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Snap-on Incorporated (NYSE:SNA)

Q1 2008 Earnings Call

April 22, 2008 10:00 am ET

Executives

Marty Ellen –SVP, CFO

Nick Pinchuk – President, CEO

Analysts

Jonathan Steinmetz – Morgan Stanley

Alexander Paris – Barrington Research Associates

Jim Lucas – Janney Montgomery Scott

Operator

Please stand by. We are about to begin. Good day ladies and gentlemen and welcome to the 2008 first quarter results conference call hosted by Snap-on Incorporated. (Operator instructions). I would now like to introduce your host for today’s conference, Mr. Marty Ellen, Senior Vice President and Chief Financial Officer. You may begin your conference, sir.

Marty Ellen

Thank you, Anthony, and good morning everyone. Thank you for joining us today to review Snap-on’s first quarter 2008 results. By now, you should have seen our press release issued this morning. We believe that despite more difficult business conditions in certain markets, this quarter continues to demonstrate the strength of our business model and the progress we are making in many of our core operating and growth initiatives. We will 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 achievements this quarter. I will then provide a review of our financial results, and afterward we will take your questions.

Consistent with past practice, we will use slides to help illustrate our discussions. 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 re-broadcast by any means without Snap-on’s express permission. With that said, I will now turn the call over to Nick. Nick?

Nick Pinchuk

Thanks, Marty. For those of you following the slides my comments are outlined starting on slide #5. In general, Q1 was another encouraging period for our corporation – sales of $722 million and earnings of $0.97 a share. Having said that I think we all know that the business environment was quite turbulent, and for Snap-on, that resulted in some specific positives by favorable interest rates and, of course, it created some general negatives like lower demand for larger purchases. Overall, the operating earnings were up almost 36%, or $25 million.

This is even though our sales were up only slightly after adjusting for currency and offsetting the timing of our OEM facilitation program. Nine million of that increase came from our Financial Services segment. That was reflecting continued strong yields, ongoing solid delinquencies, and lower market interest rates. And all of that came together to drive that improvement. Now, we cannot take credit for the earnings that resulted from interest rate movement, but what we can be encouraged by is executing our strategic initiatives across the corporation.

With that overview, I would like to give you my take on the quarter. Looking at slide 6 – North American demand for hand and power tools remains strong. Innovation and continuing demand for immediate productivity solutions, they are serving us well. On the other hand, sales of big-ticket items – things like tool storage boxes – they were impacted significantly by the economic atmospheres. Beyond our home market, diversification has been an asset. Our Worldwide businesses provided offsets to the North American turbulence.

I believe I highlighted in the last quarter that Snap-on is increasingly an international corporation. In fact, in the period, 44% of our sales came from outside the United States, and it helped. A good example was the Worldwide Industrial business with global reach and with customers in critical industries like aviation, natural resources, and power generation, and, therefore, with activities in sectors that follow a diverse set of macroeconomics, that business grew pretty robustly. Emerging markets were also strong, although expansion in that area is on a relatively small base.

As we announced in our press release, we just completed the acquisition of a 60% majority ownership of Wanda Tools. It is now named Wanda Snap-on Tools. It is located in Zhejiang, China about 2 ½ miles southeast of Shanghai, and it is probably, we believe, the premier manufacturer of pliers in China. The venture employs about 1,000 associates and has over 750,000 square feet of manufacturing space, and it brings with it extensive and relatively sophisticated product test labs that will serve us well going forward. Wanda provides Snap-on, as we see it, extensive capacity for Asia-based, high-quality, hot-forged hand tools, and we are confident it will be a major contributor to the future of our corporation. We have very pleased to welcome Wanda associates to our Snap-on family.

We also recently approved another capacity expansion to add tool storage manufacturing capacity for our plant in Zhejiang, China. If you put them together, Wanda Snap-on and Zhejiang expansion, these are two more important steps in filling out our product line and building our capabilities in the critical Asia Pacific theater. We expect them to play a growing role in our path to the future. Now on slide 7, the first quarter also saw continuing product innovation. We believe in innovation that is consistent with our strong brand position.

Innovation of investments across the corporations are continuing at a rapid. In every business, in every product category, from hand tools, to power tools, to equipments, to diagnostics, to information-based products and across numerous dimensions with advancements in metallurgy, ergonomics, technology, processes, content management, and imaging. The new products that we have spawned from those efforts are tremendously important to us, particularly in today’s environment and difficult economic environments that we see today. A great example is the NG725 pneumatic impact wrench – Light magnesium body, extraordinary power, great ergonomics – it is the market leader now.

Talking about power tools if we could for a moment, a recent Frost & Sullivan survey, a survey of North American auto technicians, confirmed what we had already known. Based on innovations like the NG725, Snap-on power tools are now the top choice of technicians, and we are pulling away from competition. Over 40% of techs now prefer the Snap-on Grand, and that is up substantially from just a short time ago. So that is part of the reason that power tools products have remained strong even in these difficult times.

With that overview, let me landscape the individual groups. As shown on slide 8, the Commercial and Industrial group, we call it C&I, registered sales increases of about 3.5 or 3.4% excluding currency. As I mentioned before, Worldwide Industrial and Asia Pacific were prominent contributors. Those increases, however, were partially offset by a shortfall in S&A. Europe, our tool business in Europe, where we saw some weakness that surfaced in the slowing economies of Southern Europe, particularly in Iberia. Earnings for the group were up 36%.

These included gains from currency translations and lower restructuring expenses. But having said that, the primary earning drivers were the increased volume and strong cost reductions across the business, which more than offset higher levels, about $2.4 million higher, of investment in new markets for the period. For C&I, I believe we can safely observe that Q1 was a confirmation of the group’s diversity, its ability to withstand strong headwinds, and its continuing opportunity for efficiency improvement.

Let’s talk about the Tools group. That is slide 9. Overall sales were down 2% compared to 2007, 3% in North America. This reflects the continuing lag in North American van count versus last year, and it is also due to a difficult comparison with the 2007 introduction and initial van fill of our mid-tier product line. The van count was, in fact, up sequentially from the fourth quarter of last year. Reduced franchisees, terminations, and ongoing recruiting efforts made progress. That is the second straight quarter we have had an increase after a relatively long string of decline. That is the good news. The difficulty is that when compared with the levels of last year’s first quarter, the van count was down by about 1.4%. In addition to that hurdle, the mid-tier line was rolled out in Q1 of 2007. Comparison against that initial van fill resulted in another 1% or so of sales shortfall.

If you step back from those structural items, the ongoing van business did see continuing strength in hand and power tools. As I believe I said in last quarter’s calls, these are the products which immediately help detect [unintelligible] money, and the demand has remained robust. As you might expect, though, bigger purchases like tool storage boxes have been impacted by the environment. They are down substantially over last year at this time, and on balance, we saw a flat quarter for US vans. Big-ticket reductions offset the strength in hand and power tools.

Going forward, though, we believe filling open van territories is a near-term opportunity. We continue to work hard in recruiting, training, and other initiatives to continue that improvement quarter-by-quarter, and we do, therefore, expect to see year-over-year progress as well as continuing strength in our hand and power tool line. Looking inward, execution across the group is improving. Terminations are down, complete and on-time deliveries are improving, our COT, or complete and on time, rates are up to 94%, that is an increase, and costs are being reduced in line with the times. Along that line, we improved the field organizations significantly in the quarter reducing the regional sales offices from 13 to 9. That move will result in lower cost and better resource alignment to support the franchisee, so we expect significant benefits for the Tools group from that change going forward.

In the Diagnostics and Information group, organic sales growth was 5%. Now that excludes the OEM Facilitation business where because of the wind down of two essential tool programs, they experienced a $19.5 million sales decline. When we step back from that, I believe when we look at the organic growth, it is clear evidence that our software and information based products are continuing to sell and sell with reasonable strength, and they are contributing substantially to the improved profitability of that segment. Also in the quarter, Snap-on Business Solutions performed consistent with our expectation, and made the solid contribution we always anticipated it would when we acquired it.

Turning to slide 10, it is appropriate in rounding out my comments that I touch on our Global RCI and Lean initiatives. We are spending quite a bit of time, energy, and commitment to imbed those processes into our culture, and I think it is clear they are paying big dividends. It is making us more responsive to our customers and helping us to reduce cost. An example, the first quarter is a great example. In the first quarter, we show that rising global commodity prices and other inflation pressures clearly raised our cost, maybe in the neighborhood of $8 million compared to a year ago. While our RCI initiatives more than offset that ride and made a significant contribution to earnings growth in the period. Consider that our consolidated operating margin in the quarter reached 12.5%, that is up 290 basis points from a year ago. Excluding the contribution from Financial Services, operating margins would have been up 11.1%, up 190 basis points. In a world of increasing inflation and competition and economic bad news, we believe that is solid evidence of continuous improvement.

In closing, I want to thank our franchisees for their loyalty and their ongoing contributions, which are a major strength for our corporation. I also believe that it is important to note that these results would not have been possible without the efforts of our associates across the globe, and to each and every one of them I offer my congratulations and my thanks. Now Marty will take us through the financial results. Marty?

Marty Ellen

Thanks Nick. I will begin on slide 12. Net sales of $722 million in the quarter increased $16 million from 2007 levels. Currency translation added $33 million while our OEM business declined by $19.5 million as Nick already mentioned. As we have said before, our revenue comparisons can be significantly impacted by the timing of these OEM programs. Factoring out the impacts of both currency and OEM programs sales decline, sales for the quarter across all of our other businesses were up slightly.

On the positive side, we continue to experience higher sales to industrial customers worldwide and growth in emerging markets as well as increased sales of higher-margin diagnostics and information products. On the down side, we experienced a 3.1% decline in US franchise sales in the Snap-on Tools Group. As a measure of productivity improvement, sales per associate were up 10.5% from comparable 2007 levels as we continue to advance our RCI initiatives.

In our Financial Services segment, revenue increased $12 million, and operating income improved $9 million, primarily reflecting lower market interest rates. Consolidated gross profit of $326 million was up $16 million compared to the first quarter of 2007. In dollar terms, the gross profit improvement includes $11 million of currency translation, nearly $7 million of savings from RCI initiatives, which more than offset $5.6 million of material and other cost increases. Restructuring costs were lower by $3.6 million, and LIFO-related inventory costs were lower by $2.1 million.

These increases were, of course, partially offset by the effect of the lower organic sales. As a percentage of sales, gross margin improved to 45.2% in the quarter, up 130 basis points from prior year levels. The improvement in the gross margin rate was also due to an improved sales mix that resulted from higher sales of higher margin diagnostics and information products and lower OEM facilitation sales, which typically have lowered comparable margins.

Operating expenses of $245 million in the quarter were essentially flat with 2007 levels. Unfavorable currency translation added $8.6 million. Increased spending to further expand our presence in emerging and growth markets added $2.4 million. These were largely offset by over $6 million of benefits from RCI initiatives and $4.6 million of benefits from lower franchisee termination costs.

Operating earnings of $93 million for the quarter were up nearly 36% from 2007 levels. With currency translation contributing $3 million of the nearly $25 million increase. Operating earnings as a percent of total revenues improved 12.5%, up 290 basis points from the 9.6% earned a year ago. Interest expense in the quarter is down $1.8 million as a result of declining interest rates on our floating rate debt.

Our effective income tax rate in the first quarter of 33.4% is up slightly from the 33% that we have previously communicated. This is due primarily to the geographic mix of our earnings. We anticipate that our full-year 2008 effective tax rate will now proximate the first quarter rate of 33.4%. As a result of these factors diluted earnings per share from continuing operations of $0.97 in the quarter were up 52% from the $0.64 earned last year.

With that as an overall summary, I will now turn to our segment results. Starting with the Commercial and Industrial group on slide 13, segment sales of $357 million in the quarter increased nearly $35 million over 2007 levels. Currency translation added about $24 million. Organic sales growth was 3.4%. Organic sales increases included higher sales of tools to industrial customer, continued strong sales growth in emerging markets, and increased sales of power tools.

These increases were partially offset by lower sales of BAHCO professional tools, primarily in Southern Europe, although recent sales order activity has improved. First quarter operating earnings of $38 million for the C&I group were up 36% year-over-year on higher sales, ongoing contributions from RCI, and $3.9 million of lower restructuring costs. Currency translation added $1.6 million to operating income. Our industrial business has sales growth of 17% and contributed importantly to the operating income increase in the segment. RCI improvements more than offset about $4.8 million of inflationary and other cost increases. We also spent an additional $2.4 million to further expand our sales and manufacturing presence in emerging and growth markets. As a percentage of sales, operating earnings in the C&I segment improved 200 basis points in the quarter to 10.7% as compared to 8.7% a year ago.

Turning now to slide 14, the Snap-on Tools group had first quarter sales of $289 million, which were up slightly from prior year levels. Without the contribution from $7.5 million of currency translation, organic sales declined 2.3%. In the US, sales declined 3.1%. US van count this quarter-end was up slightly from year-end, but down 1.4% as compared to last year’s first quarter. About 1% or so of the US sales decline resulted from lapping the van fill associated with our mid-tier product launch last year. While sales of large ticket tool storage and equipment products declined, this was mostly offset by increased sales of hand tools.

First quarter operating earnings for the Snap-on Tools group of $34.4 million were up over $5 million from prior year levels. The impact of the lower organic sales in North America was more than offset by benefits from cost improvements and RCI initiatives, including $4.6 million of lower franchisee termination costs due to lower number of terminations and improvements in the process. Operating earnings improved from 10.2 percent of sales for the first quarter of 2007 to 11.9% of sales in 2008. This year’s first quarter included very little LIFO effect, but the year ago quarter included $2 million of LIFO-related charges. Currency translation added $1.4 million to operating income.

Turning to the Diagnostics and Information group, which is shown on slide 15, first quarter sales of $155 million were down $11.5 million before $2.7 million of contribution from currency translation. The OEM Facilitation business experienced a $19.5 million sales decline. They were lapping a first quarter 2007 roll out of a major essential tool program in North America and the wind down of a program in Europe. The rest of the segment grew 5.1% on higher sales of diagnostics and Mitchell 1 information products. As a percentage of sales, operating earnings of $20.4 million in the quarter improved to 13.2% in 2008 from 12.6% in the first quarter of 2007.

Turning to slide 16, our Financial Services segment revenues were $25.4 million compared to $13.4 million last year while income from Financial Services rose from $3.7 million last year to $12.8 million this year. The increase in both revenues and income relates primarily to our US Credit business as a result of lower market interest rates. The discount rate on extended credit contracts fell by about 290 basis points when compared to a year ago.

Now let me turn to a brief discussion of our balance sheet and cash flow. As seen on slide 17, our accounts receivable and inventory levels increased $63 million from year-end levels with about $30 million of the reported increase coming from currency. The three-day increase in day sales outstanding to 76 days was primarily due to a shift in business mix. Inventories in Industrial and Asia increased to support higher sales growth. Our net debt position at the end of the first quarter is $409 million, which is down from $425 million at year-end 2007. Our net debt to total capital of 22.8% is down from 24.9% at year-end 2007 and down from a high of 31.5% shortly after the Business Solutions acquisition.

Turning to slide 18, cash provided by operating activities in the quarter was $74 million, up significantly from $27 million in the first quarter of 2007. Free cash flow of $59 million was also up significantly from $13.7 million last year. We also completed the acquisition of a 60% interest in Wands Tools, a hot pour, hand-tool manufacturer in China, at a cost of $13.4 million. The acquisition, which closed in March, had no material impact on quarterly operating results.

This concludes my remarks on our first quarter performance. Now I would like to briefly review with you some financial considerations for the balance of 2008. These are shown on slide 19. With respect to full-year 2008, we expect to continue to invest in our growth initiatives including further investments in Asia and other global emerging markets. 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 $15 to $20 million and full-year capital expenditures to be in a range of $55 to $60 million. And, as I already said, we also expect our 2008 effective income tax rate will approximate 33.4%. As a result, we continue to expect that full-year 2008 sales and operating earnings will improve over 2007 levels.

Before opening the calls for questions, Nick would like to provide some closing thoughts. Nick?

Nick Pinchuk

Thanks Marty. I believe we can summarize by saying the first quarter results were affected by some big winds: favorable interest rates in an unfavorable North American economy. The results reflected some challenges, weak big-ticket sales, working off our year-over-year lower van count, and the timing of the OEM essential tool programs. It also represented some nice gains: worldwide Industrial serving critical industries, Asia Pacific increased and growing our capability, and our Diagnostics and Information software sales remain strong. It is also worth noting that RCI again played a big part in our quarter. The operations overcame cost increases and then some with strong productivity and efficiency gains.

Going forward we are quite positive. This corporation has strong positions, robust business models, extraordinary brands, and a diverse customer base and significant runway. As we have said in the past, there also remains abundant opportunity for improvement throughout the organization. On top of that, we believe we have a strong team that is committed and capable to take full advantage of the opportunities going forward. With that, operator, I will turn the call over to questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions). We will take our first question from Jonathan Steinmetz at Morgan Stanley.

Jonathan Steinmetz – Morgan Stanley

All right, great, thanks. Good morning everyone, can you hear me okay? So a few questions. First, starting in the dealer group can you just elaborate a little bit upon the $4.6 million of lower franchisee terminations? Just talk a little bit maybe about what exactly this consists of and if you are able to provide the absolute levels year-on-year so that we can compare it and try to get an idea of how long this can persist.

Marty Ellen

Good morning, John, it is Marty. That is the lower cost of terminations associated with a lower number of terminations. So terminations are going down, that is the good news. You should surmise that from the fact that our van count is starting to level out over the last couple of quarters, and we have improved the process. Our field structure, our franchise performancing structure, one of the reasons it was put in place to work more closely with our franchisees, and those that are in trouble we are working with sooner in the process, and by doing that we recover more in the termination process, particularly in terms of inventory recovery, which the more we get back from them, the lower our accounts receivable exposure is. So that was an important process improvement. I do not have last year’s number, Jonathan, but we actually think going forward we should still expect some favorability in terms of lower termination costs.

Jonathan Steinmetz – Morgan Stanley

So not just staying at this level, but from a year-on-year perspective, continuing to be favorable?

Marty Ellen

We think because we have improved the process, remember that is a big part of our CI is process improvement, we will have terminations, hopefully lower terminations. That continues to be our plan as we build the fleet back of vans and franchisees, but because of the improvement in the process, lower terminations, we expect some upside still in future quarters.

Jonathan Steinmetz – Morgan Stanley

Okay, and I know you don’t know the exact number, but just maybe order of magnitude. I am just not exactly sure whether this is a $15 million line item or $20 or $30 or whatever it is, but any order of magnitude that you can provide.

Marty Ellen

I would characterize it in the mid teens.

Jonathan Steinmetz – Morgan Stanley

Okay. Sticking with the dealer group, you guys commented that big ticket items were down substantially and some of the hand tools were up. Can you talk about how far down they were and maybe what percentage of your business this consists of, because it seems like hand tools would have had to be up a lot to get you even to where you were.

Nick Pinchuk

Jonathan, this is Nick. Hand tools and power tools were both up. They were up between 5 and 10%. The big ticket items were down somewhat more, closer to 10%, so that’s the kind of balance. We actually sell more power tools and hand tools in aggregate than we do tool storage and what we would classify as big-ticket items. What you do is you have a bigger base of hand tools moving up pretty robustly between 6, 7, 8% depending on what product line you look at, and tool storage is down close to 10%.

Jonathan Steinmetz – Morgan Stanley

Okay, we can triangulate with the mix. And the last question I guess I would have is on the finance income. Do you think $12 to $13 million, is that sort of a sustainable level in your view as we move throughout the year? I am just trying to short rate to move back up a little bit in the last few weeks. I am just trying to understand. We have clearly been unable to model this line item, so I am just curious. I know you do not provide guidance, but how should we think about that going forward.

Marty Ellen

John, this is Marty. As you know, first of all, the revenue, it is the US part of the business that is driving all of this. The revenue that we report comes from the sales of contracts, so the discount rate is very sensitive to that gain and, of course, as I said rates were down 290 basis points. The benchmark rate, I would need look at, there is a two-year treasury given the average term of those contracts. So one has to take a view on where you think interest rates are going to model that. That is point one. I am not going share our view. Everybody has got, probably, their own view. We think rates will stay at these levels for a little while.

The other comment I would make is originations are obviously the underlying volume measure you saw in the slide. Originations were up a little bit. Stuff that gets financed through our credit business are the larger ticket items. And actually, interestingly, while we commented tool storage, for example, was down in the quarter if you look at the trajectory through the quarter, it actually picked up a little bit as we exited the quarter. So maybe that is a good sign. But to model it, you really have got to think about the movement and underlying [unintelligible] treasury, and you have got to think about the level of originations.

Jonathan Steinmetz – Morgan Stanley

Yeah, and I guess with the originations picking up it seems like there is a little bit of a disconnect, so are people going to you guys more for financing as a source of credit ability, and lastly here, and I’ll jump off and let someone else go on. You had talked in the past about delinquency statistics here without seeing a big uptake are you starting to see any change at all there?

Marty Ellen

First of all, John is right. I mean, obviously with sales down and originations up that meant more business came. But not surprising over the last couple of years we competed with cheap credit card offerings and like, and of course, those had simply gone away. So we become the next best attractive financing alternative. And the portfolio continues to perform very well. In fact, when we look at 30 days plus and 60 days plus delinquency trends, they are actually down at the end of March and still at very low historic levels, that uptake a little bit we commented at last quarter at the end of December. So that draws the contribution as Nick said, the portfolio yields. We have not changed our pricing parameters. We have priced this credit risk, we think very appropriately, and when we have managed delinquencies well and then get the tailwind associated with a low discount rate, as you have seen here. You would see it again if you went back to 2003 when rates were low, we get a very nice contribution from that business.

Jonathan Steinmetz – Morgan Stanley

Okay, thank you.

Operator

We will go next to Alexander Paris at Barrington Research Associates.

Alexander Paris – Barrington Research Associates

Good morning, great quarter. Of course we would like to see a little better top-line growth. Speaking of that, the RCI, do you have enough projects out there to keep the same kind of net positive contribution or close to it for the remaining quarters of the year to you think?

Nick Pinchuk

I think we feel pretty strongly that that is true. I think we said that we had 103 or 104 dedicated RCI people sprinkled throughout the organization. They are all working diligently. We have people here guiding them. We are still involving [not a clue] from Japan. So we feel pretty strong about the opportunity. I think I have shared this with you perhaps before when Marty and I or Jack walk around the corporation, we just see so many ways in which we can improve. And I think we have said that we are targeting 2010, we see ourselves making strong mid double digit returns, and we feel we can get there pretty much through cost reduction. Or we would like to get there through balance, but if we had balance between sales and cost reduction, but if the sales turned down, we believe we have a lot of runway in cost improvement.

Alexander Paris – Barrington Research Associates

Great. Looking at China now that you have made the other acquisition, how do you see that business developing? I imagine there is good opportunity, but in terms of your three segments. For example, is there a possibility of van business in China or is it all going to be more C&I and D&I?

Nick Pinchuk

I think right now the way I see the China market, there is little possibility of van business. Generally, the vans are effective where technicians own their own tools, and the jurisdictions where that does not happen they usually are relatively marginal. So in China, as most of the world, the technicians do not own their own tools, so the proprietary model will not work.

We believe, however, that we have technology and product quality and ergonomics will set us apart from other people and, therefore, be able to get a kind of proprietary priority position in the marketplace. We are seeing that somewhat in equipment now where we throw out our imaging product in there, we are gaining share dramatically, one that will give us a base to start that with hand tools. We have not in the past because we have been lobbing hand tools in there from Europe and the United States, and they just do not have the cost position that can compete in that market.

Alexander Paris – Barrington Research Associates

Okay, thank you. Just one other question. I know in the past, once in a while, you have a surprisingly poor third quarter because of some big jump in gasoline prices. How would you see a possibility of a magnetive effect on your third quarter if gasoline goes to $4 as a lot of people are talking?

Nick Pinchuk

We have looked at the effect of gasoline on our franchisees. There are probably two factors. One is the lower driving. Generally, though, when we step back and look at the macros in the marketplace now, the spending on automotive repair has remained fairly strong, fairly reasonable. So we feel relatively good about that going forward. Now I can’t predict how that would be affected as the gasoline prices go up and up. On the other hand, on our vans their costs go up. So their costs have probably doubled in the last say six or seven months, and we have been working with them on productivity to make sure that they can make up some of that in terms of their margin expansion. And in the time in which the gasoline prices have risen over the last six or eight months, we have seen our franchisees’ general profitability rise. So we have been able to offset it just by projecting our CI improvements in the franchisee system.

Alexander Paris – Barrington Research Associates

Great. Thank you very much.

Nick Pinchuk

Sure.

Operator

(Operator instructions). We will take our next question from Jim Lucas at Janney Montgomery Scott

Jim Lucas – Janney Montgomery Scott

Thanks. Good morning guys. Could you give us a reminder on a couple of these headwind issues which are more timing related, both the van count and the OEM project. At what point do we get to more of an apples to apples comparison? Is that the second half of the year?

Nick Pinchuk

Looking out into the second quarter, we see the OEM’s start to decay. I think we would say it would be about half of what it is today, and then it starts to decay down in the third quarter and fourth quarter from that level. So you can see it go from 19, you might chop it in half in terms of effect, and then it gets much less significant in the third and fourth quarter.

In terms of the van count, we start to catch up… Our goal is to try to catch up as soon as possible, but you start to get easier comparisons in the third and fourth quarter.

Jim Lucas – Janney Montgomery Scott

Okay. I was a little bit surprise to hear about the softness that you are seeing in Southern Europe. When you look at the Western European economy, if you step away from… if we count Eastern Europe as more of an emerging market than Western Europe in general, whether it is in your industrial or equipment businesses, what does the overall environment look like today for you?

Nick Pinchuk

Jim, we are actually seeing reasonable growth in places like the UK and Scandinavia and the low countries. We got hurt in the quarter in Spain and Portugal, and if you look at the economic news there in the first quarter, they revised downward their G&P assessments. So we think that had our distributors take a pause. We had the same kind of thing in Italy, which has been slow for some time. So we kind of see that as a quarter effect. What we are seeing now is better order rates. And, in fact, the order book is relatively strong in Europe, so we expect to see some recovery in the second quarter in that area.

Our take on that is is that the economic news hit in the first quarter in Spain. We are the market leader in Spain by a long shot, and in Portugal, and in some of those Southern European countries, and distributors just wanted to take a pause. Now we are seeing them come back. The magnitude of that comeback, I am not sure. We expect to see some recovery.

Jim Lucas – Janney Montgomery Scott

Okay. And when we take a look here, I mean I think you have done a good job in terms of mapping out the issues impacting the organic numbers in the first quarter and how that potentially gets better as the year progresses. Margins continue to be a great upset prize as well as financial services. When we look at the balance sheet and you had this nice small strategic acquisition in the first quarter, but can you talk about capital allocation priorities? We highlight them every quarter, but have they changed. Are we seeing anything different out there?

Marty Ellen

Jim, it is Marty. I will make a comment, and then maybe Nick wants to make a comment. First of all, just to add some color, I think we are not just in Spain, but elsewhere I said tool storage seems to be picking up. So hopefully we have got some positive trajectory coming out of first quarter in terms of top line, and we will continue to expand margins as we have said. We remind everybody by 2010 we expect to be mid-teens operating profitability, and we think we are moving directionally there. So we are pleased with that.

Capital allocation continues to be the same. Yes, we made a small acquisition. We continue to look for acquisitions like that that will give us a very immediate ability to grow in the markets that are growing or to expand our product offering through our existing distribution or gain access to distribution and customers. Nothing transforming, nothing large, and we continue to want to work the balance sheet to generate as much free cash flow as we can. The priority has always been our dividend, of course, and we look at raising that each and every year if our board so chooses. Share repurchases to offset dilution, we will continue to do that. I have guided you guys on capital spending including the capital addition that we are making in China to bring tool storage manufacturing capability into China. And that is sort of the goal to keep the ship in that straight line for now.

Jim Lucas – Janney Montgomery Scott

Okay.

Nick Pinchuk

I would like add one thing to that, Jim, is that I would just slightly clarify the characterization of Wanda as a small acquisition. It was small in terms of financial impact, but the physical capabilities are a monster. It is 750,000 square feet of fine manufacturing space. It is a number of product labs. It is 1,000 capable associates. This is a very strong company, which we feel very [unintelligible] about being able to wield to our advantage in the future. I hope someday I can guide you on a tour of the facility. I think you would be impressed.

Jim Lucas – Janney Montgomery Scott

I will look forward to that. All right, thank you very much.

Operator

(Operator instructions). And with no further questions left in the queue Mr. Ellen I would like to turn the conference back to you for any additional or closing remarks, sir.

Marty Ellen

Well thank you everybody, and thank you for your interest in Snap-on. Have a good day.

Operator

This does conclude today’s presentation. We thank everyone for their participation. You may disconnect your lines at any time.

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Source: Snap-on Incorporated Q1 2008 Earnings Call Transcript
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