Stanley Black & Decker Earnings Call INSIGHTS: Security Margins Synergy, M&A Strategy
Security Margins Synergy
Mike Wood – Macquarie Capital: To get to the relatively flat Security margins for fiscal year ’12, it implies a large ramp up in the second half. Can you talk about the timing of specific actions that are hitting in terms of what’s driving that expense (churn) on the weak organic growth in the segment?
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John F. Lundgren – President and CEO: I think it’s really two things that are occurring there. Of course, the continued execution of the Niscayah integration as we see more synergies occurring in the back half of the year and as we go into 2013 as well as the very proactive cost actions they’ve taken at the beginning of this year as well as the most recent ones we’re looking at where $100 million of an annualized program across the whole company, certainly Security will have a significant portion of that. I guess the last thing I would mention is that they’ve been very proactive around passing on price to the customers where appropriate given certain inflationary pressures that have kind of occurred in the past. We would expect those price increases to stay in place and be able to drive improved margins in the back half.
Mike Wood – Macquarie Capital: Then within that segment, can you help us understand how that 6% order growth that you reported last quarter impacted 2Q? So were there customer delays in terms of those orders turning into sales or was there just a substantial weakening in orders in this current quarter?
Donald Allan, Jr. – SVP and CFO: I think the dynamic that’s happening there, you’re primarily referring to our CSS, or Convergent Security Solutions business, where we did have backlog growing at the end of last quarter and clearly this particular industry is feeling a little bit of pressure around subcontract resources in that space. As the subcontractors that are used in the space are used for not only our business but they are used by the cable companies, the telephone companies, etc. So there is a bit of a resource strain right now in that space that’s causing a little bit of drag and then you combine that with some of the restrictions we’re experiencing in the government channels as well that’s putting a fair amount of pressure on both order trends and what I would say convergent of orders into revenue.
James M. Loree – EVP and COO: This is Jim. The last few years I think we’ve been pretty good at getting the orders in CSS and not as good at converting the backlog in a timely fashion, and I think part of that underlies the leadership change that we made in CSS North America where we now have somebody in place who is a more generalist type of a leader who has got the operations capabilities and focus as well as the sales and marketing.
Jason Feldman – UBS: On M&A, you described this pause as a tactical change and I am sorry, I didn’t mean to mischaracterize it, but I guess I am just curious as to why you think this is the right time. I understand that you need to focus on integrating what you have, but you seem to have strong confidence in your cash flow. You’re possibly selling HHI with sales, that are rather depressed and valuations and multiples on potential acquisitions look relatively attractive where they are available. So, isn’t this actually the time where you’d almost want to do the opposite for now and then come back to the integration and organic growth initiatives going forward, sometime in the future?
John F. Lundgren – President and CEO: Jason, your observation is very logical but what you’re leaving out or missing that I think will be helpful for you and everyone else, is we look at three things, all of equal portion as we evaluate acquisition. This hasn’t changed since 2004. Specifically, and you are well aware, we look at strategy, the strategic fit to fit our with our growth platforms as Jim very articulately described them. Is it high growth, is it where we can compete, is it where we can have (global cost) leadership, is it where our brands matter. That’s the first screen. The second screen, is the financial hurdle, does it significantly achieve our cost to capital. We might discriminate in favor of an acquisition where we could use overseas cash because obviously it’s earning such a low return, but simply said, if it’s a small bolt-on, it has to get to our financial hurdles 15% operating margin, 15% ROCE quicker than the large one, but that’s the second, if you will filter. The third is organizational capacity, and I think maybe that’s the one that you’re leaving out in your observation. Specifically, we are as likely to walk away from the deal or not pursue a deal because we don’t think we have the corporate or business specific capacity to aggressively integrate it, manage it. Two things, A, what comes with the acquisition in terms of management; and B, to the extent management we are as comfortable with the management that comes with the acquisition, what exists in-house within our various businesses to give us the confidence we can successfully integrate. If you just look very quick within our segments, our CDIY team is incredibly capable, that being said, for 2.5 years been integrating Black & Decker, that’s been 75% of the activity has been within CDIY. We’ve just added Powers, which as Jeff described, is strategic. It’s going well. Their plate is very full. Within Security, we bought Niscayah. We closed on that deal less than nine months ago. A lot of it’s in Europe. Niscayah didn’t come with as much operating management as we had anticipated, and as a consequence, we’ve redeployed some of our more capable executives to oversee that business. It’s going very well, but Bontrager and his very capable team also have a very, very full plate. That leaves the industrial platform or some of the opportunities are smaller, one of our more capable tested, proven teams with arguably the organizational capacity is industrial and general and our engineered fastening team in particular, which is why Don referenced and Jim did that we’re looking at something in that space. So when you cut through it all, the organizational capacity issue digesting what we have, making sure that we’ve properly integrated them, set a solid foundation and teeing them up for strong organic growth is every bit as important as the other two I’ll say filters that you I think appropriately pointed out.
Donald Allan, Jr. – SVP and CFO: And I will just add to that that we always look at one of thing, which is our capital allocation strategy over the long-term, which has been to take about two-thirds of our capital, excess capital and allocate it to acquisitions and the other third to return to the shareholders in the form of dividends and share repurchases, and we tend to favor share repurchases at moments when we think the stock is grossly undervalued, and it’s difficult for us to look at Stanley Black & Decker’s world-class series of franchises trading at six times EBITDA and then go buy some small private company for a $200 million at 9 or 10 times EBITDA and justify why we would want to do that in our heads. So we are going to work on organic growth, digesting some of these acquisitions for all the reasons John said and we’re going to take the excess cash for that period of time and we’re going to maintain our creditworthiness and whatever’s left over we’re going to buy back our own shares until we get to a point where the arbitrage is more closer and makes more sense.
Jason Feldman – UBS: And then just lastly but in terms of the repurchases the way that I thought I heard Don describe it, the new repurchase authorization seems to be largely a potential redeployment of the HHI proceeds assuming that that deal happens. Jim, did you just suggest that basically the two-thirds that’s normally is used for M&A, free cash flow is also on the table for potential repurchases?
John F. Lundgren – President and CEO: Well, historically Jason, the allocation is two-thirds, but historically it’s – in my last five years, it has been close to 50-50, between buyback and dividends, 45% to 55% of our cash has been returned to shareholders over the last five years, despite the, if you will, ideal allocation over time that Jim described as basically two-thirds, one-third.
James M. Loree – EVP and COO: What that enables, if you think back to the long-term financial objectives that we’ve had in place since 2004, is that we’d like to grow our revenue organically about 3% to 4% a year, and then we’d like to grow our total revenue somewhere in the neighborhood of 10% to 12%. We’ve far exceeded the total growth rate over the last decade growing closer probably to around 20%. However, that was aided by that one very large acquisition or merger, Black & Decker. I think if you take that away, probably closer to right around the stated goal that we had. So, that particular – there’s no real magic to that other than the fact that our capital allocation between 50% and two-thirds of our excess cash flow with the prices that we typically pay for acquisitions enables us to achieve that math, and that math when we grow the top line 10% to 12% a year, our goal is to grow to expand margins at the same time and to achieve mid-teens earnings growth and we have definitely achieved that over the last decade, and that’s what we’re going to continue to do over the long-term. That’s why we used the word tactic to describe this because we do occasionally have a tactical change here where the organizational capacity becomes an issue or the arbitrage, the valuations become an issue or an opportunity maybe to characterize it more positively, and under those circumstances we typically will shift to a more repurchase kind of focus for a period of time. That served us very well. In the in the early part of the last decade we bought back several hundred million – probably close to $600 million worth of shares in the 20s. Couple of years ago bought back another similar amount in the 40s and so, I think we have a pretty good sense to as to when the stock is grossly undervalued and I feel like we’re in that kind of a mode right now. So this makes perfect sense especially given our organizational capacity constraints at the same time.
John F. Lundgren – President and CEO: Jason, one final point because you guys do follow-up and you get cut off, as it relates to buybacks, also keep in mind where that cash is. As most U.S. multinational, the majority of our cash generated overseas, buybacks with overseas cash obviously are not terribly tax efficient. So, our desire to do that – to do more is somewhat constrained by where our cash sits. That being said, there are way to work with that, work through that, work around that and Jim’s point is really important one. We think the best investment out there is SWK at $60, so that hurdle for an acquisition is higher than it’s ever been.