The Stanley Works Q3 2009 Earnings Call Transcript

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The Stanley Works (NYSE:SWK) Q3 2009 Earnings Call October 21, 2009 10:00 AM ET


Kate White – Director of Investor Relations

John F. Lundgren – Chairman and Chief Executive Officer

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

Donald Allan Jr. – Vice President and Chief Financial Officer


Peter Lisnic

Sam Darkatsh

Nigel Coe

Eric Bosshard

Kenneth Zener

Michael Rehaut


Good morning. My name is Sarah and I’ll be the conference operator today. At this time I’d like to welcome everyone to The Stanley Works third quarter 2009 results conference call. (Operator Instructions) Thank you.

I’d now like to turn the call over to Kate White, Director of Investor Relations. Miss White you may begin your conference.

Kate White

Thank you so much, Sarah. Good morning everyone and thank you all for joining us on The Stanley Works third quarter 2009 conference call.

On the call in addition to myself is John Lundgren, Stanley’s Chairman and CEO; Jim Loree, Stanley’s Executive Vice President and COO; and Don Allan, Stanley’s Vice President and CFO.

I would like to point out that our third quarter earnings release, which was issued this morning, and a supplemental presentation which we will refer to you on the call and are on the webcast are available on the brand new Investor Relations portion of our website,

This morning John, Jim and Don will review Stanley’s third quarter 2009 results and various other topics followed by a Q&A session. The entire call is expected to last approximately one hour and a replay of the call will be available beginning at 2:00 PM today. The replay number and access code are in our press release. And as always, please feel free to contact me with any follow up questions after today’s call at my number which is 860-827-3833.

We will be making some forward-looking statements during this call. Such statements are based on assumptions of future events that may not prove to be accurate, and as such they involve risk and uncertainty. It is therefore possible that actual results may differ materially from any forward-looking statements that we might make today. And we direct you to the cautionary statements in our 8-K which we filed with today’s press release and our most recent 34-A.

With that I will now turn the call over to our CEO, John Lundgren.

John F. Lundgren

Thanks Kate and thanks for all of you on the phone for joining us this morning. Let me spend just a minute on the state of Stanley in terms of an overview.

First of all, we reported third quarter diluted EPS from continuing operations of $0.77 a share. Regrettably in reporting our results one or two of the news agencies dropped this number, which was actually in the headline of the press release we issued this morning, so some of you may have had to search the text and our exhibits a little bit more than we intended. But it’s $0.77 EPS, very clear and straightforward which compares to $0.97 a year ago from continuing operations, 3Q ’08. And on a GAAP basis the $2.04 that we recorded last year included $1.07 gain on the sale of our CST laser measuring business. So hopefully all that’s clear and we can move forward from there.

We are still experiencing mid-teens volume and revenue declines versus a year ago, but we were encouraged by modest sequential revenue growth in the third quarter given the lack of seasonality in our business. We were even more encouraged by margins, a record quarterly gross margin of 41.3% which was achieved due to good pricing discipline as well as some meaningful cost productivity initiatives.

Commodity deflation which we are experiencing was essentially offset by the impact of the volume under absorption. So those in a sense offset one another on an equal basis.

Cash flow was also encouraging, $158 million for the quarter. That was up $55 million versus the same period year ago as we continued to execute our Stanley Fulfillment System and that process and program gains traction. And as a consequence we’re able to raise our cash flow guidance for the year, and we now expect to exceed $300 million in cash flow.

Security segment achieved a 3% revenue growth and 13% profit growth versus prior year. And within our convergent or electronic sub-segment organic revenues increased 5% sequentially which was also encouraging given the state of the market.

CDIY did show signs of sequential demand stabilization around the world. The focus going forward particularly in the fourth quarter is going to be new product roll outs, which we tend to do twice a year in waves and normally in the second and fourth quarter to stimulate further demand.

As a consequence of third quarter results, as well as our assessment of the environment over the next two to three months, our full year EPS guidance has also increased to a range of $2.84 to $2.94.

Taking a geographic look at revenues, all major regions continue to absorb double digit declines which is indicative of the weakness in global economic conditions. The U.S. which accounts for nearly 60% of our revenue was down 17% organically, 16% in total. Europe was off about 22% organically, 16% in total as acquisitions played a role there, as well as Asia and Australia down similar measures. So no particular large geography in terms of our revenue was affected [inaudible] it’s a fairly broad scale softness which I’m sure you’ve heard on many calls and Don’s going to talk a little bit more about what we’re experiencing later.

In terms of our third quarter results per se, operating margins rose 40 basis points to 14.4%. You can see the EPS of $0.97 that I referred to a year ago versus $0.77 this year. Tax rate was favorable by 240 basis points, 22.2%. And we were a little bit affected by share count being up marginally, up 800,000 shares to 80.6 million. So pretty straightforward in terms of EPS. Reasonably a strong performance despite the continued volume headwinds which is obviously having an impact.

Looking at revenues for the third quarter as mentioned they did improve sequentially to $936 million from $919 million in the previous quarter, but importantly we’re down 16% versus the same period year ago. Looking at the left of the chart in terms of sources of growth, as mentioned volumes down 20%. We got some help from price with continued discipline of 2% favorable so that’s the organic 18% revenue decline to which we referred.

Currency was negative but less so than in previous quarters, as you can see the trend as the dollar strength changes relative to foreign currencies. And acquisitions was positive, but that was also less help than in previous quarters. It added 4% to our total revenue base versus 7% and 6% in prior quarters. So in total revenues down 16% versus the same period year ago.

Looking at the segments, I won’t spend too much time on revenue because Jim is going to take a much deeper dive into that a little later on in the presentation but it’s clear from the segment chart that our Industrial businesses around the world are under the most pressure in terms of revenue. CDIY is still experiencing external headwinds but certainly it appears to be abating to some extent. And Security’s holding up pretty well under the circumstances and obviously contributing to some of the stability that we’re experiencing.

Moving on to volume trends, they are stabilizing to some extent and that’s due in part as to simply the mathematics of weaker comps that are present beginning 2Q ’09 which was essentially the beginning of the downturn. The chart I think is fairly straightforward where you see our third quarter unit volume down 20% and revenues down 16% which I suggested. And those comps will be a little easier or a little more favorable in the fourth quarter as we look to close out the year.

We were encouraged by our working capital performance. Despite a 16% revenue decline, our turns improved 8% as previously mentioned as the Stanley Fulfillment System gains further traction.

We took three days out of inventory versus the same period year ago, nine days out of receivables. Payables were unfavorable by seven days. The negative impact is due to a combination of lower volume, less CapEx, and in some cases concession on terms as we’ve leveraged our strong balance sheet to get more favorable discounts and pricings based simply on an ability to pay our bills on time. And supplier credit is always good to have and so were large discounts when you’re able to achieve them.

So in total we’ve seen turns improve from 4.8 to 5.2% which as Don has talked on previous calls is a tremendous source of cash flow.

Finally last but not least for my piece a minute on our record gross margins of 41.3% and very strong operating margin of 14.4%, which hopefully this chart indicates is not a short term phenomenon. A lot of things going on to achieve this as well as the cash flow, especially within our core businesses. It’s not happening on their own and what Jim’s going to take you through is how SFS or the Stanley Fulfillment System are driving both margins and cash flow, as well as a little more granularity on SG&A. Jim’s piece will show you that we’re building our brand while still maintaining I think very good control over discretionary spending, and then a closer look into the segments. And Don’s going to close with a look at some of the market trends that are affecting both our cash flow and our fourth quarter guidance.

So let me turn it over to Jim Loree, our COO.

James M. Loree

Okay. We’ll stay on the margin chart just for a minute here and I find this extremely encouraging considering the 16% volume decline and the 23% reduction in inventory. As John mentioned we closed out the quarter 41.3% gross margin and that’s an all-time record for the company as he did mention, and the first time in my ten years that we’ve been greater than 40% which is a big milestone.

And this was done at a time as I mentioned when the production volumes are down greater than 30% versus last year. And to expand a little bit on some of the key drivers, the strength of our value propositions has really enabled us to achieve solid price realization. And that’s offset cumulative $440 million of inflation since 2004.

The Stanley Fulfillment System is a key to this and transformational lean has been driving productivity in our factories and in our supply chain for quite some time. Business mix has also helped as Security’s become a larger part of the portfolio. And of course the $370 million of cost cuts, a portion of those were in cost of goods sold and have helped enable us to deal with the steep volume declines while protecting our margins.

And all this raises the obvious question is this sustainable? And there will be some headwinds going into 2010 as tools and storage mix is up and some of the cost cuts, probably about 25% or so, come back. But it’s safe to assume that we’re now operating in the neighborhood of 40% and that’s what we expect to record for the year and I would expect that you can think of the company as a 40% gross margin company on a prospective basis.

I mentioned the Stanley Fulfillment System. I want to spend a little more time on that. It involves four components. Let’s start with the upper right, Sales and Operations Planning. This is simply keeping supply and demand in balance, so not making too many things when you don’t need them. When volume is down you make less. When volume is up you make more. We have a phrase we have coined, sell one, replenish one. And the idea is to try to make every day what the customers need that day. We’re not there yet, but that’s the direction we’re going in and I think we’ve done a pretty good job of keeping our inventories in check through a robust sales and operations planning process throughout the company.

Now we’ll move to the lower left, Transformational Lean. This is the implementation of lean in all our factory supply chains and back offices. Now many, many companies do lean and do this every day. I think the thing that differentiates us is that we actually have trademarked our Transformational Lean phrase because what we try do is to instead of just incrementalizing improvements we try to step back and say how can we change the business model utilizing lean to create a sustainable competitive advantage. And done that in a few cases, not throughout the company but that’s starting to take effect. And the benefits from lean are felt every day in our productivity performance.

Now moving to the lower right, Standardization of Processes and Platforms across the company to provide us with scalability. That’s another important part of the Stanley Fulfillment System.

And then finally, the toughest nut to crack but the one that we’re making some progress on now and we’ve been at it a few years is this Complexity Reduction or Complexity Management. And this is all about simplifying every aspect of the business to drive profitability and asset efficiency. You can see that manifested in the results.

Now move on to SG&A. The SG&A expenses are down 9% versus the prior year, but that doesn’t tell the full story because when you net out the acquisitions we’re really down 14%. You can see the $16 million increase from acquisitions. We’ve also made $5 million worth of incremental investments in the third quarter, about $20 million annualized. Had a little inflation. Some benefit from foreign exchange. And then the actions totaling about $41 million have really enabled us to achieve that minus 14% performance in SG&A.

And despite that reduction in SG&A, the company now is really aggressively building its brand up there globally. But let’s start with the USA. It’s playoff season. That means our major league baseball presence is at its strongest. Right now we are in three out of the four playoff teams in a very prominent way and we’re starting to see some early evidence of increased aided brand awareness in a quantitative sense. And we’ll have much more information on that as we close out the season and we’ll probably share some of that with you at our analyst meeting in November.

The next and newest area is our major thrust into global brand development. And we are sponsoring the English Premier League and International World Cup qualifiers with signage at the base of the perimeter of the field, electronic signage which comes up and is seen on TV and often seems to be prominent right at the time when goals are scored or people are watching. This is seen by more than 1 billion viewers per week and interestingly 40% of the impressions are actually from outside of Europe. And you can start to, when you talk to some of the Asian folks in our company, you can start to hear the buzz about what their customers are saying about the Stanley brand and the fact that they see it on football.

Moving up to the upper left we’re also moving aggressively into social media. Four months ago we had no presence on Facebook and Twitter. Today we have over 1,000 followers on Facebook and 800 or so on Twitter. And then finally I’m pleased to invite you to surf our just upgraded IR website at And it’s a very impressive piece of work.

Now I’m going to spend some time on the segments. Well Security once again was the gem of the quarter. Revenues were up marginally, up 3%. Organic growth was down slightly, down 6%. But segment profit was up in double digits and the profit rate exceeded 20% which was very, very impressive performance.

Convergent, the electronic business, revenues were up 13%, organic was down 5% but recurring monthly revenue was up 5% organically. The profit rate was up 150 basis points over the prior year and even though the declines in installations slowed, the national account installations increased. And the CapEx constraints while not completely gone are starting to loosen.

The big news in mechanical access was the profit rate as well. They did a nice job on price realization, class reduction actions, etc. But the Stanley branded hardware rollout at a major North American retailer is well underway now, will be meaningful from a revenue perspective in the fourth quarter and next year. And the early signs at the point-of-sale are very encouraging.

Moving on to Industrial, the steep revenue declines took their toll on profitability in this segment during the quarter with organic growth down a staggering 30%, not unexpected but certainly a difficult story to deal with from a profitability perspective. And our costs in Industrial tend to come out a little bit more slowly than they do in the rest of the company because this is the most concentrated segment that we have in Europe where the cost take-outs take a little longer to manifest themselves. Segment profit was down 53% to $19 million and the profit rate was right around 9%, which is where it was in the second quarter as well. We believe this is kind of a trough area of segment profit rate for industrial and we’ll talk a little bit about what we think is happening on a prospective basis in a minute.

The inventory corrections continued to be a headwind. We expect them to continue perhaps at a slightly lower level into the fourth quarter. And then they should be gone by the first quarter as the Industrial buyers start buying in proportion to their production volume which is increasing now as we look at the economic statistics.

We’ve divided the segment into two sub-segments for the purposes of describing it to you. It also happens to be the way we manage it at the company, Industrial and Automotive Repair Tools which is Facom and Proto on the left hand side in the lower left. Facom was down 27% in revenue but their new product development remains strong and the Facom products are also being cross-fertilized in some of the other areas such as Proto and Mac. I mentioned the European cost reductions and the lagging effect there. On Industrial and Automotive Supply, which is Mac, Vidmar and Supply and Services, the Mac profitability was encouraging. They did have double digit revenue declines but they made good progress from a profitability perspective.

I think the good news when we step back from the overall segment is that the gross margin and the contribution margin rates are holding up. So we should as I said be in a trough here and positioned for strong leverage when the volume resumes, probably in the first quarter.

Moving on to CDIY, from my perspective CDIY was a pleasant surprise this quarter. Volume was still anemic. You know revenues were down 23%, organic growth down 21% but the segment profit was down only 11%. And very encouraging was the segment profit rate resumed its expansion and is now hovering around 15%, up to 110 basis points over the prior year and also up 210 basis points versus second quarter.

The organic revenue declined. We’re seeing some early signs of stabilization as John alluded to and I think most encouraging here is that the Bostitch integration benefits, which yielded significant cost productivity gains in this segment, are taking hold. They’re ahead of plan. Bostitch profitability is strong and improving and I think, knock on wood, that the long saga of Bostitch related profitability problems may be in the rearview mirror.

And then finally, the wave of new product introductions that is taking place in this overall segment is going to be significant in the fourth quarter and is expected to accelerate our market share gains. So stay tuned. This strong, strong franchise is going to get even stronger with an array of new, exciting products in the fourth quarter. And on top of that, we have the intensifying brand support and brand strength that I talked about earlier. So we’re very, very excited about the future here coming out of hopefully trough conditions in the marketplace.

And now I’ll turn it over to Don Allan who will take you through some more color on the segments.

Donald Allan Jr.

Thank you Jim. Page 16 is a new page we added this quarter which is a way for us to help communicate some of the key trends in the three different segments, both historical, and then some of our thoughts going forward here in the short term.

So if we start with the Security segment, which is on the left side of the chart, the top part of the chart gives a historical trend of the segment profit rate which is the line and then the bar graphs are the unit volume declines that we’ve experienced in each segment.

So as we dive a little bit deeper into Security and start with the convergent business, convergent revenues as you know from installations has been down but we believe its likely bottomed out in the second quarter. And we also think that attrition peaked in the second quarter as well. And we’re beginning to experience some stabilization in our order rates in the convergent business which is a positive sign.

One thing that we’ve discussed in previous calls is commercial construction and some of the delayed and abandoned projects that we’ve seen. That continues to be a headwind. But the good news in that particular story is that it’s still more of a delayed situation versus an abandonment of projects. And as long as that continues, that trend, then we believe that we’ll be able to continue to show modest declines and eventually growth in this segment over time.

Focusing on commercial construction as an impact to our company, as many of you know from the end market charts that we provided in the past, it’s important to remind you that commercial construction is only 15% of our Security segment and only slightly greater than 10% of the total company. So even though we are experiencing a little bit of headwind there, it’s important to keep in mind that it’s not a very significant portion of our total company.

And last but certainly not least, as Jim mentioned in the previous slides, the profit rate accretion in Security has been a very good story considering the declining volume environment we experienced over the last seven quarters where we’ve gone from a 16% segment profit rate in the first quarter of ’08 up to almost 21% in this particular third quarter. And that’s really all those actions Jim mentioned around pricing with our customers, cost actions and then as some benefit of deflation in commodities, and in particular mechanical Security business.

Shifting to Industrial in the middle of the page, clearly Industrial proven in this particular set of businesses is lagging behind CDIY in particular and obviously Security. And as [inaudible] we continue to see improvement in Industrial production data, which is showing positive growth and moderating signs. However, our business does lag those indicators and we would expect that we would eventually feel that positive impact as that trend continues, likely in early 2010.

The inventory corrections have clearly been significant throughout the year and will likely continue at a modest pace in the fourth quarter of ’09.

We believe the profit rate has stabilized but we would expect improvement in that profit rate to be likely in the fourth quarter, as many of the cost actions will be completed in our European operations and we do believe that those inventory corrections will abate.

Last but certainly not least is the CDIY segment. As you can see, Jim mentioned this, that the operating margin rate or the profit rate has gone to 14.8%. So it went from the bottom at 6.4% in the fourth quarter of last year and has really kind of emerged back to very normalized levels for this segment, or very close to normalized levels.

But economic conditions continue to be a little tough in this area, although we’re starting to see a little bit of positive signs. In particular, the U.S. housing starts have stabilized. We believe they’ve bottomed out. Consumer confidence is improving in both the U.S. and the Euro region in comparison to the second quarter of this year. And as a result, you’re seeing the impact in our revenues as our revenues are flattening out on a sequential basis when you look at the second and the third quarter. And we would expect that trend to likely continue into the fourth quarter. We do expect to experience some modest revenue growth in the beginning of 2010 or the first quarter of 2010 if these trends continue.

And last but certainly not least that significant profit rate as I mentioned is largely due to the CT&S and Bostitch integration that Jim discussed. So we feel like that’s a nice summary of our three segments and key trends based on history and then some thoughts going forward.

Moving to free cash flow which was a really nice story this quarter, our third quarter free cash flow exceeded prior year levels and that was while our continuing ops earnings was actually down from $78 million to $62 million or 21%. Another item to focus on here is working capital. As John mentioned earlier, a very nice working capital performance where we had a positive working capital benefit and cash flow of $32 million when we had a 20% unit volume decline in the same quarter.

One thing I want to point out here is the other line. If you look at last year, John had mentioned that the sale of CST, there’s a gain of $84 million that’s showing as a negative in other last year and also the taxes paid on that of about $34 million, which is really driving that. And the total of that is close $120 million of a negative out flow. So if you remove that, it’s a slight positive and its more in line with the $25 million positive that we saw in the third quarter of this year.

CapEx continues to be a good story as we continue to control where we’re spending our money and make sure we’re spending it efficiently. And we’re tracking to that $85 million number for the year and on pace for that.

So the end result is free cash flow of $158 million versus $103 last year, which is a 50% improvement year-over-year with earnings being down 21%.

As I mentioned on the last quarter call, we have set a guidance of $300 million of free cash flow for the year. And at that point in time we were at about $1 million of free cash flow year-to-date. Now we’re at $183 million, which would be a little more than 60% of that $300 million previous guidance we have provided. Based on the work that we’re doing in working capital and all the different efforts around SFS, we actually think that we can exceed $300 million this year. And that would be consistent with some of our historical trends if you look back through three quarters. We tend to be anywhere between 57% or 65% through three quarters in comparison to the annual objective.

Moving to the balance sheet, it continues to be a positive story for us. As many of you know we’ve been focused on de-leveraging our balance sheet this year. Our goal we established was $200 million of a debt reduction or de-leveraging goal. We’ve achieved $161 million of that through three quarters so we feel like we’re tracking very nicely to that objective. And our debt to capital ratio is now down [audio impairment] which sequentially improved where it was at 46% in the second quarter. And when you adjusted for our equity and debt hybrid instruments, its now 31% to 33%, which again is an improvement from the second quarter where it was at 34 to 37%. And we feel very good about our de-leveraging plan and how we’re on track in that regard.

The next page is an update on guidance. As all of you have seen we have increased our guidance compared to July, so what I’d like to do is just walk through some of the changes in that guidance. On the left side of the page, our July guidance was a range of EPS of $2.34 to $2.84, which was a $0.50 range. What was driving the bulk of that range was [audio impairment] assumption, which we assumes a negative 18 to a negative 20% at that timeframe for the year. We are starting in the start with our midpoint to that range, which is $2.59. That implied guidance assumption of about a negative 19% unit volume, which is what we’re currently estimating for the year.

If we take our gross margin rate improvement that John and Jim both talked about earlier, we believe that for the year we will be approximately 40% gross margin. And in July I indicated that we thought for the second half of the year we would be somewhere between 38% and 39%. So now we believe we’re going to be above 40% in the second half. And its really being driven by all of the things that were articulated earlier around price, productivity, around cost, deflation and etc. So we feel positive about that going forward.

The last item is what we call Other, which is several different things. Clearly we’ve benefited from FX as the weaker U.S. dollar versus some of the major currencies that are prominent in our world such as the euro and the Great Britain pound. But we also think that we could have potentially lower restructuring and slightly lower taxes as well as we close out the year.

I will point out that the restructuring we’ve provided, the guidance is about $45 million the previous call. We expect it to be probably somewhere to be between $40 and $45 million so it won’t be significantly lower than that number.

So the end result is a current guidance range of $2.84 to $2.94. If you exclude the gain on the debt extinguishment, that means its $2.50 to $2.60, which is an increase from the $2 and $2.50 that we provided in July.

Moving to free cash flow, as I mentioned earlier we expect to exceed $300 million in free cash flow. And that’s really due primarily to two things as you can see on the chart here. First our improved earnings outlook, which is about $0.25 to $0.35 EPS. And then our continued belief that we will be able to exceed prior year working capital levels. In the fourth quarter of ’08 we achieved 5.9 working capital turns and we still feel that we will be able to achieve in excess of 6 working capital turns by the end of this year, which is all being driven by the Stanley Fulfillment System and the process controls that we’ve put in place as Jim articulated earlier on this call.

So in summary, we feel like we’re well positioned to continue to gain market share. We’ve made investments as you know around our brand and in some cases advertising. We continue to invest in new product development and increase our direct to customer interactions in the Security segment in particular to really drive those results.

We’re seeing modest signs of sequential improvement which are encouraging and particularly in Security and CDIY. Industrial is lagging, but we do believe is 2010 begins that that segment will begin to improve. And operating margins are on track and remain strong for the full year. And as Jim mentioned, we do feel that we’ve established a new line around gross margin, what we think we’re now a 40% gross margin company.

And then last but certainly not least, we continue to be dedicated to our ongoing success of SFS, both as a source of cash as well as a competitive advantage.

Kate White

Sarah we’re ready for questions whenever you are.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Peter Lisnic.

Peter Lisnic

I guess first question on CDIY is if you look at it in dollar terms, $100 million decline in revenue and operating income only down $6 or $7 million, can you give us some color commentary on exactly how that’s occurring in terms of the structuring savings, mix and price? Because that would seem like you know things are holding up a lot better than I thought they would be in that volume pressure.

John F. Lundgren

Yes, Pete, things are holding up better than you might think in terms of the volume pressure. The biggest driver, Jim touched on it and didn’t get much more granular than we intend to. The biggest driver is improvement within the Bostitch business. We talked about you know our intent when we started a massive improvement effort on Stanley Bostitch to take it up maybe 100 basis points a quarter for eight quarters to get it back to double-digit operating margins. We were well on the way a year-and-a-half ago with that program when Bostitch was the business within Stanley hit the hardest by the both Industrial and the domestic housing downturn.

We made the decision this time last year to basically combine the CDIY and Bostitch business, excuse me the CT&S, our consumer tools and storage, and Bostitch business which in retrospect was a good decision and we knew it was. Not only because we took a lot of cost out, you know business running separately that we were running as part of a CT&S business but it really reinvigorated the product development program, the focus on margin, added some rhythms to a business and both at the customer level and internally. That’s had a tremendous impact. We don’t intend to get in the margin by business because we found that you know all that by sub-segment, all that really does is creates more questions than it raises. But we have Bostitch back to historically I’ll say high or it’s [wide] average profitability level. That in and of itself is 70% of the improvement.

Jim may want to add a little more granularity to it.

James M. Loree

Think Bostitch improvement within CDIY, Pete, and that’s the big one.

Donald Allan Jr.

And I’ll just address the other 30%, and its really a combination of all the things I talked about extensively on that gross margin page. You know the Stanley Fulfillment System, the transformational lean, the price inflation recovery and all of those elements. As well as there may be some minor mix in CDIY as well with the Bostitch improvement.

John F. Lundgren

And I’ll just follow up so you can get in your follow without getting cut off. We’ve talked about SFS. We’ve talked about it a lot because our consumer tools and storage business was a large, well managed, global business with a global platform. They were 12 to 18 months ahead of the rest of Stanley in terms of truly implementing SFS. The S1R1 to which Jim referred. And so we’ve gained more traction quicker in that business and of course the Bostitch business has benefited from that as well.

Peter Lisnic

A follow up question on pricing, again a plus to this quarter and plus all year. How sustainable is that? You know what piece of that is just related to unrecovered commodity costs that you’ve incurred in the past versus new products and you know proactive pricing policies, I guess?

James M. Loree

Most of the 2 points is carryover. If you recall we had a big surge in inflation in the middle of last year. It was in third quarter of last year that we really aggressively implemented price increases to cover that inflation and we’ve benefited from those in the fourth quarter of last year and the first three quarters of this year. But we’re going to start to see the price realization kind of adding back to a more normalized level. It may be up 0 to 1%, something like that. And most of that will be in all likelihood in the businesses that incur some sort of commodity inflation. And we have a mixed bag there with different businesses.

And as you can imagine, with all the different commodity fluctuations that go on, if steel goes up you know the nail business is affected more dramatically than say the Security business. So you can’t really predict which segment it might occur in. But we will continue to price to our value proposition and continue to price to recover inflation as and if it occurs.


Your next question comes from Sam Darkatsh.

Sam Darkatsh

Jim in your prepared remarks you mention that in 2010 a number of the discretionary cost cuts that you made in ’09 and would likely be coming back. Can you help quantify that a little bit? And would that entirely be on the OpEx line?

James M. Loree

Yes, it would entirely be in the OpEx line. And you know there was $370 million of total cost improvements that were implemented. And of the $370, it’s our collective view here that about $100 million or so is likely to come back you know at some point. Whether they all come back next year or not we’ll see. But there are things like discretionary cuts where we may have cut travel by pick a number 40%, and maybe we’ll let 20% of that you know come back, because we have the volume to compensate for it.

But that said we’ve changed a lot of our practices related to areas and you know T&E is a good example where today we have implemented extensively Telepresence, Cisco’s Telepresence. And you know that’s providing us a structural cost reduction in T&E so we don’t expect all of the T&E cuts for example to come back. And I think there’s many other stories like that you know as we look at the cost cutting.

In addition to that we’ve made several structural changes in our various businesses and John already talked at length about the Bostitch and CT&S integration. That’s not coming back. You know that’s a permanent change. We also made some changes in the Industrial business where we combined and you saw the subsets and when I was going through the Industrial page we combined the management of Focom and Proto and we combined the management of Mac, supply and services in Vidmar. And those changes aren’t coming back. So we feel very comfortable that approximately 25% or so of the cost cuts will come back in successive years. And I’m not sure they’ll all be next year but that’s the way I would think about it.

Sam Darkatsh

And then where you look at raw materials right now, assuming it’s essentially flat on a go forward basis, what is the 2010 versus 2009 variance look like from a raw materials standpoint?

John F. Lundgren

We’ve gotten to a stage where we have some pluses and some minuses but we’re not looking at any significant deflation or inflation at this time.

Donald Allan Jr.

And I’ll add, Sam, to Jim’s point that he made during his prepared remarks, whatever benefit or I guess it was actually my prepared remarks, we obviously do this as a pretty collaborative effort. What we benefited this year from raw materials deflation and you know us well enough that 60 to 70% of our raw materials are steel, then its non-ferrous metals, plastic resin, etc. What we benefited from we’ve more than lost in volume absorption or lack thereof. So you know what’s going to affect our margins as much or more than the inflation pricing hedge or arbitrage you know is where volumes settle out next year relative to this year.

But I think we’ve gotten much better at responding quickly to inflationary pressure in terms of our pricing. Jim’s words, and they’re the right ones, were you know pricing to be paid for our value proposition. And where we don’t think we have a value proposition to shrink or get out of those businesses as quickly as we can.


Your next question comes from Nigel Coe.

Nigel Coe

You’ve talked about the CDIY margins in some length already, but just interested to get your perspective. You talked about this being sort of a mid-teen, 15% type margin business but given that Bostitch is back on track, you’ve got also some SFS coming through, if you recapture that [inaudible] volume drop, do you think margins will be sort of more towards the high teens going forward?

John F. Lundgren

We’re not going to forecast margins by segment, Nigel. By now you should know that your question is a logical one and a fair one. We’ve just got a lot of history that says forecasting margins by segment and sub-segment, we’re never rewarded for it when we get it right or exceed it and we’re punished for it when we don’t. It’s not good for us internally or externally. It’s why we have three distinct segments that we think gives us some internal diversification, so your observations are logical but we’re simply not going to go there.

Nigel Coe

Then maybe just going a little bit closer to home. You know you talk about the Industrial cost savings in 4Q. Can you maybe just quantify those? And I’m assuming that they will be sufficient to get you back into the double digits in 4Q.

James M. Loree

You’re looking for a quantification of the Industrial cost savings in the fourth quarter that might be incremental to what was in the third quarter? Is that the question?

Donald Allan Jr.

Because of the European action.

James M. Loree

Oh, yes. It would be difficult to put an exact number on that but you know I would say that the cost reductions we implemented were roughly distributed equivalently across the three segments. Security was a little bit less than CDIY and Industrial. So on a proportionate basis you know the $370 was allocated essentially that way. And so it’s fair to say that if Industrial is you know pick a number, 25% of the revenues roughly, then 25% of the $370 applies to Industrial and you can assume that probably about you know 10 to 20% of that is yet to be materialized.

Donald Allan Jr.

And Nigel we know you’re not going to get to ask a follow up. That’s just the way the process works. But to just elaborate a little further, the other point being 50% of our business in Europe is Industrial. So some of the costs will come back as Jim referred to. But some of the cost actions we’ve taken as you understand well, it does take longer to realize the benefits of those cost actions in Europe. So there’s as large a benefit but a meaningful delay in [audio impairment]. That will provide a little bit of an offset to the costs coming back. So we’re looking for sequential improvement.

James M. Loree

And just to be clear about my math, if we say 25% of $400 is $100, then you know 10 to 20 of that might actually be yet to be realized, you know we’re talking $10 to $20 million. That’s annualized so you’d have to divide it by 4. So that’s probably roughly ballpark what you could expect there.


Your next question comes from Eric Bosshard.

Eric Bosshard

I have two questions. First of all, I understand not projecting margins by segment, but getting to that 20% margin in Security, that was a long, long ago projection so it’s nice to see that number achieved after the long ride.

James M. Loree

Well we took a lot of heat for like four or five years which is why John said what he said.

Eric Bosshard

The two questions that I have, first of all you talked bullishly about the CDIY volumes and that you saw improvement across a number of regions, the U.S. volumes I think in CDIY were identical, the year-over-year decline was identical, 3Q as it was in 2Q. And you mentioned in your script that you thought actually you could have some growth out of that segment in the first quarter, so I’d love to get a little bit more color on what’s going on in terms of the improvement there. And should we see improvement in 4Q? And then secondly, can you just talk about the incremental cost saves that you should achieve in 2010 from the programs that have been implemented over the last nine months.

John F. Lundgren

If we start with the CDIY question, as I mentioned in that particular chart you know we’re clearly seeing a stabilization effect in that particular business. And even some modest improvements. And its really being driven by the two economic factors that I mentioned in the U.S. as well as in Europe. So as we look at the business going forward, you know we don’t expect a dramatic improvement in the fourth quarter around revenue. There could be a slight improvement due to some new products roll outs in that particular quarter. But at this point in time we’re not anticipating that.

But in the first quarter we do expect to see some modest improvement in growth in that particular segment because we will first of all have anniversaried a lot of the significant declines. And its under the presumption that these economic conditions have stabilized around housing starts and consumer confidence in particular. And we’ll begin to see very modest growth rates there.

The second question was around carryover effect I believe. As Jim mentioned you know we do have about $100 million of cost carryover into next year. And so we had $370 million of costs that were executed on, $265 are 2009 [audio impairment]. And then about $100 [audio impairment] or more [audio impairment]. The real question is how much of that will be sustained and Jim gave a lot of feedback [audio impairment]. Over time, which he was referring more to long term, 25% of that will probably creep back into the system. That does not mean in 2010 that $100 million of costs will creep back into the system to offset the carryover effect that we expect to experience. [Audio impairment] estimate for 2010 that you know we would be able to maintain anywhere from 50% to 75% of that carryover in 2010.

Kate White

Sarah, we can move to the next person.


Your next question comes from Kenneth Zener.

Kenneth Zener

I wonder if you could comment on Security integration, to maintain your growing share and how that relates to you know the people you’ve acquired so your feet on the street approach, your market share enhancement and if that really did impact smaller accounts.

James M. Loree

I think I understand your question, Ken. Let’s start with we’ve made one mid-sized acquisition in the last two years and it’s going extraordinarily well. We at this stage would regard Sonitrol and HSM as fully integrated and functioning as a very cohesive unit under Brett Bontrager’s and Tony [Barley’s] direction. You know producing nice margins, doing a good job on national accounts, as you know we have a very strong presence in retail. Retailers in general are under a lot of pressure so when a retailer goes out of business the objective is to get more than our fair share of re-signs, which we are doing and doing a pretty good job at. So we’re maintaining or gaining share with national accounts and Tony’s team’s doing a real nice job with some of the smaller businesses, you know rolling them up and gaining share at the local level.

In Europe, the GDP acquisition hasn’t a full year anniversary yet. I can say that’s going very well at the same time. As we’ve mentioned on previous calls, our Security business in Europe is relatively small. It was UK centric. We’ve inherited an extraordinarily capable management team with GDP, a management team that was interested in carrying on with Stanley. And they’ve done a very, very nice job leveraging their strong market position and gaining share, primarily in France and Belgium where they’re a strong number two in the marketplace as well as expanding across borders. So I hope that gets at the question you were asking.

Kenneth Zener

And then could you talk about the contribution from the load in or sales that you expect as the hardware reloads and how that can impact 2010 organic?

John F. Lundgren

Sure. We’re happy to do that. Go ahead Jim.

James M. Loree

Ken, you may not recall because I don’t think you were following us at the time, maybe you were, February ’07 analyst meeting we talked extensively about the loss of a major customer in the hardware business which actually cost us over $50 million of lost revenue. And we indicated at the time that we would pursue other customers because we really believe in the strong brand pull and user demand for Stanley hardware in the marketplace. And so we indicated at the time we thought for various reasons we weren’t going to recover anytime soon with the customer we lost the business with that we thought we would pursue other customers, and in fact committed at the time to replace at least 50% of the lost revenue over the coming years. And as it turns out I think this program that we’re implementing right now with about 300 stores into it and has about 1,400 to go next year, annualized it should have an impact of greater than $30 million and next year probably three-quarters of that.

John F. Lundgren

So simply said we’ve replaced more than 60% of the lost business and we think in due course we will have replaced it all. But its going to take another year or so to get us there.


Your last question comes from Michael Rehaut.

Michael Rehaut

The first question just and I know you don’t get into you know forecasting by segment, but more just trying to get a sense of timing if you will. You know when you look at the CDIY improvement and you know certainly a good portion of that from Bostitch but also from your you know productivity in SFS, etc., you know I would assume obviously you’re doing a lot in the industrial segment as you’ve been mentioning as well, can you give us a sense of timing in terms of perhaps when you might expect those cost saves you’ve mentioned that you would expect them to bear fruit in 4Q, but are we looking at like a 12 month or 24 month improvement? Or maybe even shorter than 12 months, given the solid improvement that we’ve seen in CDIY?

Donald Allan Jr.

Mike, this is Don. I’ll be happy to answer that question. As I mentioned a few minutes ago, our cost programs have been fully executed except for the European actions and some small actions in our CT&S and Bostitch integration. We would expect by the end of this year 2009 that all the European actions will be complete and behind us. And Jim mentioned that you know on an annualized basis those actions in Europe probably add up to about $20, $25 million on an annualized basis.

So by the end of this year those cost actions will be complete and behind us. And what I was referring to earlier for 2010, around $100 million of carryover, that would be the carryover costs of all the actions that we completed this year. And that’s specifically what I was referring to.

Michael Rehaut

And just a second question, you know on the new product rollout that you’ve mentioned. You know earlier in the presentation you talked about you believe it’s going to be a very positive impact, market share gains, etc., a wave of new products and I think I heard towards the end of the presentation perhaps Don you had been talking about more of a slight improvement from new product rollouts. So I’m just trying to maybe reconcile those two comments and trying to get a sense of what actually you’re expecting in terms of a contribution to sale growth.

John F. Lundgren

Mike, this is John. I guess two things. As you know because you’ve followed us a long time, we have a tried, tested and proven, steadfast, etched in stone rule. We don’t talk about or show a new product to the investment community until our customers have seen it. That’s served us well over time. And that won’t change. You’ve been invited to and hope you can make our we think very comprehensive analyst meeting on November 17 in New York where our business heads, specifically Jeff Ansell, Brett Bontrager, Justin Boswell and Jim and three of his leaders in the Industrial segment will be talking about all of their products. Then you’ll actually be able to see them because we will have presented them to the customers. We intend to have a vitality index that stays above 25%.

And the reason I couldn’t answer your question even if I wanted to, you know that’s what’s new, how much of it is incremental, we were very pleasantly surprised when we introduced FatMax Xtreme as a good example, going back a year or two, that far less of the Xtreme volume cannibalized FatMax. So in fact that was a much bigger lift on a net basis than we’d anticipated. We have no way to predict that at this stage so I couldn’t answer your question if I wanted to other than historically. You know we’ve had as much as $70 million on an annual basis of revenue growth from new products. The question is that’s never 100% incremental. Its how much of its cannibalized and it remains to be seen.


There are no further questions at this time. We now turn the call back over to you, Miss White.

Kate White

We want to thank everybody for participating in our call and our webcast today. As I said at the beginning of the call if you’ve any questions or need further information, please feel free to reach out to me.


This concludes today’s conference call. You may now disconnect.

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