實耐寶 (SNA) 2004 Q2 法說會逐字稿

Good day everyone and welcome to today's Snap-On Incorporated Second Quarter Results Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to William Pfund, Vice President of Investor Relations. Please go ahead sir.

Good morning everyone. Thank you for joining us to discuss Snap-On's second quarter results. With me today are Dale Elliott, Chairman and Chief Executive Officer, and Marty Allen, Senior Vice President Finance, and Chief Financial Officer.

Today we'll be using a set of slides to help illustrate our discussion. For those of you listening to our Web cast, you should have found the slideshow accompanying the Audio Icon, when you logged on. You will need to flip through the slides, and we'll let you know as we move on to a new slide. These slides will be archived at our Web site along snap-on.com along with a transcript of today's call. As is consistent with our policy and past practice, we encourage questions during the call. We will not discuss undisclosed material information off-line. Also any statements made during the call, such as management expects, or believes, or which otherwise state the company's projections for the future are forward-looking statements and we would caution the listener that actual results could differ materially from those made in such statements.

Information and the factors that could cause actual results to differ from those in the forward-looking statements are contained on Slide 2 in the news release in 8-K issued this morning by Snap-On and in our 10-Q, 10-K and other periodic reports filed with the SEC. This call is copyrighted material by Snap-On Incorporated and 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. The 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 to Marty Ellen to review our financial results.

Thank you, Bill, and good morning everyone. I will begin my remarks with Slide 3. Total revenue in the second quarter of 2004 was $612.1 million and included $20.8 million from the consolidation of our Worldwide Financial Services businesses. Net sales of products and services in the second quarter were $591.3 million, up $26.1 million or 4.6%. Organic sales increased $10.6 million or 1.9% year-over-year. Currency translation accounted for $15.5 million of the sales increase. I will address the components of our sales performance in a moment, as we review each operating segment.

Consolidated reported net earnings were $0.38 per diluted share, the same as they were, a year ago. Diluted EPS includes $0.06 per share of costs for continuous improvement actions worldwide. In last year's second quarter, continuous improvement costs were $0.03 per share. The current quarter also includes $0.04 per share for the recently announced charge associated with settling 2 government services administration contract audits. The settlement agreement covered sales over the 8 years from March 1996 through the July 23rd settlement date. Turning to Slide 4, Snap-On's consolidated gross profit, defined as net sales less cost of goods sold was $255.9 million, up $9.8 million over last year, or 4%, and was up $6.6 million sequentially from the first quarter on essentially flat sales.

As percent of sales gross profit margin was 43.3% in the quarter, and was reduced by 80 basis points to $4.6 million for continuous improvement costs. These costs include $2.2 million related to the U.S. hand-tool plant closings in Kenosha and Mount Carmel, and $2.4 million for other facility consolidations and activities underway, principally in Europe, and relating to portions of the commercial and industrial group footprint. Last year's second quarter gross profit margin was 43.5%, which included only 20 basis points or $1 million of similar costs.

Overall, we are encouraged by the underlying progress being made. Although we are realizing the benefits of our hand-tool plant consolidations more slowly than we had anticipated, as a result of certain production inefficiencies. While costs are declining, manufacturing productivity improvements are being affected by certain other factors, which Dale will elaborate on. Turning to Slide 5, operating expenses were $235.9 million, including $11.2 million resulting from the consolidation of financial services, the $3.6 million dollar charge for the GSA settlement and $1.1 million of continuous improvement costs. Included in last year's results are continuous improvements costs of $2 million. Absent the influence of these items, operating expenses were 37.2% of net sales this year, compared with 38% last year.

Research and Development expenses of $15.3 million grew 4.8% year-over-year in line with our efforts directed at continued new product innovation. As you would expect, a significant portion of our operating expenses relate to people. Salaries, wages, pension, medical, and other costs associated with employment. This year, we've been able to offset most of the upward pressure on these with productivity improvements. Let me now turn to a review of our segment results starting with the Snap-On Dealer Group segment. In the Worldwide Dealer segment, as seen on slide 6, second quarter total net sales were $274.7 million in 2004 compared with $281.3 million in 2003. On a currency neutral basis, segment sales were down $11.1 million.

Sales in the U.S. Dealer Business declined 2.3% in the quarter. The average number of dealer vans in operation for the quarter on a year-over-year basis was down 2.9%, reflecting a greater number of open routes. This is largely the result of a lower level of dealer additions in the near term, while the number of dealers leaving the system was essentially flat year-over-year. As a part of Snap-On's continuing efforts to strengthen the financial health of its franchise dealer system, recruitment standards for dealer prospects have been tightened and a new trial franchise program has been launched in 2004.

This new program offers starting dealers a 3-year alternative that is expected to help them increase their equity sooner. The result of our efforts, have been that fewer dealer prospects have been graduating from our trial program to become full-fledged dealers. At the street level, however, we are pleased to report it appears that our dealers continue to do well. The data they have reported to us for the second quarter indicated year-over-year growth in their sales to their customers at a low single-digit rate in the United States. In our International Dealer operations on a currency neutral basis, sales were lower year-over-year against the strong sales performance last year. Operating earnings for the Dealer group shown on Slide 7 were $24.9 million after deducting $1.9 million of continuous improvement costs. This compares to $23.6 million last year after deducting $1.5 million of similar costs.

On a sequential basis, operating earnings were also up from the first quarter's $11.6 million, which included $9.7 million of continuous improvement costs. The operating margin for the dealer group in the second quarter was 9.1%, compared to 8.4% last year. A little more than half of this improvement came from lower operating expenses, the balance, from gross margin expansion. Operating earnings benefited from reduced bad debt expense and lower pension, other retirement and insurance costs which in total declined by $5 million.

On the other side, we incurred $1.1 million of higher freight, as freight rates are up and our shipping volume is up as we are making more frequent deliveries. Turning to the Commercial And Industrial Group shown on Slide 8, sales of $308.6 million increased $26.3 million year-over-year, or 9.3%. Sales were about flat sequentially with the first quarter. The second quarter sales increase includes $9.2 million as a result of currency translation and $17.1 million from higher organic sales. This represents a 6.1% organic rate of growth. Demand for tools in Industrial and Commercial Applications increased in both Europe and North America. This continues the improved trend and demand that began late in the fourth quarter of 2003. Worldwide equipment sales also increased in the second quarter, up about 6% on a currency neutral basis. In the U.S., year-over-year sales growth was achieved, and we are now past the 1-year anniversary of the launch of Tag, our Technical Automotive Group direct sales channel. We remain focused on continuing the trend of productivity and profitability improvement. This follows 4 years of cyclical downturn, and we are encouraged by continued increase in sales leads and the increased involvement of Snap-On dealers in generating those leads.

On the down side, we experienced a decline in sales in our OEM facilitation business, where we provide new car dealership purchasing and distribution services. This was a particularly tough comparison year-over-year, due to strong sales performance last year. I would remind everyone, however, this is a low margin business and thus has a relatively small impact on profitability. Turning to Slide 9, the Commercial and Industrial group reported an operating loss of $1.6 million in the second quarter, compared to operating earnings of $800,000 last year. Negatively affecting operating results, were certain higher costs and charges, including the $3.6 million for the resolution of the 2 GSA contract audits. As we have previously disclosed in our 2003 Annual Report, Snap-On has government contracts with federal departments and agencies, 2 of which were under audit by the GSA. The 2 contracts involved sales from March 1996 through February 2001 and sales since February 2001.

On July23rd, we reached a settlement of all issues for $10 million. The charge in the second quarter is to cover the costs not previously accrued. Additionally, segment results also include $3.6 million for continuous improvement costs. These primarily relate to the consolidation of certain European facilities, as well as the segments $300,000 portion of the U.S. hand-tool plant closing costs. The European actions include the closure of a German hand-tool plant, which is being consolidated into our Spanish operation and the elimination of 1 Spanish plant through further consolidation. Some of these continuous improvement actions will continue through the third quarter, and into the fourth quarter. This 3.6 million of continuous improvement costs compares with $1.5 million of similar costs last year.

A couple of other items to point out in the quarter include $1.4 million of adverse currency effects primarily related to products manufactured in Sweden, but sold in the U.S. Furthermore, we are expanding our distribution and operating presence in Asia, and we incurred about $1 million for start-up and other expenses associated with this effort in the second quarter. Asia offers significant long-term potential for sales of tools and vehicle repair diagnostics and equipment. 2 weeks ago, we cut the ribbon on our first 100% owned facility located near Shanghai. Turning to the Diagnostics and Information group on Slide 10, you will see that sales were $82.2 million in the quarter, up from $75.9 million a year ago. Growth was fairly broad, including hand held diagnostics, diagnostic products for diesel engines and the large over the road trucks and off-road vehicle markets, and Mitchell 1 information products in North America.

Operating earnings for the Diagnostics and Information group were $7.9 million, or 9.6% of sales compared with $5.1 million, or 6.7% of sales, a year ago. The earnings gain was principally driven by the increase in sales, including the sales of hand held diagnostics through the Snap-On dealer group. Turning to the financial services segment on Slide 11, operating earnings were $9.6 million. Last year, comparable net finance income was 11.2 million. The largest component of our financial services operating earnings comes from our domestic credit business through our joint venture, Snap-on Credit. Dollar volume of contract originations was essentially flat year-over-year, at approximately $130 million. However, since these finance contracts have a fixed interest rate, the increase in market interest rates year-over-year lowered the earnings contribution. With that completing my operating segment review, now let me turn to a discussion of cash flow, which is shown on Slide 12. Snap-On generated $57.8 million of cash flow from operating activities, up sequentially from the $31.2 million of cash flow from operating activities in the first quarter. It was also up substantially from $37 million, a year ago.

Capital expenditures increased to $10 million in the quarter compared with $6.8 million a year ago. For the full year, our expectation for capital expenditures remains in a range of $40 to $45 million. After capital expenditures, free cash flow increased to $47.8 million from $30.2 million, a year ago. Depreciation and amortization was flat year-over-year in the second quarter. The components of working investment, inventories, receivables and payables contributed $10.3 million to the higher cash flow in the second quarter. For the full year, we expect 2004 depreciation and amortization to be between $55 and $60 million, exceeding our capital spending. It remains our high priority to continue to improve working investment turns and generate free cash flow. Going forward in the near term, our priorities on the use of cash flow can be seen on Slide 13.

We expect to maintain our emphasis on our dividend, and as we stated last quarter, we did accelerate our share repurchase activity, buying 600,000 shares for $19.9 million in the second quarter. This brings our share repurchase activity to a total of 750,000 shares year-to-date. We do expect to continue to repurchase shares to offset dilution, as has been our past practice. Furthermore, we presently believe we have no requirements to make additional pension contributions this year. Major acquisitions are not a likely use of cash near-term. Our acquisition opportunities are concentrated on near neighbor product line acquisitions much like the 2002 purchase of Nexec (ph). As a result, for the next few quarters, we believe the leverage in our capital structure will remain below our long-term target of net debt to total capital in the range of 30 to 35%. As you can see on Slide 14 at the end of the quarter, after netting our cash of approximately $127 million against total debt of $331 million, our net debt was $204 million or 17.2% of total capital, down from 19% at yearend 2003, and down from the 25.3% a year ago.

Other balance sheet highlights at quarter end include inventory being down $9 million sequentially from the first quarter and down $41 million versus a year ago. For the second quarter 2004, inventory turns were 3.8 turns compared with 3.3, a year ago. Total current accounts receivable at the end of the second quarter were down $18 million sequentially from the first quarter on essentially flat sales. Receivables were down $23 million versus second quarter a year ago, despite the consolidation of Snap-on Credit, which added $15 million year-over-year. Looking at it from a day sales outstanding perspective, Snap-On improved by 7 days on a year-over-year basis and 2 days, on a sequential quarterly basis. We believe we are on track to achieve our working investment goals ahead of the targeted date of yearend 2005.

That goal was expected to generate over $250 million in cash from the beginning of 2001 to the end of 2005. We have already exceeded that portion of the goal, having generated more than $260 million. Those conclude my remarks about our financial performance. Now let me turn the call over to Dale Elliott.

Thank you, Marty and good morning everyone. Generally our operating trends were largely as expected but we're still not satisfactory, nor up to our expectations. 3 years ago, we embarked on a journey of significant improvement, setting out to improve profitability and return on capital and laying a foundation for sustainable and profitable growth.

While our pace of change has not always been as fast as we would like, I can tell you that our culture is changing and the foundation stones for a stronger future have been laid and will continue to be built upon. Today, for example our accomplishments of more directly seen in the improved cash flow and stronger balance sheet. Additionally, we are also seeing evidence of improving underlying operating margin trends after considering the impacts from the financial items Marty pointed out in his commentary.

I will also share more specifically, some of the culture and performance mind-set changes that have taken place within our businesses to demonstrate that real change and improvement is occurring. A good place to start is with the Diagnostics and Information group, where the operating margin has been expanding nicely and is approaching our interim 10% goal. This segment consists of what had been a number of businesses acquired over the years to build upon the electronics lineup that had existed within Snap-On.

Each of the businesses had unique cultures and different business models. Today these operations have been rationalized and integrated with significant cost benefits. The Nexec (ph) which was acquired in 2002 was integrated within the first 90 days. Product lines have transitioned from the former large platform products like the Sun Machine to a world-class hand held lineup capable of diagnosing the sophisticated computerized electronic vehicles of today. The product array includes everything from simple component testers, to basic scanners, to the modus diagnostic system, which has no equal in the marketplace. Snap-On's information and vehicle data stream analysis capabilities are comprehensive and world class. From the expert advice troubleshooter products, to the broad based vehicle repair information available through Mitchell 1. Our recognized expertise in this area was recently highlighted by our strategic agreement with Qualcomm. Shortly we will explore opportunities in the commercial clean area additionally around remote diagnostics.

With a number of new vehicles continuing to expand and technology becoming ever more sophisticated we believe there is substantial opportunity to continue to grow this business. New product launches are planned to continue at a healthy pace worldwide. I am pleased to note that we just introduced a revolutionary new scanner, the Solis, to build upon our success in the marketplace and our installed base. Solis sold through the Snap-On dealer system features a new approach to software updates, coupled with improved customer focused features and capabilities. It has received a very positive response from both our Snap-On dealers and technicians. This unit is a good example of how focus on operational fitness creates resources that can be turned into profitable growth. Turning to the Dealer group, the most visible event has been the consolidation of our 2 largest hand-tool plants. We were able to consider such bold action because of the positive changes that have taken place under Driven to Deliver.

The transformation of the Snap-On mind-set to 1 of continuous improvement coupled with a culture that emphasizes value and performance, results in projects such as this coming forth. Lean Tools (ph) allow people to make great strides in moving towards cellular white piece manufacturing flow, and eliminating waste in the process. Empowerment was a key element in our success. Within the plants, organizational responsibilities were realigned from traditional departments to responsibilities by value stream. From raw material as it enters the plant to the finished products as they leave the plant, what was once organized along department lines like machining and plating, is now the responsibility of the value stream teams, and encompasses all activities related to a particular value stream such as pliers.

However, we are still in the midst of fully digesting all of the activities surrounding that change. We have used the relocation as an opportunity to make other significant changes beyond (ph) SKU and portfolio management changes outlined last quarter. This move of production presented somewhat of a green field opportunity to address a number of manufacturing and supply chain process improvements. The move allowed us to surface manufacturing bottlenecks and process inefficiencies that had remained hidden and therefore not addressed for many years. We have reduced manufacturing costs primarily in labor and facility related costs, as you would expect. But importantly we have identified areas that have been holding back progress in the past.

The increase in capital expenditures during the last quarter reflects the addition of new equipment to improve process speed and eliminate these newly identified bottlenecks. And unfortunately while we've been working to solidify and improve processes, we have had to deal with the disruptions caused by the uncertain steel situation. Production inefficiencies are still not where we believe they ultimately will be, and we do not expect to see all of the benefits from this consolidation until the end of 2004. However, we have prioritized the challenges and through Lean events our employees in the plants and in the supply chain are actively engaged in bringing these improvements to the bottom line.

Shifting to the sales side, another important change relates to the new option for prospective dealers that Marty mentioned. The new 3-year trial program has many benefits. The most significant being, it provides new dealers with a way to increase their franchise equity. It also creates an opportunity to develop appropriate operating habits through greater discipline and regular quarterly performance reviews. This provides for more frequent reviews at regular intervals to evaluate the likelihood of success.

From a financial point of view, the initial inventory for those in this program is consigned and only sales to end customers are recorded as our sales. While this lowers report in sales, negatively impacting the comparisons in those of the first year, we believe it is the right program for the future. Over time, we believe this can be a significant improvement, one that can make a lasting distribution to a stronger dealer system.

Within the Commercial Industrial segment, improving economic trends in North America and in a key market in Europe is leading to stronger demand for tools used in industrial and commercial applications. We also continue to see encouraging signs on the part of vehicle repair shop managers to make equipment purchases and reinvest in their businesses, particularly among the regional and national account chains, something we have not seen for some time.

While the segment's operating margin in the second quarter was clearly impacted by the charge related to the GSA matter and continuous improvement costs, there are encouraging signs that underlying financial trends are improving. We still have many improvement initiatives in progress, and much of the anticipated costs for continuous improvement actions in the third/fourth quarter are largely for these activities. For example, we have a hand-tool facility that is being closed in Germany, which will be completed in the third quarter with most of that production moving to our Spanish operation. We are streamlining the administration organization of Bahco and the worldwide equipment business is continuing to shrink their plant footprint with significant improvements in productivity and no loss in capacity.

We have good people leading these initiatives and we continue to expect that the operating results of this segment will show improvement during the remainder of 2004 as current and new projects are completed. At the same time, we will continue to monitor and evaluate the strategic positioning and financial progress of all our businesses for their ability to generate shareholder value. In the case of operations that do not fit our strategic profile, or whose financial return and performance is not acceptable, we would expect to take appropriate steps. As I stated in the annual report, our task is clear. Accelerate the pace of change, execute our plans seamlessly and make our goals as reality. Let me close by talking more specifically about our expectations for the remainder of 2004. Like many companies, we are carefully monitoring steel and energy costs. With regards to steel cost increases, we have taken a number of steps consistent with the competitive marketplace, including selective product price increases, which were affected in the third quarter.

Because certain of our steel needs are specialty alloys, we are working closely with our suppliers to provide assurance that we get delivery and as appropriate we will try to maintain higher inventory levels in an attempt to alleviate any potential disruptions. Relative to energy, while the price run up in the second quarter was concerning to us, this is a fluid situation and one that will remain a watch item for us as long as fuel prices are this volatile. Results will continue to be impacted by the ongoing costs for continuous improvement actions. Continuous improvement costs are expected to be approximately $6 million in the third quarter with another approximately $4 million in the fourth quarter. That will bring the anticipated full year amount to about $26 million or $0.28 to $0.30 on a per diluted share basis.

Converting to a lean approach, presents us with opportunities for action by its very nature. We have chosen to move forward as these high return projects have been identified. Our 2004 full year outlook for earnings is $1.72 to $2 per diluted share. It assumes low to mid single digit revenue growth across all the operating segments in the third and fourth quarters, which we believe is achievable. It also assumes operating margins will expand as a result of volume improvement and the realization of further costs and efficiency enhancements from our hand-tool and other plant consolidation activities. Although more of these benefits are expected to be realized in the fourth quarter.

Finally it also reflects lower expected levels of income from financial services due to the rising interest rate environment. We expect cash flow to continue strong through the remainder of this year, as we remain focused on improving working capital turns. And as we reach our current goal of four turns, it is our intent to raise our target to 6. We still have a long journey ahead of us, but the organization is responding in a positive manner to our need for change and we do expect further gains. I believe the journey is progressing, and we will continue our efforts to accelerate improvements that will strengthen our competitive position in the marketplace and improve financial returns for our shareholders. And now we will take your questions. Operator?

Thank you. The question and answer session will be held electronically today. If you'd like to ask a question, you can do so by pressing the * key followed by the digit 1 on your touch-tone telephone. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, that is * 1 on your touch-tone telephone to ask a question. And we'll pause for just a moment to give everyone the opportunity to signal for questions. Again, that is * 1 on your touch-tone telephone for any questions. Our first question will come from Jonathan Steinmetz (ph) with Morgan Stanley.

Good morning everybody. Can you hear me?

Good morning, Jonathan. Yes.

A few questions. The first - I may have missed this - did you quantify the steel impact in the quarter?

Jonathan, we did not. It's Marty. But I'd be happy to give it to you. In the second quarter year-over-year steel cost increases were about $1.4 million.

Okay, and looking forward, do you see that amount greater or something similar to that run rate?

Let me give you the numbers. And what I'm quoting for the most part are the numbers coming out of the largest part of our business, which is the tool and box plant activities supporting the dealer industrial businesses. Our other businesses are tackled on a much smaller basis. For the third quarter, we expect steel costs year-over-year to be up $1.5 million. For the fourth quarter, we expect them to increase year-over-year by about $2.9 million.

Okay, is that because you have certain contacts or something that would start to impact in the fourth quarter?

Right. Really you know, the exploration of certain agreements that have to be renegotiated and advanced in our current discussions and understanding -- those are the current estimates.

Okay. Switching to the Dealer group, it's been several or many quarters in a row here where we've had this disconnect between what you guys think end demand is, and what sales in the system are. So a couple questions around that. When do you see this gap starting to narrow? And second is can you talk a little bit about the change in the dealer system and why you've moved to this consignment model and this different sort of franchise agreement? ?

Sure John. Let me take the second question first if I will. The new trial franchise program was designed to address a long-standing issue we've had in the Dealer group and that is reflective of the fact that normally the highest percentage of our turnover occurs in the first 3 years of association if you will. And when we went back and analyzed what was the root cause of this increase in turnover in that particular period of time we found there were several factors relating to how an individual started up the business that contributed to that. And this new 3-year trial franchise is aimed directly at solving some of those issues. And then as I mentioned in the comments, we've also raised the amount of training in this period, the amount of individual reviews in this period. So we really are trying to activity do a couple things. 1, make sure we get the right person coming into the program, and then designing a very comprehensive program around that individual, so that we make sure that they're shepherded through that first 3-year period, as effectively as possible. On your first point on the sales disconnect, I can imagine that does maybe cause some consternation out there because we've had a variety of ups and downs, sometimes in (INAUDIBLE) sometimes little higher, sometimes little less. And unfortunately I have no real great guidance in that area for you, except to say that again over time we think they should get back in more line. But we have been very favorably feeling about what our dealers have been doing on their own personal balance sheets if you will, getting their inventory back in line. We did contribute to this gap, as Marty said, somewhat by the fact that we did tighten up on the amount of people we've added into the system, which depressed the sales connection. And again we've had the exasperating factor -- the 3-year trial franchise, which also depressed the relationship. Again I would suspect if they would get more back in line as we go through the back half of this year, probably the first quarter next year, fourth quarter this year. But there are a lot of factors that drive into that in addition to the ones that I mentioned, including new product active et cetera, etcetera. So while we keep a sharp eye on it, as you might imagine, we're pretty encouraged by the fact that we're taking the right steps for the long-term and that this will shake out overtime and get back close proximity.

When did you start the trial franchise program and how many franchisees do you currently have under that program now?

John that's Marty. Let me go back and you should know that we've always had a 1-year trial franchise program for dealers. At the end of that 1-year period, the dealer have stayed on with us through that program would then be obligated at that point to purchase all of the consigned inventory on the truck, and that would be recorded as a sale by us. At the beginning of 2004, we introduced the 3-year program to allow dealers 3 years to ramp up their business and offered those on the existing 1-year program that wanted to stay in, the opportunity to do so. So there were a number of dealers that did not flip, if you will, and that was probably worth a couple million in the quarter in large sales. So it's really somewhat of an extension of the existing trial franchise program to allow us to work more closely with these dealers and get their performance standards up, which, you know, first and foremost are getting them to a level of weekly sales that we believe allows them to be successful. I think it goes without saying that it doesn't do any of us, our dealers or us, any good to not have them sustain a certain performance level, because of course turnover costs of this business can be quite high. We had about, at the end of the second quarter, 190 total trial franchisees

Okay, and last 1. I'll let other people come (ph) on -- you mentioned that price increased selectively, I guess, to try to cover raw materials. If you aggregate across the product line, do you know what that would work out to roughly on a percentage term, and when did you communicate it to the dealer base? In other words was there any pre-buying likely ahead of this?

Well I have to give you a little range on that as you'd imagine, depending on the business unit, the relationship changed quite significantly. I would say most of the ranges of increases have been around 3 to 5%, some significantly higher than that. As far as timing, most of our product, or most of our units rather, changed to product pricing normally around July 1st in any condition. So we really had a chance to take a look at the run rate to Marty's point in the second quarter and build that into our forecast estimates of price realization for the back half.

Okay. Thank you.

Up next from Barrington Research, we'll hear from Alexander Paris.

Morning.

Morning Alex.

Just going back to this dealer trial program. So, when do you book -- so for 3 years the inventories that you will have in terms of your sales will then reflect only the end results for those dealers? You won't have this disconnect between you sell it to them -- it's not considered a sale when you give it to them on consignment?

Alex, it's Marty. That's correct. We record the sale when the dealer sells it to their end customer. So at any point in time, the inventory that's off the truck is our inventory. If this were a full-fledged dealer, of course, that would be their inventory. They would have already purchased it.

So this kind of eliminates that problem where you were selling -- they were getting good returns, but when you were trying to improve their turnover your sales to them was less than their final sales. So this will bring them a little closer together?

Year-over-year, it does have an impact on the trends. .

Just looking at the -- you've been doing things for several years now to cut costs, and of course that's a problem bringing those benefits down if you don't have any top line growth. So just looking at the growth in the industry starting with the dealers, you used to reflect the growth in mechanics, as a potential market, the aging car population. What do you see the normalized growth there now? Mechanics, for example. Is the mechanic population growing?

Yeah. I think your point, Alex, that's an element we keep an eye on. I think what our figures show -- I guess you'd say intrinsically we think it's a low single digit rate over time. There is a factor coming through the technician population that we're all trying to get a handle around, not just us but a lot of people that operate in that and related spaces, and that is the turnover effect as the baby boom generation retires. If you look at 1 set of analyses, you could see that that could trigger a very strong demand for new technicians above this low single digit I mentioned earlier. Again, if you normalize that over a period of time, it may back fall in the range I mentioned of a low single digit range. But I think overall, if you look at a GDP type growth curve that's a pretty good proxy for what we think is going to happen there.

For the overall dealer industry?

Right, now within that as I said, though there are a great many opportunities for new products and some other activities that could probably give us access to growth higher than that for a specific period of time, i.e. the new diagnostic equipment we've talked about. We've launched a new line of toolboxes that are initially receiving very favorable response. Power tools have had some good response too. So there are some share gains we could make above and beyond the intrinsic rate of growth in that market if we're successful in new products and our other activities.

So just to repeat then, longer term you're looking at CAP GDP type growth for the Dealer industry, call it, and you would expect to therefore do better than that? ?

Well, again, depending on the mix of product, we think the dealer business itself should be in a GDP type growth. We think the Diagnostic side has a higher than that, I'd say mid to high single digits. And then the Industrial businesses would be back more to a GDP type growth. .

Okay and on your Dealer business, the number of open territories that you have is significant? I know years ago, it was considered that maybe you were as far as you could go in terms of saturation and then that got you going more overseas to Europe and Japan and so forth.

Right. I don't think we're near that saturation point. I think we stated before that we think we can grow the dealer force around 3 to 4% a year for the foreseeable future in the next 10 years or so, and I would still agree with that. The current situation as Marty pointed out, is more due to the fact that we've been a little bit more particular on how we're adding people into the system, again trying to address that first 3-year turnover figure that we've concerned with. But long-term I think there's still plenty of opportunity out there. As we've said in the past, there's still fully 25% of the technicians out there that don't see a Snap-On dealer on a regular basis and that still clearly is up side potential for us.

Well, just looking at the whole company looking forward, what kind of growth would you be, say, satisfied with, or planning on, in terms of the top line?

Well, again, actually, I think not including any acquisition activity, I think we've looked at a low single digit figure in the past, again not looking at an aggressive acquisition schedule. And that's pretty much an open-ended depending on what we would approach. .

Okay and then just going to the costs, your continuous improvement cost, that's been going on for 3 years now. Right? Under the big plan.

Right.

And it's still going through this year $6 million, $4 million. Is there a point here where you're going to reach that you're not going to talk about that separately? Now there's always continuous improvement going on there but ...

I hope so, Alex. Rather sooner than later as I'm sure you would agree. I think the major heavy lifting, if you will, is going to start coming to an end here. I can't say never, because we've learned some things during this whole lean conversion that says to your point. Continuous improvement costs are always with you and should be a normal part of doing business. But I would think again, some of the heavy lifting that we've done, again shutting a lot of plants rather aggressively like we have, in this last 2-year to 3-year period would start to sunset. And I would hope by the end of this year those costs would somewhat fall to the background, and we'd start talking about margin expansion because of the flow through benefit of previous projects would start coming to be visible. That would be our hope or expectation for the future on that.

And just to repeat, the reason you've been breaking them out for the last couple years is because you considered them a part of a 1-time 3-year extraordinary plan catch-up consolidation, restructuring and so fort.

I think it's more to the size and type of projects. Again, one normally doesn't close, for example, the 2 largest plants in the system, on a regular basis.

Right.

We won't be able to do that again because that effort is past. Or in Europe, as we said, we've really readjusted the footprint in our equipment business in Europe now that we're down to, fundamentally, a single location. So those type of things are behind us and the size and scale of those should also be behind us. But as we get into normal projects of lesser scope, and we've said that that could average around $3 to $4 million a quarter, to your point you'll see us stop talking about that and hopefully talk more about the flow through benefits. .

I've been trying to adjust the earnings for those, considering them nonrecurring. But if they you know, if they keep going, you have to stop that ...

Correct.

...And stop adjusting for it. So the $4 million that they say at the end of the fourth quarter, would you consider that big 3-year plan essentially done? As I say, I know the costs don't go away completely.

I would say primarily, but as I said earlier, you can never say never. The whole emphasis on Lean is continually challenging the organization of, "Can you get by with less footprint, can you get by with less overhead and capacity?" Utilization is key to some other factors. So - but again I don't see that the pace and significant size and opportunities in there anywhere near like we've been doing in the last few years.

All right, just 1 other small question. With the gasoline prices at this level, are they at a high enough -- I know that a few years ago, you had a tough third quarter when the gasoline prices skyrocketed suddenly. Are they at a high enough level that they are affecting driving habits in this key third quarter?

Well, we haven't seen any data come back yet out of the normal agencies that provide that information yet to say that there's been a huge drastic fall off in miles driven. I think our position, based on the anecdotal evidence that we have is that the driving habits have probably held up remarkably well. I will tell you though that personally, I am concerned that that run up did have somewhat of a chilling effect out there but it's almost impossible to quantify that given the amount of factors that were operating in that time period. Normally, as you said before, years ago when we got over the $2 a gallon rather, threshold, we saw significant a fall off in miles driven. I don't anticipate that occurring to that degree this time. It's really more related to how fast the price per gallon moves and over what period of time. So if we get a large run up over a very short period of time, I still believe that that would have a deleterious effect on miles driven. But as the price kind of moves a more of a slower pace, I think people tend to absorb the increases and not change their driving habits. So as I mentioned in my speech, it's something we keep a sharp eye out on, and really keep hoping that the transition will be smooth, and that it will come back to some degree of normalcy here.

Just one more quickie here, your guidance for the year, for the full year in earnings that includes the $0.27 or so to $0.30 continuous cost?

Correct.

Okay. Thank you. .

Up next, we'll hear from Nick Panatatus (ph) with Monnas Crispy (ph).

Thank you. Just a couple of follow-ups on the Dealer group issue. With regards to the tighter recruitment requirements, and the 25% or so technicians that aren't being called on. Is there a point where you start to look at that and say, "Well, maybe we need to either adjust our requirements back or perhaps restructure what we have with regards to the existing franchise network because these are lost sales -- that we have the potential never to recover this share." And secondly, on the Financial Services side, do you have some sort of a metric that you could provide with regards to higher interest rates, or at least the anticipation of that moving forward to get some sense, you know, of what a 25% -- 25 basis point change in rates does, to the income on that line? ?

Let me take the first question and I'll lateral the other one to Marty. Relative to the dealer position in the marketplace, I think it's important to know a couple of things. 1, our data indicates that we have not lost share in this period of time. So I wouldn't confuse the fact that we've not added as many dealers in this last quarter with a loss in share in the market. Quite the contrary. Our indications from our data says that we've maintained share and increased it in some categories. But your point, what it is allowing us to do, is come back reevaluate our whole recruitment area and that has been done, and we are now entering between now and the rest of this year, a rather aggressive recruitment campaign built around the 3-year trial franchise. And another important point, which we have talked about in the past, which is the second van (ph), second franchise opportunity. As you say, the 25% that's not being called on by a Snap-On dealer on a regular basis is for a variety of reasons, some of it's geography, some of it's open routes, a variety of reasons. But between the second van, second franchise capability and our new trial franchise program, we think we've got a good methodology for extracting our fair share of that 25% potential and I think you'll see evidence of that as we close through the back half of this year. Marty, do you want to talk about the credit company?

Nick, for purposes of thinking about modeling or sensitivity for the credit company, 3 quarters of the credit company's business is done with EC contracts, extended credit contracts. The underlying benchmark rate for those contracts is fundamentally the 2-year treasury. I would tell you to use a rule of thumb that every ten basis point increase in the 2-year treasury, would lower our earnings on an annual basis, not quarterly, annual - pre-tax by about $375,000. . Okay, so $375,000.

Annually.

Okay. Okay, thank you. .

From Lehman Brothers we'll hear from Darren Kimball.

Hi, guys.

Hi Darren.

I'm not sure this has been asked in quite this way; so let me give it a shot. Well, first of all, on the steel, the numbers that you were giving out earlier, are those intended to be just sort of the cost side, or is that sort of the net effect after recoveries?

That is the cost side. And we expect to actually recover more than that through our price increases. The numbers, I quoted again were predominantly for our tool business, tool and storage business, the dealer business as we think about it. Our annual price increase had always been scheduled to be July 1st long before even the run up in steel prices. As a result of the run up in prices, we looked at our pricing action, took it up a little bit more, over and above what we would have, to compensate for this even further, and so we are more than covered. I think to keep steel in perspective for the main of our business, the Dealer group, our annual spend for raw and components is only in the range of $30 to $35 million or so. So just to keep this number in perspective.

Okay. That's interesting. So steel not only is not a negative; it may wind up being a positive. .

We took pricing up a little bit more to cover it. Normally, as everybody knows, we tend to have an annual price increase with our dealers, and we notched it up very modestly to cover the anticipated increase that we saw in steel.

Okay, thanks. And the other question I had was on your dealer van count. I was just wondering if you could, sort of, get into a little bit more detail about, sort of, the rate of additions versus the attrition rate, because I was under the impression that the van count was growing nicely under the Feet on the Street Campaign, and so I'm wondering what your attrition rate is and is that something that's kind of running higher than historical numbers. Is that why your dealer van count is shrinking? And also when did this -- I don't know if this was talked about in the first quarter. I didn't see it in the first quarter slides. But when did this trend start, as far as the Feet on the Street ceasing to grow and starting to decline?

Well on that point, I think again it's not -- their overall dealer count is still up over historical averages. What we're talking about really in this last quarter where we did not add as many dealers in, as we have had in the past. So it's not a long-term issue, Darren. It's more of the last quarter, as a result again of this new program that started at the first of the year. And as I said earlier, we are going to accelerate the activity in the back half of the year. So this is not something that I think you ought to change your model of the number of dealers. If anything we will exit this year with an increase in the amount of dealers. The amount of open routes we talked about in the past were around a 100. We're still less than 200 in open routes now. So we're not talking an order of magnitude change here. I think it's more attributable to a quarter in which, because of the new standards and the focus that we got a little disconnected between ads and those coming out of the system.

But again, you said your dealer vans and operations are down 2.9% year-over-year. And maybe you could just give some detail in terms of like you know, how many you added and how many you know, retreated and retired and quit and that kind of thing. .

Let me give you numbers. Let me just -- to close on Dale's comment, if you go back and when we really started more aggressively adding dealers in 2001, you go back to January, 2001, our dealer count is up over 7% since then. Termination levels year-over-year have been about 230, 240 in the first 6 months, both this year and last year. That really hasn't changed. The difference is we only added about 80 dealers the first 6 months of this year. We added about 250 dealers the first 6 months last year. And again that, you know that the major factor being our view of making sure that the people we add can be successful. Because over time we'd really like to eliminate and reduce the turnover number. It's been what it's been, but we really think there's a great opportunity for the company in reducing that number. As you can appreciate, the success rates for small businesses are not great in almost any business, and any franchise system sand that's why, as Dale said earlier, we really need to be focused on getting our dealers through the most critical period, that first 3 years, and help them develop their business in their territory.

That was really helpful. Thank you.

Okay.

From Janney Montgomery Scott, we'll hear from Suzanne Rafael.

It's actually Jim Lucas and all questions were answered. Thanks.

Moving on, we'll hear from David Leiker with Robert W. Baird.

Good morning.

Morning David.

I want to follow up, Marty, on the comment you said to dealer comes up 7% from when you started the Feet on the Street program. I thought that number had gotten to 10% or better. So you've had some demarcation (ph) in the dealer (INAUDIBLE) year beyond - it sounds like probably beyond what we're seeing here in this quarter or not?

The 7 - been about 7.5% since January 2001 we're up still. In this quarter alone, we said we're down on average 2.9%. I think, David, if you add the dip that Marty mentioned plus what he just said, you get back close to 10%.

But just the change in business -- but the decline in vans isn't the same as a decline in dealers is it?

In franchisees you mean?

Yes.

yeah, we're talking van count. Not number of franchisees. .

Okay. Looking at the second half, your guidance here looking down into the second half, is pretty substantial improvement in earnings. I was wondering if you could walk through, and quantify a little bit, how you got from second half earnings last year of $0.70 this year to $1.25 basically.

David, let me handle this question. As we said in our release, you know, we're looking for low to mid single digit revenue growth, and that would be absent currently. The biggest -- a big factor is our expectation that we're going to get-- the manufacturing improvements we had anticipated on the hand-tool closures in the fourth quarter, those are behind. Our own internal schedule, although costs are improved year-over-year, they're not where we had internally wanted them to be. We understand the issues there. We've seen the plans for those issues. And that's very much a fourth quarter item. We also, as I said, have our July 1st price increase for the Dealer groups, so we do not take pricing off January 1st as we have had in prior years. We intentionally decided to make our pricing move July 1st. That had always been in our plans so that's why we had always had a view of a much stronger back half than front half. Those are a couple major factors. You know, we are seeing cost and margin expansion. You know, Alex sort of circled around these issues because we understand sometimes that, with some of the one time -- I hate to call them one time, but they tend to recur. But issues - you know, we have seen cost reduction and margin expansion in this quarter alone, without the GSA and without the continuous improvement costs. But not taking out operating matters like manufacturing efficiencies. We had the 80 basis point margin expansions -- operating margin expansion year-over-year. So a lot of things that we've been doing -- the European plant closure activities that we talked about in Germany, and in Spain, many of those plans are to be completed here in the back half of the year. So we're anticipating a very strong fourth quarter and much more the back half earnings to be in the fourth quarter, as opposed to the third quarter.

Okay, and then the savings from the consolidation at the hand-tool plants, what was that number again? I don't recall. .

We were anticipating on an annualized basis to get, David, $12 million.

And then the originations number in a finance business being flat year-over-year. I mean in the past we've talked about that being a proxy of the flow through in the end market and kind of confirmation that end market demand was growing but getting mapped by things that are being done at the corporate level. I mean it seems like it's somewhat disturbing that that number is flat year-over-year.

Well, actually, I mean when you think about it as a proxy for the volume in the Dealer business, our Dealer business was down. That number is also impacted obviously by the mix. And as we sell more higher priced products like Diagnostics, that I know endures to the benefit of Snap-on Credit. So that's -- mix will be a factor that will cause the trend in that number to maybe vary from the trend in dealer numbers.

David, I think - so the point on mix that Marty's talking about, we're talking about the mix of financing activities. Our extended credit contracts, which are built to your point, around product sales are up. The activity that's down is dealer financing, which as you could imagine, with a lower amount of dealer additions that pulled it down. And quite honestly our dealers are paying back their debts and obligations to us, which also pulls down the financing. The DSOs that go down without a good reason. So I think from - when we look at as far as the product related pace, we still would agree that we see that low single digit activity connection there. But there is a mixed factor both on the type of financing, and the type of contracts put out there.

Okay, great. Thank you. .

From A.G. Edwards we'll hear from Boyd Preston. .

Thank you. Good morning. Return on sales -- end market sales to the repair shops up low single digit, 1, 2% during the quarter, how much difference was there April, May, June going through the quarter in that number, if any?

I don't think we have that data with us, Boyd. As I said, the only anecdotal thing I could tell you was that the June did, I think, have a little bit of a chill in it with what we've seen again anecdotally. But I don't think it was an order of magnitude difference between the beginning to the end.

Okay, on this new consignment program, you threw out a number I think $2 million, which it might have cost you in sales. Was that for the second quarter or year-to-date?

That was second quarter.

What would be year-to-date number if you had to guess?

Probably $3 to$ 4 million if I had to guess that, approximately.

The production disruptions at the plants as you consolidate the 2 plants you closed, to what extent has there been any effect on orders by dealers to get the product? Have you been able to deliver on time to your dealers when they order product?

Yeah. That depends on the item, Boyd, as you'd imagine. I think we're in good shape in the majority of the product line. What we ran into issues with was around certain product families. Notably as I mentioned in my comments that we found process problems that we needed to fix in order to react. In addition to that, as an added issue, we've talked about the steel availability. We had to digest the steel issues, and we did have some spot outages there as we rationalized the production forecast around the demand curve, and we did have increased demand, unfortunately on products that we had process issues that we had to fix. So we kind of leaned into a left hook in some cases on that. From a backlog standpoint, we think we've got a pretty good handle on it now and we'll see a fundamental elimination of that issue through the third quarter and fourth quarter. But as I mentioned earlier, these were good problems, in many cases defined because we kind of solved some things that have plagued us for many, many years and should be eliminated completely for the future. So we did have some product dislocations in the quarter, not extreme, somewhat disappointing, given the sales impact obviously, but clearly fixable, if you will, for the future. These aren't drastic shut the plant down issues. .

And finally on Commercial/Industrial, what now would you target as a operating margin possibility, say, for the second half and into '05? ?

This is Marty.

Including continuous improvement costs of course. And you might, if you could, come out with those for that segment for the third and fourth quarter as you see it now.

I don't know if I have the data with me for that segment for the third and fourth quarter to break out the totals. Absent those we'll still confident we can get the Commercial/Industrial segment even in the year to next year and a half, into the high single digit rate. It's not where we want it to be. We want all of our business to be at 10% or greater. But by looking at their plans we see they've got a planned pathway to get into the high single digits. .

Okay. Thanks. .

Up next we'll hear from Fred Speece (ph) with Speece Thorson (ph).

Thank you. This dealer thing is obviously something new for us. 190 dealers and the inventory they carry is in your books, and so your inventory actually went down $40 million for the 12 months, including adding this amount, which you hopefully would tell us, it's in inventory with the dealers on consignment?

That's correct.

How much is there?

Well, Fred (ph) it's - you know, a dealer is going to carry roughly 80 to 100,000 on the truck. It's just that one turn of the inventory. As he turns his inventory, we record the sale. So it's sort of accumulative aggregate number. It's that sort of one turn, that initial stock on the truck that we don't recognize, but as he turns his inventory, we do recognize it and you are correct that what's on the truck at the end of the quarter is included in our reported inventory. .

Right. Right. And this reduction in dealers added, are the consigned people included in that? Are they not added as a dealer till the 3-year term is up?

No. They're added as a dealer when they start.

Okay. And then, in the past, you've had this chart that shows us the progress of the TAG group. That's not there. You've annualized it. Can you help us on that one?

Yes. That continues to improve. We have anniversary of the first year of that program and sales are up over the prior year, and well in excess of what the old model had, so that continues to follow a more normalized path to your point.

Okay, thank you.

To the point Fred raised on TAG, I'd just add that we actually surpassed the prior level back in the first quarter, and so the reason we discontinued that is now that we've anniversaried it, we got there so our expectation is that we continue to keep growing that business. .

And at this time, gentlemen, there appears to be no further questions. Mr. Pfund, I'll turn the call back over to you for any closing remarks.

Thank you Operator. Thank you all for joining us on the discussion of our second quarter results. And should you have any kind of follow-on discussion, I'll be in my office all day today. Thank you very much. .

That does conclude our teleconference for today. We'd like to thank you all for your participation. You may now all disconnect.