Illinois Tool Works Inc (ITW) 2009 Q2 法說會逐字稿

Welcome to the Illinois Tool Works second quarter 2009 earnings conference call.

At this time, all participants are in a listen-only mode.

(Operator Instructions).

Today's conference is being recorded.

If you have any objections you may disconnect at this time.

I will turn the call over to your first host today.

Mr.

John Brooklier, Vice President of Investor Relations.

Sir you may begin.

Thank you.

Good afternoon, everybody, and welcome to ITW's second quarter 2009 conference call.

As noted, I'm John Brooklier and with me today is our CEO, David Speer, and CFO, Ron Kropp.

Thanks for joining us today.

Now, let me turn the call over to David who will make some very brief remarks on what turned out to be a better than expected quarter for us.

Thank you, John.

I'm pleased to report that our recently concluded quarter represented an improvement on a number of fronts, especially when you compare our second quarter to our first quarter 2009 results.

While base revenues were still significantly negative at minus 22% in the second quarter compared to 2008, our base revenues do appear to have stabilized.

Sequentially, base revenues in the second quarter were modestly better than the base revenues at minus 23.3% in the first quarter of the year.

And we have now seen four consecutive months of reasonably stable base revenue performance.

Sequential operating margins significantly improved in the second quarter, with margins at 9.9%.

Excluding the impairment we experienced in the first quarter, our second quarter margins were 410 basis points better than our first quarter margins.

Much of this improvement was due to the benefits of the restructuring programs that have been underway the last several quarters.

While our second quarter earnings of $0.36 a share were significantly lower than the year ago period, they represent real improvement from the first quarter.

Please note our earnings in the quarter were negatively impacted by discrete income tax charges, and a higher than expected tax rate.

As a result, the Q2 earnings were reduced by $0.05 per share.

Our very strong free operating cash flow of $567 million was $213 million higher than the year ago period, and represented a significant net income to free operating cash flow conversion rate of 321%.

Our first half 2009 free operating cash flow total was $950 million.

Our strong free cash flow year-to-date has largely been driven by significant reductions in working capital.

And finally, we are pleased with the upward trajectory of the Company's operating margins and earnings.

We remain mindful that the macro economic data and the worldwide end markets in aggregate remain weak.

At best, we expect minimal end market recovery in the second half of the year and into next year.

Now, let me turn the call back over to John.

Thanks, David.

Here is the agenda for today's call.

Ron will join us shortly to join Q2 financial highlights.

I will cover operating highlights for our reporting segments, and then Ron will address our 2009 third quarter forecast.

Finally, we will take your questions and as always we ask for your cooperation for the one question, one follow up question policy.

We are targeting a one hour completion time for today's call.

First let's cover some of the usual items.

Please note that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Private Securities Litigation Reform Act of 1995, including without limitations, statements regarding operating performance, revenue growth, diluted income per share from continuing operations, restructuring expenses and related benefits, tax rates, end market conditions, and the Company's related forecast.

Important factors that could cause actual results to differ materially from the Company's expectations are detailed in ITW's Form 10-K for 2008.

Finally, before we get to Ron, please note that the telephone play back of this conference call is 203-369-3416, no pass code necessary.

The play back number will be available through 12 midnight of August 5th, 2009.

As always, you can access our second quarter conference call PowerPoint presentation via the ITW.com Web site.

Now, let me introduce Ron who will talk about the 2009 financial highlights.

Thanks, John.

Good afternoon, everybody.

Here are the key items for the second quarter.

Revenues decreased 26% due to significantly lower base revenues.

Operating income was down 56% and margins of 9.9% were lower than last year by 670 basis points.

But, improved from the first quarter margins, ex the impairment charge by 410 basis points.

Diluted income per share from continuing operations was $0.36, which was lower than last year by $0.65.

Excluding the impact of the higher expected tax rate of 34%, EPS would have been $0.41, which was the high end of our forecast range.

Despite of the significantly lower income, free operating cash flow was very strong at $567 million or $213 million higher than last year.

Now let's go to the details of our operating results.

Our 25.5% revenue decrease was primarily due to three factors.

First, base revenues were down 22.2%, which was favorable by 70 basis points versus the first quarter.

As David discussed.

we continue to see weakness across our end markets and geographies.

North American base revenues decreased 26.8%, which was 60 basis points more than the first quarter.

International base revenues decreased 17.3%, which was an improvement of 170 basis points from the first quarter.

Next, currency translation decreased revenues by 8.8% which was unfavorable by 160 basis points versus the first quarter negative currency effect.

Lastly, acquisitions added 5.3% to revenue growth, which was 90 basis points lower than the first quarter acquisition impact.

Operating margins for the second quarter of 9.9% were lower than last year by 670 basis points.

The base business margins were lower by 400 basis points, primarily due to the lower sales volume.

However, non-volume added items increased base margins by 310 basis points, as lower costs as a result of restructuring programs and lower raw material costs had a favorable impact.

In addition, acquisitions reduced margins by 80 basis points, translation diluted margins by 70 basis points, and higher restructuring costs reduced margins by 130 basis points.

Restructuring expense for the second quarter was $65 million, which was almost twice as much as the first quarter.

When I turn it back to John, he'll provide more details on the operating results and discuss the individual segments.

In the non-operating area, interest expense was higher by $7 million as a result of the higher interest rates on the long-term bonds issued in March.

Other nonoperating income and expense in the second quarter was unfavorable by $44 million, mainly due to a loss related to the venture capital investment and higher foreign exchange losses.

The second quarter effective tax rate of 34% was higher than the forecasted rate of 25%, due to discreate charges related to German tax audits and the reclassification of the decorative services segment back into continued operations during the quarter.

The higher tax rate reduced earnings by $0.05.

The on going tax rate for the third quarter is expected to be in the range of 27.75% to 28.25%.

Turning to the balance sheet, total invested capital increased $218 million from the first quarter, primarily due to currency translation, as the US dollar weakened during the quarter versus our major currencies.

Accounts receivable DSO was 63.5 days versus 63.2 at the end of the first quarter.

Inventory months on hand was down to 1.9 at the end of the quarter, versus 2.2 at the end of the first quarter.

Excluding the impact of translation, inventory levels were reduced by more than $200 million during the second quarter.

For the second quarter, capital expenditures were $57 million and depreciation was $101 million.

ROIC declined to 8.6% versus 18.8% last year, largely as a result of the lower base business income.

On the financing side, our debt decreased $839 million from the first quarter, as strong free cash flow and proceeds from overseas repatriation were used to pay down commercial paper.

As a result, our debt to capital ratio decreased to 28% in Q2 from 34% in Q1.

Shares outstanding at June 30th were $499.7 million, note that the effect options typically adds 2 million shares to the dilutive share calculation.

Our cash position decreased $505 million the second quarter, as our free operating cash flow of $567 million were utilized for debt payments of $966 million, dividends of $155 million, and acquisitions of $49 million.

Despite the lower income levels, we were able to generate strong free operating cash flow by reducing our working capital, especially inventory.

Regarding acquisitions, we acquired five companies in the second quarter which have annual revenues of $54 million.

We continue to see a reduced level activity in our acquisition pipeline.

I will now turn it back to John to provide more details on the second quarter operating results.

Thanks, Ron.

Now let's review our second quarter highlights.

Starting with industrial packaging, segment revenues declined 35.9% and operating income fell 82.8% in Q2 versus the year ago period.

Operating margins of 3.5% were 970 basis points lower than the year earlier period, due to 710 basis points of margin dilution, 150 basis points of dilution related to translation.

On a sequential basis, operating margins improved 400 basis points in Q2 versus Q1.

A 35.9% decrease in Q2 revenues consisted of minus 26.1% from base revenues, 0.8 from acquisitions, and minus 10.6% of translation.

Moving to the next slide, the industrial packaging segment's Q2 base revenue of minus 26.1% were slightly more negative than base revenues of minus 24.5% in Q1.

The modest sequential fall off in base revenues was largely attributable to negative industrial production rates in key geographies.

For example, US industrial production declined 15.2% in June of 2009, versus the decrease of 14.6% in March 2009.

Euros in industrial production declined 16.8% in May 2009, versus the decrease of 18.5% in March 2009.

These important indexes, along with ongoing weakness to key end markets such as primary metals, construction related materials and manufacturing, led to tepid demand for industrial packaging, consumables, and equipment.

As a result, total North American and international base revenues declined 31.9% and 27.3% respectively.

These metrics were more negative in Q1 when North American base revenues declined 30.1% and international base revenues fell 24.4%.

In the power systems and electronics segment in Q2, segment revenues declined 38.6% and operating income fell 57% versus the year ago period.

Operating margins of 15.3% were 616 basis points lower than the year earlier period, with base margins accounting for 460 basis points of dilution, and restructuring 120 basis points of dilution.

Excluding impairment in Q1 2009, operating margins improved 260 basis points.

The 38.6% decrease in Q2 revenues consisted of minus 36.5% for base revenues, 2% from acquisitions, and minus 4.1% from translation.

Some of the underlying data in the power systems electronic segment, base revenues showed further signs of weakness in Q2, with base revenues at minus 36.5% in Q2, versus minus 31.9% in Q1.

The businesses in this segment largely are welding and PC board fabrication units, are sensitive to both industrial production demand and CapEx spending.

In welding, total world wide base revenues fell 37% in the quarter, with North American base revenue down 41.3%, and international base revenues down 26.4%.

PC board fabrication base revenues declined 59.2% in the quarter, largely due to weak demand for consumer electronic products.

The one bright spot in the segment continued to be our ground support equipment units, which supply at the gate power unit for airplanes at commercial and military airports.

Base revenues grew 4% for these worldwide businesses in Q2.

Moving to the transportation segment, Q2 segment revenues fell 20.3% and operating income declined 75.6% versus the year ago period.

Operating margins of 4.8% were 1100 basis points lower than the year ago period, with base margins accounting for 670 basis points of dilution.

The remainder of the margin dilution was almost equality split between translation, acquisitions, and restructuring.

The better story in the segment is excluding impairment in Q1 2009, operating margins improved 800 basis points in Q2 versus Q1 1.

The 20.3% decrease in Q2 revenues consisted of minus 23.7% for base revenues, 12.7% from acquisitions, and minus 9.4% for translation.

The transportation segment's base revenues improved notably in Q2 versus Q1.

Segment base revenues declined 23.7% in Q2 compared to a base revenue decrease of 35.5% in Q1.

This improvement in base revenues was directly tied to significantly improved auto builds in Europe in Q2.

Our international automotive base revenues declined 22.5% in the second quarter, versus the decrease of 44.1% in Q1.

These improving numbers were a result of build of 4.1 million units in Q2 versus 3 million units in Q1, in part due to the cash for clunkers auto incentive program underway in Europe.

In North America, our base revenues fell 39.5% in Q2 versus a decline of 46.4% in Q1.

as auto builds reached 1.8 million units in Q2 versus 1.7 million units in Q1.

On a year-over-year basis, North American auto builds declined 49% in Q2 with Detroit Three builds down 46%.

And the Detroit Three break out is GM down 54%, ford down 34%, and Chrysler down 85%.

New domestic builds declined 39% in Q2.

Finally in our auto aftermarket set of business, base revenues declined only 12.7% in Q2 as consumers continue to utilize auto aftermarket service and appearance products, as part of the trend of consumers holding on to vehicles for a longer period of time.

Moving to the food equipment segment, Q2 segment revenues declined 16.2% and operating income fell 20.7% versus the year ago period.

Operating margins of 12.9% were 80 basis points lower than the year ago period, mainly due to 50 basis points of dilution related to restructuring activities.

Base margins actually improved 20 basis points in the quarter.

Sequentially, operating margins improved 260 basis points in Q2 versus Q1.

The 16.2% decrease in Q2 revenues consisted of minus 8.5 for base revenues, 1.6% from acquisitions, and minus 9.3% for translation.

Food equipment base revenue performance improved modestly from Q2 to Q1.

Base revenues were minus 8.5% in Q2 versus 9.2% in Q1.

The modest sequential improvement was due to better sales performance in North America.

Specifically, total North American food equipment based revenues declined 8.4% in Q2, compared to a decline of 13.7% in Q1.

Notably, institution equipment sales were down 13.2% in Q2, versus a decrease of 18.1% in Q1.

Sales weakened internationally with food equipment based revenues decreasing 10.2% versus a decline of 5.5% in Q1.

Moving on to the construction product segment, Q2 revenues fell 34.5% and operating income declined 72.8%.

Operating margins of 5.9% were 820 basis points lower than the year ago period, mainly due to 570 basis points of base margin dilution and 210 basis points of dilution associated with translation.

Sequentially, operating margin improved a substantial 910 basis points in Q2 versus Q1, as the cumulative benefits of restructuring impacted the bottom line.

The 34.5% decrease in Q2 revenues consisted of minus 22.1% for base revenues, 0.7% from acquisitions and minus 13.1% for translation.

The construction segment's base revenue decline of 22.1% in Q2 was essentially in line with base revenue decrease of 21.2% in the preceding quarter.

We believe we witnessed signs of end market stabilization both in North America and internationally during the quarter.

In North America, base revenues fell 34% in Q2 versus a decline of 31 in Q1.

More notably, our residential units base revenue declined 43% in Q2, the same as in Q1, even as housing starts were down 48% in Q2 versus the year ago period.

Sequentially, US housing starts in Q2 rose 1% versus Q1.

In the commercial sector, our base revenues declined 32.7%, versus a decrease of 32% in Q1 and in the renovation category, base revenues fell 19.6% in Q2 versus the decline of 18% in Q1.

Base revenues for international businesses declined 20.2% in Q2, versus a decrease of 19.7% in Q1, and European based revenues fell 30.2% and Asia Pacific based revenues fell a mere 2.5% in Q2.

Both metrics were roughly in line with Q1 performance.

The next segment, polymers and fluids, Q2 revenues fell 6.9% and operating income declined 46.1% versus the year ago period.

Operating margins of 10.4% were 750 basis points lower than the year ago period, mainly due to 310 basis points of dilution from acquisitions and 190 basis points of dilution from restructuring.

Excluding impairment, in Q1, operating margins improved 650 basis points in Q2 versus Q1.

The 6.9% decrease in Q2 revenues consisted of minus 15.1 for base revenue, 19.2 from acquisitions and minus 11 from translation.

The polymers segment's base revenues declined 15.1% in Q1 versus a decrease of 16.9 in Q1, as industrial production rates and MRO demand continued to be weak.

This modest sequential improvement in base revenues is primarily a result of better performance from the international units within the segment.

In fluids, worldwide base revenues decreased 15.9% in Q2 versus a decrease of 19.9% in Q1.

The international fluids business saw base revenues decline only 11.2% in Q2 versus 16.4% in Q1, and the North American fluid base revenues declined 22.9% in Q2 versus a decrease of 25.1% in Q1.

Worldwide polymers base revenues fell 17.4% in Q2 versus a decline of approximately 18% in Q1, and international polymers base revenue declined 7.9% in Q2 versus a decrease of 15.4% in Q1.

North American based polymers fell 28.6% versus a decrease of 21.5 in Q1.

Moving on to our decorative surfaces segment, Q2 revenues declined 23.4% and operating income fell 27.2% versus the year ago period.

Operating margins of 13.2% were healthy and were only 70 basis points lower than the year ago period.

There's 160 basis points of dilution from restructuring.

Notably, base margins improved 40 basis points on a year-over-year basis.

Sequentially, operating margins improved 110 basis points in Q2 versus Q1.

The 23.4% decline in Q2 revenues consisted of minus 16 for base revenues, and minus 7.4 for translation.

As noted, the decorative surfaces segment base revenues declined 16% in Q2 versus a base revenue decrease of 17.1% in Q1.

The segment's overall performance continues to benefit from its largely commercial construction mix and ability to continue to take market share in a variety of worldwide high pressure laminate end markets.

The North American laminate business's base revenues declined 20% in Q2 versus the base revenue decrease of 18.6% in Q1.

The business unit's high definition laminate product continued to be attractively designed, and price competitive alternatives to competitive natural and manufactured stone product.

In fact there were a variety of HD premium products that were successfully launched in June of this year.

In Q2 international base revenues declined 11.6% versus base revenue decrease of 13.2% in Q1.

The base revenues from our French and Asian operations were weaker while our UK unit's base revenues out performed in the quarter.

Finally, to our last segment, all other, in Q2, segment revenues declined 18.2%, and operating income fell 46% versus the year ago period.

Operating margins of 13.2% were 680 basis points lower than the year ago period, with 300 basis points of base margin dilution and 230 basis points of dilution associated with restructuring.

Excluding impairment, in Q1, operating margins were 180 basis points higher in Q2 versus Q1.

The 18.2% decline in revenues consisted of minus 20 from base revenues, 8.6 from acquisitions, and minus 6.8 from translation.

As we noted earlier, the all other segment consists of four major reporting categories, test and measurement, consumer packaging, finishing, and industrial appliance products.

The segment's base revenues were modestly more negative in Q2 with base revenues declined 20% in Q2 versus a base revenue decline of 18.9% in Q1.

Very quickly, in test and measurement, worldwide base revenues declined 15.3% in Q2 versus a decrease of 13.2% in Q1.

This modest fall off in base revenues was the result of weakening CapEx spending and North America, Europe, and to a lesser extent Asia.

Consumer packaging, world wise base revenues actually improved in Q2 versus the first quarter, with base revenues declining 12.9% in Q2 versus the base revenue decrease of 15.2% in Q1.

The high coal multi-packaging can and bottle businesses, and its resealable packaging businesses led the way during the quarter.

In finishing, worldwide base revenues for the paint spray, systems and components fell 38.7% at Q2 versus a decrease of 24.1% in Q1.

Sequential slowing was attributable to slower manufacturing and CapEx spending in various geographies.

Finally, in industrial appliance, worldwide base revenues were basically sequentially flat as Q2 based revenues declined 26.9% versus a decrease of 27.8% in Q1.

Declines on housing and renovation activity continue to pressure the appliance portion of this business.

Now, let me turn the call back over to Ron, who will briefly cover our third quarter forecast and related assumptions.

As a result of the on going broad base weakness we have limited our long-term visibility to our worldwide end markets.

Therefore, at this time, we are limiting our forecast to just the third quarter of 2009.

For the third quarter, we are forecasting diluted income per share from continuing operations to be with within a range of $0.39 to $0.51.

The low end of this range assuming a 26% decrease in total revenues from 2008, and the high end of the range assumes a 20% decrease.

The midpoint of this EPS range of $0.45 would be 49% lower than 2008.

Given the economic situation, a more relevant comparison may be to the second quarter of 2009, third quarter 2009 forecasted revenue change from the second quarter of 2009 would be in a range of negative 1% to plus 4%, and the third quarter forecast EPS would be higher by 8% to 42%.

Other assumptions included in this forecast are exchange rates holding at current levels, restructuring costs of 30 to $50 million for the third quarter compared to $65 million in the second quarter, net operating expense in a range of 40 to $45 million for the third quarter, and a tax rate range between 27.75%, and 28.25% for the third quarter versus our tax rate in the second quarter of 34%.

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

Thanks, Ron.

Now we will open the call to questions and I will remind everybody once again we ask everybody please honor our one question and one followup question request.

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions).

One moment, please.

Our first question comes from Terry Darling with Goldman Sachs.

Sir, your line is open.

Thanks.

Afternoon, gentlemen.

Hi, Terry.

Wondering, just trying to decipher r what you really telling us with the low end of 3Q guidance.

If I take the low end of revenues and the high end of restructuring and the high end of tax, I -- for what the decremental margin assumption would have to be on a 2% drop in revenue.

It is like a 60% decremental if I have the math right.

What would have to happen for that to actually occur?

Is there some pricing concerns?

Is there something in the second quarter that, maybe feels a little one-time.

Any help on that for us.

If you look at the revenue range first of all, you have to understand that the third quarter has built into it, the normal seasonal weaknesses that we expect to see in Europe as that is a heavy period of vacations and factory shut downs.

So that sequential comparison, we expect the third quarter even on a normal basis is somewhere in the 5% range lower than our second quarter.

I think obviously the broad ranges lead to some different calculations that could lead you to look at comparisons such as what you have made given the broad range of activity.

Clearly the trends we saw with the margins in the first or excuse me, the second quarter improving to 9.9%, our base assumptions would have those margins north of 10% during the quarter, and I think if you look at all ends of this, the range of earnings therefore becomes much broader, as Ron pointed out, it is a range of improvement over Q2 of 8 to 42%.

So a pretty broad range.

So I think in terms of the math on the low end you could end up with a calculation I haven't done it that would have decrementals like that but the likelihood of decrementals like that based on those revenue assumptions are remote.

Okay.

That's helpful then if we go to the high end of the range just ton revenue discussion, which segments would you expect to be that driver, is that mainly transport, or are there other segments that are obviously uncertain at this point, but most likely to be driving that kind of a sequential improvement?

Well, I think if you, if you look at the overall mix of businesses as John and Ron ran through those detail, you will see a number of the businesses, as indicated in my earlier comments, a number of the segments have stabilized.

There are still some like the welding group in particular, that we have continued to see some decline.

So I can't say that those businesses have bottomed, but the ones that clear slay been more stable and would suggest at least that based on the data we have that would look better in Q3,would certainly be transportation, construction to a lesser extent, food equipment.

So I would say, it is pretty broadly spread as the second quarter results show.

The stability is, I would say fairly broad at the moment with really only the welding organization to a lesser extent a little bit in food equipment with some declines.

Okay.

And just lastly, David, the cash flow very strong this quarter, and the repair of the balance sheet happened sooner than we thought.

What are the triggers that you are looking for in order to move back on to the offensive with the balance sheet, presumably it is not anywhere in the near term you see things stabilize a little more.

If you can help us understand where, how low you are willing to see that net debt to cap ratio go before you get back on the offensive here.

The big variable is obviously acquisitions and acquisitions have been very light.

I wouldn't expect to see a significant change certainly not in the trajectory we see a significant improvement in the acquisition activity.

And we have said since we provide guidance originally this year that we saw a weak, a weakening acquisition environment, and we are comfortable, obviously storing cash and storing our credit capabilities for when that environment improves, because we believe it will be significant opportunities for the Company.

So I don't expect to see any change upward in that debt to cap which I think was what was your question aimed at until we see a significant improvement in acquisition activity.

Thanks very much.

The next question comes from Deane Dray with FBR Capital Markets.

Sir your line is open.

Thank you.

Good afternoon.

Hi.

It has been a while since we got to talk about decorative services and now it is back in the core business.

And one of the things that struck me on the results of the quarter is how skewed it is to the commercial construction markets.

And if we are at the beginning of a significant downturn there, how badly do you think this business fares in as you start to see the fall off?

Well, certainly it, Deane, as you know and pointed out in your comment, the commercial markets are the most important segment overall for the Company here, for the decorative services business.

About 65% of their business is in commercial.

Now it is not all commercial construction as in building per se, but it ends up in commercial buildings, commercial businesses.

So a fair amount of that is in retail store fixtures, case goods, items like that, office furniture certainly is a portion of that.

So, a broad variety of end markets that end up in various commercial areas.

What we have seen happen, Deane, is that the advent of a lot of our newer product ranges in decorative services, particularly the high definition series has helped us gain market penetration in some of those commercial markets, where people are looking at using those premium, laminate products as in some cases a trade down and a cost savings alternative to using other surface materials like natural stones or even engineered stone products.

So while the trajectory in commercial is down, it certainly don't think we have the same kind of trajectory in those businesses certainly.

In Europe it is a much more balanced as it is in Asia where it is primarily a commercial category.

However for a broad variety of end market activities and certainly in those markets we have not seen the same declining we have seen in the commercial markets here.

That's very helpful.

And just, my follow up to an earlier comment on power systems, I believe I heard you say you are not expecting to see that have stabilized here.

That's one of ITW's more late cycle businesses, but just take a tour geographically, what end markets and the expectations and how power systems fares.

Well, I think what I said Deane was that we have not seen the stabilization I described earlier stabilization as being three to four months of relatively consistent activity.

We have not seen that overall, the power systems and electronics, notably the welding businesses we have seen more stability recently but frankly only for a couple of months, so hard to call that yet.

The electronics segment we have not seen any stability yet.

Although we have an order book that is looking at least modestly better.

Too early to call any turn there.

So I would expect that we will see some choppy numbers in Q3 in those markets.

And probably during the quarter, we may well be able to say that we have seen stabilization but certainly entering the quarter we can't say that.

That's helpful.

Thank you.

The next question comes from Jamie Cook with Credit Suisse.

Your line is open.

Good afternoon, and nice quarter.

First question, we saw another improvement in decremental margins the second quarter versus the first quarter, your margin of 9.9% was slightly better than what I thought.

I am just wondering if you can comment on how you see margins trending toward the end of the year.

Can we get to the 12% or better given the second quarter performance and if there's any improvement on the decremental and then David if you can just talk about how you are thinking about auto production potentially in 2010 when you think about the US and Europe?

Sure.

Well, the relation to decrementals, there were two primary drivers of good performance in the quarter.

Certainly, the impact of restructuring, which we have been talking about now for several quarters had a huge impact on the improvements as we talked in our first quarter call, our efforts were really to get our businesses right sized to a much lower market activity level than what we anticipated when we started the year.

We spent $65 million in the second quarter on restructuring, we spent 35 in the first quarter and nearly the same amount in the fourth quarter of last year.

So all in in the last three quarters, we spent $130 million plus dollars in restructuring.

We are now obviously beginning to see those benefits.

The second major factor was the positive impact on the price cost relationship, during the quarter, we had a positive impact of nearly 170 basis points on price cost.

And as you may recall, we were also signaling that we saw some recovery occurring there as costs began to mediate and the impact of cost increases particularly toward the end of last year began to come into play.

So those, those are very favorable obviously.

Going forward, I would expect that the strength of restructuring, we will continue to see margins powered forward on those.

We are have not yet seen all of those benefits, certainly not all of the benefits for the second quarter, and to some extent, even not those from the first.

Clearly our expectation is without any significant improvement in revenues, that we would expect to see the margins climb certainly well into the double digit territory in the next couple of quarters.

In terms of the auto build for next year we haven't formed a view of exact numbers for next year in North America.

If you look at the current assumptions for 2009 coming out of CSM we are talking about an auto build of somewhere around 7.8 million vehicles, and I think from just our brief review and our long range plan discussions, our folks are probably looking at something between 8.5 to 9 million vehicles next year, but it is very preliminary data at this point.

Don't have any read on Europe yet, although the European numbers are clearly the last half of the year would expect to be somewhere in the 8 million range in terms of the overall build, which is roughly in line with sequentially what occurred in the second quarter.

So, I don't have any read yet though on the European build for 2010.

Thank you.

I will get back in queue.

Your next question comes from Andy Casey with Wells Fargo Securities.

Good afternoon, everybody.

Is that Andy Casey from Wells Fargo?

yes.

Changing my -- everything.

Change your business card?

I got the grandpa specs on everything.

On the first point, trying to understand your consumable versus equipment split in packaging and power systems, was there any improvement in the rate of change in Q2 versus Q1 due to among other things lower rates of destocking?

Boy, on the two sides, industrial packaging, no real significant change in either the equipment or the consumable profile.

So the mix there again is a roughly 70/30, 70% consumables, 30% equipment.

In the industrial packaging.

No notable, no notable changes there, although I would say their businesses are in that category of having reached a reasonable level of stability the last months but no notable change in mix if that was your question, Andy.

On the power electronics side, we have seen better numbers on the consumables than we have on the equipment.

Most of the declines have been related to the equipment.

The consumable volumes have actually stabilized in the last several months, and certainly here in North America, and in Asia.

But the equipment volumes have been much more choppy in the electronics business.

Okay.

Thanks for that clarity.

Then digging into the nonoperating margin improvement contribution, out of the 310 basis points, David I think you indicated about 170 of that was price cost benefit.

Could you give a little color kind of overall on what the other roughly 140 was?

yes, I will let Ron answer that for you.

yes.

So total non-volume impact is 310 basis points for base, 170 is price cost.

The other 140 is all related to cost reductions.

And a large portion of that related to the benefits of restructuring, where we have reduced overhead and other manufacturing costs as a result of restructuring projects.

We also have a lot of on going cost reduction initiatives that don't involve restructuring going on in our various business units, reduced the costs there, and improved margins as well.

The biggest, the biggest segments that have, restructuring benefits are, power systems is one.

Also, construction, FEG and power fluids.

Okay.

If I could follow up on that, just some of the other companies have reported.

We've had some inventory accounting benefit in the margins.

Did you guys see any of that?

No, not this quarter.

Okay.

Thank you.

The next question comes from Joel Tiss with Buckingham Research.

Hey guys, how is it going?

Hey.

I wonder if you can talk a little bit about the snap back in the packaging margins, why does it seem so tame versus what we are seeing in some of the other segments?

You are talking about the improvement in margins.

Yes, yes, just the margins are getting a little bit better versus we have seen some snapbacks in others.

Sure.

Well a large portion of the restructuring that is underway right now in the industrial packaging segment is international.

So we have not yet seen the benefits of those restructuring projects as you may recall, Joel, those take generally, those restructuring projects internationally, the pay back on them is more like 10 to 12 months.

So while we have invested in those, we have yet to see any of the significant benefits yet.

I would expect that over the next several quarters we will begin to see those trends change.

On the cost margin side, they have done reasonably well in terms of cost recovery but they have now begun to see cost increases, particularly in the steel products.

So some of that is mitigated what we expected to see albeit with more stable prices, stronger margin improvement.

Okay.

Also you mentioned a couple of segments that we should see some, continued strength going into the rest stove year and into 2010, you didn't really mention transport.

It seems like auto is snapping back harder than some of the others.

Is there anything below the surface that we should know?

I think what Ron was referring to is where we have significant restructuring benefits coming forward.

I'm not, no I think the transport business segment we should continue to see better margins.

Obviously, the build rates for the rest of the year, in the OEM auto businesses will be better.

Clearly than what we saw in the first two quarters.

And we have done a significant level of restructuring those businesses.

I would expect to see good margin improvement.

Last quick one, have you given us a free cash flow estimate for 2009?

No, we have not.

We know it is 950.

Yes.

The only thing we can say, is that, it is very strong in the first half.

We have done a very good job in both the first and second quarter reducing working capital, receivables the first quart inventory, the second.

And so we have been generating a lot of free cash above and beyond our net income in the first half.

Some of those -- yes, we still have opportunities there, but we won't see quite the impact of reducing the balance sheet as we did in the first half.

So it would be closer to, a little bit more than one time net income, as opposed to, this quarter, was 300 plus percent of net income for cash flow.

Okay.

Thank you very much.

The next question comes from Mark Koznarek with Cleveland Research.

Good afternoon.

Hi, Mark.

I spoke a little bit about restructuring a little bit earlier.

I just want to see if, basically ask the question, what have we got for our $100 million that we have spent year-to-date?

A d what do you expect to get for the remainder of the second half?

And I know obviously the answer is 410 basis points of margin improvement you got so far in the quarter.

But how did that occur?

Specifically can you give me an idea, what amount of head count reduction has been undertaken or have there been facilities that have been shuttered to a material extent.

Can you quantify what you guys have actually done?

Well, most of the restructuring charges and benefits are related to head count.

So if you look across the spend, more than 80% probably closer to 85% of it is related to reduction in personnel.

Don't have a precise number for the reduction for the first two quarters in terms of what were in those restructuring projects, but over the last four quarters, the overall work force reduced by something close to 7,000 people overall.

So somewhere in the 12% range in terms of overall head count.

In terms of the look forward, clearly, as we have moved in the second quarter to more international restructurings, the pay back on those is longer so the margin improvement profiles have been slower on those, but nonetheless we would expect to see continued margin improvement on the basis of what we have already spent.

As Ron highlighted in his earlier comments we expect to spend somewhere in the $40 million range restructuring again in Q3.

So I think the expectation is that we will continue to see margin improvement.

If you look at the second quarter profile, the bulk of the margin improvement, more than two-thirds of it come from the benefits we saw from restructuring projects.

So we would expect that to continue.

Overall the restructuring projects typically if you take the balance between our international and domestic restructuring projects we typically are seeing paybacks that would be in the nine month range if you look at them cumulatively and benefits that are somewhere in the order of 1.2 to 1.3 times the cost.

So we have spent 100 million so far this year, if you just tried to monetize that annualized basis, you would see that being benefits around 120 to $125 million.

Just on the year-to-date.

Correct.

And you can apply the same math as the fourth quarter of last year for the 33 or so we spent.

It is hard to put it in precise quarterly buckets because it doesn't flow.

We believe some of those would have been approved toward the end of the quarter.

You can't really precisely determine the line up by quarter.

That's roughly the way it works.

And you would see that in the impact of the second quarter.

Obviously the full impact of what we were doing in the fourth quarter, and the partial impact on the first quarter realized on the second quarter results.

And the restructuring is happening in the business level.

That's how we do it in our decentralized environment.

So there is a lot of different kinds of restructuring happening at all different times and you asked about shuttering plants.

There are some of those.

It is primarily head count.

There's a lot of flavors of that spread throughout the world in all of the various business units.

Okay.

Great.

That's real helpful.

And we got you to walk out on a limb asking about the future look for vehicle production.

Could I ask you about your outlook on housing starts and commercial construction both domestic and international?

We will start a new segment called forecasting and we will charge for these if we are accurate.

How is that?

My view on the housing front is, we have been bouncing around on the bottom for June that just came out last Friday were modestly better than the ones for May.

They were up about 6%.

We have seen now about 7 months of reasonable stability in the single family housing number.

In fact the single family housing number in June was over 400,000.

It is pretty much in line what we with have been saying.

I think we will see a slow and modest recovery in the housing numbers.

I don't expect to see any significant improvement.

I think by the end of the year we will probably be in a range of annualized activity of probably 550 to 600,000, and I don't see any significant catalyst to change that number remarkably in 2010.

While it will be sequentially better than what we have seen and certainly as the months go on we will see improvements in the 6 to 7% range like we did in June.

I don't expect we are going to see a robust recovery in 2010 in housing.

I think housing is at least a 2011, recovery in terms of significant improvement.

Commercial continues to fall.

The FW Dodge numbers for contracts awarded are still down in the range of minus 50% in terms of square footage on those projects year-to-date.

And the activity levels across the major different segments are still down significantly.

Office down 63%, retail stores down 58, hotel down 57.

Manufacturing 54.

So there's a lot of damage still to be done or realized in the commercial construction markets because these are starts equivalent to starts which means that we are still trending down from buildings that are being completed that were starting in 2006, 2007.

So I think we will continue to see a negative trajectory in the commercial market.

I would expect that the numbers next year won't be as bad as this year, but they'll still be negative but I expect negative mid teens to low 20s.

Okay.

How about international?

International, there is no international indices.

I would expect that in Europe we will see as we have seen recently stability in a number of their commercial markets and that could possibly lead to some more positive comparisons next year.

They have an opportunity to have some positive growth in commercial albeit modest in Europe.

The numbers in Asia clearly have moved upward, particularly as related to infrastructure in markets like China but again there's no one overall index in terms of the international markets.

The international markets would clearly be more favorable than here in US.

I would remind you our international exposure on the commercial side is for bigger than North American.

Remember in construction, 60% of the business is outside of North America.

Right.

Right.

Okay.

Good.

Thanks for that.

Appreciate it.

The next question comes from Daniel Dowd with Bernstein.

Good afternoon.

Hi, Dan.

Let me turn to the acquisition pipeline for a minute.

Are you seeing any differences in the willingness of is sellers in key emerging markets that is different from what you are seeing in North America and Europe or is it pretty uniformly dismal everywhere?

That may be hard to put too much flavor on, Dan because I don't know I have a lot of data specifically on emerging markets, I can tell you I haven't seen anything that would flag anything significantly different: their markets have not been impacted as much as the marks here in terms of revenue and earnings so they are probably not in quite the same situation, but nonetheless, the multiples and the overall valuations in those markets have also been impacted by the downturn particularly to the extent that business in the emerging markets are relying on exports to the developed markets.

I don't think there's much difference but I don't have a lot of data to draw on.

I can say that the pipeline for us is still about what it looked like before, the pipeline in terms of size is in the $300 million range, not a lot of new stuff flowing into the pipeline but I can say that in the last probably four to six weeks I can see more activity and discussions going on around things that could end up going into a pipeline at some point, which is clearly different than what we would have seen 90 days ago.

Maybe we are starting to see early signs of the market adjusting to the realities of valuation which is really the primary issue here.

All right.

Well, let's assume then that the pipeline is pretty weak for the next 12 months or so.

Where do you see your balance sheet ending up at this time next year?

I am not assuming it will remain weak for 12 months but you can do your math on that.

You saw the power of what we were able to do in the second quarter.

As Ron pointed out, a lot of that is based on significant reductions in working capital, which as things stabilize, you won't see those reductions continue to occur but certainly if you look at where we are today in the 27, 28% range, if we continue to see the modest activity we are seeing, we would clearly be in the low 20s, I guess.

That's not my expectation.

I do expect the acquisition market to improve, probably not significantly in our numbers this year but I would expect by the fourth quarter of this year we will be talking about a different look at the pipeline than what we are seeing today.

Is there a debt to equity at which you shift from debt reduction to share buy back?

There could be, but that's not on my radar right now.

Thanks, guys.

The next question comes from Rob McCarthy with Robert W.

Baird.

Good afternoon, guys.

Hey, Rob.

You were kind enough to give us a view of price costs versus call them structural cost benefits in the second quarter.

For restructuring, you should be able, I hope anyway to tell us what $40 million of restructuring expense in the third quarter would mean in terms of margin impact year to year.

It is about 1.2 times, that's been the norm but that's annualized rate so it wouldn't all be realized on the calendar year 2009, but roughly the conversion is about 120%.

If I understood your question correctly.

I'm not sure I understand your answer.

$40 million of spend in Q3 would yield roughly a $48 million benefit on an annualized basis.

That's right.

So it wouldn't all be realized in the calendar year 2009.

It would be realized annualized basis going forward.

So, typically, the restructuring projects the mix of international and domestic have about a 9 month payback, so we would see roughly Q1, Q2 next year, we would see the full impact of those benefits.

If you are talking about, you are talking about the benefit that we get from it, but in terms of knowing what you are going to spend next quarter, and based on your revenue guidance, you should have a view of what kind of dilution of third quarter margin year to year would be created by a $40 million of restructuring spend.

Oh sorry.

I misunderstood your question.

Ron, perhaps you can take it.

Yes.

I think the, if we look at the margins for the third quart looking in the 120 negative basis points, 110 or so negative basis points end margins related to restructuring.

And it would be fair to say then as you go to the fourth, you anniversary large charges last year, I would assume you have some visibility of what you are likely to do this fourth quarter.

We don't on a restructuring basis yet but we would expect it to be less than the third quarter.

Which means then by definition it would be less than the fourth quarter of last year.

Absolutely.

Correct.

Yes, the fourth quarter of last year we spent $35 million.

We would expect at this point to be less than that.

Last year in the third quarter we spent around $20 million or so.

Yes.

What was that?

About double the rate this year of what we spent last year.

Yes.

Sorry.

We only spent 5 million in the second quarter, the third quarter of last year.

So significantly higher this year.

Okay.

Can you give us any idea of what your, I assume the price, your assumption for price cost continues to widen in the third quarter?

And can you tell us what you have embedded in your third quarter guidance, Ron?

Yes.

So, for the second quarter, it was favorable by 170 basis points.

Right.

We have probably reached the the bottom as far as the cost levels.

We are starting to see some of the costs tick up a bit.

So we would expect that the benefit in the third quarter would be less than 170 basis points.

Probably closer to 100.

All right.

Without getting too specific.

Philosophical question, I, you have got recognizing this is a different downturn than past downturns, you have some different businesses than you had in past downturns.

I wonder how you feel about the performance you are seeing out of test and measurement, which is showing overall year-over-year organic declines sort of in line with the industrial production indexes?

And recognizing that they serve more industrial markets wouldn't you have expected a little stronger performance out of that business.

Given it is a capital equipment business it has held up well.

If you look at the other capital equipment businesses, the big plunge occurred in the equipment first and consumables second, and the equipment volumes have remained down.

So in fact at minus 15% in Q2 there's no question in my mind they picked up market share penetration.

In most of our other equipment business, we are talking about declines that are 30% plus in the same economic environment.

So, given the mix of their business which is primarily an equipment business, they have done quite well actually.

In a market that you think is down, compared to the other CapEx markets.

Correct.

Yes.

A lot of it is the same kind of end market so we know the CapEx spend in some of our other business is the same, end markets are down north of 30%, which is pretty consistent to a number of different businesses.

All right.

Thank you, guys.

The next question comes from Ben Elias with Sterne Agee.

Thank you, gentlemen.

I was wondering if you could elaborate a little bit on the food equipment segment, seems to me that North America is improving.

If you could just sort of walk through some of the trends you have seen there, when it comes to the delays and deferrals and CapEx spending and heavy end market.

Thanks.

Sure.

Well, two-thirds of our third business in food equipment is related to institutional which is a more stable base than the casual dining or restaurant businesses.

So that has clearly held our equipment businesses up somewhat better than what you would think about when you look at the overall food markets, at least from a restaurant standpoint.

Institutions being hospital, school, universities, large scale operations.

So, that has had certainly a positive impact, although even in the equipment areas and those categories we are talking about double digit declines.

The strong metric for us in food equipment is a third of our business is aftermarket service.

And the aftermarket service has held up obviously quite well in this market environment, which is obviously made the overall results much more favorable in terms of comparisons when you look at other markets.

So the food service, the aftermarket service is a significant component that has basically been flattish for the last several quarters.

So when you look at the overall mix, it gives us, declines that are less than double digit declines in North America.

The mix is similar internationally, although the equipment sales internationally are a little more diverse in terms of end category, more restaurant concentration, not quite as high as institution concentration.

So a little more volatile on the equipment side internationally.

And the aftermarkets pick up that was largely accounted for the improvement in margins or in the first quarter?

No.

We had some restructuring in there and some of it would have been the impact of the aftermarket service, the margins in those businesses are quite good.

Thank you.

The next question comes from Henry Kirn with UBS.

Good afternoon, guys.

Wondering if you can talk about if you see any impact from the global stimulus packages and maybe on the back of that where in your portfolio you think you might have some exposure?

Global stimulus.

That's an interesting question.

I would say that we haven't been able to measure it yet, but we are hopeful.

Certainly here in North America, the stimulus package as it relates to our kind of businesses, we would expect to see it in construction at some point, we would expect to see it in some other businesses impacted by some of the spend around facilities and research and development.

So probably in some of our test and measure business as well.

We have seen activity on the research and development side, in terms of quotations by a number of groups that would benefit from the stimulus package.

On the construction side we have seen some modest activity in the bid stage but nothing that has materialized.

The transportation infrastructure dollars are beginning to flow, but much of that was already sort of planned projects they now have funding to spend on.

I can't say we've seen a tremendous impact yet, but our prediction was we wouldn't see much impact in 29 on the infrastructure spend here in North America.

As it relates to other markets, it is clearly being utilized in China now.

The stimulus package is on the street and spending is going on.

We have begun to see that in a couple of our segments.

There hasn't been a very well coordinated stimulus package per se in Europe, but one element of what you can call a stimulus package was highlighted earlier in John's comments, which is the Cash For Clunkers European program that spread across several markets, France, Germany, the UK, where there are discounts for trading in older vehicles.

That clearly had an impact on the second quarter auto build in Europe, driving it up to more than 4 vehicles after a 3 million build in the first quarter.

That's probably as much flavor as I can give you on where we see the stimulus and where we expect it will come.

That's helpful.

And in terms of destocking, can you talk a little bit about which categories that might be coming to an end, and where there might still be some destocking to come?

Yes.

It is hard to get an exact read but we think the destocking now is largely over in most of our businesses here in North America.

There's some still modest level of destocking going on in the welding organization, but short of that, most of it seems to be behind us, albeit, they were still performing at much lower market levels of activity.

The European businesses again, most of that destocking would appear to be behind us at this point.

But there's no precise measurement.

So these are sort of gut feels, but I think frankly given what we seen in terms of declines, in the first four or five months of the year, I think it is reasonably safe to assume the vast majority of destocking is done.

There's not a significant level of restocking however that is being initiated.

That's helpful.

Thanks a lot.

We will take one more question.

The last question comes from Ann Duignan with JPMorgan.

Good afternoon, guys.

I snuck in at the end here.

Like last quarter when I didn't get on.

So that's good.

I want to take a step back at the auto production again North America, I am just curious, everybody has seen DSM forecast.

Everybody has an expectation that production is going to pick up after the first half but I am curious if you have gotten any build schedules yet out of the OEMs that is actually is hard evidence that production schedules are pushing up?

North American OEM?

Yes, North American.

North America.

I guess the answer is you can talk about schedules but -- that's probably not a good linkage.

Got you.

The current schedules would suggest that the build in Q3 should be somewhere around 2.1 approximate million vehicles.

That would be up 300,000 from Q2, still down 30% from last year, but certainly sequentially a much better quarter.

I would say that our guys, from initially what they have seen that looks like a reasonable number at the moment but you have to remember also that people like Chrysler as John represented earlier in his comments were down 85%.

So if they build anything in the is second quarter it is an improvement, but we expect that we will see auto numbers in the third quarter somewhere near that number.

Okay.

Good.

And then can you talk a little bit about where demand, I am thinking of things like maybe perhaps and tell me if this is too much a stretch but I am thinking of businesses like Signode, if you're putting more steel into an automotive plant or more components into an automotive plant maybe something like a straps business might start to pick up on the back of that also?

Yes, you might see some of that.

Remember the primary industrial packaging markets for Signode, the number one market for them is metals.

That's steel and aluminum.

And that is really in the mill.

So until you see significant rise in steel output and aluminum output, you are not going to see a significant improvement in that number.

The second biggest market for them is construction materials, lumber, brick, block, items like that are primarily directed toward residential construction.

So until we see a significant rise there, I don't expect we will see it in those markets.

The next biggest market is the general industrial market, and if shipments of goods begin to increase, we certainly would expect to see some increase there, primarily though in consumables because most of the customer base to most markets have plenty of excess capacity.

So I would doubt we would see much in terms of equipment sale uplift but maybe some increases in consumable output.

Okay.

Our colleagues here are anticipating a pretty significant pick up in steel production, on the back of the automotive production, obviously.

Maybe that would have an impact.

If that comes we will certainly see it, yes.

Just one quick follow up on price cost, which raw materials are you seeing the most relief on in terms of cost, is it the oil-based inputs?

Well, actually the biggest improvement that led to the margin improvement we talked about in Q2 was actually around steel, less so around the plastic but as Ron pointed out in his comments, we see now steel at least in most markets has bottomed and several markets we have seen increases in steel.

So, and I would expect to see that the steel profile is going to continue to be one where we will see commodity costs begin to rise from some reasonably good declines.

The plastics and chemical categories which are tied to generally oil-based products, they have been rather choppy, not any significant upward movement but no significant downward either.

So even in a stable environment with those, we would expect to see some price cost improvements as our purchasing power generally helps us in those kind of market environments.

Okay.

I will leave it at that.

I appreciate getting on the call.

Thanks.

Thank you.

Thanks everybody for joining us.

We will talk to you next quarter.

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