派克漢尼汾 (PH) 2004 Q1 法說會逐字稿

Good morning, my name is Jami. I will be your conference facilitator today. At this time, I would like to welcome every one to the Parker-Hannifin fiscal year 2004 earnings conference call. All lines have been placed on mute to prevent any background noise. If you would like to ask a question during this time, simply press star, number 1 on your telephone key pad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Ms. Pam la, vice president and treasurer.

Thanks, Jami. Good morning, everyone. As Jami said, this is Pam Huggins speaking. I would like to welcome you to Parker-Hannifin's first quarter fiscal year 2004 earnings conference call. As usual, commencing with the earnings release itself I have a few comments for you. First, the format that we will be using today along with my commentary will remain on Parker's website at PH.com.

Secondly, if you have not already done so, would you please register on our website to receive e-mail alerts on an on going basis going forward? Finally, consistent with the past, when we get to the Q&A session, would you please limit your questions to one at a time. This is preferable so that everyone has a chance to participate in the Q&A session. With that, I will move to the first slide. This once again is our disclose our statement addressing forward-looking statements. I urge you to read this in its entirety. You have had it some time. If you haven't had a chance to do so, please do so. I will start off with a summary of earnings per share for the first quarter. Fiscal year 2004 versus same quarter one year ago. Subsequent to that, I will move into an update on acquisitions, divestures. Then I will provide the financial results for the first quarter, by segment. Then I will cover the balance sheet, consolidated statement of cash flows. I will conclude with a current business update within our business segments, our earnings outlook for the rest of fiscal year 2004 subsequent to the outlook the session will be open to Q&A. Once again, we have this slide on non-GAAP financial measures. The numbers that I am going to be speaking to you about today are on a GAAP basis, there is one exception with that. That is with respect to the sales numbers. We have taken that liberty here to reconcile from a GAAP basis sales without acquisitions, divestures without the movement. This allows people to meaningfully evaluate a changes in sales on a comparable basis from period to I need to log off will log back again, a mentioned, this is on a GAAP basis, you can see it is 48 cents versus 52 cents in the same period one year ago. As you probably recall from the press release, 4 cents realignment that we incurred in the first quarter fiscal 2004 this compares to 1 cent for the same quarter a year ago. On acquisitions, divestures side, there really were no acquisitions or divestures during the first quarter. This slide details sales for the first quarter versus sales for the same quarter, one year ago. Sales came in at 1.587 million, this compares to $1.586 million for the same period one year ago. Essentially 10 basis point improvement. Sales from acquisitions and divestures resulted in about $5.1 million being added to the sales figure. If you exclude this sales were essentially flat for the period. A movement added about 58 million to the sales numbers for the period, excluding the FX movement, along with the acquisitions, divestures. Sales were 1 billion 524 million versus $1 billion 581 million a year ago. That resulted in a 360 basis point decrease in sales for the comparable period. I will now move to the income statement for the first quarter. This slide details the consolidated income statement for the first quarter fiscal year 2004 comparing it to the first quarter of 2003. Along with a percentage of sales for each line item having covered sales on the preceding slide, looking at cost of sales, you can see that we had an improvement of 20 basis points. If you remember, we had [INAUDIBLE] in our outlook that aerospace margins would be down this year. They had declined in the fourth quarter of last year stabilizing in that quarter. We felt that they would stay at that comparable level for this particular year. So, we also mentioned that PIM, what we call PIM, pension, insurance, medical, would be up 75 million for us in this quarter. So in despite of the increased PIM that we experienced, in spite of the aerospace margin decline, we were able to increase our gross profit by 28 basis points. There were some I don't have sets to that, however, selling, general and administrative expense went up by 30 basis points as a result of the current--incentive plans. Interest expense was up by 20 basis points as well. That was the result of rolling out the $225 million in senior debt in February. There was some negative arbitrage with respect to the interest relative to that in addition, we do renew our credit facility this year. We expended it out over five-years, there was some unadvertised issue an--unamortized issuance fees that needed to be met. 20 basis point decrease is basically the result of write-offs disposal of fixed assets. Income taxes, rate went from 33.5% down to 33%, saving us some expense on that particular line. So to summarize for you, with basically a 360 basis point decrease in sales for the period, we were able to maintain the net income at a fairly stable level with only a 20 basis point decrease. Now I will move to the segment data for you, start with industrial North America. Sales as reported on a GAAP basis of 685 million for the first quarter, fiscal year 2004 was 5.8% below the first quarter of the same a year ago, 728 million. Acquisitions.

This was 15% higher of sales in the prior year of 356 million. Minimal acquisition contribution to the sales line, about half a mill so the sales period to period, relatively the same with that. However, quite a substantial currency effect, 45 million excluding this currency, then excluding the minimal acquisition contribution. Sales of 377 million compares to 366 million for the same period a year ago. A 3.1 increase-- 3.1% increase in sales. Our operating margin of 31.3 million, a 7.4%, return on sales, compares to 27 million a year ago, 7.3%. So, on a 3%--3.1% increase in sales, merchants went from 7.3% up to 7.4%, a 10 basis point improvement. Aerospace sales as reported were $267 million, that is 3.8% below the 277 million in sales for the first quarter of 2003. Acquisitions didn't contribute anything to sales in this particular segment. There weren't any. Last year, if you recall, there was a divesture. That resulted in 4.6 million of sales being excluded there. Without acquisitions, if you exclude that, sales in the aerospace sector were down 2.2%. There was minimal impact from currency of FX, if you exclude that, then the effect is 2.7%. So down 2.7%, operating margin, 34 million for the first quarter, fiscal year 2004, that compares to 43 million for the same quarter a year ago.

You can see there's a 260 basis point decrease in the operating margin for aerospace. This is not different than what we expected. This pretty much matches our outlook, what we have been saying all along. Moving to climate and investor controls, this is the new segment that we broke out in fiscal year 2003, I think you recall we needed to break this out from the other category. You should be able to get the historical data from our website going backwards so you have comparable numbers but sales in climate controls of $156 million for the quarter down 5.3% from the same quarter a year ago when they were $165 million. Acquisitions didn't contribute anything, there were none in the industrial control segment however the FX amounted to 2.7 million, excluding that, sales excluding FX, down 6.9% year over year. Moving to operating margins for climate, industrial controls, came in at 17.5 million.

That is versus 15 million a year ago, margins went from 9.1% up to 11.2%. This is a -- we need to clap for this particular segment, they did a good job, 210 basis improvement on 6.9% decrease in sales. Other, not unlike climate and industrial controls did a good job, sales of 57 million compares to 51 million a year ago. 12.1% increase. However, once you take out the FX movement sales were relatively flat from period to period.

However, the operating margin went from 3.8 million last year up to 5.7 million. A 260 basis point improvement on flat sales. Now, I will move to the balance sheet for you, I just want you to know, just to remind you, this is a year over year comparison, comparison 9/30/03 to 9:30/02. I am going to skip the cash line and come back to that when I talk about the debt on the next page when we get into liabilities. So I will start with accounts receivable. You can see that it increased by 22 million resulting in a one day increase in DSO. This is just a result of late shipments in September. Inventories, in line with our lean initiatives and our win strategy, we're doing well. Inventories are down 55 million year over year, that's a four day decrease to DSI.

So we continue to move our inventories downward as -- you know, in line with our objections in connection with the lean initiatives. The deferred income taxes -- that's just a function, basically, of the minimum pension liability that we mentioned at the end of fiscal year '03. Plant and equipment is down 50 million, and it's even down from the end of fiscal year 2003 -- in June it was slightly higher. Goodwill: 50 million increase in goodwill. There's a little bit in there from the NTS acquisition; however, this is primarily due to FX. Other assets, again, is the result of the minimum pension liability that we booked last year. Moving to the liability side of the balance sheet: Notes payable is down 164 million; long-term debt is stable. So we have over 200 million on the balance sheet today, in addition to being able to accumulate 200 million on the balance sheet, we were able to reduce our debt by 163 million.

Pension and other post-retirement benefits up 420 million; again, due to the pension adjustment, the minimum pension liability adjustment that we made last year in line with lowering our discount rate, and in line with lowering our long-term rate of return. Shareholders equity, although it looks like it is down from a year ago, really, it is up from the end of June by about 70 million. Moving to the statement of cash flow: Three items basically contributed 150 million this particular quarter, net income, rounded at about 60 million, depreciation, amortization, again, approximately 60 million. With the force of working capital of close to 30. So out of 150 million in total cash flow, we spend about 40 million investing in our business and capital expenditures, and we paid down debt 145 million.

So cash decreased by about 40 million in the quarter; however, we still have 200 million on our balance sheet, and we have been able to reduce debt substantially. Our debt to debt equity ratio went from 35.6% for fiscal year 2003, down to 32.5%. This is well below our stated goal of 34 to 37%. At this time, I will conclude with our outlook going forward. Starting with the order rates; and again, beginning with industrial North America. I can see that in September, orders were up 1% versus September a year ago. And just to give you a little bit of history on that, if you go back to fiscal year of '02, you will see that in July through January, our order rates were running substantially at negative, they were high negative numbers. That's about the time 9/11 occurred, as well. And then from January through September, they actually moved back into the positive range. And this is what created the very good first quarter that we had in fiscal year '03. As a reminder, in fiscal year '03, we had a very, very strong quarter; in fact, it ended up being the strongest quarter of the year. Historically, that is not our pattern. But after September, then, order rates, um, they stabilized -- at that depressed level they stabilized. And that [INAUDIBLE] number, it's really never changed from that. We have not moved back into a real positive position since then. And at that same time, we had the Iraq war and the SARS effect. And if you look at the--most of the world, industrial rest of the world, excuse me, it is up 4% versus September a year ago. And again, looking at the pattern, very much the same as what you see in North America. On the aerospace side, orders were up 11% in September versus a year ago. However, I want to point out here that this is really the result of easier comparisons. There isn't anything in the business that has changed itself that we haven't talked about. The commercial business remains down, it continues to be down. Defense spending is relatively stable, and the after market declined -- although it hasn't worsened, it hasn't gotten any better. Moving to climate and industrial controls, this particular segment is very heavily dependent on the automotive industry. We have had a run rate of 17 million production for three-years in that particular industry. We knew that it would probably be off. It has been off; whether it is going to be in the double digit range or not remains to be seen. We are hopeful that it won't be, but we are waiting to see where that falls out. Also in this segment, residential air conditioning -- they are fairly heavily dependent on the secondary market, and as I mentioned before, with the weather, etc,, that particular segment hasn't come down. So looking forward, we don't see that could change in the near term; however, they will start building for air conditioning going forward, probably in January. As far as the outlook for the remainder of 2004, you are not going to see a--you will not see anything much different here today than what you really saw when we did our earnings release for fiscal 2003. It is--fiscal '02 2003 fairly unchanged from last quarter, in industrial North America 2 to 5% increase. Industrial rest of the world up 5 to 8. Aerospace, in line with what we thought, down 5 to 8.

Climate and industrial controls would be flat to a negative 3%. And there would be an increase of 2 to 5% in the other segments. On the operating income side, again, you are not going to see anything much different than what you saw last quarter. Industrial North America up 20 to 30%, industrial, rest of the world, 20 to 30%. Aerospace will be down 15 to 30%, climate and industrial controls, 0% to plus 10, and other, an increase of 10 to 20%. Moving below the line on corporate administration, in our prior outlook, we had plus or minus 5%. That has changed to a plus 5 to 10% as a result of some of the incentives and some of the consults fees and legal fees that we have incurred. However, that increase in corporate administrative expense, will be offset by a reduced tax rate. Our tax rate before was 33.5%. We are moving it down to 33%. We have tax strategies that we're working on, which has been contributing to some of the increased expense in corporate administration as well. Interest expense is remaining the same at plus or minus 5%. And other expense and income, the same in fiscal year 2003 and the same as the outlook that we gave last quarter. In summary, looking forward, we really don't see things changing a whole lot from what we told you a quarter ago. There are bright spots, obviously. All the economic indicators that we see out there look good, but to be -- and although distribution is fairly positive, we are not seeing it in our order rates. So at this time, I will open it up to Q&A.

Thank you. At this time, I would like to remind everyone, in order to ask a question please press star 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Joel Tiss of Lehman brothers.

Hi, guys, how are you doing?

Good, how are you.

All right. Can you give us a sense of why the operating margins jumped so much in the climate in industrial business? I mean, I am still combining them, and, you know, on the lower revenues?

Sure. Sure. In the climate and industrial control segment, first of all, not unlike what you have heard from me before, we really are very focused on our win strategy. And climate and industrial controls has done a very good job on that. They are very focused on the cost reduction side of the business, they are working on procurement, they are working on liening out their operations. Some of the things that they first did is some restructuring that climate and industrial controls has taken on in Europe. They've -- you know, you've talked about me in low-cost countries, moving from Western to Eastern Europe. And climate and industrial controls has participated big in that. So that is really, really, what is happening in that particular sector. They are very focused on the win strategy. They have done some restructuring to be able to lower their cost base.

Wouldn't -- intuitively, wouldn't we be able to feel that same sort of power throughout the rest of the segments?

And I do think that we are seeing it. I think if you look sequentially at the numbers, I think we are seeing that.

Thank you. Your next question comes from Mark Koznarek of Midwest Research.

Good morning, Pam.

Hi, Mark.

Can I ask you to clarify something just to get started, which is, when you were talking about the outlook, the numbers that you stated are different than the ones in the slides. And I just want to clarify what is the growth outlook for the full year for North American and rest of world industrial.

Industrial North America on the sales side is 2 to 5%.

Okay. In the slides it says 2 to 8, at least the version I have, in your 8K. That is not correct, huh? It is 2 to 5?

It is 2 to 5.

-- quarter.

Yes, I don't know what that might be, Mark, because we are seeing 2 to 5 on the slides. Yeah. I don't know. I don't know what that might be. I have to look into that for you. But thank you for bringing that to our attention.

Okay. So the industrial rest of the world is then 5 to 8, because in the 8K it says 5 to 5, just so you know, okay. Really no change from a quarter ago?

Thank you. No, there isn't any change. Thank you for bringing that to my attention. I will look into that as soon as the call is over.

Okay. Here is my question, please. Is, you know, it is kind of similar to what Joel just asked by focusing on North America, because here you had, you know, nearly a $45 million sales decline. And yet when you add back, you know, probably 10 million of your PIM, your income actually rose by 5 or 6 million, you know, really remarkable performance, so can you give us some color of how that was achieved?

Yes. If you look at North America, I mean, what you are going to see going back to third quarter fiscal year 2003, the margins were running about 5.8%. Then they actually declined a bit in the fourth quarter, down to 4.8%, then obviously this quarter jumping up to 6.8%. Mark, the only thing I can tell you is that with respect to the win strategy initiatives, those initiatives are very hard to implement. I mean, they sound easy when you talk about it. You can say, yeah, everybody is doing them. But living it is a different story. I mean, I came in from operations and was living this. And it takes a long time to really get these programs moving. And there is a lot of work up front that needs to be done until you start seeing the benefits. I think that most of us here have been saying that we are going to see these benefits, we are going to see we are working on it, we are doing all the right things with respect to those programs. So, you know, we have the concern, we have the pension, the insurance, and the medical. And that set us back a little bit.

And then the other side of the coin is, we have had restructuring. We have had relatively high restructuring costs going back in history. So I think what is happening here is you are seeing some of the results of the restructuring that is taking place. And you are seeing win initiatives really at work.

Pam, if I could just ask ask a follow-up, is there any kind of unusual product mix in here?

No. I don't think that is the case. I don't think there is anything unusual that is causing that. I think that is the result of really being focused, and following through.

Okay, thank you.

Thank you. Your next question comes from Gary McManus of JP Morgan.

Good morning.

I notice you didn't provide a [INAUDIBLE] quarterly guidance like you did in the last conference call. Can you explain why you didn't do that?

That's a good question. Good question. We decided not to do that, but basically, to give you a flavor for what we are thinking here is, we really think that it is going to be slightly better than the same quarter a year ago. As we move forward, you know, second quarter is a really tough quarter for us. We have all the holidays, we have Thanksgiving, we have Christmas. And in many cases, it is even worse than the first quarter with respect to the European holidays. So we have that looking forward, we are really not seeing anything much different. We think we will better than the same quarter a year ago. But--

So, if I looked--I think your guidance suggested a number of around $2 a share for fiscal '04, which kind of suggests about 20% [INAUDIBLE]; you're not expecting that kind of growth in the second quarter, you expect stronger growth in the second half, is that fair?

That's fair.

Okay, and just as a follow-up. The North American volumes are down about 7%, North American industrial down about 7%, you X currency and acquisitions. Can you give us a flavor of which end markets were particularly -- will you kind of give me a sense on how that 7% would look by the very same markets?

Well, I can tell you that in two big markets, the agriculture and construction markets, were really just not seeing much. Semi-con continues to be down. We are not seeing anything that particular market. And then the big [INAUDIBLE] construction and ag we are not seeing anything. We are feeling a bit more positive on the construction side, but, ag, we're not seeing it. Mobile, in general, we feel a little bit positive on. But auto is not good. You know, I can't give you any more specifics in that. But I can tell you that in the big ones, auto, construction and ag, we are not really seeing much. And semi-con continues to be down.

Okay, thank you.

Thank you. Your next question comes from Anne Duignan.

Hi, Ann.

My questions are on the aerospace business and the guidance that you gave for the full year. You expect that business to be down somewhere between 8 to 5%, yet when we look at the monthly orders, monthly orders have been positive since April. Can you explain what your rationale is in the guidance, and is it just a conservative outlook and a hedge?

Well, on the aerospace side, again, you know, I think if you look at what happened last year, you see a steady decline. If you look at it quarter to quarter from last year, it just steadily, steadily declines. And we knew that that was going to happen with a commercial aftermarket business being way off, and no projections for that to come back. We felt that pretty much we would stay consistent with the fourth quarter. Now, in terms of volume, if nothing changes, I mean, on the defense side, I am not sure, it is relatively stable. But looking out, I am not sure that is really going to change. I mean, that whole industry is going through such a change right now that it is very difficult to really get a handle on it. But, it--maybe we are being a little bit conservative. I mean, maybe at the end of the day we are being a little bit conservative. But not a lot.

Yeah, just as a follow-up, Pam, I know that your military after-market orders tend to lag at the end of the war by somewhere between 9 months and 12 months, and couple that with your great wins on India program and the recent China regional [INAUDIBLE] sector, it would appear to me that things ought to be getting a little better in that business. Am I wrong in my thinking process? Or --

No, I think your thinking process is good, Anne. The problem is, these programs are such long-term programs, like the ARJ-21, we are really not going to see anything from that until 2007, 2008. So even though we are working every day on the future in that particular business, we will see that, but we are not going to see that for a while. But you are right, the regional jet business is good. But it is not the major portion of the business. We have 20% of the business that is on commercial transport, and -- I think it will be a while. I don't think aerospace is really going to pick up until 2005.

Okay, thanks, Pam.

Thank you, your next question comes from David Raso of Smith Barney.

Hi, good morning.

Hi, David.

One clarification on the pension insurance incremental cost, what was the number again, first quarter over first quarter, what was the incremental amount?

I didn't give you an incremental amount for the first quarter. But it is about--we are planning on about $75 million for the year.

So roughly 19-ish?

Right.

I suspect most of that would show up in the cost of goods line?

Most of it, absolutely.

I am trying to figure, I guess what is impressive about the margin performance here is, the SG&A was up, the gross margin X the pension insurance, were up 120, 130 basis points.

Right.

I am trying to get some guidance, if you could break that out for us, what it is the thought on the gross margin for the year, and again, anything unique at all in there in the cost of goods to drive that?

I don't think there is anything unique. But, again, we are working on our win strategy very heavily. And obviously, that's where a lot of that shows up. And as we said before, going out, we figured we would get 1% on our wind strategy last year. We think we have done that. We think we have demonstrated that. And now this year we are expecting to get another 2%. And that is where a lot of those initiatives show up, is in that cost of goods area.

So the 2% of last year, the gross margins were 17.5; again, is that the idea then, 19.5, discount a bogie?

Yeah, your in the -- yeah.

Just round those numbers out, if that gross margin performance continues, obviously the guidance is a little bit light. Am I missing something on the SG&A then?

No. No.

Thank you. Your next question comes from Andrew Casey of Prudential Equity Group.

Good morning, Pam. On the restructuring, could you help us understand where that mainly occurred? Just basically, so we can get a more clear understanding of what the incremental margin changes were?

Well, I can tell you that--I should say, looking at North America, if you look at North America, we went from 6.8% -- really like around 7-- yeah, 6.8%, 7%, 6.8. And those margins, really, in North America, with the realignment would have been 7.4%. And the rest of the world would have been about 9.1%. So that should give you a feel, at least for the two basic big areas.

Okay. Thanks. Couple more, when you answered Gary's question about guidance, the second half pickup, does that mean that you expect acceleration in win areas or are you building in some market group?

Well, I do think win--not that they are accelerating, but they will gain momentum. What happened was we started out with procurement in the beginning, started out with procurement and have successfully completed that in North America for the most part, moving to the rest of the world. Then we moved into the pricing, pricing being a little more difficult to get off the ground, takes a lot more work in the beginning to get that going. So, we have gained momentum on that in North America. So I expect to see results from that in North America this year and rest of the world. We still have the momentum going on the procurement side and the rest of the world, we are gaining momentum on the pricing side, and then we are working to lean all the way through. We are putting an emphasis on increasing productivity. We are not exactly happy with where that is at at the current moment. And we are continuing to focus on driving the inventory down.

Okay. Thanks, lastly, very quick. Are you building in additional restructuring charges the last three quarters of the year in your guidance?

On our restructuring side, we have had relatively--we have had high restructuring costs. And what we would like to do, going forward, is to eliminate talking about restructuring costs, quite frankly. In my opinion, they have gotten to a level that I would consider to be normal in running our business. There is a certain amount of restructuring costs that you are going to have every year, year after year, and I think that we have reached the level where we should stop talking about this. And we should just talk about numbers on a GAAP basis. We feel that restructuring is going to be somewhat less than what it was last year. It was 12 cents, I think. We went from 16 cents to 12 cents. It was 12 cents last year. We feel it will be somewhat less than that.

Thank you.

Yes.

Thank you. Your next question comes from Steve Volkmann of Morgan Stanley.

Hi, Pam.

High, Steve.

Can we talk about the cash for a second? Obviously, you are already below your targeted debt to cap range. Presumably you will continue to generate cash this year. You know, do we--should we be expecting more acquisitions? If so, what kind of flavors? If not, is share purchase at these levels still an option? Just discuss that a little.

Well, we are real happy with our debt to equity and our cash generation. We had record cash flow in 2002. Would have had another record cash flow year in 2003 had it not been for the pension adjustment. And Steve, as you know, we are always looking for acquisitions. A lot of our success has been built on that. And we continue to look for good acquisition. We are in talks with several people, which we normally are. We have long relationships with most of them, so we are continuing to talk to them.

And should the right thing come along, obviously, we are going to take advantage of it. I don't think we will go out, make an acquisition for the sake of of making an acquisition. It will be very strategic to our business.

We want something that is going to obviously contribute to the bottom line immediately. So that is the type of thing we are looking for. There's not a lot, like I say, available in some segments of our business. But in others, there is a lot available. In terms of pricing, it is really a mixed bag out there. There are people who still think, you know, they are still looking for top dollar, have their heads in the clouds, so to speak. There are other people that realize that they need to come with someone like Parker, because they need to expand globally. And we are a company that can take them there, so -- but there are a lot of other things that enter into it besides just being strategic to our business. And sometimes things that are out of our control, out of their control and out of our control. We keep working it. We would like to make a nice acquisition, but it has got to be the right one at the right price.

Tim used to have some type of calculation he would do to give them a sense of whether he wanted to repurchase the stock or not. He never shared the calculation, but he would sometimes give a sense of how the current levels sort of worked into the calculus. Is this a price at which it makes sense to repurchase your stock?

Well, we do have a chart. We do have a grid that we follow in connection with share repurchase. I would say we are outside of that grid right now. We wouldn't be looking, I don't think, to repurchase shares right now.

Thank you, your next question comes from David Bleustein of UBS.

Good morning. Pam, if ag and CE are not seeing much, semi-con is down and auto is not good, what are the positive offsets that have kept you're order rates roughly flat, at least in the last three-month period,or at least in the last month?

Right. I think part of it is the fact that we -- you know, we constantly work with the customer very closely in connection with fulfilling their needs. And so we always have -- I don't want to call it new product development -- but we always have changes to products that obviously fit the customer's needs. We are very focused on trying to satisfy they're particular -- we come up with solutions to satisfy their problems.

So I think a lot of it stems from -- I don't want to call it R&D type of new products, but new products that we constantly come up with to be able to satisfy the solution from a systems perspective. So I think that is part of it. I think pricing is part of it. I think that we have seen some things in the market. Oil and gas has been a little bit strong for us. We have seen that. Not necessarily offshore drilling, but in the other areas, power GEN, we have seen spots of strengthen in that particular market. Actually, though I hate to say this, we have seen spots of strength in machine tools.

All right, related question. Can you talk about your manufacturing footprint? Basically, how much of your production is based in the United States, has dollar content. How much is Western Europe, and how much have you moved into low-cost locations?

Can you repeat that question for me, I'm sorry.

Sure. I really just wanted to understand your manufacturing footprint as it stands today. How much of your value added manufacturing production is based in the United States. How much is based in Western Europe?

Okay.

And how much you have already moved, as you mentioned, to lower cost locations?

Okay, okay, now. Basically it follows same as sales.

Our manufacturing print isn't much different from our sales print. For instance, we have about 45% of our sales are in North America. We have about 25% that is in the rest of the world. Then we have 10% that is in climate and industrial controls, of which about 80% of that is North America. 17% is in aerospace. The majority, frankly, primary, most of that is North America. And then we have 3%, which is the other category of which about 70% of that is in rest of world.

So you know, you can figure out from there, the portion North America, rest of the world. It really is not much different. When you look at rest of world, there is about 70% that is really European. And the remaining part is Asia/Pacific and Latin America. I would say that manufacturing really doesn't differ that much from the sales footprint, which is what I just gave you.

Thank you. Your next question comes from Joanna Shatney of Goldman Sachs.

Hi, Joanna.

Good morning. Can you just talk about -- if we just average the three-month order rates, excluding September, because I know you probably didn't ship a lot of that yet. It locks like your backlogs have grown in both North American industrial, rest of the world. Is that true? If so, why the conservatism on the second quarter?

Joanna, that is a good question. Backlogs actually have increased slightly in North America and the rest of world. There is a slight increase in the backlog. But if you look at our plan, if you look at last year, we had that really strong first quarter, and then we had -- we never equaled that first quarter again last year. We came out of the chute, like really it was a great quarter, but we never got back to those levels again the next three quarters. So this quarter, looking at the order rate, you have to average last three -- it looks like we are heading into a really tough quarter for us, with all the vacations and everything going on, December is going to be a tough quarter. And we don't know what is going to happen beyond that, quite frankly.

Are there--

If you look at the outlook, I think somebody else had mentioned before, obviously, we need some increases in the third and fourth quarter to get to that outlook, and without any indication that things are really going to change even if the backlog is up a bit, if you look at the order rates, things really haven't changed that much.

Okay.

Thank you. Your next question comes from John McGinty of Credit Suisse First Boston.

Hi, John.

Good morning, Pam. Let me ask this quick question a slightly different way. Your guidance for the full year did not change at all. Yet the first quarter, your guidance -- I am looking at the slide -- the first quarter was going to be 20 to 30% below the first quarter a year ago, and it in fact, if I am doing the math right, it's 7%, so it's like 8 cents better. I guess maybe a better way I to ask the question is --well, one answer would be the guy that did the first quarter forecasts was different than the guy who did the full year forecasts, but how can you expect to do that much better in the first quarter than you expected, not change the year, or maybe the way to ask it is, what was the surprise in the first quarter relative to what you guys were looking for? Was it in the sales side, the gross margin side, was it just an ultra sense of conservatism? Could you kind of help us understand why you outperformed relative to what you said, and yet you are not doing anything going forward?

Well, in connection -- John, in connection with the win strategy, it is very difficult to determine how much of that is really going to flow through. But I mean, that is one thing. It is real hard to determine, to quantify some of those benefits flowing through. In addition, there are some synergies from all of those, procurement pricing and liens going on at the same time, there's some real synergies between the three of those. It is very hard to quantify that data. I don't think we are surprised it is a good quarter. I mean, yes. It is different than our outlook, but I think we have been working very hard to show those results. We kept saying that they were going to happen.

Why isn't--in other words, if things are getting better on the margin side, why are you saying it is not going to continue to get better?

I think on the basis that we are just not seeing anything in our order rates. We are really not seeing the change. And because it is very difficult to quantify when we see it, then we will be willing to talk about it, like, to kind of guess. I don't think we are ready to guess on that.

Thank you. Your next question comes from Wendy Caplan of Wachovia Securities.

Hi, Pam. Could you comment on input costs in the quarter, what your assumptions are going forward, specifically energy costs and steel?

Going back, I know I sound like a broken record here in some cases, but we are working heavily on our procurement initiatives. The work that we have already done on that, we think, is going to pan out for us here. One of the things that we have done, we have really locked our suppliers in a time period with respect to the prices.

And you know, we went out with them and said, hey, we want a partner, we feel we want to be partners for life. And we didn't go with the intention of just getting a price reduction, but obviously, that is one of the results of what we did. So our purchase prices are pretty much locked in for a time period. So we really don't see that affecting our business materially in the near future.

And they didn't affect the business materially in this quarter, either?

Well, there is some effect in there. Obviously, as a result of the initiative, there is some. But, you know, exactly how much that is, I really -- I can't tell you. I really don't know the exact impact of that. But we know that it has affected us. We know that our initiatives are paying off, we know that procurement, there has been reductions. But, you know, it is based all upon how much you are purchasing in the time period and the contract that's been established, and because of our decentralization it is difficult to get an exact handle on it. But that's about all I can tell you.

Thank you. Your next question come from Robert McCarthy of R.W. Baird.

Hello, Pam. Hello, can you hear me?

Hello, yes, I can, hello.

I wonder if you can help us in the two primarily industrial segments, America and rest of world, when you look at organic growth in North America, down 7, up 3 rest of world. It seems to me that there are three primary components of that change. One of those would be the overall change in your end markets. One of them would be what you are getting in price. I am interested in update there. Of course, you have shared with us that you all picked up in excess of 1.5 points in overall price last year. Another piece of it would be how much business you have been willing to walk away from because it no longer meets your desired price parameters, if that is the right way to put it. Can you give us an idea of how you think that adds up in those two markets?

Well, with respect to marketing a round figure, your last item first. With respect to walking away from business, I mean, typically, that is not our approach. Obviously if at the end of the day, that is the only thing that you can do, we are not afraid to do that. But our first line of defense would be to try to make both sides happy.

So, you know, we don't look to really walk away from business, and there isn't a lot of that, I think, that quite frankly occurs. If you look at the sales, what is going on there, with respect to the end markets, I think, you know, you look at the national flood power association statistics that are out. And obviously, they are down more than what we are. So a big portion of our business, with respect to full power, isn't down as much as what the statistics would accomplish. So the end market is down more than we are, so we feel that we are, you know, doing okay there. Aerospace--

Is the difference maybe a reasonable proxy for what you are getting in price? Are you saying that you think you are gaining share?

Yes, I do. I think we are gaining share. I don't think we are down as much as our end markets are down. In any case, you look at automotive, how and much that is down, I think close to 11%, you look at construction, it's down 8%, you look at residential housing, it is down 3%. You look at the semi-con market, how much that is down. That would tell me that, if anything, we are gaining share.

But you believe--you do believe that you are continuing to get positive price realization don't you?

Yes, we do believe that.

All right. Just to clarify what you are saying, I naturally understand that you don't intentionally walk away from any business, but what I meant to suggest was that you were going to show some discipline in some markets on enforcing higher prices, and that might cost you some business, and you would be willing to absorb that if necessary in order to have discipline on getting stronger pricing. Is that a fair characterization, or --?

Yes, I think probably what you are thinking about is maybe some of our industrial [INAUDIBLE] business, you could be talking about that, I don't know what you are talking about specifically. But yes, it is something that we would look at and evaluate. There are times when you have to make that decision. But, for the most part, we try to reduce our costs. We try to be the low cost producer, regardless of what product we are in.

Okay. Thanks.

Thank you. Your next question comes from Barry Bannister of Legg Mason.

Hi, Pam.

Hi, Barry.

Just a clarification and a question. On the clarification, last quarter, you reported operating income of 44 cents. That is what First Call picked up. This quarter looks like 52 cents. I think that is what First Call is going to pick up. I can't say that I disagree with your policy. In fact, I probably like it. But what I want to know from you is, what is the breakdown of the 4 cents by division so that this one last time we can do our models correctly? Are you there?

Yes, just a minute. Let me just take a peek here. Give me just a moment -- let me go back to what I said before -- I don't have the breakdown exactly the way that you are asking for it. But as I said before, in North America, for first quarter fiscal year 2004 we reported a 6.8% margin, that would have been 7.4% with the realignment charges back. International would have gone from 7.4% to 9.1%. Aerospace would have gone up 10 basis points. Climate and industrial controls would have gone up 30. Then, in the other category, it would have gone up 120 basis points. So, I think, you know, you should be able to figure it out with that information.

Thank you. Your next question comes from Robert Shenowsky of CIBC.

Morning, Pam.

Hello.

Two quick questions for you. One, can you give us the number in terms of what currency added to operating profit in the quarter?

You are speaking on the income statement?

Yes.

I can tell you that the run rate right now is about 13% below what it was last year.

Okay, very good. And then secondly, in the top line forecast that you offered specifically for industrial rest of world as well as north America, what currency assumptions have you but in there as a percent of that growth?

We haven't built anything in it.

Just to clarify, you are assuming a flat Euro dollar with where we are today?

Correct.

Okay. Thank you.

Thank you your next question comes from Larry Robbins of [INAUDIBLE] Capital.

Excuse me, Jami, can you hear me?

Yes, ma'am.

At this point, I would like to take this question and one more if I may.

Okay, thank you. Mr. Robins, your lines open. Hello? Larry Robins, your line is open. Larry? The question has been withdrawn. Your next question comes from Alex Blanton of [INAUDIBLE].

Hi, Alex.

Good morning, Pam. Before I start, thanks for changing the format on the slide so we could print them more easily. That was good. But I do notice that the operator is still cutting some people off before they say thank you; in other words, before they finish. So I would appreciate that not happening. A lot of my questions have been asked, but on the realignment charges, you really are showing a substantial difference in rest of world after taking them out. 7.4%, you reported 9.1%, that is the kind of thing that we need to continue to get a feel for in the future. I understand what you are saying about trying to stop talking about them. But the trouble is, the numbers in many cases aren't comparable, if you don't have these, have this information.

Right, Alex. and I agree with you. But my point, I think, going forward, is I feel they are going to be fairly comparable. I think that the realignment has gotten down to a small enough number, at least our expectations are that it will be a small enough number by the end of the year, that it probably represents normal course of business as opposed to realignment. It will be consistent from year to year. There will be a certain amount that will be in there every year from year to year. So we won't need to call it out. There was a time in the past where the numbers got so large that it became essential to talk about them. But I think they are approaching a level now where I would really prefer to move away from it, but I understand your point as well.

I have a follow-up before that, I just want to comment, you should get with First Call, decide whether they will take GAAP estimates, because it looks like we will have to go to that.

Alex, I need your help.

Okay. Secondly, there seems to be a disconnect between what you are saying in the outlook, no economic growth is what you are assuming, that isn't anyone's outlook. I don't recognize some of the things you just said about your markets, for example, construction down 8%, what number is that? That's not what is going on at Deere and Caterpillar.

I know, no, I know. I know exactly what you are saying, I know that the retail sales at Caterpillar are down; in the near term, you are right, I am speaking of a longer term when I talk about that kind of number. In the near term, you are exactly right. I know the retail sales at Cat are up, I know their inventory is low, but Alex, we are not seeing it. And until we see it -- we are not seeing any orders as a result of those.

You said your share was up because construction was down 8%, but what is down 8%? I am not familiar with that number.

I would just say that over the long term, construction has gone down 8%, in total.

Because machine tool orders are strong. I mean, semi-conductor equipment backlogs are rising, it was just reported this morning, heavy truck is better. So it would seem to me there is some disconnect between what you are seeing in your order rate and what goes on in the economy.

Well, there is a disconnect between the order rate and what is going on in the economy, the economic indicators for sure and what we're seeing here, but I go back, even though our backlog is up some, I think that until we really start seeing it in our order rate, because we did that in the past. There have been many times in the past where the economic indicators were very good, yet, you know, look at a couple of years ago, they said, oh, it is going to come back in the second half, everything is coming back in the second half. And that is what our outlook included, and it didn't happen even.

Okay.

So, Alex, why don't you and I discuss this a little more.

Okay.

Off line.

Thank you.

Okay. I will like to thank everyone. Thank you very much for joining the conference today. I will be available the rest of the day for phone calls, and tomorrow.

Thank you. This concludes today's conference. You may now disconnect.