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

Good morning. Thanks for joining us. My name is Luke Junk. I'm the Baird analyst covering vehicle tech and mobility. Really great to have Snap-on with us this morning, as you probably know, is a leader in the auto aftermarket and other industries. Really happy to have Nick Pinchuk, CEO of the company with us here this morning. Once we get settled in here, Nick, do you want to kick us off with some introductory comments?

Sure. Okay. If you're not familiar with Snap-on, I'll give you a brief people's view of it. We're a company that operates in the critical. So in other words, our customers are those people who are looking to solve things, where the penalty for failure is high and the need for repeatability and reliability justifies a special tool, as special as a Snap-on tool. It's a lot of different industries, automotive repair, aviation, you can think about quite a few, and they are natural customers. And how do we pursue that? Well, our principal value-creating mechanism is to go actually to the place of work, not survey, not analyze, go to the place of the work -- that work and observe the work and figure out which work is particularly difficult, critical and therefore, would benefit from a Snap-on Tool. We bring it back and we make the tool for it. And it doesn't really matter to us how widespread that problem is. We try to solve problem after problem after problem. So we've got 85,000 SKUs and growing. We're kind of like complexity headquarters with regard to products. Now how do we handle that? Well, we have something called Snap-on Value Creation, processes and safety, quality, they're kind of obvious. You got to be safe if you make things for people, for workers, you got to keep your own people safe. You want to have quality because people don't want the tools to break down. But then we have something, as I just described to you, customer connection. That's what we call. We go into the work and observe the work and take the insights and use innovation in a number of different forms to create a new product. But then we have something called rapid continuous improvement. At every site in Snap-on, there's somebody dedicated to it. There are thousands of events every year. And therefore, we're able to manage this complexity, without it killing our costs. And the evidence of that is over the last, say, 15, 16, 17 years, Snap-on has increased its OI margin, an average of 85 basis points every year. Now that puts us into -- we organize -- we have different organizations that face off in customer base. So we have the Snap-on Tools Group, which is what everybody thinks about Snap-on. It's 4,800 vans, franchise vans worldwide, and they call directly on the customer, the people toil the branches, that business was up in the quarter about 1%. It made 21.7% OI margin, and that was up 10 basis points year-over-year despite the tariffs. Then we have the C&I business, which calls on people -- no, we have the RS&I business, which calls on a different customer, not the mechanics who actually toil the wrenches, but the owners of the shops and the managers, sells things like software and lifts in vehicle repair. And that business was, I guess, there's a lot of adjustments in the quarter because we had a legal settlement in that group. But when the dust settles, they were at 25.6% OI margin, up 20 basis points. And then we had the Commercial Industrial Group, which calls on people outside the garage, like aviation, oil and gas, general industry, mining, education, military and also calls direct. That business was down -- was up in the quarter in sales, but was flat in the quarter in sales. But it was down a little bit in terms of OI margin. I think it was 15.6%, down 110 basis points. A lot of that was currency, though, and a lot of it was -- some of it was tariffs. And you think in this time of tariffs, I have one other piece of data to tell you, and that is we make in the markets where we sell. It's part of our manufacturing doctor. We have 36 factories worldwide, 15 are in the United States. So generally, we know how to make everything here. So in this time of tariffs, our gross margins this quarter were 50.9%, down 30 basis points, almost all described by currency. So we just took the tariffs and went like that. That's my story.

Okay. Great story, Nick. Join into the conversation, I believe the e-mail address for this room is [email protected]. I'm going to start with the Tools Group. And the third quarter that you reported a few weeks ago, and frankly, the #1 question that we've gotten about the company recently is around seasonality. If I look over the long history of our model, 2Q to 3Q, very long time that has been down seasonally. Last 2 years, it's been up seasonally. What do you think is -- what's going on there? Is this a permanent change, do you think, in terms of your ability to execute through that?

I mean the thing is the third quarter is always squirrely. I say it on every conference call in the third quarter or even rolling up to the third quarter. And the reason it is different is, because in our world, there are a lot of vacations that run through the summer. Remember, we're calling on individuals. They go on vacation. right? And so you have that. The franchisees who call on them for the Tools Group in vehicle repair. When I'm talking about customers for the franchise business, they are vehicle repair technicians. We call on almost 1 million of them every year, every week, every week. So we go up and call on these people every week, and that's the cadence of the sales in the Tools Group. Well, some weeks, they aren't there. And then there's no opportunity to sell. Some weeks, some third quarters, they are there. So we have that variation in that group. And then secondly, we have our Annual Snap-on Franchisee Conference, where the franchisees come in and we -- it's like 1/3 training. We train them in the new products like our new Diagnostics product, which are difficult, very complicated and very powerful, but they got to be trained in the issues. So we have lots of training seminars, 1/3 training seminar, 1/3 buying show. We had, I think, three football fields of product. And so they go around, they actually touch the product, which they might not be able to do unless they order it. So they do this at this event, so they order and 1/3 is [ pep rally ]. I'm in charge of [ pep rally ]. So generally -- but if you think about it, okay, 85% to 90% of our franchisees pay their own way to come to the site where we have the conference. They pay their own airfare, they pay their own hotels. But more than that, they come out of the field. So they park their vans. So there's 1 week at least of the 13 in third quarters always that's kaput, at least several days. And so therefore, this combination of vacations and the SFC makes the third quarter extremely hard to predict. Now let me put it this way, having the third quarter up is deeply against the tides of seasonality. So for us, while the quarters are squirrely and there's a lot of variations, having the third quarter up over the second quarter has only happened 2 or 3 times in my tenure, and I've been around a long time. And so therefore, even though it's not completely definitive, it's better than a poking the eye with a sharp stick, it's pretty good. So I think that's how I can describe it. I don't think it's definitive, but it does seem to fill because -- to fit the Tools Group profile lately because Tools Group has been improving, as it was set back by the uncertainty with technicians. Technicians, automotive repair has not stepped back. Actually, it didn't step back during the great financial recession. During the great financial recession, the Journal was writing articles like economies glum, repair shops hum. And so it is. If you look at the BOL's data, household spending on vehicle repair is up double-digits. And it's been continually going up double-digits because cars keep getting more complex. And so that's driving their business. Technician pay is going up mid-single digits because they're doing more things. And a senior technician has to know 2,000 procedures. How many procedures does a surgeon know? By the way... Not 2,000, I bet. Okay. So they have to know a lot of things. And so therefore, they have cash. But the current environment made them tremendously uncertain. They are not buoyed by Wall Street. Now I'm not saying it's bad to be buoyed by Wall Street, but they don't care whether the stock market is up or not. They don't care whether the Fed is backing off in interest rates. It doesn't affect them at all. What they worry about are things like inflation and the wars and the sort of rapid fire things that are coming out of Washington now. They don't worry so much about the tariffs, but they say if we change so many things, something is going to come off the rails. They feel like they're on space mountain. So therefore, they don't buy part of our product line. They tend to pivot toward what we call quicker payback items. About 1/3 of our product line are big things like Tool Storage Boxes. We finance them the $10,000, a mechanic signs up for 4 years of making weekly payments. They've slightly shifted from that to things we sell them that are cheaper, like a Power Tool and it's paid off over 15 weeks. So that created turbulence for the Tools Group. And what we've seen since then as Tools Group is starting to regain its momentum. Third quarter was another example of that. Profitability was the second best ever for the third quarter.

Well, speaking of a pretty good trend in the third quarter, Diagnostics really was a star in 3Q. What do you just think about the outlook there? Does it have legs? I think there's a product launch that was part of the story in the third quarter here. And relative to that sentiment that you touched on, does Diagnostics as a category say anything about big-ticket demand and the margin going forward, Nick?

I think it says something but not so clear. The thing about it is that it says something about the power of our Diagnostics. It says something about the compelling nature of our Diagnostic offering, which will allow you to solve problems or fix the cars much faster, much faster and with much more accuracy. Now we get our pound of flesh for that and price for that Diagnostics, but people bought it heavily in the quarter. And see, I think the urgency of that, the idea of that overwhelms some things. If you think about it, Luke, our Tool Storage business was down like, I don't know, let's say, originations were down 5% or 6%. They were down 10% in the prior quarter. And so originations mean how many loans we give out? So it's a measure of how many big-ticket items we sell. So it's down -- I was on a franchise van. I'm on franchise van all the time. I was just meeting someone in San Diego. I said, how is it going with big ticket tool storage? Going okay. And I'm thinking the results are dog food. And then I did the math. He sells -- this guy sells 10 Tool Storage Boxes every quarter. So what that meant was he didn't -- he only sold 9. So if you were calling on people every day, one down wouldn't seem like that much to you. But to us, it's like -- we're like the princess in a [indiscernible], it's a significant effect for us. So I don't see -- what I see in the Diagnostics, not so much is a shift -- a willingness to finance. I see a recognition that I got to have this new hot new product that's going to make my job easier and really save money. So it was a more compelling offering than others. Now I do think that if you go forward, one of the things that happens about this is people see different events in the environment and they say, okay, they start to get used to it. For example, one of the things that -- these are guys, the technicians, why do they get nervous about Ukraine or the Middle East? They think like this. What do you think sons or daughters are going to fight if the U.S. gets in a war? They think it's there. So they're much more worried about this. They make a lot of -- they're comfortable in terms of cash, but they know if things go off the rails like the space mountain car goes off the rails, they're not sure they have enough cushion to absorb that problem. Therefore, they're more conservative. But I do believe as you go longer, people got to start to get used to the environment and therefore, be a little more comfortable with it and believe, well, the cataclysm hasn't come. The world hasn't ended, and therefore, I can go back to my normal activity.

Can you talk about Power Tools? I mean it does seem like one of the areas that at least for me has been harder to model, just maybe unpack what's been going on in that business and some of the opportunities in the near term?

Power Tools tends to go by new product, tends to go. People love to see a new power tool. And so we had a great new product in the quarter. So it came out of the SFC with a lot of momentum. Things like, I think our Long Neck Ratchet. Now you say what the **** is this thing? Okay, a ratchet is something that will remove or replace a fastener. And in automotive repair, if you think about it of almost all the things we deal in, automotive repair is a place where the workers, the person who does the work actually has to do it in tight quarters. An engine compartment is pretty tight. And so sometimes you can't reach-in to get the fastener. You have to dismantle everything to get to it. Well, we got this ratchet, 13 inches neck, a 13-inch long neck that will reach-in for you. And we made the power of it 30% more than anything on the industry, and it's 50% longer than anything on the industry. See it turns out a metallurgy and the dynamics of a product like that, putting the force at a distance is a metallurgical and physical challenge. And so we're able to do it, and that's sold like hot cakes. We just brought out something called the Nano, which is a 7.5-volt Power Tool that fits in your pocket. So there's a whole bunch of stuff under a car that isn't quite high-torque, but you've got to do it like if you're under the dash or and you're in some place where it's tight, these people can carry it around. And when they're confronted with this easy stuff, they can just whip it out, they don't have to go back to their box and get a Power Tool because they wouldn't want to be carrying a Power Tool all the time if they weren't using it. This thing is very versatile, and it's selling like hot cakes. So new products, we're kind of sanguine about our new products in that situation. We'll see how it works out.

Okay. Tariff is obviously very topical right now. I want to put it through the lens of your footprint, which is mainly very U.S.-centric. Can you talk about maybe opportunities to press the advantage on that front into next year? Are there any areas that you can push on?

Sure. I mean it's like this. Our manufacturing doctrine is, because we get benefits from being in the workplace. And because we bring that to -- we create the insight for the innovation for the product development people, we like to be close to the customer-only manufacturer. So we tend to make in the markets where we sell. So the U.S. is one of those. So as I said before, just a small [ praises ], we have 36 factories, 15 in the United States, but more than that, virtually everything -- 80% of what we sell off-demand was already made in the United States, has been made in the United States. But more than that, we pretty much know how to make everything in the United States. So we imported some Power Tools from, say, our factory in Kunshan, China. The small ones, but we can make them in the United States. In fact, we're making them now in the United States. We just shifted in the United States. So where will we have advantages? I think the advantages we have are that we're unaffected and therefore, don't have to adjust price or we can raise price to be -- to match the rising prices of anybody else. We can do either one of those. We're pretty profitable already. And we believe our RCI, our rapid continuous improvement can keep making us more profitable, and I think it has over the years. So -- and we are the price leader already. So I think this is a situational thing. I would suggest it gives us great flexibility, whether to figure out we want to pump volume or we just want to hold and maybe get some pricing on the thing. The cool thing is we probably can pump volume without changing pricing.

You mentioned mechanic sentiment. Let's look at something that's more real in terms of mechanic health. Just what you're seeing in credit and collection trends right now that inform sort of the real trend within your customer base?

Yes, the credit and collection -- well, the credit, I would say the cycle losses are up some. They're creeping up to a point where they're among the highest they've ever been. But put it this way, our yield in this portfolio is ballpark 17% and change, 16.5% and change. The losses are in the 3% range, 3.5% range at the highest levels. So that doesn't seem to be a daunting situation. What we are seeing now, I think, is that certain customers are saying, geez, they have other obligations and they're kind of having a more difficult time. Not -- they're still trying to pay our stuff, but some of them get overwhelmed. And it's a small number, so you see it moving up. But generally, that portfolio has been stress tested in the great financial recession, in the pandemic where it didn't burp. And now in the great uncertain -- I would call this the great sea of uncertainty we see throughout America these days, I think it holds pretty well, and still is quite profitable. And we don't see it as an avalanche or anything like that.

So clicking into next year, you don't give guidance, so that's not even an issue.

We do.

Well, the CapEx guidance.

No, no, no, hold it. Let me correct you for a minute. We give guidance, in that we say our expectation is to grow at 4% to 6% in sales, and we expect our OI margin to go up every year.

Well, that's what I want to talk about that.

That's our guidance. That's our guidance. We don't give specific guidance because we don't have backlog. So why would I do that? Okay. So go ahead.

Tools Group, I think, would be more 4% to 5%, that long-term guidance.

Sure.

What do you have to do in '26 to get to that level, Nick?

We got to continue to pivot. The pivot seems to be working for us. So by that, I mean, when you're a guy like me and you're selling 30% of your business is sold to big ticket items. That means you design them, you manufacture them, you promote them and you roll them out to the marketplace, putting them into the actual hands of the end user through the Tools Group. And then the other 2/3 of the business is the smaller ticket items. So when you see that customers now prefer to spend their money on smaller ticket items or quicker payback items, I should say. So therefore, they liquidate the problem. They don't -- they're not tied to long-term debt. You have to adjust the product design. You have to adjust the manufacturing and you have to adjust the promotional program. And we've been doing that. It's pretty easy to adjust the promotional program. But in terms of design and manufacture, a little longer wait, and we're building momentum in that situation. So I think we need to keep doing that. We need to keep bringing out new products like Diagnostics, which -- like the Triton Diagnostics, which puts a boost, and that gives you a little boost there. And we need to keep -- I think those things will lead to a return to this kind of thing, 4% to 6% -- 4% to 5%. We always say that will be at the bottom of the end because they have -- boy, they have pretty dominant -- pretty good, I shouldn't say dominant. My lawyer will have me off the stage. But we have a fairly strong market share. So you're probably not going to gain too much market share, but you can. And I think -- so we see it at 4% to 5%.

Let's talk about C&I. So maybe nearer term, some of the key end markets that you're focused on in terms of incremental growth opportunity? And maybe if we zoom-out bigger picture over the next, say, 5 to 10 years, should we expect this to be a bigger business? And how can you invest to really drive that idea?

Yes. Well, look, C&I is a number of different businesses. I think I could call it -- you can think of it in three pieces. One, is the pure critical industries business that sells to customers outside of the garage. We say C&I is where we roll the Snap-on brand out of the garage. It's a direct sales business. And it is -- we call on customers that have big projects and then afterwards, want maintenance those projects. And so the customization to those projects is important. So to this group, we'll sell -- let's say, somebody has a big project in the military. Let's say, the F-35 fighter, they will buy from us a box of tools like this that gets populated with different tools, most of which are Snap-on, but not all -- but the others we smear the Snap-on patina over. And if they want to change, we'll change it and give them a different product. So our ability to bring together all those tools, put them in a box and have a never-ending variety of these customizations for different projects is one of the things we need to keep investing in. This business just went like this, except for the last couple of quarters, but had been going like this because we just gave it more capacity. We built a new building that allowed us to have more capacity to create those customized kits. We're going to keep doing that. The second thing about that is we have to keep investing in direct salesmen, so they can keep going out and observing the work and then figuring out what new tools it is. See on the vehicle repair side, we've been in it like 120 years -- not 105 years, 105, I got carried away, 105 years. But -- so we know vehicle repair. If you want to get your car fixed, come to Snap-on. 300 guys in the headquarters know how to fix your car. But it isn't like we know the military as well as vehicle repair. We don't know oil and gas as well. And so we keep gaining that understanding and that will drive it. This business is a good business. I mean, we're talking margins toward the top end of our margin range and maybe higher. And it grew at 3% in the quarter. Now one of the things about that particular business is it's a little bit off where we want it to be. We expect it to grow at 3% to 6% -- like at the top end, the 4% to 6% range. But in this particular period, the tariffs are causing us a little problem here, not because of our cost because of our customers'. Now you might say, well, why did the tariffs cause problem to the customers, its like this. I think generally, there are two phenomena here. You may not fall pray to this, but I found when I go on the shows like spot buys or anything like that, just saying, why aren't manufacturers moving? Why don't you have plans now to move? Well, through the lens of a manufacturer, the time constants are much longer. If you think about, if you're in the financial community, you can change your portfolio pretty quickly. And execution isn't so much of an issue. It's the decision is everything. In factories, the decision isn't everything. Decision is one piece of it, then execution is another. And so it can't happen that quickly. That's one. It takes a while. Secondly, at this particular interlude, we tend to think that the tariffs have settled down. Now things are more or less settled down. Wrong. The tariffs for Canada, Mexico and China are all unsettled. They're all unsettled if you look at it. And these are three of the four main sourcing partners for anyone who would have a project associated with manufacturing. And so if you're a guy like me, you're saying, I'm not going to present to my Board that I'm going to build a new plant. I'm going to adjust something, I'm going to make a major capital investment because of the tariffs because I don't know where the tariffs are. And if they change, I got to go back and say,"never mind", it's not -- and so what's happening is a portion of that business has become delaying projects, keeping their powder dry. Now what will happen is this all come -- should explode later on when tariffs get settled, that should be good. So then the other -- so I think those are the places where we need to make the most investment. We have an Asia Pacific business in C&I, and we have a European Hand Tool business. And the European Hand Tool business just has to convert from distributors to more direct because direct is our thing. And Asia Pacific actually is -- I don't know, I don't know if you looked at the economies of Asia lately, but they're all screwed up. Everyone has got some problems. I mean the Korean President was just put in jails prices. Thailand's market -- Thailand's auto market was down like 30% 30%, right? This is big. And India is always kind of a basket case. In China, there's a lot of discussion about China, but there's a lot of uncertainty in China and people are disgruntled. Xi Jinping has got a tiger by the tail trying to manage that economy. So you have those things. Those things you have to clear up. But it doesn't matter. We keep investing in the physicals and product to make sure we can take care of those markets, when it comes out of these difficulties.

Maybe last question, a question from an investor, just how you view the trade-off between the capital allocation between internal investment, M&A and buybacks and maybe to quantify return potentials across those choices?

Best return is invest in ourselves. That's the best return. So we invest in ourselves. For better or worse, this may horrify everybody in the room, but Snap-on is a working capital hog. When we add business, we add a lot of working capital because we don't want to lose any business because of that and because of the complexity associated with our products. But if you look at it, our returns on assets are pretty good. So we get our pound of flesh out of the -- so we need to have good resources ready to support our business as it grows. Secondly, you got things like AI coming now, which, by the way, I think asymmetrically empower Snap-on because we're at the point of sale, we have a rich group richer array of data to feed into such mechanisms. See our data really goes down to what size the shorts are for the mechanics? And so I think these things will benefit us greatly. And we're working some of this stuff. I mean, I think it's early days for AI and this stuff, but people are going to be making some investments in that, that will be capital expenditures and so on. So we tend to invest in the business first. Then we have M&A, of course. We can afford -- we have a lot of capacity. We have a lot of dry powder, so we can have M&A. We look at a wide group of businesses. And anything that would enhance the van channel, expand our position with repair shop owners and managers, extend the critical industries or build in emerging markets, we will acquire. And then we've paid a dividend every quarter since 1939, and we have never reduced it.

We'll leave it there, Nick...

I manage it right there. I didn't have to answer...

Management will be available in the Oak room for a follow-up. Thank you.

Okay.