Snap-on Incorporated
Q3 2008 Earnings Call Transcript

Published: 27 Oct 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the 2008 third quarter results conference call hosted by Snap-on Incorporated. At this time all participants are in a listen-only mode. At the conclusion of our remarks we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference call, Marty Ellen, Chief Financial Officer.

[Martin Ellen:]

Thank you Sean, and good morning everyone. Thank you for joining us today to review Snap-on’s third quarter 2008 results. By now you should have seen our press release issued this morning. Despite increased challenges in the economy, we believe that our third quarter results demonstrate our continued progress in our core strategic and operating initiatives. We’ll discuss these with you today. Joining me is Nick Pinchuk, Snap-on’s President and CEO. Nick will kick off our call this morning with his perspective on our business and results. I will then provide a more detailed review of our financial results and afterwards, we’ll take your questions. Consistent with past practice, we will use slides to help illustrate our discussion. You can find a copy of these slides on our website next to the audio icon for this call. These slides will be archived on our website, along with a transcript of today’s call. Any statements made during this call relative to management’s expectations, estimates or beliefs, or otherwise state management’s or the company’s outlook, plans or projections, are forward-looking statements and actual results may differ materially from those made in such statements. Additional information and the factors that could cause our results to differ materially from those in the forward-looking statements are contained in our SEC filings. This call is copyrighted material by Snap-on Incorporated. It is intended solely for the purpose of this audience. Therefore it cannot be recorded, transcribed or rebroadcast by any means without Snap-on’s expressed permission. With that said, I will now turn the call over to Nick.

[Nicholas Pinchuk:]

Thanks, Marty. It appears we live in interesting times. Uncertainty seems to be the order of the day, and of course, Snap-on is not immune. What you can still depend on is that enabling solutions, real products for critical jobs, continue to be in demand, even now, and that’s what Snap-on is all about. What’s also reliable, even in these times, is the strength of our corporation’s business model; the breadth of our customers; the power of our value creating processes, and most importantly, the capability and commitment of our team. In this past quarter, those extraordinary characteristics were on display again. Sales growth was a lot tougher but the strength of our brands and the pull of our new innovative products provided what I think was significant buoyancy. All of that combined to create record earnings for the quarter. Operating margins expanded 170 points to over 12%. The EPS of $0.94 is a record for any third quarter, any time in the history of our corporation, and for the nine months completed so far this year, operating margins reached 13%. Those of you who have been listening to us for some time might recall that this was the very goal we set for ourselves a couple of years ago. It was a goal we thought would be achieved, but we thought it would be achieved in 2010. We’re ahead of our own targets, despite the macroeconomic difficulties. Now I’ll be giving you some more specifics as we go forward, but before I do, I want to note that we could not have accomplished this past quarter’s performance without the extraordinary efforts of all our associates and franchisees. I know many of you are listening in today to what is your call. My congratulations and my thanks to each and every one of you. It’s clear that these are turbulent times. There is significant uncertainty for both businesses and individuals. As I’ve said many times, Snap-on is not immune. We’re fully aware of the difficulties and we’re vigilant regarding the potential impact and the need to act against the eventualities. But having said that, we believe our strategies and business models do create resiliency. We have a growing global position with an expanding presence in emerging markets. We benefit from a diverse set of professional users in critical industries from vehicle repair to aerospace to natural resources to alternate energy. Those are fairly favorable places to be in difficult times, places where Snap-on products fill crucial needs, enhance productivity, and in the end make money for our customers. Beyond that we hold some of the strongest brand positions anywhere. Underpinning all of this, is our value creation approach with differentiating processes like Rapid Continuous Improvement, enabling innovation and passionate customer care. So having said that as an overview, let me give you some highlights of our results. This year for the nine months, almost 45% of our sales were outside the U.S. That compares to about 42% for the same period just a year ago. About 8% of our global sales, are now in the emerging markets of Asia Pacific and Eastern Europe. If you look at international in a broad sense, the slowdown of Western European economies and the generally tighter credit conditions did make it even more challenging this quarter for both our SNA Europe tools business and for our European based equipment operations, but the rest of our international businesses remained strong contributors throughout the period. Even a casual attention to the media I think today would lead you to question the global economy. We still see opportunity and runway. We’re continuing to invest in emerging markets. Progress continues on our third plant expansion in Kunshan, China. We’re already producing power tools and under-car equipment and hacksaws in that location. Now we’re adding a third facility, supporting new products for Asia like band saws and tool storage. We’re continuing on schedule with that project and we expect to be up and running in about six months for both of those product lines. The first quarter acquisition of our 60% interest in Wanda Snap-on is also proceeding well. That new venture is providing what I consider to be high-quality hot-forged hand tool capacity for our markets throughout the world. Let’s talk for a moment about Eastern Europe. I don’t know that we’ve highlighted that region as much as we might have, but we continue to see growth opportunities in those unclaimed markets, and we’re moving forward successfully with the relocation of our plant in Belarus. I think I mentioned in the last quarter that that facility makes important cutting tools and they are low-cost and very high quality. So we’re looking forward to expanding those capabilities as we go forward. Eastern Europe is a strategic growth region for us. Sales there are starting to be significant and they grew in the quarter by almost double digits and that’s excluding currency. We’re excited about the growth prospects in Eastern Europe and we’re going to keep investing. Overall about emerging markets there’s still an awful lot for us to achieve; we’re only scratching the surface. So we’re going to keep investing, keep pursuing opportunities aggressively. Now turning to slide 6, let’s talk about our markets and our customer base. We feel we’re in an encouraging position. For vehicle repair technicians

[Martin Ellen:]

Thanks, Nick. Turning to slide 9, net sales of $698 million in the quarter were up 2.5% from last year; without currency, sales were up just under 1%. Clearly, this was a much tougher quarter in terms of sales growth. In the U.S., sales were up 1.3%. Our U.S. franchisee business, comprising 26% of this quarter’s sales, was down three tenths of 1%. Our U.S. industrial business grew 2.8% in the quarter, substantially less than the 21% growth last quarter. We believe a substantial amount of this variation over the last two quarters resulted from timing of customer order activity. We believe this business will return to double-digit growth in the fourth quarter. In Asia-Pacific and the developing economies of Eastern Europe, which comprised about 8% of sales, reported growth was relatively robust at 15.3%, and it was 9.1% without currency. However, in Western Europe, which comprised about 27% of this quarter’s sales, our commercial and industrial tools and under-car equipment businesses faced increased head winds due to the slowing economies. Spain and Italy have experienced some of the more severe slowdowns and our SNA Europe tools business does have some concentration of its business in these countries. As many of you already know our equipment business, which sells more expensive capital equipment and has a reasonable presence in Europe, faced the challenges of not only economic slowdown, but tighter credit conditions. A continuing bright spot in Europe is our U.K. franchisee business, which had another solid quarter reporting 13.5% growth without currency. Consolidated gross profit of $312 million represented 44.7% of sales and improved 50 basis points over last year. Higher price realization along with $5.2 million of benefits from RCI initiatives more than covered steel, freight and other product cost inflation. Partially offsetting these improvements in gross margin was less favorable U.S. sales mix in the Snap-on tools group. Lower restructuring costs this year of $2.2 million also benefited the gross margin rate. Operating expenses of $230.6 million in the quarter declined to 33% of sales compared to 34.4% last year. Major cost improvements were achieved through $6.4 million of benefits from ongoing RCI initiatives and $2.6 million of lower franchisee termination costs. Financial services contributed $4.8 million of operating income, compared to $5.6 million last year. I will cover financial services in more detail in a moment. Operating earnings of $86.4 million for the quarter were up 19.3% over last year. As a percent of total revenues, operating earnings improved to 12.1%, up 170 basis points from the 10.4% earned a year ago. For the nine months this year, we achieved an operating margin of 13% and believe we have opportunities for further margin expansion. Interest expense in the quarter is down $4.8 million from 2007, primarily as a result of lower interest rates on our floating rate debt and lower average debt levels. With the recent rise in short-term interest rates, we expect interest expense will be about $8.5 million in the fourth quarter. Our effective income tax rate on earnings before equity earnings and minority interests is 33.3% in the third quarter and we anticipate that for the full-year we will remain at this rate. Diluted earnings per share of $0.94 in the quarter were up 34.3% from the $0.70 earned last year. With that as a consolidated summary, I will now turn to our segment results starting with the commercial and industrial group on slide 10. Segment sales of $338.1 million in the quarter were up $10.2 million or 3.1% over 2007. As I just mentioned, our European tools and worldwide equipment businesses experienced sales declines. Those larger businesses on a combined basis had relatively flat reported sales, but growth was down 5.6% on a constant currency basis. However higher sales of tools, kits and tool storage products to U.S. industrial customers, increased sales of power tools and continued growth in Asia and in Eastern Europe resulted in an overall reported segment sales increase of 3.1% and a less than 1% decline without currency. Notwithstanding the challenging sales environment, third quarter operating earnings of $40.7 million for the segment were up 24.5% from prior year levels, including $4.9 million of savings from RCI and cost reduction initiatives, along with contributions from higher pricing. Restructuring costs were lower by $1 million. As a percentage of sales, operating earnings in the C&I segment improved 200 basis points in the quarter to 12% from 10% last year. Turning now to slide 11, the Snap-on tools group reported third quarter sales of $269.5 million, which was up $7.5 million, or 2.9% from last year. The group’s international operations again reported double-digit growth, and despite the continued economic headwinds in the U.S., sales in our U.S. franchise operations [audio gap] relatively relatively flat; as I said, down three-tenths of 1%, while van count actually improved slightly both on a sequential and year-over-year basis. Third quarter operating earnings for the Snap-on tools group grew 14.6% from last year. Operating earnings benefited from the higher international sales volumes, but this was tempered by a less favorable U.S. product sales mix. Pricing improvements, net of commodity cost increases were about neutral for the quarter. Operating earnings improved as a result of $2.6 million of RCI savings and $2.6 million of lower franchisee termination costs, consistent with the lower level of franchisee terminations. As a result of these factors, operating earnings in the quarter improved to 10.5% of sales, compared to 9.4% last year. For the diagnostics and information group, which is shown on slide 12, third quarter sales of $155.1 million were up $3.1 million from prior year. Our OEM facilitation business in North America fulfilled an essential tool program in the quarter. We also achieved increased sales of diagnostics products in Europe, and higher sales of Mitchell 1 information products. These increases were partially offset by lower U.S. sales of diagnostics and lower activity of Snap-on business solutions resulting from the planned exit of certain non-core business product lines. Operating earnings of $27.2 million for the segment improved $5 million or 22.5% from 2007, primarily due to $4.1 million of savings from RCI initiatives. As a percentage of sales, operating earnings in the quarter improved 290 basis points year-over-year from 14.6% last year to 17.5% this year. Turning to slide 13, financial services revenues increased nearly 14% year-over-year on higher originations and, in our U.S. Snap-on credit business, revenue growth was aided by an approximate 180 basis point reduction in the year-over-year discount rate on extended credit contracts sold. Many of you have recently asked about the credit quality of the portfolio of Snap-on credit loans to technicians. Let me give you some additional data and trends. Accounts 60 plus days delinquent, at the end of September were about 1.9%. At the end of 2007 and 2006 they were about 2%. The high water mark was about 3% at the end of 2005

[Nicholas Pinchuk:]

Thanks Marty. I’d just like to end by once again noting that the third quarter represented a significant increase in earnings and it was a record despite the difficult environment. I want to once again thank our associates and franchisees for making that happen. Congratulations. I’d also like to end by saying that we’re confident of our business models, of our runway and of our people. Having said that, it’s clear that the current economic volatility has rendered projection I think less certain and so as befits such situations we’re taking action now to reduce costs, to restructure and to accelerate productivity. As I’ve said on practically every call, the opportunities for such improvement on Snap-on are abundant and we’re increasing our emphasis on cost. It’s helped us so far; it will continue to help us in the future. But at the same time, we also continue to see opportunity. Opportunity in emerging markets, in innovative products, and in critical industries; places where working people need real solutions to crucial tasks. So we’re continuing to pursue those opportunities even in these difficult times. As we move into the fourth quarter, we know no one has great visibility in this environment. But for Snap-on, we’ll maintain our core strategic initiatives but at the same time, we’re confident we have the flexibility and the options to balance among the areas of sales growth, cost reduction, working capital utilization, and capital investment. We’re confident our operations can create a focus appropriate to the economic and business environment as it unfolds. As a result, we believe that Snap-on can continue its trend of encouraging progress as we go forward to the days and the years ahead. Now I’ll turn the call over to the operator.

[Operator:]

(Operator Instructions). Our first question is from Jim Lucas - Janney Montgomery Scott.

[Jim Lucas:]

First question, could you expand a little bit on restructuring? That’s going to come in just a little bit lower than anticipated earlier in the year. How you’re going to approach restructuring as you think about what’s clearly becoming an even more challenging environment?

[Nicholas Pinchuk:]

A couple of things. One is, we’ve said all along that, yes, our formal restructuring numbers are lower year-over-year but we have a number of smaller actions which have served us well in productivity and cost reduction that don’t necessarily qualify for restructuring in the classical sense and that’s driven our cost reduction going forward. If you look at our numbers going into the fourth quarter, we’re going to look hard at the capacity of our facilities and improving administration in terms of productivity. I think it’s just doing Jim, what we’ve been doing all along. If you look at our numbers, we’ve been making some pretty good headway out of – I don’t want to say flat sales, but modest sales increases. I think you’re going to see us doing that forward and I think going forward, I think the only thing about this current situation is we kind of got our alert up about trying to make sure that we match our capacity and our capabilities to the volumes as we see them.

[Jim Lucas:]

Okay. Fair enough; that’s exactly the point I was looking for …

[Nicholas Pinchuk:]

I think you’re going to see us taking a look at plants; you’re going to see us look at lot of things, but it’s not so much different than we’ve done before, maybe we ratcheted it up because of the current economic uncertainty. I think we stand on our record of improving costs over the last several quarters.

[Jim Lucas:]

Okay. And you made a comment in your closing remark about working people seeking solutions to real tasks and you know specifically one of the areas that’s gotten a lot of focus through earnings season was the credit crunch and what’s happened over the last, essentially, month. When you look at your industrial markets and you look on both the tools and the equipment side, what impact has credit or lack of credit access had on that business and just any commentary about near-term trends there.

[Nicholas Pinchuk:]

Let me parse between it. We haven’t really seen a lot of impact in the industrial business. Generally we’re in industries where these are critical industries that seem to be going forward and I think I’ve stated that with the order rates have remained strong. So we feel pretty good about that runway. If you want to expand it to some of the other businesses, I think we said the equipment business; they have some challenges associated with the capital investments in some of their areas. They were down, I think, excluding currency, 5% in the quarter and that’s directly traceable to this. In the tools business, we see the same kinds of things with big-ticket items

[Jim Lucas:]

Okay. And two final unrelated questions. First, any commentary on pension as you look at that going forward and secondly with the strengthening dollar, you’ve had a nice tailwind on translation for quite some time; what impact do you see FX have going forward?

[Martin Ellen:]

First of all on pension, I can give you the data we have as of the end of September. Given pension asset values mark-to-market as of September 30, and everybody should recall that our funding policy over the past years has pretty much been and our cash flow has allowed us to fund to the PBO level, our biggest funded plan being in the U.S. But given current asset values, but at the same time, an increase in the liability discount rate, again, looking at that rate at the end of September all these valuations will have to be redone at the end of December, but if we just take that point in time, we are modestly over funded on a PBO basis; meaning we don’t foresee making any pension contributions. Second question on currency rates; no question the dollar has strengthened. I’ll just pick the euro for example, last year in the fourth quarter, the average rate that drove our P&L was about $1.45. I think yesterday I’ll say $1.32, so clearly the dollar strengthened and you see that across the Pound and in the Canadian Dollar and the Swedish Kroner which are the more important currencies for us. That being said, when you look at the overall impact of both translation, which by the way added very little to this quarter, a few hundred thousand dollars; but also the transactional exposures that result from us having, for various of our businesses, the cost base in, say, Europe and in sales in dollars outside Europe, or vice versa like in the tools group that makes a lot of product in the U.S., that gets exported into markets in Europe. The effect has been relatively neutral, in fact in this quarter, when you take translation and transaction, I think the effect on operating income was negative, about $1.5 million. The effect of the strengthening dollar, will it erode reported dollar sales vis-à-vis last year? Not clear to us it’s going to have a significant impact given our global model in terms of operating profits.

[Jim Lucas:]

Okay. Great. Thank you for the clarity.

[Operator:]

Our next question is from Alexander Paris - Barrington Research.

[Alexander Paris:]

Hi, good morning, nice quarter again.

[Martin Ellen:]

Thanks Alex.

[Alexander Paris:]

You’re doing a great job on costs obviously, and sales is still dragging a bit and I would imagine that even though you’ve got some good potential ahead for more cost-cutting, I’m just wondering, you want to get your sales up; it sounds like Eastern Europe and China are the expectations for the biggest source of growth, is that right?

[Nicholas Pinchuk:]

Well, no. Those are two places which are very strong for us, but I think I would also offer that the whole industrial sector is a big area. We see that being pretty strong. That rides on two things, I think Alex

[Alexander Paris:]

Part of the strength in the commercial and industrial, is you’ve added more direct sales ...

[Nicholas Pinchuk:]

We added in fact in the quarter; I don’t know the exact number, but we’ve added like 25 in the quarter. So other people are contracting, we’re adding, because we believe in that business. Now that may prove to be wrong. But I think that should emphasize some confidence.

[Alexander Paris:]

One other question. In the North American dealer, you didn’t give the account. How many vans do you have at the end of the quarter?

[Martin Ellen:]

Alex, at the end of the quarter in round numbers we had about 3450.

[Nicholas Pinchuk:]

It’s up very slightly, but we think it’s a major departure year-over-year from what we’ve been living with.

[Alexander Paris:]

But the territories that you have uncovered, if you were very successful in covering them with new people, what would that add?

[Nicholas Pinchuk:]

Roughly 10% of our territories are uncovered and that’s come down a little bit, because we increased a little bit here, but 10% is a good number.

[Alexander Paris:]

So you could get another 10% vans without any growth overall in terms of [inaudible]?

[Nicholas Pinchuk:]

We think so and I like our positioning versus our competitors in this marketplace. If you look at the balance between OEM dealerships and independents, our share is stronger in independents. Our franchisees depend less on OEM dealerships than others. So if you think, as some people do – I’m not prognosticating because that’s difficult in this environment – if you think that the OEMs are going to reduce by say 800 or 900 rooftops over a period of time, then I think that shifts in our favor. By the way, over that same period of time, U.S. household spending on auto repairs continues to increase; it increased again in August. The repair is going to go some place.

[Alexander Paris:]

Right.

[Nicholas Pinchuk:]

And as the OEMs contract, we see the independents ascendant somewhat. We like our positioning in that.

[Alexander Paris:]

Lower new car sales is a negative in terms of warranty work and so forth but again, that’s probably more than offset by the aging car population?

[Nicholas Pinchuk:]

Sure.

[Alexander Paris:]

And more of that goes to the independent dealers than the OEM?

[Nicholas Pinchuk:]

Yes, and by the way, if you think about it, our data tells us this, the independent dealerships per bay buy more equipment and tools than the OEMs.

[Alexander Paris:]

Now that you’ve hit your operating margin at 13% a year earlier, do have a new target now?

[Nicholas Pinchuk:]

Actually I think it’s two years early, isn’t it? But anyway, I had to take full credit for something. I think we’ve talked about targeting in these calls from time to time, but I think in this environment I don’t want to get into prediction basis, I think saying that we are going to be up in the fourth quarter in earnings is enough for me.

[Alexander Paris:]

Okay. Thanks a lot and again great job.

[Operator:]

(Operator Instructions). Our next question is from David Leiker - Robert W. Baird.

[Analyst for David Leiker:]

Hi, good morning. This is Keith on the line for David. I just have two quick questions here. If we look at the pace of demand as you exited the quarter, a lot of people are talking about Europe slowing meaningfully towards the end of the quarter. I was just wondering if you could you talk about the pace of each of the businesses as we exited the quarter.

[Nicholas Pinchuk:]

I’ll try to give you some overview. Basically on an overview basis, we had a pretty strong September, actually. The tools group in the United States had a terrific September and they were up year-over-year nicely. So they had a good September; they had a weaker July and August. In this business you get little bit of calendarization around that. But they exited very well. Equipment had an average September; average to the quarter; they had a September that was about the same. If you look at Europe they exited weaker than they entered. I’m talking about SNA Europe now, and the SNA Europe business exited weaker. Asia Pacific and Eastern Europe were both up substantially in September. So they continue to go sort of excelsior, ever upward. Diagnostics and Information had a good September. I think in a broad sense tools was strong; diagnostics was pretty good; international tools was also strong; the C&I group was mixed; SNA Europe was down and industrial had a good September.

[Analyst for David Leiker:]

Perfect. And then if we look to the fourth quarter, with the year-over-year increase in earnings, is this going to be driven more by revenue growth with what’s coming in the normalization in the C&I business or is this more of a margin story in the fourth quarter?

[Nicholas Pinchuk:]

I don’t think I really want to specify between that. As I said I think in my remarks, I think we have confidence in our ability to balance between sales growth and cost reduction. We feel pretty good about the cost reductions we see going forward. If we get some revenue growth that will be nice as well, but I think it is very difficult to predict the way in which such a thing that might eventuate in this environment. So I don’t think I will.

[Analyst for David Leiker:]

Okay. Thank you very much.

[Operator:]

And it appears we have no further questions on the phone at this time. I would like to turn the call back over to Marty Ellen for any additional or closing remarks.

[Martin Ellen:]

Thank you again everyone for joining us this morning. We appreciate your interest in Snap-on. Good day.

[Operator:]

Ladies and gentlemen we thank you for your participation. You may disconnect at this time.