Black & Decker (BDK)
Q3 2007 Earnings Call
October 25, 2007 10:00 AM ET
Executives
Mark Rothleitner - IR
Mike Mangan - CFO
Analysts
Analyst for Kenneth Zener - Merrill Lynch
Michael Rehaut - JP Morgan
Armando Lopez - Morgan Stanley
Mark Montana for Stephen Kim - Citigroup
Nishu Sood - Deutsche Bank
David McGregor - Longbow Research
Peter Lisnic - Robert Baird
Omar Lim - ClevelandResearch.
Analyst for Sam Darkatsh - Raymond James
Operator
At this time, I would like to welcome everyone to the Black& Decker third quarter conference call. (Operator Instructions) I would now like to turn the call over to Mr.Mark Rothleitner, Vice President, Investor Relations and Treasurer. Sir, you may proceed.
Mark Rothleitner
Thank you operator. Good morning and welcome to Black & Decker’s third quarterconference call. On today’s call ourChief Financial Officer, Mike Mangan, will discuss our third quarter resultsand outlook for the remainder of 2007. His comments should take about 15 minutes and then we will answer yourquestions.
In keeping with SEC requirements, I advise that during thiscall, we will be making forward-looking statements that involve risks anduncertainties. For a more detaileddiscussion of the risks and uncertainties that may affect the Black &Decker Corporation, please review the reports we have filed with the SECincluding the 8-K filed today.
In addition, we will be referring to non-GAAP financialmeasures within the meaning of SEC Regulation G. A reconciliation of the differences betweenthese measures and the most directly comparable financial measures calculatedin accordance with GAAP is included on the corporation’s website under theInvestor Relations section.
Now, I will turn it over to Mike.
Mike Mangan
Thanks Mark. Thismorning Black & Decker announced earnings per share of $1.59 for the thirdquarter, above our guidance of $1.40 to $1.45. Sales were also better than our forecast, which drove most of the EPSout-performance. As we anticipated,margins were down primarily due to raw material and inflation. Therefore, EPS was 9% below the record $1.74per share in the third quarter of 2006.
Sales increased 1% to $1.6 billion for the quarter, ahead ofour projection. Organic volume was down1%, price was flat and foreign exchange contributed 2%. As we have described all year, outstandinginternational sales growth mitigated weakness related to the U.S.housing industry. This quarter, we alsoposted sales gains in two of our segments, Hardware and Home Improvement andFastening and Assembly Systems.
Operating margin for the third quarter was 10.1% slightlyahead of our expectations. Commodityinflation remains the biggest challenge to our margins. We had roughly $40 million of year-on-yearpressure this quarter, which we could not fully offset with productivitygains. Our SG&A percentage alsoincreased, largely due to lower sales volumes in the North American Power Toolsand Accessories business.
We generated $113 million of free cash flow in the thirdquarter bringing the year-to-date total to 413. Adjusting for a one-time tax payment related to HACA in early 2006, freecash flow increased by more than $50 million year-to-date. We continue to hold capital spending belowdepreciation and working capital remains favorable to 2006 year-to-date. Each quarter, this year inventory has beenbelow the prior year level excluding currency.
As we announced last week, we used our cash to repurchase4.3 million shares during the quarter. This brings the total 5.4 million year-to-date and 7 million over thelast four quarters. As a result, ouroutstanding and average diluted shares are 8% lower than a year ago. Share repurchase activity contributed approximately$0.02 to EPS versus our prior guidance. Our average purchase price this quarter was approximately $85 below theaverage closing price for the quarter and year-to-date. Last week, our boardadded 4 million shares to our authorization bringing our repurchase capacity tonearly 5 billion shares. We willcontinue to repurchase our stock opportunistically and pursue bulk onacquisitions.
Now I’ll discuss our individual businesses in moredetail. Sales in our Worldwide PowerTools and Accessories segment decreased 3% in the quarter. Sales outside of North Americaremained extremely strong; however, these results could not fully offset theNorth American decline.
In the U.S. Industrial Products Group, sales decreased midsingle-digits. Considering the dramaticdecline in housing and the high single-digit sales decrease in the secondquarter, we consider this a respectable performance. The year-on-year change again driven by adouble-digit decline in the independent channel. Many of our customers in this channel servedthe residential construction market and their orders declined across allcategories.
In the Home Centerchannel, sales were down low single-digits and the sellthrough trends continuedto stabilize. In addition, our Cordlessbusiness faced a tough comparison. Lastyear XRP launched late in the second quarter where as our new nano 18-volt lineis launching in the fourth quarter this year. The Accessories category was a bright spot for the Industrial businessas successful promotions and new products helped us grow sales in a toughenvironment.
The U.S. Consumer Products Group had a disappointing quarterwith the sales decline in the teens. Sellthrough at the home centers was down only modestly similar to thesecond quarter. Order rates however weredown significantly at all key customers. Two categories were most responsible for the decline: automotive andelectronics and consumer tools.
The Vector Automotive and Electronics business we acquiredin 2006 had fewer new products this year and some existing products did notmeet our expectations. We are rebuildingthat portfolio and rolling it out internationally which should help our 2008results.
In Consumer Tools, part of the decline relates to timing ofnew products. We benefited from the AutoWrench, Handy Saw, and other key products in the third quarter last year. This year, our major launch is the DPXlithium-ion cordless line, which recently started to ship to retailers. We expected sales in the Consumer businesswill stabilize in the fourth quarter and that DPX will provide a growthplatform for 2008 and beyond.
In Europe, sales rose double-digits,our best organic growth in a number of years. The Industrial business delivered a double-digit gain for the thirdstraight quarter. We posted outstandingperformance in all key geographic regions driven by France,Eastern Europe and the UK. Our investments in new products, building aDeWalt brand and developing a salesforce are paying off.
The Consumer business also posted solid sales growth in Europethis quarter. We benefited from growthof key customers in Germany,the launch of automotive and electronic products and a late season rebound inthe UK outdoormarket.
In Latin America, sales grew in thehigh teens this quarter and over 20% year-to-date. All major product lines and regions postedsales growth again this quarter. The Asiaregion also contributed double-digit sales growth this quarter with stronggains in Korea,Japan and China.
Return on sales for the Power Tools and Accessories businessdecreased 190 basis points to 10.2%. Around two-thirds of the decline was from a higher SG&A percentagedue to lower North American sales volume. The remainder was in gross margin, as productivity did not fully offsetcommodity inflation. The US Consumerbusiness accounted for most of the segments margin decrease. Operating margins remained in thedouble-digits in both Europe and Latin America this quarter
In our Hardware and Home Improvement segment, salesincreased 6%. Price Pfister continued togrow double-digits aided by a somewhat favorable comparison. Kwikset rebounded well this quarter postingsales growth in a very tough environment.
Our U.S. Lockset business had strong results at retail thisquarter. We completed the launch ofSmartKey to a large customer and the early sellthrough data is veryencouraging. We also posted solid salesgrowth at another key retailer and benefited from price increases implementedlate in 2006. Kwikset’s success in recent quarters supports our view that lockset purchases are less discretionary then purchases of higher ticket remodelingitems.
The construction channel remains challenging but was morethan offset by gains in retail. Inaddition, Baldwin delivered steady sales improvementeach quarter this year.
The Price Pfister faucet business continues to make goodprogress as well. There have been anumber of line reviews in this category and we have been successful inrepositioning our product lineup. Largely as a result of these transitions, we posted a significant netincrease in sales to key customers this quarter. We also continued to convert homebuilders toPrice Pfister and grew in this channel despite weak housing starts.
The Hardware and Home Improvement segment had a year-on-yeardecrease in operating margin to 12.3%; however, margins continued to improvesequentially. The decline versus 2006was primarily in the faucet business, which had not reached the anniversary oflarge commodity cost increases. We havealso incurred significant store reset costs due to faucet line reviews.
The Lockset business has done a good job of offsettinginflation with price and productivity and margins for this segment shouldimprove as we pass the anniversary of cost increases.
In the Fastening and Assembly Systems segment salesincreased 7% led by the Automotive businesses. In Automotive, we had strong equipment shipments following delays bycustomers earlier in the year. We areespecially pleased that our North American Automotive business rebounded thisquarter.
Sales in Europe increased double-digitswith sales growth outpacing automotive production. The Asian business posted a high single-digitincrease including rapid expansion in China. Volume leverage and favorable pricing enabledthe segment to increase its operating margin to 15.5% for the quarter.
Now let me discuss the outlook for the rest of 2007. As we have said all year, we are cautiousabout the macroeconomic environment. Weare not expecting near-term improvement in housing or robust consumer spendingthis holiday season. However, wecontinue to expect sales and EPS growth in the fourth quarter for tworeasons.
First, we have a very favorable comparison to the fourthquarter of 2006. You will recall thatlast year our U.S.customers dramatically reduced their inventory levels, which negativelyaffected our sales by roughly 5 percentage points. Our customers will likely remain cautious oninventory levels this quarter but we are not expecting an inventory correctionlike last year.
The second reason is our new products and commercialsuccesses. These should help us build onthe positive momentum from the third quarter. As I mentioned earlier, Dewalt’s much-anticipated 18-volt nanolithium-ion line launches this month. This line is backward compatible to take advantage of our #1 position in18-volts. We’re confident it willfurther strengthen our leadership in cordless.
Under the Black & Decker brand, the DPX line offersconsumers a new platform they can use around the house. Its lithium-ion batteries offer twice thepower to weight ratio of Ni-Cad. Theyalso hold the charge better to provide power when the user needs it. Some products take one DPX battery; somerequire two ensuring the right amount of power for the job. DPX will start with a wide variety ofapplications including drills, cut saws, screwdrivers, flashlights, inflators,handheld vacs and portable power. Weintend to further build on this platform in the coming years.
We are very pleased that our other two segments increasedsales this quarter and expect continued growth in the fourth quarter. HHI should build on the success of KwiksetSmartKey and Smart Scan as well as higher sellthrough for Price Pfister. In fastening, we expect growth in the globalauto industry as well as our sales. Across our segments, we believe our international momentum willcontinue. In total, we expect modest organic sales growth in the fourth quarterand mid single-digits including favorable currency.
The outlook for operating margins is mixed. Volume growth should help margins and wecontinue to get some benefit from currency. Commodity inflation will remain a headwind with pressure accelerating inPower Tools due to the timing of price increases on batteries. We expect $175 million of full year inflationincluding the impact of China’snew VAT policy. We should offset some ofthe commodity inflation with productivity gains. Consideringall these factors, we expect modest year-on-year margin improvement in thefourth quarter.
For the full year this outlook implies roughly flat organicsales, and low single-digit reported sales growth including currency. Wecontinue to expect an operating margin decline of approximately 100 basispoints for the full year.
Based on shares repurchased through the third quarter expecta diluted share count around 63.5 million for the fourth quarter and 66 millionfor the full year. Due to sharerepurchases, our interest expense forecast has increased to around $85 millionand we continue to expect a full-year tax rate of roughly 27%.
In total, we expect diluted EPS in the range of $1.55 to$1.65 for the fourth quarter and $6.50 to $6.60 for the full year. Our full yearguidance is higher than in July as we expect most of our third quarter out performanceto read through.
Finally we expect to convert over 100% of our full year netearnings to free cash flow. Becausetiming of receipts and payments around year-end can significantly skew cashflow, we generally do not give more specific forecasts. However, our outstanding cash generation sofar this year gives us confidence we will deliver another strong free cash flowperformance.
In summary, Black & Decker’s results significantlyexceeded our expectations this quarter. We reported EPS of a $1.59, $0.14 above the top end of our guidancerange. Despite a difficult environment, we grew sales. We delivered impressivesales growth in two of our segments and outside North America.We continue to develop and market new products with meaningful innovation forend users including cordless and lockset technologies.
We generated an outstanding $413 million of free cash flowyear-to-date. We used our cash to repurchase over 4 million shares of our stockduring the quarter and 5.4 million year-to-date while continuing to evaluatepotential acquisitions, and we increased our EPS guidance to virtually flat forthe full year, which would represent a strong performance in light of ourhousing and commodity headwinds.
Black & Decker has made significance structural changesin recent years, to become a more balanced, consistent company. We have atalented, experienced management team that is committed to weathering thecurrent downturn effectively. With outstanding people and sustainablecompetitive advantages we are in an excellent position to become even a bettercompany in the future.
That concludes my prepared remarks. Now I will turn it backto the operator and we’ll take your questions.
Question-and-AnswerSession
Operator
Your next question comes from Kenneth Zener - Merrill Lynch.
Analyst for KennethZener - Merrill Lynch
Your 4Q guidance, it seems to have remained relativelystable, maybe be even declined slightly from what was implied last quarterdespite the $4.3 million buybacks. Am Ithinking about this correctly? It thismainly due to just incremental commodity inflation or a more cautious outlookon sales? What else could be going on there?
Mike Mangan
I think you’re thinking about it correctly. If you just lookat quarter-on-quarter guidance and look at the math from share repurchase ourguidance for the fourth quarter is a bit more cautious than it would have beenimplied last quarter. So a little morecautious on the outlook for one, a little incremental commodity inflation two,and as a result you’re seeing the $1.55 to $1.65 guidance for the fourthquarter.
Analyst for KennethZener - Merrill Lynch
You’d previouslymentioned, I think back in Q1 that there is a couple of bolt-on acquisitions inthe pipeline that you are pretty optimistic about. Are you still looking atthese? Generally, how is the acquisition environment looking?
Mike Mangan
We continue to look at a handful of opportunities is maybethe best way to characterize that. There’s one earlier on in the year that I’vementioned which was probable, it is still on the drawing board. I wouldcharacterize it now as possible as opposed to probable, but that as well as ahandful of others are acquisition opportunities we’re continuing to evaluate.
In terms of the overall market, certainly deal flow hasslowed. To this point, I’m not sure we’ve seen a significant change in pricingexpectations, but you would expect over time that those will probably come in,not only because of the amount of money chasing deals, less leverageobviously but as well probably a bitmore cautious outlook in the underlying businesses.
Again we still have a handful that we’re looking at,continuing to evaluate that and hopefully we’ll be able to bring one or more ofthose to the finish line in the coming months.
Operator
Your next question comes from Michael Rehaut - JP Morgan.
Michael Rehaut - JPMorgan
Just going back to the power tools segment and you continueto look for a positive contribution in the fourth quarter from DPX and the nanoLithium-ion lines. If you look at ‘07 and perhaps are looking at ‘08 in termsof the overall net impact from new products, as far as I understand, for ‘07perhaps or even ‘06, the new product contribution may have been a little bitless than previous years.
I was wondering if you’re thinking that ‘08 might be anabove-average year or in terms of a contribution to sales growth? Perhaps you can couch it in those terms, interms of helping us looking forward into 4Q in ‘08, how powerful this newproduct cycle is compared to the last couple of years?
Mike Mangan
It’s tough to put precise numbers around, Mike, but as youlook here in the fourth quarter we have some outstanding products coming. Youmentioned the Lithium-ion line and DeWalt as well as on the Black & Deckerside, so ‘07 overall was probably an average year. The fourth quarter I thinkit’s clearly above average, which will drive at probably an above-average yearfor 2008.
Also we’ve rolled out significant new products in our HHIbusiness as well with the SmartKey and Smart Scan product lines, and those arecontinuing to roll out through distribution and across channels. So that will provide us some momentum goinginto ‘08, and we will continue to see expansion for the channels for thoseproducts in ‘08 as well. So in generalterms, ‘07 was a solid year, Q4 above average which will drive probably aboveaverage 2008.
Michael Rehaut - JPMorgan
My second question also in this vein, I guess. With hardwarecoming in well above our estimate in terms of sales, and I guess that alsobenefited margins coming in better than we were looking for given the highervolumes. You mentioned that you had particular success at one key retailcustomer.
How should we think about that going forward? Is this something where the Kwikset with theSmart Key is that something that maybe makes the next three quarters, given ahigher level of sales, is that something that we can model in? Or the successwith this one key customer, is that more of an initial buy-in?
Mike Mangan
Kwikset obviously is selling into some relatively volatilemarkets. Obviously the housing side of that has been challenged. Having said that, because of their newproduct portfolios into retail it’s been very solid. During the quarter webegan the rollout of Smart Key. That went into a customer, provided some topline there and point-of-sale again was very encouraging. That product will continue to roll out sowe’ll go to additional customers here in the fourth quarter and then go intosome of the home-building channels into 2008.
So we’ve obviously got some tough end-markets. You have thenew product portfolio there. It’s really helping to drive sales growth. Now predicting three quarters from now is a littletough, given some of the uncertainty in the environment, but we do certainlyhave some momentum in that business.
Michael Rehaut - JPMorgan
While there was a good benefit at one key customer thisquarter, you are still expecting some incremental roll-out next quarter, so notto necessarily expect a drop back into a decline for 4Q?
Mike Mangan
That’s correct. We’re expecting growth in the HHI segmentand in Kwikset specifically as we continue to roll out Smart Key.
Michael Rehaut - JPMorgan
Last question just on Price Pfister. Up double-digits. I was wondering if you could give us someinsight in terms of obviously in that industry you have Delta and Moen beingthe two big shares positions in the industry. Have you been gaining share this quarter or the last few quarters? Where do you see the opportunity for thatbusiness over the next couple of years?
Mike Mangan
A couple of things that have helped us there. First off, it is not a business historicallythat has had much penetration in the new housing industry, so as a result wehave not had that headwind. Now we arestarting to gain some traction there because we have been working on trying togain penetration into homebuilders. That grew during the quarter so that didhelp our top line.
As well, over the last let’s call it two quarters, therehave been a number of line reviews that have allowed us to reposition some ofour product in our key big-box customers. POS rates there have been verystrong, again supporting us much more of a remodel product than a new housingmarket product. It’s really driven some much better selling.
So as we look to the fourth quarter, we would expect to havesome continued momentum in that business and some positive sales based on theremixing of our product portfolios within the retail channel.
To your share question, I can’t imagine that the overallmarket is growing. Certainly not because of the new housing side, so as aresult of that I don’t have specific data but would expect that we are probablyincreasing some share in the faucets’ business.
Operator
Your next question comes from the line of Armando Lopez withMorgan Stanley.
Armando Lopez -Morgan Stanley
Mike, can you comment on inventory in the channel? You had mentioned a slowdown in orders butthe sellthrough continued to be relatively stable.
Mike Mangan
Sellthrough was pretty good during the quarter. We are basically flat year-on-year POS-wiseat our big-box customers in both professional as well as consumer. As Imentioned, and to your point having said that, that we saw sell-in drop particularlyon the consumer side. Net-net of that as we think inventory position in thechannel is in good shape. Would notexpect to take any dramatic actions relative to inventory. Having said that, given all the uncertaintyin the market we would not expect them to be overly robust in terms of sell-in andwill in large part match sellthrough that we would expect during the fourthquarter.
Armando Lopez -Morgan Stanley
Can you comment on the FX impact on the profit line from atransaction and translation perspective?
Mike Mangan
Sure. FX continued to help our results as you would expect,given the weakness in the dollar during the third quarter. It added about $0.08to the bottom line.$0.05 of that would be translation. About $0.03 of thatwould be transaction so it obviously accelerated a little bit from the firsthalf pace where I think during the first half we had about $0.12 or $0.13benefit to the bottom line.
You can expect that if the dollar continues in and aroundits current range that would be favorable to the fourth quarter as well.
Armando Lopez -Morgan Stanley
One last one. In terms of the fastening business and theauto side of things, can you talk a little bit about where you’re seeingpockets of strength, and from a margin perspective, was that more a mix issueor a pricing issue?
Mike Mangan
It was a bit of both. We had seen delays in some new product programs that were being rolledout to not only American but as well other global customers. We had a strong shipment quarter of newsystems during Q3, and those tend to have higher margins, so we got some mixbenefit there. We got some price benefit as well that we’ve been increasingprices and managing our price pretty aggressively. That’s been going on anongoing basis, both of which helped our margins as well as volume leverage.
Armando Lopez -Morgan Stanley
How much is price up on year-over-year?
Mike Mangan
Overall for the company during the third quarter pricing wasflat on a rounded basis. It was actually up a few basis points. We saw pricing significantly positive in ourHHI business. I think we had some modestpositive price in our fasting business and our tools business was downslightly.
Operator
Your next question comes from the line of Stephen Kim - Citigroup.
Mark Montana forStephen Kim - Citigroup
With respect to the domestic TT&A results, I know youmentioned a new 18-volt line will hit the shelves this month. I’m just wondering when exactly the 28-voltlithium-ion hits the shelves and what type of response you are seeing to thoseintroductions?
Mike Mangan
Okay; just for everyone’s background: the 18-volt product isshipping as we speak, so you’ll see that showing up on shelves very, verysoon. Our 28-volt product is supposed toship here later during the quarter, I think late November. That is primarily going into the industrialchannels of distribution so you will not see that product in big boxes. That’sconsistent with where you’re seeing our 36-volt line as well, which again is inthe industrial channels.
Mark Montana forStephen Kim - Citigroup
Gotcha. So youhaven’t seen the traction from those results at all yet?
Mike Mangan
Starting to see that during this quarter, didn’t see that inthe third quarter; but we now shipping 18-volts, so that is benefiting ourfourth quarter.
Mark Montana forStephen Kim - Citigroup
Secondly, HHI results were impressively strong, especiallygiven this challenging macro environment. I know you mentioned price increases as well as Kwikset’s Smart Seriesproducts, as a couple of the reasons for this performance. In response, I’m just wondering is yourpricing there fully offsetting the commodity cost inflation?
Mike Mangan
In HHI, and in particular at our Kwikset business, ourcombination of price and productivity has been offsetting inflation.
Mark Montana forStephen Kim - Citigroup
Fully?
Mike Mangan
Fully.
Mark Montana forStephen Kim - Citigroup
And then, is one of three Smart Series products, I know youhave the key, the code and the scan, is one of those exhibiting particularstrength relative to the others?
Mike Mangan
Well, SmartKey just began to rollout during the thirdquarter, so that’s gone into, as I mentioned, one channel and it’s done very,very well. So that, in size and scope aswell, is a much bigger product line, so that will be a much more significantdriver of Kwikset’s results than the other two.
Smart Scan has done well; that’s been out now for, I think,six months or so. The Smart codeproduct, again, is a repackaging of an existing product, so that has been onthe marketplace, actually, for a number of years. So in terms of the big incremental volumebenefit, SmartKey is the key.
Mark Montana forStephen Kim - Citigroup
Which month was that actually rolled out?
Mike Mangan
The SmartKey?
Mark Montana forStephen Kim - Citigroup
Correct.
Mike Mangan
It began shipping in the third quarter, precisely whichmonth, I’m not sure if it was July or August, I don’t recall.
Operator
Your next question comes from the line of Nishu Sood - DeutscheBank.
Nishu Sood - DeutscheBank
I had a bit of a longer-term question on your margins. Mike,a few years ago, when we were considering the longer-term margin potential ofthe power tools business, looking at your capacity for innovation, yourrestructured lower-cost manufacturing base, we talked about sustainable marginsin the kind of low teens, maybe the 12% range. Obviously if I take the fourth quarter, barely double-digits, it doesentail a pretty big gap there.
So my question is given the commodity cost environment,should we be reevaluating the longer-term sustainable margins and if not, what’s going to get us back to that?
Mike Mangan
I would not suggest to you that we should move off ourlong-term margin expectations in that 12% to 13% range. Obviously what we are seeing now are thechallenges of weak end markets, particularly the UShousing, and significant commodity inflation. We’ve taken, you know, $300 million, $400 million of commodity inflationover the last 3 or so years.
Over time, obviously when markets settle back down and beginto grow, that will drive some volume leverage. We are continuing our productivity initiatives; we’ve continued toevolve our manufacturing footprint as well. They’re not as dramatic as the changes that we announced back in the2001 timeframe, but we’ve done some plant consolidation in Asia;we’ve opened up a plant for HHI in Asia. We’ve closed down some accessories plants andconsolidate some of that in Asia as well.
So there is continuing productivity to be had across ourbusiness categories. As well, newproducts are obviously going to continue to be a key so we can start drivingthat top line. Part of that will come fromprice and as we’ve rolled out new products as we’ve talked about in the past,that’s where we get our price and we’ve seen that here during 2007, obviouslynot as aggressive as we would like, given the weakness in the market. But pricing will be part of that aswell.
So again as you look longer-term for us, I think we can seeour way back to 12%, 13% margins now. Obviously one of the things we’re going to have to have to get that issome help from the market; hopefully we’ll see some either easing in commodityprices are we’re going to have to see some more aggressive pricing.
Nishu Sood - DeutscheBank
Just on the issue of the volume getting back to better fixedcost absorption. Comparing to last yearin the fourth quarter when you had awful fixed cost absorption because of that11% organic decline, I was a bit surprised to see that obviously with yoursales budgeted to be flat to slightly up here, that getting back that horriblefixed cost absorption of last year is almost entirely offset by the commoditycost issue. Is that something that isgoing to be a headwind going into the first half of next year? When should we really begin to see someimprovement signs?
Mike Mangan
The challenge there to your point is that our volume levelsrunning through the plants and we are down a couple of percentage points duringthe third quarter, our plants in the fourth quarter will run pretty flat. So the challenge on the gross margin side hasnot been absorption, particularly the way we run our manufacturing facilitiesthese days. The challenge has been commodityinflation and that’s running $175 million incremental 2007 and we will carrysome of that incremental into 2008, so we will start the front half of the yearwith some headwinds now.
One of the things impacting our fourth quarter is batterycosts; nickel as you may recall, spiked up pretty significantly earlier in theyear; that was in and around the time we were renegotiating our batteryprices. As we get into 2008, we shouldsee some productivity there given nickel coming back as it has.
We have not seen much in the way of copper prices comingdown; zinc’s off its highs but we’ll have to see were all these go. The combination of easing and commodityprices and pricing will reestablish those margins back to those historicallevels. But there will have to be abetter end market environment to be able to accomplish that.
Nishu Sood - DeutscheBank
Corporate expense. What should we be expecting for that in the next couple quarters?
Mike Mangan
As you think about it for the year, we’ve been guiding andbeen guiding all year long to the $95 million to $100 million range, so wewere, I guess, what, about $19 million, I think, during the third quarter. I guess that will translate into a fourth quarternumber is in and around $20 million, so relatively flat in the third quarter.
Operator
Your next question comes from the line of David McGregor - LongbowResearch.
David McGregor -Longbow Research
I’m wondering to what extent was pre-VPX clearance a factorin the negative consumer revenues and margins?
Mike Mangan
That was not a factor for us, David. I’m not sure I’m exactly following yourquestion, but we had expectations coming in to third quarter; it was inherentin our guidance that it was going to be a tough quarter for the consumer powertools business in the US.
On the tools side, we had some launch comparisons that madeit a bit difficult; we had the Auto Ranch Handy Saw that rolled out last year,DPX this year is a fourth quarter item. So that led to some differential there. Automotive electronics, as I mentioned in my comments, has beendisappointing.
Again, strong new products last year like Simple Start; wedon’t have the breakthrough product this year and, candidly, some of theproducts we’ve introduced on the portable power side have beendisappointing.
David McGregor -Longbow Research
The question I was driving at was more just with respect tothe retail channel and whether retailers, in anticipation of a substantial DPXrollout, might’ve got a little lighter on the Firestorm line or some of theconsumer tools in advance of that rollout. I was just wondering if that was a factor.
Mike Mangan
Yes, DPX really is more incremental, so we didn’t a pullbackand sell into the channel as a result of DPX coming.
David McGregor -Longbow Research
And then, how should we think about launch costs as anincremental expense in fourth quarter?
Mike Mangan
Our launch costs and reset costs are much more significantin our HHI business, the way that business merchandises that retail. So we’llhave some headwinds in HHI for that. Inour power tools business, the way that business merchandises and our historicalexperience there, we actually do a pretty good job of managing our way throughthose costs. So don’t expect that to bea significant challenging to margins and tools during the fourth quarter.
David McGregor -Longbow Research
The final question just had to do again with raw materialcosts. I’m just wondering if you’ve gotsome higher priced hedges that might have been set at some point when commodityprices were much higher than where they are today coming off here in early ‘08and whether that would provide you with some relief?
Mike Mangan
On the battery side, nickel, we had reset those costs backin the late summer through year end 2007. As we go into 2008, we should be ableto generate some productivity on batteries because of lower nickel prices.
On the other core commodities like copper, has really notcome of its highs; zinc is off its highs, but still trading at a significantpremium to where it was two or three years ago. So where it has spiked down, like nickel, you’ll see some productivityfor us next year. You know copper, zincreally have not provided us much help at this point.
David McGregor -Longbow Research
Plastics and resins and steels and some of the othercommodities?
Mike Mangan
Resins, I think have been down a bit, but and some concernsthere with what’s going on with oil prices. We’ve seen some productivity, Ithink on the steel side. Again some ofthat is impacted by nickel as well, so as we go into 2008, that could be somebenefit as well, particularly at our fastening business. Fastening we’ve been very successful inovercoming inflation; with the incremental price it’s been a little bit morechallenging than some of our other business.
Operator
Your next question comes from Dan Oppenheim - Banc ofAmerica Securities.
Dan Oppenheim - Bancof America Securities
I was wondering if you could just talk about what you aredoing with the launch of the 18-volt Lithium-ion? You talked about how you’re a little bit morecautious in the outlook for the fourth quarter. Are you doing anything, more promotions or marketing, just to ensure thesellthrough of those products?
Also a few just quick comments in terms of your negotiationswith retailers in terms of having the right shelf space for those products asthey’re launched?
Mike Mangan
Significant support from both our large customers, as wellas our third large retailer on the consumer side for DPX. So it’s got a broad listing across all 3channels there and then for our two major channels, Home Depot, Lowe’s and the18-volt Lithium-ion product, very, very strong support.
So across the board getting support; as you looked at thequarter overall versus last year, and given some of the weakness out there, weplan to more aggressive relative to promotions. We’ve got a good promotionalcalendar played out for the fourth quarter, which we think will help continueto drive POS and POF rates. So we thinkwe’re reasonably well set as we look here into the fourth quarter.
Now, obviously that will be modified or potentially changedas we see how POS actually does.
Operator
Your next question comes from the line of Peter Lisnic - RobertBaird.
Peter Lisnic - RobertBaird
Mike, can you give us some more insight into the NorthAmerican power tools business and the independent channel being down doubledigits? Just trying to get a sense as towhat really drove that in the quarter, you know?
Mike Mangan
What is driving that, obviously, is lower housingstarts. Housing starts are downsomewhere between 20% and 30%. That channel in large part serves USresidential construction. Now there is acomponent of that as well that serves other markets like commercial, but in theportion of that channel that is serving UShousing, is obviously having a difficult time.
Some people call it a recession in US housing, so that’sdriving our results. Our listings are strong across those channels, but they’rebeing obviously cautious about their sell-in because of the difficulty of sellthrough withthe decline in housing. On thecommercial side: hanging in much better. Having said that, I think the channel as well is just cautious about thefuture. So we’re seeing sell-inbasically match sell through.
Peter Lisnic - RobertBaird
If you wouldn’t mind maybe a little bit more insight on whathappened at Vector and some of the product resets that need to occur there?
Mike Mangan
As I touched on earlier and touched on in our comments, 2006good quarter for Vector. We rolled out SimpleStart and some other products. This yearour new product portfolio has not been as robust nor the products that we haverolled out, quite frankly, just have not been as successful as we would havehoped. Came out with a line of portablepower products, which have just not done particularly well. So it’s been a disappointing couple ofquarters for Vector’s top line.
Having said we’ve put significant resource intore-invigorating our portfolio, positioning it for Europe so we’re starting toroll their products out through our European product tools organization andthat will drive some growth overall for that category for us during the fourthquarter and continuing to work on our product growth here for 2008.
Operator
Your next question comes from Omar Lim - Cleveland Research.
Omar Lim - Cleveland Research.
Two questions this morning. First you mentioned on pricing, power tools are down a little bit in thethird quarter, how can we think about that for 4Q pricing and tools?
Mike Mangan
We expect, given our additional promotional activity that wewould have negative price in power tools during the fourth quarter. Overall for the company we would expect ourpricing to be relatively flat.
Omar Lim - Cleveland Research.
Should we expect the fourth quarter at the margin to be more negative than what wesaw in the third quarter in tools?
Mike Mangan
Directionally yes itwill probably get a bit more negative in the fourth quarter than it is in thethird quarter.
Omar Lim - Cleveland Research.
Secondly you mention POS was flat year-over-year in both proand consumer at the big box and you gave the color in the second quarter interms of sell-in versus POS. Wassell-in, in the third quarter also flat?
Mike Mangan
No our sell-in during the third quarter was down so we sawdeclines not only in our professional business but, as well, particularly inour consumer business. So sell-in didnot match sell through during the quarter. As a result that’s one of the reasons why we think our inventorypositions in the channels are in reasonably good shape.
Operator
Your next question comes from Sam Darkatsh - Raymond James.
Analyst for SamDarkatsh - Raymond James
My first question in the power tools and accessoriessegment, order rates you mentioned decreased significantly, it sounds like alot of that may be due to timing. I waswondering, first of all, did you see any pick up in orders toward the end ofthe quarter or as you moved into Q4 because of that?
Could you provide us order rates for consumer and industrialtools maybe both in the USand overall?
Mike Mangan
Change in order rates through the quarter or going into Q4, wehad mentioned in the comments our USprofessional business was down mid single-digits. Our U.S.consumer business sell-in would be down in the teens, mid double-digits.
Operator
We’ll proceed with your next follow-up question, sir. It is from Michael Rehaut with JP Morgan.
Michael Rehaut - JPMorgan
On the raw material side, Mike you had mentioned that youexpected it to flow over into ‘08 given that it’s risen throughout this yearand that you’ve been able to partially offset it through price andproductivity.
Looking just though at the price and productivity part ofthe equation which is obviously a little bit more in your power to control, howare you thinking about ‘08 at this point in terms of what you can get in ofeither price increases or positive mix contribution as well as if you have aninitial idea of productivity gains?
In the past, from the productivity side, you guys havetalked about $90 million to $100 million a year, I think that’s edged downrecently in the last year or two but if you can give us some idea in terms ofwhat you expect from that side as well?
Mike Mangan
In terms of the pricing environment, we will continue toobviously assess that as we go. Clearlyas we roll out new products we’ll be able to get some price. Absent some help from the marketplace hereit’s difficult to get price when markets are as they are today with seeing someweakness particularly given the issues with housing.
You know productivity, if you go back historically, one ofour goals is always to offset negative price with productivity. Over time we’ve done a pretty good job ofdoing that, your point getting to 2.5 points of productivity each year are thekind of goals we set out for our team.
Obviously those the been dwarfed by the commodity inflationthat we’ve seen here of late so going into 2008 trying to drive productivitynumbers like that would be expectations we would have for our team.
The wildcard there continues to be commodity inflation andwe will take some carry on inflation in and then depending on what happens withcommodities could obviously get some additional productivity or have someadditional headwind.
Any other questions?
Operator
We will proceed with our next question, which is a follow-upfrom Raymond James.
Analyst for SamDarkatsh - Raymond James
Yes, thanks for taking my follow-up. You sound comfortable with where retailerinventories are. I was wondering, end of Q4, the end of the year, where wouldyou expect retailer inventories to be on a year-over-year basis?
Mike Mangan
End of Q4, year on year, I guess we would expect to berelatively flat, maybe up a touch because during the fourth quarter of lastyear we saw significant inventory corrections so we came into 2007 with very leaninventories in the channel.
I wouldn’t necessarily expect them to be as lean here in2007. So flat, to maybe up marginallyyear on year.
Analyst for SamDarkatsh - Raymond James
Okay and then for your inventories, would it be safe toassume kind of a similar flat to up slightly year-over-year?
Mike Mangan
We expect our inventories absent FX to be flat to down. We’ve been pretty tight on our inventorycontrols so you should see those again without foreign currency to be down yearon year.
Analyst for SamDarkatsh - Raymond James
Could you give us your expectation for unit productionyear-over-year for the full year?
Mike Mangan
For the full year our production volumes are relativelyflat, that’s dollar wise not unit wise. So obviously that would include some inflation. Again, going to a unitbasis our unit volumes for the year are probably flat, maybe down a bit.
Operator
Your next question is a follow-up question from Omar Lim -Cleveland Research.
Omar Lim - Cleveland Research.
I apologize, I misspoke earlier, just to be clear on the POSbig box, in the second quarter POS was down modestly I recall and here it isimproved to flat, both pro and consumer -- do I have the correct?
Mike Mangan
Right. If you go backthrough a bit of the history here as you may recall we had during the firstquarter, our POS year-on-year was down around 5% that improved to the secondquarter to being down around 2% and during the third quarter --again this isboth pro and consumer combined, both large customers combined – it is in andaround flat, down 1% Roughly flat.
Operator
Sir, there are no further questions at this time. Do you have any closing remarks?
Mark Rothleitner
Thank you very much. Again a great quarter for Black & Decker. Mark and myself as well asRoger Young will be available through the rest of the day to take anyadditional questions you may have. Thankyou very much.
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