派克漢尼汾 (PH) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter Parker Hannifin Corporation earnings release conference call. My name is Nancy. I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today's conference, Ms. Pam Huggins, Vice President and Treasurer of Parker Hannifin Corporation. Please proceed, ma'am.

Thank you, Nancy. Good morning, this is Pam Huggins speaking, just as Nancy said. I'd like to welcome to you Parker Hannifin's second quarter fiscal 2009 earnings release teleconference. Joining me is Chairman, President and Chief Executive Officer, Don Washkewicz, and Executive Vice President and Chief Financial Officer, Tim Pistell. As normal, let me just address a couple of administrative matters prior to beginning with the actual earnings release. First, for those of you on-line you may follow today's presentation with PowerPoint slides that have been presented, and for those of you not on-line the slides will be posted on the Investor Relations portion of Parker's website at phstock.com. I want to call your attention to slide two which is a Safe Harbor disclosure on forward-looking statements and ask that you take note of this statement in its entirety.

Third, moving to slide three, this slide, as required, indicates that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers. Then moving to the agenda on slide four, the call will be in four parts today. First, Don Washkewicz, Chairman, President and Chief Executive Officer, will provide highlights for the quarter. Second, I will provide a review, including key performance measures of the quarter, concluding with the revised outlook for fiscal 2009. The third part of the call will consist of the standard Q&A session, and as a reminder, please ask one question at a time. My goal today is to keep this call to no more than an hour, so please be courteous and get back in the queue if need be. And for the fourth part of the call today Don will close with final comments. At this time I will turn it over to Don and ask that At this time I will turn it over to Don and ask that you refer to slide five titled second quarter highlights.

Thanks, Pam, and good morning to everyone on the call. I want to make a few brief comments, and then Pam will run through a more detailed review of the quarter. First of all, I wanted to share some key aspects of our performance for the quarter. It has become clear in recent months that the global recession has grown deeper and wider than any of us originally anticipated. As evident in reports from other manufacturers in our own orders, we are seeing a significant pull-back in demand across many markets in all regions which has impacted our performance. You may recall at the last meeting, the rest of the world was still doing fairly well. Well, that situation has changed pretty dramatically since.

Numerous customers shutdowns occurred in December, and we brought that up at our December meeting with the analysts here in town. And a lot of those shutdowns now are continuing on into January, so we've seen impact from those shutdowns in our second quarter. We are going to see additional impacts in our third quarter as well. Sales in the second quarter were $2.7 billion, a decline of 5% compared with last year's quarter. What you need to know about that number is that while acquisitions contributed 6%, this was more than offset by negative foreign currency translation of 6%, and a decline in organic sales of about 5%. The drop in sales volumes, of course, led to a decline in earnings. Our earnings per share declined 20% to $0.96 in the quarter. Cash flow from operations year to date was $444 million or 7.7% of sales. And we're fairly pleased with that level of cash flow. That's only off about 6% from last year so it remains at a pretty high level, and, of course, we're planning on continuing to work cash flow throughout the balance of this year.

I am pleased that we're also able to manage and control our inventories on a real-time basis. Excluding acquisitions, inventory is actually down. We'll talk more about that a little later. A bright spot in the quarter is the positive performance of our aerospace segment which delivered 10% sales growth and significantly improved profit and margin performance. On another positive note, recently we were awarded a contract by Rolls Royce valued at $2.5 billion in revenue over its lifetime. That brings our total contract awards over the past two years in aerospace alone to over $12 billion. So we're pretty excited about.

Markets, just a couple comments on market and what we're seeing. As noted in our press release, total orders are down 20% in the quarter versus a year ago. Industrial North American orders decline 18%. Industrial international continued to weaken as we posted a 28% decline in orders, keeping in mind that this is compared with a record demand level in prior year quarter. Orders in the climate industrial control segment declined almost 22% as housing, truck, and automotive markets, in the United States, continued to reel from the credit crisis. We don't see any of that changing in the near term. Aerospace orders did increase a modest 2% as calculated on a rolling 12-month basis. Another bright spot is that distribution is holding relatively steady. Of course, they have been impacted in December with the big drop-off as well, but overall they're holding up well. Since half of our industrial business goes through this channel, that's good news. Given these trends, we have decided to revise our fiscal 2009 earnings guidance downward to a range of $3.85 to $4.25 per diluted share.

As I have shared with everyone on the call before, much of the work that we have completed under the win strategy over the past seven years has been designed to reshape Parker and better prepare us for such a downturn. Although current conditions are somewhat unprecedented, we stand ready to address the challenges ahead, and I am confident we'll emerge even stronger as conditions improve. To prepare for these challenges, we have already initiated appropriate actions throughout the company to reduce workforce and expenses and we have contingency plans in place for further actions should they be required. While there can be no guarantees about what lies ahead, my expectation is that Parker should perform at a much higher level through this downturn than what we did during the previous cycles. We remain focused on our long-term objectives and initiatives as articulated in the win strategy, while simultaneously adjusting our costs to reflect near-term demand. So with that little intro, I'm now going to turn it back over to Pam for a little bit more detail.

Thanks, Don. For more detail on the quarter please reference slide number six at this time, and I will begin by addressing earnings per share. As you can see on this slide, earnings per share for the second quarter is $0.96, and this compares to $1.23 for the same period last year. Moving to slide number seven, the earnings per share decreased in the quarter, versus the same quarter a year ago, as a result of decreased sales of 5%. Obviously as a consequence of the unanticipated and unexpected OEM shutdown. And this was offset by lower tax expense and fewer shares outstanding. Moving to slide eight, and looking at the top line, sales for the quarter, as I said, decreased 5% to $2.7 billion from $2.8 billion last year. Just to give you the components of the 5% reduction in sales, acquisitions contributed 6%. However, this positive effect of acquisitions was offset by currency, which turned negative in the quarter at minus 6%. This which turned negative in the quarter at minus 6%. This was mostly due to international industrial, mainly the euro, as a result of the strengthening dollar. And organic or core growth for the quarter was minus 5%.

Moving to slide number 9, you can see that Parker closed eight acquisitions in the quarter with revenues of $520 million, and on a year-to-date basis, that's $532 million, total of nine acquisitions. Sales in the quarter were aided by aerospace that posted a 10% year over year increase for the quarter. Slide number 10 focusing on segments commencing with North America -- industrial North America, I think most notable with respect to North America is in that spite of the recession, second quarter sales are up .2% and operating margins are 10.8%. Slide 11, continuing with the industrial segment, moving to international, as I mentioned before, currency turned negative in the quarter. It was minus 11%, and this is versus the positive 4% for the previous quarter. Acquisitions added 7% to sales in this segment, and organic growth was minus 7%, obviously up against tough comparisons a year ago. And margins as a percent of sales were double digits at 11% for the quarter. Moving to the aerospace segment, sales increased 10% and margins increased 260 basis points, and this is mainly due to strength in the commercial aftermarket.

Moving to slide 13, climate and industrial control segment, as mentioned previously, softness in North North American and automotive, heavy-duty truck and residential air conditioning is affecting this segment. In addition, due to automotive shutdowns and the continued decline of housing starts, sales are down 17% organically. Our currency at 5% of sales is a deduction to sales for the quarter, and restructuring, as discussed on the last quarterly call, impacted margins. Restructuring was about $5.3 million in this quarter. So moving to orders, for the quarter, Don mentioned some of this, but on slide 14, details orders by segment, and remember, these numbers represent a trailing three-month average and are reported as a percentage increase of absolute dollars year-over-year excluding acquisitions and currency except for aerospace, and aerospace, as will you recall, is reported using a 12-month rolling average. As you can see from the slide, orders are down 20% from the December quarter just ended. This compares to a positive 1% last quarter and a positive 10% a year ago. North American orders for the quarter are down 18% year-over-year. And last year at this time orders were positive 4%, and this compares to a positive 2% sequentially from the September quarter.

Industrial international orders declined 28% year-over-year. However, this is up against a positive 16% last year. And this negative 28% compares to minus 4% last quarter. Aerospace orders were up 2% for the quarter. This compares to 9% last quarter and 19% a year ago. Moving to climate and industrial controls, orders are down 28% for the quarter, and this is down from a positive 5% last quarter and negative 6% a year ago. So at this time moving to the balance sheet, you can see that Parker's balance sheet remains solid. Cash on the balance sheet at quarter end was $262 million. Commercial paper outstanding was $932 million.

Day sales and inventory increased to 71 days from 70 last year, excluding acquisitions. And accounts receivable, in terms of DSO, is 50, flat with last year. Weighted average days payable outstanding has increased from 41 to 47, and this is on a year-to-date basis. So just moving to slide 16, you can see that operating cash flow year to date is $445 million. Of this $445 million, $174 million was used in connection with capital expenditures. Dividends were paid in the amount of $81 million. The remaining cash flow, an additional $834 million, mainly debt, commercial paper for the first half of the year, allowed acquisitions to the tune of $705 million and share repurchases in the open market of $434 million. And just to clarify, not $705 million in revenues of acquisitions, but that was the cash flow impact. So on slide 17, you can see that the debt to total cap ratio is 38.8%, but on a net basis, it's 36.6%.

So now addressing the guidance for fiscal year 2009, which is detailed on slide 18 through 20, on slide 18 the guidance for sales and operating margin by segment has been provided, and on slide 19, guidance has been provided for the items below segment operating income. Slide 20 summarizes the guidance on an earnings per share basis from continuing operations. And as you can see from this slide, the guidance for fiscal year 2009 for earnings per share from continuing operations is projected to be $3.85 to $4.25. Please remember that this forecast includes acquisitions that have been closed, but it excludes any acquisitions that may be made going forward. The full year revised guidance assumes the following. Sales growth decline approximating 10.8% to 11.2%. Segment operating margins as a percent of sales in the range of 11.2% to 11.9%. Corporate administration costs projected to be 6% to 10% lower than fiscal year 2008. Interest expense is projected to be 3% to 10% higher than last year. Other expense projected to be 30% to 40% lower than fiscal year 2008. And we've assumed a tax rate of 27%. Also noteworthy is that the fourth quarter will be slightly better than the third quarter. So at this time, we'll open the call to begin the question-and-answer session.

(Operator Instructions) Stand by for your first question. And your first question comes from the line of Eli Lustgarten. Please proceed.

Good morning, Eli.

Good morning. I wonder if you can help me, if you look out in your volume forecast, you gave the full year, production in North America, down about 8.5%. And in order to get there, I guess we have really big decline, 20% odd in the next two quarters, and the same thing is true for international. You are like down 30% the next two quarters, even with the acquisitions that were made. Wonder if you can help me what are you seeing out there, and what kind of volume decline? The orders are down close to 30% actually. Are you assuming that continues all year and that gets a little worse?

Eli, what we're saying right now is that we don't have any reason to think there's going to be any change at this point in time. I think there's too many unknowns. This is Don speaking. So what we're doing is we're just assuming the state that we see right now is going to continue on throughout the balance of the fiscal year. International, as you know, the orders are down close to 30%, and, of course, 20% elsewhere. So we think that's probably going to continue. If that changes obviously that will change our projections going forward. But that's our best guess right now.

And to follow up, there's no pricing -- is pricing holding? Is there any pricing differential? What's going on in the pricing versus input costs at this point?

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

All right. I'll get back in queue. I guess that's the rule.

Thanks, Eli.

Your next question comes from the line of Nigel Coe.

Good morning, Nigel.

Good morning. Yes. Don, you were quite mixed on the outlook in December. Could you just maybe characterize how end market conditions changed from December to where you are now? And if could you maybe clarify what your organic assumptions are by segment for the full year.

Nigel, this is Pam. You want the organic assumptions in total or what are you looking for exactly?

By segment. You have given us the revenue.

Okay. Let me give you -- he wants it by segment. If you look at the -- let me give you the second half numbers, because I think that will be most helpful to you as you guys are trying to do your work. So North America, the second half, we have that down 26% to 27%, international, 29%, and aerospace, 3%, and climate and industrial controls, down 23%.

And is that organic or was that reported?

That's organic.

Organic. Okay. Thanks.

Your next question comes from the line of Terry Darling from Goldman Sachs.

Thanks. Don or Pam or Tim, I wonder if you would talk about the improvement in decremental margins that's assumed in the second half of your guidance. In that context I'm wondering why we're not talking about more detail about cost-cutting initiatives, costs of those initiatives, timing of savings, magnitude of savings. Fill in some blanks there for us.

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

And two things occurred here really. One is inventory reductions. If we look at the inventory, we took about $75 million out of inventory in this quarter, excluding acquisitions. That has an impact of around 30%, 35% of those dollars will be the impact to us on the operating line. And so we have that effect. The other thing is we have the force reductions and reductions in force. And I guess probably now is as good a time as any to get into that. We've been working on this for weeks actually, where we stand today. It would appear that -- now, operating off a base of around 60,000 employees, plus or minus, it looks like over the course of this year, we're going to have reductions in force of around 9,000. So around 15% of our associates here. About half of that is done, okay, and about half will be done over the coming months. And that's going to be done at a cost of around $30 million, and we think after that is all done and the costs are behind us, it will generate improvements of about $100 million going forward.

So, now, what occurred in this quarter was about $10 million on these RIFs, we call them, reductions in force. So between the inventory reduction of $75 million and the RIFs, if you will, the adjusted MROS comes down about 35%. And actually if we take a look, we did a couple of big acquisitions in the quarter. They don't contribute much in the first quarter. Frankly, if we back those guys out too in their first quarter, we'd be right around the 30%. So that's how we're thinking. That's how we're managing, and that's how we reconcile the numbers. Going forward, as Pam articulated and Don, we're looking and you hear the organic decreases we're building in. We had hoped they'll be better than this, but right now this is what we have to deal with. And we're going to manage to that 30% MROS as best we can.

Okay. Just a couple clarifications there. First, the $10 million was the cost this quarter with no benefit, correct?

Very little benefit in the quarter, that is correct.

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

No, it will be $30 million cost for -- if $30 million is total, we've incurred about $10 million of that. Probably incur another $20 million in the second half.

Okay. That's very helpful. Wondering if on the second half organic numbers, Pam, that you gave, down 30% for industrial international, wonder if you could give us a little color versus Europe versus Latin America versus Asia Pacific.

Sure, I can do that. As you well know, the downturn happened in November. That's when things kind of fell off of a cliff. But in December it continued to get worse. If you look at the steepness of the decline, the steepness was probably greatest in Latin America, believe it or not, and secondly, in Asia Pacific. So you have to remember that the biggest portion of our business is really in Europe. And so if you look geographically and look at the countries in Europe, and you say, okay, where was the steepness of the decline there? Germany and Sweden had the steep. You can look at any country for the most part in Europe, and they were all down significantly beginning in November and extending through December.

And the same sort of balance as you look out to the second half of the fiscal year? You're expecting Latin America, Asia Pacific worse off that 30% bogey in Europe, something under that?

Yes. I think what's safe to say is the decline that we've seen we've built into the forecast going forward.

This is Terry, right, still?

Yes.

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

Understood. Appreciate it.

Thank you.

Your next question comes from the line of Mr. Andy Casey from Wachovia Securities.

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

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

And then flipping that, are there any industries that saw any sort of acceleration, or is it just more moderation, if it's positive?

You mean acceleration on the decline?

No, in terms --

In the uptick?

Yes.

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

Okay. Thank you very much.

All right.

Thank you, Andy.

Your next question comes from Ms. Ann Duignan of JPMorgan. Please proceed.

Hi. Good morning, guys. Hope you're all well there. One question and a follow-up. First, Don, you said something interesting. You said the distribution in North America was holding up, I think you said slow, but holding up reasonably well. Can you give us some color on that? And then with industrial production activity slowing so rapidly, would you anticipate that that piece of the business would slow significantly in the back half?

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

Okay, thanks, that's good color. And then my follow-up question is just on the nonoperating items, each of those line items change significantly from the last quarter. Could you walk us through what the major changes are for corporate admin, interest expense and other expenses? The tax rate, I think I understand that, but the three nonoperating line items. It.

Yes. Ann, this is Pam speaking. Obviously you know the tax rate. Took it town to 27%, so that made a difference. Depending on how you calculate it, 10% to 12%, whatever. Obviously share repurchases, we're continuing to purchase on our 10b51 program, and so there is an impact, about $0.04 in terms of the share count differential. Also, corporate administration, there's some benefit from that, around $0.09, and that's basically just the result as the income comes down in the second half, so do incentives. So there's some positive on that front as well.

I'm sorry, Pam.

The biggest portion obviously being the segment operating income.

Okay. And just on the corporate -- or on the share repurchases, you are going to continue to repurchase shares?

We are -- Ann, this is Tim. We are doing our 10b51, that's a very minimal program. That allows us, of course, to purchase through blackout periods and everything else. That is only about $20 million a quarter, so other than that there's no major repurchase activity. The big repurchase activity occurred in the first quarter.

Okay, because I would have anticipated you would want your full cash for acquisitions. Thank you. I will get back in line.

Thanks, Ann.

Next question comes from the line of David Grazo.

Hi, good morning. Further on the decremental margins the second half implies 26.7%, still better than the 30%, Tim, you backed into for the second quarter. We have to believe pricing is going to erode into calendar '09. Is implicit in the improved incremental margins some improvement on price versus input costs? Can you give me some color on your input costs versus price?

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

Part of our issue with some of these customers, you said you were going to take $10,000, now you said you are only going to take $7,000 a month or $5,000 a month, so that's a much reduced quantity than what you said, so we have that issue on our side and so this is all the give and take of the whole thing. So there we are. It's going to be a major struggle, but at this stage which consistent with what you've heard from us over probably the last several years, is that we will work awfully darn hard to balance the two. Work the procurement, work the pricing, and not be on the call telling you we have some big blow up because we didn't work either side of that very well.

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

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

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

There is not any widespread list of plant closures. There are some specific ones but frankly, David, those would have occurred anyway. These were just in the ordinary course, in the ordinary course we are going to do a few every year so there isn't anything that is a result of the slowdown that is forcing that out. So I would say that our people to date are doing a great job. The other thing I would point out to you, if you can do the math on how we'd compare to other companies, the cost of doing these reductions you are going to I think come away with saying is fairly low compared to some other people. A lot of these people were not full-time employees.

We, as we've told you, building in cyclicality, contingency measures, carry a lot of temporary workers, carry a lot of consultant type people, etc., and so even though we count them in our headcounts, because we don't like people -- we want everyone accounted for, if they are temporary agency consultant, then, of course, they can be reduced at a much lower cost. So that's why I think the cost of our reductions are going to be less than maybe some other people.

One last quick one, and I'll get in queue. The destocking process, when customers are shut down, that's severe. I assume they're not shut down for six months. Where do you think you are on your production verse your assumed retail? In your guidance, is the destocking process largely done, and now you are going to produce where you think demand is, or are you further going to underproduce for the next quarter or two?

David, this is Don. I think we're pretty much in sync with what we're seeing out there. We've been making the reductions as we go along, and I think we're going to continue to do that. As we've executed lean in the company we're getting to be more and more real time, as far as our execution execution of the inventory adjustments on a month-to-month basis. And I'd say, we mentioned earlier we're down $75 million in inventory. That is pretty much in line with what's happening in the markets, excluding acquisitions, of course. And I think we will continue along that pace throughout the fiscal year. And that's a message, frankly, that we passed on to the entire organization about six or seven months ago now, that we are going to go through this period in much better control than we have in the past, as far as inventory. And we're going to maintain our productivity better than what we've done in the past. And I think we're going to prove that that's going to be the case here.

Great. Thank you very much.

Thank you.

Your next question comes from the line of Mr. Alex Blanton.

Good morning, Alex.

Yes, good morning. I lost my sheet here. Okay. The order trend across the quarter, you mentioned that it started down in November. And then got worse in December. You used to report your orders monthly, so now we don't have that guide anymore. But can you give us a better idea of the sequential decline across the quarter, so we know where we are decline across the quarter, so we know where we are versus October?

Alex, this is Pam speaking. When you get into November and December, we saw some declines as high as 35%.

Overall for the company?

Right.

And they were --

A lot of that had to do -- Alex, this is Don, with the shutdowns that we mentioned earlier. There was just nobody buying anything. There was no orders coming in, everything was shut down, holidays were in there, and that seemed to carry over into January as well. So -- go ahead.

You said that at the conference in December, somebody at the end asked you for an update on the current state of business because you had spent a lot of time on the future at that meeting.

Right.

And basically, you said there isn't any. Everybody is shut down. Now, that's certainly an overstatement, or you wouldn't have had any orders, but how much of this -- and you mentioned some people are still shut down. How much of this is an inventory correction in the supply chain? Can you tell? Are people not ordering because they're trying to get inventory off the shelf and could you answer that for MRO as well as OEM?

Alex, that's a hard one to answer. I'm going to let Tim make a comment as well. I think what's happening is with all the bad news that has happened as a result of the financial meltdown and all the ramifications that that has brought, the ripple effect throughout the industries that we serve everywhere around the world. And, of course, what happened here with the housing crisis now is packaged up, we packaged all that up and sent it to the foreign countries, so we made this a global problem for the world. And I think, frankly, I think that the world is now just waiting to see what the heck is going to happen here, what's the stimulus going to be, how we're going to dig out of this mess. And so, frankly, I think it was just -- we're not going to order anything. We're just not going to order anything. There's -- we're not going to get ourselves hung out there in a situation where we could get trapped with a lot of orders coming in, inventory going up. We're just going to be ultraconservative and wait and see. I think the waiting and seeing now is coming close to happening here because they're talking about $850 billion, or whatever, stimulus, and you have seen the components of that.

The question is what impact will that have on our markets, and that remains to be seen. Likewise you heard about China, with their $600 billion plus. Frankly, I don't know when that is going to be implemented, and how long that will take to get that moving over there in China. Of course, you heard about Germany. I think they're EUR50 billion. But the key is I think everyone is in a state of paralysis, frankly. No one is going to do anything, no one is going to spend money no, one is going to make any moves until they have a real comfortable feeling that this horrible situation that we got ourselves into is under control. That's just my gut feel, and Tim might have add few things he wanted to add.

Alex, the only thing I wanted to add too, on these order rates, keep in mind that our businesses typically carry about three months worth of future demand in their backlogs, all right. So let's say, again, someone was wanting 10,000 units a month, and that's what they had loaded in the backlog. Now they disappear for a while, and they come back, and they say, well, we're back in business, but we don't want 10,000, we only want 7,000 a month. That means -- you have to go back and adjust your backlog, and that negatively impacts that. You have to run that through the system, if you will. So part of what we're seeing here, and this is hard to valuate these numbers, is that, okay. There's rescheduling going on, and you're doing a little catch-up.

Having said that, and I break it down, aerospace, fine. Aerospace, unto itself is -- they're separate than all this. Don indicated earlier that distribution, the after market, is also completely different. Are they down? They're down a little bit, but they're holding up extremely well comparatively. Now they service the aftermarket. The problem for us in trying to get our arms around this are the major customers, some of which, again, haven't come back, and some of these adjustments that are going through. So it is -- that's what is making it very difficult to judge and tell you what we think the real run rate going forward is going to be.

Just one final thing. This $825 billion stimulus, published last Friday, the house released numbers, the transportation and infrastructure, part of that was only $78 billion.

Isn't that amazing.

It was in the "Wall Street Journal". And that's a two year program. So it's $39 billion a year, which is less than 4% of total construction of $1.1 trillion.

So how is that going to --

So how much stimulus can there be here?

How is that going to stimulate any jobs, right, or generate any jobs? That's what we're wondering.

That won't even offset the decline in non-res.

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

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

Thank you.

Thanks, Alex.

And your next question comes from the line of Mr. Mark Koznarek from Cleveland Research.

Good morning, Mark.

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

Well, no, we agree with you 100%. Inventories have to come down more. What you had was, beginning in the quarter, booming business, then all of a sudden the world came to an end. You can't just turn the switch on and off real easily. I mean, I was extremely impressed, the fact that we got $75 million out in a relatively short period of time. But we clearly are not where we want to be. Our DSI did go up some. We don't like that.

We want the day sales inventory to come down, and we want the absolute dollars to come down. But to get it down, of course, you got to get all the purchases out, a whole bunch of stuff on order. Some of that was still in the pipeline coming in. You've got to cut off the purchasing, recalibrate it down, and the people have to go, because if people are there, they're going to be making parts. So we're doing that, and you will undoubtedly, Mark, the inventory dollars continue to come down over the second half.

So we are going to be underproducing demand by a material amount across the second half, and even with that, we're going to be able to maintain these incremental margins at around the 30% level.

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

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

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

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

Yes, sir.

And so that's part of the positive that will help your incrementals.

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

Okay. Got it. Thanks very much.

Your next question comes from the line of Mr. Daniel Dowd from Bernstein.

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

Well, this is Don. We basically have completed what we wanted to do this year for acquisitions this fiscal year, so we're not planning to do anything major for the remainder of this fiscal year. There could be a small one here or there that we might do, but we acquired, I think it was $520 million, $530 million in sales volume and that's close to the 5% target we have for acquisitions a year, and 5% of sales. So we're okay right where we're at, so I would say don't expect to see anything much happening between now and the end of the fiscal. We're going to conserve cash, we're going to be generating positive cash flows here going forward. That's our priority right now. And acquisitions, frankly, it's what I've been telling the troops here, let's fund the farm, let's work the acquisitions that we've made. We've made (inaudible) in Detroit, we need to integrate those, execute the win strategies on those, and bring those around so that they're giving us some positive -- having a positive impact on our P&Ls, if you will. So that's kind of where we are. We're kind of in a -- we've pretty much done it in the first half and we don't need to do much more in the second half.

Okay. And on the issue of suppliers, is the macro economic conditions and the credit crisis combining to put any of your suppliers in extremis yet?

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

Alright. Thank you.

Thank you.

And your next question comes from the line of Mr. Robert McCarthy from R.W. Baird.

Good morning, everybody.

Good morning.

Can you hear me okay, Pam?

Yes, I can. You're good.

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

You mean by segment?

No, I just meant for -- I'm just looking for a gross number that I'm going to realizes in savings this year. In other words --

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

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

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

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

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

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

Well, I think -- that's a good question, too. I think that what they have been telling us all along, since the last downturn, is that that's exactly what they were disappointed with. So I would say, the decremental margins, the drop-off from peak to trough in the last cycle had them very concerned. It was like a 60% or 65% drop-off in earnings per share, something to that order of magnitude. So I think that would be the first thing, because that's what they're going to be watching for, and I think cash will be the other thing they will be looking at and cash flow generation. So you really to have look at both sides with us, because when we make these acquisitions, we're writing off a lot of intangibles, and that's a noncash outlay, so if you don't look at the cash side of the equation, you don't see the full picture. But I think that -- I think what they should be focusing on is exactly what they have been very critical of Parker about, and that's that big drop-off peak to trough in the last cycle. And of course, everything we've done since then, that we've been talking about, the proof is here, or the proof will be here shortly as we move through this difficult period.

We talked a little earlier about the plants. In the last cycle, we closed or consolidated over -- about 120 facilities, somewhere thereabouts. It's huge. Tim indicated earlier we have a few that we're, of course, in the normal course we are going to be adjusting here but nothing anywhere near the order of magnitude of what we've done before. A lot of that movement of plants, movement of product lines, all out of that disruption we went through in the past, we're not doing that this time. So all of that underabsorption, all of that production variance, all the scrap, all the quality issues, and everything else associated with that is going to be much less now. So I think we're pretty excited about trying to prove something here, and I think we're taking the appropriate actions, and time will be our judge. I'm pretty confident that we're going to like the end result of what we see.

Okay. Thanks, Don, good luck.

Thanks.

Your next question comes from the line of Mr. Henry Kirn from UBS.

Morning, guys. When you are looking at your guidance what do you view as the key swing factors that take from you the high end to the low end? What could go right to get you to the high end?

Well, one thing is aerospace. We have not seen the fall-off in the commercial aftermarket. This is just one. I'm throwing out one example. But everybody has been talking about it, and our forecast does assume that commercial aftermarket will fall off in the second half. If you look at revenue passenger miles, you look at available seat miles, obviously, all indications are that it shall decline. We have not seen that in the first two quarters. So the question comes in, is there anything that Parker is doing differently that maybe would cause that to stay up, and it all revolves around planes, when they're reaching a certain part of their life where there's a lot of maintenance, repair and overall. So that's one example that could possibly have us do better. Distribution is another example. Distribution is expected to do well during the downturn versus the OEM side of things. So that's a factor in there.

I think the -- this is Don -- I think those will be key ones. The other, of course, is the impact of any of the stimulus, and whether that would even hit this fiscal year yet. Now, we have five or six months left to go, so we're hopeful that if there were going to be an impact we'd see some of in the year. But the effect that it will have on the construction equipment markets, the effect that will have on automotive, and I think just the feeling out there that people want to spend money again. I think we're in a mode now where no one wants to spend any money because there's so much uncertainty. Unemployment is going up, people are out of work. If any of that changes, if we really do get things moving in the right direction, and the employment numbers start shifting in a more positive direction, people are going to -- and the people are more secure in their jobs and in their futures, I think they're going to want to spend maybe some more money, maybe take out a mortgage to buy a house, maybe they'll buy a car. And all of these things that will be pushing us in a positive direction. And that of course, as all of that happens, it impact on Parker as well. When I say that, I'm saying that not only for North America, I'm saying that for the world. Because we have the same things going on in Asia and Europe as are happening right here.

So everyone right now is in a state of paralysis as we come out of this, and people feel more confident, I think -- and they can get loans, they can get financing, I think we will be the beneficiaries of anything that happens as a result of that, positive in the markets.

Okay. That's helpful. And just a quick follow-up. In terms of currency imbedded in your guidance, what do you have for the rate and what type of headwinds do you have to EPS from currency?

In the guidance, we have -- I will just give you the second half percentage, if that's okay. Then you can work at that it way. But we have about 5% baked in. A little over 5%.

Okay. Thanks a lot.

Yes, thank you. Nancy, this will be our last question, please.

And the last question comes from the line of Jamie Cook from Credit Suisse.

Hi. Good morning. It's actually [Chase Baker] in for Jamie. How are you? Two quick questions for you. First one, with respect to the restructuring for the balance of the year, I believe if I heard correctly, at the beginning of the conference call, you said that roughly $5 million was in CIC, so that's about 50% of the $10 million. Should we expect a similar percentage to be allocated to that division going forward in the back half of the year, or is that how we should think about?

I don't think -- there will be more there, but I don't think it will be that big of a percentage of the total.

Okay. And then follow-up on the impact of FX on the bottom line this quarter. Sorry if I missed that. Did you provide that?

Well, yes. What we said historically, which I will saying again. This is Tim. What you do, take the -- host of what we sell there, what we make there, so what you have to do, once you get the revenue number, then you have to drop down to the margin level, and then you got to drop a few other percentage points to get the pre-tax tax effect that that's kind of the EPS. Okay? You have to go through that exercise. What's the margin on that business and what do you get after tax.

Okay. And then last question, just if I look at slide 17, where you provide your debt to total capital, it looks like year to date right now it's slightly above where you were in the previous downturn. Wondering, over the next couple quarters, just what the focus is. I know you said that you have a very minuscule amount dedicated to repurchase activity, but how should we be thinking about that over the next couple quarters, at least in terms of allocation of cash?

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

This is Pam speaking. Yes and obviously our ratings are very important to us. So we're going to do what's required to keep our A ratings. With that, I'm going to end the question-and-answer session, and I would like to thank all of you for your questions. I want to turn it over to Don, however, here, who has a few closing comments.

Okay, I'm going to keep this fairly short, because I know everyone wants to get and tune into the inauguration, which I believe is just starting now, so just a couple final comments. I think, again, I'd just like to reiterate that the conditions in our markets are certainly challenging. I think you have heard all of that in the teleconference today and the outlook really remains uncertain. We're going to be updating you as time goes on. We'll learn more when our customers come back in January and when we hear more details on the stimulus that's going to be happening here and elsewhere around the world. You can be assured that Parker a very seasoned management team. We've been through recessions in the past, six or seven between Tim and myself and the others here. We've been through quite a few of these, and we're adapting as required to lower demand and are prepared to make the further adjustments necessary to achieve our goals.

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

Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.