Kate White – Director Investor Relations
John Lundgren – Chairman, Chief Executive Officer
Jim Loree – Executive Vice President, Chief Operations Officer
Donald Allen – Vice President, Chief Financial Officer
Eric Bosshard – Cleveland Research
Peter Lisnic – Robert W. Baird
[Sam Sargach – Raymond James]
[Jeff Kessler – Ontario Capital]
Kenneth Zener – Macquarie
Michael Rehaut – J.P. Morgan
Stanley Works (SWK) Q4 2009 Earnings Call January 27, 1010 10:00 AM ET
I would like to welcome everyone to the Stanley Works fourth quarter and full year 2009 results conference call. (Operator Instructions) I would now like to turn the call over to our host, Miss Kate White, Director of Investor Relations.
Good morning everyone. Thanks for joining us today on the Stanley Works fourth quarter and full year 2009 conference call. 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 Allen, Stanley’s Vice President and CFO.
I’d like to point out that our fourth quarter earnings release which was issued this morning and a supplemental presentation which we will refer to during the call are available on the Investor Relations portion of our website stanleyworks.com.
This morning, Jim, John and Don will review Stanley’s fourth quarter 2009 results and various other topical matters followed by a Q&A session. The entire call is expected to last approximately one hour and a replay will be available beginning at 2:00 pm today. The replay number and the access code are in our press release.
We’ve also added a new option for you to be able to listen to the replay. You can download it as a Podcast from I-tunes and even set up a subscription for all future replays of calls that we post. You can access this within I-tunes itself by typing in Stanley Works in the search window or from the link on our website. This should be posted within 24 hours.
And as always, please feel free to contact me with any follow up questions after today’s call at my number which is 860-827-3833.
Lastly, we will be making forward-looking statements during the call. 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 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 the 8-K which we have filed with today’s press release and in our most recent ’34 Act.
With that, I will now turn the call over to our CEO, John Lundgren.
Thanks Kate. Let’s start by looking briefly at some highlights from the fourth quarter and the full year 2009. First, as it relates to the fourth quarter, we recorded diluted EPS of $0.89. That does exclude $0.22 related to the transaction and integration planning costs primarily associated with the Black & Decker merger.
Diluted EPS from continuing operations on a GAAP basis then was $0.67. I think important to note, $0.04 to $0.05 of the $0.89 was an unanticipated tax benefit and the remainder of the tax benefit was included in our guidance as explained in the press release, and that we’ll cover in a little bit more detail later on in this morning’s presentation.
So for the year, diluted EPS was $2.80 versus $2.74 in 2008 again excluding the $0.22 per share in the fourth quarter related to the Black & Decker transaction. Fourth quarter was $0.89 and for the year that brought us to $3.02 which did include the gain of the debt extinguishment reported in the second quarter 2009.
So EPS for the year up 10% versus 2008 excluding the fourth quarter charges and 2% on a GAAP basis including those charges.
Quarterly gross margin rate 40.7% was quite encouraging and it was our second consecutive quarter above 40%. Pricing, cost productivity initiatives and commodity deflation all continued to offset the impact of the volume under absorption and that led us to a record annual gross margin for the year of 40.4%.
Cash flow was encouraging as well, $446 million for the year, up 6% versus 2008, and working capital reached 7.9 turns, another record. And that’s due to the ongoing success of the Stanley fulfillment system that Jim Loree is going to talk to you a little bit more about in his part of the presentation.
Looking very briefly at some of the segment highlights, Security achieved 20% operating margin while absorbing a 4% revenue decline. The CDIY segment profit improved $17 million or 71% while the Industrial profit rate improved sequentially to 11.3%, and Don Allen is going to give you more detail on the segments in his portion.
Last, but certainly not least, the planning for the pending combination of Black & Decker remains on track. Close is expected at the end of the first quarter or the beginning of the second quarter and I’m going to spend a few minutes updating everyone on that which may help or even preempt some of the questions, and everybody will be on the same page.
Two slides on the transaction; the first one is just a bit of a refresher and the second one, think of it as an update. The benefits of this combination are compelling to say the least. The strategic benefits which we’ve talked about before will make us a global leader in both hand and power tools with an iconic brand portfolio and over 250 years of combined history.
We’ll have greater scale in both hand and power tools as well as storage, mechanical security and engineered fastenings, a world class innovation process, global, low cost sourcing and manufacturing platforms and additional presence in high growth emerging markets.
Both companies are growing rapidly from a low base in India, China and the rest of Asia and Black & Decker as many of you know brings a very strong presence in Latin America to the combination.
The financial benefits we believe are equally compelling. It will be highly accretive with $1.00 per share of accretion projected by year three, $350 million in cost synergies on an annual basis with the opportunity for margin improvement both from the cost synergies as well as embedding SFS across a larger volume base.
Free cash flow is anticipated to be in excess of $1 billion and with $1.5 billion in EBITDA by the third year of the transaction. And of course, with that cash flow we’ll have increased resources to invest in security solutions, engineered fastening, other high growth platforms as well as organic growth at the core businesses, and as we’ve stated before, our capital allocation going forward is planned to be similar to what it’s been in the past; roughly two-thirds of our cash flow focused on strategic, accretive acquisitions and one-third being returned to the shareholders in the form of both dividends and selected stock repurchases.
A strong balance sheet is also important. We’re going to have a strong balance sheet going in and it’s going to be strengthened further over time.
In terms of an update on the transaction, what have we done to date and what do have left to be done. As you know, we have received HSR approval. The period expired on December 29, and we’ve established January 12, 2010 as the record date for shareholders to be involved in voting for the transaction.
We filed a preliminary S-4 with the SEC for review and we’re awaiting comments on the second version of that document. We’ve announced an integration team with co-leaders from both Stanley and Black & Decker; I’ll touch more on that in a minute, along with a new organization design and a senior leadership team for the combined company.
And let me say what I can about that now because we’ve certainly had a lot of questions and we want to be sure everybody’s on the same page and has the same information.
The senior corporate structure going forward was in fact identified in the press release. Jim Loree, Don Allen and myself will essentially have the same positions in the new company going forward as we have at Stanley.
We have established a synergy steering committee that Nolan Archibald with co-share and [Jim Don] along with Mark Matthew, our head of Human Resources in [Mosel Agrasse], head of our European business and our global industrial and automotive platform will sit on that synergy team.
As I mentioned, we’ve established integration management office that’s co-chaired by Brett Bontreger, a tested and proven Stanley executive who was involved in integrating Facom among other things, and most of our major acquisitions, along with Tony Milando from Black & Decker, who is currently Vice President of Operations for the worldwide power tools and accessories business.
Under Brett and Tony there are fourteen dedicated teams focused on various businesses and functions with one member from Black & Decker and one member from Stanley on each of those teams and importantly, no business leaders are on those teams, and the business leaders will be charged with focusing on the core business and continuing to do what they do best, and the integration teams will collaborate closely with them to ensure that we achieve the synergies.
Looking quickly at the segments, going forward our intent is to report externally in the same three segments that Stanley currently reports. In Security, the Convergent Security Solutions business will essentially remain intact while the Black & Decker Hardware and Home Improvement business will be integrated within the Mechanical Access Security business.
On the Industrial segment, that essentially will remain intact as well with the global platform leaders in Industrial and Automotive repair and infrastructure reporting to Jim Loree as they do now.
The Black & Decker Engineered Solutions business, probably better known as MHAR will also remain intact with Mike Tyll who currently heads that business for Black & Decker managing that business and the Stanley Assembly Technologies business will be integrated within MHAR.
And finally, the Black & Decker worldwide Power Tools and Accessories business along with the Stanley Construction and Do-It-Yourself business will become the new CDIY segment. It will be under the leadership of Stanley executives and six of the top ten executives in that organization will at this stage, are planned to come from Black & Decker.
That will ensure the knowledge; the skill sets that are unique to power tools as well as the knowledge that exists within the business will carry forward in the new organization. Collaboration to the extent that we’ve been allowed to do so has been quite encouraging so far.
And lastly, on the geographies looking at Europe, Asia and Latin America, existing leaders will focus on either the core business or growth opportunities depending on the geography and there’s a somewhat equal distribution at this stage of Stanley and Black & Decker executives.
That’s all that I’m really able to say about the organization at this stage, but the structure as announced, is consistent with the dual objectives of protecting the core franchise while integrating the two companies as rapidly and as prudent as we can as we convey to achieve the potential synergies that are available from this transformational opportunity.
Jumping back quickly to the slide, what’s left to be done; we need to continue to execute on our 2010 goals, and of course we need to obtain the remaining regulatory approvals from the EU as well as other foreign jurisdictions.
We need a shareholder vote. We need approval from both the Stanley and Black & Decker shareholders and of course we need to retain key talent on both sides of the organization. That all leads as I mentioned to expected close somewhere near the end of the first quarter or the beginning of the second quarter.
Solid progress we think we have achieved on all fronts. Integration planning is well underway and hopefully that answers a lot of questions that you might have had and we can focus on some other things the rest of this call.
So let’s get back to Stanley’s fourth quarter. Looking at revenues around the world, they declined in most of the world as you’ll see in the U.S. on the left hand side, second from the top, revenues down 14% both as reported and organically excluding any effects of currency and in Europe, down 9%, down 16% excluding currency and acquisitions.
Asia and Australia did show some growth and it’s a complicated chart with a lot of numbers on it but we’re trying to provide you as much data as possible and hopefully the message is clear. Revenues remain down but the rate of decline was lower and revenues actually increased on a sequential basis as shown on the next slide.
Looking at fourth quarter revenue by segment, again a lot of data on this chart but what I really wanted to point out is some of the trends by segment to supplement what we just showed you by geography.
Volume and sources of growth is identical to what we listed in our press release in terms of the do to or the walk, but if we focus on the fourth quarter, you see volume down 16% for the entire company offset by price, was 1% favorable so organic growth declined 15%.
Currency helped 4%. There was no impact from acquisitions in the fourth quarter as previous acquisitions anniversaried by the end of the third quarter so total revenues down 11%. That is all in our press release.
Looking at the segment results, just a couple of things to focus on; CDIY down 8% in total, 14% volume decline which was the 8% revenue decline was obviously a significant improvement on a sequential basis.
Security held up fairly well, volume down 9%, revenue down 4%. So the total company as you see got 11% in revenue, volume down 16%.
Moving on to earnings, at a high level you see the 11% volume decline, but still translating to $0.89 of earnings which is 39% improvement versus the fourth quarter of 2008. Within the fourth quarter of 2008 as stated in our press release, there were $0.59 of restructuring costs taking GAAP earnings to $0.05 a share.
This year, per our press release, $0.89 of operating earnings, $0.22 of charges related to the Black & Decker transaction costs, resulting in GAAP earnings of $0.67.
Looking at margins, a nice improvement of 210 basis points. Both Jim and Don are going to talk about how that worked by segment as well as what’s driving that margin improvement and looking at the tax rate of minus 4.4%, you see a little bit of an explanation in the box. It’s the effect of resolution of some income tax audits.
The tax rate would have been 22% excluding this $14 million benefit. And again, as referenced in the press release, $11 million of that $14 million benefit was due to the closing of U.S. audits through 2006. The other $3 million was a favorable adjustment in the U.K. around the deductibility of certain interest payments.
As you know, we’re not allowed to based on recent FAS rule changes to release any of those reserves until the audits are formally closed. The audits closed in the fourth quarter. We released the reserves, and that’s the impact as it related to EPS.
Let’s turn it over to Jim who’s going to talk to you about some very encouraging margin performance driven by a combination of cost control, targeted investments and most importantly, the benefits of the Stanley fulfillment system.
Thanks John. As you indicated one highlight for 2009 was the extraordinary in the area of gross margin. We achieved 40.4% for the year, a record with a 40.7% rate in the fourth quarter. For the full year that’s a 260 basis point increase over prior year, and this was achieved with the backdrop being the worst economic conditions in 60 years.
And the 2009 performance, as well as the long term positive trend is really a function of four factors. One is the tight operational management across our businesses as it related to productivity projects, supplier management, price realization, product mix and new product vitality.
Secondly, it’s the strength of our value propositions for our customers, able to get paid for those. And we also are benefiting quite extensively from the implementation of the Stanley fulfillment system which I’ll talk about more in a moment and then finally the deliberate shifting of our portfolio in higher margin, higher growth area.
And now as we look forward, the challenge will be as we merge with Black & Decker and their gross margins in the low 30’s so on a weighted basis when we put the companies together, we’ll be right around 35% or so, and we need to begin this march forward over the coming years to get the combined company back up to these levels over time. And that will be an exciting challenge that we’ll take on with the integration process.
Now moving to working capital, I have to say our fourth quarter working capital performance was a very pleasant and positive surprise. Coming into the end of the year, we were confident that we had plans in place to achieve mid to upper six turns for the year and we basically blew that number away with a volume performance which was essentially in line with what we were expecting, and we achieved 7.9 turns, a feat which I think will put us in good stead with best in class as it relates to our peers.
It was a two turn increase and up almost three turns versus Q3 sequentially and was a major driver behind our $446 million of free cash flow which was our second best ever free cash flow performance, again in this very tough economy.
As you can see, inventory dropped 15 days. Receivables dropped 11 days. We were able to hold payables, so a nice performance across the elements and in total, a very significant $243 million decrease in working capital.
Moving to the how, it’s all about the sustained process improvement through the Stanley fulfillment system. And with Black & Decker as we integrate, we see an opportunity here as well in the coming years. They’ve been making good progress in working capital as well, but not as dramatic and not as quick, and I think we can assist them with that and really unlock several $100 million worth of cash flow.
Here’s a little more information and color on SFS. As I mentioned before, it has four elements. Let’s start in the upper right hand side with the S&OP process. That’s all about keeping supply and demand in balance.
Then we move to common platforms in the lower right. That is basically standardization of process and IT platforms to provide scalability and efficiency. Now this is an area where conversely, Black & Decker can help us because they’ve made excellent progress in this area in their worldwide power tools and accessories business which is about 70% of their company and depending combination will actually accelerate Stanley’s standalone ability to drive towards common platforms. We’re very excited about that.
Then we move to the lower left hand part of the slide and we talk about transformational lean. Stanley’s trademark transformational lean methodology combines traditional supply chain and manufacturing lean with back room and then combines what I call incremental lean which is what most people do with respect to lean, with an even more powerful application of lean to gain changing transformation of business models in order to create competitive advantage.
In this area it’s early days for us. We have some really interesting experiments going on and implementing here. We’ve made good progress on the incremental part. Now we move to the business model transformation part and we see tremendous opportunity here in the coming years.
Then finally, complexity management in the upper left, it’s all about eradicating complexity in everything we do except where customers gain value from complexity in what we offer, and then it’s about providing it most efficiently and then getting paid for it.
Those are the four elements of the Stanley fulfillment system. They work in concert. They’ve been working well. It’s early days as we look at the implementation of the system and we’re very proud of the accomplishments so far but there’s many, many more to come in this area.
My final slide today is about the brand. There are several key messages here. Number one, the spending is up. If we look at the spending it’s not on the chart, but if we look at it over the ’05 to ’09 time frame, we were averaging about $21 million a year of spend. That’s in stark contrast to the ’01 to ’03 time frame when we were investing $10 million a year.
What we achieved from ’05 to ’09 in terms of unaided awareness improvements and frankly improvements across the spectrum of various measurements of types of awareness. In 2005 we had a 27% unaided awareness number and that went to 35% in ’06 and 41% in ’07, 43% in ’08 and finally 48%, a big increase this year, and we’re currently approaching the level that Stanley had at its peak historical level achieved in the early 80’s of 55%.
So lots of good progress in the last five years, and one of the other themes is that we’re trying to spend our money much more wisely and get the biggest bang for our buck so very little TV advertising, and then spreading it around several different areas.
The latest initiative that we have is we have become the official tool provider of the Walt Disney World Resort and we have a partnership with Disney which is a 10 year alliance. It brings branding in the parks, B to B opportunities and other elements with a select group of alliance partners.
We have construction wall signage throughout the Walt Disney Resort. Stanley, Mac and Vidmar products are highlighted in the Lights Motor Action garage. We’re also providing cabinets, tools, branded benches, cabinets and tools and accessories for the test track line area and the ride itself. So that’s very exciting and just getting underway.
Of course we continue to be a Nascar sponsor. We have sustained brand exposure over 38 weekends with primary sponsorship in 20 races, extensive customer and user activation and numerous race related in store and on track promotions, and a very healthy menu for 2010.
Last year’s big story for the brand awareness moving the needle was the Major League Baseball sponsorship. In 2009 we had 11 teams. We’re going to add one in 2010, thus giving us signage in 40% of all the games and we have really placed our signs strategically to maximize television exposure and we love and thank our Hartford neighbors at ESPN folks for their sports center coverage of our brand and its saturation that we get from all that exposure.
And then of course last year we also began sponsoring the English Premier League which is the number one soccer league in the world and 650 million people around the world watch that every week and it’s an exciting initiative.
Now I’ll turn it over to Don Allen who will take you through some of the numbers.
Thanks Jim. The next page is walk of the SG&A in the fourth quarter. As we typically try to show you each quarter, we take last year’s SG&A and walk it forward. I’ll start with the right side of the chart.
If you look at the cost reductions that we’ve done throughout the year, just as a reminder, in total we reduced cost by $265 million in 2009. Of that number, about $150 million impacted SG&A and the head count impacted was just under 3,000 individuals. So in the fourth quarter we saw a $37 million benefit of that which is 13% reduction to the base versus the fourth quarter of ’08.
And then looking at some of the increases on the left side of the chart, we did have some integration costs associated with the planning of the merger of Stanley and Black & Decker of about $5 million.
FX was a negative impact year over year of $10 million and then we continued investments in SG&A. Jim just spent a fair amount of time talking through the brand investments and the significance of that. As many of you are aware we made investments in our Security businesses to put more feet on the street and focus on certain share gains we can achieve.
And then as we began to re-instate some of our employee benefits in the fourth quarter that were suspended earlier in the year, we begin to see some cost increases there. So the net result is about a 2% decline in SG&A and we continue to see the impact of our reductions in the fourth quarter.
Now I’d like to spend a little bit of time walking you through the segments. We start with the Security segment. Once again Security was the gem of the quarter. In the four quarters of 2009 we experienced in essence a single digit revenue declines but have been improving their profit rate throughout the year and year over year as well.
So if we look at revenues, as John mentioned, revenues were down 4%, organically down 7% so a consistent trend that we’ve seen throughout the year. The good news is that the segment profit was actually up 4% on that small revenue decline which resulted in segment profit rate of 19.9% so just under 20% which was off of last quarter which was close to 21%, so 150 basis point improvement versus the fourth quarter of ’08.
Looking at the two sub business within our Security segment, starting with Convergent Security Solutions first, revenues declined similar in line with the total segment, single digits. They continue to see weakness in the installation revenues and health care capital expenditures affecting some of the small health care businesses in this business.
That continues to be a constraint as we move forward. The good news is their recurring monthly revenues continue to grow and we saw growth in the fourth quarter again in the low double digits range.
So as we move forward looking at profit rate and revenue trends, I’ll spend more time later on, but we’ve seen a continual trend in the Convergent business of improving their profit rate performance because they’re really been focused on the integration of the acquisitions, driving the benefits and cost reduction, productivity in their cost base, and obviously the mix towards more RMR versus installation improves their profit rate as well.
On the Mechanical Access side of the segment, similar story but slightly different reasons for them. Revenues declined a little bit more significantly than we saw in the Convergent side. They have been affected by the slowdown in commercial construction more than we’ve seen in Convergent.
However, they’ve been very focused on retaining and maintaining certain national customers, and that’s something we will continue to be focused on as we got through this slowdown in commercial construction.
A great story for them in line with the overall working capital story for the company is that working capital turn for MAS were up 14.7% and along with that they improved their fill rates. So last but not least, their profit rate improved as well through price realization, the deflation that we saw in commodity prices and then the continued cost reductions that they’ve done throughout the year.
Moving to the Industrial segment, Industrial as you know throughout the year has really suffered on the top line. They’ve seen significant inventory corrections throughout the supply chain to our end customers, and in the fourth quarter we did see significant revenue declines again, although not as significant as we saw on the previous three quarters of 2009.
So revenues were down 23%, organically 26% and the segment profit was only down 14% versus that revenue decline as we did see many of the cost actions that we started in Europe in the spring of 2009 were completed in the fourth quarter so we saw the benefit of that in the segment profit, and as a result, the segment profit rate was at 11.3% which was a sequential improvement from the third quarter where it was at 9.2%. So we saw a nice impact of those cost actions coming through in the fourth quarter.
As I mentioned, we did see significant destocking trends throughout the year. We believe that they have ceased in the fourth quarter in the Industrial segment and I’ll talk more about what we think that means for next year later on in the presentation.
Facom’s revenue decline has slowed to 11% where we saw significant declines in the previous quarter in the mid 20% to 30% range, and they’ve been very focused on their new product development along with the Proto business and how we can actually gain share in this type of declining environment and that continues to be something that’s always been significant in the Facom business and will be going forward.
The last item to mention is the Mac tools business. Mac has significantly improved their profit share over the year and that was despite an 18% drop in their unit volume as they were very focused on price realization and actions with the end customers and cost reductions.
CDIY had a nice quarter as well in the fourth quarter as we continue to see and experience further stabilization in this segment. The revenues were down 8% as John mentioned. Organically they were down 13%, and so in the first three quarters revenues were down 25%, 28% and 23%, and now only down 8%.
Part of that is certainly the comps we’re comparing to in the fourth quarter of ’08, but it’s also an improvement on a sequential basis, so we are seeing nice stabilization and the potential for some growth as we move forward.
Segment profit up 71%, really being driven by the integration of the Bostitch business in the consumer tools and storage throughout the year, significant productivity within the plants, some of them associated with Bostitch but also just the normal productivity programs that we implement and then certainly SG&A actions that they’ve taken have assisted in getting to almost a 12% segment profit rate in the fourth quarter.
The last think I’ll mention here on CDIY is that the working capital turn has improved to 7.9 turns. That almost a two turn improvement versus the prior year. So clearly, SFS has really taken hold on our CDIY segment.
On the next chart I’d like to spend a little bit of time talking about some of the key trends as we move forward. If we start with Security, the way this chart works, we showed it for the first time for you last quarter, is up top, the yellow line represents the segment profit rate over the previous two years, and then the gray bars represent the unit volume decline within revenue.
In Security, as I mentioned earlier, installations within our Convergent business are showing some signs of slight improvement in Europe but they continue to be very weak within the U.S. and that will be something we continue to monitor as we go into 2010.
Commercial construction continues the slowdown. The slowdown in commercial construction continues to impact both businesses, but even more in our Mechanical Access business. So we’re beginning to focus on other areas such as education and health care verticals to try to offset the impact of that as we move forward.
We would expect that any slowdown or recovery in commercial construction market would probably lag a recovery in the residential construction market, so it appears that residential construction has stabilized, and we’ll see as we move forward what the time frame for both those recoveries are.
Last but not least, we believe our profit rate will likely continue to very strong in our segment as we continue to focused on price inflation management as well as effective cost management, and trying to gain share in all different areas as much as possible.
Industrial clearly is lagging behind both businesses and lagging behind CDIY. We do believe that the vast majority of the inventory destocking we saw is behind us. Industrial production worldwide continues to be up so we do believe that will ultimately have a positive impact on our business moving forward but we are cautious as we move into 2010.
We believe the destocking is behind us as I mentioned and there is a suggestion of a possibility of improvement as certain restocking may need to take place in this segment because of the low inventory levels throughout the supply chain.
But we’ll be focused on top line weakness and really trying to maintain our profit rates as we experienced in late 2009 and ensure that our cost base is appropriately adjusted and maintained to where it is today. The profit rate has probably bottomed out in the third quarter in the low 9% range. We think that it will likely continue moving forward at a trend that we saw in the fourth quarter.
CDIY clearly has stabilized as I mentioned and as many of you know this segment is impacted by housing starts and consumer confidence, and so we believe there will be modest growth in this segment in 2010. We do think the growth in the U.S. will be muted and emerging markets will be much stronger, but it’s something that we’ll keep a close eye on to see if there is a stronger recovery as we move into 2010.
Again, being very focused on new product development, innovation, our marketing to be a key driver to our top line, gain as much market share as we can in this difficult environment. And then profit rates continue the migration back to historical levels in 2010.
So that’s the segments. Let’s spend a little bit of time on free cash flow which is the next page. Jim touched on the significant working capital performance of 7.9 turns which resulted in over $200 million of working capital positive cash flow in the fourth quarter and for the year, $226 million.
The net result of our earnings and our working capital turn performance offset by our planned capital expenditures was $263 million of free cash flow in the fourth quarter which is up significantly over $100 million versus last year’s fourth quarter mostly due to the working capital performance.
And then for the year, our free cash flow was $446 million, up almost $25 million versus last year or 6% which is a significant performance considering the revenue pressures that we saw throughout 2009.
Next, our balance sheet; as many of you are aware we had a plan to deleverage ourselves in 2009 by $200 million. We slightly over achieved that where our debt went down $229 million and our adjusted debt to capital is right around 30% which is exactly what we were targeting for the year.
So we’re very pleased with that. Obviously the cash flow that we experienced and the significant working capital, turn improvement really facilitated us achieving that goal.
So let’s move to guidance. The first thing I want to note is that the guidance we’re providing excludes any impacts of the Black & Decker and Stanley merger so this would be Stanley standalone for 2010.
We believe that the EPS will range from $3.00 to $3.25 on a standalone basis and there’s certain assumptions that we’ve put in place that align with that particular net result. Net revenues should increased 2% to 4%. That’s primarily unit volume revenue increases.
We believe it reflects a modest economic recovery. Each one of our segments will be impacted differently as I just described, but we think it’s a reasonable modest recovery.
There are a couple of non recurring items in 2009 that you need to factor in as you look at our 2009 EPS and try to roll forward to this guidance, the first of which is a $0.34 gain on debt extinguishment that we did in the second quarter where we were actually able to repurchase over $100 million of our junior subordinated debt securities for about $55 million for a $44 million gain.
John mentioned the Black & Decker transactional cost in the fourth quarter of $0.22. And then the next item would be a reminder to folks that we will have a diluted impact of some shares that we need to issue around May of 2010. It will be about $0.16 EPS dilution and it’s associated with our equity unit hybrid instrument.
The proceeds from that will be used to pay down other debt maturities that obviously mature at certain points throughout 2010.
The tax rate we expect to turn back to more normalized levels. That’s a diluted impact of about $0.20 to $0.25 year over year.
And then the next items which is certainly significant, as we’ve mentioned during the year, we expect about $100 million of cost carry over from 2009 to 2010. We have $75 million here as we have reinstated certain employee benefit costs as well as certain other costs that we are allowing to go back into the system so it nets to $75 million carry over.
And we have certain investments we want to make, continue to make in brand and security as we move forward and those investments will certainly be monitored as we move throughout the year and ensure that our top line actually performs in the 2% to 4% range.
Restructuring and impairment related charges should be flat to 2009. They were $45 million in 2009. We had $41 million in the restructuring line and about $4 million in the OM lines up above, so we expect that to be relatively flat as we will continue certain plan rationalization activities in line with our SFS.
And then we expect a net zero impact from price and inflation. We currently have very little inflation in our estimates as they’re based on current commodity prices and if commodity prices increase and we experience inflation, we would expect that we would be able to pass that onto our customers in a price increase.
Free cash flow estimate is about $300 million to $350 million. We’re estimating a relatively modest improvement in working capital for Stanley as we will be investing a lot of time in the merger of Stanley and Black & Decker and also trying to implement a lot of the SFS principals within the new company.
And last thing I’ll mention here is that we still are committed to the financial guidance provided with respect to the new combined company of Stanley and Black & Decker as we rolled out in November of last year.
So in summary, we continue to move forward on a rigorous integration planning for Black & Decker. It’s something that a lot of us are investing a great deal of time in at this point. We’re very much focused though on making sure that our core businesses continue to perform strongly and we’re focused on market share gains, customer services and keeping our fill rates up and improving them.
We do see modest signs of growth potential within CDIY and that’s encouraging, but we are being cautious as we move forward here to make sure that if a market recovery happens, we’re ready and prepared to handle it, but if it doesn’t we have contingency plans in place to accordingly.
SFS is going to play an integral role in really navigating any significant upswing in demand that we experience as well as the successful integration of Black & Decker. We believe we’re ready to serve our customers in the event of any volume surge that might occur throughout the year.
That concludes our presentation.
(Operator Instructions) Your first question comes from Eric Bosshard – Cleveland Research.
Eric Bosshard – Cleveland Research
Can you talk about the source of the 2% to 4% revenue growth? You seem optimistic about some progress in CDIY and a little bit more conservative in the other two segments. I’m just wondering if you can talk a little bit about the why the 2% to 4% revenue expectation and where you expect that to come from? Secondly, I’m interested in your thoughts on free cash flow especially in light of the six million additional shares coming out in 2010 and if there is any consideration to buy back stock to offset that.
2% to 4% we think is modest as I mentioned. If you look at our three different segments, we do think CDIY will likely have some nice growth during 2010. Industrial has the potential but we’re very cautious for growth as it’s difficult to see how the supply chain is going to react to their customers in that segment.
And in Security, we think relatively modest growth. There will be pressure associated with the commercial construction slowdown and how long that lags on. We think the vast majority of 2010 commercial construction will be relatively slow.
I think obviously our history as a company around share repurchases, we evaluate those on a case by case basis. We will have a fair amount of need for cash associated with the Black & Decker Stanley merger. There’s a lot of one time costs, restructuring and other payments that will need to be made. There is about $670 million of one time costs. Of that, about $470 million is cash so there will be significant cash obligations in connection with that.
But we’ll have to see as the two companies come together what the projections we have for cash flow are in the first two to three quarters.
Your next question comes from Peter Lisnic – Robert W. Baird.
Peter Lisnic – Robert W. Baird
First question, on the 40% gross margin this year, and that’s in the context of volume down 20%, how should we think about that going forward if we get basically volume under absorption dissipates as you progress with better comparisons going forward? And then on the strong free cash flow in the fourth quarter, does that have any implications for what you might be able to extract out of BDK and that $1 million target that you said?
As far as the second question, I’ll start with that one. We have no idea what their cash flow looks like in the fourth quarter or what it might look like prospectively until we have a much deeper integration process and we close the deal. So it’s really a difficult question to answer without the requisite information.
As far as the gross margin rate goes, we’re pleased with the 40% and excited about the progress. We don’t see anything that suggests that on a standalone basis the gross margin rate would go down any time soon in the company and obviously there will be all sorts of things that we’ll have to deal with along the way such as the CDIY business grows at a faster rate than the Security business.
That’s going to put a little downward pressure on it. We’re pretty confident that we’ll continue to see progress in productivity including the effect of absorption benefits that should accrue as volume begins to come back in general.
So we those two as more or less offsetting and then we’ll continue to work all the levers that I mentioned when I went through the gross margin chart, the price inflation recovery. If you go back to 2004, we’re still almost $90 million short in terms of the recovery of inflation through pricing. So we’re not building any kind of a price umbrella at all, and we’re not over extended in that area.
However, you never know what competitive conditions are and how they’re going to evolve. So we’ll continue to manage that with our pricing center of excellence and all the folks that we have out in the business coordinating very carefully on that one. Then we have our productivity, our mix management, our new product innovation and as I said earlier, getting paid for the value proposition.
So we’d like to see that 40% carry on. We think we can do it and I guess time will tell.
Just to supplement what Jim said, with 39.9% in the second quarter and then third and fourth quarter both above 40% in the face of the volume decline that we cited, I think demonstrates we strongly believe demonstrates that we have right sized our company to make money and to achieve a 40% gross margin in a volume environment that’s 15% to 20% below our highs in 2007 and 2008.
That being said, obviously we’ll get tremendous leverage from any upside volume improvement some of which will be reinvested in growth initiatives because we were really encouraged with the results of those modest investments that we experienced during 2009.
Your next question comes from [Sam Sargach – Raymond James]
[Sam Sargach – Raymond James]
You have taken great pains to itemize all of the cost savings opportunities with the transaction and obviously it’s a key focus of the organization. Talk about what you’re dong to maintain and possibly grow market share of the combined company beyond just the verticals of Black & Decker is strong in Latin America and Stanley is strong in the automotive. Oftentimes when you have these combinations, you have cuts in sales and marketing and R&D departments and it tends to hurt market share a little bit. The second question would be what the interest expense expectation of the organic business would be in 2010?
The answer to the first one is simple. Talk to us again in April or May when the deal is closed. Your question is a very fair one. It’s one that I wish we had a better answer to. It’s one where I wish we could collaborate more closely with Black & Decker because getting to know the people and the capabilities that exist within that organization has been extraordinarily encouraging.
That being said, we’re not legally able to coordinate, collaborate to the extent required, quite frankly the answer to your answer. We can do a lot of things, but we can’t collaborate on markets. We can’t collaborate on strategy, even product development, anything that’s forward looking, and you’ll understand the legal constraints for that.
While we don’t essentially compete in the marketplace, the products are complimentary, we are in the same marketplace so we essentially have to think about what we’re going to do independently until the deal closes, and then we’ll get the collective best heads from both companies together and we’ll have a much better answer to your question than we’re able to provide now.
Let me just further say is what we can answer is on the standalone basis what we’re doing, and just very quickly, in the CDIY business, the name of the game has and will continue to product innovation and we’ve just sat through several days a few weeks ago right before the end of the year of an update on what they were doing, what they’ve got planned for this year, and it’s really exciting.
It continues to be a new product machine let by Jeff Hansel and his team. And then in the Industrial business, they’ve done a lot of work in harnessing the power of the combined platform. So whereas in the past we used to go to market as Mac and Facom and Vidmar separately, effective January 1, we put that all in one business leader with a functionalized organization as well as a regionalized organization where they’re sharing new product development.
They’re sharing global strategy development and market development. So I think you’re going to see a real power house initiative in terms of market share emerge from them, and then of course in Security we have new products in Mechanical.
We have the YQ product in particular in both Electronic and Mechanical. We have the addition of feet on the street which Don mentioned is a significant investment in Security, and all of those I think are geared along with our significant increase this year in brand investment to continue to push the needle in that area, all in there interest of market share gain.
As you know, interest expense is about $61 million in2009. We would expect it probably to be somewhere between $52 million and $54 million in 2010.
Your next question comes from [Jeff Kessler – Ontario Capital]
[Jeff Kessler – Ontario Capital]
With the increase that you’ve shown in margins relative to sales in particularly in the Convergent side of Security, I’m wondering what are you doing to increase your RMR component both in the quality of the RMR as well as the absolute amount of recurring revenue that you’re getting from that division?
You almost answered the question in that it’s the quality of the RMR and increased percentage of RMR that is driving the margin improvement within Security. It’s a bit of a double edged sword. As our business mix improves, as we fully integrate HSM and GTP, we’re getting a much higher MRM component.
That in and of itself, those very solid companies that [Rick Von Trager] and the team have done a very, very job bringing on board. That’s helping a lot. The double edged sword is as commercial construction is down, regrettably install as a percent of the total revenue was also down. So that’s driving a mix based margin improvement which has been very favorable the last couple of quarters.
Importantly, you understand this business well; we need to pick up on the installations. They’ll be profitable installations, but they’ll be less profitable than the RMR element in order to fuel our fund that future RMR.
So we’re at a bit of a crossroads. We’re at a really good position where we are in terms of mix and now with a little help from the marketplace and aggressive share gain program on the installations, we’ll drive some installations to make sure the RMR pipeline stays full.
[Jeff Kessler – Ontario Capital]
And as a follow up to that, you’ve made an announcement you’ve settled the law suit with the franchisee group that was suing you. Is that issue effectively put to bed and will the cost effect along with that be put to bed?
The issue is put to bed. The cost I’ll go so far as to say diminutive and we’re going to move forward. A lot of noise. You follow this industry very closely. A lot of noise and a lot of sizzle but not a lot of steak. Consider it behind us.
I would also say that we had a very, very satisfactory session with them shortly after the beginning of the year and I think we’ve turned to corner now in terms of how the franchisees view us and we view them. It’s a much more positive win win approach and now the proof will be in the execution but the spirit is there.
Your next question comes from Kenneth Zener – Macquarie.
Kenneth Zener – Macquarie
I wanted to ask a broad question then ask about CDIY. But first, your 2010 sales guidance of 2% to 4%, I’m wondering just conceptually how you can, or any comments you have relative to the 2% flat line growth you’ve given for the merged companies in your 1, 2, and 3.
Basically if you look at the Stanley projections that are in our S-4 it was about just under 2% growth for 2010. That was in there. I can’t speak to the Black & Decker projections going forward whether there are any revisions associated with that.
But on the Stanley side, just under 2%. Now we’re thinking a range of 2% to 4% and it’s really I think an indication of some of the trends that I mentioned around CDIY and in particular that makes us feel a little bit better about that.
Kenneth Zener – Macquarie
It does seem rather low. On CDIY which did obviously good margins year over year but I think in the quarter sequentially it was perhaps a little bit low. I wonder if you can talk about the margin puts and takes there given that revenue actually in 4Q was actually than 3Q so I would have thought your absorption was there. If you could just go into some of those details; I think that was one item that might have caught people’s eye in the quarter.
Historically if you look at the CDIY business, although they’ve experienced significant under absorption during 2009 even in the later stages of 2008, in the fourth quarter we do historically have significant shut downs above and beyond just normal volume trends.
So we tend to see somewhat of a dip in the segment profit rate in the fourth quarter from the third quarter to the fourth quarter. That’s the main driver of that.
Don’s referring to the fact that you understand as well, home centers are a large source of revenue for CDIY. As you know the home centers close their books at the end of January and as a consequence, orders and shipments are very light in late December and early January.
Historically there are always several hundred basis point decline all other things being equal in margins in that segment third to fourth quarter which is why we don’t spend a lot of time tracking sequential margins by segment and talking to it externally unless there was an unanticipated event.
To come back to the whole year, the biggest driver in the CDIY margin improvement which we’ve talked about a little and maybe not enough is the tremendous success of the integration of Bostitch within the consumer tools storage business to form the new CDIY platform.
Bostitch which is was a struggling business and facing unprecedented volume declines, many of which were market driven has dramatically improved its margins within CDIY despite the fact that its 20% to 25% less volume. So that’s a huge driver within that segment, but the sequential decline was no surprise at all to us.
Your next question comes from Michael Rehaut – J.P. Morgan.
Michael Rehaut – J.P. Morgan
I wanted to get a little more color on your outlook for next year. Obviously we’re just at the beginning of the year but as it more relates to the Security segment where you said that you gave some general comments on each segment but with Security said perhaps modest growth because of the commercial construction slowdown, and I was wondering if you could first, remind us of the breakdown in terms of your exposure to commercial construction by CSS and MAS and it appears that despite that, you’re still looking for overall perhaps a little bit of modest growth in the segment, so how do you get there? And number two, just more broadly if you could remind us how you think about the end markets and the longer term growth outlook perhaps over the next five years as it relates to the comments that you’ve made in the past about the way those markets grow and your positioning within those markets.
I’ll try to summarize the questions for Don. What is our exposure to commercial construction in our Security business and what’s our view on some of the end markets as it relates to our projection of 2% to 4% revenue growth in 2010?
Just as a refresher, there is actually a nice end market chart that I believe is in the appendix of the presentation, but Kate White can get it to anyone who’s looking for it.
Commercial construction for total Stanley is 11% of our revenues. You look at the Mechanical Access and Convergent businesses, for Mechanical it’s about 12% and then for Convergent it’s about 17%.
So it’s not a huge portion of the business but it’s certainly significant and it’s something that can have a bit of a negative impact on us and we would expect a little bit of a negative impact in 2010 from that.
But there are other sectors as I mentioned such as health care, education, and government that are significant in both the Security businesses. In the case of Convergent, health care is almost 23% and then government and education combined is about 14% in Convergent and about the same number in Mechanical.
So there’s some nice verticals in both businesses that have not been as dramatically impacted by the slowing economy nor do we think they’re going to be significantly impacted as we go into 2010. So you have a dynamic that’s happening in our Security segment where they will have a negative drag around commercial construction, but we do think there’s some verticals that can offset that and result in slightly modest growth for the year.
Michael Rehaut – J.P. Morgan
And then in terms of longer term how you think about Security and the different end markets in the annual growth potential?
We’ve always said long term that we believe that the Security businesses will grow anywhere from 3% to 6%. It really depends on which component of the business. The Convergent business or the Electronic piece would grow at the higher end of that range and Mechanical at the lower end of the range.
Who knows exactly when these economic circumstances get back to normal, but over the long term that’s what our expectation would be.
One benefit of what Don said is historically we were always in a position to say we’re making a trade off. When Convergent was growing faster but margins were lower, so we were balancing growth and margin within our Security platform. Steve has done a really nice job as evidenced by Jeff Kessler’s question, basically getting the Convergent margins up to or even above a level of Mechanical, and while we don’t spend a lot of time focusing on margins by segment, right now we’re quite encouraged because we have a high growth high margin in the Convergent security business as well as a very, very profitable but more modest growth on the Mechanical Security business.
This concludes the allotted time for today’s questions. I turn the call back over to Kate White.
I want to thank you all for spending time this morning to discuss our 4Q and full year 2009 results with us. As always, I’m here to help with any questions you may have. All my contact information is on the website. Please feel free to reach out to me if you need anything further. Thank you.