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Snap-on Incorporated (NYSE:SNA)

Q3 2008 Earnings Call

October 23, 2008 10:00 am ET

Executives

Nicholas Pinchuk – Chief Executive Officer and President

Martin Ellen – Chief Financial Officer and Senior Vice President of Finance

Analysts

Analyst for David Leiker - Robert W. Baird

Alexander Paris - Barrington Research

Jim Lucas - Janney Montgomery Scott

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: remember, they are served by our Snap-on tools distribution channel, the van.

With those customers we remain the leader, the aspirational brand of choice; this is clear. That’s a relatively long wave segment. At this point we see a mixture of both headwinds and tailwinds.

For example, fuel prices have begun to decline. That’s probably the one bright spot in the macroeconomic situation. But that will lower cost for our franchisees and will possibly dampen what we’ve seen to be the downward trend in miles driven.

But in addition for that segment, government data through August continues to report an increase in household spending on vehicle repair. I guess that’s not surprising given the dramatic decline in new car sales.

Think of it this way: as I believe I’ve said before, almost 40% of the car park in the United States is now older than 10 years and it’s getting older. So increased spending on repair seems logical, it seems right.

Beyond the vehicle age, I also think we must consider that much of U.S. driving is not discretionary. With the non-discretionary nature of the driving we’d expect repair to remain somewhat resilient, even in the face of economic slowdown and that’s what we’re seeing.

With all of that said however, technicians are certainly exposed to the uncertain atmosphere. We expected both technicians and garage owners to be more cautious in their spending and it’s played out, it appears to be so.

It’s not a surprise that the sales of higher priced tool storage products were again soft and the volume of our larger diagnostics products in the United States was down in the third quarter.

But overall, technicians are still spending on the innovative tools that make them money. We’ll speak in that context later when we talk about power tools and some of the innovations we’ve brought to the market in that product line.

As I said, the U.S. auto market, some headwinds, some tailwinds, but all in all, one of the more reliable segments of the day.

Let’s talk about the tools group. We’re pleased this quarter that we did have a slight uptick in U.S. van count, both versus 2007 and on a sequential basis versus last quarter. Significantly this is the first year-over-year improvement in some time, so we’re encouraged.

But while we’d like to fill the open territories even faster, we’re being selective in recruiting. We believe that’s been the right thing to do. It’s lowered new franchisees’ terminations and reduced termination costs. That’s been a help. Selectivity notwithstanding though, we continue to recruit actively and we expect further increases in van count in the fourth quarter.

Let’s talk about our franchisees for a minute. We believe the outlook does remain positive. In early August, we had a U.S. franchisee conference in Las Vegas. I spent three days with many of the almost 2000 franchisees attending. Their attitudes were positive and they were quite excited about our new product lineup. In fact future orders from that get together vastly exceeded our expectations.

Even in August though, we recognized the need to help the franchisees offset cost pressures. A significant portion of that colloquium was dedicated to raise van efficiencies, dedicated to improving items like fuel costs, selling methods and communications charges.

The training was as enthusiastic as we’ve seen and we think it’s working and we’re confident it will serve us well going forward. Despite the convention success however, we need to be mindful that more economic uncertainty has arisen since early August. So we are cautious, at least for the fourth quarter for our U.S. franchisee business.

While the U.S. business saw a decline in the quarter, the results were very different for the franchisees in Canada, U.K. and other international franchise operations.

In those jurisdictions, we achieved growth of almost 10%, driven largely by innovation, a number of new product launches in areas like diagnostics and power tools; all of them had significant success in moving the technicians to purchase.

Let’s talk about our industrial business. Our focus remains on critical customer segments like the military, aerospace, natural resources, alternate energy and automotive vocational training.

We’re rolling the Snap-on brand out of the garage and it’s working. Growth did slow from 21% last quarter to about 3% the past period, but year-to-date it’s 14% and we believe the variation over the last two quarters was influenced strongly by customer order timing and a strike at one of our large customers.

Order activity for industrial is now very strong, so we expect a return to double-digit growth in the fourth quarter. We’re positioning to serve the tool storage and control needs of great opportunities like the expanding natural resources sector and the new major airframes being introduced around the world.

We continue to invest in industrial product and resources to support that business and we see abundant runway going forward in that area and we’re going to take full advantage; we’re determined to do it.

Two of the more challenged businesses in the quarter were our European tools business and our worldwide equipment business. At SNA Europe, while the market coverage is fairly broad based across Europe, the operation has some concentration in Southern Europe, particularly in Spain where sales declined in the quarter by 20%.

While the economic conditions have slowed throughout the region, Spain has been weaker than most and that’s resulted in a challenge for SNA Europe.

In the global equipment business, which sells larger priced capital goods, sales were down 5% without currency. That’s not unexpected in this tight credit environment.

But even though the sales environment has become more challenging, we’re continuing to advance our technologies. Over the last few years product innovation has been the key to significant improvements we’ve see in equipment and that’s continuing.

In this past quarter we introduced our Prism imaging alignment system, which won Motor Magazine’s Top 20 Tools award. Sales by Prism are exceeding expectations despite the overall downturn and volume in the bellwether imaging aligner category for equipment was up significantly.

In equipment, we are continuing to innovate and as a result we’re advancing penetration of our targeted key accounts and despite the softness, we believe we’re gaining market share although it is in a weak market.

Also in the C&I segment, let me talk for a moment about automotive power tools. They had a terrific quarter and it aided the franchise business significantly. Sales improved almost 34% and this is just another innovation story.

Our new NG725 pneumatic impact wrench and our CT4410 cordless impact, both are power to weight leaders and have and continue to be enormous successes. As with our equipment business, power tools has had a string of successful new product launches and we have a solid pipeline of new products coming to us over the next few quarters.

We’ve consistently said for technicians, power tools are an essential purchase. They translate into immediate productivity and therefore will do well even in a softer environment; so far this appears to be the case.

The diagnostics and information group also had an encouraging quarter, considering the market for bigger ticket items. The European diagnostics business expanded in the period and our OEM facilitation won an essential tool deployment in North America that significantly aided its third quarter.

Now while business solutions sales did decline, much of that was expected as a result of exiting small peripheral lines of business. Activity in the SBS, the Snap-on business solutions core, however was favorable in the quarter.

In total, for the diagnostics and information group from a profitability perspective, that organization achieved an operating margin of 17.5% and the profits represented a growth of over 20% for the quarter.

Now let’s turn to slide 7. I think this is important because it’s authored our success for many quarters: we continue to drive improvement across our business. We drive it with a suite of strong and critical processes; we call those activities Snap-on value creations. That helped author our third quarter and it will drive further improvement going forward; we are confident.

I’ve already mentioned a few of the innovations; there are many more across all the businesses. But we’re going to keep investing in innovation. In fact next month we’ll be opening another Snap-on Innovation Center, right here in Kenosha. We call it the Snap-on Innovation Works.

It will include areas to observe customers interacting with products; a modern auto repair garage; space for both two and three-dimensional prototyping; and an area specifically devoted to the critical industries I talked about before.

I look forward to many of you visiting and when you do, you’re going to get a first hand view of Snap-on innovation taking shape.

Another process that’s important to us and crucial to us is rapid continuous improvement or RCI. It’s played a major role in our progress. We see its results almost everywhere, from manufacturing to administration to product design.

For example, our COT in our U.S. distribution business continues to perform in the mid-90s range, and while that’s good and much improved over just a short time ago, we need to make it better and we will.

From a productivity viewpoint, RCI has enabled us to raise sales for associates by over 8%. In the past quarter, we did see more than $10 million of commodity cost inflation. Those increases were substantial, but they were more than offset by our RCI activities.

While the commodity price increases are softening going forward, we still feel, I believe, that fourth quarter costs for steel freight packaging and other items will increase by about $12 million. But we’re confident that we can achieve offsets through RCI just as we’ve done so far.

While economic difficulties clearly increased in the third quarter, I think you can say that the Snap-on team met those challenges and prevailed. Sales were tougher to come by, but we continue to seize opportunities in those places where growth was made available by our diversification.

We continue to innovate, stimulating demand, even in the face of economic weakness. We continue to aggressively deploy RCI, further improving processes and reducing costs.

While inventories have risen somewhat, there were clear purposes for that positioning. We believe that some of that paid off in capturing additional businesses in emerging markets and with selective customers. That drove up our return on capital.

Having said that though, some was aimed at sales that didn’t materialize and we’ll begin correcting for that in the fourth quarter. As I said, the fourth quarter was a strong quarter. Our business models, our brand, our innovation, prevailed in economic difficulties.

Now I have Marty here to give you some of the details.

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: not reflective of credit deterioration, but of higher franchisee turnover and consolidation of Snap-on Credit’s field organization.

For years prior to 2005 and going all the way back to 2001, the highest level experienced was about 2.2%. We believe this demonstrates the discipline, strength, and tight integration of our Snap-on Credit and franchisee distribution businesses.

While operating earnings in financial services were down year-over-year for the quarter, this had nothing to do with their core credit operations. We incurred $1.4 million of one-time expenses primarily related to an information systems project.

Let me turn to a brief discussion of our balance sheet and cash flow. As seen on slide 14, our accounts receivable increased $19.3 million from year-end levels, primarily due to higher levels of sales and receivables outside of the United States.

Notwithstanding generally longer payment terms outside the U.S., days sales outstanding of 73 days was equal to last year. All of our businesses are being extra vigilant in managing customer credit in this environment.

Inventory performance has been somewhat disappointing with inventory turns declining from 4.9 times at last year-end, to 4.5 times currently. Of the nearly $66 million inventory increase over the nine-month period, we believe about $20 million or so is the result of lower than expected sales.

The remainder includes higher material and other cost increases, planned builds ahead of certain production line relocations, and some seasonal build for school programs and other specific fourth-quarter sales initiatives.

As Nick said, we’ve already begun addressing this inventory position and even with the added level of working investment, pre-tax return on invested capital continues to improve.

For the trailing 12-month period ended September, it was 22%, and for all of calendar year 2007, it was about 20%. For the comparable September 2007 period it was 18.4%. Our net debt position at the end of the quarter is $397.6 million. Our net debt to total capital of 22.4% is down from 24.9% at year-end 2007.

Our liquidity position remains strong. Besides the cash flow generated from operations, we currently maintain a $500 million revolving credit facility provided by a strong diversified group of international banks and another $20 million of committed bank lines.

All $520 million of this borrowing capacity is not presently used and our revolver does not expire until August 2012. Our current A2/[P-1] short-term credit rating also allows us to access the commercial paper market should we need to do so. We presently have no commercial paper outstanding.

Turning to slide 15, cash provided by operating activities was $20.4 million, or $39 million lower than the third quarter last year. The primary reason for this decline relates to the inventory build I just mentioned, which amounted to about $23 million for the quarter, as well as other timing differences primarily related to accounts payable and accrued liabilities.

This concludes my remarks on our third-quarter performance. I’d like to briefly review with you some financial considerations for the balance of 2008, which are shown on slide 16.

Regarding full-year 2008, we expect to continue to invest on our growth initiatives, including further investments in Asia and other global emerging markets, while aggressively managing cost.

We also expect to continue implementing our other strategic and RCI initiatives intended to enable higher levels of growth and profitability. We anticipate full-year 2008 restructuring costs to be in a range of $12 to $14 million and we expect capital expenditures to be in a range of $60 to $65 million.

As I said, we also expect our 2008 effective income tax rate to approximate 33.3%. Finally, we expect earnings will improve over 2007 levels for the balance of the year.

Before opening the call for questions, Nick would like to provide some final thoughts.

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.

Question-and-Answer Session

Operator

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

Jim Lucas - Janney Montgomery Scott

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 - Janney Montgomery Scott

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 - Janney Montgomery Scott

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: big tool storage equipment, big diagnostics. Having said that, though, the message of the call I think was for equipment and for the tool side, innovation is selling; those two power tools are great tools and they are selling.

The Prism new aligner is selling; the imaging aligner business is up substantially because of that. Some of our other product is off, you might say even further, but in fact we believe as we see our new products roll out and we look at our pipeline and feel pretty good about it, it impels purchase even in this difficult time.

Jim Lucas - Janney Montgomery Scott

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 - Janney Montgomery Scott

Okay. Great. Thank you for the clarity.

Operator

Our next question is from Alexander Paris - Barrington Research.

Alexander Paris - Barrington Research

Hi, good morning, nice quarter again.

Martin Ellen

Thanks Alex.

Alexander Paris - Barrington Research

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: one is the critical industries that we refer to, things like aerospace, oil and gas, and natural resources and the like are continuing to be reasonably robust and there is demand.

Secondly, we’re gaining share because pretty much the Snap-on brand was trapped in the garage for a long time. So we’re rolling it out of the garage and it’s capturing the attention of quite a few users. We believe pretty clearly that we continue to gain share in that sector.

You could say the four big drivers would be, sure the emerging markets, Eastern Europe and Asia-Pacific; two, critical industries; and three – and I want to emphasize this – innovation, because in this market, innovation is still selling.

To our customers, innovation is still selling. We saw that with the 2000 franchisees in August and we saw a number of activities in this past quarter, the Prism is one of them.

I could also add based on innovation, we haven’t really unleashed our diagnostics product in Europe yet. The sales there have been relatively small and over the last quarter, we’re starting to unlock some of that potential. I might add diagnostics in Europe to that play.

No one can predict where we’re going in this volatility. I think you guys read the same articles and see the same papers that we see. No one can predict it. But I’ve been around the block and there is no group of businesses, no group of business models, no brands, no pipeline of products that I’d rather go to war with than the hand we’re sitting on right now.

Alexander Paris - Barrington Research

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 - Barrington Research

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 - Barrington Research

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 - Barrington Research

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 - Barrington Research

Right.

Nicholas Pinchuk

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

Alexander Paris - Barrington Research

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 - Barrington Research

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 - Barrington Research

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 - Barrington Research

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 - Robert W. Baird

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 - Robert W. Baird

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 - Robert W. Baird

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.

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Source: Snap-on Incorporated Q3 2008 Earnings Call Transcript
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