Snap-on Incorporated ($SNA)

Good morning, and thanks for joining us. The next meeting is going to be with Snap-on. With us today is President and CEO, Nick Pinchuk. Aldo Pagliari, CFO, is here as well. I'm your host, Scott Stember. I'm the senior analyst at ROTH. If anybody has any questions after this, they could shoot me an e-mail at [email protected]. And thank you, everybody, for being here. Thank you, Nick. Thank you, Aldo. Maybe to start off...

First question is did you go to the Chicago party last night? I heard it almost slipped out of control.

Yes. Yes. I was there. I enjoyed it thoroughly.

You keep clothes during the...

Yes, I kept my clothes on, and I didn't go up on stage. So Nick, you are often asked to speak in the media about since all the different touch points that Snap-on has in the economy, asking you about how is Main Street going? And what are you seeing? So maybe you could just -- before we get into the questions, maybe you could just start off by talking about what you're seeing and what you're hearing on the ground.

Well, look, I mean, I think the thing is that what we found starting some time ago that the grassroots, which is one of our principal customers, we have really 3 customer bases. One is the mechanics. We call on 1 million of them every week. And then -- so we're in the garages talk to them all the time. We have the garage shop owners and managers, which are kind of small business and then we have bigger businesses in critical industries. But the grassroots have been uncertain for some time, and it's only built. It's -- and it's very different than you will hear on business channels on TV because they had such a different experience during the pandemic. They work the whole time. They weren't sheltered, not at all. They never looked at their posts. So their view after that became much more detached from what I would call the organized sector, certainly in terms of the finance community. And they started to sense uncertainty, say, in the end of 2023 because of the Ukraine war. And then it just built on that with the Middle East and the inflation and the border and the election and then the rapid fire stuff out of Washington. And so the result of that has been that they have shooed big ticket items. These are pretty smart people. They say their business themselves, the auto industry -- the vehicle repair business is booming really. Nominal spending on repair is up mid-single digits. The wages are up. The number of technicians are up, all kinds of things, and it just keep going positive because the cars are getting more complex and they're needed. And so they have cash, but their confidence is poor. And the way that plays out in the commercial environment is they're unwilling, they don't want to tie themselves to a set of long-term payments, which means bigger ticket items, they don't want to buy. So they buy the smaller ticket items. And our job in serving them has been to try to pivot our product offering and our focus to give them quicker payback items. And I don't see that changing right now. Do you think it's any more uncertain today than it was, say, 6 months ago?

Maybe.

You think? I don't know. I don't know. The thing about this is, though, remember, you're talking to the mechanics. And what they feel is if we go to war, their children will fight. They're convinced...

Got it. So maybe just talk about the secret sauce, which makes Snap-on so unique in the auto parts world. The value creation model, I guess, that you call it with the mechanics, new products, systems. Maybe just -- I don't know if everybody here can appreciate how valuable that is to Snap-on.

Sure. Look, Snap-on is in 3 pieces, and this applies to our whole business, but it's most -- it's easiest to understand with the van business. This is franchise vans, 3,500 of them in the United States, 4,800 worldwide that go through and call on garages. Actually, the mechanics, not the garages, they call on the mechanics every week, which means that we're kind of a very integrated business. Raw steel comes in the back of the factory. We do a -- and we make a hand tool out of it in some really complex processes, and we ship it all the way into the hands of the end user. And we do that for diagnostics with a little bit less vertical integration. But the thing about this is our shtick is we say we have advantages in product and brand and people. So what's the root of our advantage in product is we are in the garages for more -- in the shops for more hours, for more times than anybody else. And so we don't survey people about what they need. We watch what they need and therefore, come up with particular tools that will solve this problem like the low-profile socket that will take -- help you take off the filter at the bottom of the 6.7-liter engine on Ford F-350 trucks. Now you might say, boy, that's a low volume and it is, but people will pay premiums for this. It's the secret of our margin improvement is that these products have come out. So we have an advantage in product because the mechanism itself keeps working. We're actually in the garages. And we -- over the time, we've become experts at the work, and we have 85,000 SKUs and growing. 85,000 SKUs and growing. So we're the anti -- we're complexity headquarters. And so one of the things -- and that's a product line that almost no one else can duplicate. Secondly, our brand actually does impart value. The display of the Snap-on brand is the outward sign of pride and dignity working men and women take in their profession. And I think like almost no other brand. They actually use this brand and they want to display it because it marks them as a professional and somebody who is doing something special. We have people put our wrenches in the hands of their newborns because they believe what the baby touches first will influence the rest forever and ever. We have people ask us to give them small boxes so they can bury their loved ones' ashes in it because the loved one was most proud of Snap-on tools. It really is. It provides something to them, so it provides value. Thirdly, our people are pretty good and their experience, the average guy at Snap-on has been there 15 years, but here's why it's important is because managing that brand and making sure that we do nothing that undermines that special nature is an art, not a science. And our people have been around so long they have that art. And then secondly, the idea, 85,000 SKUs, it's a complex environment. How do you keep management? You have to keep improving every day, every day. And our people have that written on their shorts. And they get up every day thinking about improving, which is why our margins have improved. I think it was 2006, it was 6%. Last year, it was in the 22% range. That's continuous improvement against the complexity, growing complexity. We have competitors who make 200 million sockets and have 450 varieties. We make 20 million sockets, 1/10, and we have 4,500 varieties. That's -- our scale is 1/100th. Our people are pretty good at this. Almost no one else can do that. Okay. So those are the advantages -- that's the secret sauce. Our advantages in product, brand and people.

So within tools and speaking to the, I guess, the confidence portion from the repair technicians. You started to see sales or demand start to stabilize in the second quarter, third quarter and fourth quarter, fell back pretty much in line. But you've been pretty much able to -- despite this, able to move the needle forward. There was a lot of pivoting that went on to new types of products. Maybe talk about some of those. And are we fully pivoted to the market right now?

Yes, it takes a long time to do this. You have to move your manufacturing. You have -- marketing is pretty easy, but you have to come out with products. And so it really, for us, it means that if you look at our main product lines, the products which are big ticket that get financed over 3, 4, 5 years are things like the tool storage boxes. A tool storage box from Snap-on costs you $10,000. Now mechanic buying a tool storage box for $10,000 is like the people in this audience buying a Lamborghini. And so they want to finance it. And our diagnostics units, some of them are affordable, but others are -- require some financing and several other products. But things like hand tools, power tools, certain portions of what we call shop and tech that are specialized product, and they're smaller. So what we did was when we started seeing this, we started to move our product development toward spending more time on bringing out those smaller products. Now you can't abandon the big products because we sell some of them. I mean they're not completely gone. What I'm saying is that those products are down 15% or 20%, but still 80% good profit products. So you got to keep bringing it out. So we've pivoted in that direction. And I told you some of those -- another area where we kind of created a lot of positives for us in small ticket items out of the Tools Group. We made this -- we installed a process called cold forging. It's a forming of a tool by an unusually complex product under cold pressure, and it makes for a lot stronger plier, and we're able to create a whole line of pliers, which we have sold. At the same time, in diagnostics, where we have some things that are diagnostic units or nonpareil, but we came out last year with an MT2600, which is much lower cost. And for entry-level technicians, if you're going to -- by the way, if you're going to -- even if you're going to do oil changes and brakes these days, you need some kind of guidance, and this puts those people right on target. So those are the kinds of things we're doing. Of course, you got to make your manufacturing because these are all manufactured, we have to shift our manufacturing to that, and we have.

Got it. So let's move over to the loan portfolio. A lot of people focus on this as well. Delinquency rates and write-downs have come up just a tick, and it sounds like that's all part of the usual variations of the business. But maybe just talk about the favorable risk/reward scenario that you have, factoring in some of the lending -- the controls that you have in place at the shop level.

You mean like we loan to sub subprime customers and our yield is 17% and our losses are 3%. Those are the kinds of numbers we get. So this is a pretty lucrative business. And part of the reason it works is because it is enabled by possibly the best credit collection force in the world, that is our franchisees. Now you might say this is bold. Stuff like this is another CEO who is super excited about his own company or has an aberrated view of that. But it's true. These guys call on mechanics every week. And if the mechanic gets on the van and says, I want to have a tool storage box, the franchisees, okay. So they apply for credit. And if they don't get -- if they have the right credit bureaus, they get it and it's paid over, let's say, $10,000 over 4 years, $45 a week. And he collects -- our franchisee is calling on him every week collects that $45 passed by the credit company. If he doesn't pass the bureaus, many of our franchisees, we've got stripes. So they say, we still want to lend because I know this guy is a great guy. This guy really is a great guy. We still lend in the same role. By the way, the franchisees, if the things go bad, the franchisees on the hook for 25% of the loss. We would repossess the box and probably sell on a secondary market because it was a strong one. But here's the thing, that's 35% of the business. But if a guy wants to buy a power tool, that power tool is $600, let's say, he didn't say $600. He says $50 a week for 12 weeks. And they make a credit decision like that. I've seen guys get on vans who want to buy that power tool, the guy says, I don't think so. This probably doesn't fit your business. And I ask him -- when I asked the franchisee, why didn't you sell them a power tool for $600, he says his daughter is starting in college. He's already popping me for $100 a week. I want to see him pay that $100 while his daughter is in college for a little while before I do this. They know them that well. They're like local bankers. And so what this -- and then they collect every week, and that's their nickel. It's not financed by the company. But the long and the short of this is everything which is sold off a Snap-on Van, big ticket or low ticket or small ticket is on credit. And the franchisee is involved in the credit approval process in everything, and he collects every week. So for a franchisee, every sale, a credit decision, every interaction, he meets 1 million technicians once a week is a collection. They're possibly the best credit collection force. And that's why 17% yield, 3% losses, even with sub subprime, even with sub subprime. I'm getting excited I'm moving that away.

So moving away from tools, let's talk about RS&I. This has been a nice bright spot, particularly over the last couple of years. Maybe just talk about what's driving that.

A lot of things. Look, I think this -- RS&I is the company that sells to repair shop owners and managers. They don't call weekly, but they have direct salesmen and they have distributors. And basically, if you think about what's -- they basically facilitize a repair shop. So they give them the computer systems to run the shop. They give them the lifts, which will lift those cars up, tire balancers, aligners, many of those are high-margin stuff. They'll also sell diagnostics, which analyzes the car and we will help you figure out what to do by the way. So we have a particular advantage in diagnostics because the repair in a car is like this. Car comes in. It's got check engine light. So the easy thing is -- first thing you got to do these days, you used to listen to the motor, now it's so complex, it's difficult, so you got to connect to the car and look at this tens of thousands of trouble codes, and it's a blizzard. But you can scan the codes, and that's the most pedestrian of things people do for technicians. They help them scan the codes and they leave it to them to figure out these codes what's wrong. Secondly, though, okay, we do that, but you also have -- we also have a database based on 3.5 billion actual repairs. This was wrong. This was what fixed it, and this is Audi with 100,000 -- 2020 Audi with 100,000 miles on it. And we give the technician a Pareto diagram that says, 69% of the time, it was a mass airflow sensor. Now he could diagnose it himself by a series of physical tests like a decision tree, this voltage, that voltage, that takes up a lot of time. This guy is paid -- the technician is paid by the job. So we'll give it -- all he's got to do is go and test the mass airflow sensor. Boom, done. If it isn't the mass airflow sensor, he tries another one. And if it's none of the things on the Pareto chart, we have a 600 billion data point database, which will help him solve those things that only happen on alternate Wednesdays with months that have an R in the number -- in the name. Then, okay, that doesn't mean he knows how to take it apart. By the way, that's a proprietary database for us. I think if you know anything about AI or the efficacy in companies, the real value is to be able to mine large proprietary databases to pattern recognition of those things. That's part of what we're doing in these things, and it's really set us apart. But nobody has that data. It's proprietary to us because nobody is in the shops as much as we are. The other thing you got to do is he might not know how to take out the mass airflow sensor on Audi. So we have a database, which will show them how to do that. And then all of this, I haven't said anything about how hard it is to take it out even if you know how to do it, and we'll sell them the tools to do that quicker than anybody else. And that's based -- much of that is based in the diagnostics business. It was -- its profitability was 25.2% last quarter, OI margin. Margins were about flat. They spent all their money. And we like spending money actually. Actually, one of the things about this though, this is -- you can take this from me. If you have a company that has an advantage on product and brand and people, particularly brand, you spend like it. If you don't, you lose position. So we kept spending through the pandemic and through this period, and it played us -- well, during the pandemic, we said we're going to keep spending. We came out like gangbusters. This period of uncertainty, we've kept spending. We kept spending.

Let's move on to...

Investing, I should say, right? Spending is the kind of thing you do when you go to a Chicago party.

Let's move on to commercial and industrial. Critical industries, I guess, in particular, has been doing really, really well the last few quarters. Maybe just talk about how critical critical really means and how consistent it really is.

When we first -- Snap-on a couple of years ago, we got a little bit lost -- not a couple of years ago, 25 years ago, we had a little bit lost. And one of the things we tried to figure out is, well, how come we're lost? And part -- and we looked at what we did and a lot of people said and our own people said, Snap-on is a place that makes wrenches, sells through franchised vans and sells to mechanics. And that -- we did that well, but that was a focused portion of what we did. What we realized is that isn't what we really did. What we do is we're in the workplaces, observing the work, using the insights to create a tool that will move the world forward. But the similarity between all -- and that can be any industry, any industry. But not just auto repair, but here's the unifying principle. It's got to be critical. The definition of critical is the penalty for failure is high and the need for repeatability and reliability justifies a Snap-on level product. So 2 of our groups, the Tools Group, which is the franchisees, sells to mechanics. RS&I sells to the repair shop owners and managers. C&I sells to critical industries. We roll the Snap-on brand out of the garage. The respect for the brand is just as high on a flight line as it is in a vehicle repair garage and criticality may be even more. So the margins are pretty good in this business. So we're expanding it. And so you got places like the military, .50-caliber bullets if I can attest this. If the .50 caliber bullets are flying overhead and you got to fix the vehicle, it sounds critical to me. You got the flight line. So aviation is big. You've got general industry where you got things rolling down the line. You got oil and gas. You got education where you got to educate these people and make them Snap-on customers for life. So that's the business we're working and that seems to be moving pretty well. And the cool thing about it is people thought when we rolled out of the garage, we couldn't get our pound of flesh for value, and we do, the margins are pretty good in that business.

We'll take a moment to see if anybody in the audience has a question.

Amazing storytelling, by the way. Thank you. What are the key metrics that you watch when you run the business?

Sales, operating income and OI percentage. That's it. The thing is we also watch some other stuff. That was a little bit of a blip. But I'm really -- when at Snap-on, we just finished 2.5 weeks of reviewing the divisions and thou shalt improve your sales, OI and OI margin and ROA a bit, return on assets. You got to do those, and I don't really care how they do it. Within certain envelopes, for example, there's a commandment at Snap-on, which is, if there's any commandment is thou shalt not sell to do-it-yourself people because that would -- we could make a lot of money at that. We could build our volume but the brand would be kaput because one of the reasons why Snap-on is such a special brand is we only sell them to professionals. And so you have that kind of thing. So we focus on those things. Other sub things we look at, for example, we bring out thousands of -- last year, we had 1,620 ideas for new products. We bring out new products all the time, huge numbers. But what we focus on is how many hit products do we bring out. That is $1 million in the first year of -- after the launch. So that number just keeps going up. Last year was up 8% over the prior year, and it's gone up like 8x over just maybe 15 years ago. So those are the kinds of things and some specifics for each business. But I'm not a guy who will tell the general managers, okay, I want you to manage your working capital. I don't like your inventory. I don't care about their inventory as long as there's no obsolescence and they got a good return on our assets. If they get a return on their assets, it must be good, maybe they know what they're doing. So we don't do that at my level. The simple thing is Snap-on doesn't measure things, but we have concepts. We choose strengths over weakness. We decide what we're going to be strong in, and we invest in those things, the other things we don't care about. We choose critical. We choose critical over the popular. So we'll sell to the people who -- where the penalty for failure is high, and it doesn't matter how much volume there is with popular things like DIY. We choose pride over the practical. So we'll spend money making the franchisees feel good about themselves, and we won't skimp on it because it's so important to us. Even though we could get away -- we have a Snap-on franchisee conference every year, we could do it for much cheaper. But on the other hand, you see if you want to enlist a franchise business, these are individual businessmen. They have to feel that they've been listed with a company that's worthy of their time and will create a value for themselves and others that they could not create individually. And part of that value is being able to go to some place like where we have our franchisee conferences because they couldn't create that individually. But they also know that the tools they couldn't figure out individually. They also know that the brand couldn't be like this. And they also know that our people understand the auto business, the auto repair business, not auto parts business, by the way, you said auto parts in the beginning, we're not a parts company, better than they do. And so those are the kinds of things we pay attention to. After that, it's simple. My job is so simple. I'm kind of a trained dog that stands on the x and the other guy just runs the business. Okay. What else? Is that it?

Yes, we're just about out of time. So I want to thank everybody for joining us.

Okay. Thank you.