Snap-on Incorporated (SNA) Earnings Call Transcript & Summary

Thanks for joining us. I'm Sherif El-Sabbahy with BofA on the machinery engineering and construction team within Equity Research. Really glad to have Nick with us here from Snap-on really fortunate, and thank you for being here.

Sure.

Just to start us off, for those in the audience who may be less familiar with Snap-on. Could you provide an overview of the business model, your position in the market and a high-level operating backdrop?

Sure. Look, Snap-on is a company that has been around 105 years, started in 1920, and it basically started in the vehicle repair market. And the idea was there was very few cars on the road, about 7 million cars on the road at that time. The people didn't know what mechanics were going to do or what. And we're in the mechanic, of the repair business and didn't know what tools mechanic would have. So this engineer from Milwaukee, Wisconsin gets the idea, I can consolidate the tools and he puts it together. So he gets this idea, take 5 handles of different configurations, like a T, a crank, an ellipse and put them together with 10 handles -- 10 sockets of different dimensions and fashion them so they snapped on interchangeably. He said these 5 tools did the work of 50, and they did. They revolutionized tool sets all over the country. And the idea of observing the work as he did, in the garage and figuring out how to make it easier is what drives us today. Secondly, he made the tools of great quality. You can pick them up in our museum and you'd say, if you put your back yourself back into 1920, you would say these are made a great steel. But the third thing he did was most lasting and most unusual is he said, okay, we're going to bypass the usual distributors that sell tools, and we're going to go right into the garage and talk to the mechanic and lay the tools out on greenfield as if they were as precious as surgeon knives, implying that the mechanic used these tools, he would declare to the world he was doing something special, perhaps as special as a surgeon. And the idea that the Snap-on brand, the display of the Snap-on brand or the use of the Snap-on tools was the outward sign of pride and dignity that working men and women taking their profession is with us today, and it marks everything we do, which is about observing the work, figuring out how to make it easier and imparting and almost defining the mechanic or any worker that they are a professional by using such a special tool. Now it's evolved over the years, and we've become what we've become with 36 factories around the world and $5 billion worth of sales and the market cap wherever it is today, and 13,000 employees, but 85,000 SKUs. And we're in 3 divisions, sort of like descendants of those first tools. The first is the Tools Group. And the Tools Group sells to those same mechanics. They sell to the actual guys who make the repairs. The guys who toil the wrenches and punch the buttons and touch the screens. And they sell -- we sell through about 3,500 franchise vans in the United States. And these franchise vans call on a route, which calls on the same technicians every week. So what it means is every week, we call on 1 million technicians. So we're very vertically integrated. We make -- we get -- we make the tools from raw steel in the back of the factory. We roll it down a line with a bunch of special processes, and we put it in the hands of the end user. That business is 40% of our business. And it makes about 25% margin. In the quarter, it was down because of the uncertainty, but it's a strong business. And I would say it's a business model that fell from Saturn, we have about a 55% share, 50% to 60% share. Then a cousin of that business, which started later, selling to a customer which is about the same stands contiguous with the mechanic itself. That is the owner of the shop or the manager of the shop. They buy a different -- they don't buy under a weekly cadence. They buy under like a semi-capital expenditure basis. And we sell them things that are in that you see in shops. We sell lifts that you see in shops or aligners or tire changers or balancers or software, which run the shop or manage their electronic parts catalog. That's about 28% of our business. It was up 3.7% in the quarter, and it made 25.7% OI margin, up 140 basis points. And then the third business, which is about 28% of our business sells to people outside of automotive repair. We call it critical -- we call it commercial and industrial. That business sells to other industries, but still critical. Industries where the penalty for failure is high and the need for repeatability and reliability justifies a Snap-on level product. And there are things like the military, aviation, oil and gas, education, mining, anything you might imagine, natural resources, you might imagine, boy, if you screw up, bad things are going to happen. That's where we sell. And it's all taken together. It's put together with the commonality of criticality that is the penalty for failure is high, and it's driven by our principal value-creating mechanism, which just like in the beginning, we go right into the place of work, observe the work, figure out how to make it easier with either a wrench or a piece of software and therefore, make the job easier and more profitable for our customers. We also have a credit company, which supports the sales primarily to the technicians, and that's about a couple of billion dollar portfolio. That's our business.

Understood. And as we look at the tools market, there's a number of public players out there that sell tools. How do you look at the -- how do you fit into the competitive landscape? And maybe how does Snap-on differentiates itself versus some of these other players in the market?

Okay. All right. We -- everything I told you is different mostly than what the other people do. Snap-on is, of course, a premium tool. And yes, we have people who sell through those 3 divisions all have competitors, but let's take the Tools Group, which is what people think of. There's a couple of -- there are a few other mobile tool stores. But generally, if you put together the idea of the being in the workplace, observing the work, creating a tool which specifically will help that work like taking out the spark plugs of an F-350 truck because you can't reach the back ones or matching the bumpers of a Silverado so you can get behind it without taking it off or providing a software patch for other products or diagnosing what a product is based on a database as opposed to a time-consuming process. We have an advantage in product. We have an advantage in brands. I talked about the greenfield. Well, people wear our jackets. I get on a van and the guy says, he sold 80 jackets in 2 weeks to his 250 customers. You go to a county fair, you'll see Snap-on hats and jackets. I have people send me pictures of the weddings in front of Snap-on boxes and on Snap-on Vans. I have people send me pictures of their newborns with Snap-on wrenches in their hands because they think if it touches the baby first, it will influence their life for better or worse. And I have people who ask me for small Snap-on boxes so they can bury the ashes of their loved ones in them because Snap-on tools was such a big part of their life. Nobody else has that kind of brand activity. And it basically defines the person as a professional. And so I think we have that position. And generally, we have pretty good shares. Like I said, we have 50% to 60% -- way over 50% share in the -- with the technicians, 1/4 of the repair shop owners and managers and varying shares depending on what the critical industries are. So I think we have a pretty good position.

Understood. And turning to tariffs for a moment just because they've been so topical. I understand that for Snap-on, maybe it's not as significant an impact since you produce mostly in the region for your tools. But is there any impact there? And then secondly, does it impact the competitive landscape at all or some of these other producers for some of the lower-end tools?

Well, first of all, remember, we talked about this is that yes, everybody wants to know what's the impact on your competitive activity. It's been like 5 weeks since the tariffs started. Everybody has inventory, there's not going to be any impact right away. If you ask about impact, you got to be crazy. But the thing is that in truth, we have -- we are advantaged in tariffs. We're not immune to tariffs. We are resistant to tariffs, but we are advantaged by strategy and by structure, because I said our principal value-creating mechanism is to go into the workplace, not ask the technician what's wrong, not survey people from a distance. We go into the actual workplace with people who are experts in the work, and they observe it and say, this guy is having trouble with this. We'll try to fix that. Now we don't make things possible. We make things easier. He's working on it now. It's taken a lot of time. So we do that. Now what does that mean? You've got to be in the workplace. So what it means is that we tend to make in the markets where we sell, so we're close to that process. So we make in Asia for Asia, we make in Europe for Europe, and we make in America for America. 80% of the vans I talked about, 3,500 vans, I talked about, 80% of what we sell off those vans is made in America. So by strategy, we have an advantage. I don't think anybody else quite does that way. Secondly, we have an advantage by structure. And the structure is this. We have 36 factories around the world, but 15 of them in the United States. And we expanded the biggest ones in the last 2 years. So we have the capacity in place. And we make virtually -- not that we make -- we bring stuff here, I said 20% is from outside the United States. We bring stuff here from other factories like from Europe or Asia that we sell. But we make a version of virtually all our major product lines here. So we have the know-how. And then one of the biggest barriers people will tell you about trying to manufacture in the United States is getting people. We don't have any trouble getting people because we never laid off anybody in the pandemic. And so our people stay with us, and we have a reputation in those places. So fundamentally, we have that structural advantage. People will say, it's 3 to 5 years. You've heard people say it's going to take 3 to 5 years for us to move this manufacturing back. So it isn't going to take us that long if we have to produce everything because we have the know-how, we have the structure, and we have the people. And if we have to source anything outside, let's say, one of the big problems, I think, today is, if you look at, okay, you can talk about, okay, they reduced the -- what the reciprocal tariffs 10%, but there are other tariffs in the Section 301 tariffs are 7.5% or 25%. You lay on top of that the IEEPA tariffs, and you've got tariffs just today in China of 37.5% or 55%. And so those are a problem today. And okay, maybe if the 10% goes to 30%, those numbers go to 75%. So you're going to have to make adjustments as they make -- as they change the tariffs, and we're going to do that. Plus there'll be adjustments in things like when they launched the tariffs on April 2, they talked about Vietnam at 46%, Taiwan at 32%, Thailand at 28%. I think Malaysia was 24% -- sorry, 38% rather, Thailand. And so then they said, never mind, it will be 10% for 90 days, then they're going to go back and say, what are they going to be in the future? No one knows. So no one can do any of that. But what we can do is we have 25 factories outside the United States, which means 25 sourcing centers in different places. So we can plumb the depths of a lot of different sourcing areas if we need to provide other components. So we think we're in pretty good shape. We don't think -- we think virtually not many of our competitors or other manufacturers are in this kind of position. So I think we're advantaged by this. Whatever emerges from this tariffs, and it is a fog. It's a fog of tariffs. Nobody can predict what's going to happen, I think. I don't think the White House can predict what's going to happen really. And so we have to be flexible. And we think in a flexible environment in an environment that requires flexibility, we are advantaged.

Understood. And also along with tariffs, there's been this sort of secondary impact that's been a bit more prolonged about 1.5 years now sentiment has been quite weak among mechanics and consumers. And alongside that, there's been the pivot away from larger item purchases. You've responded to that by pivoting towards quicker payback items, which is where the customers are sort of at in terms of what they're looking for. Maybe how has your response changed over the last few quarters in terms of new product introductions? And just among mechanics, maybe how has their outlook changed at all in the last few quarters, just given that they've been sort of deferring these purchases?

A bit of explanation. Okay. There's always been a difference between the grassroots and the financial economy. When you call on 1 million technician, this presses heavily on your chest. But it got bigger during the pandemic. And the reason is during the pandemic, the people of work were at their posts. They weren't sheltering in place. They kept working. We worked every day because our factories work. I couldn't face the factory workers, if they didn't work. And so they kind of -- their experience got wider. So coming out of the pandemic, they were euphoric when Wall Street was talking about, hey, J. Powell is going to increase interest rates and recession is coming, recession has come. They were very positive during that period. Then as bad news started to pile up for breakfast like the Ukraine war, then the Middle East war, then the tit for tat for China, then the Houthi war, then the idea that there was inflation and the prices didn't come down. Beef is still 44% above pre-pandemic levels and gas is -- not gas, but milk is still 23% above and eggs or God knows how much about. And so people worry about this kind of thing. And so they started to get, I would say, uncertain even though they had cash, people kept pounding their cars through the garages. They were cash rich, but confidence poor. We have seen this phenomena before in the great financial recession, which I was around for and the pandemic. It turns out that the people of work are more influenced by their emotions than the data by what they see. And that's what we saw. So we saw that last year. And what that meant for us is we sell a couple of kinds of products. One, big toolboxes or $10,000 and other things like diagnostic units, and we finance it through our credit company over 3 to 4 to 5 years. And then other types of product like might be hand tools, power tools or some of the smaller diagnostics, we might finance those -- the franchisee will finance those over 15 weeks. So what we found is the -- our customers, our technicians started to pull away and be reluctant to tie themselves to longer payback items. They didn't want to tie themselves to 3- to 4- to 5-year cash flow requirements. And so they pivoted toward the 15 weeks. And so we started to pivot. We started to pivot in terms of our product development, full product development off of big -- there's a good concept when you see something like this, don't pour water up a rope. And so the idea is you don't want to keep pounding away at something somebody doesn't want. And so we did. We said, okay, we'll start pulling away, and we'll push more into hand tools and power tools away from tool storage. And so we did that. And so we worked that. And in fact, that pivot was working as we started to close the gap year-over-year, culminating in -- we had a 1% reduction in the fourth quarter of 2024 versus, let's say, mid-single digits gap versus prior year in prior quarter. So we were squeezing it up. But then what happened was -- now that didn't have anything to do with abating uncertainty, uncertainty still stayed constant during that whole 2024, but our pivot started to better match with customers. Than what happened was as we came over the year and the administration got into place and you had the rapid fire out of Washington, things like we're going to put casinos in Gaza and we're going to invade Greenland or something and Panama and the blast of tariffs, boy, people started to worry. And these are people, by the way, I might add, that always did and still today are fans of the President. They believe he's going in the right direction. I think I've said in many venues that it's sort of like space mountain. They're on space mountain -- they're in the dark. It's going left and right, left and right, left and right, they believe where they're going because they're going to go a safe place at the end, but they think the thing is going to go off the rails. So this is why you saw consumer sentiment going down. Consumer sentiment dropped 30% in 3 months. After December, it dropped to the second lowest time ever. And the first and the only time worse than that was after the great Shanghai closing in 2022 when the supply chain seemed to be completely disrupted. People, it turns out, worry more about supply than they do about price actually. We learned this when we had the gas crisis in the '70s and early '80s. People worried about supply, not so much price. So anyway, that's what happened. So you saw it go down. So that outran our pivoting. Even though the pivoting was working, we're still pivoting. And we think as that flattens out, even at the low level, we start to gain on it again. The things we learned a little bit was, I don't pour water up a road, but we learned in the past quarter is that one of the things you can do is chip away at the bottom end of the bigger or longer payback items. So we focused not only at the traditional quick payback items like the hand tools and power tools, but we started to say, okay, what about cheaper -- the lower-end diagnostics? What about if we could make some less expensive toolboxes, a version of less expensive toolboxes that would have certain features, and we'd sell them to people. And that seemed to work in the quarter, and we think it will work when we go on.

And as we think about some of those items at the lower end shipping away, is that something that, for example, a mechanic might purchase a car that would defer maybe a purchase of a larger box for several years? Or how do you think about the...

It's like a car. It's like a car. People buy -- everybody -- every mechanic has a toolbox. I mean some of them may have some of the dog food from our competitors, you know what I mean? But in fact, you want to buy a box, it's like buying a car. And so people move up for a bunch of reasons. For example, a mechanic may figure I want to buy a toolbox that might seem like to us like a discretionary purchase, but he might say, look, if I can buy this box, this has got this feature where I can charge all my power tools here. I don't have to walk to any place to charge a power tool. That saves me time. I can make more money because a mechanic is paid not by the hour, by the job. So that might move them up even if he buy something today. So it's hard to predict that kind of thing. But of course, some people would say, well, I bought a low-end one, I may delay a little bit. But then he may jump to even higher box than he would have originally. So it's hard to characterize that situation. I wouldn't say we don't look at it like we're reducing the opportunities in the future by selling the products we're selling today because we always bring out products. Remember, when we bring out products, we bring it out because we observe the work and figure out how we will make the technician or workers' job easier, and that applies to tool storage boxes.

And I want to turn for a moment to C&I. In the last quarter, defense was a bit weaker. Just weak or defense sales had slowed somewhat due to some of the administrative changes, which isn't uncommon. When we think about that, how often during these periods of change, how long do they last? And maybe what do you keep your eyes on for signs that it's sort of clearing through?

It's hard to predict because what happens is, I think you said it correctly, every time the administration -- not every time, but many times when the administration changes. Now we have a lot of orders in defense. But every time the administration -- many times the administration change and there's a new [indiscernible] in town, and he won't be pushed around. He goes down there and he says to everybody, okay, we're going to redo all the purchasing. Well, usually, some of that is good and some of it screws everything up and slows everything down and then crust things. And eventually, they find his direction in a more efficient way. And many times, it's driven by the capitulation to the actual war fighter saying, the 50-caliber bullets are going overhead, and I don't have the tools to repair my vehicle. That usually gets people's attention. And so eventually, that wears down the changes. It's hard to say how that will be, but we don't expect it to be that long this time because, boy, there are 2 hot wars. And the Houthis are kind of a half war for us. We're kind of piling stuff on them. And so -- and then everybody is worried about China, so you don't want to fall behind. They talk about China building all the ships and stuff. So I wouldn't expect it to last that long. But it's hard for me to predict in the time constant of the market where everybody is worried about. They're asking me now about the effect of tariffs that were put in place 6 weeks ago. You know what I mean, it probably doesn't change that quickly. But we don't give guidance. So I'm not saying anything about second quarter. We may be booming, you don't know. But I think the other critical industries are doing pretty well. In fact, C&I was down, what, 2.9% organically, but all of it was explained by the military. It was up in general overall. Profitability was up 15 -- it was 15.5%, up 10 basis points, and the gross margins were up 180 basis points. So the business was really robust even as the military was down. It was just that we kept spending at lower volumes because we have a lot of faith in the future of the business. That's, in fact, the fact throughout. That's one of the themes that runs through our quarter. Our OI margin was down some, but gross margin was up -- was 50.7%, one of our highest, and it was up 20 basis points, but it was the operating expense that was -- as a percent of sales was higher because we refused to back off spending because we think this is a blip.

Understood. And outside of defense, you mentioned that the other end markets were strong across the board. We've seen a lot of machinery fleets.

Yes.

Replenished the last few years. Just as we think about long-haul trucking, et cetera, some of these markets that are weakening, does that have any pull-through impact to tool or repair demand for C&I?

For C&I, maybe. Of course, these markets, all of them, every quarter, there are some markets that's weak. C&I has about 8 markets or 9 markets. I wish they were all strong all the time. We think they should be, but they go up and down. So heavy-duty might go down. I don't think we see that ourselves. But if you're telling me long-haul trucking is going down, which I've heard it is, it might eventually work into our system. But remember that what we sell is usually critical. And it makes work easier. So people tend -- even during downtime, sometimes people invest in it. This is particularly true in auto repair. People ask me all the time, wow, if we're not selling that many new cars, it isn't going to kill your business because the dealerships aren't going to buy anything. Well, maybe, except dealerships happen to make more money in repair and parts than they do in selling new cars. So many times, it ends up more business for us because they get -- they're no longer distracted by that weaker margin business of selling new cars. It's more or less they want to keep supporting our customers better and making more in terms of service. So they tend to invest in our business. So our business generally doesn't follow so clearly new equipment sales almost in any place. It follows the sort of like repair cycle.

And you mentioned dealerships and their equipment. As we look at RS&I, that's been a great performer for a long time now. What sort of sentiment among the shops, the dealerships? And in terms of news flow, we've been hearing about bonus depreciation, does that drive them investing in CapEx?

Sure. I think they're small companies. I mean I think -- look, I think -- I don't know. Yes, it will. I mean the thing is these are small. I think they're pretty much pass-through businesses, LLCs. And so therefore, a lot of the things they're talking about in the new taxes should encourage them. I don't know if it makes a boom. You know what I mean, but it's got to help their view. I mean, there are the whole thing about the trifecta about interest and bonus depreciation and all this kind of stuff and expensing. And then there's also the 199A deduction, which you now get for a small business, a pass-through business that you get to deduct from your income depending on how you work. I think it's 20%. And so that's -- they're all talking about that being renewed permanently. So if they do that, it's got to encourage people. But I think I would say, in American terms, those people right now are from Missouri, show me before they get too excited based on somebody saying they're going to do this. I think they want to see it. Once they do it, I think it will help some.

Understood. And I just wanted to turn to the balance sheet for a second. You've got a really strong balance sheet that affords you a lot of flexibility and cash position. Just as you look at that sort of net cash position that's building, does that change your priorities in terms of capital allocation at all?

No. Look, I think this, I think probably we look at it every quarter. We try to think about what we should do. I think this is a time when there is a lot of uncertainty with our customers, whoever, who knows what that's going to happen. And we feel pretty strong. But on the other hand, I don't mind having a little cash at this point. Our priorities are like this. We invest first in our business. And we are working capital hogs. We use a lot of inventory and a lot of receivables in our business. Now one of the metrics that we use for all our divisions is return on assets. But it turns out we deploy assets as our sales go up. I think it's in the 30s or 35%. Our working capital turns are pretty negligible really. But we like it because we make a lot of money on that product, and we use it. That's because we're so complex. We have some -- we have 85,000 SKUs. So that's the first priority. Second priority is acquisitions because we keep looking at coherent acquisitions. We're not looking to transform our business. We're looking to find businesses that do what we do, and we know dramatic -- we know clearly who we are. We are a company who doesn't make their money by the penny, makes their money in the critical where we can get a premium for solving these problems. If we see somebody who operates in the critical, we'll consider acquiring them. But we won't go into retail, we won't venture into things like retail to follow them, okay? Then we do dividends. We have paid a dividend every year. We have paid a dividend every year since 1939. -- and we have never ever reduced it. In fact, we've increased our dividend every year for the last 15 years. It was up 15.1% in the last year. So you can probably figure out my approach to dividends, who wants to be the first guy to reduce the dividend in a 105-year-old company, not me. And so then finally, we think about buying back shares. And so we look at those every time. So I can only tell you that we look at it, consider the possibilities and go forward. We haven't changed our priorities, though, in that situation.

As we think about the longer term, historically, you've grown earnings, call it, high teens outside the pandemic on mid-single-digit to high single-digit revenue growth, so outgrown revenue. Just as we look forward, do you see a pathway or any deviation from that? And as we think about growth in the future, what are you most excited about in terms of verticals or new products?

I'm excited about critical industries. I'm excited about the changes in automotive repair that are happening like electric vehicles, plug-in hybrids, the ADAS, the Advanced Driver Assist Systems, the autonomous car idea because every time a car changes, technicians need new tools and they need help to diagnose the car. For example, you're trying to diagnose a car, it's pretty difficult. There are tens of thousands of trouble codes, and it's very difficult to ferret your way through this in a standard way is to go through a bunch of decision trees, which take time. You got to test this. It's a physical decision tree. This is what the cars tell me, I'm going through this decision tree. The OEM tells you to do that. We have a database, 3 billion records that allows you to shortcut all of that because we've seen these cars before, we can tell you when the car says this, this is likely. And so it can shortcut that. And if that isn't one of them, we give a [indiscernible] diagram, if 1 of the 3 or 4 things, one we give a [indiscernible] dig. If 1 of the 3 or 4 things comes up on alternate Wednesdays, on months that have an R in them. And so the unusual things, and we are the only ones that have this database. The OEMs are blind to it. So as the cars get more complex, people are going to have to turn to this big database. And AI in some ways, I hate to say that because it's too pack now allows us to manage that database a little bit better and access it better, but it's getting stronger and stronger for us. So I like that advantage, the advantage all the way through from scanning, telling what the car is going to say because we have the best library being able to diagnose it, telling people how to actually do the repair. By the way, the average mechanic needs to -- the senior mechanic needs to master about 2,000 procedures. How many procedures does a surgeon have to master. By the way, I don't think that many. And so we can tell them how to do it. And then with our tools, observing the work and figuring out how to make it easier, we can make it easier for him. So I see that as where we're -- I like those areas. I like that trend as cars get more complex for both repair shop owners and managers and for tool guys. And I like the idea of getting into more into critical industries because there's a lot of opportunity there. And then I think we can keep improving because we are heavily vertically integrated. We're from -- raw steel comes in the back of a factory. We rolled through a bunch of difficult procedures, 4 or 5 difficult procedures, some that grind the tool to 1/30 of a human hair. And we put it in the hands of the actual end user vertically integrated, and we have 85,000 SKUs, which means our OI margin last year was 22.7%. And and we carried an incredible complexity burden in making that. Some of our competitors have scales that are 100x ours, and we make more money. So the idea that we can still wring out improvement is clear based on that. So I have faith that if we never increased another $1 of sales, we would keep our margins going up. Now we have increased sales. So if you look over the last 19 years, in a tool business, right? It's a tool business. We've increased sales by 4% a year. Now that's not bad, but better -- not that's great, but it's better than GDP. And our profitability has improved an average of 85 basis points every year.

It seems like complex...

We can keep that going.

Well, it seems like complexity is your opportunity. So as we think about that complexity is increasing exponentially, does that change the way you develop products or your product development cycle at all?

Actually, no. No. Actually, the complexity is -- Again, it's -- we keep changing the way we develop. For example, one of the things we've been able to change is because when you produce a lot of products, we produce sometimes thousands of products in a year, is prototyping becomes a heavy cost. And so the idea of new technologies around 3D printing or direct laser metal sintering allow you to shortcut the prototyping process. We keep working on that. So that's the kind of things we work on to make our development of tools more effective. But it doesn't change our idea. The more complex it is, the more opportunity we have and when we can get a tool that will fix something, people will pay us a premium. And then behind that wave, we can keep making it cheaper and cheaper by our rapid continuous improvement structure, which everybody at Snap-on gets up every day and says, we're going to make things easier. We're going to do our job more productively. That's our culture.

Well, thank you so much. With that, I think we're just out of time. Thank you so much for joining us.

Sure.

Thank you to everyone in the audience.