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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day everyone, and welcome to the Snap-on Incorporated 2017 Fourth Quarter and Full-year Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Leslie Kratcoski with Investor Relations. Please go ahead, ma'am.
Thanks, Tony, and good morning, everyone. Thanks for joining us today to review Snap-on's fourth quarter 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 some closing thoughts, we'll take your questions.
As usual, we've provided slides to supplement our discussions. These slides can be accessed under the Downloads tab in the webcast viewer as well as on our website, snapon.com, under the Investor Information. 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, this presentation includes non-GAAP measures of financial performance, which are not meant to be considered in isolation or as a substitute for their GAAP counterparts. Additional information regarding these measures, including a reconciliation of non-GAAP measures is included in our earnings release and conference call slide deck, which can be found on our website.
With that said, I'll now turn the call over to Nick Pinchuk. Nick?
Thanks, Leslie. Good morning, everyone. I'll start with the highlights of our fourth quarter and our year and I'll give you my perspective on the results, on the market environment and on progress we've made. After that Aldo will move into a more detailed review of the financials.
This is not a typical quarter. There are a number of special non-recurring events that impacted result, the legal charge, and the transition associated with the new tax law. But when you look through all that, Snap-on again showed overall and significant progress along our runways, achieving both growth and profitability.
As with most quarters, we had headwinds and we had opportunities. We took advantage of the opportunities and we overcame the headwinds. Overall sales in the quarter were $974.6 million, 9.5% higher than last year, strong. That total included $29.7 million of acquisition-related volume from last year's Car-O-Liner and Sturtevant Richmont operations and this year's BTC and Norbar businesses, and $16.2 million of favorable foreign currency. Our organic growth was 4.3% relatively encouraging with varied results across the groups.
Let's start by looking at the non-recurring events. First, the one-time legal charge. A judgment in a pat-related litigation matter that is being appealed. It impacted operating income by $30.9 million and the earnings per share by $0.33. Second, a $7 million or $0.12 EPS charge associated with the implementation in the new U.S. tax legislation.
Excluding the legal charge, OpCo operating margin was 19.4% of sales, down 40 basis points, reflecting primarily a 30 basis point dilution from lower margin acquisitions and the impact of favorable foreign currency.
For Financial Services, operating income of $54.4 million compared to last year's $51.6 million. As-reported, the EPS was $2.29, but excluding the legal charge and the impact of the tax legislation, earnings per share as-adjusted grew to $2.69, that's an increase of 8.9%. That's our result.
And our market, what we believe the automotive repair segments continue to remain favorable, although, we again saw mixed results in that arena, new technologies, aging vehicles, requiring innovative tools and specialized equipment and updated diagnostics and more repairs continue to make that a favorable place to be. As I said though, we had mixed outcomes.
Our Tools Group was below trend and in the U.S., looking similar to what we saw in the third quarter, unsatisfying. However, the Repair Systems & Information or RS&I Group continued its considerable advancement serving repair shop owners and managers.
From an overview level, we believe the ongoing progress of RS&I, taken together with what we know would be the strong fundamentals clearly indicate that there's ongoing and abundant opportunity available in the segment.
Now if you look to Commercial & Industrial – now our Commercial & Industrial, or C&I Group, it had one of its strongest quarters. Organic sales were up nicely across almost all industries and geographies, including Europe and Asia. Performances in the period from our critical industries focused business with the Industrial Division and SNA Europe, both experiencing strong double-digit growth, were especially encouraging.
Within Industrial, an area that's on an upward trend, nearly all segments generated double-digit growth with natural resources, military and general industry leading the way. And SNA Europe's volume in the period was similarly positive again, reflecting gains across almost all geographies.
So across the corporation, I'd characterize our markets as mixed, but on the whole, clearly positive. With overall strength in automotive repair, notwithstanding the outcome of our Tools Group and continuing strength in the critical industries and gains across geographies, despite the challenges of the quarter and headwinds will always exist.
We remain confident that our businesses are well-positioned to capitalize on the possibilities, on the opportunities that do exist along our runways for growth. And looking ahead, we also see clear runways for improvement. We said this many times. Snap-on Value Creation Processes, safety, quality, customer connection, innovation and Rapid Continuous Improvement or RCI driving, ongoing and significant advancements as they have for some time.
Now for the full-year, sales of $3.69 billion represented an as-reported increase of 7.5%. The organic volume gain was 3.4%, with the RS&I Group up 7.6%, the C&I Group rising 4.5%, and the Tools Group roughly flat.
As-reported EPS for the year was $9.52, but excluding the legal matters and the impact of the tax legislation, earnings per share as-adjusted reached $10.12, that's an increase of 10%.
OpCo OI percent as-adjusted was 19.3%, up 20 basis points, overcoming 50 basis points dilutive impact from acquisition and a decrease of 20 basis points associated with unfavorable currency.
And when we include the income from Financial Services of $217.5 million, which rose $18.8 million, the consolidated operating margin for the corporation as-adjusted was 23.2%, up a similar 20 basis points, the quarter and the year, sales gains and profit increases, taking advantage of opportunities on our runways for growth and driving down our runways for improvement.
Now, let's move to the individual operating groups and their fourth quarter results. The Tools Group. Organic sales down 3% and operating earnings of $67.3 million, representing a margin rate of 16.4%, down 120 basis points. We do believe our actions to reinvigorate the van channel sales will be effective, but they didn't create improvement in the fourth quarter.
In the quarter and throughout the year, however, the Tools Group did confirm the strength and the market-leading position of its van network. It wasn't evident in the recent financials, but it was clear in the franchisee health metrics we monitor each period. The franchisees are strong and the turnover is low and that positivity was once again acknowledged by multiple publications, listing Snap-on as a franchise of choice.
And just this past quarter, Snap-on was ranked among the top franchise organizations, both in the U.S. and abroad. We were again recognized by Franchise Business Review, which collects franchisee's satisfaction data. And in its latest ranking, lists as Snap-on as a Top 50 franchise, marking the 11th consecutive year we received that award based on satisfaction.
We were also once again recognized by the Military Times, which includes Snap-on on its Best for Vets annual ranking, coming in at number five for the second year in a row and the only mobile tool franchise on the entire list.
And abroad, Snap-on was ranked number two in the Elite Franchise magazine's Top UK franchises for 2018, finishing above many UK-only franchises and ahead of some very popular global brands.
Now this type of recognition reflects the fundamental strength of the franchisees in our van business and it would not have been achieved without a continuous stream of innovative new products. And in 2017, once again, the Tools Group increased its number of hit products, those $1 million sellers developed from direct observations gained in the field that I think you've become familiar with.
Tool Storage sales were still a shortfall in the quarter, but we're taking action. You heard me speak of migrating some premium options like the PowerDrawer, the speed organizer into our lower ranges, we're doing that. We're introducing new features and new themes. We're retooling the Rock N' Roll vans and we'll be expanding our line with a model that offers attractive capacity in a compact footprint, some high-end features at a price that's affordable to young technicians. A unit aimed at making them Snap-on customers for life and contributing to a restart for the Tools Group.
And just in December, probably too late to affect the fourth quarter, we introduced our new series of 12-point high-performance ratcheting box wrenches, whole form gears, proprietary steel for durability, extended handle for leverage, 8-tooth pole to minimize the swing arc, another unique tool reducing technician job time, particularly in difficult and critical situations. The Tools Group may be below trends, but we keep building its strength with new product and network vitality, well that's the Tools Group.
Now let's move to RS&I. Volume in the fourth quarter was $356.8 million, with an organic rise of 6.2%. Double-digit sales gains in the OEM dealerships and low single-digit increases in diagnostics and repair information products. Operating earnings of $89.8 million, increased $7.3 million for an OI margin of 25.2%, down 60 basis points from last year, but with a 50 basis point decline from lower margin acquisitions and negative currency effects.
Once again, we saw some compelling products, giving us more to sell to those repair shop owners and managers, offerings like the NEXIQ Blue-Link Mini, our electronic logging device. It won a Professional Tool and Equipment Innovation of the Year Award at the SEMA show in Las Vegas. The Blue-Link Mini logs driver hours, vehicle movement, engine hours, vehicle performance data like, and vehicle performance data like speed and miles per gallon. All of that allows heavy-duty customers to meet the electronic data logging regulation that took effect in December. And it appears to be a winning product with great customer reception. We saw that.
Our diagnostics and repair information businesses were also led by new products. We mentioned last quarter, the launch of our game-changing handheld intelligent diagnostics, the ZEUS. Well, it's selling well.
Hardware and software subscriptions, yes, subscriptions, a new focus for one of our introductions. A great unit raising the bar in advanced repair, and helping to offset the difficult comparison of last year's fourth quarter, both in the launch of the MODIS Edge handheld and our very popular Thermal Imager in that category.
RS&I also advanced in its position in the repair information space, the Mitchell 1 business, enhancing our ProDemand software by adding a new user interface. It takes repair information to a whole new level of intelligence with advanced search technology that scans the vast Mitchell 1 database and returns exactly the specific information the technician needs for that particular job.
OEM data and Snap-on's proprietary SureTrack real-world data, real-world information is now more tightly integrated and the new interface amplifies the power of that combination. It makes the technician's diagnosis job easier, quicker and more accurate.
Finally in the period, RS&I's equipment division introduced the new V2100 imaging wheel aligner. It's targeted squarely at meeting the needs of independent shops that work on a multiple brands of vehicles and perform a variety of repair services. Those shops typically can't have a dedicated alignment guy. They just don't do that many alignments. What they do need is an ease-of-use mid-tier unit. Different vehicle brands have varying alignment procedures. It's a major challenge for a general tech. Well, the V2100 is the right unit within an intuitive interface that will guide through the multiple approaches to align with clarity.
For a general tech, it reduces alignment time by 30%, a great saving and a nice boost to our equipment lineup. We keep driving to expand RS&I's position with the repair shop owners and managers, offering new products to sell, developed by our customer connection and innovation processes or added by our strategic and coherent acquisitions. And you can see it in the numbers.
Now, on to C&I. Sales increased in the period 19.4% from 2016, helped by – I want to say that again – sales increased in the period 19.4% from 2016, helped by $19.1 million in acquisition-related volume and $6.8 million of favorable currency.
Organic sales were up 10.1%, among the highest we've ever seen at C&I. That year record increase reflects improvements from almost every operating division, including gains by Industrial, SNA Europe, Power Tools and the Asia-Pacific division. The group's operating income was $50.9 million. That's up from the $43.9 million reported last year. Operating income margin was 14.9%, down 40 basis points, but reflecting a 50 basis point impact from the acquisitions, dilutive acquisitions, and another 50 basis point decline from unfavorable currency. In fact, those impacts notwithstanding, 14.9% is among the highest margins we've seen for the group in the last several years, last four years or so. In effect, C&I had one of its strongest quarters.
Reassuringly, SNA Europe again posted increased organic sales, up double-digits, continuing its progress, now 17 quarters in a row of year-over-year growth and profit climbed right along, up 19 straight quarters. 19 quarters in a row of profitability improvement, reflecting Snap-on Value Creation at work with innovative new products and improved new processes, driving positive trends and some pretty challenging geographies.
Also in C&I, our Industrial division made encouraging strides. As I mentioned before, strong double-digit growth, driven in part by our strong double-digit growth for our Industrial division, driven in part by a widening array of new products. Having been up and down in recent periods, aerospace showed good progress in the quarter, rising worldwide.
First time in a while, we vision both in domestic and international on a boost from customer connection, authoring products like our new cordless grease gun kit. Many planes have service requirements, which prohibit them from using this industry standard units with customer connection Snap-on developed a new gun, which limits the grease delivery pressure, matching a special aircraft requirements.
And based on further customer connection, we also added improvements like an extended length pressure hose, giving technicians that added reach to reach and service landing gear and a clear grease cartridge tube, allowing users to quickly identify the type of material in the gun. Now these are, seem like simple improvements and they are, but they're quite effective in making critical work easier in special aerospace situations.
Just like in the Industrial division, SNA Europe has also been using customer connection and innovation to drive its continuing expansion. For example, in the critical power generation industry in Europe, with a significant amount of oil in Northern Europe being pumped from offshore, there was opportunity for a special tool kit for servicing the individual ocean rigs.
Customer connection, observing the environment and tasks led to the development of what we're calling the pump-man tool kit, combining bottles tools at height with safe when you use them at height with the safety suspenders and with our large array of – combining those tools at height with a large array of our non-sparking tools, eliminating fire hazards and addressing the service and safety needs for the critical oil rig environment. The specialized kits – these specialized pump-man kits were released just this year, but based on early receptions, we believe will be a big driver for our expansion in the oil and gas industry and a great help in continuing SNA Europe's upward trajectory.
Power Tools division returned to growth in the quarter and new product paved the way. One winner was our new CDRR761, a 14.4 volt, 3/8 inches, MicroLithium right-angle drill, lightweight, provides up to 150-inch pounds of torque, offers two-speed ranges at a variable speed switch. It's great for driving screws with control.
It was launched to help technicians get into small tight spaces under – like under the dash and on the firewall and it has an integrated LED light to illuminate that dark work. It was introduced in the fourth quarter and it's already $1 million seller, one of our hit products that drive growth.
Well, that's our fourth quarter. OpCo organic sales rising 4.3%. Progress along our runways for coherent growth and advancements down our runways for improvement, safety, quality, customer connection, innovation and Rapid Continuous Improvement.
Tools Group, working on regaining growth. RS&I continuing its considerable strength and C&I starting to show its potential with much more to go. All of it driving a 19.4% adjusted operating margin, despite the dilutive acquisition and an as-adjusted EPS of $2.69, up 8.9%. That's our fourth quarter.
Now, I'll turn the call over to Aldo. Aldo?
Thanks, Nick. Our consolidated operating results are summarized on slide 6. Net sales of $974.6 million in the quarter increased 9.5%, reflecting a 4.3% organic sales gains, $29.7 million of acquisition-related sales and $16.2 million of favorable foreign currency translation.
The year-over-year organic sales growth, which was the highest level achieved of any quarter in 2017, reflects ongoing progress in serving repair shop owners and managers in the vehicle repair sector as well as broad-based growth in the businesses that comprise the Commercial & Industrial segment.
Consolidated gross margin of 47.7% declined 220 basis points, primarily due to higher sales of lower gross margin products, 60 basis points of lower gross margins on an acquisition-related sales and 20 basis points of unfavorable foreign currency.
The operating expense margin of 31.5% increased 140 basis points as 320 basis points related to the legal charge that, as Nick has mentioned, is being appealed. These were partially offset by benefits from sales volume leverage and a 40 basis point benefit from operating expenses for acquisitions.
Operating earnings before Financial Services of $157.7 million or 16.2% of sales, includes the legal charge and compares to $176.1 million or 19.8% of sales in the prior year. Excluding the legal charge, operating earnings before Financial Services, as-adjusted was $188.6 million or 19.4% of sales. Financial Services revenue of $79.9 million and operating earnings of $54.4 million increased $5.7 million and $2.8 million, respectively from 2016.
Consolidated operating earnings of $212.1 million or 20.1% of revenues compared to $227.7 million or 23.6% of revenues a year ago. Excluding the legal charge, consolidated operating earnings as-adjusted was $243.0 million or 23.0% of revenues.
Our fourth quarter effective income tax rate of 33.0% was reduced by 120 basis points as a result of the legal charge, but increased by 360 basis points as a result of a $7 million charge related to the implementation of the new tax legislation in the United States.
This tax charge includes an estimated transition tax, an unremitted foreign earnings of $13.7 million, partially offset by an estimated tax benefit related to the revaluation of deferred tax assets and liabilities of $6.7 million. Excluding both the legal and tax charges, the effective tax rate in the fourth quarter of 2017 as-adjusted was 30.6% as compared to 30.8% in Q4 of 2016.
Finally, net earnings of $129.5 million or $2.24 per diluted share compared to $146.3 million or $2.47 per share a year ago. Excluding the legal charge and tax charge, net earnings as-adjusted was $155.6 million. Adjusted diluted earnings per share of $2.69, represented an increase of 8.9%.
Now let's turn to our segment results. Starting with the C&I Group on slide 7. Sales of $341.7 million in the quarter increased 19.4%, reflecting a 10.1% organic sales gain, $19.1 million of acquisition-related sales and $6.8 million of favorable foreign currency translation.
The organic sales increase includes double-digit gains in sales to customers in critical industries and in European-based hand tools business as well as low single-digit gains in both the segments Power Tools and Asia-Pacific operations. The gains in critical industries were positive across the board, including strong growth in international aviation and the military, two areas, which were weaker earlier in the year.
Gross margin of 39.2% declined 110 basis points from 40.3% a year ago due to higher sales of lower gross margin products and 50 basis points of unfavorable foreign currency effects. The operating expense margin of 24.3% improved 70 basis points, primarily due to the benefits of sales volume leverage, partially offset by 50 basis points of operating expenses related to our acquisitions.
Operating earnings for the C&I segment of $50.9 million increased 15.9% and the operating margin of 14.9% compared to 15.3% a year ago, including the 100 basis point impact from currency and acquisitions mentioned above.
Turning now to slide 8. Sales in the Tools Group of $409.2 million decreased 2%, reflecting a 3% organic sales decline, partially offset by $4.3 million of favorable foreign currency translation. The organic sales decrease includes a mid-single digit decline in the U.S., which was only partially offset by a mid-single digit sales gain internationally.
Gross margin of 41.4% decreased 60 basis points year-over-year due to the lower volume in related cost. The operating expense margin of 25% increased 60 basis points year-over-year, primarily due to the effect of the lower sales. Operating earnings for the Snap-on Tools Group of $67.3 million, decreased 8.4% and the operating margin of 16.4% compared to 17.6% in 2016.
Turning to the RS&I Group shown on slide 9. Sales of $356.8 million increased 11.6%, reflecting a 6.2% organic sales gain, $10.6 million of acquisition-related sales and $6.2 million of favorable foreign currency translation. The organic sales increase reflected a double-digit gain in sales to OEM dealerships and a low single-digit increase in sales of diagnostic and repair information products.
Gross margin of 45.4% declined 240 basis points as a 110 basis point impact from acquisitions, higher sales of lower gross margin products and 10 basis points of unfavorable foreign currency were partially offset by savings from RCI initiatives. The operating expense margin of 20.2% improved 180 basis points due to the higher sales volume and 80 basis points of benefits from acquisitions, partially offset by 10 basis points of unfavorable foreign currency.
Operating earnings for the RS&I Group of $89.8 million increased 8.8% from prior year levels. The operating margin of 25.2% compared to 25.8% last year, including a 30 basis point impact from acquisitions.
Now turning to slide 10. Operating earnings from Financial Services of $54.4 million on revenue of $79.9 million compared to operating earnings of $51.6 million on revenue of $74.2 million a year ago.
Financial Services expenses of $25.5 million increased $2.9 million, primarily due to a $2.4 million year-over-year increase in provisions for losses on finance receivables, which totaled $16.0 million in the quarter. This is up $3.2 million sequentially from $12.8 million in the third quarter of 2017 and compares to third to fourth quarter sequential increase in the prior year of $2.8 million.
As a percentage of the average portfolio, Financial Services expenses were 1.3% in both the fourth quarters of 2017 and 2016. In the fourth quarter, the average yield on finance receivables was 17.8% in 2017, compared to 18.2% in 2016 due in part to the portfolio mix as well as higher percentage of originations utilizing marketing rebates in 2017. Respective average yield on contract receivables was 9.2% and 9.3%.
Total loan originations of $265 million in the fourth quarter increased $4.7 million or 1.8% year-over-year. As higher originations of contract receivables principally franchise finance were partially offset by a decline in finance receivable originations due to the lower year-over-year sales of big-ticket items in the U.S. by the Snap-on Tools Group.
Moving to slide 11. Our quarter-end balance sheet includes approximately $2 billion of gross financing receivables, including $1.74 billion from our U.S. operation. Our worldwide gross Financial Services portfolio grew $28.1 million or 1.4% in the fourth quarter.
As for finance portfolio losses and delinquency trends, they are, as expected, tracking higher year-over-year, similar to what we've seen over the last several quarters and also reflecting typical seasonal increases. We believe these, trends however, continue to support our view over an appropriate risk reward balance in this segment of our business.
As it relates to extended credit or finance receivables, the largest portion of the portfolio, trailing 12- month losses of $46.7 million, represented 2.92% of outstandings at quarter-end, up 61 basis points year-over-year and 15 basis points sequentially.
The 60-plus day delinquency rate of 1.9% for U.S. extended credit increased 20 basis points sequentially typical of the seasonal increase from the third quarter to fourth quarter. Overall, operating earnings in the Financial Services segment rose 5.4% year-over-year. Their allowance for doubtful accounts reflects the above-mentioned trends in the portfolio's performance.
Now turning to slide 12. Cash provided by operating activities of $193.5 million in the quarter increased $41.8 million from comparable 2016 levels, due primarily to lower discretionary pension contributions and cash paid for income taxes in 2017. Net cash used by investing activities of $59.0 million included net additions to finance receivables of $38.2 million, down from $53.6 million in the fourth quarter of 2016.
Capital expenditures of $24.7 million in the quarter compared with $17.7 million last year. Net cash used by financing activities of $136.6 million included dividend payments to shareholders of $46.4 million and the repurchase of 472,000 shares of common stock for $75.3 million under our existing share repurchase programs. Full-year 2017 share repurchases totaled 1.82 million shares for $287.9 million.
Turning to slide 13. Trade and other accounts receivable increased $76.8 million from 2016 year-end levels, primarily due to higher sales, $21.7 million of foreign currency translation and $9.5 million from acquisitions. Days sales outstanding of 66 days was up from 63 days a year ago, but down from 67 days at the end of the third quarter.
Inventories increased $108.3 million from 2016 year-end, primarily to support increased customer demand in certain segments and new product introductions. Foreign currency translation and acquisitions contributed $23.9 million and $5.7 million of the increase, respectively. On a trailing 12-month basis, inventory turns of 3.2 compared to 3.3 at year-end 2016. Inventories decreased approximately $11 million from the end of the third quarter.
Our year-end cash position of $92 million increased $14.4 million from 2016 year-end levels. Our net debt to capital ratio increased to 27.0% from 26.3% year-over-year. In addition to cash and expected cash flow from operations, we have more than $700 million in available credit facilities. As of quarter-end, we had $151 million of commercial paper borrowings outstanding.
That concludes my remarks on our fourth quarter performance. I'll now briefly review a few outlook items for 2018. We anticipate that capital expenditures will be in the range of $90 million to $100 million. As a result of the recently enacted tax legislation in the United States, we currently anticipate that our full-year 2018 effective income tax rate will be in a range of 24% to 25%. This compares to a full-year 2017 effective tax rate on a reported and on an adjusted basis of 31.1% and 30.6%, respectively.
I'll now turn the call back to Nick for his closing thoughts. Nick?
Thanks, Aldo. Well, I started by saying that we were encouraged but unsatisfied in the quarter and we were. The Tools Group remain below trend, not yet recovering, but we continue to have confidence in the market and in our inherent strengths. We do have a strong franchise network. The turnover and our franchisee health metrics say so.
And we are investing in new products and support to restart the growth engine. You can see it in the ZEUS, revolutionizing vehicle diagnostics and moving us further into subscription-based software. But despite the Tools Group challenges, we overcame again. Organic sales growth was 4.3% and the as-reported number was 9.5%.
The RS&I Group and the C&I Group both had strong quarters. RS&I as-reported growth, 11.6% organic and inorganic gain of 6.2% and OI margin 25.2%, a significant contribution to our performance.
C&I had a near-record quarter, rolling the Snap-on brand out of the garage with success. As-reported sales of 19.4% and an organic increase at 10.1%, OI margin of 14.9% among the group's highest.
The results in the quarter I think clearly demonstrate that our coherent runways for growth, expanding with repair shop owners and managers and extending to critical industries are wide with abundant opportunities, and we're confident we have the strength and the position all along our runways for further growth – all along our runways. We have the strength and position for further growth and more improvement amplified by the new tax rates to maintain our positive performance trajectory as we move through 2018 and beyond.
Before I turn the call over to the operator, I'll speak directly to our franchisees and associates. The performance of our fourth quarter and of the year and our clear opportunities going forward would not be possible without your extraordinary contributions. For your ongoing achievements, you have my congratulations, and for your continuing dedication and commitment to our team, you have my thanks.
Now I'll turn the call over to the operator for questions. Operator?
Thank you. We'll go first to Liam Burke with B. Riley FBR.
Yes, thank you. Good morning, Nick. Good morning, Aldo.
Hey, Liam.
Nick, in the core Snap-on Tools Group, you highlighted the fact that storage sales were down again. But how did the core hand tool business fare this quarter on the year-over-year basis?
Well, the hand tool business was I think improved from the fourth quarter, but it's still down some. And we're still suffering I think the results of maybe the less than overwhelming offerings, coming out of the SFC. So, we're seeing an improvement, but not where we want it to be. The big factor, the good news in the quarter I think is associated with the ZEUS, the effect of the ZEUS and its sale off the vans, which is very encouraging for us. That's the silver lining in the quarter, I think. But in general, we still got to keep working on the Tools Group, new product, new support.
Okay. And on a free cash flow basis, Aldo, you're up about 35%. Does that change your capital allocation outlook? You went through a good part of your buyback authorization. Does that become an increasing part of your capital allocation strategy?
Certainly. The share repurchase is part of our allocation strategy, but I think our priorities remain the same, Liam. We have good access to capital markets, the new tax action provide more cash generation opportunities, but serving organic sales and then M&A opportunities still becomes the two most important items on the list, but certainly share repurchase, dividend strategy, pension contributions factor into that decision as well.
Thank you, Nick. Thank you, Aldo.
Thanks, Liam.
Next is David MacGregor at Longbow Research.
Yes. Good morning. Do you hear me okay?
Yeah.
Yeah.
Okay. Great. A couple of questions. First of all, just on the C&I, pretty remarkable organic growth. It's nice to see you follow – sort of firing on all the cylinders. I guess the question is just how sustainable is it? And just talk about – I know you don't provide quantitative outlook and guidance on your head, but if you could just talk about how sustainable that organic growth might be, given the strength you're seeing in critical industries and European hand tools?
Look, I think you can look at it this way. I believe that SNA Europe was up double-digits and you might not say double-digit every quarter, but I think we said in our thing, it's been up 17 quarters in a row in terms of sales; and 19 quarters in a row in terms of profit. And we think it's still got considerable headroom. It's still not back to where it was prerecession. So it took a big dip in a recession and we keep making it stronger, so we're positive about SNA Europe and I think we have abundant demonstration of that.
The Industrial business is now through the downturn in the industrial sector in oil and gas and others. We kept investing in new product and our understanding of marketplace and I think you're seeing that come to fruition.
Now I'm not going to say until you see those two big cylinders, I think working, based on improved capabilities that you can see coming through in the results to us. Now whether that's going to offer double-digit growth or not, is another question. I think we prefer to say that we look at our growth on an organic basis at 4% to 6% and we see C&I at the top end of that, but it appears as though in this environment with the strength we have, we got two big pistons there.
And the other place, Asia-Pacific, had pretty good growth particularly in China and in India, in turbulent markets, I would say. And Power Tools came back, so I think you'd say C&I has positioned pretty well and the numbers showing that. If you take a look at those numbers, this is what we meant by rolling the Snap-on brand out of the garage.
Well, congratulations on all the progress there. I guess my second question was on the Tools segment and just if you could talk about franchisee order patterns through the quarter and what was changing there. I know your contract receivables are up, and you talked about that being driven by franchisee sales. Is your sense that inventories are maybe up a little, accumulating within the franchise network?
Actually no. I don't think the inventories are accumulated.
The contract receivables, David, are up principally because of the launch of new vans and the franchised channel, so a lot of franchisees have upped the size of their advance they're putting on the street, and that's one of the key drivers in franchise finance.
We would say the opposite actually that, if anything that we don't have perfect visibility on this. If anything, the franchisees inventories are coming down a little bit.
I think the principal component of the franchisee story is the ZEUS. The ZEUS is selling well off the van and I don't know if the import of my remarks hits, but the franchisees are selling this big revolutionary new ZEUS at higher levels than we've seen for a large unit and they are selling what we call a data package, which is three years of subscriptions. We never really sold subscriptions with a launch before, and that's happening at record level.
So I think if you look at the franchise interface level, one of the real great stories is around that revolutionary diagnostic, which is changing the industry, recognizes the market leader and is pulling us more into subscriptions-based software.
Now when you do this kind of thing, it doesn't always register for the Tools Group right away, because the franchisees sell for three year subscription boom and it gets financed or sold in other way. And we, in the Tools Group, recognize on an amortized basis over the month. So they see that kind of thing, but if you look at that level, the franchisees are pretty happy about this.
And last question for me is just on the Tools business. You talked about the gross margin pressure there and I appreciate you breaking it out for us. To what extent, this promotional pressure or promotional programs sort of a headwind on gross margins, and if you could tie that in with just some commentary around the general competitive environment tools that would be helpful?
I'll say it this way. Look, I'll say it this way. Look, the Tools Group volume is down. They're vertically integrated, so you know that's going to play out in some kind of loss margin plus absorption and that kind of situation; but also, they want volume. If you're in the position of the Tools Group, if you want volume and so they're working pretty hard to take advantage of every possible piece of daylight they can. That's not the most efficient way to sell.
All right. Thank you.
Sure.
We'll go next to Gary Prestopino with Barrington.
Hey, good morning, everyone.
Good morning Gary.
Nick, on the Tool Storage area, I mean, how far are you on the product refresh that I think you – we had talked about couple of quarter – over the last couple of quarters, then you mentioned it a little in your earlier comments. I mean are you basically done with that product refresh?
I ain't done at all. I'm not done, but we were – we brought out some stuff. I think I said in the – some different themes and some different features and we migrated some features down into smaller – into the – some of the middle – mid-tier line, and we're continuing to do that. And I think we continue to make changes associated with the Tool Storage, because we think it didn't move – what happens to it, Gary, it didn't move this quarter. Some of that stuff worked, but not enough to move the overall needle, so you keep bringing out new stuff to try to make sure you can make the change.
I think one of the things we're kind of encouraged about is this entry-level thing for the technicians, which we're kind of focused on in this situation. We're kind of – we're seeing some reasonable effects at the top end of the line and then – so we'd like to get these guys to – at the lower end with a little more activity. So you're seeing some of that.
Then you go back to the Rock N' Roll Cabs. The Rock N' Roll Cabs, we're refurbishing them and we finished the first half of that refurbishment program right at the end of the year, so they really weren't – if you look at it, they really weren't on the road. And we expect to get the other half finished in another quarter, let's say, for government work. So you'll see those rolling out.
So I don't – if you're looking for me to tell you when the thing is going to turn around, I guess I can't, but I have every confidence we can do this. And the reason I do this is because, when you look at our van network, you talk to our franchisees, you see our product line, pretty strong.
Now we have gaps and it's caused us some difficulty, but the Tools Group, each one of our groups go up and down like this and we bring them back. I think the thing about the quarter is, is for the second quarter in a row, the Tools Group had difficulty and we achieved anyway because we had great quarters with RS&I and C&I.
No, no. I understand and get it. No, I'm just trying to try and get an idea of when we could see an inflection point in the Tools Group?
Yeah. Look, I think, I said, the meaning of my word unsatisfied is this, Gary. We expect to grow every quarter.
Right.
And so, we don't grow in one of these divisions, while there is the possibility of having a difficult quarter, we're not satisfied. So our expectation would be to grow, but I can't – in terms of forecasting for a financial situation, I can't be saying that we're doing that, but I can tell you internally, we're looking for it.
And then what – in terms of refurbishing the van, the Rock N' Roll, vans, cabs.
Yeah.
What are you doing there?
First of all, you start from the outside in. You make the outside look differently, you do different wraps. You go inside, you reorganize the structure of the vans themselves, you put new stuff on, you organize a more robust refreshment of the Tool Storage boxes on the van, you try to make sure you have different examples, and we install a new computer system, which will – a new 3D modeling system, which if you doesn't see it on the van, or you see it on the van and you like a different color, you get a great picture of it.
Okay.
So, we do those kinds of things. It's really to try to make it seem different, so when the technician gets on the van, he says, oh, this is different I want to take a look at this stuff.
Okay. And then getting back to the ZEUS, which is interesting.
Yeah.
Is this a federal – what is it, a federal regulation now that you have to monitor your mileage or something?
No, no, no. Sorry, I probably confused you on this. The ZEUS, I was talking about the NEXIQ Blue-Link Mini. It's an electronic data logging. That's in the heavy-duty business that you put on trucks that monitor the daily log. There was legislation that took place that took effect in December, which drove that sales. ZEUS is for, your average vehicles in your – in Bimmer's auto repair, down in Illinois or something like that, or a muffler shop.
Okay. Thank you.
Sure.
All right. Thanks.
The next to David Leiker with Baird.
Hi. This is Joe Vruwink for David.
Hello.
I was hoping to peel back the onion a bit more on the Tools Group. So if I look at finance receivable originations, and that's my proxy for big-ticket product sales, that was down 1% to get to Tools Group of down 3%, it means the core hand tool, power tool business, let's call it, was down 4% and that down 4% is a weaker number than it's been tracking all year long.
So I'm just wondering within Q4, what trends did you see that might explain maybe a weakening or I'm wondering since we're talking about the ZEUS, are your franchisees spending more time selling ZEUS and maybe less time selling Tools and that might be getting caught up in this number?
Let's just talk about this for a minute. As you know, I know you know this well. There isn't a perfect linkage between the Tools Group sales and originations. One thing, there is a time lag, probably the stuff that's originated in the fourth quarter, some significant portion of that got sold by us in the third quarter, that's one thing, I think. Clear, you know this. The work that gets into the van, they got to sell it and so on. That's one thing.
And ZEUS introduced a new wrinkle for this. ZEUS is two pieces. It is the hardware itself, revolutionizing, intelligent diagnostics, faster stream, better color resolution, all that stuff and then it's a software package, a data software package underneath the intelligent diagnostic.
Well, the data software package sells for thousands of dollars because it's three years and that gets financed, but it doesn't get recognized at the Tools Group, except on a monthly basis, amortized like a subscription. So not only is there – is this new wrinkle introduced by ZEUS, and that you have franchisees financing something, which doesn't really get recognized as immediately by a sale, by the Tools Group because it's the subscription-based software. We think it's a great situation because we're going to subscription base, that creates some of that disconnect. And so, I think you could talk to us a little more extensively and we can talk about this a little bit more and go through it, that's number one.
Number two is your point is well taken though, I think. The ZEUS is a very expensive unit and we do have to take a lot of effort in training the franchisees and having our diagnostics, our 130 diagnostic systems developers and the Techno van supporting them and it takes a lot of effort to sell it. So a successful ZEUS sale can be drawing attention from other things, that's true. It's hard to quantify that though, Joe, you know. But that does happen.
Okay. The point on software sales, that makes a lot of sense. Maybe if I spin the question around a little bit. So, U.S. down mid single-digits. That was a consistent number as in Q3. Obviously, tool storage has been weak. We've talked about that, but in thinking about the core mechanic customer, what is your sense on just the backdrop there whether the BLS has data, it shows hours worked up, hiring up, earnings way up. It would seems like that customer is able to buy more tools. What is your sense on Snap-on's ability to tap into what is ultimately a pretty strong, I'll call it, wallet growth?
I agree. That's why I'm saying the automotive repair market is a robust market with abundant opportunity that we can drive down. We think we have the capability to do it. I mean, I think the fact that we're selling the ZEUSs in pretty good numbers, basically last year, we had a boffo quarter with the thermal imager. You know what, we sold a lot of them in the fourth quarter and at the franchisee level, they're overcoming that with ZEUS. And so what you got is people are playing the ZEUS list price, some people have looked at it, all-in is like $17,000. Now that's like a car price. There's a lot of versions of that, that gets sold, but it's thousands of dollars, and we're selling it successfully. So we're able to tap into it I think if we have the right product.
And you think recent, you've talked about coming out of the franchise conference, that product introduction, but have there been other items launched in the back half of the year? We're entering Q1 or we're over a month into Q1, what have been more recent trends than just that undertaking around new products?
That's why I put the power tool in the script. The power tool that we talked about, that 3/8 inch mini power tool right angle drill sold out right away and it became a $1 million seller, a hit product. So we are launching products. Our problem is, we're not selling enough tool storage, and there are other issues, but the thing is that, we need to turn around tool storage. That's what I think. Now there are other things we'd like to see go better. So we are seeing encouraging. When we have the product, we believe we sell it.
And then my last question, A lot of our focus over the past year has been on finance receivables, but let's maybe talk about contract receivables. How much of the asset book is that category? And then can you just segment of contract receivables, how much is maybe more of a commercial loan with the shop? How much is going to be van leases? And are the growth in van leases going on right now? Is that historically a leading indicator of future activity or anything you can kind of foot to for why franchisees are reinvesting right now?
Joe, actually, there's not a lot to be gleaned. The mix within the portfolio has been rather constant. If you look at the end of Q4, 81% of the portfolio is extended credit, 15% is franchise finance and 3% is to leases of equipment to shop owners. That vacillates between 3% and 4% over the years. The franchise finance goes from 13.5% to 15.5%, so it's kind of all within range. I think it's a sign of prosperity and confidence when you see the franchisees up into a new van, particularly a larger van. I think they wouldn't make an investment like that if they didn't show their commitment to the future and want to keep growing their business.
Okay. I'll leave it there. Thank you very much.
Thanks.
We'll go next to Christopher Glynn with Oppenheimer.
Thanks. Good morning. I think last year, maybe a couple of phases you tightened credit a little bit. Just wondering what the results, learnings were around that, what the latest toggles are if that subsequently yielded to some opportunity to lose some credit backup perhaps?
I think we look at credit each and every quarter, a little bit harder at certain times of the year than others, Chris. It evolves, but not big movements in terms of decision making, we're always trying to tweak the portfolio in a positive way, try to put our franchisees and ourselves in a better place. Try to make sure we match our customers' needs up with what we were offering. So loosening credit, I wouldn't say that per se. I think we're judicious in terms of how we counsel the franchisees and approaching the situation. Having said that, one of the callers earlier made the comment that I think mechanics' wallets are getting bigger. I think that means that there probably is more capacity over time. We were trying to identify where that credit capacity is and loan to those mechanics.
Okay. And then on the core vans channel, wondering if you're seeing any apparent rebalancing in the vans channel marketplace around historical price spreads around the few key competitors and maybe any changes on the relative under-penetration of some of your stronger peers?
Look, certainly if you looked at our numbers and you looked at some of the other numbers, you would conclude there's some change. We don't hear it from our franchisees. We don't hear them saying, oh, by the way, I have trouble competing with this guy or that guy over a particular product. So to the extent other people are growing, I guess you could argue that they're making inroads, where we could have had those inroads, but, or had that business. But you don't hear at the level. Nobody comes up and says, boy, you got to match this or we got to do this, or this is giving me problems. You don't hear it.
Okay. And then just final, bookkeeping, if you told us I missed it, but what's the finance receivables allowance balance down the year?
The balance is about 3% of the portfolio, if you look at the coverage ratio.
Okay.
A little bit more.
If we move to the next question please.
Pardon me. Thank you. We'll go next to Scott Stember with C.L. King.
Good morning, guys.
Good morning.
Most of my questions have been answered, but I have one question. Nick, you had referred to the SFC, and I guess you're referring to the big pack of tools and maybe some bundling or unbundling that didn't go well, I guess from a pricing and just the actual packaging. Could you talk about what you've done to remedy that? And how long would we take to see that with an improved numbers within the Tools Group? Thank you very much.
Look, I think, yeah, the thing is that generally hand tools are something which are a little different than tool storage or diagnostics or anything else. The hand tools inventory is fairly ubiquitous on the van itself. They have a lot of handles, but generally, they have to be – you have to attract them to a bundle. It didn't work so well, some people took it in the SFC. We've tried to counter that by bringing out some tools, that's why I talked some individual tools that would be attractive.
So, when I talked about the ratcheting wrenches and the specific high-durability ratcheting wrench that gets into certain small spaces, that's the kind of thing we're doing. And remember, I could have talked for the whole call about those kinds of things and so that's what we're trying to do to try to restart that. I think if you're dangerous, if you're looking at any one quarter at any particular group, because you do even in the good – when they were growing like a 7%, you saw ups and downs in those things so you can't necessarily conclude that hand tools because it's up and down, would be in trouble in terms of a tool category or be wanting in any way, we just didn't quite have the right package and we're trying to restart that with new product.
Got it. That's all I have. Thank you.
Okay. Thank you.
Next to Bret Jordan with Jefferies.
Hi. Good morning, guys.
Good morning.
Are you seeing any kind of a market share struggle, I guess. I mean, the question was kind of asked earlier. I have heard from mechanics and some of your other franchise peers are being aggressive on pricing at the shop level. And is that something that you're hearing at all from your franchisees?
You know from the – Bret, from the 80,000 foot level, you would say, we must be seeing something like that, if other people are growing faster than you are. I don't know if the mechanisms for that competition are price or what, but when I ride and I was just on a van the other day and guy never mentioned Mac or Matco, or any other competition.
Now of course, he is talking to me and you can argue this, but I do meet with these guys a lot and often, they're just talking about ourselves, we could have – we could use different tool storage. We could use a new model in tool storage to address this kind of thing. We like the ZEUS. It takes – we're enthusiastic about the ZEUS. The feedback I get is all associated with ourselves. So I don't think we're feeling something that other people are doing other than maybe we're not doing as well as we could do versus what we expect of ourselves, that's the difference, I think. Really.
Okay.
I think the Snap-on franchise – you ask people about the preferred form of hand tool, that seems rock solid.
Okay. And then a housekeeping. On rates, would you expect and I guess the rates were down and maybe I think Aldo mentioned some promotional issues on the quarter on the funding rate, but would you expect rate to be up going forward just given the increasing rate environment? Or do you think we're still sort of – we're going to be kind of flat?
I think they stay, Bret. It wasn't by a couple promotions. The products that fascinated the customer is what we call featured products. Featured products usually have rebates associated with them. That marketing expense comes off of the interest income that we calculate and the uptake on those was just better than what it had been in Q4 of last year. So you get a little bit of a depressant effect.
And then the mix in the portfolio tend to be a little bit better quality credit and a lot of the shop owners with the ZEUS that Nick mentioned, the principal buyers of that are pretty good credit quality customers that drives the rate in the portfolio down a bit. So it depends on the mix of those. To answer your question, I think it stays in the 17% to 18% range on a holistic basis for finance receivables.
Okay. Great. Thank you. I appreciated it.
Thank you.
That concludes today's question-and-answer session. At this time, I'd like to turn the conference back to Leslie Kratcoski for any closing remarks.
Thanks for joining us today. A replay of the call will be available shortly on snapon.com. And as always, we appreciate your interest in the company. Good day.
This concludes today's conference. We do thank you for your participation. You may now disconnect.