Snap-on Incorporated
Q3 2012 Earnings Call Transcript

Published: 18 Oct 2012

[Operator:]

Good day, and welcome to the Snap-on Inc. 2012 Third Quarter Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Leslie Kratcoski, Vice President, Investor Relations. Please go ahead, ma'am.

[Leslie H. Kratcoski:]

Thanks, Jennifer, and good morning, everyone. Thanks for joining us today to review our third quarter 2012 results, which are detailed in our press release issued earlier this morning. We have on the call today Nick Pinchuk, Snap-on's Chief Executive Officer; and Aldo Pagliari, Snap-on's Chief Financial Officer. Nick will kick-off our call this morning with his perspective on our performance. Aldo will then provide a more detailed review of our financial results. After Nick provides some closing thoughts, we'll take your questions. As usual, we've provided slides to supplement our discussion. You can find a copy of the slides on our website next to the audio icon for this call. The slides will be archived on our website along with the 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. With that said, I'll now turn the call over to Nick Pinchuk. Nick?

[Nicholas T. Pinchuk:]

Thanks, Leslie. Good morning, everybody. As usual, I'll start today's call with highlights of the quarter's results. I'll provide my perspective on the operations and on our various markets around the world then Aldo will cover the financials in more detail. The results in the quarter were encouraging again. EPS of $1.26 and our organic sales increase of 4.6% from last year. Performance from our operating company or OpCo, as we call it, was strong with 13.5% operating margin. And as expected, Financial Services also had expanded profitability, growing its on-book portfolio. FinCo OI of $27.9 million was up from the $20.8 million of last year. And I believe that all of these are encouraging absolutes. As we highlighted on our release, there is a year-over-year comparison impact that results from the substantial movements in our share price in the third quarters of both last year and in this year. As a result of the related mark-to-market effects, this year, there was an unfavorable $4.4 million adjustment. Last year's third quarter included a favorable $7.8 million mark-to-market adjustment. Absent this $12.2 million unfavorable swing, our OpCo operating margin in the quarter increased 170 basis points from 2011 levels, an encouraging apples-to-apples rise. Now the sales increase in the quarter came against clear headwinds. Those gains generally represent a continuation of the same progress we've been registering over the past few periods. We're not really seeing much change in the overall market dynamics. Europe, for sure, remains tough. It's our most significant challenge and it has been for some time. And we also have other headwinds, I'll speak about those in a moment in the segment discussion. But when you operate in diverse geographies and markets, there will always be some challenges. Our strengths though, are more than overcoming those headwinds, with a clear focus on the 4 areas we've identified as being decisive for our future

[Aldo J. Pagliari:]

Thanks, Nick. Our third quarter consolidated operating results are summarized on Slide 6. Net sales totaled $711.6 million, representing an organic sales increase of 4.6%. This increase included positive organic growth in each of our operating segments. Consolidated gross profit of $340.4 million increased $11.1 million from 2011 levels and gross margin of 47.8% improved 60 basis points from 47.2% last year, largely due to savings from RCI initiatives, including benefits from restructuring. Operating expenses of $244.2 million were up $9.2 million from last year. As a result of the increase in the quarter-end Snap-on stock price, operating expenses in the third quarter included an unfavorable $4.4 million of stock-based mark-to-market expense. Last year, you may recall, operating expenses in the third quarter were partially offset by $7.8 million of benefit from mark-to-market as a result of a decrease in the Q3 2011 quarter-end stock price. The operating expense margin of 34.3% in the quarter increased 60 basis points from 2011 levels, as favorable sales volume leverage was more than offset by the $12.2 million or 170 basis points of higher mark-to-market expense. Restructuring cost totaled $2.3 million in the quarter compared to $2.9 million last year. Operating earnings before Financial Services of $96.2 million increased $1.9 million year-over-year despite the $12.2 million of higher mark-to-market expense. As a percentage of sales, operating margin of 13.5%, including the adverse 170 basis points impact from higher mark-to-market expense, was unchanged from last year. Operating earnings from Financial Services of $27.9 million increased $7.1 million or 34.1% over prior year levels. Consolidated operating earnings of $124.1 million in the quarter increased $9 million over last year's levels, and the operating margin of 16.5% improved 70 basis points from 15.8% a year ago. Finally, third quarter net earnings of $74.1 million or $1.26 per diluted share compared to $67.8 million or $1.16 last year. Now let's turn to our segment results. Starting with the Commercial & Industrial or C&I group on Slide 7. Third quarter sales of $280.4 million were up 4% organically from 2011 levels. This growth resulted primarily from mid to high single-digit sales increases in the businesses serving customers in critical industries and in the emerging markets of Asia, coupled with a double-digit increase in sales of Power Tools. These increases were partially offset by a mid-single-digit decline in our European-based hand tool business as a result of continued market weakness, particularly in Southern Europe. Gross profit totaled $103.7 million with gross margin of 37%, improving 10 basis points from last year. Operating expenses of $70.3 million decreased $2.9 million from 2011 levels and the operating expense margin of 25.1% improved 120 basis points from 2011 levels, primarily due to benefits from sales volume leverage and RCI initiatives. As a result of these factors, third quarter operating earnings of $33.4 million for the C&I segment increased 12.8% from 2011 levels and the operating margin of 11.9% improved 130 basis points from 10.6% last year. Turning now to Slide 8. Third quarter sales in the Snap-on Tools Group of $308.8 million increased 11.1% organically, reflecting double-digit sales increases in both the company's U.S. and international franchise operations. Gross profit of $131.3 million increased $6.1 million from 2011 levels. Gross margin of 42.5% in the quarter declined 230 basis points from 44.8% last year, primarily due to increased promotional programs associated with sales gains, including expanded participation at this year's Annual Snap-on Franchisee Conference. Operating expenses totaled $91.1 million and the operating expense margin of 29.5% in the quarter improved 260 basis points from 32.1% last year, largely due to sales volume leverage. Operating earnings of $40.2 million in the quarter for the Snap-on Tools Group increased $4.6 million or 12.9% from last year's levels and the operating margin of 13% increased 30 basis points from 12.7% last year. Turning to the Repair Systems & Information or RS&I group shown on Slide 9. Third quarter sales of $222 million increased 2.7% organically, primarily due to a high single-digit increase in sales of diagnostics and Mitchell 1 repair information products and a mid single-digit increase in worldwide sales of equipment. These increases were partially offset by a mid single-digit decline in sales to OEM dealerships, particularly in Europe. Gross profit totaled $105.4 million, with gross margin of 47.5%, increasing 200 basis points from 45.5% last year. This improvement is primarily due to savings from ongoing RCI initiatives, as well as a more favorable sales mix that included higher sales of diagnostics and repair information products. Operating expenses totaled $55.9 million with the operating expense margin improving 70 basis points to 25.2%, reflecting sales volume leverage and contributions from RCI. Third quarter operating earnings of $49.5 million for the RS&I group increased $5.8 million or 13.3%. And the operating margin improved 270 basis points year-over-year to 22.3%. Now turning to Slide 10. Third quarter earnings from Financial Services increased $7.1 million, primarily due to the growth of the on-book finance portfolio. Originations of $179.6 million in the quarter rose 17.7%, reflecting both higher sales in our Snap-on Tools segment and increased participation in our credit programs. Moving to Slide 11. Our quarter-end balance sheet includes $1.06 billion of gross financing receivables, including $893 million from our U.S. Snap-on Credit operation and $169 million from our international finance subsidiaries. In the U.S., $714 million or 80% of the financing portfolio relates to extended credit loans to technicians. Since the beginning of 2012, our on-book financing portfolio has grown approximately $128 million. Approximately $108 million of the expanded portfolio relates to the U.S., while $20 million is associated with our international finance subsidiaries, including $6 million of positive currency effect. For the remainder of the year, we anticipate that the worldwide finance portfolio will grow by an additional $20 million. Regarding finance portfolio losses and delinquency trends, these continue to be in line with our expectations. Now turning to Slide 12. Third quarter cash provided by operations of $69.7 million in 2012 increased $27.7 million from prior year levels and includes the effect of $16 million of additional third quarter discretionary cash contributions to our U.S. pension plans. This contribution is in addition to $26.7 million of discretionary contributions made earlier this year. Depending on market and other conditions, we may elect to make additional discretionary cash contributions to our U.S. pension plans. Capital expenditures totaled $19.7 million in the quarter and $59.5 million year-to-date. We anticipate full-year capital expenditures will be in the range of $75 million to $80 million, including the construction of a fourth factory at our Kunshan China location, which is expected to be completed by year end. As seen on Slide 13, days sales outstanding for trade receivables of 59 days compare to 58 days as of 2011 year end. Inventories increased $31 million from 2011 year-end levels, primarily to support continued higher demand largely in the United States. On a trailing 12-month basis, inventory turns of 3.8x compare to 4.2x at 2011 year end. Our quarter end cash position of $176 million decreased $9.5 million from year-end levels, primarily due to the continued year-to-date funding of new loans originated by Snap-on Credit, U.S. pension contributions of $61 million, share repurchases of $61.8 million, capital expenditures of $59.5 million and dividend payments of $59.4 million. These year-to-date uses of cash were largely offset by cash generated from operations. Our net debt to cap ratio of 31.9% compares to 34.3% at 2011 year end. In addition to our $176 million of cash and expected cash flow from operations, we have more than $700 million in available credit facilities and our current short-term credit ratings allow us to access the commercial paper markets should we choose to do so. As of quarter end, no amounts were outstanding under any of these facilities. This concludes my remarks on our third quarter performance. I'll now turn the call back over to Nick for his closing thoughts. Nick?

[Nicholas T. Pinchuk:]

Thanks, Aldo. Well, that's Snap-on's third quarter. Clear progress along our runways for growth and for improvement, overcoming the turbulence of Europe and the general economic uncertainty. Snap-on value creation is driving improvement. Our innovation and customer connection processes are combining to create product excitement and real customer value. And when combined with RCI, they enable progress. Adjusted for mark-to-market, OpCo OI margin rose significantly. And we are moving forward along our runways for growth, recording solid organic gains. Those results confirm that our efforts are paying off in each of the 4 areas we've identified as decisive for our future. Consider the quarter's performance, building in emerging markets -- we had strong gains in places like Thailand, Indonesia and Russia. Extending into critical industries -- we saw significant growth in sectors like aerospace and natural resources, overcoming the challenges in the military and offsetting the weaknesses of Europe. Expanding in the repair garage -- diagnostics and repair information up strongly in independent garages, more than balancing the unevenness in the activity with the OEMs. And undercar equipment sales in Russia and in Brazil and in North America, overcoming the ongoing challenges due to the European macros. Enhancing the franchise network, double-digit gains in the U.S. for the ninth straight quarter. An enthusiastic network that showed up in greater numbers than ever before at our Annual Franchise Conference, celebrating their success, while training to further improve their businesses. That's thousands of small business owners, energetic, invested and optimistic. Optimistic about their place on the Snap-on runway for growth. Yes, there are challenges but just like past periods, Snap-on's progress in the areas of opportunity have overcome the difficulties and achieved a favorable balance. And because of that, we are encouraged and clearly confident. Encouraged by the ongoing results and confident of our possibilities for growth and improvement as we move forward. Before I close, I want to recognize our associates and franchisees. Many of you, I know, are listening. I know that third quarter results and the favorable trends reflect your effort, your capability and your commitment to our team. For all of that, you have my congratulations and you have my thanks. Now I'll turn the call over to the operator for questions. Operator?

[Operator:]

[Operator Instructions] We'll take our first question from David Leiker with Baird.

[David Leiker:]

I wanted to start on the Snap-on Tool business, in particular, international. You have got a great track record under your belt here in the U.S. with the performance there. That double-digit gain in the international breaks the trend there of low single-digits for a long time. Can you talk about what specifically on the international side has changed that and whether that's something that is sustainable going forward?

[Nicholas T. Pinchuk:]

We think it is. Well, I don't know. Double digits I -- even though we've had a run of double-digits, David, I think I've been pretty consistent on these calls to say I'm not sure that kind of -- I would say, stratospheric -- growth can continue, but I think the strength in those places are pretty solid. The U.K. has improved substantially in the last, I would say, over the last couple of quarters and that is driving this. We've made great strides forward in terms of improving our product line and our relationship -- productivity with our franchisees there. Australia has been contributing quite well. And Canada has been very strong. We've actually spent a lot of time and a lot of focus, maybe off-camera a little bit, focusing on those areas and what you're seeing is the result of that focus, doing the same kinds of things adjusted for the -- that we did in the United States -- adjusted for the local market. So it’s a sum of Canada, U.K. and Australia all doing better.

[David Leiker:]

On the U.S. side, in terms of the sustainability, the track record you put there, could you characterize at all? I mean obviously market share is a piece of that, but between market share, kind of deeper market penetration areas you haven't been, the product offering, can you put those into buckets of the contribution to that great performance in the U.S. at all?

[Nicholas T. Pinchuk:]

No. I don't think I can actually. But there clearly are 2 elements of it. One is we are, because of our new ways of marketing, able to sell more to the same customers. I think the idea of the traveling -- the idea of the Rock 'n Roll Cab Express, and I think we're at the end of the quarter, we're at 28, we're going to go upwards almost -- we're going to expand that quite a bit going forward and -- because they've been so successful. So that's clearly a kind of wrinkle on the Van business in allowing us to sell more to pretty much our existing customers. Then on top of that, as I've said often, we are calling on more customers because our vans are becoming more productive and our product line is becoming wider and appealing to them. I can't put those into buckets. And I hate to talk market share because it's a very imprecise exercise when you're talking about tools and you start to have such a wide universe of possible products, it's very difficult to describe. I do think though, we're making great gains in the Tools group now. It's clear, after 9 quarters of double-digits, the Tools Group team has got this businesses, which is one of the world's great businesses, I think. That team has got this business resonating.

[David Leiker:]

[indiscernible] with the Rock 'n Roll Cab Express, do you think you're getting folks to buy more products than they normally do buy or are they buying it at Snap-on instead of at Sears or Lowe's?

[Nicholas T. Pinchuk:]

I think there's both of those things. I think we think they're buying it from us as opposed to possibly, other places. But there's both of those things. I mean, David, as you know, it's like a new car purchase. All of a sudden, we now have showrooms in the field as opposed to catalogs. And so that's generally it. You were buying the thing, they were buying the thing from more or less from a catalog and now, they have showrooms. And you can think about how that excites people and it wins customers and it also accelerates the buy from some people. I mean, I think that some people probably are buying toolboxes, already have Snap-on toolboxes, they see a new one, they say boy, I can't live without that one, I'm going to have it. And then the other people were competitors and they see what the quality offerings we have. And we believe we have some really great offerings that are superior to the competitors based on innovation and they're coming over to our side. But I can't tell you how much -- which is which.

[Operator:]

We'll go next to David MacGregor with Longbow Research.

[David S. MacGregor:]

Just while we are on the topic of storage, with that organic growth of 11.1%, how much of that was storage?

[Aldo J. Pagliari:]

Well, I don't like to talk about that, but -- to give those numbers, but -- in that detail -- but I will tell you that the tools storage product line grew substantially higher than the 11% of the U.S. business or the overall tools business -- if it gives you any view.

[David S. MacGregor:]

And is there any way for us to think about that? I mean, you talked about 28 showrooms that I guess, we can call them and you're going to growth that. At what rate does that grow and how does the productivity from that grow?

[Nicholas T. Pinchuk:]

I don't know. I mean, that will be too precise for -- I'm not smart enough to say that, I think. I think it's like this, I believe that every one we add gets more sales. At least as far as we can see now, that's why we're doing this, that's why we're doing it. But, but, but we'll keep doing it until we see diminishing returns, I believe. So far, we haven't seen anything in the way of diminishing returns.

[David S. MacGregor:]

That makes sense. Well, congratulations on the success of that program. You talked in the C&I business about pricing being up mids to high single digits. I was just wondering, my guess is probably not a lot that was in Europe, although maybe I'm wrong, but can you just help us understand how that experience might have played out over critical industries versus emerging markets?

[Nicholas T. Pinchuk:]

Say that again. You mean...

[David S. MacGregor:]

The pricing in the C&I, you said was up mid to high single digits, I'm just wondering across those 3 businesses -- my guess is there's not a lot in Europe, but maybe I'm wrong on that. But can you talk about pricing, critical industries versus emerging markets?

[Nicholas T. Pinchuk:]

Sales were up. Sales were up mid single-digits. That's a component of our emerging market growth. Emerging markets are now about 10% of our business and critical industries are a significant piece of that. I'd say that -- let me see if I can help in this way. The C&I Group grew at about 4%, the emerging markets, which is about 10% of our total business, which is mostly in C&I grew close to double digits.

[David S. MacGregor:]

Maybe I could follow up with you offline on that. Then on the RS&I business, you said there was a high single-digit increase in the diagnostics and Mitchell 1 business, I know you've got a lot of innovation and new product in that business right now. Was there anything there last quarter or is this all just sort of emerging...

[Nicholas T. Pinchuk:]

Actually let's -- for government work, the RS&I business looks sort of the same as last quarter in mix. Mitchell 1, the Repair Systems & Information business was up sort of right close to double digits. In fact, I think it was just over the double-digit boundary and that's the Repair Information business driven by what I call ProDemand repair information software. It's a new offering which has more information and the navigation is much simpler than anybody else's anymore. So it's a very attractive offering, combining state-of-the-art navigation with the best database available and people are lining up to subscribe to that. So that business has been growing pretty well and the diagnostic business -- and that happened last quarter, too, happened last quarter.

[David S. MacGregor:]

Nick, does it accelerate into the fourth quarter?

[Nicholas T. Pinchuk:]

Accelerate, I don't know. But I think we feel encouraged by our prospects there. I think we feel positive about our position looking at independent garages. The diagnostics business, I was going to say that's the handheld, the software, the hardware and software business, the laptops for cars grew at mid or high single digits. And those have been the same for a couple of quarters, give or take, a few basis points. So I don't know, I mean, we don't really give guidance but we feel good about our position.

[David S. MacGregor:]

That sounds great. And the last question, just on the tools business, aside from the storage business, I was just wondering if you could talk about trends and big-ticket sales off the truck?

[Nicholas T. Pinchuk:]

Looks okay. I think it looks okay. I mean, that's one of the things we always watch. So I suppose the operative question is this, is that, are you seeing downturn in big-ticket which would precursor maybe a cooling off of everything? And I don't think we do. Now you might say well, do you have visibility because you've got this new marketing program and are you able to pierce the veil of the marketing program to see what's actually happening in what I call just a pre-demand type activity in the marketplace? And I think we can and I don't think we see a downturn.

[Operator:]

We'll go next to Mike Wherley with Janney Capital Markets.

[Michael J. Wherley:]

Obviously, the Tools Group has been very strong for many quarters now, and I'm just wondering do you -- when you're looking forward 1 quarter, 2 quarters, 3 quarters, when do you feel like there might be some tough comps that are going to be difficult for your business to sort of keep the growth going? I mean, not that it's going to grow at double digits, but might it flatten out altogether if you run into tough comps?

[Nicholas T. Pinchuk:]

Well, look, I think we've said in many forums that we expect to grow as a corporation, 4% to 6% organically. I didn't mean by that, that we would do it every quarter, although we have been able to do it most quarters. I think probably, almost all quarters -- but we feel confident of our ability to keep growing at that rate. I'm not saying we'll do it every quarter, I mean, that's not what I mean. But I mean, if you're talking about the trend, we feel okay about that. Yes, the comps get tougher, but they got tougher last year and the year before that and the year before that. So I don't think we're so worried about that. Now it's a challenge, but we're not wringing our hands over it.

[Michael J. Wherley:]

Okay. What about the -- just sort of thinking about it this way, just to be devil's advocate. If you're talking about selling more to the same customers and you're talking about this Rock 'n Roll Cab Express that's selling big-ticket items, that maybe some of these wouldn't have bought if this Cab Express didn't roll into their garage. I'm wondering now, at what point does selling more to the same people lead to a smaller wallet in the future?

[Nicholas T. Pinchuk:]

I mean, well, I don't think it leads to a smaller wallet but it might lead to people who have used up their capacity to, you might say, it's led to their people -- people to use up their capacity to buy. I don't think we've seen the bottom of that yet. I don't think we believe we've seen the bottom of that yet. But it's a reasonable point, as you lay out over distance, but what you have there is a couple of things. First is, is underlining this business, repair is a good solid business. Every quarter for a number of quarters, the household spending on automotive repair has been up. So the underlying demand is good. By the way, that's in independent shops and so our core customer is growing and getting more business, that's number 1. Number 2 is we keep -- the cars keep changing, we keep changing the products, they can see ways -- I was just out on a van on Monday, I was out on a van on Monday and you can see these guys talk to you. They say, gee could you get me -- it's like customer connection. You go there and they say, I need a special tool to help me pull this engine so I can do some work on it because this particular vehicle has some particular geometry, and if I do that, I can make more money. So part of the key here is every time they pay, every time they give us money, they make more money. So the more they spend with us, the better they -- the more money they make. So there's a kind of offset to the idea of the wallet reaches an end, that's 1. And not just from attenuation [ph] but 2, we have said that there are customers out there that we don't call on. Maybe they were Matco customers for a time, maybe they were Mac customers, maybe they were geographically undesirable, maybe they were in places that weren't target-rich and because we have more productivity and a wider product line, we are going to them and that's going on here too. So I'm optimistic about the Tools Group possibilities. Now, I'm not here to sign up for continuous double-digit growth though, in the Tools Group. I think I said, I'm signing up for 4% to 6% for the total corporation over time. We feel confident about this.

[Michael J. Wherley:]

But do you think the Tools Group can sustain something higher than what you've said? Can it sustain 5% to 6% on its own?

[Nicholas T. Pinchuk:]

They're starting to make me look dumb, aren't they? But I still say I like our other businesses. I like the opportunities of C&I to grow at the high end of that. I like RS&I, we're seeing a particular time when they are muted by Europe, 33% of C&I is in Europe, 17% of it is in Southern Europe. All right? And it's still growing at 4%. 25% of RS&I is in Europe and we got the OEMs kind of nervous and so we got this lumpy business. So I see the opportunities of those businesses to grow.

[Operator:]

We'll go next to Richard Hilgert with MorningStar.

[Richard J. Hilgert:]

A couple of questions here on my end. In the European market, obviously, the U.K., new car sales are doing pretty well there. I would imagine that they're not experiencing some of the economic issues that the mainland Europe is experiencing, aftermarket probably isn't doing quite as bad there either and so I was wondering if you could kind of compare and contrast between the two. And also, in Europe, it seems to me like the European downturn is harsh enough that we're going to see consumers postponing aftermarket repairs for quite some time. And I'm wondering if you could talk a little bit about the correlation between when we start -- when should we start to see the aftermarket coming back, when people would start making repairs again versus when you see new-car sales start to improve coming out of an economic trough?

[Nicholas T. Pinchuk:]

It's tough. But I'll say this. For my money, for my money, there's no correlation between new car sales and our business. We don't see that, really. I think, to the extent that new car -- I suppose you could say that to the extent new car sales go down, we may see a slight burst. But generally, the thing is, in the U.K., as in the United States, what are new cars sales in the United States? This year they're forecasted at 15.2 million or something like that, well there's -- North America, rather. There are 300 million vehicles on the road. So new car sales are kind of like a blip in the after -- I think driving our aftermarket business anyway. So we don't really see it that way. It is true though, you are right though, that the U.K. is a stronger market. We found it to be uniformly for all our businesses and this is businesses both in automotive repair and critical industries, to be a better market for us than the rest of the -- than the continent, for sure. And so, we were kind of cautiously positive about that view. And I don't know if that continues or not, I think part of it is that people in the U.K. -- I think people don't necessarily postpone repair, I think they postpone new purchases. So I don't really see a downturn in repair there so much. Now remember, in Europe, our businesses are broader-based than in the United States so we have less of the business in automotive repair and more in the industrial and other places like agriculture. So we're more broadly based in terms of vertical industries in Europe. So you got to take that into account. Now, if you say the rest of Europe and when is it going to recover and when are people going to start spending again? I'd give you two thoughts, I think the South -- in fact, I'll just say traditional Europe, Western Europe, I'm not making any predictions. On one of these calls, I said once that Spain, I thought, had hit the bottom. Well, that was wrong and that was like 2 years ago. So I don't think anybody can actually predict this. All we can say for sure is our base customer base. Our base customer base seems to be intact so we believe it comes back. Now if you talk about the periphery of Europe, if you talk about Eastern Europe, you talk about Turkey, you talk about Maghreb countries, those businesses by and large, they have their ups and downs in every quarter, by and large, they've been pretty good for us. I don't know if that helps you any but I get -- in summary, I think the U.K. is okay and reasonable. I think nobody knows what's going to happen in Continental Europe, and I think the periphery is pretty good.

[Richard J. Hilgert:]

Just the follow-on to an earlier question about the same size wallet, putting out more for additional tools. It seems to me like part of that, that you have to figure into that equation is the advancement of technology over time. For example, Nissan is talking about launching within the next year, Drive-by-Wire in its Infiniti brand. This is going to the first mass-produced use of this technology and that means that the tools and the diagnostics and things that are going to be needed to work on that kind of thing in the garage are going to have to change and you're going to have to come out with new tools. So it seems to me like the kudos that you're getting from the industry magazines all the time and industry studies being done and the drive from the innovation that you do is part of getting that additional amount for the same set of garages that you're already in. You mentioned also earlier in the call, how you have the research that you do there in Wisconsin where you're bringing in people and you're observing them working on vehicles, do you do that kind of thing and is the innovation is as strong over the European market because obviously, you've got a different product set over there that you have to deal with versus what's here in the States.

[Nicholas T. Pinchuk:]

Yes, we do it in Europe and in places but the landscape in Europe, for example, our share of automotive repair is much larger in the U.K. than it is say, Germany or say, Sweden. So we do it. If you're talking about the garage and our observation in the garage, U.K., that model is pretty good, but we don't have a center like we do here. But let me offer this, is that the big customer connection flow, the information flow is not really in Innovation Works. Innovation Works is where we brought observations together with product design closer than ever before. But the by and large -- the blocking and tackling of innovation and customer connection, is every day when the franchisees and our salesmen go into garages and factories and repair facilities and see how things are working, that's how it happens, more than just having it here. And we have that in U.K. Now, what you said about innovation and change, this is our bread and butter because if you think about it, just think about hand tools, we guarantee hand tools for life. So if we didn't have -- if there weren't requirements, different requirements, we wouldn't have a business. So for 9 decades, we've been staying -- we've been having a business based on just the very kind of innovation you described. Nissan changes their cars, we got the best tools.

[Richard J. Hilgert:]

Great. Last area I wanted to talk a little bit about was credit and I was wondering if, first of all, if you could give a little bit more details on the increase in delinquencies, is that Europe and because of the economic conditions over there or something else causing that? And was also curious is how do you handle the differences between -- credit is a very legislated industry and you've got some major differences now between the U.S. and Europe and how do you look at the policies for the 2? How are they distinguished? And in the U.S., with the consumer protection agency now getting really ramped up into more full activity, is there anything coming along there on the credit side that you're going to have to look at when it comes in terms of your policies for setting credit out in the field?

[Aldo J. Pagliari:]

Richard, Aldo here. Let me just jump in and take -- I'll take the easier one of your questions first and that's -- let's talk about delinquencies. Actually the delinquency trends have a seasonal element to them and they're tracking right where we expect them to be in a favorable manner. They will tend to run up slightly up until after the Christmas holidays and when people start getting their tax refunds back in March -- I'm not making this up, you'll see that we usually get a trend that starts to go in other direction. So the trends, if you look back over prior years, it's fairly consistent with our expectations. So if you go back to the quarter Q3 of last year, they were exactly 1.4% as well. So that's a good point. Your questions regarding compliance, sure. Watching compliance is a complicated area and we keep our eyes open but I want to remind you, we are commercial lenders and we strive to be interpreted as such under whether they be state regulations, a U.S. government regulations or are the same in other fields of -- other country operations. And again, there's always new compliance, rules and regulations on the horizon. We do our best to stay abreast of that. We feel we do a good job of complying with that. Should we add some incremental expenses to deal with that, we go with -- we pay that as we go. So we feel pretty comfortable that yes, it's an area that will continue to see more regulation and we're prepared to deal with it accordingly as it comes up.

[Operator:]

We'll go next to Alek Gasiel from Barrington Research.

[Alek B. Gasiel:]

Just a couple of things. Gary -- I'm sitting in for Gary, but kind of getting back to the whole promotional thing in the Tool group, are you able to actually substitute that for the under -- for areas that the van are under-penetrated in? Or is that...

[Nicholas T. Pinchuk:]

No, that's not -- I don't think that really is how it happens. One of the things, we did have more promotions in the quarter in the Tools group, but one of the things that -- one base knowledge that's useful, I think, in this is every month, every week, in fact, we have promotions throughout the Tools group. It's part and parcel with the activity there. It's kind of an excitement builder that rolls through. And so fundamentally, what happened in the Tools group is basically, we're more active in promotions in the quarter. Some of that had to do with the SFC, the Franchisee Conference, where it's kind of the most exciting promotions are sometimes there. We had more people at the Franchisee Conference than ever before, the take-up rate was high and the promotions we offered there, and so that tended to drive some of that increase. That's really it. Those weren't aimed at reaching out to other new technicians or anything like that. The reaching out is more a productivity issue, actually.

[Alek B. Gasiel:]

Are you seeing an increase of people wanting to sign up to be franchisees now?

[Nicholas T. Pinchuk:]

I think we are but we're being very selective. We're not looking to increase the franchise. I mean, you will see the odd franchise, I think we probably went up 1 or 2 vans this quarter and so that happens. We're being very selective and we're happy with the people we're getting. What we're trying to do is make sure -- try to make sure we can anticipate who wants to retire and match up a person in that jurisdiction at that time. That's really the trick now, is to reduce the time to open. We eventually get a guy, but we want to reduce the time. And so, you can appreciate if somebody wants to -- if the franchisee in Tuscaloosa, Alabama wants to retire, you got to have a guy in Tuscaloosa. A guy in Des Moines doesn't help you and so we're working on that now.

[Alek B. Gasiel:]

Okay. And you commented about the muted OEM dealers particularly in Europe. I wonder if you could provide any color on North America. What are you seeing...

[Nicholas T. Pinchuk:]

What I meant by that, if I said OEM dealers, I didn't mean that. I meant OEM manufacturers. What happens is, is that in that particular business, the OEM manufacturers decide to commission an essential tool, often like a special diagnostic unit, a laptop for cars, say Toyota might do it or Honda, or somebody like that, that might say make this diagnostic unit for just my vehicle and distribute it through my dealerships. And they'll have programs that they author and the program might last 8 months, 9 months, a year or something like that where they say they are going to roll these out. And then once it's rolled out, it's over. And then you wait -- you have to get another program to continue the business and we have a series of programs. All we were saying was, is that the programs in Europe are running out and the European OEMs, we believe, are a little bit keeping their powder dry, looking at the economics. Even though new car sales are not so down in Europe, I think they're down about 8% -- but still, I think they're being very careful. And so that's what we're seeing in Europe. In the United States, we're seeing less of that, but it's down slightly, down slightly. And I think that's partially because new car sales aren't bad, but the sort of economic uncertainty, the fiscal uncertainty is dominating whether you want to invest in a long-term program like that.

[Alek B. Gasiel:]

And then, I keep reading about the headline risk and the softness reporting in China. Does that have any impact on you?

[Nicholas T. Pinchuk:]

Well, it can from time-to-time. I mean, we sell into factories, factories are closing down and we sell some into factories. It can from time to time, but we have some offsets to that -- we sell into Repair and the Repair business moves up. So I think our direct linkage to that is unclear and kind of nebulous. GDP was down, I think it was 7.8% but if you looked at power consumption in China, the Industrial business, the industrial consumption of power was down but the consumer consumption was up. So that kind of says that well, the industrial sector is weakening, but the consumers are rolling up and in that balance, I'm not sure how that would affect us really. The big thing is China is a great opportunity for us and we keep building physicals there.

[Alek B. Gasiel:]

One last question. And I know you provided already some color on this. Just on Europe, what is their -- what are you hearing in some of the attitudes from the people you talk to there? And, I mean, just kind of looking at certain pockets of areas, I mean, are Scandinavian countries still holding up or I know...

[Nicholas T. Pinchuk:]

You know, look -- sorry, go ahead, keep going.

[Alek B. Gasiel:]

And I was just going to say I think you commented that Western Europe was down single digits, right?

[Nicholas T. Pinchuk:]

Yes. I would characterize it like this. Of course, the South, Spain and Portugal and those places and Italy and so on, know they are in bigger trouble -- and Greece. They know they've got problems. So when you talk to people, whether your customers -- and our customers are businessmen in most -- by and large, either small or large. And our people, they're very, very, I would say, muted. But they have confidence that they're going to muddle through, they're going to get through this. If you talk to people in what I'll call the other areas of Europe like the U.K. or Scandinavia or France or Germany, they're more positive. They just view this as hey, this is a bump in the road, we're going to batten down the hatches and we're going to go forward. I think our view of -- I think if you read the U.S. papers and you look at Europe, you get more alarmed about the long-term than the impression you get when you walk the grassroots path in Europe. Now I'm not sure who's right, to tell you the truth but you don't get -- I would say, you don't get, I would say, fatalism in Europe. Our people, our customers believe the world's coming back and we believe they're coming back with us.

[Operator:]

We'll go next to David Leiker with Baird.

[David Leiker:]

Just a couple of quick follow-ups here. I hope [indiscernible] On RS&I, Nick, on this OEM dealer business, what's the scale of that these days? How important...

[Nicholas T. Pinchuk:]

I don't know. But by and large, the OEM facing business, the pure OEM facing business is about 1/3 of the business. There are types of the segment -- sorry, the segment, yes. Sorry I misspoke. It's roughly like this, David, the OEM facing business is 1/3, the independent facing business is 1/3, and equipment, which plays in both territories is another 1/3.

[David Leiker:]

And is that -- given the lumpiness of that business, are those returns such that, that's a space you want to stay in or not?

[Nicholas T. Pinchuk:]

Well, the business can be lucrative for us when it's rolling. It is lumpy, but it's not unprofitable now for us. It's just less profitable than the other ones. And one thing that comes through, we like being at least, some of our business, close to the OEMs because we believe it informs us about what's going on for forward thinking around innovation and what's coming in the OEM's product lines. We believe that [indiscernible] something to us.

[David Leiker:]

And then on the power tools side, how much -- do you have any sense of the tools your franchisees sell off the truck? How many of those tools are your tools versus somebody else's and if there's still an opportunity for you to penetrate that deeper?

[Nicholas T. Pinchuk:]

I don't have hard numbers for you but I believe now, a huge share of the tools, the power tools we sell off the truck are Snap-on. I believe, a huge share.

[David Leiker:]

And how important has that been to driving it as opposed to end markets or products or other elements?

[Nicholas T. Pinchuk:]

It wasn't a factor in this quarter. But over time, I can't tell, but not that significantly. When I'm talking about over time, I'm talking about back when I was in C&I, we used to talk about bringing it home, and that now, we're talking what? 2003, 2002, 2004, we used to be -- I ran the business that had power tools in it. We used to talk about gee, we need to get our franchisees confident in our tools so they won't sell other people's, and we did. And that happened gradually over that time.

[David Leiker:]

Okay. And then the last item here as we look at the balance sheet, the manufacturing company here is essentially debt-free. The asset base on the credit company has been rebuilt back to where you wanted it to be. With this cash flow you generate now, what are the priorities for that going forward?

[Nicholas T. Pinchuk:]

Priorities are first, organic growth and we had some pretty good organic growth in some places, dividends and acquisitions and offsetting dilution. Those are the 4 priorities.

[David Leiker:]

And in the organic growth, I mean, the business is essentially self-funding I mean, you throw off more money than you generate there...

[Nicholas T. Pinchuk:]

Well, we're starting to, for sure, yes. I mean, I think you'd be fair to say that we'd start to build up some cash sort of next year, towards the end of next year sometime. And we can put that cash to work.

[David Leiker:]

And then on the dividend, you're paying about 25% of your earnings. Are you implying that, that number can go -- I mean once upon a time, you're paying out almost half of your earnings.

[Nicholas T. Pinchuk:]

Yes, but that was because our earnings were lower. I think the denominator was changed. I think, look, we don't have a set number as a percentage. Our unifying principle around dividends is that we have paid the dividend every year, every quarter since 1939 and we have never reduced it, and that's it. And so every quarter, we assess whether we want to bring our dividend upwards and that's basically what we do.

[David Leiker:]

And then lastly on the acquisitions, you haven't really made anything significant since the Business Solutions business. What are your priorities or where your focus areas in terms of acquisitions?

[Nicholas T. Pinchuk:]

Okay, first, may I simply say though, before I say that is that I kind of view the credit company as a pretty big acquisition. If we had goofed it up, people would've been talking about integration and things like that. So I think it was a kind of acquisition in a way. But look, here's our priorities

[David Leiker:]

And understanding that timing of those things can be challenging, is that something that's 3 years from now, you hope to be able to execute on some of those or is it -- if something comes along it comes along?

[Nicholas T. Pinchuk:]

Well, I think we believe there's opportunities. We believe we're coming out from under the credit company, we believe we turn the cash on other things. I mean, I think it's timed by the credit company coming out of getting fulfilled. And so that's when we start looking at that. I think I've been saying this to other people for a while. But I think as I said, sort of next year, we're starting to get in that situation where we're looking very aggressively at these kinds of things. And we -- most us have quite a bit of experience integrating and acquiring companies. So I don't think we have any trepidation about doing any of this stuff.

[Operator:]

Thank you. I'd now like to turn the conference back over to your host, Leslie Kratcoski.

[Leslie H. Kratcoski:]

Thanks for joining us, everyone. A replay of the call will be available shortly on snapon.com. And as always, we appreciate your interest. Thanks very much.

[Operator:]

That does conclude today's conference. Thank you for your participation.