in our P&L of about $790 a ton. That of course is above the current spot price, but I think – and it creates $130 a ton headwind for us in the first quarter. And I think it’s important to note we did a good job throughout the year delaying some of these increases three to six months.

And we do have steel in inventory and that we’ve purchased in the fourth quarter and contractually even into the first quarter at higher prices. And we’ll see some of the deflation that we’ve talked about in previous calls and the anticipated deflation starting to show up in our P&L midway through the second quarter.

So on a year-on-year basis, inflation will be a reality in early ’09 and of course the jury’s still out, but Don’s guidance talks a little bit about how we’ve accounted for that in our P&L.

Let me now turn it over to Jim Loree, who’s going to take us through the segments and then we’ll go on to Don Allan.

James M. Loree

Thank you John. We were very pleased with how the Security segment performed during the quarter. We started building this business back in 2002 in order to diversify our revenue base and to provide a long term source of growth. And in the quarter we certainly accomplished both of those objectives.

As you can see, revenues were up 14%. It’s now at a run rate of about a $1.6 billion annual revenue business. Segment profit was up 28% to $75 million and the segment profit rate surged to 18.4%. A lot of this was driven by the convergent – the convergent Security Solutions business, also known as our Electronic Security business which is installation and monitoring electronic security systems.

We had two major acquisitions during the year, Sonitrol and GDP and we also enjoyed the benefits of the reverse integration of our United States Systems integration business into the HSM business model, really reaping the synergies that we expected when we did that acquisition. Great story and kudos to [Brett Bontrigger] and his management team for excellent execution in this area.

Mechanical Access had a solid quarter under the circumstances. They had to deal with a continued loss of the Home Depot hardware business, which has now finally anniversaried, and they did really well offsetting their volume declines with both price and productivity. So all in all a pretty good story in the Security segment.

I’d like to talk a little bit now about the portfolio shift that we’ve been undertaking since 2002. And as you can see from the next chart here, back in 2002 the revenues from our Construction and DIY segment were approximately two-thirds of the company and Industrial and Security were the remainder. As we look to 2008 on the upper right part of the chart, you can see a much more balanced revenue diverse revenue base in the company with the Construction and DIY business being 36% of the company, but the other two segments being very close in size, so a very balanced portfolio.

It’s even more interesting, I think, when you look at the bottom part of the chart and look at how the operating margin mix has changed over the last six, seven years. Where the Construction and DIY business was contributing about 80% of the company’s operating margin back in 2002, you can see today that’s down to 31% although it has increased in dollar terms. The growth in the other two, the Industrial and Security segment, have dwarfed on a percentage basis the Construction and DIY.

And now Security represents in terms of operating margin 43% of the company’s operating margin. So a really good story there and certainly one that served us well during this timeframe. And as we move on to the next chart, you can see we’ve also accomplished a reasonable amount of diversification as it relates to the end markets. And the residential construction part of our business is now approximately 33% with about half of that directly in the U.S.

But we also have considerable positions in other areas. As you can see, 24% is in this Industrial area on the left upper part of that pie. We also have some commercial construction, about 12% of our revenue base which has held up well even though the market has been down in the U.S. in particular over the last year. We were slightly positive in terms of our revenue performance in commercial construction.

Then you see retail. We have some activity particularly in our Security business in retail and mostly in the Access Technologies automatic door business, and that business actually had positive revenue growth last year. So again, even with the exposure to retail they’ve been able to gain share and they’ve been able to do a lot of refurb type of activity in that particular market.

Then we have exposure, about 12% of the end market, in healthcare education in government, automotive repair which is not the manufacturing type of automotive volume but rather the auto mechanics, supplying tools to auto mechanics. Again that market has held up reasonably well. Mac and Facom you know are the big elements of our activity there. And then I mentioned Industrial and other.

So a good, diverse revenue base in terms of end markets which has also served us reasonably well in this market. But that said, we haven’t had a – we haven’t been immune to the market declines in the Industrial segment and the CDIY segment. I think this next chart sort of puts that in crystal clear perspective.

In the quarter for Industrial as we look at the left hand side of the chart, revenues were down 10% and the operating segment profit rate fell to 10.3%. It was down almost 500 basis points in light of the steep volume declines. Industrial and automotive repair revenues, particularly hurt by the Industrial markets in Facom. Organic revenues declined 8%. That was a pretty significant drop for them.

In our North American Industrial and automotive repair business we did have the issue of economic contraction, particularly in our Industrial business. And then in the automotive repair business most of our issues there were self-inflicted as the driver count decreased in that particular business. And we are working diligently on fixing that issue as we speak.

We also had growth. In Engineered Solutions we were up in double-digits there. That was driven primarily by acquisitions and a modest improvement in our storage business.

If we look over at the Construction and DIY segment on the right-hand side, you can see even more dramatic revenue declines and even a more marked profit rate decline, almost 700 basis points, the operating profit dropping to about 6%. We like to think that this is a kind of trough profit rate for this particular business with these types of revenue declines that we’re experiencing. But we continued to have weakness in the U.S. residential construction markets. I don’t think that will surprise anybody.

And in Europe we also had organic revenue declines, which were different than in the beginning of the performance in the beginning of the year when we actually had increases in Europe. So as time went on during the year, and we had talked about it on some previous calls, the organic weakness spread to Europe in the construction markets. And so now we pretty much have it across the board, and as well in the emerging markets. So it’s a global phenomenon not surprisingly.

And the Bostage margin rate was negatively impacted by inflation, as steel inflation surged again although we don’t see that continuing in the future here in that particular business. And then their volume had some decline related to their continued market weakness.

So that’s the story of the segments. Now as we move to working capital, I think this is a tremendously positive story. John mentioned the 0.6 of a turn improvement from 5.3 to 5.9 turns. That was $133 million reduction in absolute dollars of working capital and over $120 of that was directly cash related. There was a little bit of exchange impact as well.

But as you look across the board, inventories came down $41 million. If you think about the fact that we had a double-digit unit volume decline, the degree of difficulty in order to accomplish that was extremely high and we were able to do it. And then on the receivable side we brought the accounts receivable down $128 million, which included $40 million or so of reduction in overdues from a year ago. So in this difficult economy with the credit issues and so forth we were actually able to reduce the overdues in our portfolio by $41 million with a concerted effort.

And then of course payables dropped slightly, not surprisingly with the reduction in volume in inventories. What this says basically is that the Stanley Fulfillment System that we put in place several years ago is gaining momentum as we speak and it couldn’t be happening at a better time.

I want to emphasize that the benefits from the Stanley Fulfillment System are primarily process related and they are not a one time phenomenon. These are fundamental changes that we’re making to the company’s processes and the way we do business that are having a positive impact on our cash generation. And in that regard as I said they are very timely.

We’ve been at it a couple years. As I said this is not an overnight sensation. This is three yards and a cloud of dust. There’s four elements to the Stanley Fulfillment System. It involves something we call transformational lean, which is Stanley’s version of lean manufacturing, and enterprise lean.

Also tremendous progress in something we call S&OP which is the way you synchronize the front end of the business with the back end of the business. And we’ve made enormous improvements across the company in S&OP and that’s why we’re able to endure a volume reduction of this magnitude and still bring our inventories down.

On top of that, we have two other elements. One is complexity reduction and that is reducing the complexity of our products, the way we do business and our manufacturing footprint; and finally platform standardization. And so all of these things are progressing as we speak and contributing to this tremendous improvement in working capital. And obviously as I mentioned that’s had an impact on cash flow.

And now I’m going to turn it over to our CFO, Don Allan. He’s going to talk about our cash flow performance.

Donald Allan Jr.

Thank you Jim. On Page 13 I just want to spend a few minutes and talk about that cash flow performance, focused primarily on the year. As Jim mentioned the working capital contribution really bolstered our cash flow and our free cash flow performance for 2008 with about

$127 million of a contribution in that regard.

And our operating cash flow was $560 million which was an increase over the prior year of about $20 million, which is an impressive performance when you consider the fact that our net income from continuing operations before the restructuring charges in the fourth quarter was actually down 12%. And so with that decline and with the focus on working capital, we were still able to achieve a sizable or decent increase in operating cash flow.

John mentioned earlier on that our capital expenditures were slightly higher than we anticipated. It did increase about $50 million versus 2007. Approximately $30 of that was really planned strategic investments that we had in the pipeline since the beginning of the year. And then we had about $20 million of certain leasing structures that were terminated in the fourth quarter that due to the difficult credit markets we were not able to enter into new leasing structures at that point in time. So that’s really driving that increase.

But still a very healthy free cash flow performance of almost $420 million in 2008. Regarding CapEx, as we look at 2009 we would expect that our CapEx would get down to more historical levels as a percentage of revenue, which would be about 2% as we mentioned in our press release this morning.

The next page, if we take a look at our credit and liquidity status, it’s something that obviously everyone is concerned with the current economic environment. And we thought it would be good to just refresh everyone’s memory on a few things related to that. The first thing we want to mention is obviously we’ve had a long standing strategy to remain single A as far as our credit rating, and it’s served the company very well over the years. That is still a very important strategy for us going forward.

In addition to that, we took several actions, two in particular in 2008, to insure that we had ample liquidity. In particular, in October when the markets were fairly turbulent, we did term out about $250 million of debt that will mature in 2013. In addition to that, we increased our credit line which really gives us approximately $800 million of liquidity, and in this time and economic circumstances it is a wonderful thing to have available to us.

And then the third thing to mention is we really have no major unfunded obligations until 2012 as the chart depicts here on the right. Due to the equity unit structure that we entered into a few years ago, we will have a cash inflow as a result of the shares issuance in that transaction of

$330 million in 2010. That will help us fund the bond obligation we have of $200 million in that year. So we feel that we’re in a very strong position regarding credit liquidity at this stage.

As John mentioned earlier, we saw unprecedented unit volume declines in the fourth quarter here, 10% of volume decline. In our press release in December we indicated the importance of having to realign our cost base and our cost structures due to that, as well as due to the outlook we were seeing for 2009. So we took some significant actions as that press release indicated.

Specifically our headcount was reduced over 2,000 employees which is approximately 10% of our workforce. We did certain reorganizations and elimination of management layers. And then we also had a closure of three plants in the United States as part of that restructuring. Then last but certainly not least we did suspend certain U.S. employee benefits on a temporary basis to really assist in those cost reduction actions, and to avoid to have to do additional headcount reductions.

The cost associated with these actions was for the year, the entire restructuring was $92 million. The specific fourth quarter restructuring was $67 million, which is about just less than $0.60 EPS. The total year restructuring charges were $0.80 per share.

The cash outflow associated with these restructurings we would expect about 85% of them are cash outflows and the remaining 15 are non-cash, in other words asset impairments. And we would estimate about 60 to 70% of that cash would be paid in 2009 and the remainder would be paid in 2010, as it does the process in Europe is much longer for doing these types of actions.

The savings associated with all this is $140 million associated with the headcount reductions and that includes what we did throughout the year, not just in the fourth quarter. And so we feel like we’ve taken the appropriate steps there. In addition to that, we really attacked our discretionary costs, $55 million of actions, focuses on T&E and car and fleet costs, etc. And that’s something we’ll continue to attack as we go through 2009.

The EPS impact added a positive $1.75 per share as a result of those actions, with $0.24 of that carrying over to 2010.

Moving to the next page, we made a decision as you saw in our press release, not to provide 2009 guidance at this point until we see the economic conditions and the end markets begin to stabilize. However, we continue to constantly monitor these variables and we’ll post them as we go forward.

But we did want to be able to provide as we indicated in our December 11 press release some assumptions to assist the financial community with some things that we’re seeing in ’09 as well as some assumptions to assist you with your modeling. And we have updated that in this press release this morning.

If we start with unit volume, which is clearly the largest variable that we have at this point, as we head into the year it appears that the 10 to 12% unit volume decline is what we’re seeing in the early stages. If that was to continue throughout the entire year, the negative impact on our EPS would be $2.00 to $2.25. Now some of that’s volume associated just from the lost sales, but of course this is also an impact of under absorption in our plants that’s factored into that EPS assumption.

Currencies as we mentioned in our December press release will have the same significant impact as well, as the U.S. dollar strengthened against some of the major currencies that we have like the euro, the Australian dollar, and the Canadian dollar in particular. And we’re estimating that on current exchange rates that it would be about a $0.50 negative if those exchange rates remain constant throughout the year.

If the exchange rates move 5% either way, it probably is about a 10 to 12% impact, positive or negative depending on which way they move. Now the impact will likely be most of it will occur in the first half of 2009, about 90% of that is what we expect as exchange rates begin to or the U.S. dollar began to strengthen as ’08 continued on throughout the year.

Looking at inflation and pricing, which is an area which everyone is very interested in, we do expect as John mentioned to see some inflation especially in the first quarter and the early part of ’09 as we have that carryover effect. If we look at commodity prices today, there is a possibility that we may have some deflation in the back half of the year, but that’s difficult to predict at this point in time.

Pricing, we will certainly have a carryover effect as mentioned in our press release. That would likely contribute $30 to $50 million of a positive. So overall our view is that we will likely have some type of modest positive impact as a result of those two items. But clearly there’s variables that could change the result of that going forward.

I mentioned the cost reduction program of $1.75 already. As far as restructuring charges, we mentioned in our press release this morning that we expect to probably have approximately 50% of our ’08 level charges, which would be about $0.40 EPS in 2009.

And then last but certainly not least, accretion for the 2008 acquisitions that we’ve already done, will be at $0.10 to $0.12 EPS. So we feel this is helpful information for all of you as you begin to look at our company in 2009. Just keep in mind that we continue to be committed to take the actions to protect our earnings and our cash flow and our balance sheet going forward.

As we summarize the call this morning, just looking back, a few things to point out. We feel we’ve taken as I mentioned the aggressive and proactive restructuring actions to adjust our cost base and prepare ourselves for 2009 and be ready when the economic conditions begin to improve. We also demonstrated the ability to mitigate inflation with customer pricing actions where we had $140 million inflation in 2008, with offsetting $123 million in price recovery.

Free cash flow is a great story, really driven by that strong working capital performance with a proven success of the Stanley fulfillment system. As we look forward, we are dedicated as I mentioned to continue to take steps needed to maintain our upper tier credit rating. And I had also mentioned that we have no unfunded debt obligations until 2012 and we feel very good about our liquidity position.

As all companies who are multi-nationals like us, we will be subject to potential negative impact of fluctuations in currencies and that is something that we monitor as we go throughout the year here. And certainly last but not least is we will continue to be focused on successful integration of our acquisitions we’ve done and maximize those synergies going forward, as well as focus on SFS in 2009 and beyond.

Kate White

Jennifer, now we are ready to take question and answers.

Question-and-Answer Session


Your first question comes from James Lucas.

James Lucas

Factoring in the volume decline of down 10 to 12% and you look at your contingency planning and 2009, at what point do you think about having to take additional actions or do you think that you’ve got the cost structure in line if things were to remain stable today? And secondly, cash flow has been a fantastic story and otherwise there hasn’t been a lot of good news. When you look at the job you’ve done on working capital, what opportunities remain there?

John F. Lundgren

Jim, this is John. Good morning. I’ll take the first half and I’ll let Jim take the second part of that question because he took it in the presentation and some of the initiatives that he’s leading are really, really the drivers in cash flow.

Your question on contingency planning if you will, or is there yet another way that is right on it’s a topic that as recently as the middle of December and again already this year we’ve discussed with senior management. If volume continues to decline at the rate it’s declined the last two quarters, and we may well need another round of downsizing businesses later on in the year. Without being terribly specific, it would be in the second half of the year. Everything we’ve talked about and everything we’ve done it’s going to take us six months to get it implemented.

So sometime between April and June, we’ll have a look forward. Hopefully the situation will be a little more clear. If it’s no worse than it is now, what Don’s put forward in terms of guidance suggests we’ve done everything we can do with a reasonable payback. If the situation’s worse, sometime in the third quarter we have contingency plans, I would say 50% developed and we’ve got three to four months to finalize those for yet another round, which of course we’re hoping isn’t necessary. But I think we’d be less than responsible as an executive management team if we didn’t have those contingency plans in place.

I’m going to let Jim talk about the continued operations and on continued opportunities in cash flow, primarily via FSS because as Don suggested it’s working capital in general is a huge source of cash for us. We are not going to let up. And I’m going to turn it on over to Jim.

James M. Loree

Okay. Thank you John. Well I think first of all, we could have done better than 5.9 in turns had it not been for the precipitous volume decline and so I think there is a calibration that can occur where we clearly believe that in ’09 that we can do better than 5.9 turns. Starting with that, I think that is relatively clear to us. As we get into north of 6 turns and north, it gets a little murkier. We do know that we have great momentum. We do know that we have a business process transformation and not just a one act play.

And there is a lot of act –

[Audio Impairment – 22 seconds]

John F. Lundgren

- that historically we’ve proven that providing it gives more information to more people than quite frankly we want to have out in the public domain. We’ll say two things. Acquisitions contributed for two reasons. One they were positive and Brett’s team did a really good job bringing them on board quickly and having them up and running as part of our business in absolute terms.

Secondarily, we acquired albeit at relatively high prices, we acquired some very high margin businesses with the equivalent to become even higher margin when we started to realize the synergies.

Number one. Number two, their markets were not as adversely impacted as I suggested by some of the macroeconomic factors, so there was some reasonable organic growth. Third and last, offset by as Jim touched on on the mechanical side the continued headwind from the loss of about $50 million annually or $12.5 million a quarter of high margin hardware business.

So to summarize, great performance in convergent, both in terms of growth and margin enhancement and synergy achievement; solid performance in our mechanical side, somewhat offset by the volume in margin drag of hardware which as Jim pointed out has anniversaried so we see some potential for some reasonable momentum in the mechanical segment going forward.

[Unidentified Analyst]

What I’m wondering is, has the structural profitability of the convergent business improved when you do take out the acquisitions that sort of mix up the margin?

James M. Loree

Absolutely. I mean, what I think you basically have – when I talked earlier about the benefits of the reverse integration, that is said another way, what’s happened is we’ve taken the legacy systems integration business that we had before we bought HSM and we’ve converted it to the HSM business model. Now what that means is recurring revenue has become an extremely important part of – first of all, you can’t distinguish between the two organizations any more. They’ve become one.

And secondly the folks that used to sell systems integration, which was basically installation, are now selling monitoring in addition to their installation which in and of itself drives higher gross margins and higher operating margins. And that’s what’s happening. And the segment is basically legacy operating margins have gone from mid-single digits up to double-digits. And at the same time HSM brought in very high operating margin and Sonatrol with the synergies in addition to GDP all mix up the operating and the gross margins.

Kate White

Next question, Jennifer.


Your next question comes from is from Eric Bosshard.

Eric Bosshard

First of all, the lack of providing 2009 guidance you attributed to the volatility. Can you just talk about where you see the greatest volatility or uncertainty in 2009 that’s sort of pushing you to that decision?

John F. Lundgren

I think yes, Don provided the guidance obviously with a unanimous agreement from Jim and me and others. And a big piece of it of course is volume because we’ve had a 7 and 10% consecutive volume decline. So economically and numerically that’s the biggest piece. But Don why don’t you address the first – the first half of Eric’s question?

Donald Allan Jr.

Yes, Eric, I think the volatility clearly is in the unit volume. And the difficulty of seeing out beyond a few months is very hard for many companies including us to see. And the performance we saw in the fourth quarter with our different segments where we are CDIY and Industrial segment having significant volume losses, and those would be the ones that we would be the most focused on. You know, what it would mean for them going forward into 2009.

Obviously the Security segment we want to monitor closely as well to insure that there’s no volume loss and impact there. But it’s the first two segments that we’re really focused on going forward.

John F. Lundgren

And Eric so you don’t cut off and you get to ask your second question, let me just add, you know our business extraordinarily well. With the exception of some of our Security business and our Engineered Storage Solution business and hydraulics, these are very short cycle businesses. Particularly CDIY and Bostage and many of our smaller Industrial tool business, I know you know and most of the people on the call, you know, understand that a major customer orders on Monday and we ship it on Wednesday.

And that’s, you know, we have our supply chains linked as well as we can. But you know simply said that the short cycle nature of those businesses and the recent history that’s just so out of proportion with anything else we’ve ever seen is what causes let me say our lack of clarity into the even short term future. But you had a follow-up I know.

Eric Bosshard

Yes. The follow-up is in Security, the flat organic performance in the fourth quarter is impressive. As you look at historically and you’ve talked a little bit about the order book in that business and can you just give us a little bit of sense of what that looks like and how we should even be thinking about that business in total for 2009 based on sort of indications in orders and quoting activity you’re seeing now?

John F. Lundgren

No, all we want to say you know although I’d argue we have probably better visibility into Security than others, but we really don’t want to be talking about order books on this call. Two things happened. Two things that I think are appropriate and hopefully helpful. One is a relatively small percentage of our Security business, mechanical and convergent, is based on new construction. A smaller percentage than one might think.

Second, regardless I could give you a number for the order book and it would not help you unless I were to give you more granularity than is readily apparent, because it could be a contracted breadth business as won for a new hospital that’s going to be constructed in December, or it could be an installation at a retailer next week. So the number itself depending on when those projects are scheduled to be performed you know really wouldn’t help you. But candidly it’s a fair question, but it’s not just one we want to be talking about on an earnings call.

Kate White

Next question, Jennifer.


Your next question comes from Sam Darkatsh.

Sam Darkatsh

First off, your pricing in Q4 was up 4 and if I recall correctly it was up 3% in the third quarter. Does that imply that you had perhaps a small round of price increases in the fourth quarter? Or was that a timing issue as to when the pricing went through in the third quarter? Was that mixed? That was the first question.

Second question would be, what are your trends you’re seeing sell through versus sell in? And the last question would be, I don’t recall whether you said what convergent organic growth was. You mentioned what it overall was but not organically. Those are my three questions.

James M. Loree

Okay. Well, let’s address them in reverse order. How about that? Although I think the limit is two questions, isn’t it? That’s all right. We’ll do both of these. So as far as the convergent organic growth, it’s very difficult to give an accurate number for the sub-segment of convergent because the HSM acquisition and all the acquisitions are mixed together. But as far as we can tell, we were up modestly, up a point or two. Something like that. Nothing dramatic. But I wouldn’t take that number to the bank and bet on it. But I think directionally it’s accurate.

The sell throughs, sell in, retailers in the United States were very judicious with their inventory management. If anything, they’re average to slightly below average levels with their inventory at this point in time. So I think that bodes – you know our inventories are in good shape. Their inventories are in good shape. If we ever get any stabilization in housing prices, it could be very interesting in terms of volume. But we don’t see that at this point in time. Or housing sales. Housing prices we’re beginning to see some stabilization.

And then the third question was – yes, do you want to take that one?

John F. Lundgren

Simply said, Sam, very few pricing actions implemented in the fourth quarter. What you saw in the third quarter or fourth quarter were actions taken in the second half of the year and reflected in Don’s outlook is the fact that despite what’s going on in materials market it took us a while to get those prices. We do see some carry forward that is going to help us in the early parts of the year and of course it should be clear as close as you follow Stanley what focus we place on price realization through our COE and maintaining those prices as long as we can.

Because it took us three to six months to get them, despite 88% recovery. So it’s important that they don’t decline faster than it took us to realize them. And that’s the positive lift. But it’s much more carry over than it is new actions.

Kate White

Next question, Jennifer.


Your next question comes from Nigel Coe.

Nigel Coe

Inventories was obviously just a fantastic storage in the quarter particularly when you think about the price inflation within those inventories. What impact did that have on the margins year-on-year?

John F. Lundgren

The impact of the price inflation arbitrage? Is that what you’re –

Nigel Coe

No, no, no – it’s inventory reduction.

John F. Lundgren

Oh, inventory reduction. Well the exact impact on margin year-over-year is difficult to assess. But certainly as you lower your volumes, you lower your inventory, you definitely get a negative impact to your margin rate. And it can – it’s certainly part of the kind of assumptions we gave you for ’09 related to the volume impact. As far as inventory, I would say that it was not a huge impact in 2008. But it did have a slight negative impact.

Nigel Coe

I think S&P announced last week they’re putting you on reviewing the rating. Can you just confirm that there would be no impact from losing a notch or two of your rating?

John F. Lundgren

Well, last I heard it was Moody’s and not S&P and what they did was they put us under review for possible downgrade from single A where we are at this point in time. That is about a several month process, where we have the opportunity to go talk to them and explain our situation in more detail. And then have a discussion with them about what we might to prospectively if they have continuing concerns after that. And we’ll see how that plays out. So there’s nothing that is cast in concrete at this point in time.

It clearly is a possibility. We don’t see why it makes sense. However, you know, we want to talk to them and get their perspective on it.

Kate White

The next question, Jennifer.


Your next question comes from Seth Weber.

Seth Weber

Could we just go back to the Security margin and acquisition question again for a second? Do these acquisitions that you made, do they change the historical seasonality that we’ve seen in the margin in that business, you know where fourth quarter is typically lower?

John F. Lundgren

A little bit. You’ll recall there were two things. And what it will do is partially mitigate it. The two things historically driving the large swings in margins 200 to 400 basis points in a quarter were second and third quarters were historically higher than fourth and first quarters were primarily in our mechanical security segment. Those seasonality elements still exist, which is one reason we’re not providing margin by sub-segment within sub-segment, because it’s more information than anybody can realistically or practically use.

But we do a tremendous amount of mechanical locking business on university campuses. We normally do that when university students are not there. Those tend to be the months of June and July, which are in the second and third quarter and that’s very good. It’s incremental high margin business, which inflates second and third quarter at the expense if you will of first and fourth quarter.

The second issue is on installs, which relates primarily to our access technologies business, secondarily to some of our monitoring and other businesses where we encounter site readiness issues in the first and fourth quarter, where we show up to put in a door and the concrete hasn’t been poured because of the snowstorm or because of rains in the Southwest or something of that nature.

Again, so we get some unanticipated and difficult to plan volume reductions, weather related in the first and fourth quarter which are rarely an issue in the second and third calendar quarters. Because HSM, Sonatrol, GDP have added meaningful revenue and they’ve added it in convergent and they are less susceptible to site readiness issues and slightly less involved in particularly campus university installations, although they do do some of that, that seasonality will be partially mitigated. But it will not disappear.

Seth Weber

And if we could just flip over to the other two business segments, I think on the call last quarter you talked about a new fairly large contract or some sort of award that you’d won on the CDIY business. Did that weigh on the margin at all in the quarter? And then my follow-up question would be, I think Jim you had mentioned that you kind of hoped the CDIY margins have bottomed here. You didn’t make that some comment on Industrial. Do you think Industrial margins could yet still go down further?

John F. Lundgren

We as a policy don’t name customers names on this call, but the contract we won is encouraging. There was little impact in the fourth quarter although what impact was there was positive, you know, and it will offset some of the headwinds going forward in the first quarter. On the CDIY business, Jim, do you want to take the second half?

James M. Loree

Yes, I mean, I think there’s a number of things that are going to occur within Industrial, that might occur within Industrial, that could move the margins down a little bit. Probably not precipitously from here; on the other hand they could go up. So it’s a little bit of the same kind of issue that we had relative to guidance. There’s the big $64,000 question is what’s unit volume going to do? And what’s the economy going to do? And clearly there’s a healthy dose of fixed costs in the Industrial business, definitely as much as anywhere from a manufacturing perspective in the plant system.

And so there is a significant absorption issue in this segment when volume goes down. By the same token, you get benefits when it goes up. So I can’t give you a specific answer per se, although I will say that the unit volume declines that the company has experienced over the last two quarters are unprecedented. In looking back all the way to the ‘70s, we have not ever had two quarters where the unit volume declines were greater than 7% for two consecutive quarters.

So now we have had that, for the first time, and so we’re now in uncharted territories. We expect as we indicated in our documentation, we expect that we’ll have similar unit volume performance in the first quarter that we had in the fourth. That would be three consecutive quarters. It’s difficult for me to imagine that this could go on at this level for an extended period of time. However, you know, we have to prepare for the possibility that it could and we are preparing for that possibility, although we don’t expect it to occur.

If we had a dramatic further drop in volume in Industrial, yes, they could go down further. And yes, we would take action.

Kate White

Next question, Jennifer.


Your next question comes from Michael Rehaut.

Michael Rehaut

First question just on unit volume, you know, when you did the prerelease about a month ago you indicated expectation for volume down 12 to 14% and it came in a bit better than that. But you also at the same time in the ’09 sort of guidelines kind of took the range a little bit lower, I guess being a little bit more cautious or conservative there in terms of first negative 10, you went to negative 10 to 12.

I just wanted to know if there was anything that occurred I guess in the December month that you know caused the 4Q volume decline to be a bit better than initial guidance and if that had anything to do with a little bit more conservative take in the ’09 guidelines?

John F. Lundgren

Yes. I mean simply said, December ended a little better than we had anticipated, given where our order book stood on December 11 when we did a prerelease. The teams did a nice job, shipping what we had on order. At the same time as Jim demonstrated quite well, we did nothing to pull any business forward. We worked hard on balancing production with demand. And as a consequence the last two weeks of December were a little better than we anticipated that they might be.

And as a consequence we said this wasn’t our intent but to the extent that any of that came out of the first quarter, the first quarter could be a little softer. As I know you’re acutely aware, the home centers and all large retailers given that their fiscal years end January 31, the month of January is a very, very difficult month to project business. And it’s not even always a good indicator of the quarter. Specifically, it’s the way the business models work, orders tend to be light as do shipments in the month of January.

And quite often the lighter they are in January, the better they are in February and March, thus making first quarter a relatively normal quarter in terms of volume. Given the tremendous uncertainty out there right now, it makes it even more difficult to project December actuals and January orders into a first quarter number. So simply said, we’ve changed nothing, Mike, from the long term perspective.

December was a little better. We said if that unintentionally came out of the first quarter of the year, it might be a little worse.

Michael Rehaut

First just a follow on to that, where was it a little bit better in December than you anticipated? And I just don’t want to get cut off in terms of my actual second question, but any type of comments you can give in terms of pension expense expected in ’09 versus ’08, given the declines in the equity markets for the extent that you can help us in terms of your thinking for budgeting there?

John F. Lundgren

That’s fine, because I think it’s a relevant question and because it’s a non-issue for Stanley, I’m glad you asked it and it’s one that Don will address. In terms of the volume, quite frankly it was better literally across the board. Both Security businesses finished strong, our CDIY segment did not finish as weakly as we’d anticipated, and there were as you know our Industrial segment is a very large diverse portfolio of businesses, some a little up, some a little down. But simply said it was across the board with convergent and mechanical Security finishing strong.

Neither Bostage or consumer tools and storage finished strong but they weren’t quite as weak as we’d anticipated, and mixed results across our Industrial portfolio. Don do you want to talk a little bit about pension expense?

Donald Allan Jr.

Sure. As you’re probably aware, you know, pension expense is not a big number for Stanley Works. We don’t have many defined contribution plans which would drive a lot of pension expense.

John F. Lundgren

We provide benefit plans. We have a lot of defined contribution plans.

Donald Allan Jr.

And as a result, we don’t expect our pension expense to go up much at all in 2009. It could be a modest increase but the overall number is relatively immaterial for the company and the increase would follow that same way.

John F. Lundgren

And as a consequence that’s probably nothing we need to adjust existing models for.

Kate White

Last question, Jennifer.


Your last question comes from Kenneth Zener.

Kenneth Zener

Just looking at Security and the convergent side of that business, I think about 30% of that business currently is recurring revenue. Given the backward integration that you’re having in HSM and the likelihood that installs will fall at a greater rate than recurring revenue, I assume, can you talk about where that might go in terms of some level of sensitivity? If your install slides down, could that convergent get to 40 plus percent of recurring revenue?

James M. Loree

First of all convergent recurring mix and convergent is about 40%, not 30. And at the moment we’re not expecting a significant contraction in the installs, nor are we experiencing one. If it were to occur, basically the profit margin on install is considerably less than it is on the recurring revenue. I mean you’re talking about gross margins that are double on a rate basis on the recurring side. So you know it’s not going to have a dramatic impact because it will have some negative impact if we had a big dive in installations, but not a dramatic impact because the mix - the rate mix would go up.

It would have a longer term impact for sure because that stream of recurring revenue over time would be affected by lower installs. So that’s really the dynamic there.

Kenneth Zener

And that 40% number that includes the recent French acquisition I assume?

James M. Loree

Includes everything, yes.

John F. Lundgren

Includes everything. All in breadth convergence business as we reported.

Kate White

Thank you very much everybody for your participation today. Again if you have any questions please call Corbin Walburger or myself. Our contact information is both in the press release and on the website and have a wonderful day. Thank you.


This does conclude today’s conference call. You may now disconnect.

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