Parker-Hannifin Corporation F2Q09 (Qtr End 12/31/08) Earnings Call Transcript

Parker-Hannifin Corporation (NYSE:PH)

F2Q09 Earnings Call

January 20, 2009 10:00 am ET

Executives

Pamela J. Huggins – Corporate Vice President & Treasurer

Donald E. Washkewicz – Chairman of the Board, President & Chief Executive Officer

Timothy K. Pistell – Chief Financial Officer & Executive Vice President Finance and Administration

Analysts

Eli Lustgarten – Longbow Research

Nigel Coe – Deutsche Bank

Terry Darling – Goldman Sachs

Andrew Casey – Wachovia Securities

Ann Duignan – JP Morgan

Unidentified Analyst

Alex Blanton – Ingalls & Snyder LLC

Mark Koznarek – Cleveland Research

Daniel Dowd – Sanford Bernstein

Robert McCarthy – Robert W. Baird & Co., Inc.

Henry Kirn – UBS

Analyst for Jamie Cook – Credit Suisse

Operator

Welcome to the second quarter Parker-Hannifin Corporation earnings release conference call. My name is Nancy and I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question and answer question at the end of today’s conference. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference Ms. Pam Huggins, Vice President and Treasurer of Parker-Hannifin Corporation.

Pamela J. Huggins

This is Pam Huggins speaking, as Nancy said. I’d like to welcome you to Parker-Hannifin’s second quarter fiscal year 2009 earnings release teleconference. Joining me today is Chairman, President and Chief Executive Officer Don Washkewicz and Executive Vice President and Chief Financial Officer Tim Pistell.

As normal, let me just address a couple of administrative matters prior to beginning with the actual earnings release. First, for those of you online, you may follow today’s presentation with the PowerPoint slides that have been presented and for those of you not online, the slides will be posted on the investor relations portion of Parker’s website at [www.PHStock.com].

I want to call your attention to Slide Two which is the Safe Harbor disclosure on forward-looking statements and ask that you take note of this statement in its entirety. Third, moving to Slide Three, this Slide as required indicates that in cases where non-GAAP numbers have been used they have been reconciled to the appropriate GAAP numbers.

Then moving to the agenda on Slide Four, the call will be in four parts today. First, Don Washkewicz, Chairman, President and Chief Executive Officer will provide highlights for the quarter. Second, I’ll provide a review including key performance measures of the quarter concluding with the revised outlook for fiscal year 2009. The third part of the call will consist of the standard Q&A session and as a reminder, please ask one question at a time.

My goal today is to keep this call to no more than an hour so please be courteous and get back in the queue if need be. For the fourth part of the call today Don will close will some final comments. At this time I’ll turn it over to Don and ask that you refer to Slide Five entitled second quarter highlights.

Donald E. Washkewicz

I just want to make a few brief comments and then Pam will run through a more detailed review of the quarter. First of all, I wanted to share some key aspects of our performance for the quarter. It has become clear in recent months that the global recession has grown deeper and wider than any of us originally anticipated as evident in reports from other manufacturers and our own orders we are seeing a significant pull back in demand across many markets and all regions which has impacted our performance.

You may recall at the last meeting the rest of the world was still doing fairly well, well that situation has changed pretty dramatically sense. Numerous customer shutdowns occurred in December and we brought that up at our December meeting with analyst here in town and a lot of those shutdowns now are continuing on in to January so we’ve seen impact from those shutdowns in our second quarter, we’re going to see additional impacts in our third quarter as well.

Sales in the second quarter were $2.7 billion, a decline of 5% compared to last year’s quarter. What you need to know about that number is while acquisitions contributed 6% this was more than offset by negative foreign currency translation of 6% and a decline in organic sales of about 5%. The drop in sales volumes of course led to a decline in earnings. Earnings per share declined 20% to $0.96 in the quarter.

Cash flow from operations year-to-date was $444 million or 7.7% of sales and we’re fairly pleased with that level of cash flow. That’s only off about 6% from last year so it remains at a pretty high level and of course we’re planning on continuing to work cash flow throughout the balance of this year. I am pleased that we were also able to manage and control our inventories on a real time basis. Excluding acquisitions, inventories were actually down. We’ll talk more about that a little later.

A bright spot in the quarter is the positive performance of our aerospace segment which delivered 10% sales growth and significantly improved profit and margin performance. On another positive note, recently we were awarded a contract by Rolls Royce valued at $2.5 billion in revenue over its lifetime. That brings our total contract awards over the past two years in aerospace alone to over $12 billion. So, we’re pretty excited about that.

Markets, just a couple of comments on markets and what we are seeing, as noted in our press release, total orders are down 20% in the quarter versus a year ago. Industrial North America orders declined 18%, industrial international continued to weaken as we posted a 28% decline in orders keeping in mind that this is compared with a record demand level in prior year quarter.

Orders in the climate industrial control segment declined almost 22% as housing, truck and automotive markets in the United States continued to reel from the credit crisis. We don’t see any of that changing in the near term. Aerospace orders did increase a modest 2% as calculated on a rolling 12 month basis. Another bright spot is that distribution is holding relative steady. Of course, they’ve been impacted in December with the big drop off as well but overall, they’re holding that pretty well and since half of our industrial business goes through this channel, that’s good news.

Given these trends we have decided to revise our fiscal 2009 earnings guidance downwards to a range of $3.85 to $4.25 per diluted share. As I’ve shared with everyone on the call before, much of the work we have completed under the win strategy over the past seven years has been designed to reshape Parker and better prepare us for such a downturn. Although current conditions are somewhat unprecedented, we stand ready to address the challenges ahead and I am confident we will emerge even strong as conditions improve.

To prepare for these challenges, we have already initiated appropriate actions throughout the company to reduce workforce and expenses and we have contingency plans in place for further actions should they be required. While there can be no guarantees about what lays ahead, my expectation is that Parker should perform at a much higher level through this downturn than what we did during the previous cycles.

We remain focused on our long term objectives and initiatives as articulated in the win strategy while simultaneously adjusting our costs to reflect near term demand. So, with that little intro I’m now going to turn it back over to Pam for a little bit more detail.

Pamela J. Huggins

For more detail on the quarter please reference Slide Six at this time and I’ll begin by addressing earnings per share. As you can see on this Slide, earnings per share for the second quarter is $0.96 and this compares to $1.23 for the same period last year. Moving to Slide Seven, the earnings per share decrease in the quarter versus the same quarter a year ago is the result of decreased sales of 5% obviously as a consequence of the unanticipated and unexpected OEM shutdowns. This was offset by lower tax expense and fewer shares outstanding.

Moving to Slide Eight and looking at the top line, sales for the quarter as I said decreased 5% to $2.7 billion from $2.8 billion last year. Just to give you the components of the 5% reduction in sales, acquisitions contributed 6% however, this positive effect of acquisitions was offset by currency which turned negative in the quarter at -6%. This was mostly due to international industrial, mainly the Euro as a result of the strengthening dollar. Organic or core growth for the quarter was -5%.

Moving to Slide Nine, you can see that Parker closed eight acquisitions in the quarter with revenues of $520 million. On a year-to-date basis that’s $532 million, a total of nine acquisitions. Sales in the quarter were aided by aerospace that posted a 10% year-over-year increase for the quarter.

Slide 10 focusing on segments commencing with industrial North America. I think most notable with respect to North America is that in spite of the recession, second quarter sales are up .2% and operating margins are 10.8%.

Slide 11 continuing with the industrial segment moving to international, as I mentioned before currency turned negative in the quarter, it was -11% and this is versus a positive 4% for the previous quarter. Acquisitions added 7% to sales in this segment and organic growth was -7% obviously up against tough comparisons a year ago. Margins as a percent of sales were double digit at 11% for the quarter.

Moving to the aerospace segment, sales increased 10% and margins increased 260 basis points and this is mainly due to the strength in the commercial aftermarket. Moving to Slide 13, climate and industrial controls, as mentioned previously, softness in North America automotive, heavy duty truck and residential air conditioning is affecting this segment. In addition, due to automotive shutdowns and the continued decline of housing starts, sales are down 17% organically.

Currency at 5% of sales is a deduction to sales for the quarter and restructuring as discussed on the last quarterly call impacted margins. Restructuring is about $5.3 million in this quarter. Moving to orders for the quarter, Don mentioned some of this but on Slide 14 detailed orders by segment and remember these numbers represent a trailing average and are reported as a percentage increase of absolute dollars year-over-year excluding acquisitions and currencies except for aerospace.

Aerospace as you’ll recall is reported using a 12 month rolling average. As you can see from the Slide, orders are down 20% for the December quarter just ended. This compares to 1% last quarter and 10% a year ago. North American orders for the quarter are down 18% year-over-year and last year at this time orders were 4% and this compares to 2% sequentially from the September quarter.

Industrial international orders declined 28% year-over-year however, this is up against 16% last year and this -28% compares to -4% last quarter. Aerospace orders were up 2% for the quarter. This compares to 9% last quarter and 19% a year ago. Moving to climate and industrial controls, orders are down 28% for the quarter and this is down from 5% last quarter and -6% a year ago.

So at this time moving to the balance sheet you can see that Parker’s balance sheet remains solid. Cash on the balance sheet at quarter end was $262 million. Commercial paper outstanding was $932 million. Days sales in inventory increased to 71 days from 70 last year excluding acquisitions. Accounts receivables in terms of DSO is 50 flat with last year. Weighted average days payables outstanding has increased from 41 to 47 and this is on a year-to-date basis.

Just moving to Slide 16 you can see that operating cash flow year-to-date is $445 million. Of this $445 million, $174 million was used in connection with capital expenditures. Dividends were paid in the amount of $81 million. The remaining cash flow and additional $834 million mainly debt, commercial paper for the first half of the year allowed acquisitions to the tune of $705 million and share repurchases in the open market of $434 million. Just to clarify, not $705 million in revenues of acquisitions but that was the cash flow impact.

On Slide 17 you can see that the debt to total cap ratio is 38.8% but on a net basis it’s 36.6%. Now, addressing the guidance for fiscal year 2009 which is detailed on Slide 18 through 20. On Slide 18 the guidance for sales and operating margin by segment has been provided and on Slide 19 guidance has been provided for the items below segment operating income.

Slide 20 summarizes the guidance on an earnings per share basis from continuing operations and as you can see from this Slide, the guidance for fiscal year 2009 for earnings per share from continuing operations is projected to be $3.85 to $4.25. Please remember that this forecast includes acquisitions that have been closed but it excludes any acquisitions that may be made going forward.

The full year revised guidance assumes the following, sales growth decline approximating 10.8% to 11.2%, segment operating margins as a percentage of sales in the range of 11.2% to 11.9%, corporate and administration costs projected to be 6% to 10% lower than fiscal year 2008. Interest expense is projected to be 3% to 10% higher than last year, other expense projected to be 30% to 40% lower than fiscal year 2008 and we’ve assumed a tax rate of 27%. Also note worthy is that the fourth quarter will be slightly better than the third quarter.

At this time we’ll open the call to begin the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eli Lustgarten – Longbow Research.

Eli Lustgarten – Longbow Research

I’m wondering if you could help me, as you look out in your volume forecast, you gave the full year for example industrial North America down around 8.5% and in order to get there I guess we have really big declines, 20% in the next two quarters and the same thing is true in international, you’re down like 30% the next two quarters even with some acquisitions that were made. I wonder if you could help me what are you seeing out there and what kind of volume big declines, the orders are down 20% not 30%, well close to 30% but are you assuming that continues all year and that it gets a little worse?

Donald E. Washkewicz

Eli, I think what we’re saying right now is that we don’t have any reason to think that there’s going to be any change at this point in time. I think there are just too many unknowns. So, what we are doing is we’re just assuming the state that we see right now is going to continue on throughout the balance of the fiscal year.

International, as you know, the orders are down close to 30% and of course 20% elsewhere. We think that’s probably going to continue. If that changes then obviously that will change our projections going forward but that’s our best guess right now.

Eli Lustgarten – Longbow Research

A follow up, there’s no pricing? Is pricing holding? Is there any pricing differential or what’s going on in the pricing versus input costs at this point?

Donald E. Washkewicz

I’d say pricing is pretty much where it has been. I would say it’s holding as you put it. There’s really no price increasing going on but of course, as contracts come due on our OEM customers we’re renegotiating prices. But, prices also fluctuate with the order size as well so I would say there are no real major changes going on right now with respect to pricing. Likewise, raw materials is pretty much stabilized at the level that they’re at. I don’t see any demand for raw materials going on out there so I think that the input costs are going to remain relatively low.

Operator

Your next question comes from Nigel Coe – Deutsche Bank.

Nigel Coe – Deutsche Bank

Don, you’re quite negative on the outlook in December, can you just maybe characterize how end market conditions changed since December to where we are now? And, if you could just clarify what your organic assumptions are by segment for the full year?

Pamela J. Huggins

You want the organic assumptions in total or what are you looking for exactly?

Nigel Coe – Deutsche Bank

By segment. You’ve given us the revenue.

Pamela J. Huggins

Let me give you the second half numbers because I think that will be most helpful to you as you guys are trying to do your work. North America, the second half we have that down 26% to 27%, international 29% and aerospace 3% and climate industrial controls down 23%.

Nigel Coe – Deutsche Bank

Is that organic or is that reported?

Pamela J. Huggins

That’s organic.

Operator

Your next question comes from Terry Darling – Goldman Sachs.

Terry Darling – Goldman Sachs

Don, or Pam or Tim, I wonder if you could talk about the improvement in decramental margins that’s assumed in the second half year guidance? In that context, I’m wondering why we’re not talking in a little bit more detail about cost cutting initiatives, cost of those initiatives, timing of savings, magnitude of savings, can you fill in some blanks there for us?

Timothy K. Pistell

Let me try to answer your questions Terry. First of all, we did an in depth analysis of course of this second quarter versus the second quarter. The first quarter was an all time record, life was good and all this happened in the second quarter so we looked at that hard. What we’ve seen is when we go segment by segment or in total that our MROS and as you know we try to manage all the businesses against this MROS, the MROS on the downside here if you look at just the raw numbers is 44%. The segments aren’t too far different between them excluding aerospace which of course had a good quarter but the other three were all kind of down 44% total.

Two things occurred here really, one is inventory reductions. We took about $75 million out of inventory in this quarter excluding acquisitions. That has an impact of around 30% to 35% of those dollars will be the impact to us on the operating line and so we have that affect. The other thing is we have these force reductions, reductions in force and I guess probably now is as good of a time as any to get in to that.

We’ve been working on this for weeks actually. Where we stand today it would appear now operating off a base of around 60,000 employees plus or minus, it looks like over the course of this year we’re going to have a reduction in force of around 9,000 so around 15% of our associates here. About half of that is done okay, and about half will be done over the coming months and that’s going to be done at a cost of around $30 million.

We think after that is all done and the costs are behind us, it will generate improvements of about $100 million going forward. Now, what occurred in this quarter was about $10 million on these RIFs we call them, reduction in force, so between the inventory reduction of $75 million and the RIFs if you will, the adjusted MROS comes down around 35%.

Actually, if we then take a look at we did a couple of big acquisitions that came in the quarter, they don’t contribute much in the first quarter and frankly if we back those guys out too in the first quarter it would be right around 30%. So, that’s how we’re thinking, that’s how we’re managing and that’s how we reconcile the numbers.

Going forward as Pam articulated and Don, we’re looking and you hear the organic decreases we’re building in, we hope they’ll be better than this but right now this is what we have to deal with and we’re going to manage to that 30% MROS as best we can.

Terry Darling – Goldman Sachs

Just a couple of clarifications there, first the $10 million was the cost this quarter with no benefit, correct?

Timothy K. Pistell

Very little benefit in the quarter, that is correct.

Terry Darling – Goldman Sachs

So the all in kind of cost benefit is $40 million cost for $100 million benefit?

Timothy K. Pistell

No, it will be $30 million cost - $30 million is total, we’ve incurred about $10 million of that, we’ll probably incur another $20 million in the second half.

Terry Darling – Goldman Sachs

Then just wondering if on the second half organic numbers Pam that you gave, the down 30% for industrial international, I wonder if you can give us just a little bit of color around Europe versus Latin America versus Asia Pacific.

Pamela J. Huggins

Sure, I can do that. I mean as you well know the downturn really happened in November, that’s when things really kind of fell off of a cliff. But, in December it continued to get worse. If you look at the steepness of the decline, the steepness was probably greatest in Latin America, believe it or not and secondly in Asia Pacific. But, you have to remember that the biggest portion of our business is really in Europe.

So, if you look geographically and look at the countries in Europe and you say, “Okay, now where was the steepness of the decline there?” Germany and Sweden had the steep. But, you can look at any country for the most part in Europe and they were all down significantly beginning in November and extending through December.

Terry Darling – Goldman Sachs

And the same sort of balance as you look out towards the second half of the fiscal year? You’re expecting Latin America, Asia Pacific worse off that 30% bogie and Europe something under that?

Pamela J. Huggins

I think what’s safe to say is the decline that we’ve seen we’ve built in to the forecast going forward.

Timothy K. Pistell

Frankly, talking the other day this is sort of the random walk technique because we’re in to something none of us have ever seen before and some of our major customers are not back to work yet so we cannot even communicate with them as to what the thinking is on their production schedules until they get back. So, right now we can only use what we have, the most recent we have.

Operator

Your next question comes from Andrew Casey – Wachovia Securities.

Andrew Casey – Wachovia Securities

Just a follow up on the previous question and then I’ll move on. When you look at the major customers that you talked about Tim that are not back to work could you kind of give us not the customers but the industries that you’re talking about?

Timothy K. Pistell

Yes, I can. It’s certainly the automotive pretty much across the board, it is heavy truck, it is ag, it is construction, it is [man lift] and I’m not sure what I left off frankly but, it is very broad based.

Andrew Casey – Wachovia Securities

Then flipping that, are there any industries that have any sort of acceleration or is it just moderation if it’s positive?

Timothy K. Pistell

Do you mean acceleration on the decline?

Andrew Casey – Wachovia Securities

No.

Timothy K. Pistell

Any uptick?

Andrew Casey – Wachovia Securities

Yes.

Timothy K. Pistell

Yes, there is a few but boy I’ll tell you you’ve got to look hard to find it. Certainly there are things in oil and gas that are still good, certainly there’s things in alternative energy that are still good, there are parts of marine that are good as well especially as it pertains to the offshore oil and gas, there are parts of life science that are good. So, there are pockets here and there but boy, you really have to scratch to find them.

Operator

Your next question comes from Ann Duignan – JP Morgan.

Ann Duignan – JP Morgan

I’ve got one question and a follow up, first Don, you said something interesting, you said that distribution in North America was holding up, I think you said it was holding up reasonably well. Can you give us some color on that? Then, with the industrial production activity slowing so rapidly, would you anticipate that that piece of the business would slow significantly in the back half?

Donald E. Washkewicz

That’s a good question Ann. I would say when I’m talking about relatively well, we’re seeing 20%, 30% drop offs in these other areas, we’re not seeing anything near that order of magnitude in distribution, maybe it’s off 5%. I think overall because of the broad diverse markets that they’re serving they’re holding up much better. We anticipate that will continue. I don’t think it’s going to get down to the OEM levels that we’re seeing here with these huge drop offs in many of the major OEM markets that we serve. It’s all relative but distribution is holding up better than any of the other segments.

Ann Duignan – JP Morgan

Then my follow up question is just on the non-operating items, each of those line items changed significantly from the last quarter, could you walk us through what the major changes are for corporate admin, interest expense and other expenses? Tax rate I think I understand that but the three non-operating line items?

Pamela J. Huggins

Obviously you know the tax rate took it down to 27% so that made a difference and depending on how you calculate it $0.10 to $0.12, whatever. Obviously, share repurchases we’re continuing to purchase on our 10B51 program so there is an impact, about $0.04 in terms of the share count differential. Also, corporate administration there’s some benefit from that, around $0.09 and that’s basically just the result of as the income comes down in the second half so do incentives so there’s some positives on that front as well. The biggest portion being obviously being the segment operating income.

Ann Duignan – JP Morgan

Just on the share repurchases, so you are going to continue to repurchase shares?

Timothy K. Pistell

We’re doing our 10B51, that’s a very minimal program. That allows us of course to purchase through blackout periods and everything else. That is only about $20 million worth a quarter so other than that there is no major repurchase activity. The big repurchase activity occurred in the first quarter.

Operator

Your next question comes from Unidentified Analyst.

Unidentified Analyst

Further on the decremental margins, the second half implied $26.7, still better than the 30% that Tim you backed in to for the second quarter. We have to believe pricing is going to erode in to calendar ’09. Is implicit in the improved incremental margins also some improvement on price versus your input costs? Can you give us some color on your input cost thoughts versus price?

Timothy K. Pistell

Well I think as you can appreciate, this is going to be a real battle and it’s using our strategic procurement against our strategic pricing initiatives. So, there is no doubt that many of our key basic material costs have decreased and they will come through. Now, there is a phenomena in accounting where you have to write some of that stuff back out of inventory which we’re feeling the pain of that but it will come through and it will help us. Our customers, of course know that as well and they’re asking and in some places it’s built in to our contracts so they are indexed and they will pass through.

Part of our issue with some of these customers is that you said you were going to take 10,000 a month and now you’re telling me you’re only going to take 7,000 a month or 5,000 a month so that’s a much reduced quantity than what you said and so we have that issue on our side so this is all the give and take of the whole thing.

It’s going to be a major struggle but at this stage, which consistent with what you’ve heard from us over probably the last several years is that we work awfully darn hard to balance the two, work the procurement, work the pricing and not be on the call telling you that we have some big blow up because we didn’t work either side of that very well.

Unidentified Analyst

So then in the guidance you do not assume a better price versus cost spread in the second half?

Timothy K. Pistell

That is correct, we don’t have any negative nor do we have any great positive in either direction. We presume our people will keep it in balance.

Unidentified Analyst

Regarding the headcount reduction, I mean it’s a pretty sizeable number, the 15%. As we all remember five, six, seven years ago the downturn the margins were hit obviously with all the massive number of plants that you were closing and moving. Obviously, we’re not going to see that same magnitude of plant closures but with 15% headcount reduction are there some notable plant closures involved in this restructuring?

Timothy K. Pistell

There is not any widespread list of plant closures. There are some specific ones but frankly those would have occurred anyway, these were just in the ordinary course. In the ordinary course we’re going to do a few every year so there isn’t anything that is a result of the slowdown that is forcing that out. So, I would say that our people to date are doing a great job.

The other thing that I would point out to you is if you can do the math and how we compare to other companies, the cost of doing these reductions you’re going to think come away saying is fairly low compared to maybe some other people. A lot of these people were not full-time employees. As we’ve told you in building in cyclicality, contingency measures, carry a lot of temporary workers, carry a lot of consulting type people, etc. and so even though we count them in our headcounts because we want everyone accounted for if they are temporary agency, consulting then of course they can be reduced at a much lower cost. That is why I think the cost of our reductions is going to be less than maybe some other people.

Unidentified Analyst

One last quick one and I’ll get in queue. The destocking process, I mean obviously when customers are shutdown that is severe, let’s assume they’re not shutdown for six months, where do you think you are on your production versus your assumed retail? In your guidance is the destocking process largely done and now you’re going to produce where you think demand is or are you further going to under produce retail say the next quarter or two?

Donald E. Washkewicz

I think that we’re pretty much in synch with what we’re seeing out there. We’ve been making the reductions as we’ve been going along and I think we’re going to continue to do that. As we’ve executed lean in the company we’re getting to be more and more real time as far as our execution of the inventory adjustments on a month-to-month basis. I’d say, we mentioned earlier we were down $75 million in inventory, that is pretty much in line with what’s happening in the markets, excluding acquisitions of course.

I think that we will continue along that page throughout the fiscal year. That’s a message frankly that we passed on to the entire organization about six or seven months ago now that we are going to go through this period in much better control than we have in the past as far as inventory and we’re going to maintain our productivity better than what we’ve done in the past. I think we’re going to prove that that is going to be the case here.

Operator

Your next question comes from Alex Blanton – Ingalls & Snyder LLC.

Alex Blanton – Ingalls & Snyder LLC

The order trend across the quarter you mentioned that it started down in November and then got worse in December. You use to report your orders monthly so now we don’t have that guide anymore. But, can you give us a better idea of the sequential decline across the quarter so we know where we are versus October?

Pamela J. Huggins

When you get in to November and December we saw some declines as high as 35%.

Alex Blanton – Ingalls & Snyder LLC

Overall for the company?

Pamela J. Huggins

Right.

Donald E. Washkewicz

Because a lot of that had to do with the shutdowns that we mentioned earlier. There was just nobody buying anything, there were no orders coming in, everything was shutdown, holidays were in there and that seemed to carryover in to January as well.

Alex Blanton – Ingalls & Snyder LLC

You said at the conference in December, somebody at the end asked you for an update on the current state of business because you had spent a lot of time on the future at that meeting. Basically you said, “There isn’t any, everybody is shutdown.” Now, that’s certainly an overstatement or you wouldn’t have had any orders but how much of this, and you mentioned some people are still shutdown, how much of this is an inventory correction in the supply chain? Can you tell? Are people not ordering because they’re trying to get inventory off the shelf? Could you answer that for MRO as well as OEM?

Donald E. Washkewicz

Alex, that’s a hard one to answer. I’m going to let Tim make a comment as well. I think what is happening is with all the bad news that has happened as a result of the financial meltdown and all the ramifications that has brought, the ripple effect throughout all the industries that we serve everywhere around the world. And of course, what happened here with the housing crisis now, we packaged all that up and sent it over to all the foreign countries so we’ve made this a global problem for the world.

I think frankly the world is just now just waiting to see what the heck is going to happen here. What is the stimulus going to be, how are we going to dig out of this mess. So frankly, I think it is just we’re not going to order anything. We’re just not going to order anything, we’re not going to get ourselves hung out there in a situation where we could get trapped with a lot of orders coming in, inventory going up, we’re just going to be real ultra conservative and wait and see.

I think the waiting and seeing now is coming close to happening here because they’re talking about $850 billion or whatever stimulus and you’ve seen the components of that. Now, the question is what impact will that have on our markets and that remains to be seen. Likewise, you heard about China with their $600 plus billion and frankly, I don’t know when that is going to be implemented and how long it will take to get that moving over there in China.

Of course, you heard about Germany, I think they’re $50 billion Euros but the key is I think everyone is in a state of paralysis frankly. No one is going to do anything, no one is going to spend money, no one is going to make any moves until they have a real comfortable feeling that this horrible situation that we got ourselves in to is under control. That’s just my gut feel and Tim might have had a few things he wanted to add.

Timothy K. Pistell

Alex, the only thing I want to add to is on these order rates keep in mind that our businesses typically carry about three months of future demand in their backlogs alright. So, let’s say again someone was wanting 10,000 units a month and that’s what they had loaded in the backlog. Now, they disappear for a while and they come back and they say, “Well, we’re back in business but we don’t want 10,000 we only want 7,000 a month.”

That means you have to go back and adjust your backlog and that negatively impacts, you have to run that through the system if you will. Part of what we’re seeing here and this is hard to evaluate these numbers, is that. There is rescheduling going on and you’re doing a little catch up. Having said that, let me break it down, aerospace fine, aerospace unto itself is separate than all of this. As Don indicated earlier, the distribution, the aftermarket is also completely different. Are they down? They’re down a little bit but they’re holding up extremely well comparatively, now they service the aftermarket.

The problems for us in trying to get our arms around this are the major customers, some of which again, haven’t come back and some of these adjustments that are going through. That’s what is making it very difficult to judge and tell you what we think the real run rate is going forward is going to be.

Alex Blanton – Ingalls & Snyder LLC

Just one final thing, this $825 billion stimulus, they published last Friday, the House released numbers, the transportation and infrastructure’s part of that was only $78 billion.

Donald E. Washkewicz

Isn’t that amazing.

Alex Blanton – Ingalls & Snyder LLC

It was in the Wall Street Journal and that’s a two-year program so it’s $39 billion a year which is less than 4% of total construction of $1.1 trillion annual. So how much stimulus can there be here?

Donald E. Washkewicz

How’s that going to stimulate or generate any jobs? That’s what we’re wondering too.

Alex Blanton – Ingalls & Snyder LLC

It won’t even offset the decline in non-res probably.

Donald E. Washkewicz

I think that’s absolutely right Alex. I think what they’ve done in China is quite the opposite. I think that will stimulate activity, infrastructure activity over in China. What we’re doing here – well, it’s amazing. You’ve seen the number $75 billion is a drop in the bucket.

Timothy K. Pistell

For everyone else on the call that clearly is another problem for us because there’s a lot of talk, I mean every day you pick up the papers and some other country has announced some new stimulus around one, or two, or three. We don’t know what we’re doing in this country yet so there is a lot of talk and not that many of them are really coming out that you can really apply. But, I do think the countries that are really going to end up with hard assets for their money are going to be the ones who spent their money a little better than the rest.

Operator

Your next question comes from Mark Koznarek – Cleveland Research.

Mark Koznarek – Cleveland Research

I just want to burrow in to this inventory reduction issue a little bit more because just looking at the balance sheet we’ve got $1.5 billion of inventory and of course some of that is raw material and work in process. But, you know the $75 million cut is only 5% of that and if your second half industrial activity is going to be down in the range of 30% it does suggest that you ought to be cutting back on inventories a lot more than you already have. So, can you true up that prior statement about kind of where you want to be on in house inventories?

Timothy K. Pistell

We agree with you 100%, inventories have to come down more. What you had was the beginning of the quarter a boom in business and then all of a sudden the world came to an end and you can’t just turn the switch on and off really easily. I mean, I was extremely impressed with the fact that we got $75 million out in a relatively short period of time. But, we clearly are not where we want to be.

Our DSI did go up some, we don’t like that, we want the days sales inventory to come down and we want the absolute dollars to come down. But, to get it down of course you’ve got to get all the purchases out, you have a whole bunch of stuff on order, some of that was still in the pipeline coming in, you’ve got to cut off the purchasing, recalibrate it down and the people have to go because if people are there they’re going to be making parts. We’re doing that and you will undoubtedly see the inventory dollars continue to come down over the second half.

Mark Koznarek – Cleveland Research

Okay so you’re going to be under producing demand by a material amount across the second half and even with that we’re going to be able to maintain these all in incremental margins at around the 30% level?

Timothy K. Pistell

Yes, it’s all in there. I think historically if you go back and you look at our performance through the last several recessions you will see that we brought down inventories as a percent of sales through that recession. We will work awfully hard to do the same thing again.

Mark Koznarek – Cleveland Research

So as an offset then, are you guys expecting to get any benefit of this staff reduction at all in the second half? Like for instance in the fourth quarter, at a run rate near your $100 million or is that all rolling in to your fiscal ‘010?

Timothy K. Pistell

We’re starting to see some of it right now from those actions that were taken before the holidays. A lot of this frankly we held off doing it until after the holidays and so it will take a little while. Some is running through now, some will come rolling in, we will not see the full impact until we get in to the first of next fiscal.

Mark Koznarek – Cleveland Research

But there will be a bit dropping in to at least fourth quarter?

Timothy K. Pistell

Yes.

Mark Koznarek – Cleveland Research

That’s part of the positive that will help your incremental?

Timothy K. Pistell

That’s why the fourth quarter is a little better than the third.

Operator

Your next question comes from Daniel Dowd – Sanford Bernstein.

Daniel Dowd – Sanford Bernstein

I wanted to just touch base on a couple of things, first on the acquisition environment, obviously you’re continuing to acquire. Certainly, with multiples where they are you could imagine lots of companies wanting to hold off, on the other hand clearly some companies can be getting themselves in to trouble here. What are you seeing in the acquisition environment and how is that different geographically?

Donald E. Washkewicz

Well, we basically have completed what we wanted to do this year for acquisitions this fiscal year. So, we are not planning to do anything major for the remainder of this fiscal year. There could be a small one here or there that we might do but we acquired I think it was $520 or $530 million in sales volume. That’s close to the 5% target that we have for acquisitions a year, 5% of sales.

So, we’re okay right where we’re at so I would say don’t expect to see much happening between now and the end of the fiscal. We’re going to conserve our cash, we’re going to be generating positive cash flows here going forward. That’s our priority right now. Acquisitions, frankly what I’ve been telling the troops here is, let’s farm the farm. Let’s work the acquisitions that we made. We’ve made [La Gree], [Orega] and Detroit and we need to integrated those, execute the win strategies on those and bring those around so that they’re having a positive impact on our P&Ls if you will.

That’s kind of where we are. We’ve pretty much done it in the first half and we don’t need to do much more in the second half.

Daniel Dowd – Sanford Bernstein

On the issue of suppliers, is the macroeconomic conditions and the credit crisis combining to put any of your suppliers in extremeness yet?

Donald E. Washkewicz

That’s a good question too because I think that we were asking ourselves the other day if anyone has heard anything? I haven’t heard anything as far as any of our suppliers in peril right now but we’re certainly watching that closely and we’ll report as we go forward. But, right now I would say no we haven’t heard of any major issues there.

Operator

Your next question comes from Robert McCarthy – Robert W. Baird & Co., Inc.

Robert McCarthy – Robert W. Baird & Co., Inc.

Can we actually put a number to what proportion, at least roughly of the $100 million of savings that you expect to realize in the current fiscal year ballpark?

Timothy K. Pistell

You mean by segment?

Robert McCarthy – Robert W. Baird & Co., Inc.

No, I’m just looking for a gross number that I’m going to realize in savings this year?

Timothy K. Pistell

We’re going to incur all $30 million costs this year and our thinking is that within the year we’ll recover that $30 million and hopefully there will also be a little bit of a plus to it.

Robert McCarthy – Robert W. Baird & Co., Inc.

The implication being that you’ll be maybe approaching the annualized run rate in the fourth quarter?

Timothy K. Pistell

We’ll be at least neutral on this program by the end of the year. We’re in the hole right now but we’ll be hopefully at least in a neutral position by the end of the fiscal.

Robert McCarthy – Robert W. Baird & Co., Inc.

I hate to keep coming back to the same subject but clearly if you guys can deliver less than 30% incremental or decremental margins on 25% plus organic declines in the industrial segments this will be a major shift in performance for the company. So, you’ve got the employment savings coming through, is there implied in a much stronger distribution business in a much weaker OEM contribution in the second half itself, is it then imply a favorable mix shift that would also be helping the decremental comparisons?

Donald E. Washkewicz

I think that would be true Rob definitely because of what we’re seeing at the OEM levels. OEMs have really been devastated here the last several months and distribution as I indicated earlier has been holding up much better. So, we would expect that going forward to remain kind of in that ratio that we’re showing right now. It could change, it could change any day but we just don’t know, we’ll know more in February when most of the OEMs are back working full shifts again.

Robert McCarthy – Robert W. Baird & Co., Inc.

Well then, I’d like to follow up on something you said and a bigger picture question that you mentioned in your opening remarks again the concept that Parker is going to do better in the down cycle which everybody would hope to see from you. Given that there’s every indication that this is going to be a much worse downturn, a much more significant management challenge than the last couple of downturns, is decremental margin is that the primary metric by which you would recommend investors judge Parker’s performance through the downturn? Or, are we talking about return on capital at the trough? What would you suggest Don?

Donald E. Washkewicz

That’s a good question too. I think that what they’ve been telling us all along since the last downturn is that is exactly what they were disappointed with, the decremental margins. So, I would say the drop off from peak to trough in the last cycle had them very concerned, it was like a 60% or 65% drop off in earnings per share, something in that order of magnitude. So, I think that would be the first thing because that is what they’re going to be watching for.

I think cash will be the other thing that they’ll be looking at and cash flow generation. You really have to look at both sides with us because when we make these acquisitions we’re writing off a lot of intangibles and that’s a non-cash outlay so if you don’t look at the cash side of the equation you don’t see the full picture. But, I think what they should be focusing on is exactly what they’ve been very critical of Parker and that is that big drop off peak to trough in the last cycle.

Of course, everything we’ve done since then and we’ve been talking about, the proof is here or the proof will be here shortly as we move through this difficult period. We talked to you a little bit earlier about the plants. In that last cycle we closed or consolidated about 120 facilities, somewhere there abouts, huge. Tim indicated earlier that we have a few that we’re in the normal course we’re going to be adjusting here but nothing anywhere near the order of magnitude of what we’ve done before.

A lot of that movement of plants, movement of product lines, all of that disruption that we went through in the past, we’re not doing that this time. So, all of that under absorption, all that production variance, all the scrap, all the quality issues and everything else associated with that is going to be much less now.

I think we’re pretty excited about trying to prove something here and I think we’re taking the appropriate actions. Time will be our judge. I’m pretty confident we’re going to like the end result of what we see.

Operator

Your next question comes from Henry Kirn – UBS.

Henry Kirn – UBS

When you’re looking at your guidance going forward, what do you view as the key swing factors that take you from the high end to the low end? What could go right to get you to the high end?

Pamela J. Huggins

Well, one thing is aerospace. We have not seen the fall off in the commercial aftermarket, this is just one, I’m throwing out one example but, everybody has been talking about it and our forecast does assume that commercial aftermarket will fall off in the second half. If you look at revenue passenger miles, you look at available seat miles, I mean obviously all indications are that it shall decline.

We have not seen that in the first two quarters. So, the question comes in, is there anything that Parker’s doing differently that maybe would cause that to say up? It all revolves around planes, when they’re reaching a certain part of their life where there is a lot of maintenance, repair and overhaul. That’s one example that could possibly have us do better. Distribution is another example, distribution is expected to do well during the downturn versus the OEM side of things so that’s a factor in there.

Donald E. Washkewicz

I think those are the key ones. The other of course is the impact of any of the stimulus and whether that would even hit this fiscal year yet, we have five or six months left to go so we would be hopeful that if there was going to be an impact we’d see some of it this year but, the effect that would have on the construction equipment markets, the effect it would have on the automotive.

I think just the feeling out there that people want to spend money again. I think that we’re in a mode now where nobody wants to spend any money because there is so much uncertainty, unemployment is going up, people are out of work. If any of that changes, if we really do get things moving in the right direction and the employment numbers start shifting in a more positive direction, and if people are more secure in their jobs and in their futures, I think they’re going to want to spend more monies, maybe they’ll take out a mortgage to buy a house, they’ll buy a car.

All of these things then will be pushing us in a positive direction. Then of course, as all of that happens that impacts on Parker as well. When I say that I’m saying that not only for North America, I’m saying that for the world because we have the same things going on in Asia and in Europe as is happening right there. Everyone right now is in a state of paralysis as we come out of this and people feel more confident and they can get loans, they can get financing, I think we will be the beneficiaries of anything that happens as a result of that positives in the market.

Henry Kirn – UBS

Just a quick follow up, in terms of currency embedded in your guidance, what do you have for the rate and what types of headwinds do you have to EPS from currency?

Pamela J. Huggins

In the guidance we have – I’ll just give you the second half percentages if that’s okay and then you can work at it that way. We have about 5% baked in, a little over 5%.

Operator

Your last question comes from Analyst for Jamie Cook – Credit Suisse.

Analyst for Jamie Cook – Credit Suisse

Two quick questions for you, first one, in respect to the restructuring for the balance of the year, I believe if I heard correctly at the beginning of the conference call you said that roughly $5 million was in CIC so that’s about 50% of the $10 million. Should we expect a similar percentage to be allocated to that division going forward to the back half of the year? Is that how we should think about it?

Timothy K. Pistell

No, there will be more there but I don’t think it will be that big of a percentage of the total.

Analyst for Jamie Cook – Credit Suisse

Then a follow up on the impact of fx on the bottom line this quarter. I’m sorry if I missed that, did you provide that?

Timothy K. Pistell

No, what we said historically which I’ll say again is that what you do is most of what we sell there we make there so what you have to do is once you get the revenue number, then you drop down to the margin level and then you’ve got to drop a few other percentage points to get to pre-tax affect, that’s kind of the EPS okay. So, you have to go through that exercise of what’s the margin on that business and what do you get after tax.

Analyst for Jamie Cook – Credit Suisse

Last question, just if I look at Slide 17 where you provide your debt to total capital, it looks like year-to-date right now it is slightly above where you were in the previous downturn. I’m wondering over the next couple of quarters what the focus is? I know you’ve said that you have a very miniscule amount that is dedicated to repurchase activity but how should we be thinking about that over the next couple of quarters at least in terms of allocation of cash?

Timothy K. Pistell

What you’re going to see is that we are in a cash mode. Actually, we’ve touched on bits and pieces, acquisitions are pretty much at a halt, share repurchase pretty much at a halt except for the small program and so we are going to continue to generate a lot of cash and so forth. Of course, pay our dividends and generate so you’ll see that leverage come down as we go forward which is what we do and what we want to do, build up capacity and take advantage of the situations when they present themselves later.

Pamela J. Huggins

Obviously our ratings are very important to us so we’re going to do what’s required to keep our A rating. With that I’m going to end the question and answer session. I would like to thank all of you for your questions. I want to turn it over to Don however here who has a few closing comments.

Donald E. Washkewicz

I’m going to keep this fairly short because I know everyone wants to tune in to the inauguration which I believe is just starting now. Just a couple of final comments, again I’d just like to reiterate that the conditions in our markets are certainly challenging. I think you’ve heard all of that in this teleconference today and the outlook really remains uncertain. Of course, we’re going to be updating you as time goes on.

We’ll learn a lot more I think when our customers come back in January and when we hear more details on the stimulus that’s going to be happening here and elsewhere around the world. You can be sure that Parker has a very seasoned management team. We’ve been through recessions in the past six, or seven between Tim, myself and the others here. We’ve been through quite a few of these and we’re adapting as required to lower demand and are prepared to make the further adjustments necessary to achieve our goals.

These are of course challenging times for all of us and I very much appreciate the hard work and dedication of all Parker employees worldwide. I truly believe as I indicated that Parker will emerge stronger as demand improves. Once again, I want to thank everyone on the call for your participation. We certainly appreciate your interest in Parker. If you have any additional questions, Pam will be around the balance of the day and so enjoy the rest of the day. Good bye and have a great day.

Pamela J. Huggins

Thank you.

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