派克漢尼汾 (PH) 2003 Q1 法說會逐字稿

Welcome to the earnings release conference call of Parker Hannifan. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star and then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Please limit questions to one per person. Thank you. Mr. Pistell, you may now begin your conference.

Thank you, good morning. This is Tim Pistell speaking. I would also like to welcome you to Parker's first quarter FY '03 teleconference. It is part of our ongoing commitment at Parker to premiere customer service we are debuting some new technology this morning to provide you with some visual AIDS to go along with my prepared remarks. The slides that will be used this morning will then remain available on Parker's website along with the audio portion you can access at your leisure. After I conclude my prepared remarks and the slides, the teleconference as has been indicated will then be open to your questions.

So right now, I'm going to keep my fingers crossed as we try this new technology for the first time and let's begin. And first, I'd like to call your attention to our disclosure regarding any forward-looking statements contained within this presentation. I trust that all of you will take the time to read this detail of this at your convenience. Next, take a look at the agenda for today. We will begin with a look at our earnings per share performance both with and without restructuring items.

Next, we'll follow an update on any acquisition divestiture activity within the quarter. We'll then move on to the financial results and to some detailed analyses of these financial results for the quarter including the consolidated income statement, the business segment analyses, balance sheet, and cash flows. We will conclude our prepared portion with a current update of business conditions within our business segments. And that will lead into our earnings outlook for the second quarter and for FY '03 in total. The conference will then be opened for your questions and now to begin with the numbers.

Earnings per share for the first quarter of FY '03 is 52 cents as reported. This compares to the 52 cents as reported during the first quarter of the prior year. This comparison is not, however, a fair comparison to our predicted range of 35 cents to 45 cents indicated on the slide as this prediction excluded any non-recurring items. So we really need to look at the next slide which does compare the first quarter of FY '03 to the first quarter of the prior year without the restructuring items. There was one cent of non-recurring items this quarter, first quarter, versus 3 cents of non-recurring items in the first quarter of the prior year. So the 53 cents of adjusted EPS this year compares to the 55 cents of adjusted EPS the prior year and is the proper comparison to our expected range that we gave you of 35 to 45 cents.

On acquisition and divestiture activity in the quarter, you can see not applicable this period. We did actually purchase one small product line quite immaterial, but otherwise, no material acquisitions or divestitures in the quarter. As we had said earlier, we were to slow down that activity and that's indicative of that. So then turning to the next slide, which analyzes the sales change in this quarter for Parker in total, sales for the first quarter of FY '03 were a billion 586 million, a new record for first quarter for Parker and up 7.5 percent from the prior year's $1,476,000.

The first quarter this year contained $117.6 million of new acquisitions. While the first quarter of the prior year contains 26.6 million of sales from Wynn's Warranty which has subsequently been divested. So without these acquisitions and divestitures, sales would have been up 1.3 percent. Foreign currency movements were 21.4 million favorable to revenues, largely due to the weakening of the dollar versus the Euro. Otherwise, base revenues would have been down 0.2 percent.

Looking at the income statement on the first quarter, on the next slide, this first quarter of '03 with percent to sales before and after non-recurring items. Percent to sales after non-recurring items are then compared to the first quarter FY '02, also without non-recurring items. You should note at this time that you can find the same detailed analysis of the first quarter of FY '02 income statement in an appendix of this presentation. So would you'd the same full amount of detail down below. The increase in cost of sales from 80.8 percent the prior year to 81.9 percent this year is primarily the result of a change in mix, with the industrial segment sales increasing while the aerospace sales are decreasing. And really, it is primarily all attributable to that.

Offsetting this adverse mix change were decreases in our percent to sales for SG&A, for interest expense, and for income taxes. Now to look at the segments and begin with the industrial North America. Sales of 727.6 million in the first quarter are up 11.8 percent over the prior year. Acquisitions added 60.1 million, otherwise sales would have been up 2.6 percent. Foreign currency was actually unfavorable by 1.6 million, this reflects both the Mexican peso/Canadian dollar. Without this, sales would have been up 2.8 percent. Operating margins of 51.1 million as reported in the quarter is 7.0 percent of sales versus the 6.2 percent as reported the prior year. Without non-recurring items, the comparison is 7.1 percent this year versus 6.6 percent the prior year. The improvement in margins is due both to a slight improvement and volume improvement coupled with the benefits from our realignment efforts and our strategic initiatives to enhance margins.

Now looking over to industrial rest of the world, for industrial rest of the world sales of 365.7 million are up 23.4 percent from the prior year. Acquisitions contributed 37.9 million to the quarter. Without these sales, would only be up 10.6 percent. Foreign currency movements added another 17.9 million. When you adjust for this along with the acquisitions, base business was up 4.6 percent. Operating margin as reported were 7.3 percent of sales this year versus 6.7 percent the prior year. Adjusting for non-recurring items in both periods, the comparison becomes 7.6 percent this year versus 7.0 percent the prior year.

The margin improvement is once again the result of slightly higher volume coupled with the benefits of our realignment efforts and strategic initiatives. Now turning over to aerospace. Aerospace for the quarter had sales of 277.3 million, down 11.3 percent from the prior year, which was, if you remember, still a very strong period of business for our aerospace segment. There are no acquisition or currency impacts within the aerospace segment. So that sales change remains the same. The margins within aerospace decreased to 15.3 percent of sales versus the 18.2 percent from the prior year. All of the results of the decreased volume.

Now looking over at the other segments, the ads reported sales of our other segment of 215.3 million show a 0.4 percent decline from the prior year's first quarter of 216.2 million. Adjusting for new acquisitions in the current year of 19.7 million and the divestiture of Wynn's Warranty in the prior year worth 26.5 million the sales this year, then, are up 0.8 percent from the prior year. Operating margins as reported this quarter is 8.7 percent of sales versus the 7.9 percent the first quarter of last year. Adjusting for non-recurring items, the comparisons on operating margins become 8.7 percent this quarter versus 8.1 percent the prior year. And now to look briefly at the consolidated balance sheet and to begin with the assets, number one, restricted investments have been eliminated with the divestiture of the Wynn's Warranty business.

Two, accounts receivable have increased 25 million year-over-year, but this is all from acquisitions and actually our day sales outstanding has actually improved by two days year to year. Inventory is a better story. Inventories have decreased despite the acquisitions and our day sales in inventory has actually improved by six days from last year to this period.

Turning now to plant and equipment, they are up $82 million, all from acquisitions as our depreciation and amortization now exceeds our capital expenditures. Within intangible assets, the increase is due to the acquisitions we did over the course of the year. Within other assets, this increase is essentially all due to an entry to record prepaid expenses associated with our minimum pension liability. That was done at year end of last fiscal year. Now turning to the liabilities and equities side of the balance sheet, first of all, notes payable and long-term debt are down $50 million due to our continuing very strong cash flows and debt paydowns.

Accounts payable are up but that is from acquisitions. Down in pension and other post-retirement benefits. These liabilities are up $296 million mostly due to decreases in the fair market value of the assets and the pension plan, plus a decrease in the long-term rate of return assumptions of the performance of the assets which all led to creating an increase in our minimum pension liability of $287 million, which again was recorded June 30th tend of the previous fiscal year. Despite all this, there are very difficult period and they haven't recorded some of these entries, you will see the shareholders's equity has increased 33 million from the prior year.

Now looking to the consolidated statement of cash flows, for the quarter ended September 30, 2002, net income of course gave us 61 million. Depreciation and amortization added another 64 million. The good news, working capital continued to be a positive, gave us another 27 million. Skipping down, Capex cost us 39 million. And dividends required 21 million. All of these major items allowed us to actually decrease debt in this quarter by 90 million dollars. And I would state here again as we have before that during a recessionary environment, downturn, we at Parker managed for cash and not necessarily for earnings and I think the strong cash performance of last year that's continues into this year is reflective of that. Now, looking just briefly at the financial leverage, our debt-to-debt equity ratio has now dropped to 35 percent. And it is actually approaching the low end of our targeted range. I would also say that all of our liquidity coverage ratios are showing nice positive improvements and we're feeling very good about where we sit financially.

Now, turning to the earnings outlook and this must begin with a look at our incoming order rates which I think you're also familiar with they are available on the website. They are posted tip evening of the third workday unless we get into holiday problems in Europe and then they end up the fourth workday. And to begin with industrial North America, you can see the month of September was a plus 7 percent over the prior year. Comments related to that, and order rates did begin to improve in December '01 and they continued to improve sequentially right through March of '02. This was being led by the large mobile OEM accounts primarily heavy truck, the Ag Construction, and also a few other markets such as semicon. Since March, though, the order rates have essentially plateaued. We do not see our major industrial customers spending capital.

Distribution channels remain soft. And as of today, we are receiving recent news and a lot of this is still anecdotal, so we are hearing more and more that there will be some extended shutdowns over the upcoming holiday period. And so it looks like people are going to take advantage of the slowdown to do some extended shutdowns here in North America at least. Turning to the industrial rest of world in September, this was up 3 percent over the prior year. Europe also improved December '01 but really pretty much flattened after that. I would say recently we have started to show a very little bit of improvement recently, especially in September. Asia-Pacific remains positive for us, but we must say that much of this is probably market share gains as we spread our presence in Asia-Pacific. Latin America certainly very volatile down there these days, but it really has been performing in positive territory for us up until now. We'll see where it goes with some of the elections coming up in Brazil and so forth. But up until now, it has been a good positive story for us.

Now, looking again at aerospace and remember that this comparison always is on a moving 12 month average comparison, and September was minus 24 percent over the prior year. And order rates seemingly are stabilized within aerospace albeit at these depressed levels and on the commercial side. And what we mean is on the commercial OE, they are still running down around 30 percent. The commercial MRO after market is running down around 20 percent. The good news is on the military defense side, where we're running 10 to 15 percent positive will continue to go on.

The business jet outlook is not turning, I would say, has definitely turned negative. The only positive we can say, besides the military, is there is a strong secular outlook for the regional jets and they're down now as well but we think they will be the first segment of this of aerospace to turn positive when those things get turned around there. They should be the first. Now going into our earnings outlook for '03. This chart is still in accordance, the slide with our original outlook for the year which by segment will mean the following, industrial North America, we are still looking for revenue growth of 6 1/2 to 8.5 percent over the provider year. There are acquisitions in there. Without acquisitions, that increase is 3 1/2 to 5.5 percent. And the operating margins we are looking to be in a range improved to 8.4 percent to 9.4 percent.

Industrial rest of world, again, we're looking at 9.5 percent to 11.5 percent increase. But again, significant amount of acquisitions in industrial rest of world with the ITR purchase in particular. So without those, the increase is only 1.5 percent to 3.5 percent. So you will note that there is a lag built into improvements in the Europe or rest of world. The operating earnings margin guidance is in that 7 1/2 to 8.5 percent range, again an improvement. Aerospace right now is looking for revenue down 5.5 percent to 7.5 percent that could shift a little bit more negative here as we stay tuned what the Airbus and Boeing people are saying in particular. But we are expecting the operating earnings to perform very well in a toughen environment coming in at 12 to 13 percent range. Finally, in the "other" segment, which is our CIC group and a couple of other noncore businesses, CIC is a core business but there are some other non-core in there from acquisitions.

We said the year-over-year revenue would decrease 5 percent to 7 percent. But that was because we divested the Wynn's Warranty. Without that divestiture, the volumes actually be up in 3 percent to 5 percent. And the operating margins will be in the 8.1 percent to 9.1 percent range. Now it give you sort of below operating margin assumptions, corporate admin for the year, these are annual, looking at that to be 78 to 82 million. Interest expense likewise to be in a range of 78 to 82 million. Other income expense always a tough one for us and for you guys, but we largely driven by fixed gains or loss on fixed assets disposals and we have closed a lot of facilities and we are closing more. So you know, I think at this stage we are going with an 18 to 22 million of expense for that. And the tax rate we had given you is holding also at 33.5 percent.

All of this gives us our updated earnings outlook for the second quarter we are saying 33 cents to 43 cents. I have to tell you, this anticipates as stated earlier extended shutdowns in our industrial sector. This will be led now by the large mobile OEs, the heavy truck construction and Ag, plus there will be a further decline in aerospace revenues probably in the neighborhood of 15 to 20 million. Sequentially from the first quarter down -- the second quarter down from the first. However, we are, on our guidance for the entire fiscal year, still remains the same at 2.20 to 2.50. I will, once again, explain how we arrived at that range. It is not meant to just cut to the middle whatever that number is.

What we have said is we believe with the realignment, the strategic initiatives and with the little incremental volumes that we are actually receiving on the industrial side, we can get to the 2.20 number. The 2.50, then, is all dependent on upside. We think the recovery will kick in in our third and fourth fiscal quarters. I guess some people are still skeptical of that but we still think we're seeing the beginnings of it and we think it will get better as we go along.

Anyway, so we think the worst case at this stage, with the little volume we have is the 2.20, hopefully we can have more. and I guess supporting that again, as I say, our average daily order rates are improving slightly, little by little and we are seeing that. I need to remind you that there are more workdays in our third and fourth quarter, our second fiscal half, than the first half and it's almost about 10 percent more workdays. So the combination of those two additional benefits from the restructuring-realignment and then we're all hoping some more upside and that's how we got at those numbers. We're not changing those numbers at this time. And really, after that, I would open it to your questions and answers.

At this time, I would like to remind everyone in order to ask a question, please press star and the number one on your telephone keypad. Please limit questions to one per person. Your first question comes from Steve Volkmann of Morgan Stanley.

Can you hear me?

Yes, Steve. Go ahead.

Good. Just wanted to check in on a cash flow situation a little bit. Two part question, I'll do it all at once. The outlook for the rest of the year, would you expect working capital to continue to be a source of cash? And if you continue to generate cash like this, you are below your target in terms of debt levels. You've already said and I've heard that you are going to kind of back off the acquisition front for a while here. That, to me, only leaves kind of one other alternative in terms of the use of cash going forward. So can you talk about how much catch we might expect to generate this year and then I guess your purchases is the next question.

Fair enough. First of all, working capital has been a source. We have the dynamics there is and we think we do a real good job on receivable and we did squeeze a couple more days out but we're getting down pretty tight. So any incremental volume will probably drive receivables up. But we do have a goal to continue to bring the inventories down and we're hoping that at least that will be a push from here on out, or it will be a positive. So that's what we are striving to do.

Now, you are correct we have had great progress on the cash and bringing the leverage down, and we are going to get below what is our ideal range and what do we do. Steve, there's actually three things on the list. I'd say, at least that we're looking at it very closely. One of which is share repurchase. Clearly, where we are trading today in our minds is a very compelling buy. We are a bit biased over here, but we think it's a fairly compelling buy and the share repurchase at this level would certainly be something that we do. Again, we're obligated.

We want to do enough to share creep offset that and so forth. So that is one possible use. Acquisitions are another possible use. We have gone pretty dormant and quiet now. But again, we know these things can change fairly quickly. We have a long list of people who want to talk to us about selling their business to us right now. But we have been in this mode and we really would like to see more of a recovery under way before we take any more on. But that is alternative and there are people knocking on the door. But the third consideration that is quite high on our list would be some discretionary funding into our pension plan. We're in a situation right now where we're not necessarily obligated to fund. We think we could give pretty much full tax benefit from the funding, and that could work some very nice metrics for the company. So that's high on the list, as well.

Great.

Your next question comes from David Raso of Salomon Smith Barney.

Good morning, Tim.

Hi, David.

Hi. A question on the margins for the quarter which were pretty strong. In North America, the core sales, if I have all the numbers correct, were up about 2.6 percent. The margins year-over-year were up to 40 basis points?

Yes.

But for the full year, you are looking for a core growth up 3.5 to 35 1/2%?

Right.

But margin to be up 310 to 410?

That's correct.

What should we expect the next three quarters to create that large a margin gain year-over-year relative to what we just saw? Is there a big step function kicking in for restructuring benefits? Is it mix or is it still some of the thought on semiconductor coming back which is high margin? How will you be gaminging that?

What it is, is that typically, the first quarter is our toughest quarter. The second quarter is usually tough, as well. But equally tough this year, as you've heard. We think that actually just because of our major customers, the second quarter may be, in fact, tougher than the first quarter and so forth. And we have seen some benefits coming through on the realignment and the strategic initiatives. We will expect those to build over the course of the year. And then, of course, we do have anticipated additional business and additional volume starting in the third quarter and being better even in the fourth quarter. And we would be looking to make pretty high marginal returns on those early pickups on those volumes. So it's a combination of all of that.

Okay. So it would be heavy third and fourth. Just given 40 basis points on 2.6, the second quarter would be pretty challenging, as well. Is it really a big margin expansion in the third and fourth?

It is. I tell you, we're trying to get better at this forecasting thing here. We haven't done so good the last couple of quarters here but a little better this quarter. And I think we are getting a little better at it. I think we've looked at it and you know, it appears very doable. You know, even though the second quarter is tough, we think it's there right now and we can deliver.

Your next question comes from Ann Duignan of Sanford Bernstein.

Hi, Tim. It's Ann. Good morning. My question is on the margin side, also, on aerospace. Very strong margins at above 15 percent in the environment. Should we expect aerospace could be the positive surprise right through the entire year?

Unfortunately, I don't think so, Ann. I think we have pretty good visibility for those people out over the whole course of the year. And I think that what we gave you for the year is probably going to be where we're going to end up. I'm a little concerned -- I think they are very, very dedicated to try to bring those margins in, that 12 to 13, at the end of the year. There clearly could be more decrease on the top line than we have given you to date. But, they had expected again because they're working out a backlog to a degree still to start out better and then fade. But I think the original projection right now is still online for that 12 to 13.

And that would include any restructuring? You are not going to take restructuring below the line for aerospace, is that correct?

Well, if we had any, we would. But they have already done some. Again, I mean, if there would be a major restructuring, I think they would have to under -- they think they would have to undertake, I think we would break that out separately but they have been doing some as they went and, you know, in the numbers you've seen to date. You know, we have not reported a lot on them. They have just taken the action.

Thanks. I'll get back in line.

Okay.

Your next question comes from Gary McManus of J.P. Morgan.

Hi, Tim.

Hi, Gary.

If I take your midpoint for your second quarter forecast, we got a 90-cent first half and just to get to the low end of 220 for the year, we need a $1.30 in the second half and I recognize there is some seasonality, but I don't think it's to that degree. So I'm wondering, what are the kind of underlying assumptions that we get in such a big second half growth? I mean, I think this has been kind of asked before: How much is due to volume? How much is due to restructuring? Just give us some sense on what are the underlying assumptions to show such a strong second half number versus the first half.

Yeah. I think again, we had sort of gone on record here and there along the way that we think that just all the noise of the restructuring realigning we were doing was costing. And reducing people in inventory was costing us the 100 basis points maybe up to 200. We also are hoping that we can get at least 100 basis points improvement out of the strategic initiatives on procurement, lean, and pricing and we still feel pretty good about that. So it's a little bit incremental volume, too. I mean we are getting some now, and we need to get a little more. But we need that along with those other items to get there. And we think that those items are coming through quarter by quarter. They didn't all happen in the first quarter this year, but they are going to get better as we go along.

And if I compare aerospace profits in the first half versus the second half, we have a fairly big drop-off in profitability in aerospace. That's kind of embedded in your forecast?

That is correct.

Okay. Great. Thanks.

Thank you.

Your next question comes from David Bleustein of UBS Warburg.

Hi, Tim.

Good morning, David.

Tim, aerospace results better than expected. Can you try to break it out between how much was due to internal initiatives coming through, how much was due to stronger defense, and comment on how the commercial after market performed relative to your expectations?

David, the aerospace in this first quarter didn't come in a whole lot better than we expected. We didn't give it quarter by quarter on the segment. And we did expect aerospace to start with a pretty good quarter. But as I'm telling you, the second quarter they are going to lose is $15 million to $20 million additional revenue and it's going to start sliding down from there. I can't characterize aerospace as coming in much different than we thought in the first quarter. Again, what we've put out there was for the year and I think at the end of the year, that's where we're going to end up.

Let's try a different question. On the pension fund you changed return assumption. Can you just quantify that? Can you give us some sense of where the stock bond percentages are within the fund and if you make contributions to the pension fund, what do you expect it to do to your tax rate?

Okay. Well, I can't give you all of that. But let me give you this, because this has come up quite a bit recently, and this is the proper forum to be able to tell everybody at once where we're at.

I had mentioned that we had lowered our long-term rate of return assumptions built into this year's numbers already. And as you know from last year, we did lower down from 10 percent to 9.5 percent in '02. We went into '03 using an assumption of 8.5 percent long term rate of return.

Now, that's not a finalized number. So I caution you there. We don't have to finalize that number until the middle of the fiscal year. So that could change a little bit. But right now, I don't see any reason why it would. And we did lower it to that and that's what we're booking to. Okay? So I can give you that but I cannot give you all of the other ins and out, though, David, on this call. I'd have to get back to you later.

Your next question comes from Mark Koznarek of Midwest Research.

Question on the European restructuring initiatives. Correct me if I'm wrong, but that's most of this additional 43 million of charge that you are going to be taking later this year? Is that right?

No, I don't think -- 43 this year. I thought we carried 13 million over. Uhm... we recorded -- mean, 26 million -- I think the numbers were 26 million in the fourth quarter. And we had to carry over 13 million into this year on restructuring.

Okay. And is there some other kind of P&L impact beyond that?

No. I don't have them with me, but we broke that down by segment, and I can give that to you again. But there's always additional P&L impact, because all you're capturing there is the severance payments to the people leaving and maybe loss on disposition of assets. What you never capture is that you have to move that production somewhere else and there is inefficiencies in the higher scrap rates and all that while you are getting up and running again. So there are added costs. But those are the ones that we report, the ones we can capture and tell you.

Your next question comes from Joanna Shatney of Goldman Sachs.

Good morning, Tim.

Hi, Joanna.

Can we just break apart the aerospace stuff? I think your comment said the military business is running up 7 to 15 and the original equipment is down 30 but your sales numbers aren't down as much as your order books. Can you just talk about how much you are actually shipping in the military business? Is it at the high end of that range or is it more than that? And can you just comment, Airbus and Boeing have been kind of hinting that maybe their build assumptions were too aggressive and what's the number you are using for plane production for next calendar year?

I think we're all concerned that Boeing and Airbus are maybe a little too optimistic on their -- we all know that '03 is going to be a bad year. Now the question, '04, what's going to happen then? I think most people are feeling that they are going to have to lower their production levels out in '04 and that the real recovery will not begin until '05. And, you know, I guess we're watching that with interest as well and to see what comes.

Are you using the 257 to 300 for Boeing?

We are, for '03. We're only worried about in getting out through June of '03, yeah, that's what we would be using to finish out '03.

And what about the current quarter? Are you shipping greater than the military about 10 to 15 percent?

No, I don't think so. I think you got to remember that there's about a year's worth of backlog in aerospace so obviously, they have been holding up well better than we expected, because they have been living out of that backlog. But clearly, the backlog has been decreasing significantly and, you know, and they're running out of that. I mean, it's starting to catch up to them. So, as I say, we will lose another 15 to 20. We are going to get down to these lower levels that we said we would.

Your next question comes from Jeff Hammond of McDonald Investments.

Hi, good morning, Tim.

Hi, Jeff.

My question relates to the current quarter and the trends you are seeing. Maybe differentiate between the restructuring benefits you are seeing in the International rest of world industrial versus North American industrial. Particularly, with respect to the international volumes is a bit better and not really seeing that the incremental operating leverage was there.

I'm not sure that if that's fair or not. I think when you eliminate the acquisitions and the currencies and all that, we are seeing North America up around 2.8, 3 percent. And we are seeing the international up a little better, 4.6 percent. I think part of that is you have to all remember that the rest of World didn't fall off nearly as severely as North America did.

We said at the time we didn't think they would fall off nearly as deeply as we did over here. And they haven't. So looking at the marginal returns, they seem okay to us in terms of with a little bit of sales increase and with the beginning of the initiative; and the margin improvements are pretty good. This is one of our toughest worst quarters especially international. In Europe, all goes on holidays. All in all, we felt pretty good about what they delivered.

Okay. So you would say that the benefits you are seeing from the restructuring internationally are generally in line with what you've seen in North America?

Yeah, very much so. Very much so.

Your next question comes from Alex Blanton of Ingalls & Snyder.

Hi, Tim.

Hi, Alex.

This is not a question. It's a comment first. I thought the slides worked well.

Good.

Did you say that they would be available to print off later?

Yes, sir. They will be on about an hour after we're done here. They will be out on the website and you will be able to click on both the slides and get the audio portion again if you wish, as well.

Okay. Second, your operator is cutting people off again before they have a chance to respond to your answer. That's not good because if you don't give the right answer or don't answer the question, no one has a chance to find that out from the questioner because the operator has already cut her -- she... cut off the questioner and gone on to the next person. That's just an observation. Now my question. Uhm... could you just tell us more about why the earnings were so much higher than expected in the quarter in general? I mean, some people have asked about specific parts of the business, but could you just give a complete answer to that?

Yeah, actually, I can. We were surprised, frankly, that how many of the benefits I guess sort of the realignment and the initiatives showed up in the quarter. We had a relatively decent quarter. There were some shutdowns but not nearly as many as we think we're going to see now with the end of the year. So the environment was a little improved over the year before no doubt about that. And -- but largely, it was the strategic initiatives and realignments that really showed up. So in a nutshell, that really is where it came from.

So this really makes the second half restructuring savings a little more visible?

Yes.

Is that correct?

That is correct. And we're very pleased with what we started with and we think they will get better. Again, we will yield more as we go forward.

Okay, thanks.

Thank you.

Your next question comes from Andrew Casey of Prudential Securities.

Good morning, Tim.

Hi, Andy.

Kind of a two-part question. In terms of the potential plant shutdowns, you are talking about for Q2, have you noticed any inventory restocking in the channel in advance of that? And then secondly, on the 100 basis points improvement that you are looking for in the year in margins, due to the lack of realignment costs, if I understand it correctly -- Can you remind us how the cost weighting occurred last year first half versus second half?

Okay. As we talk about the plant shutdown, we did announced at the end of last fiscal, six more plant shutdowns, three in North America, three in Europe. One of those I think is now out in the public domain here in North America, plant up in Minneapolis. And again, when we close something down it doesn't mean we are going out of business, it means we are going to move the production somewhere else. We try to make that as seamless as possible with the least disruption to the customers as possible.

We would hope to build a little bit of inventory, get the production going in the new place while you run it down to build a little bit of a buffer and all that, so I think those are the dynamics of what's going on. Not a lot of restocking, but there may be a little bit of a build that goes with that. In terms of the realignment and how that occurred -- boy, Andy, I don't think I can give that to you. That 100 basis points, I don't think I can give it to you quarter by quarter at least not right now. So we might have to talk more on that later.

Sure. Tim, on the plant shutdowns, what I meant was your customers' plant shutdowns.

Oh!! I'm sorry. I'm sorry. I was completely going down the wrong road there. I'll tell you what, they are not carrying any inventory. They are depending on us pretty much for just in time. They got busy again. We cranked up. But they did not rebuild inventory. And so they don't have a bunch of it lying around. But if they close these plants for, well, you know, a week at Thanksgiving and two weeks over Christmas, and all that, which is kind of what we're hearing, that's going to just mean zero shipments to them over those periods. And that will take, you know, a healthy chunk out of revenues.

Thanks a lot.

Right.

Your next question comes from Robert McCarthy of Robert W. Baird.

Good morning, Tim.

Hey, Rob.

I'm not sure if I'm going to be asking the same thing Andy just asked you, but in helping us understand, second half versus first half dynamics in your outlook -- I have a couple of questions or couple of issues. One, in terms of the 100 to 200 basis point penalty that you think you suffered last year for inefficiencies that really weren't reflected in any particular charge, just --

Right.

-- dealing with the puzzle, wouldn't you agree that that was a greater issue in the second half of last year than the first half?

Yeah. Absolutely because we got misled. You know, we got suckered in on a head fake. We thought that the December-January -- we thought, hey, things are turned, here it comes, everything's great. And such was not the case. And we had to accept that and then take, a whole 'nother series. So, yeah, it was much more painful in the second half than the first half.

And similarly, wouldn't it also be fair to expect that the benefits of the completed reaction to events last year, restructurings, et cetera, would likely show a more material impact in the second half of this year than in the first as they mature in a sense?

Again, correct. It just doesn't happen overnight. And very similar to making an acquisition that we make and we then have to charge in there and sort of integrate and Parkerize and all that stuff. A lot of the benefits of that does not show up for probably about a year. That's what we've learned.

Okay.

Let me just trouble you for two numbers and I'll get off. One, can you tell us what the revenue contribution was in last year's second quarter from the divested business? And can you talk about what foreign exchange or translation effect you have assumed in your very detailed outlook that you gave us? I do not have the revenue contribution from the Wynn's Warranty business that was divested. But I can get back to you. I wouldn't think it would have differed a whole lot from the number that you saw in this quarter which was, what, 26, 27 million? I guess it would be very close to that, Rob, but we can see if I would assume that unless you hear otherwise.

Okay. in terms of the FX rates, one thing we have learned around here is we are hardly experts. The bottom line impact to currency is fairly nominal for us because most of what we make in an area or sell in an area, we make in the area and all that.

The worst dynamics going on, we got the good news, with the relationship between the Euro and the dollar. The dollar having weakened against the Euro and shows those positive. The real concern is we're back into hyperinflation accounting in Argentina and Brazil. And those create immediate hits to your income statement. And we're not sure where that's going to go. So, that's a long winded non-answer to your question. I would have to look and see what they have in there on currency. I'm not sure what they did there I'd have to get back to you.

Your next question comes from Eli Lustgarten of H.C. Wainwright.

Good morning, can you hear me?

Sure can.

Okay. Can I get two clarifications? The clarification is one, can you explain the other category in the first quarter? Two, when you talked about uses of cash, you left out the word dividends.

I'm sorry.

Whether that's going to go. And then three, can you talk a little bit about what's going on in rest of world, particularly in Europe, while, you know, you're worried about this second quarter shutdown. We are hearing slowing in Europe, too. And can you talk about what you're seeing there even though you had a good first quarter, whether that's any fear? Do you have to have better year volume to meet your numbers?

Absolutely. Let me start with the dividends first. Eli, we've paid in 48 straight years and we have increased in 46 straight years so that's kind of come off the top. So the dividends will be there and that is something we subtract before we get to kind of precash flow that we can use. So the dividends that will be there and I think we need to increase them this year if we're going to keep our record intact. So I think you can pretty well count on us doing that sometime over the course of the rest of the fiscal year. Within the other category, I'm not sure what the clarification is that you needed.

It's supposed to be 4 million a quarter and it's not.

I'm sorry. You mean the other expense?

Other expense, yeah.

Yeah. Well, we never know and I put it in there because I thought there was going to be a lot of disposals with all the shutdowns and that those would take losses on it and there you are.

There is nothing in this quarter of any strange -- any asset sales or anything like that?

I don't think there was more than -- it was a little higher. I'm looking at the number here. I guess it's a little higher than we expected, but I don't think anything strange. Maybe we'll get them done earlier and less later. It's a funny number that, you know, moves around a little bit. So I mean, I think our 20 for the year is still good.

Your next question comes from John [INAUDIBLE]

I don't know if you answered that question, but what are the industries other than autos that you think are going to take extended shutdown during the holiday period?

If we can get back to Eli, I think the other third part of the question we didn't get to. So Elizabeth we need to try to get back to Eli right away. Well, on the autos, I'm not so sure but what we're hearing and this is anecdotal and I can't give you specific customer names, because we wouldn't do that, but we are hearing in heavy truck as we all know, you know, after the October emissions deadline there, it looks like it's going to be pretty quiet for the rest of the calendar year. So we're anticipating it in heavy truck. And we are also hearing it out of as they say both our construction and our Ag customers that they are contemplating some pretty extended shutdowns over the holiday season. So that's where we're hearing the most of it.

Are you hearing anything in auto?

I have not. I can't say that I've heard anything there. I have not heard it.

Thank you.

Right.

Eli Lustgarten your line is re-opened.

The question I was asking was on European volumes, giving you're hearing some slowing over in that part of the world too.

Oh, yeah. I'm glad we did get back to that you're absolutely right, Eli. Some of these names are global customers -- Global suppliers. And I think they would be contemplating doing the same sort of actions in Europe as they are here. So yeah, we are expecting the same thing over there to a degree.

And the issue is whether or not you need to pick up in volume there to be able to make your numbers. I mean, how critical is that?

You mean in the next quarter?

Well, not next quarter, second half of the year.

No. We do need pickup there, too, a little bit. I mean, for where we're going. What we're saying here is that the per-day order rates coming in are pretty good. And they are seemingly increasing. That's the good news. The bad news is that some of our big customers are saying they are not really pleased with their end markets and they think they are going to take this opportunity to do these shutdowns. So on the one hand, we are going to definitely lose business this quarter. On the other hand, we think that things are getting better and that when we come back out of the holidays, we'll be at a higher rate. And we still feel that will be the case.

All right. Thank you.

Right.

Your next question comes from Chuck Harris of Solomon Asset Management.

Good morning, Tim.

Hey, Chuck.

Two quick questions. The first one is, what is the maximum amount that you can contribute into the pension plan on a discretionary basis before you don't get a tax deduction, do you know?

I can't give you the exact number. Let me just tell you that I think we could do up to 100 million and probably still get tax deduction. That's sort of a ballpark.

Okay. And then the second thing, and I haven't gotten a chance to run all the numbers yet, but given your outlook for the aerospace margins, for the year, which I think were 10 to 12 percent, right?

No. We're 12 to 13.

12 to 13. Given where you're starting, is there an implicit comment here that the fourth fiscal quarter is -- or is it the second half of the year really going to take it on the chin starting at 15 percent plus?

I think the bottom line is we got nice 15 but we are going to get down to that 12 to 13 range pretty quickly. We'll see. Maybe having bank of 15 in the first quarter, you know, if we average 12 to 13 over the next three quarters, we'll end up --

A little better?

A little better, right, exactly.

Okay. I guess what I'm trying to figure out is you're not assuming that this thing gets down to 10?

Oh, no.

This year on a quarterly basis? All right. That's not the implied comment here, right?

Right.

Okay. Thank you.

Right.

Your next question comes from Barry Bannister of Legg Mason.

Hi, Tim.

Hi, Barry.

When I think about your aerospace division, I tend to associate your commercial side with Boeing. And yet Airbus is doing quite a few contract wins. And when I think of the military side, I associate it with tactical, and it seems like the cargo and pilotless are getting a lot of share.

Yesterday, Eaton reported their military aerospace grew 19 or 20 percent year-over-year. The industry was up about 13 and it looks like you were only up in line with the industry. So on that two-part question there, would you give us some feedback on whether your aero markets are in the right customer, in the right end markets, on a go-forward basis since we seem to have peaked out on this regional jet thing at least in the near term?

Yeah, fair enough. Well, let's talk to the commercial first. All of you are aware, we have been a very major (indiscernible) part of Boeing for a number of years. And we continue to do so. They build a plane, we're on it. Our building material is always bigger than the plane they built before, so we're very appreciative of that relationship.

Airbus has been a lot tougher thing for us to break into. But having said that we are making some headway now especially on the fuel management side, big win on the 340s, the new version of the 340 and on the 380s. And great, great successes there. And we're continuing to do all we can to get in there further, and we have to. You're absolutely right there.

Airbus is doing very well and solidifying their share and Parker needs to be on their airplanes. As I say, we're working on what we have had some good successes, and you can plan on us keeping that up.

On the military side, you're right. It's important what programs you are on. And I would just say this, maybe in terms of where we are. We love where we are. We love our building material. We think we're on all the right programs. We'll be showing an updated chart of that here in the next couple of weeks. We are on the right program. And I would just say that with what you mentioned our competitor here in town. They had mentioned I believe on the new C-17, the additional 60 planes that that was generating, I think it was, 60 or $80 million of business for them.

Our billing material on the C-17 is about 3.4 million per plane. So... that 60 equates to $200 million worth of business to Parker.

On the joint strike fighter, the F-35, I'm not sure -- people picked up on the differences but I know Eaton put out an announcement that that was going to be worth $1 billion for them. I'm not sure if they were including just the OE, or that also included the after-market. But our billing material on F-35 is about a million dollars. So on 5,000 planes, which is what is expected right now,and that's 5 billion dollars for us and the after-market should be at least equal to that. So that could be $10 billion or North of a $10 billion contract for us. So we think we know we're on the right programs. We think we're doing really well. And wouldn't trade our position with anybody.

Tim, just one quick follow-up on that may.

Okay.

You have the cash flow and the borrowing power and so far, I have been clearly underestimating the aerospace potential. Why not make acquisitions in there to expand your product breadth and maybe break into the European market a little bit better and get into some of the areas maybe in military you are not in now? Why rule out acquisitions in aero?

Okay. Now, I got to give you a little tongue and check here to begin with because there are certain analysts here one of which was -- again, we have to be careful about doing too many acquisitions and we respect that. You know?

As I say, we have been trying to farm the farm and do a good job with what we bought, okay? And through these tough times. We are absolutely interested in doing acquisitions in aerospace.

We are entering a period where probably the multiples of the purchase prices are going to come down some, be a little more reasonable. I mean, my God, you know, a year and a half ago or so you wouldn't believe what people wanted, you know, to sell their business. But there are some good properties out there maybe the multiples are getting better. We absolutely would like to add on to our franchise what we're good at, and that certainly would be something that would be high on our list when we see this thing turn around.

Okay. Keep doing a great job managing that division. Thanks.

Yes. We have, thank you.

Your next question comes from Karl Mergenthaler of Bank of America Security.

Question about capital spending. I think in the past you talked about Capex being about 4 percent of sales. Does that still hold true? And can you just comment on willingness to make capital allocation decisions at a headquarters and whether you are getting the business line managers, you know, really pounding the table for capital spending projects at this point internally?

Karl, I'm glad you asked that question because that is good. That gets us into something which I'm not sure if everyone has heard it. But I would like to relate a little story here and that is that in June of this year, when we were doing our reviewing the groups plans for the coming fiscal year, all seven industrial groups came in and said they had to have increase Capex budget. They had been very frugal the last couple of years, like they should, and but now they just had to have more money to do some basic replacements, repairs, and to get on with some of these key programs. And in fact they all were approved for increased capital budget.

The interesting thing is to date, they are not spending it. You know, sometimes we wonder what's going on with our customers and look in the mirror. All those group leaders are also a little cautious, a little concerned and are kind of holding back and not spending the money that they have actually had increased and budgeted for them in terms of where we're going to be. We used to run 5 percent of sales. We now realized that was a little too generous and a little too capital-intensive now that we're in our lean journey. We are targeting as low as 3 but more realistically maybe 3.5 percent of sales as sort of the Cap ex spend rate.

Great. Thank you very much. We'll see new New York next week.

All righty.

Your next question comes from Karen of GIC.

Hi, Tim.

Hello, Karen.

Two things I need to ask. One, I missed the second and third use of cash after stock repurchase because I got called by my trader so could you just give me the second and your priorities for use of cash again?

Okay. Well, I wouldn't say they're all priorities. But we'll take care of that. Clearly that Capex at 3, 3 1/2 and the dividends but we should still be left with a lot of free cash flow.

Definitely.

And so share repurchase, especially where we're we are at today, is pretty high on the list. The other one is acquisitions.

Right, of course.

There are a lot of people knocking at the door. We have just put them off. We said we wanted some time to do what we had to do internally. And so those could be back on the table come the second half. And the third one was discretionary contribution to the pension fund.

Right, okay.

Those are sort of the three biggies.

And then the other thing goes back a ways, but correct me if I'm wrong, but don't you, in a normal year, let's say, where we're not at an inflection point in the economy or whatever, don't you usually earn 40 percent in the first half and 60 percent in the second half? I mean, or 45, 55? Those are the relationships I remember. Which would get you to the 2.20 without any change in the economy. Is that relationship right? I mean, that's just the number I remember.

Yeah, you have been around a while, Karen. [ Laughter ] Yeah, so yeah, your memory is pretty good. Again, the revenue split for Parker, because of the way our fiscal year falls. Starting in July, June 30. The revenue split all things being equal is typically, around 48, 52 first half -- second half, or 47/53. Okay? Sort of in that range. The earnings split is, therefore, 40/60, or maybe 45/55.

Okay. Okay.

All right? I guess you could split the difference on those two and that would be what you could use. Yes.

And that's without an economy inflection point in the economy so if you assume that you get any help at all from the economy, there is a possibility that you do get to the higher end of that 2.20 to 2.50 depending on what your economic assumption is and the last question is you said you have six plants left to close in '03? Can you just remind me how many plants you closed in '04 so we can get a feel for the level of inefficient sir, the level magnitude versus last year?

You didn't mean '04. You meant '02.

Yeah, I meant '02. Sorry.

Yeah, I can go back into '01.

Okay.

In '01, we did 28.

Okay.

Now, this is 28 facilities.

Yes, right.

Those are not all manufacturing plants.

Yes.

Likewise, last year, we did 50. Now of the 50, I will tell you that about two-thirds of them were manufacturing plants and then probably five maybe 10 percent were sales offices. Maybe with minor inventory-stocking type of things. And then the rest were kind of warehouses.

Okay.

Okay. So that's sort of the split. The six this year are all manufacturing.

Okay. Okay. Thank you.

Okay.

Your next question comes from Michael Braig of AG Edwards.

Good morning, Tim.

Hello, Michael.

Maybe I'm missing something, but for the second quarter, you have emphasized that you expect trucks and heavy machinery to head down late in the quarter. Yet for industrial North America, you are talking about small volume gains. Can you characterize where the offsetting gains are coming from?

You mean for the year, then?

For the year is fine.

Yeah. For the quarter and now, you guys can work the numbers here and so forth. But as I said for the second quarter, we're expecting aerospace to just fade a little more and it looks like they got some of the same issues with the holidays and all that. That they are going to lose sequentially revenue of 15 to 20 million.

When you get to industrial, and this is both North America and rest of world, if what we're saying here, that means we're probably going to lose, you know, revenues in that area anywhere from 65 to 75 million between North America American and rest of world and that's because of these extended shutdowns we are going to see. Having said that though, the average daily order rates, you know, are good and they are getting a little better. And so right now, we're feeling that after we get through the holiday period, come the third quarter, we're going to kick back in at a pretty good level and we're going to slowly build up from there. That is how we get to our annual increases despite taking the hits in the second quarter.

So if I could just follow up and make sure I understand what your expectations are, while you are looking for a Thanksgiving and Christmas shortfall in the heavy machinery and heavy truck area, it is primarily the rebound in the second half from those same areas that carry you to your full-year revenue expectations for industrial North America rather than --

Right.

-- industries or customers other than in those two sectors?

Oh, no. I'm sorry. It's a combination of the two.

We would expect that those people would come back from holiday and we would be back in production levels again albeit, you know, maybe reduced from where they were and on top of that, we will continue to see improvement in many of our other markets. We are beginning to see, you know, a little improvements here and little improvements there in the industrial markets.

Can you describe or highlight those other segments that are currently positive?

Yeah. I can touch on some of them. One of which is just really general industrial machinery. We are seeing those people spend some money. Machine tool people are getting some pluses out of Detroit. Detroit has recently released some money and so the machine tool people are seeing a little bit out of them. I say the general industrial machinery is good. You know, semicon was very good for us through most of the year. It's gone soft now. But the anticipation is that next year with the new 300mm wafer and all that, that that's going to pick back up again and be good, so it comes from other than just the big mobile guys.

Okay. Thank you.

You have a follow-up question from Mark Koznarek of Midwest Research.

Hey, Tim. I didn't get my question in last time really. I was talking about the restructuring which I understand is going to be focused principally on Europe, yes or no on that?

You mean the restructuring this year?

Yes.

No. It's pretty much half and half but at least there's three plants in North America and three plants in Europe. The dollars might be a little bigger in Europe than they are over here.

Okay. When Nick spoke the other day, you said that everyone was coming out of year of Europe, the 1,000 heads.

No.

Here's my question and maybe it is less material because of the split, but it seems that in the quarter here, you spent only 1-cent on restructuring and you have more yet to spend later in the year?

Right. And we had a nice margin snapback versus fourth quarter, perhaps because of the absence of restructuring action. And you are going to dial back restructuring later in the year.

Should we be concerned about this P&L impact that hurt the fourth quarter so badly you know, trimming margins back in perhaps the second and third quarter before we finally get the whole program resolved?

Mark, I think it's a very fair question. I think that we learned our lessons last year. In those last couple of quarters of how difficult they are and how much it hurts and, how many problems they cause. So the six that are planned for this year, I mean, I think we have planned fully for those to occur and there will not be anything over and above what we had anticipated. So I think it's built into the numbers so to speak.

Built into your overall margin?

Correct. Our numbers and our guidance, yes.

But that would include some kind of inefficiency impact when the restructuring does gear back up again?

That is correct. But I mean, I think, we have realized that we got to anticipate that as well and it's in the numbers.

Okay. Thank you.

Right.

Your next question comes from John McGinty of CSFB.

Tim.

Hi, John.

Sorry it took me a while to get on the phone. I just wanted to get one kind of follow-up on this which is to say that your daily run rate is running along at a comfortable level but you're anticipating the reductions in the fourth quarter from slowdowns or shutdowns, extended shutdowns people are taking.

One clarification. Is that going to show up in the daily order rates, or in other words, how does that manifest itself? In other words, if somebody says, okay, fine, this is the production rate what I want, but I'm going to shut down for two weeks or a week, does that take the rate down? Or how does that show up in your order numbers?

Well, you're right. It could be hidden because the average daily rate could look pretty good, but we maybe only had 10 days, not 20. So the absolute dollars won't be so good. I mean, that's the effect that we are going to have to watch and talk about that when we get to those months.

When we're looking at the -- I mean, it just seems to me to be a juxtaposition of saying we're going along and now we're worried about extended shutdowns, people are obviously nervous on the heavy equipment, the Ag, trucks and so on for whatever reason, they are taking extended shutdowns. But then when we get through the holidays, are you actually expecting -- in order to get to the 2.20, to get to the low end of your number, are you expecting a pickup in the average daily run rate, you know, from where we are now, or just that we return to it in absence of the shutdowns? I'm thinking of the same head fake in essence that you saw last year, the concern about that.

Yeah, I think that the, uhm -- I think what we would expect is a bit what happened over the July/August period where we had a lot of shutdowns as well this summer where, you know, and we had a normal sequential drop June down to July, we lose about 5 percent. And then July to August we usually lose another 5 percent. But, you know, if they come back and all things being equal, they will be in September they will be back up around the June rate. That's what occurred. Okay?

Okay.

So that is what we would anticipate here as well, that the daily rates would be okay. It's just all of a sudden, we are going to lose, you know, 35 days or 10 days of that business. And then come first of January, after the first, we would anticipate coming back in here like we did after Labor Day and be back up to the rates that we were running pre the holidays. And then from there, we would we do expect those rates to improve over the next six months.

And you need that improvement to get to the 2.20 or you need that improvement to beat the 2 town 20?

We need that improvement and good question. Come back after January 1, we would need to be back to the rates pre-holidays.

The October early November levels.

To get the 2 town 20.

Okay.

Now, to get to 2.20.

Okay.

Now, to get to 2.50, we need that rate to improve.

Just come back to the October, early-morning November rate in January, and stay there, in other words, we just flat line that thing, that still hits 29.20?

Right.

That was clear. Thanks very much.

You're welcome.

You have a follow-up question from Ann Duignan from Sanford Bernstein.

One point of clarification. I think it was interesting that you said that you're also seeing Ag customers talk about extended shutdowns. Is that driven primarily by Deer's move -- build to order away from forecast and would that mean a strong rebound early next year or is it something more subtle than that?

That's a good question and I'm getting it all second handled, you know. Information really. I'm just hearing from key people that they are hearing from key customers that they are considering doing these shutdowns. So that's, you know, that's how that's coming through.

I think your question is a good one from the standpoint that everybody's thinking, I think Ag might be okay next year because of a lot of things and, you know, crop prices and all that sort of things. And farm subsidies and all. So you know, if that is true, then I would guess that these actions were one just to kind of clean up things at year end and get ready to roll after the first of the year. But I don't know why. I have just heard that they were being considered.

Okay. Thanks.

Your next follow-up question comes from Robert McCarthy of Robert W. Baird.

Hey, Tim. Could you tell us either how much aerospace backlog declined in the quarter or give us an approximation of a book-to-bill ratio for the quarter?

Actually, I can't do either right now. But I can get back to you on that.

Okay. All right. Thanks.

Right.

Your next follow-up question comes from Steve Volkmann of Morgan Stanley.

No, I'm done. Thanks.

There are no further questions at this time.

Great. I'm sure how many of you are still on the line. I know a lot of people had to jump off on to another call. But any of you people who out there who are on the line, I would very, very much appreciate you giving me a real brief email at my address tPistell@Parker.com on this new technology, how it went today. And any suggestions. So we can improve this going forward. Other than that thank you very much. I will be around here all today and I'm around most of tomorrow. And to field your calls. So call me at your convenience. Thanks.

Thank you. This concludes today's Parker Hannifan first quarter of fiscal 2003 earnings release conference call. You may now disconnect.