實耐寶 (SNA) 2012 Q2 法說會逐字稿

Welcome to the Snap-on Incorporated 2012 second-quarter results call. Today's conference is being recorded. At this time, I would like to turn the conference over to Leslie Kratcoski, Vice President, Investor Relations.

Thanks, Rica, and good morning, everyone. Thanks for joining us today to review Snap-on's second quarter 2012 results, which are detailed in our press release issued earlier this morning. We have on the call today Nick Pinchuk, Snap-on's Chief Executive Officer, and Aldo Pagliari, Snap-on's Chief Financial Officer. Nick will kick off our call this morning with his perspective on our performance. Aldo will then provide a more detailed review of our financial results. After Nick provides closing thoughts, we'll take your questions. As usual, we've provided slides to supplement our discussion. You can find a copy of the slides on our website next to the audio icon for this call. These slides will be archived on our website, along with the transcript of today's call.

Any statements made during this call relative to management's expectations, estimates, or beliefs, or otherwise state management's or the Company's outlook, plans, or projections are forward-looking statements, and actual results may differ materially from those made in such statements. Additional information, and the factors that could cause our results to differ materially from those in the forward-looking statements, are contained in our SEC filings.

Finally, today's discussion and presentation include reference to certain non-GAAP financial measures that exclude an $18 million arbitration settlement gain recorded in the second quarter of last year. Please refer to our earnings release issued this morning and to the slides accompanying this webcast for a reconciliation of these non-GAAP financial measures to those most directly comparable GAAP financial measures. With that said, I'd now like to turn the call over to Nick Pinchuk. Nick?

Thanks, Leslie. Good morning, everybody. As we normally do on these calls, I'll begin with some of the highlights of our second quarter, and I'll provide my perspective on the business and on the various markets in which we operate. Then I'll turn the call over to Aldo for a detailed review of the financials. I will say that the we were encouraged by the results. EPS of $1.30 represents a rise of 14% from last year's comparable $1.14. Organic sales were up 4.5%, despite the clear headwinds of Europe. The [Opco] operating margin of 14.2% increased 60 basis points, overcoming an $8.3 million in higher restructuring charges. And Financial Services added $25.6 million in operating earnings, up from a comparable $17.5 million in 2011. I'll remind you that in the second quarter of last year, we resolved the dispute with our former Financial Services joint venture partner and recorded at that time a one-time $18 million pretax arbitration settlement gain. That settlement was worth $0.19 a share. And given the nature of the item, I've excluded it, as we believe is appropriate, from the [Thinco] earnings and the EPS comparisons I just referenced.

On balance though, the quarter was another positive point, extending and encouraging growth trend. That continuing trend demonstrates significant progress along our clearly defined runways for growth, extending into critical industries, building in emerging markets, enhancing the franchise network, and expanding in vehicle-repair shops. And the operating margin's expansion is a reflection of our Snap-on value creation processes at work. As I said before, these are a crucial set of principles that we apply every day. Our focus on safety, on quality, customer connection, rapid continuous improvement, or RCI, and on innovation. It's a powerful framework, and it is helping to fuel our results.

I mentioned that the Opco operating margin expanded by 60 basis points from last year, but I'll also point out that this year's restructuring charge in the second quarter included $6.8 million for the settlement of a pension plan related to our Canadian tool storage facility, which we closed last year. But for that item, the margin expansion would have been 150 basis points. That increased profitability is strong testimony that the positive contributions of Snap-on value creation.

Now regarding sales growth, the numbers appear to validate that we are building advantage in each of the four areas we've identified as being decisive for our future. Critical industries, where the penalty for failure is high, another double-digit gain for our Industrial division, with the growth rate in the aerospace sector leading the way. Emerging markets, in addition to strong double-digit growth in -- double-digit gains in China, as you probably would expect, we also saw particularly large uplifts in places like Indonesia and Russia. The franchise channel, where we call on auto mechanics or auto technicians, volume's up 10% in the quarter with strong operating margins. And finally, in vehicle-repair shops, we saw growth in categories that are quite important to those shop owners and managers. Sales in RS&I business that provide diagnostics units, repair information, and shop-management systems were up high single-digits. So we're clearly progressing along each of our runways for growth.

That said, Europe remains a major headwind. No surprise to anybody, I guess. But the macroeconomic environment in Europe is muting the progress being achieved in other arenas. As in the first quarter, the mature markets in Europe were down from last year. But we're somewhat encouraged that despite the general news, the comparisons haven't gotten any worse since the last quarter. Overall, Europe remains a mixed story. The core mature markets are down, similar to last quarter, and the emerging East, especially Russia, continues to expand robustly. It helps to offset the larger declines in the South. So Europe remains a challenge, but for us, it's been that way for some time. And on balance, we've been able to navigate the turbulence and register encouraging results overall.

Now let's have some of the highlights for each of the segments. The C&I group. The C&I group grew organically by 5.1%. This is a group of businesses where we have much of our focus on emerging markets and on serving customers in critical industries. And there was strong progress on each of those runways. Our Asian operation and our Industrial division, the bellwether of our clinical industry activity, both registered double-digit increases versus last year.

But the C&I group, besides being the home of our critical industries and our emerging markets efforts, is also the home of SNA Europe and the ongoing challenges of that particular geography. That means the overall C&I growth was achieved while more than offsetting the turbulence of Europe. Now, the operating margin in the C&I segment was 11.6%, up from 10.4% last year. And this year's results of 11.6% includes $3.2 million in restructuring, substantially greater than the $0.5 million we spent last year. Given that C&I is where we have our largest European footprint, the results are encouraging. The Snap-on value creation processes are driving improvements, and our growth runways are yielding results. In the Industrial division, the critical industries center, we had solid gains in serving natural-resource customers.

We also had strong growth in aerospace and aviation. It was the highlight of the quarter, so I will offer some color on that sector. Aviation certainly fits the definition of a critical industry. And in that way, our automated control unit, ATC, continues to be an important product that raises -- that has raised Snap-on's profile. Each quarter, this high-tech package, which improves productivity, along with asset control, is showing up on more [flight lines]. We're seeing it in more repair maintenance and overhaul operations and in more aircraft-mechanic training facilities. Coupled with our expanded tool offering, we are filling those smart boxes with a wide array of Snap-on product and fueling Industrial division growth.

Another example of focus on aviation customers is during the quarter, we began serving with far greater intensity the largest airline maintenance facility in the United States, a location that employs over 4,000 technicians. They wanted Snap-on there full time, and we accommodated. So focus, product, and presence. We are expanding each in the critical industries, and it's paying off. One final note on aviation. It's an area that's importantly driving international expansion for Snap-on, helping to offset some of the European impact. In fact, our international rise in the Industrial division actually outpaced the growth in the US. More and more, we're selling expanded toolkits around the globe to airlines, to aircraft manufacturers, and in support of military, F-15 and F-35 fighter fleets.

Now speaking of international expansion, in Asia, our new under-car products, designed specifically for customers in that region, helped drive the double-digit growth of our Asia-Pacific operation. This high-visibility, high-value product category is particularly important in our emerging markets. And in both India and China, we saw growth rates for under-car equipment that substantially exceeded our overall growth rates for those countries. As the repair wave rises in Asia, we're particularly well-positioned, and liner sales are a testimony to that effect.

Moving to the Tools group, [buys] were up strongly in the second quarter, rising 10% above last year's level. The operating margin of 13.7% compares to 15.5% last year. Now remember, this year's results do include $6.8 million of restructuring charges for the pension settlement related to last year's facility closure. Without that charge, the margin this year would have been 15.8%. I believe that these overall numbers speak to the absolute strength of the van channel and to the trends that continue to be positive. We believe strongly that enhancing the van network is an important runway for Snap-on.

One way we're doing that is with innovative new marketing campaigns, generating excitement with mechanic customers. In the second quarter, we launched what we call our Masters of Metal Tour. It's a traveling caravan that offers outstanding opportunity -- it offers an outstanding opportunity for new as well already-committed customers to experience first-hand Snap-on's latest innovations and our hottest tool offerings. That customized mobile showcase celebrates automotive technicians as masters of their trade and Snap-on factory associates as masters of their craft. It features state-of-the-art touch-screen technology that gives attendees the opportunity to see just how Snap-on innovative products are designed and are engineered.

Each tour's also paired with a specially equipped truck that we call the Rock 'n Roll Cab. It's loaded with a large range of tool-storage products that allows those big-ticket products, big-ticket boxes, to be presented with a visibility and a variety that's not possible on a typical franchisee van. When a Snap-on tour comes to town, it really is quite an event, generally taking on a party-like atmosphere. Oftentimes, it coincides with a car show or a fundraiser for a worthy cause, and the local franchisees gather their vans right alongside of it. That mobile tour can demonstrate and sell the tools, and all this serves to generate significant brand exposure for Snap-on. It's been one of the drivers behind our robust Tools group growth this quarter.

One of the innovative products -- it's got a number of products on this tour -- but one of the innovative products highlighted on that tour is our new line of quick-release ratchets. They incorporate our unique Dual 80 Technology, along with a locking feature that holds the socket in place when needed and a push button for easy removal. That's a clear productivity enhancer. But in the past, these types of ratchets were considered to be not as durable as traditional tools. Well, Snap-on engineering has made the new ratchet almost 30% stronger than the competition. We believe it's the best such product on the market, and the reception seems to confirm just that.

I have often talked about big-ticket sales in this conference and in these calls. Big-ticket items in the Tools group in particular, higher-dollar purchases of diagnostics and tool-storage units. These purchases represent a larger commitment, and therefore, they serve as a barometer of customers' financial well-being, as well as their confidence. Well, sales of big-ticket units items remain at robust levels. In fact, tool store sales have been particularly strong as a result of the Rock 'n Roll Cab. You see, not only are these Cabs traveling with the Masters of Metal tour, we also have a small fleet of them operating singly, accompanying individual franchisees to repair-shop locations, calling on technicians with their unique mobile showrooms. I'll tell you, when these Cabs go into a franchise route, they drive tool-storage sales, and you can see that in the Tools group second-quarter numbers. So that's some of the highlights for the Tools group.

Now on to the Repair System and Information, or RS&I, group. This is where we serve primarily garage owners and managers and where we're expanding Snap-on's presence throughout the vehicle-repair shop. Sales in RS&I were up only slightly, 0.2% from last year. RS&I does have a large under-car equipment business in Europe that was down, reflecting the overall macros. Outside of Europe, for both the overall RS&I group, and for the under-car equipment business, the gains were mid-single-digits. So I think it is fair to say that the group is moving forward, but that progress is masked by the European turbulence.

Now, operating margin for RS&I rose strongly to 23%, up substantially from 20.9% last year. That increase was driven by growth, high single-digits, in the higher-margin businesses, the operations that provide, as I said before, diagnostics, repair information, shop-management systems to the independent garages, all places where Snap-on has great product and strong position.

Speaking of independent shops, last quarter I mentioned the launch of our new Mitchell 1 repair-information product. We call it [Pro Demand]. I'll give you a quick update. This new software enhances technician productivity. It offers faster and more accurate searches and improved access to other online data, like wiring diagrams and technical-service bulletins. It's been a big hit. Customer enthusiasm is apparent, and we are expanding our position as a result. That's one of the reasons why we're seeing the sales up in this area.

Another innovation helping expand Snap-on's presence in the garage is our recently launched alignment audit system. It uses computerized 3-D modeling, high-resolution cameras armed with an extensive database of vehicle information to provide a quick alignment audit. It significantly improves shop efficiency, and it does generate more shop revenue. With the new Snap-on system, any service technician can perform the audit in approximately 60 seconds and present the customer with a complete color-coded report that helps sell needed service that might otherwise have gone unnoticed. Early reaction, I have to tell you, has been very positive, with shop managers commenting that the unit provides a better return on investment than any equipment currently available.

The Snap-on alignment audit system joins a list of other new under-car equipment products, like our RSV-2000 diagnostic wheel balancer, which just won an innovation award at an important trade show in Germany. Our new semiautomatic tire changer, our new aligner, specifically designed for the Russian market. All those are good, strong new products in the segment. Customer connection and innovation. Snap-on value creation processes, resulting in attractive new products that are helping us to expand with vehicle-shop owners and managers.

Heavy-duty diagnostic's been another positive for RS&I. We made a commitment a few years back to expand in that area, and that effort's paying off with good growth rates. We started expanding government fleets, and it's an attractive opportunity that would not have been possible without the investments. So all these innovative products, from Pro Demand information system to the alignment audit, have been crucial in offsetting Europe and in driving the strong profitability for RS&I.

So those are the highlights as I see them. Overcoming headwinds to post sales gains, expanding operating margins, and clear progress along our strategic runways. The second quarter was an encouraging confirmation that even in turbulent times, our strategic initiatives, even in turbulent times, continue to offer growth, and our Snap-on value creation continues to drive improvement. Now I will turn the call over to Aldo for a review of the financials. Aldo?

Thanks, Nick. Our consolidated operating results are summarized on slide 6. Net sales in the second quarter totaled $737.9 million. Excluding foreign-currency translation, organic sales increased 4.5%, led by double-digit growth in Snap-on Tools and across the majority of our businesses serving customers in emerging markets and critical industries. Consolidated gross profit of $349.9 million in the quarter increased $7.7 million from 2011 levels. And gross margin of 47.4% improved 30 basis points from 47.1% last year. Operating expenses of $245.3 million in the quarter were up $1.9 million from 2011 levels, and the operating expense margin improved 30 basis points, from 33.5% last year to 33.2% this year.

Restructuring costs in the quarter of $10.2 million were higher by $8.3 million as compared to prior-year levels, largely due to the inclusion of $6.8 million, as anticipated, for the settlement of the pension plan following last year's closure of the Newmarket Canada tool-storage facility. Operating earnings before Financial Services of $104.6 million increased $5.8 million year-over-year and improved as a percentage of sales 60 basis points from 13.6% last year to 14.2% this year, despite 110 basis points of higher year-over-year restructuring costs.

Operating earnings from Financial Services of $25.6 million in the quarter increased $8.1 million, or 46.3%, from comparable 2011 levels, which exclude last year's $18 million arbitration settlement gain. Operating earnings of $130.2 million in the quarter increased $13.9 million from comparable prior-year levels, excluding the settlement gain, and operating margin improved 130 basis points from 15.4% a year ago to 16.7% this year. Finally, net earnings in the second quarter of $76.4 million, or $1.30 per diluted share, increased 14.2% from comparable 2011 levels of $66.9 million, or $1.14 per share. Again, excluding the settlement gain related to last year's earnings, we had $1.33.

Now let's turn to our segment results starting with the Commercial and Industrial, or C&I, group on slide 7. Sales of $283.4 million for the quarter were up 5.1% organically from 2011 levels, primarily as a result of continued double-digit sales increases across the majority of our businesses serving customers in emerging markets and critical industries. These increases were partially offset by mid-single-digit sales decline in our European-based hand tools business as a result of further market weakness, particularly in southern Europe. Gross profit of $104.3 million in the quarter increased $1.9 million from 2011 levels, and gross margin of 36.8% improved 20 basis points year-over-year, largely due to the savings from ongoing RCI initiatives and favorable foreign currency effects. These gross margin improvements were partially offset by $2.6 million of higher restructuring costs to improve the segment's cost structure in Europe.

Operating expenses of $71.5 million in the quarter decreased $1.7 million from 2011 levels, and the operating expense margin of 25.2% improved 100 basis points year-over-year, primarily due to benefits from sales-volume leverage. As a result of these factors, second-quarter operating earnings of $32.8 million for the C&I segment increased 12.3% from 2011 levels. Operating margin of 11.6% in the quarter improved 120 basis points from 10.4% last year, despite a 90-basis-point impact from the higher restructuring costs.

Turning now to slide 8. Second-quarter sales in the Snap-on Tools group up $325 million increased $29.5 million, or 10%, organically, largely due to continued higher sales in the US. Gross profit of $137 million increased $4.6 million from 2011 levels, despite $6.2 million of higher year-over-year restructuring costs, as anticipated, to settle the Newmarket pension plan. As a result of the expected higher restructuring costs, gross margin of 42.2% in the quarter declined 210 basis points from 44.3% last year.

Operating expenses of $92.5 million in the quarter increased $6.3 million from 2011 levels, primarily due to higher volume-related and other expenses. The operating expense margin of 28.5% improved 30 basis points, largely due to the benefits from sales-volume leverage and contributions from ongoing RCI initiatives. Operating earnings of $44.5 million in the quarter for the Snap-on Tools group declined $1.7 million from $46.2 million last year, as contributions from the higher sales volumes were more than offset by expected higher restructuring costs. Operating margin of 13.7% in the quarter decreased 180 basis points from 15.5% last year, including 190-basis-point impact from the higher restructuring cost.

Turning to the Repair Systems and Information, or RS&I group as shown on slide 9, second-quarter sales of $227.4 million increased $0.4 million organically from 2011 levels, as a high single-digit sales gain of diagnostics and Mitchell 1 repair information products was partially offset by reduced under-car equipment sales in Europe and a low single-digit decline in sales to OEM dealerships. Gross profit of $108.6 million in the quarter increased $1.2 million from prior-year levels. Gross margin of 47.8% in the quarter improved 200 basis points from 45.8% last year, primarily due to a more favorable sales mix that included higher sales of diagnostics and repair-information products. Gross margin also reflected savings from ongoing RCI initiatives, including contributions from design-cost reduction.

Operating expenses of $56.4 million in the quarter decreased $2 million from 2011 levels, and the operating expense margin improved 10 basis points to 24.8%. Operating earnings of $52.2 million for the RS&I group increased $3.2 million or 6.5%, and operating margin improved 210 basis points to 23%.

Now turning to slide 10. Second-quarter earnings from Financial Services of $25.6 million increased $8.1 million, excluding last year's settlement gain, primarily due to continued growth of our on-book finance portfolio. Originations of $175.6 million in the quarter rose 14.7%, reflecting both higher sales in our Snap-on Tools segment and increased participation in our credit programs. Moving to slide 11, as of second-quarter-end, our balance sheet included just over $1 billion of gross financing receivables, including $854 million from our US Snap-on Credit operation and $156 million from our international finance subsidiaries.

In the US, $693 million, or 81%, of the financing portfolio relates to extended credit loans to technicians. Since 2011 year-end, our on-book financing portfolio has grown approximately $75 million. The pace of the portfolio's growth has continued as expected and is naturally decelerating as the transition of the CIT-owned portfolio nears completion. In 2012, we continue to anticipate that for the full year, the gross on-book portfolio will increase by approximately $125 million over 2011 year-end levels. Regarding finance portfolio losses and delinquency trends, these continue to be in line with our expectations.

Now turning to slide 12. Cash provided by operations of $91.7 million for the quarter includes the effect of $20 million of additional discretionary cash contributions to our US pension plans. In 2012, we also intend to make required contributions of $12.6 million to our foreign pension plans, and depending on market and other conditions, may make additional discretionary cash contributions to our US plans. The $91.7 million of cash provided this quarter from operating activities compares with a $13.7 million use of cash in the second quarter of last year, which primarily resulted from the return of $89.8 million of cash previously withheld from CIT following last year's arbitration settlement.

Capital expenditures totaled $18 million in the quarter and $40 million year-to-date. For the full year, we currently anticipate capital expenditures of $70 million to $80 million, including the construction of a fourth factory at our Kunshan, China location, which is expected to be completed by year-end.

As seen on slide 13, days' sales outstanding for trade receivables of 56 days improved from 58 days as of 2011 year-end. Inventories increased $15 million from 2011 year-end levels, largely to support continued higher demand in the United States. On a trailing-12-month basis, inventory turns of 3.9 times compared to 4.2 times at the 2011 year-end. Our quarter-end cash position of $174 million decreased $12 million from 2011 year-end levels, primarily due to the continued funding of new loans originated by Snap-on Credit, US pension contributions of $45 million, share repurchases of $38.1 million, and dividend payments of $39.6 million. These year-to-date uses of cash were largely offset by cash generated from operations.

Our net-debt-to-cap ratio of 33.2% compares to 34.3% at 2011 year-end. In addition to our $174 million of cash and expected cash flow from operations, we have more than $700 million in available credit facilities, and our current short-term credit ratings allow us to access the commercial paper markets should we choose to do so. As of the second quarter-end, no amounts were outstanding under any of these facilities. This concludes my remarks on our second-quarter performance. I'll now turn the call back over to Nick for his closing thoughts. Nick?

Thanks, Aldo. We are encouraged by the second-quarter results. More than anything else, we believe it confirms Snap-on's abundant runway for improvement and for growth. It extends our favorable trends, achieved despite turbulence in Europe, which given our position in Spain, has been with us for some time. The quarter shows that we are making strategic progress in the areas that we believe are decisive for our future.

The van network is stronger. Sales were up double-digits again, with the US leading the way. We are extending into critical industries, also up by double-digits in the quarter. A strong position is being built in emerging markets. Sales growing substantially above local GDPs, and physical capabilities, factories, product lines, distribution, all strengthening. And we do see progress with repair-shop owners and managers. Although overall RS&I is flat, the crucial high-margin core of diagnostics repair-information and shop-management systems grew at a high single-digits, bringing RS&I profitability to a high level.

And again this quarter, we're seeing Snap-on value creation processes driving progress on our runways for improvement. Opco OI of 14.2%, up 60 basis points despite substantial increased restructuring. I think everybody knows that these are interesting times, and there are challenges. But we've been facing headwinds like Spain for some time. We're confident of our capabilities, encouraged by our strengthening position, focused on our abundant opportunities, and believe that we will continue to find advantage despite the turbulence.

Before I close, I believe it's appropriate to recognize that Snap-on's results, and the encouraging trends, reflect the extraordinary effort and our strong commitment, and the strong commitment of our associates and our franchisees around the world. I know many of them listen to this call. So for your energy, for your dedication, and for your support, you have my congratulations, and you have my thanks. Now I'll turn the call over to the operator. Operator?

Thank you.

(Operator Instructions)

Mike Wherley, Janney Capital Markets.

Congratulations on another great quarter.

Thanks.

I wanted to talk a little bit about the critical industries. You mentioned that you signed on with a large airline-maintenance facility, and I am wondering, are there other potential opportunities like that? And do they deliver the same margins that you might get in your other critical industries than this?

There are different -- there are many more opportunities, of course. That's the biggest one, United States, is why mentioned it. But what I meant there was focus, product, and presence. And at the base of our extension into critical industries is the fact that in the past, Snap-on would sell on an almost default basis to some of those customers. We were calling on the 4,000. We were calling on that site, but very sporadically. We never focused on it as a distinct customer base that we wanted to solve their problems and make their work easier. And this is an example of what we will be doing around the country with other places. Focus on them, call on them as they need, provide a product line that fits them. Now, we are doing that there. It's just early days. We started that in the quarter, but there are many other places to do that in -- to do the same thing. Regarding margins, the margins are just as good with that business as they are throughout the Corporation.

Okay. And is it something where you have a direct way to sell to those technicians? Or is it something where the maintenance facility just buys them for the technician?

It's a mix. In this particular -- in fact, I think in this facility, it's a mix. The facilities buy some, and the technicians buy some. And we sell it through a direct presence that's there virtually every day.

Okay.

Kind of direct sale, and if you look at the landscape throughout the country, or throughout the world, you would find a mix of what you just described. In some facilities, the facility buys and provides the tools. In other facilities, it's the technician themselves.

Okay. And then just one other question I had --

Let me offer, in any case, that's a classic example of the Snap-on positioning. It's why it does not matter to us so much who buys, because the buyer is usually not a corporate buyer. It's a buyer located very close to the point of use. Even if it's the facility, he's up close -- that buyer's up close and personal to the technician himself. So the technician has a great influence on what actually gets purchased. So that means that our -- the capabilities of the Snap-on products are quite appreciated and weigh heavily in the purchase. That's why we get the margins.

And will you be extending credit to those technicians?

[We will.]

Okay. The other question I had was on the restructuring that you're doing in Europe to reset those costs levels in the SNA Europe. Is that complete? And when do expect the benefits to be fully realized?

It's not complete. That's an ongoing basis. You'll probably see some more restructuring going forward, the kind of restructuring you've seen in other quarters. If you look back in our history, you'll see that we're kind of a controlled restructure. And we have had restructuring in most quarters, and you're going to see that in our future, much of it directed at SNA Europe. So that'll happen. When you see benefits, I would say it's hard to say. It varies from project to project. But a good rule of thumb would be to say two-year paybacks. And that will give you some indication of how -- what gets offered from extending.

Okay. Thanks so much.

David Leiker, Robert W. Baird.

This is John on the line for David. On the C&I margin this quarter, it was up 140 bps on what essentially is flat revenue quarter-over-quarter. I'm just wondering what exactly is going on there, whether it is mix, or some of the European restructuring already is starting to take place?

I think it's -- I don't know what you mean by flat. I think it is up 5.5% on organic basis.

Sequentially, sorry.

Yes, right. Are you saying sequential?

Yes, sequential.

I think 5.5%. If you talk about reported, that has currency inside it. But on an organic basis, it's up. It is sequentially flat, I know. What you are seeing in C&I is a number of different things. One is of course the effect of the Snap-on value creation process, as we obviously turned a focus on it in the past couple of quarters. You're seeing that flow through in terms of things like RCI, rapid continuous improvement. And then you are seeing some improvements in Europe and the bottom line associated with some of those restructurings coming through. You're seeing both of those effects happening. I don't think you can call it a mix thing. We're not seeing much mix in C&I. What you're seeing there is pure productivity.

Okay, great. Thanks. On the -- for a long time, you've had a 15% OI margin target for the Opco. And essentially you are already there if you make the adjustments. I'm just wondering when looking ahead and looking at the further leverage you can pull, is it more on the manufacturing side where we could expect a greater improvement in gross margins? Is it on the operating expenses, or SG&A? Any feel you might have for that?

Well, I think it is all of the above there. I think there are -- I think we have said fairly consistently over the years that we see two distinct runways. One, what you are referring to, are runways for improvement, that rapid continuous improvement driving better efficiency and productivity even at flat sales. And you see that play out both in gross margin and in SG&A in operating expense. And then you'll see leverage associated with growth that goes forward because we believe those runways are open to us, things like extending the critical industries and expanding in the repair drive and building in emerging markets, and the van network, which has been double-digits for three or four quarters now. I can see all three of those things in play. The kind of efficiencies around both areas and margins and expenses and the leverage associated with volume. Now I'll quickly say that the leverage is not always as definable each and every quarter as you might think, because sometimes you get more sales. And the RCI effect to handle those sales, to raise the productivity of your factory, does not adjust quickly enough, and you will get some inefficiencies at first. And as RCI catches up, that drops to the bottom line much more effectively to get that leverage. We see that in some of our results, particularly in the Tools group this time.

The other thing I would emphasize pretty carefully as I look out and I see these runways for growth, and see that growth happening and I see the operating margins happening, this is over a longer term. When we look forward, like to the third quarter for example, everyone will probably want to know about the third quarter. This is the most uncertain quarter for us every year. There's a lot of [windage] in our third quarters. We see things like the effect of European vacations and the effects of the van vacations. You remember the van drivers are owner-operators, usually single person in the business. When they take the couple weeks off or a week off for a vacation, the van does not roll. So our third quarter is not a trend quarter. It is a quarter that has a lot of variation in it. When you look out over time, we're going to see those three things in place, leverage, and productivity improvements, both at the gross margin line and operating expense line.

Okay, great. That's helpful. Just wondering, given where the euro is and the potential headwind it creates, how much of your SG&A is incurred in -- or denominated in euros?

I guess I don't know if I have that number exactly. I can offer this to you, that about -- what did we say -- that about 22% of our business is in Europe. And the euro denomination, about 15% of our activity is in the euro currency. So, if that's helpful.

No. Yes, that is helpful. And then my last one is on the growth in the Tools group. You had -- Mac Tools had high single-digit growth during the quarter, so you've obviously beat that. And I'm guessing if I did a US to US comp, your US Tools business grew above the 10% that the overall segment did.

Yes, it did.

Okay. So trying to get a sense of or put my thumb on what exactly is going on. And one of the things, just thinking about it, having [met] the credit operation internally now, have you been able to pull some levers or do some creative promotions, now that you are managing that, you that you weren't able to do when CIT was running it that might be helping you capture incremental tool buyers?

Actually, you said a lot of great things there that are accurate. Let me just say first, the Tools group has put together three or four outstanding growth quarters around 9%, 10%. And you have to give credit to the team there. They are hitting, in baseball terms, they are pounding the ball. And so a lot of credit has to be given to that team there for this. And what you are seeing with them are a couple of things. One is, is that we have some great new products, like I've talked about, the ratchet, the flexible ratchet. Then we have the marketing efforts like the Rock 'n Roll Cab, which is generating -- if you think about it, that van is really small. So how may boxes can a van driver carry on his van? So when a mechanic gets on, he can only see two colors or two sizes.

The Rock 'n Roll Cab, he can see a whole wall of this stuff, and so it generates sort of the impulse purchase. And so you are seeing that great marketing effort. And then our van network has just been getting stronger and stronger. When you look at the health metrics of the van, the sales are up. The equity is up. The terminations are down. It is just gotten stronger right out of the recession because we invested in them. And finally, we have invested in productivity in our van so that our drivers are spending more time selling. You've got those three things happening. You have got all four things happening, that's driving those sales. So that's how I explain that, the van business and the expansion there.

Okay, great. Thanks, guys. Good quarter.

Dax Vlassis, Gates Capital Management.

Nick, just curious on the margin side, if you add back the restructuring charges, you are well in excess of a 15% target. And I am wondering, there was another question about the growth of that and the sustainability of that. Can you speak to the new benchmark you have set as far as margins and the go-forward from here, if some of that --?

Okay, I am really happy about the 15.8% in the Tools and the number without the -- but it is one quarter, so I don't know if I'm actually resetting my benchmark yet. I got to think about it. And I would also say that when you look -- I just want to emphasize -- when you look forward, things happen from quarter to quarter. We feel pretty good about our trends, but this is one quarter. And I am confident in our upward trend. I am confident in the runways for growth and improvement. But am not sure I yet want to reset my target based on one quarter achieving it.

But around this level, let's say in the first half of this year, did you feel that that's a sustainable-margin basis to look at the business?

Sure. I think so. But I want to say that we have been here. We're just getting to this level. And when I say something I don't mean every quarter.

No, of course not.

Every quarter. I'm talking about -- I think is a great, sustainable direction. I've already said that the third quarter is kind of squirrelly, and you can never predict anything about this. But I think over the trend, this is a good base for thinking about our business. And I've also said to many -- I think maybe I said to you when I met with you -- is that I believe that Snap-on -- and I've been around the block, this is not my first rodeo, you know. And I have been around the block and Snap-on has a great, great franchise in the broadest sense in terms of brand, in terms of product, in terms of customer reception, customer loyalty. And if we can't get top-level returns, then we would be disappointed.

Okay. And then my second question is around the cash flow. It looks like, especially given the contributions that the free cash flow, cash flow from ops minus CapEx, that you generated in the quarter was the highest in two years. It is great to see you generating such strong cash. Can you talk about your future? It looks like you're stepping up a little bit on the CapEx for the second half of the year. And can you talk about your working-capital management and whether you expect to sustain this great cash flow? And then on top of that, to add on to that question, is uses of cash. Can you talk about the acquisition environment? And if there's any areas that you could put a larger amount of shareholder capital to work at good returns?

Yes, look, I think talking about moving forward, our uses of cash, I think I've said in the past, are to invest in the business. And you have seen us step up CapEx. I think we raised our target this time because we can see opportunities to invest in, particularly in things like capacity and so on, and in emerging markets. So we can see great opportunities for payback in those things, and we're actually getting more capable in spending. One of the things that keeps you -- that makes this possible is we are just getting more effective in managing those CapEx expenditures.

Secondly, you did talk about it, the working capital. As you grow, you need working capital. I have cautioned everybody that I don't see working capital as a source of cash going forward. It will probably be a use of cash going forward, because we expect to grow. And then I see M&A, I see acquisitions around the coherency of our businesses, around the critical industries, around the repair shops serving owners and managers, and in emerging markets. I see acquisitions to make in those areas. And so those are the places where we will be spending our money.

Yes, but have you seen any -- are you closer to doing something then you have been in the past, or is it --?

I don't think we comment on those kinds of things. But I think we are obviously closer. We're getting further out of the credit company.

Okay, my final question is with respect to the earning assets of the [Thinco]. Are there any -- I know there is going to be some further growth for the rest of this year given the targets that you've set for 2012. But it is really not that much in capital investment from here as far as receivables and contract receivables and finance receivables. What would be the growth rate past 2012? Are we getting to the point where you are not going to have to make any more investment, then it'll just be pure cash that rolls off from the operating income of that business? Thanks a lot.

This is Aldo. Just a comment, Dax. I think if you look past 2012, the growth of Snap-on Credit will be more closely aligned with the growth of the Snap-on Tools group. Largely the CIT transition will have been completed by the end of this year. So whenever the Tools group grows, it will never much up perfectly quarter-to-quarter, but it is a good reflection. And what that means is that you'll still probably see the portfolio growth be consuming slightly more cash than what you would get if you allocate interest expense and taxes, as we do in our cash flow slide, to the Financial Services segment. So we'll still be a user of cash to some extent, but not to the extent that it is today.

I appreciate it. Thank you.

Let me just add one thing at the end. I mentioned the use of cash, and I take it as a given around here, and that is dividends. We have paid a dividend every quarter since 1939, and we have not reduced it. That is part of our DNA here, so that would be another use of cash that I want to make sure that I don't overlook when I discuss this here.

Gary Prestopino, Barrington Research.

Nick, going through your narrative, you mentioned some countries in Europe that were particularly strong, and I couldn't all write that all down. So could we go through that? I mean, and then some of the weaker ones --

I think I only mentioned Russia, pretty much, in Europe, in the script anyway. But what you can think of -- really what we're talking about here is the periphery, the Eastern Europe, and we put Turkey in there, and things like Belarus and other places. And if you think about actually the Maghreb countries would be part of that, so they would be -- we happen to sell into northern Africa. So I think of it is a circle around Europe in the middle. We're selling some in those areas. So that is where the business is up. Why we are encouraged by that is is that speaks to us to confirm that the business in Europe is still robust and has a great value proposition. As long as the economies are unafflicted, people keep buying.

These are our newer countries, so this would be considered part of your emerging markets initiative, or am I incorrect?

Yes, I think mostly. Actually, not North Africa so much. We have been in North Africa for a dog's age, but Russia and Belarus and places like that.

What I'm trying to get at -- so in your established countries, you said Spain and Italy are bad.

Bad.

Very bad. As you went through the quarter, ex- Spain and Italy, in your more established countries, did you start to see a slower growth, if that is the best word or more of a --?

No, you know what we saw? Those are down. It is like this. How I would describe Europe is like this. The -- Spain, deep, deep reductions. Spain, the southern Europe, big reductions is what we have seen. The periphery up robustly and the core is mid-single-digits down. That is what we are seeing. What we -- I think of one little nuance in this call is, or this report is, we are not seeing acceleration of that downward motion.

Okay.

It is still down, but the comparisons are about the same. But they haven't gone -- they haven't gotten worse. That is the report I would give you as our look on Europe.

So it doesn't feel like it did in 2008?

Well, yes, right. Yes, 2008, yes, doesn't feel like that. No, it doesn't feel like it was in the first quarter. I think things -- we thought things as the fourth and the first quarter of 2011, in the first quarter, we saw things getting deeper. On a year-over-year basis, things are not getting any deeper now. There's still agony on a year-over-year basis, but it isn't -- the hole isn't deepening.

And just as kind of a rhetorical question.

Yes.

Your sales were up about 1.5% quarter-over-quarter. Without foreign currency, it was about 4%.

On average.

Even given that low single-digit sales growth numbers, if we extrapolate that going forward, do you still feel these RCI initiatives would be enough to expand your margins, even with such sluggish sales growth?

First, I beg to -- if it is possible for me, I beg to differ a little bit in your characterization of 4.5% as low. I have always characterized our growth as 4% to 6% organically.

Right.

And 4.5% is within that range. And so therefore from my perspective, this is just another data point. I never said we were going to hit 5% every year right in the middle of that every quarter. So to me, the organic growth is kind of what you expect. We will see some bigger than that. But I like being in the range. And I believe Snap-on value creation -- I think I've said this before -- Snap-on value creation, that authors improved profitability at flat sales, let alone small growth. So I think that is a factor. Of course, your margin expansion gets slower then. But you still get that margin expansion.

Okay, thanks, Nick. I appreciate that.

Richard Hilgert, Morningstar.

Okay, just a few quick questions here. With the economy here in the States appearing to slow down a little bit, are your drivers seeing, and are you seeing, fundamentals in the repair businesses still holding up? I know the revenues were good in the quarter still, especially in the Snap-on Tool business. But I'm curious here as you exited the quarter, what's some of the driver feedback you're getting? Have collections started to be a bit slower? And are folks looking to repair their vehicles a little bit less at this point and trying to postpone some repairs?

No, the answer to this is no. I was just -- about two weeks ago, I was with 700 customers at the national NHRA championships in Joliet. I didn't get to meet all 700, of course, but I got to meet quite a few of them, and they were uniformly positive. And just a couple days ago, I was out on a van, riding around the countryside, stopping at garages and shops and so on and they seemed, I would say they seemed fairly positive and full of business. So I don't think at the grassroots level you see much out there in terms of moaning or saying this is -- things are tough anything like that. I don't see that.

Now, there's the odd person that has a problem depending on what has been happening, particularly if it is a franchisee and let's say Ford and General Motors have closed a dealership in his area, so he is readjusting with other stops we give him. But generally, I am seeing fairly good positioning. Now I'll remind you that we all view ourselves as recession-resistant, not immune. So what happened last time is when the recession eventually rose, people kept buying -- people kept repairing cars. The Journal was running articles like economy is blown but repair shops hum. And what happened was our customers kept buying short payback items like wrenches and hand tools, but they stopped buying big-ticket items, like tool boxes, tool-storage units. And we are still seeing that business robust.

Okay. How about on the Industrial side?

You know, I don't think so either. We're not -- again, we operate in criticality. So generally, our customers hold onto our buys a little longer. And what I mean by operating in the space of criticality is that you are selling to someone who knows that if the machine he is -- or whatever he is maintenancing, whatever he is supporting, has a problem, the consequences of failure are high. Therefore, he has a tremendous motivation to try to pay for the repeatability and reliability of the Snap-on level product. And so that tends to be more resilient. Now it is not unaffected by recession either, but we were up double-digits in that business. And there is a lot of landscaping there. The military was flat. The government was flat. The aerospace is up. Natural resources is up, and it's always so. There's always landscaping, but it was pretty good.

Emerging markets, people ask about emerging markets all the time, but everybody is talking about China slowing down. It may be so, but if you think about this, repair business in China has not even started. The repair wave hasn't started. They sold more new cars in China than anyplace else in the world last year, but all the cars on the road are new versus -- and not many of them. 68 million, 70 million cars on the road, and they're all new, versus the United States, where there are 300 million cars on the road and the average is 11 years old. The business has not even started in China. It is just rising. When we look at our results, we are not a good barometer of economy there. We should be rising anyway, because our sector is just rising.

Right. Okay. The $21 million currency hit in the quarter in revenue? You have got operations set up over in Europe. Do you have their costs pretty much in line with your revenues in terms of a currency impact?

Actually yes, the profitability impact was lower than that.

Okay.

So it's not -- you are looking at -- that $21 million is give or take for our [soft string], our government work is 3% impact. The profitability impact is substantially lower than that. Looking forward, you will see you can -- if the exchange rates stay as they are, you could be thinking about 3% again, I guess. And then I think when you start to look at year-over-years, the comparisons get a little easier as you get out at the other quarters.

Right. Okay. So in an environment where the euro is gaining ground against the dollar, we would see more of an increase in revenue but less of an increase in profitability?

Yes, right. Sure, sure.

Okay. All right. On the RCI initiatives, what kind of a cost savings run rate would you project coming of RCI? You've been doing this program for quite a while now. What would you expect in terms of the kind of magnitude of cost savings that you can continue to get from RCI?

Well, I think that's hard to say. But I think you could say $25 million, $30 million a year, something like that kind of number. I don't know. We try not to put a number on that. I tried to address that when I said that the restructuring payback was two years in Europe. The -- I think --

Do you count restructuring the same as RCI?

No, not -- no, it is not the same.

Okay.

We have restructuring, but we also get RCI. They're different. They're distinct things. But I guess maybe I was trying to give you some kind of view of the kinds of numbers we were going to get out of restructuring. But you can look at that number. You can go back and look at our productivity numbers, you can see the kinds of numbers we've generated on an annual basis on flat sales, and I think you can see that going forward. Normally how I answer this question is that -- people I think -- I do not know if this is your concern -- is that maybe you'll run out of opportunities. And I don't think we are.

I think (multiple speakers) Snap-on, mainly because there are a lot of processes at Snap-on. A hand tool that's heavily integrated, if you think about it, you don't buy many components. You have a piece of steel comes in the back of a hand tool plant, and the finished product goes out the front. And really, pretty much everything that goes into the hand tool is done inside the plant. You don't buy anything for it. So there's a lot of opportunities for RCI. And then you have 65,000 SKUs, which creates a complex landscape. So we see a continuous run. But I hate to commit to any one particular number. I know you'd like to have one for your model, but I hate to commit to that. I would just say that I believe that we hold ourselves to a standard that on flat sales, we expect to have improvement.

Okay, good enough. On that Masters of Metal Tour, I hope you're in a rush towards of pot of sales gold at the end of the rainbow and it that won't turn out to go over like a Led Zeppelin.

Okay, right.

Thanks, guys. Good quarter.

We'll follow the stairway to heaven and get a little more profit.

All right. Sounds good.

And that was our final question. Ms. Kratcoski, I will turn it back over to you for closing remarks.

Thanks, everyone, for joining us this morning. A replay of the call will be available shortly, and as always, we appreciate your interest in Snap-on. Goodbye.

And that concludes today's conference. You may now disconnect.