實耐寶 (SNA) 2003 Q3 法說會逐字稿

Good day, everyone, and welcome to today's Snap-on Incorporated third quarter results conference call. Today's call is being recorded. At this time, for opening remarks and introductions I would like to turn the call over to Mr. William Pfund, VP, investor relations. Please go ahead, sir.

Good morning, everyone and thank you for joining us to discuss our third quarter results. With me are Dale Elliott, Chairman and CEO; and Marty Ellen, SVP, finance, and CFO. Today we have a little different format for our call. We will be utilizing a set of slides available on the SnapOn.com website to help illustrate our discussion. For those of you listening to our webcast, you should have found the slideshow that accompanies the audio when you logged on. You will need to flip through the slides as we go along. The slides will be archived on our website.

Consistent with our policy and past practice we encourage your questions during this call. We will not discuss undisclosed material information off-line. Also, any statements made during this call that state management expects, believes, anticipates, assumes or otherwise state the company's plans or projections for the future are forward-looking statements and actual results might differ materially from those made in such statements.

Additional information concerning the factors that could cause actual results to materially differ from those in the forward-looking statements is contained here on slide 2 and in the news release and 8-K issued this morning by Snap-on as well as in the last 10-Q, 10-K and other periodic reports filed with the SEC.

In addition this call is copyrighted material by Snap-on Incorporated. It is intended solely for the purpose of this audience. Therefore please note that it cannot be recorded, transcribed or rebroadcast by whatever means without Snap-on's express permission. In addition this call is being recorded and your participation implies your consent to our recording this call. Should you not agree to these terms simply drop off the line.

Now let me turn the call over to Dale Elliott.

Thank you, Bill, and good morning, everyone. Let me start with some overall observations regarding the third quarter. On slide 3 there is a brief recap of Snap-on's financial results, showing sales were up 4.6 percent.

Increases in tools and handheld diagnostics in the technician marketplace were offset by decreases in big-ticket equipment, while sales of tools in our industrial and commercial businesses were largely flat, year over year.

Our EPS results included 15 cents of cost for the two plant closures that we previously announced in July. During the quarter, we again realized strong cash flow. Cash generated from operations was $84.4m, a 33 percent increase over last year's third quarter, with a significant contribution from improvement in receivables and inventory.

Working investment turnover improved to 2.8 turns, and remains on-track to reach our target of four turns at the end of 2005. While progress is on-track, I do look forward to the day when I can share with you a turnover figure starting with a three, a level not historically associated with Snap-on.

The improvement in cash flow is a very visible indicator of our operational progress. As we turn to slide 4, I would point out that our results this quarter were achieved with little discernible help from the economic recovery. We continue to see significant opportunities for improvement and growth in our business, and assure you that we are still very focused on the implementation of our driven to deliver initiatives, working to further strengthen our processes and enhance our sustainable long-term cash flow and operating margins. Obviously this is still a tough environment, and we are working hard to take care of our customers and not overlook any sales opportunities.

As you know, substantial investments have been made to strengthen the foundation of our business, and we have accepted the costs of making those changes, even if they tend to mask the benefits of our improvements. Improving inventory turns for both the company and our dealers, and streamlining our manufacturing and supply chain processes has taken discipline.

Our vision is to internalize these disciplines across the company, so that we continue to deliver real value to our customers and in so doing, deliver significant value to our shareholders.

In the third quarter the payback on these investments is beginning to become more visible. Sales in the North American Snap-on franchise dealer business grew 5.7 percent and approximated the overall dealer sell-through to end users, primarily vehicle repair technicians. Unfortunately, this was offset by the continued weakness in marketplace demand for large, platform-based diagnostics sold through the tech rep organization.

During the past few years we have implemented a number of initiatives that have helped dealers improve their working capital utilization, just as we have been working to raise Snap-on's working investment terms. The net impact of these actions achieved a leaner inventory position for dealers, but it also created a temporary reduction in Snap-on's sales growth in previous quarters.

We will continue to work in tandem with our dealers to improve their inventory turnover and enhance their fiscal strength, as we continue our commitment to improve Snap-on's inventory turnover.

As was noted at our last conference call, we believe that future sales growth in the franchise dealer business should be consistent with the overall activity in dealer sell-through to end users.

Within the commercial and industrial segment, most of the weakness was confined to the equipment marketplace worldwide. Tools sold in industrial and commercial applications were essentially flat. Importantly, the sales decreases during the past few years, as best we can determine, were largely the result of declining industrial activity and not the result of any loss in competitive position.

During the third quarter there were some bright spots, which may indicate that the economists who have been predicting further economic growth might be right. We certainly hope so.

In the North American equipment marketplace, the ramp up of the direct sales and marketing operations, the technical automotive group or TAG, continued in the quarter following its second quarter launch. Sequential improvements were achieved in sales, customer leads and gross margin, despite the traditional seasonal softness in the third quarter and the weak economic environment for capital goods equipment overall.

However, as expected, the near-term impact continues to be negative in comparison to last year. With the benefit of additional sales people in the field and their continued seasoning, we believe that we will achieve a positive comparison in the traditionally strong fourth quarter. Marty in his comments will share some further insight into their performance and why we are encouraged by recent trends.

Since TAG is still rather new, let me again spend a moment reiterating the strategic importance of this move. During the past few years, significant effort and investments were made to rationalize and consolidate the footprint of our equipment business. In addition, considerable resources were expended to strengthen the new product development process and pipeline.

As a result of these investments, we have a leading technology position today and a strong portfolio of high value-added productivity enhancing products. We believe a dedicated, highly focused and technically capable sales and marketing organization is the best way to capitalize on these new capabilities and drive and enhance profitability.

During the third quarter, the diagnostics and information group continued to enhance their contribution. Sales growth of handheld diagnostics was strong, and the continued weak market for large platform diagnostics offset that growth. As part of the process improvements in the equipment business, production of certain products were transferred to the commercial and industrial group which had already handled the distribution of these products. This change lowered reported inter-segment sales of the diagnostics and information group.

As a result of past restructuring efforts in the European diagnostics business, and ongoing improvement action throughout the group, an 11 percent operating margin was achieved for the quarter, exceeding our 10 percent target. This is a clear indicator of success in our effort to improve all of our business units operating profitability.

Let me assure you that we believe this is just a first step toward achieving those targets, and we do not expect to become complacent. Now let me turn the call over to Marty for his review of our third quarter financial results.

Thank you, Dale and good morning everyone. I will begin with slide 5. Net sales were $525.6m for the third quarter of 2003, of which currency translation accounted for $19.7m of the increase. I will address the components of our sales performance as we review each operating segment.

Snap-on's third quarter consolidated reported net earnings were 30 cents per share, compared with 33 cents per share a year ago. Before costs associated with the two plant closings, earnings increased as a result of the small sales gain before currency impacts, and from our operational improvements. Reported EPS in the quarter included 15 cents of costs associated with two plant closings, as well as costs for other continuous improvement actions and a benefit in the current year from a lower tax rate in the quarter.

Turning to slide 6, Snap-on's consolidated gross profit was $221.8m compared to $227.8m a year ago. Included in gross profit are $13.3m of costs related to the plant closings in Kenosha and Mount Carmel.

These costs primarily relate to the recognition of accelerated pension and post-retirement and medical plan curtailment expenses. Gross margin was negatively impacted by 250 basis points as a result of these costs. Additionally, we recorded $5.1m of LIFO benefits in the quarter, as a result of our success in reducing inventory levels in the period. However, for the most part this benefit was offset by lower manufacturing cost absorption and other inventory-related costs, also largely associated with the same inventory reduction initiatives.

Regarding the plant closings, the transition is progressing. Notices have been given to employees that the facilities will be closed by the end of the first quarter of next year. Closing negotiations with the unions are under way. Under current accounting rules, closure costs relating to benefits are not recognized until they have been finalized and communicated. As a result, the expected accounting to recognition has been delayed, although the total cost of the plant closures which includes pension curtailment, severance, transition and other expenses is still expected to approximate $26m as we announced last quarter.

Our latest estimate is that approximately $4m to $5m in transition costs will be incurred in the fourth quarter of 2003 and that the remainder, or approximately $8m to $9m in total costs will be recognized in the first quarter of 2004. These future costs will also primarily be included in COGS. As we previously noted, we expect to realize approximately $12m of cost savings annually beginning in 2004.

Turning to slide 7, operating expenses were $200.7m in the quarter, including $6.6m of higher costs due to currency translation. As a percent of sales, operating expenses were 38.2 percent in 2003, compared with 39.6 percent a year ago. Savings of $4.4m were achieved from prior continuous improvement and other cost containment actions. These savings, however, were partially offset by $3.5m of higher pension, other retirement and insurance costs.

Costs for continuous improvement actions, other than those related to the two plant closings were $700,000 in the third quarter, compared with $1.6m a year ago. Our drive to become a more competitive, performance-oriented and customer responsive organization will continue. As a result, we expect future periods to include continuous improvement costs as these actions are implemented. In this year's fourth quarter, we expect approximately $2m to $4m of such costs in addition to the amounts for the two plant closings.

It's hard to predict beyond the fourth quarter, other than to reiterate what we said in the past, that there could be $2m to $4m of these kinds of costs in future quarters, before taking into account the benefits of past actions.

For example, in this recently completed quarter we recognized only $700,000 of continuous improvement costs, again before the plant closures, but we also benefited by $7.5m in year over year savings.

Let me now turn to our segment results. In the worldwide dealer segment, as seen on slide 8, third quarter total net sales of $251.6m were up $8.3m or 3.4 percent compared with the third quarter of 2002. Admittedly, $5.3m of foreign currency translation is included in the sales increase.

A bright spot this quarter is that sales in the North American franchise dealer business increased 5.7 percent compared with a year ago. Unfortunately, this was offset by the continued weakness in marketplace demand for large, platform-based diagnostics sold through the tech rep organization.

As Dale previously noted, this increase approximated the growth in dealer sell-through to end users. From data supplied to us by our dealers, the sales off the trucks to technicians grew approximately mid-single digits in the third quarter as well as for the nine months. Tools, handheld diagnostics and in particular, tool storage items all did well. As to international, dealer sales were up due to favorable currency effects.

Operating earnings for the dealer group were $8.2m, after costs of $11.5m from the previously discussed plant closing actions. This compared with operating earnings of $11.7m a year ago. Benefits from higher volume and some favorable price realization, together with cost reductions were partially offset by the higher pension, other retirement and insurance costs.

Turning to slide 9, you can see the sales trend on a trailing four quarters basis for the dealer group. The trend is improving, despite the actions that were taken that temporarily constrained our sales. Importantly, on slide 10, the trend in operating earnings for the dealer group turned upward in the third quarter as we expected.

As you can see from the margin trend, we have significant opportunity and work still ahead of us, but we believe we are on the right track. In the commercial and industrial group on slide 11, sales of $264.6m increased $11.6m, or 4.6 percent year over year, including $13.1m as a result of currency translation. Within the segment, sales of tools for industrial applications were essentially flat year over year.

The continued weak economic environment in the third quarter in such sectors as aerospace and aviation, general manufacturing and non-residential construction were offset by our focus on new customers and other sectors that are showing some growth, such as the oil and gas industry and power generating plants.

During the third quarter, weak economic conditions continued to effect the sale of capital equipment to vehicle repair shops in North America. In addition, as Dale mentioned, the year over year comparison includes the impacts from the changes made in the North American equipment business distribution channel. While sales growth was achieved in the company's facilitation business, where we provide purchasing and distribution services, it is a relatively lower gross margin business.

Operating earnings for the commercial and industrial group were $3.8m in the second quarter of 2003, including there a $1.8m portion of plant closing costs. This compared with operating earnings of $9.2m in the prior year. The impact of the lower sales volumes offset savings from prior restructuring activities and benefits from new products. In addition, there were higher costs for pension, other retirement and insurance.

Operating earnings improved sequentially compared to the second quarter. In light of the seasonally lower volumes in the third quarter, we are pleased with the sequential improvement in our TAG group. We believe further improvements will occur in the fourth quarter, reflecting both volume increases from this seasonally stronger period, further improvements by the TAG's sales force and benefits from ongoing continuous improvement actions.

If you turn to slide 12, you can see the monthly trend in equipment sales related to the TAG launch. The drop in volume in April as we launched TAG and experienced a decline in shipments, and the resulting monthly improvements thereafter.

In the second quarter, sales were 42 percent of the year ago level, improving to 76 percent of prior year sales in the third quarter. We believe that in the fourth quarter sales levels will approximate the year ago level and that profitability will be up.

Sales in the diagnostics and information group, which you can see on slide 13, were $79.5m in the third quarter, down from $85m a year ago. This was primarily due to a decline in inter-segment sales. Increased sales of handheld diagnostics were offset by a decline in large platform diagnostics in North America, which are primarily sold through the dealer group's tech rep organization.

In addition, production of certain European equipment previously handled by the diagnostics group was transferred earlier this year to the commercial and industrial group. This realignment represented about one-half of the inter-segment sales decline.

Operating earnings for the diagnostics and information group were $9.1m, representing an 11.4 percent operating margin in the third quarter of 2003. Operating earnings were up 12 percent from a year ago. This earnings improvement reflects the benefits from prior restructuring efforts in Europe and the ongoing continuous improvement savings, despite the lower sales volume.

Shown on slide 14 are the trends over the last five quarters. In spite of the decline in inter-company sales, you can see the improvements being made in the operating margin and operating earnings.

Now let me turn to a discussion of cash flow, shown on slide 15. Snap-on generated $84.4m of cash flow from operating activities in the third quarter. This was an increase of 33 percent from a year ago. Cash flow from earnings and depreciation and amortization was about flat year over year, while the $36.2m reduction in working investment components improved by nearly $8m year over year.

After taking into account the reduction in capital expenditures, free cash flow improved 50 percent for the quarter on a year-over-year basis. Our approach under the Driven to Deliver framework is every bit as disciplined when it comes to capital spending, which focuses us to invest in value-adding growth projects, while eliminating waste. Capital expenditures of $5.7m in the quarter and $18.7m year to date were down substantially, reflecting the early benefits of our lean transformation, where production versatility and creativity before capital are two important concepts.

In addition, we are reaping the benefits from lower maintenance spending on our smaller footprint as a result of our consolidation efforts over the past five years. We now expect that our capital expenditures for the full year 2003 will be around $30m.

A priority for Snap-on has been to use our free cash flow to reduce debt. Going forward in the near term, our cash flow priorities can be seen on slide 16. First and foremost we are continuing to invest in those internal programs that would drive new product development and further enhance our operating productivity. These investments generate the highest returns. We expect to maintain our dividends and to make share repurchases to offset dilution.

As we have noted in the past, our pension requirements are quite manageable. We have contributed $14m year to date, and with some of our discretionary cash flow near term, we will consider additional voluntary contributions in the fourth quarter.

Significant size acquisitions are not a likely use of cash near term. Our acquisition opportunities can be classified more appropriately as near neighbor product line acquisitions, much like the purchase of Nexiq which occurred last December. As a result, for the next few quarters cash is likely to build, even though we are below our longer term target of 30 percent to 35 percent for debt to capital.

As a result of the strong cash flow and our improved operating discipline, our balance sheet continues to strengthen. On slide 17 we've provided some highlights. The ratio of net debt to invested capital was 21.2 percent at the end of the third quarter, down from 29.2 percent at 2002 year end.

Included in this reduction is approximately 160 basis points of favorable impact caused by the increase in equity due to currency translation. But, this is still a major improvement. It was just one year ago the ratio stood at 32.1 percent.

At quarter-end, inventory was $40m lower than a year ago, and $20m lower sequentially from the second quarter, even after the unfavorable impact from currency translation. At the end of the third quarter, inventory turns improved to 3.3 from 2.8 turns in the comparable period a year ago.

Total accounts receivable at the end of the third quarter were up 2.5 percent on a 4.6 percent sales increase. Looking at it from a DSO perspective, Snap-on improved by two days on a year-over-year basis. The improvement in inventory and working investment turns remains a strong point of emphasis across the company. We believe we are on track to achieve our inventory targets by the end of 2004, and the overall improvement in working investment by the targeted date of year-end 2005.

That goal is expected to generate cash in excess of $250m over the target period from the beginning of 2001 to the end of 2005. Since 2001, that initiative has generated $170m of cash flow.

Now let me conclude by sharing with you some of the assumptions and operating trends included in the press release issued this morning. They are outlined on slide 18.

Let me emphasis our earlier comments. We are fully committed to continuing our efforts towards achieving stronger cash flows, sustainable operating margin improvements and increasing our returns on capital employed. By focusing on these value-added drivers and greater customer responsiveness, we believe we can deliver greater shareholder value.

For the balance of 2003, we do not see any significant near-term events that are likely to change trends experienced in the technician marketplace served by our dealer business. Overall, we expect a traditional fourth quarter seasonal upturn in volume across our dealer and equipment businesses.

Despite the predictions of some economists, we have not factored any substantial recovery into our forecasts, which is a more conservative view for the fourth quarter than we had previously held, particularly for Europe.

As we've already said, our outlook for the fourth quarter includes approximately $4m to $5m of costs we expect to incur for the closing of the two hand tool plants, as well as another $2m to $4m for other continuous improvement actions. We also expect a continued level of higher year-over-year costs for pensions and insurance.

As a result, Snap-on expects full year 2003 earnings to be in the range of $1.50 to $1.55 per share. Thank you, this concludes our prepared remarks, now we will take your questions. Dawn.

Thank you. (Operator instructions) Our first question comes from Alexander Paris with Barrington Research.

Good morning. Just a couple of quick questions. Your guidance that you just mentioned, that $1.50 to $1.55, I think that's about 10 cents lower than your last forecast. It looks like the plant closing costs I think were a little bit less than you expected. It was $5m, now it was reported $4m to $5m. Where is the difference? Was that $2m to $4m continuous costs, was that in your prior guidance?

It's Marty. No, it was not. And so if you look at the adjusted plant closing costs for those hand tool plants we talked about last quarter and add now some of the additional activities that have hit our screen for the fourth quarter, that impact is about a push. And so the real factor behind the reduction is, truthfully, our becoming more conservative about economic activity in the fourth quarter relative to our thinking a quarter ago, when we were much more optimistic about a more robust, if you will -- that may be too strong a word -- but recovery than we've now experienced in our business for the third quarter, or that we are prepared to assume for the fourth quarter.

And that was mostly the downturn in Europe?

This is Dale, Alex. That's really what is kind of the cold shower that we got in the third quarter. The traditional rebound that we get in September, as you may recall, coming back from vacations in Europe was much more muted than we expected. And we've seen some economies that have been relatively stronger in this period start to show some signs of weakness. Spain would be a good example of that.

So really, it's a combination of what Marty outlined, continued concerns that I have personally about European progress, and then quite honestly the last piece is, even in the domestic market here, as you may remember, we kind of took the head-fake last time about a back-half recovery. It looks like to me that we might have a fourth quarter recovery because the third was pretty anemic, I think, by any measure. So I think it's a dose of conservatism on our part overall, coupled with some near-term concerns on Europe and the charges as Marty outlined that generate that change.

I am sorry, just to repeat. You mentioned on these $2m to $4m, the ongoing continuous improvement costs, you said that was offset by -- so that's not new?

Let me go back, Alex, and let's get clear on the continuous improvement and plant closure costs. What we said a quarter ago was that we expected $17m in costs for the two hand tool plant closures in third quarter, with about another $4m in the fourth quarter, so that would have been $21m of total costs in 2003.

Because the union negotiations were not concluded at the end of September, we could only recognize in the third quarter about $13m in costs for the pension and post-retirement, medical curtailment expenses. And now have said $4m to $5m should end up in the fourth quarter along with another $2m to $4m for other actions.

So if you put the two together, it totals out, it will still be about the same in 2003, albeit for different reasons.

Okay. And then on that same subject, in the first quarter, you're estimating $8m to $9m of the plant closing costs compared to your $5m in your previous guidance. Is that just, is it costing you more than you thought?

No, it's not costing more. You just have to think about it in the sense that a lot of the costs will be spread between the time we provide the official notifications and the completion of the closures. So we are condensing that time frame down with more of it proportionally occurring in the first quarter.

I see, okay. Just a couple other real quick ones. Your tax rate is going to stay at 35 percent in 2004?

Our tax rate will be 35 percent in the fourth quarter of 2003. We have not made a final determination of what that rate would be yet for 2004.

Just one other question. Your industrial tool business was flat in the third quarter. Was that an improvement from the second quarter? Was that still declining in second quarter?

Yes, that is an improvement, and that's the area that I mentioned earlier that we have seen some bright spots in, Alex. Again, not enough to build a story of a return to prior history, but clearly much more upside weighted than downside as we've experienced for the last couple of years.

Thank you very much.

Your next question comes from Greg Faje with Morgan Stanley.

Good morning. Three quick questions here. What were the dealer additions in the quarter?

This is Bill, Greg. Dealer count is up about 1 percent on a year over year basis at the end of the quarter. That's pretty much in line, we expected a small increase this year, so I think we're pretty much on track.

What drove the lower tax rate within the quarter?

I don't want to go into that beyond what we said in our release. So it was sort of a one-time event that occurred in the quarter and we expect in Q4 to return back to our 35 percent rate.

The financing to come here. You guys talked about flat originations volume. I'm just trying to correlate that with the increase you saw in the North American dealer sales.

There's a little timing difference in there between when the sales get originated and when they get approved and financed on through the Snap-on Credit Corporation. Their product portfolio includes a few different financing products. They also do some dealer financing, and that activity was actually down. So while EC originations were up, which is the major part of their portfolio, dealer financing activities were down.

That is for new dealers? You are referring to dealer financing, is that for the new dealers?

This is the new and existing.

New and existing. So should I see an up tick then in the fourth quarter here, if it's a timing issue?

We generally expect that business to show growth in originations consistent with increases in sales by the dealer group.

Over the long haul?

Correct.

Thank you.

From Baird we will now hear from David Leiker.

Good morning.

Good morning, David.

Marty, I want to go back on this tax item. I don't really see an explanation in the release on it. Can you give us some more color on what was behind that in the quarter?

David, I'm sorry. Other than we had a benefit in the quarter, it's not going to continue, it's one-time and we are going to return to our effective rate in the fourth quarter of 35 percent.

Are you going to disclose in your 10Q what the benefit was from?

I haven't seen our 10Q yet and don't know what we will say about it, but probably not.

Okay. On page 8 I want to reconcile two numbers, or slide 8. North American sales to franchises was up 5.7 percent , which approximates dealer sell-through. The next line says, Dealer sell-through in mid-single digits. Are those the same numbers?

The way we define them, David, yes, that would be comparable.

That's an up tick from what the recent trend had done. Is that market share growth or is that end market growth?

That's a good question, David. As you know, there are no formal share calculations made, but our estimates show that we have improved our position over the last year and in the third quarter. We did see some up tick in sales, but you'd have to weight that down through new product activities and some other actions. Again, as I said earlier, I'd be hard-pressed to signal this was a key inflection point and it was taking off. I think it was just a solid quarter for a variety of reasons that ended up with that result.

And then last year in the fourth quarter, if I am doing my numbers right, you took about $60m out of working capital. Is that a number we can expect to see this year in the fourth quarter?

It might be a little higher, David, than in past. There were some special circumstances I think in the fourth quarter last year that resulted in that. But as Marty pointed out, we're still targeting to our get our four turns and we expect to continue to see good benefits of that activity.

The third quarter cash flow was very pleasant, that's a feeling I'm hoping to continue. If we continue to execute the plans in the fourth quarter we should see a sizable increase as well.

And then lastly on the capital spending, it looks like, if you are going to hit $30m for the year, that's a pretty meaningful step up in Q4 from what the spending rate has been YTD. Can you give a little bit of color behind that?

There is some timing into the $30m. We are seeing some, I guess you would say relatively larger projects coming through. Some of the plant moves would impact that number, for example.

But on the positive side, David, I had an interesting experience this week. I was up at our Milwaukee facility talking to the employees there and I had an opportunity to view a brand new cell that we put in, in Milwaukee in the last few weeks, done totally with the existing equipment. This was a cell that was probably one of the better ones I've seen executed in the last few months. It fundamentally cost us the cost to hook up the electrics and the air.

So again, as we mentioned earlier, as the plant consolidations flow through, coupled with the creativity before capital mantra we've been beating the drum on, if you will, for some time, you're going to see that show up in the capex.

One last point on that, just so everybody is clear. I have not, and that is clearly not, cut back on projects at all that have great paybacks or have new product activity. So we are not short-shrifting capital to hit the cash flow number. So the good news is we're getting there, but we're getting there the good way, if you will.

Thank you.

Moving on, we'll hear from Darren Kimball with Lehman Brothers.

Hi, I was just wondering in terms of how you think we should look at the dealer group performance. Sort of the North American franchise component I guess reflects an improvement, but you had actually greater offsets in terms of the tech reps and the international. What's the right perspective on that?

I think the way you've characterized it is pretty fair. We did have in the core North American dealer group a very solid quarter. We did have challenges in Europe as I've outlined before, and the large platform diagnostic equipment has been the area that's been the biggest challenge.

We've had somewhat of a perfect storm going on in that in the shift from large platform diagnostics to handhelds, the virtual elimination of the emissions market, and also we've had a big downturn in again, larger items like air conditioning service equipment in the last few years.

So that has really been the tale as far as the challenge that the dealer groups had to offset in total sales those types of decline. I think in the near term, the tech rep situation, we are addressing through various means. You'll see that anniversary. Longer term, we are hoping to get the dealer group back on the path to get to its historic profitability ratios that we've set as a goal for ourselves. So I think the third quarter was a step in that direction.

And in terms of hand tool restructuring, I'm just wondering if the delay in getting the sign-off with labor delays the expectations of savings? I mean, is it now three-quarters of the year benefit instead of a full year?

That's a good question. No, it doesn't. It will delay the recognition of the costs, but has not delayed any of the activities. We've already, as Marty outlined, notified and have laid off individuals in both locations. The plan to reestablish production in the new locations is on schedule. So all of the real activities, if you will, are continuing and therefore the benefits we expected to accrue next year should occur. But it's purely more the timing and the recognition given the accounting rules of the expense that we're talking about.

Okay. And can you quantify the net loss to sales from TAG in the C&I segment and what the fourth quarter expectation should be there? Do you sort of get back to year over year neutral impact?

On a quarter-by-quarter basis, Darren, that's correct. In the fourth quarter, I think as Marty mentioned, that we're expecting to achieve roughly equivalent sales as to prior year.

If we look year over year just in the third quarter, we'd quantify the sales reduction about $7m.

I guess lastly, and then maybe I'll jump back in the queue, I'm still struggling with the new fourth quarter guidance. I'm just wondering if you can just add any more clarity in terms of what's changed. I understand directionally what's changed, but more specifically where you see weakness that you didn't anticipate before. Ostensibly it's not North American franchise dealers. Where is it?

Well as we mentioned earlier, the real issue that's caused us to be concerned is the continued challenges in Europe. We've seen other economies starting to show up as well as the traditional problems we've had, which was Germany and France, but we're seeing signs that Spain and Italy are also slowing down significantly. So that's a large portion of the delta.

Then again, the last piece is my belief that the unevenness of this recovery is going to be with us and has a much different shape than we initially expected in the third quarter. I don't think the rebound is going to be as broader-based and as high as initially expected.

So the other half, if you will, is our belief in taking a conservative posture on that, and we are moving, as Marty pointed out, our earlier estimates of a fourth quarter improvement due to the economy.

So your comments are highly economic in nature rather than sort of cost issues that you are aware of hitting in the fourth quarter. And I know there were some of those as well.

Correct. We're keeping our head down and expecting as we've had this last year to continue to grind out improvements operationally, but there is no denying that an economic effect on that was something we were also expecting and hoping for. So this is more an example of us keeping our head down and focusing on the things that we can control and getting through the year.

Now again, having said that, operationally we still expect to have a measurable improvement in the fourth quarter this year over last year. So this is not where we're not abrogating entirely the improvements we've seen year to date. It's just more of a cautionary tone given the uncertainty that we see out there.

I guess the best measure maybe to summate that is that we don't feel that we're losing market share in these positions at all. Even in the tough European market that I mentioned earlier, for example, we have information that we're gaining share in almost every product category in equipment in the German market despite the softness. So these are the type of combinations of economics and operational issues that we've dealt with all year.

Thank you.

Saul Rubin with UBS Warburg has the next question.

Good morning.

Good morning.

A couple of questions here. First, on the capital spending, $30m this year. Is that a level you expect to be able to go on at?

I don't think so. We haven't provided any information for next year yet, but I would anticipate that that would increase somewhat next year. But again, we'll be giving the information on that in the first quarter.

Okay, fine. Can you talk a little bit more just about the impact the inventory work then is having on the business in general? It seems to have a positive impact, due to the LIFO accounting, but then you say there are costs associated. Presumably as you work out inventory, it takes away from the top line over time, at least temporarily. Can you just talk broadly about how we should think about that as it impacts revenues and earnings until you reach your 4X turn target?

Correct. I think that's a good question. We've been attacking this not only on inventory but as a total working investment profile. So that's an important understanding for you to have. But focusing on inventory in particular, we are taking the analogy people use is we are taking the river down and exposing the rocks. And that's your point, is what causes us to step up and deal with some of the inventory issues that occur as a result of that.

In addition, when you close factories and distribution locations, that also has a tendency to expose issues where you just say, look, we don't want to deal with this anymore and we're deciding to exit that product.

Now to your point, we are also trying to do some product adjustments as well. For example, on the two plants that are closing, roughly 30 percent of the SKUs manufactured in those plants will not be transferred. They'll be discontinued.

So those elements kind of wrapped up together are what results in the inventory performance that we've seen so far. Having said that, clearly 4X turns is not world-class by any stretch of the imagination, and we think there is opportunity to get that more into a 6x to 8x turns range. That would be our next goals to tie off on once we have achieved the 4X.

Okay, but I mean, as this process continues, just in order of magnitude, what kind of impact does it have on your earnings potential over that period?

Well aside from the absorption issues that would be a drag on earnings in the short term, there really shouldn't be much issue at all on earnings potential. A lot of these items that we've discontinued are a very, very small percent of our total sales, hence the reason they are being discontinued and being dealt with. So you're not looking at a huge delta in sales reduction as a result of product SKU elimination or inventory reduction.

Okay. Continuous improvement costs of $2m to $4m a quarter. Can you talk about exactly what you're expensing here, and is this related to the turns?

It's for a variety of reasons, depending on the unit and the project. The $2m to $4m is a rough guideline. This covers everything from our footprint changes, elimination of sales offices, for example, head count elimination due to consolidation of plants, or just overall reengineering of processes. So it's a variety of elements that roll up into those estimates.

Okay, good. And last question, I suppose its an obvious one, but debt to cap now at 21 percent and cash is still rolling in. What are your plans beyond the fourth quarter pension contribution?

Really none. We just want to continue doing what we're doing and keep focused on the improvements, both operationally and on the balance sheet. As I said in my prepared remarks, for the near-term the consequence should be that we build cash.

Thank you.

Up next we'll hear from Fred Speece, with Speece Source and Capital.

Thank you. The LIFO benefit. How soon, as you increase your turns, will you continue to see this? How much do you expect in the fourth quarter?

There could clearly be some more in the fourth quarter, maybe not dissimilar to what we saw in the third quarter.

Okay. On the TAG situation, the chart's very helpful; you're showing the revenue. The margins, when you look at the fourth quarter, help us in the margins. There was some loss there.

Generally, what you'll be seeing out of TAG, Fred, is gross margins up significantly over the prior, and then again correspondingly we anticipate an operating income improvement as a result.

Right. How many people do you have in the TAG team and where are they in the learning curve?

It's around 110 to 120. I don't have an actual, because it changes daily. Again, we're getting more and more of these people into the 90-day plus tenure, which is where we're seeing kind of a kicker point in productivity. So again, every week that goes by, they're more skilled, they have better relationships with the customers and we find them to be more productive.

And the first bunch of 50, their productivity versus the last 40? There are some categories you have.

That's a great question, Fred. When we plot and we do this weekly, we plot sales averages per duration of time with us. You can see a clear, kind of a 45-degree positive slope angle after people have been with us a number of weeks and their sales productivity.

To your point, the folks that have been with us the longest are above the threshold levels that we were targeting for them at their sales performance. So we're seeing the gross margins that we expected, the sales average that we expected, and, I think more importantly then many of that, which is kind of more of a transitional situation, the lead generation is going up strongly as well. That was really the key to doing this in our minds.

And the last question on the TAG, this is an important change in the way you are doing business. The quality of the leads. When you had sort of a mind-boggling number of leads, thousands. How is the quality of that proving to be?

That's turning out to be better. As you'd imagine, whenever you start into a new program, you do get a flurry of leads, some of which are high quality, some of which are not so high quality. But in discussions with our credit operation, we're seeing a vast improvement in the quality of leads and we're now into a backlog situation of approved deals within the TAG force, which is something we also were looking for as a positive indicator.

When you finish up 2003 and look back, what percent of your sales will be from new products initiated in the last year?

In the last year?

Whatever measure you like.

We use a three-year measure. The last number I saw we were on-track to do about 25 percent to 23 percent of our sales from products less than three years old. The 25 percent, again, it depends on the fourth quarter being a seasonally higher quarter. Obviously if we do better there, the 25 percent could be exceeded as well.

And how many SKUs have you eliminated, and what percent of your sales is that?

The last figures I saw that the sales impacted were around 1 percent to 2 percent. We haven't finalized the discontinuance list at all yet. As far as number of SKUs, I really don't have a fresh number for that off the top of my head.

Thank you.

Michael Prober from Clovis Capital is next.

Hi guys. Just a question, Marty, on the LIFO, just so I understand. So that $5.6m, that's a pretax number or after-tax?

Pretax.

Pre-tax. So it's around, after tax, about 5 cents or 6 cents a share, something like that?

Right.

Michael Prober So that's in the fourth quarter we get that, let's say it's roughly 10 cents for this year. What happens next year? If you keep getting the turns up, do we still see that 10 cent benefit next year, or we don't get that?

Well we continue to see benefits as we eat into the old LIFO layers. I don't have a number for next year at this point. When we roll up our plans now in the fourth quarter, including our inventory reduction plans, we'll then be able to translate that into what we think it means in terms of LIFO benefit.

But we should see some next year?

We should see some indefinitely.

Okay. And then you mentioned in your prepared remarks that you will repurchase shares, cost at dilution. Do you know how much that would have to be, cost at dilution?

It roughly is 100,000-150,000 shares a quarter. If you look at our cash flow statement, you'll see that the dollars of repurchases offset what we've issued. We do try to focus not so much on dilutive effect of un-exercised stock options. We try to focus on repurchasing shares actually issued.

Okay. And then you mentioned the facilities business, that lower margin facilities business. Can you just go through how big that business is and how much it grew, how much that adds to revenues, just that business?

In the past we've given guidance that that's around a $100m business.

And in the quarter, did it grow?

On an annual basis, excuse me.

And in the quarter you said it grew quicker than the rest of the business. Can you just help me to quantify that? Was it 20 percent or 10 percent?

Like a high single digit.

Great. And then I noticed, just a couple of cash flow things. In the cash flow statement the depreciation was up year over year for the quarter. That may be depreciation and amortization, I wasn't clear. But it looks like you are closing plants and your capex is down but your depreciation is up. Why would that be?

I don't know if I have that readily in front of me.

Okay. I'll get back to you on that one.

On your earlier question on the facilitation business, on chart 11 I gave you a bad number. The facilitation business is up 10.7 percent year over year. We call that out in the middle of page 11 on the attached slide. It's about, again, based on the total yearly I gave, it's a couple million dollars in the quarter.

In your press release, you give a slide on the accounts receivable. I assume this is on Snap-on's books, and it shows that the loss reserve went up year over year. Why did that happen? Are you just being more conservative in your reserving?

Yes. We do a regular analysis every quarter and we look hard at our receivables. And yes, as a percentage of gross receivables, it's up 7.5 percent, a year ago it was 6.8 percent. There's nothing special in there but the result of our analysis and our desire to keep a conservative reserve.

So you aren't necessarily seeing increased in chargeoffs? You're just trying to be more conservative, based upon Dale's expectation and your expectation of the economy over the next year?

That's correct.

Okay, great. Thanks, guys.

We do have a follow up question from Alexander Paris with Barrington Research. Mr. Paris, your line is open. Mr. Paris, if you are using your mute button, please release it.

Alex, we're not able to kind of hear your question, so if you've got a follow on dial back in or follow up with me later during the day, I'll be around all day. Operator, maybe if there are any other questions out there, since we are not able to hear Alex?

Hearing no response, that does conclude today's session. I will turn the call back over to you, Mr. Pfund, for any additional or closing remarks.

Okay, thank you, Dawn. Again, as I just mentioned, I will be around and available all day if anyone should thing of some additional points that they would like to dwell in on. Otherwise, again, we thank you for listening in and appreciate your interest in Snap-on. Thank you.

That does conclude today's teleconference. Thank you for your participation. You may now disconnect.