實耐寶 (SNA) 2006 Q2 法說會逐字稿

Good day, everyone and welcome to the Snap-on Incorporated 2006 second quarter earnings results conference call. As a reminder, today's call is being recorded. Now for opening remarks and introductions, I will turn the call over to your host Mr. Martin Ellen, Chief Financial Officer. Please go ahead, sir.

Thank you, Jake. Good morning. And thank you for joining us in our review of Snap-on's second quarter results.

With me this morning is Jack Michaels, our Chairman, President and Chief Executive Officer. Consistent with past practice, we will utilize slides to help illustrate our discussion this morning. You can find a copy of these slides on our website next to the audio icon for this call. These slides will be archived on our website along with a transcript of today's call.

Following our remarks, we'll open the call for questions. We encourage your questions during this call, as we will not discuss undisclosed material information offline. Also any statements made during this call relative to management's expectations, estimates, or beliefs or otherwise state management's or the Company's outlook, plans, or projections are forward-looking statements and actual results may differ materially from those made in such statements. Additional information and the factors that could cause actual results to differ materially from those in the forward-looking statements are contained in the company's SEC filings. This call is copyrighted material by Snap-on Incorporated. It is intended solely for the purpose of this audience, therefore, please note that it cannot be recorded, transcribed, or rebroadcast by any means without Snap-on's express permission.

I will now turn the call over to Jack, who will share his observations on our important key inutilities and accomplishments. I will then provide commentary on our financial results and then Jack will provide some closing thoughts. Jack?

Thanks Marty and good morning. And thank you for joining us today. As I have said before, when I arrived as CEO late in 2004, the mandate was clear, accelerate change and build long-term sustainable value. And that mandate remains unchanged today. To accomplish this, we immediately began to focus on taking better care of customers, reducing complexity and cost, improving our manufacturing effectiveness, and driving new product and market initiatives all towards creating sustainable, profitable growth.

Before Marty provide his commentary on our second quarter financial results, I would like to review how we are doing against these priorities in each of our business segments, beginning with the commercial and industrial segment. Our commercial and industrial segment continues to show considerable progress across its businesses. And as you can see from our second quarter results, operating profits have improved dramatically. Initiatives directed at developing new products, exploiting new market opportunities, and migrating higher cost operations to lower cost regions are progressing.

Our new TechAngle Wrench developed by our CDI subsidiary just received the top automotive industry award and is an excellent example of innovation in product design and function. Our power tools continue to raise the competitive bar through increases in cordless offerings and continued advances in power and speed. All of which meet our overall company stated mission of the most valued productivity solutions in the world.

Our sales in Asia doubled in Q2 albeit on a small base, and our infrastructure in China is expanding and becoming a strategically important sourcing base for a number of our businesses. And finally I am pleased with the progress we are making in migrating away from some of the high-cost manufacturing facilities in Europe and our progress in entering other emerging markets.

In our Diagnostics and Information segment, we're continuing to advance our integration of repair and shop management information together with our diagnostics capabilities as to create end-to-end solutions for our customers. In our OEM business, we continue to expand our OEM relationships. And as a result, we recently began working on an essential diagnostics program for a major OEM.

Now, at the beginning of this year, we shared with you our strategies in our Snap-on tool segment that were developed during 2005 to build long-term sustainable value for both our franchisees and Snap-on. We believe we are making progress and we are on schedule, but still have much to do. All of our key initiatives in the tool segment relate to two fundamental business goals; number one, improving the profitability and strength our franchise distribution system; and two, serving those franchisees with higher service levels throughout the cost effective supply chain.

Initiatives focused on improving the profitability and strength of our franchises include improving the field support structure through the establishment of a four-person franchisees performance teams. Much of this change in structure was put in place in the second quarter. Through this process, we evaluated every field person in a number of important areas. And not everyone met the job or skill requirements. So we are actively recruiting for a number of open positions, which currently is approximately 40 positions.

Other important initiatives related to franchisee training and development are route design and optimizations, full marketing programs, product and brand strategies and the format and design of the franchise itself, which is being tested through a number of pilots. And we are very encouraged with the pilots that have been put in place at this point. We are making steady progress in each of these areas, and we are seeing an improvement in sales per franchisee, which in Q2 increased 4.1% from last year. We're pleased with the trend and with the feedback from our franchisees.

Our supply chain initiatives are proceeding, but we have much yet to do. We're in the midst of making changes to our US distribution system to better manage our high-volume SKUs. We are renovating our main distribution center in Crystal Lake, Illinois, to accommodate this and have been restocking all of our low volume SKUs in the Crystal Lake from the three outlined distribution centers, as these outlined centers will only handle high-volume products going forward.

As you can imagine, with all of these physical changes occurring while still running the business day-to-day, it's been quite challenging for our people. And at this time, I want to thank our associates for all of their extra efforts. Because of these changes, overall complete and on-time or COT as we call it, fell to about 83% to 84% in the US tool segment in June as somewhat expected. But it is now back to 87% and trending up. More importantly, on the initial 2100 SKUs being piloted through our new distribution model, COT is running at 93%. We continue to believe we will hit our year-end COT goal of 96% on our way to our 2007 goal of 99%.

Our rapid continuous improvement initiatives and activities are beginning to bear fruit with many ongoing initiatives in our plans to improve flexibility, productivity and reduce costs. In fact in the second quarter, the financial benefits obtained through improvement actions or more than able to cover the higher cost of steel in both our tool storage and hand tool plants. That's a pretty good snapshot of where we are today. And I am excited. Moving forward, with this goal we still have much more to do.

Now, Marty will comment on our financial results. Marty?

Martin Ellen Thank you, Jack. We will begin on slide one. Net sales of 624 million for the quarter were up 5.4% from last year. This was due primarily to higher sales in our US and Canadian franchisee businesses. Sales increases in the US and industrial hand tools, increased OEM facilitation actions and growth in emerging markets. These higher sales were achieved with improved productivity and sales per employee are up 2.5% to date in 2006 as compared with last year.

In our financial services segment, revenue declined 4.5 million and operating income declined 2 million mostly due to lower net interest spreads. Current share earnings were $0.60 for the second quarter, excluding the $0.40 per share related to the previously disclosed franchisee litigation settlement. Excluding the settlement, per-share earnings in the quarter were up 30.4% compared to prior year.

Operating results for the quarter benefited from the higher sales volume, increased pricing, and benefits of 9.1 million from improved productivity and rapid continuous improvement. These improvements occurred notwithstanding our increased spending to fund our growth strategies, which Jack just covered. Consolidated gross profit was 281 million, up 12.4 million from prior year.

This increase was driven by higher sales increasing as well as benefits from cost reduction initiatives and improving productivity trends in our manufacturing facilities worldwide. Increased production and material costs of 5.4 million, including higher steel cost, partially offset these improvements. As a percentage of sales, gross profit of 45% was essentially flat with last year.

Beyond the factors I just mentioned, we also experienced a higher level of sales contribution from our OEM business, which has somewhat lower gross margins. Operating expenses excluding the litigation settlement were essentially flat with prior year. As a percentage of sales, however, operating expenses improved 200 basis points over 205 levels -- due to improved productivity and improvements.

Included in the quarter was 6.8 million of cost to support strategic growth initiatives. Stock option and other share based compensation expense as a result of the adoption of stock option expensing rules in 2006 was 1.8 million in the quarter.

Let me now review our segment results. Please turn to slide two for the Snap-on tools group. For the Snap-on tools group, which serves the worldwide franchise distribution business, sales in the quarter were 271 million, up 3.9% from year ago. This is a much improved performance over recent periods. For sake of recent trends, in the first quarter of this year, segment revenues were down 2.8% year-over-year. And in the fourth quarter of last year, they were down 5.8%. So clearly this quarter's trend is much improved. Sales in the North American franchise business were up 3.7% year-over-year.

And in the United States, Snap-on's sales per franchisee increased 4.1%. The number of US franchisees', as expected, continued to decline. On a year-over-year basis, the average number of franchisees in the US declined 3.7% during the quarter. Sales in our international franchise operations increased 4.6% year-over-year, primarily due to strong sales activity in the UK.

Operating earnings for the tools group, excluding the impact of the litigation settlement, were up 13.2% to 26.5 million or 9.8% of sales as compared to 9% of sales last year. Benefits from higher sales and pricing and 4.8 million of productivity and cost reduction improvements were partially offset by higher planned spending of 3.6 million to support our strategic supply chain and franchise improvement strategies as well as higher material and production costs of 3 million. We're on track with the supply chain and franchise improvement initiatives that we discussed back in February and that Jack is updated for you today.

Turning to the Commercial and Industrial Group shown on slide 3, net sales of 300 million increased just under 2% year-over-year. Currency translation was minimal in the quarter. We continue to make solid progress with our expansion initiatives in Asia and emerging markets. Sales in the Asia-Pacific region more than doubled albeit on a small base.

Sales of tools for commercial and industrial applications in the US also continued to show significant improvements, increasing 11% year-over-year. Sales in our North American equipment business increased year-over-year, which is a positive sign for this business. Offsetting these improvements, however, were generally weak sales comparisons across Europe.

Segment operating earnings of 27.6 million were up 54% or 9.7 million year-over-year. Gross profit increased 7.8 million or 200 basis points to 36.6% of sales, reflecting both increased volume and pricing as well as improved productivity and efficiency savings despite higher production and material costs. Benefits from rapid continuous improvement initiatives and further footprint consolidations were major contributors to the earnings improvement.

In particular, the profitability of the worldwide equipment business continued to demonstrate substantial year-over-year earnings growth as a result of its continuing cost improvement efforts and prior restructuring actions. Partially offsetting these improvements in the segment was the planned higher spending to expand our sales and manufacturing presence in the emerging growth markets and lower cost regions.

Turning to the Diagnostics and Information Group on slide 4, net sales were 129 million in the quarter, up 10% compared with a year ago. Higher sales in our OEM facilitation business were partially offset by continued softness in Europe and lower sales of air-conditioning and other equipment.

Segment operating earnings of 13.8 million were essentially flat with prior year. Gross profit margin of 37.9% in the quarter was down due to a shift in segment business mix and included higher OEM facilitation sales, which have a lower contribution margin. Benefits from rapid continuous improvement actions were more than offset by costs related to growth initiatives.

Turning to financial services on slide 5, operating earnings in the second quarter were 3 million and 11.7 million of revenue. Year-over-year, the decline in trend in operating earnings results primarily from lower net interest rates spreads resulting from higher market interest rates as well as lower yields from certain new financing programs. Despite a lower number of franchisees, however, originations remained strong, up 6.4% from prior year levels.

That completes my operating segment review. Let's now turn to a discussion of our balance sheet and cash flow beginning on slide 6. At quarter end, after netting cash of 190 million against total debt of 214 million, our net debt of 24 million is down 21 million from the first quarter and is down 157 million from levels of a year ago. On a net debt basis, we are essentially now debt-free.

Inventories are up 27 million from year-end, mostly reflecting seasonality, but 56 million compared to last year. Turns of 3.8 are still below where we would like to be, but they are slightly improved from a year ago.

Receivables increased 23 million from the year-end due to the sales increase in the currency translation. Days sales outstanding at 77 days is consistent with prior year. While progress has been made in improving working investment, we believe that there is still much more work to be done.

As we have said, in the quarter, we recorded a $38 million charge to settle franchisee litigation matters. The terms of the settlement are, of course, subject to final court approval and the settlement amount is subject to change depending upon the actual number of claimants and the payment formulas included in the agreement. The accrued litigation settlement is reported as a current liability on the balance sheet, as we anticipate that the funds related to this settlement will be disbursed prior to year-end.

As can be seen on slide 7, cash flow from operating activities for both the quarter and year-to-date remained strong. Cash from operations of 46.5 million in the second quarter was up almost 15 million from a year ago. Capital expenditures were 9 million in the quarter and 20 million year-to-date, principally to improve manufacturing and distribution effectiveness. We continue to expect full-year capital expenditures to be in a range of 50 million to 55 million.

Net shareholder distributions in the quarter, which include cash dividends paid and share repurchases net of proceeds received from option exercises and from other share purchase plans was 28 million in the quarter and 44 million year-to-date. During the quarter, we repurchased 800,000 shares of common stock for $32 million. That's compared to 150,000 shares for $5 million in the year-ago quarter.

Those conclude my remarks about our second quarter financial performance. Now, we'd like to briefly share with you our assumptions and trends impacting our outlook.

We intend to continue to emphasize the implementation of our 2006 strategic priorities, including focused innovation of product, process and improving manufacturing costs and effectiveness, growth initiatives in emerging markets, and our actions to further enhance value and service to Snap-on's franchisees and customers.

As previously stated, the expected cost to enhance steel support and for other franchise system initiatives in the Snap-on tools group is anticipated to be 5 million to 7 million in 2006, of which approximately 4 million has been incurred to date. We continue to believe that the implementation of our other customer service and supply chain initiatives along with new marketing programs will require spending of 8 million to 10 million in 2006 as originally anticipated.

Spending in the first half of 2006 for the customer service and supply chain initiatives approximated $2 million. The remaining spend is expected to be incurred over the balance of year. We are encouraged by the progress to date in our key initiatives including those in the commercial and industrial and diagnostics and information segments to support emerging market, new products, and other important growth initiatives.

The financial-services segment is expected to continue to be challenged by higher interest rates, and its operating results for the full year are expected to be lower than the results achieved a year ago. Based on these factors, we expect modest year-over-year earnings improvement in the second half of 2006 for all of Snap-on.

Now, I'd like to turn the call over to Jack to share some closing thoughts.

Thanks, Marty. As I said earlier, I am pleased with our progress to date. Key indicators are pointing to improvements in taking better care of customers, reducing costs and complexity, improving manufacturing effectiveness and market expansion as well as new innovative products. We will shortly be announcing a new position in our corporation as the Chief Innovation Officer, because we are committed to providing the most valued innovation solutions in the world.

Our strategic initiatives are on track and rapid continuous improvement is becoming a way of life throughout the organization, which we believe will lead to long-term sustainable profitability for associates, franchisees and shareholders. However, we also realize that we are still early in our transformation and in a number of important areas. And certainly, we have much more work to do.

As we confront our internal challenges in driving our strategic initiatives, we are also faced with the external headwinds of rising steel prices, rising oil prices and rising interest rates. These challenges make our commitment to rapid continuous improvement more important than ever before.

In closing, I would like to take this opportunity to thank all of our associates worldwide for their hard work, accomplishments and continued dedication and focus toward achieving our goals.

And now, I'd like to turn the call over to the operator for questions.

Thank you, sir. [Operator Instructions]

And we'll take the first question from Alexander Paris with Barrington Research.

Good morning.

Good morning, Alex.

Very nice quarter.

Thank you.

In fact, almost too nice. I am just wondering if was there anything special in there or did we pass a kind of a major turning point? I see the spending for your initiatives, adding the two together, you mentioned it's still less than halfway through. And yet, did you pass the kind of a crossover point where the benefits are significantly outweighing the continuing cost or is it mostly improved volume?

No. I think obviously, there has been some improved volume, and we're pleased with that, particularly in the North American tool segment. But I think another element, Alex -- this is Jack obviously speaking. I think that our rapid continuous improvement programs are starting to really begin the yield results.

We have still a long way to go in the whole process, but I am encouraged in the quarter we've started to hitting our bottom line. So I think there is -- was there anything special in the quarter? It's just a lot of hard work, a lot of initiatives that we began to implement some 18 months ago that are starting to pay off.

Okay. Just a couple of questions on the tool part of the business. With the productivity of franchisees up quite a bit, is that high enough to where that warrant -- you're close enough to your target where that would warrant a much more aggressive new dealer procurement?

Well again Alex this is Jack speaking. We're still not where we want to be. There' still -- as Marty laid out, if you look that we have been declining. Now we are starting to improve. So we still have a lot more room to improve in our existing dealers. As we said, we continue to look at our route configurations.

To say that we need a lot more new dealers, it is too early for us to really draw that conclusion. The pilot models that we're running with existing franchisees -- some single franchisees, some with multiple bands has been very encouraging to date. But it's still too early for us to really draw definitive conclusions. But we are encouraged.

So I think there's still more headroom in our existing dealers. And obviously we will have the opportunities and continue to have the opportunities every day as we do add new dealers even in the current situation.

Could you just -- I'm a little confused about your -- You're talking about 40 open positions you want to fill. I would suspect after declines for a couple of years, you would have potentially more positions to fill than that?

Alex the 40 open positions that I alluded to or stated in my comments had to do with our internal sales organization. Those were 40 positions from the 92 field performance teams that we'll have. Keep in mind each of those teams will have four individuals. So we've got four times 92 of which we are recruiting for 40 positions.

Okay. So you are -- aside from them then as far as the dealer, you are already working more aggressively to fill -- to expand the list since your productivity has been rising?

Alex this is Marty. We continue to recruit franchisees; we continue to work on the training development program. We continue to bring people into the trial program, which we think is the right initial program for new entrants to the business. So that keeps going -- I guess I would say we're not prepared to necessary put our foot on the accelerator yet for all the reasons Jack sighted, as we continue to work the pilots, as we continue to improve the supply chain, we continue to get -- we need to get the field FPT structure completely in place.

We said earlier this year, we thought we could maybe reverse the trend and sort of the franchisee count by the end of the year. That may still happen. But we've got some gating items that have to occur first to ensure ourselves that when we bring the -- build back the franchisee organization it is done right.

One of the other elements -- one of the strategies I guess I didn't really talk about and should is that we're also taking rapid continuous improvement to our franchisees. We want to improve their productivity. The time they have in front of a customer is limited to only a few minutes. We want to be sure they are selling and not doing administrative tasks. So we're working to reduce that as we go forward. So that's an ongoing active program as well.

So are their purchases from you now rising as fast or faster than their end market demand?

About the same.

About the same now and we obviously want to change that trend. We want our purchases to be higher. So we've got to go back and gain some sales that we lost earlier to other suppliers.

Okay. Thanks very much.

And now we will move to Andy Keller with Mirage Research.

Yes a couple of questions. First of all Jack congratulations on your first 18 months. You've obviously had quite a few accomplishments so far.

Well thank you. But it's really the team. It's not just me, trust me. It's the entire team and all of our associates.

Well it's great to hear you take pride in every employee that works for Snap-on. A couple questions regarding your selling process. Going into the -- further in the future, how are you guys going to be streamlining the selling process to reduce order inaccuracies for your franchisees and your channel partners? This alone can help better effectively manage your customer base?

Well probably the most important element will begin with pull marketing. So we have launched pull marketing. We are just in the very early throes of it. So we want to create the demand from the technician through the franchisee, then back to us. And so that will be probably the largest single selling initiative and change that we will have in the marketplace and our business structure.

Okay. And how do you see that impacting your business in terms of better configuration of orders and more customers, what have you?

We'll be supplying to demand. In other words, what we really intend to do in our distribution centers, which we will be calling for the high flying stuff, our velocity centers, they will keep a certain level of inventory. As the technician needs the product, and he buys from the franchise and we ship it then we will just replenish it. So what we're trying to move away from is trying to build stuff always through a forecast. And as we all know, forecasts are only forecasts and their accuracy is not so great.

So how do you feel like this will help reduce order inaccuracies? That's pull marketing, is that what you're doing?

It will have a tremendous impact because we will only replenish what is actually being sold.

Okay. Right now for the next year, how do you guys plan on reducing DSO? Do you see that as a concern right now and what are your plans to reduce those?

Andy, it's Marty. We continue to focus on all working investments. We've made improvement over the years in DSO. We think we have more opportunity in a couple of our businesses. If we had to point to opportunities in working investments, there's probably more total dollars of opportunity in inventories for reduction than there is in receivables.

Okay. No problem. And final question for you. In working with the dealer channel over the next year, what would you say is your number one challenge and how do you plan to tackle that challenge to provide overall better service, improved revenue, improved margins?

Well this is Jack again. Number one challenge, I think the pull marketing will be a huge challenge to us because it is one of those things that we have to implement change in the marketplace. And we're making change through our franchisees. They're not our direct employees obviously.

So once you bump into that then you've got to really convince the franchisees that this is in everybody's best interest. I think we're beginning that process but I think it will still be one of our largest challenges moving forward. I think the second one might be the route reconfiguration. If we need to make any changes to a given route, we have to work with the franchisees again. It is really our ability to influence and convince the franchisees that we are moving in the best possible, positive direction.

And how will that impact like Internet sales? How are you guys looking at Internet sales as well?

Well I think the Internet sales will always be there. If you look at the number of customers in the world, that buy tools and would like to buy Snap-on, they may not always know where to even go. They may not even know the local dealer. So what we do, we make that available on the website so they can buy. Obviously we inform the dealer.

And after, I believe it's two or three purchases over the website, its definitely turned over to the dealer. So I think we'll see more emphasis on website, but it will be not at the detriment of the franchisee. In fact, that would be a positive expression for the franchisee because he will be getting some new customers.

Perfect. Jack, I wish you and your outstanding team further continued success down the road.

Thank you.

[Joe Hart] with Merrill Lynch will take the next question. Go ahead, Mr. Hart. And that line disconnected, we'll now move to Saul Rubin with Rockhampton Management.

Hi, hello. I had a few questions. First of all, could you talk a little bit about 2007 in terms of capital spending expectations, how we should think about that? And also, these costs that you're incurring to improve the business running at sort of 15 million to 20 million this year, do you expect that there will be continued costs like that as you go into 2007?

Saul, this is Martin Ellen. Good morning. Firstly our capital expenditures in '07, it's a little early for us to give much guidance there. I would -- as we said this year, 50 million to 55 million, so a little more back half this year as we upgrade certain capabilities in our plants for manufacturing reasons and new product reasons. Sitting here today, I would say for your purposes you can think about that kind of level carrying over to 2007 for your financial planning purposes.

We have had -- with respect to sort of ongoing continuous improvement costs, we have been running in this roughly $5 million range quarterly amount or 20 million a year. And given what we need to do and some of the initiatives Jack mentioned, including continue to looking at the footprint and where we want our cost basis to be around the world for the time being, I would continue to plan that level of ongoing cost as well.

Okay. Great. On another matter, you talk about the European market being somewhat soft. I think it's been somewhat depressed for quite a while in the commercial and industrial space. Are you seeing any signs that it may turn the corner at some point in time?

Well, I think, as we said, if you look at Western Europe -- sorry to use that term -- there is where we have seen a larger part of the softness. But as we enter into the emerging markets in the Eastern Europe portion, there's an emerging market for us. So we see opportunities there. So it is a little concerning to us that the more developed markets are soft.

We've seen some recent improvements in Germany and the UK, but they are just too many. But Saul, it's really too early to say that we see signs of recovery in the more developed parts of Europe.

Okay, fine. I just have two more. Firstly, just on steel, I suppose we all thought that that was behind us, but now it looks like steel prices are beginning to go up again generally. Can you talk a little bit about how that's going to -- I mean I know it affected the second quarter, but how you look about going through the rest of the year and into 2007, and just remind us of how your contracts work?

Well, we have contracts. We went out last year and did a great deal of negotiating through some RFPs with the suppliers. Some of those suppliers are obviously service centers, and they were unable to always honor agreement because of the increased prices that they were getting from the mills. I believe that we will see some -- I think prices for us will start moderating to some degree, but they will still be up slightly.

But having said that, we are taking a more aggressive view and actions to see what can be done with steel pricing looking on a worldwide basis. Steel is a worldwide product. It isn't just, you know, US obviously you have to take into account, but -- it's our largest commodity that we purchase. So obviously, it's our largest amount of our attention and we have still more work to do.

But I think that there will be some moderation in price increases. I think they'll be up -- continue to go up somewhat, but I don't think nearly as much as we've seen them increase in the past several months.

Okay. Great. Thanks. And finally, just to understand your numbers again and the outlook, can I just clarify, in the second quarter, am I right in saying there were restructuring charges in the second quarter of last year of about 7 million? Is that correct?

That's correct.

Okay.

It's about 5.8 million this year. It will be a little less this year.

Okay. And then on the outlook, you are saying that you should see moderate growth. Just to clarify, is that on GAAP EPS -- reported EPS because the Bloomberg numbers are sometimes different.

Saul, that is -- yes.

Okay. Perfect. Okay. That's everything. Thanks very much.

[Operator Instructions]

We will now move to a follow-up from Alexander Paris with Barrington Research.

Yes. Looking to the Diagnostics and Information Group that includes the OEM facilities facilitation or is that in the C&I Group?

It's in Diagnostics.

Right. That's what I thought. The sales gain -- what would the sales gain in the second quarter would have been, excluding the OEM facilitation increase? Was that all of it or --?

No. The OEM facilitation increase was probably in the $15 million to $20 million of total sales.

That was total. And the total increase in sales was what, 11.7 million?

No. In that segment?

Right.

In the segment, yes.

So now would you have a sales increase excluding gains from OEM facilitation?

They would be down right in the segment. In the segment --

Segment would have been down?

OEM drove the segment increase. As I said in Diagnostics where we sell a -- we have a bunch of different product lines, including air-conditioning, cooler recovery equipment, some other equipment, outside the handheld, under the good stuff that they had some lower sales in some of those product lines.

Okay. Just going back for a minute -- just real quickie on gross margins, you've got more spending, but also you are seeing improvement -- cost improvements. Would you expect your gross margin to edge higher in the second half?

Yes, I do. In fact, I would like to seen it in the second quarter as well. But as we continue with our rapid continuous improvement, I think that we'll start seeing it edged up. But I don't know -- as I said, I was hopeful in the second quarter and we didn't see it. So -- but the RCI should -- a rapid, continuous improvement should lead us there.

And just a couple of more quick question on the Dealer Group B. Is the mechanic population, is that still growing? And would you expect it to continue growing? Like roughly 1.5% or something like that?

The answer Alex, yes it's growing. I don't have the amount or percentage change. If you look at the published data of the industry it is still growing. And demand for tech schools are still sort of enrollment in the tech schools are still up double-digit year-over-year.

And there is still lack of available technicians.

Okay. And in terms of the end market demand for the dealer based tool industry -- what is that roughly, 3% or 4% or something like that?

When you say demand, are you talking about sort of technician purchases?

Well, the industry in which you have the dealer base, you have three major companies in that. What is that end demand?

If you want to start with end demand driver, you start to look at the total amount of spending in automotive service and repair. Because that drive -- sharp activity drives technician income, which only drives their ability to purchase tools and products.

It's interesting now within the higher gas prices and some softness and mild driven in recent months, you see in the March, I am looking at sort of April, May data and March, April, May data. You will see industry spending in as we collected from an organization 155 billion up from 140 to 143 billion year ago. So we've got whatever that percentages 5% or 6% in spending. And that's good for our business.

And so that kind of growth you would expect to be mirrored in your -- for the end market demand for your dealers, right?

Not perfectly, but it starts there.

I guess, I am asking that because you've got a lot of catch-up business to do. Would you expect now that the maybe the top-line is growing for a year or two? You would be growing significantly faster than the industry until you catch up and add more dealers?

I think as we continue to implement our strategies that we laid out. I think yes, we ought to be growing faster than the market. When we get into how much more significantly and will recur. I don't think -- we may see the continuation from our growth we had in the second quarter, but I think the major part of the growth probably will occur late in 2007 as we go into 2008. Because that's about a time that most of our initiatives are strategic initiatives are completed or largely completed in their implementation.

Okay. Thank you. Just one final question. When you look at your overseas dealer chain, have they been essentially sensitive to the same problems that you have in North America? That is, have you been holding down the expansion of dealers working on a less than optimal business model for them and so forth? Is it essentially mirroring North American dealers?

No, in fact Alex, it has not mired in North America. In fact Canada didn't mired United States. Our primary issues are in the United States. The overseas or outside the United States, just to say that they ran under different systems and had different business models. And it was I think more appropriate for the business than the model we operated within the US.

I see. Okay. Thanks very much. Again, a very good quarter.

Thanks.

[Operator instructions]

Moving now to Fritz Van Karpe with Sage Asset Management.

Fritz von Karpe Yes. Good morning, gentlemen. I just wanted to follow-up on some of the last callers' questions. How do we think about the risks to underlying demand, you know, that you were talking about, given fuel prices and miles driven and so forth, I mean, -- I know I guess that's sort of the vague an open-ended question. But, I mean, I'm sure these are topics that have crossed your mind before, and I would like to know your thoughts around it?

Yes. Absolutely. This is Jack. Let me try to -- obviously, we track them very closely. We want to look at the age of vehicles on the road. We see that increasing. We have seen miles driven increase. But as we went back and looked at when we have had spikes in prior periods of oil and gasoline prices had really dramatically changed miles driven.

And we've also not had those spikes as prolonged as they are today. So now, we're in new territory. We think that miles driven might decline just moderately. But it's not going to be a major change. I think if anything will occur, it might be the type of vehicles that people are driving. But I think the miles driven -- I mean, my personal observation -- I just drove a couple thousand miles here a couple of weeks ago.

I would ask, are you seeing less gasoline being acquired?, or the filling stations are obviously filling up. I don't think there's going to be a huge impact. There might be some moderation, but I don't think it will be substantial. I think we went back and tried to look at the headwinds and the tailwinds. There will be some more changes. Hybrid cars may become more popular.

That will be an opportunity for us because it takes different types of tools, obviously. As other technologies come about, we think there will be more opportunities. The headwinds are that cars have better quality than they have had in the past. So we try to look at this. And on balance, I think, we would see from an industry point of view over the next 10 years there are about a 4% growth.

And that kind of ties in with what Marty had answered, too, on an earlier question. Clearly, we believe that we'll outgrow that because we'll continue to gain back some market share that is there for us to a have, to achieve.

Fritz von Karpe Did you say that -- but that surprises me that you said a fleet of cars is getting older. I would think with all of the incentives in Detroit that the fleet would be getting younger?

All because -- you know, I was somewhat personally surprised, too. Fritz, but I think what we realized that, as you think back, one of the major changes occurred was when cars no longer rust like they used to. So the sheet metal stays on a car like because they went to double-coated zincking on both sides of the metal.

So as a result, cars stay longer on the road has been increasing this. The latest data that we had that I saw was the average car on the road is 9.2 years of age. So that was surprising.

Fritz von Karpe What was it a year ago? Do you have that number by chance?

What was it a year ago? No, I don't have that here. But it has been increasing. I just don't have it here with me.

Fritz von Karpe And you said that miles driven has continued to grow? Have we seen some moderation in that?

We have seen moderation here just recently.

Fritz von Karpe But it's still growing?

April and May looked to be flat. It could be down less than 0.5%. That's a most recent data we have in front of us.

Fritz von Karpe Thank you. Thank you, guys. I'll give it up now. Thank you.

And that was the last question in our queue. I'll turn it back to your host for closing remarks.

Thank you everyone for joining us this morning. If you have any follow-up questions, my contact information is in the new release. Thank you.

And, I would just like to add that, again, we're very encouraged about our second quarter results. But we also have a lot more to accomplish. So thank you for joining us this morning.

That does conclude today's call. Once again, thank you for your participation. Everyone, please have a nice day.