實耐寶 (SNA) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to today's Snap-on, Incorporated, 2005 third quarter earnings 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, Vice President, Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and thank you for joining us to discuss the result of Snap-on's third quarter, 2005. With me this morning are Jack Michaels, Chairman, President, and Chief Executive Officer, and Marty Ellen, Senior Vice President, Finance and our Chief Financial Officer.

Today, as usual, we'll be using a set of slides to help illustrate our discussion. For those of you listening to our webcast, you should have found the slide show 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 on our website at Snapon.com along with a transcript of today's call. Following our remarks, we'll open the discussion for questions.

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, plans, estimates, believes, anticipates, targets, or otherwise state management's or the Company's outlook, plans, or projections for the future are forward-looking statements and actual results may differ materially from those made in such statements.

Additional information and the factors that could cause actual results to materially differ from those in the forward-looking statements are contained on Slide No. 2, as well as in the latest Form 8K, 10Q, 10K, and other periodic reports filed with the SEC. 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 re-broadcast 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 Jack Michaels to offer his observations on our performance.

Thanks, Bill. Good morning, everyone. Let me start by thanking all my fellow Snap-on associates around the world who helped contribute to our improved third quarter operating performance. Our people are responding to the need for focus. It's our call to action to make Snap-on a better place to work with a clear line of sight towards achieving strong, long-term performance. A number of our operating businesses, and the many associates working in them, are tackling our challenges head on and achieving better results. We are focused on turning Snap-on around and establishing its capabilities to generate sustainable, long term, aggressive, profitable growth. Please refer to Slide 4. Let me remind you that our target is an operating profit of 10% as an intermediate step, and longer term attaining historical levels of profitability, which would be on the order of 10% net income margin.

The trend in financial performance of the Commercial and Industrial Group is clearly heading in the right direction. On Slide 5, you can see the trends in sales and earnings over the last 5 quarters. Over the past few years, they have done a significant amount of facility rationalization and restructuring throughout the world. Coupled with an emphasis on rapid continuous improvement, margins have begun to show considerable progress. You notice that I use the word rapid continuous improvement. You will hear us talk more about rapid continuous improvement, emphasizing the rapid as well as continuous. And clearly, we know we're behind our major competitors. We must act rapidly and with great quality and give continued daily efforts.

Let me continue. Sales are improving in the industrial tool businesses around the world. In North America, for example, improving [floor] rates are aiding our Snap-on industrial business, although we still have a long way to go. In Europe, the combination of Bahco and Eurotools is continuing to proceed. This offers new opportunities for sales throughout Europe and the world. It also allows for better integration production and supply chain efficiencies over time.

And in the emerging markets such as China, India, and Russia, we're continuing to invest by putting people on the ground and then establishing a brand presence and sales distribution network.

In our equipment business, improvements have been made. Innovative products incorporating advanced technology are providing a strong brand position and many product categories. Significant work has gone into integrating what had once been multiple companies, each with their own brands, product platforms, and distinct organizations. The results are turning in the right direction. The operating team is focused on generating further improvements.

Now for the Diagnostics and Information Groups, they have a difficult comparison due to last year's successful launch of new products. Yet, putting their performance in perspective, they have shown dramatic margin improvement over the last 3 years. They successfully combined and integrated the acquisitions from the 1990s that formed the operating basis of the group. The operating team aligned and focused their people on making the product transformation to an information and handheld diagnostics-based sales platform. They have reduced complexity, lowered their cost structure, consolidated facilities, and significantly improved their performance. Longer term, the goal for the diagnostics and information group is to more aggressively pursue growth in their dynamic marketplace.

It was about 11 months ago that I joined Snap-on as CEO. Please refer to Slide 6. It was at that time we made taking better care of our customers our highest priority. During the past 11 months, we have been improving manufacturing capabilities in our Snap-on tools facilities and significantly strengthening the supply chain to begin to do just that. You'll remember that our first time fill rates to dealers and Snap-on industrial customers had sunk dramatically during the past year. In fact, I would tell you for the Snap-on Dealer organization, in early year, we were down to about 65%, and our historical high levels had been in the 85%.

But again, back orders climbed due to the disruptions in our U.S. hand tool plants from past consolidation efforts. Our dealers and customers told us that we had to improve, and we have. First time fill rates have now reached new records, attaining 90%, again from the historical highs of 85 in the U.S. dealer operation. Unfortunately, much of this progress has been accomplished through long hours, very hard work on the part of our associates, and often just muscling our way through things.

While progress has been made in terms of improving processes, we still do much that is inefficient and wasteful in terms of scrap, rework, and overtime. These are our future opportunities that we are attacking. However, coupled with higher expected freight and steel expenses, our costs will continue to be up year-over-year in the fourth quarter.

We believe we are establishing, with this investment, a more flexible and responsive organization capable of sustaining a [pole] base manufacturing and delivery capability. Changing a culture is never easy, but we are making the touch decisions needed to lay the strong foundation for future benefits. We are maintaining laser sharp focus on, again, rapid continuous improvement.

It was only this past March that Al Biron, as a result of his demonstrated accomplishments in Diagnostics and Information, took over the leadership role for the worldwide Snap-on Tools and Dealer Group. During this time, he and his leadership team have listened to our customers, our dealers, and the marketplace. Much work has gone into identifying the opportunities, not just at the manufacturing level internally, but also externally in the world marketplace. We have involved many people throughout the organization to analyze the marketplace and listen to our dealers. I am happy to report that the dialogue with our dealers is improving where they can see some of the improvements, especially in terms of their order fill rates.

In another area during the third quarter, we realigned our field management organization as to provide more consistent contact and support to dealers, collapsing 29 offices into 13 regional offices, with each led by an experienced and capable manager. Our dealer recruiting efforts have been centralized and strengthened. The abilities and qualifications for becoming a new franchisee are becoming more strenuous and uniform across the country as a result. We are beginning to see these efforts pay off. The number of newly trained dealers entering the business during the last weeks of September hit a 3 year high. Unfortunately, these additions were still offset by continuing high turnover among newer dealers, not totally unexpected as weaker dealers leave the system.

Importantly, our focus is not simply on the sheer number of dealers. We are also focused on continuing to make enhancements that will increase the strength and success of our franchise systems by further enhancing the quality and skill of our dealers. One measure of the improving quality over the last few years is that even as the number of dealers has declined, median reported sales for the franchise network have increased, and as noted in the press release again this quarter, sales on a per van basis continue to grow.

During the coming months, we will continue to address the concerns and needs of our dealers in our effort to help continue to improve their sales growth and profitability. Further enhancing and strengthening the franchise proposition is our most important initiative. For example, one area of improvement is focused on dealers' technology capabilities. This will allow franchisees to take advantage of new management and sales tools to improve their productivity and increase the quality time spent with customers. Some of these advances are just now being rolled out, with many still in the development phase.

Now finally, before I turn the call over to Marty, I would like to comment on our two recent senior management additions. Joseph Abbud, Vice President of Rapid Continuous Improvement, and Andy Ginger, Vice President and Chief Marketing Officer for Snap-on, Incorporated, each of whom reports directly to me. We expect both to provide critical roles in ensuring that we build a balanced foundation for our future growth, that we pay equal attention to both our traditional strengths and brand building and sales, as well as to manufacturing and our supply chain.

Importantly, I believe we have high caliber people throughout the world at Snap-on, whether they are in Diagnostics and Information, in the Commercial and Industrial Group, or in the Dealer Group. And I believe they will continue to identify our potential opportunities, address the challenges, and then proactively undertake those initiatives that will create sustainable and aggressive profitable growth for the long term.

Now finally, some of you that have known Snap-on for some time will find it of interest that we are making today's call from our new offices in our old general office building in Kenosha. We are in the midst of consolidating our Kenosha-based people to improve communications and alignment. Having people spread amongst two buildings was both costly and, I believe, reduced the sense of urgency around tackling the challenges.

Now Marty will discuss our financial results.

Thank you, Jack, and good morning, everyone. Please turn to Slide 7. Total revenue in the third quarter of 2005 was 567.2 million and includes 13.1 million from Financial Services. This compares with 568.8 million of total revenue last year, which included 17.9 million from Financial Services.

Net sales of products and services in the third quarter were 554.1 million, an increase of 3.2 million. On a currency neutral basis, net sales were essentially flat. Excluding currency, sales growth of 6% was achieved in our worldwide Industrial and Commercial Tools businesses, as well as 6% growth in our International Dealer operations. However, these increases were mostly offset by sales declines in our North American franchise dealer business and our OEM dealership facilitation business. Furthermore, diagnostic product sales declined year-over-year as new product launches were greater in the year ago quarter.

Consolidated reported net earnings were $0.36 per diluted share for the third quarter. This compares with $0.39 a year ago. Diluted EPS this quarter includes $0.05 per share, or $2.8 million of additional U.S. income tax expense. This relates to the repatriation of $75 million of accumulated foreign earnings under the American Jobs Creation Act of 2004. Last year's EPS included $0.06 of tax benefit as a result of the conclusion of prior year's tax matters. Assuming our normalized tax rate of 35%, EPS was $0.41 per share this year versus $0.33 a year ago.

Turning to Slide 8, Snap-on's consolidated gross profit, defined as net sales less cost of goods sold, was $247.2 million. The reported gross profit margin was 44.6% and was reduced by approximately 10 basis points, or $800,000 for restructuring. Last year's third quarter reported gross profit margin was 43.5%, which included approximately 40 basis points, or 2.6 million of restructuring, primarily related to plant consolidations in Europe. Absent restructuring in both years, gross margin was up by 80 basis points. Higher selling prices across all segments and improved product sales mix, better manufacturing cost and productivity achievement in the Commercial and Industrial, as well as Diagnostics and Information segments, more than offset higher steel costs, and a higher production cost in our Snap-on tools manufacturing facilities.

Turning to Slide 9, operating expenses were 217.5 million in the third quarter, including 9.5 million from Financial Services. A year ago, operating expenses were 220.8 million, which included 10.5 million from Financial Services. Restructuring costs this year were 3.2 million, including costs for consolidating branch sales offices in the dealer segment and the ongoing integration of the Bahco and Eurotools businesses in Europe. Absent these items, as a percentage of net sales, operating expenses were 37%, down from 37.9% a year ago. As an indicator of overall productivity improvement, sales per average employee were $201,000 in the quarter, up approximately 6% over a year ago.

Let me now turn to a review of our segment results, beginning with the Snap-on Dealer Group shown on Slide 10. For the Worldwide Dealer segment, third quarter 2005 total revenues were 244.8 million, compared with 248.9 million in 2004, a decrease of 1.6%. Sales in the North American Dealer operation were down 4.3% year-over-year. We had approximately 6% fewer dealer vans in operation at the end of the third quarter compared to a year ago. On a per van basis however, our sales were up about 1.5%. And as reported to us by our franchise dealers, their same-store sales grew by about 3.5% in the quarter.

There continues to be strong demand for the Snap-on franchise opportunity. The number of franchisees in our trial program is up 123 year-over-year to a total of 347, the highest it has ever been. However, as we have previously said, we will only convert trial franchisees to the standard franchise program when they are able to meet our owner defined performance metrics. Similar to the experience of the third quarter, we expect that the fourth quarter will continue to show some reduction in total U.S. dealer van count.

Operating earnings for the Dealer Group, shown on Slide 11, were 20.1 million this year, compared to 12.8 million last year. Higher selling prices for the quarter and improved product sales mix warded off the higher steel and freight costs and the continued higher production costs relating to improving manufacturing flexibility and service levels. We are experiencing improvements in order fill rates and in reducing the level of backorders. However, these achievements have come with a higher level of spending.

Turning to the Commercial and Industrial Group shown on Slide 12, sales were 262.4 million, compared with 255.2 million a year ago. Currency translation accounted for 1.7 million of the sales increase. Excluding currency, worldwide sales of tools for industrial and commercial applications increased year-over-year by 6%, even though our businesses in these markets have a significant sales base in Europe, where activity has been sluggish. Our global equipment business experienced a decline in sales. About half of this business is in Europe as well where, again, market conditions have not been favorable.

Turning to Slide 13, Commercial and Industrial segment operating earnings were 17.8 million, up from the 3.5 million earned a year ago. Improved productivity worldwide, reflecting the benefits from our continuous improvement initiatives, as well as footprint consolidations, were major contributors. We also were able to realize higher selling prices to more than offset $2.6 million of higher steel costs.

Turning to the Diagnostics and Information Group on Slide 14, total revenues were 100.4 million in the quarter, compared with 129.2 million a year ago. This sales comparison reflects the successful launch in the third quarter last year of new diagnostics and software products. Additionally, our OEM facilitation business experienced an $8 million decline in sales year-over-year. The operating income decline caused by the sales volume reduction was significantly offset by benefits of continuous improvement initiatives and then increasingly higher sales mix of information of software related products.

On Slide 15, you can see the trend of earnings improvement for the Diagnostics and Information Group on a rolling 4 quarter basis. Diagnostics and Information products are playing an increasingly important role in the automotive service, and we are well positioned to meet those marketplace needs.

Turning to Financial Services on Slide 16, operating earnings in the third quarter were 3.6 million. Year-over-year, the trend in operating earnings continues to reflect higher year-over-year market interest rates and lower credit originations, resulting in Financial Services revenue declining to 13.1 million from 17.9 million.

With that completing my operating segment review, now let me turn to a discussion of cash flow shown on Slide 17. In the third quarter of 2005, Snap-on generated 65.6 million of cash flow from operating activities, leading to an increase of 47.7 million in cash for the quarter. Overall, changes in operating assets and liabilities added 26.8 million to operating cash flow for the quarter, compared to 3.8 million a year ago.

Capital expenditures were 8.8 million in the quarter. For the full year, we believe capital expenditures will be in a range of 37 to 40 million, roughly similar to the 39 million last year. This largely reflects the investments being made within our manufacturing facilities to increase production flexibility and productivity. Depreciation and amortization is anticipated to be about 50 million, or about 12 million more than capital expenditures.

With respect to the balance sheet, it continues to be strong, reflecting the improvements made during the past few years. As noted on Slide 18, at the end of the quarter, after netting our cash of approximately 178 million against total debt of approximately 311 million, our net debt was 132 million. Net debt is down 46 million from the end of the third quarter a year ago, and down 49 million from the beginning of 2005. Our net debt to invested capital ratio declined further to 11.3%, compared with 15.1% a year ago. Subsequent to quarter end, we retired out of available cash our $100 million 6 5/ 8% 10 year notes.

It should be noted that inventories were reduced by 39 million in the quarter, despite the unfavorable impact of 3 million from currency translation. Year-over-year, net inventory declined 18 million. Importantly, the operating improvements are beginning to translate into increased financial returns. As of the end of the third quarter 2005, our operating return on invested capital was 13.2%, compared with 11.2% a year ago.

Those conclude my remarks about our financial performance. Now let me spend a few minutes outlining some of our expectations for the balance of 2005 that were included in our press release.

Overall, our first priority continues to be in improving manufacturing, our supply chain effectiveness, and efficiency so that we can take better care of our customers, as Jack has already discussed. While we do not provide specific quarterly EPS guidance, I would like to comment on some of our assumptions in operating trends.

Looking at our Commercial and Industrial segment, we are particularly pleased with their improvements. The continuous improvement actions and initiatives that underlie those trends are encouraging, and we anticipate further earnings increases in the fourth quarter in this segment.

Our Diagnostics and Information Group has made considerable improvement during the past few years in increasing profitability. This has come largely from their emphasis on the introduction of innovative, productivity enhancing tools. Technicians have to interface with the ever increasing complexity of advanced, on board electronics technology, and this provides significant potential for continued long-term growth. We believe the Diagnostics and Information Group continues to have a strong and exciting future. However, their operating results have a difficult comparison in this year's fourth quarter because of the strong new product introductions in the second half of last year.

Within the Snap-on Dealer segment, our third quarter market data indicates that technician purchases of tools through mobile van distribution are growing, and we continue to experience strong demand for the Snap-on franchise opportunity.

Our chief priorities remain taking better care of our customers and reducing our complexity and cost. We believe we are focused on the important initiatives that will continue to further enhance the franchise proposition. Looking to the future, we believe we are making the proper decisions that will strengthen and grow our dealer business over time. Similar to the third quarter, we anticipate that the fourth quarter will continue to experience some reduction in total U.S. dealer van count.

We must also continue to invest in making improvements in our manufacturing and supply chain to deliver the flexibility and service levels we desire. This will require a higher level of spending when compared with a year ago. As a result, we expect fourth quarter operating results to be less than a year ago in the dealer segment.

We also expect that Financial Services operating earnings will experience, as they have year-to-date, a decline in the fourth quarter compared to a year ago, mostly resulting from continued higher market interest rates. The retirement of our $100 million 6 5/8% bonds will decrease interest expense by approximately 1.7 million for the fourth quarter.

As a result of the aggregation of these trends and assumptions, we expect the consolidated reported net earnings will not achieve the level of a year ago in this year's fourth quarter. With an expectation for continued working capital improvements, we expect strong operating cash flow performance in the fourth quarter of 2005.

Before we open it up for questions, Jack, would you like to add any comments?

Yes, thanks, Marty. I think in summary, clearly, we are please with our third quarter operating earnings improvement. But we continue to have much to accomplish to achieve our desired net income margins. We are focused on the needed improvements -- the tool group clearly strengthening our franchise system and reducing our manufacturing costs, and the C&I Group, or Commercial and Industrial Group, continue their improvements, as we have outlined today. We're continuing that trend. And obviously, in the Diagnostics and Information, we're looking for more growth.

So with those concluding remarks, we would be happy to take any questions or comments.

Thank you, gentlemen. [OPERATIONS INSTRUCTIONS.]

We'll take our first question from Alexander Parris with Barrington Research.

Morning.

Morning, Alex.

On your fourth quarter guidance, what restructuring cost, roughly, is included in that conclusion that your earnings will be down from a year ago? Were they up from the third quarter?

Alex, roughly 3.5 million for the fourth quarter.

So that's roughly just a little bit more than the third quarter?

Third quarter we had about the same amount, about 4 million.

Okay. And the foreign -- repatriation of foreign earnings, is that done? Or will there be more in the fourth quarter?

No, all the tax effects of that have been provided for in the third quarter.

Okay. Because that expired at the end of the fourth quarter?

Yes, it expires at the end of the year.

Right. And so your tax rate goes back to the 35%?

That's the expectation.

Okay. In the -- in terms of the dealers, are you assuming that you're going to continue to see a high rate of new dealers, but offset by turnover again like the third quarter?

Yes, I think that trend will continue. I think -- we don't see anything that would change that, but as I indicated in my comments, we're continually raising the bar as qualifications to come into the system as a franchisee. But I would expect the trend to continue, both in terminations and in new dealers coming in.

So the turnover rate is running higher than historical in the third quarter and assumed in the fourth quarter?

Yes, that's correct.

Okay. Just going back to your dealer, the on-time delivery rate that dropped down to 65%, did that drop down before you closed the hand tool plants, or was that already depressed before that? In other words, it wasn't -- was it mostly the disruption of the closing of plants?

Alex, I would say to you that it was depressed, but it was only down in the low 80%, and with the consolidation of the factories, then it dropped down dramatically, and it's taken us time to work it back to the current 90+% level.

Right. So you started out a little bit below your target now of the 99%, and --

Now, our goal is to be at 99% complete and on time by the end of 2006.

All right. So you were below what you wanted to be and maybe competitors before the consolidation, and it got worse, and now it's back up at or above where it was?

That is correct.

Okay. And in the Financial Services, you implied from the last comment there that most of the decline was the interest rate and not the originations?

That is correct.

Okay. Okay, that's all. Thank you very much.

Thanks, Alex.

And now we'll move on to Jonathan Steinmetz with Morgan Stanley.

Hi. This is actually [Bahla] standing in for Jonathan. I have a question on the hand tool diagnostic margin. We've seen a decline in the operating margin levels in the current year and [inaudible] last year from a high of 24% to now we're on 14%. What would be the ground rate which we could expect in this segment?

I'm sorry, [Bahla]. Repeat the question. Are you referring to the diagnostic segment or the tool segment?

The diagnostic segment. The margin has come down from 24% in last year to around 14% levels this year. What do you expect going forward would be the ground rate in this?

I mean, first of all, let me comment. Obviously, the decline has resolved the volume reduction in sales, and so we had pretty good margins last year with the higher volumes. So it's very volume dependent. This is -- clearly, their products offer some of the highest margins we have across the product lines, as you'd expect in a software based business. And so we'd expect strong sort of double-digit margins in that business.

Okay. And the other question is, you said the total trainees in the dealership segment was around 347 year-to-date?

Correct.

And the client increase was around 123 new trainees?

That's correct.

Okay. Because last -- in the second quarter you said we have a total around 300 trainees year-to-date, so the total rate is really high in third quarter, and do we expect it to continue in fourth quarter?

Well, we expect it to continue, but as both Jack and I said in our remarks, while we've got a lot of people on trial, at the same time, they need to demonstrate that they can achieve increasingly stringent performance metrics before they'll become standard franchisees. So yes, the number's been grown, 347 up from, what, 224 a year ago, actually up from 147 the year before that at the end of September, which we're pleased with, but again, they have to demonstrate that they can be successful. That's really the key.

Yes, clearly -- this is Jack. Clearly, we're interested in quality, not just quantity. I mean, that really is one of the key takeaways I'd like to leave with the audience today.

Okay. Thanks a lot.

[OPERATOR INSTRUCTIONS.]

We'll now hear from Boyd Poston with AG Edwards Asset Management.

Yes, good morning. Just to clarify on the dealers, the turnover rate, excluding the older dealers that are not in this new program, you had originally said that the inflection point would be positive before the end of the year as far as new dealers versus ones that are not staying, that there'd be a net increase in new dealers. Now that's delayed, I guess, until the first or second quarter. Are you seeing among this new trial franchisee, the ones that are staying are taking longer to convert, and/or are there more dropping out of this new program than you originally thought?

Boyd, it's Marty Ellen. Clearly, the data has shown over the last few years that -- at least I've seen this data -- that a preponderance of the turnover is in the zero to 1 to 3 year category of dealers. And that's what really caused us to, A, convert to this new trial program a couple years ago where they remain in trial for 3 years and not just 1 year, and to be real diligent with respect to defined performance metrics that we believe are important if the dealer is to -- for the trial franchisee is to be a successful dealer. That was really the thinking and the reasons for the expanded trial program. And so even today we still see most of the turnover in that category. If you look at dealers 8 years or more with us, that's one of our break points, and then 12 or more years with us, the turnover has been much, much lower.

Well, the 347 number, say, 224 a year ago, 347, that includes -- is that just 100% additions, or there's a certain amount of additions minus some that have gotten out to get the difference between 224 and 347?

That's correct. That's the net. That's the net. There's turn, there's adds and deletes, if you will, as we measure that number over time.

Okay then, once again, you had thought that number would be positive during the second half of this year, that you wouldn't still be losing dealers. I'm just trying to get the exact reason of why that number got pushed out until 2006 because you said fourth quarter would be like the third quarter -- you're still -- you'll be net less dealers, and you had said you'd be net positive dealers by the second half of this year originally.

Boyd, it's as simple as early in the year, our expectations were we'd see more success coming out of that group, and it's not there, and we're not intending on doing anything to sacrifice what we think are the benefits of having a good trial program.

Okay. Can I drill down a little bit on the fourth quarter comparison? The fourth quarter normally would be sequentially higher than the third quarter. You didn't give a single point estimate, but obviously, the fourth quarter could be lower than the third quarter number. Are we talking some of the factors -- the D&I, you had warned that would be lower. Is the margin decrease and the sales decrease both in third quarter and the fourth quarter lower than you had thought 6 months ago?

Was your question just to diagnostics or to the whole -- ?

Just Diagnostics and Information. We all knew it was going to be lower. But is the percentage sales decrease in the margin decrement lower than you had thought?

Not necessarily lower than we had thought. I mean, we knew we'd have a difficult comparison in the fourth quarter because of Solace and other product launches a year ago.

Is the fourth quarter going to be a more difficult comparison than the third quarter?

It's going to be a little more difficult for them. They had very strong activity in both the third and fourth quarter.

What is the new product flow there? What products -- do we have new products coming out that'll kind of pump up the sales growth again?

Well, we have a new product called Advantage that's now in the marketplace, but clearly, the significant new products that we had were a year ago, so they will not be back to the level that we had a year ago. I mean, they're continually coming with new products, but basically, it's selling updates to the current product that they launched in prior periods.

Right, so a lot of their -- what you'll see on the diagnostics is periodic software updates as they continue to update the software library for makes and models of vehicles.

On same-store sales by the van, you said 3.5%. Was that number consistent through the quarter, and especially in September, did that number change from the beginning of the month through the end of the month into October?

Boyd, I don't have visibility here to that number on a monthly basis. I only know that it was 3.5% for the quarter.

So you don't know if high energy prices and gasoline prices started to affect that number? You have no sense of that?

We have no sense of that with respect to that number. However, I will say that, and particularly again for the fourth quarter, we are concerned about what the high gas prices are going to do with respect to driving and with respect to service bay activity. I mean, some very, very early indications are that activity levels have dropped and softening a bit, and that is a concern to us.

So you have built something in for that definitely in that fourth quarter preliminary -- ?

I mean, we've though a lot about it. It's hard to build it in precisely, but yes, we've thought a lot about it.

Let me make one other comment back on technology and new products. Actually, this year, the number of applications that we'll be making for patents is up over a year ago. So I don't want anybody to leave to think that -- are on the call that we're not focused on new products because clearly, we are. A lot of it in the Diagnostics and Information is timing.

Okay, thank you.

You're welcome.

David Leiker with Baird has our next question.

Good morning.

Morning.

What's your dealer count in the U.S. right now?

David, our total van count at the end of the quarter is 3,756.

And that's down from what as of peak?

In June, David, we were 3,804.

And that was the peak?

Pardon? I'm sorry.

Was that the peak?

The peak in our history?

How many -- yes, you hit a peak within the last couple of years.

Oh, yes, we were up --

We hit a peak at the end of 2003, and that was about 4,250.

That's correct.

Okay. At what point -- I mean, everyone's kind of dancing around it, but at what point do we see -- it's great that you're seeing sales per van growing, but if the dealer count is falling, your sales pace continues to fall. What's the timing of seeing that turn around in the U.S. that you're actually posting sale gains?

David, I think it will be, obviously, some time next year. It's not going to occur this year, as we had previously discussed. But I think it will be, at best, sometime next year. And again, the reason being is this whole thing of quality versus quantity. We want to be sure that those we bring in to the franchise system are those that are going to be successful in the system, and so in essence we have raised the bar. And we continually look at that, because it's -- obviously, it hurts our franchisees, but it hurts us as well if we bring somebody new in, and then they exit the system, as Marty's said, in the first 3 years. I mean, it's not what we're looking for.

Yes, so I understand that. But what about -- are there any metrics you can give us relative to second van or multiple vans, how many of those have collapsed back down to single vans in the third term?

Well, David, actually, on the second van program, that's where we've seen really more than half of that 6% decline year-over-year, and so there obviously, the question is can successful primary van operators be successful in running a part time van with a part time employee? That was a part of the model that we designed and work with our dealers on, and I think it's one part of the model that we have to look carefully at going forward.

And let me make one other comment. This is Jack again. One of the things that we will be emphasizing is looking at right sizing the franchise network. We want to be -- that's something that we continually do, but clearly, moving forward we will have great emphasis placed on that as well as looking at the qualification.

Okay. Did you buy any stock back in the quarter?

Yes, we did.

I didn't -- if you said it, I didn't hear it. How much did you buy back?

Approximate share count, about 140,000 shares.

And the dollars spent on that?

It's in the cash flow. Somebody got that quickly?

I can back into it off the [inaudible] --

It should be in the cash flow statement, David. It's attached to the release.

I was just looking for the quarter instead of year-to-date. And then --

It was 5 million in the quarter, David.

Thank you. And then, I don't know, this is kind of a conceptual question for somewhere down the road. And Jack, your initial focus here has been on operational improvement and customer service and --

Correct.

-- speeding up the pace of continuous improvement and change. You seem to be in a little bit of a retrenchment mode here from a revenue side.

Right.

When we look at your dividend at a dollar, I think historically, the stated case has been that you want a 1/3 payout ratio, which means earnings of 3 bucks at some point. Is that a prospect that's 2 years on the horizon? Is it 5 years on the horizon? Is there any way you can give us some kind of road map of getting to that kind of an earnings level somewhere down the road?

Yes, I -- David, I think that -- I've always said that 2006, we'll continue restructuring, right sizing, taking costs out, and as I said earlier, strengthening the franchise system. I think that you will see improvement and greater improvement in 2007, and certainly in 2008, I think we should be largely towards our intended goals, our desired levels that we talked about in the call today.

Okay. In terms of your targeted margin and return on capital?

Correct.

Okay.

In other words, I wish I could tell everybody this is going to happen overnight, but it isn't and --

It doesn't work that way.

No, it doesn't work that way. And there's fundamental things, and they are clearly fundamental. This is really blocking and tackling. This is not anything exotic that we need to do, and I think we're strengthening the organization as I indicated with on the continuous improvement. I think Andy Ginger will bring us a lot in terms of brand and revenue opportunities, and he'll be working with all the groups to achieve that. But at the same time, I think we have our plate full; there is no question about it.

David, let me just -- this Marty. Let me offer a follow-up comment though, just to be clear on the dividend, because we have no plans to change our dividend, and so your sort of view that we would have target of a 30 or 35% payout is really not necessarily our target. It's all about where we need to make investments, and absent that, our expectation is to continue to return cash to our shareholders.

That's a change, though, from previous statements.

Well, not really. I mean, it's been our -- it's really about what are the cash flow prospects for the business? We think they're strong. What are the needs for cash in the business? There are no large acquisitions or haven't been large acquisitions. We have paid down debt over time. We did that again as expected after the end of this quarter. We continue to pay our dollar dividend. We continue to buy back shares to offset dilution. That's been our policy, and I think as we've communicated -- or as I've said to people over maybe the past year and to the extent that our cash balance has continued to grow without need, it is the lowest earning asset on the balance sheet, and we understand that, and we should repatriate that to our shareholders.

Okay. All right, thank you.

And [Peter Lottman] from KLCM has our next question.

Good morning, guys.

Good morning.

Morning, Peter.

Marty, to kind of follow up on the same thought process there, I think you've said in the past your optimal capital structure would be about 30% debt?

It would be -- that target would keep us at our single A credit rating.

Okay. And how do you reconcile the 20% differential between where you are and what optimal would be?

Well, I think we're comfortable right now with the level of debt and the lower level of debt, and as I just said, it's about what we're going to do with our cash flow over time, with respect to investment opportunities that exceed our cost of capital and add value to our shareholders or return it to the shareholders for their investment.

But you're already several hundred million dollars under leveraged at this point, or over capitalized from an equity standpoint, and the cash flow just keeps coming in. I mean, what are you waiting for?

Well, I think right now, the issue is we want to see operating improvement in the business, and we know that while we have very, very conservative leverage on the balance sheet, which is good from a credit rating point of view, that does provide cushion with respect to what's otherwise a lower level of profitability than we should have at our credit rating level.

Let me just -- this is Jack. Let me just add another comment. Obviously, that would provide us the opportunity for acquisitions. And clearly, as I indicated earlier, particularly in the Diagnostics and Information, we want them to grow. And if we can find opportunities that generate economic value beyond the cost of capital and create shareholder value, we're interested. So, that's -- we're not, obviously, ruling that out at all.

Okay. I just see a lot of latent potential there on the balance sheet that's not doing shareholders any good, and it's been a long, hard slog, and it seems --

Right, I think --

You said you expect the cash flow to be strong. There's no at large acquisitions on the table here, so I just don't see the --

At this time there aren't; that's correct.

Yes. Okay. Are we seeing a troughing in the dealer count right now? I mean, when do you expect to see some material improvement there?

I think definitely for the long term we will, but again, we're looking at the right sizing the network. We're looking at the qualifications of the individual franchisees, particularly the new ones coming in, and so I don't think those are going to be something that will give us immediate increases in the total net account.

Okay. Maybe you could refine the guidance just a little bit. Last year's fourth quarter, was the number -- the EPS number you were looking at $0.42?

That's correct.

And then, seasonally, the fourth quarter is usually stronger across the board than the third quarter.

Correct.

And, I mean, so are you saying that fourth quarter's going to be somewhere between this year's third quarter and last year's fourth quarter, or can you help me on that? I just am having a hard time reconciling where this fourth quarter's landing.

Well again, let me, again -- Commercial and Industrial, we'd expect it to be up over last year's fourth quarter, all indications are. Diagnostics and the Information Group, it's going to be flat to down. Financial Services will be down, and probably by half what they did a year ago or more because of interest rates. Then the issue is the Dealer Group. And as we said earlier, we're anticipating lower van count. We're uncertain as to the impact of what's going on in the service bays with respect to gas prices.

I didn't really comment in my prepared remarks about, it'd be about 160 dealers or so that have been affected in varying degrees by all this hurricane activity. Many of them are not back to work yet. We're not sure of the status of some of their routes. Some we're in process of moving, to give them a livelihood, to other parts of the country. So there are a lot of moving pieces to the top line, as we've said. We've got to keep investing in the manufacturing operations. We're going to have higher spending in our plants in the fourth quarter. That number by itself could be up as much as 5 million over a year ago just in planned spending. So the dealer group is expected to be down.

How about corporate expense? Could you help us on the fourth quarter? I mean, that bounces all over the place. And then maybe, what is a normal run rate for next year?

Well, corporate expense and the corporate segment, the run rate might be in the range of $10 million or so per quarter. And it does bounce around.

Okay. Thank you, guys. Good luck.

Okay.

And Alexander Paris with Barrington Research has a follow-up question.

Hi. Looking at international dealers, are you adding, or are dealers there or are they having the same problems overseas?

No, we don't have the same problems at all. In fact, as we made a comment, our international is --

It is flat.

Yes, yes, we're flat. But their performance is, frankly, better than the performance we achieved in the U.S.

Are you talking about on-time delivery?

Well, follow-on time, but I'm also talking even the bottom line. Our margins are better in our international operations than they are in our U.S. operations.

To get that growth, so the dealers are flat or up overseas?

Correct.

And is that because -- have you gone in to any new territories?

No, not basically. No, those are in primarily Canada, Australia, Japan, and the U.K.

Okay.

That's outside of -- they've actually kept the standard high within their franchise organization.

Okay. And you mentioned the storm effects on the dealers from the hurricanes. But have you -- can you document any effect on the miles driven going down because of the surge in gasoline prices?

Well [inaudible], we believe it is down, but we are not at this point able to give any specific numbers. Perhaps somebody on the call has the number, but we don't have one at this point. We're certainly following it very closely, but don't have that information available as we are speaking here this morning.

I know in the hurricane areas there was a strong impact in New Orleans, but then did you get the ones that have been put out of service temporarily? Was that increased by Rita into Texas and other places -- ?

Yes, absolutely. And we are not certain yet about what Wilma may have done in Florida to us.

In terms of just going forward on the interest costs, your debt at the end of the third quarter, then you take away 100 million for the repayment or the calling up of the debt or retiring of the debt, and your interest rate on the rest of the debt?

The remaining debt, Alex, is a $200 million bond issue. It matures in 2011, and the rate on that is 6.5 or slightly less. It's in 3/8 or 6.5, it's in a quarter.

Okay.

And there's a bank credit line too that you're using or not?

Our credit facility is not in use.

Okay. Good. Just one other thing, a while back there was a judge, I thought it was in Texas, that ruled that the wives of dealers could sue regardless of the arbitration agreement that you had. Is that true? Did I remember correctly?

That's a procedural issue.

Has that had any effect on -- is this still the same lawyer that years ago was doing all of this?

Yes, same group.

Same group?

Yes.

And have you seen any effect on that since that ruling in terms of lawsuits or impact on you -- ?

No, not really, not at all.

All right. Thanks very much.

And it appears there are no further questions. At this time, I'd like to turn the conference back over to you for any additional or closing remarks, gentlemen.

Well, again, I would just like to thank you for joining us this morning, and thank you for your questions. Hopefully, we've adequately addressed them. Bill, do you have anything to add?

No, I'd just remind everybody that I'll be around today, so if you've got some additional detail or color that you're looking for, I'd be happy to go over that color with you. Thank you very much.

That concludes today's conference. Thank you for your participation.