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Executives

Gregory Waybright - Former Vice President of Internal Audit

John F. Lundgren - Chairman, Chief Executive Officer and Chairman of Executive Committee

James M. Loree - President and Chief Operating Officer

Donald Allan - Chief Financial Officer and Senior Vice President

Analysts

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

Adam Baumgarten - Macquarie Research

Jason Feldman - UBS Investment Bank, Research Division

David S. MacGregor - Longbow Research LLC

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Michael Dahl - Crédit Suisse AG, Research Division

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Jeremie Capron - CLSA Limited, Research Division

Michael Sang - Morgan Stanley, Research Division

Stephen S. Kim - Barclays Capital, Research Division

Joshua Wilson

Stanley Black & Decker, Inc. (SWK) 2014 Investor Update Conference December 12, 2013 8:00 AM ET

Operator

Welcome to the Stanley Black & Decker 2014 Investor Update Conference Call. My name is Dawn, and I will be the operator for today's call. [Operator Instructions] Please note that this conference is being recorded.

I would now turn the call over to the Vice President of Investor and Government Relations, Greg Waybright. Mr. Waybright, you may begin.

Gregory Waybright

Thank you, Dawn. Good morning, and welcome to our December 2013 Investor Update Conference Call. With me today is John Lundgren, Chairman and CEO; Jim Loree, President and COO; and Don Allan, Senior Vice President and CFO.

A replay of this call will be available beginning at 2:00 p.m. today. The replay number and the access code will be included in our press release, which will be issued after the call. As reflected in our presentation agenda, John, Jim and Don will be commenting on various matters, including key company messages and our global franchises, and we'll also provide an update on certain items discussed during our November 6, 2013, investor communication relating to our Security improvement plan, capital allocation actions and our 2014 planning assumptions, building off of the framework we provided in early November, followed by a Q&A session.

During this call, we will be making some forward-looking statements. Such statements are based on assumptions of future events that may not prove to be accurate, and as the 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. We direct you to the cautionary statements in the 8-K we will file with our press release and in our most recent '34 Act filing.

I will now turn the call over to our Chairman and CEO, John Lundgren.

John F. Lundgren

Thank you, Greg, and good morning, everybody. The purpose of this morning's call, primarily, is to reinforce that our long-term strategy and financial objectives remain intact. I think, but of equal or greater importance, we're implementing several near-term adjustments to boost returns: first, by focusing on key operating levers, in order to drive organic growth to improve Security margins, to achieve operating leverage and to continue with our, thus far, successful program of working capital turns improvements and generating cash flow.

Next, to ensure that we achieve the planned operating leverage, we're executing an $85 million cost action program. That's the 2014 impact or benefit, about half of which or $45 million will be in our Security business to address the margin opportunity, and the remainder or about $40 million will be surgical cuts spread across the rest of our business that will enable operating leverage while, at the same time, we continue to fund our growth investments.

And in terms of capital allocation, and Don will provide you some more detail later in the call, we plan to return between $1.5 billion and $2 billion of capital to stakeholders during 2014 and '15, over 2 years, by extending the acquisition moratorium we've discussed by 1 or 2 years, repurchasing up to $1 billion in stock after de-leveraging, in line with our rating goals, which, together, should result in the 200- to 300-basis-point CFROI improvement. So our goal is to maximize shareholder value while we continue to position the franchise for long-term outperformance.

So before Jim and Don go into a little more detail, dive deeper into some of the specifics, let me just spend a couple of minutes highlighting our global franchises and the long-term value drivers that are part of the Stanley Black & Decker offering. The strength of our CDIY and our IAR segments makes Stanley Black & Decker #1 in tools and storage. I think our brands are well known, and we believe them to be the best stable of brands in the industry. They're certainly the most recognized and most highly regarded.

We're a proven innovator based on both vitality indices and share gains across the globe, with a global footprint, approximately 50% of our revenue outside the U.S. and relevant positions in virtually each and every geography. We're the world's largest tool company by a factor of 2, with some unique competitive attributes. We're strong in both power and hand tools. No one else can say that. We participate in both the construction and industrial and automotive repair aftermarkets, and we have specific products for developed and developing markets, which is continuing to contribute to the share gains on both of these sets of markets, which, quite frankly, have some very -- have some unique channel and end-user needs. And it also leads us to believe, as a result, we are implementing a winning emerging market strategy.

We're #2 globally in engineered fastening, with highly engineered solutions, with an attractive recurring revenue model, again, a market-leading innovator and a global footprint that's rapidly expanding its end market penetration in vertical markets served beyond the OEM auto market. And last, but certainly not least, we're #2 in commercial electronics security services. We're the only integrator in the business with scale in both mechanical and electronic. We have a well-coordinated global footprint, growth to be fueled by differentiated vertical market solutions.

We've spent some time talking about this on various calls, and it's a very important part of our go-to-market strategy. It has low capital requirements relative to the residential model, and high-margin recurring revenue stream remains the lifeblood of this business. And as we talked about on our third quarter earnings call, the Niscayah situation provides a tremendous opportunity for margin improvement or a margin-accretion opportunity.

Jim is going to give you some more detail on that, so let me turn it over to him to review both the status of our organic growth initiatives, as well as provide just a little more detail into activities within our Security businesses, both in the U.S. and in Europe.

James M. Loree

Okay. Thank you, John. One of the most important value-creating activities that we have undertaken is our organic growth initiative. It was first announced in July of 2012, and implementation plans were completed during the second half of 2012. And then execution began at the beginning of this year. And during this time period, we've added 400 people, about 75% of those have been in the emerging markets.

And at the time we announced the program, we also announced a goal, and the goal is to drive 3 points of incremental organic growth by 2015. And the way that would occur, according to our goal, is 1 point of growth in 2013, 2 points in '14 and 3 points in '15. And I'm pleased to say that the organic growth initiatives are performing well. They're continuing to gain traction on a sequential basis and are performing actually slightly ahead of plan for this year. This year, they'll deliver 2 points of growth as opposed to 1 that we committed to and another 2 points in 2014. So right on track in 2014, a little ahead in 2013.

So the next step with these initiatives is to ensure continued momentum into 2014 and then get the growth rate elevated to the point where we deliver the 3 points in 2015. And we think that driving the organic growth rate higher in this company is one of the most important things that we can do to create value, as I said. And we have a stable or an array of initiatives here that total about $850 million of cumulative growth during that 3-year time frame.

And we started out with, as you can see on the left-hand side of the chart, a lineup of these initiatives that added to $850 million, which included $350 million for emerging markets; and then $150 million for what we call growth verticals, primarily in Security; $100 million for smart tools and Storage, which mostly relate to the Industrial & Automotive Repair business; and $100 million in offshore Oil & Gas; and then $100 million in U.S. government sales; and $50 million from the Black & Decker revenue synergies that we hadn't previously counted.

And as it turns out, everything is either on or ahead of schedule here, with one exception, and that is the government sales. And the government sales initiative actually is quite effective. It's just that the market has collapsed in that area. So we really don't have the ability to drive the growth, the incremental growth that we'd hope for there. And in fact, I think the resources that we put in place have helped us minimize the negative aspects of the government sales, but we certainly have not generated any growth and nor do we see that coming in the near future.

So we have reallocated our target, and we've basically taken our government sales target to 0 and moved the M&A revenue synergy target up to $150 million because we continue to see excellent opportunities and outperformance in both the Black & Decker synergies, things like the DeWalt Hand Tools are going extremely well and then you have a new initiative, which we implemented in Europe this year, which are the Stanley FatMax power tools. And that program is really driving extra growth in Europe, as you saw in the third quarter, where the organic growth was up about 3% in Europe. So that's where the $850 million is going to come from. In total, as you can see in the current column, everything else remains essentially the same, and as I said, everything is performing well.

Now we've invested a significant amount of SG&A in these initiatives this year, about 70 basis points of SG&A increase, and they have been modestly dilutive in 2013. However, in 2014, the incremental investment subsides, and this is just pretty much as we planned. And we really will begin to see the operating leverage from these investments, and we're excited about that. So this program is very much on track, and we're pleased with it.

The second topic I will cover is Security, and I think it's well understood by the investment committee that we've had some challenges this year with one of our historically high-margin businesses. Instead of generating operating margin growth, as it normally does every year, this year, Security contracted its operating margin, with rates down about 300 basis points versus the prior year. And as you would expect, as a management team, we have been deeply involved in understanding the issues and most importantly, putting fixes in place. And I think we made some good progress there, and I'll share some of that with you.

So there's 2 different stories here: one is North America and the second one is Europe. In North America, there were 3 things that were undertaken in the Security business this year, major change programs that kind of contributed to our issues in one way or another. They were all well intentioned and they're all important initiatives, but in any event, not all went exactly according to plan.

So let's start with, we transitioned to a distributor-based go-to-market model in the mechanical business. This is -- this was a difficult but a much-needed change. We implemented it this year because we saw, on the horizon, a recovering non-resi market, and it was time to go from the direct model that we had previously to a distribution model, which is where all the share gain and revenue growth will be as we look forward, and this change gives us access to the non-resi construction market, but there was a lot of heavy-lifting associated with it. And there was a transition from a direct model to a distributor-based model, which meant lower pricing, and at the same time, we had to lower the SG&A in order to reflect the indirect model benefits.

We also had to add specifiers, because in the construction market, that's how you get the business. And we've doubled the number of specifiers that we have in the marketplace, and we're continuing to grow off this base. And the specifiers take some time to -- there's some cycle time to get the specifications written and then the project is underway. And then, ultimately, the locking systems are pretty much the last thing -- one of the last things that gets installed in the projects. So all this was undertaken successfully, and we really had taken some deep dives into the performance of this.

However, there was a trough of operating margin performance that was created in the middle of the year as a result of the revenue ramp going at a certain pace and the cost takeouts we're not -- we were not able to implement the cost takeouts at the pace that we had hoped to, and so there was a temporary performance issue in this business. And I'd say, everything we're looking at right now looks positive for 2014, and we look like we're well positioned to enjoy the benefits of the recovering non-resi market.

The second thing we did was we invested in the vertical market initiatives in Security, and these are really exciting. And some -- I know some of you folks were at the ASIS show in Chicago earlier this year, and you saw these vertical market initiatives and you saw the power of them. And we've added quite a few go-to-market resources and product development resources to drive the solutions, to develop the solutions and then take them to market. And we've had tremendous success, I would say, in driving an order run rate. We started the year effectively with 0, and we're running about $90 million of annualized order rate right now on the vertical market initiatives. And we will record $38 million, we think, in sales this year as a result of these activities.

So a really successful first year with a growing backlog. One of the favorable aspects of these is they have tremendous value propositions. They're not commodities, and the gross margin is accretive to our gross margin rate by about 10 points, about 10 points higher on a -- versus a normal install. So this has been a successful program. It's been a somewhat expensive one, with some significant investments, and that's had some -- put some downward pressure on the operating margin, but it's also one that we are going to really benefit from as we go forward.

And then finally, I'll characterize the final initiative that we undertook at the beginning of the year as a miscalculation or mistake. In the sense that we had decided to move to a decentralized management model in the electronic business at the beginning of the year and we basically went away from what I'll call the HSM management model, which was a very centralized kind of highly metric-driven model to a more decentralized P&L model, with about 80 to 90 P&Ls in the United States geography. And we just weren't ready for that, and it's really not the right way to run the business in retrospect, as we sit here today.

So in the August, September time frame, we recognized the error of our ways there, and we rapidly moved back to the centralized management model. And that has driven a very, very positive change very quickly in the CSS business. What happened when we implemented the decentralized model is we ended up with productivity issues primarily, where we were -- it was costing too much to install jobs because we weren't managing them at the -- with the same level of alacrity that we do with the centralized model. So that's the story in North America. The improvements are all well underway. I think we are seeing the sequential improvement in the operating margin rate as we sit here today. We saw some in the third quarter. We'll continue to see progress there.

Europe is a somewhat different story, mainly from the standpoint of the issue really boils down to the Niscayah acquisition and what we acquired when we acquired Niscayah. And we did acquire a very important strategic footprint in Europe, which gives us tremendous advantages in the global accounts area, scale, in general. And just having one of the best global footprints in the world in Electronics Security. However, it really was a significantly larger task than we anticipated when we bought it, and as we've said before, we were unable to do due diligence because it was a publicly contested situation.

And so it was sort of a bit of a "wait and see" when we acquired it, and it turned out that we had to do a major management overhaul. We had to replace the entire management team at the headquarters level. We had to replace 4 of the large -- 5 largest country management teams. We spent -- pretty much spent the first year doing that, as well as getting tremendous synergies out of this. For a $1 billion business, we, up to this point, have taken out about 13% of the costs and still have some struggles with it. So you can see that the issues were relatively deep there.

But we have -- we understand them, and we're implementing the centralized management model that I talked about in North America. We're just basically taking it from North America and implementing it in Europe. That's very helpful. Attrition was a big issue. When we bought the company, it was an 18% -- at an 18% attrition level. It did not even calculate attrition. So we figured that out, and we've managed that down to about 12% and change right now as we sit here today. And we need to get it to 10% in order to make sure that we no longer have negative organic growth in this business

And just to understand this, the attrition relates to the recurring revenue part of the revenue base, which is about 50% of the total revenue. So 18% attrition gives you a 9% reduction in revenue before you book your first order in the year, and so you really have a very, very significant hill to climb to get over that. And so when you get down to 10%, that's around where the industry runs. In the U.S., we run around a stable 8%, which is good. So getting to that 10% is really critical in order to get the revenue growing again. And if the revenue grows, then we will no longer have to take out costs. But right now, we're faced with a situation where we're now taking out some costs to resize the business, and that is in progress, as Don will talk about.

And then in late 2014, well, the intent with Europe is to transfer the vertical market solutions in from the U.S. They'll be ready for them by then, and we will achieve flat organic growth in 2014 in this business as we get the attrition under control. And I will say the order rates are very strong here. So we have replaced about 50% of the sales force in this organization, and so that side of the equation is not an issue as we sit here today. Next year, we do expect the organic growth to be down about 1 to 2 points, and the reason for that is that it will be flat, excluding some major customer exits that were -- deals that were taken before we acquired the company that we have decided that are just unprofitable.

And as we look at the horizon for this business, we see about 150 basis points of improvement a year and operating margin for about 3 years. So it's going to be a nice source of operating margin growth as we go forward. We do expect North America to be up about 2% to 4% organically on the strength of the organic growth initiatives. And then as I mentioned, Europe will be down slightly, and we'll get that sequential progress in 2014, with 150 basis points. And then, as we go forward into 2015 and beyond, we expect this business to be a terrific 3.5% -- 3% to 5% organic growth business, with operating margin plateauing around 16%.

And with that, I'll turn it over to Don Allan. He'll take you through some capital allocation comments.

Donald Allan

Thanks, Jim. So let's start with capital allocation. As many of you know, our capital allocation priorities continue to be focused on improving shareholder return. And there's really 3 things that I want to discuss today that achieve that objective. The current is really what you heard from John and Jim specifically around our focus on addressing the Niscayah integration issues and just as importantly, improving our operating leverage as a company. And we believe the extension of the self-imposed M&A moratorium on major transactions for the next 1 to 2 years allows us to do that. After that, post 2015, we anticipate returning to our 50-50 long-term capital allocation strategy, where 50% of the capital will go back to our shareholders and 50% will be invested in M&A activities.

The second area is making sure that we maintain our strong investment-grade credit rating, which is consistent with our long-term financial objectives. As many of you know, we've been focused on de-leveraging since the merger with Black & Decker and a few other acquisitions we've done post the merger, and that has continued to be one of our near-term priorities to achieve a debt-to-EBITDA ratio of approximately 2x. And we've done a few things here in the fourth quarter and we'll do one more thing in the upcoming month or 2 that continues down that path.

The first is issuing some hybrid capital. As I communicated externally in early November, we felt the need to do that to achieve our objective for 2013 and assist with our objectives for 2014. And so we issued some mandatory convertible debt, as well as junior subordinated debt, with a total value of $745 million. Additionally, as I mentioned in early November, we are committed to offsetting any potential share dilution that may result from these transactions as part of the objective over the next 3 years.

The second thing that we want to do in this area is we would like to early debt extinguish -- or extinguish some debt early of approximately $300 million, hopefully in the fourth quarter or early in 2014. That will result in a charge of $25 million that I'll discuss in a little more detail later on. The net impact of these various items will result in some increased interest expense in 2014, with a higher interest associated with hybrid capital but obviously, offset by the early debt extinguishment partially.

The third area is, which is really exciting, is focusing on -- once we achieve these de-leveraging objectives, any excess cash flow that we generate will go towards share repurchase. And the way that we've structured it, because we do feel that our stock price is at a value where we want to be able to take advantage of the price, although we do not have the cash available at this time to do a share repurchase, we were able to enter into a $1 billion of equity derivatives, cap call options specifically, in the month of November that allow us to do those share repurchases over the next 2 years when the cash becomes available.

These 3 things, over the next 2 years, are very focused on improving the capital returns to value-accretive levels for our company. And the net impact of them will be a 250-basis-point improvement in CFROI over that time horizon. And we think it clearly demonstrates our commitment to continuing to maximize the shareholder returns.

So with that, I'd like to spend a little bit on time on 2014 guidance. Before I do that, though, we are reiterating our Q4 2013 EPS estimate of $1.24 to $1.34 and $800 million of free cash flow for the full year of 2013. However, there is one change associated with that, specifically related to the M&A onetime charges. We will be increasing that estimate as a result of the Q4 actions that we're taking and the debt extinguishment by $150 million, and now the total charges for the year will be $400 million. And the GAAP -- resulting GAAP EPS for the full year will be $3.05 to $3.15.

So let's talk a little bit about those incremental charges of $150 million. Within that is the $25 million of the debt extinguishment charge that will likely get recorded here in the fourth quarter, and then we have $125 million of charges associated with the restructuring across all our businesses. As John mentioned and Jim, $85 million of cost-savings benefit is expected in 2014 associated with those charges. The annualized impact of that is $120 million.

If we break down the $85 million in 2014, you heard that $45 million of that is associated with the continued focus in Security and really making sure that the profitability of that business begins to move in the right direction. And then the remaining $40 million is across all our other businesses and our corporate locations, and it actually is approximately 1/3 CDIY, 1/3 industrial and 1/3 corporate locations. The headcount reduction is approximately 1,100 people. That gives you a little bit of detail associated with the charges, as well as the savings associated with them.

So for 2014, we believe our EPS will be in the range of $5.30 to $5.50, which represents a 7% to an 11% EPS growth year-over-year. On a GAAP basis, we anticipate it to be $5.20 to $5.40. Let me walk through a little bit of the assumptions associated with that on the page. Specifically, let's start with organic growth. We believe organic growth will approximate 4%. That includes our -- the impact of our growth investments and our growth initiatives in the top line. And we believe the accretive EPS impact is between $0.50 and $0.60 associated with that.

As you heard from Jim, the Security margin improvement will be 150 basis points, which will contribute approximately $0.15 of EPS. The cost actions that I mentioned outside of Security and CDIY, industrial and corporate will be accretive by $0.20 of EPS. And then we do have some carryover effect associated with Infastech and a few smaller acquisitions as well that will be a tailwind of approximately $0.10 in 2014.

There are a few items that are more nonoperational in nature that are partially offsetting some of these positives. They are foreign exchange. As we've mentioned before, we had a significant shift in foreign exchange in the middle of 2013. The currencies that are primarily driving that are the Brazilian real, Argentinian and Australian currencies as well. That is primarily a carryover effect based on the current rates today. We expect to have slightly higher tax rate of approximately 21% to 22% versus the 19.5% in 2013, causing a little bit of pressure, and then you heard about the interest expense pressure and a few other items and other net causing some pressure as well.

We have dramatically reduced the onetime charges for 2014. We expect that to be $25 million to primarily support the Infastech integration. And so one of the main objectives, as many of you are aware, for 2014 is that those charges go down dramatically, and we believe we've set a process in place to ensure that, that happens. However, we will see a carryover effect in our free cash flow related to the charges that we're taking in the fourth quarter, as well as the $25 million in 2014. And so our free cash flow estimate for next year on a GAAP basis is $675 million, which includes $250 million of onetime payments associated with these charges.

Moving to a little more detail on the segments on the right side of the page. CDIY, we expect to have mid-single-digit organic revenue growth, so an anticipated continued improvement in this business as the housing market in the U.S. slowly continues to improve. The operating margin rate is expected to increase year-over-year due to the cost reductions and the volume leverage we expect to achieve but will be somewhat offset partially by the currency effects that I mentioned earlier.

Jim touched on Security in a fair amount of detail, so I won't repeat that. You could see the information again here on this page. And then industrial, the mid -- we expect mid-single-digit organic revenue growth for 2014, and the operating margin rate is expected to increase year-over-year, as we have the same impact as CDIY with the cost actions and the associated volume leverage and slightly offset by some negative FX. So organic growth, cost actions and the Security improvements really drive our 2014 EPS up to $5.30 to $5.50 range.

As a summary for our presentation today, our company is very committed to driving both the long-term and the near-term shareholder value. And our first priority remains to protect and continuously improve the value of our well-established global franchises, as you heard from John. We have taken several actions, and they are significantly underway to improve the near-term returns and relative performance of the company. The first is the continuing ongoing impact of our organic growth initiative. The second is the Security margin improvement that Jim went into great amount of detail on, the surgical cost actions to ensure that we really get the right operating leverage across all our other business platforms. And we can't forget about the ongoing working capital turn focus as we continue to drive the company to 10 working capital turns.

We've also done a significant rebalance of our capital allocation that will really impact the company over the next 2 years, as I mentioned, that 250-basis-point improvement in CFROI through the acquisition moratorium extension, the share repurchase program and our continued de-leveraging. We believe strongly that our long-term strategy and financial objectives remain intact.

And with that, we have completed the presentation portion of the call.

Gregory Waybright

Great. Thanks, Don. As Don said, this concludes our prepared remarks. Dawn, we can now open the call to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Rich Kwas from Wells Fargo.

Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division

A couple of questions. Just on -- Don, on the share repurchase, my understanding is that won't be really done until '15. So the impact on share count going forward is still going to be somewhat muted even if we're looking out to 2015. Is that the right way to think about it?

Donald Allan

I think the way to think about it, Rich, is that there'll be a relatively small impact in 2014, really, primarily focused on keeping the share count flat. And as the cash -- as we de-leverage and more cash flow becomes available later in 2014, into '15, you'll see a much more significant impact in 2015.

Operator

Our next question comes from Mike Wood from Macquarie.

Adam Baumgarten - Macquarie Research

This is Adam in for Mike. A quick question on Niscayah. What sort of level of operating margins on average are the current contracts you're bidding today versus sort of the segment average last quarter?

James M. Loree

We are focused on getting Niscayah to about a 15% operating margin. And as I indicated, it would be a couple -- it would be a longer-term exercise. It will take about 3 years to get there. So it's -- the contracts themselves are being bid at rates that will allow us to get to that 15% operating margin, and really, it's a matter of getting some of the near-term actions implemented and driving operating margin growth while we do that. So it's -- you've got a cost base that needs to be resized, you've got attrition that needs to be 10% in order for us to have any kind of growth at all or at least to maintain the revenue base. And so that's job #1 and 2. And then as we take on these contracts, we're acutely aware of the notion that growth with low-margin contracts is not the kind of growth that we're looking for. So we've got checks and balances in place, very robust processes in place to make sure that new business that's taken on is not problematic because those mistakes have been made by past management teams in both Niscayah and other security businesses around the world. And we're not going to make that mistake at this point in time. We're well aware of the risks.

John F. Lundgren

Yes. And just to add because you'll -- the process will only allow you 1 question. Jim didn't give you a specific number because it's not relevant. I mean, the answer is they're higher, and I think Jim explained that quite well. And the reason a specific number isn't relevant is, as I know you're aware because you understand this business quite well, if it's purely a systems integration contract, it better come at a much higher margin or it won't be profitable. If it's a system integration contract with which a tremendous amount of recurring revenue is staple to it, you can do the installation at a much lower margin because, as we all know, the recurring revenue is what we desire. So you need to look at a contract "cradle to grave". Is it purely a systems integration or installation contract or is it a contract that comes with a significant amount of recurring revenue? They will be dramatically different. We'll bid the systems integration or installation portion of it dramatically different depending on that. But -- and the simple answer is, I think as Jim explained very well, they're higher.

Operator

Our next question comes from Jason Feldman from UBS.

Jason Feldman - UBS Investment Bank, Research Division

So on tax, I think for a while now, you've talked about some of the issues in terms of repatriating cash. But it looks like, at least for the next 2 years, essentially all of your free cash flow is going to be used within the United States, both debt reduction and then share repurchases. Has something changed there? Is this sustainable longer term? Or is this going to limit your flexibility after these 2 years even further? If you can just kind of walk through the dynamics there.

Donald Allan

Yes. I think the dynamic isn't -- nothing has really changed. The reality is, is we don't have a great deal of cash on our balance sheet outside the United States. So we have a little bit of cash that we can bring home over the next year or so, but we really need to build those cash balances up. And as we build them up, we will be bringing that money home over the next 2 years to do the things that are associated with that de-leverage and share repurchase. So I think, as you think about it, cash flow is generated for the next 2 years. That cash flow is going to be generated, a large part of it, 70% to 80% of it , outside the United States. And as it's generated outside the United States, that money will be brought home to some of the tax structures that we've created to allow us to both de-leverage and to buy back shares.

John F. Lundgren

And you didn't say this, but implicit in what you were saying was efficiently brought back home.

Donald Allan

Absolutely. Efficiently brought back home, which is what I've previously communicated, so well said.

Operator

Our next question comes from David MacGregor from Longbow Research.

David S. MacGregor - Longbow Research LLC

I wonder, within Security, if you could just isolate for us the 2014 margin impact or the benefit of the combination of the distribution model changes and resolving your field cost inefficiencies, those 2 together.

James M. Loree

Well, the North American margins, I'll give -- we don't usually give this detail in margins, but since we gave you so much detail, I might as well just go ahead and give you a little bit more. So about 200 basis points of margin improvement, I'd say 180 to 200 basis points in North America, and Europe will be improving about 120 basis points. So the North American improvements total about 200 basis points. If we had to split the difference, I think it would be very difficult for me to do that right now. But in terms of what impact from efficiency versus the mechanical transition and so on, because there's a lot of factors in at play there, including volume growth, cost takeout, cost efficiencies in the field and so on. But I think you can get a sense that the North American business is improving faster, and the European one is taking a little bit more time. And I don't think that will surprise anybody. When you have a European business and you need to improve it by taking out costs and effecting process improvement, usually, it takes a little bit longer due to the complexity and some of the social constraints.

Operator

We have Peter Lisnic from Robert Baird.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Just looking at the -- on the Security forecast, the 1% to 2% organic in Europe, which, I think, if the comments are right, your recurring piece is down, call it, 5% to 6%. It's an implied growth for non-recurring pieces. A lot of it is single digits. Can you give us a sense as to how that compares to the market? And is there something in there that you're doing to maybe gain share?

James M. Loree

Yes. We are going to grow installations around 8% to 10% in Europe next year, and we are running at that rate right now in terms of orders. So we don't have a lot of concerns about that. As I mentioned, we've replaced about 50% of the sales force. You recall the Securitas -- under the Securitas relationship that they had before the spin -- or before we acquired them, they were providing us with lot of business, providing Niscayah with a lot of business. That has ceased. And so -- and previously, the Niscayah sales force would -- tended to be more farmers than hunters, as we've said previously. So we have added a lot of hunters, and we've also improved the customer service dramatically, which is helping our reputation in the marketplace. In combination with those 2 things, we've done a rebranding, which -- and a fair amount of marketing. And so we have a pretty good commercial machine going right now, I'd say, over there. Whether we're gaining share or not is a -- I think is a question mark. I think we will over time. Certainly, when we get to the 3%, 4% organic growth and we bring the vertical solutions in, we'll definitely be gaining share. Right now, we're not losing share, I'm pretty sure about that, if we get it to flat to down a point or so.

Operator

Our next question comes from Michael Dahl from Crédit Suisse.

Michael Dahl - Crédit Suisse AG, Research Division

Jim, I wanted to stick with the Security theme here. And if we think about the cost cutting that you're announcing today, you've already had a tremendous amount of turnover in the business, particularly on the Niscayah side. So I imagine it's kind of a delicate balance between taking out costs and trying to stabilize and grow that business. So can you talk us through a little more detail on where the cost is coming? And how do you think that will impact the top line as well?

James M. Loree

Yes. We can't get into detailed discussions about cost takeouts in Europe because there's protocol. It has to be followed, and certain communications have to be taken with the employees before anything can happen or be discussed publicly. So there will -- I can't provide any detail. But what I will say is that the turnover that has occurred has largely, predominantly, been very, very good for the business, and it's not always the case. When you have turnover, obviously, we know that sometimes turnover can be bad. Most of this turnover was deliberate turnover that was effected by us because when we acquired the company, we realized that the teams that we had in place in these various places weren't going to be able to get the job done. And the farmers weren't going to be able to sell the product and so forth, and so a lot of folks had to be replaced. And a lot of costs had to be taken out because the business was shrinking and there was a lot of unprofitable business that had to be ejected as well. So it is a dynamic situation. I will tell you that it's more stable than you would think, and it's moving in the right direction. And so I think most of the turnover has been pretty good for it.

Operator

Our next question comes from Michael Rehaut from JP Morgan.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

I just had a question on the EPS guidance. I believe, at the end of the third quarter call, you talked about EPS growth of 7% to 9%. Today, you're saying 7% to 11%, but you have roughly $0.40 of benefit from the cost actions that largely drive that growth that wasn't in the guidance from 3Q. So if you strip out the cost benefits, which are new action -- or a new item since the third quarter communication, what was the incremental negative that you've seen over the last month, 1.5 months to just give us a better picture of how your thoughts have changed regarding 2014?

John F. Lundgren

Yes. Mike, Don will give you some more detail. But you're missing the big -- you're missing half of the equation. Within the guidance Don gave in the third quarter, the improvements in Security and the cost takeouts were in that guidance, and we weren't as specific at the time for some of the reasons Jim talked about. But let me ask Don to give you a little more granularity.

Donald Allan

Yes. That's exactly right, what John just said. I mean we -- specifically, the Security cost actions were already baked into that estimate and an additional amount of cost actions as well. What we've done, though, subsequent to that, we have had -- we have seen some additional FX pressure since that time frame, and so we actually increased our cost estimate a little bit associated with that. That was about $15 million or so roughly of an impact. But the vast majority of the $85 million, about $70 million was baked into that estimate of 7% to 9%. We just -- we're not able to communicate the details at the time for some the reasons that Jim was touching on earlier around the European cost actions. So the large part of these cost actions are in Europe, specifically for Security and for our industrial businesses as well. So we need to make sure that we go through the right process before we communicate that externally.

James M. Loree

And it's also -- the level of risk associated with exchange right now, in our opinion, is higher than normal because of the likelihood that tapering will take place. And then some of the foreign currencies, you will see some -- potentially, some more stimulative monetary policies in Europe, and Latin America, where we have a large business base, is pretty volatile right now. And if tapering does occur, it's likely that there'll be some more pressure on the Latin American currencies. So the forecast that we've given you is risk-adjusted for some currency risk that hasn't occurred yet. And that's why the range has kind of been widened because we do have more positives that you've referred to, but we also have more concerns about FX risk as we go forward.

John F. Lundgren

Yes. And Mike, this is John. And really, for everyone on the call, at the risk of summarizing something that probably about 80% are acutely aware of and this relates to any restructuring that goes on in Europe in any company, American or anything else. Jim talked about it. Don talked about it. There's no hidden agenda here, and I don't want anyone to come away with the impression that there aren't plans. But as I say, at the risk of spending a minute on something everyone knows, there is a very formal process, much more formal than in any restructuring activity in the U.S., even in a union-dominated environment. And specifically, it requires consultation with the works council. It requires consultation with the unions. It requires formal notification of the employees. And as many of you know, I've spent 15 years of my life living and working in Europe, and it is a very formal process. And the best way to ensure success or increase the likelihood of success is to follow that, follow it rigorously. Try to expedite it, try to cut a corner, try to circumvent it, you're subject to, first, just overall a failed program. And it could fail in terms of work stoppages. It could fail in terms of government intervention and many other things. So with apologies for our inability or lack of willingness to provide detail, it's in the best interest of our company and our shareholders that, obviously, bode for us to follow the formal procedures, and that's exactly what we tend to do.

Operator

We have Jeremie Capron from CLSA.

Jeremie Capron - CLSA Limited, Research Division

A question on the charges that you announced for the year, so estimated around $400 million. Can you walk us through the detail of this $400 million? I understand you have an extra $85 million coming from the cost actions that were announced today. But what about the rest? And if you could compare that to last year in terms of where those costs are coming from that would be very helpful.

Donald Allan

Yes. As I mentioned in the presentation, the $400 million, we're raising it -- we've basically raised our original estimate back in October, which is about $250 million. And those $250 million are associated with completing the Black & Decker integration, initial Infastech integration costs, Niscayah and some very other -- various other smaller transactions that are underway from an integration perspective.

James M. Loree

That's $250 million.

John F. Lundgren

$250 million.

Donald Allan

So $150 million on top of that gets you to $400 million. Within that -- as I've said, within that $150 million, $25 million is related to the early extinguishment of debt, so the charge is associated with that. That will drive a significant benefit and basically have less than 2-year payback on that charge. And then there's $125 million of restructuring costs associated with the Q4 actions that drive an $85 million benefit in 2014 and an annualized benefit of $120 million. So it's basically almost a 1-for-1 payback associated with the cost actions we're taking in Security and the surgical cost actions across the other business.

John F. Lundgren

Just want to talk about the change versus '12.

Donald Allan

As far as the change versus '12, it's actually relatively in line with what the charges were in 2012. So it's roughly about $400 million was previous year as well.

Operator

Our next question comes from Nigel Coe from Morgan Stanley.

Michael Sang - Morgan Stanley, Research Division

It's actually Mike in for Nigel. Just a couple of follow-ups on the free cash commentary. The $800 million, I guess, is adjusted x charges, x payments. What's the GAAP number? And we're 3 weeks away from the end of year. How are you guys tracking to that number?

Donald Allan

The GAAP number is going to be probably about $400 million to $450 million for 2013. And I would say that cash flow is always an interesting item to forecast because, in our company, a lot of it happens in the month of December. And as we really shut down our factories, we collect the receivables associated with Black Friday and other activities that happened early in the quarter. So at this point, we're tracking to that number. But there's a lot of intense activity that needs to happen over the next 2 to 3 weeks to make sure that, that comes through.

Operator

We have Stephen King (sic) [Kim] from Barclays.

Stephen S. Kim - Barclays Capital, Research Division

It's Steve Kim from Barclays. So you had made commentary earlier about the attrition rates driving, I think, about a 9% headwind sort of on an annual basis. I was curious if you could give us a little bit of color -- historical perspective on that? Has that increased since you acquired the Niscayah asset? Or is that something that has been pretty consistent at that rate for a number of years?

James M. Loree

So Steve, let me clarify. When we calculated attrition for the first time, it was 18%. So 18% on 50% of the portfolio was the 9% that you're referring to. Since we have discovered that the attrition was so problematic, and any Security company that's well managed calculates attrition and has detailed robust processes around attrition prevention and then attrition analysis and then root cause analysis behind that and then root cost fixes, and so none of that existed in this company. So when we took it over, it was 18%. Today, it's running at 12% and change. And we need to get it to 10%, and we will get it to 10% by next June. So we have made tremendous progress going from 18% to 12%, and it's a function of basically putting the routines in place that I described and then making sure that those routines are managed very, very carefully and effectively.

Operator

Our next question comes from Sam Darkatsh from Raymond James.

Joshua Wilson

This is Josh filling in for Sam. I wanted to -- a real quick clarification question and then I'll ask my main question, too. First, are there no restructuring charges in 2014 related to this new restructuring plan and that's all in 2013? And then my main question, could you detail a little more on the cost synergies side? I know you mentioned an 1,100 reduction in headcount is the entirety of the cost savings that you're detailing today coming from headcount. Or are there other items where you're able to have some cost savings as well?

Donald Allan

Don will take that. Don mentioned in his presentation that the estimate for restructuring or onetime charges in 2014 will be $25 million. And that's our effort to respond to the need and a lot of guidance in our objective of having GAAP earnings and reported earnings to be quite consistent. So when you have $400 million in '12 and '13 going to $25 million, I think we've accomplished that objective. But Don, go ahead.

Donald Allan

Absolutely. And as far as your question related to Q4 restructuring charges we're taking this year, the $25 million next year is related to the Infastech ongoing integration and a few other smaller integrations. So it's not associated with any of the cost actions that we're taking right now. And what was the second question again? Is that it?

John F. Lundgren

No. Well, it was -- Don, it related to are all the synergies -- the benefit coming from headcount or are there others.

Donald Allan

Okay, yes. That was the question. So if you look at the benefits, actually about 80% of it is coming from headcount. And the other 20% would be non-headcount-associated actions that are specifically against our run rate, so certain types of consulting costs, D&E costs, et cetera.

John F. Lundgren

And the head -- importantly, the headcount reductions are spread across a multitude of functions. Don't jump to the conclusion it's all production, it's all feet-on-the-street. It's a combination of production, distribution models, SG&A, et cetera.

Operator

That was our last question. I will now turn the call back to Greg Waybright for closing remarks.

Gregory Waybright

Dawn, thanks. We'd like to thank everyone again for calling in this morning. And obviously, please contact me if you have any further questions, and again, thanks for your participation.

Operator

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

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