Illinois Tool Works, Inc. Q1 2009 Earnings Call Transcript

Apr.17.09 | About: Illinois Tool (ITW)

Illinois Tool Works, Inc. (NYSE:ITW)

Q1 2009 Earnings Call

April 16, 2009 2:00 pm ET

Executives

John Brooklier – Vice President of Investor Relations

Ronald D. Kropp – Chief Financial Officer & Senior Vice President

David B. Speer – Chairman of the Board & Chief Executive Officer

Analysts

Robert Wertheimer – Morgan Stanley

John Inch – Bank of America Merrill Lynch

Henry Kirn – UBS

Mark Koznarek – Cleveland Research Company

Jamie Cook – Credit Suisse

Andrew Casey – Wachovia Capital Markets, LLC

Daniel Dowd – Bernstein

Joel Tiss – Buckingham Research

Ann Duignan – J.P. Morgan

Shannon O’Callaghan – Barclays Capital

Eli Lustgarten – Longbow Research

Operator

Welcome to the Illinois Tool Works first quarter 2009 earnings conference call. All participants will be able to listen only until the question and answer session. This conference is being recorded. If you have any objections you may disconnect at this time. I’ll turn the call over to your first host today, Mr. John Brooklier, Vice President of Investor Relations.

John Brooklier

Welcome to our first quarter 2009 conference call. With me today is our CEO David Speer and our CFO, Ron Kropp. At this point David will make some brief remarks on what was a difficult and very challenging quarter for us.

David B. Speer

Certainly no question the recently concluded first quarter was extraordinarily difficult as we clearly were faced with very troubling economic trends in virtually all of the major global economies. The dramatic declines in virtually all of our key end markets have provided clearly unprecedented challenges for our global businesses.

From a macro data standpoint US industrial production excluding technology fell for the fifth straight month hitting a -14.6% in March. In Europe the industrial production numbers ranged down from -20% to -12% for the major economies of the UK, France and Germany. As you know the ISM Index for both US and European countries continue to hover around the mid 30s indicating real signs of growth are certainly really an aspiration rather than a reality.

From an end market perspective our industrial production businesses, our auto businesses and our construction businesses all continue to face very unique challenges. The further declines in worldwide industrial production has certainly impacted our welding and our industrial packaging businesses. Auto build declines were at record levels in the quarter and had negative consequences for all of our auto units and stubbornly negative construction trends in North America and declining trends internationally were evident in our Q1 results for our worldwide construction businesses.

Despite this very challenging environment, we continue to make longer term investments that we believe will position us for future growth. We spent $33 million during the quarter on restructuring initiatives and we expect to spend another $60 million of restructuring in the second quarter. You may recall that we originally forecasted restructuring costs for the entire year to be in a range of $60 to $100 million. It’s clear to us that we’ll exceed that at the higher end of the range for the full year 2009.

The associated benefits of these restructuring programs will become more apparent as 2009 progresses. We have likewise continued investing in key innovation programs that offer significant long term growth potential when the end markets begin to recover. We are also encouraged by our strong first quarter free operating cash flow of $386 million. This level of free cash flow is only modestly lower than the year ago period and underscores our ability to drive reductions in working capital throughout the company even in this challenging environment.

Finally, we remain confident that whenever economic trends and end markets do begin to improve ITW and our relatively short lead time businesses will benefit in a meaningful and measureable fashion. Now, let me turn the call back over to John.

John Brooklier

For everybody on the call here the agenda for today, Ron will join us shortly to cover Q1 financial highlights. I will then cover operating highlights for our reporting segments, Ron will then address our 2009 second quarter earnings forecast.

You may have seen from this morning’s release that due to lack of long term visibility we have opted at this point in time to only forecast the second quarter. Finally, we will take your questions. As always we ask for your cooperation per the one question, one follow up question policy. We are targeting a completion time of one hour for today’s call.

First, the usual items, please note that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Without limitations statements regarding operating performance, revenue growth, operating income, income from continuing operations, diluted income per share from continuing ops, restructuring benefits, free operating cash flow, end market conditions and the company’s related forecast.

These statements are subject to certain risks, uncertainties and other factors which could cause actual results to differ materially from those anticipated and you can see those material changes that are detailed in our Form 10k for 2008. Finally, the telephone replay for this conference call is 402-220-3690 no pass code is necessary. The playback number will be available through 12 Midnight of April 30th. You can also access as always our first quarter conference call PowerPoint presentation via the www.ITW.com website. Please access the investor relations section and then look for the event presentation tab.

Now, here’s Ron Kropp who will talk about financial highlights for the 2009 first quarter.

Ronald D. Kropp

As David mentioned, this has been a difficult and challenging quarter. Before I go through the first quarter results I thought it would be important to discuss two unusual charges that we had this quarter and take you through their impact on the reported results. Excluding these two charges EPS from continuing operations was $0.17 per share which was just over the high end of our revised forecasted EPS range of $0.08 to $0.16.

These two charges reduced earnings by $0.23 per share which resulted in the reported loss of $0.06 per share. The first charge relates to impairment of goodwill and intangibles. As you may recall we test all of our goodwill and intangibles in the first quarter of each year. In addition, this quarter we were required to adopt a new accounting standard FAS 157 which changed the way that fair value is determined for our impairment testing.

As a result, we’ve recorded a pre-tax impairment charge of $90 million in the first quarter primarily related to two business platforms that we acquired in the last few years. Our pressure sensitive adhesive businesses and our PC board fabrication businesses. The impact of this impairment charge was $0.17 per share.

The second item relates to several discreet tax charges recorded in the first quarter which totaled $28 million. Of this amount, $11 million related to the reduction of tax loss carry forwards in certain foreign jurisdictions. The remainder related to adjustments to our tax reserves for various international issues. The discreet tax charges reduced EPS by $0.06 per share.

Moving on to the reported results for the first quarter, revenues decreased 24% due to significantly lower base revenues. Operating income was down 90% and margins of 2% were lower than last year by 13.2 percentage points. Excluding the impairment charge margins would have been 5.1%. The diluted loss per share from continuing operations of $0.06 but excluding the charges I discussed we would have had income of $0.17 down from $0.70 last year. Despite the significantly lower income, free operating cash flow is very strong at $386 million.

Now, let’s go to the details of the operating results. Our 23.8% revenue decrease was primarily due to three factors. First, base revenue was down 23.3% which was unfavorable by 14.1 percentage points versus the fourth quarter of 2008. As David discussed we saw significant weakness across all of our end markets and geographies. North American based revenues decreased 26.7% which was significantly worse than the 12.3% decrease in the fourth quarter. International based revenues decreased 19.5% versus a decrease of 6.2% in the fourth quarter.

Next, currency translation decreased revenues by 7.3% which was unfavorable by 2.8 percentage points versus the fourth quarter negative currency affect. Lastly, acquisitions added 6.6% to revenue growth which was 1.2 percentage points lower than the fourth quarter 2008 acquisition affect. Operating margins for the first quarter of 2% were lower than last year by 13.2 percentage points. The base business margins were lower by 7.4 percentage points primarily due to the lower sales volume. In addition, the impairment charge reduced margins by 3 percentage points, translation diluted margins by 1.2 percentage points and higher restructuring costs reduced margins by 1 point.

Restructuring expense for the first quarter was $33 million which was similar to the restructuring amount in the fourth quarter. As a result of significant restructuring we have done over the last six months, we have reduced our base business overhead cost by more than 10% from the first quarter 2008 levels. When I turn it back over to John, he’ll provide more details on the operating results as he discussed the individual segments.

In the non-operating area interest expense was lower by $6 million as a result of lower interest rates on commercial paper. Other non-operating income and expense in the first quarter was favorable by $17 million mainly due to a German transfer tax expense in 2008. The first quarter effective tax rate was 230% due to the non-deductable impairment charge and the discreet tax charges of $28 million. Absent the impact of these charges the effective tax rate would have been 26%.

Turning to the balance sheet, total invested capital decreased $486 million from the fourth quarter primarily due to lower operating working capital of $282 million and lower goodwill and intangibles of $178 million, some of which was due to the impairment charge. Although cost receivable DSO was 64.1 days versus 59.4 at the end of the fourth quarter, it was lower than the 66.4 days at the end of the first quarter of 2008. Inventory months on hand was 2.2 at the end of the quarter versus 2.1 at the end of 2008.

For the first quarter, capital expenditures were $61 million and depreciation was $82 million. Excluding the impact of the impairment and tax charges ROIC declined to 4.2% versus 15% last year largely as a result of the lower base business income. On the financing side, our debt increased $194 million from last quarter. On March 1st, we repaid maturing debt of $500 million.

In late March we decided to take advantage of the favorable credit markets to term out some of our short term commercial paper borrowings. We issued long term debt of $1.5 billion, $800 million of five year bonds and $700 million of 10 year bonds. The proceeds of this bond offering were primarily used to repay commercial paper.

As of March 31st proceeds of $260 million were still held as cash on the balance sheet pending repayment of additional commercial paper that matured in early April. Our debt to capital ratio increased to 34% from 32% last quarter primarily due to the bond proceeds of $260 million that were still held as cash. Use of this cash in April to repay debt will bring the leverage ratio close to the fourth quarter level.

Shares outstanding at March 31st were 499.3 million. Note that the effective options typically adds up to 2 million shares to the dilutive share calculation. Our cash position increased $378 million in the first quarter as our free operating cash flow of $386 million and net debt proceeds of $196 million were utilized for dividends of $155 million and acquisitions of $65 million. Despite the lower income levels, we were able to generate strong free operating cash flow by reducing our working capital.

Regarding acquisitions, we acquired six companies in the first quarter which have annual revenues of $75 million. We’ve continued to see a reduced level of activity in our acquisition pipeline. I will now turn it back over to John who will provide more details on the operating results.

John Brooklier

Now, let’s review our first quarter segment highlights and we’ll start with the industrial packaging area where segment revenue has declined 32% and operating income fell 106.3% in the quarter. Operating margins of -1% were 12 percentage points lower than year ago period largely due to 10.6 percentage points of base margin dilution and 1.3 percentage points of dilution related to translation. The 32.3% decrease in revenues consisted of the following: -24.5% from base revenues; 0.7% from acquisitions; and -8.5% in translation.

Moving to the next slide; the industrial packaging segment Q1 base revenues of -24.5% represented a significant decline from Q4 2008 when base revenues declined 5.7%. The substantial sequential decrease in base revenues was linked to declining industrial production rates in key geographies. For example, US industrial production excluding technology declined further to 14.6% in March of 2009 and as David noted earlier in Europe we’re seeing similar trends.

Industrial production rates fell to -20% in Germany, -16% in France and -12% in the UK and that’s through February ’09. These indexes along with weakness in key end markets such as construction related areas such as lumber, brick and block as well as primary metals led to falling demand for both strapping and equipment products as well as stretch wrap and protected packaging products. As a result, total North American and international industrial packaging base revenues declined 30% and 24% respectively in Q1. Within the segment worldwide insulation was the segments best performer with base revenues down only 9% in Q1.

Moving to power systems and electronics; in the first quarter segment revenues declined 32.1% and operating income fell 80.2%. Operating margins of 6.2% were 15.1 percentage points lower than the year ago period with impairment negatively impacting margins by 6 percentage points, base margins declining 5.1 percentage points and restructuring costs negatively impacted margins by 2 percentage points. The 32.1% decrease in revenues consisted of the following: -31.9% from base revenues; 3.2% from acquisitions; and -3.4% from translation.

As noted earlier power systems and electronic segment base revenues declined 31.9% in Q1, a substantial decrease from Q4 when base revenues fell 10.8%. In welding which accounts for roughly three quarters of the segment revenues, falling industrial production demand globally drove total worldwide welding base revenues to -31% in Q1 with North American base revenues at -36% and international base revenues at -16%.

The PC board fabrication business saw its base revenue decline more than 50% as consumer demand for electronic products including popular cell phones and PDAs drop markedly in the quarter. The only bit of good news in this segment was the ground support equipment business which supply at the gate power units for commercial and military airport infrastructure type products. Base revenues grew 16% for these worldwide business units in Q1.

Let’s move to the transportation segment; in Q1 segment revenues decreased 26.8% and operating income fell 118.7%. Operating margins of -4% were 19.5 percentage points lower than the year ago period largely due to unprecedented declines in Q1 North American and International car builds. More on that later.

Base margins declined 14.7 percentage points in the quarter with restructuring and translation accounting for 3.1 percentage points and 2 percentage points of dilution respectively. The 26.8% revenue decrease consisted of the following: -35.5% from base revenues; 15.6% contribution from acquisitions; and -7% from translation.

As noted, segment revenues here declined 35.5% in Q1 versus a base revenue decrease of 20.3% in Q4. As noted earlier, the explanation was simple both the North American and international auto builds reached extraordinary low levels in Q1. Our North American automotive base revenues declined 46% in Q1 as North American auto builds which includes both Detroit three and new domestic production fell 51%. Detroit three build actually declined 54% in Q1 with GM down 59%, Ford down 49% and Chrysler down 65%.

New domestic builds fell 45% in the quarter. Internationally the build environment was also problematic. Our automotive international base revenues declined 44% in Q1 as total European car production fell a similar 44%. Key European OEMs struggled with builds in Q1, Renault was down 51%, GM Group down 48%, [inaudible] Group down 44%, Fiat down 39%, Ford Group down 38% and VW Group down 32%.

Looking ahead our CSM auto build tracking service is now predicting some modest improvement in Q2 builds both in North America and internationally with Q2 North American builds down approximately 40% and international builds down approximately 32%. This is versus Q2 2008. The only symbol of some good news in this segment was our automotive aftermarket business which saw base revenues decline only 10% in Q1.

Moving to food equipment which was our strongest performing segment in the quarter, segment revenues declined 15.4% and operating income fell 37.4%. Operating margins of 10.1% were 3.6 percentage points lower than the year ago period mainly as a result of the base margin dilution of 2.8 percentage points. The 15.4% decrease in revenues consisted of the following: -9.2% for base; 1.3% contribution from acquisitions; and -7.5% for translation.

Food equipments base revenues decreased 9.2% in Q1 versus base revenue growth of 1.7% in Q4. The decline in Q1 revenues was attributed to further weakening in both North American and International customer demands for equipment. In Q1 total food equipment North America base revenues declined 14%. Notably, institutional based revenues were down 18% as customers representing airports, universities, hospitals and casual dining restaurants deferred equipment orders in the quarter. The service portion of the business was also impacted modestly as base revenues declined 3%. Internationally base revenues fell 6% with European food equipment declining 5% in the quarter.

Moving next to construction products; in Q1 segment revenues fell 33.1% and operating income declined 121.9%. Operating margins of -3.4% were 13.8 percentage points lower than the year ago period mainly as a result of 9.5 percentage point declines in base margins, a three percentage point decrease due to translation and a 1 percentage point decline due to restructuring. The 33.1% decrease in revenues consisted of the following: -21.2% from base revenues; 0.6% contribution from acquisition; and -12.5% from translation.

Looking further at the construction segment worldwide base revenues decreased 21.2% in the quarter compared to a 14.6% decline in Q4 and the main drivers of the more negative sequential results encompass both North American and International end markets. North American base revenues fell 31% in Q1 with residential based revenues down 43%.

These housing related numbers come as no surprise given the fact that housing starts declined approximately 50% in Q1 versus the year ago period. In our other North American construction category our commercial construction based revenues declined 32% versus a decrease of 51% in the latest Dodge Commercial Construction Index which is based on square footage through March of ’09.

Finally, our renovation based revenues fell 18% in the quarter largely due to weakness at the big box stores. Internationally, construction activity weakened worldwide. Total construction fell 20% in Q1 with Europe down 29% and Asia Pacific down a more modest 5%.

Moving to polymers and fluids, in Q1 segment revenues decreased 2.9% and operating income fell 246.7%. That number obviously impacted by the impairment. Operating margins of -20.8% were 34.5 percentage points lower than the year ago period mainly as a result of 24.3 percentage points of dilution due to impairment, 4.3 percentage points of base margin dilution and 3.6 percentage points of dilution due to acquisitions. The 2.9% decrease in revenues consisted of -16.9% from base revenues; 23.7% contribution from acquisitions; and -9.7% from translation.

Looking a little closer at polymers and fluids, segment revenues declined 16.9% in Q1 versus a decrease of 7.9% in Q4. Again, the sequential weakening of revenues reflect a further fall of in industrial production rates in both North America and international locals as well as slowing in demand from a wide array of MRO products. Worldwide polymer based revenues declined 18% in Q1 with North America down 22% and international down 15% and worldwide fluid based revenues decreased 20% in the quarter with North America down 25% and international down 16%.

Finally our all other segment in Q1 segment revenues declined 15.4% and operating income fell 46.9%. Operating margins of 11.1% were 6.6 percentage points lower than the year ago period largely due to 4.4 percentage points of base margin dilution, 1 percentage point of acquisition dilution and 0.5 percentage points of dilution associated with restructuring. The 15.4% decrease in revenues consisted of -18.9% base revenues; 8.7% contribution from acquisitions; and -5.1% from translation.

As noted the all other segment produced based revenue decline of 18.9% versus a decrease of 7.5% in Q4. This segment principally consisted of four major categories: test and measurement; consumer packaging; finishing; and industrial appliance products. All four categories saw further weakening of base revenue performance in Q1 versus Q4. More specifically test and measurement, worldwide base revenues declined 13% in Q1 versus growth of 3% in Q4. This sequential decline was a result of both a weakening cap ex spending in North America, Europe and Asia.

The consumer packaging worldwide base revenues totaled -15% in Q1 versus -8% in Q4 as weakening demand for graphics, decorating and marketing businesses outweighed positive performance by the zip pack consumer packaging business. In the finishing area worldwide base revenues fell 24% in Q1 versus a base revenue decline of 8% in Q4 and in Q1 North America finishing was down 33% and international finishing was down 22%.

Finally, industrial appliance products worldwide base revenues declined 28% in the quarter versus a base revenue decrease of 15% in Q4 but worldwide appliance subcategory base revenues decreased 24% in the quarter as housing starts and renovation activity continued to weaken in the quarter.

Now, at this point I’ll turn it back over to Ron who will take you through the second quarter 2009 forecast.

Ronald D. Kropp

As a result of the ongoing broad based weakness we have limited long term visibility to the worldwide end markets therefore, at this time we are limiting our forecast to just the second quarter of 2009. For the second quarter we are forecasting diluted income per share from continuing operations to be within a range of $0.25 to $0.37. The low end of this range assumes a 28% decrease in total revenues from 2008 and the high end of the range assumes a 23% decrease. The midpoint of this EPS range of $0.31 would be 67% lower than 2008.

Given the economic situation a more relevant comparison maybe to the first quarter of 2009. The second quarter 2009 forecasted revenues would be higher versus the first quarter by a range of 5% to 11% and the second quarter EPS would be higher than the first quarter by 47% to 118%.

Other assumptions included in this forecast are exchange rates holding at current levels, restructuring costs of $50 to $70 million for the second quarter which compares to $33 million for the first quarter, net non-operating expense in a range of $35 to $40 million for the second quarter and a tax rate range between 24.75% and 25.25% for the second quarter.

I will now turn it back over to John for the Q&A.

John Brooklier

We’ll open the call to your questions. We’ll ask once again very politely to please honor our one question, one follow up question policy.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Wertheimer – Morgan Stanley.

Robert Wertheimer – Morgan Stanley

First question I guess would be whether you have given any guidance to your units or whether they’ve conveyed up to you sort of what level of business they’re trying to size for? It’s sort of a question of how much of the downturn is inventory or not but, obviously you can make some cuts that would impair future growth or you can believe that there’s no future growth for a while and you can cut deeper. So, I guess that’s the question if you’re able to address it.

David B. Speer

Rob, we’ve been at this from a sizing standpoint here for the last three quarters in a number of our businesses and in auto and construction even longer. It’s not a perfect science, it’s hard to give you a precise answer to your question but clearly as we approached 2009 as I think we’ve shared with you folks in the past, we were looking at a first quarter that we felt was going to be down 16% in our base businesses and as Ron just told you as he went through the numbers it was closer to 24% so clearly a 50% lower activity level than what we had projected.

So, we entered the year with businesses collectively looking at their own markets but, overall that was what we were expecting so clearly during the quarter we took further restructuring measures as a result of looking at even weaker activity levels. It’s hard to predict how weak some of those activity levels will be going forward as John pointed out with the auto data as an example. The first quarter was clearly a significantly lower quarter, the second quarter looks to be somewhat better.

So, sizing the business in this environment is not a very accurate science. I can tell you that we’ve made adjustments based on what we expect now to be lower operating levels than what we had originally projected for Q2 and frankly, for Q3 and Q4 it’s not even appropriate for us to comment at this moment because until we get through Q2 it’s hard to predict what those quarters will look like.

But, the last three months we have seen base business declines in the 20% plus categories so the numbers have been similar from January through March although the differences is among segment and between domestic and international have been somewhat different. So, we’ve clearly spent a significant amount of money in restructuring the last two quarters. Between the fourth quarter last year and the first quarter of this year we’ve spent over $60 million and we’re targeting to spend another $60 million during the second quarter.

So, we continue to allow our businesses to determine what the right balance is between restructuring and investing in the long term and we really use the bottoms up approach in generating these restructuring projects.

Robert Wertheimer – Morgan Stanley

As a follow up I guess if I can ask it, can ‘010 earnings be up from ’09? And, if so, will it be because you’ve restructured and you’re actually aiming to be profitable at this business level or will it be because the markets come back?

David B. Speer

Well, it’s clearly difficult to give any view of ‘010 in terms of any finite numbers but clearly I would expect with what we have done in restructuring and with what I would anticipate to be, albeit modest summer coverage in end markets in 2010, I would certainly expect earnings in 2010 to be greater.

Operator

Your next question comes from John Inch – Bank of America Merrill Lynch.

John Inch – Bank of America Merrill Lynch

The revenue guidance, the up 5% to 11%, what does that impute to with respect to the base business range? What kind of base business are you expecting in the second quarter?

Ronald D. Kropp

Low 20s.

John Inch – Bank of America Merrill Lynch

Is there kind of any material difference in base business versus the trend or no?

Ronald D. Kropp

I think the way to think of it is, it is up from the first quarter 5% to 11% sequentially or it would be but, if you look at just the last half of the first quarter it’s more in a range of 0% to 6% above that last half because the first half of the quarter was typically lower in the January and December time frame for international that falls in our first quarter.

David B. Speer

There’s also a larger translation headwind in the second quarter as well, 10%.

John Inch – Bank of America Merrill Lynch

But basically the question really is if you factor in sort of those sorts of data and just the comparisons is base business stabilizing or is it getting a little bit better, a little bit worse, how should we think about that?

David B. Speer

John, I think the way to think about it overall is that the numbers the last two months have been pretty consistent but it’s made up of a lot of moving parts. So, while auto improved in March over February, other businesses decreased from February to March. But, the overall numbers the last two months have been in that 22% to 24% range in terms of base so from that standpoint we haven’t seen any further declines.

I would expect that based on what we’re seeing in some of the end markets that we would expect to see as our second quarter outlook suggests, some modest improvement in these end markets but still on a comp basis compared to the second quarter of last year the comps on a base business basis would actually be higher.

John Inch – Bank of America Merrill Lynch

So I understand this, seasonally your second quarter is traditionally a little bit stronger so you’re saying that trend is likely to continue. If you look at the year-over-year deltas they’re kind of in the same zone, is that fair?

David B. Speer

That’s a fair statement.

John Inch – Bank of America Merrill Lynch

Although you said David you thought auto is going to get a little bit better so I’m just wondering if that was material enough to sort of uplift the whole thing?

David B. Speer

No, I was just using auto as an example of something that’s gotten better in the last couple of months but no, auto alone is not significant enough to raise the whole [inaudible].

John Inch – Bank of America Merrill Lynch

Then my follow up then is really just a question on variable contribution margins. I think on the base again, these are just your numbers, it looks like it was down about 39% year-over-year. So, what does that number kind of in the second quarter? What sort of variable detrimental margins if you will, are you expecting on base business? Are you expecting it to get better, worse, constant?

Ronald D. Kropp

I think pretty similar, maybe slightly better given the level of restructuring we’ve had but definitely in the less than 40% range. I mean detrimental we’re talking about here so less is better. So, a little bit better than 39%.

John Inch – Bank of America Merrill Lynch

When you say a little bit better you mean is it better than 30%?

David B. Speer

No, no, no maybe a point or two better. Maybe 35% or 36% not 30%.

Operator

Our next question comes from Henry Kirn – UBS.

Henry Kirn – UBS

A quick question on the destocking, where are we with distributor and [OEM] destocking at this point?

David B. Speer

That’s a great question, I’m still looking for the answer myself Henry. I would say that clearly in some businesses we know that the inventory is not really in the pipeline. I would say that is true in our residential construction businesses. We know that there has not been inventory in the pipeline for some time so that’s really not been an inventory correction scenario. Some of the later cycle businesses like our welding businesses we suspect we’re still seeing destocking going on. In fact, we know that by comparing with some of our larger channel partners what their end sale activity is versus their purchases from us. So, we know there’s still a disconnect there.

I would suspect that it’s probably given that some of those later cycle businesses only really began to decline towards the later part of the fourth quarter that we’re probably going to see some continued destocking in the first month or so of the second quarter. I would think overall though here certainly in North America we would have to begin to see that destocking activity really come to an end sometime really during the second quarter.

The international markets, Europe in particular it started later, I’m sure that it’s going to take a little longer for that to work through the system but it would be I suspect less material impact by the second half of the second quarter if you will than what we’ve been seeing.

Henry Kirn – UBS

Could you talk a little bit about pricing power across your end markets? Are you competitors behaving rationally or are you seeing spots where folks are discounting?

David B. Speer

Well you see obviously in any of these kinds of markets with the kind of displacements we’ve seen you see a variety of activity. You see some that are making pricing decisions in order to move inventory. We’ve discovered that in order to move inventory you have to actually have an order so the time to cut prices is not then. I think really what we’re seeing overall is generally price stability in most of our markets.

In fact, during the quarter we gained about 150 basis points on the price cost scenarios. So, costs have come down more rapidly than prices have so I think that’s pretty much what we have seen across our businesses.

Operator

Your next question comes from Mark Koznarek – Cleveland Research Company.

Mark Koznarek – Cleveland Research Company

A question on the auto, the transportation business in the quarter it looks like you guys actually outperform the unit build by about 10 percentage points and is that something we ought to expect to continue in the second quarter?

Ronald D. Kropp

I think the out performance was more like five or six points.

David B. Speer

But on a percentage basis he’s right.

Ronald D. Kropp

On a percentage basis yes.

David B. Speer

Mark, I would say that our typical performance from a penetration standpoint is in the four to five point range and I think that’s probably more typical. I think it is very dependent on what vehicles get built during the quarter and I would not suggest that the 10 point gains that we saw are what I would dial in for the year. I think more typical is in the five point range.

Mark Koznarek – Cleveland Research Company

Then just kind of stepping back, the overall decision to withdraw guidance for the year here, there’s been a couple of comments and discussions already about how the business you know maybe stabilized is the wrong word if you can apply that to down 20% but if the last three months you’ve had a relatively consistent pace of decline each month why pull the guidance? Why not conclude that possibly the year stays down 20%. Is it that the potential range would have been just so broad to not be valuable or do you actually think things could further weaken from here?

David B. Speer

Well, I think you’ve answered the question in what you just said there, it could weak from here, it could strengthen from here. It’s hard enough to look at the quarter let alone begin to look at what the year might yield. I would expect that if the trend we have built in to our second quarter outlook in fact come true in the revenue line then we will be able to say we’ve seen some stability in some of these end markets and perhaps we’ll be in a better position to look further ahead but at this point it’s very difficult to look further forward.

You may recall that only in January we were talking about auto builds that were expected to be in the 10 million range and by the end of February we were talking about auto builds that were in the eight million auto range. So, pretty hard to put together a very accurate forecasting around these end markets as they continue to be volatile and adjust as quickly as they have.

So, it’s really a question of visibility and as you know we traditionally provided annual guidance and I think when we see enough stability in the end markets to be able to look at activity levels with some levels of confidence we’ll certainly return to doing that.

Ronald D. Kropp

I would also add Mark that unlike many companies, we’ll still be providing you with monthly updates so we can confirm on the off months the quarterly guidance that we’re giving you so I think that should give you at least some quasi direction in terms of what might be happening longer term.

Mark Koznarek – Cleveland Research Company

That stability you’re looking for would that be something across the board or is there like one or two key indicators that really you focus on?

David B. Speer

I’d be looking for it to be reasonably across our various segments. You know, we may see some stability in one or two segments before we see it in all of our segments so I wouldn’t want to predict exactly what it’s going to take but it’s going to take overall more stability in terms of market outlooks than what we clearly have today.

Operator

Your next question comes from Jamie Cook – Credit Suisse.

Jamie Cook – Credit Suisse

My first question I just wanted to follow up on I think an earlier one. David, you mentioned that when you mentioned EPS for 2010 could possibly be up you talked about some markets possibly being up, so which ones do you anticipate to sort of trend up first? Then, if you could just walk me through we talked about you had I think $33 million in restructuring in Q1 and will see another $60 or so in the second quarter, I’m just trying to think about how I should think about those cost savings as we roll in to the second half of the year and the implications for ‘010? We can make our own assumptions on what the markets will do!

David B. Speer

I think if I were to talk about end markets that I would expect to see improvements in ’010 I mean obviously it may be a bit premature to put any range on those but I would expect that with an 8 million vehicle build in the US as an example and a 15 million vehicle build in Europe this year, that we would expect to see some upside in those markets as an example. We’ve said in our original discussion about 2009 when asked about what we saw in terms of timing for an industrial recovery that we didn’t believe that would occur to sometime mid next year. I think that’s probably likely as well.

So, I would expect based on what we would expect to see in terms of cyclical recovery that we would begin to see a number of end markets respond with more favorable conditions. But, we’ve also said that we don’t expect this to be a very fast and dramatically upward recovery in a lot of these end markets. I think it’s going to be a much slower recovery, the slope of the curve will be much different than it was clearly going in to these downturns and so I think the improvements while I expect them to be modest improvements, I think they’ll be by the middle of next year much more broad based than just a handful of markets that we might see towards the end of the year.

As it relates to the restructuring numbers, clearly the reason for a bigger number in the second quarter is particularly a number of our international businesses are adjusting to the new realities of their end market demands. That’s clearly true in Europe and to some extent in the Asia Pacific regions and we continue with some of our later cycle businesses here to really resize the businesses based on what looks like different activity levels and what they began their planning scenarios with this year. I don’t know Ron whether you have any other comments you’d like to add to that?

Ronald D. Kropp

I think the way to think about the savings is typically we’re able to do better than a one-for-one payback on the spend. So, if you look at the fourth quarter of ’08 and the first quarter of ’09 that’s $65 million or so spend so you’re probably looking north of that for the 2009 benefit and obviously there will be benefit around the $60 million spend in the second quarter but not a full years worth.

Operator

Your next question comes from Andrew Casey – Wachovia Capital Markets, LLC.

Andrew Casey – Wachovia Capital Markets, LLC

A question on the industrial packaging, just within that have you seen any rate of decline moderation for North American consumables?

David B. Speer

No, we have not so far Andy. If you look at the key end markets that we highlight when we talk about the business here certainly if you talk about the metals market, the steel and aluminum markets primarily, those markets are clearly well down. Those markets as you know serve key end customers like automotive and appliance markets and those markets are well down. The second big category for them are building materials, lumber, brick block, pavers, etc., those markets are also well off.

So, we’ve seen no significant improvement in consumable demand and obviously not on the equipment side either. In the general industrial markets we’ve likewise have continued to see declines there although not at the same rate as obviously the metals and the construction markets.

Andrew Casey – Wachovia Capital Markets, LLC

Lastly, could you possibly give us an update on the progress for the divestitures?

David B. Speer

Sure, let me give you a quick update on where we are at. As you know, we have several businesses held in the discontinued operations category. The Click Commerce software business is the first one that I would talk about. We’ve been at that process now in terms of divestiture I guess now for probably about three months in terms of actively marketing the business. We are in the final rounds of discussions with several potential buyers at the moment and if the timeline we have at the moment holds we would expect to divest that business sometime during the second quarter.

On the decorative surfaces group, that process has been much slower. It required audited financial statements given its size and significance which we are just finalizing now with the auditors. Obviously, the market conditions since we announced this in August have changed significantly so over the next several months we will be accessing the market conditions and see what kind of process we think we can actually run with those businesses and we’ll make a determination based on that as to how we proceed and what the likely outcomes are.

Operator

Your next question comes from Daniel Dowd – Bernstein.

Daniel Dowd – Bernstein

Can you spend some time talking about the acquisition pipeline if you’re seeing any activity in any particular areas or what kind of areas you’re seeing it in?

David B. Speer

Dan, we have not really seen any significant improvement first of all. As you saw from the data that Ron talked to earlier we did six deals for $75 million in the first quarter. The pipeline right now in total is under $300 million in size. To put that in perspective, this time last year it was about four times that size so the same phenomena we reported when we talked about fourth quarter in the pipeline as we look at this year continues and that is that a lot of potential sellers have clearly either decided to push back from the table or are reevaluating all together whether they want to be in the market selling at this moment.

We’ve not seen any significant change in that regard. The acquisitions that we’ve done in the quarter we did two in the industrial packaging space and several others spread around different groups so there’s been no significant areas. Obviously, as you can see from the numbers, none of them were large individual transactions. The outlook for the second quarter in terms of the pipeline remains roughly the same as what we saw in the first quarter. It might be modestly better but again, too early to predict any precision on the numbers. So, no material change I would say is the best way to sum up what we see in the pipeline at the moment.

Daniel Dowd – Bernstein

So if we assume that the pipeline remains as slow in Q2 and probably in Q3 as you’re seeing now and potentially the Click Commerce deal closes, what would you have to see in the macro economy or in your specific order book to make you think about or review your options for the cash on the balance sheet or the cash that will be building up?

David B. Speer

Well, I think as we’ve said all along Dan we’re clearly interested from an acquisition standpoint, that is a definitely preferred use of free cash. Obviously, we’re opportunistic in terms of how we look at those acquisitions and valuation discipline. So, we have to have ready and willing sellers on the other side of the table to be able to transact. With that said, I’m not worried about accumulating cash in this environment because I do believe that at some point whether it’s in the third quarter or the fourth quarter or maybe even early next year, this acquisition environment is in fact going to change.

It’s clear that there are going to be a whole host of sellers in the market that due to lots of different reasons reality sets in-in terms of earnings potential, perhaps lenders set in-in terms of their willingness to renew lines of credit. There will be lots of different circumstances that I think will create a much more robust environment and we’re going to be patient and be ready to react when in fact that happens.

We’ve got a laundry list if you will, of targets we’d love to be able to transact going forward and I think as the market improves and as those assets become available we’re going to be ready to move. So, I think that any storage of cash in my view from an acquisition standpoint is not going to be a long term issue for us.

Ronald D. Kropp

The other thing that I would add is that one of the reasons we decided to take advantage of the credit markets this quarter and issue some bonds was to give ourselves the flexibility longer term for acquisitions as the market frees up.

Daniel Dowd – Bernstein

I assume, the way you’ve stated your policy on dividends it’s about a trailing net income, that would imply given what’s happened to net income that your dividends are heading down. But, I assume with this level of cash build up you’re not anticipating any changes to the dividend?

David B. Speer

Well, our dividend policy is based on a trailing two year look so the real dramatic decline in earnings is a 2009 phenomena which means that would that would have a 2010 impact as we evaluate it. That’s certainly not me signaling any suggested change in the dividend. We’re comfortable with the cash flows and the dividend rate we have at the moment. We’ve made no decisions around changing that and we evaluate our dividend policy annually, our dividend payout and I expect that as we do that again this year we’d expect to see the normal approach that we’ve used in a similar outcome. I would not signal anything that would suggest that because of the weaker operating environment that we’re making any decision about changing our dividend approach.

Operator

Your next question comes from Joel Tiss – Buckingham Research.

Joel Tiss – Buckingham Research

Can you just talk for a second maybe Ron about this assets held for sale line because I see year-over-year its risen a lot. Is there anything else in there besides Click Commerce and the decorative surfaces business? And maybe, how do you account for the values of the properties in there also?

Ronald D. Kropp

So, the way discontinued operations accounting works is you classify the assets held for sale for the businesses that are considered for sale and you don’t necessarily go back and restate the prior period. So, if you’re looking back at this time last year on the balance sheet you have to remember the biggest piece in there is the decorative services group the [inaudible] business and that became part of discontinued operations in the third quarter of 2008. So, that would not be included in the numbers if you look a year ago there.

Joel Tiss – Buckingham Research

Is this your best guess at realizable value today or is this just what sort of the asset values of the businesses are?

Ronald D. Kropp

It’s the historical costs basis of asset values. The only adjustments you make for value is if your cost basis is higher than what you expect to get from a proceeds perspective.

Joel Tiss – Buckingham Research

Then just a quick to drill in to the food business a little bit, can you talk about if you’re seeing any potential positive impacts in the food segment from some of your competitors becoming so levered?

David B. Speer

No, we have not seen any significant change if you’re talking about on the competitive front, no. Obviously, I’m not spending a lot of time focused on what our competitors’ numbers look like but certainly we’re pleased with given the environment what we’ve been able to accomplish in those businesses. The services volume as Ron pointed out was down 3% in the quarter here in North America. We have seen service push back as some customers have delayed doing service all together but clearly at -3% compared to the end markets, that’s a pretty good outcome but, I can’t say that we’ve seen any significant change in the competitive profile in the markets certainly in the last 90 days.

Operator

Your next question comes from Ann Duignan – J.P. Morgan.

Ann Duignan – J.P. Morgan

Can I dig a little bit more in to restructuring and can you help me figure out for the monies that you’ve spent what percent of your workforce have you reduced or intend to reduce or can you give me absolute numbers? I’m just trying to keep track of the percent of headcount reduction?

David B. Speer

Yes, absolute numbers would be tough to give you but if you look at it on sort of a global headcount basis at this point in our restructuring over the last probably six to nine months we have probably reduced our headcount somewhere in the 2,500 to 3,000 range. As a percentage it’s hard to give you a precise percentage because our numbers also include acquired businesses which have brought in a significant number of employees to our overall headcount. So, I can’t really give you a precise answer looking at it on quite that basis Ann.

Ann Duignan – J.P. Morgan

And looking forward then with the monies you’re going to spend this quarter, you’ve spent about roughly $60 million and you’re going to spend roughly another $60 million. Should we conclude that the headcount reduction will be somewhere in the order of magnitude of 5,000 to 6,000 total by the time we get done?

David B. Speer

Yes, probably by the time we get done that’s reasonable, yes. About 75% to 80% of the restructuring dollars are related to people related expenses. So, that’s a pretty good measure.

Ann Duignan – J.P. Morgan

And that’s exactly what I wanted to follow up on, of the 25% to 15%, the remaining spend are you taking permanent capacity out at this point or are you still kind of running at sub optimum capacity utilization levels in the hope that when these cycles turn they’ll go back to where they were or do you think some of these industries, let’s take automotive for example that it’s never going to go back to 18 million par and so you’re permanently right sizing some of these businesses? Can you just give me some color on that, that would be great.

David B. Speer

We’ve done some of all of that Ann, some of this is capacity that we basically have moth balled. In other words we haven’t rid ourselves of the capacity but we’ve basically put it moth balls with the expectation that we’ll be able to use it again in the future. We’re not clear when that future is but we feel comfortable enough that we think we’ll need it. In other cases we have made permanent capacity reductions. We are not of the belief that the US auto market is going to return to 17 or 18 million vehicle builds anytime soon and so we’re not making our planning scenarios around anything that would look like that.

I just use that as an example of an end market that clearly we don’t expect to return to those kinds of levels. In some cases these are short term adjustments, in other cases as we get more clarity around where we think the end markets will end up over the next several years we’ll make longer term decisions so it’s really a combination. I would say the majority of what we have done has been more downsizing the labor force to utilize the capacities that we have meaning that we’ve moth balled more capacity than what we’ve retired.

Ann Duignan – J.P. Morgan

Just real quick, you’ve always given us some good color on the challenges facing some of your customers and particularly your small customers, I mean you were one of the firsts to talk about the lack of private availability out there for example for food equipment customers. Can you give us any color on what you’re seeing out there now? Have you seen any opening up of private to some of these smaller customers?

David B. Speer

I think inside the smaller to medium size customer base maybe some modest improvement in credit but not significant. There’s clearly still a significant fear factor in those markets. They were clearly displaced for a period of time in terms of having access to the credit lines that they thought they had so some of them have over reacted and are now storing cash and are making decisions around working capital that you would not make in a normal business environment. So, while I think availability maybe improved modestly the reaction of the segment is still very, very hand to mouth in terms of how people are thinking of investing in those segments today. So, I think there’s still a high degree of nervousness.

If you look across the housing market, clearly the foreclosure issue still has not been effectively addressed and I think until that gets effectively addressed we’re going to continue to see big concerns about what happens with housing values. The end market numbers in terms of starts and permits, they have stabilized at a relatively low level. I say stabilized they bounced around between the high 400s and the mid 500s for the last four months but I don’t see us getting any significant improvement in those markets until we see some real fundamental improvement in the foreclosure process. We’re still seeing a lot of properties dumped on the market of distressed values which are driving down housing values. So, it’s kind of a viscous circle in some of those markets.

Operator

Your next question comes from Shannon O’Callaghan – Barclays Capital.

Shannon O’Callaghan – Barclays Capital

Historically you guys get kind of a seasonal lift in 2Q and then in the second half you’re sort of the same or maybe slightly down from there. It doesn’t sound like you guys are expecting a lot of help from end markets. Are there other things that would hit in that second half that alter that seasonal pattern meaningfully? I mean, is restructuring going to be a net benefit in the second half or what other moving parts are there to think about in that second half?

David B. Speer

Certainly as Ron pointed out the restructuring that we’ve done in the fourth quarter and the first quarter of this year will have impacts clearly in the second half of the year for sure. On the revenue side, it’s great to talk about seasonality and that’s something that we often would look at in a more normal environment but I would also point out that we had a significant decline in the first quarter from the fourth quarter and that’s not normally the trend.

Hard to talk about any level of seasonality especially when you pour into the sort of granular details of some of these markets. I think our expectation in the second quarter is in terms of the modest lift we see is probably not so much about seasonality as it is that we’ve seen some signs we’d expect to see activity levels overall slightly better, but I would describe a whole lot of what we’re looking at as expectations of significant seasonal changes.

Perhaps as we move through the second quarter, we’ll get a better look at that and we may have a different view when we approach the third quarter but I certainly wouldn’t look at any normal seasonal pattern in our numbers as anything we’d expect to see obviously this year.

Shannon O’Callaghan – Barclays Capital

The restructuring benefit in the second half, what did you say again about the high end? Are you going to be above the high end? How much P&L expense are we going to have for restructuring in the second half?

David B. Speer

We haven’t talked about the second half restructuring, we talked about the second quarter at $60 million. But clearly if you take the first quarter at $33 million and the second quarter at $60 million, we’ve already spent the upper end of what we have provided in our original guidance.

I would expect that if we achieve the kind of numbers that we have put out for the second quarter, I would expect the restructuring in the second half of the year to be less than what we’re doing in the first half of the year but I wouldn’t be able to give you any precise look at that until we get a better handle on it.

Operator

Your next question comes from Eli Lustgarten – Longbow Research.

Eli Lustgarten – Longbow Research

One quick clarification, you had a 7.3% I think foreign translation hit in the first quarter. Did you use 10% in the second quarter or the same number?

Ronald D. Kropp

No, I think it’s 10% or 10.2%. 10.2% for the second quarter, Eli.

Eli Lustgarten – Longbow Research

So you were having a bigger hit in the revenue numbers as a 10% number?

Ronald D. Kropp

Yes, the second quarter I believe was the peak in terms of currency valuation. The third quarter was pretty close. Second and third quarter we’d expect to be in that 10% plus range in terms of just The translation differences.

Eli Lustgarten – Longbow Research

Can we talk a little bit about both transportation and construction? Both of them lost money in the quarter. Can you look at volume levels in the second quarter, can we get to break even in those businesses in the second quarter or by the end of the year?

More importantly, given as I said your 8 million cars and you’re not going back to 15 million plus so quickly, can that business get back to double digit margins in the next 12 or 18 months based on modest improvements in volume or does it really take to get back closer to prior levels to get to the double digit margins?

David B. Speer

I think a couple things. First of all yes we look at the transportation segment in particular the auto builds were the most dramatically declined, they were down more than 50% globally in the first quarter. Obviously we weren’t sized for that number one, and number two we don’t believe that’s the ongoing market demand. We think it’s modestly better than that as our Q2 numbers would suggest.

We would clearly expect the transportation segment to return to profitability. I believe that’ll happen in Q2. In terms of being able to get back to double digit operating margins, certainly with this hole in the first quarter I wouldn’t expect that probably to happen this year. I think on a quarterly basis I would expect to see it happen during the year on an annual basis certainly in 2010.

I think it’s a similar story on the construction side. I would expect that as we begin to see the construction volumes improve, the end market activities improve, that we’re going to see improvement in those numbers. These numbers are also impacted by a fairly significant spend in restructuring we have not recognized the benefits of yet which we’ll see in the latter part of the year.

The answer to your question in both cases is I would expect them to be profitable for the year and I’d expect them to be able to return to double digit annual profits hopefully in the 2010 timeframe.

Eli Lustgarten – Longbow Research

Just one follow up, with all the restructuring and acquisitions that you’ve made, is there another list of businesses you’re looking at internally that you may want to divest? You made $5 billion worth of acquisitions but are you taking a hard look at everything to see whether you should be increasing that pipeline of assets for sale?

David B. Speer

We do that as I think we’ve described in the past. It’s an annual process we go through. That process usually begins in the second quarter so we’ll go through that process again. We may well end up deciding that there are other assets that we think don’t fit long term but we haven’t made any of those decisions yet. But that typically is something we do in Q2, Q3.

David B. Speer

Kathy, this’ll be our last question.

Operator

At this time I show no further questions.

David B. Speer

We thank everybody for joining us today and we look forward to talking to you again. Thank you very much.

Operator

This concludes today’s conference call. You may disconnect at this time.

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